This publication was brought out to mark the 50th Anniversary of the Development Finance Corporation of Ceylon (DFCC) and is published by the World Bank. Naoko Ishii, the current World Bank Country Director in Sri Lanka, in her Foreword to the publication states: ‘In much of the world, the development finance institution (DFI) model has not often proved successful…. DFCC Bank evolved over the years to become one of the more successful banks in the country, and probably in the region, without losing its focus on development’. Why and how did the DFCC succeed when other similar institutions around the world failed? What did it do which others did not? What was unique in its governing framework to withstand the varied political pressures it may have been subjected to as a DFI that worked closely with the government? These are some of the questions addressed in this publication.
It follows from Naoko Ishii’s Foreword that the World Bank considers DFCC as one of its success stories in the developing world that deserves wider publicity. For this purpose, the World Bank commissioned this study hiring a local expert. A broad overview of the conception, birth and growth of the bank is followed by the governing framework. Chapter 3 is on dilemmas of Development vs Profitability and Chapter 4 is on the key lessons from the 50 years experience of the bank. The chapters are supported by some data in the Appendix. The publication builds on the Pioneers Journey—the publication brought out by the DFCC to mark its 40th anniversary in 1997.
To begin with the fundamentals, the DFI model according to Ishii has not often proved successful. Why is this so? Large scale long term oriented financing was not attractive to the private sector five decades ago, thus there existed a major market failure in the provision of this type of financing and the government had to come in with financial resources fully or jointly with the private sector to rectify the failure. The correction of the market failure obviously led to some form of government ownership of the DFIs and they were expected to function in public interest. This led to an anomalous situation where DFIs had to serve the private sector and maintain profitability. This became a challenge to most DFIs and those that could not maintain an acceptable rate of return on the funds invested proved to be failures. According to the publication, the DFCC managed to maintain the delicate balance of public interest through development activities and earning profits by prudent lending and this was the key to its success.
Among many factors highlighted in the publication, the unique governing framework that the DFCC has enjoyed since its inception, the visionary leadership it had at its hour of need, and external presence in the Board via international funding clearly stand out as key factors behind the success. All other contributory factors to this success are in one way or another related to these three factors. Although the governing framework was created by an Act of Parliament, it had specific clauses which introduced features typical of a company structure and which made it somewhat of a hybrid organization. The regulations provided for accountability of the management to the Board and to the shareholders—holding of the annual general meeting, submission of annual audited accounts to the shareholders, the passing of shareholder resolutions, the election of directors by shareholders, and so on. Unlike the two state banks (Bank of Ceylon and People’s Bank) where accounts are audited by the Auditor General, the DFCC accounts are audited by two qualified auditors annually appointed by the shareholders. And unlike in the two state banks, the Minister in charge of Finance can issue directives only ‘in consultation with the Board of Directors’ and directives can be only ‘general directions on matters of policy’ (p. 15). This unique governing framework gave it a degree of autonomy and insulated it from certain political pressures.
Second, all financial institutions function in an ever-changing dynamic global and local environment. Their success and survival depends on their ability to adapt to such changes and reinvent themselves from time to time. DFCC was able to do so fearlessly, move from the narrower confines of a DFI to become a multi-product bank, due to the youthful and dynamic leadership it enjoyed especially after the early 1980s.
Leadership mattered at crucial times and it was readily available at the correct time. A case in point is at the time of entry of the National Development Bank (NDB) to the market. Until the NDB arrived in 1979, the DFCC enjoyed monopoly power in development lending. But the lending volume of the DFCC did not increase significantly because the monopoly position was enjoyed during a closed economic regime when private sector activities were less. The NDB came to the market with more than 25 times the paid-up capital of the DFCC and was thus in a position to quickly carve up an apex role for itself. Pushed to the wall the DFCC had to meet the challenge. Here the leadership of Maxi Prelis (GM/CEO from 1981-1999) went a long way—the DFCC Act was amended (1982), inter alia, enlarging the institution’s scope of powers, increasing the authorized capital, and enabling it to accept fixed deposits and engage in a full range of development banking activities. These measures enabled the DFCC to increase its issued capital by a bonus and public share issue.
Team effort inspired by leadership also contributed to the success. The publication documents the noteworthy lending of the DFCC to the hotel sector, particularly after Black July 1983. This was risky business at that time when there was over-exposure to the hotel sector but the management team took the risk which later paid dividends.
A change in corporate culture, characterized increased market orientation, recruitment of better qualified staff, greater efficiency in operations, and greater focus on the bottom line, was pursued with vigour. Discipline and professionalism were nurtured as a consequence of its relationship with multilateral lenders. In a Survey done by Asiamoney in 1995/96, DFCC was named the ‘best managed company of Sri Lanka’. In the late 1990s, the government and multilateral institutions took the decision to disengage themselves from direct lending and discontinue the practice of providing cheap funds via credit lines to DFIs to facilitate on-lending for investment in projects. DFIs had to become self-reliant—thus universal banking was embraced by many DFIs.
During this time, DFCC saw a change of leadership and like his predecessor Prelis, the new GM/CEO, Nihal Fonseka, took DFCC to greater heights. In 2003, for instance, DFCC went into commercial banking with the establishment of the DFCC Vardhana Bank which proved a commercial success with advances and deposit portfolios exceeding Rs. 12 billion and commanding 32 branches island-wide.
Third, the external lever was an equally important component of success, especially the role of the ADB and the World Bank. Their lines of credit had covenants which made bowing down to political pressure difficult. External shareholder presence, viz., IFC (International Finance Corporation), KfW (German Development Bank) and FMO (Dutch Development Bank) from the early years of the open economy also gave it an autonomous identity. As the government was relying on some of these donors for project lending, it did not dare unnecessarily antagonize them by interfering with the DFCC functioning.
There are three minor shortcomings. The publication overemphasizes the unique structure bestowed by the Act of Parliament as the key factor to the success of the DFCC. While it was a necessary condition it was by no means sufficient and there are reasons to believe that all the above-mentioned factors played a significant role. In other words, the hybrid structure could be preserved and made functional by dynamic leadership and the structure could be best made use of by strong external stakeholders’ presence.
The publication states: ‘The absence of a single shareholder with controlling interest and efficacy of checks and balances built into the incorporating statute to safeguard management independence have undoubtedly contributed significantly to its success’ (p. 3). Till the late 1990s this was valid but no longer with the growth of powerful players in the share market. DFCC’s hyper-success also made it a target and the Act does not have any safeguards to prevent an interested investor through related parties becoming a dominant shareholder and moving in loyalists to the governing board and seeking full control over the bank. This has already happened and it is now up to the other board members, especially the external funding agency representatives, government nominee, and the CEO to ensure that the DFCC does not deviate significantly from the original mandate. The publication avoids commentary on this crucial area which is of public interest. What needs emphasis here is that while the Act was used by the leadership of the Bank to keep the government at a distance and consolidate the DFCC, it was not amended to discourage large corporate investors from taking over the Bank.
A map with milestones of the DFCC’s journey—as presented in the last two Annual Reports of the DFCC—in the Appendix would have kept track of the key events. A table depicting the changing pattern of ownership over each decade, especially after 1977, would also have been useful. Some boxes highlighting the international experience on DFIs—those that have ceased to exist either because they became financially unviable or ending their mission with deepening of the financial market—would have further enriched this narration of the Sri Lankan success story. Have the DFIs that were conceived during the post-World War II era of reconstruction and development outlived their usefulness? No, not in developing countries with shallow financial markets, but the sustainability of DFIs in the modern world requires repositioning to meet the wider financial requirements of their customers in a changing financial landscape. This is manifest in most DFIs that have embraced universal banking, but alternative routes may be considered. For instance, the DFCC and NDB have taken different paths in transforming themselves into universal banking. While the NDB has merged its development banking with commercial operations laying more emphasis on the latter, the DFCC continues to maintain its separate identity for development banking activities while diversifying with new products. The NDB has exited from the Act of Parliament and is now governed by the Companies Act. The publication says that it is too early to judge which path is more sensible but laments the changes that have taken place in the NDB and casts doubts whether such changes will make pure commercial interests drive lending strategy thus undermining developmental lending.
Does the government and the private sector in Sri Lanka think that DFIs are not relevant now ? Here again the answer is no, but as correctly pointed out in the publication, the government involvement in establishing DFIs like Lankaputra and SME Banks (now merged under the former) is not the answer because they are vulnerable to political directives and thus their long term sustainability is questionable. The SME White Paper of 2002 which was produced by a team that included the current GM/CEO of the DFCC and which was chaired by the reviewer, never advocated an SME Bank very well knowing such pitfalls. But the political establishment thought otherwise when the DFCC experience clearly showed that DFIs work when the government is kept at a distance.
So what is the answer for growing development finance in Sri Lanka? The DFCC, with its current footing in the economic system and other commercial banks which have a window for long term lending will have to come up with innovative and affordable finance packages for development lending. In this process, the DFCC cannot afford to rest on its laurels, for the competition is getting tougher by the day. The challenge is to retain its development financing while continuing to build on its commercial success. Under the new ownership control, only time will show whether the DFCC will live up to this challenge and remain the premier development bank in the country.
This publication can be recommended to those interested in the financial market, and above all economists and policy makers.
Saman Kelegama is Executive Director, Institute of Policy Studies of Sri Lanka.