CENTRAL EUROPEAN UNIVERSITY DEPARTMENT OF ECONOMICS MONEY, BANKING AND FINANCE Feasibility of the German-type model of Universal Banks

in the Post-Communist Ec onomies. The Case of Russia Professor: Jacek Rostowski Prepared by: Asenka Asenova MA in Economics, 1styear ID# 161801

Spring Semester, 2006, Budapest Pages of Contents Introduction I. The German-type model of universal banks 1. Key characteristics 2. The German model and economic growth II. Feasibility of the German model in the post-communist economies in the e arly years of transition III. Feasibility of the German model in the later stages of transition IV. The case of Russia 1. General overview of the Russian banking sector 2. Empirical evidence for the bank-enterprise relationships Conclusions Appendices List Appendix no 1: Indices of real credit and real GDP in Russia, 1992-1995 Appendix no 2: Credit and non-performing loans in the Russian banking sector, 19 92-1997

Introduction Banks are essential for each countrys economy, since no growth can be achieved un less savings are efficiently channeled into investment. In this respect, the lac k of a full-fledged banking system has often been identified as a major weakness of the centrally planned economies. Therefore, reforming the banking sector in the former communist countries and creating a new culture of trust and confidenc e has been a crucial task in the process of transition to a market economy. Because of the vital importance of the banking reforms in the post-communist eco

nomies, a considerable amount of literature has focused on the issue of designin g an optimal financial system as a critical element of structural reforms. Undou btedly, the fact that establishment of a German-type model of universal banks in the former communist countries from Central and Eastern Europe has occurred is probably proof that it was the most desirable outcome, and moreover, an outcome that complies with the spirit of the European financial institutions (Grosfeld, 19 94). However, in this paper I shall examine the feasibility and desirability of the G erman-type model in the transition countries in the early and intermediate stage s of transition for the accomplishment of sustainable economic growth. In analyz ing this issue I will provide empirical evidence from the evolution of the banki ng system in Russia in the period between 1991-1995 from the viewpoint of the re lationship between enterprises and banks, and the impact of these relationships on investment and economic growth. I. The German-type model of universal banks 1. Key characteristics Following Grosfeld (1994) I shall use a distinction of three major functions per formed by the financial institutions, while characterizing the main features of the German-type model of universal banks, namely: financing, information and con trol. Financing is defined by the author as creating channels to transform savin gs into investment; the information aspect here is analyzed from the viewpoint o f generation of information on the value of the firms and on different investmen t opportunities. Finally, control, is viewed as imposing monitoring on the corpo rate management. A major distinction of the German-type financial system is the dominance of a re latively small number of banks (the big three or big four largest banks), involved i n both commercial and investment banking and, maintaining close relationships wi th the industry. German-type banks provide a wide range of financial services bu t the element of key importance is the accent on long-term money lending to ente rprises. On the information part, little information on the value of securities is made publicly available; instead, banks have a rather privileged access to it through the established close links with the industries (Grosfeld, 1994). Lastl y, with respect to corporate control, the German-type model has as a main featur e high concentration of ownership, i.e. companies own substantial stakes of each other. As expected in this situation, banks have both the incentives and the ab ility to take active participation in shaping the major decisions of the enterpr ises. The last means that banks are in a position to also influence the investme nt decisions of non-financial companies. Hostile takeovers and leveraged buy-out s are rare in the German-type model. In short, the German-type model of universal banks has as a core element the clos e participation in the ownership and control on non-financial firms (Rostowski, 1 998, p. 320). The impact of this particular system on economic growth has been a source of numerous arguments and the next section will present some of these vi ews. 2. The German model and economic growth Many authors have eloquently supported the idea of German-type banks. According to Mayer, for example, the distinctive feature of successful financial systems is their close involvement in industry (Mayer, 1988). Additionally, Gerschenkron (1 968) argues that in the middle of the nineteenth century universal banks in Germ any a combination of commercial and investment banks strongly contributed to the industrialization of the economy serving as a substitute for the insufficiency of wealth and entrepreneurial expertise (Gerschenkron through Rostowski, 1998). A similar case regarding provision of funds available for investment, has receiv ed large support by several authors claiming that a banks stake in an enterprise would prevent banks from behaving too cautiously when providing credit through a llowing them to reap some benefits from financing riskier projects (see e.g. Dew atripond and Tirole, 1991). Another, mostly theoretical, argument in support of the idea