No-grow in Eastern Europe: 'Bankrupt' banks lack the capital to help business, writes Tony Barber

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SERIOUS difficulties in Eastern Europe's banking sector are throwing into question the region's ability to promote private enterprise and prime itself for economic modernisation. Most banks have too little capital, and many of the biggest are burdened with bad loans from the communist period.

Four years of recession and half- hearted efforts at reform have done little to brighten the picture. The president of the National Bank of Poland, Hanna Gronkiewicz-Waltz, has estimated that about 300 trillion zloty ( pounds 12bn) will be needed to raise the capital reserves of Polish banks to adequate levels.

According to a study by the European Bank for Reconstruction and Development (EBRD), the International Monetary Fund and the World Bank, bad debts account for 60 per cent of the balance sheets of Eastern Europe's largest banks. Some Western bankers believe that, if international auditing standards were applied to Eastern Europe, a majority of the region's banks would be declared bankrupt.

Small wonder that many European Union officials view the admission of Eastern European countries into the EU before the turn of the century as an unrealistic prospect. They cite bad management practices, slow technological development, government interference and corruption as other reasons for the woeful condition of Eastern European banks.

In the Czech Republic, Hungary, Poland and Slovakia, the banking system, though no longer under strict central control, continues to favour loss-making state-owned industries at the expense of new private companies. Private entrepreneurs who want to borrow capital in Hungary are forced to pay interest rates about 10 per cent higher than the rates earned on savings accounts.

Few banks have been privatised in Eastern Europe, mainly because most investors do not want to buy into institutions with such poor balance sheets. Only last month, Poland's new left-wing government annulled a public tender for shares in Bank Slaski SA of Katowice. The tender had been designed to attract one big investor, but none came forward with a satisfactory offer.

'The most important obstacle to transforming the existing banks into genuine banking institutions is that, despite the superficial reforms, the existing banks have inherited the modus operandi of their communist predecessors,' an EBRD report on Eastern European financial conditions said earlier this year.

What this means in practice is that state-owned banks prefer to carry on lending money to the same state-owned companies with which they had close ties under communism. In many cases, representatives of these companies have even acquired seats on the banks' boards of directors, from where they can ensure that the loans continue to flow.

Even if clearly bankrupt, the banks and companies are capable of putting up stiff resistance to being shut down. They argue that the closure of a bank would cause the collapse of companies dependent on its funds and would result in thousands of job losses.

Most Eastern European governments, grappling with high unemployment rates and fearing social unrest and electoral retribution, are sensitive to such warnings. But they also co-operate with state-owned banks because of the pressing need to finance their budget deficits, which are rising under the impact of social services spending.

For the banks, lending money to the government is perhaps the safest and most profitable business of all. It also fits in with the banks' traditional roles as conduits of government policy. However, it creates even more difficulties for new private companies seeking credit.

Dozens of small private banks have sprouted in Eastern Europe in the past four years, and many benefit from the lack of bad debts that afflict their state-owned rivals. The Czech bank Pragobanka, set up in 1990, has founded 16 branches around the Czech Republic with the help of a wealthy insurance company, Ceska Pojitovsna.

However, it is unlikely new private banks can provide enough capital to give the Eastern European economies the lift they need. Apart from the EBRD and other international institutions, the only obvious candidates for that role are foreign banks. Some have established a firm foothold: Citibank is already Hungary's most profitable bank. But the EU's association agreements with Eastern European countries bar EU-based banks from undertaking certain operations in the region for 10 years. This reflects not only a desire to protect local banks but a more general suspicion, rooted in the region's history, of foreign capital and its potential for limiting a country's independence.

(Photograph omitted)