Transformation of the Banking Sector in Czechoslovakia

by Andreas Marathovouniotis

Czechoslovakia's financial system, prior to 1989, was made up of four banking institutions, which were supported by an insurance company in each republic, together with a separate savings bank. These institutions were state owned, except the Czechoslovak Obchodni Bank (COB) which was organized as a joint stock company. 

The center of the system was the State Bank of Czechoslovakia, established in 1950, and functioning both as a central bank and a commercial credit bank. The State Bank was therefore responsible for issuing currency, holding the official reserves of gold, preparing the annual monetary plan and refinancing other banks. In its capacity as a commercial bank, the State Bank provided banking services to cooperatives and enterprises. 

Fifty-one percent of the Obchodni Bank was owned by the State Bank and forty-nine percent by foreign trade enterprises. Thus the COB, was responsible for the conduct of foreign exchange operations related to the financing of Czechoslovakia's foreign trade. The COB also helped the country's external debt. 
The Zivnostenska Bank carried out financial transactions for non-profit institutions and private individuals. Lastly, the Investment Bank handled the state budgets of the federation.

The 1989 new Central Bank Act and the new banking law prepared the separation of the State Bank's central bank activities from it's commercial bank activities. In this way the role of the other banks would have widened and competition encouraged. On 1 January 1990, separation was achieved. The central bank, the new State Bank with headquarters in Prague, was provided with the means to conduct monetary policy and had regulatory authority over the banks. 

The commercial activities of the State Banks were handed over to two newly created banks, one in each republic. The Commercial Bank of Prague initially operated in the former branches of the State Bank in the Czech Republic. The General Credit Bank of Bratislava held similar responsibilities in the Slovak Republic. The Investment Bank, based in Prague, had most of the long term assets of the State Bank transferred under its authority. 

In 1989 the legal framework was also established for the creation of the new domestic and joint-venture banks. Licensing was issued by the State Bank and later the Ministry of Finance was consulted upon the registration applications. Fifty million koruny was the initial capital requirement for the new banks which had as a result the creation of small banks with very low capital base. The capital requirements gradually increased and reached the three hundred million koruny level by 1991. Asset growth of some of the newly created banks was limited due to the capital adequacy requirements. By 1991 there were thirty seven banks but a very small share of total deposits and credits was accounted for the new banks. According to the OECD survey in 1991, the total deposits and credits accounted for around "twelve percent of total credits and just over eight percent of primary deposits". The profits of the new state owned banks were subject to tax, seventy five percent in 1991, and thus did not account directly to the state budget.

The COB remained responsible for the activity associated with the foreign trade by cooperatives, but the other banks were also authorized to undertake such a responsibility. The savings banks operated as before and the Zivnostenska Bank still undertook the responsibility of foreign transactions of private citizens. Foreign banks were allowed to create joint venture banks or subsidiaries in the Czech and Slovak Republics. The large French Bank was the first allowed to establish and after 1991, nine other foreign banks received licenses to operate. 
After the break up of the federation, the Slovak National Bank (SNB) was established in Slovakia and had as a principle task to maintain control over monetary policy and inflation, to ensure currency stability and to supervise the banking system. The SNB received help from the British know-how fund and the Austrian National Bank which provided training courses for staff. The collapse of the currency union with the Czech Republic, together with the run on reserves made the SNB look forward to a more stable environment. The central bank enjoyed the independent status modeled on the German Bundesbank, and thus instead of the Finance Ministry, the central bank took the initiative, in July 1993, deciding upon the devaluation of the currency. 

Then on the central bank could resist devaluation. According to the Patrick Blume article "A model from Frankfurt", in November 1993, twenty six commercial banks were established in the Slovak republic together with seventeen universal banks of which six had foreign currency licenses and nine foreign bank branches. Foreign institutions that existed in Slovakia, included the Banque Paribas of France, Internationale Nederlanden, Bank of the Netherlands, Credit Lyonnais, Creditanstalt and Osterreichishe Volksbanken of Austria, as well as banks from the Czech Republic, Germany and Russia.

In June 1993, the total subscribed bank capital was SK11.8 billion with foreign participation of SK1.6 billion. Some of the problems faced by the Slovak banks were with modernizing their operations and introducing new technology and services. In addition, banks were forced to raise their bad debt provisions due to doubtful loans to military and other state industries. On the other hand, the Czech National Bank was reported in the Financial Times in August 1994, to be able to repay the IMF debt earlier than 1996, due to the strength of the country's official foreign exchange reserves. Big capital inflows were attracted into the Czech banks together with the $6.8 billion dollar reserves in the banking system, by July 1994. Estimates of foreign capital inflows, from the national bank, were raised from Kcs60 billion to Kcs100 billion in 1994. Then M2 money supply was also expected to grow from 14 percent to 17 percent. Inflation was to be dampened by the rise in the minimum reserve requirements of Czech banks from 9 percent going to 12 percent in August 1994.

Financial institutions play an important role in the privatization process. By giving technical, legal and financial advice, commercial banks can greatly contribute to the restructuring of enterprises. Furthermore, financial restructuring of firms may directly involve the creditor state banks, for instance by absorbing loan losses. Banks are also crucial in the post-privatization period when, for example, they provide loans for modernization purposes, on a commercial basis after enterprises have been privatized. According to the OECD survey, new financial instruments, such as mutual funds and unit trusts, are very important in the process of mass privatization. These instruments permit portfolio diversification to inexperienced investors and also help in the development of "more effective management and control mechanism in privatized enterprises" (p.35). Lastly, investment funds rise and provide capital for privatization. The banking sector thus played a crucial role in the privatization process. In the Czech Republic, three commercial banks were privatized by 1992, and by 1994 the majority of the remaining banks were privatized.

As a conclusion, Czechoslovakia had the comparative advantage to have had, under the command system, a long tradition of prudent monetary and fiscal policy, and reliable solid principles of banking conduct. Specific problems were tied to the transformation period such as bankruptcies connected with restructuring the economy and forced inter-enterprise credit. Czech banks still have the false hope that by further extending the credits to bankrupt enterprises, they would be able to eventually recover and repay their huge loans to the banks. In this way Czech banks are in bad shape. The banking system in both the Czech and Slovak Republics is growing fast and as the OECD said "a sound banking system is the cornerstone of any financial system".

Prust, Jim and an IMF Staff Team, The Czech and Slovak Federal Republic, an Economy in Transition, IMF, Washington D.C., Oct. 

OECD survey, The Czech and Slovak Republic, 1991.

Blum, Patrick, A Model from Frankfurt, The Financial Times, Nov. 2, 1993.

Boland, Vincent, Czechs to Repay all IMF Debt Early, The Financial Times, Aug. 16, 1994.

Robinson, Anthony, Structural Reform Gathers Pace, The Financial Times, July 19, 1993.




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