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. Last Updated: 07/27/2016

Developing a Good Banking Idea

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President Vladimir Putin's administration has introduced a bill to the State Duma calling for the creation of a national development bank to stimulate economic growth by attracting more investment to the economy and increasing the effectiveness of investment already in place. The focus is to be on the consumer goods, labor and service sectors that have so far been unattractive for private banks.

The creation of such a bank is timely. Similar institutions in other countries have helped develop the type of investment activity Russia so clearly needs. The economy would continue to grow on its own on the strength of increasing consumer demand, but this is unlikely to be enough to keep growth rates at current levels over the long term. A different foundation, in the form of investment, is necessary.

There are 750 development banks in the world, and they play a major role in stimulating national economies. There are even interstate banks linking national economies. The role that these institutions play is key.

What is important in the Russian case is to understand the country's own experience with such institutions, what lessons have and have not been learned, and what needs to be done to ensure success this time. There is no point in pretending that we are starting with a blank slate. We need to examine the local history.

The Government Investment Corporation, or Gosinkor, was established in February 1993 to stimulate foreign and domestic investment. It was liquidated in 2003. According to the corporation's own statistics, it managed to attract $1.1 billion in foreign investment alone. Gosinkor consisted of about 30 organizations, including Guta Bank, Inkor Bank, Gosinkor Trust and others. But the increase in the quantity of new financial entities did not seem to be matched by a growth in their quality. If the corporation had really been effective, there would have been no reason to break it up. Some of the individual projects, like Guta Bank, did go on to further success, but not in line with the original rationale behind Gosinkor's creation.

The Russian Financial Corporation, or RFK, was founded at almost the same time as Gosinkor, in March 1993. It established the same goal of increasing investment effectiveness by creating favorable conditions for the attraction of financial resources. The RFK was initially a state-owned enterprise, but was incorporated in 2003, and then sold to a single individual in 2005. According to RFK statistics, the bank was able to attract more than $70 million of nongovernmental funds to its various investment projects. This paltry sum demonstrates that, despite some positive accomplishments, the RFK did not exactly become a development institution of national scope. Today it functions as a small commercial bank.

There was a clear difference in the amount of capital provided for the two institutions, with the RFK being given a mere 50 million rubles in core capital, against a substantial sum of $1 billion for Gosinkor. The funds involved didn't really matter in the long run, as the problem in both cases ended up being poor execution.

There was one more attempt on the development front, with the creation of the Russian Bank of Development in 1999. Created as a private company and functioning as a state credit organization, it provided credit for investment projects, receiving part of its funding from the state development budget. The primary function of both that and the current development has been to finance infrastructure projects identified as being of strategic significance and to manage their development. The initial capital provided for the Russian Bank of Development was only 3 million rubles.

But the bank's initial experiences with providing credit for investment projects raised doubts as to whether the organization actually functioned as a national development institution. In 2001, the bank provided credit for 15 investment projects. They were all more or less typical projects, but had proven unable to receive credits on purely commercial terms. This sparked a debate over whether this was what the bank was created to do. Even the Audit Chamber chimed in with questions about these lending practices.

So, by December 2006, when the government decided to create a new national Bank for Development, there had already been three similar attempts. Unfortunately, nobody has made much of an effort to explain how attempt No. 4 will differ from those in the past or what might deliver greater success this time out.

The new project, however, is different in some ways. One of the key differences is that the new bank is to be set up as a state corporation, meaning that it will be a noncommercial organization. As such, the bank's main activities will not be aimed at turning a profit. Gosinkor, the RFK and the RBD, on the other hand, were all commercial organizations.

The new bank will enjoy the advantage of functioning in the current economy, which differs significantly from the deep economic crises of 1993 and 1999.

The government officials behind the plan have maintained from the outset that the Bank for Development will not finance projects that could otherwise arrange for adequate financing at favorable terms on the commercial market. This is the right approach. But it must also be kept in mind that those applying for loans will always try to portray the specifics of the programs in question in the most positive light possible. This means that the bank will have to develop a formal system for evaluating projects right from the start. Otherwise, large-scale investment projects of a national scope and operating with a zero-loss policy will quickly be replaced by purely commercial projects of lesser importance.

All ambiguities and discrepancies in the bank's aims and procedures have to be cleared up in advance if it is to function effectively. The planners maintain, for example, that the bank should provide credit services to medium- and long-term projects in priority sectors of the economy.

This automatically raises a number of questions: What are the priority sectors? How is this to be determined? Will these priorities be left up to the bank itself to define? Without answers to these questions, the bank will again be eviscerated as a national institution.

The need for a national development bank is real, and questions surrounding its creation are related to its form rather than its existence. Given Russia's own experience, the simple explanation that the idea has been successful in other countries is not enough. But clearly defining the bank's objectives and activities right off the bat is vital. The bank's reputation and the reputations of the people who will manage it are already being formed, and for a financial development institution, reputation is everything.

Igor Nikolayev is director of the strategic analysis department at FBK Company. This comment appeared in Vedomosti.