Driving digital in development banking

By Holger Harreis, Mariana Miron, and Henning Soller

Development banks have an operating model that was designed to support their work with large counterparts—major public institutions, corporations, and financial intermediaries—while remaining purposely distanced from many end beneficiaries, such as small and medium-size enterprises (SMEs). This model has now become an impediment, resulting in significantly lengthier and more burdensome processes to secure funding for projects.

Meanwhile, development banks have had to expand their array of services to address emerging needs, including engaging directly with end customers and providing urgent support for pandemic- or climate-related action. Many of these projects are smaller and more fragmented, thus raising the administrative burden. As a result, these institutions have found their existing IT capabilities particularly inadequate to support their operations. A digital transformation is now more urgent than ever.

Built-in constraints on digital transformations

Development banks have generally attempted to follow the lead of retail and corporate banking when it comes to integrating digital technologies into their operations. However, the peculiarities of their operating model pose significant challenges to such ambitions (exhibit).

Development banks are facing significant challenges.

Direct end-customer business

Most development banks have yet to establish the processes, operations, and channels needed to directly interact with a wider pool of end customers. Our research found that just two of the top ten development banks have some form of customer platform. These institutions represent a relatively small market, so off-the-shelf software solutions are often not readily available. Consequently, the existing systems at most development banks are slow, outdated, drowning in legacy architecture, and incapable of supporting a go-to-market revolution.

Significant increase in the volume and complexity of requests

Typically, the processes in a development bank’s back office are not standardized or set up to scale easily. An internal request for a new product might take several months, and any deviation from the standard parameters is often handled with manual work and Excel spreadsheets. Most institutions have not invested in building the capabilities and workforce required to upgrade their solutions. Outsourcing isn’t a viable option, because software vendors lack the knowledge and understanding of development banks to produce targeted solutions. Yet our research found that a majority of the top ten development banks outsource their IT competencies.

Cost pressures

For the past couple of decades, the arbitrage position of AAA development banks has been eroded by ultra-low interest rates globally. That has placed institutions and their IT functions under increased pressure to cut costs or to cover more ground with the same budget. Migrating to cloud could reduce IT costs over the long term, but currently none of the top ten development banks uses cloud capabilities.

Pressure to reduce bureaucracy

Politicians, intermediaries as customers, direct customers, and the public all expect development banks to be more innovative and modern in their operations. Calls for “more-digital” operations can be perceived as a desire for less bureaucracy.

Potential technology solutions

Addressing this situation requires a massive revamp in three areas:

  • Set up digital channels for end customers to support emerging needs. These channels would enable direct lending while allowing development banks to flexibly change channels and their front ends to fulfill specific requests.
  • Standardize and professionalize processes, specifically in the back office, through increased automation in the workflow. These actions could sustain much higher levels of throughput and facilitate the scaling of current activities.
  • Scale and revamp the current IT department with a focus on improving and expanding the internal engineering team. Software providers and external support alone cannot solve the unique challenges of development banks. Development banks must become relevant as employers of technology talent and shift the IT department’s role from that of a service provider to a co-shaper of the digital agenda. Enabling banks to make relevant decisions and design tech solutions tailored to the challenges at hand can translate ideas into action.

A digital transformation requires change beyond technology alone

The typical structure of development banks—multigovernment ownership and one that is highly risk averse to maintain a low level of defaults—is a barrier to these necessary changes that cannot be easily overcome with a typical business-as-usual approach. Instead, banks must establish a dedicated, programmatic task force to manage cultural and organizational change. Several elements are required as part of such an approach.

Mutual understanding and support at the senior management and executive levels

Typically, the first step in a digital transformation is to achieve a mutual understanding among board members and management about the transformation and the support required to achieve lasting change at scale. Leadership must understand that the digital transformation is much broader than just a technology initiative. For the transformation to be successful, managers should own it and the board should fully support it. In addition to advocating for funding, board members should encourage managers to question existing processes and controls.

Bold moves decoupled from legacy

The pursuit of partial greenfield solutions or the creation of a stand-alone digital bank would open the possibility for a truly rapid transformation. With differentiated digital solutions, a development bank can act as an intermediary (with the unique guarantees only it can provide) for lenders and investors interested in the respective customer segments (for example, SMEs). Solutions can take the shape of a digital platform connecting demand and supply, with the added benefit of generating and monetizing data for areas with limited transparency, such as the demands of SMEs by country or region. There is also the opportunity for the co-creation of digital solutions with other development banks, considering their (generally) noncompetitive mandates. This collaboration could extend to a shared high-quality talent pool for digital projects.

A dedicated program to drive digital

The technology and business teams must be able to devote the necessary time to the change initiative. A dedicated transformation team is needed to track progress not only on technology initiatives but also on cultural and process changes. Importantly, banks also need to replace a siloed approach with a truly enterprise-wide program.

In our experience, development banks that have undergone a digital transformation are perceived more favorably by their governing bodies and beneficiaries. They also have managed to significantly increase their business, while more traditional development banks receive more scrutiny regarding their role, capacity, and effectiveness.

Holger Harreis is a senior partner in McKinsey’s Düsseldorf office, Mariana Miron is a consultant in the Bucharest office, and Henning Soller is a partner in the Frankfurt office.