It is necessary to create a Mediterranean Development Bank
Along with these significant funding requirements, the Milhaud Commission adds the need to develop restricted investments aimed at production sectors and regions that remain under-developed, with an emphasis on long-term projects or those with financial and stock market potential. The region also lacks: coordination between different donors, mobilization of private savings, and support for finance engineering, especially for SMEs and infrastructure projects.
The Arab spring, with its demand for an economically sustainable environment and democratic public life, intensified the need to support southern economies in their development.
It is therefore the right time to put a financial architecture in place specific to the region in order to respond to structural needs reinforced by the economic situation, and create an economically integrated region in the long term. There are objective reasons for putting this architecture in place progressively and relatively quickly: (i) Europe must identify growth drivers in its immediate environment; (ii) SEMCs, in full democratic transition, cannot individually find the means to face up to monetary risks, oversupply risks, long-term FDI risks, and export risks.
Following the example of the World Bank, which has set up a global-scale set of instruments capable of identifying projects and providing funding, guarantees and training, the Mediterranean area should put similar functions in place, under the impetus of a specific development bank. The creation of a Mediterranean Development Bank is a strategic objective that does not respond to moral, ethical or historical considerations. It is above all an economic necessity, both for countries south and north of the Mediterranean.
A specifically Mediterranean financial development institution would bring the region undeniable added value. Its creation would give investors a strong signal. It would contribute to restoring confidence in the region, banking systems and industrial partners. States and national and international public institutions participating in it would help create a considerable lever on public and private resources collected thanks to their credibility and public regulation. They would also use their engineering skills for regional-scale innovation, with a strategic vision for economic development and integration in the Mediterranean.
Through its very existence, this bank would contribute to improving security conditions for savings and investment flows:
- By spurring the move from a fund transfer approach to one of durable regional integration.
- By facilitating the transformation of surplus cash into long-term funds and fostering conditions for stability and monetary anchors.
- By carrying out essential functions centred on raising the level of economies in the region and financing SMEs in the private sector.
- By contributing to improving project quality in the from of expertise and a capacity to identify and assess risks, both of which are greatly lacking in the region.
- Lastly, by supporting cross-cutting, ambitious and mobilizing projects, e.g. TGVs in the South, electricity interconnections, transnational highways.
Through its very existence, this bank would contribute to improving security conditions for savings and investment flows:
- By spurring the move from a fund transfer approach to one of durable regional integration.
- By facilitating the transformation of surplus cash into long-term funds and fostering conditions for stability and monetary anchors.
- By carrying out essential functions centred on raising the level of economies in the region and financing SMEs in the private sector.
- By contributing to improving project quality in the from of expertise and a capacity to identify and assess risks, both of which are greatly lacking in the region.
- Lastly, by supporting cross-cutting, ambitious and mobilizing projects, e.g. TGVs in the South, electricity interconnections, transnational highways.
Basic principles governing the Mediterranean Development Bank’s creation and action:
The Milhaud Commission insisted on the basic principles that should accompany the Mediterranean Development Bank’s creation and action. These include cross-compliance, inter-dependence, subsidiarity vis-à-vis the private sector, and AAA rating.
1. Cross-compliance: reforms should be made in the region to put a stable governance model in place that protects investments, and an institutional framework favourable to the market economy. A development bank cannot make up for an absence of reforms of this type, but it could encourage transition towards setting up a framework more favourable for business.
2. Inter-dependence: the bank should not be a substitute existing institutions operating in the region, but rather coordinate its activities to provide functions and skills that are either scantly, badly, or not at all covered by current stakeholders.
3. Susidiarity vis-à-vis the private sector: the bank’s vocation is not to replace the private sector by intervening in its place. It should act as a support to the private sector by trying to achieve maximum leverage and supplying financial means that do not exist in local markets
4. AAA rating is a prerequisite for creating the bank. AAA rating will be essential to the bank’s financial viability and constitute a guarantee of its financial soundness, rigorous risk management and exemplary professional management.
The Milhaud Commission insisted on the basic principles that should accompany the Mediterranean Development Bank’s creation and action. These include cross-compliance, inter-dependence, subsidiarity vis-à-vis the private sector, and AAA rating.
1. Cross-compliance: reforms should be made in the region to put a stable governance model in place that protects investments, and an institutional framework favourable to the market economy. A development bank cannot make up for an absence of reforms of this type, but it could encourage transition towards setting up a framework more favourable for business.
2. Inter-dependence: the bank should not be a substitute existing institutions operating in the region, but rather coordinate its activities to provide functions and skills that are either scantly, badly, or not at all covered by current stakeholders.
3. Susidiarity vis-à-vis the private sector: the bank’s vocation is not to replace the private sector by intervening in its place. It should act as a support to the private sector by trying to achieve maximum leverage and supplying financial means that do not exist in local markets
4. AAA rating is a prerequisite for creating the bank. AAA rating will be essential to the bank’s financial viability and constitute a guarantee of its financial soundness, rigorous risk management and exemplary professional management.
The Mediterranean Development Bank’s missions:
The Mediterranean Development Bank should have four major missions that are crucial to the region, with a strong underlying “financial engineering transfer” component for each mission.
The bank’s missions should bring about profound changes in existing management systems. This will involve training bank managers on how to assess risk, providing support for setting up institutional and regulatory frameworks to encourage long-term investment, disseminating better practices in terms of governance, and making available top-level expertise for certain activities like coordinating financial markets. The missions that should be assigned to the Mediterranean Development Bank would make up for the inadequacies of local finance measures and offer financial products that are not supplied in a coordinated way by development institutions operating in the region. The bank would make use of various tools, including loans, equity investments and guarantees.
Principal missions:
1. Transform local savings into mid-term investments
2. Support the private sector, in particular growing SMEs
3. Provide backing for innovative funds for early stage projects
4. Support the activation of financial markets
Transform local savings into mid-term investments
South and East Mediterranean countries possess abundant cash. These local savings are currently mainly invested in property or placed in savings accounts. On the other hand, there is a lack of funding for mid- and long-term projects.
Initiatives have already been set up to develop mid- and long-term investment, notably via local banking sectors and PPP projects. Credit lines granted to local banking systems have also been set up by international donors in the region. However, these funds come up against two obstacles: credit limits that stop at 5 years, and the overcollateralization of credits required by local banks. Local banks focus on the short term.
Local banks prioritize major companies and demand guarantees that discourage SMEs. For this reason, South and East Mediterranean Countries as a geographical zone have one of the highest self-funded business rates in the world (over 2/3). When it comes to PPPs, the main hindrance is the absence of stable, protecting frameworks for investors, the lack of funding in local currency and instruments for covering foreign exchange risk.
The Mediterranean Development Bank should facilitate the transformation of a share of local savings into long-term funds, which will make it possible to either finance or guarantee financing for production investment and infrastructure projects. A financial institution guaranteeing long-term variable funds that local banks are incapable of covering (they need to cover themselves on the markets) would help free up numerous projects. In this perspective, the bank would propose mid- to long-term credit guarantees and counter guarantees so as to encourage more long-term savings and thus increase long-term funds in local banking systems.
Support the private sector, in particular growing SMEs
Several factors explain the difficulties encountered by growing SMEs looking for funding adapted to their needs in SEMCs. Firstly, banks require extremely high collateralization ratios that often exceed 100%, systematically calling for personal collateral in addition to guarantees. What is more, companies do not fulfil accountancy transparency requirements and the informal sector remains considerable. Lastly, the credit line mechanisms that several multilateral institutions allocate to banking systems for companies, with a priority on SMEs, are subject to long, bureaucratic procedures that do not correspond to the realities of local SMEs.
This observation justifies taking a new approach: make it easier for companies, especially SMEs, to get funding by making technical assistance to local banks and companies a condition of receiving the funding. Prerequisites include bringing accounting practices up to standard and adopting a notation-based risk model. Another way of offering funding to SMEs would be to support the emerging capital investment industry. To do this, the Mediterranean Development Bank would itself need a capital financing activity.
Lastly, in the long term, the Mediterranean bank could encourage the presence of funds of funds in the Mediterranean and the creation of funds to accompany IPOs.
Provide backing for innovative funds for early stage projects
There are very few innovative funds devoted to early-stage projects in the Mediterranean. The Mediterranean Development Bank could be a driving force at this level, by financing innovative funds focusing in particular on early-stage or seed projects (venture capital, business angels). It would thus fulfil a necessary role without taking the place of private initiatives.
As an example, it could support the set-up of a guarantee fund for SMEs centred on clusters, with contributions from regions. The objectives of this type of fund are to concentrate resources with a view for efficiency, and to support business creation with a view to territorial development. The new institution should also be able to participate in individual funds as a means of transferring financial know-how and understanding the characteristics of local markets.
Support the activation of financial markets
Some SEMCs possess technically sophisticated financial markets. However, markets suffer from a lack of cash, partly due to a strong state presence, and the absence of investors, particularly institutional ones (e.g. insurance companies, retirement and health funds). Existing funders have rarely solicited bondholder domestic markets in the southern Mediterranean. Developing these markets requires banks to mobilize more local savings than currently, including through bondholder fund raising on markets for their own account.
The Mediterranean Development Bank’s participation in bond-holder issues will be used to supply long-term lending funds for local banking systems with attractive conditions, made possible by the AAA rating.
The Mediterranean Development Bank, which will be a front-line multilateral financial institution, i.e. AAA, would be able to issue with a wide range of maturity dates and reassuring conditions for investors and savers. A systematic policy of bondholder issues would make it possible to offer a comprehensive, active panel of rates for all maturity dates.
The Mediterranean Development Bank should have four major missions that are crucial to the region, with a strong underlying “financial engineering transfer” component for each mission.
The bank’s missions should bring about profound changes in existing management systems. This will involve training bank managers on how to assess risk, providing support for setting up institutional and regulatory frameworks to encourage long-term investment, disseminating better practices in terms of governance, and making available top-level expertise for certain activities like coordinating financial markets. The missions that should be assigned to the Mediterranean Development Bank would make up for the inadequacies of local finance measures and offer financial products that are not supplied in a coordinated way by development institutions operating in the region. The bank would make use of various tools, including loans, equity investments and guarantees.
Principal missions:
1. Transform local savings into mid-term investments
2. Support the private sector, in particular growing SMEs
3. Provide backing for innovative funds for early stage projects
4. Support the activation of financial markets
Transform local savings into mid-term investments
South and East Mediterranean countries possess abundant cash. These local savings are currently mainly invested in property or placed in savings accounts. On the other hand, there is a lack of funding for mid- and long-term projects.
Initiatives have already been set up to develop mid- and long-term investment, notably via local banking sectors and PPP projects. Credit lines granted to local banking systems have also been set up by international donors in the region. However, these funds come up against two obstacles: credit limits that stop at 5 years, and the overcollateralization of credits required by local banks. Local banks focus on the short term.
Local banks prioritize major companies and demand guarantees that discourage SMEs. For this reason, South and East Mediterranean Countries as a geographical zone have one of the highest self-funded business rates in the world (over 2/3). When it comes to PPPs, the main hindrance is the absence of stable, protecting frameworks for investors, the lack of funding in local currency and instruments for covering foreign exchange risk.
The Mediterranean Development Bank should facilitate the transformation of a share of local savings into long-term funds, which will make it possible to either finance or guarantee financing for production investment and infrastructure projects. A financial institution guaranteeing long-term variable funds that local banks are incapable of covering (they need to cover themselves on the markets) would help free up numerous projects. In this perspective, the bank would propose mid- to long-term credit guarantees and counter guarantees so as to encourage more long-term savings and thus increase long-term funds in local banking systems.
Support the private sector, in particular growing SMEs
Several factors explain the difficulties encountered by growing SMEs looking for funding adapted to their needs in SEMCs. Firstly, banks require extremely high collateralization ratios that often exceed 100%, systematically calling for personal collateral in addition to guarantees. What is more, companies do not fulfil accountancy transparency requirements and the informal sector remains considerable. Lastly, the credit line mechanisms that several multilateral institutions allocate to banking systems for companies, with a priority on SMEs, are subject to long, bureaucratic procedures that do not correspond to the realities of local SMEs.
This observation justifies taking a new approach: make it easier for companies, especially SMEs, to get funding by making technical assistance to local banks and companies a condition of receiving the funding. Prerequisites include bringing accounting practices up to standard and adopting a notation-based risk model. Another way of offering funding to SMEs would be to support the emerging capital investment industry. To do this, the Mediterranean Development Bank would itself need a capital financing activity.
Lastly, in the long term, the Mediterranean bank could encourage the presence of funds of funds in the Mediterranean and the creation of funds to accompany IPOs.
Provide backing for innovative funds for early stage projects
There are very few innovative funds devoted to early-stage projects in the Mediterranean. The Mediterranean Development Bank could be a driving force at this level, by financing innovative funds focusing in particular on early-stage or seed projects (venture capital, business angels). It would thus fulfil a necessary role without taking the place of private initiatives.
As an example, it could support the set-up of a guarantee fund for SMEs centred on clusters, with contributions from regions. The objectives of this type of fund are to concentrate resources with a view for efficiency, and to support business creation with a view to territorial development. The new institution should also be able to participate in individual funds as a means of transferring financial know-how and understanding the characteristics of local markets.
Support the activation of financial markets
Some SEMCs possess technically sophisticated financial markets. However, markets suffer from a lack of cash, partly due to a strong state presence, and the absence of investors, particularly institutional ones (e.g. insurance companies, retirement and health funds). Existing funders have rarely solicited bondholder domestic markets in the southern Mediterranean. Developing these markets requires banks to mobilize more local savings than currently, including through bondholder fund raising on markets for their own account.
The Mediterranean Development Bank’s participation in bond-holder issues will be used to supply long-term lending funds for local banking systems with attractive conditions, made possible by the AAA rating.
The Mediterranean Development Bank, which will be a front-line multilateral financial institution, i.e. AAA, would be able to issue with a wide range of maturity dates and reassuring conditions for investors and savers. A systematic policy of bondholder issues would make it possible to offer a comprehensive, active panel of rates for all maturity dates.
Financing and governance of the Mediterranean Development Bank:
The Mediterranean Development Bank’s capital should be mostly public, mainly to ensure AAA rating, while remaining open to other funding sources, e.g. sovereign funds, private sector. An initial estimate of the capital required to launch the activities of this institution is around 10 to 15 billion euro.
The public sector involved in financing the bank would include multilateral financial institutions (e.g. EIB, BERD, World Bank) along with national institutions working on development funding (e.g. AFD, KfW) and countries in the North and South that wish to do so. States’ involvement would indicate their de facto acceptance of the bank’s action regarding companies on their territory, in favour of integrating a regional financial area whose common rules each state will have contributed to defining.
The Mediterranean Development Bank should propose a new mode of governance in conformity with co-development imperatives. With this new mode, SEMCs would be more closely involved in putting together projects and in decision-making mechanisms. This participation will encourage states to review their relations and operating methods and lead them to work with a more regional view.
The Mediterranean Development Bank’s capital should be mostly public, mainly to ensure AAA rating, while remaining open to other funding sources, e.g. sovereign funds, private sector. An initial estimate of the capital required to launch the activities of this institution is around 10 to 15 billion euro.
The public sector involved in financing the bank would include multilateral financial institutions (e.g. EIB, BERD, World Bank) along with national institutions working on development funding (e.g. AFD, KfW) and countries in the North and South that wish to do so. States’ involvement would indicate their de facto acceptance of the bank’s action regarding companies on their territory, in favour of integrating a regional financial area whose common rules each state will have contributed to defining.
The Mediterranean Development Bank should propose a new mode of governance in conformity with co-development imperatives. With this new mode, SEMCs would be more closely involved in putting together projects and in decision-making mechanisms. This participation will encourage states to review their relations and operating methods and lead them to work with a more regional view.