Banks need to shape up in eastern Europe - Editor's Blog -

A new report from the EBRD champions equity over debt and bank finance as the way forward for countries aiming to avoid the middle-income trap, as Brian Caplen describes.

Foreign banks dominate the landscape in most central and eastern European countries, many of which are now facing the so-called 'middle-income trap'. This term is used to describe how, after a rapid transition from low to middle income, the next stage of economic transition to high income can prove elusive. As 5.5 billion people, accounting for three-quarters of the world’s population, reside in middle-income countries, it is a hugely important issue.

The EBRD’s ‘Eight things you should know about middle-income transitions’ report comes up with a sobering conclusion for those foreign and local banks operating in the region – equity, not debt or bank finance, is the best financing option for moving to a hi-tech and green future.

Why is this? The EBRD report argues that banks are more likely to lend to older, tested technologies they understand rather than newer innovative businesses in which the assets may be intangible, firm specific and linked to human capital.

The EBRD’s research shows that equity markets as well as non-bank finance instruments such as private equity, venture and seed capital, are best suited to backing the innovative companies that will create a high-income growth story.

A key feature of high-income transition is that pollution levels are reduced and here again equity markets, not banks, provide the best financial support, according to the EBRD. “Banks often operate on a shorter time horizon (the loan maturity) than equity investors. They are consequently less interested in whether assets are likely to become less valuable (or even stranded) in the distant future [due to stricter environmental standards],” it writes.

The banks of course have a problem in that the post-financial crisis regulations have made longer term and riskier lending (for example, to start-ups) so costly it has become prohibitive in many cases. But it is essential they take as broad approach as possible or risk getting left out of the next stage of eastern Europe’s development. 

Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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