Development finance: Complexity and IT considerations

Dec 22, 2020 - 7 min read
Ronan du Halgouet, Commercial Lending Product Manager at Sopra Banking Software

The role of development finance institutions (DFIs) has expanded in the past decade as their numbers have grown, and they’ve been granted larger amounts of capital. Today, there are an estimated 400 development banks worldwide, with combined assets of $11trn.

With a mandate to help countries achieve sustainable development goals, DFIs often take on more risk and adopt longer-term perspectives than typical commercial lenders. As a result, DFIs face unique loan management challenges, which include finding IT systems that can support their requirements.

Dimensions of development finance

To understand development finance IT challenges, it’s first important to consider the complexity they face based on three dimensions: the scope of the DFI charter, financial products offered, and sources of funding.

DFI scope

There are different types of development banks, based on how they are created and who they serve.

National development banks (NDBs), created by a country’s government, provide financing to that same country. Loans operate in the same financial and legal ecosystem from the lending and borrowing side. Most likely, disbursement, collection, reporting and accounting occur in the same currency. NDBs are not exposed, by definition, to currency risk and cross-accounting standards. In addition, NDBs have a limited number of funding sources.

Bilateral development banks (BDBs) are financial institutions established by one individual country to finance development projects in an emerging country. In this broader ecosystem, transactions are more complex and include multi-currency disbursement and exchange swaps. Sovereign projects may include additional covenants and project follow-up requirements.

Multilateral development banks (MDBs) are financial institutions created by a group of countries in order to provide development financing. MDBs have memberships including both developed donor countries and developing borrower countries. This type of development bank operates within different financial and legal ecosystems, as well as multiple accounting standards. Currency risk is carried on the borrowing and funding sides. Multiple agencies around the globe add complexity including multi-language user interfaces and application and transaction up-time.

Financial products
DFIs offer a broad range of products including:

  • Loans
  • Equity
  • Guarantees
  • Grants

Add to this list a myriad of hybrid and specialty offerings. DSI products can inherit additional complexity when applied to the private vs. public sector. In addition, a financed project can involve multiple tranches, based on different products with diversified sources of funding.

Sources of funding
In order to finance larger projects and mitigate risk, DFIs often create large syndicated loans with other counterparts or commercial banks. DFIs can act as a syndication participant or leader. 

Internally, DFIs can be organized in multiple funds. Most of the time, there is a main source of funding. But some contributor(s) or specific initiatives can be settled in a trust fund with a specific mandate. These trust funds can fund some loans under the umbrella if the DFIs act as guarantor or subsidize other operations.

Specific pain points for IT

From product types and pricing, to partnerships, procedures and workflows, development finance is more complex than traditional commercial lending. What are the specific IT pain points and requirements for development finance?

Loan complexity
The credit agreements issued by a development bank are elaborate. To support such loans, a system must manage intensive calculation methodology and variable formulas, i.e., simple interest, compounding, averaging and the use of indices.

Multi-currency environments
Development banks fund in different currencies, using more than one accounting standard. A loan management system must be flexible enough to accommodate this multi-currency, multi-standards and multi-reporting requirement, including the re-evaluation of different balances to report on and structure the currency risk.

Loan terms
With a focus on development results, such as sustainability, DFI investments are less commercially driven by nature. These investments may translate into long-term loans that can last more than 20 years. Given these kinds of timeframes, it’s extra challenging to manage data and consistency. Both can be affected by different IT projects and changes in geopolitical and economic conditions over time. If there is a major disruptive event, such as the end of LIBOR, a development bank can be impacted by several simultaneous transitions in their portfolio. For example, managing the transition to a risk-free rate on large multiple tranches is complicated for IT systems to handle.

Bridging sectors
Public-private partnerships are a valuable vehicle for governments to secure financing and expertise for infrastructure development. As DFIs are active in both the public and private sectors, their loan management system needs to address the unique requirements of each.

Multiple funding sources
Whether a syndication leader or participant, specific follow-up and reciprocal transactions need to be triggered in the supporting IT systems based on the lifecycle of the underlying loan. Syndication changes generate multiple procedures, and these procedures also need to be reflected in complex data points – such as accounting and billing – in the servicing platform.

Intricate workflows
Development bank lending typically requires intricate internal workflows. These workflows need to be pliable, with the ability to accommodate various funds, local and non-local currency accounts, and intermediary bank accounts. For instance, loan agreements and restructures are more open than standard loan agreements, which generate many divisions and exceptions in the workflow. Transfer of funds, sales of participation or partial payoffs can trigger a waterfall of change data points in the system.

Project monitoring
DFIs are project-oriented. Within a project, the bank may propose multiple layers of financing. Managing the risk associated with loans requires a development bank to consistently monitor the execution of a project and the utilization of its budget. For example, with a sovereign loan, a DFI needs an IT system that can closely track the project in order to disburse funds per the agreed upon terms.

Product silos
In development finance, avoiding product silos is critical. Ideally, a single financing project can be handled by multiple tranches based on different products with a diversified source of funding. For a global view, there needs to be IT management and reporting that links tranches at the project level.

Trust funds
DFI IT systems need to report and account for the trust fund’s currency, and specific reflow transactions need to be administered.

Long billing cycles
Development banks bill well in advance. This larger lead time must be enabled by the loan management system, including any prior adjustments in the following bill. The complexity of the billing requires that the bill review process is based on clear rules to avoid triaging between Straight-Through-Processing (STP) and non-STP bills.

Keeping pace

In a world ruled by digitalization, STP and AI, DFIs face a challenge to rationalize and streamline their industry without compromising the important products they deliver. Despite the complexity, development banks can and should automate their lending processes.

Customizing a core banking solution or using different systems to meet development finance specificities is costly and blocks upgrade possibilities to extend ROI. On the other hand, pre-configured development finance solutions implemented by a team experienced with the nuances of the industry, enable these institutions to cost-effectively automate lending operations, free up resources and focus on their most important job: promoting social and economic wellbeing.