1. 1 Towards a Sustainable DFI -Lessons from the Experience in Japan- November 5, 2014 Eishi Yasunaga Japan Economic Research Institute Inc. ADFIAP 10 th International CEO Forum

2. 1.Discussions on the Advantages and Controversy regarding DFIs 2

3. ・ Strong support from the government ・ Accessibility to long-term funds ・ Willingness to be exposed to long-term financing and green field projects ・ Focus more on viability of projects rather than collateral pledged Advantages regarding DFIs 3

4. ・ Should DFIs be regulated the same way as commercial bank ? ・ How important is profitability for a DFI ・ Could state intervention be totally eliminated? ・ Could market discipline be solely relied upon? Controversy regarding DFIs 4

5. World Bank’ s View on DFIs ・ World Bank (WB) states that many DFIs perform poorly and state owned ones are worse. ・ Political intervention in favor of non-viable projects is a part of reasons. ・ Given these bad examples, after the 1980s WB has been suspicious to cooperate with DFIs. ・ In Africa, WB engaged in structural adjustment extensively, which affected many DFIs. ⇒ To sustain a good DFI, certain lessons from Japan could be useful. 5 5

6. 2. Viability of Past Japanese DFIs including Development Bank of Japan (DBJ) 6

7. (billion US Dollars) Major Policy-based financial Institutions to be established after 1945 Governing Agency Loans outstanding Share as of March 2004 Development Bank of Japan (DBJ)MOF130.810% Japan Bank for International Cooperation (JBIC)MOFA180.614% Japan Finance Corporation for SMEMETI67.25% National Life Finance CorporationMOF89.17% Housing Loan CorporationMLIT536.142% Agriculture, Forestry and Fisheries Finance Corporation MAFF30.52% Japan Finance Corporation for Municipal Enterprises MIC220.217% Okinawa Development Finance Corporation Cabinet Office 13.31% Total1267.7100% Major DFIs in Japan as of 2005 7

8. 8 1. Respect for the market economy The existence of private business and the presence of private banks 2. Close relationship with the economic plans & policy Public savings framework, Fiscal Investment and Loan Program (FILP), Industrial policy 3. Respect for independence of management Sound financial practices, Neutral and fair appraisal system ⇒ Among the Japanese DFIs, the experience of DBJ provides. a good example in terms of a sustainable DFI. The Characteristics of the past DFIs in Japan 8

9. Profile of DBJ Established:1951 Former Japan Development Bank (JDB) 1999 Development Bank of Japan (DBJ) 2005 Decision of DBJ’s Privatization by Government 2008 DBJ Inc. (Conversion to a Joint Stock Company) Total assets:USD 172.8 billion (As of March 31, 2014) Loans:USD 148.0 billion (As of March 31, 2014) Capital adequacy ratio:15.36% (As of March 31, 2014) Credit Ratings:Aa3 (Moody's Investors Service, Inc), A+ (Standard & Poor's Corp.) Number of employees:1,189 (As of March 31, 2014) Offices:Head Office, 10 Branch offices, 8 representative offices, 1 overseas representative office, 3 overseas subsidiaries Governing Law:Development Bank of Japan Inc, Law Ownership:The government of Japan (100%) 9 Source: DBJ

10. 10 Changes in Priorities of DBJ Loans (1955 ～ 2005) Electric Power Others Ocean Shipping Coal Mining Regional Development Others Regional Development Development of Technology Ocean ShippingUrban Development Improvement in Living Standards Resources and Energy Others Regional Development Development of Technology Community DevelopmentEnvironmental Conservation and Sustainable Societies Creation of New Technologies and Industries Promotion of Social Capital Creation Coal Mining NEF’s Regional Development Regional Development Resources and Energy 30972 Improvement in Living Standards Improvement in Key Transportation Systems Telecommunications and Information Network Development of Industrial Technology Internationalization of Japan 16 10 Source: DBJ

11. DBJ’ CSR Activities -Rated Loan Program- ( 2004 ～）  Evaluate enterprise value more properly using non-financial information in addition to financial statements.  Sometimes the three areas identified in the chart tend to be recognized as costs; therefore, DBJ helps as follows. ▪ Informing the financial market about model companies’ socially responsible activities ▪ Organize BCM CLUB for companies' information exchange Environment Enterprise resilience (Business Continuity Management) Health management DBJ-rated loan program Green building certification 11 Source: DBJ

12. Application Disaster preparedness monitoring Evaluation of company credit risk, collateral and other factors Loan agreement and disbursement Disaster prepared -ness screening (Prevention plans, Business Continuity) Financing judgment (Rank A to D) and economical condition decision Press BCM Rated Loan Program 12 Source: DBJ

13. 3. Approaches for a Sustainable DFI 13

14. 14 Discussions with the World Bank on Policy-based Finance Major Questions from World Bank to the past DBJ Do such measures encourage the substitution of credit for the borrowers’ own funds and promote excessive indebtedness? ⇒ This can be prevented provided that appropriate appraisal exists. Do such measures encourage corruption and the rationing of credit in favor of groups that already benefit? ⇒ With independent management and professional appraisal as well as proper monitoring, this is “no” as the Japanese example testifies. Do such measures weaken the incentives of both borrowers and lenders for debt repayment? ⇒ No, it does not weaken it if an appropriate financial discipline exists. Do such measures add to the fiscal deficit? ⇒ No, if DFIs can finance only viable projects resulting in small written off and larger tax revenue and obtain inexpensive funds from ODA. 14

15. 15 Throughout its history, DBJ has implemented the following approaches to achieve a sustainable operation. As a result, DBJ has kept low bad loan ratio. To change its priorities in loan areas in line with policy direction and to design new loan programs such as the ones related to CSR. To avoid political pressure to finance non-viable projects. To make independent loan decisions based on rigorous appraisal by high standard of professional staff. To supplement or encourage finance by commercial banks through joint financing. To implement appropriate monitoring and strict audit. Lessons from the Experience of the past DBJ 15

16. Project Preparation Stage Project Appraisal Stage Project Monitoring Stage Funding Government selection of projects for political reasons (lack of governance) Insufficient equity No rigorous appraisal, due to government’s intervention Malfunction due to government’s intervention Financial Situation of Banks Process for Individual Projects Decline of profit Weak supervision by government e.g. lack of guidelines to ensure the DFI’s financial soundness Cause Reasons for the past failures of some DFIs in Developing Countries Approaches in Japan Efficient mobilization of domestic capital (e.g. FILP in Japan) Appraisal and monitoring with expertise in each DFI Division of responsibility in lending between government and DFIs (non-intervention by government) Harmonization of projects with the national development plan (exchange of opinions between public and private) Rigorous audit by government (accountability) 16 How to Use the Approaches in Japan to other DFIs Source: JICA Study Team