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TheStreet Open House

A Briefing on Russia's Twisted Bank Tale

  • Michael S. Bernstam and Alvin Rabushka, Fixing Russia's Banks : A Proposal for Growth, Hoover Institution, 1999, 114 pages ($16.95)
  • About $40 billion in U.S. currency is stuffed under Russian mattresses, just one little sign there's something terribly wrong with the Russian banking system.

    Reforming that system is the premise of Fixing Russia's Banks, written by Michael S. Bernstam, a research fellow at the Hoover Institution at Stanford University, and Michael Rabushka, a senior fellow. Until Russia's banks are fixed, the much-vaunted economic boom expected after the break-up of the Soviet Union won't happen, because banks are the engines that drive growth, the authors note.

    The problem in Russia is that banks are imitation, or "ersatz," banks, the book asserts. While real banks accept household deposits and make loans, Russia's banks don't. Instead, they are owned by private companies as financing tools and are buoyed by subsidies from the Central Bank of Russia. These "inferior imitations of banks" continue to blur the boundaries between the private and public sector, the authors say: "The establishment of real commercial banks, independent of government, becomes the vehicle to break up the financial chain of socialism."

    This slim volume is worth readers' time, particularly if Russia's banks are a new area of interest. In just 114 pages, it manages to adequately cover the country's economic scene since 1991, when Russia was established as a separate state. While expectations were high for an economic boom -- the authors cite the country's highly educated population, its huge savings rate and its vast natural resources as the fuel for that boom -- it has not materialized because of the inferior banking system, which is a "winding maze" of insider lending and bad loans. Virtually all of the country's banks are illiquid and insolvent, staying afloat only with new injections of cash from the government.

    "The story was that the government subsidized banks, which bought government debt, which was used to finance subsidies to the banks. The real economy was nowhere to be found in that equation," Bernstam and Rabushka say.

    It's no surprise that uncovering the truth about the Russian banking sector is difficult. The authors point out that many of the official figures released are manipulated to paint a picture of a healthy banking industry, while others are outright "falsification." According to official figures, the country's commercial banks had equity of about 66.7 billion rubles (US$2.7 billion) in January 1996. But according to Bernstam and Rabushka's estimates, equity was actually a negative 32.9 billion rubles (US$1.3 billion), while nonperforming loans were at a whopping 28%.

    Written much like a textbook, with many tables, graphs and charts, the book explains things in a manner that people unfamiliar with banking can understand. However, while the saving grace of the book is its brevity, even 114 pages were a few pages too much. In an effort to hammer home many of the points they deem critical, the authors repeat themselves frequently.

    They should have worked harder to get to the point: the "modest proposal" outlined in the last chapter of the book.

    The linchpin of the proposal involves a swap of assets, of debt for equity. The ersatz banks could swap their government liabilities (back taxes of the enterprises that own the banks and receive loans) for the banks' bond holdings. The government would recover its bonds instead of repurchasing them, greatly reducing internal debt and debt service costs.

    Another part of the plan is the establishment of funds, much like mutual funds, owned by various groups that hold the government's debt. Capitalized with real assets, such as natural resources, pipelines and farm land, these funds could establish new banking institutions by taking over the nation's insolvent banks. The new banks would not have access to government subsidies, cutting the apron strings once and for all.

    Bernstam and Rabushka hypothesize that the swap would establish efficient ownership. The new banks would have no interest in rolling over bad debts, unwilling to risk their good capital. Instead, they would invest in profitable enterprises or make good loans, sparking the long-awaited economic boom.

    Central to the success of the plan is that foreign managers would run the new banks, since Russian bankers are deeply distrusted by the Russian public. (That's why all those U.S. dollars are safely stashed in mattresses, not Russian bank accounts.)

    The authors consider their proposal to be "economically rational" but concede it may not be politically feasible. They say that while government officials and banking authorities may not like it, the "Russian public would surely favor this reform."

    Whether U.S. bankers would favor this reform remains to be seen. Just last year, the Russian government gave approval to Bank of America and J.P. Morgan, as well as two German banks ( Deutsche Bank and Commerzbank), to open subsidiaries in Russia. By the time the book was published, another 16 foreign banks had applied for licenses to set up subsidiaries in Russia.

    As Russia strains to keep its currency stable, it is even more important to take that first step toward economic reform, Rabushka and Bernstam say.

    Now that is worth repeating.

    Janice Wood is a Summerville, S.C.-based freelance writer. She previously wrote for American City Business Journals in Los Angeles, Dallas and San Antonio, as well as the Pacifica Tribune in California. She can be reached at woodfam@wpmedia.com. TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TSC. TheStreet.com selects books for review solely on the basis of merit for its readers.

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