Front Matter Page
Research Department
Contents
Summary
I. Introduction
II. The Role of the Banking Sector
1. Bank recapitalization and privatization
2. Market structure and the role of banks
III. Financial Structure and Discipline
1. Privatization and the separation of ownership and control
2. Agency problems in privatized firms
a. Capital structure and discipline
IV. Universal Banks and Capital Markets
1. Universal banks
2. Capital markets
a. Equity markets
b. Bond markets
c. Capital market development in central Europe
3. Investment funds
4. Markets for derivative securities
V. The Role of Financial Institutions in the Transformation in Hungary, Poland and the Czech and Slovak Republics
1. Restructuring of the banking sector
2. The development of capital markets and investment funds
VI. Conclusions
References
Tables
1. Structure of the Banking System in Selected Central European Countries
2. Balance Sheet Restructuring and Bank Privatization in Selected Central European Countries
3. Regulatory Environment for Banks in Selected Central European Countries
4. Regulatory and Legislative Framework for Securities Markets in Selected Central European Countries
5. Types of Securities Issued and Trading Activity in Selected Central European Countries
6. Investment Funds in Selected Central European Countries
Summary
The economic transformation under way in the former centrally planned economies (FCPEs) was motivated in part by the recognition that central planning has failed to allocate financial and real resources efficiently. This paper addresses the question of what kind of financial system should replace central planning in allocating capital and maintaining effective corporate governance during the transformation period.
Financial sector reform has, at times, been portrayed as. a question of adopting either a bank-based or a (securities) market-based model. In the bank-based model, commercial banks, often licensed as “universal” banks, take the lead in financing enterprise restructuring and investment. Proponents of the market-based model argue that the structural problems in the banking sector cannot be overcome easily; so firms will have to look to equity and bond markets for sources of new capital.
Equity and bond markets in the FCPEs are not sufficiently well developed to support significant issues of new securities or to provide a mechanisms for corporate control. They lack adequate liquidity, regulatory oversight, information disclosure, and clearing and payment systems. The important role of banks in maintaining the payment system and in providing credit to market participants to support trading and settlement means that until banks are restructured and recapitalized, securities market development will be constrained.
Investment funds emerging from mass privatization schemes may create concentrations of equity ownership that would allow them to play an important role in corporate control and perhaps, too, in finding sources of investment capital. They are a relatively recent innovation, however, and it remains to be seen how active they will be in financing and managing privatized enterprises.
The authorities should first establish a healthy banking sector, because it is the banks that are the most promising source of working capital and corporate control. This does not mean that securities market development should be ignored, only that it should not be a priority use of scarce government resources at the present time.
Many observers recommend that banks be given the power to act as universal banks, combining lending with securities market operations and equity investment. The potential problems associated with such a model in the FCPEs during the transformation period outweigh any potential benefits. It is recommended, therefore, that commercial banking and investment banking activities be separated, at least until banks have demonstrated competence in their commercial lending operations.