Banking in the Former

Soviet Union

Marc Lieberman

As this book goes to press, the former Soviet Republics are attempting to reform their banking systems along market-oriented principles. To understand why this is such a difficult and all-encompassing task, we must first understand what Soviet banking was. We begin with a general comparison of banking in market-type and centrally-planned economies, then outlines the structure and operating principles of Soviet banking in particular. The article concludes with a few thoughts on future reforms.

Market-Type Banking versus Soviet-Type Banking

Every nation has its own unique banking system, and any simple division into two categories "market-type" and "Soviet-type" of necessity blurs the differences within a category. But we lose very little and gain quite a bit by doing so. To compare, for example, the old Soviet and Polish banking systems is like comparing two different species of plants; to compare Soviet banking with, say, American or French banking is like comparing plants with animals.

The most striking differences between the two systems are as follows:

(1) Basic structure: In market-type economies (MTEs), the banking system is almost always "two-tiered". The top tier is a government-run central bank, while the bottom tier consists of numerous private banks and other lending institutions. The functions of the two tiers are usually non-overlapping: the central bank regulates private banking behavior and controls the national money supply, while private banks take deposits and make loans to the private sector.

In Soviet-type economies (STEs), all banking functions were performed by the State bank, which Western observers aptly called a "monobank." Private banks were not permitted to exist.

(2) Credit Allocation: In MTE's, the allocation of credit is decentralized, since it is performed by thousands of independent lending institutions, all attempting to maximize the profits of their owners. In addition, individuals and enterprises can extend credit to each other, bypassing the banking system entirely. For this reason, one expects credit allocation in a MTE to be efficient; credit flows to those firms that can pay the highest rates of return, i.e., to those that respond best to consumer desires.

In a STE, credit allocation was entirely centralized a by-product of the centralized production plan. The monobank played an essentially passive role, providing credit wherever the plan directed. If the plan called for capital expansion in a particular enterprise, the monobank would grant long-term credit to purchase the new equipment. When the plan required an enterprise to purchase inputs before it received revenue from outputs, the monobank granted short-term credit. Thus, the allocation of credit in a STE was no more efficient than the plan itself. There was no profit motive, no competition among lenders or borrowers, no threat of bankruptcy, nothing at all to force credit allocation to respond to consumer desires.(1)

(3) Monetary Policy: In MTEs, the central bank possesses a monopoly on the creation of currency reserves which it exploits to influence the money supply. In this way, it can affect key important macroeconomic variables interest rates, output, employment, and prices.

In STEs, this kind of monetary policy did not exist, for two reasons. First, as explained below, the monobank had no discretion over the quantity of money. Its money-creation activity like its credit activity was entirely passive, arising as a byproduct of the production plan. Second, changes in the quantity of money or credit would not have affected important macroeconomic variables anyway, because these were all fixed by the planners. An increase in money or credit might lead to additional household spending, but this, in turn, would only lengthen lines at state-controlled stores, or increase prices in the black market. It would have no effect on officially set prices and interest rates, or centrally planned output and employment levels.

We can see that "banking" in the traditional STE was very different from what we call banking in a market economy.(2) In the rest of this article, we focus on banking in the former Soviet Union. Nevertheless, much of the discussion pertains to other STEs, whose banking systems, to a greater or lesser extent, all sprang from Soviet parentage.

The Banking System of the Former Soviet Union

The Structure of the Soviet Banking System

Gosbank (literally, "State Bank") has traditionally been the core of the Soviet banking system. Shortly before the dissolution of the Soviet Union at the end of 1991, Gosbank had over 150,000 employees working in over 6,000 branch and collection offices nationwide. Over 250,000 enterprises, 40,000 collective farms, and nearly half a million government organizations held accounts with Gosbank.

In addition to Gosbank, three other financial institutions comprised the Soviet monobank. Sperbank ("Savings Bank"), with over 70,000 branch offices, was the sole bank for household savings deposits, which earned a positive but very low rate of interest.(3) Stroibank ("Investment Bank"), was responsible for disbursing funds to enterprises for long-term investment, according to the dictates of the central plan. Finally, Vneshtorgbank ("Foreign Trade Bank") handled all transactions involving imports and exports.

Even though the Soviet system (like that of other STEs) was divided into more than one "bank," it was still a "monobank" in the sense described above. The additional "banks" merely administered funds or accepted deposits from households. They did not compete with Gosbank, and were ultimately under the orders of the same central authorities as Gosbank. Indeed, Sperbank became an official department within Gosbank in 1963.

Money in the Soviet Union

In developed market economies, the fundamental types of money are cash (coin and currency) and the private checks of households and businesses. In the Soviet Union (as in most other STEs), there were few private checking accounts. Nevertheless, there was something like a checking account in the enterprise sector, and that was "bookkeeping money" on account with Gosbank.

Indeed, these bookkeeping accounts were the only type of money used between one enterprise and another. Whenever one enterprise shipped its output to another enterprise which used it as input, the Gosbank account of the "output-enterprise" would be credited, while that of the "input-enterprise" would be debited. In this way, goods made their way through the production process without occasioning any exchange of cash.

Besides this "bookkeeping money," there was cash, which was used for only two purposes. First, enterprises paid their workers with cash provided by Gosbank (the account of the enterprise would be debited). Second, households purchased goods with cash, which was then turned over to Gosbank (the account of the store would be credited).

The participation of Gosbank in virtually every financial transaction not only provided the financial clearing operations for these transactions to take place, but also enabled Gosbank to closely monitor adherence to the production plan. This monitoring function of Gosbank was known as control by the ruble.

Control by the Ruble

Let us take a simple example of consumer goods production in the Soviet Union: a milk farm produces milk and ships it to a cheese factory, which turns it into cheese and ships it to a State store. Finally, the State store sells the cheese to a household. How would Gosbank be involved in each of these transactions?

When farm delivered its milk output, it would obtain a document from the cheese factory verifying that the latter had received its milk input. The document was then turned over to Gosbank, which credited the farm's account according to the value of the milk delivered, and debited the cheese factory's account by the same value.

Likewise, after the cheese was produced and shipped to the State food store, the cheese factory obtained a document verifying its delivery of cheese. Again, the document was turned over to Gosbank, which this time credited the cheese factory's account and debited the store's account. Finally, when households purchased the cheese with cash, the State store deposited its cash receipts with Gosbank and was given a credit of equal value.

With this simple example, we can see how every transfer of physical output from one location to another, and every bit of value added in production, was mirrored by an associated financial transfer through Gosbank. If less than the planned amount was delivered on any given day, Gosbank would know. If delivery were late, Gosbank would know. If inputs or outputs were stolen and diverted to the black market, Gosbank would know. Of course, this did not mean that everything went according to plan. Shortages, time delays, and diversion to the black market were notorious problems of Soviet central planning. But control by the ruble did mean that glitches were discovered, investigated, and dealt with in some manner.

Control by the ruble was strengthened by severe restrictions on the use of money and credit in the Soviet Union. As for bookkeeping money, inter-enterprise credit was simply not allowed; one enterprise could not "lend" bookkeeping money to another by permitting late payment for goods received. Also, enterprise accounts with Gosbank were "blocked," that is, they could only be used to pay for the type and quantities of inputs that were specified in the plan. Otherwise, Gosbank would refuse to release them.

As for cash, enterprises were virtually forbidden to hold it for any purpose other than payment of wages. Even the cash receipts of State stores had to be deposited with Gosbank, and then withdrawn again to pay the wages of the store workers.

Finally, control by the ruble extended to imports and exports as well. All goods produced for export were "sold" to Vneshtorgbank, which credited the producer's account with bookkeeping rubles. Vneshtorgbank would then sell the goods abroad for foreign currency. In turn, the foreign currency was used to pay for imports into the Soviet Union, which were then sold to a Soviet enterprise whose bookkeeping rubles would be debited. In this way, the authorities could carefully monitor foreign currency exchange, and ensure that scarce "hard currency" (i.e., freely convertible currency like U.S. dollars or German marks) was used only for "desired purposes."

In general, control by the ruble was designed to prevent deviations from the central production plan. But since the plan itself was often inconsistent, providing an enterprise with too little of one input and too much of another, managers in order to meet their output requirements were forced to develop sources of supply that could bypass Gosbank's clearing operations, i.e., sources that required neither bookkeeping money nor cash. Hence, the immense amount of interfirm bartering that took place in the Soviet Union. An enterprise with excess coal might be lucky enough to trade it for some desperately needed steel. More likely, it would trade its excess coal for some rubber that it didn't need, and would then go about finding an enterprise that had excess steel but needed rubber. Or, worse still: it would trade coal for rubber, then trade rubber for steel knives, and finally melt down the knives to obtain raw steel.

Of course, barter requires human resources that could otherwise be used productively. In this way, control by the ruble was another cause of economic inefficiency in the Soviet Union, above and beyond that caused by inconsistencies in the plan itself.

Banking and Macroeconomic Balance

The most unpredictable component of Soviet central planning was the purchase of household consumer goods. Microeconomically, it was impossible to predict how a given amount of spending would be allocated among different goods and services. Macroeconomically, planners had difficulty predicting even the total value of goods and services consumers wished to buy in state stores. Consumer goods were purchased exclusively with cash, so to understand the source of macroeconomic imbalance in the Soviet Union, we need to understand how the supply of cash was determined.

Ignoring some minor details, cash followed a very simple route in the system: from Gosbank to enterprises to households (for wage payments); and then from households back to Gosbank again, either directly (as savings deposits) or indirectly (as cash revenue of stores which was then re-deposited into Gosbank). The process is outlined in diagram 1(4).

If, for simplicity, we assume that movements of cash into and out of savings accounts were about equal, then for Gosbank equality between inflows and outflows of cash would require that wage payments equal purchases of consumption goods. We can call this situation "macroeconomic balance," and it is essentially what the planning authorities strived for each year. Macroeconomic balance meant that Gosbank would be able to pay all wages from its cash inflows, so the supply of cash rubles could remain constant.

But macroeconomic balance was rarely achieved. Most commonly, especially in the late 1970s and 1980s, cash outflows for wages consistently exceeded cash inflows from goods purchased, primarily because consumer goods (at least those desired by consumers) were in short supply. As long as unemployment could not be tolerated and wages had to be paid, Gosbank had no choice but to print up additional cash for wages. The result was an ever-increasing supply of rubles, without a matching increase in supply of goods.

The consequences were: (1) ever lengthening lines at State stores with fixed prices; (2) continuing inflation in the unregulated kolkhoz and black markets; and (3) a continual flow of "forced savings" into Sperbank or into cash hoards, since there weren't enough goods and services to absorb all the rubles households might wish to spend.

The later result is of particular importance for reform efforts in the former Soviet Union, for after years of forced saving, there exists a considerable stock of liquid wealth in the household sector, both in the form of deposits with Sperbank, and also cash hoards stuffed into jars and flower pots and dresser drawers. In early 1991, estimates of this ruble overhang in the USSR ranged from 50 billion rubles to over 200 billion rubles, a huge source of potential spending with dangerous inflationary potential.

The Reform of Soviet Banking

The Gorbachev Reforms

Before the dissolution of the Soviet Union in late 1991, several important changes were made in the Soviet banking system. While these reforms moved the system closer to Western-style banking, they did not move it very far. The most important elements of the banking reforms, which began in earnest in 1987, were as follows:

(1) Private banking was legalized as part of the 1988 "Law on Cooperatives." Banks could be organized as joint-stock companies (with stock owned by enterprises, local governments, or social organizations) or as cooperatives. Enterprises were now permitted to maintain surplus cash, and the new banks were free to compete for household and enterprise deposits and to make long- and short-term loans. At the time of the dissolution of the USSR, there were several hundred of these banks in existence.

(2) Commercial bank operations (allocating credit, accepting deposits) were stripped from Gosbank and transferred to three new specialized banks (Agroprombank, Promstroibank, and Zhilsotsbank) each handling deposits, lending, and payments services in a different sector of the economy. The intention was to convert each of these banks into a joint stock company, although by late 1991, this had only been accomplished for Agroprombank, the agricultural-sector bank. Sperbank (Savings Bank) continued to accept household deposits, although now it had to compete with private sector banks and was forced to raise interest rates. And enterprises were given more freedom to deal in foreign currency, reducing the power of the foreign trade bank (which had been given the new name, "Vneshekonombank").

(3) Gosbank began its transformation into a Western-style central bank, establishing reserve requirements, capitalization requirements, and lending regulations for the nascent private banking sector.

These steps fell far short of what the most radical reformers thought necessary. In particular, the Gosbank monopoly on enterprise loans and deposits was simply replaced with three new monopoly banks, each responsible for its own sector of the economy. None of the three new banks were permitted to compete for customers or clients with the others, and Sperbank, with its 70,000 branch offices, retained a virtual monopoly on household savings deposits, since its only competitor was the tiny commercial banking sector. Finally, monetary policy remained essentially passive, since Gosbank was still forced to print up cash to finance wage payments in State enterprises.

The gradual dissolution of the Soviet Union led to a virtual collapse of Gosbank by the end of 1991. Increasingly, individual republics (most importantly, the RFSR) ordered enterprises within their borders to turn over cash revenue to them, then used it to expand the role and size of their own governments. Since the central Soviet government refused to shrink itself out of existence, Gosbank was forced to accelerate cash-printing to pay the wages of workers in enterprises and agencies still controlled by the center. In the first 11 months of 1991, the quantity of rubles in circulation increased from 132 billion to 234 billion. By late 1991, the only constraints on cash growth were physical: the printing presses which were capable of printing notes of specific denominations only (the largest being a 200-ruble note) were running 24-hours a day.(5) Shortages of consumer goods intensified, lines at State stores grew even longer, and the inflation rate reached roughly 3 percent per week by late 1991.

The Future of Banking in the Former Soviet Republics

As this article is being written, the banking system in the former Soviet republics remains very much undefined and unstable. The Russian Central Bank has taken over most of the functions of Gosbank, and the Russian government has indicated a desire to move rapidly toward a Western, perhaps American model, but it remains unclear how quickly it will move, and to what extent the Russian financial umbrella will extend over the other republics. There remain several troubling obstacles to successful banking reform in the former Soviet republics.

First, the pace of banking reform is inextricably tied to the pace of reform in other areas. Three examples of this are as follows:

(1) A decentralized banking system can allocate credit only if private banks have a way of ascertaining the credit risks of potential borrowers. This, in turn, requires the development and application of market-type accounting procedures, as well as the establishment and strict enforcement of truthful disclosure laws. Progress on both of these fronts, in turn, requires transformation of human capital in the legal and accounting professions. A glitch in any one of these processes can sidetrack the development of the banking system.

(2) If credit-allocation is to be even roughly efficient, then the ability to repay loans as assessed by banks must correspond in some way with the pattern of consumer desires. Thus, soft-budget constraints and State price controls (see Kornai, Article 2), which enable firms to escape the harsh rule of consumer sovereignty, hinder the development of efficient banking.

(3) Without a social safety net that enables the body-politic to tolerate temporary unemployment, the central bank will face tremendous pressure to print money in order to keep troubled firms afloat. In the troubled economies of the former Soviet republics, this would certainly lead to hyperinflation, loss of faith in the currency, and ultimately, to a barter system in which financial services would have no value.

Thus, political developments that inhibit price reform, budgetary reform, or technical assistance from the West will surely delay progress in the development of the banking sector.

Second, efficient banking will require a significant transformation of public attitudes about banks and bankers. Western observers are often amazed at public statements by the Soviet "man on the street" who, before the CNN television cameras, makes speeches about the market system that sound as if scripted by Milton Friedman. We need to remind ourselves that these educated, English-speaking, gregarious Muscovites are a random sample of a very special subset of the Russian population; we simply do not see the others.

More scientific public opinion polls show a lingering skepticism and resentment about capitalist institutions and values.(6) Even in the non-communist world, banking has been the capitalist institution least understood and most readily attacked by those who do not fully understand it; among those steeped in Marxist culture, this tendency is even more extreme. A people may be willing, even anxious, to get on with needed market reforms, but their negative views of banking and bankers will not disappear overnight. An efficient, decentralized banking system will require thousands of competing banks with hundreds of thousands of professional employees; in a hostile social atmosphere, potential bankers may shy away.

Finally, a stable banking system requires a (semi)-permanent decision on the degree of financial integration among the former Soviet Republics, and this must be decided in the context of economic integration more generally. At present, the desired extent of unity is unclear. Individual visions of the new Commonwealth of Independent States vary from little more than a free-trade area to full economic integration with a common currency.

The advantages of a single currency controlled by a unified central bank are clear, as the twelve nations of the EEC have recently recognized. It has been estimated that, in the EEC, firms spend $13 billion each year in commission charges for currency conversion. Billions more are spent on accounting staff to track costs and revenues in twelve currencies, and financial staff to assess and manage exchange-rate risks whenever inputs or outputs cross international frontiers. These factors so reduced the gains from comparative advantage in production, and hiked the cost of capital investment throughout the EEC, that monetary sovereignty seemed insignificant in comparison; in December 1991, the EEC reached a decision (with the possible, wavering exception of Britain) to adopt a unified currency by 1996. The argument for monetary union in the former Soviet republics may be even stronger, since years of Stalinist specialization have left the productive infrastructures of the republics even more interdependent than those of the EEC nations. Since the republics will need to trade so intensively anyway, why not take away the obstacles and inefficiencies of different currencies?

On the other hand, the cost of giving up monetary sovereignty may be larger in the former Soviet republics than in the EEC. The Soviet republics, unlike the EEC, face an unprecedented transformation of their economic systems, but they differ widely in standard of living, level of education, and political culture. They also differ as to the desired pace and ultimate goals of market reforms. A common currency would tend to constrain different republics to move in tandem, which could harm (and perhaps even halt) the reform process in many of them.

An example of this constraint on the pace of reform occurred on January 2, when the Russian Republic hiked prices on a wide variety of goods and services. In order for the price hikes to help reduce shortages, it was decided that Russian wage earners would not be fully compensated, and purchasing power went down dramatically. The Ukraine and Belarus did not want to move quite so fast in cutting standards of living, but if they refused to raise prices in tandem with Russia, they would have to choose between: (a) permitting a flood of Russians crossing into their republics to buy up cheap goods, exacerbating their own shortages; or (b) refusing to sell to non-residents and thus beginning a trade war in the new Commonwealth of Independent States; or (c) establishing their own money supply, and thus introduce new risks and inefficiencies into inter-republic trading. In the end, a compromise solution was chosen: prices were hiked as in Russia, but the two republics distributed coupons to supplement their residents' ruble incomes and keep standards of living temporarily unchanged. Thus, the fiction of a common currency was, for the moment, maintained, even though in reality the two republics had effectively established independent money supplies.

As the example shows, banking reform and the degree of economic integration are closely linked, and deciding on the precise form of economic integration in the former Soviet republics will not be easy, nor will any solution necessarily be stable. This may well be the most serious obstacle to banking reform in the former Soviet republics.

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