Motivation of the Chapter

Development banking is a special form of banking that differentiates itself from commercial banking by the provision of long term loans to socially beneficial projects or profitable projects that need substantial volume of debt capital (Diamond, 1957; Armendariz de Aghion, 1999; Boskey, 1961; Cameron, 1972). Most of the devel- opment banks are state–owned banks, and the focus of the lending activity is not commercial activities or individual borrowings but rather development activities. Development banks continue to give impetus to the process of industrialisation, al- though the tasks of these banks evolved considerably. Besides providing long–term loans to the projects, many of these banks are re–equipped with new tasks like alle- viating poverty, funding small and medium enterprises, raising technical capacities in high–technology industries.

The discipline of development banking has its origins in growth theories of the 1950s (Diamond, 1957). The dominant view in the theories was that the growth of income was related directly and positively to savings. In the shortage of savings, long–term financing was considered to be vitally important for investment and high growth rates. Under the post–war circumstances in the world, there appeared the necessity of a vehicle that could provide long–term financing to revitalize capital investment. Development financing institutions emerged as a viable solution for long–term financing needs. Developing countries 8 _{were encouraged to establish}

8_{There are different usages to define the term ”underdevelopment” in development economics}

and practice. The countries where development process is still in progress are generally named

as ”developing countries”. Yet, the use of ”least developed countries” and ”emerging market

their national development banks to bridge the saving and investment gap in their home countries. The intention was to provide long–term financing for profitable and socially beneficial projects in almost every area of the economy. Development banks were also encouraged to provide technical expertise to the project holders who lack expertise.

Development banks provided long–term financing in line with development goals of governments. The project evaluation process of these banks used to be par- ticularly detailed to assess the economic and social impacts of the project on the economy. The emphasis of development in development banking has faded consider- ably after the 1980s (World Bank, 2012). Bruck (2002) argues the ”banking” aspect of these institutions started to dominate ”development” aspect after the 1980s. De- velopment banks differentiated their financial services especially after the 1980s with the new demands of the market9_{. Development banks’ intention to change over time}

to accommodate the recent necessities of development should not be surprising. To stay competitive, these banks are faced with a conundrum between development activities and banking business.

Even after the 1980s, state intervention in banking business is justified by market failures. It is still widely accepted that governments can correct the disruptions in financial sector which can severely affect the overall economy (World Bank, 2012). In many countries where private financial institutions fail to maintain development activities, development banks are still perceived to be a viable means for such activ- ities. In recent years with the impact of the 2008 financial crisis, the world economy has witnessed a revival of interest in development banks. World Bank (2012) doc- uments several new development banks that have been established in developing countries (for example, Bosnia and Herzegovina, India, Malawi, Mexico, Mongo- lia, Mozambique, Serbia, and Thailand) as well as in some advanced countries (for example, Green Investment Bank of the United Kingdom (UK)). The interest to-

except for advanced ones, not otherwise defined, will be called as ”developing countries”.

9_{Developments banks currently contribute to development financing through new facilities like}

wards development banks has been fuelled by their potential countercyclical role during the course of crisis. To address the adverse impacts of the crisis, these banks were employed with unique mandates to mitigate contractions in credit supply. Al- though the resurgence in development banking is apparent, there is still suspicion about the benefits of development banking. World Bank (2012) argues that most of the development banks are far from adopting best practices in governance and risk management. This survey also indicates that these banks are still susceptible to unproductive political interference.

There are relatively few papers about development banking in the literature. Armendariz de Aghion (1999) develops a model in which banking system is highly decentralised. This model shows that decentralised banks fail to provide long–term funding if state does not intervene. The basic finding of this study suggests that state intervention in the form of development banking can be a panacea to lack of long–term financing once certain type of cooperation with private banks is estab- lished. Co–financing arrangements with private banks and co–ownership structures in development banks (state and private ownership) can improve the efficiency of development banking. Cross country evidence, however, suggests that the directed credit programs of development banking activities distort the allocation of resources in developing countries (Odedokun, 1996). Over a panel of 38 countries, this study shows that development loans in relation to the GDP have negative impacts on the efficiency of investment utilisation. There are also a few papers investigating single country cases. Bandyopadhyay (1978) examines development banking in India in the 1970s. This paper discusses several issues in operational, organisational, and planning structures of these banks and proposes operational research can be effec- tive to solve problems in these areas. Padin (2003) analyses the long–term effects of liberalisation on development banking in Puerto Rico and its impact on the develop- ment trajectory of the country. This paper uncovers the conflict between domestic business class and interventionist state and discusses the background of the failure of developmental state projects.

This chapter aims to fill the gap in development banking literature by examining the case in Turkey. Development banking in Turkey is not unique in terms of its history. The early examples of these banks were founded just after the establishment of the Republic of Turkey. The need for urgent industrialisation of the country was partially fulfilled by state–owned banks which were typically in charge of the tasks attached to development banking. The import substitution industrialisation (ISI) strategies implemented during the 1960s also invigorated development banking in the country. These banks continued to be influential until the liberalisation of the 1980s10. Due to the structural problems both in the banking system and the general

economy during that time, the ISI project did not continue successfully. The failure of ISI strategies in addition to the discourse of the liberalisation policies disrupted development banking. Foreign bank entries, widespread privatisation, creation and enhancement of equity markets etc. have all scaled back the breadth of development banking in the country. Nonetheless, development banking in the banking system still survives.

Although development banks are actively present in Turkish banking system, there is a general scarcity of evidence on development banking in the country 11.

From this departure, this chapter will shed more light on development banking in Turkey by studying regional level data during 1963–1994.