Restructuring banks and enterprises : recent lessons from transition countries

The collapse of central planning and the opening of the ex-socialist economies of Central and Eastern Europe and the former Soviet Union have had two major implications for enterprise and bank restructuring. First, state-owned and "socially owned" enterprises for the first time faced the test of the disappearance of their traditional Council for Mutual Economic Assistance (CMEA) markets, state-owned enterprises (SOEs) experienced dramatic cuts in output following economic liberalization. Second, many turned to banks to obtain credits that allowed them to temporarily escape hard budget constraints and delay restructuring or liquidation. This led to a rapid deterioration of state-owned commercial banks' loan portfolios, which were already burdened by risky portfolios inherited from the former monobanks. Increasing spreads crowded out economically viable investments by the emerging private sector. The deteriorating position of the banks resulted in an increasing liability for the State, as implicit deposit insurance precluded the closure of large State banks. The nexus created by SOE losses, deteriorating State bank porfolios, and increasing government liability is on the critical path to systemic transformation in transition economies. Governments are following a wide variety of approaches to deal with these problems. Key issues include: 1) the imposition of hard budget constraints on loss-making banks and enterprises to promote macroeconomic stabilization; 2) the pace of enterprise and bank privatization to improve management, governance and overall performance; 3) institutional capacity, legal and regulatory frameworks, bank supervision and financial sector infrastructure to improve the enabling environment; and 4) centralized vs. decentralized solutions to work out impaired loan porfolios, restructure loss-making enterprises and develop the human capital and market conditions needed for a competitive banking environment. The purpose of this paper is to review early experiences in bank restructuring and the role of banks in enterprise restructuring in 23 transition countries. The discussion focuses on: 1) financial and operational restructuring of banks, changes in the financial sector enabling environment, and the reorganizing of banking systems; 2) court-led bankruptcy/liquidation proceedings and out-of-court conciliation procedures for enterprise restructuring, including the role played by banks in the restructuring of enterprises; 3) the mode of government intervention to recognize past losses incurred by SOEs, including the role played by government in the restructuring of the enterprise sector; and 4) the timing and sequencing of enterprise and financial sector reforms in relation to the pace of privatization and systemic transformation in the economy.