Development banks include multibillion-dollar entities like the World Bank, but most are smaller regional and local lenders spread throughout the world. They exist to fund projects that improve the material well-being of people, particularly those living in poverty. A development bank, in short, does what most commercial banks cannot do: it funnels capital into projects of dubious profitability. To achieve these ends, most development banks—and there are perhaps hundreds in the United States alone—are geared toward grassroots economic assistance.
There are two kinds of development banks:
The two types have little in common from an organizational point of view, but they share the common goal of combating poverty and economic hardship by infusing capital into local economies.
Although they are private institutions, community development banks differ from commercial banks in salient ways. They are always located in depressed urban and rural areas, where there are very few if any banks or bank branches. While they offer such standard commercial services as checking and savings accounts and loans, they also have important nonbank functions, such as investing in low cost housing projects and in technical assistance programs. For these reasons, development banks, unlike commercial banks, have access to many private and government grant funds. Development banks also are more stringently regulated by the federal and state governments. Even lending services of development banks differ from commercial banks, since the former are mandated to provide loans as small as $500, which commercial banks would consider unprofitable. Development banks promote these enterprises by providing loans on easier terms, often for smaller sums than would be profitable for most commercial banks.
Still, community banks are by and large profit-making institutions, with additional, nonprofit functions. They are almost always established by individuals and organizations rooted in the community they wish to serve. They often evolve from a grassroots community development project. For example, a recent Newark, New Jersey, housing association, initially financed by charities and government subsidies, is now a development bank. By injecting depressed urban and rural areas with much needed capital, these banks empower their communities to revitalize their neighborhoods and strengthen local businesses. A major reason for the endemic poverty of many urban and rural areas is the absence or near absence of financial institutions. Southeast San Diego, for instance, a depressed neighborhood of 250,000 residents, possessed only one branch bank until a development bank was founded.
Not all development banks are successful. The undertaking of such an enterprise is risky, due to factors often beyond the control of most banks of this kind: the prevalence of urban crime and the inexperience of many in the local community with even such basic banking services as checking and savings accounts. The risks of lending to startup businesses in poor areas also are higher than in affluent areas. However, Chicago's South Shore Bank, a national model of a community development bank, established in 1973, began with only $42 million in assets which, by 1998, had risen to $650 million. Because of the profitability of South Shore Bank and the resulting economic revival it has nurtured in Chicago's traditionally depressed south side, this bank has had many imitators.
The community development bank idea is not new. In fact, providing financial services to the entire community, including impoverished people, is what small banks used to do. Small banks and credit unions, however, are struggling for survival nowadays, especially since the banking industry was deregulated in the 1980s. As a result of the intensification of competition among banks, they are reluctant to establish branches in areas that entail unusually high risk and the expectation of low returns. Were it not for the federal Community Reinvestment Act of 1977 (CRA), which stipulates that commercial banks must provide credit services to all segments of the community in which they are located, most banks would be unwilling to invest in community services or provide loans to nonprofit institutions at the rate that they do. This still does not make them development banks, but it does mean that all banks since 1977 have some development functions. Amendments to the CRA in the mid-1990s strengthened its requirements that banks document how they benefit their communities.
By contrast, regional development banks have tended to deal with governments, both as backers and as clients, but this has been changing. They also raise a great deal of their capital through financial markets, such as by issuing bonds, and like all banks, through the successful performance of their assets. Among the major international development banks are
The World Bank, by far the best known of these, actually consists of several member organizations that undertake its operations. The unit that conducts most of the banking operations per se is the International Bank for Reconstruction and Development, which lends member countries a collective average of $20 billion per year. Other World Bank agencies educate and train people in ways to best use the resources at hand. Examples of this work include promoting sustainable and effective agricultural practices, advising governments on economic policies, and teaching private-sector managers and workers how to use new technology.
Regional development banks finance a wide number of projects, ranging from construction of hydroelectric plants to deployment of fiber-optic cable. Many are also actively engaged in advancing social policies that promote freedom and human rights. The trend in development loans has been toward greater private-sector involvement. Many of the most prominent development banks, including the World Bank and the NADBank, are dealing more with private lending institutions and securing funds for ambitious private-sector projects. In this role the development banks have used their influence—but not necessarily their reserves—to secure private funding for worthy causes. Contributing some capital along the way, the banks also take on the functions of economic advisers and investment bankers. These efforts to align development banks better with commercial interests and practices have been well received, and stand in contrast to the banks' former image as lethargic financiers of government works projects.
SEE ALSO : Banks and Banking
Hinchberger, Bill. "Thinking Small in a Big Way." Institutional Investor, March 1997.
North American Development Bank. About the Bank. San Antonio, TX, 1998. Available from www.nadbank.org .
Pavlenko-Lutton, Laura. "Chicago's South Shore Says Buyout of Black Bank Has Paid off for Community." American Banker, 13 April 1998.
"The PrivateSector Trend." Banker, April 1998.
The World Bank Group. Annual Report 1998. Washington, 1998. Available from www.worldbank.org .