2. Important lessons for the future

To set these important learnings above in context, Part II briefly sketches the Covid-period financial landscape to show how the actions of PDBs contributed to relief and recovery. From the start of coronavirus, lockdown, and social distancing policies in early 2020, public development banks (PDBs) played a significant role in the outpouring of counter-cyclical support to the economy. They met the need to create credit; to guide credit where it was needed; to on-lend government resources; to offer expertise and advice, including to governments; to create co-financing and collaborative partnerships with other banks, including MDBs and RDBs, and institutions; and to reach a diverse range of clients including firms, especially SMES; local authorities and in some cases households 2. Section I below sets their role within the broader financial landscape of the time, alongside other financial institutions, and government agencies. Every country was hit, even those that did not experience coronavirus or did not put in place lockdown policies as global trade collapsed, capital flows ricocheted (especially from developing countries to safer havens abroad) and firms and households suffered an immediate hit to revenues, working capital and liquidity. Longer-term investment projects such as infrastructure typically went on the backburner, and that finance which was still searching for yield was channeled into new and growing business opportunities in IT, or into financial assets such as real estate and equities as opposed to physical businesses. This section shows that public and development banks, often working closely with governments, played an essential role by going against that general trend.

2.1. The financial landscape under Covid-19 and the need for counter cyclical lending

The impact of COVID on economies was massive, due to the economic shock of travel restrictions, lockdowns and quarantines, which hit both the supply (production), but later also the demand of goods and services, as incomes fell. In the context of high uncertainty, and declines of sales by firms, the private financial system did not, on its own, want to lend, leading to a pro-cyclical response, which we illustrate below, by examining trends in capital flows to emerging and developing countries. As shown in Fig 1 net capital flows were strongly negative through 2020, if fluctuating, translating into a vicious cycle of currency devaluation for many countries, further weakening debt sustainability, in a context of reduced fiscal space, which implied governments (especially in certain regions and income categories) had difficulty issuing new debt on international financial markets and limited resources with which to meet the news needs of their people.

In this context, most PDBs (at a multilateral, regional, national and sub-national level), expanded their lending significantly; their counter-cyclical response in part helped compensate the procyclical response of the private financial sector (both national and international) and the shock of sudden-stop to anticipated revenues of companies, a dearth of working capital and tightened liquidity. Action by PDBs was complemented at national and at regional level, as clearly illustrated by the EU experience, by major support from national governments, especially in the developed countries, that had more fiscal space. Many developing country governments however had very little capacity to respond (TDR 2020); other emerging country governments did respond more, but at the cost of higher external debt levels, and increases in inflation, which is restricting their ability to continue supporting economic recovery at present.

2 See also MacDonald et al 2020 and Gutierrez 2021 for reviews of this period.

While this experience was broadly felt across the globe, on closer inspection the shock to GDP, investment and financial flows stemming from covid-19 seems to have varied greatly across countries, sometimes even within and between regions (see Figure 2). The European Union region experienced the biggest shock to GDP since WWII with a 14% drop in output from 2019 to 2020 and falls in the primary income to households in the order of minus 7% (EIB 2021:9). Gross Fixed Capital Formation, a measure of investment, fell sharply down 14% from 2019 to 2020. In North America, GDP contracted by 3.5% with the nation also experiencing the worst recession since WWII, even as government contributed to maintaining aggregate demand with a $1.9 trillion package, some 9% of GDP (TDR 2021:31-38). Latin America was also severely hit with both a high contagion and mortality rate and a sharp economic turndown; GDP for the region fell 7% in 2020 and with low growth recovery expectations for the subsequent year to come. This has set back, or even reversed, the rather impressive social development and poverty reduction achieved in previous decades. African economies also experienced large recessions of 3.4% on average for the region, which wiped out years of development and brought tens of millions of African citizens into further poverty (World Bank 2021a and 2021b). South Africa, in particular, experienced a contraction of 7% of GDP, in 2020 alongside massive disruptions and serious setbacks to health, education and investment.

South Asia was also hard hit with a sharp contraction of 5.6% of GDP in 2020, and deficient healthcare systems and a high level of informality magnified the health and economic impacts. South East Asia contracted by almost 4% as some of the larger economies in the region struggled, especially those that were dependent on tourism and travel. East Asia was the region showing the most resilience with a growth rate of 0.3%, where economies such as China and Korea were able to minimize the disruptive impact on economic growth; although Japan experienced an annual contraction of close to 5%. The timing and prospects of recovery for all regions are still somewhat unclear as even by mid-2022 Covid was not over, and trade and business have not recovered pre-Covid levels.

2.2. Counter-cyclicality – defining characteristics of scale, speed and direction

Before we start analyzing the counter-cyclical support provided by PDBs, we would like to highlight what a good counter-cyclical response means. As shown in Figures 1 and 2, the financial sector as whole tends to respond in a pro-cyclical fashion, accentuating and magnifying the trend whether positive or negative. Counter-cyclicality means essentially going against this, swimming upstream, or entering the financial market when others are retreating. Hence in our analyses it meant firstly, and perhaps most important, a significant scaling up and increase of lending and guarantees by the PDB, which is higher than increases in previous years. Secondly (and drawing also on our interviews), it implies accelerating the speed at which loan commitments are made and disbursed compared to previous periods, whilst trying to maintain the quality of evaluation. The use of digital technology, both by the PDB and by the borrowers, was very helpful in this. Thirdly, it refers to portfolio choices – counter-cyclical support meant allocating more funds to sectors and borrowers particularly badly hit by the COVID crisis, eg. services, and in some cases, exports; also to local authorities.

All of our interviews with the senior officials of PDBs revealed a high level of awareness and sensitivity to the need to provide a counter-cyclical support and what this would entail. Some, in particular the EIB, highlighted the significance of the reappraisal of the role of PBs that has evolved in recent years and subsequent much wider acceptance of the need for PDBs in general to exercise a counter-cyclical role. As mentioned above, the EIB Board had had much debate about the need for it to play a counter-cyclical role at the time of the Eurozone debt crisis, but by the time of Covid, the need for counter-cyclical support from development banks did not have to be discussed, as the idea had become widely accepted; this also seems to be the case for several other development banks (see Boxes in Annex 3, on Colombia and the German bank, KfW, for example). Therefore, there was in many PDBs, a significant increase of lending and financial support as private lending retreated, or grew less than in the past; in particular PDBs tended to channel funds into sectors, firms and households that were otherwise not receivingor receiving less- revenues; without such PDB lending such firms could otherwise have collapsed due to a lack of sales and liquidity. In some cases where banks were not able to do this, they were severely undercapitalized for what was needed.

There is also a matter of speed, as pointed out above, – using existing mechanisms and instruments that are fast or creating new ones. All around the world these tended to be needed in sectors and firms that were strongly dependent on trade, whether as part of global value chains or because they were highly export oriented, but also in sectors relying on private domestic consumption, especially in services where movement and personal closeness is essential, which fell significantly, as a result of quarantines and in some cases, restrictions on domestic and international travel; these included transport and tourism firms impacted by the sudden stop in travel and movement and construction and infrastructure projects where working from home was not an option; furthermore, given the fall in aggregate demand in goods and services, companies invested much less.

Another particular sector where support from PDBs was crucial concerned the efforts for vaccine finance, this included the Covax program which may need public support because its activities and benefits are regional rather than national; also investment in the vaccine itself because of the risks and uncertainty (see case-study EIB, in Annex 3). Furthermore, the role played by PDBs like the EIB to help finance Bion-tech, which led to the development of the Pfizer/Biontech innovative anti-Covid vaccine made a major contribution to Covid control worldwide. (Griffith-Jones and Carrera, 2021)

2.3. How development banks contribute to counter-cyclical support

Against this backdrop, the rolling out of governments’ increasing support to companies and for maintaining jobs, as well as household protection schemes and the supportive role of development banks is clearly going in a counter-cyclical direction. PDBs responded rapidly and in a counter-cyclical direction– rapidly providing working capital, loans and ‘breathing space’ to distressed firms and households by negotiating payment moratoriums or grace periods, restructuring existing loans and extending new ones, as well as providing guarantees and other forms of support to commercial banks to increase their lending (Macdonald et al 2020; Gutierrez 2021; World Bank 2021).) See also Appendix 2, showing increases in lending during 2020, as compared to 2019, in a number of PDBs.

Most PDBs made an extra effort to be fast and flexible in meeting urgent needs, quickly learning and adopting new digital technologies and processes in their efforts, whilst accepting higher levels of uncertainty and risk, to provide a timely support service that was distinctively different from that offered by the market. They determined to provide additional and counter-cyclical support as pro-cyclical sources of finance dried up or fell in response to the uncertain and fearful times. This section presents an overview of some of the main and salient trends.

Based on our interviews and literature studies, in Europe, DBs support helped compensate for the negative health, social and economic impact of COVID itself, going in the opposite direction from the private financial sector. In most countries economic recovery happened quite quickly when economies opened up, with GDP returning to pre-covid levels, for example, by the second quarter of 2021 for at least 20 EU members and a liquidity crisis has till now been averted (EIB 2021). In several European countries, public development banks helped support the recovery, In some banks increased lending was especially marked, including KfW (+78%), EIB (+ 65%) (See Table in Annex 2). Some individual countries however remained in pain, especially in Southern Europe: for 9 EU members, GDP did not regain pre-pandemic levels by the start of 2021 (EIB 2021). The impact of PDB lending is difficult to assess precisely, but clearly a stronger PDB response contributed to smaller economic downturns and speedier recoveries Some industry sectors also continued to be hard hit across the board – notably trade, tourism, and services in general and some public finance responses directly targeted these sectors.

Of course, the role of PDBs was complemented by other public sources of finance and this is particularly the case in Europe, where the EU governing authorities initiated a series of supportive financial measures and packages 3.In a recent 300-page report by the EIB 4 on this period there is plenty of discussion of public guarantees, subsidies, loans, grants and other forms of support.

In other regions, especially where the financial sector is less deep than in the European countries, and there is often less fiscal space for Governments to increase their spending and guarantees. the role of PDBs may be even larger, or more apparent, especially if they can leverage resources to support the productive economy and public services(especially health) when others cannot

3 The suspension of the EU Stability and Growth Pact’s deficit and debt rules at national level, enabling coordinated more expansionary national fiscal responses; secondly grants and subsidized lending facilities offered to firms and individuals at the national level, complemented by the SURE job protection facility, the European Guarantee Fund and the European Stability Mechanism’s crisis response, and above all the Next Generation EU, which combines recovery from COVID, with the long-term support to make Europe greener, more digital and more resilient. A third response was the European Central Bank’s large-scale purchases of euro area government bonds.

4 https://www.eib.org/attachments/publications/economic_investment_report_2021_2022_en.pdf do this. They achieved it either by borrowing on the capital markets or by obtaining funds from other sources, such as multilateral and regional PDBs. While there are some broad trends emerging in each region, experiences differ at the level of individual banks, reflecting their individual contexts, structures, and resources. In Latin America, the role of bank guarantees appears to have been particularly significant, given their value for dealing with uncertainty.

More broadly, in the Latin American and Caribbean region, the response of both national development banks and regional ones was very positive, especially the former ones, as detailed below. According to CEPAL estimates, during 2020 and till February 2021, the multilateral InterAmerican Development Bank (IDB) and sub-regional development banks (the Development Bank of Latin America (CAF), the Central American Bank for Economic Integration (CABEI) and the Caribbean Development Bank (CDB)), committed US$ 8 billion and US$ 12 billion, respectively, to fight the pandemic, which in total represented 0.5% and 1.9% of regional GDP and of exports of goods and services respectively. These funds were targeted to finance emergency programs, including health-related measures, as well as the provision of contingency credit lines, especially to national governments. In the case of IDB, the expansion in lending to confront the effects of COVID-19 on the region in fact surpassed those following the global financial crisis of 2008-2009 For their part, national development banks have committed the equivalent of US$ 90 billion in financial support in the same period, which amply exceeds that provided by regional and sub-regional development banks Moreover, national banks have supplied liquidity support through a variety of instruments, including guarantees, grants and refinancing schemes, focusing on lending to the private sector, especially SMEs. The emergence of national development banks as key players in the provision of finance points to the need to foster greater cooperation and coordination between regional/sub-regional and national development banks. The lending capacity of some regional development banks was increased through increased capitalization. For example, CABEI increased its authorized capital by 40% (US$ 2 billion) in April 2020. 5

In Africa, guarantees were also important as a tool for DBs to help support their clients, and some banks further cited their dependence on sovereign guarantees for their ability to borrow on international markets. At the regional level, the African Development Bank increased lending by 36% and several national banks by a much larger magnitude.

Comparing the range of these experiences, some banks were clearly better placed to respond to the crisis conditions thrust upon them than others. Standing back and looking just at banks’ lending and other empirical evidence across all the regions, we found some examples of very significant increases in lending commitments and disbursements and in other measures of counter-cyclical support, such as guarantees. Notable examples of very large increases in commitments are, in alphabetical order, AIIB, EIB, KfW, Nigeria Development Bank, and Uganda Development Bank (see Table 1, and Annex 2). Others did not succeed in increasing lending https://repositorio.cepal.org/bitstream/handle/11362/46711/1/S2100063_en.pdf commitments in 2020. In a few cases, lending commitments actually went down, signaling that the bank was unable for various reasons to play its much-needed counter-cyclical role, and was in fact pro-cyclical. (One such case was BNDES). For several banks, increases in commitments did not go hand in hand with increased disbursements (Table 2); and in others, commitments fell while disbursements actually increased (e.g., AfDB). (For more details, please see Boxes below). For others, commitments fell, and disbursements also fell, but by a lesser amount (e.g., DBSA, Black Sea). It is important to understand these different experiences because all banks aimed to be relevant and of support, especially in countries where their firms and households had few options to turn to. Also, they will all be expected to do the heavy lifting in any future crises, whether immediate ones such as the recent Covid one, the impact of the Russian invasion of Ukraine and its global effects or future financial or other crises; as well as long-term issues for resilience, climate change adaptation and mitigation.

5 CEPAL (2021). Financing for development in the era of COVID-19 and beyond, March 2021.

Banks with increases in Covid-year lending commitments

More than 20% increase

Korea EXIM +23%, Korea DB +25%

BOAD +36%

Rwanda DB +42%

EIB 65%

Uganda DB +73%

KfW 78%

Industry bank Turkey +50%

Nigeria DB +99%), AIIB (120%)

Less than 20% increase

BD Canada (+4%, CAF +8%

China DB +10%

SMI (+8% CDP Italy +14%

Korea Industrial Bank +12%

Banks with decreases in commitments

More than 20% decrease

Black Sea -25%

DBSA -65%

AfDB -42%

Less than 20% decrease

JICA -4%

SIDBI -10%

IsDB -15%

Table 2. DB changes in loan disbursements Year 1 of Covid-19 (% change 2019 to 2020)

Banks with increases in Covid-year lending disbursements

More than 20% increase Bank of Nigeria +79%, AfD +36%, Uganda +32%, BOAD +32%, SIDBI +22%, BOAD +32, Exim bank of Korea +23%

Less than 20% increase Bancoldex +11% BNDES +17.37%, CAF + 3%

Banks with decreases in disbursements

More than 20% decrease

DBSA -23%

Less than 20% decrease Black Sea -8%, BNDES –10%, Rwanda DB -17%, Islamic ICD -15%

Source: Data based on annual reports of banks, websites and other available literature. See also Table in Annex 2.