The growing push for using securitisation markets for development finance is fraught with multiple dangers ahead. Rick Rowden sounds a warning.
The international development finance club has been increasingly experimenting with various types of “blended finance” mechanisms in recent years. The aim is to entice the huge resources of private finance to invest in development by reducing the risks they face. The claimed mission is to help developing countries meet the internationally-agreed Sustainable Development Goals (SDGs) by 2030. Unfortunately, the effort relies on scaling up the use of some of the same financial innovation mechanisms that got global finance into trouble in the lead up to the 2008 crash. Given this track record, the prospects don’t look good.
The latest push in this direction came in October 2018 with the release of the report from the so-called Eminent Persons Group advising the G20 on finance. The report, Making the Global Financial System Work For All had a noble ambition you would think. It called for two major overhauls of the international development financing system: much greater coordination of international lending bodies and financial mechanisms to pool resources; and the use of securitisation markets to de-risk investments for private investors.
“Its investment instruments are often so complex and opaque that many investors
and even regulators have difficulty understanding them.”
But using securitisation markets is packed with dangers.
Securitisation relies on the so-called shadow banking system – the non-regulated part of banking. This system offers very high degrees of leverage and sketchy tactics like rolling over short-term loans to finance long-term investments. Its investment instruments are often so complex and opaque that many investors and even regulators have difficulty understanding them. So the actual degree of risk involved is often unclear.
As they are not regulated neither is the degree of risk and over-leveraging. Nor are such institutions backed by traditional federal deposit insurance or other central bank guarantees during a financial crisis. Thus tens of billions of dollars of public development financing could be put at risk. For securitisation to work, developing countries will have to deregulate their financial markets significantly. So they will lose much of their ability to steer financing into projects they actually need for long-term development. Instead, private capital would be free to invest in more speculative activity rather than the real economy. Such deregulation would un-tether financial sectors from their domestic economies, while also making developing countries more susceptible to volatile fluctuations in global financial markets beyond their control.
An additional concern is that the financial sectors of developing economies could grow quicker than the rest of the local economy, adding to concerns about too much finance. The IMF, Bank for International Settlements (BIS), the OECD and others have been producing a whole new area of academic research highlighting the dangers of letting the size of the financial sector get too big relative to the real sector. This has been dubbed the finance curse when too much investment capital is diverted to speculative activities, economic growth slows and inequality escalates.
Just as these complex financial instruments make the risk opaque, they could have the same effect on the accountability for the environmental, social and governance (ESG) of development projects on the ground. Depending on the types of securities used, the direct links between lenders, the development projects and the underlying assets, could become totally obscured as financial instruments are internationally traded to maximise returns.
So what of the people on the ground at the other end of this huge planned marketisation of development finance? Well the surge of privatisation in the 2000s didn’t end so well. The World Bank’s attempts to privatise water and other public utilities and public services led to a huge backlash from Bolivia to South Africa as prices for the poor increased to provide adequate returns to private investors. In the past few decades there have been over 800 cases of “remunicipalisations” of public services involving more than 1,600 cities in 45 countries in which cities reclaimed previously privatised public services and assets.
“Why is the international financial development club not learning from its very recent experience?”
So why is the international financial development club not learning from its very recent experience? The new initiative ignores critical lessons from the global backlash against privatisation as well as the failure of regulators to control the degree of risk in securitisation markets that worsened the 2008 global financial crisis.
Instead, it would be far wiser for the G20 and leading development finance institutions to re- double support for traditional forms of public financing mechanisms. They could take a page from the origins of the modern European welfare state in the 19th and 20th centuries: it was based on the principle that large, long-term public investments in financing free or highly subsidised public health, public education, and public transportation and utilities best enable the whole society to move forward with national economic development.
