World Bank: Corporate Financing Through Unpaid Debts Undermines Banking

Certain companies in Romania have discovered that it is easier and cheaper to accumulate arrears than to finance their operations through bank loans, World Bank experts say in their latest Report on the Romanian economy. Not paying debts - irrespective of whether the creditor is The State or an utility provider - has become common practice even among companies with a solid financial situation. The result: Romania has the lowest financial intermediation rate in CEE. Financial indiscipline in the Romanian economy is amplified by legal and institutional deficiencies. The combined effect of these factors has bore a negative influence on banking intermediation, in terms of both lending and saving, according to The World Bank Report headlined: "Restructuring for EU Integration - The Policy Agenda - Country Economic Memorandum." The Report points out that not paying debts has become common practice, not only among companies in financial difficulty, but also among those with a healthy financial situation, which prefer to defer payment of their taxes and are encouraged to do so by a long history of budget arrears and The State's tolerance towards debtors.

Financing business operations by accumulating quasi-fiscal deficits is channeling resources to non-viable companies and is one of the factors that keep Romania's financial intermediation rate low, by comparison to other CEE countries. The financial intermediation rate in the Romanian economy, expressed as the ratio between banking assets and the GDP, was 32.6 percent last year - the lowest value in CEE. This index ranges between 60 percent and 80 percent in most of the countries in the region and even exceeds 100 percent in The Czech Republic or Croatia. Companies have discovered that it is easier and cheaper to accumulate arrears than to finance their operations through bank loans, WB experts say. On the other hand, banks are reticent to lend money to companies who have accumulated arrears, which obviously creates a vicious circle that can only be broken through strict financial discipline throughout the economy. The Report indicates that banks prefer to keep their liquidity rate high rather than grant risky loans to company that incur losses and have great arrears, the Report further indicates. It is also said in the Report that lending risks are amplified by legal deficiencies related to contractual obligations and the application of The Bankruptcy Law. Commenting on this matter, Bogdan Baltazar, president of The Romanian Bank for Development (BRD) - Groupe Societe Generale, told "Bursa" that "financial indiscipline is a great problem to the banking system. We have made the natural decision to stop financing companies that have arrears and losses. As far as assets are concerned, The State controls 60 percent of the economy, and most of the companies controlled by The State are losing money. We do care about the level of State budget arrears, because it causes a huge fiscal burden that affects our customers: individuals and competitive private companies."

Under these circumstances, the liquidities in the banking system do not go into the real economy and constitute an inflationary risk. It is The National Bank's job to see that these sums do not generate inflation and the fact of the matter is that The National Bank has been making huge efforts in this respect. In April, for instance, The National Bank kept two billion dollars available in its accounts throughout the month. The sum had been deposited by commercial banks and bore interest.

The banks' policy to avoid becoming involved in a rigid and unreformed economy is also revealed by the fact that bank loans granted to private companies accounted for 14.5 percent of the GDP at the end of last year. Romania ranks second among countries in the region listed according to this index.

All these negative effects and dysfunctions are caused by the slow pace of economic reform, which has allowed the practice of not paying debts to thrive, WB experts conclude. They also believe that achieving a high degree of financial intermediation that would efficiently allocate resources to viable enterprises depends on several factors: renouncing indebtedness as a policy, renouncing bartering, completing the banking system privatization, improving banking regulations and precautionary measures and applying the IAS.