Mona Lisa effect and development finance

In explaining the puzzle of today’s post-pandemic economy, The Economist refers to the Mona Lisa effect: “At first glance the subject of the world’s most famous painting seems to be smiling. Look again and her smile fades. When it next reappears, it is a different sort of smile. Leonardo da Vinci achieved this ambiguous effect with the use of sfumato, where he blurred the lines around Mona Lisa’s face. No matter how many times you look, you are unsure quite what is happening.”

Today’s economy is such an enigma. Forecasting has become a challenging task. The range of analysts’ expectations for American quarterly gross domestic product growth has been twice as wide as in 2019. The word “uncertainty” appears more than 60 times in International Monetary Fund’s latest global outlook. Christine Lagarde, the European Central Bank President, was quoted as follows: “It is not possible to determine at this point in time what the path will be going forward.”

The Economist likewise discusses the dilemma faced by development financial institutions (DFI) worldwide. In theory, development finance helps solve market imperfections that would leave either profitable projects or projects that create positive externalities without financing. DFIs can alleviate capital scarcity and promote entrepreneurial action to boost new and important industries. They help address the problems of climate change, promote sustainable development goals and finance the riskier undertakings, solving failure in credit markets that inhibit growth in the right place. DFIs go where private investors fear to tread.

Paradoxically, however, The Economist observes the many DFIs prioritize the need “to do good without losing money.” They often look for cheap co-financing from donor agencies that give grants on concessional loans, in order “to take the risk off the table.”

DFIs are aiming to achieve competing expectations. “Governments want them to generate a financial return, to go where private investors will not and to draw more private investors into their projects.” These goals can contradict each other. To lend to companies that would not have undertaken the project without capital support is getting into areas not normally supported by private investors. They may have high potential economic and social returns but at-risk levels not acceptable to profit-oriented institutions.

Given the Mona Lisa scenario in the macro economy, development finance must be bolder in their capital allocation decisions, lest it leads to suboptimal investments. The private sector is expected to be more cautious. DFIs are needed to address failures of the marketplace. They must be in the forefront of affirmative action.

To illustrate, the Land Bank of the Philippines and the Development Bank of the Philippines must de-prioritize being the top banks of the country. Their primordial goals must be to service their respective mandates — agriculture, social development, infrastructure, small and medium enterprises — instead of competing for attractive investments that are readily within private financing realm. If by doing their mandates, they end up in the top 10, that is fine. The underserved and undeveloped sectors must be topmost in their goals, without sacrificing sustainability.

How can we ensure that our development banks indeed work within their primary objectives? In my view, there should be a strong focus on processes and consequently, good governance. It starts with choosing the right leaders and Board members for their merit and competence, not simply as rewards for political support.

A focus on people competence will build a cadre of professional, well-motivated development bankers, hopefully divorced from patronage politics, and concentrated on doing their jobs. The bank’s personnel must have their heads and hearts in the right place, technically equipped and well-trained for their jobs while also possessed of a missionary zeal. Development banking is not just a commercial job but an opportunity to make a difference for a greater good.

Process review should look at the impact of decisions on firm-level investment and performance, and on the selection mechanisms through which bank clients are filtered. Analyzing the way by which bank loans affect productivity and improve investments and performance of its clientele is important. The organization must frontally address the financial inclusion agenda.

State-led credit and savings programs can serve as a mechanism to unlock pioneering investments in areas beneficial to the people and economy. It should compete with private banks only to the extent that it paves the way for further deepening of the financial sector. Despite the liquidity available in our financial system, the private banking community is said to be risk averse. In this milieu, a pro-active and bolder development banking system can help propel the growth of critical impact sectors.

The opinion expressed herein does not necessarily reflect the views of these institutions and BusinessWorld.


Benel Dela Paz Lagua was previously EVP and chief development officer at the Development Bank of the Philippines.  He is an active FINEX member and an advocate of risk-based lending for SMEs.  Today, he is independent director in progressive banks and in some NGOs.