After a period of so-called transformation recession the Czech economy started to grow in 1994. In 1995 and 1996 real GDP growth was around five per cent. Almost all foreign and domestic experts expect GDP growth of between five and six per cent to last till the end of the decade. Both GDP and Total Factor Productivity growth indicate that the catch-up process in the Czech economy has started.

Investment has been, and is to remain, the most dynamic factor of economic growth in this country, being supported by a relatively high degree of domestic savings as well as by foreign capital inflows. An adverse effect of capital inflows and a high investment wave is the present trade deficit - a phenomenon which, however, is fairly typical for the initial phase of economic catch-up.

Another problem is inflation: despite the fact that inflation in the Czech economy has decreased to one-digit levels (being one of the lowest among Central and East European countries), cutting it below the present nine per cent level will be a very challenging task for economic policy. Bearing in mind rather robust GDP growth, one can hardly expect inflation to be under five/six per cent by 2000.

Among the typical features of the Czech economy are low unemployment and balanced public budgets. As far as unemployment is concerned, one can expect a slight increase from today's three per cent rate to 4.5 to five per cent in the next three or four years. At the same time, continuation of the policy of balanced budgets can be expected.

Within this framework, there is a realistic hope that today's rating of the Czech Republic - BAAl by Moody's, and A by Standard & Poor's - will gradually improve.

The Czech banking sector has undergone fundamental transformation, as has the whole economy. From now on commercial banks in the Czech Republic will be faced with 'standard' problems typical for banks in any market economy, rather than with specific problems of the start-up period. Czech banks are increasingly facing competition from foreign banks (especially in providing longer-term loans to Czech enterprises). They also face the challenge of extending their commercial activities to external financial markets - both in obtaining credits and issuing or placing bonds and equities.

Additional steps are still needed to bring the Czech banking sector closer to the international level by 2000. The banks' efforts will concentrate on bringing interest rates on loans down, and narrowing the interest spread. Here, success depends both on more efficiently run banks and on the speed of disinflation in the Czech Republic. Another challenge is to offer a complete array of services, to increase their quality and speed.

The main problem currently facing the Czech banking sector is the need for consolidation of some banks which either have a low degree of capital adequacy, or are burdened with too many risky loans.

This situation is the result of several factors:

• the fast Czech privatisation (both small and large-scale) was only possible with the massive participation of bank credit. Understandably, the risk of this operation was above the average, and resulted in bad loans in the banks' portfolios. By now, the home and foreign markets have in principle picked the 'winners and the losers' among Czech enterprises. After the initial stage of selection within the enterprise sector, it is now time to restructure the banking sector;

• banking activity in the newly emerged private sector remains risky. Due to the lack of longer-term bank client history, the degree of insecurity in credit activities is higher than in standard market economies. This calls for strict rules of risk management within the Czech banks - perhaps stricter than international standards;

• part of the bad loans is accounted for by bank staff's lack of experience, especially in newly established small banks;

• at the start, all Czech banks were strongly undercapitalised (with capital-adequacy ratio between one and three). The central bank set gradual targets, requiring all banks to reach the capital adequacy level at the end of 1996. At the same time, the central bank gradually raised the minimum basic capital requirement for establishing a new bank. All these steps were necessary, but could not fully prevent serious problems for some banks.

Last year - 1996 - was a consolidation year for Czech banking. Restructuring within the banking sector will clear it of inefficient and poorly equipped banks, increase the competitiveness of Czech banks and improve their efficiency reflected in the value added per employee.

In addition to credit activities, Czech banks will offer a wider range of services in the capital market. This still requires breaking the tendency of Czech firms to rely on credit, neglecting the opportunities for financing their strategic plans through the bond and equity markets. In this respect, Czech banks can, and will, learn from foreign investment banks, including possible mergers with foreign partners to cover this field of activity.

Among foreign specialists a frequent point of discussion is the widespread ownership of Czech firms by banks, or by investment funds established by banks. This is connected with discussion on whether the US or the German system of corporate governance is more appropriate for the Czech economy.

Clearly, introduction of the US system was impossible at the start when no capital market existed in practice. Moreover, some specialists argue that the 'German' model is more appropriate for at least the first ten to 15 years. Generally, the choice of the model has been left to the market, and at present some mixture of both models exists in the Czech economy. For the future, however, one should not forget that we exist in the context of continental Europe where the so-called German model prevails.

Finally, a remark concerning the relation between concentration and competition in the Czech banking sector. Increasing requirements on capital adequacy and stricter rules for entry into banking presently foster concentration tendencies in Czech banking. This trend will grow even stronger under the impact of increasing foreign competition. In general, the competitiveness of Czech banks will not primarily be determined by the number or size of banks, but by the degree of liberalisation of the banking sector. An association treaty with the EU requires a full opening-up of the Czech banking sector to EU competition by 2006. Czech banks are presently accelerating their efforts to be prepared for this situation.

Dr Richard Salzmann was appointed Vice-Chairman of the newly established Komercni banka and took the position of President of the Board and Chief Executive Officer in 1991. He is also a member of the Board of the Prague Stock Exchange