Financial regulation of national development banks - NDBs

History shows that financial crises have been a significant driver of banking regulation evolution, since the 1930s. Although Basel III made much progress in building a safer and less leveraged system, the SDGs, the climate crisis and the COVID crisis require bold action. Financial regulation on Development Banks should be discussed, considering not only a secure payment system but also a system that meets sustainable development goals. As the paper argues, these are not contradictory objectives. Development banks have unique characteristics to manage risk and can contribute to a more sustained growth path, which actually helps reducing overall financial instability. This paper is policy oriented and intends to promote a dialogue among governments, development banks and regulators. It aims to discuss the potential trade-offs of Basel III capital framework for National Development Banks regarding their ability to fulfil their developmental mandate. Do these banks deserve special treatment? What can regulators do to adapt Basel rules in order to reduce possible impacts? In particular, it discusses Basel III higher capital requirements, capital buffers, as well as the changes made on the treatment of market risk, concentration, liquidity risk and operational risks. The paper starts with a brief history of banking regulation and a summary of the main theoretical approaches that justifies it. It provides an analytical discussion of Basel III standards, considering NDBs’ characteristics and discusses how specific Basel III standards affect the ability of NDBs to fulfil their missions. The paper presents and compares three large non-retail-deposit-taking NDBs experience on Basel II implementation: BNDES of Brazil, CDB of China and KfW of Germany, drawing on both secondary information and interviews. The paper concludes that some of Basel III rules do not affect NDBs’ roles. However, some specific rules can constrain them in straightforward ways. The biggest constraint seems to come less from the levels of comprehensiveness and complexity of the framework, and more from tightening the levels of capital requirements and demanding better capital quality. Although in the three cases, capital has not been a binding constraint for them in regular times; it can become so in times of crises. The second area of contention for these big banks is the disincentive to the use of internal models, which, again, may imply more capital requirements and less risk adequacy. A third area is the new large exposure rule, which is problematic for all three banks, given their focus on large, infrastructure projects. A fourth area refers to the high-risk weights required for exposures to project finance and equity. These are financing modality and tools NDBs use extensively to support large and complex projects, and activities that involve innovation financing. A final area concerns changes in the method used for the calculation of operational risks.This Research Paper is published in the framework of the International Research Initiative on Public Development Banks working groups and released for the occasion of the 14th AFD International Research Conference on Development. It is part of the pilot research program “Realizing the Potential of Public Development Banks for Achieving Sustainable Development Goals”. This program was launched, along with the International Research Initiative on Public Development Banks (PDBs), by the Institute of New Structural Economics (INSE) at Peking University, and sponsored by the Agence française de développement (AFD), Ford Foundation and International Development Finance Club (IDFC).Have a look on the key findings for a quick overview of the research resultsSee the video pitch