TIME EUROPE
October 2, 2000, Vol. 156 No. 14
Doing Well By Doing Good
After a tumultuous first decade, the European Bank for Reconstruction and Development searches for new approaches to fulfill its conflicting mandates
By JENNIE JAMES London
Muscovite sergei teteryuk had a great idea. After leaving the army in 1993 he started up a small business specializing in household fix-up products like wall paneling. Despite the vagaries of Russian commercial life, his firm Alta-Profile began to turn a profit. But last year he ran into the same problem faced by nearly every small enterprise around the world: he could not get the capital he needed for expansion at a reasonable interest rate. "We kept looking for a creditor, but the terms we were offered were not acceptable," says Teteryuk.
Then he saw an advertisement in a Moscow daily for KMB Bank, especially created to provide credit for small businesses, and went to see one of its loan officers. With a minimum of red tape, he got the capital he needed at an interest rate that wouldn't break him. What the 33-year-old capitalist did not know at the time was that his tiny company's loan was made possible by a financial institution based in the City of London. The European Bank for Reconstruction and Development had extended a $60 million line of credit to KMB so it could make loans to small and medium-sized enterprises (smes) just like Alta-Profile.
Teteryuk has plenty of company. The EBRD currently helps banks make about 50,000 loans to smes a year, and it wants to support 100,000 new loans a year by 2002. To date, the bank has launched small business financing programs in 10 countries aside from Russia, including Ukraine and Albania, and plans are in the works for programs in 10 others within a year. Says Elizabeth Wallace, the EBRD's head of small-business lending: "It changes lives and it changes the local economy."
Changing lives and economies in post-communist Europe is the reason the EBRD opened for business almost ten years ago, funded by 40 countries, the European Community and the European Investment Bank. Lately, the EBRD has begun to focus on small business finance as part of its mission to bankroll projects that can foster market-oriented economies across the region. The bank has also said that by 2003 it intends to increase its equity investments, take a greater role in helping to run the companies that receive its funding and allocate a higher proportion of its resources to the eastern part of the 26-country region in its purview — a geographical remit that stretches from Poland to the Bering Sea. The bank's attempts to chart a new course for itself in its second decade will be overseen by a new chief: former French Treasury director Jean Lemierre took the helm last July, succeeding Horst Köhler, who left to head the International Monetary Fund.
Lemierre faces a daunting task. "Let us ask the cruel question," says Roger Alford, senior research associate at the London School of Economics. "What exactly is the role of the EBRD?" An equally tough question is how it should operate. The EBRD can often appear risk-averse, bloated and slow-moving. And it is hampered by a cumbersome internal bureaucratic culture and a series of schizophrenic mandates. "There are too many opposing interests," says Jiri Huebner, a former director of the EBRD's Czech and Slovak team and now head of Strategic Investment Services, a consulting firm for companies operating in Central Europe. "Too many policies, too lofty objectives ... and not enough deals."
The EBRD faces a central conundrum: the for-profit bank's charter demands that it both do good and do well — forcing it to walk a fine line between selecting high-risk projects to further market-oriented development in the region while playing it safe financially. "The contradiction is there," acknowledges Lemierre, seated on a couch in his office overlooking the City of London, "but it's the business we have to do."
The EBRD's biggest immediate challenge is deciding where to conduct that business. The transition from socialism to market-based capitalism has been remarkably uneven in the former Soviet bloc. For post-communist Europe as a whole, the financial requirements are mammoth: to close the income gap between the EBRD countries and the rich nations of the Organization for Economic Cooperation and Development, the EBRD says total annual investment in its region would have to rise from less than $200 billion today to more than $500 billion by 2010.
Although the EBRD is the largest single investor in Eastern Europe over the past nine years, such sums dwarf the bank's current commitments of about $9.5 billion. And while the bank expects economic growth in 2000 in all 26 of its countries of operation, past events are as likely to influence its investing as any guarded optimism about the future. In 1998, the EBRD was hit by the financial crisis in Russia. Along with some of its other investments, its stakes in the commercial banks Tokobank and Inkombank were wiped out, and it was forced to declare a loss of $226 million. In 1999, shaken and gun-shy, the EBRD steered only 10% of its annual commitments toward Russia while placing 42% in the so-called advanced countries such as Poland and the Czech Republic that are on their way to European Union membership.
The bank bounced back in 1999, when it recorded a profit of $37 million, but repeating that performance may be made more difficult by its intention to spread its largess more evenly in the future. By 2003, it hopes roughly 30% of its commitments will be in Russia and a similar proportion in the advanced countries, with the remaining 40% earmarked for the poorer nations in Central Asia and southeastern Europe.
This proposed distribution has done little to placate those who say the EBRD is doing too much for the advanced countries. Other sources of finance are available there, and soft public money can upset the market for commercial lenders. "The more advanced a country is, the more it will have access to private sector funding," says Wike Groenenberg, an Eastern Europe economist at Schroder Salomon Smith Barney.
Indeed, an influx of venture capital and other sources of funding has begun to marginalize the bank's role in previously lucrative sectors. Hubert Warsmann, the EBRD's Budapest-based director for Hungary and Slovenia, has seen a change since he arrived in 1994: the early EBRD practice of lending money mainly to large Western corporations such as General Motors, says Warsmann, is now "game over. The commercial banks are more than willing to do it." Echoes Attila Chikan, chairman of the Council of Economic Advisers to the Hungarian Prime Minister: "I think its role has been mostly completed."
Lemierre, however, thinks the EBRD still has a role to play in those countries where the move to a market-based economy is well under way — financing public sector projects, particularly in the development of infrastructure. "We are not going to leave," says Lemierre of the advanced countries. "We have to shift to sectors and companies where progress has not been sufficiently made."
The EBRD is also returning to Russia. Earlier this year, the bank announced it would invest as much as $600 million in the country in 2000, up from just over $173 million in 1999. Next month, it plans to release an updated investment strategy for Russia: along with activity in the automobile and metals industries, it hopes to sponsor projects in relatively untapped areas such as home mortgages and venture capital.
Behind the new projects and sectors lies a new way of thinking. After the Russian collapse, the EBRD's top bankers decided that focusing solely on project finance would not be enough to foster the EBRD's goals. The aim is now to develop the overall business environment of the countries under its mandate, tackling issues like legal and regulatory frameworks and corporate governance. The EBRD may soon get the chance to test its resolve: before the end of October, the bank's board is poised to review a proposed $250 million loan to Gazprom, the gigantic Russian gas company. The loan is significant not just because it involves a corporation that sits on about 25% of the world's gas reserves and production, but also for the conditions that accompany it: increased corporate transparency and stricter accounting standards. "What is important," says Lemierre, "is what we are trying to do through this deal."
Perhaps, but the bank's attempts to change post-communist Europe by pressuring companies and governments have had mixed results. The EBRD claims some credit for the 1998 shake-up in the management board of Czech bank Ceska sporitelna whose privatization was completed this year (see following story). But other attempts have ended in abject failure. In April this year, a small delegation from the EBRD travelled to Turkmenistan, where the bank's portfolio of five projects with a value of about $190 million makes it one of the country's three largest foreign investors. Worried about scant progress toward political and economic reform in the Central Asian country, the delegation scheduled a meeting with Turkmen President Saparmurat Niyazov to discuss the EBRD's intention to stop funding public projects until the country showed a willingness to move toward multiparty democracy. The President's reaction was, in the word of one EBRD insider, "contemptuous." He did not even bother to turn up.
Yet the bank's supporters insist that it can be a catalyst for change, enticing other investors into regions they might otherwise avoid. "As a yardstick you need EBRD everywhere you cannot transfer hard currency or where such a transfer risk might materialize," says Martin Frank, head of project finance at Bank Austria Credit Anstalt, which has co-financed $225 million worth of projects with the EBRD. For Frank, the EBRD still has a vital role to play in much of the East European region. "You still have a lot of countries, the Ukraine for example, where there is no framework in place and you cannot lure medium-term finance by commercial banks. There, the EBRD umbrella certainly helps."
Getting under the EBRD umbrella, however, can take time. On average, a project takes six months to clear the bank's internal procedures, but it can take a lot longer — approval for one $24 million water-treatment project in Slovenia took five years. Such delays are a source of frustration for the bank's co-financiers. Says a Vienna-based banker, "The red tape is terrible."
Indeed, the faltering transition of parts of post-communist Europe seems to have taken a toll on the EBRD itself. When it started lending in 1991 under the direction of flamboyant French economist Jacques Attali — who resigned two years later following an outcry over how much the bank had spent on its swanky headquarters — some observers then believed that the transition to market-based economies would be a straightforward task for the countries in the region, accomplished within a decade, after which the bank would be redundant. With this brief life expectancy, the bank attracted young recruits from the commercial world, keen to cut their teeth in East European banking before moving on.
Now the bank may instead be drawing careerists, keen to set themselves up in the EBRD's comfortable London premises. But with the realization that transition may take at least a generation or more in some areas, the EBRD wants to revamp itself. The bank now emphasizes decentralization, sending bankers into the field to find projects and work at the grass roots level. In 1999, the proportion of staff in the field, as opposed to headquarters, grew to 34% from 29% in 1998. Still, the bureaucracy can be frustrating to EBRD staff, especially those who joined from the commercial banking world. "Sometimes you feel like blowing the top off," laughs Reinhard Schmalz, EBRD director of marketing business development.
The EBRD management registers these complaints but notes that, while it functions as a commercial bank in some respects, its mandate requires it to act as no other commercial bank would. Every project, for example, is examined for its environmental impact. Lemierre insists, too, that the EBRD is not risk-averse — indeed, the bank wants annual loan disbursements to rise to $2.6 billion, up from the current average of $1.7 billion. Amid all the talk of grand objectives, however, it is the small-business finance plans that could best fulfill the EBRD's mandate of promoting change while making a profit. In Russia, says sme chief Wallace, the loans in her area have a 99.7% repayment rate. "You have a much better chance of doing good banking with the little guys," says Wallace. In a wry tone, she adds: "Big guys can buy courts — they don't necessarily feel the need to repay."
That was one of the lessons EBRD's management had to learn the hard way. The transition to market capitalism has proved more difficult than the bank's founders expected. The good news is that both the bank and its potential clients are beginning to understand that the EBRD's task in that transition is far more complex than just sitting in a marble-paneled building in London doling out mega loans.
With reporting by Angela Leuker/Vienna, Jan Stojaspal/Prague and Yuri Zarakhovich/Moscow
This edition's table of contents
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October 2, 2000
EUROPE
To the Last Drop
As blockades threaten to clog still more of the Continent's arteries, European politicians are starting to feel the pain
A Rationale for Murder
Police arrest 36 people suspected of links to the Basque separatist movement ETA, but triumph is overshadowed by more violence
Terrorism
License to kill
MIDDLE EAST
Shalom to All That Gravity
TIME's Jerusalem bureau chief bids farewell to Israel, a land burdened by its history and lightened by its humanity
New Blood to Shed
A rising generation of young Palestinians rallies to fan the flames of opposition to Israeli occupation
OLYMPICS
Europe's Grabbing the Gold
No amount of Yankee brashness and Aussie hometown hype could steal the thunder of the Continent's swimming sensations
Olympic Innovations
When still waters run fast
FINANCE
Doing Well By Doing Good
After a tumultuous first decade, the European Bank for Reconstruction and Development searches for new approaches to fulfill its conflicting mandates
Paying the Price
For most of the '90s Czech governments delayed the necessary restructuring of the country's banking system. Now the bill has come due
A League of Their Own
German women — and some financial firms — have learned that investing is not necessarily man's work
THE ARTS
The Girls' Night Out
The dominant theme at Toronto's festival was women's problems and glories — and frequent superiority to men
DEPARTMENTS
On Your Own Time
Sophia Antipolis, France
World Watch
WHAT DO YOU THINK?
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