State-Owned Banks in the Transition: Origins, Evolution, and Policy Responses Khaled Sherif, Michael Borish, and Alexandra Gross Contents Acknowledgments vii Executive Summary 1 Chapter 1 The Early Stages of Transition 7 Economic Structure of Transition Economies in the Early 1990s 7 Monetary and Fiscal Trends in 1989­95 8 Notes 11 Chapter 2 State Banks Early in the Transition 13 Early Structural Changes in the Banking Sector 14 Traditional Roles of State Banks 17 Governance, Management, and Operating Standards of State Banks 21 Roles of Specialized State Banks 22 Notes 27 Chapter 3 State Banks in the Mid-1990s 29 Diverging Patterns of Development 29 Broad Trends in Financial Intermediation 31 Emerging Role of Private Banks 36 Diverging Approaches to Reform 39 Notes 41 Chapter 4 State Banks Since 1995: Continuing Problems 45 Progress in Privatization 45 Financial Condition of State Banks 47 Notes 64 Chapter 5 The Costs of Delay and Approaches to Reform 67 The Costs of Maintaining the State Bank System 67 The Costs of Delayed Reform in the Banking System 68 Approaches to Resolving Problem Assets and Restructuring Banks--and the Costs 70 The Special Costs of Weak Laws and Regulatory Forbearance 71 Progress and Challenges 72 Notes 75 Chapter 6 Findings and Recommendations 77 Main Findings 77 Prospects for Privatizing State Banks 78 Preconditions for Privatizing State Banks 79 Recommended Approaches to Reforming, Privatizing, and Liquidating State Banks 80 Notes 84 Case Studies 87 Romania: Closing Bancorex 87 Ukraine: Liquidating Bank Ukraina 89 Ukraine: Toward Restructuring Oschadny Bank 93 Czech Republic: Privatizing Ceska Sporitelna 95 Russian Federation: Holding onto Sberbank 97 Latvia: Restructuring and Privatizing Unibanka 99 Azerbaijan: Committing to Privatization of the International Bank of Azerbaijan 103 Annexes Annex 1 Financial Profile of Selected State Banks 106 Annex 2 Financial Profile of Selected State Banks 108 Annex 3 Financial Profile of Selected State Banks 110 Annex 4 Market Ratios of Selected State Banks in Transition Economies, 1999­2000 112 Annex 5 State Banks Included in the Analysis for End-2000 114 Annex 6 Different Types of Arrears as a Share of GDP in Selected Transition Economies, 1992­2001 115 Annex 7 The Study's Methodology 117 Bibliography 119 Tables 1.1 Selected Fiscal and Monetary Indicators in Central and Eastern European Countries, 1990-95 9 1.2 Selected Fiscal and Monetary Indicators in the Baltic States, 1990­95 9 1.3 Selected Fiscal and Monetary Indicators in the Commonwealth of Independent States, 1990-95 10 2.1 Profile of State Banks in Transition Economies, 1992 17 2.2 Assets and Global Asset Ranking of Large State Banks Early in the Transition 18 2.3 Industrial Banks in Transition Economies, 1992 23 2.4 Agricultural Banks in Transition Economies, 1992 24 iv CONTENTS 2.5 Savings and Postal Savings Banks in Transition Economies, 1992 25 2.6 Foreign Trade and Export-Import Banks in Transition Economies, 1992 25 2.7 Social, Housing, and Related Banks in Transition Economies, 1992 26 3.1 Number of Foreign Banks in Transition Economies 37 3.2 Banking Intermediation Statistics for Private Banks in Transition Economies, 1995 39 4.1 Remaining State Banks as of End­2001 46 4.2 Loans and Net Domestic Credit Exposure of State Banks in Transition Economies, End-2000 50 4.3 Assets in State Banks in Transition Economies, End-2000 52 4.4 Deposits in State Banks in Transition Economies, End-2000 54 4.5 Bank Loans, Deposits, and Loan-to-Deposit Ratios in Transition Economies, End-2000 55 4.6 Capital in State Banks in Transition Economies, End-2000 56 4.7 Bank Capital-to-Asset Ratios in Transition Economies, End-2000 58 4.8 Bad Loans and Bad Loan Ratios in Transition Economies, End-2000 59 4.9 After-Tax Earnings and Return Measures for State Banks in Transition Economies, End-2000 62 4.10 Capital Increases for Banks in Transition Economies, 1999­2000 63 4.11 Asset Increases for Banks in Transition Economies, 1999­2000 64 5.1 State Ownership of Banks and Net Spreads in Transition Economies, SelectedYears, 1996­2000 68 5.2 Arrears as a Share of GDP in Selected Transition Economies, 1992­2001 69 5.3 Basic Funding Indicators in Transition Economies, 2000 73 Annex 1 Financial Profile of State Banks in Transition Economies, 2000 106 Annex 2 Financial Ratios of State Banks in Transition Economies, 1999­2000 108 Annex 3 Macroeconomic-Financial Ratios of State Banks in Transition Economies, 1999­2000 110 Annex 4 Market Share Ratios of State Banks in Transition Economies, 1999­2000 112 Annex 5 State Banks Included in the Analysis for End-2000 114 Annex 6 Different Types of Arrears as a Share of GDP in Selected Transition Economies, 1992­2001 115 Figures 1.1 Structure of Transition Economies, 1992 8 3.1 Bank Assets as a Share of GDP in Transition Economies, 1995 31 3.2 Loans and Deposits in Transition Economies, 1992-93 and 1995 32 3.3 State and Private Banks' Shares of Credit Exposure in Transition Economies, 1995 33 3.4 Average Assets of State and Private Banks in Transition Economies, 1995 34 3.5 Per Capita Deposits in State and Private Banks in Transition Economies, 1995 35 3.6 State and Private Banks' Shares of Deposits in Transition Economies, 1995 35 3.7 State and Private Banks' Shares of Bank Capital in Transition Economies, 1995 36 4.1 State Banks in Transition Economies, SelectedYears, 1992­2001 45 4.2 Share of Bank Assets Held by State Banks in Transition Economies, 1996­2000 47 4.3 Volume of Assets Held by State Banks in Transition Economies, 1996­2000 47 CONTENTS v 4.4 Loans as a Share of Net Domestic Credit for State and Private Banks in Transition Economies, 2000 49 4.5 State and Private Banks' Shares of Net Domestic Credit Exposure in Transition Economies, End-2000 51 4.6 State and Private Banks' Shares of Assets in Transition Economies, End-2000 53 4.7 State and Private Banks' Shares of Deposits in Transition Economies, End-2000 55 4.8 State and Private Banks' Shares of Capital in Transition Economies, End-2000 57 Boxes 2.1 Profile of Selected Commonwealth of Independent States State Banks after the Breakup of the Monobank System 15 2.2 State Banking in Countries of the Organisation for Economic Co-operation and Development 19 3.1 Latvia's Successful Restructuring and Privatization of Unibanka 40 4.1 Ukraine's Oschadny Bank: Becoming Competitive--or Risking Failure and Crisis? 60 vi CONTENTS Acknowledgments The authors wish to thank Paul Siegelbaum, The authors would like to express their directoroftheWorldBank'sPrivateandFinancial appreciationinparticulartoAlexanderPankov Sector Department for the Europe and Central for leading the major research and data gath- Asiaregion,forhissupportofthisstudythrough- ering effort on the state banks, and Anna out all stages of its development. His important Sukiasyan for working to compile the required guidance has greatly contributed to the final data. Alexander Pankov is also the primary product and conclusions. Luigi Passamonti and author of the most cases on individual state HormozAghdaeyservedaspeerreviewers,con- banks in the annexes. The authors would not tributing greatly as well through their thought- have been able to produce this report without ful feedback. Alexander Fleming, Julian their thorough research, effective output, and Schweitzer, Andrew Vorkink and Daniela tireless effort. Gressanialsoofferedtheirsupportandprovided George Clarke compiled much of the a number of useful comments to the authors. macroeconomic data used and produced the TheauthorsalsowouldlikethankJohannesLinn, data on arrears that have been incorporated vice president of the World Bank's Europe and into the text. The many task managers and Central Asia Region, for his support in putting researchers who assisted with data requests, the important issue of state banking on the clarifications, and opinions also helped regional agenda. immensely with the effort. vii Executive Summary C ontinued state ownership of banking ommendationsforpolicymakersonapproaches systems in transition economies has toendingstateownershipofbanksintheregion. undermined economic reform efforts Thefindingsindicatethatrestructuringofstate and distorted emerging markets. Where coun- banks has proven time consuming and costly, tries have been slow to reform their troubled and governments are better off moving swiftly banking systems, the delay has added greatly to privatize or liquidate their remaining state to the economic costs. These costs have been banks than to attempt to rehabilitate them. evident not only in the Commonwealth of Thestudyalsoincludessevencasestudiesof Independent States (CIS), where the transi- individualstatebanksthathavebeenreformed tiontoamodernbankingsystemhasbeenmost or privatized over the past decade. The case difficult, but also in the countries of Central studies highlight the challenges of imple- and Eastern Europe and the Baltics, where mentingvariousreformmeasuresandillustrate governments have been more willing to pur- howsuchchallengeshavebeenaddressedindif- sue many economic reform measures. ficult economic and political contexts. After more than a decade of financial sec- Inthisstudy, a"state"bankhasbeendefined torreform,however,manycountrieshavefailed as a bank that has a minimum of 25 percent of to solve their problems with lingering state- its shares owned by the government. The defi- owned banks. How should such countries deal nitiondoesnotincludethemany"private"banks with their remaining state banks, especially that have emerged in the region that also have given that most have poor prospects for pri- strong ties to the government. A full analysis of vatization? What are the lessons from the past such private banks is beyond the scope of this decade? And what strategies and approaches study, although the governance and non-com- have proven most effective? mercial management decisions of such banks This study examines the history and evolu- also weaken financial systems in the region. tion of state banks in the transition economies ofEuropeandCentralAsia.Chapters1­4review Main Findings and Lessons the experience with state banking over the last decade, explore the roles that state banks have Continued State Ownership of the Banking played since the early stages of transition, and Sector Has Big Economic Costs examinetheproblemsthatexisttoday.Chapter 5 compares various approaches to reform and Many of the distortions in poorly performing calls attention to the significant costs associ- economies do not originate in the banking sec- atedwithcontinuedstateownership.Thestudy tor. But where state banks still control a large concludeswithlessonsfromexperienceandrec- share of the resources in the banking system, 1 they continue to pose a risk to macroeconomic banks, the delays have ultimately led to higher and fiscal stability. State banks are typically recapitalization costs and weakened the finan- vehicles for patronage that worsen the cial sector overall. While there have been cases prospectsforcompetitivemarketdevelopment. when continued state ownership of the bank- Alternatively, these state banks can be inef- ing sector has helped to maintain stability in a fectiveshellsthatfailtoperformausefulinter- country's financial sector (such as in Latvia), mediation role once the government imposes postponing reforms with interim measures or effective hard budget constraints and a mod- restructurings fails to resolve core issues and ern supervisory system. shouldbedoneonlyforalimitedperiod.Delayed The presence of state banks has deterred reformshavealsoresultedinsignificantmacro- prime-ratedforeigninvestmentfromthebank- economiccosts--highinflation,highrealinter- ingmarket,andthepotentialdistortionsresult- est rates, fiscal deficits, exchange rate ing from patronage or preferential treatment depreciation, and balance of payments pres- of state banks have deterred these and other sures stemming from higher debt service banks from taking on more risk. Consequently, requirementsandlowerinternationalreserves. incountrieswherestatebankscontinuetoplay Thetroubledbankshavealsogeneratedadeep aprominentrole,lendinghastendedtobescarce lossoffaithinpublicinstitutions,whichhashad andcostlyformanyenterprises,puttingabrake ramifications throughout the banking sector oneconomicgrowth.Wherebanksarestillused andcivilsociety--throughlowerdeposits,lower fornoncommercialpurposes--suchasdirected intermediationrates,andtaxevasion.Forthese lending to enterprises--these practices have reasons, delayed reforms have been correlated more often than not led to a severe financial with sluggish economic performance. crisis in the banking system, high levels of cor- Many transition economies have adopted ruption, and big costs for the government. laws designed to move toward modern bank- Themostproblematicstatebankshavebeen ingsystems.Butevenwherelawsareadequate, agricultural and industrial banks, whose orig- theinstitutionalcapacity--judicial,regulatory, inal role was to finance state farms and indus- and supervisory--needed to effectively carry trial enterprises that employed large numbers outthelawshasbeenslowtoemerge.Andmany of people and served as the backbone of the countries have not yet adequately addressed socialist economic model. Because these banks poor financial discipline, loan defaults, weak focused on lending to what eventually became legal support for secured transactions, lack of loss-making farms and enterprises, they veracity in financial information, and other became the most deeply insolvent. In addition, problemsthatfurtherunderminemarket-based because of their perceived importance, they banking.Asaresultmanybankingsystemscon- have often been considered "too big to fail." tinue to perform poorly. Efforts to shore them up as going concerns have generally required repeated recapital- Banking Systems Have Shown Diverging izations and involved regulatory forbearance Performance Across Regions that has distorted markets and prevented the emergence of more efficient banking systems. Whilealltransitioneconomieshavefacedcom- mon problems in their banking sectors during Delaying Banking Sector Reform Only Adds to the transition, in the CIS countries the tran- the Costs sitiontosound,stablebankingsystemshasbeen far more difficult. There are several reasons In transition economies that have been slow to forthisdifference.Whilehyperinflationwiped takecorrectiveactiontodealwithtroubledstate out asset values in the CIS, inflation was less 2 EXECUTIVE SUMMARY devastatinginCentralandEasternEuropeand Liquidation is an important means for con- somewhatlesssointheBalticstates.InCentral solidating banking systems and creating open, and Eastern Europe governments were more competitivemarkets.Withoutsuchmarketcon- willingtopursuebroadrestructuringprograms ditions, banks will not assume risk, and inter- before privatization, resulting in healthier mediation will remain limited and distorted. banks. CIS countries sometimes set up paral- lel structures for commodity resources con- Governments Should Include Measures to sidered strategic and essential for foreign Mitigate the Social Costs of Privatization exchange earnings. As monetary systems imploded, CIS countries shifted increasingly A main deterrent to privatization is the fact toasystemofarrears,barter,andnetting,often that many state banks serve as very large bypassing the banking sector. employers. Governments resist privatization Thusbythemid-1990stheCIScountrieshad and liquidation often because it means that muchoftheireconomicandassetvaluesinnon- thousands of individuals will lose their jobs. bank institutions, while countries in Central Sberbank, the Russian state savings bank, for and Eastern Europe and the Baltics focused on example has more than 200,000 employees buildingastablebankingsystem.Inthesecoun- working throughout the country in 21,000 tries the practice of directed lending through branches. statebanksslowlyunraveledasmacroeconomic As a result of such social pressures, suc- pressures called for hard budget constraints, cessful financial sector strategies must include solvencyandliquiditystandardsweretightened, specific measures to mitigate social costs of effective new private and foreign banks privatizing state banks. In rare cases, it may emerged,and,forsomecountries,negotiations be necessary to keep certain state owned began for entry into the European Union. banks open for a limited period to avoid a Banksnowshowstrongergrowthindeposits crisis. This may require short term technical and capital in many countries in Central and assistance or strict controls on lending to Eastern Europe and the Baltics, suggesting impose limit on spending and prevent addi- that these countries have put into place struc- tional losses. Privatizations of state banks-- tures that have helped to restore confidence as with privatization of any state-owned inbankingsystemsamongcreditors,investors, enterprise--that will result in large disloca- and the public. By contrast, deposit mobiliza- tions of labor should also be accompanied by tion has been more limited in the CIS coun- social protection programs to retrain staff tries, and banks have undergone significant and help employees find new jobs. decapitalization since 1995. Recommended Strategies Most Remaining State Banks Should Be Treated as Resolution Cases Governments need to design strategies to reduce state banking in order to help create Withfewexceptions,theremainingstatebanks a stable banking environment. Governments carry large burdens of nonperforming loans privatizing their banking system have a few and have a big share of their assets invested broad options: in government securities, raising questions · Restructuring: In general restructuring has about their future earning prospects and sol- proven to be a difficult and costly exer- vency. For these troubled banks, liquidation cise. Experience has shown that govern- should generally be the solution, not restruc- ments are often much better off moving turing or recapitalization. swiftly to liquidate their state banks. Where EXECUTIVE SUMMARY 3 there is potential for privatizing a bank savingsoragriculturalbanks,becausethere through sale to strategic investors, how- havebeenfewalternativesforpeopleinrural ever, restructuring is probably warranted. areas and because these banks have served Whether restructuring should precede or many older people uncomfortable with the follow privatization needs to be decided prospect of change. While these are under- case by case, taking into account economic standable reasons for deferring closure, in and market conditions. realitycontinuedsupportofthesebanksdis- · Consolidation: Consolidating banks before torts the market, reduces competition, and privatization may help reduce the transac- limits development of viable private bank tioncostsofnegotiatingprivatizationtrans- and non-bank financial institutions. actions, but it has often turned out to be · Ensuring Access to Services for Poor or complex and costly, and the results subop- Target Groups: Governments often keep timal. Relying on market mechanisms to state banks alive because of both perceived consolidatebankingsystemsisusuallyabet- and real benefits to poor, rural or target ter choice. Most of the remaining state populations. In certain countries with banks could probably be consolidated more poorly developed financial systems, state efficiently by simply offering them for sale banks are sole providers of financial ser- to banks--domestic and foreign. vices to remote or rural areas or pension- · Purchase and Assumption: Given poor pri- ers. In addition, many people in both rural vatization prospects, a purchase and and urban areas rely almost exclusively assumption exercise is probably the fastest on state banks for delivery of their welfare way to modernize the banking system. This benefits, to pay for utility bills, and to make approach,inwhichunwantedpartsofabank other transfers. They also perceive state- being privatized are spun off to another ownership as offering an implicit guaran- bank that might be able to give them some tee of their savings. As a result, many value, allows the market to determine what governments bail out failing banks because is salvageable. It thus sends a signal that they fear leaving large or disadvantaged markets are open and transparent and that groups without access to services. the state is getting out of activities better In such cases, where the state bank in left to the private sector. fact is the sole provider of financial services · RegulatoryApproach:Wheremarketmech- tocertaingroups(suchasinRussia,Ukraine, anisms are not sufficient to consolidate the orAlbania),governmentsmaydecidetokeep banking system, the regulatory approach is thebankaliveforagivenperiod.Duringthis an option. A separate administration could time, however, they can take measures to work with specialists to establish a consol- limit damages and prevent further losses idation plan for banks that focuses on a such as narrowing the licenses of the bank strategic economic or financial objective so it cannot continue to lend and does not andincludesindicatorstomeasureprogress worsen its loan portfolio. Government poli- toward that objective. ciesshouldalsoencouragecommercialbanks · Liquidation: For a bank with no potential and non-bank financial institutions to for commercial viability, liquidation should expand services to rural areas and provide occur promptly. Branches can be spun off to incentives to serve other hard to reach other interested parties, including nonbank groups. Microfinance institutions and leas- financial institutions such as credit unions ingcompaniesmayinfactofferservicesbet- andmicrofinancegroups.Manygovernments tertailoredtothepoor,smallentrepreneurs, have resisted liquidation, particularly for and rural populations in the long run. In 4 EXECUTIVE SUMMARY pursuing such a strategy, however, the gov- ernment should have strict criteria to iden- tify what banks should be kept open, for example, by share of the market, or out- reach to certain areas to be sure that it is not subsidizing services that could be alter- natively be provided by the private sector at a lower cost to the financial system. · Improving the Business Environment: Governments should take measures to improve the business environment as part of a broad overall strategy to strengthen the financial system and end state ownership of banks. Such measures include providing support to improve corporate governance, reform judicial systems, build registries of collateral, reinforce creditors' rights and contract enforcement, modernize account- ing and auditing practices, reduce admin- istrative obstacles to business registration, and modernize bankruptcy laws. EXECUTIVE SUMMARY 5 Chapter 1 The Early Stages of Transition A t the beginning of the 1990s, the tran- 39percent(theshareinRussia),andtheyaver- sition economies of the region aged about 35 percent. The service sector embarked on a remarkable transfor- showed low levels of development in the Baltic mation.Thefinancialsystems--whichprovided states, particularly Latvia and Lithuania. the backbone of the socialist economies-- Agriculture played only a limited role. required massive structural change to meet Indeed, Central and Eastern Europe showed the needs of the emerging market economies. extraordinarilylowagriculturaloutput,atonly 8 percent of GDP. This figure may understate Economic Structure ofTransition output, however, as many people in the region Economies in the Early 1990s rely on subsistence farming as part of their safety net. Moreover, because private farm- Whenthetransitionbegan,theformerlysocial- ing was permitted in several countries of ist economies were generally oriented toward Central and Eastern Europe, much of the out- industry (figure 1.1). In 1992 the industrial put is presumed to have gone unrecorded.2 sector produced 47 percent of total output. Only Albania recorded agricultural output Services accounted for about 38 percent, most amounting to more than half its GDP. In many of it related to government. Agriculture pro- CIS countries this share was about a third. duced only about 15 percent of recorded out- With this kind of economic structure, most put, although this figure does not capture banking was geared to financing industry. subsistence farming. By contrast, in OECD Foreign trade banks attempted to sustain tra- countries in 1992, services accounted for 66 ditional trade links integral to central plan- percent of output, industry for 23 percent, and ning, but these generally imploded when the agriculture for only 5 percent.1 Soviet Union collapsed. When trade opened, The structure of transition economies var- these banks financed the export of goods for ied little. A few countries, mainly in Central hard currency. This kind of export financing and Eastern Europe, had prominent service had already been taking place in such coun- sectors. For example, Hungary, FYR tries as Hungary, Romania, and Yugoslavia, Macedonia, and Slovenia all had service sec- which had opened their trade regimes well tors that accounted for more than half of GDP, beforethecollapseoftheSovietUnion.Insome suggesting that beyond direct government cases these functions focused on agriculture, administration there were enterprises active agro-processing, or commodities (for exam- in transport, distribution, tourism, and related ple, oil in Azerbaijan and Kazakhstan, natural activities. But in the CIS and Baltic states gas in Turkmenistan, and cotton in Tajikistan services(includinggovernment)didnotexceed and Uzbekistan). 7 FIGURE 1.1 Structure ofTransition Economies, 1992 and no country had year-end inflation (as mea- sured by the consumer price index, or CPI) Percent exceeding 33 percent. 8.8 Agriculture The weakness was more on the fiscal side. Loss-making enterprises continued to receive 44.3 financing--from the banks (usually state 46.9 Services Industry owned), the budget, or off-budgetary accounts 16.7 21.1 or through arrears to state companies and Agriculture Agriculture Central and energy suppliers. While lower than in earlier Eastern 26.7 36.5 Europe years, fiscal deficits averaged about 3.3 per- Services Services cent of GDP (on an unweighted basis) in 1995. 47.3 52.2 Industry Industry Consolidated deficits were respectable by 1995, but they understated the softness of Commonwealth of Baltic Independent States states budget constraints on the state sector due to the buildup of arrears. Moreover, lending Note: GDP data for FYR Macedonia and Turkmenistan are based on per capita income times population. to the state sector still accounted for stocks Source: World Bank (1994b); EBRD, Transition Report 2000 and Transition Report 2001. and flows of bank lending.4 Continued state ownership in the banking sector, particularly in "large" banks with large exposures and Monetary and FiscalTrends in long-standing ties to state enterprises and 1989­95 farms, made the continued lending to the state sector possible.5 State banks' asset During the early period of transition, the mon- shares were declining in CEE countries in etary and fiscal trends varied widely across the the early to mid-1990s, yet were still high. region. Overall, the countries of Central and In 1995 state banks accounted for more than Eastern Europe did not suffer from the very half of all banking system assets in most of high inflation experienced in the Baltics or the these countries, even where their shares were hyperinflation experienced in the CIS, and as reported to be less. a result, pursued largely different monetary and fiscal policies. The Baltic States Central and Eastern Europe The Baltic states had higher inflation rates than the CEE countries, most of which kept Following the initial shocks in the early 1990s inflation below about 340 percent. Year-end most Central and Eastern European (CEE) CPI rates in the three Baltic states peaked at countries tightened monetary policy if they about 1,000 percent in the early 1990s, per- had not already done so and, by extension, haps because they faced greater monetary the regulations limiting risk-seeking behavior challenges (table 1.2). The Baltic states in the banking system. These countries had showed a high level of discipline, however, shown earlier signs of monetary discipline and bringing their (unweighted) average inflation central bank independence, resulting in rate in 1995 to about 29 percent--a small frac- greater stability by the mid-1990s. Inflation tion of earlier peak levels.6 Meanwhile, mon- rates averaged 15 percent (on an unweighted etary discipline was reinforced by fiscal basis) in 1995, far lower than peak rates just discipline as all three countries kept spend- a few years before, in 1990­94 (table 1.1).3 ing within reasonable bounds, even during the Six of 10 countries had single-digit inflation, period of hyperinflation. 8 CHAPTER 1 TABLE 1.1 Selected Fiscal and Monetary Indicators in Central and Eastern European Countries, 1990­95 (percent) Fiscal deficit as a State bank assets as a Inflation rate share of GDP share of total Country 1990­94 1995 1990­94 1995 1992 1995 Albania 237.0 6.0 ­31.0 ­10.3 97.8 94.5 Bulgaria 338.9 32.9 ­10.9 ­6.4 82.2 82.2 Croatia 1,149.0 3.8 ­3.9 ­0.9 58.9 51.9 Czech Republic 52.0 7.9 ­3.1 ­1.8 20.6 17.6 Hungary 32.2 28.3 ­8.9 ­6.2 81.2 52.0 Macedonia, FYR 1,935.0 9.0 ­13.8 ­1.2 -- -- Poland 249.3 21.6 ­6.7 ­2.8 86.2 71.7 Romania 295.5 27.8 ­4.6 ­2.6 80.4 84.3 Slovak Republic 58.3 7.2 ­7.0 0.2 70.7 61.2 Slovenia 247.1 9.0 ­0.3 ­0.5 47.8 41.7 Unweighted average 459.4 15.4 ­9.0 ­3.3 62.6 58.9 -- Not available. Note: Data for inflation rates (year-end CPI) and fiscal deficits (general government balance) refer to the peak in 1990­94. State bank shares of assets are the earliest reported if not available for 1992 or 1995.The small state share of bank assets in the Czech Republic reflects the exclusion from the data of two large banks (Ceska Sporitelna and Komercni) with major ownership by the National Property Fund. Source: EBRD. TABLE 1.2 Selected Fiscal and Monetary Indicators in the Baltic States, 1990­95 (percent) Fiscal deficit as a State bank assets as a Inflation rate share of GDP share of total Country 1990­94 1995 1990­94 1995 1992 1995 Estonia 953.5 29.0 ­0.7 ­1.3 28.1 9.7 Latvia 959.0 23.1 ­4.0 ­3.9 7.2 9.9 Lithuania 1,161.0 35.5 ­5.5 ­4.5 53.6 61.8 Unweighted average 1,024.5 29.2 ­3.4 ­3.2 29.6 27.1 Note: Data for inflation rates (year-end CPI) and fiscal deficits (general government balance) refer to the peak in 1990­94. State bank shares of assets are the earliest reported after 1992 or 1995 if not available for those years. Source: EBRD. Thecombinationofmonetaryandfiscaldis- banking supervision, an approach consistently cipline imposed hard budget constraints on reinforced by the central bank since 1995. thestateenterprisesector,andby1995Estonia and Latvia showed small state shares of bank The Commonwealth of Independent States assets. Estonia reduced the state asset share fairly systematically, liquidating loss-making Meanwhile, the CIS countries faced the enor- banks that had been branches of the Gosbank mous challenges of hyperinflation and a weak system.OnlyLithuaniatookseveralmoreyears fiscal base. By all measures the CIS countries to reduce the state share of bank assets. Still, had failed to achieve the macroeconomic sta- "private" ownership alone was not sufficient bility needed to accommodate structural for sound performance. In Latvia, where the reform. That triggered a downward spiral state share of bank assets was low before 1995, greater than those in most CEE and Baltic the largest bank collapsed in 1995 while tech- countries, with a larger drop in output.8 As a nically a private bank.7 This prompted a more result the CIS countries have found it much disciplined approach to financial services and moredifficulttorecoverfromcentralplanning. THE EARLY STAGES OF TRANSITION 9 TABLE 1.3 Selected Fiscal and Monetary Indicators in the Commonwealth of Independent States, 1990­95 (percent) Fiscal deficit as a State bank assets as a Inflation rate share of GDP share of total Country 1990­94 1995 1990­94 1995 1992 1995 Armenia 10,896.0 32.0 ­54.7 ­11.0 1.9 2.4 Azerbaijan 1,788.0 84.5 ­15.3 ­4.9 88.7 80.5 Belarus 1,996.0 244.0 ­2.5 ­1.9 69.2 62.3 Georgia 7,488.0 57.4 ­26.2 ­4.5 98.4 45.9 Kazakhstan 2,984.0 60.0 ­7.9 ­2.7 19.3 24.3 Kyrgyz Republic 1,363.0 31.9 ­17.4 ­17.3 100.0 69.7 Moldova 2,198.0 23.8 ­26.2 ­5.7 0.0 0.3 Russian Federation 2,506.0 128.6 ­42.6 ­5.9 -- 37.0 Tajikistan 7,344.0 2,133.0 ­30.5 ­11.9 -- 5.3 Turkmenistan 9,750.0 1,262.0 ­1.4 ­1.6 26.1 26.1 Ukraine 10,155.0 181.0 ­25.4 ­4.9 -- 13.5 Uzbekistan 1,281.0 117.0 ­18.4 ­4.1 46.7 38.4 Unweighted average 4,979.1 362.9 ­22.4 ­6.4 37.5 33.8 -- Not available. Note: Data for inflation rates (year-end CPI) and fiscal deficits (general government balance) refer to the peak in 1990­94. State bank shares of assets are the earliest reported after 1992 or 1995 if not available for those years. Earliest data available for Russia,Tajikistan, and Ukraine are for 1996. Source: EBRD. Thisdifficultywasevidencedfirstbytheextra- national treasury accounts. All this made for ordinarily high inflation, with peak rates aver- a very unstable environment for normal bank- aging nearly 5,000 percent (table 1.3). This ing operations. high inflation led to the introduction of new Against this backdrop CIS countries often currencies in CIS countries, including eventu- imposed hard budget constraints--in some allyinRussia,whichintroducedanewrubleon cases more by circumstance than by choice-- January 1, 1998. Even by 1995 the CIS coun- on the state sector. But CIS countries were tries still faced significantly higher inflation also caught in the difficult situation of seek- than the CEE and Baltic countries, with sev- ing to maintain or revive production to pre- eral remaining at hyperinflationary levels. serve jobs and reactivate the fiscal base. In a Moldova was the only CIS country whose infla- tight money regime this led to budgetary sub- tionratewaslessthantheaverageforthethree sidies and transfers, concessionary rollovers Baltic states that year. Among CEE countries, from the banking system, and arrears to enter- only Bulgaria, Hungary, and Romania had prises, social funds, workers, and fiscal author- higher rates that year than Moldova. ities (see annex 6). Interestingly, the CIS At the same time CIS fiscal deficits were countries showed a state bank share of assets about twice those of the CEE and Baltic states, about half that registered in the CEE coun- averaging more than 6 percent of GDP. The tries. This indicates that "private" banks in large deficits related in part to the collapse of the CIS were largely used as financing vehi- the industrial sector, as enterprise sales had cles for their enterprise owners and other generated much of the earlier fiscal revenue related parties rather than as channels of flow in the form of turnover taxes.9 With sales financial discipline. These "privatized" prac- now plummeting and often unrecorded (to tices reflect weaknesses in the banking sec- avoid tax payments), government revenues tor framework and incentive structure in the declined. Corruption also played a part, with CIS countries and inherent flaws in owner- taxes being paid but not making their way into ship transformation. 10 CHAPTER 1 Notes 1. In OECD countries financial services 5. The classification "large" is based on nomi- accounted for 19 percent of GDP. While reliable fig- nal balance sheet values, not discounted for risk uresarenotavailableforthe27transitioneconomies and quality. In reality, virtually all "large" banks at the time, the share of financial services in GDP would have been much smaller had they written was considered to be much lower. down their assets and capital to reflect interna- 2. Bulgaria, Poland, and the former Yugoslavia tionally accepted standards for accounting and val- permitted small-scale private farming during the uation. These banks eventually faced up to this socialist era. reality in the second half of the 1990s. But bank- 3. EBRDdatashowameaninflationratein1995 ing systems in the CIS and in several CEE coun- of 20.5 percent for Central and Eastern Europe and tries are still dealing with these issues. the Baltics, 39.4 percent for southeastern Europe, 6. Similarly, in the CEE countries the 1995 and 350 percent for the CIS countries. unweighted average inflation rate was 3.4 percent 4. Quantifying bank lending to the state sector of the unweighted peak average rates in 1990­94. withprecisionisdifficultbecauseoftheprominence 7. See Fleming and Talley (1996). of large industrial enterprises that were partly pri- 8. On average, CIS countries now operate at vatized or classified as "private" even though the about 60 percent of pretransition levels, compared "strategic investor" might have been the National with the Baltic states at 70 percent and the CEE Property Fund. In most CEE and Baltic countries countries at around 90 percent. See Fischer and (except Estonia), however, state enterprises often Sahay (2000). benefited from less than hard budget constraints. 9. See Barbone and Marchetti (1994). THE EARLY STAGES OF TRANSITION 11 Chapter 2 State Banks Early in the Transition B anking system reform in postsocialist insufficient, however. Moreover, supervisory Central and Eastern Europe and the capacity was undermined by poor accounting former Soviet Union has shown com- and financial information in the banks, weak mon patterns yet produced broadly divergent off-site surveillance capacity, and lack of expe- results. Most transition economies introduced rience with on-site examinations. two-tier systems around 1989 as communism After an initial period of experimentation and its monobank system collapsed. This with low minimum capital requirements and change placed monetary policy and its imple- a push to liberalize the licensing process for mentation in the hands of the central bank new banks, most transition economies expe- and established the basis for normal banking rienced severe instability in their banking sec- functions by a second tier of commercial and tors. These problems were part of the larger other banks. Before 1989 these functions had structuralproblemsinpostsocialisteconomies, all been part of one monobank system in most reflecting macroeconomic disorder (hyperin- socialist economies. Thus merely configuring flation, exchange rate instability), the break- the institutions of financial intermediation down of traditional trade patterns and represented a challenge to transition econo- distribution channels, and the severe decline mies. It involved defining new roles and in the purchasing power of enterprises and responsibilitiesforthenewsystemandconcept- individuals. Liquidity shortages triggered a ualizing how intermediation could occur at a dramatic increase in interenterprise, tax, and time that traditional production, trade, and other arrears while debt service payments to investment were in a state of dislocation and banksdeclined.Arrearsalsobecamemoregen- even collapse. eralized, particularly in the CIS countries, Aspartofthereconfiguration,centralbanks where power companies, fiscal accounts, wage were generally entrusted with banking super- earners, and pension, health, unemployment vision because of their monetary policy role. compensation, and other social funds effec- As laws were introduced for both the new cen- tively became net creditors to the economy. tral bank and the second-tier banks, funda- Despite some preliminary efforts to have mental prudential norms and initial measures banks operate on a commercial basis, govern- to establish supervisory oversight of the banks ment officials in most transition economies werealsointroduced.Theseinitiallydealtwith couldnotresistusingatleastsomeofthebanks ownership, capital, lending exposures, report- as vehicles for directed lending. Banks oper- ing requirements, and other common compo- ating "privately" often did so on behalf of their nents of banking legislation and regulation. connectedshareholdersratherthanonthebasis The prudential requirements proved to be of normal commercial banking principles. 13 Meanwhile, state-owned banks continued to hadnoopportunitytoexerciseindependentjudg- serve as the primary banking vehicle for ment.Instead,theymerelyallocatedinvestment directedlendingandquasi-fiscalfinancing,usu- funds to state-owned enterprises in their sector ally for loss-making state-owned enterprises according to central planners' instructions. and collective farms. These experiments signaled the failure of Some countries were seeing the slow emer- the traditional system to meet the broad bank- genceofprivatebanksandprivatesectordevel- ing needs of the economy. But as a result of the opment, including in Central and Eastern continuedstatecontrolinmostcases,theexper- Europe (in the Czech Republic and Hungary iments led to little real change in the way the inparticular),wherehighlevelsofdirectinvest- socialist economies operated. Moreover, ment and remittance flows were catalyzing Bulgariawasmoretheexceptionthantherule. modernizationandprivatization.Nonetheless, Even as the earlier system failed to meet any- most intermediation occurred through state thing more than rudimentary banking needs, channels.Asaresulttheloanportfoliosofthese other countries made little effort to push for banks deteriorated rapidly and for the most reformsuntilafterthesocialistsystemcollapsed. part irretrievably. Apart from Yugoslavia, which established a two-tier system in 1971, Hungary was the Early Structural Changes in the only other real exception to the rigid socialist Banking Sector model.Hungaryintroducedamarket-oriented two-tier banking system in early 1987. The Virtually all the centrally planned economies National Bank carried out monetary policy, hadmonobanksystems,thoughafewhadcom- while independent commercial banks operat- mercial banks that functioned more indepen- ing in a competitive market undertook credit dently. In addition to the central bank, most activities. Poland followed Hungary's lead in had a small number of specialized state banks January 1989, and Bulgaria, Czechoslovakia, suchassavings,foreigntrade,industrialinvest- and Romania did so in January 1990. ment, and agricultural banks. While this sys- These exceptions notwithstanding, cen- tem might seem to resemble the two-tier trally planned economies generally relied on system established later, these banks func- the Gosbank system, with departments that tioned more like departments of a single bank specialized in meeting the financing needs of than as independent commercial banks. different sectors. This functional specializa- Lateinthesocialistperiod(mid-1980s)some tion helps explains why the initial two-tier governments began timid attempts to decen- banking system was still characterized by sec- tralize the banking sector by establishing new, tor concentration (agriculture, industry, specialized commercial banks. For example, in export-import, housing, savings) in state 1987thegovernmentofBulgariamovedtoestab- banks in 1992. In some countries, such as lish seven such banks (in addition to the four Croatia, Estonia, FYR Macedonia, Poland, existing state banks), each serving a particular and what is today the Slovak Republic, some industrial sector. The new banks provided cur- of the state banks were small and commer- rentaccountfacilities,accepteddeposits,made cially diversified yet still geographically con- loans in both local and foreign currencies, and centrated, just as Gosbank branches were.1 provided"venturecapital"forfirmsintheirsec- Often these banks were owned by state enter- tor. But decentralization went only so far. None prises. In other countries the banks were spe- of the new banks had branches, and they dealt cialized by economic subsector.2 In general, with their customers through the local offices the large state banks created from the oftheNationalBank.Moreimportant,thebanks monobank system represented the core of the 14 CHAPTER 2 BOX 2.1 Profile of Selected Commonwealth of Independent States State Banks after the Breakup of the Monobank System Armenia Armenia inherited all five state-owned banks that had operated on its territory before the breakup of the former Soviet Union (FSU) in 1991. These were the specialized Bank for Industry and Construction (Ardshinbank), which separated in 1991 from its FSU counterpart Promstroybank; the specialized Agrobank, which also separated from its FSU counterpart in 1991; the Export-Import Bank of Armenia (Armimpex Bank), reorganized on the basis of the former Vnesheconombank, which carried out all foreign exchange transactions in Armenia; Econombank, which did not specialize in any industry; and the State Savings Bank (Sberbank Armenian Savings Bank, or Sberbank ASB), which separated from its FSU counterpart (Sberbank) at the end of 1991, when it accounted for most household deposits in the system.All except Sberbank ASB were incorporated as joint stock companies in 1992, although the majority of shares remained in the hands of the state or were sold to state-owned enterprises.These five banks remained the largest in the country from 1993 through 1996, despite the entry of many commercial banks. In 1993 the state banks accounted for more than 70 percent of the banking system's balance sheet measures. But the banks were weak and unprofitable, a legacy of the directed credit policy.As a result of large loans extended to state-owned enter- prises under government pressure, most of their assets were nonperforming. A major restructuring of the former state banks was initiated in 1996. Latvia Following the breakup of the Soviet Union Latvia found itself in much the same position as the other FSU countries. It inherited branches of the specialized Soviet banks: the Savings Bank (Latvijas Krajbanka), Agricultural Bank, Industry and Construction Bank, Housing and Social Development Bank, and Foreign Trade Bank. In addition to inheriting large portfolios of nonperforming loans and management unused to lending along commercial lines, these branches were suddenly cut off from their former head offices. Moreover, the authorities in Moscow were unwilling to pass on the assets needed to cover a substantial portion of their liabilities. While most other newly independent countries converted the branches they inherited into nationally owned specialized banks corresponding to the old Soviet banks, the Latvian gov- ernment placed all the branches of the specialized banks (except those of the Savings Bank) under the direct supervision of the Bank of Latvia (the central bank).These branches dominated the credit business, since the Savings Bank initially did not make loans to private or public enterprises. As a result, at the end of 1991 the 45 branches controlled 83 percent of all credit to business and held three-quarters of enter- prises' demand deposits. Russian Federation In 1991 the Russian government broke up the two-tier system, consisting of the Gosbank (the central bank) and five specialized banks, that had existed in the Soviet Union since 1987.This reform led to the creation of some 800 new banks, which took the capital of the former state banks. In 1992­95 the num- ber of banks grew enormously, with nearly 2,500 banks operating in Russia by 1994. Still, the system was characterized by significant concentration.The largest 10 banks accounted for 50 percent of assets in 1995. Most of these banks were spin-offs of former Soviet specialized banks, or new commercial banks created with limited capital.Thus the nearly 2,500 commercial banks had only a limited impact on the real econ- omy through lending to enterprises. Many were speculating heavily in hard currency and then diversifying their asset holdings into treasury bills and equity stakes in blue chip enterprises.These practices proved unsustainable, and the number of banks declined sharply. By 2000 Russia had 1,311 banks, about half the peak in 1994. (Box continues on next page.) STATE BANKS EARLY IN THE TRANSITION 15 BOX 2.1 Profile of Selected Commonwealth of Independent States State Banks after the Breakup of the Monobank System (continued) Ukraine Early in the transition Ukraine's banking system consisted of four state-owned specialized banks that were spun off from the corresponding Soviet banks as Ukraine gained its independence in 1991.The state banks special- ized in agriculture (Ukraina), industrial lending (Prominvestbank), social programs (Ukrsotsbank), and house- hold savings (Oschadny Bank). A fifth state bank, Ukreximbank, was formed in 1992 to process Ukraine's foreign trade payments.All the specialized banks except Oschadny and Ukreximbank were corporatized (and thus nominally privatized) in 1992.This occurred primarily through ownership transformation, with a number of large state-owned enterprises taking substantial ownership shares in the banks serving their sector. During the ensuing years the ownership structure of these corporatized banks became more complicated as a result of a 1993 government order requiring the transfer of all state enterprise shares in the banks to the Ministry of Finance.This order prompted the banks to devise a method of transferring ownership through the distrib- ution of shares to the employees of client enterprises and of the banks themselves.Ownership became diluted among tens of thousands of shareholders, most of them individuals. But most major policy and personnel deci- sions were still made by top managers of the state enterprises that had been majority shareholders before the share redistribution.Thus the state continued to exercise a great deal of influence in the banks' affairs. Source: See case studies and bibilography for references. new banking system, which remained state mately triggered many banking crises and sub- owned and highly concentrated in nearly all sequent failures. Nonetheless, estimates based transition economies (box 2.1). on existing data and converted to U.S. dollar With the onset of transition, the number of exchange rates put the total asset value of banks increased quickly. By the early 1990s, these banks at about 16 percent of GDP by shortlyaftertherapidmovetoownershiptrans- the mid-1990s, most of it in Central and formation and private entry, the 27 formerly Eastern Europe.4 This translates into an aver- socialisteconomiesofEuropeandCentralAsia age asset value for state banks of about $654 had roughly 2,350 banks. Of these, only 200 million.5 The real average could be much wereconsideredtobemajorstatebanks.3Russia smaller, however, if the denominator included alone had 1,306 banks in 1991, 2,456 banks in the many small banks over which state or local 1994,and2,297banksin1995.Earlyinthetran- governments continued to exercise influence sitionperiodtheCISaccountedfor1,841ofthe and control. The real average would also have 2,350 banks in transition economies, and by shrunk if international accounting standards 1995, for 3,171 of the 3,783 banks. Thus the had been applied, which would have adjusted CIS countries consistently had about 80 per- balance sheets (and earnings) for nonper- cent of the licensed banks in transition forming loans, overvalued fixed assets and economies through the mid-1990s. secured loans, asset revaluation from hyper- By the mid-1990s, shortly after the mono- inflation, and related practices that made the bank system was dismantled, state banks banks' financial position look better than it accounted for a nominal $131 billion in assets. actually was. The real market value figure is virtually impos- Mosttransitioneconomieshadatleastthree sible to estimate because of inaccurate specialized state banks, and by 1992 the aver- accounting methods, overvalued properties age for the 27 countries was about seven major and loan portfolios, inadequate provisions and state banks.6 As noted, in some countries state reserves, and the general market risk that ulti- banks did not specialize by sector but instead 16 CHAPTER 2 TABLE 2.1 Profile of State Banks inTransition Economies, 1992 Foreign trade/ Country Industrial Agricultural Savings EXIM Other Albania Armenia Azerbaijan Belarus Bosnia and Herzegovina Bulgaria Croatia Czech Republic Estonia Georgia Hungary Kazakhstan Kyrgyz Republic Latvia Lithuania Macedonia, FYR Moldova Poland Romania Russian Federation Slovak Republic Slovenia Tajikistan Turkmenistan Ukraine Uzbekistan Yugoslavia Source: BankScope; EBRD;World Bank; IMF; and a number of other sources as listed in the bibliography. focused on local markets. But the vast major- economies, but around the world. Although ityoftransitioneconomieshadstatebanksthat state banking played a particularly important specialized by function, with some crossover role in many economies of Europe and Central in some cases (table 2.1).7 Asia, many industrialized economies such as The countries with noteworthy state banks Germany, France and the United States also were Yugoslavia, Poland, the Czech Republic, have supported and continue to support state Hungary, and Bulgaria. Yugoslavia had 8 of the banks as well. 24 largest banks8 in the transition economies, accounting for $50 billion in assets in 1991 State Banks in Industrialized Countries (table 2.2). Poland had 7 large banks, although they recorded only about $27 billion in assets, While many proponents of state owned-banks half as much as the major Yugoslav banks. in developing countries point to relatively suc- Hungary had 4 banks with $16 billion in assets. cessful examples of state-owned banks in Czech Republic and Bulgaria accounted for OECD countries, studies have shown that the the balance. economic costs of public ownership of banks have been high and the benefits less than Traditional Roles of State Banks expected.Inparticular,arecentanalysispoints togreaternegativeeffectsofstatebanksinlow- Government ownership of banks is a perva- income countries where there is less financial sive phenomenon not just in transition sectordevelopmentandweakerpropertyrights STATE BANKS EARLY IN THE TRANSITION 17 TABLE 2.2 Assets and Global Asset Ranking of Large State Banks Early in theTransition Assets Bank Country (millions of U.S. dollars) Global ranking Beogradska Banka Yugoslavia (Serbia) 15,983 287 Bulgarian Foreign Trade Bank Bulgaria 14,151 312 Sberbank Russian Federation 13,000a -- Ljubljanska Banka Yugoslavia (Slovenia) 9,121 425 Komercni Czech Republic 9,085 426 OTP Hungary 8,575 448 Jugobanka DD Beograd Yugoslavia (Serbia) 7,542 475 PKO BPb Poland 6,923 -- Bank Handlowy & Warszawie Poland 6,756 497 PKO SA Poland 5,722 548 Privredna Banka Sarajevo Yugoslavia (Bosnia and Herzegovina) 5,307 580 Vseobecna Uverova Banka Czech Republic 4,839 606 Privredna Banka Zagreb Yugoslavia (Croatia) 4,295 636 Zagrebacka Banka Yugoslavia (Croatia) 3,852 683 Bank Gospordarki Zywnosciowej (food industry) Poland 3,150 757 K&H (Commercial & Credit) Bank Hungary 2,923 786 Stopanska Bank Yugoslavia (FYR Macedonia) 2,752 804 Magyar Kulkereskedelmi (Foreign Trade) Bank Hungary 2,675 818 Vojvodjanska Banka Yugoslavia 2,357 860 Bank Przemyslowo Handlowy (industry and commerce) Poland 1,826 918 Budapest Bank Hungary 1,793 925 Bank Slaski Poland 1,650 942 Mineral Bank Bulgaria 1,420 968 Wielkopolski Bank Kredytowy Poland 803 993 -- Not available. a. Data are for 1995. b. Although PKO BP had sufficient assets, it was not ranked. Source: For Sberbank, Moody's Banking Statistical Supplement, 1998; for all others, The Banker, July 1992. protection.9 In addition, many state-owned getsbyindustryorsectorforachievingnational banks also suffer from some of the same man- and multiyear economic goals. Once these tar- agement and governance problems as in tran- gets were set, budgetary resources were allo- sition economies and are criticized for often cated and transmitted through the banks to controversial government-direct lending pro- state farms and enterprises. Thus banks were jects and fiscal irresponsibility (box 2.2). essentially passive administrative units rather thanactiveprocessorsofcreditinformationand State Banks in Europe and Central Asia risk-takersoperatingoncommercialprinciples. As a result, when the monobanks were split Underthesocialistcommandsystemstatebanks and new second-tier state banks were created, playedvariedrolesintheeconomy,however,did the banks had neither the orientation nor the not offer a very extensive range of financial skills or experience to impose financial disci- productsoverall.Whiletheirkeyfunctionswere plineonenterprises.Instead,atleastintheearly lendingtostatefarmsandenterprisesandmobi- years, they retained an administrative orienta- lizing and safeguarding deposits, they served tion, processing loans and payments based on above all as conduits for the financing of line theinstructionsoflineministriesorenterprises. ministries' production plans and targets. As their enterprise clients became increasingly Centralized planning routinely set output tar- subject to market forces or unable to rely on 18 CHAPTER 2 BOX 2.2 State Banks in Selected Countries of the Organisation for Economic Co-operation and Development State banking became important during the last century in some OECD countries and declined in the 1980s. State banking was demanded by sectors that were pressed to invest but that could not find access to long- term credit because of the marginal importance of small and local banks in countries with centralized mar- ket and state institutions. State banks first appeared in some countries in the form of agrarian mortgage banks and gained momentum before the wars, with the creation of banks for industry, and during the postwar decades, reach- ing their peak in the 1960s.They have been declining ever since. State banks assumed considerable impor- tance in Belgium, France, the Netherlands, Norway, and New Zealand, but remained of limited importance in Britain, Italy, Japan, Spain, and Sweden. State banks were insignificant in Denmark, Canada, Switzerland, and the United States. Germany:Westdeutsche Landesbank In Germany public banks have played a large role in the banking system for decades.While government own- ership in banks declined throughout most European countries, the market share has remained comparatively high in Germany. In fact, the state ownership in German banking system's assets declined from 52 percent in 1970 to 36 percent in 1995, whereas the market share of assets in public banks in 1995 was 25 percent for European Union and 28 percent for OECD countries. State banks have historically been less problematic in Germany than in other countries.This due in part to the fact that the banks operate in a well-developed financial system and the public banking system is decentralized. Local ownership and control make the banks more transparent. Some policymakers argue, however, that the importance of state banks in Germany has hurt competition in the market and as a result, Germany has a lower level of foreign penetration than most European countries.The European Commission, with support of private sector banks, argues that guarantees for state-owned Landesbanken and municipally- owned Sparkassen are incompatible with European Union law. Together with state-controlled savings banks, the 12 Landesbanken account for more than half of all bank assets in Germany. Westdeutsche Landesbank enjoys government backing from the state of North Rhine- Westphalia and gets government guarantees on the debt it raises from the markets. It is the largest lender to industry in North Rhine-Westphalia and a strong force in the Frankfurt capital markets. Like other Landesbanken, it provides wholesale and investment banking services for local savings banks and acts as house bank to the local government. Westdeutsche Landesbank is the country's fourth-largest bank with assets of $390 billion. Many critics and policymakers argue that breaking it up would spur a much-needed restructuring of German finance and create a more level playing field between public and private sector banks. Successive German governments, however, have refused to reform the Landesbanken because state governments count on them to finance government-sponsored projects. France: Credit Lyonnais In the mid-1980s, Credit Lyonnais, a French state-owned bank, was one of the world's largest banks. But by the early 1990s, it excessive lending, bad management, rapid expansion, caught up with it, resulting in massive losses and scandal.The bank required successive bailouts of nearly $20 billion (FFr120 billion).The near col- lapse of the bank led to a decision of French government in 1993 to replace the management, clean up the bank's lending practices, and prepare it for privatization. The privatization of Credit Lyonnais in 1999 has reduced the state ownership in the bank from around 90 percent to 9.7 percent.The bank's main group of shareholders now include several international banks and insurance companies owning 32.3 percent of the capital; the balance of shares is owned by the general public. In view of the reduction of its international activities in recent years, Credit Lyonnais' significance as an international bank has diminished, however, its importance in the domestic market continues today. (Box continues on next page.) STATE BANKS EARLY IN THE TRANSITION 19 BOX 2.2 State Banks in Selected Countries of the Organisation for Economic Co-operation and Development (continued) The bank's profitability has steadily recovered due to rigorous actions taken to cut costs and improve asset quality. Net income has gradually increased with a 9.6 percent net return on equity for 2000. A com- plete overhaul of Credit Lyonnais' risk management systems, a substantial shrinking of its balance sheet, and more selective lending have contributed to significantly improved asset quality. Loan loss provisions fell to 0.40 percent of average loans for 2000. In addition, Credit Lyonnais has built up a cushion of general loan loss reserves (almost EUR 1 billion) that, when added to specific reserves, cover non-performing loans by over 90 percent. Credit Lyonnais' capital ratios have risen significantly over the past few years and are now in line with those of other major French banks. United States: Export-Import Bank The United States Export-Import (Exim) Bank is an official export credit agency of the US government. It was created to provide guarantees of working capital loans for US exporters, guarantee the repayment of loans, and make loans to foreign purchasers of US goods and services.The bank also provides credit insur- ance that protects US exporters against the risk of non-payment by foreign buyers for political or commer- cial reasons.The bank aims not compete with commercial lenders, but to assume the risk they cannot accept. In 2000 it supported about $15.5 billion worth of exports by authorizing $12.6 billion in loans, guarantees, and export insurance. Exim Bank is a valued source of export subsidies for major US firms. Exim Bank ben- efits several strategic industries in particular including aircraft manufacturing, energy-generation equipment, and transportation. Critics of Exim Bank argue that it is a device for channeling public money into a narrow set of industrial interests.Although created as a lender of last resort and authorized to extend credit only when private credit markets fails to do so, some economists and policymakers argue that in practice the bank's activities are unnecessary. If the private market will not make a loan, it is because the loan is too risky. Source: La Porta 2000; Helk 2001; Fairlamb 2000;Verdier 2000; Fitch Ratings 2001; and Oxford Analytica 2001. the state for financial help to keep them going, nificantbranchpresenceandmaintainingpass- the state banks inevitably ran into severe loan booksavings,processingpensionpaymentsand portfolio problems. While the state and former other compensation awarded to people as part state banks continued to operate largely under of their benefits package (mainly the respon- traditional assumptions and processes, govern- sibility of savings banks), and carrying out sub- ments were introducing new prudential norms sidyandotherprogramstosupportagriculture as they began to tighten monetary policies and and agroprocessing. But this trust evaporated introduce hard budget constraints to rein in in CIS countries with the loss of savings value hyperinflationandunsustainablefiscaldeficits. resulting from hyperinflation and the inabil- These conflicting approaches to prudence in ity of governments to bail out banks in the face monetary and banking matters combined with of fiscal pressures. In non-CIS countries con- conditionsintherealsector--whichwasuncom- fidence levels varied with the degree to which petitive and suffering breakdowns in produc- banks could accommodate withdrawals and tion,trade,andinvestment--resultedinmassive the level of deposit protection provided in the volumes of unrecoverable loans. event of a bank failure or liquidity crisis. In banks' other key area of responsibility, While other transition economies lost sav- safeguardingcitizens'savings,manyofthetra- ings through hyperinflation, the breakup of ditional savings banks and some of the agri- socialist Yugoslavia presented a distinct set of cultural banks appear to have earned citizens' circumstances. Banking systems in all the for- trust. They had done so by establishing a sig- mer Yugoslav republics faced a crisis in 1992 20 CHAPTER 2 with the freezing of foreign currency savings Governance, Management, and deposits, which could no longer be honored Operating Standards of State after the central government confiscated and Banks spent the hard currency assets funding those accounts. Slovenia and Croatia issued bonds Because the state banks were still social and early in the 1990s to provide some cover for politicalunitswhentheywereestablished,gov- the account holders. FYR Macedonia, with a ernancewasgenerallyexercisedthroughboard more fragile economy, issued bonds later in representation from the ministry of finance. the1990s.Depositorconfidencehasbeenmore Bank managers often had been trained in the difficult to restore in Bosnia and Herzegovina, publicenterprisesystemandwereusedtooper- FYR Macedonia, and the Federal Republic of ating in that domain, whether in banking or Yugoslavia as a result of the many crises in another field. Many managers were experi- the Balkans during the 1990s. The relatively encedinthesectoronwhichtheirbankfocused newgovernmentofSerbiahascommitteditself (for example, industrial engineers often man- to honoring the frozen deposits over a period aged industrial banks). The shortcomings of of years. How that action will affect depositor this approach eventually manifested them- confidence remains to be seen. Evidence in selves in poor financial performance. most of the countries suggests that local citi- Most state banks continued to lend as zens have little trust in domestic banks. They instructed or for patronage purposes (though arewillingtoplacetheirfundsinforeignbanks, the tightening of monetary policy and pruden- however, as has been particularly evident since tialnormsreducedtheiruseasvehiclesforlend- late 2001 and the conversion of the deutsche ing to uncompetitive enterprises). Thus their mark and other EU currencies to the euro. commercializationasjointstockcompanieswas During the socialist period and early in the not accompanied by sufficient commercializa- transition, active campaigns to increase retail tionoftheircreditmanagement,productdevel- depositswererarebecauseprivatesavingswere opment, service levels, operational efficiency, limited in most countries. Exceptions some- or risk management. All this meant poor loan times occurred during national emergencies performance and eventually insolvency. Many (such as wars or floods), but these were gov- factors worked against early detection of such ernmentdirectedratherthancommerciallydri- problems--pooraccountingandauditingstan- ven.10Moreover,incountrieswithcomparatively dards, inexperienced supervisory personnel, high private savings (Slovenia, today's Czech inadequate prudential regulations, decentral- andSlovakRepublics,Poland,Hungary),11peo- izedandoftenincompleteinformationsystems ple often kept resources outside the banking (with branch accounts not consolidated with systemtoavoidadministrativeharassmentfrom headquarters accounts), and the traditional the authorities.12 Thus while state banks ful- relianceonthegovernmentforadditionalfund- filled their fundamental role as safekeepers, ing when liquidity became short. they were ill equipped to pursue commercial Since the banks were not run according to campaignstoattractprivatesavings.Andtheir market-based norms, governance standards inability to protect the value and availability of oftendeviatedfrombestpractices.Somebanks deposits and pensions was exposed in the CIS operated according to reasonably professional by the hyperinflation, nonindexation, and col- standards, with management focusing on lapse of the ruble (and then other local cur- increasing profitability, boosting capital, man- rencies)intheearly1990s.Mostofthenon-CIS aging liquidity, containing risk, and building countries also suffered shocks and losses, franchisevalue.Butotherswerepoorlymanaged although the damage was less. andlessconcernedwithfinancialsustainability. STATE BANKS EARLY IN THE TRANSITION 21 Boardmembersoftenlackedqualificationsand as savings banks were developed to reach tar- adequateinformation.Internalauditfunctions get populations with financial services. were underdeveloped and had little autonomy. Management information systems were weak. Industrial Banks All these factors worked against timely and effective scrutiny of management behavior. Early in the transition most transition Annual shareholder meetings were often for- economies had at least one major state bank malendorsementceremoniesratherthanseri- that focused on industry, usually with a bias ous evaluations of performance. The absence toward heavy industry (table 2.3). These ofmarketinformationandinvolvedinstitutional banks functioned largely to sustain produc- shareholders further weakened prospects for tion and employment levels and to generate active, effective governance. Moreover, the some fiscal revenues. The banks often weaknesses allowed many managers to take propped up loss-making enterprises because advantageofpreferentialdealsthatreinforced the enterprises served as a source of tax rev- traditional networks of patronage but under- enue (turnover taxes from sales proceeds) mined the banks' commercial prospects. for the government. While no reliable finan- Bank operations were generally manual, cial data are available for the early transi- whichmeanthighstaffinglevelsandinefficient tion years, these banks were generally processes. This inefficiency is still evident in loss-makers from the outset. Set up to finance the high employment figures for many state troubled companies, they were often doomed banks compared with those for private banks. from the start--serving administrative, polit- Akeychallengeforstatebankshasbeenreduc- ical, or patronage purposes rather than com- ingcosts,increasingproductivityandefficiency, mercial ones. Most have been restructured, and balancing the needs of the emerging mar- recapitalized, or liquidated. Only a few have ketplace with the demands of stakeholders, been successfully privatized. oftentransmittedthroughworkers'oremploy- Several specialized banks also performed ees' councils. When privatization initiatives other functions, such as providing savings facil- were announced for state banks, many of the ities and trade finance. Particularly in the for- banksincludedset-asideprovisionsforemploy- mer Yugoslavia, which had a less centrally ees (for example, 5 percent of shares) as an planned economy than other formerly socialist inducement to cost containment and modern- countries,bankshadmorediversifiedactivities. ization. But overall state banks continued to As a result the industrial banks in Bosnia and be highly inefficient compared with the new Herzegovina,Croatia,FYRMacedonia,Slovenia, banks emerging with better systems and bet- and Yugoslavia were less specialized than the ter trained and motivated staff. industrial banks in other transition economies, althoughtheirownershipstructureandlending Roles of Specialized State Banks activities did have an industrial orientation. In most transition economies, governments Agricultural Banks supportedanumberofspecializedstatebanks, each that supported a particular element of Although agriculture played a relatively minor theeconomythatthegovernmentdeemedvalu- role in the transition economies, the sector ableorstrategicsuchasindustry,foreigntrade, employed a large number of people, often oragriculture.Asaresult,mostoftheseindus- through state farms, collectives, and cooper- tries depended on state banks to finance their atives. Like most of the world's governments, investmentandcreditneeds.Otherbanks,such central planners were concerned with food 22 CHAPTER 2 TABLE 2.3 Industrial Banks inTransition Economies, 1992 Central and Eastern Europe and the Baltic States Commonwealth of Independent States Country Banks Country Banks Albania National Commercial Bank Armenia Ardshinbank (Bank for Industry Bosnia and Herzegovina Privredna and Construction) Bulgaria More than 7 specialized banks Azerbaijan Promstroibank Croatia Privredna; HBRD; several smaller Belarus Belpromstroibank banks focused on shipbuilding Georgia Industriyabank finance Kazakhstan Turan Bank Czech Republic Investicni Banka Kyrgyz Republic Promstroibank Estonia Bank of Industry and Moldova Moldindconbank Construction Russian Federation Promstroibank Macedonia, FYR Stopanska Banka Tajikistan Tajikbankbusiness;Tajikorientbank Hungary Magyar Hitel; Hungarian Credit (previously Promstroibank) Bank Turkmenistan Investbank; Gasbank Latvia Industry and Construction Bank Ukraine Promstroibank Lithuania No specialized bank Uzbekistan Uzpromstroibank Poland Bank Handlowy; Polish Investment Bank Romania Banca Comerciala Romana Slovak Republic Priemyselna Banka; Investicni Banka Slovenia No specialized bank, although Nova Ljubljanska played this role Yugoslavia Jugobanka-Bor; Jugobanka- Beograd; Beobanka Belgrade; Invest Banka; Beogradska Banka; Vojvodjanska Note: The banks shown were generally the country's major state banks focusing on large-scale industrial enterprises.They include "apex" develop- ment banks established to help allocate or direct lending from abroad to selected companies and sectors. Source: World Bank; IMF; and a number of other sources as listed in the bibliography. security, stockpiling, warehousing, distribu- Most transition economies had at least one tion, postharvest losses, and similar issues. dedicated agricultural bank by 1992 (table Moreover, trade networks often relied on the 2.4). These banks have generally been deep shipment of cereals and grains and the export loss-makers, and some have since been liqui- of processed foods in exchange for inputs and dated. Nonetheless, they have often been pro- other needed goods. For example, small coun- tected because of the political patronage tries like Armenia, Georgia, and Moldova were resulting from close ties to agricultural or known to ship wine and brandy to Russia. Such farmers' movements and because of the exten- trade arrangements were not limited to CIS sive branch coverage that many offered. countries: Bulgaria, Hungary, Poland, and Romania also shipped processed foods to Savings Banks Russia, in exchange for energy supplies. Agricultural banks financed the central In most transition economies new savings planners' directives for domestic and export banks were established when the monobank production, serving the needs of the farms, systemwasbrokenup(table2.5).Someofthese collectives, and cooperatives and often those (Sberbank in Russia, Uzsberbank in of food processors and beverage and tobacco Uzbekistan, Sberbank in the Kyrgyz Republic producers as well. They also sometimes took andTajikistan,CeskaSporitelnaandSlovenska deposits, providing basic services for rural Sporitelna in the Czech and Slovak Federal communities. Republic) were very narrow institutions that STATE BANKS EARLY IN THE TRANSITION 23 TABLE 2.4 Agricultural Banks inTransition Economies, 1992 Central and Eastern Europe and the Baltic States Commonwealth of Independent States Country Banks Country Banks Albania Rural Commercial Bank Armenia Agrobank Bosnia and Herzegovina No specialized bank Azerbaijan Agroprombank Bulgaria Agrarian and Cooperative Bank Belarus Belagroprombank Croatia No specialized bank, although Georgia Agroprombank some regional banks focused Kazakhstan Kazagroprombank on agribusiness Kyrgyz Republic Agroprombank Czech Republic Agrobank Moldova Agroindbank Estonia No specialized bank Russian Federation Soviet Agroprombank (later Macedonia, FYR No specialized bank renamed Rosselkhozbank) Hungary Agrobank Tajikistan Agroinvestbank ("Shark Bank") Latvia Agricultural Bank Turkmenistan Agroprombank Lithuania Agricultural Bank Ukraine Bank Ukraina Poland Bank Gospodarki Zywnosciowej Uzbekistan Uzagroprombank Romania Banca Agricola Slovak Republic Slovak Agrobank (Slovenska Polnohospodarska) Slovenia No specialized bank Yugoslavia Vojvodjanska Banka (agro-processing) Source: World Bank; IMF; and a number of other sources as listed in the bibliography. essentially placed all their savings in cash played for the government.15 This was the deposits with the central bank or other state- case particularly in Central and Eastern owned banks or in government securities to Europe, where the savings banks have been helpfinancethebudgetastaxrevenuesshrank among the last banks privatized in most coun- and fiscal deficits grew.14 However, some of the tries. Indeed, in Poland PKO BP remains state banks, such as those in the Czech and Slovak owned. The Czech Republic privatized Ceska Federal Republic and Russia, later took on Sporitelna only in 2000, about the same time more diverse activities characteristic of com- as the Slovak Republic privatized Slovenska mercial banks. Other savings banks (PKO BP Sporitelna. Moreover, even when countries in Poland, OTP in Hungary, CEC in Romania, have opted for strategic privatization, the DSKinBulgaria)wereusedasbeforetofinance ownership of savings banks' shares after pri- housing and other fundamental household vatization has sometimes been more diluted needs. In fact, savings banks often pursued than that at other banks, impeding effective basic asset-liability matching strategies under governance.16 central planning, matching long-term savings In the Baltics the Lithuanian Savings Bank with long-term housing loans. Thanks to the wasprivatizedaslateas2000,whiletheLatvian strict price controls and suppression of infla- Savings Bank was still in state hands in 2001. tion in most transition economies, the banks In the CIS too, savings banks remain among had no need for sophisticated strategies to the last to be privatized. However, in most CIS manage interest rate, market, or foreign countries the savings banks were hit particu- exchange risk. Postal savings banks also larly hard by hyperinflation, and most indi- existed, sometimes as part of the larger sav- vidual accounts were devastated. This ings banks. undermined the integrity of implicit deposit Savings banks were often protected guarantees, and public confidence in many of because of the important financing role they these banks remains low.17 24 CHAPTER 2 TABLE 2.5 Savings and Postal Savings Banks inTransition Economies, 1992 Central and Eastern Europe and the Baltic States Commonwealth of Independent States Country Banks Country Banks Albania Savings Bank Armenia Armenia Savings Bank Bosnia and Herzegovina No specialized bank Azerbaijan Sberbank Bulgaria Durzjavna Spestovna Kasa Belarus Savings Bank Croatia No specialized bank Georgia Savings Bank Czech Republic Ceska Sporitelna Kazakhstan Halyk Savings Bank Estonia Savings Bank Kyrgyz Republic Sberbank Macedonia, FYR No specialized bank Moldova Savings Bank (Ekonomii) Hungary Orszagos Takarekpenztar es Russian Federation Sberbank Kereskedelmi (OTP) and Tajikistan Sberbank Postbank Turkmenistan Sberbank Latvia Savings Bank Ukraine Oschadny Bank Lithuania Savings Bank Uzbekistan Uzsberbank Poland PKO BP and PKO SA Romania CEC Slovak Republic Slovenska Sporitelna; Postovna Banka Slovenia No specialized bank Yugoslavia No specialized bank Source: World Bank; IMF; and a number of other sources as listed in the bibliography. TABLE 2.6 ForeignTrade and Export-Import Banks inTransition Economies, 1992 Central and Eastern Europe and the Baltic States Commonwealth of Independent States Country Banks Country Banks Albania No specialized bank Armenia Armimpex (Export-Import Bosnia and Herzegovina No specialized bank, although Bank); possibly Econombank Union Bank (formerly Azerbaijan International Bank Jugobanka) tried to play this Belarus Belvnesheconombank role Georgia Eximbank (privatized in 1992) Bulgaria BulgarskaVnushnoturgovska Banka Kazakhstan Alem Bank Croatia No specialized bank Kyrgyz Republic No specialized bank Czech Republic Obchodni Banka; Zivnostenska Moldova Vneshekonombank Estonia No specialized bank Russian Federation Vneshtorgbank Macedonia, FYR No specialized bank Tajikistan Tajikvnesheconombank Hungary Hungarian Foreign Trade Bank Turkmenistan Vnesheconombank Latvia Latvian Foreign Trade Bank Ukraine Ukreximbank Lithuania No specialized bank Uzbekistan National Bank of Foreign Poland Bank Handlowy; Bank for Export Economic Affairs Development; Bank PeKao (Bank Polska Kasa Opieki) Romania Bancorex; EXIM Bank Slovak Republic Obchodna Banka; Slovak Zarucna Banka Slovenia No specialized bank Yugoslavia Eximbank Source: World Bank; IMF; and a number of other sources as listed in the bibliography. STATE BANKS EARLY IN THE TRANSITION 25 TABLE 2.7 Social, Housing, and Related Banks inTransition Economies, 1992 Central and Eastern Europe and the Baltic States Commonwealth of Independent States Country Banks Country Banks Albania No specialized bank Armenia No specialized bank, although Bosnia and Herzegovina Most banks were regional or local ASCB's early role is unclear. and provided loans for social, The Bank for Industry and housing, and other purposesa Construction and Econombank Bulgaria Stroybank (construction); Mineral may have provided some Bank (SME financing) housing loans Croatia No specialized banks, but local Azerbaijan No specialized bank, although banks made housing and con- Promstroibank may have pro- struction loans vided construction and housing Czech Republic No specialized bank loans Estonia Estonian Social Bank Belarus About 13 small, geographically Macedonia, FYR No specialized bank, although the focused banks provided loans Macedonian Bank for for housing, construction, and Development Promotion the like financed social, housing, infra- Georgia Zhilsotsbank structure, and other activities Kazakhstan Kredsotsbank (housing) Hungary Konzumbank Kyrgyz Republic Zhilkomhozbank (housing) Latvia Housing and Social Moldova Moldsotsbank Development Bank Russian Federation No specialized bank, although Lithuania No specialized bank Sberbank made housing loans Poland PKO BP (housing) Tajikistan No specialized bank Romania CEC (housing loans); Romania Turkmenistan Turkmenbank, Gasbank, Bank for Development Senegatbank Slovak Republic Slovenska Zaruchna Bank Ukraine Sotsbank (guarantees, specialized in Uzbekistan Four sectoral banks provided spe- support to small enterprises) cialized support (for example, Slovenia No specialized bank Phat Bank and the cotton bank) Yugoslavia No specialized bank a. Among Bosnia and Herzegovina's 23 banks, 17 accounted for only 21 percent of bank assets.With total assets equal to only $3.1 billion in 1997 (and with these values overstated due to weak classification and provisioning), most banks were very small.These 17 banks had average assets of only $38 million. Source: World Bank; IMF; and a number of other sources as listed in the bibliography. Foreign Trade Banks casesbanks)emergedtoencouragethesetrade and investment links. Foreigntradebankswerecommonandincreas- In the CIS markets there was clear interest ingly active in the transition economies of early on in establishing trade and investment Central and Eastern Europe, in part because ties with Russia and with the other CIS coun- trade in these countries shifted more rapidly tries with strategic resources, such as from the former Soviet Union to the more Azerbaijan, Kazakhstan, and Turkmenistan, lucrative markets of Western Europe than it with oil and gas. But neither trade nor invest- did in other transition economies (table 2.6).18 ment flourished in the CIS, and only Russia Moreover, Western Europe showed early inter- receivedmuchdirectinvestmentfromabroad.19 est in direct investment in such countries as In 1993 the CIS countries had only about 36 the Czech Republic, Hungary, and, later, percent as much trade with the European Poland. Romania and Yugoslavia, because of UnionasCentralandEasternEuropedid.Thus theirgreaterpolicyemphasisonnonalignment, whilebanksexistedtoaccommodatetradeand also established early trade links with Western investment links, they did not have the prod- and other markets. As a result foreign trade uct range or volume that those in Central and banksandexport-importfacilities(andinsome Eastern Europe did. Moreover, many of the 26 CHAPTER 2 largest CIS companies, such as Gazprom and trade, housing, and foreign currency savings). In Lukoil, were able to obtain financing from Croatia most of the banks had a local orientation. Western banks or markets through syndicated 2. For example, Bulgaria had specialized banks loans and issues of depository receipts. By con- for transportation, chemicals and biotechnology, trast, smaller companies were often unable to electronics and defense goods, and building and penetrate Western markets because of qual- construction. In Central Asia several banks were ity or scheduling issues, which only added to specialized by commodity (such as cotton in their difficulties in arranging financing. Uzbekistan and natural gas in Turkmenistan). 3. This figure may underestimate the number Other State Banks of smaller banks that remained publicly owned-- by the state, municipalities, local government, and Several transition economies had other state funds (such as the National Property Fund) that banks to finance infrastructure and social pro- were influenced or controlled by the government. grams, many of them dedicated to housing and For example, Russia had more than 400 state banks construction (table 2.7). In addition, some in the early 1990s, although the government did banks tried to stimulate small loans to house- not own majority stakes in most of these. Sberbank holds for development of small enterprises. and Vneshtorgbank were the two large state banks In Hungary Konzumbank represented con- by 1992, while others were relatively small. sumer cooperatives. Similarly, Yugoslavia had the "big six," but more As state budgets tightened, however, sup- than 20 other smaller banks were state owned, port for these banks often diminished. And socially owned, or both. most of the banks appeared to be relatively 4. AssetandGDPmeasuresneedtobeusedwith ineffective. For example, housing finance some caution. However, state banks are estimated remains scarce in most transition economies, to have had $130,758 million in assets, and GDP with Poland the possible exception. More was roughly aggregated at $804,405 million. recently, mortgage lending has increased in 5. $130,758 million/200 state banks = $654 such countries as Bulgaria, Croatia, Hungary, million. and the Czech and Slovak Republics. But lend- 6. This is the average number of major state ing for housing construction remains limited, banks. As noted, many governments had smaller and mortgage bonds and securitization even stakes in banks that could be technically classified more so. And lending for small enterprise has as state banks, or at least as government-owned often depended on donor funding. More banks, including at municipal and local levels. recently, commercial banks in the most sta- 7. Several specialized banks played multiple ble markets have increased their lending to roles (for example, many industrial banks also householdsandsmallenterprises.Butthistype financed foreign operations and construction activ- of lending has often become sustainable only ities, some savings banks made housing loans, and after serious reforms. foreign trade banks financed export manufactur- ers). Similarly, several nonspecialized banks pro- Notes vided savings facilities, trade finance, loans to industry and agriculture, and financing for hous- 1. In Poland, for example, nine of the smaller ing, construction, and the like. Thus an empty cell Treasury-owned banks were specialized geograph- in table 2.1 does not mean that the country's banks ically though diversified in their banking activi- did not provide that particular type of financing. ties.Separatefromtheinitialfourlargestate-owned Instead, the table simply highlights the banks ded- banks spun off from the central bank, these banks icated to particular sectors, largely reflecting their specialized by function (such as agriculture, foreign earlier focus as part of the monobank system. STATE BANKS EARLY IN THE TRANSITION 27 8. These 24 banks were those ranking among 12. This was less the case in the Czech and the 1,000 largest in the world in 1991. Slovak Republics, where inflation was kept low, 9. La Porta, et al. (2000) accounts were often numbered to protect privacy, 10. The state's "official obligations" (similar and savings were traditionally high. to bonds) were a major instrument for encourag- 13. See Oxford Analytica (2001, 2002). ing savings in the Soviet Union. These instruments, 14. Some of these narrow savings banks may of varied kinds, were often issued to support a spe- have had small amounts of loans on their books. But cific cause, such as development of the air force and by and large they focused on savings and had lim- navy in the 1930s. The biggest effort was mounted ited commercial lending. during World War II, much as in the West. All these 15. Public sector ownership of savings banks is obligations turned into worthless paper after 1991. not restricted to formerly socialist countries. It has Issuing such securities was a common practice in also been common in many euro zone countries. other socialist countries, especially in the first post- Austria, Finland, France, Germany, and Sweden all war decade. For example, in the early 1950s the gov- have savings banks that have been at least partly ernment of Hungary issued a bond called "Loan for ownedbycentralorlocalgovernmentsformanyyears. the Peace." People were forced to spend a certain 16. For example, in Hungary the ownership percentage of their salaries to purchase these secu- structure of OTP when "privatized" was as follows: rities. There were no maturity dates, nor was inter- the state owned 25 percent plus one share; two state est paid, and the vast majority of the securities were social security funds owned 20 percent; domestic repurchased at face value at the end of the 1960s. investors owned 27 percent; 100 foreign investors 11. The comparatively high savings rates in owned a total of 20 percent (up to 2.5 percent indi- these countries reflected conditions that differed vidually); and Creditanstalt and Schroeders each from those in other formerly socialist countries. owned 2.9 percent. Slovenia was a major exporter in the former 17. Sberbank of Russia may be an exception, Yugoslavia and, like Croatia, benefited from rela- with substantial deposits and assets (see case study tively open borders to accommodate the tourist on Sberbank). trade, part of which was serviced by the private 18. Central and Eastern Europe had about $120 sector (lodging, cafés, restaurants). The Czech and billion in trade with the European Union in 1993, Slovak populations traditionally maintained high the first year for which statistics are available for savings; numbered accounts appear to have pro- all countries, and about $223 billion in 2000. vided most people with a sense of privacy and some 19. Foreign direct investment in the CIS in 1992 measure of confidence. Poland benefited from sig- was only $226 million, of which $200 million went nificant private remittances from abroad and from to Ukraine. By 1995 it had risen to $3.7 billion, of informal commercial trade. Hungary too benefited which $1.7 billion went to Russia and nearly $1.0 from remittances from abroad. billion to Kazakhstan. 28 CHAPTER 2 Chapter 3 State Banks in the Mid-1990s B y the mid-1990s, after several years of Baltic banks. Meanwhile, the larger foreign difficult transition, the number of banks catered mainly to a small segment of major state banks in transition the corporate market and took on only limited economies was roughly the same as in 1992, balance sheet risk. Thus by the mid-1990s pri- about 200.1 Yet there was growing recogni- vate banks still had not triggered the shift in tion of the need to restructure and privatize intermediation fundamentals that policy- these banks to modernize banking sectors. makers had hoped for earlier in the decade. This process began in Central and Eastern These fundamentals did show improvement Europe and the Baltics, prompted largely by in several markets a few years later and lend- the failure of many state banks, the high cost ing flows based on commercial criteria had to the state of keeping banks, and the supe- begun to increase by late 1995 in some coun- rior financing capacity and global informa- tries, such as Hungary, Poland, and the Czech tion that many foreign banks brought to the and Slovak Republics.3 domestic marketplace. The growth in trade, and its shift away from the CIS and toward Diverging Patterns of the European Union, was linked to expand- Development ing foreign direct investment, which sharp- ened foreign banks' interest in markets in By 1995 banking systems in the different tran- Central and Eastern Europe and the Baltics. sition regions had already taken different All this created more intense competition for paths. The CIS countries continued to have a the state banks and began to challenge their far larger number of banks, although these dominance. By contrast, in CIS banking mar- banks were much smaller on average. Most kets strategic, prime-rated foreign direct operated as "pocket" banks, subservient to investment was still limited in 1995, although theirenterpriseshareholdersandotherrelated some major banks did have operations in some andcontrollinginterests.Bycontrast,theCEE of the CIS countries.2 and Baltic states were already consolidating Structural reform and ownership changes their systems, actively restructuring and in sometimes led to disappointing outcomes. most cases recapitalizing their domestic banks Many private banks were undercapitalized, as foreign investment in the sector began to poorly managed, or used for personal gain. materialize or was on the verge of doing so.4 Although these problems were particularly With the exception of Slovenia, however, the prevalent in the CIS and Balkan markets, they former Yugoslav republics had not moved also emerged in parts of Central and Eastern ahead with major bank restructuring, largely Europe and were still evident in some of the because of the war and civil unrest in the 29 Balkans. But even poor countries such as compensate depositors who lost foreign cur- Albania were beginning to attract foreign rency savings when the National Bank of branches and investment, and other countries Yugoslavia froze their accounts in 1992. For whoseeconomieswereperformingpoorly,such these reasons state banks had larger balance as Bulgaria and Romania, were also able to sheets in the CEE countries than in the CIS. attract investment in the banking sector. There are two other explanations for the On average, the CIS countries each had 264 differences. One is that CIS countries some- banks by 1995, of which 7 were state banks times set up parallel structures for commod- accounting for about a third of bank assets. ity resources (such as the Oil Fund in The CIS countries had total banking system Azerbaijan) that they considered strategic and assets of about $83 billion in 1995, of which essential for foreign exchange earnings. The $74 billion were in Russia. State banks in the secondisthattheCIScountriesshiftedincreas- CIS countries had about $30 billion in assets, ingly to a system of arrears, barter, and net- with Russian state banks accounting for about ting as the monetary system imploded, often 90 percent. The Russian state savings bank, bypassing the banking system (see annex 6). Sberbank, alone dominated the market since Thus by the mid-1990s the CIS countries had its establishment as a joint stock company in much of their economic and asset values in 1991 (see case study on Sberbank). nonbankinstitutions,whiletheCEEandBaltic While the CEE countries had fewer banks, countries focused on eventually building a sta- those banks had greater assets. In 1995 all ble banking system. In the CEE and Baltic the CEE countries and the Baltics together countries the practice of directed lending had 537 licensed banks, less than 25 percent through state banks for preferred farms and of the number in Russia alone. On average, enterprisesslowlyunraveledasmacroeconomic the CEE and Baltic countries each had 45 pressures called for hard budget constraints, banks,ofwhich8werestateowned.Bankassets new regulations required stricter bank adher- totaled about $192 billion, more than twice the ence to solvency and liquidity norms, new pri- assets of CIS banks, with state banks account- vate and foreign banks demonstrated superior ing for about 65 percent on average. Thus the capacity, and, for some countries, negotiations state banks in the CEE and Baltic countries began for entry into the European Union. had a more prominent role than their coun- On a stock basis, asset measures appeared terpartsintheCIS,withmorethanthreetimes reasonable in the CEE countries, lower in the the assets (about $100 billion). Baltics, and microscopic in the CIS countries. One reason for the differences is that while BankassetsintheCEEcountriestotaledabout hyperinflation wiped out asset values in the 58 percent of GDP in 1995, compared with 126 CIS, inflation was less devastating in Central percent in OECD countries (figure 3.1). These and Eastern Europe, and somewhat less so in stock figures should be treated with caution, the Baltics. A second reason is that CEE gov- however, because in many cases assets were ernments were more willing to recapitalize overvalued.Whenloans,securities,realestate, major state banks as part of broad preprivati- and other assets were more properly valued, zation restructuring programs that occurred balance sheets usually shrank for the largest at varying speed and scale through the 1990s. and most exposed banks--usually state banks For example, Croatia, the Czech and Slovak thatwererecapitalizedandrestructuredbefore Republics, Hungary, Poland, and Slovenia all privatization, sometimes more than once. In undertook at least one major recapitalization, the three Baltic states bank assets were about andRomaniaalsorecapitalizedbanks.5Inaddi- 24 percent of GDP, while the CIS countries had tion, Croatia and Slovenia floated bonds to a ratio of about 18 percent. The ratio for the 30 CHAPTER 3 FIGURE 3.1 Bank Assets as a Share of GDP in BroadTrends in Financial Transition Economies, 1995 Intermediation Percent 70 Lending and deposit mobilization were slug- gish throughout the banking systems of nearly 60 all transition economies in the mid-1990s. Net 58 loans increased by only $36 billion from 1992 50 to 1995, little more than $1.3 billion in each countryonaverage.Withthe3,783banksoper- 40 ating in transition economies, this amounted toabout$10millionperbank,6suggestingthat 30 most banks were doing little if any new lend- 20 24 ing.Netdepositsincreasedby$60billion,about 18 $16millionperbankonaverage.7Thesetrends 10 suggest that most banks continued to suffer from weak funding bases as they mobilized 0 little in the way of additional deposits, lacked Central and Baltic Commonwealth of Eastern Europe states Independent States accesstosyndicateddebtmarkets,andhadfew opportunitiestoincreasecapitalthroughearn- Note: Data are for 1995 or earliest year reported after 1995. No reliable data are available for Tajikistan, Turkmenistan, Uzbekistan, or Yugoslavia. ings or new issues. They also point to risks in Source: IMF, International Financial Statistics; EBRD, Transition Report 2001; authors' calculations. the interbank market, where relatively weak banks often borrowed funds. CIS, where GDP was so low, illustrates the The CEE countries showed the greatest severe decline in asset values resulting from increase in loans and deposits between 1992 the collapse of central planning. It also shows and 1995. Loans grew by nearly $26 billion, how irrelevant most banks had become in CIS withthebiggestincreaseintheCzechRepublic economies. (figure 3.2).8 That country and Poland By the mid-1990s state banks accounted for accounted for about 80 percent of the region's a smaller share of lending flows, although they net increase, while Bulgaria, Hungary, and the continued to hold a disproportionate share of Slovak Republic showed net declines. The CIS total bank assets in CEE economies. State countries had a net increase in loans of about banks had higher credit figures than private $10 billion, with Russia accounting for more banks, but a large share reflected overvalued than $12 billion, second only to the Czech claims on government rather than loans to Republic among the transition economies. creditworthyenterprises.Statebanksalsooften Several CIS countries showed net declines, held significant shares of deposits, although including Kazakhstan, Turkmenistan, and theircapitalpositionswerenotalwaysasstrong Ukraine. Loans increased by nearly $1 billion as those of private banks, even before adjust- in the Baltic states. ing for risk and capital adequacy. As coun- Deposits in the CEE countries increased by tries asserted increasing monetary discipline nearly $42 billion, about two-thirds of the total to control inflation, the role of state banks depositsmobilizedintransitioneconomiesdur- started to become even less important. And ingtheperiod.TheCzechRepublicandPoland as it became clear that bank assets were over- accounted for nearly half the growth, while stated, it also became clear that state banks FYR Macedonia saw a net decline. In the CIS held most of the assets that would later be countries deposits increased by nearly $18 bil- reclassified and written down. lion--a positive development after the devas- STATE BANKS IN THE MID-1990S 31 FIGURE 3.2 Loans and Deposits inTransition Economies, 1992­93 and 1995 Billions of U.S. dollars Loans Deposits 120 $119 100 $101 80 $78 $75 60 40 $47 $35 $29 20 $25 $1 $2 $1 $2 0 1992­93 1995 1992­93 1995 Central and Baltic states Commonwealth of Eastern Europe Independent States Note: Loan data were derived from data from the IMF's International Financial Statistics on net domestic credit to enterprises and households but exclude claims on government. Data are the earliest after 1992 and 1995 if not available for those years (1993 in many cases, 1994 for Albania and Belarus). Source: IMF, International Financial Statistics; authors' calculations. tating effects of hyperinflation in the region. state and private, were in Central and Eastern But Russia was responsible for all the gains, Europe, mostly in the Czech Republic and while all other CIS countries except Belarus Poland. Private banks in the Baltics and the had limited growth or none at all. Several CIS CIS had particularly small credit exposures. countrieshadnetdeclines,includingArmenia, Like general asset values, loan values were Moldova, Turkmenistan, and Ukraine. broadly overstated and so were some overall Meanwhile, deposits in the Baltic banks credit values--as became clear when some increased by nearly $1 billion, slightly out- CIS governments eventually defaulted on pacing the growth in loans. This development domestic debt. In most transition economies too is important, given the crash of Latvia's in 1995 loan quality was poor, and classifica- largest bank, Bank Baltija. But Latvia's per- tion standards were neither strict enough nor formance lagged behind that of Estonia and properly applied. Had sound provisioning stan- Lithuania, reflecting its 1995 banking crisis. dards been in place at the time, the net loan figures on state banks' balance sheets would Loans and Net Domestic Credit have been smaller. Given the structure of most transition At the end of 1995 the 200 state banks in the economies at the time, state banks would have transition economies had about $95 billion in had more credit exposure to state-owned outstanding credit.9 That translates into an enterprises in industry than to any other sec- average credit exposure of about $472 mil- tor or class of borrower. (The industrial sec- lion for state banks,10 while private banks had tor accounted for 21­42 percent of the an average credit exposure of only about $31 economy, or an unweighted average of 33 per- million (figure 3.3). The largest banks, both cent.)11 The second largest exposure would 32 CHAPTER 3 FIGURE 3.3 State and Private Banks' Shares of Credit Flow measures showed an increase in credit Exposure inTransition Economies, 1995 in most transition economies. As noted, bor- rowers often used the proceeds of new loans Percent to reconcile accounts and pay down arrears ratherthantoinvestorretool.Inaddition,con- 41.1 trolling interests often diverted funds for uses State 58.9 Private that undermined the positions of both the debtors(enterprises)andthecreditors(banks). Central and These practices reflected the deep structural Eastern problems of many state bank clients as well 27.1 33.8 Europe State State 66.2 72.9 as weaknesses in the legal framework and in Private Private corporategovernanceandmanagement.Inthe end the bank losses flowing from the problems Commonwealth of Baltic of loss-making enterprises became so severe Independent States states that governments were unable to either fund Note: Data for total number of banks are for 1995 except for Bosnia and them or come up with the investment capital Herzegovina. Total number of banks for Yugoslavia is estimated for 1995. The number of state banks is estimated for 1994. Data on credit exposure to restructure and modernize without major are for 1995 or the earliest year reported after 1995. No reliable data are available for Tajikistan, Uzbekistan, or Yugoslavia. job losses, debt write-downs, and the like. Source: IMF, International Financial Statistics; EBRD, Transition Report 2001; Claessens 1996. Assets have been to the agricultural sector. Services would have accounted for little of the out- By 1995 state banks accounted for $131 billion standing credit. Although services were con- in assets while private banks held $149 billion, tributing to an increasingly significant share or a little bit more than half the total in tran- of GDP by the mid-1990s, most of the growth sition economies. In the CIS and Baltic coun- came from small private companies without tries state banks' share was larger, about 73 access to bank financing. percent. In the CEE countries, where large Of course, stock measures of credit should banks remained in state hands, state banks not be confused with new loans. While bal- still had 55 percent of assets. The CIS and ance sheet exposures to state farms and indus- Baltic countries had only 27 percent of assets trial enterprises remained high, these often in private banks. represented delinquent loans that were rolled The state banks in the CEE countries were over without restructuring and with little significant even in 1995, with about $985 mil- increase in collateral backing or other mea- lion in assets on average (figure 3.4). CIS state sures to reduce risk. Moreover, even when banks had an average of about $328 million loss-makers received new credit, they often in assets, while those in the Baltics were much used the funds to pay down arrears to smaller, with $155 million.12 Private banks had employee wage accounts and to government only a fraction of the assets of state banks. accounts for social benefits. Enterprises still ThoseintheCEEcountriesaveraged$213mil- lacked the financing to replenish working cap- lion in assets, while those in the Baltic states ital, fund capital improvements, or take other averaged$41millionandthoseintheCIScoun- actions to foster profitable production. Thus tries $17 million.13 Even so, the private banks much of the stock of credit in transition intheCEEcountrieshadachievedcriticalmass economies in 1995 consisted of old, nonper- by the mid-1990s. By contrast, in the CIS and forming loans, despite what the banks' for- Baltic markets only state banks seemed large mal books said. enough to develop significant earnings. But STATE BANKS IN THE MID-1990S 33 FIGURE 3.4 Average Assets of State and Private Despitethefavorabletrends,significantmoney Banks inTransition Economies, 1995 wasstillheldoutsidethebankingsystem.Broad money measures routinely highlighted large Millions of U.S. dollars 1,000 shares of GDP circulating outside the formal 985 system, particularly in the CIS, while the ratio of bank assets to GDP remained relatively 800 low in most transition economies. From the point of view of individuals, there were many 600 reasons not to place funds with banks. Neither state nor private banks gave households sig- nificant incentives to deposit their funds, pay- 400 ing interest rates that were generally negative 328 in real terms. Confidence in the stability of 200 the banking system remained low. And many 213 155 relied on private cash or barter transactions ivate 41 State Pr 17 rather than formal payment channels to avoid 0 paying taxes. Central and Baltic Commonwealth of Eastern Europe states Independent States By1995depositsinthetransitioneconomies amounted to about $169 billion. A large share Note: Data on total number of banks are for 1995 except for Bosnia and Herzegovina (1996). State banks are major state banks in 1994­95. Data (about 71 percent) were held in banks in on assets are for 1995 or earliest year reported after 1995. No reliable data are available for Tajikistan, Turkmenistan, Uzbekistan, or Yugoslavia. Central and Eastern Europe, mostly in Poland, Source: IMF, International Financial Statistics; EBRD, Transition Report 2001; Claessens 1996. the Czech Republic, Hungary, and the Slovak Republic. Among CIS countries only Russia the state banks' prospects were undermined had any substantial deposit base. But with 15 by their poor loan quality as well as by poor times the population of the Czech Republic, service, weak systems, excess staffing, lack of Russiastillhadonly1.2timesthedepositsheld innovation, and a limited array of financial by Czech banks. And with a similar demo- products. graphic advantage over Hungary, Russia held only 2.6 times as much in deposits as Hungary. Deposits Thus CIS banks had generally ceased to serve any useful savings mobilization role by 1995, Banks in transition economies held roughly with the possible exception of Russia's $108 billion in total deposits in 1992­93. If Sberbank, which accounted for at least a third most of this value was held by state banks (a of Russia's $42 billion in banking system reasonable assumption, given the prominence deposits.16 Per capita deposits in 1995 were at the time of savings banks and of foreign nearly $1,000 in Central and Eastern Europe, trade banks holding hard currency deposits), but only $280 in the Baltic states and $165 in average deposits would have been as high as the CIS countries (figure 3.5). $570million.14Butbecausemostdepositswere Putting a precise figure on deposits held held in local currency and thus subject to the by state banks is difficult. But it is estimated ravaging effects of hyperinflation in nearly that these banks accounted for a large share every transition economy, many of the deposit of the deposits because of the role played by accounts were wiped out.15 state-owned savings banks and because the In the mid-1990s deposits held with banks other large state banks that held major for- were still relatively low, although they had eign currency assets generally were not pri- increased about 56 percent since 1992­93. vatized until after 1995. Even CIS countries 34 CHAPTER 3 FIGURE 3.5 FIGURE 3.6 Per Capita Deposits in State and Private State and Private Banks' Shares of Banks inTransition Economies, 1995 Deposits inTransition Economies, 1995 U.S. dollars Percent 600 52 48 500 509 State Private 479 banks banks 400 Central and Eastern 36 32 300 Europe State State 64 68 banks banks Private Private banks banks 200 191 Commonwealth of Baltic 100 Independent States states 105 89 ivate 60 Note: Data on total number of banks are for 1995 except for Bosnia and State Pr Herzegovina (1996). State banks are estimated for 1994­95. Data on 0 deposits are for 1995 or the earliest year reported after 1995. Central and Baltic Commonwealth of Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); EBRD; Eastern Europe states Independent States authors' calculations. Note: Per capita deposits were calculated based on data on aggregate and state bank deposits and total population, both for 1995. Capital Source: IMF, International Financial Statistics; EBRD, Transition Report 2001; World Bank data. Data for 1995 show that state banks had about that transformed the ownership of their banks $47.5 billion in net capital on their balance by "privatizing" Gosbank branches still gen- sheets, about 46 percent of the total bank cap- erally had state-owned savings and foreign ital in transition economies.20 State banks in trade banks. Estimates for all transition theCEEcountrieshadabout$14billionincap- economies in 1995 based on the state banks' ital at the end of 1995, much of it in Poland share of total assets suggest that these banks ($8.1 billion). Russia accounted for $7.1 bil- had $79 billion in deposits, or an average of lion,whileCroatiaandRomaniaeachhadmore about $397 million,17 far lower than the $570 than $1 billion.21 million average two to three years earlier. In Statebankshadaveragecapitalof$112mil- the CEE countries state banks had average lion. The CEE countries again rank at the top deposits of about $612 million in 1995, while in bank size: state banks in this region had an the average in CIS countries was $185 million, average $143 million in capital. State banks in and in the Baltics, about $98 million.18 CIS countries averaged $84 million in capi- These estimates show that private banks tal, although this was skewed by figures for had already begun to capture a fairly signifi- Sberbank of Russia. Baltic state banks were cantshareofdepositsbythemid-1990s(figure generally very small, averaging only $4 million 3.6).Indeed,privatebanksheldmorethanhalf in capital. theaggregatedepositsintransitioneconomies, Private banks accounted for about 54 per- even though they had smaller average deposit cent of banking system capital in the transi- holdings than state banks.19 As in other bal- tion economies in 1995 (figure 3.7). Most ancesheetcategories,privatebanksinCentral private bank capital was in the CIS countries, andEasternEuropeweremarkedlylargerthan which accounted for $13 billion, or 52 percent theircounterpartsintheBalticstatesandeven of the total. CEE countries had $12 billion in larger than those in the CIS countries. private bank capital, while the three Baltic STATE BANKS IN THE MID-1990S 35 FIGURE 3.7 State and Private Banks' Shares of Bank ment of risk weights, and a general under- Capital inTransition Economies, 1995 statementofrisks(includingoff­balancesheet transactions and posted collateral values). Percent Once adjustments were made, banks experi- enced major financial crises and severe dete- 46 54 Private rioration in solvency. Because of the poor State banks banks accountingandclassificationstandardsinmost transition economies in 1995, the published 12 Central and State banks data provide too little information to deter- Eastern 36 mine what would have been appropriate cap- Europe State banks 64 88 ital-to-asset ratios in that risk environment. Private Private banks banks So while capital ratios were reasonable on the surface in 1995, they proved to be low for Commonwealth of Baltic most state banks (and often for private banks) Independent States states unless they had sound backing from their own- Note: Data are for 1995 unless not available (1997 for Bosnia and ers.Thatmeantfiscalresources,accesstointer- Herzegovina). Capital is capital accounts plus or minus other items net. The state share of capital was calculated by applying the state share of national capital markets, some measure of assets to capital, with the private bank share the residual. Source: IMF, International Financial Statistics; EBRD; authors' calculations. monetary compensation (such as higher net spreads to recapitalize), or regulatory for- bearance. The monetary and fiscal measures states combined had only $193 million. Private often proved costly to the economy and weak- banks were smaller than state banks, averag- ened the macroeconomic framework. And for- ingonly$7millionincapital,andinmostcoun- bearance often led to a distortion in the tries were substantially smaller. While CEE competitive environment by at least partly banks had $28 million in capital on average, shielding state banks from market discipline. CIS and Baltic banks had only $3­4 million. The largest private banks in terms of capital Emerging Role of Private Banks were in the Czech Republic and Poland.22 Although private banks accounted for more Private banks played a very limited role at the than half the banking system capital in the outset of the transition, although many coun- transition economies in 1995, in 13 of the 27 tries had already permitted their formation. economies state banks still held more than Whilethelargestbanksthroughthemid-1990s half. Thus it is fair to say that transition were state banks, new banks emerged quickly economies were at the midpoint of the shift once the monobank system was broken up. As from state to private. Regardless of ownership, early as 1991 there were more than 2,000 pri- mostbanksintransitioneconomiesweresmall, vate banks in the formerly socialist countries with only a handful of state banks showing rel- of Europe and Central Asia, mostly in Russia atively large capital positions by 1995. and other CIS countries.24 Non-CIS countries State and private banks reported similar had 448 private banks in the early 1990s, with basic, nominal capital-to-asset ratios in 1995.23 Poland and Bulgaria accounting for more than State banks reported average ratios of 16.8 a third of all banks in Central and Eastern percent, and private banks average ratios of Europe.25ThethreeBalticstateshad61banks. 17.2 percent. But while many countries had Foreign banks played a particularly impor- high capital-to-asset ratios (and high capital tant role during the transition, several mov- adequacy ratios), these generally reflected ing quickly as strategic investors in the region. improper classification, inappropriate assign- Thus, the number of foreign banks increased 36 CHAPTER 3 TABLE 3.1 Number of Foreign Banks inTransition Economies 1994 2000 Number Foreign Number Foreign Country of banks owned of banks owned Albania 6 3 13 12 Armenia 41 1 31 11 Azerbaijan 210 2 59 5 Belarus 48 -- 31 6 Bosnia and Herzegovina -- -- 56 14 Bulgaria 40 1 35 25 Croatia 50 -- 44 20 Czech Republic 55 13 40 16 Estonia 22 1 7 4 Georgia 226 1 30 8 Hungary 43 17 38 30 Kazakhstan 184 8 48 16 Kyrgyz Republic 18 3 22 6 Latvia 56 -- 21 12 Lithuania 22 0 13 6 Macedonia, FYR 6 3 22 7 Moldova 21 1 20 11 Poland 82 11 74 47 Romania 20 3 33 21 Russian Federation 2,456 -- 1,311 33 Slovak Republic 29 14 23 13 Slovenia 44 6 28 6 Tajikistan 17 -- 17 4 Turkmenistan -- -- 13 -- Ukraine 228 1 154 14 Uzbekistan 29 1 34 6 Yugoslavia -- -- -- -- -- Not available. Source: EBRD Transition Report 2001. dramatically duringthetransitionperiod,par- about $2.2 billion in commercial credit expo- ticularly in CEE and the Baltics (table 3.1) sure. And Yugoslavia had official and commer- While many governments welcomed foreign cial credit exposure dating to the Tito era. participation,expectingthatreputableinvest- orswouldbringaddedstability,skillsandknowl- Private Banks Emerge with Strong Ties to the edgetotheregion,therecordsofforeignbanks Government have been mixed. This emphasizes the need to create the right incentives for banks-- Generally, however, private banks early in the whether they are domestic or foreign--to lend transition period were small startups or pri- andprovideabroadrangeoffinancialservices. vatizedbranchesfromtheearlierGosbanksys- Some foreign banks tended to have limited tem. Most of these banks were little more than balance sheet exposure to the transition captive finance companies of state enterprises economies but were involved in international that insiders and shareholders used for per- paymentsandtransactions(suchastradefinance sonal gain and patronage. anddonor-financedinfrastructureprojects).For In the CIS and Baltic states many of the example, Hungary, Poland, and Romania had initial private banks resulted from the rapid about $2 billion in official credit exposure in spin-off of branches of the Gosbank into pri- 1992 (originating in the pretransition era) and vate hands--or ownership transformation. STATE BANKS IN THE MID-1990S 37 Particularly common in Russia and Ukraine, The intermediation role of private banks ownership transformation generally involved remained limited through the mid-1990s in changing the legal status of small banks that the transition economies. Part of the reason had been spun off from the monobank system was that they were generally small to begin tojointstockcompaniesandthensellingthese with,withfewresourcestolend.Hyperinflation banks to new shareholders. This type of own- had erased most of the value of local currency ershiptransformationwasaproxyforbankpri- savings in the CIS, while in the former vatization in the absence of major capital Yugoslavia war and cross-border disputes investment in these banks. In most cases the (including on the issue of frozen foreign cur- newshareholdersweretraditionalstateenter- rency deposits) undermined deposit mobi- priseborrowers,andthetransformedbanktook lization and banking stability. Thus in all but on the character of a captive finance company a few transition economies domestic private rather than a commercial bank. Some of these banks had very poor development prospects banks were new only to the extent that they earlyinthetransition.Meanwhile,largerbanks sought licenses from the regulatory authori- from abroad were seeking only the best of the ties with "new capital" based on low minimum corporate clients. capital requirements for entry. Poor lending By 1995 private banks accounted for $110 decisions,badgovernance,weakmanagement, billion in credit exposure in transition and the collapse of local currencies all pushed economies, about 56 percent of the total. On these banks into financial trouble within a rel- average, that is equivalent to only about $31 atively short period. million in credit exposure per bank.27 Private By the mid-1990s the CIS countries (and banks in the CIS were particularly small, aver- Estonia and Latvia) had most bank assets in aging only $13 million in credit exposure, com- "private" banks' hands. But because most pri- pared with $158 million for their counterparts vate banks in CIS countries continued to oper- in Central and Eastern Europe (table 3.2).28 ate as they had before--as pocket banks, or By international standards these were exceed- captives of the key state enterprises they ingly small averages. financed--there was little change in lending Private banks had made modest progress activityandgeneralbankingoperations.These in attracting deposits away from the state banks were able to turn to the state for financ- banks by 1995, although both aggregate and ing when they needed it, often calling on average deposit levels remained low. Private patronage networks and political ties. This banksintheCEEcountriesaveraged$133mil- practice contributed to the widespread cor- lion in deposits, far higher than the average ruption that has undermined development of only $10 million in the CIS and $22 million since the early 1990s. in the Baltics.29 The low deposit levels reflect InCentralandEasternEuropeprivatebanks a variety of factors, including tax avoidance, proliferatedinresponsetonewincentivesaimed the lack of confidence in the banks, the low at stimulating competition in the banking sec- real rates paid by banks on deposits, the lack tor.InnearlyallcountriesexceptSloveniabanks of confidence in deposit guarantees (implicit could obtain licenses with very low minimum or explicit), and the limited cash on hand capital.26Thiseasyentrypolicytriggeredalarge among households and enterprises. increase in the number of banks. However, Private banks in all transition economies despitetherapidgrowthinprivatebanks,which held about $90 billion in deposits. With the came to far outnumber state banks, most bank population totaling 414 million, that trans- assetsinCentralandEasternEuroperemained lates into per capita deposits in private banks in state-owned institutions. of only $216.30 While per capita holdings in 38 CHAPTER 3 TABLE 3.2 Banking Intermediation Statistics for Private Banks inTransition Economies, 1995 (millions of U.S. dollars except where otherwise specified) Credit Deposits Number of private banks Total Average Total Average Central and Eastern Europe 437 68,878 158 58,129 133 Baltics 68 1,547 23 1,471 22 Commonwealth of Independent States 3,081 39,957 13 29,943 10 Transition economies 3,586 110,382 31 89,543 25 Source: IMF, International Financial Statistics. privatebankswere$479inCentralandEastern capital. In the absence of protection and sup- Europe,theywereonly$191intheBalticstates port, banks' performance suffered from poor and $105 in the CIS countries (see figure 3.5). corporate governance, weak internal systems, Even so, private banks had larger per capita inadequate management, related party abuse, holdings than state banks in the Baltics and pooraccountingstandards,aninadequatelegal the CIS. And there was growing convergence framework for secured transactions, weak for- in Central and Eastern Europe, with private mal debt collection and liquidation systems, banks accounting for more than 48 percent of and, for most enterprises, information inade- per capita deposits. These trends show that quate for modern underwriting requirements. deposits were gradually migrating to private These weaknesses made it virtually impossible banks by 1995, even though traditional sav- to move quickly to a financial system that ings banks were still state owned in the major was sound, stable, and commercially viable. CEE countries.31 Compounding the challenge was the huge cost of systems and human capital development Diverging Approaches to Reform required to carry out such a transition. As early as 1995, however, there was evi- In the wake of the initial breakup of the dence of regional disparities. CIS countries monobank system and, especially, the macro- experienced far more adverse effects, while economic chaos and instability accompany- many CEE countries and the Baltic states ing the early stage of the transition, there showedgrowingfiscaldisciplineandlowervul- was fairly widespread recognition of the need nerabilitytohyperinflation.Hyperinflationand for greater monetary and fiscal discipline by fiscal deficits were declining, thanks in part to the mid-1990s (and sometimes sooner). the hardening of soft lending conditions Hyperinflation alone had led to massive shock throughthebanks.InmanyCEEcountriesand in most countries, a problem compounded by the Baltics the tightening of monetary policy fiscal revenue losses and the inability of gov- was accompanied by a stricter prudential reg- ernment institutions to finance services and ulatoryframeworkforbanksemphasizingloan investment commitments. classification,provisioningstandards,andmore In banking sectors these macroeconomic accurateaccountingofprofitandloss,retained developmentstriggeredandwerereinforcedby earnings,andcapitalmeasures(includingmore structural challenges involving financial, insti- suitableriskweightsforcapitaladequacymea- tutional,andincentiveissues.Bankingsystems sures).ManyoftheCEEcountries,theBaltics, facedportfolioerosion,declininglendingflows, andsomeoftheCIScountriesalsomadeefforts loss of confidence in the banks' safekeeping to strengthen banking supervision capacity. capacity, a general decline in savings, lack of These efforts focused on early warning signals otherborrowingsources,andpersistentlyweak of financial sector instability, general off-site STATE BANKS IN THE MID-1990S 39 BOX 3.1 Latvia's Successful Restructuring and Privatization of Unibanka Latvia's Universal Bank of Latvia, or Unibanka, is a rare success story.While the bank initially engaged in activ- ities that undermined the quality of its loan portfolio and put bank capital at risk, it was successfully restruc- tured and,as a result,able to withstand systemic weaknesses in the mid-1990s and to attract strategic investment in the second half of the decade. Unibanka was formed on September 28, 1993, from the rump of 21 branches from the newly reorga- nized Savings Bank. Most of the bad loans (40 percent of total assets in March 1994) were concentrated in these branches.As part of the rehabilitation process,these loans were taken off Unibanka's books and replaced with seven-year government bonds in the amount of 25 million lats (LVL), or about $50 million. The government created Unibanka in part to provide an insurance policy against catastrophic failures in the private banking sector.This logic was put to a serious test in the first half of 1995, when the insolvency of the country's largest bank (Bank Baltija) triggered a systemic crisis in which about 40 percent of the assets and liabilities of the banking sector were lost and 7 banks, including 3 of the 10 largest banks, collapsed.The crisis had a big effect on both the large state banks, the Savings Bank and Unibanka. But Unibanka was not directly involved in the crisis, did not need to be closed or bailed out, and was less badly harmed than the Savings Bank. In fact, Unibanka benefited (and the Savings Bank suffered) from a flight to quality following the crisis as depositors reallocated assets toward banks that appeared better managed, better capitalized, and less risky. In surveys, Latvian banking professionals consistently rated Unibanka as the safest bank in Latvia. Privatization procedures were launched at Unibanka on October 3, 1995.The board of the Latvian pri- vatization agency approved basic privatization regulations providing that Unibanka would be privatized in four years. In the first stage, carried out in 1995, share capital was increased to LVL 11.5 million (about $23 mil- lion), and then a little over 50 percent of the shares were sold for privatization certificates. Of this 50 per- cent, 22 percent were sold publicly, 13.5 percent were sold to customers of Unibanka, and 14.5 percent were sold to employees.The privatization agency held the remaining shares. In October 1995 the bank's share- holders decided to reorganize the bank as a joint stock company, Latvijas Unibanka. And in January 1996 it became the first company to list on the Riga stock exchange. The bank's privatization regulations called for increasing its share capital in the next privatization round by attracting capital from a strategic investor. In May 1996 Unibanka's share capital was raised by LVL 6 mil- lion (about $12 million),and the European Bank for Reconstruction and Development (EBRD) and Swedfund International AB purchased the newly issued shares.The EBRD gained control of about 22.6 percent of the total shares, and Swedfund control of about 7.5 percent. Over the next three years most of the remaining state-owned shares were sold in the international market through a global depository receipt program, and part were sold through special auctions at the Riga stock exchange. By the time privatization was complete in late 1999, the state had received LVL 66.1 million (about $113.4 million)--LVL 21.3 million in cash and LVL 44.8 million in privatization vouchers. By September 2001 Unibanka's paid-up share capital amounted to LVL 37.1 million ($59.9 million). More than 98 percent belongs to the Swedish bank Skandinaviska Enskilda Banken (SEB).A major force in the bank- ing sector consolidation in the Baltics, SEB initially purchased a 23 percent interest in Unibanka at a special auction at the stock exchange in late 1998. It then steadily purchased shares from the bank's other share- holders, including the EBRD. surveillancebasedonregulatoryreporting,and tions and personnel for a broad range of super- the coordination and scheduling of compre- visory functions. Another factor was the diffi- hensive on-site examinations. culty that supervisors often had in executing Many countries had taken initial measures their mandate, particularly when state banks tostrengthenbankingsupervisionbefore1995. violatedprudentialnormsandwereoutofcom- Butthesemeasureswerenoteffectivelyimple- pliance or when "private" banks with close ties mented until later. These delays were often togovernmentofficialsobtainedspecialfavors. due to the time needed to develop institu- In some cases these mandates simply lacked 40 CHAPTER 3 sufficientlegalbacking.Mostimportant,bank- high levels of nonperforming assets, a drain ing supervisors often found weak political sup- on the budget and the economy, distortions in port for their mandate. This changed after the competitive environment, and an erosion banking crises had occurred in most transition of confidence in civil institutions. economies and as international institutions encouraged greater observance of standard Notes norms in support of financial sector stability.32 The performance of CIS and non-CIS bank- 1. This figure excludes the many Russian banks ing systems had begun to diverge even as early in which the state had small stakes. There are no as 1993­94. In many non-CIS countries recog- precisenumbersonthestate-ownedbanksinRussia nition of solvency and liquidity problems trig- in 1995, given the large number of banks in which gered a series of recapitalizations and the state or other public authorities had minority restructuring programs geared to restoring stakes. But the state continued to control the bank- stability in the banking system and getting ing system from 1992 to 1995, dominating savings banks on track toward commercial profitabil- through Sberbank (which held 70 percent of house- ity. Poland's 1993­94 restructuring program hold deposits) and providing directed lending to was followed in the late 1990s by a surge of state enterprises through many new and regional strategic investment and privatization. In banks. In 1992­95 the number of banks grew enor- Hungary the decline in fiscal and balance of mously, so that by 1995 there were more than 2,200 paymentsfundamentalsby1994hadprompted banks operating in Russia, although the largest 10 an acceleration of privatization throughout banks accounted for 50 percent of assets. the economy starting in 1995­96, including a 2. ING, ABN-Amro, Deutsche Bank, Société push for strategic investment in the banking Générale, Citigroup, and HSBC were among the sector. Estonia moved aggressively to liquidate major banks operating in CIS markets in the mid- weak banks in the early 1990s and to consoli- 1990s. dateinthelate1990s,attractingforeigninvest- 3. See Borish and Noël (1996). ment from Scandinavia and Europe as an 4. The Czech Republic, Hungary, Poland, and anchor. Where problems were not identified Romania had already attracted direct investment and addressed early on, major collapses fromeurozoneandotherWesternbanksintodomes- prompted intensified reform efforts to pre- tic banks or startups. Other countries (Bulgaria, empt a recurrence of widespread instability the Slovak Republic, Slovenia) were also begin- (suchasinLatviain1995,Bulgariain1996­97, ning to attract limited investment in the form of and Albania in 1997). In all these cases gov- bankbranchesorsmallcapitalinvestmentsinbanks. ernments moved to restructure their banks 5. See Borish, Long, and Noël (1995). under strict guidelines and with a clear objec- 6. $36,276 million/3,783 banks = $9.6 million. tive of privatizing them, usually with some 7. $60,203 million/3,783 banks = $15.9 million. form of strategic investment (box 3.1). 8. Loans are defined as banks' claims on enter- Countries where reforms and performance prises and households. This is distinct from net have lagged have taken a different approach. domestic credit, which includes banks' claims on Statebankshaveoftenbeenkeptafloatbecause governments. of the perception of their importance to the 9. Thesefiguresarecalculatedbyapplyingstate economy. Others have been "privatized" banks'sharesoftotalbankingsystemassetstoaggre- through ownership transformation, resulting gate credit figures, which include claims on gov- inthecontinuationofmanyofthelendingprac- ernment. Credit exposure is defined here as ticesthathadgottenthestatebanksintofinan- on­balance sheet and does not account for off­bal- cial trouble. Invariably, the results have been ance sheet items because of data deficiencies. STATE BANKS IN THE MID-1990S 41 Reviews of the banks' financial condition based on private bank capital. But because of poor account- more recent data need to take such items and con- ingstandardsin1995,capitalformanyprivatebanks tingencies into account for a sound accounting of was probably also overstated. their status and risk. 21. The Czech Republic may have understated 10. $94,482 million/200 state banks = $472 itsstatebankcapitalandoverstateditsprivatebank million. capital.TheNationalPropertyFundhadlargestakes 11. See World Bank (1997). Albania had the in several banks that may have been considered pri- smallest share of industrial value added (21 per- vate for statistical purposes. cent), while Ukraine had the largest (42 percent). 22. The average for private banks in FYR 12. CEE:$99,524million/101statebanks=$985 Macedonia was $145 million. But this appears to be million. CIS: $30,147 million/92 = $328 million. a statistical error given the earlier hyperinflation Baltic states: $1,086 million/7 = $155 million. in the former Yugoslavia, the sanctions imposed by 13. CEE: $92,852 million/436 private banks = Greece, and the general difficulties the country had $213 million. CIS: $52,899 million/3,079 = $17 mil- in dealing with banking sector problems early in lion. Baltic states: $2,801 million/68 = $41 million. the transition. Although FYR Macedonia launched 14. $108,296 million/190 banks =$570 million. structural reforms in 1995, it is the authors' view 15. Hungary and the Czech and Slovak that average private bank capital was overstated. Republics are the only transition economies whose 23. Capital-to-asset ratios should be distin- year-to-year average CPI inflation from 1990 on guished from capital adequacy ratios. Capital-to- never exceeded double-digit rates. All other tran- asset ratios are direct balance sheet measures sition economies experienced triple-digit rates at withoutadjustmentsforrisk,whilecapitaladequacy least one year in the period after 1989. ratios are risk-weighted and more accurately mea- 16. AccordingtoBankScopedata,Sberbankheld sure the depth and quality of a bank's solvency. 65.6 billion rubles in deposits at the end of 1995, or While state and private banks had roughly the same $14.3 billion--a third of the total in Russia. But capital-to-asset ratios, these ratios would have to most reports put Sberbank's share far higher. These be adjusted for the risks of losses from nonper- assessments could be more recent, reflecting losses forming assets or for overvalued assets. Had that by other banks resulting from the flight of hard cur- been done, the ratios for state banks and many pri- rency deposits out of the country after 1995 and the vate banks would probably have been far lower. loss of value of local currency deposits after the 24. In the early 1990s transition economies collapse of the ruble in 1998 (although the ruble already had 2,350 banks, most of them private (fig- collapse would also have affected Sberbank's house- ures are from 1990 or the earliest year reported hold deposit base). thereafter). Russia had 1,306 banks in 1991, while 17. $79,477 million/200 state banks = $397 all CIS countries together had about 1,841. million. 25. Poland had 87 banks as early as 1993, and 18. CEE:$61,772million/101statebanks=$612 Bulgaria had 75 as early as 1992. million. CIS: $17,019 million/92 = $185 million. 26. To encourage mergers and consolidation of Baltic states: $686 million/7 = $98 million. the system, Slovenia increased its minimum capi- 19. CEE: $58,129 million/436 private banks = tal requirement for a full banking license from $133million.CIS:$29,943million/3,079=$9.7mil- DM 5 million to DM 60 million (about $35 million lion. Baltic states: $1,471 million/68 = $22 million. at the time) in 1993. By contrast, other countries 20. The 1995 figures on capital are derived from generallyhadminimumcapitalrequirementsequiv- the IMF's International Financial Statistics, with alent to euro 5 million or less, and most CIS coun- EBRD ratios of state bank assets applied to total tries had far lower requirements. assets. This calculation is not exact and probably 27. $110,382million/3,583privatebanks=$30.8 overstates state bank capital while understating million. 42 CHAPTER 3 28. CIS: $39,957 million/3,079 private banks = $13.0 million. CEE: $68,878/436 private banks = $158.0 million. 29. CIS: $29,943 million/3,079 private banks = $9.7million.CEE:$58,129million/437privatebanks = $133.0 million. Baltics: $1,471 million/68 private banks = $21.6 million. 30. $89,543 million/414 private banks = $216 million. 31. Examples include PKO BP and PKO SA in Poland, OTP in Hungary, Ceska Sporitelna in the Czech Republic, Slovenska Sporitelna in the Slovak Republic, CEC in Romania, and DSK in Bulgaria. 32. This effort accelerated after the East Asian crisis in 1997, and in 1998 the urgency was rein- forced by the collapse of the ruble and the delete- rious effects this had on CIS economies. STATE BANKS IN THE MID-1990S 43 Chapter 4 State Banks Since 1995: Continuing Problems R ecognizing the continuing problems deficits in Hungary served as a catalyst for its related to state banks, many transi- acceleration of privatization in financial ser- tion economies have intensified their vices and the real sector in 1995­96. Hungary privatization efforts. While many countries, has finalized the privatization of major bank- particularly in Central and Eastern Europe ing institutions with strategic investment, as and the Baltics made substantial progress in have the Czech and Slovak Republics. Poland consolidating, liquidating, or privatizing many isdowntotwomajorstatebanks.1Bulgariaand of their largest state banks, reforms moved at Croatia recently privatized their largest state a much slower pace in the CIS. banks. And FYR Macedonia and the Baltic stateshaveverylittlestateinvestmentremain- Progress in Privatization ing in their banking systems. The progress in privatization since the start of transition is reflected in the sharp decline FIGURE 4.1 in the number of state banks throughout the State Banks inTransition Economies, region (figure 4.1 and table 4.1). While the SelectedYears, 1992­2001 number of banks has been reduced overall, 117 many of those that remain, particularly in the 120 111 Balkans and CIS countries, continue to dom- inate the banking sectors and pose important 100 92 risks to the financial systems overall. 80 73 Progress in Central and Eastern Europe and 63 the Baltics 60 43 43 41 In Central and Eastern Europe, Albania is 40 expectedtohaveafullyprivatizedbankingsys- tem by end-2002, just a few years after state 20 11 banks controlled nearly 100 percent of the 7 4 3 assets.Theaccelerationinitsprivatizationpro- 0 gram was triggered by the damage done to 1992 1995 2000 2001 the economy and the civil society by the pyra- Central and Commonwealth of Baltic states Eastern Europe Independent States midschemesin1997.Whilefarlessdamaging, the buildup of fiscal and balance of payments Source: IMF; World Bank; EBRD; authors' calculations. 45 TABLE 4.1 Remaining State Banks as of End­2001 Country Status of state banks Albania The Savings Bank is expected to be privatized in 2002. Armenia ASB was privatized in 2001. Azerbaijan United Universal is still undergoing consolidation. IBA is still state owned. Belarus Several banks remain state owned, with no formal program to move forward with privatization. Bosnia and Herzegovina Most state banks are being privatized or liquidated in 2002, although progress is slow in some cases. Bulgaria Two of the last three state banks are being offered for sale in 2002. Croatia Only HRB remains state owned. Czech Republic The major state banks, CSOB and Ceska Sporitelna, were privatized in 1999­2000. Four banks remain state owned. Estonia The system is fully privatized. Georgia No state banks remain. Hungary Two banks remain state owned. Kazakhstan The government reduced its 80 percent stake in Halyk (in December 1999) to the current level of 33.3 percent plus one share.The state initially planned to sell its remaining stake in 2001, but this tender has been postponed indefinitely. Kyrgyz Republic Kairat is 100 percent state owned, and Energo Bank is partly state owned.The Savings and Settlement Company is a state financial institution with a limited banking license. Latvia Full privatization is planned for the Latvian Savings Bank. Lithuania Only the Agricultural Bank is state owned. Macedonia, FYR Only MDB remains state owned. Moldova The system will be fully private after the sale of Banco de Economii. Poland Two large banks remain state owned (PKO BP and BGZ) along with two other banks that are com- paratively large for the region. Romania Three banks remain state owned (the state holds about 40 percent of assets). Plans are to privatize one (BCR), to restructure and eventually privatize the savings bank (CEC), and to reorganize (and delicense) the EXIM Bank. Russian Federationa More than 460 banks are state owned, with as many as 679 having shares or stakes from all public institutions (including the central bank).The state (all-inclusive) held controlling stakes in 62 and blocking shares in 80.The state plans to divest all holdings of less than 25 percent, leaving Sberbank,Vneshtorgbank,Vneshekconombank, and a small number of new specialized banks (export-import, agricultural, and development banks) as state-owned institutions. Slovak Republic Several small banks remain state owned, but these are not viewed as highly distortionary.The major remaining state-owned bank is Postovna Banka. Slovenia The major bank remains state owned. Tajikistan Sberbank is the only remaining state bank. Turkmenistan Although data are limited, it appears that five state-owned banks remain. Ukraine Two state banks remain, including Oschadny (the savings bank). Uzbekistan One bank is fully state owned (the National Bank of Uzbekistan), and 15 others are joint stock companies with direct or indirect state ownership. Yugoslavia Four state banks are being liquidated. However, the government just opened a state-owned savings bank and plans to open a few more state banks. In addition to the "big six" banks, in 2001 there were around 20 smaller banks in which the majority of assets are controlled by the state or by socially owned enterprises and banks. Most of them are deeply insolvent and are scheduled for liquidation in the near future. a. One report claims that as of October 1, 2001, Russia had more than 1,300 lending institutions, of which 638 were at least partly owned by the state if the central bank's shares in commercial banks and other lending institutions are included. See Builov (2002). Source: IMF;World Bank; and EBRD. Progress in the Commonwealth of private as soon as the state sells its last shares Independent States in the Banca de Economii (the former savings bank). Kazakhstan has significantly reduced Among CIS countries, Armenia and Georgia the share of state bank assets since 1998. have fully eliminated state ownership.2 The Across the transition economies, state bank Kyrgyz Republic has only three nonprivate assets have declined substantially (figures 4.2 banks. Moldova's banking sector will be fully and 4.3). At the end of 1996 state bank assets 46 CHAPTER 4 FIGURE 4.2 FIGURE 4.3 Share of Bank Assets Held by State Banks Volume of Assets Held by State Banks in inTransition Economies, 1996­2000 Transition Economies, 1996­2000 Percent Millions of U.S. dollars 50 100 Commonwealth of Independent States 80 40 Central and Eastern Europe 60 Central and 30 Eastern Europe 40 Commonwealth of Independent States 20 Baltic 20 states Baltic states 10 0 1996 1997 1998 1999 2000 1996 1997 1998 1999 2000 Note: Data was used for previous years when not available for a given Note: Data was used for previous years when not available for a given year in certain countries (Bosnia and Herzegovina, Moldova, Russia, year in certain countries (Bosnia and Herzegovina, Moldova, Russia, Turkmenistan, Ukraine, Uzbekistan, and Yugoslavia). Data for Hungary Turkmenistan, Ukraine, Uzbekistan, and Yugoslavia). Data for Hungary for 2000 are for the third quarter only (for other countries end-year data for 2000 are for the third quarter only (for other countries end-year was used). data was used). Source: IMF; EBRD; authors' calculations. Source: IMF; EBRD; authors' calculations. were estimated to be about $125 billion (these for directed credit. Countries in which state figures exclude Bosnia and Herzegovina, banks (without major subsequent ownership Tajikistan, Turkmenistan, Uzbekistan, and changes) still had asset shares exceeding 20 Yugoslavia,whichwouldprobablybringthetotal percent in 2000 included Azerbaijan, Belarus, to about $130 billion). By 2000 this estimate Lithuania, Poland, Romania, Russia, Slovenia, had dropped by nearly a third, to about $88 bil- Turkmenistan, and Uzbekistan.4 And coun- lion.3 The decline resulted primarily from the tries with smaller shares of bank assets in state privatization of banks. But it also reflects bal- hands still run the risk of systemic problems ance sheet shrinkage in many remaining state because of the strategic nature of the remain- banks where provisions have been more strin- ing state banks and their use for political gentlyappliedtotroubledloanportfolios,over- patronage (Ukraine is an example). valued fixed assets and real estate have been soldormoreappropriatelyvalued,depositshave Financial Condition of State shiftedtootherbanks,governmentandcentral Banks bankfinancing(throughloansordepositplace- ment) has diminished, and capital has been In 2000 state banks accounted for about a third adjusted for declining asset values and rever- of the credit, assets, and deposits in the bank- sals of income and accruals. ingsystemsoftransitioneconomies,butforonly Still, several countries retain state banks in about a fifth of the capital. Their capital ratios thehopethattheirfranchisevaluewillincrease are far lower than those of private banks, with time and eventually generate higher pri- although this cannot automatically be equated vatization proceeds--or, more immediately, with lower quality or greater risk. In the CEE thatthebankscancontinuetoserveasvehicles countries many of the state banks are simply STATE BANKS SINCE 1995: CONTINUING PROBLEMS 47 holdinggovernmentsecuritiesandmakingfewer at 33 percent of GDP in 2000,10 the figure for loans, both in recognition of the high risks flow- depositsinstatebankssuggeststhattheyaccount ingfromtheimpairedbusinessclimateinthose for about 32 percent of total broad money in countries and to more easily comply with pru- transition economies.11 Estimates based on the dential norms governing liquidity and capital. same figures suggest that there is substantial Meanwhile, after-tax earnings have been rela- liquidityamongthemajorremainingstatebanks tivelylowintheCEEandBalticstates.CIScoun- relative to their exposures, with loans only 56 tries show better returns, although these are percent of deposits. But this needs to be evalu- suspect because of weak accounting standards. atedcasebycase,particularlyassomebanksare Asset growth among banks in transition exposed in the interbank market and at risk, or economies was concentrated primarily in dependentongovernmentdepositsforfunding. Poland and Russia, with little net increase Theestimatesalsosuggestthatmanybanksare amongtheothercountries.Assetsgrewinboth placing their deposits in government securities state and private banks, suggesting that the rather than in lending activities. This practice growthpartlyreflectedbroadermacroeconomic is often prudent and helps banks comply with trends rather than strictly structural develop- regulatory norms for liquidity and capital. But ments. That Poland and Russia accounted for it also reflects the use of state banks as sources such a substantial share of the growth also of financing for fiscal and quasi-fiscal activities reflects the continued cleanup and consolida- thatoftenweakenprospectsforeconomicgrowth tionintheCzechRepublicandHungary,where and competitiveness. banks had negative asset growth in 2000. State banks showed only about $10 billion State banks had about $108 billion in total incapital,or9.3percentofassets,in2000.Most assets in 2000, equivalent to about 14 percent state banks are very small, as demonstrated of the total GDP of the transition economies.5 by the fact that the six state banks with more Most of the state banks had less than $1 billion than $500 million in stated capital accounted in assets, although 20 had more than $1 billion for 54 percent of the total.12 That leaves $4.6 (seeannex1).Fiveofthese20bankshavesince billionincapitalspreadacross71banksreport- been privatized (Komercni and VUB) or are ing data (including some that have since been being liquidated (Beogradska, Jugobanka, and privatized or are being liquidated). After the Invest Banka). six major state banks are excluded (and with- Attheendof2000statebanksshowedabout out accounting for adjustments for classified $46 billion in loans, or 6 percent of recorded assets or other charges), state banks had an GDP.6 A large share of these loans (71 percent) average of about $65 million in capital. wereconcentratedinonlyabout10banks,each State banks reported about $329 million with more than $1 billion in loans posted on in after-tax earnings in 2000. But for banks its balance sheet.7 Four of these banks have other than Sberbank in Russia, PKO BP in since been privatized (Komercni and VUB) Poland, Vneshtorgbank in Russia, and BCR or are being liquidated (Beogradska and in Romania, earnings were meager. Only eight Jugobanka). Excluding these four banks statebanksreportedafter-taxearningsexceed- reduces the loan figures for the major state ing $20 million. Thirteen reported losses, and banks by about $8 billion. 33 reported earnings at or barely above On the funding side, deposits in state banks breakeven ($0­2 million). (See annex 2 for a were about $82 billion, or 11 percent of GDP.8 range of financial ratios for state banks.) Deposits were even more concentrated than Overall, state banks still possess sizable assets,with14banksaccountingfor81percent.9 market share in many countries (see annexes Withtotalbroadmoneyfortransitioneconomies 3 and 4). In Albania, Azerbaijan, Belarus, and 48 CHAPTER 4 FIGURE 4.4 Sloveniastate-ownedbanksheldmostbanking Loans as a Share of Net Domestic Credit system assets at the end of 2000, and in for State and Private Banks inTransition Romania about half. The state-owned share Economies, 2000 was particularly high in Belarus, where the Percent six major state banks account for more than 100 90 percent of total assets. The story for loans Private is a little different, with Belarus the only coun- 80 All try where state banks account for a majority banks of loans. This indicates that private banks are emerging as the major lenders, while state 60 banks' earning assets (to the extent that they State are generating income) are more often in gov- 40 ernmentsecurities,fixedassets,orotheritems. Still, state banks accounted for more than half the deposits in Albania, Azerbaijan, Belarus, 20 Lithuania,Russia,andSlovenia,andabouthalf inBosniaandHerzegovinaandRomania.13But 0 they accounted for more than half the capital Central and Baltic Commonwealth of in only two countries, Belarus and Romania, Eastern Europe states Independent States and about half in one, Slovenia. Note: Private loans were derived as total loans to state enterprises and the private sector (from the IMF's International Financial Statistics) less loans on state banks' balance sheets. Loans and Net Domestic Credit Source: IMF, International Financial Statistics; Bankscope (Fitch IBCA); authors' calculations. State banks are less prominent than private banks takes the form of loans. In fact, loans banks in active lending to the real sector. Data accountforonly44percentoftheircredit,com- for 2000 indicate that state banks had about pared with 87 percent for private banks in the $82.5 billion in net domestic credit on their region (figure 4.4). This record lags behind balance sheets. Of this total, about $40 bil- trends in the Baltic states, where overall loans lion was estimated to be loans to households accounted for a larger share of net domestic andenterprises,and$42.5billion14tobeclaims credit and for private banks loans accounted on government, mostly in securities invest- for 84 percent of net domestic credit. In the ments. Altogether, state banks accounted for CIS countries only 54 percent of state banks' about 36 percent of total net domestic credit net domestic credit took the form of loans, in transition economies.15 while the share for private banks was about About two-thirds of state banks' net domes- 78 percent. Altogether, 71 percent of net tic credit in 2000 was in the CEE countries,16 domestic assets were in the form of loans, where most of the largest state banks remain mainly from private banks in all three regions. (apart from Russia). Russia and Poland alone These differences matter for risk man- accounted for half the total, largely because of agement. CEE state banks are more vulner- Sberbank and PKO BP. These two countries, able to government (domestic debt) risk than along with the Czech Republic, Slovenia, and to enterprise or household risk, while the the Slovak Republic, accounted for 78 per- reverse is true for state banks in the Baltic cent of the total. Uzbekistan also has a large states and the CIS. Meanwhile, private banks volume of state bank credit.17 in all three regions, but particularly in Central Further analysis shows, however, that less and Eastern Europe and the Baltics, are more than half the net domestic credit of CEE state vulnerable to the enterprise and household STATE BANKS SINCE 1995: CONTINUING PROBLEMS 49 TABLE 4.2 Loans and Net Domestic Credit Exposure of State Banks inTransition Economies, End-2000 (millions of U.S. dollars except where otherwise specified) State bank share of Country Total bank credit credit (percent) State bank credit State bank loans Albania 1,312 91.4 1,199 10 Armenia 229 1.3 3 3 Azerbaijan 544 93.6 >509 185 Belarusa 1,405 101.2 1,422 1,075 Bosnia and Herzegovina 2,064 7.8 161 89 Bulgaria 2,512 32.2 809 429 Croatia 9,741 14.1 1,375 647 Czech Republic 30,578 36.0 11,002 3,752 Estonia 1,407 0.0 0 0 Georgia 229 0.0 0 0 Hungary 18,230 9.1 1,657 599 Kazakhstan 2,750 24.0 661 385 Kyrgyz Republic 60 10.0 6 2 Latvia 1,683 18.3 308 149 Lithuania 1,983 14.8 293 201 Macedonia, FYR 755 1.1 8 8 Moldova 211 12.8 27 13 Poland 64,795 32.1 20,813 10,179 Romania 3,865 92.3 3,566 1,015 Russian Federation 52,100 41.1 21,400 10,234 Slovak Republic 12,497 35.3 4,408 2,723 Slovenia 8,877 74.3 6,600 3,499 Tajikistan -- -- -- 3 Turkmenistana 1,887 104.0 1,962 1,803 Ukraine 3,963 13.1 519 322 Uzbekistan 5,040 77.5 3,906 2,525 Yugoslavia -- -- -- -- Total 228,717 36.1 82,614 39,850 Central and Eastern Europe 155,226 33.2 51,598 22,950 Baltics 5,073 11.8 601 350 Commonwealth of Independent States 68,418 44.5 30,415 16,550 -- Not available. a. Data irregularities for Belarus and Turkmenistan account for state bank share credit exceeding 100 percent. Note: Data are for 2000 unless not available (in which case data for 1999 were used). Net domestic credit includes claims on central and local gov- ernments. Loans include only loans to enterprises and households and exclude securities investments.The state bank share of credit is based on state bank statements, with private bank shares serving as the remaining share of credit. Data for Yugoslavia are excluded because of liquidation procedures being applied to big banks. See annex 5 for the banks included in the data analysis. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); authors' calculations. sectors than are state banks. In the CIS, how- figures are consistent with those above show- ever, where private banks hold about 22 per- ing that less than half of state banks' earning cent of net domestic credit in the form of assets are in the form of loans. In the Baltic government securities, private banks also states both credit and loans were negligible need to be on their guard against domestic and have dwindled even more since 2001 with debt risk given past government defaults in the privatization of Lithuania's Savings Bank. some countries. The CIS countries had the highest share CEE countries had an (unweighted) aver- of net domestic credit in state banks at the age of about $4.7 billion in state bank credit, end of 2000, at about 45 percent (table 4.2; with $2.1 billion of this in loans, while CIS figure 4.5). The CEE countries had about a countrieshadanaverageof$2.8billioninstate third of net domestic credit on state banks' bank credit, with $1.5 billion in loans. These balance sheets. The Baltic state banks were 50 CHAPTER 4 FIGURE 4.5 State and Private Banks' Shares of Net State banks had an average $765 million Domestic Credit Exposure inTransition in net domestic credit at the end of 2000, com- Economies, End-2000 paredwithonly$67millionforprivatebanks.18 Thus state banks' average lending and invest- Percent ment in government securities has increased 33.2 significantlysince1995(whentheirnetdomes- State bank 66.8 assets Private tic credit exposure averaged $480 million), in bank assets part because of the large decline in the num- 11.8 ber of major state banks in transition State bank Central and assets economies (from 200 to about 108). And while Eastern 44.5 Europe private banks remain small, they too have State 55.5 bank Private expanded lending and investment activity, as assets bank 88.2 assets Private bank reflected in the increase in their average expo- assets sure from only $31 million in 1995. Commonwealth of Baltic Independent States states Growthtrendsshowsomeconsistencyacross regions.IntheCEEcountriesstatebanks'aver- Note: Data are for 2000 unless not available (in which case data for 1999 were used). Net domestic credit includes claims on central and age credit exposure increased between 1995 local governments. The state share of credit is based on state bank statements, with private bank shares serving as the remaining share of and 2000 (from $709 million to $846 million), credit. Statistics for some countries appear inconsistent, such as for as did private banks' (from $158 million to Belarus and Turkmenistan, where negative loans are shown for private banks. No data are available for Tajikistan. $243 million). In the CIS countries state banks Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); EBRD; authors' calculations. also showed an increase in credit exposure (from $253 million to $707 million), while pri- again relatively insignificant, accounting for vate banks remained small on average. In the about 12 percent of total net domestic credit. Balticstatesaveragecreditexposureincreased Data on the net domestic credit exposure slightly among the few remaining state banks, of state and private banks show a wide range and private banks grew. ofdifferencesacrosscountries.In12of25coun- tries for which data are available, state banks Assets accountedforlessthan20percentoftotalexpo- sure (see table 4.2). But in 7 of the other 13, In 2000 state banks had more than $97 billion state banks accounted for more than 50 per- in total assets on their balance sheets, about cent. Even more important, in many of the 31 percent of total banking system assets in largest transition economies such as Russia, the 25 countries for which data are available Poland, and the Czech Republic, state banks (table 4.3).19 Thus while state banks in tran- had 20­50 percent of the exposure. sitioneconomiesgenerallyarerelativelysmall, Thus, on a weighted basis, state banks' they remain influential in their markets. shares of net domestic credit remained sig- Of the state banks' assets in 2000, about nificant at the end of 2000. Moreover, state 86 percent were estimated to be in the form banks have the greatest amount of exposure of net domestic credit, including securities in countries often considered to be advanced investments.20 About 61 percent of total state in the reform process. While some of the bank assets were in CEE countries,21 with largest banks have been privatized since the Poland and the Czech Republic accounting for end of 2000, such as VUB in the Slovak $36 billion. Together with Russia, which had Republic and Komercni in the Czech Republic, $27 billion in state bank assets, these coun- state banks continue to hold significant stocks tries accounted for 66 percent of total state of credit. bank assets.22 STATE BANKS SINCE 1995: CONTINUING PROBLEMS 51 TABLE 4.3 Assets in State Banks inTransition Economies, End-2000 (millions of U.S. dollars except where otherwise specified) State bank share Country Total bank assets of assets (percent) State bank assets Albania 1,993 61.7 1,230 Armenia 348 2.6 9 Azerbaijan 1,010 64.7 653 Belarus 2,207 77.1 1,702 Bosnia and Herzegovina 2,774 10.2 284 Bulgaria 4,622 20.1 931 Croatia 13,521 10.9 1,475 Czech Republic 49,265 25.9 12,757 Estonia 3,162 0.0 0 Georgia 322 0.0 0 Hungary 24,714 7.8 1,931 Kazakhstan 3,302 23.3 769 Kyrgyz Republic 96 9.4 9 Latvia 4,017 9.2 369 Lithuania 3,025 13.8 417 Macedonia, FYR 1,279 1.1 14 Moldova 323 10.8 35 Poland 87,744 26.6 23,315 Romania 7,607 60.0 4,564 Russian Federation 61,573 44.1 27,181 Slovak Republic 15,252 32.2 4,911 Slovenia 12,847 56.0 7,188 Tajikistan -- -- 9 Turkmenistan 2,075 100.0 2,075 Ukraine 5,799 13.6 790 Uzbekistan 4,432 100.0 4,432 Yugoslavia -- -- -- Total 313,309 31.0 97,050 Central and Eastern Europe 221,618 26.4 58,600 Baltics 10,204 7.7 786 Commonwealth of Independent States 81,487 46.2 37,664 -- Not available. Note: Data are for 2000 unless not available (in which case data for 1999 were used). No reliable data are available for Yugoslavia.There are slight discrepancies between these figures and the analysis conducted for figure 5.6 below, suggesting some smaller state banks are included in the analy- sis used for figure 5.6 but not in this table. See annex 5 for the banks included in the data analysis. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); authors' calculations. Many countries had large shares of their While the CEE countries have the largest banking system assets in state banks. Among aggregate amount of state bank assets, they CEEcountries,Albania,Romania,andSlovenia also have significantly greater private bank had more than half their assets in state banks assets and larger private banks. For example, at the end of 2000, while among CIS countries, statebanksinCentralandEasternEuropehad Azerbaijan and Belarus did (see case study on 1.55timestheassetsofthoseintheCISin2000, International Bank of Azerbaijan). And butprivatebanksinCentralandEasternEurope Tajikistan, Turkmenistan, and Uzbekistan had hadnearlyfourtimestheassetsofprivatebanks virtually all their bank assets in state hands. in the CIS. Meanwhile, the Baltic states had As a group, the CIS countries had the highest thehighestshareofbankassetsinprivateinsti- share of banking system assets in state hands, tutions at the end of 2000, at about 92 percent. at about 46 percent (figure 4.6). For the CEE Onaverage,statebankshadabout$900mil- countries the share was about 26 percent, and lioninassetsattheendof2000,comparedwith for the Baltic states, only 8 percent. only $99 million for private banks. That shows 52 CHAPTER 4 FIGURE 4.6 State and Private Banks' Shares of for 86 percent of total state bank deposits at Assets inTransition Economies, End-2000 the end of 2000. On average, state banks in the CIS coun- Percent tries had the largest share of total deposits in 26.4 State bank the banking system, at about 58 percent, much assets larger than their share of credit (figure 4.7). 73.6 Private Those in Central and Eastern European coun- bank assets tries had about a third of total deposits, about 7.7 the same as their share of credit. State banks State bank Central and assets in the Baltics also had closely matched shares Eastern 46.2 Europe of deposits and credit, though at only about 53.8 State Private bank 12 percent. bank assets 92.3 assets Private bank At the end of 2000 about a third of transi- assets tion economies still had more than 50 per- Commonwealth of Baltic Independent States states cent of total deposits in state banks. These included Russia, with nearly 60 percent of Note: Data for FYR Macedonia, Turkmenistan, and Uzbekistan are estimates. Figure excludes data for Yugoslavia because of expected write-offs of about deposits in state banks, mainly in Sberbank.26 $6 billion due to liquidation procedures for the major banks. Source: IMF, International Financial Statistics; EBRD, Transition Report 2001; Another five countries had 20­50 percent of authors' calculations. total deposits in state banks, including Poland, the country with the largest amount of bank an increase in state bank assets from 1995, deposits among the transition economies and whentheyaveraged$664million.Theincrease about 30 percent of total deposits in these occurred primarily in the CIS, where state economies at the end of 2000. banks' assets rose from an average $335 mil- On average, state banks had much larger lionin1995to$876millionin2000.Thegrowth deposits than private banks at the end of of Sberbank of Russia accounted for much of 2000--$714 million compared with only $60 the change, along with the decline in the num- million. The difference is most dramatic in the ber of state banks as a result of privatization, CIS, where state banks had an average $675 consolidation, and failure.23 CEE and Baltic million in deposits, and private banks only $12 countries' state banks had roughly the same million. This disparity largely reflects the near levelofassets,withtheBalticstatebanksshow- monopoly that savings banks have had in CIS ing a slightly larger percentage increase. countries, particularly in local currency. CIS state banks experienced sharp growth in aver- Deposits age deposits, up from less than $200 million in 1995. But as with other indicators, these State banks had about $77 billion in deposits averageswoulddeclinesignificantlyifallbanks attheendof2000,about37percentofthetotal in which the Russian state authorities had for reporting countries (table 4.4).24 About 62 shares were included in the denominator. percent of the deposits in state banks were in State banks in the CEE countries also had Central and Eastern European countries.25 large deposits at the end of 2000--an aver- Russia and Poland accounted for 56 percent age of $779 million, more than three times of the total, attesting to the importance of the average for private banks in these coun- Sberbank and PKO BP in mobilizing deposits tries. Average deposits grew for both state and in transition economies. These two countries, private banks between 1995 and 2000, nearly together with the Czech Republic, Romania, doubling for private banks. Even so, the Slovenia, and the Slovak Republic, accounted increase for state banks was about 1.4 times STATE BANKS SINCE 1995: CONTINUING PROBLEMS 53 TABLE 4.4 Deposits in State Banks inTransition Economies, End-2000 (millions of U.S. dollars except where otherwise specified) State bank share of Country Total bank deposits deposits (percent) State bank deposits Albania 1,605 73.3 1,176 Armenia 167 5.4 9 Azerbaijan 546 88.8 485 Belarus 1,156 111.2 1,285 Bosnia and Herzegovina 834 18.9 158 Bulgaria 2,785 28.1 782 Croatia 8,085 8.9 720 Czech Republic 32,796 30.2 9,915 Estonia 1,590 0.0 0 Georgia 156 0.0 0 Hungary 17,814 7.4 1,314 Kazakhstan 1,981 32.7 648 Kyrgyz Republic 68 10.3 7 Latvia 1,447 19.4 281 Lithuania 1,946 16.5 322 Macedonia, FYR 531 0.0 0 Moldova 170 15.3 26 Poland 62,837 31.7 19,944 Romania 6,145 58.9 3,619 Russian Federation 39,903 58.0 23,156 Slovak Republic 11,265 34.8 3,922 Slovenia 8,277 72.3 5,988 Tajikistan -- -- 8 Turkmenistan 434 100.0 434 Ukraine 3,387 17.1 578 Uzbekistan 2,384 100.0 2,384 Yugoslavia -- -- -- Total 208,309 37.0 77,153 Central and Eastern Europe 152,974 31.1 47,538 Baltics 4,983 12.1 603 Commonwealth of Independent States 50,352 57.6 29,012 -- Not available. Note: Deposits are customer and short-term funding.Total deposits for Turkmenistan and Uzbekistan are estimates. See annex 5 for the banks included in the data analysis. Data irregularities account for share of deposits exceeding 100 percent for Belarus. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); authors' calculations. that for private banks.27 Private banks in the countriesandtheBalticsshowedloansatabout Baltics had smaller average deposits than 85 percent of deposits. This ratio is about as those in CEE countries but larger deposits high as is prudent, since classified loans in than those in the CIS countries, while state these countries averaged an estimated 16.3 banks in the Baltics had smaller average percent of total loans at the end of 200028-- deposits than state banks in both the CEE and or about 12 percent of total deposits.29 CIS countries. State banks' loan-to-deposit ratios gener- Average loan-to-deposit ratios for state and ally appeared fairly conservative. Their credit private banks at the end of 2000 suggest that risk is a mix of government and company risk, most were conservative and prudent except with the balance of their net domestic credit those for private banks in the CIS countries in government securities. Central and Eastern (table 4.5). For these banks, loans were about European banks had the lowest average loan- 1.4 times deposits. Any erosion in loan qual- to-deposit ratio, at 74 percent, with average ity among these banks would endanger the ratiosforbanksintheBalticsandtheCISabout safety of deposits. Private banks in the CEE 10­20 percentage points higher. 54 CHAPTER 4 FIGURE 4.7 State and Private Banks' Shares of anddeposits,pointingtothepossibilitythatstate Deposits inTransition Economies, banksareundercapitalizedrelativetotheirpri- End-2000 vate counterparts. The smaller share of capital may also reflect in part more conservative risk Percent weighting by state banks because of the larger 31 State bank proportion of government securities in their deposits asset holdings, or implicit guarantees of state rescue should these banks face serious solvency 69 Private bank orliquidityproblems.Suchrescueshavealready 42.4 deposits 12.1 Private bank occurredinmanytransitioneconomies,andthey State bank deposits Central and deposits continue to pose a macroeconomic risk and the Eastern 57.6 Europe potential of competitive distortion in markets State bank 87.9 where state banks are particularly active. deposits Private bank deposits State banks in the CEE countries had about $5.5billionincapitalattheendof2000,mainly Commonwealth of Baltic Independent States states in Poland and the Czech Republic. Together with Russia, the other major market where Note: Deposits are customer and short-term funding. Total deposits for Turkmenistan and Uzbekistan are estimates. Figure excludes data for state banks had a fairly sizable share of capi- Yugoslavia because of liquidation procedures under way for major banks. Statistical irregularities are acknowledged by the authors for Belarus, tal, Poland and the Czech Republic accounted where negative deposits appear for private banks. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); for $5.9 billion in state bank capital, 56 per- authors' calculations. cent of the total in transition economies. Belarus, Romania, Turkmenistan, and Capital Uzbekistan had the biggest shares of bank- ing system capital in state hands. But their At the end of 2000 state banks had about $9.7 state banks held a total of only about billion in capital on their balance sheets, a lit- $1.9 billion, with the largest part of it in tle more than 19 percent of the total bank cap- Uzbekistan. State banks accounted for 20­50 ital in transition economies (table 4.6).30 This percent of total capital in several countries shareissmallerthantheirsharesofcredit,assets, of Central and Eastern Europe, including TABLE 4.5 Bank Loans, Deposits, and Loan-to-Deposit Ratios inTransition Economies, End-2000 (millions of U.S. dollars except where otherwise specified) State banks Private banks All banks Loans Deposits Loans Deposits Loans Deposits Central and Eastern Europe 22,864 47,538 90,034 105,436 112,898 152,974 Baltics 350 603 3,757 4,380 4,107 4,983 Commonwealth of Independent States 16,742 29,012 29,603 21,341 46,345 50,352 Total 42,282 77,153 123,395 131,156 163,350 208,309 Loan-to-deposit ratio (percent) State banks Private banks All banks Central and Eastern Europe 48.1 85.4 73.8 Baltics 58.0 85.8 82.4 Commonwealth of Independent States 57.7 138.7 92.0 Total 54.8 94.1 78.4 Note: Loan data are unavailable forTajikistan.Table excludes data forYugoslavia because of liquidation procedures under way for major banks. Private loans were derived from total loans to state enterprises and the private sector (from the IMF's International Financial Statistics) less loans on state banks' balance sheets. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); authors' calculations. STATE BANKS SINCE 1995: CONTINUING PROBLEMS 55 TABLE 4.6 Capital in State Banks inTransition Economies, End-2000 (millions of U.S. dollars except where otherwise specified) State bank share of Country Total bank capital capital (percent) State bank capital Albania 292 11.3 33 Armenia 27 0.0 0 Azerbaijan 184 13.0 24 Belarus 378 85.0 321 Bosnia and Herzegovina 298 32.2 96 Bulgaria 1,027 11.2 115 Croatia 1,976 23.0 454 Czech Republic 5,335 21.4 1,144 Estonia 408 0.0 0 Georgia 100 0.0 0 Hungary 2,404 21.0 504 Kazakhstan 794 9.6 76 Kyrgyz Republic 11 12.9 1 Latvia 305 6.9 21 Lithuania 307 10.4 32 Macedonia, FYR 404 1.0 4 Moldova 90 4.5 4 Poland 12,758 14.6 1,857 Romania 594 -- -- Russian Federation 15,317 18.6 2,849 Slovak Republic 2,699 21.8 588 Slovenia 1,693 40.2 681 Tajikistan -- -- -- Turkmenistan 21 100.0 21 Ukraine 1,225 4.9 60 Uzbekistan 851 100.0 851 Yugoslavia -- -- -- Total 49,496 19.6 9,718 Central and Eastern Europe 29,480 18.5 5463 Baltics 1,020 5.2 53 Commonwealth of Independent States 18,997 22.1 4,202 -- Not available. Note: Data are for 2000 unless not available (in which case data for 1999 were used). Capital is capital accounts plus or minus other items net.The state share of capital was derived by applying the state share of assets to capital, with the private bank share serving as the remaining share. No reliable data on bank capital are available for Tajikistan and Yugoslavia. See annex 5 for the banks included in the data analysis. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); EBRD; authors' calculations. Bosnia and Herzegovina, Croatia, Hungary, capital still predominant in only a few. Across the Slovak Republic, and Slovenia. Several the transition economies, private bank capital of these countries have reduced the state totaled $39 billion, with about 60 percent of it share since 2001. in Central and Eastern European banks.31 State banks had about 21­22 percent of Most banks in transition economies remain capital in the CEE and CIS countries at the small, with an average of only $22 million in end of 2000 (figure 4.8). In the Baltics, state capital at the end of 2000. Average capital banks'$53millionincapitalaccountedforonly was particularly small in the CIS, at $11 mil- 5 percent of the total. lion. Baltic banks averaged about $25 million Private banks accounted for about 80 per- in capital, and CEE banks about $61 million. cent of total capital in transition economies at Buttheseaveragesconceallargedifferences the end of 2000. Although private banks' share between state and private banks. State banks was largest in the Baltic states, it was fairly had an average $97 million in capital, while highinthevastmajorityofcountries,withstate private banks had only $18 million. By region, 56 CHAPTER 4 FIGURE 4.8 State and Private Banks' Shares of age ratio for state banks is low and would ordi- Capital inTransition Economies, narily require corrective action unless a bank End-2000 is assuming no risk. But a bank assuming no riskraisesquestionsaboutitsearningsstream, Percent itsabilitytoincreasecapitalfromordinarybank- 18.5 State bank ingoperations,anditslong-termviability.Many capital statebanksmayhavelowcapital-to-assetratios because of heavy investment in government 81.5 Private bank securities.32 But is income from securities 22.1 capital 5.2 State bank State bank enough to enable these banks to recapitalize capital Central and capital forlong-termcommercialviability--andifitis, Eastern 77.9 Europe is this the best use of fiscal resources in these Private bank 94.8 countries? Conversely, if fiscal prudence keeps capital Private bank capital this earnings stream low, questions again arise about state banks' cash liquidity, solvency, and Commonwealth of Baltic Independent States states long-term commercial viability. Privatebanks'averagecapital-to-assetratio Note: Data are for 2000 unless not available (in which case data for 1999 were used). Capital is capital accounts plus or minus other items net. The of 12.5 percent compares favorably with the state share of capital is based on public bank statements. No reliable data are available for Romania, or no capital for Tajikistan or Yugoslavia. BankforInternationalSettlements'(BIS)gen- Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); EBRD; authors' calculations. eral guidelines (8­10 percent), although each bank's ratio would have to be tested for ade- statebanksinCentralandEasternEuropehad quacy relative to the levels of risk assumed. slightly larger average capital ($101 million) Average ratios were at double-digit levels in than those in the CIS ($98 million) and much abouthalfthecountries.Inthecountrieswhere larger average capital than those in the Baltics nonperformingloanswereathighlevels(equiv- ($13 million). alent to more than 50 percent of capital) at Private banks in Central and Eastern the end of 2000--Azerbaijan, Belarus, Bosnia Europe were considerably larger than their andHerzegovina,Croatia,theCzechRepublic, counterpartsintheBalticsandtheCIS.Private the Kyrgyz Republic, Poland, the Slovak banks in the CIS showed very little capital at Republic,andUkraine--stateorprivatebanks, the end of 2000, and the total private bank cap- or both, may be undercapitalized. ital in all CIS countries was only $14.8 billion, equivalenttothetotalinPolandandtheCzech Asset Quality Republic alone. Moreover, Russia accounted for $12.5 billion of it. Badloansintransitioneconomiesamountedto Statebanksshowlowratiosofcapitaltoassets a troubling $26 billion at the end of 2000, equal in most transition economies (exceptions are to about 16 percent of total loans (table 4.8).33 Belarus, Romania, and Uzbekistan). Capital- Nearly $19 billion of these loans were in CEE to-assetratiosforstatebanksaveraged3.3per- banks, and less than $7 billion in CIS banks. cent at the end of 2000, only about a quarter of ThefigurefortheCISmaybeunderstated,how- averageratiosforprivatebanks,at12.5percent ever,assomeCIScountriesreportedsuspiciously (table4.7).Capitalratioscannotautomatically lowlevelsofbadloans.Forexample,Uzbekistan be associated with risk or asset quality--banks reported 0 percent nonperforming loans, and with high ratios can be insolvent, while banks Turkmenistan only 0.5 percent. with relatively modest ratios might be more There is also the larger issue of bad credit in financiallysound.Evenso,the3.3percentaver- the economy as a whole. Bad credit often exists STATE BANKS SINCE 1995: CONTINUING PROBLEMS 57 TABLE 4.7 Bank Capital-to-Asset Ratios inTransition Economies, End-2000 Total capital Total assets Capital-to-asset ratio (millions of (millions of State banks Private banks Country U.S. dollars) U.S. dollars) (percent) (percent) Albania 292 1,993 1.7 13.0 Armenia 27 348 0.0 7.8 Azerbaijan 184 1,010 1.9 16.3 Belarus 378 2,207 14.5 2.6 Bosnia and Herzegovina 298 2,774 3.5 7.3 Bulgaria 1,027 4,622 2.2 20.0 Croatia 1,976 13,521 3.4 11.3 Czech Republic 5,335 49,265 2.3 8.5 Estonia 408 3,162 0.0 12.9 Georgia 100 322 0.0 31.1 Hungary 2,404 24,714 2.0 7.7 Kazakhstan 794 3,302 2.3 21.7 Kyrgyz Republic 11 96 1.5 10.4 Latvia 305 4,017 0.5 7.1 Lithuania 307 3,025 1.1 9.1 Macedonia, FYR 404 1,279 0.3 31.3 Moldova 90 323 1.2 26.6 Poland 12,758 87,744 2.1 12.4 Romania 594 7,607 9.1 ­1.3 Russian Federation 15,317 61,573 4.6 20.2 Slovak Republic 2,699 15,252 3.9 13.8 Slovenia 1,693 12,847 5.3 7.9 Tajikistan -- -- -- -- Turkmenistan 21 2,075 1.0 -- Ukraine 1,225 5,799 1.0 20.1 Uzbekistan 851 4,432 19.2 -- Yugoslavia -- -- -- -- Total 49,496 313,309 3.3 12.5 Central and Eastern Europe 29,480 221,618 2.8 10.5 Baltics 1,020 10,204 0.5 9.5 Commonwealth of Independent States 18,997 81,487 5.2 18.2 -- Not available. Note: Data are for 2000 unless not available (in which case data for 1999 were used). Capital is capital accounts plus or minus other items net.The state share of capital is based on state bank statements, with the private bank share accounting as the remaining amount. A statistical irregularity should be noted for Romania, accounting for the negative percent for private banks. No reliable data are available for Tajikistan or Yugoslavia. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); authors' calculations. outsidethebankingsystemintheformofarrears billioninbadloans.Datafor2000forthemajor to utility companies, fiscal accounts, employee statebanksreportinginthesecountriesshowed wage accounts, and obligations to other enter- loanlossreservesintherangeof5­15percent.35 prises.34Arrearsareparticularlyproblematicin Further deterioration would probably trigger CIS countries and to a lesser degree in many of a need for additional injections of capital. the Balkan states (see annex 6). Overall ratios of bad loans to capital While the bad loans were equivalent to only exceeded 75 percent for several countries in 12.5 percent of total deposits, the amount was 2000, including Azerbaijan, Bosnia and more than half the total bank capital in tran- Herzegovina, the Czech Republic, the Kyrgyz sition economies. This high ratio of bad loans Republic, the Slovak Republic, and Ukraine. to capital again points to the risk of under- Some of these countries have already taken capitalization.Theproblemappearstobemost or are planning corrective measures. Bosnia acute in the Czech Republic, Poland, and and Herzegovina is liquidating and privatiz- Russia, where banks hold an estimated $18.2 ing many of its remaining state banks. The 58 CHAPTER 4 TABLE 4.8 Bad Loans and Bad Loan Ratios inTransition Economies, End-2000 Value of Number of loans bad loans State Private (millions of Bad loans as a percentage of Country Total bank bank U.S. dollars) Total loans Deposits Capital Albania 182 10 172 77 42.6 4.8 26.5 Armenia 0 0 0 0 6.2 0.0 0.0 Azerbaijan 446 184 262 166 37.2 30.4 90.3 Belarus 1,254 1,075 179 191 15.2 16.5 50.5 Bosnia and Herzegovina 2,052 89 1,963 322 15.7 38.6 108.1 Bulgaria 1,970 343 1,627 215 10.9 7.7 20.9 Croatia 7,258 647 6,611 1,430 19.7 17.7 72.4 Czech Republic 26,483 3,752 22,731 5,111 19.3 15.6 95.8 Estonia 1,332 0 1,332 20 1.5 1.3 4.9 Georgia 226 0 226 13 5.6 8.1 12.7 Hungary 4,469 599 3,870 139 3.1 0.8 5.8 Kazakhstan 2,338 385 1,953 136 5.8 6.8 17.1 Kyrgyz Republic 56 2 54 9 16.4 13.5 83.5 Latvia 1,399 149 1,250 88 6.3 6.1 28.9 Lithuania 1,377 201 1,176 149 10.8 7.6 48.5 Macedonia, FYR 643 8 635 173 26.9 32.6 42.8 Moldova 182 13 169 38 20.6 22.1 41.9 Poland 50,328 10,179 40,149 8,002 15.9 12.7 62.7 Romania 2,641 1,015 1,626 100 3.8 1.6 16.9 Russian Federation 33,420 10,234 23,186 5,113 15.3 12.8 33.4 Slovak Republic 10,105 2,723 7,382 2,647 26.2 23.5 98.1 Slovenia 6,767 3,499 3,268 575 8.5 6.9 34.0 Tajikistan -- -- -- -- 10.8 -- -- Turkmenistan 1,884 1,803 81 9 0.5 44.8 44.8 Ukraine 3,815 322 3,493 1,240 32.5 101.2 101.2 Uzbekistan 2,525 2,525 0 0 0.0 0.0 0.0 Yugoslavia -- -- -- -- 27.8 -- -- Total 163,152 39,757 123,395 25,963 15.9 12.5 52.5 Central and Eastern Europe 112,898 22,864 90,034 18,792 16.6 12.3 63.7 Baltics 4,107 350 3,757 257 6.3 5.2 25.2 Commonwealth of Independent States 46,147 16,543 29,603 6,914 15.0 13.7 36.4 -- Not available. Note: Data on bad loans are for 2000 unless not available (1998 data were used for Latvia,and 1999 data forAzerbaijan,Kazakhstan,andTurkmenistan). Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); EBRD; authors' calculations. Czech Republic has privatized Komercni. The bad loans represent for banks and the effect of Kyrgyz Republic has essentially placed Kairat weak earnings on banks' ability to modernize. Bank under administration. And the Slovak Considerablecapitalinvestmentisstillneeded Republic has successfully privatized VUB. In inCentralandEasternEuropewherebadloans Ukraine, however, problems remain with sev- accounted for 64 percent of capital at the end eral banks, including possible risks associated of 2000, although modernization efforts are with the recently intensified lending activi- already well under way in many countries. ties of the wholly state-owned Oschadny Bank The CIS countries face greater obstacles (box 4.1 and case study on Oschadny Bank). to modernization. To begin with, the lower Thedataonbadloanssuggestthattheprob- ratio of bad loans to capital in these countries lem is not an issue just for state banks but also may well be an error. It probably reflects an for private banks. That raises several concerns understatement of bad loans.36 Moreover, it for countries seeking to modernize their bank- says nothing about the problem of the system ing sector, including the drag on earnings that of barter and arrears that has functioned STATE BANKS SINCE 1995: CONTINUING PROBLEMS 59 BOX 4.1 Ukraine's Oschadny Bank: Becoming Competitive--or Risking Failure and Crisis? Oschadny Bank's asset size and retail network make it one of the largest banks in Ukraine. In late 2000 it had about 35,000 employees and controlled 25­30 percent of household deposits. Still, total household deposits amounted to only about $330 million in late 2000,small for a country of 50 million people.Thus while Oschadny is perceived as large in Ukraine,its significance in aggregate intermediation is small,reflecting the relative insignif- icance of banking and financial intermediation in the economy. Like other state and quasi-state banks, Oschadny saw its financial situation deteriorate in the late 1990s. There are several reasons for this. Excessive branches and personnel and other operating inefficiencies have led to high operating costs. Government-directed lending has damaged the bank's loan portfolio, reduced earnings ratios, and led to after-tax losses. The bank faces ongoing governance problems--central and regional governments are involved in decisionmaking, and key business groups connected to the bank's man- agement and related authorities also intervene, with a complete lack of transparency.The government is unable or unwilling to honor its financial obligations to the bank, whether payments on guarantees or capital contributions.And the bank has been slow to upgrade its management and information technology systems to lower costs--and slow to enforce central policies in its regional offices. Oschadny suffered after-tax losses of $22 million in 2000, and there are concerns that its losses since may have been even more severe or that earnings may be artificially inflated by questionable loan classification practices. Meanwhile, despite its portfolio problems and its orientation as a traditional savings bank, Oschadny expanded lending rather than pursue a more prudent course of taking corrective action. In addition, in mid- 2000 Oschadny was appointed by the government as the authorized bank to service clearing accounts of electricity utility companies and their branches. Oschadny performed this responsibility until October 2001. The losses that might have arisen from these operations and from the incremental lending remain to be seen. Whether the problem of Oschadny can be solved depends largely on Ukrainian authorities' willingness and ability to take prompt action. Although strict market logic argues for closing the bank, its crucial place in Ukraine's social fabric makes that solution unlikely in the foreseeable future.To reverse current losses, the bank's management has pursued a cost reduction strategy, releasing staff and closing some nonviable offices (148 branches and 2,933 operational offices between January 1, 1998, and December 31, 2000). Despite these moves, it remains questionable whether Oschadny can become competitive without a big push to accelerate restructuring and reduce cost coupled with significant government assistance.Preliminary estimates in early 2001 showed that Oschadny would need to reduce its costs by about 40 percent to achieve breakeven. The key is to avoid using Oschadny as a quasi-fiscal institution or as a vehicle for directed lending--as has so often been done in the past. These practices subject the institution--and the government, as its sole shareholder--to a high level of financial risk.At a minimum, firewalls and safeguards need to be put into place to ensure that Oschadny's decisionmaking is grounded in commercial principles."Social" or "governmental" activity should be off­balance sheet and subject to commercial pricing.Any lending or investment should be explicitly guaranteed so that Oschadny assumes no risk. The depth of Oschadny's financial distress raises a risk that the bank will seek to grow out of its prob- lems, attempting to leapfrog from specialized savings bank to full-service universal bank.That move would be premature given the bank's weak financial condition and limited institutional capacity. Oschadny might be tempted to assume excess risk so as to generate high earnings and reverse its accumulated losses.The risk of adverse selection under those circumstances would be high, especially since the bank does not accurately measure risk and return. almost in parallel with the formal banking shortage of the financial resources needed and fiscal systems for nearly a decade. Thus to develop modern, competitive banking sys- while bad loans may be only about 14 per- tems. Until these issues are addressed and cent of deposits and 37 percent of capital in confidence is gradually restored, the CIS will the CIS countries, deposits and capital are continue to lag behind Central and Eastern also lower than in other transition economies. Europe and the Baltics, notwithstanding its Thus the CIS countries face an even greater lower bad loan ratios. 60 CHAPTER 4 Earnings Performance and Solvency Issues Croatia, Hungary, Kazakhstan, the Kyrgyz Republic, and Romania. Since then, some of Earnings performance has varied among state the loss-makers have been privatized (Bank banks. After-tax earnings among state banks Agricola in Romania, Dubrovacka in Croatia) in Central and Eastern Europe and the Baltic or placed under administration (Kairat in the markets were generally poor in 2000, while Kyrgyz Republic). Several other state banks earnings in the CIS countries were buoyed by that showed low earnings have also been pri- the results of Sberbank of Russia. Sberbank's vatized (Komercni in the Czech Republic). earnings performance was supported in part The $152 million in after-tax income byareboundincommoditypricesandimprove- appears particularly modest given the num- ments in several CIS economies (such as ber of major state banks in 2000 and the size Kazakhstan, Russia, and Ukraine). But there of some of them.38 Banks' average after-tax are questions about the accuracy of the CIS earnings were only $1.4 million, far short of earnings data because of the weak loan clas- what is needed to modernize and become glob- sificationstandards,pooraccountingandaudit- ally competitive. Moreover, netting out the ing practices, and investors' general view that $843 million for the four banks with more than risk-related information is insufficiently dis- $100 million in after-tax earnings in 2000 and closed. These problems make it difficult to offsetting the $681 million in losses in ascertain the real earnings of CIS state banks Yugoslavia leaves the other state banks with as well as measures of returns. These caveats essentially flat net earnings (a $10 million loss need to be taken into account in interpreting across100banks).Theaveragereturnonassets the earnings performance of CIS state banks. was only 0.2 percent for state banks, well below CIS state banks reportedly generated $710 the 2­3 percent norms in OECD markets. million in after-tax earnings in 2000, most of it State banks (excluding those in Yugoslavia) in Russia (table 4.9). These figures represent had a total net capital increase of $1.7 billion a 2.1 percent return on assets and a 19.3 per- in 2000, well above the reported $152 million cent return on equity. By contrast, state banks inafter-taxearnings(table4.10).Thatsuggests in Central and Eastern Europe (excluding thatstatebanksincreasedcapitalfromretained Yugoslavia)generatedonly$118millioninafter- earnings as well as from other sources. In stark tax earnings, about $2 million per state bank. contrast, however, is the increase in capital for The return on assets was only 0.2 percent, and private banks, which, at $5.8 billion, was about the return on equity 2.0 percent. If Yugoslavia 3.4 times that for state banks. The capital isincludedinthesemeasures,theyallturnneg- increase for private banks probably represents ative, as table 5.11 shows.37 The Baltic state a combination of retained earnings and direct banks showed better returns on assets and investment. For state banks direct investment equitybutonly$5millioninafter-taxearnings. remainsamoredifficultprospectgiventhepre- Total after-tax earnings in the transition carious monetary and fiscal positions in many economies, based on reports from about 65 economieswherethesebanksplayaprominent state banks, were about $152 million in 2000. role. Moreover, the capital increase for private Thisfigureisabout$170millionlessthanother banksshouldnotbeoverstated.Dividedamong estimates from varied sources. Regardless of the 2,181 private banks operating in transition the figure used, there was clearly a high con- economies in 2000, it amounted to an average centration of profits, with only three banks netcapitalincreaseofonly$2.6million,farless generating more than $100 million in after- than the average of $15.7 million for state tax earnings. State banks in several countries banks.39 Even when Sberbank's approximately showed losses in 2000, including those in $315 million capital increase is netted out,40 STATE BANKS SINCE 1995: CONTINUING PROBLEMS 61 TABLE 4.9 After-Tax Earnings and Return Measures for State Banks inTransition Economies, End-2000 After-tax earnings Return on Return on (millions of assets equity Country U.S. dollars) (percent) (percent) State banks included in the data Albania 26 2.1 ­173.3 Savings Bank Armenia 0 0.0 0.0 Armenia Savings Banka Azerbaijan 10 2.1 55.6 IBA, United Universal Belarus 10 0.6 2.8 Belpromstroibank, Belagroprombank, Belbusinessbank, Belgazprombank, Belarusbank, Belvnesheconombank Bosnia and Herzegovina 2 0.6 1.5 Investment Bank, Central Profit Bank, Gospodarska, Privredna Bulgaria 13 1.5 12.4 DSK, Biochim, Central Cooperative Croatia ­33 ­2.2 ­6.9 Dubrovackaa, Croatia Bankaa, Croatian Bank for Reconstruction and Development, Hrvatska Postanska Czech Republic 16 0.1 1.4 Komercnia, Ceskomoravska Zarucni, Ceska Exportni Estonia 0 0.0 0.0 No state banks Georgia 0 0.0 0.0 No state banks Hungary ­17 ­0.8 ­3.9 Magyar Fejlesztesi, Postbank Kazakhstan ­5 ­0.8 ­6.7 Export-Import Bank, Halyk Kyrgyz Republic ­1 ­11.1 ­82.5 Kairat, Energo Bank Latvia 3 0.9 14.6 Latvian Mortgage and Land Bank, Latvian Savings Bank Lithuania 2 0.5 6.5 Agricultural Bank Macedonia, FYR 0 0.0 0.0 Macedonian Development Bank (estimated) Moldova 3 10.7 136.4 Banca de Economii Poland 19 0.1 1.0 PKO BP, BGZ, National Economy Bank, Bank Ochrony Srodowiska Romania ­90 ­1.8 ­17.2 Banca Agricola (1999)a, BCR, CEC, EXIMBank Russian Federation 577 2.4 24.2 Sberbank, Medium- & Long-Term Credit Bank, Vnesheconombank, Russian Bank for Development Slovak Republic 101 2.0 17.5 VUBa, Investicna a Rozvojova, First Building Savings, Slovenska Zarucna a rojvojova, Banka Slovakia, Exportno-Importna Slovenia 81 1.1 12.0 Nova Llubljanska, Nova Kreditna Maribor, Postna Banka, Slovene Export Corporation, Slovenska Investicijska Tajikistan -- -- -- Insufficient data available Turkmenistan 3 0.2 15.4 Bank for Foreign Economic Affairs Ukraine 9 1.3 17.0 Ukreximbank, Oschadny Uzbekistan 104 2.3 13.5 State Housing Savings Bank, Asaka, Uzpromstroybank, National Bank for Foreign Economic Activity Yugoslavia ­681 -- -- Insufficient data on banks available Total 152 0.2 1.6 Central and Eastern Europe ­563 ­1.0 ­9.7 Baltics 5 0.7 9.7 Commonwealth of Independent States 710 2.1 19.3 -- Not available. a.These banks have been privatized or liquidated since the end of 2000. Note: Data are for 2000 unless not available (in which case data for 1999 were used). No reliable data are available forTajikistan. Profits for several banks were derived by applying the return on assets to average assets for 1999­2000. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); authors' calculations. 62 CHAPTER 4 TABLE 4.10 Capital Increases for Banks inTransition Economies, 1999­2000 (millions of U.S. dollars) Private banks State banks Total 1999 2000 Net 1999 2000 Net net Country capital capital increase capital capital increase increase Albania 326 259 ­67 ­63 33 96 29 Armenia 36 27 ­10 0 0 0 ­10 Azerbaijan 15 0 ­15 12 19 7 ­8 Belarus 89 57 ­33 404 321 ­83 ­116 Bosnia and Herzegovina 152 202 50 102 96 ­6 44 Bulgaria 916 925 9 94 102 8 17 Croatia 1,451 1,522 71 504 454 ­50 21 Czech Republic 5,957 4,191 ­1,766 1,130 1,144 14 ­1,752 Estonia 374 408 34 0 0 0 34 Georgia 95 100 5 0 0 0 5 Hungary 2,042 1,980 ­62 362 504 142 80 Kazakhstan 524 718 194 74 76 2 196 Kyrgyz Republic 9 10 1 1 1 0 2 Latvia 169 284 115 20 21 1 116 Lithuania 252 275 23 30 32 2 25 Macedonia, FYR 392 400 8 4 4 0 8 Moldova 71 86 15 0 4 4 19 Poland 8,332 10,901 2,569 1,771 1,857 86 2,655 Romania 175 ­96 ­271 356 690 334 63 Russian Federation 8,265 12,468 4,203 1,914 2,849 935 5,138 Slovak Republic 1,679 2,111 432 573 588 15 447 Slovenia 1,045 1,012 ­33 668 681 13 ­20 Tajikistan -- -- -- -- -- -- -- Turkmenistan -- -- -- 18 21 3 3 Ukraine 870 1,165 295 46 60 14 309 Uzbekistan -- -- -- 695 851 156 156 Yugoslavia -- -- -- -- -- -- -- Total 33,235 39,003 5,768 8,715 10,408 1,693 7,461 Central and Eastern Europe 22,467 23,407 940 5,501 6,153 652 1,592 Baltics 795 967 172 50 53 3 175 Commonwealth of Independent States 9,973 14,629 4,656 3,164 4,202 1,038 5,694 -- Not available. Note: Data are for 2000 unless not available (in which case data for 1999 are used). No reliable data are available for banks inTajikistan andYugoslavia or for private banks in Turkmenistan and Uzbekistan. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); authors' calculations. state banks still showed average increases of technologies, perpetuating inefficiencies that about $12.9 million in 2000.41 make it difficult for these banks to compete While the after-tax earnings of state banks without preferential treatment or protection. were positive, this does not account for tax Many countries appear to have recognized breaks, forbearance, and other forms of "cor- the need to address undercapitalization as a rective action" needed to improve their sol- fundamental step in reversing financial weak- vencyandliquiditypositions.Thissuggeststhat ness and helping to build sound financial sys- thereislittleornoinvestmentinterestinthese tems. Total assets for banks in transition banksshortofprivatization,andkeepingthem economies increased from 1999 to 2000. Banks afloatasgoingconcernswillcontinuetorequire in Poland and Russia were responsible for tax breaks, forbearance, and similar benefits. most of the asset growth in 2000, while those Moreover,manyofthesebankshaveheavyper- in the Czech Republic and Hungary experi- sonnel loads and limited investment in new enced major declines in assets (table 4.11). STATE BANKS SINCE 1995: CONTINUING PROBLEMS 63 TABLE 4.11 Asset Increases for Banks inTransition Economies, 1999­2000 (millions of U.S. dollars) Private banks State banks Total 1999 2000 Net 1999 2000 Net net Country assets assets increase assets assets increase increase Albania 684 763 79 1,197 1,230 33 112 Armenia 279 339 60 9 9 0 60 Azerbaijan 423 357 ­66 307 653 346 280 Belarus 369 505 136 1,836 1,702 ­134 2 Bosnia and Herzegovina 2,775 2,490 ­285 259 284 25 ­260 Bulgaria 3,712 3,691 ­21 795 931 136 115 Croatia 10,679 12,046 1,367 1,564 1,475 ­89 1,278 Czech Republic 40,400 36,508 ­3,892 11,975 12,757 782 ­3,110 Estonia 2,725 3,162 437 0 0 0 437 Georgia 255 322 67 0 0 0 67 Hungary 24,607 22,783 ­1,824 2,076 1,931 ­145 ­1,969 Kazakhstan 1,712 2,533 821 477 769 292 1,113 Kyrgyz Republic 84 87 3 9 9 0 3 Latvia 2,797 3,648 851 265 369 104 955 Lithuania 2,322 2,608 286 384 417 33 319 Macedonia, FYR 1,202 1,265 63 14 14 0 63 Moldova 231 288 57 21 35 14 71 Poland 55,494 64,429 8,935 20,751 23,315 2,564 11,499 Romania 2,656 3,043 387 5,296 4,564 ­732 ­345 Russian Federation 36,039 34,392 ­1,647 21,367 27,181 5,814 4,167 Slovak Republic 10,144 10,341 197 5,458 4,911 ­547 ­350 Slovenia 5,685 5,659 ­26 7,022 7,188 166 140 Tajikistan -- -- -- -- -- -- -- Turkmenistan -- -- -- 1,827 2,075 248 248 Ukraine 3,470 5,009 1,539 586 790 204 1,743 Uzbekistan -- -- -- 4,703 4,432 ­271 ­271 Yugoslavia -- -- -- -- -- -- -- Total 208,744 216,268 7,524 88,198 97,041 8,843 16,367 Central and Eastern Europe 158,038 163,018 4,980 56,407 58,600 2,193 7,173 Baltics 7,844 9,418 1,574 649 786 137 1,711 Commonwealth of Independent States 42,862 43,832 970 31,142 37,655 6,513 7,483 -- Not available. Note: Data are for 2000 unless not available (in which case data for 1999 were used). No reliable data are available for banks in Tajikistan and Yugoslavia or for private banks in Turkmenistan and Uzbekistan. Source: IMF, International Financial Statistics; BankScope (Fitch IBCA); authors' calculations. In Russia, however, the assets of private banks But these are not viewed as major competitors to declined, while those of state banks grew. In the private banking system. Poland private banks were the primary dri- 2. Armenia's last state-owned bank, the vers of the growth in assets, although state Armenian Savings Bank, was privatized in 2001. banks also showed increases. Overall, state Before that, four other state banks had been reha- banks had greater asset growth than private bilitated by 1998 and subsequently privatized. banks, the inverse of what happened in cap- 3. These figures are based on EBRD estimates ital growth. ofstatebankassetsasashareoftotalbankassetsand differ from tallies from the financial statements of Notes state banks. For example, in 2000 state banks' finan- cial statements showed assets approximating $108 1. Hungary, Poland, and the Czech and Slovak billion. With figures from the IMF's International Republicsallhaveother,smallerstate-ownedbanks. Financial Statistics used as the denominator, this 64 CHAPTER 4 would mean that state banks had a slightly larger 11. $82 billion/$255 billion = 32.1 percent. share of total banking system assets than reflected 12. $5.4billion/$10.0billion=54.0percent.The intheEBRDestimates.Butmanyoftheseadditional state banks with more than $500 million in capital assets are in banks that are being liquidated, such as were (from high to low) Vneshtorgbank in Russia, more than $6 billion in major banks in Yugoslavia. Sberbank in Russia, National Bank for Foreign Thus the figure is probably closer to about $100 bil- Economy in Uzbekistan, Komercni in the Czech lion, but could be closer to the $88 billion estimate Republic, PKO BP in Poland, and BCR in Romania. onceadjustmentsaremadeforwrite-offsandthelike. 13. Lithuania can be included only if deposits in 4. Albania, Bosnia and Herzegovina, the Slovak the Savings Bank are combined with those in the Republic, and Yugoslavia had high shares of state stillstate-ownedAgriculturalBank.TheSavingsBank ownership of bank assets (more than 50 percent) ofLithuaniahasbeenprivatizedsincetheendof2000. in 2000, but privatization and liquidation have since 14. This figure differs slightly from some of the reduced these shares. loan figures above because of differences in sources 5. $108 billion/$768 billion = 14.1 percent. andmethodologies.Butthedifferencesarenotcon- 6. $46 billion/$768 billion = 6.0 percent. These sidered material for purposes of the analysis. figures include the $6 billion or so in loans reported 15. $82,537/$228,717 = 36.1 percent. by the big banks in Yugoslavia. These loans are 16. $51,521/$82,537 = 62.4 percent. excluded from several tables because of the liqui- 17. Banks that accounted for a major share of dation process in place for these banks. If the $6 the net domestic credit in these countries in 2000 billion is excluded, the ratio is only 5.2 percent. include Komercni (Czech Republic), Nova 7. $32.6billion/$46.3billion=70.5percent.The Ljubljanska(Slovenia),VUB(SlovakRepublic),and banks with more than $1 billion in loans were (from the National Bank for Foreign Economic Activity high to low) Sberbank in Russia, PKO BP in Poland, (Uzbekistan). Komercni in the Czech Republic, Nova Ljubljanska 18. These averages assume 108 state banks and in Slovenia, National Bank for Foreign Economy in 2,181 private banks at the end of 2000. In fact, there Uzbekistan, BGZ in Poland, VUB in the Slovak weremorethan108statebanks,buttheserepresent Republic, Vneshekonombank in Turkmenistan, themajorstatebanks.Theotherswereprimarilythe Beogradska Bank in Yugoslavia, and Jugobanka in nearly 700 banks in which nonprivate authorities in Yugoslavia. Noteworthy is the number of banks with Russia held shares. The number of private banks is large assets that do not have major loan exposures estimated from the total recorded in the EBRD's on their books. TransitionReport2001lessthe108majorstatebanks. 8. $82 billion/$768 billion = 10.7 percent. 19. Three sources of data are used for bank 9. $67.0 billion/$82.5 billion = 81.2 percent. The assets--the IMF, International Financial Statistics, majorstatebankswithmorethan$1billionindeposits theEBRDTransitionReports,andBankScope(Fitch at the end of 2000 were (from high to low) Sberbank IBCA)--of which the last two are used for state inRussia,PKOBPinPoland,KomercniintheCzech banks. The data are not always identical, and mar- Republic, Nova Ljubljanska in Slovenia, BGZ in ginal differences appear among some of the tables Poland,VUBintheSlovakRepublic,Vneshtorgbank as a result. However, as with other balance sheet in Russia, Vneschekonombank in Russia, National measures, the differences are not considered mate- Bank for Foreign Economy in Uzbekistan, Banca rial for the analysis. Comerciala in Romania, Moscow Municipal Bank in 20. $82,537 million/$96,426 million = 85.6 Russia, Nova Kreditna Maribor in Slovenia, Savings percent. Bank in Albania, and SKB in Slovenia. 21. $58,600 million/$96,426 million = 60.8 10. $255 billion/$768 billion = 33.3 percent. percent. Data for Turkmenistan are for 1999, while those for 22. $63,253 million/$96,426 million = 65.6 all other countries are for 2000. percent. STATE BANKS SINCE 1995: CONTINUING PROBLEMS 65 23. The average asset size of CIS state banks 34. For more on this topic see Siegelbaum and would be considerably smaller if the nearly 700 others (2002). banks in which the Russian government, central 35. For example, Komercni (Czech Republic) bank, or other public sector agencies had a minor- reported loan loss reserves of 14.03 percent of gross ity share were included in the denominator. loans at the end of 2000, little changed from 14.56 24. Differences between this figure for total percent at the end of 1999. Sberbank's loan loss state bank deposits and those elsewhere in this reserves were 11.96 percent of gross loans at the report reflect issues in Lithuania, Slovenia, and end of 2000, down from 18.41 percent in 1999. Yugoslavia. The higher figures for deposits include Meanwhile, in Poland, PKO BP reported loan loss the now private Savings Bank in Lithuania. They reserves of less than 5 percent, and BGZ had no may reflect some double counting of deposits in data available but reported a reversal of provisions Slovenia. And they include deposits in Yugoslavia's on its income statement in 2000. This suggests that major banks that are excluded from the lower fig- the bad loan problem in Poland might be a greater ures because of the liquidation process under way. issue for private banks than for state banks. 25. $47,538 million/$77,153 million = 61.6 36. This problem is not restricted to the CIS. percent. While the bad loan ratio for Yugoslavia increased 26. Sberbank alone accounted for about three- in 2000 from earlier years (implying more overt quartersofthedomesticcurrencydepositsandabout recognition of bad loan problems), at 27.8 percent half the hard currency deposits in Russia in late it is understated relative to the billions of dollars 2001. in loans that may eventually be written off with 27. Average deposits in CEE state banks the liquidation of the major banks. increased by $161 million from 1995 to 2000, while 37. Beobanka Belgrade reported an estimated those in CEE private banks increased by $114 mil- $500 million in after-tax losses in 2000, and Invest lion. Banka $181 million in losses. These losses alone 28. $19 billion/$117 billion = 16.3 percent. CEE would turn the region's earnings into net losses. countries had higher levels of nonperforming loans 38. Komercni,PKOBP,andSberbankcombined than the Baltic states. for only $568 million in after-tax earnings on $45 29. $19 billion/$158 billion = 12.1 percent billion in average assets in 2000. That return on 30. Capital is net, derived from the IMF's assets is only 1.3 percent, suggesting high costs, International Financial Statistics by subtracting weak operations, inefficient use of assets, and insuf- (or adding, if positive) "other items net" from ficient earnings from other sources and activities. "capital accounts" for banking and deposit-taking 39. Private: $5,768 million/2,181 = $2.6 million. institutions. State: $1,693 million/108 = $15.7 million. 31. $23,327 million/$39,088 million = 59.6 40. Equity-to-asset ratio in 2000 was 7.55 per- percent. cent on $20 billion in total assets = $1,510 million 32. Government securities are usually assigned in equity. Equity-to-asset ratio in 1999 was 7.47 per- a zero risk weight for regulatory capital (capital cent on $16 billion in total assets = $1,195 million adequacy) purposes. But several countries (includ- in equity. Therefore, Sberbank's equity increased ing Russia and Ukraine) have defaulted on their about $315 million. domestic debt, suggesting that zero risk weights 41. $1,378 million/107 = $12.9 million. Mean- should not be automatic and that capital should while, PKO BP ($139 million) and Komercni ($43 therefore be higher. million) accounted for $182 million of the remain- 33. BadloanpercentagesarebasedonanEBRD ing $1,378 million in state banks' capital increases. survey of central banks. They refer to substandard, Thus excluding Sberbank, PKO BP, and Komercni, doubtful, and loss loans as a percentage of total state banks averaged about $11.4 million in net cap- loans. ital increases in 2000. 66 CHAPTER 4 Chapter 5 The Costs of Delay and Approaches to Reform T he role of state banks as overdraft The Costs of Maintaining the providers for troubled state farms State Bank System and enterprises in transition econo- mies has steadily diminished over the years, Continued state ownership in the banking sys- though in response to different conditions. tem has often been harmful to transition In most CEE and Baltic countries such lend- economies. The presence of state banks has ing declined once new prudential norms deterredprime-ratedforeigninvestmentfrom were introduced and enforced and as banks the banking market, and the potential distor- recognized the need to recapitalize. The tions resulting from patronage or preferential banks saw that continuing to lend to trou- treatment of state banks have deterred these bled enterprises would only jeopardize their and other banks from taking on more risk. ability to comply with tighter prudential reg- Consequently, in countries where state banks ulations, while investing in government secu- continue to play a prominent role, lending has rities was a far easier way to generate the tendedtobescarcerandcostlierforenterprises. profits. The changes in lending behavior in That has undercut financial intermediation: these countries have coincided with an because enterprises find it difficult or uneco- improvement in the legal and institutional nomical to borrow from banks, they have less environment for creditors, resolution of incentivetoplacefundswithbanks.Mostcoun- problem assets, and enhanced financial trieswithextensivestateownershipinthebank- discipline among private borrowers. The ingsystemhavehadlargenetspreadsbetween result of all this has been stronger returns loan and deposit rates that make borrowing and capital positions for banks, greater com- costly for enterprises (table 5.1). petition, a wider array of financial products, It is recognized, however, that poor portfo- and improved service. lio quality and high intermediation costs are By contrast, in CIS countries lending to not only a function of ownership, but also are all sectors has eroded. Meanwhile, there has a function of the macroeconomic framework been no improvement in the environment for and standards of governance. In several coun- creditors or debtors, nor has confidence tries where state ownership of bank assets fully returned after hyperinflation and has declined in recent years, nonperforming numerous banking crises. All this has led to loans and net spreads have stayed high or a weaker deposit and capital base for banks, increased (examples are Albania, Croatia, much lower financial intermediation, a lim- Georgia,theKyrgyzRepublic,FYRMacedonia, ited range of financial products, and poor Moldova, Romania, and Ukraine). Part of this service. has to do with banks' need to increase earn- 67 TABLE 5.1 State Ownership of Banks and Net Spreads inTransition Economies, SelectedYears, 1996­2000 (percent) 1996 1998 2000 State State State ownership ownership ownership share of Net share of Net share of Net Country banks spreads banks spreads banks spreads Albania 93.7 7.2 85.6 8.5 64.8 13.8 Armenia 3.2 34.2 3.7 23.6 2.6 13.5 Azerbaijan 77.6 20.0 65.5 16.8 60.4 15.0 Belarus 54.1 29.9 59.4 12.7 66.0 30.1 Bosnia and Herzegovina -- -- -- 21.6 55.4 15.8 Bulgaria 82.2 48.8 56.4 10.3 19.8 8.4 Croatia 36.2 16.9 37.5 11.1 5.7 8.3 Czech Republic 16.6 5.8 18.6 4.7 28.2 3.7 Estonia 6.6 7.6 7.8 8.6 0.0 3.9 Georgia 0.0 27.3 0.0 30.0 0.0 28.6 Hungary 16.3 5.1 11.8 3.1 8.6 3.0 Kazakhstan 28.4 24.1 23.0 3.9 1.9 4.3 Kyrgyz Republic 5.0 28.3 7.1 37.6 7.1 33.5 Latvia 6.9 14.1 8.5 9.0 2.9 7.5 Lithuania 54.0 7.6 44.4 6.2 38.9 8.3 Macedonia, FYR 0.0 8.0 1.4 9.4 1.1 7.7 Moldova 0.3 11.3 0.3 10.6 9.8 10.5 Poland 69.8 6.1 48.0 6.3 24.0 5.8 Romania 80.9 14.7 75.3 16.6 50.0 20.3 Russian Federation 37.0 91.7 41.9 24.7 41.9 17.9 Slovak Republic 54.2 4.6 50.0 4.9 49.1 6.4 Slovenia 40.7 7.5 41.3 5.5 42.2 5.7 Tajikistan 5.3 13.0 29.2 34.0 6.8 ­8.4 Turkmenistan 64.1 70.0 77.8 34.4 -- -- Ukraine -- 46.3 13.7 32.3 11.9 27.8 Uzbekistan 75.5 22.0 67.3 21.0 77.5 -- Yugoslavia 92.0 162.4 90.0 44.1 90.9 43.3 Regional averages Central and Eastern Europe 53.0 23.9 43.0 12.2 36.7 11.9 Baltics 22.5 9.8 20.2 7.9 13.9 6.6 Commonwealth of Independent States 31.9 34.8 32.4 23.5 26.0 17.3 -- Not available. Note: Countries for which no data are available are excluded from regional averages. Source: IMF, International Financial Statistics; EBRD; authors' calculations. ings to recapitalize, particularly as tougher be used for noncommercial purposes. In many prudential norms go into place and the gov- ofthelatereformingcountriesstatebanksstill ernment eliminates or reduces refinancing account for a large share of bank assets, loans, options for poorly performing banks. and deposits (though proper provisioning and write-down practices would reduce loan and The Costs of Delayed Reform in asset values considerably). Meanwhile, poor the Banking System asset quality undermines earnings perfor- mance, slows capital formation, and props up In most CIS countries and several non-CIS high real intermediation costs. countries needed banking reforms have been Delayed reforms in these countries have delayed, governance remains weak, and state generally been correlated with sluggish eco- banks (and some "private" banks) continue to nomic performance.1 Even where laws are 68 CHAPTER 5 TABLE 5.2 Arrears as a Share of GDP in SelectedTransition Economies, 1992­2001 (percent) Country 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Azerbaijan 60.6 100.2 68.3 96.8 148.2 166.1 200.0 215.6 -- -- Belarus -- -- 30.4 13.5 18.2 13.3 23.1 19.2 22.4 19.1 Bulgaria 68.8 60.6 47.5 41.7 66.3 27.9 24.1 19.9 -- -- Croatia -- -- 3.4 6.2 7.4 8.1 11.4 20.1 14.4 11.6 Kyrgyz Republic -- -- -- 7.3 -- -- -- 6.3 -- -- Lithuania -- -- -- -- 9.3 9.0 -- -- -- -- Romania 34.6 23.9 26.1 25.2 36.1 33.7 36.2 42.2 -- -- Russian Federation -- -- 14.8 13.3 23.4 29.1 47.8 30.3 23.7 -- Ukraine 8.0 6.0 13.0 20.0 24.0 85.0 98.0 -- -- -- -- Not available. Note: Enterprise arrears to government may not equal tax arrears, since tax arrears include those from households and enterprise arrears to gov- ernment can include other forms of arrears. Source: All data compiled by George Clarke from Tacis Programme (2000) for Azerbaijan; ECSPF (1998) and IMF (2000, 2002) for Belarus; IMF (2001) for Bulgaria;World Bank (2001) for Croatia; IMF (2000) for the Kyrgyz Republic; ECSPF (1998) for Lithuania; IMF (1998, 2001) for Romania; Bagratian and Gürgen (1997) and Russian-European Center for Economic Policy (2002) for Russia; and IMF (1999) for Ukraine. adequate, institutional capacity has been slow drop since 1997. Arrears to banks accounted to emerge. Many countries have not yet ade- for only a twentieth of the total, with the rest quatelyaddressedissuesoffinancialdiscipline, to suppliers, government, the state pension loan default, collateral, veracity of financial fund, employees, and other accounts. In information,andotherstaplesofmarket-based Croatia arrears amounted to nearly 12 per- banking. Where poorly performing banks have cent of GDP in 2001 and were as high as 20 failed as a result, public confidence in banks percent of GDP in 1999. More serious, has been undermined, particularly when peo- though, are arrears in Romania, which ple have lost their savings. climbed steadily to reach 42 percent of GDP Meanwhile, the delay in reform has allowed in 1999. Most are due to suppliers, govern- for a weak financial system overall and per- ment, and other accounts, with those due to mitted a wholesale shift away from formal banks equal to 6.4 percent of GDP. financial institutions in many CIS countries. The long-term overdue payables are symp- One sign of this is the huge stock of barter and tomatic of major problems in the payment arrears in the enterprise sector, equivalent to system. They also point to the cash con- many times the outstanding credit of banks. straints of enterprises, which continue to InUkraine,forexample,netenterprisearrears emphasize tax avoidance at the expense of are estimated at four to five times the total long-term performance and competitiveness. credit from banks to the enterprise sector, and Although most of these enterprises are state in 1998 arrears were estimated to be 98 per- owned, some are "privatized" but run accord- cent of GDP. In Russia arrears were estimated ing to earlier methods. These operating prac- to be nearly 24 percent of GDP in 2000, most tices have depleted cash and capital and of them to nonbank accounts (suppliers, tax reduced or eliminated creditworthiness as accounts, and off-budget funds). Similarly, measured by traditional commercial bank- Belarus has had arrears estimated at 19­23 ing standards. Moreover, the poor condition percentofGDPsince1998(table5.2;seeannex of enterprises has reduced tax payments, 6 for more detail). including for social insurance, exacerbating Nor has this problem been limited to CIS the poor state of public finances. countries. In Bulgaria state enterprise Where banks are still used for noncom- arrears amounted to about 20 percent of GDP mercial purposes, they are often state owned. in 1999, though that reflects a significant The banks' noncommercial approaches have THE COSTS OF DELAY AND APPROACHES TO REFORM 69 often been reminiscent of old-style manage- Approaches to Resolving Problem ment and governance--directed lending for Assets and Restructuring Banks-- political purposes, a traditional orientation and the Costs toward state farms and enterprises, and a socially oriented banking culture that finances Transition economies have taken different production to meet output targets, ensures approaches to solving the problem of bad loans that everyone has access to a bank branch, and andbuildingviablebankingsystems.Achieving maintains employment. Even where govern- these goals clearly depends on a multitude of ments have recognized the unsustainability of factors, not the least of which are stable busi- these banking approaches, they have often put ness environments, functioning institutions, offharddecisionstoprivatizeorliquidatethose stable macroeconomic frameworks, and cred- that are technically insolvent because of the itworthy and "equity worthy" enterprises and political difficulties associated with such steps. households. Trying to solve financial sector Thus in the end noncommercial banking problems in the absence of progress in the approaches have often led to a financial crisis enterprise sector has often led to frustrating in the banking system, high levels of corrup- results. Without a healthy enterprise sector, tion, and big costs for the government. And banks and other financial institutions have wheretraditionalsavingsbankshavebeenused been unable to prosper even when inflation for purposes other than savings (such as for rates have been stabilized, banks have been channeling loans that later became nonper- reformed, and funds are available for lending forming), this has raised concerns about and investment. deposit safety and public confidence in the Most CEE countries and the Baltic states banking system. have broadly addressed the fundamental weak- These problems point to weaknesses in nessesintheirfinancialsectors,withtheexcep- corporate governance structures. Perfor- tions of the Balkan countries that were torn by mance in corporate governance and the war. These countries are considered likely to be degree of preference for state banks has var- able to sustain financial sector stability, though ied from country to country and still remains there is always a potential for shocks and dis- weak in many cases. But countries have grad- turbances.Vulnerablearesmallopeneconomies ually recognized the need to address weak such as the Baltics, which can fluctuate from corporate governance as a precondition for year to year with economic developments in stable banking systems and to prevent major trading partners. And countries such as damaging bank collapses. Several countries Romaniafaceariskoffutureinstabilitybecause have taken concrete steps--improving the of delayed progress on structural reform, accounting framework, introducing tougher notwithstanding potentially large markets and requirements for internal operations, improvedeconomicperformance.Still,CEEand strengthening the internal audit function, Balticcountriesaregenerallyconsideredtohave restricting the issuance of banking licenses pushedaheadwithmanyofthereformsneeded when "fit and proper" standards are not met, to become competitive, driven by the lure of and calling for more professional standards accession to the European Union. and qualifications for board members. Much What have been the costs of the bad loans of this has contributed to strengthening mon- andthedelaysinresolvingstructuralproblems etary policy, enhancing banking supervision, in banking? Estimates have varied. One study implementing stricter prudential norms, and estimatedthecumulativecostsofbankrestruc- meeting requirements for increased inte- turing and deposit compensation in 1991­98 gration into the global marketplace. as29.6percentof1998GDPinFYRMacedonia, 70 CHAPTER 5 26.0 percent in Bulgaria, 20.9 percent in the italizedfourstate-ownedbanks).Butmanystate- Czech Republic, 18.4 percent in Kazakhstan, owned or formerly state-owned enterprises and 12.9 percent in Hungary.2 More recently, received bailouts through other means--bank the National Bank of Croatia estimated the rollovers of de facto nonperforming loans and cost of bank rehabilitation in that country at the run-up of arrears. These practices, still evi- about 26 percent of GDP from 1991 to 2000.3 dent in many state-owned banks,5 have under- Not all countries endured high explicit costs. mined efforts to achieve competitiveness in the Some,suchasEstonia,Lithuania,Poland,man- banking sector and the economy. agedtoworkoutproblemsovertime,whileoth- The practice of rollovers, rooted in impru- ers have experienced limited growth and dent loan classification and provisioning prac- development in their banking systems such as tices,hasdelayedrecognitionofassetproblems Georgia, the Kyrgyz Republic, and Latvia.4 thatultimatelydecapitalizedbanks.Oncesuch Among these countries the costs of bank problemswereuncovered,oftenthroughexter- restructuringanddepositcompensationranged nal audits according to international account- from0.1percentofGDPin1991­98inGeorgia ing standards, many CEE and Baltic banking to4.9percentintheKyrgyzRepublic.Butthese systems introduced stricter prudential frame- figuresdonotnecessarilytakeimplicitcostsinto works.Thesebankingsystemsgenerallymoved account.Theseincludehighernetspreads,for- on to restore confidence, improve credit man- gonelendingtosoundcompaniesforsoundpro- agement skills, boost resources and capital, jects, forgone GDP growth, and the diversion andbecomemoreeffectiveintermediaries.But of deposits from the banking system. wheretheseproblemshavenotbeenresolutely Whileestimatesofthecostsofbadloanshave addressed, nonperforming loans have reduced varied,thereisbroadagreementthatlong-term bank liquidity and capital. support has rarely succeeded without major financial,managerial,andoperationalrestruc- The Special Costs of Weak Laws turing. Several countries that deferred major and Regulatory Forbearance restructuringofbanks,experiencedsevereeco- nomic collapse late in the transition, such as Much of the problem for banks in lagging Moldova, Russia, and Ukraine and thus were economies has related to distortions in the unabletorelyonthefinancialsectorasasource credit markets. Most important has been the of stability. And several countries such as lack of support for secured transactions in the Bulgaria,Croatia,theCzechRepublic,Hungary, legalframework.Inmosttransitioneconomies Kazakhstanhavehadtorecapitalizebanksmul- bankruptcy legislation and enforcement have tiple times because initial measures proved been weak. Although some countries have insufficient(seecasestudyonCeskaSporitelna). made progress, building judicial capacity and Forthecountriesthatdidtakeaction,theques- restructuring incentives toward creditors (to tion is whether banking systems were ade- increasetheirwillingnesstoassumecreditrisk) quately restructured. Other countries that has taken time. Where the legal environment undertooklessexpensiverestructuring,suchas remains weak, banks' prospects for seizing and Estonia and Poland, did so only once and ulti- selling collateral to recover part of the value mately emerged as more competitive. ofbadloanshavebeenpoor.Nonetheless,most InmostCIScountriesenterprises,banks,and banks have assigned collateral higher values depositors were all left broadly exposed rather or inadequate risk weights relative to its real thanbailedoutthroughformalrecapitalization market value. That has led to both an over- mechanisms (there are some exceptions, such statement of asset and capital values and an asinAzerbaijan,whichconsolidatedandrecap- understatement of risk. THE COSTS OF DELAY AND APPROACHES TO REFORM 71 Moreover,statebankshaveoftenbeenmore tor, state banks often operate with some pro- willing to assume risk because they know they tectionthroughregulatoryforbearance.Inthe will be bailed out by the government. That has end the preference for state banks undercuts sometimes led to imprudent cross-ownership bank supervisors' ability to enforce their man- or traditional lending to affiliates and related dates in support of banking, financial sector, parties. In the absence of consolidated super- and monetary stability. This problem is wide- vision of the financial sector state banks are spread in transition economies. vulnerable to large losses from their exposures Where state banks are protected and losses to leasing companies, insurance firms, pension mount, there is ultimately a macroeconomic funds, investment funds, and other financial cost, as most transition economies have expe- services companies. In fact, these ventures rienced. As the sole or major shareholder, the have targeted state savings banks because of state has a financial obligation to recapitalize their household deposits and retail networks. state banks as going concerns. Avoiding the In the end state banks' inability to manage failure of banks and the resulting loss of con- these risks according to strict commercial fidence may require fairly continuous recapi- guidelines has led to losses, undermining pub- talizationandliquiditysupportfrommonetary lic confidence and often requiring costly inter- or fiscal resources. More recently, as central vention by the state. banks have become fairly disciplined and have While lack of consolidated supervision has focused on pricing stability, most of the leak- contributed to the risk associated with impru- agehascomefromthefiscalside.Thissupport, dentcross-ownership,itisonlypartoftheprob- politicalbydefinition,oftenlackstransparency. lem. Where good governance and sound Governments often provide financial support management are lacking, imprudent cross- for state banks from extrabudgetary sources ownership has been harmful across the board. or, where cash resources are constrained, Many of the lingering problems faced by the through arrears (on taxes, social funds, elec- CzechRepublicrelatebacktoweaknessesasso- tricity payments, and other obligations). ciated with cross-ownership. Banks' relatively recent ownership of investment funds in Progress and Challenges Romania has similarly raised questions about financial sector stability. Relative Progress in Central and Eastern Regulatory forbearance has also added to Europe and the Baltics the problem of state banks. While banking supervision has been tightening for years in Funding trends in many of the CEE and Baltic transition economies, every system exercises states--growing deposits, rising ratios of some forbearance. But regulators have long broad money to GDP, and increasing capital-- allowed state banks disproportionate forbear- suggest that these countries have put into ance, to allow them time to restructure and place structures that have helped to restore recapitalize. This is legitimate where privati- the confidence of creditors, investors, and the zationistheobjective,becauseprivateinvestors public in banks. On average, CEE countries will not buy an insolvent institution. But the have seen the biggest improvement in deposit rehabilitation process has often been dragged mobilization and capital formation, while the out for noncommercial reasons, distorting the Baltic states have also shown positive trends market.Severalcountrieshaveprotectedtheir (table 5.3). In the CIS countries deposit mobi- markets from foreign competition while their lization has been more limited, and banks statebanksrestructure.Butevenwhenforeign have undergone significant decapitalization investmentismaterializinginthebankingsec- since 1995. 72 CHAPTER 5 TABLE 5.3 Basic Funding Indicators inTransition Economies, 2000 Change in Change in Ratio of ratio of Change in deposits since broad money broad money capital since 1995 (millions of to GDP to GDP since 1995 (millions of Country U.S. dollars) (percent) 1995 (percent) U.S. dollars) Albania 909 60.1 1.3 174 Armenia 130 14.7 7.0 ­28 Azerbaijan 387 17.5 5.2 26 Belarus ­63 17.7 2.7 184 Bosnia and Herzegovina 247 27.6 12.8 3 Bulgaria ­4,420 34.8 ­30.1 263 Croatia 4,111 46.1 21.2 ­570 Czech Republic ­1,517 75.7 ­2.9 373 Estonia 978 39.3 12.6 319 Georgia 108 10.3 2.8 28 Hungary 1,623 46.8 4.9 611 Kazakhstan 981 15.4 4.0 537 Kyrgyz Republic ­7 11.9 ­5.3 ­53 Latvia 815 30.4 7.0 184 Lithuania 1,033 23.3 0.0 299 Macedonia, FYR 163 21.0 8.8 ­468 Moldova 36 22.4 3.2 28 Poland 28,506 42.7 8.8 1,500 Romania 581 23.2 ­1.9 ­627 Russian Federation ­1,871 22.1 4.2 ­3,836 Slovak Republic 561 67.8 3.1 1,992 Slovenia 2,309 49.5 13.0 ­188 Tajikistan -- 8.8 ­12.0 0 Turkmenistan 298 14.9 ­3.8 21 Ukraine 1,007 17.9 5.2 368 Uzbekistan 2,384 11.9 ­6.3 851 Yugoslavia -- 20.3 -- -- Total 39,289 1,991 Central and Eastern Europe 33,073 3,063 Baltics 2,826 802 Commonwealth of Independent States 3,390 ­1,873 -- Not available. Note: Data on broad money for Turkmenistan refer to 1999 rather than 2000. Source: IMF;World Bank. Bulgaria,theCzechRepublic,andRussiaall money ratios in this range, and only Moldova experiencednetoutflowsofdepositsfromtheir and Russia had ratios above 20 percent. Thus banks between 1995 and 2000, and all experi- the general funding base remains weak in the encedamajoreconomicshockorsimilardevel- CIS countries. This weakness is made all the opment in that period.6 But several other more apparent by the $1.9 billion decline in countriessuchasUkrainethatalsoexperienced bankcapitalinCIScountriesbetween1995and shockshadgrowthindepositsduringtheperiod.7 2000, compared with the nearly $3.9 billion Broad money ratios continue to show that increase in CEE and Baltic countries. CEE and Baltic countries have higher inter- In part these trends reflect differences in mediation levels than CIS countries. Broad bank operations among the regions. CEE and money exceeded 30 percent of GDP in 8 of 12 Baltic countries have attracted greater foreign CEE countries and 2 of 3 Baltic states in 2000. direct investment into their banking markets Butamongthe12CIScountriesnonehadbroad than the CIS countries. This investment has THE COSTS OF DELAY AND APPROACHES TO REFORM 73 helpeddomesticbanks(directly,throughacqui- regime had been in place. The weak supervi- sition, or indirectly, through competition) to sion reflects efforts throughout the 1990s to strengthensystemsanddiversifyproductoffer- defer needed reforms in Romania. That delay ings, improving their earnings. translated into a more fragile economy, less Still, most banks in transition economies public confidence in the banks, more difficult have limited capital, particularly in the CIS (and expensive) access to international capi- but also in the Baltics and Central and Eastern tal markets, and lower capital levels. Europe. With low levels of capital, banks are unable to access the international syndicated Remaining Challenges in the Commonwealth loan market or, in some cases, even the domes- of Independent States ticinterbankmarket.Allthiscombinestomake it difficult for small banks to mobilize deposits, The transition from a monobank system to a because it undercuts their ability to invest in stable, well-funded, two-tier banking system the products and services that would attract and diversified financial sector has been far depositors. more difficult in the CIS countries. In the CIS Most CEE and Baltic countries have the trend has been toward large state banks adopted a prudential framework that appears (in most of the resource-rich countries) and adequate to maintain stability in the banking very small private banks that have served as system. While nonperforming loans remain pocketbanksforinsidersandcontrollinginter- high in many of these countries, there is bet- ests. Through the large losses stemming from ter recognition of this problem than in earlier their operations, pocket banks have under- years. Moreover, as banking supervision capac- mined economic growth, compounding the ity increases and private banks are required aftereffects of hyperinflation and the loss of to report on prospective noncompliance and confidence in domestic currencies. Among the associated risks, banking systems are proving state banks, some have made efforts to pro- capable of containing potentially damaging fessionalize and modernize. But the continued risks. This capability has been tested in sev- existence of the state banks has made it diffi- eral countries in recent years. For example, cult to create an open, competitive environ- the poor condition of Hungary's Postbank in ment for banking. early 1997 led to deposit withdrawals, but the Banks such as Sberbank in Russia remain system as a whole did not experience a major "strategic" and coveted because of their large net outflow. Instead, depositors simply trans- share of deposits. Large CIS banks remain ferred their funds to stronger and better man- essentialplayersintheircountries--Oschadny aged banks, essentially strengthening the in Ukraine, the International Bank of system at the expense of some vested inter- Azerbaijan, Halyk Savings in Kazakhstan, ests. Vneshekonombank in Turkmenistan, the But not all countries are free from desta- National Bank for Foreign Economic Activity bilizing effects. Weak regulation and supervi- in Uzbekistan, and Sberbank, Vneshtorgbank, sion in Romania culminated in a challenge to and Vneschekonombank in Russia. Some of banks in 2000 when rumors circulated about thesebanksremainimportantplayersbecause the financial condition of major institutions. they still serve as vehicles of directed lending, The National Bank signaled its willingness to others because they safeguard hard currency provide needed liquidity support, and accounts and are responsible for payment and Romania's major banks were able to handle settlementfortheeconomy'smajorenterprises. increasing withdrawals. But the rumors might Meanwhile, much of the rest of the economy have had less effect if a stronger supervisory hasfledthebankingsystem,runninguparrears 74 CHAPTER 5 to other accounts. All this points to problems economic indicators and, to the extent the bank- of funding in the real sector, weak governance ing system is exposed to these trends, banking sec- and management in the economy, and the tor indicators as well. greater difficulties of CIS countries in dealing 2. See Zoli (2001). with the challenges of transition. 3. Maletic 2002. 4. See Zoli (2001). Notes 5. See Builov (2002) on the financing of enter- prises in Russia. 1. Exceptions include countries that have used 6. The Czech Republic has battled structural cash from a strategic commodity to insulate the problems in the economy, Bulgaria faced economic economy from the negative effects of slow reform. collapse in 1996­97, and Russia experienced a col- Several CIS countries have been able to leverage lapse of its currency in 1998. favorable oil and gas prices, for example. A decline 7. Ukraine experienced an economic shock in in these prices would be expected to weaken 1998 as a result of the Russian financial crisis. THE COSTS OF DELAY AND APPROACHES TO REFORM 75 Chapter 6 Findings and Recommendations D espite more than ten years of finan- financial crisis in the banking system, high cial sector reform, state-ownership of levelsofcorruption,andbigcostsforthegov- bankscontinuestoplaguemanytran- ernment. Where state banks are more mod- sition economies. In most CIS countries and ern, their ability to increase productivity, severalnon-CIScountriesgovernanceremains efficiency, and competitiveness is still con- weak, boards lack specialized banking skills, strained by excessive staffing, low skill lev- management is entrenched, accounting is els,manualprocesses,outdatedinformation incomplete or inaccurate, and state banks con- systems, and lack of a service orientation. tinue to be used for noncommercial purposes. · Delayed reforms in the banking sector have gener- Most transition economies still have a few ally been correlated with sluggish economic per- state banks (about seven on average), and in formance. This has been shown throughout manythesebanksstillaccountforalargeshare the Europe and Central Asia region, with of bank assets, loans, and deposits, though the CIS countries, particularly in Central proper provisioning and write-down practices Asia, lagging behind others in the region would reduce loan and asset values consider- in reducing state-ownership of banks. ably. For these troubled banks poor asset qual- · Where state banks have failed or performed poorly, ity undermines earnings performance, slows theyhaveunderminedpublicconfidenceinthebank- capital formation, props up intermediation ing system, particularly where there is no deposit costs, and makes it difficult to make the invest- insurance and people have lost their savings. Such ments needed to be competitive. losses of confidence have harmed the long term development of the formal financial Main Findings sector.WhileinCentralandEasternEurope and the Baltics the banking sector has seen Following are some of the main findings asso- favorable growth trends in recent years, in ciated with the continuing presence of state many CIS countries growth in financial owned banks in the region. intermediation has been limited, and the · Where state banks are still used for noncommercial economy has shifted away from formal purposes, their quasi-fiscal function poses a risk to financial institutions. In these countries macroeconomicandfinancialsectorstability.State enterprises have operated often through banks' non-commercial approaches often barter, arrears, and netting arrangements. include directed lending for political pur- Facingcashconstraints,enterprisesempha- poses, toward state farms or enterprises, or size tax avoidance rather than long-term to meet social objectives. More often than performance. Their poor financial condi- not these practices have led to a severe tion has further reduced tax payments, 77 including for social insurance, exacerbat- Most state banks--uncompetitive, insol- ing the poor state of public finances. vent, loss making, and lacking in franchise · Continued presence of state banks has severely lim- value--have few privatization options. Some, ited financial sector and economic development in such as specialized export-import banks, do transition economies. The accumulated effects have adequate systems and professional per- ofalltheseproblems--poorstructures,incen- sonnelwhohavebeenexposedtointernational tives, and governance along with weak laws, norms of banking. In some CEE countries, for inadequateregulationandsupervision,con- example, the former state banks that were the nected lending, and political patronage-- easiest to privatize were corporate banks with have undermined confidence in banks and traditions of international exposure. In other other public institutions and made it diffi- countries, however, these banks were often cultformanytransitioneconomiestoachieve among the most troubled institutions. sustained growth. These problems have not Savings banks are often considered excep- only hindered many CIS countries in their tions because in many countries they are the efforts, but the same fate has also impeded only banks with a retail network. In countries growth in Romania, triggered collapse in with poor infrastructure, such a retail network Bulgaria,andrestrictedeffortsinmanyother could potentially have value. But more often countries in southeastern Europe. thannotcountrieswithpoorinfrastructurehave · Governmentsarebetteroffmovingquicklytoreform, pooreconomies.Thussortingthroughtheprob- privatize, or liquidate their remaining state-owned lems of a state bank with high staffing levels, banks. Experience has shown that the costs poor systems, and traditions of "social" bank- of delay are large and in general prospects ing is rarely worth the cost to the government for privatization do not increase with slow of privatizing it, even if the price is zero. and complex attempts to restructure. There are other exceptions such as in coun- The balance of this chapter provides rec- tries with strategic resources, growing pur- ommendations for policymakers on how to chasing power, and more highly populated resolve state bank issues and identifies some markets. But even in these countries defini- of the preconditions for a competitive finan- tive privatization or closure of banks combined cial sector. It compares various approaches to with a stable macroeconomic and legal frame- state bank privatization and resolution based work is a precondition for establishing a com- and offers lessons the last decade of reform in petitive environment for banking. Until open, transition economies. competitive banking markets exist, it is unlikely that adequate capital will be in place Prospects for Privatizing State for meaningful levels of intermediation. Banks Without capital and a competitive banking environment, restoring confidence will take For most remaining state banks the prospects even more time. for privatization are poor. In fact, in many of Reformingstatebankscannotbereliedupon themosttroubledeconomieswherestatebanks as a strategy to restore confidence to banking continue to play a key role, privatization systems. This is a costly endeavor, especially prospectsarelesspromisingnowthantheywere given scarce resources, and risks that state earlier. And they are less promising than banks tend to revert to traditional practices prospectsincountriesthathaveenteredformal shouldtherebeaperceptionofmarketfailure. negotiationsforentryintotheEuropeanUnion. The high cost of these practices is precisely For CIS countries the lack of options has been why transition economies need to move on a big disadvantage for the reform process. to the final chapter of privatization in the 78 CHAPTER 6 banking sector--privatization based on sound disciplined and shareholders an incentive to governance and management, accurate and monitortheirinvestmentsproperly.Italsopro- timely disclosure of meaningful information, vides a structure for orderly settlement of dis- effective banking supervision, and well-devel- putesoutofcourt,withcourtsservingasafinal oped legal systems reinforced by stable macro- arbiter if out-of-court methods fail. Courts can economic policies. However, because the state be reserved for disputes exceeding a minimum banks that remain are often among the least size,whilesmallercasesareautomaticallysent attractive to investors and the most impaired to specialized arenas. By contrast, where the as institutions, closing this chapter is a diffi- legalframeworkandjudicialsystemsarepoorly cult challenge. developed, and decisionmaking is more arbi- trary and less transparent, the unpredictabil- Preconditions for Privatizing ity of the judicial process reduces the incentive State Banks for financial firms to assume risk. Most tran- sition economies have the necessary laws in Bankprivatizationdoesnotoccurinavacuum, place but often lack court capacity, legal prece- butinthecontextofacountry'swidereconomic dentandexperience,commercialtraining,and reform program. As a result, there are a num- alternative dispute resolution mechanisms. ber of factors that contribute to successful pri- vatizationofstatebanksandhelpcreateastable Sound Financial Information financial system, as described below. Sound financial information cannot be taken Macroeconomic Stability for granted anywhere and is particularly prob- lematic in markets where information disclo- Macroeconomic weaknesses reduce prospects sure has not been a tradition. Moreover, for privatization and increase prospects for because the market test for many asset val- losses by banks. Macroeconomic stability is ues (such as real estate and collateral) is not an area where most transition economies have in place in less advanced economies, valuation mademuchprogress.Evencountrieswithweak is a challenge. This is on top of the normal economic performance have often improved issues of loan classification, financial sound- fromevenweakerperformanceearlyon.While ness of the government (as the underwriter most countries have had to battle hyperinfla- of securities held by state banks), and gen- tion, today inflation rarely exceeds 10 per- eral auditing standards. Many investors have cent in CEE and Baltic countries, and about uncovered additional bad loans in a bank after half of CIS countries have single-digit infla- the privatization transaction has been closed. tion rates. And all transition economies gen- In some cases this may be the result of the erally manage to keep fiscal deficits below 4­5 acquiring bank's own deficiencies or of mar- percent of GDP. While this performance on ket developments that reduce the quality of inflation and deficits does not match that in assets not identified as risks before the trans- strong economies, it represents a major action. But in other cases it may occur because improvement over earlier measures. of poor internal records, lack of consolidated accounting, and similar weaknesses. All this Sound Legal Framework adds to the risk of investing in a market--dis- couraging investor interest, reducing the Areliablelegalframeworkprovidesaconducive amount investors are willing to pay for a state environment for financial firms to assume risk bank, and increasing the cost incurred by the because it gives borrowers an incentive to be state to complete the privatization. FINDINGS AND RECOMMENDATIONS 79 Sound Prudential Framework only one, relatively inactive state bank). But in many other economies movement toward Independentsupervisionbasedonasoundpru- privatization has generated benefits that dential framework is an important element would not otherwise have occurred. ofastablefinancialsystem.Whiledealingwith structural weaknesses and losses in the bank- Recommended Approaches to ing system always has interim economic and Reforming, Privatizing, and financial costs, failing to address these prob- Liquidating State Banks lems only perpetuates the myth that finan- cial results are better than they are. To avoid the risks associated with state own- Overstatement of loan performance and asset ership, it is recommended that governments quality (through rollovers and capitalization design strategies to reduce or eliminate state of unpaid interest) can prolong the fiction that banking from their financial systems. This can banks have high earnings, strong capital, and be done in a way that reinforces efforts to cre- robust operations. But in the end, as they run ate a stable banking environment and helps short on cash and have to approach the gov- to accelerate institutional capacity building ernment for refinancing, the need for correc- for effective market performance. Many coun- tive action will become clear. Tightening up tries have already begun this effort to create bank prudential norms and providing the a stable banking system by introducing BIS- supervisory authorities with a mandate to recommended prudential norms and requir- enforce sanctions on banks (including state ingbankstodesigntheirowncorrectiveactions banks)fornoncompliancecanhelpmovebanks to come into compliance with liquidity, sol- toward greater discipline and proper man- vency, and other standards. agement. In many transition economies, if not Governments working to eliminate state most, the supervisory mandate has been ownership have a few broad options. These extended to most private banks but has not include restructuring or rehabilitating banks, beenequallyappliedtostatebanks.Thisundue consolidating banks, liquidating bank, reori- forbearance is costly in the long run and dis- enting banks within well-defined mandates torts the market. and risk parameters, and providing incentives for establishing nonbank lenders. Government Commitment to a Competitive Banking Environment Restructuring or Rehabilitating Banks Government commitment to an open and com- Experience has shown overall that restructur- petitive banking environment in most cases ing and rehabilitation is costly and time-con- is an precondition for strong investor inter- suming, and governments are often better off est. It is also necessary to encourage inter- moving swiftly to liquidate their state banks. mediation. Continuing to float state banks Manycountries,however,havealreadyengaged in the market delays progress toward com- in significant restructuring and rehabilitation petitiveness and distorts the sector. Building efforts, particularly in Central and Eastern a competitive banking environment takes Europe. While some have kept explicit costs time. Many small, weak economies would see down (Poland), many others have seen costs little initial benefit from a wholly privatized risetoalargeshareofGDP(Bulgaria,Croatia, banking system, as has been the case in some theCzechRepublic,Hungary,Kazakhstan,FYR CIS countries (such as Georgia) and in the Macedonia). Others have kept restructuring Balkans (such as FYR Macedonia, which has costslow,yethavelittletoshowfortheirefforts 80 CHAPTER 6 largelybecauseofpoliticalandmacroeconomic adequate strategic investors for their banks. In instability, and real sector weaknesses. There such cases, they consider restructuring of cer- have been no cases of successful restructuring taindepartmentstheironlyoptions.Experience of state-owned banks in the region that has hasshown,however,thatsuchinterimmeasures resulted in satisfactory performance. fail to address the core issues of poor manage- In deciding how to deal with a state bank, ment, weak corporate governance, and lending one question is whether the investment in based on non-commercial principles. They may restructuring and rehabilitation will generate help delay crisis, but not to avoid one overall. anadequatereturnrelativetopotentialreturns Therefore, it is recommended that govern- fromotherusesofthoseresources.Ratherthan ments only engage in technical assistance in the time-consuming process of restructuring extremelyrarecasesandwithinalimitedtime- and rehabilitation, a more efficient route to frame.Itmaybenecessary--orevenvaluable-- privatization might be to insist that the new to keep a state bank alive for a limited period owners undertake certain activities to ensure of time to maintain financial sector stability that the private sector has access to financing orallowforlegalandregulatoryreformstotake (with the government benefiting from the place or supervisory practices to take hold. resulting fiscal revenue and employment gen- However, technical assistance is not recom- eration) in exchange for concessions on the mendedasastrategyforcontinuingstate-own- sales price.1 For large banks, this approach ership in the long term. Technical assistance would probably involve bigger concessions and should always be geared toward the prepara- a longer time horizon for the new owners and tion for privatization or liquidation and with- management to achieve the objectives. out illusions of rehabilitation. For small banks, restructuring and reha- Countries that do opt for restructuring and bilitation has not proven to be worth the time rehabilitation should structure their approach and effort. Since most state banks have less around a strategic objective and include than $300 million in assets and $50 million in explicit performance indicators based on oper- capital,makingconcessionsonsalespricesand ational reforms, managerial changes, and developing a 5- to 10-year time horizon for financial requirements. Given the small cap- achieving financial and economic objectives ital of many state banks, one approach would through outside investment would probably be to seek a minimum threshold of absolute bring greater benefits for the banking sector capitalcombinedwithspecificcapitaladequacy than working through a time-consuming reha- targets that point to future soundness. bilitation and restructuring before privatiza- tion. Indeed, this choice appears preferable for Consolidating Banks before or after most countries, though there are a few excep- Privatization tions among banks.2 Otherwise, banks that are notsupervisoryconcernsandarenotlargeordi- Lack of investor interest in banks might trig- narily should be sold off quickly, with the long- geraneedtoclosethesebanksortocloseunsal- term financial and economic objectives the vageable parts of banks that have been main focus of negotiations for sale. privatized.Thiscontingencyshouldbeplanned for as a part of the negotiating process, since Providing Interim Technical Assistance investors may not want the full franchise and the associated costs of spinning off or restruc- Many governments opt for interim technical turing unwanted parts. assistance measures because they view privati- One alternative is postprivatization con- zation as infeasible politically or fail to find solidation, such as through purchase and FINDINGS AND RECOMMENDATIONS 81 assumption,inwhichunwantedpartsofafran- domestic and foreign--and relying on mar- chise are spun off to another bank that might ket mechanisms to achieve consolidation. be able to give them some value. For example, Where market mechanisms are not suffi- a small bank wanting to develop a branch net- cient to consolidate the banking system, work might value the same branches that the another option is the regulatory approach. A potentialownerofanotherbankdoesnotwant. separate administration could work with spe- While the ideal approach would be to sell the cialists to establish a consolidation plan that branches through the market, in many transi- includesastrategicobjectivewithperformance tion economies the market is limited. In these indicators.Underthisapproachthetwoormore cases the transaction could be completed institutions planning to consolidate would be through the regulatory authorities, who would required to establish an action plan and time be in a position to know whether the potential line for achieving objectives, with financial acquiring or absorbing bank meets the finan- results serving as the key measure of success. cial and other conditions for the acquisition. Theplancouldincludeperformanceincentives, Moreover,iftheunitsbeingspunoffareofques- although reasonable indicators would need to tionable value, the regulators would know besetearlyon.Forthestate,thepotentialben- whether the acquiring bank has the capacity efits would include cost savings and, in time, toturnthemaround.Ifsuchanapproachposes betterintermediation.Andiftheconsolidation risks to deposit safety or systemic stability, the involved at least partial privatization through assetscouldbeofferedtofinancialinstitutions outside investment, this would have the added that are not deposit taking or are not covered benefit of improving solvency. under the deposit insurance fund. Although consolidating banks before pri- Liquidating Banks vatization may help reduce the transaction costs of negotiating privatization transactions, Many governments have resisted the option of ithasoftenturnedouttobedifficultandcostly, liquidating banks, particularly for savings or and the results often suboptimal. For exam- agricultural banks whose branch networks ple, the Czech Republic made an effort to help cater to households and underserved rural Ceska Sporitelna, a fairly narrow savings bank regions. Regardless of their financial condi- at the time, become a more diversified com- tion, liquidating these banks has been difficult mercial bank by absorbing smaller regional for political reasons and because there has banks. In the end Ceska Sporitelna was not beenlittlealternativeforpeopleinruralareas. privatized until 2000, five years later than it Savings banks have also catered to many older might have been without the consolidation people who have small accounts and are strategy.ThePolishbankPekaoSA(nowowned uncomfortable changing banks or using elec- by Unicredito of Italy), which had franchise tronic banking methods. value in the mid-1990s, was consolidated with Whiletheseareunderstandablereasonsfor three regional banks before privatization. This deferring closure, in reality these banks can exercise turned out to be time-consuming and oftenbeliquidatedwithfewofthefearedsocial complex because of the regional specifics of consequences. Alternative institutions fully the three smaller banks, and there are doubts capable of serving households and rural com- about whether it added value or enhanced munities often exist--such as savings houses, bankingservicesinPoland.Theresultsofthese creditunions,andmicrofinanceinstitutions-- attempts suggest that most remaining state but their development has often been stunted banks could be consolidated more efficiently by politically motivated protection of savings by simply offering them for sale to banks-- and agricultural banks. Moreover, the meager 82 CHAPTER 6 earnings of state-owned savings banks raise for private banks to expand services to cer- questionsabouttheirlong-termsustainability. tain groups before the privatization or liqui- Branchescanbespunofftootherinterested dation takes place. parties--including nonbank financial institu- tions such as credit unions, microfinance insti- Narrowing the Licenses for Savings Banks tutions, or leasing companies--that focus on households,ruralcommunities,andothermar- Governments occasionally hesitate to close ket segments often neglected by mainstream down failing banks, particularly savings banks, banks. Under these circumstances the sale because they are the sole providers of finan- would simply involve a revocation of the insti- cial services in certain regions or the poor. In tution's right to market itself as a bank, an such cases, governments may decide that it is explicit and well-publicized removal of the necessary to keep a bank open for a limited institution from deposit insurance, and other period. When a government does so, however, actions that would transform the bank into a it should take specific actions to limit the dam- nonbank financial institution. ages caused by such banks. In the long run, however, if a bank cannot One alternative is to redefine the bank's be privatized or absorbed by a sound bank, it license and narrow the range of permissible should be a candidate for liquidation. If the activities. One bank operating under this bank shows no potential for commercial via- approach has been the Savings Bank of bility, liquidation should occur promptly. Albania, which was originally limited to a nar- row range of activities and failed when it took Mitigating Social Costs of Privatization or on a more diverse role. Since 1998, the bank's Liquidation activities have been narrowed with no lend- ing allowed. It has now been sufficiently recap- In reality governments often lack the politi- italized and reorganized to be offered for sale cal will to privatize or liquidate some of their to strategic investors. largest state-owned banks because of the The delay in privatization inherent in this relatedsocialcosts--bothperceivedandreal-- approach poses risks, however. If the state sav- such as unemployment, and lack of services ings banks cannot be privatized, an effort to poor, rural, or at-risk groups. For this rea- should be made to limit the kinds of lending son, it is critical that governments explicitly and investment activities they can pursue, par- build in social protection measures into their ticularly if they hold a major share of the reform strategies. This includes specific mea- deposit market. CEC of Romania had expo- sures targeted toward laid-off workers, pro- sures to an investment fund that collapsed in viding them with decent severance packages, 2000, jeopardizing its financial position. retraining, and assistance to obtain alterna- Placing strict limits on what savings banks tiveemployment. Thegovernmentalsoshould can do has both potential benefits and risks. strengthen the social safety net for the long- The strategy has a good chance of keeping the term unemployed and the poorest. banks solvent. But because their high costs If the government does move forward with and low service levels translate into small earn- privatizationofadominantbank,itmustmake ings (or losses), limits on what they can do to sure that measures are in place to continue to generate income would almost certainly provide critical financial services to the poor ensure that the banks would never be able to and target groups and to avoid a financial cri- grow or modernize unless they retain a sig- sis. Measures include building up non-bank nificant share of the deposit market (as financial institutions and creating incentives Sberbank does in Russia). And this market FINDINGS AND RECOMMENDATIONS 83 concentration is risky for systemic stability. Several microfinance institutions in the region Banks generally lack an inexpensive source of have built quite large loan portfolios based on funding if they do not have a viable deposit sound quality and performance standards. base. That limits their resource base for lend- These nonbank institutions often are far ing and drives up lending rates. It also makes more appropriate for most households than the interbank market highly dependent on a the traditional state savings and agricultural particular bank for liquidity, and it can cre- banks. But there has been resistance to their ate a vicious circle leading to collapse if the formation because of the added cost for bank- savings bank is closely intertwined with gov- ing supervision. This view is an understand- ernment finances. If the government depends able one for supervisors, but with proper on the savings bank for funding and experi- guidelinesandstaffing,nonbankfinancialinsti- ences a major downturn in its own finances, tutionscouldplayanimportantpartinexpand- a major erosion of the savings bank's liquid- ing financial intermediation. ity could result, driving up rates in the inter- bank market or causing panic. Improving the Business Environment Developing Nonbank Financial Institutions Banks are affected by all the elements of busi- ness environment that surrounds them: the Transition economies have been slow to final- legalandregulatoryframework,corporategov- ize privatization of banks in part because of ernance, creditors' rights, auditing and the underdevelopment of other financial ser- accounting standards, and the judicial system. vices. Because capital markets remain under- Weaknesses in these areas not only worsen the developed, insurance penetration low, and immediate situation of state banks, but also second- and third-pillar pension funds new or limit the prospects for growth of private banks nonexistent,institutionalinvestmentandmar- and other financial institutions. ket development have both been limited. Therefore, it is critical that governments On the lending side, there has been a address the business environment as part of shortage of nonbank creditors--such as spe- a broad overall strategy to strengthen the cialized commercial finance, leasing, and fac- financial system. Governments should focus toring companies--which can provide loans on developing comprehensive strategies without putting depositors at risk. Resolving including providing support for strengthen- legal, tax, accounting, and other issues ing corporate governance, reforming judicial related to these businesses could help encour- systems, building registries of collateral, mod- age the entry of these institutions into the ernizing accounting and auditing, reinforc- market in many transition economies. ing creditors' rights, reducing administrative Similarly, improved creditors' rights and barriers for business registration, and mod- insolvency procedures would help create ernizing bankruptcy laws to facilitate cor- incentives for lending. porate exits. Governments should also encourage other nonbank financial institutions such as micro- Notes finance institutions and credit unions that offer financial products tailored to the needs 1. The government of the Czech Republic took of small and micro enterprises. Many of these this negotiating position when privatizing Ceska havedevelopedremarkablysuccessfulmethod- Sporitelna, requiring the purchasing bank to com- ologies for savings and lending that offer finan- mit to a specified level of housing finance and cial services to the poor on a sustainable basis. venture capital as a condition for a government 84 CHAPTER 6 guarantee on half of Ceska Sporitelna's loan portfolio. Other governments have taken similar positions when privatizing banks. 2. Examples include PKO BP of Poland (already undergoingrestructuringwiththeobjectiveofeven- tual privatization), BCR of Romania (the coun- try's largest bank, already slated for privatization), and Sberbank and Vneshtorgbank of Russia. FINDINGS AND RECOMMENDATIONS 85 Case Studies Romania: Closing Bancorex T hestoryofBancorexisoneofinevitable policy of directed credit was terminated and failure.1Theinstitutionlongservedas the exchange rate liberalized in 1997. the key financial intermediary for At the end of 1997 Bancorex received $600 implementing the Romanian government's million in government bonds (equivalent to 2 poor macroeconomic policies and sustained percent of GDP) to restructure its nonper- support for loss-making state enterprises. forming loans. But the restructuring of Those operations ultimately led to unsustain- Bancorex that was to accompany the recapi- able losses and then to the bank's liquidation talization never took place. Although a new in 1999. managementteamwasappointedinApril1998 Bancorex was the largest and most trou- and other steps were taken, a comprehensive bled of the four fully state-owned banks in restructuringplanwasneverimplementedand Romania before its closure in 1999. the bank's situation deteriorated further. Accounting for about a fourth of total bank- With Bancorex in crisis again in late 1998, ing sector assets in the early to mid-1990s, the authorities considered restructuring mea- the former foreign trade bank financed a sig- sures with a view to privatizing the bank. nificant share of Romania's energy import International experience would have favored requirements as well as imports of capital liquidation, but the authorities were con- goods. In addition, Bancorex was used by the cerned about the systemic risk involved. authorities to subsidize the state-owned Instead, they proposed an up-front recapi- energy sector and the energy-intensive indus- talization followed by restructuring and pri- trial sector, which was also controlled pri- vatization. By early 1999, however, it became marily by the state. Most of Bancorex's clients clear that Bancorex was in much worse shape had poor prospects for repaying loans, not than expected and that privatization after only because of their inefficiency and poor recapitalization would be prohibitively costly. management practices but also because of A recapitalization would have required up to external constraints (particularly price con- $2 billion from the budget, or almost 6 per- trols). In the wake of exchange rate and price cent of GDP. liberalization in early 1997, the legacy of sub- An estimate at the end of February 1999 sidized loans, years of mismanagement, and put Bancorex's nonperforming loans at $1.7 behind-the-scenes political dealings caught billion--about 85­90 percent of its loan port- up with Bancorex. With heavy exposure to folio or 5 percent of GDP (this estimate was debtors that traditionally relied on directed increased as more became known about credit and the highly subsidized exchange Bancorex during its closure). Most of the port- rate, the bank was clearly insolvent when the folio was in foreign currency. At the time 87 Bancorex accounted for a fourth of total bank- · The final absorption of Bancorex by BCR ing system assets and 47 percent of foreign was completed in September 1999, while currency loans. BCR continued to exercise its right of first In April 1999 Bancorex finally collapsed in refusal on the Bancorex assets (which were a liquidity squeeze as depositors lined up to transferred to the Asset Recovery Agency withdraw their money. It became clear that inexchangeforgovernmentsecurities)well rapid liquidation was the only solution that into 2000. The Ministry of Finance agreed wouldavoidfurtherrunsonthebankandasys- to guarantee Bancorex's more than $400 temiccrisisinwhatwasafragileeconomicenvi- millioninoff­balancesheetitemsthatwere ronment. In that same month, realizing the transferred to BCR. magnitudeofBancorex'sproblem,theauthor- The closure of Bancorex removed a large ities finalized a liquidation plan aimed at its destabilizing element from the Romanian orderly removal from the banking system. financial system, though at a very heavy cost The final resolution of Bancorex was com- to the taxpayers. And it removed some $2 bil- pleted as follows: lioninnonperformingassetsfromthebanking · After the appointment of a special admin- system, helping to improve the general sound- istrator to replace Bancorex's manage- ness of the system. In the process the govern- ment (in February 1999), all bad assets ment took on public debt amounting to $1.5 at the end of 1998 were transferred to billion (net of provisions and other assets), or the newly established Asset Recovery 4.5 percent of GDP, in 1999. To this cost should Agency for loan workout and debt recov- beaddedthe1997recapitalizationof$500mil- ery by July 31, 1999. lion, the assumption by the government of · Some deposit liabilities and most foreign off­balance sheet items, and legal liabilities debt liabilities were transferred to another (the exact amount of which is still unknown). state-owned bank, Romanian Commercial The heavy fiscal costs associated with the Bank (BCR), while a large share of the liquidation and closure of Bancorex are mostly deposits were withdrawn before July 31, the realization of losses incurred before 1997, 1999, owing to delays in transfers. The caused both by the use of Bancorex as a vehi- National Bank of Romania (NBR) provided cle for quasi-fiscal payments and by the mis- special credit to stanch the bank's finan- management of the bank. Estimates indicate cial hemorrhage. Both BCR and the NBR that nonperforming loans amounted to about were compensated by government securi- $1.5 billion before the recapitalization of 1997, ties in corresponding currencies. and much of the off­balance sheet and legal · The remainder of Bancorex was merged liabilities had been incurred before then as with BCR, which absorbed its balance sheet well. Moreover, delays in the process may have (the authorities viewed an actual liquida- increased the cost to taxpayers by as much as tion as politically unacceptable and too several hundred million dollars. lengthy a process to complete). BCR received government securities to com- Note pensate for the hole in Bancorex's balance sheet and was given the right of first refusal 1. Alexander Pankov is the author of this annex. on any Bancorex assets transferred (on and Sources include C. James, Banking and Financial off the balance sheet). Sectors in East and Central Europe. Financial Times · The government approved the withdrawal Management Reports, 1993; BankScope, Bancorex of Bancorex's banking license on July 31, Report,1998;IMF(2001k);andinternalWorldBank 1999 (effective August 2). and IMF reports. 88 CASE STUDIES Case Studies Ukraine: Liquidating Bank Ukraina B ank Ukraina was one of the four state- of thousands of shareholders, most of them owned specialized banks spun off from individuals. the Soviet All-Union banks when Not surprisingly, the shareholders had no Ukraine gained its independence in 1991.1 meaningful control over decisionmaking in Throughoutthe1990sBankUkrainaremained these banks. Most major policy and personnel oneofthelargestbanksinUkraine:inOctober decisions were still made by top managers of 2000 it employed 16,600 people in a network the state enterprises that had been majority of 512 branches. Bank Ukraina focused its shareholders before the share redistribution. lending activities in the agricultural sector, In the absence of a major outside entity own- whiletheotherstatebanksspecializedinindus- ing a controlling stake, this meant that the trial lending (Prominvestbank), social pro- state continued to exercise considerable indi- grams (Ukrsotsbank), and household savings rect influence in the three banks' affairs. (Oschadny Bank). A fifth state bank, Moreover,thegovernmentexerteddirectinflu- Ukreximbank, was formed in 1992 to process ence on decisionmaking in Bank Ukraina by Ukraine's foreign trade payments. retaining a residual shareholding of at least All the specialized banks except Oschadny 13 percent until 1998, when it finally sold the andUkreximbankwerecorporatized(andthus holding for cash (the package was later alleged nominally privatized) in 1992. This occurred tobeundervalued).Thegovernmentappeared primarily through ownership transformation, tomanagetheinstitutionthroughtheMinistry withanumberoflargestate-ownedenterprises of Agriculture, the Ministry of Finance, and taking substantial ownership shares in the the National Bank of Ukraine. In addition, banks that served their sectors. During the regionalauthoritiesappearedtoexercisesome ensuing years the ownership structure of Bank control over regional offices. This complicated Ukrainaandothersimilarlycorporatizedbanks structure of governance, which effectively became even more complicated, largely as a turned the bank into a set of regional banks result of a 1993 government order requiring operating under the same name, was harmful the transfer of all state enterprise shares in to the bank's financial position. these banks to the Ministry of Finance. This At the beginning of the transition personal prompted the banks to devise a method of links with the government appeared to be a transferring ownership through the distribu- good source of financing and profit for Bank tion of shares to the employees of client enter- Ukraina. Major decisions on channeling bud- prises and of the banks themselves. Thus getary funds, financing projects, or attracting ownership of Bank Ukraina and the other two more lucrative enterprise clients were made formerstatebanksbecamedividedamongtens withtheagreementofgovernmentauthorities. 89 But despite the benefits that Bank Ukraina But Bank Ukraina failed to meet the targets received from the government during these oftherecoveryprogram.Giventhestrongdete- years (such as free access to budgetary funds, rioration in its loan portfolio (of which about state procurement contracts, and government 75 percent was nonperforming by the end of guaranteesfortradefinancedeals),bythelate 2000, or perhaps as much as 90 percent if 1990s the bank had a large share of bad assets reclassified under international accounting on its balance sheet. These were the results of standards), negative liquidity, and capital ero- poor-quality management, unmanageable lia- sion, the bank's financial condition was dan- bilities,andseriousexternalinterferencewith gerous enough to threaten the entire banking thebank'sdailybankingoperationsandstrate- system. That prompted the introduction of a gicdecisions.Tomakemattersworse,thebank's provisional administration at the bank on dire financial position was long obscured by September 25, 2000. inaccurateloanclassificationpracticesandlow After extensive analysis of Bank Ukraina's levels of loan provisioning that led to serious situation by the World Bank in early 2001, the overestimation of assets and capital. government came to realize that there was no The continuation of government-directed alternative to immediate and orderly liquida- loans to nonviable state-owned enterprises tion. Based on a balance sheet recast accord- proved to be particularly harmful to Bank ing to international accounting standards at Ukraina's financial health, because most of the end of 2000, Bank Ukraina's capital short- the directed loans were never intended to be fall amounted to UAH 900 million, with UAH repaid. When the bank prepared a list of gov- 650 million of loan loss provisions (about 56 ernment-directed loans in 2000, the govern- percent of total assets) required to cover the ment formally acknowledged only 75 million nonperforming loans. The analysis concluded hryvnias,orUAH($13.8million),2leavingUAH that there was no prospect of the bank becom- 433 million ($80 million) unacknowledged. ingcommerciallyviableorself-sustaining,even Analysis of the loan portfolio also revealed if it were recapitalized to achieve minimum highly controversial lending to shareholders capitaladequacystandards,becausecontinued of the bank, to daughter companies, and to and rising nonperformance would steadily affiliated companies. reduce the temporarily improved income Bank Ukraina's situation deteriorated dra- stream. The government had no plans to cover matically beginning in 1998. Its share of bad the capital shortfall, and no third parties were loansbecameunsustainableevenbyUkrainian willingtolendtoBankUkrainaorprovideaddi- standards, and the bank had to rely on cen- tional capital. There was thus no viable means tral bank credits to maintain its liquidity posi- by which the bank could obtain the liquidity tion. A 1998 diagnostic review led by the and capital needed to continue its operations. International Monetary Fund confirmed the The analysis showed that Bank Ukraina's bank's deep insolvency. The state-protected role as a provider of credit to Ukraine's vital bank came to be seen as having wasted the agricultural sector would not be an obstacle to country's financial resources by subsidizing the bank's liquidation. First, in 1999­2000 loss-making industries and the largely unre- Bank Ukraina had allocated only $25 million formed agricultural sector. In November 1998, a year to agriculture, a negligible amount rel- afterconsideringrenationalizingthebank,the ative to the size of the sector (which has a authorities finally put it into a rehabilitation turnover of about $8 billion a year). Second, program, and in June 1999 the National Bank Bank Ukraina had already ceased to allocate of Ukraine instructed Bank Ukraina to sign a these credits since the appointment of the pro- commitment letter aimed at bank recovery. visional administrator in late 2000. Bank 90 CASE STUDIES Ukraina simply did not have the resources to from the debt recovery process, expected to provide new agricultural loans. last at least two to three years. On July 16, 2001, after three years of delays Because the resolution process is so highly and political infighting, the National Bank of politicized, it is too early to judge the success Ukraine annulled Bank Ukraina's banking ofthelong-delayedliquidationofBankUkraina license and effectively launched liquidation or to estimate its final cost to the taxpayers. of the bank. In parallel, the Prosecutor That cost is likely to be tens of millions of dol- General's Office launched a criminal investi- lars. The National Bank of Ukraine alone has gation against the bank's board of directors, outstandingcredittoBankUkrainaofUAH398 who were suspected of abuse of office. The million($73.7million),aresultofstate-directed liquidation procedure, prepared with techni- credits to agro-enterprises and liquidity sup- cal assistance from the World Bank, is coor- port for the bank in 1996­99. It also remains dinated by the Agency on Bankruptcy Issues. to be seen how the government will handle the The technical assistance focused on deposit follow up to the Bank Ukraine liquidation. compensation, loan workouts and debt recov- Already, vague plans have been proposed at ery,staffretrenchmentandcompensation,and the highest levels of government to re-create a agriculturalfinancereforminthewakeofBank state agricultural bank from the branch net- Ukraina's demise. work and infrastructure left by Bank Ukraina. How to deal with the 1.5 million individual deposit accounts (totaling UAH 271 million, Notes or $50.2 million) posed a special challenge to the authorities because of the potential for 1. Alexander Pankov is the primary author of panic and the impact this could have on the this annex. Sources include World Bank mission banking system as whole. The liquidation plan reports;A.Roe,etal."Ukraine:TheFinancialSector entitles individual depositors to compensation and the Economy," World Bank Report, 2001; fromtheDepositInsuranceFundofuptoUAH Intellinewsreports;andtheUkrainianNewsAgency. 500 ($92.60) per account. A small number of 2. The acknowledged loans included loans individual depositors whose accounts exceed to Ukraine's state-controlled energy company, this limit stand to lose substantial amounts. NAFTA K, which was on both the list of the biggest SodocorporatedepositorsandBankUkraina's borrowersandthelistofgovernment-directedloans. creditors (including the National Bank of Bank Ukraina's total exposure to this company was Ukraine), which will have to wait for proceeds UAH 179 million ($33.2 million). UKRAINE: LIQUIDATING BANK UKRAINA 91 Case Studies Ukraine: Toward Restructuring Oschadny Bank O schadny Bank was formed as a spe- Thus Oschadny's aggregate deposit hold- cialized savings bank under the ings are not so significant that a major change initial reforms introduced after in its operations and status would be likely to Ukrainian independence in 1991.1 Before that destabilize Ukraine's financial markets. Oschadny had been part of the larger Gosbank Household deposits in Ukraine totaled only system, as a traditional state savings bank spe- about $330 million in late 2000, small for a cializing in deposit safekeeping, pension pay- country of 50 million people. Thus while ments, transfers, utility payments, and other Oschadny is perceived as large in Ukraine, its retail services. In contrast to the three other significance in aggregate intermediation is remnants of the Gosbank system (Bank small, reflecting the low level of banking and Ukraina, Prominvestbank, and Ukrsotsbank), financial intermediation in the economy. which were at least nominally privatized in the Like other state and quasi-state banks, early 1990s, Oschadny remains fully state Oschadny's financial situation deteriorated in owned. thelate1990s.Thedeteriorationresultedfrom Although small by international standards, the lack of restructuring earlier in the decade Oschadny is one of the largest banks in as well as management and operating prac- Ukraine. In late 2000, in addition to head- tices common to government-controlled banks quarters (in two buildings), Oschadny had 26 in Ukraine that have proved to be financially full-serviceregionaloffices,450branches(full- unsustainable. The bank has a very large service district offices), 7,847 outlets, and 24 branch network, large staff, and high operat- agencies. And it had 38,015 staff (35,227 on a ing costs. Government-directed lending has full-time-equivalentbasis).Inmanyruralareas weakened the bank's portfolio, reduced earn- the bank is the only formal financial institu- ing assets. And the bank has been slow to tion providing basic payment services and upgrade its management and information deposit safekeeping. The leading institution technology systems to lower costs--and slow in mobilizing household deposits, mainly in toenforcecentralpoliciesinitsregionaloffices. local currency, Oschadny holds about 25­30 Oschadny suffered after-tax losses of $22 percent of the household deposits in the bank- million in 2000. Moreover, these and other ing system. Nonetheless, general monetary cumulative losses from earlier years (as well patterns indicate that Oschadny holds only 9.8 as since 2000) may be understated as a result percent of total deposits, suggesting that most of questionable loan classification standards enterprise and foreign currency deposits are and overvalued collateral. There is a risk that placed with other banks (or held outside the Oschadny's financial condition may worsen banking system). because of its aggressive efforts to increase 93 lending as a way to grow out of its problems. investmentshouldbeexplicitlyguaranteed(in Oschadny was appointed by the government documented form) so that Oschadny assumes in mid-2000 as the authorized bank to service no risk. the clearing accounts of electricity utility com- Thereisariskthatthegovernment,toavoid panies and their branches. Oschadny per- the social consequences of closure and liqui- formed this well until October 2001, and the dation, will permit Oschadny to seek to grow potentiallossesfromtheseoperationsandfrom out of its problems by attempting to leapfrog the incremental lending remain to be seen. from specialized savings bank to full-service WhetherOschadny'sperformanceissuescan universal bank. That would be an extremely be solved depends largely on the willingness of high-risk strategy given the bank's weak finan- Ukrainian authorities to take decisive action. cial condition and limited institutional capac- Thebank'scentralplaceinUkraine'ssocialfab- ity. Under the circumstances Oschadny would ricmakesprivatizationorliquidationanunlikely be almost certain to assume more risk than is solution in the foreseeable future. To reverse prudent so as to generate high earnings and currentlosses,thebank'smanagementhaspur- fund its accumulated losses. sued a cost reduction strategy, releasing staff Even with intensive government efforts, andclosingsomenonviableoffices(148branches the bank's restructuring is likely to be costly and 2,933 operational offices from January 1, and time-consuming. It is also likely to be 1998, to December 31, 2000). However, it complex, because of the weak information remains questionable whether Oschadny can on its extensive branch network, the need for become competitive without significant finan- a more modern personnel management sys- cialassistancefromthegovernment.Preliminary tem, and the retrenchment needed to reduce estimatesinearly2001indicatedthatOschadny its costs. would need to reduce its costs by about 40 per- cent to achieve breakeven. Note At a minimum, safeguards need to be put into place to ensure that decisionmaking is 1. Alexander Pankov is the primary author of groundedincommercialprinciples.Duringthe this annex. Sources include World Bank mission restructuring, any "social" or "governmental" reports;A.Roe,etal."Ukraine:TheFinancialSector activity should be off­balance sheet and sub- and the Economy," World Bank Report, 2001; and ject to commercial pricing. Any lending or the Ukrainian News Agency. 94 CASE STUDIES Case Studies Czech Republic: Privatizing Ceska Sporitelna I n 2000 the Czech government sold Ceska stocks of nonperforming loans from the cen- Sporitelna, the state savings bank and the tral planning era, the government developed country's second largest bank, to Erste a two-stage program to financially restructure Bank of Austria.1 The sale brought to a close and then privatize the new banks.2 A total of one of the government's lengthiest and most 37 percent of Ceska Sporitelna's shares were difficultbankprivatizations.Italsohelpedpave offered for vouchers and 20 percent were sold the way for the privatization the following year to towns and municipalities, while 40 percent of the Czech Republic's largest remaining were retained by the state. The government state-owned bank, Komercni Bank. But the alsopursuedthispolicyforitsotherthreemajor saleofCeskaSporitelnacameatgreatexpense state-ownedbanks--Komercni,Investicni,and to the government. The transaction followed Obchodni--which together with Ceska several years of consolidation and restructur- Sporitelna accounted for 62 percent of bank- ing that culminated in a massive government ing system assets in 1995. By the end of 1995 bailout during the final year before the sale. the state had divested 47­63 percent of these The government strategy proved far more four banks through vouchers, with the state- costly than originally expected and probably owned National Property Fund retaining the far more costly than it would have been had largest block. While not fully privatized, the privatization been pursued more vigorously at banks were effectively "corporatized," and full an earlier stage. privatization was expected to occur after addi- tional restructuring and as accession to the First Phase of Privatization European Union neared. Founded in 1825, Ceska Sporitelna was the Acceleration of the Process: state savings bank during the socialist era Toward a Strategic Investor and remains the largest retail bank in the Czech Republic. In 2000 it had $12 billion in Despite these measures, Ceska Sporitelna lan- assets, a 34 percent market share in retail sav- guishedinitsquasi-privatizedstatusuntilmid- ings, and a network of 934 branches. As part 1999, when the government began to speed up of the Czech government's financial sector its planned sale of a majority stake in the bank. restructuring during the mid-1990s, Ceska Inthemeantimethebank'sprospectshadbeen Sporitelna was included in the first wave of hurt by poor lending decisions that had Czech privatization programs. increased its nonperforming loans. By mid- Recognizingthatthecommercialbankscre- 1999 the bank was expected to lose $389 mil- atedfromthemonobanksysteminheritedlarge lion--the equivalent of more than half its 95 capital. According to reports at the time, the foothold in the Czech market.5 It was also bank needed to cover the loss by writing off attracted by the potential for cost savings part of its capital, which would reduce its cap- through a rationalization of operations. Both ital adequacy ratio to below the legal mini- Erste and Ceska Sporitelna are retail banks mum set by the Czech National Bank. The offering a similar range of products, includ- state was forced to intervene by recapitaliz- ing investment funds, leasing, and insurance. ing Ceska Sporitelna, increasing its incentive In closing the deal, Erste also committed itself to privatize the bank.3 toamajorcapitalincreaseatCeskaSporitelna, Although several foreign banks expressed settingaside$571millionforhousingandsmall an interest in Ceska Sporitelna, the govern- businessprogramsandprovidinganadditional ment felt that some of their offers put insuf- $29 million for venture capital.6 ficient value on the bank's franchise. Rather The Ceska Sporitelna privatization offered than launching a formal tender, the govern- importantlessonsforthegovernmentasitpur- ment entered exclusive negotiations with sued its last major bank privatization the fol- Erste. Although Erste raised its bid, in the end lowing year, for Komercni Bank. Like Ceska it paid only about 1.55 times book value for Sporitelna, Komercni Bank suffered huge Ceska Sporitelna.4 Moreover, the state was losses from nonperforming loans and required forced to make significant concessions. In par- twomassivegovernmentbailouts.Manypoten- ticular, it gave Erste Bank five-year guaran- tial bidders were uninterested in Ceska tees on about half of Ceska Sporitelna's loans. Sporitelna because details of the bailout were Before the sale the state had already assumed unclear,andasaresultthegovernmententered about $1.1 billion of Ceska Sporitelna's non- a bidding process with only one major bidder. performing loans and increased the bank's It proceeded with the Komercni privatization share capital by $201 million to bolster its with those lessons in mind. attractiveness to foreign buyers. The state had a strong interest in privatiz- Notes ing Ceska Sporitelna. Most important, doing so rid the state of responsibility for the bank's 1. SourcesincludeBorish,Ding,andNoël(1996); losses before its market position slipped fur- Economist Intelligence Unit country reports for ther, reducing its appeal to a strategic investor. 1999 and 2000; and U.S. Department of Commerce, And in completing the transaction the gov- National Trade Data Bank, November 3, 2000. ernment divested one of its last two major 2. Borish, Ding, and Noël 1996. state-owned banks--a hurdle that had stood 3. Economist Intelligence Unit country reports in the way of EU accession. for 1999 and 2000. Ceska Sporitelna poses challenges for its 4. Economist Intelligence Unit country reports new owner because it historically was a loss- for 1999 and 2000. maker and and it will need a strategy for deal- 5. Economist Intelligence Unit country reports ing with its more than 16,000 employees and for 1999 and 2000. large branch network. Erste Bank took on the 6. U.S. Department of Commerce, National bank primarily because it has long-term inter- Trade Data Bank, November 3, 2000. ests in the region and was keen to establish a 96 CASE STUDIES Case Studies Russian Federation: Holding onto Sberbank S berbank is by far the largest bank in previous state banks. Sberbank was the Russia.1Thestatesavingsbankhasmore largest of these banks and one of the first to than$20billioninassets,nearly200,000 be "privatized," with the Central Bank of the employees, and 21,000 branches, a larger net- Russian Federation becoming its major work than any other bank. It has a virtual shareholder. monopolyofthecounty'sdeposits,withanesti- mated three-quarters of retail ruble deposits Sberbank's Role Since the 1998 in 2000 and 50 percent of foreign currency Financial Crisis deposits in late 2001. Recent indicators show that Sberbank con- The dominance of state banks in Russia, trolsabout23percentofbankingsystemassets. already high, has been increasing since the In addition, its share of total bank loans has financialcrisisin1998.Sberbankemergedfrom grown rapidly since Russia's 1998 financial cri- the crisis with a stronger market position than sis, increasing from 12 percent in 1998 to more ever before. While thousands of people lost than 25 percent in 2000. In some regions it their savings with the collapse of some of accounts for up to 75 percent of commercial Russia's leading banks, including Inkombank lending. and SBS-Agro, Sberbank benefited from a gov- ernment retail depositor protection scheme The Role of Sberbank in the Early that encouraged depositors to transfer their 1990s deposits to Sberbank. That helped strengthen Sberbank's public image as a secure financial During the past decade Sberbank has con- institution and reinforced the perception that tinued to play the role of a traditional state it was "too big to fail." savings bank despite the many rapid changes The 1998 crisis also led to a shift in some in the banking sector. Sberbank was created of the bank's operations. Before the crisis as a joint stock company in 1991 when the Sberbank had invested most of its assets in government broke up the two-tier banking government securities. Since the crisis it has system, consisting of Gosbank (the central aggressively expanded its lending to the cor- bank) and the five specialized banks that had porate sector. The bank has established itself existed in the Soviet Union since 1987. as the dominant source of loans to large Allowing private banks to exist for the first Russian corporations in the trade, chemicals, time, this reform led to the creation of some construction, and oil and gas sectors and to 800 new banks, which took the capital of the state and municipal bodies. 97 The Future of State Banking in The Russian government's involvement in Russia the banking sector is not limited to Sberbank. A recent study commissioned by the govern- Sberbank's continuing dominance in part ment revealed that state organizations hold reflects the slowness of the government to stakes in more than 469 banks throughout addresssomepolicyissuesthataffectthedevel- thecountry.Whilemostofthestakesaresmall, opment of the financial sector. Sberbank has the state has blocking shares in 45 banks. The severaladvantages:alargebranchnetworkwith government has announced plans to divest a broad geographic distribution, the perceived ownership in all banks where the public share state guarantee on deposits, a strong internal is less than 25 percent. While this would dra- payment system, and a key role in distributing matically reduce the number of state-owned statepensionpayments.Butitsdominantposi- banks, it would still leave Sberbank--and sev- tion in the sector comes at a significant cost to eral large state-owned banks--in the hands the banking system as it can limit competi- of the state. tion. Moreover, the government's involvement in Sberbank represents a conflict of interest: Note the Central Bank is not only the owner of the country's largest bank, but also the supervisor 1. Sources include Fuchs (2002); Aslund and of the banking system and the state authority Layard (1993); Sberbank (2000); and Builov responsible for monetary policy. (2002). 98 CASE STUDIES Case Studies Latvia: Restructuring and Privatizing Unibanka U nibanka is a rare success story in the those of the Savings Bank) under the direct transition economies.1 While the supervision of the Bank of Latvia (the central bank initially engaged in activities bank). These branches dominated the credit that undermined the quality of its loan port- business, since the Savings Bank initially did folio and put bank capital at risk, it was suc- not make loans to enterprises. As a result, at cessfully restructured and, as a result, able to the end of 1991 the 45 branches controlled 83 withstand systemic weaknesses in the mid- percent of all credit to business and held three- 1990s and to attract strategic investment in quartersofthedemanddepositsofenterprises. the second half of the decade. This strategy allowed the Latvian govern- The history of Unibanka is at the heart of ment a wider range of options than those avail- the transformation of Latvian banking from able to its Baltic neighbors, which generally its monobank roots to the current two-tier sys- kept the specialized banks separate. The gov- tem.FollowingthebreakupoftheSovietUnion, ernment could sell the branches to the emerg- Latvia found itself in much the same position ing private sector, privatize them individually as the other newly independent countries. It or in groups, or structure one or more state inherited branches of the specialized Soviet banks. But the strategy also gave the Bank of banks: the Savings Bank (Latvijas Krajbanka), Latvia a great deal of responsibility at a time the Agricultural Bank, the Industry and that the sector and the central bank were both Construction Bank, the Housing and Social undergoing dramatic transformation. In prac- Development Bank, and the Foreign Trade tice, the Bank of Latvia neither actively pro- Bank. In addition to inheriting large nonper- moted governance nor encouraged the branch forming loan portfolios and management managers to run the banks according to strict unused to lending along commercial lines, the commercial criteria. The managers, who had branches were suddenly cut off from their for- little experience in commercial banking and mer head offices. Moreover, the banks found littleloyaltytotheirnewmanagersattheBank that the authorities in Moscow were unwilling of Latvia, therefore found themselves with a to pass on the assets needed to cover a sub- great deal of discretionary power during stantial portion of their liabilities. extremely difficult external conditions. As a While most of the other newly independent result of all this, the branches developed large countries converted the branches they inher- volumes of nonperforming loans. ited directly into nationally owned special- By 1993 the government settled on a strat- ized banks corresponding to the old Soviet egy for dealing with the remnants of the state banks, the Latvian government placed all the banking sector, using a combination of the branches of the specialized banks (except for three approaches mentioned above. It decided 99 to keep the Savings Bank in the public sector fidence in the sector. That loss of confidence while providing considerable institutional spread to the Savings Bank, which held pri- developmentsupportandbringinginnewman- marilyindividualdeposits.BetweenDecember agement, and then eventually privatizing the 1994 and December 1995 individual deposits bank. The government dealt with the main in the Savings Bank fell by almost 17 percent remnant of the banking system in three ways. (in real terms), and total deposits by 13 per- First, it sold 9 branches to private commer- cent. At the same time individual deposits in cial banks. Second, it consolidated 15 of the Unibanka increased by 16 percent, and total branchesinto8newprivatecommercialbanks. deposits by nearly 30 percent. (Meanwhile, Finally, on September 28, 1993, it structured Unibanka's assets increased by 33 percent in the rump of 21 branches into one state bank-- real terms, and its profits by 77 percent.) It the Universal Bank of Latvia, or Unibanka. appears that Unibanka benefited (and the Mostofthebadloans(40percentoftotalassets Savings Bank suffered) from a flight to qual- in March 1994) were concentrated in these ityfollowingthecrisisasdepositorsreallocated branches. assetstowardbanksthatappearedbetterman- Unibanka was subjected to intense institu- aged, better capitalized, and less risky. In sur- tional development efforts supported by the veys, Latvian banking professionals World Bank, the government of Switzerland, consistently rated Unibanka as the safest bank and the European Union. As part of the reha- in Latvia. bilitation process, the bad loans Unibanka had In accordance with the government's deci- inherited were taken off its books and replaced sion, privatization procedures were launched with seven-year government bonds in the at Unibanka on October 3, 1995. The board amount of 25 million lats (LVL), or about $50 of the Latvian privatization agency approved million.Asaresultofrapidgrowthinthecredit basic privatization regulations providing that providedbyprivatebanks,Unibankaaccounted Unibanka would be privatized in four years. for only 7 percent of total credit by the end of In the first stage, carried out in 1995, share 1994. But it was the country's second largest capital was increased to LVL 11.5 million bank in terms of assets. (about $23 million) and then a little over 50 One of the main reasons cited by the gov- percent of the shares were sold for privatiza- ernment for creating Unibanka was to provide tion certificates. Of this 50 percent, 22 per- an insurance policy against catastrophic fail- cent were sold publicly, 13.5 percent were sold ures in the private banking sector. This logic to customers of Unibanka, and 14.5 percent wasputtoaserioustestinthefirsthalfof1995, were sold to employees. The privatization when the insolvency of the country's largest agency held the remaining shares. In October bank (Bank Baltija) triggered a systemic cri- 1995 the bank's shareholders decided to reor- sis in which about 40 percent of the assets ganize the bank into a joint stock company, and liabilities of the banking sector were lost Latvijas Unibanka, and a new charter was and7banks,including3ofthe10largestbanks, approved for the bank. And in January 1996 collapsed. Although the crisis had a big effect Unibanka became the first company to list on on both Unibanka and the Savings Bank, nei- the Riga stock exchange. ther was directly involved and neither needed The bank's privatization regulations called to be closed or bailed out. for increasing its share capital during the next Unibanka, already healthier than the privatization round by attracting capital from Savings Bank, was less badly harmed. Since a strategic investor. In May 1996 Unibanka's most of the deposits in the failed banks were sharecapitalwasraisedbyLVL6million(about individual deposits, people probably lost con- $12 million), and the newly issued shares were 100 CASE STUDIES purchased by the European Bank for shares from the other bank's shareholders, ReconstructionandDevelopment(EBRD)and includingtheEBRD.Byearly2001Unibanka's SwedfundInternationalAB.TheEBRDgained shares were no longer quoted at the Riga stock controlofabout22.6percentofthetotalshares exchange. and Swedfund control of about 7.5 percent. Today Unibanka is the second largest bank Over the next three years most of the remain- in Latvia and the fifth largest in the Baltics (in ing state-owned shares were sold in the inter- terms of assets). As a universal bank, it pro- national market through a global depository vides a wide range of commercial and retail receipt program, and part were sold through services,concentratingonthedomesticmarket, special auctions at the Riga stock exchange. where it has a solid franchise. SEB has helped By the time privatization was complete in late Unibankaimproveriskmanagementandretail 1999, the state had received LVL 66.1 million operations and implement credit controls. The (about $113.4 million)--LVL 21.3 million in bank'sperformancesincethecompletionofpri- cash and LVL 44.8 million in privatization vatization has been very satisfactory, and posi- vouchers. tive economic forecasts for Latvia bode well for By September 2001 Unibanka's paid-up future growth in its operations. share capital amounted to LVL 37.1 million ($59.9 million). More than 98 percent belongs Note to the Swedish bank Skandinaviska Enskilda Banken (SEB). A major force in the banking 1. Alex Pankov is the author of this annex. sector consolidation in the Baltics, SEB ini- Sources include Fleming and Talley (1996); Fitch tially purchased a 23 percent interest in Credit Agency, Unibanka Rating Report, 2000; Unibanka at a special auction held in the stock BankScope reports on Unibanka for 1999­2001; market in late 1998. It then steadily purchased and the Baltic News Service. LATVIA: RESTRUCTURING AND PRIVATIZING UNIBANKA 101 Case Studies Azerbaijan: Committing to Privatization of the International Bank of Azerbaijan T heAzeribankingsystem,atwo-tiersys- banking system remains highly concentrated tem established 10 years ago, remains and underdeveloped. at a critical stage of development.1 WhilethegovernmentofAzerbaijanhasmade Consolidation ofThree State good progress in stabilizing the economy since Banks 1995, its efforts to address structural issues in the financial sector have had mixed results. Throughout the government's reform efforts The government has made some advances in during the mid-1990s, some of the biggest loss- upgrading prudential regulations for banks, makers in the sector were state-owned banks, strengthening off-site supervision, and regu- including Amanat (the savings bank), latingforeignexchangemarkets.Butthebank- Prominvest (the industrial investment bank), ing sector still suffers from poor management, and Agroprom (the agro-industrial bank). weakgovernance,limitedtechnology,problem Nonperforming loans were particularly prob- loans, and insufficient capital. It is estimated lematicatAgropromandProminvest,account- that only 10­20 percent of the money in cir- ingformorethan90percentoftheirportfolios. culation passes through the banking system. By late 1999, after consecutive recapitaliza- Tackling the issue of state-owned banks has tionsofthesethreebankshadfailedtoimprove proved to be one of the government's most performance, the government recognized that complex tasks. Despite attempts since 1996 to it needed to take more radical measures. recapitalize, restructure, and privatize state- As a first step, in February 2000 the govern- owned banks, state ownership in the banking ment merged the viable operations of the three sector remains high, dominated by the banks into a new bank, the United State International Bank of Azerbaijan (IBA). This Industrial Bank (later renamed United bank was left with a near monopoly when the Universal Bank). The government issued the government consolidated its three other trou- entity a limited license that allowed it only to bled state-owned banks into a single entity in collectdeposits,performforeignexchangeactiv- 2000. While this step marked significant ities,investingovernmentsecurities,andprovide progress in reducing public ownership, the cash payment services for the Social Protection 103 and Pension Funds and other budget entities. Toward Privatization The terms of the license prohibited the bank from engaging in lending for two years, so that In 2001 the government reiterated its com- it will in effect operate as a narrow bank. mitment to privatizing IBA and issued a pres- The government plans to develop the oper- idential decree to that effect. The Ministry of ational structure of United Universal and Financeowns50.2percentofthebank'sshares. establish an effective lending capacity. The The EBRD, which has been providing support aim is to strengthen the bank and improve its for IBA in the form of a credit line targeted to efficiency, creating the conditions for its even- small and medium-size enterprises, has indi- tual privatization through the sale of a con- cated an interest in taking on a 20 percent trolling share to a strategic investor. equity stake. The remaining state shares are expected to be auctioned later. Continued Dominance of the IBA, despite its dominance of the banking Banking Sector by the sector, faces many governance and manage- International Bank of Azerbaijan ment problems and is plagued by inefficiency. Itshowedweakprofitabilityin2000,withafter- With the decision to create United Universal, tax earnings of only $9 million. The slight the government solidified IBA's position as the increase in profit that the bank did see was country's leading and best capitalized bank. dueprimarilytothenetinterestincomeearned IBA has 75 percent of banking sector assets on the placement of funds of the Azeri Oil and 40 percent of retail deposits. In 2000 its Fund,revenuesthatwerenotexpectedtorecur assets stood at $614 million, and its loan port- in 2001. folio grew by 22 percent. The bank has close While the government's recent moves links to many government departments and related to IBA and United Universal repre- state organizations, including the important sentprogress,privatizationisonlyoneelement Oil Fund, and acts as an intermediary for gov- of the financial sector reforms needed. The ernment-guaranteedcreditlinestoAzerbaijan. broader challenge is to make banks more cen- IBAwasestablishedin1990asareplacement tral to economic activity in Azerbaijan--mobi- fortheAzerbaijanbranchofVnesheconombank, lizing deposits, lending to businesses, and the former Soviet foreign trade bank. In keep- offering a greater array of services. ing with its origins, its foreign trade operations are well established. But IBA also accepts Note deposits from and issues loans to Azeri firms. Anditissteadilyincreasingitsretailoperations. 1. Sources include internal World Bank docu- The bank has about 700 employees and 32 ments from 1999­2000; BankScope (Fitch IBCA); branches, a relatively large network given the Economist Intelligence Unit country reports; and country's small size. EBRD Transition Reports. 104 CASE STUDIES Annexes 105 Annex 1 Financial Profile of Selected State Banks (millions of U.S. dollars except where otherwise specified) Net Number of Country/Banks Assets Loans Deposits Capital income employees Albania Savings Bank 1,230 10 1,176 33 26 -- Armenia Armenian Savings Bank 9 3 9 0 0 -- Azerbaijan International Bank of Azerbaijan 615 184 474 19 9 -- United Universal Bank 38 0 11 5 1 2,590 Belarus Belpromstroibank 299 149 239 44 5 5,192 Belagroprombank 283 220 153 113 5 7,267 Belbusinessbank 150 79 117 11 2 -- Belgazprombank 35 5 21 11 0 419 Belarusbank Savings Bank 779 579 622 108 ­2 -- Belvnesheconombank 201 73 179 19 0 2,126 Bosnia and Herzegovinaa Federation Investment Bank 62 25 -- 59 -- -- Banjalucka Banka 42 19 27 10 -- -- Privredna Banka (PBS) Sarajevo 34 9 24 5 -- -- Central Profit 162 47 115 29 1 -- Gospodarska Mostar 24 8 19 3 0 82 Bulgaria DSK Bank 588 271 492 79 8 5,697 Commercial Bank Biochim 248 72 223 23 5 -- Central Cooperative 95 86 67 13 0 -- Croatia Dubrovacka Banka 401 153 231 14 ­12 567 Croatia Banka 159 82 102 15 ­11 -- Splitska Banka 997 462 884 67 6 1,070 Croatian Bank for Reconstruction & Development 693 298 223 397 11 -- Hrvatska Postanska Bank 222 114 164 28 ­21 172 Riadria Banka 172 65 128 26 ­5 -- Czech Republic Komercni Banka 11,000 3,000 9,000 1,000 12 -- Ceska Exportni Banka 631 17 153 51 2 -- Ceskomoravka Zarucni a Rozvojavo Banka 1,126 681 762 93 2 -- Estonia No state banks left Georgia No state banks left Hungary Postbank and Savings Bank Corp. 1,193 400 986 148 3 -- Hungarian Development Bank 738 199 328 356 ­20 -- Kazakhstan Halyk Savings Bank 707 342 616 48 ­2 -- Eximbank 71 43 32 28 ­4 -- Kyrgyz Republic Kairat Bank 7 0 5 1 1 -- Savings and Settlement Company 5 0 3 1 0 -- Energo Bank 6 2 5 1 0 -- Latvia Mortgage and Land Bank of Latvia 123 87 59 13 1 -- Latvian Savings Bank 246 62 222 8 1 1,234 Lithuania Lithuanian Savings Bank 830 238 711 55 ­8 3,586 Agricultural Bank of Lithuania 417 201 322 32 2 1,769 Macedonia, FYR Macedonian Development Bank -- 14 -- 14 0 -- 106 ANNEXES Annex 1 (continued) Financial Profile of Selected State Banks (millions of U.S. dollars except where otherwise specified) Net Number of Country/Banks Assets Loans Deposits Capital income employees Moldova Banca de Economii 35 13 25 4 3 -- Poland Powszechna Kasa Oszczednosci BP 16,627 6,872 15,129 594 153 -- Bank Gospodarki Zywnosciowej 4,408 2,033 3,776 214 24 -- Romania Banca Comerciala Romana 2,769 754 1,874 539 117 -- Savings Bank (CEC) 880 56 750 110 26 12,832 EXIM Bank 203 29 35 28 ­2 -- Banca Agricola 448 313 471 26 ­85 5,837 Russian Federation Sberbank 20,000 9,000 18,000 1,000 403 197,122 Vneshtorgbank 4,414 962 2,704 1,599 170 3,669 Vneschekonombank 2,599 272 2,415 119 1 1,465 Russian Development Bank 168 -- 37 131 1 105 Rosselkhozbank -- -- -- -- -- -- Moscow Municipal Bank 1,525 848 1,348 85 1 -- Bahkir Republic Investment Bank 610 330 485 112 1 -- Slovak Republic Vseobecna Uverova Banka 3,887 1,873 2,722 278 67 -- Investicna a Rozvojva Banka 509 365 472 23 8 1,073 First Building Savings Bank­Prva Stavebna Sporitelna 834 463 643 51 16 449 Slovak Guarantee and Development Bank 140 2 21 103 6 93 Banka Slovakia 81 19 64 15 0 -- Slovenia Nova Ljubljanska Banka 5,051 2,633 4,289 429 52 4,271 Nova Kreditna Banka Maribor 1,563 674 1,344 158 28 -- Posta Banka Slovenija 259 108 223 11 0 209 SKB Banka DD 1,353 742 1,142 121 2 -- Slovene Export Corporation 182 2 31 73 1 -- Slovenska Investijska Banka 133 82 101 10 0 -- Tajikistan Savings Bank (Sberbank) 9 3 8 0 0 -- Turkmenistanb Vneshekonombank 2,075 1,803 434 21 3 341 Uzbekistan Uzbek State Joint Stock Housing Savings Bank 142 68 101 36 2 -- Asaka Bank 247 149 108 138 2 -- Uzbek Joint Stock­Commercial Industrial Construction Bank 435 245 338 55 2 -- National Bank for Foreign Economy Activity of Republic of Uzbekistan 3,913 2,227 2,071 662 2 -- Ukraine Savings Bank 390 98 333 28 ­22 -- Export-Import Bank 400 224 245 32 10 2,239 Yugoslavia Jugobanka Bor 241 133 103 7 0 -- Beobanka Belgrade 489 137 668 ­263 ­500 4,124 Invest Banka 1,541 919 416 68 ­181 -- Jugobanka Beograd 1,826 1,392 171 95 -- -- Beogradska Banka 2,018 1,804 322 209 -- -- Vojvodjanska Banka 560 324 176 93 0 3,215 -- Not available. a. No data available for PBS Srpska Sarajevo, PBS Doboj, PBS Prijedor, PBS Gradiska, PBS Brcko, UNA Bihac, Sipad, Postanska, Ljubljanska, Semberska, Postanska sed., Kristal, Rosvojna, and Agroprom. b. No data available for Sberbank,Turkmenistanbank,Turkmenbashibank, and Daykhanbank. Source: IMF; BankScope; Bulgarian National Bank; authors' calculations. ANNEXES 107 Annex 2 Financial Profile of Selected State Banks (percent) Liquid Loan Equity/ Net Return Return Net loans/ assets/ loss reserve/ total interest on on total short-term Country/Banks gross loans assets margin assets equity assets funding Albania Savings Bank 88.3 2.7 3.6 2.2 -- 0.8 100.7 Armenia Armenian Savings Bank -- 0.0 0.3 ­0.0 ­1.2 0.3 0.1 Azerbaijan International Bank of Azerbaijan 12.5 3.0 3.7 2.1 62.1 29.9 80.2 United Universal Bank Belarus Belpromstroibank 11.4 14.8 18.8 2.2 18.5 50.0 39.3 Belagroprombank -- 39.8 22.3 2.5 6.0 77.8 11.4 Belbusinessbank -- 24.9 24.1 2.9 14.4 46.9 43.8 Belgazprombank -- 31.5 13.7 0.8 2.4 14.2 102.6 Belarusbank Savings Bank -- 13.9 11.0 ­0.5 ­3.1 74.4 19.1 Belvnesheconombank 17.6 9.3 11.0 0.1 1.4 36.4 48.4 Bosnia and Herzegovinaa Federation Investment Bank 45.3 94.5 4.5 2.5 2.6 39.6 -- Banjalucka Banka 22.0 24.1 2.0 0.5 7.1 44.2 38.7 Privredna Banka Sarajevo 45.8 14.8 9.9 0.5 2.9 25.7 45.7 Central Profit 5.7 17.6 5.8 0.1 0.3 29.2 66.4 Gospodarska Mostar 15.1 13.1 6.1 1.7 11.9 31.7 81.7 Bulgaria DSK Bank 5.5 13.4 8.4 1.4 10.2 46.2 26.3 Commercial Bank Biochim 32.7 9.2 7.5 2.2 29.1 29.0 68.9 Central Cooperative -- -- -- -- -- -- -- Croatia Dubrovacka Banka 20.6 3.6 1.5 ­2.8 ­59.5 38.2 25.1 Croatia Banka 43.4 9.6 3.3 ­6.0 ­53.7 51.4 39.9 Splitska Banka 10.4 6.8 4.1 0.6 9.7 46.4 26.8 Croatian Bank for Reconstruction & Development 16.3 57.3 5.0 1.7 2.8 43.0 63.4 Hrvatska Postanska Bank 11.7 12.6 2.6 ­9.2 ­55.0 51.4 40.5 Riadria Banka -- 15.3 6.0 ­3.1 ­17.7 37.6 16.5 Czech Republic Komercni Banka 14.0 5.2 3.7 ­0.1 ­1.1 31.1 44.9 Ceska Exportni Banka -- 8.0 5.2 0.3 3.0 11.2 8.7 Ceskomoravka Zarucni a Rozvojavo Banka 5.7 8.2 0.5 1.8 17.3 60.4 9.6 Estonia No state banks left Georgia No state banks left Hungary Postbank and Savings Bank Corp. 5.4 12.4 5.1 0.3 2.2 33.5 43.2 Hungarian Development Bank 5.2 48.3 1.8 ­3.0 ­7.7 26.9 0.0 Kazakhstan Halyk Savings Bank 4.1 6.7 6.0 ­0.3 ­3.7 48.3 44.8 Eximbank -- 45.4 7.6 ­6.9 ­14.5 69.9 14.9 Kyrgyz Republic Kairat Bank 2.0 52.0 -- ­11.5 ­86.0 0.0 25.0 Savings and Settlement Company 0.0 19.0 -- 0.9 4.4 0.2 115.0 Energo Bank 11.1 12.0 1.6 0.2 1.5 36.0 64.0 Latvia Mortgage and Land Bank of Latvia 2.6 10.9 7.6 1.1 8.9 70.7 12.5 Latvian Savings Bank 4.5 3.3 5.6 0.6 17.8 25.4 8.3 Lithuania Lithuanian Savings Bank 2.1 6.7 5.2 ­1.0 ­13.6 28.6 28.7 Agricultural Bank of Lithuania 2.8 7.7 5.3 0.5 5.9 48.2 22.6 Macedonia, FYR Macedonian Bank for Development Promotion -- 100.0 6.7 3.2 3.2 -- -- 108 ANNEXES Annex 2 (continued) Financial Profile of Selected State Banks (percent) Liquid Loan Equity/ Net Return Return Net loans/ assets/ loss reserve/ total interest on on total short-term Country/Banks gross loans assets margin assets equity assets funding Moldova Banca de Economii 5.5 12.2 -- 11.5 132.8 36.2 49.7 Poland Powszechna Kasa Oszczednosci Bank Polski SA 4.8 3.6 5.7 1.0 29.6 41.3 5.4 Bank Gospodarki Zywnosciowej -- 4.8 5.2 0.6 12.0 46.1 6.9 Romania Banca Comerciala Romana -- 19.5 10.3 3.6 20.1 27.2 47.4 Savings Bank (CEC) 0.8 16.5 13.6 2.7 17.6 5.8 28.1 EXIM Bank -- 13.7 8.0 ­0.9 ­7.0 14.2 99.1 Banca Agricola 13.7 ­12.4 ­9.3 22.2 -- 12.6 41.9 Russian Federation Sberbank 12.0 7.6 9.5 2.2 29.9 44.0 48.3 Vneshtorgbank 18.2 36.2 6.0 4.7 15.0 21.8 115.1 Vneschekonombank 10.2 4.6 6.3 0.4 8.8 10.5 87.2 Russian Development Bank -- 78.2 17.8 0.5 0.7 -- 450.0 Rosselkhozbank -- -- -- -- -- -- -- Moscow Municipal Bank 2.3 5.6 0.3 1.0 16.1 55.6 40.6 Bahkir Republic Investment Bank 12.3 18.3 13.5 10.3 78.7 54.0 37.0 Slovak Republic Vseobecna Uverova Banka 13.9 8.6 2.9 2.2 27.2 58.0 32.9 Investicna a Rozvojva Banka -- 4.4 0.9 1.6 43.5 71.7 18.7 First Building Savings Bank­ Prva Stavebna Sporitelna -- 6.1 1.5 2.0 35.2 55.4 12.9 Slovak Guarantee and Development Bank -- 73.7 8.6 5.0 6.6 1.3 522.9 Banka Slovakia 7.2 19.6 3.2 0.7 3.3 23.4 72.8 Slovenia Nova Ljubljanska Banka 6.8 8.5 4.7 1.1 13.1 52.1 13.1 Nova Kreditna Banka Maribor -- 10.1 6.8 1.9 19.4 43.1 14.0 Posta Banka Slovenija -- 4.4 4.6 0.1 2.0 41.5 18.1 SKB Banka DD -- 9.0 4.6 0.2 1.7 54.8 18.4 Slovene Export Corporation 36.7 40.3 2.2 0.4 0.9 1.0 479.4 Slovenska Investijska Banka -- 7.6 2.1 0.3 4.0 61.4 14.4 Tajikistan Sberbank -- 0.5 -- 0.5 95.0 37.0 20.0 Turkmenistanb Vneshekonombank 2.3 1.0 0.6 0.2 15.5 86.9 48.8 Ukraine Savings Bank -- 7.1 -- -- -- 25.2 -- Export-Import Bank 27.3 8.1 7.9 2.6 34.6 55.9 -- Uzbekistan Uzbek State Joint Stock Housing Savings Bank 6.0 25.6 19.5 2.1 8.8 47.7 42.3 Asaka Bank 4.8 55.8 7.6 33.4 69.7 60.4 63.7 Uzbek Joint Stock­Commercial Industrial Construction Bank 3.9 12.8 4.7 1.8 13.9 56.4 36.7 National Bank for Foreign Economy Activity of Republic of Uzbekistan 1.8 16.9 2.8 0.7 4.3 56.9 62.9 Yugoslavia Jugobanka Bor 3.1 2.8 -- 0.0 0.3 54.7 -- Beobanka Belgrade 49.2 ­80.9 -- -- -- 28.0 -- Invest Banka 15.2 ­6.3 -- -- -- 59.6 -- Jugobanka Beograd 1.6 3.9 -- -- -- 76.2 -- Beogradska Banka 5.4 5.3 -- 0.1 0.9 89.4 -- Vojvodjanska Banka 0.0 16.6 -- -- -- 57.9 -- -- Not available. a. No data available for PBS Srpska Sarajevo, PBS Doboj, PBS Prijedor, PBS Gradiska, PBS Brcko, UNA Bihac, Sipad, Postanska, Ljubljanska, Semberska, Postanska sed., Kristal, Rosvojna, and Agroprom. b. No data available for Sberbank,Turkmenistanbank,Turkmenbashibank, and Daykhanbank. c. Data provided for 2000, or 1999 if that is latest date available. Source: BankScope; Bulgarian National Bank; authors' calculations. ANNEXES 109 Annex 3 Financial Profile of Selected State Banks (percent) Country/Banks Assets/GDP Loans/GDP Deposits/GDP Capital/GDP Albania Savings Bank 33.2 0.3 31.8 0.9 Armenia Armenian Savings Bank 0.5 0.2 0.5 0.0 Azerbaijan International Bank of Azerbaijan 11.7 3.5 9.0 0.4 United Universal Bank 0.7 0.0 0.2 0.1 Belarus Belpromstroibank 1.0 0.5 0.8 0.1 Belagroprombank 0.9 0.7 0.5 0.4 Belbusinessbank 0.5 0.3 0.4 0.0 Belgazprombank 0.1 0.0 0.1 0.0 Belarusbank Savings Bank 2.6 1.9 2.1 0.4 Belvnesheconombank 0.7 0.2 0.6 0.1 Bosnia and Herzegovinaa Federation Investment Bank 1.4 0.6 -- 1.4 Banjalucka Banka 1.0 0.4 0.6 0.2 Privredna Banka Sarajevo 0.8 0.2 0.6 0.1 Central Profit 3.8 1.1 2.7 0.7 Gospodarska Mostar 0.6 0.2 0.4 0.1 Bulgaria DSK Bank 4.9 2.3 4.1 0.1 Commercial Bank Biochim 2.1 0.6 1.9 0.0 Central Cooperative 0.8 0.4 0.6 0.1 Croatia Dubrovacka Banka 1.8 0.7 1.0 0.1 Croatia Banka 0.7 0.4 0.5 0.1 Splitska Banka 4.4 2.1 3.9 0.3 Croatian Bank for Reconstruction & Development 3.1 1.3 1.0 1.8 Hrvatska Postanska Bank 1.0 0.5 0.7 0.1 Riadria Banka 0.8 0.3 0.6 0.1 Czech Republic Komercni Banka 22.0 6.0 18.0 2.0 Ceska Exportni Banka 1.3 0.0 0.3 0.1 Ceskomoravka Zarucni a Rozvojavo Banka 2.3 1.4 1.5 0.2 Estonia No state banks left Georgia No state banks left Hungary Postbank and Savings Bank Corp. 2.6 0.9 2.2 0.3 Hungarian Development Bank 1.6 0.4 0.7 0.8 Kazakhstan Halyk Savings Bank 3.9 1.9 3.4 0.3 Eximbank 0.4 -- -- -- Kyrgyz Republic Kairat Bank 0.5 0.0 0.4 0.1 Savings and Settlement Company 0.4 0.0 0.2 0.1 Energo Bank 0.4 0.2 0.4 0.1 Latvia Mortgage and Land Bank of Latvia 1.7 1.2 0.8 0.2 Latvian Savings Bank 3.5 0.9 3.1 0.1 Lithuania Lithuanian Savings Bank 7.4 2.1 6.3 0.5 Agricultural Bank of Lithuania 3.7 1.8 2.9 0.3 Macedonia, FYR Macedonian Bank for Development Promotion -- 0.4 -- 0.0 110 ANNEXES Annex 3 (continued) Financial Profile of Selected State Banks (percent) Country/Banks Assets/GDP Loans/GDP Deposits/GDP Capital/GDP Moldova Banca de Economii 2.7 1.0 1.9 0.3 Poland Powszechna Kasa Oszczednosci Bank Polski SA 10.3 4.2 9.3 0.4 Bank Gospodarki Zywnosciowej 2.7 1.3 2.3 0.1 Romania Banca Comerciala Romana 8.7 2.4 6.5 1.7 Savings Bank (CEC) 2.6 0.2 2.1 0.4 EXIM Bank 0.6 0.1 0.4 0.1 Banca Agricola -- -- -- 7.0 Russian Federation Sberbank 8.0 3.6 7.2 0.4 Vneshtorgbank 1.8 0.4 1.1 0.6 Vneschekonombank 1.0 0.1 1.0 0.0 Russian Development Bank 0.1 -- 0.0 0.1 Rosselkhozbank -- -- -- -- Moscow Municipal Bank 0.6 0.3 0.5 0.0 Bahkir Republic Investment Bank 0.2 0.1 0.2 0.0 Slovak Republic Vseobecna Uverova Banka 20.5 9.9 14.3 1.5 Investicna a Rozvojva Banka 2.7 1.9 2.5 0.1 First Building Savings Bank­ Prva Stavebna Sporitelna 4.4 2.4 3.4 0.3 Slovak Guarantee and Development Bank 0.7 0.0 0.1 0.5 Banka Slovakia 0.4 0.1 0.3 0.1 Slovenia Nova Ljubljanska Banka 28.1 14.6 23.8 2.4 Nova Kreditna Banka Maribor 8.7 3.7 7.5 0.9 Posta Banka Slovenija 1.4 0.6 1.2 0.1 SKB Banka DD 7.5 4.1 6.3 0.7 Slovene Export Corporation 1.0 0.0 0.2 0.4 Slovenska Investijska Banka 0.7 0.5 0.6 0.1 Tajikistan Sberbank 0.9 0.3 0.8 0.0 Turkmenistanb Vneshekonombank 47.2 41.0 9.9 0.5 Ukraine Savings Bank 1.2 0.3 1.0 1.2 Export-Import Bank 1.2 0.7 0.8 1.2 Uzbekistan Uzbek State Joint Stock Housing Savings Bank 1.1 0.5 0.7 0.3 Asaka Bank 1.8 1.1 0.8 1.0 Uzbek Joint Stock­Commercial Industrial Construction Bank 3.2 1.8 2.5 0.4 National Bank for Foreign Economy Activity of Republic of Uzbekistan 29.0 16.5 15.3 4.9 Yugoslavia Jugobanka Bor 2.7 1.5 1.1 0.1 Beobanka Belgrade 5.4 1.5 7.4 ­2.9 Invest Banka 17.1 10.2 4.6 0.8 Jugobanka Beograd 20.3 15.5 1.9 1.1 Beogradska Banka 22.4 20.0 3.6 2.3 Vojvodjanska Banka 6.2 3.6 2.0 1.0 -- Not available. a. No data available for PBS Srpska Sarajevo, PBS Doboj, PBS Prijedor, PBS Gradiska, PBS Brcko, UNA Bihac, Sipad, Postanska, Ljubljanska, Semberska, Postanska sed., Kristal, Rosvojna, and Agroprom. b. No data available for Sberbank,Turkmenistanbank,Turkmenbashibank, and Daykhanbank. Source: IMF; BankScope; Bulgarian National Bank; authors' calculations. ANNEXES 111 Annex 4 Market Ratios of Selected State Banks inTransition Economies, 1999­2000 (percent) Country/Banks Asset share Loan share Deposit share Capital share Albania Savings Bank 63.6 5.8 71.8 13.6 Armenia Armenian Savings Bank 4.1 1.4 5.1 0.4 Azerbaijan International Bank of Azerbaijan 60.9 33.8 87.0 11.9 United Universal Bank 3.8 0.1 2.0 3.1 Belarus Belpromstroibank 16.0 10.6 20.7 12.0 Belagroprombank 15.1 15.6 13.2 30.9 Belbusinessbank 8.0 5.6 10.1 3.0 Belgazprombank 1.9 0.4 1.9 3.0 Belarusbank Savings Bank 41.7 41.2 53.8 29.5 Belvnesheconombank 10.7 5.2 15.5 5.2 Bosnia and Herzegovinaa Federation Investment Bank 2.2 1.2 -- 11.3 Banjalucka Banka 1.5 0.9 7.1 1.9 Privredna Banka Sarajevo 1.2 0.4 6.3 1.0 Central Profit 5.8 2.3 30.3 5.6 Gospodarska Mostar 0.9 0.4 5.0 0.6 Bulgaria DSK Bank 12.2 10.7 17.7 15.7 Commercial Bank Biochim 5.2 2.9 8.0 4.6 Central Cooperative 0.9 6.6 2.0 1.8 Croatia Dubrovacka Banka 3.0 1.6 2.9 0.5 Croatia Banka 1.2 0.8 1.3 0.5 Splitska Banka 7.4 4.7 10.9 2.2 Croatian Bank for Reconstruction & Development 5.1 3.1 2.8 13.0 Hrvatska Postanska Bank 1.6 1.2 2.0 0.9 Riadria Banka 1.3 0.7 1.6 0.8 Czech Republic Komercni Banka 20.8 9.6 26.8 9.3 Ceska Exportni Banka 1.2 0.1 0.5 0.5 Ceskomoravka Zarucni a Rozvojavo Banka 2.1 2.2 2.3 0.9 Estonia No state banks left Georgia No state banks left Hungary Postbank and Savings Bank Corp. 4.4 1.8 5.5 5.1 Hungarian Development Bank 2.7 0.9 1.8 12.4 Kazakhstan Halyk Savings Bank 19.3 17.2 29.0 7.0 Eximbank 3.0 -- -- 3.9 Kyrgyz Republic Kairat Bank 7.1 0.0 7.4 3.6 Savings and Settlement Company 5.7 0.0 4.4 4.0 Energo Bank 6.1 3.3 7.4 2.8 Latvia Mortgage and Land Bank of Latvia 2.8 4.8 1.9 3.9 Latvian Savings Bank 5.0 3.0 7.0 2.0 Lithuania Lithuanian Savings Bank 27.4 11.8 36.5 7.5 Agricultural Bank of Lithuania 13.8 10.0 16.5 4.4 Macedonia, FYR Macedonian Bank for Development Promotion -- 1.9 -- 2.9 112 ANNEXES Annex 4 (continued) Market Ratios of Selected State Banks inTransition Economies, 1999­2000 (percent) Country/Banks Asset share Loan share Deposit share Capital share Moldova Banca de Economii 9.3 7.0 18.9 3.8 Poland Powszechna Kasa Oszczednosci Bank Polski SA 18.9 9.4 27.8 7.2 Bank Gospodarki Zywnosciowej 5.0 2.8 6.9 2.6 Romania Banca Comerciala Romana 33.4 29.1 31.6 53.5 Savings Bank (CEC) 10.6 2.2 12.7 10.9 EXIM Bank 2.4 1.1 0.6 2.8 Banca Agricola 3.6 2.6 3.2 2.5 Russian Federation Sberbank 24.7 16.9 45.0 6.4 Vneshtorgbank 5.4 1.8 6.8 10.3 Vneschekonombank 3.2 0.5 6.0 0.8 Russian Development Bank 0.2 -- 0.2 0.3 Rosselkhozbank -- -- -- -- Moscow Municipal Bank 0.0 0.0 0.0 0.0 Bahkir Republic Investment Bank 1.9 1.6 8.7 0.2 Slovak Republic Vseobecna Uverova Banka 23.6 14.1 24.2 12.7 Investicna a Rozvojva Banka 3.1 2.7 4.2 1.0 First Building Savings Bank­ Prva Stavebna Sporitelna 5.1 3.5 5.7 2.3 Slovak Guarantee and Development Bank 0.8 0.0 0.2 4.7 Banka Slovakia 0.5 0.1 0.6 0.7 Slovenia Nova Ljubljanska Banka 38.1 24.2 52.3 26.8 Nova Kreditna Banka Maribor 11.8 6.2 16.4 9.9 Posta Banka Slovenija 2.0 1.0 2.7 0.7 SKB Banka DD 10.2 6.8 13.9 7.6 Slovene Export Corporation 1.4 0.0 0.4 4.6 Slovenska Investijska Banka 1.0 0.8 1.2 0.6 Tajikistan Sberbank -- -- -- -- Turkmenistanb Vneshekonombank -- -- -- -- Ukraine Savings Bank 6.7 2.9 9.8 4.4 Export-Import Bank 6.9 6.7 7.2 5.0 Uzbekistan Uzbek State Joint Stock Housing Savings Bank -- -- -- -- Asaka Bank -- -- -- -- Uzbek Joint Stock­Commercial Industrial Construction Bank -- -- -- -- National Bank for Foreign Economy Activity of Republic of Uzbekistan -- -- -- -- Yugoslavia Jugobanka Bor -- -- -- -- Beobanka Belgrade -- -- -- -- Invest Banka -- -- -- -- Jugobanka Beograd -- -- -- -- Beogradska Banka -- -- -- -- Vojvodjanska Banka -- -- -- -- -- Not available. a. No data available for PBS Srpska Sarajevo, PBS Doboj, PBS Prijedor, PBS Gradiska, PBS Brcko, UNA Bihac, Sipad, Postanska, Ljubljanska, Semberska, Postanska sed., Kristal, Rosvojna, and Agroprom. b. No data available for Sberbank,Turkmenistanbank,Turkmenbashibank, and Daykhanbank. Source: IMF; BankScope; Bulgarian National Bank; authors' calculations. ANNEXES 113 Annex 5 State Banks Included in the Analysis for End-2000 Albania Savings Bank Armenia Armenia Savings Banka Azerbaijan IBA, United Universal Belarus Belpromstroibank, Belagroprombank, Belbusinessbank, Belgazprombank, Belarusbank, Belvnesheconombank Bosnia and Herzegovina Investment Bank, Central Profit Bank, Gospodarska, Privredna Bulgaria DSK, Biochim, Central Cooperative Croatia Dubrovackaa, Croatia Bankaa, Croatian Bank for Reconstruction and Development, Hrvatska Postanska Czech Republic Komercnia, Ceskomoravska Zarucni, Ceska Exportni Estonia No state banks Georgia No state banks Hungary Magyar Fejlesztesi, Postbank Kazakhstan Export-Import Bank, Halyk Kyrgyz Republic Kairat, Energo Bank Latvia Latvian Mortgage and Land Bank, Latvian Savings Bank Lithuania Agricultural Bank Macedonia, FYR Macedonian Development Bank (estimated) Moldova Banca de Economii Poland PKO BP, BGZ, National Economy Bank, Bank Ochrony Srodowiska Romania Banca Agricolaa, BCR, CEC, EXIMBank Russian Federation Sberbank, Medium- & Long-Term Credit Bank,Vnesheconombank, Russian Bank for Development Slovak Republic VUBa, Investicna a Rozvojova, First Building Savings, Slovenska Zarucna a rojvojova, Banka Slovakia, Exportno-Importna Slovenia Nova Llubljanska, Nova Kreditna Maribor, Postna Banka, Slovene Export Corporation, Slovenska Investicijska Tajikistan Insufficient data available Turkmenistan Bank for Foreign Economic Affairs Ukraine Ukreximbank, Oschadny Uzbekistan State Housing Savings Bank, Asaka, Uzpromstroybank, National Bank for Foreign Economic Activity Yugoslavia Insufficient data available a.These banks have been privatized or liquidated since the end of 2000. 114 ANNEXES Annex 6 DifferentTypes of Arrears as a Share of GDP in SelectedTransition Economies, 1992­2001 (percent) Country/Type of arrears 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Armenia Wage arrears 0.9 1.3 1.5 1.6 In industry 0.5 0.6 0.5 0.6 In agriculture 0.1 0.1 0.1 0.1 In transportation 0.0 0.0 0.0 0.0 In construction 0.1 0.2 0.2 0.2 In trade, material, supply, and procurement 0.0 0.0 0.0 0.0 In education and science 0.1 0.1 0.1 0.1 In credit and insurance 0.0 0.0 0.0 0.0 In general administration 0.0 0.1 0.1 0.1 In health 0.1 0.2 0.4 0.4 In other sectors 0.0 0.0 0.0 0.0 Azerbaijan Total arrears 60.6 100.2 68.30 96.80 148.20 166.10 200.00 215.60 Belarus Total arrears 30.4 13.5 18.20 13.30 23.10 19.20 22.39 19.08 Bulgaria Total arrears 68.8 60.6 47.5 41.7 66.3 27.9 24.1 19.9 To banks 11.0 12.2 4.2 4.6 7.2 1.7 2.3 1.0 To suppliers 20.2 15.2 13.8 11.6 23.2 9.2 7.7 7.0 To workers 2.9 3.1 2.4 1.6 2.3 1.1 0.9 0.9 To government 7.8 7.5 9.5 8.5 10.4 5.5 6.1 4.3 To pensions 2.5 2.6 2.1 2.1 2.1 0.7 1.0 1.2 Other arrears 24.4 19.9 15.3 13.3 21.1 9.7 6.2 5.6 Croatia Total arrears 3.4 6.2 7.4 8.1 11.4 20.1 14.4 11.6 Kazakhstan Arrears to workers 1.9 3.0 Kyrgyz Republic Total arrears 7.3 6.3 Lithuania Total arrears 9.3 9.0 To tax accounts 1.1 1.1 0.8 0.7 To energy suppliers 0.3 0.6 0.3 0.2 0.1 To banks 4.4 5.1 To other enterprises 3.9 3.1 Macedonia, FYR Arrears to workers 5.9 5.7 5.5 Arrears to government 16.0 Moldova Wage arrears 4.6 4.1 7.0 4.5 2.8 2.0 In agriculture 2.1 2.1 2.4 1.1 0.6 0.5 In manufacturing 0.5 0.5 0.7 0.4 0.4 0.3 In construction 0.2 0.2 0.3 0.2 0.2 0.1 In transport 0.2 0.2 0.3 0.3 0.3 0.2 In real estate 0.1 0.1 0.2 0.2 0.1 0.1 In state administration 0.2 0.3 0.9 0.6 0.3 0.3 In education 0.7 0.3 1.0 0.7 0.3 0.2 In health care and social assistance 0.4 0.2 0.6 0.5 0.2 0.2 ANNEXES 115 Annex 6 (continued) DifferentTypes of Arrears as a Share of GDP in SelectedTransition Economies, 1992­2001 (percent) Country/Type of arrears 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Romania Total arrears 34.60 23.90 26.10 25.15 36.07 33.74 36.15 42.22 To suppliers 22.03 15.05 13.88 13.35 16.05 11.92 15.22 18.02 To banks 4.03 1.42 2.07 3.12 6.22 5.81 6.06 6.44 To government 0.00 2.37 4.83 5.11 6.89 6.62 8.08 8.29 To others 4.51 3.64 3.25 3.57 6.90 6.21 6.78 9.46 Russian Federation Total arrears 9.5 14.8 13.3 23.4 29.1 47.8 30.3 23.7 To suppliers 6.5 10.7 12.8 21.4 13.0 10.1 To tax accounts 3.1 4.6 6.0 8.3 5.8 4.9 To off-budget funds 0.9 4.2 5.7 9.0 6.3 4.6 To banks 2.8 3.9 4.6 9.1 5.2 4.1 Arrears to workers 0.2 0.4 0.7 0.8 1.6 1.7 1.9 0.7 0.4 In industry 0.1 0.2 0.4 0.5 1.0 1.1 1.2 0.4 0.2 In agriculture 0.0 0.2 0.2 0.2 0.3 0.3 0.3 0.2 0.1 In construction 0.0 0.1 0.1 0.1 0.3 0.3 0.4 0.1 0.1 Ukraine Total arrears 7.95 6.00 13.00 20.00 24.00 85.00 98.00 To workers 5.0 6.0 To others 6.00 13.00 20.00 24.00 80.00 92.00 Wage arrears 1.00 5.1 5.5 6.4 5.0 2.8 2.2 Note: Enterprise arrears to government may not equal tax arrears, since tax arrears include those of households and enterprise arrears to gov- ernment can include other forms of arrears. Source: Bagratian, Hrant, and Emine Gürgen, 1997; IMF; and World Bank. 116 ANNEXES Annex 7 The Study's Methodology The study team relied on primary data from Bank for Reconstruction and Development the following sources in assessing the current (TransitionReportsfor1998­2001),European state of public sector banks in Europe and Union(TacisProgrammeCountryEconomic Central Asia: Trendsreports),bankratingagencies(Fitch · Bank-specific data are generally from Bureau Research and Moody's Investors Service), van Dijk's BankScope and are based on Economist Intelligence Unit (various coun- banks' official annual reports. BankScope tryreports),andOrganisationforEconomic contains detailed information on 11,000 Co-operation and Development (annual World Banks for research and marketing. reports). It forms part of the Bureau van Dijk's col- · Publications and Web sites of government lectionofcompanyinformationproductson agencies, including the central banks the internet. The data in BankScope for (annual, quarterly, and monthly reports on somebanks(primarilyinCIScountries)are the financial sector) and the state statisti- unqualified, unaudited, or both. Internal cal committees. WorldBankdatawereusedinafewinstances · Internal World Bank documents on the (for Bosnia and Herzegovina, the Kyrgyz financial sectors of Europe and Central Republic, Uzbekistan, and Yugoslavia). Asia. · Aggregate data on banking sectors were derived Amounts given in U.S. dollars have been mostly from the International Monetary converted on the basis of year-end dollar Fund's (IMF) InternationalFinancialStatistics exchange rates (for stock figures) or average from 1992 to 2001. exchange rates (for flow figures), unless · Data on stocks and flows of arrears come primar- already available in U.S. dollars. ily from official IMF reports and working All regional macroeconomic and financial papers, supplemented with data from exter- indicators have been calculated as simple nally distributed reports of the European arithmetic averages or sums of country indi- Bank for Reconstruction and Development cators, depending on the type of indicator. (TransitionReports),theEuropeanUnion(Tacis The averages have been calculated using all Programme), and the World Bank. data available. When an indicator includes · Macroeconomic data are primarily from the different countries for different years because WorldBank'sWorldDevelopmentIndicators of data availability issues, this is noted in database. footnotes. The team used secondary data from the fol- Despite efforts to create comprehensive lowing sources to detail the history of state data sets for 1992­2000, gaps remain. Gaps banking in transition economies over the past occur particularly in aggregate and bank-spe- decade, including the case studies for selected cific data for the first half of the 1990s because state-owned banks: ofthepoordatacollectionandaccountingstan- · Official and externally distributed publica- dardsinmanycountriesduringtheearlyperiod tions by the World Bank, IMF, European of transition. ANNEXES 117 Bibliography Aslund, Anders, and Richard Layard. 1993. System in the Federation of Bosnia and Changing the Economic System in Russia. London, Herzegovina." Working paper. Sarajevo. 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