Assessing Development Finance Institutions: A Public Interest Analysis

For several decades, international donors have focused on creating and strengthening development finance institutions (DFIs). Many of these institutions, however, have encountered problems such as loan defaults, high operating costs, insolvency and subsidy dependence. Financial profitability ratios such as return on equity and return on assets have long been used to assess the performance of these institutions, but these measures have not proven useful in explaining the cost of maintaining their continued operations. This paper claims that much of the subsidization required to keep DFIs afloat has not been captured by conventional accounting procedures, which, among other things, were not designed for this purpose, and that past DFI profitability measures have provided governments, donors and DFI managements with an inadequate picture of the actual cost of DFI operations. The Subsidy Dependence Index (SDI), suggested in the paper, is a user friendly tool aimed at providing a more comprehensive public interest analysis and measurement of DFI financial performance and subsidy dependence. This type of analysis involves taking full account of the overall social costs entailed in operating a DFI, including all subsidies received by the institution. The SDI is instrumental in (1) placing the total amount of subsidies received by a DFI in the context of its activity level (interest earned on its loan portfolio), similar to calculations such as effective protection, domestic resource cost and job creation cost; (2) tracking progress made by a DFI in reducing its subsidy dependence over time; and (3) comparing the subsidy dependence of DFIs providing similar services to a similar clientele. The SDI complements conventional financial analysis and improves the evaluation of financial institutions that are subsidy recipients. In effect, the SDI goes beyond financial analysis into the area of economic analysis by providing a meaningful picture of the cost side of DFI operations, only part of which is captured in conventional financial data. The SDI computation expands and enriches traditional financial analysis in three principal aspects, since (1) it quantifies the impact of subsidies received that affect the DFI's financial performance, resolving the issue that much of the value of the subsidies is not recorded in the DFI income statement; (2) iit suggests an index that measures the overall subsidy received by the DFI, against its prime source of income-the interest earned on its loan portfolio; and (3) it imputes cost of capital of the DFI's equity. This final aspect resolves the issue of "costless" equity, thereby allowing a more meaningful comparison of the financial and economic costs of DFIs that are characterized by different equity-to-assets ratios. Finally, the SDI addresses the need to improve the measurement of progress made toward "the phasing out of credit subsidies, the assumption by the fiscal budget of funding responsibility for any remaining subsidies, and the reduction and/or rationalization of directed credit lines," as required by the "World Bank Policies Guiding Financial Sector Operations" (para 17).