Bank Restructuring and Enterprise Reform

Abstract

Enterprise reform and bank restructuring in eastern Europe are two intricately intertwined problems. Firms in distress stop servicing their loans, and non-performing loans are at the root of the commercial banks' troubles. In turn, failure by unreformed banks to enforce loan contracts adequately gives firms incentives for lax loan servicing, completing the circle of causality. The problem is compounded by the fact that, in an environment of less than ideal banking supervision and weak accounting standards, banks have an incentive to hide emerging bad loan problems through capitalising of interest and amortisation due. The standard methods to deal with enterprise and banking problems in isolation are unlikely to work well in such circumstances. In some countries, alternative approaches have been worked out. The paper compares the experience in Poland (which took a hard budget constraint approach to bank recovery and decentralised loan recovery), Slovenia (which took a hard budget constraint approach to banking reform but a centralised approach to loan recovery), and Hungary (which took a central approach to loan recovery but imposed no hard budget constraint on banks). The paper outlines the arguments for and against the various approaches, then discusses in particular the novel approach, implemented mostly in Poland, but uses the Hungary and Slovenia evidence to put some of the key results in perspective and give some impression of how alternatives might have fared.