Abstract
The paper focuses on the role of commercial banks in the economic revival of transition economies. It explains the transition economy as economy changing from a centrally planned to free market economy. This exposed the economies of these countries to a trading environment for which they were wholly unprepared and which seriously affected their economy. The economy of these countries experienced severe short-term challenges and long-term constraints on their development. Similarly, the employment and inflation increased gradually in these countries. However, the commercial banks managed to finance the viable enterprises, advise the managers, and liquidate non-viable enterprises that managed to revive the transition economies. The paper evaluates how transition economies affected the economy and how commercial banks played the role of restructuring the economy. As a result many transition economies, especially those from the former Soviet Union and Eastern Europe have increased their economic development, but old institutions are holding revival back.
Introduction
Transition economy is the economy changing from a centrally planned to free market economy. The end of the communist regimes in central, Eastern Europe and the soviet union in 1980s entailed the collapse of central planning as the prime mechanism of economic organization to free market throughout the region. This exposed the economies of these countries to a trading environment for which they were wholly unprepared and which seriously affected their economy. This was so because they opted to adopt market capitalism and discarded central planning. The rebuilding of these economies and integration into the capitalist system, comes at the time when market economies were undergoing significant structural changes. Before that collapse, the centrally planned economies in these countries experienced rapid growth in the 1960s , but growth rates declined in 1980s, resulting in a very deteriorated economic performance.
The economic reforms in the countries of central and Eastern Europe shared the strategic objective of replacing central planning by a market system. It was recognized that this transition would inevitably involve a significant adjustments to international competition, new advances and business methods. However, these adjustments led to severe economy wide falls of 20 percent in output and employment. For instance, unemployment and inflation have increased gradually in these countries. It is vivid that the countries that underwent this transition have experienced severe short-term challenges and long-term constraints on their development. However, there is possibility that commercial banks can revive the economy of countries facing transition economies. Therefore, the paper will focus on the role of commercial banks in the economic revival of transition economies.
Role of Commercial Banks In Transition Economies
In the beginning of transition economies in the central and Eastern Europe and the former soviet union, the economies were very disorganized and over industrialized. The economic structures were in bad shape and incapable of transmitting information on resource shortage. Individual enterprises were using resources inefficiently and industrial products were not competitive in the global market. Thus, a massive revival of the economies was required as part of restructuring the economy. The commercial banks were required to downsize the industry sector to have resources for the economic development (Aslund, 2009). Similarly, they were required to liquidate inefficient enterprises by searching for new markets and assisting in introducing new products and efficient production method.
Based on economic development, transition countries find themselves between less developed and industrial economies. Their level of industrialization is inherited from the socialist system, which was dominated by large scale state owned enterprises (Sweder, 2000). Thus, the end of central planning brought the demise of large-scale production and transition economies started shifting their focus toward small and medium sized enterprise. This is so because private enterprises were allowed only on a limited scale in the socialist system. The end of a central planned economy attracted a large volume of entrepreneurs wanting to materialize their business ideas. Moreover, the collapse of several large enterprises created a wave of displaced and unemployed workers who could not find jobs in the remaining large enterprises and had could not find jobs in the new small and medium firms.
The need for capital in transition economies is not limited only to new entrepreneurs because the old state owned firms from the centrally planned countries require extensive financing to renovate obsolete capital stocks (Michael, 2002). On the other hand, privatized firms need investment capital to expand operations. Similarly, demand for investment capital increased after the fall of the planned economic system in the central and eastern Europe and former Soviet union. On the supply side, capital markets in transition economies are still underdeveloped and face lower levels of capitalization than their counterparts in industrialized countries and commercial banks remain the major source of external finance.
Although there could be an informational imbalance between banks and firms, the commercial banks revived the transition economies via external finances such as securing loans. Even when these economies can provide enough collateral to secure the loan, it becomes impossible for commercial banks to liquidate the firm’s assets and collect payments for the loan.
However, commercial banks play a role in the restructuring process of enterprises using their authority as creditors to finance both profitable firms and non viable firms. For firms which are believed to be viable via debt reduction, commercial banks are supposed to work with management to generate a restructuring plan and based on plan grant the necessary debt relief. Commercial banks are expected to discipline the non-performing firms by initiating the liquidation process. Similarly, on the fully viable firms in the transition economies, the commercial bank plays role in providing loans to finance new investment required as part of the physical restructuring. Therefore, commercial banks are supposed to sit on boards of directors to help enterprises in transition economies.
Commercial banks played a significant role in reducing the unemployment rate in transition economies. Several transition economies faced increased unemployment as newly privatized firms wanted to become more efficient. The state owned enterprises employed more people than were require and as private entrepreneurs captured the market, the labor cost was reduced in order to promote efficiency.
As the newly formed private firms were subjected to massive competition, others were driven out of the market which created unemployment. Similarly, reducing the size of state bureaucracy led to several employees of the state to lose their jobs. However, financing viable enterprises by commercial banks contributed in reducing unemployment although in small margin. This enabled the enterprises to maintain employment despite the decline in output which reflect soft budget constraint. Commercial banks enabled private sector firms to draw workers from the pool of unemployment created by the initial shake out. Therefore, commercial bank financing help in reviving the transition economies via reduction of unemployment
Moreover, inflation cut the real value of commercial bank lending so that subsidies via the banking system were removed. The cut in both fiscal and financial subsidies exerted pressure on the firms to change in order to deal with decreased demand. On the other hand, the enterprises that performed poorly reacted to the imposition of an expensive budget constraint by establishing their own subsidies besides that of commercial banks. They refused to pay commercial banks, other firms, the tax authorities and the social security system. The estimate of bad debts in commercial bank portfolios in transition economies is in the range of 20 to 40 percent of total loans with significant variation by country and bank (Peev, 2012, PP. 372). These arrears loopholes are being reduced by commercial banks as the countries simply cannot afford to finance large enterprises losses. As the fiscal authorities have to cover the cost of commercial bank recapitalization, most countries have acted to reduce further losses by directing these banks to stop lending to insolvent enterprises.
Inflation in the transition economies especially in CEE has been high and affect enterprise finance in various ways. It reduces the value of enterprise debt particularly where the rate of interest is less than inflation. On the other hand, it affects the real value of deposits. To avoid the tax imposed on capital goods , those who held financial assets started investing in dollars. As a result the real value of assets in the commercial bank was affected reducing the capability of the banking system to offer firms adequate resources. Therefore, the commercial banks play a significant role in enterprise restructuring in the transition countries. In the most transition economies, the main business of commercial banks consists of offering financial services, including payment and deposit facilities and short tern commercial lending.
Similarly, commercial banks are playing significant role in corporate governance, although it is happening in a limited degree. In order to revive transition economies, commercial banks are disciplining firms via their authority to remove short term loan and initiate the bankruptcy process. Commercial banks are playing significant governance role for the firms, which they have given interest rate on capital via a liability for equity swap. For instance, Czech commercial banks exercise governance via the investment funds they run. However, there is still gaping holes in the corporate governance of the transition economies. The most profitable firms are looking for potential investors in the foreign institutions and domestic investment funds to take over power.
The commercial banks played a role in reviving transition economies via improving the transparency. Most countries experienced a severe corruption during the period of transition and this affected the effective introduction of market reforms. Several product were inefficiently produced and sold in unregulated and illegal markets. Therefore, commercial banks ensure various institutions are protected from undermining of its authority via pressure from the government. Transparency is necessary regarding allocation of tasks and disclosure of the actual distribution of responsibilities between the commercial banks and enterprises. However, transparency creates public interest and understanding of monetary policy applied by commercial banks. Thus, an opportunity created to monitor this policy by means of greater visibility of the commercial bank’s strategic and operative procedures helps in reviving the transition economies. This forces the commercial bank to greater accountability by showing greater compliance with commitments. This will prevent powerful financial institutions from corruption and abusing its given authority.
In additional, commercial banks played a significant role in reviving household debt. Applying approaches similar to those utilized in enterprise debt restructuring, commercial banks have sought to ease household debt by use of household debt restructuring programs such as mortgages. In some transition countries personal bankruptcy rules were changed and out of court resolution programs were applied. Therefore, commercial banks sought to promote expansion of mortgage loans via direct extension of loans and guarantee programs to improve the living standard in transition economies.
Moreover, industrial transition has been motivated by severe market forces and not commercial bank programs. Devastating economic shocks together with decreasing fiscal subsidies and the real value of commercial bank loan have forced changes at the enterprise level. Thus, adjustments have been defensive in reacting to deteriorating economies rather than physical revival with new investment to reorganize production.
Each transitional economy has used a diversification strategy to revive economy and coordinating the linkages. Most transition countries decided to use a bottom –up approach to economic restructure and top-down approach to banking reform (Transition Economies, 2000). The countries would control the reorganization of commercial banks and market forces were to play a significant role in forcing revival of enterprises. Commercial banks played a significant role in macroeconomic stabilization to create suitable conditions for revival, liberalization of relative prices to offer appropriate signals for decision making. Therefore, they were involved in the privatization of enterprise to produce suitable incentives and the introduction of a hard budget constraint to enforce financial discipline.
Therefore, the inherited socialist banking system could not offer the financial services needed by transition economies. The system required radical changes in their basic structure, which comprised of new strategy to commercial banking, changes in interest rate policy, new banking laws and new strategies of commercial banks to manage risk and prices. These changes were required to offer constant banking services but governments requested commercial banks play a leading role in economy's revival by identifying and liquidating nonviable enterprises and reviving viable enterprises via debt relief.
The preoccupation of macroeconomic policy in these countries has been less with the output collapse that with inflation. In several countries such as Poland, Bulgaria and other developing countries monetary discipline had collapsed before the reforms, which led to suppressed inflation. The economic restructuring vital to adjust to world markets is proceeding at a slow pace. In terms of ownership only in Russia and Czech republic has there been widespread privatization of state enterprises. In the other countries, the bulk of industrial enterprises remains in state hands, while private enterprises have sprung up and are employing a significant number of people. Therefore, intensifying competitive pressures on such enterprises via privatization can be expected to lead to further decline in employment and inflation.
Controlling inflation has proved to be a major issue in transition economies. Inflation can be considered as the hindrance to economic growth and development. However, commercial banks have been a cornerstone for controlling inflation in many countries facing transition economies. Transferring recommendations and justifications for commercial banks is vital economies because in transition countries, inflation is due to fiscal policy (Transition Economies, 2009). Similarly, it takes an entire transition period until the vital conditions for successfully controlling inflation via monetary policy by commercial banks is implemented. This is so because the critical challenge of controlling inflation in transition economies is in the transition process. The commercial banks are unable to control transition economies because fiscal policy has an influence on monetary policy. The main issue is that commercial banks cannot change the budget deficit, but can finance the deficit by creating money. This dominance of fiscal authority can be influenced by imposing independence on the commercial banks.
Commercial banks played a significant role in lending loan and providing guidance and direction to enterprise managers. For instance, Russia has relied on commercial banks in reviving its economy. Loose licensing and widespread of commercial bank in Russia are likely to have significant costs to the economy. There are positive signs resulting from this seedbed approach to developing a new banking system. Therefore, smaller enterprise banks are losing significance as firms shift their business to the commercial banks. These large commercial banks have recognized banking as a profitable business in its own right and are attempting to operate according to market conditions.
The commercial banks are not burdened with economies revival and can focus on commercial lending. For instance, in Poland, commercial banks managed to solve their bad debt issues without government assistance and were privatized. However, privatization of the banks in Poland without prior revival was not considered complete because they would require government assistance to cover debt. Rapid privatization with recapitalization was done in Estonia and Russia. There are signs that in highly unstable and uncertain economic environment commercial banks played a role in improving their own financial performance. This has been more seen when inflation affected the value of loan, which make lending importance to the financial stability of the commercial banks (Tridico, 2009. PP.125).
For the most part commercial banks are not financing enterprise revival. On the voluntary basis they are offering short term commercial credits to profitable firms with sufficient collateral. For the commercial banks this is and should be the significant focus of their lending. Reviving weak economies is a diversion because most commercial banks consider long term loans for financing physical reviving to be too risky. Even profitable firms cannot get credit, limiting the scope for expansion of enterprises. However, there is a positive aspect of this conservative strategy. Commercial banks lending may correctly reflect the best use of scarce resources.
Conclusion
The centrally planned economies in transition countries experienced rapid growth before economic reforms in central and Eastern Europe and former Soviet Union shared the strategic objective of replacing central planning by a market system. The transition economy came up when the economy was undergoing structural changes, therefore it ended up affecting the economy severely. Among the unexpected were an increase of unemployment rate and inflation among others. However, the commercial back played a significant role in the revival of the economies in the transition economies.
References Lists
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