Phase 2: A fragile banking sector
Category: Bank Management
The development of the banking sectors in most countries of the CIS as of today has led to a number of severe shortcomings that has two main effects. First, banks do not fulfils their important function of facilitating the transfers of resources from savers to investors. Second, the banking sectors are highly vulnerable for bank crises that could transform current recessions to deep economic depressions.
The following problems are currently most important: First, banks are undercapitalized and there are no indicators that this may change in the near future. This is due to a general lack of savings, quick unregulated growth of the number of commercial banks, and the high degree of macroeconomic uncertainty that depresses household’s saving propensity.
Second, many banks’ portfolios are extremely risky and no sufficient provisions have been taken. Most banks are either not able or unwilling to manage their risk in a reasonable way; portfolios are undiversified and there is no concern for sufficient liquidity in order to be able to react to exogenous shocks. Furthermore, many loans are still considered assets although they are clearly non-performing and should be quickly depreciated. Often management of banks do not even possess sufficient information about their portfolio because of poor accounting standards.
Third, depositors do not trust banks. Hence, many consumers prefer not to deposit their money with commercial banks, but invest their savings in durable goods, real estate, foreign currencies, often on accounts in foreign countries. Moreover, since there is no functioning deposit insurance, depositors fear that their savings may get lost in a crisis. Hence, they will try to recuperate their money at the first sign of a crisis, which involves the risk of a credit crunch, and a massive wave of bankruptcies. The lacking trust involves that undercapitalization sustains.
Fourth, the influence of governments of CIS countries remains predominant in many banks. In some countries, open efforts to renationalize have taken place (for instance in Belarus). In other countries, influence is exerted in more subtle way, for instance by means of subsidisation: the Central Bank provides commercial banks with cheap credits, provided that a part of these credits are allocated to politically preferred industries. Hence, banks do not fulfil their task to allocate savings to efficient investment purposes.
The main problem, however, consists in the effects of the bad loan problem on the behaviour of banks. Since regulators have not managed to “carve out” these loans in order to make banks capable to develop new business, most banks are simply administrating these loans, lobbying the state for subsidies in order to keep their debitors afloat. Besides this activities there are some short-term oriented activities, like export financing, and speculation with foreign currency on bank’s own accounts. Due to above factors, banks remain soft on existing borrowers, both SOE’s and privatized firms, but are too tough on new loan applications from the private sector. The consequence is that the economy remains paralysed: entrepreneurs cannot find sufficient funds to realise new businesses, and depositors will not change their beliefs about the credibility of banks, which in turn means that undercapitalization of banks persists. In other words: there is a state of selfulfilling prophesy in which nothing changes to the better, because everybody expects that nothing will change.