DOCUMENTATION
TWINNING - A BUSINESS D E V E L O P M E N T MODEL FOR RUSSIA by David C. Lurid Introduction This article describes a model of business development called twinning that has been used to facilitate the successful restructuring of commercial banks in Poland. The application of the twinning model in the Former Soviet Union (FSU) is directed toward strengthening the operations of a core group of private commercial banks. This application of the twinning approach is part of the Russian Federation Financial Institutions Development Project developed with the Ministry of Finance (MoF) and the Central Bank of Russia (CBR) and supported by The World Bank, the European Union and the European Bank for Reconstruction and Development (EBRD). Its potential for success suggests that the twinning model is sufficiently robust to merit further consideration in other countries; particularly those contemplating or emerging from a past marked by strong government influences on the allocation of credit and direct investment. Because of the rapid pace of technological change in financial services industries, banks in countries such as India and China, for example, might benefit from twinning relationships with foreign banks as a device to speed up technological absorption and the redevelopment and internationalization of their financial systems. The remainder of this article and an Annex on Financial Reform in the Russian Federation discuss the Polish and Russian applications of the twinning model focusing on rejuvenating formerly State owned banks in the former case, and on improving banking skills of largely private banks in the latter. Also discussed are some general characteristics of twinning arrangements, factors which have contributed to twinning's success and some lessons learned.
1.
Rationale for and General Characteristics of Twinning Arrangements
We begin with application of the twinning model to Polish banks. The aim of the twinning arrangements established in Poland is to build strong institutional relationships between entities performing similar activities, whereby more experienced entities transfer skills to less experienced counterparts. Flexible 'twinning' arrangements were tailored to the development needs, priorities, absorption capacities and financial resources of each Polish bank. Active oversight is provided by the Polish Ministry of Finance and by World Bank staff in order to promote project success at
Senior Economist, Policy Development, Economics and Statistics Administration, United States Department of Commerce. MOCT-MOST5: 91-107, 1995.
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the bank level and to ensure consistency with more general objectives of the financial reform program such as clearing and payments systems standards and bank accounting and regulatory standards. Use of leading banks from a number of Western countries both provides Polish banks with a diversity of expertise and facilitates a competitive environment among the paid foreign bank twinning contractors. Characteristics of these arrangements include the following: transferenceof skills in a one-on-one fashion is a prominent feature of twinning, to be distinguished from the development of skills more normally associated with traditional technical assistance (TA) schemes; - in some cases, such as development of strategic plans, the planning process had to be suspended until staff could be taught fundamental management concepts and vocabulary associated with strategic planning; twinning, rather than more traditional TA approaches, provides the counterpart organization, in this case the Polish bank, with established and successful ways of improving organizational efficiency and effectiveness through the selection of a Western bank twinning partner involved in similar activities; in addition to providing a predefined set of services or modules to be delivered, as specified in the Terms of Reference, a foreign twinning partner is expected to be interested in maintaining a strong institutional relationship with the counterpart Polish bank beyond the duration of the twinning arrangement; the scope of services in a twinning arrangement is quite broad and the arrangement between a Western twinning partner and the counterpart Polish institution is expected to be closer and more long-term (typically 3 years) than would be the case in more usual short-term technical assistance arrangements. -
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1.1. Participation In past twinning arrangements the selection of particular Western banks for the Polish twinning project depended on a number of factors: to participate, Western banks needed to make and be able to sustain a management commitment to the Polish bank; the Western banks had to have experience relevant to the Polish bank and the latter had to be aware of and recognize that experience and be able to accept that they needed help.
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1.2. Compensation Twinning has been successful in the Polish case, in part, because Western banks have been compensated for their participation. Western banks provide services specified in a Terms of Reference and detailed in a technical proposal developed by the Western contractor for each twinning arrangement. In addition to developing knowledge about the Polish economy and its banking environment, gaining access to the market and developing contacts which could lead to future business for the Western twinning bank as paid consultants, the twinning
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arrangements have generated substantial bank fee income with no corresponding pressure on bank capital. Over the typical three year term of the twinning agreements in Poland, outlays to the seven Western twinning banks, according to the Polish Embassy, are expected to total US$36 million. This is an annual average of US$1.7 million per bank per year. In addition to institution building through twinning, the broader World Bank financial reform effort in Poland includes US$42 million for bank automation and US$5 million to the Ministry of Finance and the Polish Central Bank for improving bank regulation and supervision as well as for other projects. Funds for these projects originated from loans and, in some cases, grants to the Polish Government from The World Bank, the European Community and the European Bank for Reconstruction and Development (EBRD).
2.
Background on the Polish Banking System
Reforms begun in 1988 introduced a two-tier banking structure to Poland, consisting of a central bank, the National Bank of Poland (NBP), and commercial banks. The former regional branches of the NBP were converted into nine stateowned commercial banks.1 These banks are located in the largest Polish cities, with networks of 30-40 branches within their regions. Bank and other economic reforms, including the liberalization of interest rates, set the stage for the development of an efficient banking system. But major weaknesses remained, including lack of autonomy and reliance on Government back-up, segmentation of activities leading to the absence of real competition, small branch networks, an inadequate financial structure and a general lack of the banking skills needed in a market economy environment. The nine regional banks in Poland were licensed as universal 2 banks. During 1990-91, the Government corporatized the banks, and by October 1991 all the new banks had been transformed into joint stock companies, 100% owned by the Polish Ministry of Finance. The joint stock companies meant that appointed supervisory boards could begin to exercise governance over the banks' managements and set the stage for an eventual privatization of the banks. Subsequently, two of the commercial banks were privatized- Wielkopolski Bank Kredytowy in Poznan (April 1993) and Bank Slaski in Katowice (December 1993).
3.
Adoption of Twinning Arrangements in Polish Banking
The use of twinning arrangements for Poland's commercial banks was based, at the outset, on a recognition that many of these banks would require a complete overhaul. Furthermore, despite the availability of initial evaluations of the banks performed by outside consulting firms, it was recognized that the identification and extent of the problems in converting formerly state-owned enterprises into competitive banks involved considerable uncertainties that would tikely require a
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longer-term and more flexible process than is the case for typical technical assistance arrangements. The twinning program designed for Poland's commercial banks emerged during negotiations in 1990 between the Polish Government, the International Monetary Fund and The World Bank. The World Bank circulated the proposed twinning program to 27 European banks in early 1991, and by April of that year partners had been selected for seven of the nine commercial banks. By mid-1992 the program was operational, with seven Polish banks signing agreements with their chosen partners. The Polish MoF, as the new owner of nine commercial banks, chose twinning as a means to address the inherited problems of many of its commercial banks, especially non-performing loans to non-bank state-owned enterprises, scarce banking skills and a weak legal and regulatory structure. The World Bank suggested to the MoF that its restructuring objectives might be achieved by the use of twinning arrangements between Western banks and the newly created Polish banks, whereby Western banks were to build up strong institutional relationships with Polish banks, including through equity participation, and to undertake comprehensive technical assistance and institutional development programs. For a variety of reasons - including the unsettled macroeconomic and political environment in Poland in 1991, the effect of high inflation on obscuring the true financial condition of the banks, unfamiliarity with Polish accounting practices and restrictions on foreign majority equity interests ,- none of the foreign banks could be convinced to take equity positions. To preserve the transfer of banking skills and other institutional relationship benefits, Polish authorities decided to pursue twinning arrangements with foreign banks without equity investments. While Western banks did not take equity positions in Polish banks, equity investments can play a constructive role in facilitating both the institutional transfer functions of the twinning process and in promoting the longevity of the business relationship. By mid-1992, seven twinning arrangements were in operation in Poland, with the participating banks paired with Western banks ranging in size from US$24 billion to US$250 billion in assets: - Powszechny Bank Kredytowy SA - Istituto Bancario San Paolo di Torino (Turin); Bank Gdafiski SA - ING Bank (Amsterdam); Bank Zach6dni SA - Midland Bank (London); Pomorski Bank Kredytowy SA - Unibank (Copenhagen); Bank Przemystowo-Handlowy SA - ABN-AMRO Bank NV (Amsterdam); Wielkopolski Bank Kredytowy SA - Allied Irish Banks, Plc. (Dublin); Bank Depozytowo-KredytowySA - Bank of Ireland (Dublin).
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T w i n n i n g - The Process and the Product
4.1. The Twinning or Matchmaking Process 3 At the request of the Polish Government, the International Finance Corporation (IFC), the private sector arm of The World Bank Group, undertook to assist in the matchmaking of Polish and suitable Western banks. The IFC visited each of the nine Polish banks and a number of foreign banks with whom it had developed good relationships in the course of its normal operations. IFC also arranged meetings in Poland so that foreign and Polish banks could verify for themselves the validity of the proposed matches and review the terms and conditions of the proposed twinning arrangements. The matchmakers play a key role in the process of pairing or twinning Western banks with their Polish counterparts since they must be able to judge the appropriateness of the match. This process is based on a combination of past World Bank experience with some of the Western banks as well as on interviews with staff and management of other Western banks which are used to evaluating the interest in and suitability of potential matches with Polish banks. Ultimately, of course, meetings and negotiations between the twinning banks must confirm the suitability of the twinning arrangement. The high caliber of the matchmaking personnel used by The World Bank has greatly facilitated the pairing process. For example, one of those involved in matching Russian and Western banks is a former chairman of a major Swedish bank. Extensive prescreening of Russian banks was used to help identify suitable candidates, and interviews with potential Western twinning banks, including a number from the United States, are being carried out. 4.1.1. Terms of Reference A detailed Terms of Reference was developed for the Polish project after an extensive initial analysis of the Polish banks, and foreign banks were also provided with diagnostic studies by international accounting firms, undertaken at the request of the Polish Ministry of Finance, to aid them in the preparation of technical proposals. In Poland, the following broad categories or modules are reflective of the work to be undertaken by the Polish and Western banks involved in twinning arrangements. More uniformity in these twinning arrangements than is likely or perhaps desirable in the Russian project partly reflects that there was only one owner overseeing the arrangements. 4.2. Work Modules The work modules are common to both Russian and Polish projects and include the following: - development of a strategic planning capability, including preparation of an initial strategic plan and supporting business plans. For some Polish banks, the Western
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banks had to halt the planning process in order to teach sufficient management fundamentals so that planning could continue; - review and revision of existing organizational setups and introduction of budgeting systems in order to build a structure and internal financial and managerial tools necessary to achieve strategic plan objectives; - strengthening of credit function by developing prudent credit policies and procedures and building an asset- and liability management (ALM) capability. For example, some of the Polish banks have already generated substantial profits by short-term interbank placements of excess liquidity which had previously been retained in unremunerated balances at the National Bank of Poland, and most have shown rapid progress in the credit and ALM areas; - building marketing and human resource development capabilities, strengthening and modernizing the internal audit function and developing large-scale staff and management training functions. Training to improve the credit functions has been widespread, and the early emergence of a wide range and higher quality of banking services is notable, but accounting and audit functions have been slow to develop. While resources management has improved, a reluctance to address overstaffing persists; 4 - assisting automation of banks' operations and building Management Information Systems (MIS). Progress here has been uneven. Although progress among the banks varied, the project (about halfway through its scheduled three year duration at the time this article was originally prepared in March 1994) was already, if unofficially, viewed as successful. It is not surprising, however, that with seven different pairs of participants not all of the twinning arrangements progressed with equal success in each of the various modules. But progress is being made and lessons have been learned which will positively influence banking reform in Poland and current and future twinning programs in other emerging market economies as well. The twinning model is also a key element of the commercial bank component of the recently announced Russian Federation Financial Institutions Development Project which is discussed in more detail in the Annex.5 Although the sequencing of, and emphasis on, the above work modules differ in the Russian program, such as an earlier emphasis on improving the credit function in Russia, the components are largely the same in both cases and will not be discussed separately in the Annex. 5.
Factors
Contributing
to
Twinning's
Success
and
Lessons
to
be
Learned
It is important to recognize that the Polish twinning program, addressing the organizational development of Polish banks, is just one aspect of a broader financial reform program which contains technological, regulatory and supervisory components. Determining which factors are most important in the success of the twinning program awaits a formal evaluation, but certain aspects are important.
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5.1. Sequencing of Technical Assistance Programs As a result of rather uneven progress in Poland in the modernization and automation of banking systems, for example, funding for bank automation in the forthcoming Russian twinning program will only be provided to banks that have developed an institutional strengthening program as part of their twinning arrangement. Outlays per bank in both programs average about US$6 million. Sequencing was also a factor in the modernization of internal accounting systems where delays in Poland hampered not only bank accounting reform but impeded automation as well until the National Bank of Poland expanded and clarified its Plan of Accounts.
5.2. Commitment to Twinning Arrangements Polish bank management must be committed to the twinning arrangement. This includes a willingness to acknowledge inexperience and to accept the Western bank's recommendations and assuring an environment that does not undermine the Western bank's commitment. Early and active involvement of the Polish or Russian bank helps avoid the perception of technical assistance as external criticism and can enhance the sustainability of the project. Management resistance, however, can arise for a variety of reasons, including the relatively high salaries paid to Western bank staff. Resolving management resistance and disputes is a key to successful cooperation. In this regard, it may be appropriate to have an independent third party available to provide quality control on the services provided by the Western bank and on the cooperation provided by the Polish or Russian bank's management, and also, perhaps, to arbitrate disputes. It follows that a Western bank management's commitment is critical to the success of a twinning arrangement. One factor which might adversely affect this commitment is whether they are limited in equity participation in banking in the country concerned, and thereby precluded from eventually pursuing a more permanent business relationship following the successful conclusion of the twinning arrangement. It is also possible that twinning may be the only way for a foreign bank to gain market access. This not only has commercial advantages for the twinning partners but can help local banks and regulators gain first-hand knowledge of the benefits of more open banking markets, thereby contributing to an acceleration of the transition to a financial system with open international access.
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5.3. Project Management In the Polish twinning arrangements, Polish banks paid for the services out of loan and grant proceeds and therefore had incentives to get the most out of the twinning relationship. However, there was occasional resentment when the Western bank employed a large staff and paid relatively high salaries. Problems of coordination suggest that the twinning process can be facilitated if the Western bank keeps its project management staff as low as possible and avoids multiple layers of project management in the field and at headquarters.
5.4. Project Staffing The Western bank can have difficulty finding qualified staff that are willing or able to spend long periods of time in the recipient country. One way around this, and also a way to avoid the resentment noted above, is for the Western bank to work with a very small resident staff, supplemented by periodic short missions from staff employed elsewhere in the Western bank's organization or headquarters. 5.5. Absorption The participating Polish or Russian bank needs to be able to absorb the advice provided by the twinning partner. This requires full-time availability of key staff, as well as foreign language skills. Language training may be a useful precondition for a twinning arrangement and the Polish or Russian banks may have to consider using incentive-based salary or equity compensation schemes to avoid subsequently losing staff benefiting from language or technical training. 5.6. Terms of Reference Developing commitment to the twinning project might be assisted in some cases by splitting the twinning process into a diagnostic phase and an implementation phase rather than by using a single, up-front Terms of Reference, as has been used in Poland. 5.7. Flexible Responses Flexible responses to changes in planned time schedules are related to project management and staffing suggestions and development of the Terms of Reference. All seven Polish twinning arrangements have experienced delays in some work modules and staffing patterns, and project management needs to be sufficiently flexible to accommodate changing realities of the project. The following points are of note: - foreign banks working with subcontractors may find it difficult to accommodate these delays;
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finding qualified staff willing to spend long periods of time in the host country can be a problem, but use of a small resident staff supplemented by periodic short missions from permanent Western bank staff may be effective; while the Russian project will provide more flexibility to accommodate institutional differences, including the fact that most of the banks in the program are private, it is very important to the success of twinning or other technical assistance programs to identify needs early on and formulate a clear and precise statement of objectives.
5.8. External Pressure Extemal pressure through shareholder or regulatory control can reinforce successful conclusion of a twinning arrangement. In the case of banks, the regulatory role is more obvious, but non-bank twinning arrangements can benefit by pressures from sponsoring organizations, banks and standards associations to adopt sound accounting and auditing practices and make other changes that may not be viewed as important by the participating organization. In addition, improved access to external capital by those bank and non-bank enterprises that do upgrade their accounting and management practices could increase incentives and accelerate institutional change. 5.8.1. Shareholder Control In Poland, the Ministry of Finance as the owner of the banks (still partial owner for the two banks that have been privatized) has exerted control through the bank supervisory boards that it appointed. Lack of this control may make it harder to successfully implement twinning arrangements. In the Russian Federation, a key element in the plan is the establishment of a Project Implementation Unit (PIU). The PIU, staffed by international bankers and located in the Ministry of Finance, will be used to monitor progress and facilitate coordination with other governmental entities. 6 5.8.2. Bank Supervision Strong regulatory authority exercised by the bank supervisory authority, such as The National Bank of Poland (NBP), can also enhance twinning cooperation and complement the foreign twinning banks' recommendations. 6.
The Possibilities for Non-bank Enterprise Twinning in the Russian Federation
The outlook for more extensive use of twinning as an institutional strengthening technique for non-bank private enterprises is uncertain at this time. There are, however, reasons to be relatively optimistic in spite of the fact that The World Bank has not, as yet, verified interest on the part of the Russian government in pursuing a broad-based program of twinning Western non-bank companies with Russian counterpart enterprises. There are several reasons for optimism.
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First, as the twinning initiative gets going in Russian Federation banks, the need for improved means of assessing the risk of loans will increase the incentives for organizational and operational reforms, including accounting and auditing, among non-bank enterprises. Second, to the extent that twinning is successful among the broadly representative core banks in the Russian program (discussed in the Annex), the utility of a twinning arrangement for non-bank enterprises as a means for institutional development and rapid transfer of know-how should become more apparent and readily accepted. Third, the core banks and their Western twinning partners will be in a unique position to identify non-bank enterprises in Russia that could benefit from a twinning arrangement and therefore be suitable candidates for twinning and other forms of assistance, including twinning arrangements with direct equity participation by Western firms.
6.1. Structuring Non-bank Twinning Agreements In structuring these agreements it is useful to consider some of the lessons learned from implementation of the Polish bank twinning arrangements and key elements in the success of these arrangements, including: - a long-term management commitment to the project by both foreign and Russian parties; - a clear and precise statement of objectives, but flexibility in project management and staffing responses to account for deficiencies in the technical proposal or changes in the underlying circumstances of the organization and changes in planned time schedules; - flexibility to adjust the Terms of Reference for the contract to reflect either mutually recognized changes in priorities or the ability of the Russian enterprise's staff to absorb the advice and support of the Western company; early and active involvement of the Russian business in developing the terms of the twinning arrangement, to avoid the perception of technical assistance as external criticism and to enhance project sustainability. This review of the Polish twinning experience and of the planned Russian Federation banking project illustrates the complexity and long-term nature of the process of transition to a market economy and suggests the importance of a formal mechanism such as the twinning model. The experience also illustrates the constructive role that can be played by a neutral third party in addressing subsequent problems which can emerge in a twinning arrangement. Twinning arrangements could be a useful complement to initial or planned equity investments in some non-bank areas, particularly in areas with extensive governmental influence such as energy production and distribution, transportation and extractive industries. Twinning could also help ensure that a third party, such as a government ministry, will take and maintain an active interest in ensuring a positive outcome to a technical assistance or equity participation project. In this regard, establishing a project implementation unit (PIU), staffed by senior managers -
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experienced in the relevant area and financed by the sponsoring organization, similar to the PIU established for the financial reform project in the Russian Ministry of Finance, could be a key element to facilitate a sustained commitment and promote a successful conclusion to projects and twinning arrangements.
7.
Conclusions and Recommendations
The Polish experience with the twinning model has been encouraging, according to The World Bank's International Finance Corporation (IFC) staff, and this review, based on World Bank and external sources, supports that assessment. Strong commitments by both foreign and counterpart banks, flexibility in staffing to accommodate delays and recognition of limits to the absorptive capacity of the counterpart bank are all critical for success. Bank governance, exercised by active shareholders and an effective prudential bank regulatory regime can strongly complement the efforts of the twinning partners and contribute to success. Several changes in the design of the twinning arrangements, from those used in Poland, should contribute to increasing the likelihood of success of twinning arrangements in Russia and elsewhere. These changes include streamlining Western bank project management, limiting subcontracting to promote flexibility and enhancing the early role of the counterpart organization in the host country- in defining the scope of work. Finally, from a more parochial point of view, just as there are considerable direct benefits to participating banks in the host country, so too there may be considerable indirect commercial benefits to a country and its exporters deriving from the participation of its enterprises in twinning arrangements. This paper was received on 9 May 1995. The views expressed are those of the author and not necessarily those of the US Department of Commerce. The usual error disclaimer applies. Assistance from Michael A. Gould, Marie Rende-Bakker, and Hosea-Antonio Mejia of The Worm Bank and Ryszard Wilczynski of the Embassy of the Republic of Poland is gratefully acknowledged. This article was prepared originally in the form of a background paper for the US/Russia Business Development Committee (BDC) and business leaders accompanying US Secretary of Commerce Ronald 11. Brown on the March 1994 trade mission to the former Soviet Union.
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Annex: Financial Reform in the Russian Federation The banking reform efforts in Russia are based on an increasing realization that sustained progress in economic restructuring of formerly centrally planned economies (FCPEs) is both directly and indirectly dependent on the development of a competitive and sound banking system. While equity markets are important for future development of the financial system and private enterprises, they are not yet a sufficient source of capital for supporting new or restructuring enterprises. At present, equity markets in many of the FCPEs lack liquidity, regulatory oversight, information disclosure and adequate clearing and payments systems. Furthermore, until enough banks are restructured and recapitalized to provide sufficient credit to equity market participants - so as to support trading and settlement - securities market development in these countries will be constrained. The reform of the financial system in Russia has been underway since 1987. As in other economies making the transition from a centrally planned economy, such as Poland, the former Gosbank was split into a central bank - the Central Bank of Russia (CBR) - and several specialized sectoral banks, and enterprises and other institutions were given the right to create their own financial institutions. According to The World Bank, directed state credits by the Government and the CBR are provided on a non-market basis - through the commercial banks - and amount to about 23% of GDP. Additional subsidies of about 29% of GDP are provided to enterprises in the form of import subsidies, lump-sum transfers and subsidized interest rates on directed credits through the central bank. Business and banking in Russia are conducted in an environment where both directed credits and subsidies contribute to high inflation, with 20% to 25% monthly price increases, and high interest rates (at the time this paper was prepared in early 1994). Interest rate pressures are compounded by the inefficiencies of the banking system, including a payments system that is so moribund that it uses the mail and requires banks and businesses alike to maintain large clearing balances.
A1. Upside down What is most different or 'upside down' in Russia from an institutional perspective, compared to Poland, is the rapid emergence of private banks (one could argue that this is actually 'right side up'). New private banks in Russia grew in number from about 100 in 1988 to almost 2,000 in 1993, according to World Bank analysts. Many of these banks operated initially as corporate treasuries for their owners, and most of their stock is still held by non-bank enterprises. A number of them, however, have been able to attract new customers and shareholders because their financial services have been better than those of the specialized state banks, despite their limited access to directed credit from the CBR. In contrast to Poland and elsewhere in Eastern Europe, where financial reforms rely largely on the transition of a relatively few specialized state banks into eventually privately-owned commercial banks, in Russia most of the commercial banks are now de facto privatized. This as an indirect consequence of the
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privatization of these banks by their owners through the mass privatization scheme under which more than 2,500 medium and large scale enterprises and about 70,000 small enterprises have been privatized. In essence, the new Russian banks are already being driven by competitive forces. The problems faced by Russian banks differ, at least in magnitude, from those in Poland, but the private banks in Russia have a considerable presence of entrepreneurial spirit which is less obvious in their state-owned bank counterparts in Poland and in Russia. Operational and infrastructure problems are similar, however, with the regulatory and supervisory framework and accounting and auditing systems in 'embryonic' states. Concerns about the inadequate capital base of many of the newly created banks - which suffer from a high loan concentration, often engage in connected lending (not surprising given their origins), have limited credit assessment skills and inexperienced management and staff- are clearly justified. Perhaps up to 100 of the 2,000 banks founded since 1987 are evolving into real banking institutions, according to World Bank assessments. These assessments were based on the results of an extensive screening of commercial banks throughout the Russian Federation, as well as from diagnostic reviews of about 50 banks conducted by The World Bank in collaboration with the Ministry of Finance (MoF) and the Central Bank of Russia (CBR). It is from this group of banks that candidates for the Russian twinning program are being selected. Twenty-two banks were selected for the first phase of the project and an additional twenty wilt be added during the second stage of this effort. 7 While they are not, as yet, 'good banks,' many of the Russian Federation banks are already good businesses. They have made a lot of progress, strengthening their balance sheets and their banking skills and, while their number and the volume of their operations are still relatively small, they are growing fast and are involved in profitable and genuine banking activities: lending to the emerging private sector, lending for foreign trade, and raising foreign currency deposits. The program for strengthening bank operations in Russia, where the preferred approach is twinning, involves over US$120 million, split about 53/47 between loans and grants. Average outlays for the twinning portion are expected to be about US$3.4 million over the life of the project, with the somewhat smaller amount, relative to the Polish project, reflecting the smaller average size of the Russian Federation banks. In addition, the technology development program, which would provide modernization and automation systems, involves substantial resources. It will be applied to those participating Russian banks that have formulated institutional strengthening programs in the first institutional development or twinning phase of the program. This aspect of the program consists of over US$200 million in loans provided by The World Bank and additional amounts by the European Bank for Reconstruction and Development (EBRD). 8 The average loan for the Russian bank automation projects is expected to be US$6.5 million, with a range of between US$250,000 and US$10 million.
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Objectives
The objectives of the project to promote institutional development of a core group of banks in the former Soviet Union are for these banks: to serve as models for other banks; to develop a private clearing system; and to serve as conduits for onlending of loans from International Financial Institutions (IFIs). The core banks in the twinning programs in Russia could serve as catalysts in a gradual strengthening of the banking system, promote prudent banking through strengthening of capital positions, and support the transition towards internationally accepted practices. Payments systems in Russia are cumbersome, with payments and settlement orders still dispatched by mail. As a result, clearing of payments takes a very long time and causes both enterprises and banks to have to maintain very high levels of clearing balances. This is particularly costly when inflation is averaging 20-25% a month and these inefficiencies are fully reflected in higher interest rate charges and operating costs. A payments system project will operate in parallel to twinning, and both projects will be closely coordinated to be consistent with the technical decisions made by the commercial banks in the modernization of their individual systems. The core banks which will come out of the twinning project can be used as onlending banks and help create the institutional foundation for the forthcoming World Bank Enterprise Restructuring Loan and related EBRD loans. In the summer of 1993, The World Bank's Russian financial reform project staff began to identify banks that might be eligible for participation in the project. By March 1994, the process of matching or twinning Russian banks with suitable foreign banks was underway. Western banks that are selected by host banks to participate in the organizational development or twinning phase serve as paid consultants, with funds and loans provided by The World Bank, EBRD, and others, as well as through grants, host government funds (partly financed from World Bank loans) and the Russian counterpart banks' own funds. A3.
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Criteria
The most important criteria used for selecting participating banks (PBs) are: capital adequacy; profitability; liquidity; credit policies and procedures; lending activity; internal controls; management capability and autonomy; degree of self-development; focus on the private sector.
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A4. Geographic Coverage The first twenty-two banks selected in the initial phase of the program serve, through their branch networks, all major economic areas of the country. An additional twenty banks will be chosen during the second phase of the program. The participating banks in the initial group are located in ten cities spanning the Russian Federation: four in St. Petersburg, seven in Moscow, one in Togliatti, two in Ekaterinburg, one in Tver, one in Tyumen, one in Omsk, two in Kemerovo, one in Khabarovsk and two in Vladivostok. The banks include new banks and spin-offs from former state specialized banks, and range in size from 30 to over 500 billion rubles in assets. The aggregate capitalization of these banks is about US$700 million. Selection of twinning partners by the Russian banks is proceeding slowly. By June 1995, six of the first 22 banks had been accredited jointly by the Central Bank of Russia and the Ministry of Finance, and four of these had decided on their twinning partners. Still pending are final negotiations of the Terms of Reference agreements between the twinning banks and their Russian counterparts.
A5. Benefits The benefits to the banks that participate and to the countries they represent are not limited to fees to be earned, although those are considerable, representing an average of US$3.44 million per bank for the duration of the twinning portion of the project. Although several Russian banks have expressed interest in pursuing a twinning relationship with an American bank, as yet only one American bank is actively involved. Western banks that twin with the Russian banks will be in a unique position regarding financing and investment opportunities in the non-bank enterprise sector. This is likely to be particularly valuable in the early stages before improvements in non-bank enterprise accounting and financial reporting begin to make the investment process more transparent. Although US banks did not participate in the Polish twinning project, the US Department of Commerce in cooperation with The World Bank encouraged participation in the Russian Federation twinning project, and The World Bank contacted a number of US banks and sought their participation. Choices of twinning banks, of course, are made by Russian banks, but improved understanding of the capabilities of the US banks and their objectives helped to facilitate the matchmaking process and eliminate concerns about US banks' experience in the areas of equity underwriting and equity investment. These activities are allowed by the universal charters of Russian banks and, initially, many Russian banks incorrectly believed that US banks did not have access to experience in the areas of equity underwriting and equity investment.
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A6. Impediments While the twinning program stands a good chance of success when it gets started in Russia, as it now is in Poland, there are impediments from the point of view of participating banks. Although twinning arrangements may be the only viable means for entry into the Russian market, equity restrictions are a serious impediment to developing adequately capitalized commercial private banks in Russia. Twinning with an option for substantial equity participation would likely be a more effective approach for many private banks in the Russian Federation.
A7. Risks and Outlook The risks of applying the twinning model in Russia are not inconsiderable, in view of political and macroeconomic uncertainties. But this review and a study of The World Bank's plans suggest that the twinning approach is sound, pragmatic and 'do-able', Perhaps the most telling evidence of the project's viability was the quick response of Western banks to the new program within days of its announcement. US and German banks also became involved in the Russian Federation twinning process, and that, plus the fact that all of the seven foreign banks which participated in the twinning program in Poland have signed on, suggests that the participants approve of the twinning model, both in concept and in practice.
Notes 1 See Institute of International Bankers (1993), pp. 67-69. 2 Universal banks are generally allowed to sell insurance, underwrite stock issues and, subject to capital limits, invest in non-bank companies. 3 The preparation of this section was aided by an unpublished paper by Marie-Ren6e Bakker (1993). 4 For an update see a sidebar on Polish twinning in World Bank (1994), p. 13. (An earlier draft version was made available to the author). 5 See World Bank/IFC (1994). 6 The Project Implementation Unit was opened in Moscow in April 1995. 7 For ongoing updates to the status and more detailed descriptions of the Polish and Russian Federation twinning projects, contact The World Bank Office of Publications or access its home page on the Internet at: http://www.worldbank.org/html/PIC.htrn. 8 As noted in the Financial Times on 23 May 1994, The World Bank and EBRD 'will provide the bulk of a US$390 million loan to build up a core or 30 to 40 Russian commercial banks.'
References Bakker M.-R. (1993), 'Twinning as a Tool for Institutional Development of Banks - The World Bank's experience in Poland and lessons to be learned for the Former Soviet Union,' unpublished paper, World Bank, July. Blommestein H.J. and M.G. Spencer (1993), 'The Role of Financial Institutions in the Transition to a Market Economy', Working Paper, International Monetary Fund, October. Institute of International Bankers (1993), 1993 Global Survey, Institute of International Bankers, September.
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Pinto B., Belka M. and S. Krajewski (1993), 'Transforming State Enterprises in Poland: Evidence on Adjustment by Manufacturing Firms', Brookings Papers on Economic Activity, I, pp. 213-270. World Bank (1994), 'Russian Federation Financial Institutions Development Project', Staff Appraisal Report, no. 12707RU, 6 April. World Bank/IFC (1994), 'Russian Federation Financial Institutions Development Project,' Project Information Document, World Bank/International Finance Corporation, 6 January.
