1481. Corporate Control in Central Europe and Russia: Should Banks Own Shares?
Peter Dittus and Stephen Prowse
(June 1995)
A governance system based on bank ownership and control of firms is not yet
feasible, but a good case can be made for allowing banks to gradually gain
experience through limited equity ownership---especially for allowing the
swapping of bad debt for equity.
Dittus and Prowse review corporate governance arrangements in the West and
conclude that for a system based on bank ownership and control of firms to
succeed, the banking system must be free of perverse incentives and state
interference, as well as subject to adequate supervision by banking authorities
and competition from market forces. Admirable progress over the past few years
notwithstanding, these conditions do not now exist in the countries of Central
Europe and Russia, so a corporate governance system based on bank ownership is
not appropriate. That is not to say that such a system would not eventually be
appropriate---but not before much more effort is made to create a competitive,
private, well-supervised banking system (which is needed in any case).
Changes in the banking system that are prerequisites for any large-scale bank
involvement in the ownership and governance of firms are simple to enunciate but
less easy to implement:
- Sever existing relationships between the state and banks. Privatization is
the strongest guarantee that bank investment decisions will not be subject to
state influence, but bank privatization has been slow in most countries. This
reflects limited understanding of the financial sector's poor condition, the many
institutional and political obstacles to bank reform, and the initial decision in
many countries to focus first on the "real economy" (a decision that in hindsight
seems unfortunate).
- Dispel the belief (which still exists in some countries) that poor lending
and investments will eventually be underwritten by the government, with few
consequences for managers.
- Greatly strengthen competition in the banking system, in part by encouraging
new private banks and the entry of foreign banks. (Some countries, such as
Poland, have taken the opposite tack, refusing to issue new licenses.)
- Provide effective bank supervision and an effective prudential and regulatory
framework. This requires investing substantially in setting up institutions,
accounting systems, and information networks, in hiring and training qualified
personnel, and in ensuring that the system is immune from political intervention.
Developing such a system will surely be long and drawn out, and may require
foreign assistance.
This paper---a product of the Transition Economics Division, Policy Research
Department---is part of a larger effort in the department to explore issues of
corporate governance in transition economies. The study was funded by the Bank's
Research Support Budget under the research project "Corporate Governance in
Central Europe and Russia" (RPO 678-42). Copies of this paper are available free
from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Grace
Evans, room N11-041, extension 85783 (39 pages).
The full report is available on our FTP server.