ABSTRACT
This paper focuses on the intertwined insolvency of banks and enterprises in the former Czech and Slovak Federal Republic (CSFR), Hungary, and Poland in the late 1980s and early 1990s. In the best of all possible situations, bank and enterprise restructuring should be achieved and a systemic banking crisis avoided with simple bank provisioning and individual loan recovery efforts and without government intervention. However, if the net worth of formerly state-owned banks is, or at least is widely perceived to be, highly negative, then government involvement in solving the stock and flow problems of bank and enterprise restructuring is inevitable. This has been the case in Central and Eastern Europe. The unrecoverable loans which the newly formed commercial banks inherited from the monobank have constituted the root of the stock Eroblem. The flow problem has been connected to all factors that have allowed bank management that is not prudent to remain in place.
The reason to resolve the stock problem as quickly as possible is that corporatization of enterprises and banks should be implemented along with hard budget constraints. Enterprises are likely to face such constraints only when the chief financiers, the banks, demand timely payment. The banks will impose hard budget constraints on enterprises only if bank management is convinced the 112state will not subsidize its own mistakes nor will funnel financial assistance directly to enterprises.
The effectiveness of enterprise and bank restructuring depends on how the authorities contribute to the recapitalization of banks and influence the incentives of bank and enterprise managers. If the authorities possess full information, they could solve the problem of determining the optimal combination of liquidation-restructuring, privatization, and government-funded recapitalization. Instead, the authorities are faced with the need to estimate the market value of each bank’s loan portfolio without knowing the private sector’s willingness to invest in the debt-ridden companies or buy their bad debt. Under these circumstances, the Polish solution appears quite reasonable, namely evaluation, by reputable outside auditors, of each major state bank’s portfolio of loans to determine the extent to which each bank will be recapitalized before bank-initiated restructuring-liquidation of enterprises begins in earnest. Then as long as the recovery agency, whether centralized or decentralized, faces an incentive structure based on recovered loan repayments and on the value of the equity obtained in exchange for debt forgiveness, the stock problem should be under control. To remedy the flow problem, all the ingredients of hard budget constraints and effective corporate governance must be present.
However, this “reasonable” approach has rarely been implemented. Moreover, in selecting quite diverse policies, authorities in these various countries have tended to ignore two key insights into the problem, namely, (Da comprehensive strategy—requiring expensive and long-term support, including privatization and involving both banks and enterprises and all of their claimants—is required to clean up the balance sheets of banks and enterprises; and (2) a normal audit rarely identifies the bad-debt problem because the loans of insolvent clients had often been rolled over and the interest capitalized. Thus, the scope of the problem is recognized only after the recovery agency has taken control of banks and exhaustive audits have taken place; and the losses from the bad-debt problem tend to be underestimated by large magnitudes in order to prevent panic.
