Finally, the American instructor and his Russian banker-trainees had found some common ground. Up to now, he felt at times as though they were not talking about the same industry. The gulf between the American and Russian banking experiences seemed as large as the gulf between the two languages.
The breakthrough came during a discussion about banking spreads - nominally the net interest margin earned on intermediating funds between investors (depositors) and borrowers. They specifically agreed that banks could achieve good profitability on spreads of 5% or 60%. However, even this apparent bit of understanding revealed another communications gulf: The American was thinking of a 5%-6% annual spread, while the Russians were thinking that a 5%-6% monthly spread seemed about right!
(Actually, in a nation where inflation ran 4% per week earlier this year, there was no way that even a monthly spread of 5%-60% was profitable. Because of rampant inflation, the Russian ruble is down 100% against the dollar since 1992. Fortunately, inflation has declined quite a lot since early 1995 as the Russian central bank and economic ministries belatedly are cooperating to try to stabilize the ruble.)
Training bankers in the ex-Soviet nations reinforces your appreciation of the unique institution of banking in America, and it forces you to rethink the fundamentals of banking competition in this country. For example, spreads - the markup on money in the financial intermediation process - have to be earned in the competitive arena. Bank customers will agree to pay given spreads only if they receive sufficient service value - what American bankers call value added." They won't tolerate arbitrarily larger spreads. If customers do not get sufficient service value for the spread (price) charged, they will find a provider that does deliver commensurate value - or they will find a lower-cost provider.
Competition in the ex-Soviet nations (and, to a lesser degree, Europe and Japan) is not so service-oriented. These one-time Soviet entities' banking markets are not developed to the point where there is meaningful competition between banks on the basis of customer service. While most American banks have begun to define themselves according to customer needs, the new banks of the Eastern nations tend to scoff at the implied American ideal that the customer is king.
Perhaps that's because these banks must cope with an issue far more basic than customer service. Many, if not most, of these banks are burdened by loads of bad loans assigned to them by the state following privatization. Many of the loans were made under socialist regimes, when lending to state-owned producers was simply decreed by political managers without regard to profit potential. Alternatively, some loans were made without rigorous evaluation or conservative underwriting standards during a naive burst of capitalist fervor immediately following the collapse of Communism.
Maslow on Banking
As American bankers know (but some periodically forget!), a sound loan portfolio to a bank is what food, shelter and warmth is to a human. As Maslow explained in his famous hierarchy of human needs, food, shelter and warmth must be satisfied before people can aspire to something greater. Banks have an analogous hierarchy of needs: Sound assets are a prerequisite to higher aspirations. Only when they secure a solid asset base can banks aspire to stable and efficient operations to insure their futures.
Stuck at the first level on the hierarchy of banking needs, the banks of Eastern Europe are not receptive to consumerist notions. They puzzle over our focus on services for fee income, cross selling and the development of customer databases. They relate more eagerly to topics of more immediate concern to them: bank funds management, cash control and credit fundamentals.
American bankers take for granted a credit infrastructure fraught with uncertainty in the nations of the former Soviet Union. Take, for example, the lack of support systems for credit investigation and analysis. Many Eastern European bankers are skeptical of the American system of credit bureaus for reporting the credit histories of potential borrowers. Surely, they say, companies would not cooperate to create such sensitive information - and if the did, it may not be truthful. Also, they do not have agencies to report analytical data by industry classification, such as those reported by Dun & Bradstreet, Robert Morris Associates and others.
Eastern European bankers are especially puzzled by the system of trade credit in American industry, which provides important financial assistance for weaker customers and is often used as a competitive tool. Trade terms may be quite liberal, allowing a customer 90 days or more to pay for purchases, especially when a producer serves an industry where customers are not financially strong. Alternatively, liberal trade terms might be offered in order to take a sale from a competitor.
The experience of bankers with trade credit in the former Soviet Union is vastly different. First, their banks prefer deals that are outstanding for just a few weeks or even days. It is difficult for them to conceive of lending against the receivables of banks customers foolish enough to voluntarily grant 60- to 90-day credit. Receivables are created more or less unintentionally, because it usually turns out that buyers lack liquid funds for making payments on time. But to create such receivables as a matter of strategy seems a high-risk venture.
Government Loan Guarantees
The banks' reluctance to lend on receivables is compounded by the rules for bankruptcy, or the lack thereof. Some of the nations have not passed bankruptcy legislation. And in nations where bankruptcy laws were passed relatively quickly, such as the Czech Republic or Slovakia, it still is unclear how the nations' legal systems will interpret and enforce the laws. As a result, creditors' rights and the hierarchy of creditors' claims under reorganization or liquidation remains too uncertain to institutionalize trade credit.
Eastern bankers are all in favor of shifting their risk to their governments through government guarantees on bank loans. After all, they operate in a very high-risk environment, and government support would overcome credit mistakes in their unpredictable economies. These bankers are impressed with the way U.S. government guarantees have supported the tremendous growth of the mortgage and Small Business Administration loan markets.
The American example of securitization in these markets and beyond suggests to Eastern European bankers that government debt guarantees would attract secondary market investors. What they forget, however, is that guaranteed products are only as good as the guarantor. Guaranteed loans will not be accepted if investors fear that the guaranteeing governments may arbitrarily change the rules governing such commitments. Sadly such reversals, are not uncommon.
Unfortunately, such reversals by government authorities are not uncommon. In addition, investors are sensitive to the actual volume of government loan guarantees. They will not be impressed by government-guaranteed loans if they believe the volume of issues exceeds the particular government's capacity to support it.
One hopeful sign of understanding between the American instructor and his Russian banker trainees is based on the latters' high education levels. Often, their initial reaction to American banking methods is simple: They will not work here. But at the end of the day, they tend to be won over to the American view when they begin to understand the logic and objectivity of U.S. financial markets and institutional competition. At such times, their highly developed intelligence shines through.
