Small-business development in Russia is a priority for the European Bank for Reconstruction and Development, set up in 1991 to speed the transition to market economies in Central and Eastern Europe and the former Soviet Union.

But the process is being constrained by Russia's weak banking infrastructure, according to a key EBRD official.

The EBRD Russia Small Business Fund was launched with $300 million, funded equally by the bank and the Group of Seven industrialized nations. A small-business financing program has always been viewed as a key objective, according to Elizabeth Wallace, EBRD's director for financial institutions and the fund's team leader. Developing this sector was "the only way to build a market economy, a democratic society," she said.

Sufficient funding is available to do the job, Wallace said. The "constraint is institutional," and Russian banks lack the capacity and the efficiency to handle the loans. When the financial crisis struck, many nationwide banks became insolvent - a tremendous problem, she said. "We could no longer work through most of them."

The fund's outstanding investment portfolio - loans due for repayment - now stands at about $70 million, with around 30,000 loans issued since the fund was launched in 1994, Wallace said. And full take-up of available finance would probably generate "several hundred million dollars more" for the program, she said.

But the Russian banking environment makes it hard to reach the targets, Wallace said. Some banks the EBRD was working with have closed or come under external management during bankruptcy proceedings, complicating matters further.

Before the crisis, the fund was working with five nationwide banks, Sberbank, Rossisky Kredit, Inkombank, Mosbusinessbank and SBS-Agro. Several regional banks -Rosestbank in Togliatti, NBD in Nizhni Novgorod, Far East Bank in Vladivostok, and Petrovsky in St. Petersburg, also took part in the program. Of the nationwide banks, only Sberbank has escaped bankruptcy or restructuring procedures, and in the regions, Rosestbank was declared bankrupt.

This meant the EBRD had to take over the portfolios of loans made under the program by several Russian banks, Wallace said, some of these as early as September and October 1998. "And others we have taken over time as banks started to fail or as they stopped using the repayments from clients with the clients."

The outstanding $13 million portfolios of three big banks - Rossisky Kredit, Inkombank and Mosbusinessbank - along with those of Rosestbank, went to the Russian Project Finance Bank (RPFB). The bank, in which EBRD holds a stake, had been working as a consultant on EBRD's bigger investment projects in Russia. Now, RPFB, Sberbank and a limited number of regional banks will be the main channel for reaching small businesses in the regions, Wallace said. Since February, when RPFB started working on the program, loans worth $7.4 million have been made to small businesses.

"Before the crisis, we had already been thinking about starting our own bank," Wallace said. "While many of the Russian partner banks were doing very well, disbursing many hundreds of loans per month to small businesses, we still thought they could do better.

"When the crisis came, it [creating a bank] became an imminent imperative," she went on. "We decided, 'Let's start our own bank - it will be a stable institution; it will be transparent with good corporate governance, which means it would be honest, unlike many other banks in Russia.' We ended up with the most expedient [option] of taking over the Russian Project Finance Bank, the bank that was controlled by EBRD anyway."

New Russian banks will become involved in the EBRD program, Wallace said, but only those committed to the program. "When we add a new bank, we are going to be quite careful: Are they really going to be committed to the target group, and do we think that the bank is transparent." she said.

The number of new loans disbursed by the fund has decreased dramatically - to 56 in September 1998 from 1,200 the month before. Now, it has increased again, to about 700 a month and the EBRD hopes to reach the 1,000 level by the end of the year.

Late payments on program loans have increased since mid-1998, Wallace said.

Based on data produced by banks that are "still operating," arrears on "micro" loans, those up to $20,000 and denominated in rubles, increased from around 1 percent before the crisis to 3.5 percent currently. Late payments on "small" loans, up to $125,000 and denominated in dollars, increased from 2.8 percent pre-crisis to 9 percent now.

Current figures show the EBRD commits $2.56 billion - about 23.7 percent of its total investment - to projects in Russia.