# **B. The Argument for Banks**

## **_Banks' current_** _involvement and the lack of other viable institutions_

One argument for giving the current state banks a role in corporate governance stems from two political realities. The first is that it may not be politically feasible to supplant the state banks with completely new institutions, as proposed by a number of western economists.44 Given that these institutions are going to continue to exist, and given that they have a very large presence in the banking and financial sectors of many transition countries (Russia excepted), they are likely to play some role in the corporate control of large firms. The second reality is that the state banks in some transition countries have already been playing an important role in the restructuring of large firms for a number of years. Primarily motivated by their need to do something about the bad loans on their books, some state banks have swapped the debt for equity in a few of these firms and have made attempts at restructuring them.<sup>45</sup> This has occurred to differing degrees in different countries and probably not to the extent anticipated a few years ago, _but nevertheless it has occurred and not without some degree of success._ Indeed, some state banks (for example, PDB in Poland) have arguably the greatest level of expertise in the country in the restructuring of large enterprises. Thus any policy on the development of a corporate control mechanism should recognise the state banks' current and likely continued role in this area.

Related to the above point is the question of who could be an active investor if it is not to be the state banks? Private and foreign banks--who might appear to be the better agents to accomplish ownership and governance tasks because they are not burdened by bad debts or have any state involvement--do not appear to be doing so, but are content with sticking to basic corporate lending to the best credits. There are a limited number of other candidates that could be viable and important players in a governance role in all but the long term. For example, pension funds or insurance companies are not large enough to be important players in the financial markets or in corporate governance for some time to come. The only serious alternative to banks, in the medium term at least, appear to be investment funds. A detailed analysis of investment funds in the Czech Republic can be found in Shafik (1994), Coffee (1994) and Claessens (1994). How effective these bank-managed funds will be from a corporate governance perspective remains, however, to be seen.<sup>46</sup> 44 See Phelps et al (1993). Of course, in Russia this has been largely achieved as an unintended side effect of the hyperinflation.

45 The relatively small number of bankruptcies in these countries (Hungary excepted) is not a good indicator of bank's involvement in corporate restructuring. Bankruptcy proceedings in all countries are very slow. Banks have attempted to deal with defaults by threatening to shut down firm's access to trade finance to force a restructuring. And at times they have indeed taken equity stakes in companies in default to them to exert direct influence on management.

46 For the purposes of this paper, two features stand out. First, the largest bank-affiliated funds created very broad portfolios, comprising between 200 and 500 companies. Hence they deliberately refrained from gaining effective control in a smaller number of companies. This is in marked contrast to some of the larger and successful private investment funds and the ones established by foreign banks which deliberately went for controlling stakes in companies, sometimes in violation of the (apparently not too strongly enforced) rules. Why did domestic banks forego this unique opportunity? A number of explanations can be advanced, ranging from carelessness to fear of not being able to invest all voucher points. Perhaps the most convincing one is that bank-affiliated funds tries to obtain small stakes in a large number of firms in the hopes of attracting banking business through those relationships. Secondly, banks apparently do not enforce strict fire-walls exist between themselves and their investment funds. In some cases bank management or employees have been used to fill the supervisory board positions the banks' IPFs are entitled to. In others there is a regular exchange of information between the bank and its IPF. The close co-operation between banks and their IPFs has not however led to improved corporate govemance as some had hoped. On the contrary, providing effective corporate governance and being actively involved in restructuring is seen by banks as high cost activities with little return - given their generally low stakes in the companies. Instead, they are using their information actively to trade securities. These are early days, and any judgement must remain tentative. But it would appear as if bank involvement in company ownership has done more to promote the trading of securities than to improve corporate govemance directly.

31