The Investors

This is most intriguing group. Normative, law abiding, businessmen, who stumbled across methods to secure excessive yields on their capital and are looking to borrow their way into increasing it. By cleverly participating in bond tenders, by devising ingenious option strategies, or by arbitraging - yields of up to 300% can be collected in immature markets of transition without normally associated risks. This sub-species can be found mainly in Russia and in Balkans.

Its members often buy sovereign bonds and notes at discounts of up to 80% of their face value. Russian obligations could be had for less in August 1998 and Macedonian ones during Kosovo crisis. In cahoots with issuing country's central bank, they then convert obligations to local currency at par (=for 100% of their face value). The difference makes, needless to add, for an immediate and hefty profit, yet it is in (often worthless and vicissitudinal) local currency. The latter is then hurriedly disposed of (at a discount) and sold to multinationals with operations in country of issue, which are in need of local tender. This fast becomes an almost addictive avocation.

Intoxicated by this pecuniary nectar, fortunate, those privy to secret, try to raise more capital by hunting for financial instruments they can convert to cash in Western banks. A bank guarantee, a promissory note, a confirmed letter of credit, a note or a bond guaranteed by Central Bank - all will do as deposited collateral against which a credit line is established and cash is drawn. The cash is then invested in a new cycle of inebriation to yield fantastic profits.

It is easy to identify these "investors". They eagerly seek financial instruments from almost any local bank, no matter how suspect. They offer to pay for these coveted documents (bank guarantees, bankers' acceptances, letters of credit) either in cash or by lending to bank's clients and this within a month or more from date of their issuance. They agree to "cancel" locally issued financial instruments by offering a "counter-financial-instrument" (safe keeping receipt, contra-guarantee, counter promissory note, etc.). This "counter-instrument" is issued by very Prime World or European Bank in which locally issued financial instruments are deposited as collateral.

The Investors invariably confidently claim that financial instrument issued by local bank will never be presented or used (which is true) and that this is a risk free transaction (which is not entirely so). If they are forced to lend to bank's clients, they often ignore quality of credit takers, yields, maturities and other considerations which normally tend to interest lenders very much.

Whether a financial instrument cancelled by another is still valid, presentable and should be honoured by its issuer is still debated. In some cases it is clearly so. If something goes horribly (and rarely, admittedly) wrong with these transactions - local bank stands to suffer, too.

It all boils down to a terrible hunger, kind of thirst that can be quelled only by denominated liquidity of lucre. In post nuclear landscape of this part of world, a fantasy is shared by both predators and prey. Circling each other in marble temples, they switch their roles in dizzying progression. Tycoons and politicians, industrialists and bureaucrats all vie for attention of Mammon. The shifting coalitions of well groomed man in back stabbed suits, an hallucinatory carousel of avarice and guile. But every circus folds and every luna park is destined to shut down. The dying music, frozen accounts of deceived, bankrupt banks, Jurassic Park of skeletal industrial beasts - a muted testimony to a wild age of mutual assured destruction and self deceit. The future of Eastern and South Europe. The present of Russia, Albania and Yugoslavia.

Sam Vaknin is the author of Malignant Self Love - Narcissism Revisited and After the Rain - How the West Lost the East. He is a columnist for Central Europe Review, United Press International (UPI) and eBookWeb and the editor of mental health and Central East Europe categories in The Open Directory and Suite101.

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Consider thorny issue of exchange rates. Financial statements are calculated (sometimes stated in USD in addition to local currency) using exchange rate prevailing on 31st of December of fiscal year (to which statements refer). In a country with a volatile domestic currency this would tend to completely distort true picture. This is especially true if a big chunk of activity preceded this arbitrary date. The same applies to financial statements, which were not inflation-adjusted in high inflation countries. The statements will look inflated and even reflect profits where heavy losses were incurred. "Average amounts" accounting (which makes use of average exchange rates throughout year) is even more misleading. The only way to truly reflect reality is if bank were to keep two sets of accounts: one in local currency and one in USD (or in some other currency of reference). Otherwise, fictitious growth in asset base (due to inflation or currency fluctuations) could result.

Another example: in many countries, changes in regulations can greatly effect financial statements of a bank. In 1996, in Russia, for example, Bank of Russia changed algorithm for calculating an important banking ratio (the capital to risk weighted assets ratio).

Unless a Russian bank restated its previous financial statements accordingly, a sharp change in profitability appeared from nowhere.

The net assets themselves are always misstated: figure refers to situation on 31/12. A 48-hour loan given to a collaborating client can inflate asset base on crucial date. This misrepresentation is only mildly ameliorated by introduction of an "average assets" calculus. Moreover, some of assets can be interest earning and performing – others, non-performing. The maturity distribution of assets is also of prime importance. If most of bank's assets can be withdrawn by its clients on a very short notice (on demand) – it can swiftly find itself in trouble with a run on its assets leading to insolvency.

Another oft-used figure is net income of bank. It is important to distinguish interest income from non-interest income. In an open, sophisticated credit market, income from interest differentials should be minimal and reflect risk plus a reasonable component of income to bank. But in many countries (Japan, Russia) government subsidizes banks by lending to them money cheaply (through Central Bank or through bonds). The banks then proceed to lend cheap funds at exorbitant rates to their customers, thus reaping enormous interest income. In many countries income from government securities is tax free, which represents another form of subsidy. A high income from interest is a sign of weakness, not of health, here today, gone tomorrow. The preferred indicator should be income from operations (fees, commissions and other charges).

There are a few key ratios to observe. A relevant question is whether bank is accredited with international banking agencies. These issue regulatory capital requirements and other mandatory ratios. Compliance with these demands is a minimum in absence of which, bank should be regarded as positively dangerous.

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Sam Vaknin is the author of Malignant Self Love - Narcissism Revisited and After the Rain - How the West Lost the East. He is a columnist for Central Europe Review, United Press International (UPI) and eBookWeb and the editor of mental health and Central East Europe categories in The Open Directory and Suite101.

Web site: