Although Russia is not regarded as offshore banking center worldwide, before the crisis it managed to attract large quantity of capital to its capital markets. Russia started reforms in the banking sector in the end of the 1980s with the formation of a two-tier banking system, composed of the Central bank responsible for carrying out the monetary policy, and five large state-owned specialized edges dealing with place collecting and money lending. Most authors argue that by the end of the 1990s three major types of edges developed in Russia: joint-venture edges, domestic commercial edges, and the so-named ‘zero’ or ‘wildcat’ edges. The last were formed by their shareholders – in most situations groups of public institutions and/or industrial firms (the so called Financial Industrial Groups (FIGs) – with the major purpose to finance their own non-financial businesses. As a consequence of the low capital requirements and nearly nonexistent bank regulation, the number of these new edges grew rapidly and as early as January 1, 1996, Russia had 2,598 edges, of which the great majority was constituted of the ‘zero’ edges.
The structure of the banking sector adopted the German-kind form of universal edges with edges being allowed to keep up substantial stakes in non-financial firms. At the same time, by cross-shareholdings the Russian firms literally owned the edges they borrowed from, consequently ‘giving new meaning to the concept of ‘insider’ lending’. Such lending practices worked well because the government underwrote the implicit debt produced by enterprise edges making risky loans to themselves. In addition to this, in the early reform stage, the government-directed credits dominated money lending; consequently, the edges’ main function was to borrow money from the Central Bank of Russia (CBR) at subsidized rates and then channel the finances to designated enterprises; the last being in most situations the de facto owners of the edges. The overall effect of this situation was, on the one hand, regarding the enterprise sector, that many new enterprises were left out with extremely limited access to funds, and however, concerning the bank sector, it implied high risk exposures as edges were unprotected to risk both as creditors to the industries and as shareholders in them. additionally, there was an additional source of risk to edges since, at the minimum theoretically, the edges bear the risk of government-directed credit to enterprises.
In addition, the macroeconomic situation in the early 1990s was characterized by extremely high inflation rates and consequently, negative interest rates (e.g. in 1992-1993 the real interest rates were -93%; in 1994 by early 1995 -40% before finally turning positive for time deposits during the second half of 1995). As a consequence, the amount of total credit to enterprises dramatically dropped during this period; in 1991 the proportion of credits to enterprises comprised 31% of GDP, while in 1995 the banking system had a book value of loans to enterprises of $26 billion, representing 8.1% of GDP. All these factors taken together rule to a rapid growth of overdue credit and by the end of 1995 one third of the total bank loans were non-performing, a proportion amounting to almost 3% of GDP. Equally important, long-term credits amounted to around 5% of total bank loans, in other words, edges focused mainly on short-term money lending (which, taking into consideration the high level of uncertainty had a relative advantage as compared to long term money lending).
The above described characteristics of the Russian banking sector in the first half of the 1990s highlight the difficult macroeconomic situation in which a German-like form of universal edges was introduced. And already in this initial stage, one has enough grounds to question the feasibility of this decision for instead of a clear inflation history – an absolutely necessary pre-condition for the introduction of a German-kind banking system – Russia had experienced extremely high, persistent inflation rates and a great macroeconomic instability. additionally, some authors agrue that edges shareholding in non-financial firms was scarce and could not reach a sufficient level of concentration to order to allow for the mecahnism propsed by Gerschenkron to work. Introducing a German-kind of banking system in Russia, consequently, seems not to be an outcome of a well-thought strategy by the policy makers, but unfortunately, as seen by most observsers, a consequence of regulatory capture by some influential private interests.
nevertheless, many authors claim that given Russia’s background, the chosen system of close bank-enterprise relationships was optimal and that edges played a major role in easing investment. In this respect, the next section of the paper will focus on providing empirical evidence on the bank-enterprise relationships in Russia and on assessing the relevance of the chosen bank form for Russia’s economy in the early change stage. In particular, two major questions will be raised: 1) how did the close bank-enterprise relationship affect (if at all) the dispensing of bank credit and the decisions of the enterprises; and most importantly, 2) did this form play the role of an instrument to raise firms’ investment as believed by Gerschenkron.