Bunchuk: Universal Banking and Innovation

Mikhail Bunchuk

Universal Banking and Innovation: the Case of Russia
Abstract

The large-scale privatization has been cited as a major unequivocal success of economic reform in Russia. However, privatization is not the end in itself, and its ultimate goal is the creation of an efficient and dynamic economy. Such an economy is characterized inter alia by a rapid speed of innovation activities. The problem of innovation is especially relevant to Russia, since this country has inherited a highly skilled labor force and a massive system of basic and applied research. In this paper, I analyze the relationship between the financial system and large firms’ innovation activities in the Russian context. I focus on the phenomenon of universal banking, or financial industrial group (FIG), that emerged in Russia several years ago. In Russia, "FIG" is a group of legal entities who wish to integrate their technological, economic and other resources to undertake investment and other projects. FIGs include manufacturing or service firms as well as banks and other credit and investment institutions. In 1996, 28 FIGs officially existed in Russia. Overall, they unite more than 450 enterprises, of the 100 largest Russian enterprises 11 are involved in FIGs; of the 30 largest Russian banks seven have either joined or formed FIGs. In 1995 FIGs produced as much as 10% of Russia’s GDP. In this paper I concentrate on a particular feature of universal banking: a close relationship between banks and enterprises, due to the fact that the bank keeps both debt and equity of the enterprise.

The existing literature on Russian universal banking is very scarce. Only several English-language articles on this topic can be found. Arguments pro and contra FIGs are also scattered in the literature on Russian economic transition. There are two major prevalent lines of argument. Firstly, it is argued that although FIGs are to be allowed, the government should stay away from any active involvement in their activities. Secondly, universal banking in Russia is sometimes rejected on the basis that the contemporary German, Japanese or Korean economies are very different from Russia’s and their particular types of economic organization cannot be transferred to the Russian economy. I agree that universal banking has an essential role to play in the Russian economy, but argue that active government involvement is necessary so that FIGs could realize their potential of actively pursuing innovations. In order to do that I incorporate a Post-Keynesian perspective on credit rationing that stresses the presence of uncertainty (rather than imperfect information) in the economy and illustrate my argument with Chilean experiences in 1973-82. To confront the latter view, I look at universal banking from an evolutionary perspective and try to analyze the role of this type of economic organization at particular stages of economic development. I show that universal banking is indispensable at early stages of economic development or in situations of disruption brought about by a heavy economic slump or a war.

Drawing upon a rich Neo-Keynesian literature emphasizing the significance of financial structure for corporate governance from the asymmetric information and moral hazard perspective, I shall compare two major financial systems that we can observe in the world economies: the one based primarily on stock markets and short-term bank lending ("transactional banking") and the one with a predominant long-term lending by banks ("relational banking"). I compare a stylized "R&D project" which can generate higher profits but takes a longer time to pay off and a "standard" short-term project. I present theoretical reasons why transactional banking systems can underinvest into long-term projects, whereas firms in relational banking based economies have easier access to low-rate long-term finance. I illustrate my arguments with empirical data.

Several facts about the state of Russian economy are especially important for my purposes:

Russia possesses a strong R&D system;
as a result of privatization, ownership of enterprises is de facto concentrated in the hands of enterprises’ top managers, which stimulates myopic behavior on their behalf;
tight monetary policy and speculation-inducing budget-deficit financing;
disruption of old information channels (ministerial links) in the economy and high level of systemic and idiosyncratic uncertainty;
currently, Russian economic development is based primarily upon unsustainable exports of traditional industries’ products and weapons;
Russian banks have an experience of speculation activities but currently move into new spheres.

I argue that the form of bank-firm relationship, which features debt- and equity-holding in the bank, stimulates repetitive contacts between the borrower and the lender and gives the banker both the means and incentives to monitor. Thus new information channels are created (or old ones get restored). In contrast to the asymmetric information perspective, however, I maintain that the "manager" does not necessarily have superior information about his project, in comparison with the "banker": information about the prospects of a project is, in fact, created in the process of interactive learning between the manager and the banker. Thus Russian FIGs are able to militate against managers’ myopic behavior and lead to undertaking longer-term projects and innovation activities on large enterprises. However, although asymmetries of information are smoothed, systemic uncertainty (which is especially high in the Russian transitional economy) is still in place. In these circumstances, both banks and enterprises within FIGs will be governed by "rules of thumb" and "conventions", based on their prior experiences. In Russia, this may lead to continuation of speculation activities by banks or investment by FIGs into profitable yet unsustainable in the long run natural resources’ exports (and we can observe this happening). Moreover, stable information channels within FIGs may well lead to "exclusion" effects, when the system gets locked into inefficient technological trajectories and neglect more efficient new ones. If the "conventions" governing agents’ behavior are powerful enough, borrowed institutions (in our case, it is universal banking) may not change agents’ incentives but get "culturally filtered" and adapted to the prevalent routinized behavior. This may lead, in fact, to a higher instability in the system, which the Chilean experience of 1973-82 amply demonstrated.

Thus, on the one hand, Russian universal banking may become a powerful engine of economic growth based on innovations, generated by the Russian R&D system; but on the other, left to themselves, Russian FIGs are unlikely to realize this potential.

The solution can be an active government involvement into FIGs’ activities. Although the government also has information problems, it has a higher ability to collect information, as well as the ability to stimulate banks and enterprises to follow its guidelines, punish and reap benefits. The task of the government is to change inefficient patters of routinized behavior and encourage learning processes in the economy along fruitful technological trajectories. The need to carry out these functions was recognized by the Japanese and many Pacific Rim countries which have demonstrated that when the government plays an active role in the banking sector and becomes the "Stackelberg leader" in the economy, the ensuing processes exhibit increasing returns and generate a dynamic economic development. Of course, if the government is thoroughly corrupt and penetrated with vested interests and lobbyism (as it is in Russia), the government may become the "Stackelberg follower" instead. Thus a reform of the public sector and education of honest public servants are desperately needed.

Notre Dame, 1997

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