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The Demand for Financial Institutions

The underdevelopment of the Russian financial market is a major constraint on the restructuring of existing firms and on the emergence of a new private sector. Private lenders provide vital discipline in Western financial markets, where banks, lenders, and trade creditors have the ability to monitor performance, establish restrictions on the policies of borrowers, and, ultimately, obtain control of the assets of an insolvent borrower. But in Russia, the legal and administrative foundations for well-functioning financial markets are still incomplete. Private property rights to land are missing or incomplete, it is difficult to use property as collateral for lending, bankruptcy laws are in their infancy, and the legal infrastructure for enforcing contracts is weak and subject to political influence. There are major information problems in assessing the performance of firms and banks. As a result of these shortcomings, savers lack confidence in domestic financial institutions, and financial institutions, such as banks and stock markets, play a limited role in mediating between savers and investors. With more than 60 stock exchanges and over 2,500 banks, 90 percent of stock trading is done over the counter and settled offshore.

A well-functioning financial system is essential to the process of restructuring. Trade liberalization leads to the collapse of noncompetitive activities, but without an infusion of management know-how, new investment, and new technology, new competitive sectors are slow to emerge. A well-functioning financial system would mobilize savings and direct investment to activities with the best prospects for profitability.

In the past 8 years, in spite of weak infrastructure, Russia has seen the rapid appearance of financial institutions, some of which have quickly developed the capacity to become participants in Western-style financial markets. These include more than 2,500 commercial banks, over 600 investment funds, over 1,000 licensed insurance companies, and more than 60 stock exchanges (down from 109 in 1993).

In contrast to the privatization program, which was initiated from the center, the development of capital markets was initiated by private actors. After the first commercial banks were established in late 1988, other financial institutions appeared rapidly. In December 1989, the Soviet Ministry of Finance issued its first treasury bills, and the USSR Bank of Industry and Construction introduced promissory notes, vekselya, opening a market in government debt.

In 1990, when the Russian government gave state-owned firms the right to sell over-contract production privately, networks of trading companies and commodity markets sprang up. The first of these was the Russian Commodity and Raw Materials Exchange, founded in 1990 by Konstantin Borovoi. Numerous stock and currency exchanges and brokerages were formed in 1991,



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