V Bank Restructuring
- Malcolm Knight
- Published Date:
- February 1998
The rapid growth in the number of commercial banks in the Baltic countries, Russia, and the other countries of the former Soviet Union following the policies of liberal market entry that were instituted in the early 1990s has exacerbated significant structural weaknesses, such as poor managerial skills and the lack of a suitable regulatory and supervisory framework. Bankers have not emphasized basic credit analysis, monitoring, and collection skills, and governments and shareholders alike have often influenced loan allocations to enterprises whose repayment prospects were doubtful. Banks’ loan classification and valuation techniques were not able to capture the persistent erosion in the quality of most banks’ loan portfolios, which resulted in insufficient loan loss provisioning, overstated profits, and a gradual decapitalization through dividend payments and taxation of fictitious profits. The banks’ true financial condition was obscured by weak accounting practices and the effects of high inflation, which helped them to appear solvent, and by generous central bank credit facilities, which helped them to remain liquid.
Initially, some banks were able to make substantial profits in currency operations, payment float, and the placement of funds in government securities at high real interest rates. However, as macroeconomic stabilization policies have taken hold and inflation has been brought under control in most countries, many of the new banks have only limited scope for sustainable profitability because of difficulties in the traditional enterprise sector and the earlier sharp contractions in real economic activity associated with the structural reform process. Improved accounting and inspection procedures, increases in minimum capital requirements, and stricter loan classification and provisioning rules have made the underlying problems in the banking system apparent.31 The median ratio of nonperforming loans to total loans in the countries under review is currently estimated to be 18 percent (Table A7), which is higher than in other countries that have faced systemic banking problems.32 Moreover, in these countries the largest share of bad debts is concentrated in the five largest banks—often the former state-owned banks (the median ratio is 73 percent). In most countries, these banks continue to account for a major share of total system assets (the median ratio is 70 percent). Nevertheless, they are typically the last to be dealt with in the context of a restructuring policy because of their size and the political implications of intervention. As indicated above, many private banks are also in difficulty because of poor management, inadequate credit analysis capacity, insider lending, and sometimes outright fraud.
The financial problems of the banking systems in the countries under study have led to a markedly diminished role of financial intermediation relative to even the depressed levels of economic activity recorded in recent years. These problems have also hampered the banks’ role in financing sustainable economic growth. Banking system claims on the private sector range from 4 percent to 20 percent of GDP in all 15 countries, compared with about 40 percent of GDP in Central and Eastern European countries and over 80 percent in the member countries of the Organization for Economic Cooperation and Development.
Since late 1995, the IMF—in coordination with the cooperating central banks, the World Bank, and other international agencies—has provided advice on restructuring the banking systems while taking account of national characteristics and constraints and the status of restructuring operations already under way in individual countries. National authorities have been advised on procedures for diagnosing the viability of individual banks and estimating total losses in the banking system as a basis for developing comprehensive systemic restructuring strategies. The need to seek broad political consensus on the basic elements of such a strategy has also been emphasized. The strategy would address a number of issues: deciding how the systemic losses should be allocated, establishing a unit or agency for managing the restructuring process, and putting in place the appropriate infrastructure for managing and recovering problem assets and the assets of banks placed in liquidation. This has proved to be a difficult task because of the above-mentioned weaknesses in the data, deficiencies in standards for loan classification and provisioning, and shortages of skilled staff.
Most countries that are reviewed in this paper have initiated some bank restructuring, often by devising a strategy based on the above principles. Although these strategies have contained common elements, no two approaches have been the same, and the stages of implementation and results to date differ widely. The countries’ starting positions have also been quite different. The number of banks that require financial and operational restructuring or closure has varied considerably across countries, as has the political will for reform. In the countries taken as a group, 13 percent of the banks in existence at the end of 1995 were closed during 1996.33 In the Baltics, the Kyrgyz Republic, Moldova, Turkmenistan, and Ukraine, the number of banks has remained broadly unchanged. Only in Tajikistan has the number increased.34 As shown in Table A8, Armenia, Azerbaijan, Kazakhstan, the Kyrgyz Republic, Lithuania, Moldova, and Ukraine have established basic institutional frameworks, beginning with the creation of a specialized policy unit or agency to deal with bank restructuring. All countries have conducted some diagnostic studies of their banking systems; in Russia, only a limited number of the larger banks have been effectively analyzed in any depth.
Formal strategies for restructuring the banking system have been developed by Azerbaijan (for state-owned banks), Georgia, Kazakhstan, the Kyrgyz Republic, and Moldova.35 In several countries (such as Belarus and Russia), restructuring has been delayed because of difficulties in determining the actual extent of financial problems in the banks. In Azerbaijan, a comprehensive restructuring plan for the four state-owned banks was launched in September 1996. Georgia is pursuing a policy of relicensing and rehabilitating banks without expenditures of state funds—although the former state banks were tackled last. Two of the former state banks that dominate the system are currently undergoing restructuring, but progress in strengthening the agricultural bank has thus far been limited, and it is now being temporarily administered by central-bank-appointed management. Kazakhstan has embarked on a steady program of restructuring, and the problems of the largest banks are being addressed comprehensively. The Kyrgyz Republic is implementing a well-structured strategy that includes creating a debt-resolution agency and liquidating some of the large former state-owned banks. In Moldova, the central bank has actively pursued the recapitalization and restructuring of the majority of banks, although the former state banks are the last to be addressed. Banks in violation of capital requirements have been required to present recapitalization plans, and a special unit has been created in the central bank to monitor problem banks.
In Armenia, although no formal strategy has been established, the authorities are moving forcefully to address banking system problems. In Tajikistan, diagnostic studies of two of the largest banks are under way, with assistance from the European Bank for Reconstruction and Development, and the World Bank intends to conduct studies of the other two banks. Ukraine has not developed a strategy for dealing with its banking problems, although a restructuring committee is reported to have been created. A retrograde trend is becoming visible in Belarus, where the thrust of government policy has been toward renationalizing the major banks and reintroducing policies that are not based on market principles.
Russia differs from the other countries in this evaluation in that the largest banks are for the most part new commercial banks. In 1996, the Central Bank of Russia created a special department to monitor the condition of these banks more intensively. With the cooperation of foreign partners, it has also strengthened its training program for bank inspectors. Finally, it has continued to close small and inoperative banks aggressively and has imposed temporary administration of a few larger ones. Notwithstanding recent efforts, much diagnostic work remains to be done, and problems in several large banks have so far been addressed in an ad hoc fashion—for example, the transfer of household deposits to the Savings Bank; arrangements with creditors to reduce or restructure their claims on banks; and recapitalization by former owners, local authorities, or other interested parties. The Russian authorities intend to continue pursuing a banking system restructuring policy based broadly on the following points: (1) closing down and liquidating smaller institutions that are insolvent or marginally solvent, but that either cannot be rehabilitated through private sector efforts or have engaged in criminal or reckless behavior; (2) encouraging the strengthening of individual banks through a higher capital requirement and through stricter supervisory vigilance; and (3) dealing with distress in banks of systemic importance on a case-by-case basis, seeking solutions that do not involve any use of federal government or central bank funds.
The assessment of various countries’ relative progress in designing and implementing bank restructuring programs is based on the following criteria: completion of a diagnosis of problems in the banking system, development of a restructuring strategy, and creation of an institutional framework (Table 5). The assessment also takes into account whether a country has been able to agree with the World Bank on a restructuring program supported by a financial sector adjustment loan.36 The assessments must be considered particularly tentative given that the full extent of the systemic banking problem in each case is not fully known. The ultimate success of the strategy being implemented in each country is therefore difficult to judge at this stage.
Priorities for Reforms
The soundness of the banking system remains a cause for concern in all of the countries in this study.37 Current efforts in bank restructuring will therefore need to be supported by the ongoing development of supervisory capacity, as well as by better accounting and legal frameworks. Except in the Baltics, priorities for reforms should be in two main areas. The first priority should be to determine the degree of undercapitalization of individual banks and of the system as a whole on the basis of consistent and realistic asset values and consequent estimates of the full cost of recapitalization or liquidation. The estimates should take account of any explicit or implicit deposit guarantees, operational costs that would be incurred during the restructurings, and interest on borrowed recapitalization funds. The second priority, where necessary, should take place in the context of a comprehensive systemic restructuring strategy that would attract adequate political support. It would include, among other things, classifying banks on the basis of their viability and importance to the economy to determine whether they should be merged, liquidated, or financially and operationally restructured; creating the legal and institutional framework for implementing restructuring; and managing problem assets and the assets of liquidated banks.