Plastic Money: Constructing Markets for Credit Cards in Eight Postcommunist Countries 9780804789592

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plastic money

a k o s r o n a - t a s a n d a lya g u s e va

Plastic Money Constructing Markets for Credit Cards in Eight Postcommunist Countries

stanford university press stanford, california

Stanford University Press Stanford, California ©2014 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying and recording, or in any information storage or retrieval system without the prior written permission of Stanford University Press. Printed in the United States of America on acid-free, archival-quality paper Library of Congress Cataloging-in-Publication Data

Rona-Tas, Akos, author. Plastic money : constructing markets for credit cards in eight postcommunist countries / Akos Rona-Tas and Alya Guseva. pages cm Includes bibliographical references and index. isbn 978-0-8047-6857-3 (cloth : alk. paper)-isbn 978-0-8047-6858-0 (pbk. : alk. paper) 1. Credit cards--Former communist countries. 2. Consumer credit--Former communist countries. 3. Post-communism--Economic aspects. I. Guseva, Alya, 1974- author. II. Title. hg3755.7.r66 2014 332.7'65091717--dc23 2013042646 isbn 978-0-8047-8959-2 (electronic) Typeset by Bruce Lundquist in 10 /14 Janson

For Judit and Adam A. R-T. For Alexey, Dasha and Artyom A. G.

Contents

Figures and Tables

ix

Preface and Acknowledgments

xiii

List of Acronyms

xix

1. Paying with Cards

1

2. The Transition from a Communist to a Market Economy

25

3. Payment Puzzles

53

4. Credit Puzzles

75

5. The Construction of Card Markets in Hungary, Poland and the Czech Republic

97

6. Russia, Ukraine and Bulgaria

151

7. Vietnam and China

203

8. Conclusion

231

Appendix 1: Data and Methodology

251

Appendix 2: Concentration in Banking Over Time

255

Notes

267

References

293

Index

311

Figures and Tables

figures

1.1 Number of Cards per Capita, 1998–2010

18

1.2 Percentage of Credit, Debit and Charge (Where Applicable) Cards Issued, 2007

18

1.3 Card Purchase Volume as Percentage of Total Card Volume (Including Cash Withdrawals), 1998–2009

20

1.4 Volume of Card Purchases in Total Consumer Payments, 1998–2009

20

2.1 Average Number of Banks in Each Country Between 1990 and 2011 (Logarithmic Scale)

35

2.2 GDP per Capita in the Eight Countries 1988–2010 at Constant 2000 USD

43

2.3 Percentage of Total Income Share Held by the Richest 20 Percent in the Late 1980s and the Second Half of the 1990s

44

2.4 Household Consumption per Capita 1988–2011 at Constant 2000 USD

45

2.5 Rate of Official Unemployment 1992–2010 (Percentage of Total Work Force)

46

2.6a Inflation in China, the Czech Republic, Hungary and Poland (GDP Deflator)

48

2.6b Inflation in Bulgaria, Russia, Ukraine and Vietnam (GDP Deflator)

48

ix

x

figures and tables

A2.1a Concentration of Banking Assets in the Czech Republic in 1995

256

A2.1b Concentration of Banking Assets in the Czech Republic in 2003 (Top Banks Named)

256

A2.1c Concentration of Banking Assets in the Czech Republic in 2011 (Top Banks Named)

257

A2.2a Concentration of Banking Assets in Hungary in 1994 (Top Banks Named)

257

A2.2b Concentration of Banking Assets in Hungary in 2003 (Top Banks Named)

258

A2.2c Concentration of Banking Assets in Hungary in 2011 (Top Banks Named)

258

A2.3a Concentration of Banking Assets in Poland in 1995 (Top Banks Named)

259

A2.3b Concentration of Banking Assets in Poland in 2003 (Top Banks Named)

259

A2.3c Concentration of Banking Assets in Poland in 2011 (Top Banks Named)

260

A2.4a Concentration of Banking Assets in Bulgaria in October 1996 (Top Banks Named)

260

A2.4b Concentration of Banking Assets in Bulgaria in 2003 (Top Banks Named)

261

A2.4c Concentration of Banking Assets in Bulgaria in 2011 (Top Banks Named)

261

A2.5a Concentration of Banking Assets in Russia in 1995

262

A2.5b Concentration of Banking Assets in Russia in 2003 (Top Banks Named)

262

A2.5c Concentration of Banking Assets in Russia in 2011 (Top Banks Named)

263

A2.6a Concentration of Banking Assets in Ukraine in 1995

263

A2.6b Concentration of Banking Assets in Ukraine in 2003 (Top Banks Named)

264

A2.6c Concentration of Banking Assets in Ukraine in 2011 (Top Banks Named)

264

figures and tables

xi

A2.7a Concentration of Banking Assets in China in 1995

265

A2.7b Concentration of Banking Assets in China in 2003

265

A2.8a Concentration of Banking Assets in Vietnam in 1995

266

A2.8b Concentration of Banking Assets in Vietnam at the End of 2008 (Top Banks Named)

266

table

A1.1 List of Interviews and Field Data

252

Preface and Acknowledgments

In an often told joke, a physicist, a chemist and an economist wreck their sailboat and find themselves on a desert island. The only food they could rescue is a case of canned beans. As their hunger grows, they consider various options for how to get the beans out of the can. The physicist proposes dropping a rock from a tree to crack the can, but the others think this would be too messy. The chemist suggests using salt water to get the can rusted enough to open it, but the others demur that this would take too long. Now it is the turn of the economist, who says with a smile, “It’s simple: let’s ­assume we have a can opener.” This book is about the can opener. All products are like beans in a can; they need to be made accessible and drawn into the world of economic exchange. To unlock a product, a market needs to be built. The market is the can opener that delivers beans, bread, cars, shoe repair, phone service, electricity and government bonds. Each market is different and has its own quirks, glitches and miracles. But just as making a can opener is different from using it once we have one, making markets is poles apart from using them once they are up and running. More than two decades ago, the largest attempt in history to build markets began in the postcommunist world. Both of us grew up under communist rule and experienced firsthand the abysmal ways of an overcentralized economy, and we looked on with great interest as the transition from a socialist to a market economy took shape. A slew of highly paid advisers, mostly economists, came to explain to befuddled local policymakers how to run a market. One of us sat on a Fulbright panel that sent scores of somewhat less highly paid experts to teach basic economics in fledgling business xiii

xiv

preface and acknowledgments

schools in East and Central Europe. These U.S. economists were on a mission to proselytize about the marvels of the market. They were explaining to hungry locals how to prepare and consume the beans once the cans were open. That the cans were sealed soon became obvious, but there was a deep conviction that cooking and eating right would somehow open the cans. They did not. Worse yet, knowledge of food preparation and consumption said little about how to make can openers. This book is about how markets become possible, and it follows the construction of a particular market in the financial service industry: the market for payment cards. Credit and debit cards are all too familiar to everyone in the developed world. They were novelty items in the postcommunist world in 1990, after the fall of the Berlin Wall, and remained rare for many years. By the second decade of this millennium, however, they are quite common in the eight countries we researched, although the careers of plastic money took many twists and turns and resulted in markets that vary among these countries. We observed these processes in three Central European (the Czech Republic, Hungary and Poland), three East European (Bulgaria, Russia and Ukraine) and two Asian (China and Vietnam) postcommunist countries, travelling to each one multiple times, interviewing the main players and gathering corporate documents, industry publications, and secondary literature over several years. Our research was sponsored primarily by a multi­year grant from the U.S. National Science Foundation (­­#SES-0242076) and smaller grants from Hungary and the Czech Republic, the University of California, Boston University and Lewis and Clark College. Just as can openers fade into the background once the cans are opened and the cooking has started, the multiyear process of research and writing that results in a book becomes invisible once the manuscript is completed, enters the publisher’s production process, and begins its new life in public. Researching and writing a book is a social process; it is embedded in personal relationships. Writing a book that presents two decades of recent history in eight countries is impossible without a lot of help. Acknowledgments allow readers a small peek into this generative process by giving credit to the many people who, although they do not appear as authors on the cover, contributed to the book in some important way. Of course any mistakes or shortcomings that remain are ours and ours alone. In China we were aided by Tamara Perkins, whose knowledge of Chinese culture, language skills, connections and research were indispensable in the

preface and acknowledgments

xv

early phase of our enterprise. In Bulgaria we had the good fortune to enlist Kristina Karagyozova, then a doctoral student writing a dissertation on Bulgarian banking at the Central European University, in Budapest. A native of Bulgaria, Kristina returned to Sofia to work for the Central Bank. In Russia, Olga Kuzina of Higher School of Economics in Moscow, an utmost expert on the financial literacy of Russians, wholeheartedly threw herself into the project, mobilizing her own networks to access potential interviewees and conducting several of the interviews herself. Early in the project, Olga introduced both of us to Dilyara Ibragimova, another Russian sociologist with expertise in financial behavior, who provided us with useful consumer survey data. Tamara, Kristina and Olga wrote excellent detailed reports on their respective countries that greatly aided our writing of the comparative chapters. We greatly benefited from the friendship of Iván Major who joined us at several interviews. His research on information economics aided us in developing ideas on information sharing. We would have been lost in Vietnam if not for Tuan Minh Pham. Tuan, a professor at Hanoi University of Technology and owner of a model management agency and a software academy, wrote the first report on the Vietnamese card market for McKinsey Consulting as a fresh MBA from New York University. He not only speaks impeccable English but is fluent also in Hungarian, and he is part of a group of experts trained in Hungary. One of the surprises of our project was that we were occasionally able to conduct interviews in Hanoi and Ho Chi Minh City in Hungarian. It was our colleague Ewa Gucwa-Leśny who introduced us to Polish banks. Ewa’s work in behavioral economics stimulated many discussions about lending. In the Czech Republic, Lubomír Lízal, director of the Economics Institute of the Center for Economic Research and Graduate Education (CERGE), lent us support and helped us better understand banking in his country. Special thanks are due to Tom Layman of Global Visions, one of the foremost authorities on credit cards and former chief economist at Visa Inter­ national; and Zsuzsanna Haraszti, one of the great card pioneers in Hungary. We are indebted to Jens Beckert, who gave us many comments over the years and whose theoretical work served as one inspiration for us. He also graciously hosted Rona-Tas several times at the Max Planck Institute in C ­ ologne, one of the best places to think about economic sociology. We are also grateful to Joel Sobel, who spent much more time than he ever wanted putting some of our vague ideas on information sharing through the rigorous and clarifying

xvi

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exercise of game-theoretic modeling. It is entirely our fault and not his that this book does not provide an elegant formal model of why rational banks have difficulty sharing information in concentrated markets. Numerous people in each of the countries helped us make the most of our research stay by facilitating our access to key informants, inviting us to give talks or helping us with accommodations. The list is long: in Russia, Pavel Ivanov, Vladimir Shavanichev, Valery Shipilov, Pavel Stromsky and Valery Torkhov; in Ukraine, Oleh Kaptar, Olga Torubara, Nelya Uss and Marina Yarovaya; in the Czech Republic, Roman Horvath and Milan Zátka; in ­Poland, Marcin Grodzicki and Marek Brejnak; in Bulgaria, Tanya C ­ havdarova, Boriana Dimitrova, Georgi Dimitrov and Roumen Avramov; in Hungary, Éva KeszyHarmath, Júlia Király, Beáta Májer, Mária Móra and Tamás Tóth, in China, Julius Song, Li Tie, Darwin Tu and Tiger Zhou; and in Vietnam, Nguyen Quang A and Greig Craft. We must thank UC, San Diego and Boston University graduate students Atanas Grozdev, Kevin Moseby, Yoshitaka Nagai, Lisa Nunn, David Pinzur and Martha Poon for their excellent research assistance, and Rebecca Farber for preparing the index. We also got valuable help from Alex Sowerby and Stuart Clayton of the Central Europe, Middle East and Africa (CEMEA) Department of Visa International, from Euromonitor International, from David Evans of PYMNTS.com, and from the Institute of Finance and Banking of the Chinese Academy of Social Sciences. We are fortunate to have received encouragement and intellectual sustenance from many colleagues, including Michel Anteby, Nina Bandelj, László Bruszt, Bruce Carruthers, Emilio Castilla, Paul DiMaggio, Roberto Fernandez, Jeff Haydu, Michael Hechter, Stefanie Hiss, Balázs Krémer, Imre Kondor, Mihály Laki, Martha Lampland, György Lengyel, Mark Machina, Ronald Mann, Gerry McDermott, Ashley Mears, Victor Nee, Victor PérezDíaz, Katharina Pistor, Woody Powell, Vadim Radaev, James Rauch, Marc Schneiberg, Richard Swedberg, Balázs Vedres, Valery Yakubovich, Ezra Zuckerman and two anonymous reviewers of the manuscript. There are also three colleagues whose extraordinary patience with us deserves special mention: Stefanie Hiss, who works with Rona-Tas on a related but separate project; Sandrine Blanchemanche, his partner in an entirely different research endeavor; and Dilyara Ibragimova, who has teamed up with Guseva on yet another collaboration. They had to suffer numerous delays because our obsessive focus on finishing this book, especially in its later stages, temporarily pushed our other lines of research aside.

preface and acknowledgments

xvii

Many friends also took interest in our project and were willing to discuss ideas or share their experiences, including Zsófia Bán, Alina Bilyk, József Böröcz, Bogdan and Marina Budnik, Mariann Csáky, János Darvas, Andrea Deák, Ágnes Deák, Juan Diez Medrano, Rachel Falik, György Geréby, Vladimir Gusyev, Róza Hodosán, András Bálint Kovács, Masha and Matt Kuntz, László Márton, Ferenc Moksony, Katalin Orbán, András Róna-Tas, Ágnes Róna-Tas, Julia Sirotina, Kata Steinberger, Anna Szemere, István Szent-Iványi, Éva Veres and Gergely Zimányi. We thank Sandy Dijkstra for advice on the title and the cover. The book owes everything to a team of professionals at Stanford, including our production editor, Mariana Raykov, and our copy editor, Alice Morrow Rowan. Our special heartfelt thanks go to our sponsoring editor at Stanford, Margo Beth Fleming, whose trust in our project, forbearance and gentle coaxing and cajoling along the way finally brought it to completion. Thank you, Margo, for bearing with us for that long. Last but not least, we want to thank our families for their unwavering support of the project, which spanned a decade, and for providing much needed distraction along the way. It is to them that this book is dedicated.

List of Acronyms

ABC  Agricultural Bank of China ACB  Asia Commercial Bank ACB  Associated Credit Bureaus, Inc. AmEx  American Express ATM  automated teller machine BIDV  Bank of Investment and Development Vietnam BIK  Biuro Informacji Kredytowej S.A. BNB  Bulgarian National Bank BoC  Bank of China BZ WBK  Bank Zachodni Wielkopolski Bank Kredytowy S.A. CBA  Czech Bankcard Association CCB  Czech Credit Bureau a.s. CCB  China Construction Bank CCR  Central Credit Registry (Bulgaria) CDMA  Code Division Multiple Access CEE  Central and East Europe CEMEA  Central Europe, Middle East and Africa CIC  Credit Information Center (Vietnam)

ČS  Česká spořitelna ČSOB  Československá obchodní banka CUP  China UnionPay Company DSK  Darzhavna spestovna kasa EMA  Ukranian Interbank Payment Systems Member Association “EMA” xix

xx

acronyms

EMV  Europay, MasterCard and Visa (global standard for chip cards) EPC  European Payment Council EU  European Union GBC  GIRO BankCard GDP  gross domestic product GSM  Global System for Mobile Communication ICBC  Industrial and Commercial Bank of China IFC  International Finance Corporation IMF  International Monetary Fund IPB Investiční a poštovní banka IT  information technology JCB  Japan Credit Bureau (credit card company) K&H  Kereskedelmi & Hitelbank MKB  Magyar Kereskedelmi Bank NBCH  National Bureau of Credit Histories NSMEP  National System of Mass Electronic Payments OECD  Organisation for Economic Co-operation and Development OTP  Országos Takarékpénztár PBC  People’s Bank of China PBC CRC  People’s Bank of China Credit Reference Center PKO  Powszechna Kasa Oszczȩdności POS  Point of Sale (machines) RUR  Russian ruble RWKB  Rada Wydawców Kart Bankowych (Bank Card Issuers Board, Poland) SBV  State Bank of Vietnam (Central Bank) SCF  SEPA Card Framework SDD  SEPA direct debit SEPA  Single Euro Payments Area SOCB  State-owned commercial banks UAH  Ukrainian hryvnia VBCA  Vietnam Bank Card Association

plastic money

one

Paying with Cards

Enter a store in the United States. Any store. You will find logos on the products sold in the store. Some logos will be familiar and others will not. The brands will be appropriate to the store: you will find a Nike swoosh in a shoe store but not in a bookshop, and the Kellogg tiger will beckon to you in a grocery but not in a hardware store. There are, however, two logos that will show up in all of these outlets. One will be a four-letter word written in blue italics on a white background, the first letter sporting an orange splash: VISA. The other will feature a Venn diagram of two overlapping circles— one fire-truck red, the other mustard yellow—across which is written, as you might have guessed by now, a compound word with an uppercase C in the middle: MasterCard. Now go to a foreign country. Any country. You will find the same two logos almost everywhere, from Shanghai to St. Petersburg, Sofia, Szczecin, and Székesfehérvár. The further you stray from the beaten path of globalization, the fewer of these two logos you will encounter, but you will be sur1

2

chapter one

prised to find them occasionally even in small, rural villages in the poorest regions of the world. Though far from everyone in countries like Hungary or Ukraine will use those two logos, almost everyone will recognize them. Today, Visa and MasterCard, together with smaller brands such as ­Diners Club, American Express and Discover, stand with Coke, Mc­Donald’s, Micro­soft and others as universally recognized brands. Credit cards are the epitome and a protagonist of globalization. As a new form of payment, they embody the effortless and instantaneous flow of money, in the form of information, from anywhere to anywhere else in the world. Cards tear down national boundaries by allowing travelers to pay easily, without the burden of having to carry wads of cash and to exchange one kind of currency for another. Today, traveling without a credit card turns simple transactions such as plane and hotel reservations into unduly cumbersome chores. Cards also make long-distance purchases possible. Without cards, the Internet, the most global of institutions, would never have been able to turn into a global retail marketplace. The global nature of commerce demanded a global payment system, and the large credit card companies built their own worldwide web of authorization and processing, linking souvenir shops and banks all over the world. It is not just Western cardholders whose convenience is served by the way the credit card weaves the world into a global bazaar. Lives in the rest of the world are also profoundly affected. Globalization expands the reach of credit card markets to the less affluent parts of the world, to places where those markets had not existed earlier—in the process transforming local populations into card-carrying consumers. In this book, we trace the course of this transformation and the paths that emerging card markets carved in Bulgaria, China, the Czech Republic, Hungary, Poland, Russia, Ukraine and Vietnam. Our story is not, however, a straightforward account of globalization. We demonstrate that despite the overwhelming similarities around the world in the appearance of credit cards (small rectangular pieces of plastic proportioned according to the golden ratio,1 with a magnetic stripe on the back exactly 0.223 inches from the upper edge, and sometimes a small embedded computer chip), and despite the undeniable ambitions of multi­ national card companies to present cards as a standard, “McDonaldized” product, postcommunist card markets neither developed according to a single “Western” blueprint nor proceeded in identical “postcommunist” ways in all of the eight countries.

paying with cards

3

Credit Card’s Dual Role: Both Payment Mechanism and Instrument of Credit The credit card stands at the intersection of two momentous changes in the world economy. As a means of payment, the card is replacing cash as well as checks (where they previously existed) with a piece of plastic and the digital flow of information. The most recent step in a long historical progression from beads and shells to gold coins and paper money, the payment card makes the link between value and its material vessel even more attenuated.2 At the same time, the credit card is also an instrument of accessing consumer credit. As such, it allows people to use money they do not yet have to buy goods now and pay for them later, and it is a major force in the rapid expansion of consumer credit and consumer culture. Thus, to understand credit card markets, we must recognize that the credit card is not one but a combination of two products: the payment card and the consumer loan. As a means of payment, the credit card helps displace cash from dayto-day expenditures, making payments more convenient, transparent and traceable. As an instrument of credit, the card provides access to small-scale renewable loans, enabling cardholders to enjoy purchases they would not otherwise be able to afford. Historically, the two products were seamlessly fused into one in the form of a piece of plastic that fueled the twentieth-­ century credit card revolution in the United States. Conceptually, they are different, however. Credit can exist without cards: in the United States, retail credit has been around for much longer than cards, and examples abound of economies where installment purchases, home mortgages and personal loans flourish but no cards exist, with payments being made exclusively in cash or by check. Cards can also exist without credit: when a debit card is used, the money is immediately deducted from one’s bank account, and the issuers of pre-paid cards do not extend any credit to cardholders; the card serves only as an instrument of payment. In fact, as we show, the majority of the Visas and MasterCards in circulation in transitional countries are debit cards, so cards extend little or no credit to customers in these countries. Each of the two products that the credit card represents—a personal loan and a payment tool—offers its own set of puzzles. For instance, as a means of payment issued to individual holders and used in a variety of retail locations, the credit card has to be peddled simultaneously to consumers and merchants, giving rise to the chicken-and-egg problem (or as we call it, the

4

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two-sided market problem). As an instrument of borrowing, the credit card necessitates solving another problem: the card issuers’ uncertainty regarding the future repayment of the loan.

Market Creation Versus Market Operation: Generative and Functional Rules Today in the developed world, the payment card is a natural part of everyday life. We take it for granted. It works effortlessly, quickly, conveniently and innocuously. It can fulfill its functions precisely because it appears ordinary, reasonable and almost inevitable. When we pull out this piece of plastic, we know what to expect. When a cashier or waiter takes our card, they know what comes next. When a bank gives us a card, it can be fairly certain what we will do with it. Things can go wrong, such as when a card is declined at the point of sale, or stolen and used fraudulently, running up a huge tab in several countries within days. But we expect these mishaps to be the exception and develop routines to deal with them. To appear natural, markets such as the ones that allow us to pay using plastic cards instead of coins or banknotes must have an explanation that captures the way the market works. For instance, if we ask people why they use payment cards instead of cash or checks, we may be told that it is a more convenient way to purchase things. This explanation makes sense, but it would be the right one only under several conditions. Paying with cards should not be much more costly than using cash, and card use should be secure enough to defend the cardholder from fraud. Another condition is that the electronic record of card transactions may not be used against the cardholder later, say, by the tax authorities. Still another condition is that there must be enough shops where the card is accepted so that it is worthwhile to carry the card around. And the list goes on. Generating the conditions under which this simple explanation makes sense is what we refer to as market creation. Creating a market means constructing circumstances that allow people to conduct business by voluntarily following rational functional rules.3 We call the principles that describe market creation generative rules. The discipline of economics is interested in the rational, functional rules that drive the behavior of market actors. These rules reproduce markets, but they only work within the margins set

paying with cards

5

by ­generative rules. Economists focus particularly on one set of powerful functional rules: those based on self-interested competition that is driven by price signals and rational calculation. As economists move away from generalized notions of the market and toward particular markets, they build more complex functional models to capture the specific features of those markets. Reproducing a market is not the same as creating it anew, just as building roads follows a different logic than driving on them. The first logic involves the tricks of moving earth, laying concrete, mixing asphalt, painting center lines and surface markings, cutting troughs for rumble strips and gluing down Botts’ dots. The second logic involves the rules of traffic and some ­basic knowledge of how to operate vehicles. Once the road is built, the generative rules fade into existing circumstances and the functional rules take over. The road will still need maintenance—the filling of potholes, the repainting of markings—but we would not be able to drive from San Diego to Boston if we had to consider each and every engineering feat, past or present, that made our journey possible. This is why getting a driver’s license does not include a test on road construction. Traditional economics dispenses with this distinction between generative and functional rules, in two ways. First, it assumes that the circumstances that serve as preconditions of markets are so general and universal that they do not merit separate study. Any surface can serve as a highway: a rocky mountainside, a sandy beach and a snow-covered tundra can all be driven on; drivers just need to make some minor adjustments. Whether one is driving on rock, sand or snow, there is traction, albeit to varying degrees. The fact that people are rational optimizers who act independently on the best information available under some very general constraints, such as scarcity of resources and available technology, will be sufficient to account for the existence of any market. Constraints, like slippery roads, will be accommodated. Second, economists may acknowledge that conditions can vary considerably, and some necessary conditions may be absent or certain adverse conditions may be present, but they posit that evolutionary forces will propel circumstances to align with rational functional rules.4 The traffic will create its own pathway and will maintain it. Its needs will force the existence of proper roads. If this is true, we can always explain road design by understanding the needs of traffic. We can account for the final characteristics of the road by keeping in mind that the engineers wanted the traffic to flow

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properly. It is not just that we can provide an explanation ex post, but we can also confidently predict ex ante that the right circumstances will materialize. If markets work by people competitively reacting to price signals, then markets will emerge as people competitively respond to shifting price signals.5 In the first instance, generative rules are irrelevant; in the second, they can simply be deduced from functional rules.6 In the road example, the separation between generative and functional rules is clear. Road construction and driving are two different activities, done by different people with different credentials, at different times. In markets, this distinction is more blurred. The same actors who lay the foundations of the card market—card-issuing banks and credit card companies—are the ones who “drive” in that market (together with merchants and cardholders). The building of markets and the operating of markets are harder to separate, and markets are often constructed on the go. If markets create the conditions of their own operation, which amounts to building roads by driving, there is no need for outside intervention. Deregulation, the removal of outside interference, is the most we can do. As we show in this book, card markets do not spring up simply as a result of banks issuing cards to consumers; instead they require a lot of concerted market-building effort on the part of banks and the state, as well as multinational corporations and institutions. There are stable markets in which the conditions are, at least for a time, relatively settled. To understand what happens in these markets, the researcher can fall back on functional rules. One can often create a rational model, beginning with laying out the market’s assumptions, inevitably followed by making some additional ones along the way, and proceeding to produce an explanation of high logical consistency. The rationalization of a market serves multiple purposes. It provides a simplified model of how it works and sometimes even allows for limited prediction. It advises actors how to behave, and makes the market legitimate by demonstrating that it functions in a reasonable and optimal manner given the circumstances. Moreover, a rational theory itself contributes to the stability of a market by providing a common language and understanding of how things ought to work. Because of their emphasis on analytic clarity and consistency, rational theories are often quite effective in coordinating people from different cultures and cognitive worlds. By justifying markets, rational theories also protect them from destabilizing moral or political criticism. But markets are rarely as frozen

paying with cards

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as economic theories portray them. When conditions shift or entirely new markets emerge, the researcher needs to look for generative rules. Besides, entrepreneurs who engage in innovation must also consider generative rules because entrepreneurship often revamps old markets or gives birth to new ones, setting up new conditions and requiring new assumptions. Our distinction between market creation and operation, between generative and functional rules, is not new at all. This contrast is recognized by both economists and sociologists. The incongruity of generative rules and functional rules will appear to economists as market failure. One of the key functional rules of the market is that the price signal drives supply and demand. One way economists understand market failure is that the price fails to include all important existing information about the product or service. Externalities are the costs and benefits that price does not capture.7 An example of possible market failure is food safety.8 Restaurants that cook under unsanitary conditions may save money by doing so and thus outcompete clean restaurants on cost, but only if they do not have to pay for the discomfort and sickness of their customers. Yet unclean cooking not only damages the cook’s reputation but also dampens people’s overall enthusiasm for eating out and thus harms all other restaurants. For this market to work properly, food safety regulations and inspections must be in place; these conditions, which are not generated by the rules of price-guided, self-­interested competition, may make the market flourish once they are installed. Then a story of rational market competition, assuming working food safety regulations and inspections, can be constructed. As long as the food safety problem is solved, these functional rules can have predictive power. Sociologists are even more aware than economists that generative rules are not necessarily those that can describe the operation of a rational market. One of the central ideas of economic sociology is that markets are embedded—that they depend on a series of social arrangements unacknowledged by economists.9 This idea can be recast as the realization that the conditions of rational economic action are generated by a different set of logics. When we argue that economic transactions are embedded in social ties or institutions or cultural understandings, we essentially argue that the circumstances that make economies function are generated outside the transaction, that functional and generative rules are different. For instance, the classic example of Orthodox Jewish diamond traders in New York observes that the selling and buying of expensive gems require trust among the traders.10 This

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condition, however, is not produced by the functional logic of the trans­ action that strives for maximum profit and thus abets opportunistic behavior. The trust is generated by a separate logic, that of the religious community with its power of socialization and sanctions. Yet once the puzzle of trust is solved—thanks to religion—a rational story of supply and demand, profit maximization, and so forth can arise. All economic sociologists agree that the market is socially constructed,11 but when they go about demonstrating how markets depend on their ­social context, they often engage in an interpretative exercise to show how different elements of an already existing rational market are linked to the social world. This linkage is then offered as evidence that the social world does something to markets that allows them to operate: Orthodox Judaism makes the diamond trade possible, or health inspections are necessary for a restaurant business to exist. Skeptical economists, however, may point out that the causation may run in the opposite direction. It is not, they may say, that trust makes the diamond trade possible but that the trade gives people a strong incentive to be trustworthy. Religion is just an incidental form that trust takes. Precious stones are traded by people other than Orthodox Jews and even by people with no religion whatsoever. By the same token, they could argue that health regulation in the restaurant industry is unnecessary as long as eateries can be sanctioned after the fact to deter unclean cooking. Proper standards of hygiene can and will be achieved one way or another. The social conditions of the market are produced by the overriding logic of supply, demand, price and rationality. We contend that these questions can be answered only if we take a historical, comparative approach, to see how things have unfolded in time, what came first and what came later, and to observe various ways in which markets have emerged or failed to do so.

Social Order Markets are a particular way of coordinating economic exchange. Building a market means building this particular form of coordination.12 There are alternative ways of organizing economic exchange, including centralized redistribution, a form of which was the centrally planned economy under communism, and reciprocity, the kind often found within families or

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close-knit communities.13 A market is characterized by the competition of self-interested, rational actors guided by price signals. Generating the preconditions of a market makes it possible for self-interested, rational actors to profit through price competition.14 Coordination of economic exchange is crucial. Coordination stabilizes expectations; without it, we cannot guess what others in the market may do and therefore cannot know what we should do. Coordination—market or any other type—lifts us from an unmanageable state of uncertainty, gives us a sense of familiarity and normalcy and allows us to act strategically. As a supplier in a market, we need to know what to expect, to predict how other suppliers and customers will react when we set out to make the product, when we deliver it, when we lower or raise prices, when we change our product, and so on. A restaurant needs to know if it will be able to get the ingredients for its cooking, whether customers will come and like the food, how much it should charge for a meal, and with which other restaurants it competes. The expectations may turn out to be wrong: ingredients may be unavailable, the cook may be a disaster, customers may not come, and so on. The important thing is not that expectations prove to be correct but that one feels able to have reasonable expectations. The first step in creating a market is to have a cast of characters. In some markets, the barriers to entry are low and the eligibility requirements are minimal. Anyone can set up a lemonade stand on the street, but not a restaurant or a diamond business. The latter two require licenses. Designating who can issue payment cards is a much more restrictive process. A legal or regulatory decision must be made about what type of organization can issue cards. Can a gas station issue a payment card intended to be used for purchases at other establishments? Can a phone company do that and collect payments with its monthly bill? Can an insurance company start a card service? Or can only banks issue cards? In South Korea and in Chile, most cards are offered by commercial firms, not deposit-taking financial institutions (we call the latter banks). In the countries we discuss in this book, with the exception of Bulgaria and the Czech Republic, only banks can issue credit cards, and even in Bulgaria and the Czech Republic banks play the dominant role.15 One of the innovations of new European Union rules is to open up payment card markets to new players, including mobile network operators.16 There are also restrictions on who can be a customer, although these are less stringent. Although banks can have their own rules for excluding certain

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groups of people from the pool of potential customers, by law they generally cannot issue cards to those who are under eighteen, to those who are without legal residency in the country, or to people who are mentally disabled, incarcerated, and so on. Before actors on both sides of the exchange are well-defined, there can be no market. Markets also cannot exist without establishing the value of their products or services. Without recognition of that value on the part of buyers, there could be no demand. Convincing prospective consumers of the value of what the market is selling is appropriately called marketing. Print, television and Internet advertisements are the most visible forms of generating demand today. Sometimes this is simple, such as when there is pent-up demand for a product; other times it takes a lot of work. Sellers must also teach customers how to tell the difference between two different offers and then how to use the product once it has been purchased. As we show in this book, establishing the value of payment cards and establishing the difference between credit and debit for both cardholders and merchants was a prerequisite for the card market to get off the ground. But banks also had to learn the value (price) of loans and the value of prospective cardholders.The two are linked: the value of a loan depends on how the client will pay in the future, and banks evaluate customers by forming expectations of their likely behavior after they get the loan.17 Finally, pure competition will never sustain markets. There is always a delicate balance between competition and cooperation, though this balance varies from market to market. Cooperative behavior is essential for developing trust in economic transactions. Whereas purchasing rice requires little trust between the buyer and the seller because to trained eyes the quality of rice is apparent upon inspection, the purchase of rubber is not possible in the absence of trust because the quality of rubber becomes evident only after it is turned into a useable good such as a latex mattress. The seller’s reputation, whether as a result of prior transactions with the buyer or through word-of-mouth, becomes particularly important here.18 Markets for credit cards require a particularly high degree of cooperation between competing banks because the service, which each individual bank that issues Visa or MasterCard offers to its cardholders, rests on the viability of the overall credit card network—a global system of merchants and ATMs serviced by their own banks. The seamless functioning of this network depends on specific types of cooperation. Standardization of payment cards is

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a must, otherwise cardholders can never know if their card will work in the next store. Also, interbank information sharing protects banks from issuing cards to those who failed to pay their debts in the past. The generative rules of a market then involve defining who can participate and how, what product value is and how actors can work together so that self-interested, rational price competition brings proper results. How hard or easy it is to establish each of these preconditions depends on the particular market one is setting out to build. Nowhere are these problems of market emergence more apparent and nowhere do local practices matter more in the course of globalization than in postcommunist countries, which have been undergoing profound institutional and cultural transformations, and whose local realities have been generally inhospitable to market development, let alone the creation of credit card markets. How markets for cards took off in postcommunist regions despite the seemingly insurmountable barriers, and how and why the eight countries differed in their approaches to market construction, is what we explain in this book. Thus, despite the keen interest that many postcommunist banks had in developing markets for credit cards, their sheer will alone was not sufficient to propel those markets toward growth and maturation. Many of the problems the issuing banks faced were outside their control, such as lack of interbank cooperation or weakness of consumer credit culture, and they required noneconomic solutions such as involvement of nation-states. Market emergence was therefore a major effort in social engineering rather than an instance of spontaneous evolution. The second issue we address here is the limits of globalization and the plasticity of card markets in local contexts. The credit card is a symbol and an engine of globalization to the degree that online and long-distance payments enable global travel and global consumption, but it has some curiously provincial features as well. For instance, although MasterCard and Visa cards are honored in countries other than the one in which they are issued, they are rarely issued to foreign nationals. Credit cards are highly standardized and at the point of payment each elicits the same ritual: the card is swiped or its number is keyed into a terminal, then a personal identification number, or PIN, is entered or a signature is given. However, although they may look very similar, different cards can embody very different financial service products and different sets of relations between key players in the credit card market: the cardholders, the banks that issue the cards, the

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merchants who accept the cards for purchases in their establishments, and the banks that process card payments. Credit card networks (such as Visa, MasterCard, and American Express) compile and distribute thick manuals and deliver PowerPoint-assisted training programs to member banks detailing numerous aspects of relations between market actors, from how to authorize payments to how to prevent fraud or settle disputes. But it is local institutional contexts (such as the spread of information technology and the state of the telephone industry or the court system) that determine practical aspects of these relations. Along with a large swath of literature in economic sociology on consumption,19 we emphasize that market creation involves not just the construction of an industry that delivers a supply of products but also the construction of demand by building appreciation and desire for the product. This is an obvious requirement for products that have never been seen before. Before smart phones appeared, few people imagined they needed one. Although payment cards and revolving credit were already widespread in the West, they had to be marketed aggressively to consumers in Central and East Europe and in Asia, most of whom did not desire cards and had to be educated about what cards are and how to use them. Because payment cards are not products that people consume but are primarily means to consume other products, and because they aid and abet purchasing consumer goods, they play an important role in the creation of a consumer culture in a wider sense.

Our Choice of Countries and the Use of the American Case as a Performative Ideal Type Our data come from eight postcommunist societies: six countries of East and Central Europe (Bulgaria, the Czech Republic, Hungary, Poland, Russia and Ukraine) that took a sharp break from their communist past, and two countries (China and Vietnam) where the communist party remained in power but nevertheless carried out fundamental economic reforms. Their transitional economies are uniquely positioned as sites for studying market emergence. When new markets emerge in stable Western economies, market builders rely on many existing institutional and cultural mechanisms that help propel markets along while leveling speed bumps and filling potholes. For instance, when the American credit card market

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emerged in the late 1950s and the 1960s, it could rely on both the cultural acceptability of consumer credit among the American middle class and the existence of credit-reporting practices that developed in the late nineteenth and early twentieth centuries.20 But in these transitional economies, which have been revamping their banking systems and legal institutions and where ­individuals have been shaping new identities to replace the ones that were lost with the fall of communism, little can be taken for granted. Instead, credit card markets have emerged alongside (and sometimes have brought about) a plethora of new organizational forms, formal and informal institutions, and cultural practices. The countries in our sample exhibit many common features. In all of them, credit card markets started to emerge tentatively in the 1990s, shortly after the collapse of communism in East and Central Europe, but began to take off only around the turn of the millennium. All of them share numerous socialist legacies, such as employers’ paternalism, the prevalence of state banking, the nearly exclusive reliance on cash in household finances, and the almost complete absence of consumer credit. None of them had developed critical financial institutions such as deposit insurance, credit reporting or personal bankruptcy. All six of the East and Central European countries underwent a period of economic recession and restructuring, accompanied in most places by hyperinflation, a drop in living standards, and a rise in unemployment. At the same time, the countries vary on several other factors relevant to the kinds of credit card markets they developed: size, level of pre-reform development, depth of economic recession and transitional trajectories, openness to foreign capital and the role of the state in economic reforms and market-building efforts. These country-level variables are key to explaining the diversity in the configurations of credit card markets across the postcommunist region, and to describing the different trajectories that the process of market-building took in these countries. Our research is based mainly on semi-structured interviews we conducted in the eight countries from 2003 through 2007.21 We interviewed people in ninety-one financial institutions, mostly banks but also a few nonbanks that issued cards. We talked to both card and risk specialists at the top levels, and in some cases with local bank officers who met with clients. We collected training manuals and application forms. Because most banks were in the process of figuring out how to deal with the puzzles of market

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creation, most were curious about our project and were surprisingly open to talking with us, though under strict conditions of confidentiality. In China, we ran up against what first looked like a data problem—all of the interviews returned nearly identical responses—and we had to disregard most of our bank interviews there. Later we found out that in China, unlike the rest of the countries, the banks were not the key actors in market making. Instead, that role was played by the state, an issue to which we return in Chapter 7. In addition to conducting these interviews, we visited and interviewed officials in bank associations, card associations, central banks and other government offices connected with card issuing. We also studied a large number of secondary documents. As a backdrop for our analysis of emerging postcommunist credit card markets, we include a brief history of the US credit card market. We do this for several reasons. First, the analytic descriptions of the puzzles of market creation have grown out of the experiences of these markets as they developed in the United States.22 Our presentation of the US case contextualizes these theories that present the problems as abstract, logical relationships from nowhere and purport to explain markets anywhere and everywhere. Second, the US market sets an example for the actors in postcommunist countries. The builders of the postcommunist markets, and to some extent even the Chinese government, have looked at how the US market came about as their blueprint. For example, one of Russia’s monthlies dedicated to the plastic card market, and widely known in the community of card professionals, in the mid-1990s translated parts of Joseph Nocera’s awardwinning book A Piece of the Action, on the history of the American credit card market.23 In Hungary, presentations and manuals by local card pioneers would routinely begin with the story of Frank X. McNamara’s famous lunch in Manhattan in 1949 that led to the creation of the Diners Club. Although some elements of the American history are highly idiosyncratic and the result of historical accidents, others represent rules or lessons that are generally applicable to other card-issuing communities. It is not a rule but rather a curious historical accident that in the United States credit cards emerged before debit cards. In fact, this sequence contradicts a logical expectation that the trajectory of card development should be in the direction of increasing complexity of products: from debit cards, which are only convenient payment instruments, to credit cards, which in

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addition to enabling noncash payments also provide access to consumer borrowing. In the United States, this order was reversed. Although in the 1950s there were several payment (debit) card programs that provided convenience but no credit, none of them managed to turn the card into a mass product. It was the charge card (on which the balance has to be paid in full each month) and its successor—the credit card (the balance on which can be paid off over time), also introduced in the 1950s—that quickly took center stage and led the revolution in card use in the United States. Debit cards did not rise to prominence until several decades later. In part this was a result of the fragmented nature of American banking in the middle of the twentieth century. Carrying a debit card would have worked well as a convenience for geographically mobile American customers, for whom having a debit card would have meant not having to haul around large quantities of cash, which can easily be lost or stolen. But because banking in the United States was largely local, debit cards issued by local banks could be used only by local residents in local stores. This dubious convenience was further constrained by lack of technology that would have enabled immediate electronic transfer of money. Credit cards, on the other hand, could be serviced with old-style paper technology, and they were potentially more appealing to the eyes of both consumers and merchants, even if both were local, because credit cards enabled purchases by those who did not have immediate access to cash. Because it was credit rather than debit cards that took hold in the United States, it was the credit card concept that was imported all over the world. When MasterCard and Visa cards were initially issued in the transitional countries we studied, they provided no credit, yet they were commonly referred to as “credit cards.” Finally, all of the major international credit card brands originated in and are administered from the United States, and they set the functional rules for issuers all over the world. These rules, to a large extent, grew out of the US experience. It is not, however, just through imitation that the US card market has affected its followers elsewhere; it has also shaped them by direct pressure and coercion. Banks that wished to issue internationally branded cards had to follow the rules written in the U.S. headquarters. Until the late 1990s, Visa did not even acknowledge a need for a differentiated approach to markets in other countries, including those with developing and transitional economies. All its products were universal, with the American

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market serving as a blueprint, and foreign banks were expected to emulate American practices.24 To capture this two-tiered relationship, between the model and the reality of the market, in which the former both describes and fashions the latter, we introduce the notion of the performative ideal type—a model that lays out the main aspects of a phenomenon by giving it an explicit description but also acts as a set of implicit instructions to follow in operating a rational card market. We borrow the concept of the ideal type from Max Weber.25 An ideal type is a set of abstract and—in this particular case—rational relationships that accounts for our understanding of a social phenomenon. It is an abstract model held together by rules of conceptual consistency. In Weber’s view, the ideal type is an image of how the world works and a tool of understanding, which Weber illustrates with an example from the stock market. Ideal types ask the question, given that we have certain conditions, what would rational, competitive actors do? The ideal type allows us to under­ stand how individuals act in a certain market by comparing the rational model with their actual behavior. In this book, we put ideal types in reverse and ask a different question: if we want rational, competitive actors to do certain things, what conditions do they need? Answering this question lets us understand how markets evolve by comparing the conditions needed with the ones that actually exist. We have added the adjective performative, drawing on the work of M ­ ichel 26 Callon, to emphasize that this ideal type is not just an inert theoretical imprint of reality, nor simply an interpretative casting of a phenomenon that gains its correspondence to reality by accurately perceiving its object of interest, but rather an active force that shapes reality by guiding actors and suggesting courses of action compatible with those descriptions. Thus, a performative ideal type achieves verisimilitude in two ways. First, it captures some essential features of reality by following its contours; second, it also shapes this reality by making the object of its focus look more like the ideal type, effectively squeezing it into its mold. This concept is similar to how a small but growing literature in economic sociology conceptualizes the relationship between real empirical markets and the discipline of ­economics. No economic sociologists and only some economists would argue that competitive markets populated by atomized rational actors exist anywhere outside of neoclassical economics textbooks. Economists insist, nevertheless, that such theoretical constructs are useful simplifications that capture the real

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workings of markets. Yet a group of economic sociologists argues that when neoclassical market principles are introduced into real markets, the markets may start functioning more in line with textbook predictions.27

Brief Review of the Evolution of Postcommunist Credit Card Markets A bird’s-eye view of the card markets gives us a picture of dynamically expanding markets in all eight countries. Aggregate data on cards and card use come from several sources: (a) international trade publications that compile data on cards and report on new developments in the industry;28 (b) central banks that regulate card markets (though the amount and detail of information they gather and disclose vary across countries); and (c) card companies (carriers of the brand), some of them multinational, such as Visa, others domestic, such as UnionPay (Chinese) and Borica (Bulgarian). There has been steady and uniform growth in the number of cards issued per capita in the countries in our sample, with China and the Czech Republic crossing the one card per capita milestone in 2006, Bulgaria in 2008 and Poland, Russia and Hungary getting very close in 2009. There was some slowing down or even decline in the number of cards in several countries (the most extreme being Ukraine) in 2007–2009 due to the financial crisis (Figure 1.1). In China, in about 2006, the growth in the per capita number of cards accelerated, surpassing the Czech Republic, which had been the uncontested leader for the previous decade. In 2008, China claimed the largest number of cards per capita among the countries in our sample—close to 1.4—and this number grew further, to 1.8, in 2010. Multiplied by an enormous population, the number of cards issued by Chinese banks is now higher than the number of Visa cards issued in the world combined. This is astounding given China’s lower literacy rate, lower GDP per capita and lower rate of urbanization compared to the other countries in our sample. Vietnam, on the other hand, is a relative underachiever, with fewer than 0.3 cards per capita in 2008. Ten years prior, 0.3 cards per capita was the highest rate of card ownership in the region, and the honor belonged to Hungary. Debit cards dominate the card market in all of the countries in our sample, ranging from 70 percent of all cards in the Czech Republic to more than 96 percent in Vietnam (Figure 1.2). The largest shares of credit cards

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Figure 1.1  Number of Cards per Capita, 1998–2010. Source: DRCnet (China), Lafferty (Vietnam), Central Bank (Bulgaria); Euromonitor. Population data: UN.

Figure 1.2  Percentage of Credit, Debit and Charge (Where Applicable) Cards Issued, 2007. Source: DRCnet (China), Lafferty (Vietnam), Central Bank (Bulgaria); Euromonitor.

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were found in the Czech Republic, Poland and Ukraine; in these three countries, about a quarter of the cards had a credit function. In 2007, in the three largest countries, China, Russia and Vietnam, only a very small portion of the cards were credit cards. Three other countries also issued charge cards, though only a few in the Czech Republic and Poland, and a negligible number in Hungary. Cards can be used by cardholders in two main ways: to pay for purchases in a store and to access cash (either from one’s own deposit account via a debit card or with the help of a cash advance via a credit card). Figure 1.3 illustrates the share of all card transactions that comprises card purchases. Because the rest of the total is cash withdrawals at ATMs, this chart allows us to investigate whether people are using cards as a way of paying or just as a tool to access their bank account or obtain a loan. It is evident that in every country in our study people continued using their bankcards primarily as ATM cards and not as payment cards. In the Czech Republic, the leader in using cards instead of cash in stores, out of every one hundred Czech crowns that people accessed with the help of their cards, seventy crowns were taken from an ATM machine as cash, and only thirty crowns were spent using their cards for direct payment. In all of the other countries, the percentage of noncash transactions was even lower. In Vietnam and Ukraine, in 2009, far less than 10 percent of the money flowing through the card was direct payment. The volume of direct payment purchases has grown in absolute but not in relative terms (compare Figure 1.4 with Figure 1.3). A relative decline in the volume of direct payment purchases within total card volume has been the case in the Czech Republic, where cash withdrawals grew from slightly more than 60 percent of transactions in 1998 to more than 70 percent ten years later (and slipped to exactly 70 percent in 2009; see Figure 1.3). This trend is even more dramatic in Vietnam, and we see something similar in Ukraine after an initial upswing. What this tells us is that as new people enter the card market, they tend to be less and less inclined to use the cards the way they were meant to be used—to pay for purchases—and in the way that makes the card a profitable business for issuers. This is most likely related to the “democratization” of the card markets over the past decade: changes in the demographics of cardholders, from elites to the masses, and the accelerated growth of debit cards, which are predominantly used for cash withdrawals rather than purchases. In Poland, an initial decline was reversed

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Figure 1.3  Card Purchase Volume as Percentage of Total Card Volume (Including Cash Withdrawals), 1998–2009. Source: DRCnet (China), Lafferty (Vietnam), Central Bank (Bulgaria); Euromonitor.

Figure 1.4  Volume of Card Purchases in Total Consumer Payments, 1998–2009. Source: Euromonitor.

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in 2000; and in China, after a quick up-and-down movement, the cards are very slowly moving away from being used only for cash withdrawal, with the most recent increase being in use of cards for direct purchases, from 10.5 percent in 2008 to 15.5 percent in 2009. Hungary and Bulgaria have managed to avoid rapid ebbs and flows, demonstrating steady growth in the relative share of direct purchases among the overall value of card trans­ actions, and by 2009 surpassing 20 percent and 10 percent respectively. Card markets are built to provide a payment and credit instrument. In the eight countries we focus on in this book, the number of cards has grown rapidly since 2000, but for the vast majority of users, the little piece of plastic with the magnetic stripe served neither as a payment nor as a credit tool. Rather, it was used as a banking tool—a key for accessing one’s account and withdrawing cash.

Overview of the Contents The next chapter lays out the historical background for the development of card markets in postcommunist countries. We address the creation of the principal players: the banks. We revisit theories of the transition, focusing on the three distinct development paths the eight countries took: the path taken by the Central European countries (the Czech Republic, Hungary and Poland), which relatively quickly integrated into the European Union and the developed world; the path navigated by the economies of East Europe (Russia, Ukraine and Bulgaria), which experienced a more tumultuous and protracted transition and a slower European and global integration; and finally the path traveled by China and Vietnam, two fast-growing East Asian economies that started from an overall much lower level of economic development and kept a strong role for the Communist state in the economy. We describe how the banking system developed, defining the key actors in the future card market and the kind of macroeconomic circumstances the banks encountered when they started to offer cards. This chapter emphasizes the similarities among the countries’ developmental paths, leaving the differences to subsequent chapters. In Chapters 3 and 4 we concentrate on the puzzles encountered by the architects of credit card markets and explain why they pose challenges to standard understandings of market economics. We identify five of them:

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two-sided markets, standardization, information asymmetry, information sharing by unequals, and market origination and expansion. Solving these puzzles involves establishing cooperation and value. We have organized them into two groups—payment puzzles (the first two) and credit puzzles (the rest)— in line with the concept that credit cards combine two functions, payment and credit. We argue that the solutions to these puzzles frequently require some sort of nonmarket intervention. To be more precise, these puzzles are such that they cannot be effectively solved by a self-regulating competitive market driven by the forces of supply and demand in the pursuit of ever-­ increasing profits. We present these puzzles in narrative form but refer interested readers to more formalized discussions. We then give a short account of how each puzzle was solved in the American market, as well as present a brief preview of ways to solve these puzzles in the postcommunist markets. In Chapters 5, 6 and 7 we focus on how the principal players—the banks in seven of the eight countries, and the state in China—attempted to create demand and solve the problems of valuation and cooperation. In Chapter 5 we focus on the group of more developed countries—Hungary, the Czech Republic and Poland—and address each of the puzzles and their solutions. For explanations of their solutions to the puzzles, we look to macroeconomic and institutional preconditions, the extent and role of foreign ownership in the banking sphere, market structure, and the advantageous position of socialist-era retail banks in each of these countries. In Chapter 6 we explain how the puzzles were approached in the three countries that experienced longer and deeper recessions—Russia, Ukraine and Bulgaria—resulting in stalled or postponed development of their credit card markets. Politically these three countries also exhibited less resolve in bringing about necessary market institutions such as deposit insurance, credit reporting, and personal bankruptcy. Yet despite the commonalities, this group of countries is diverse in at least two key aspects: their relative size and the extent to which their banking spheres were open to foreign capital. In Chapter 7 we turn to China and Vietnam, the two countries that share a political context and transition trajectory that are different from the other six countries. The case of China deserves special attention due to the country’s sheer size: it is particularly challenging to create a credit card market in a country of more than one billion people, only a small proportion of whom have bank accounts, not to mention the difficulties of establishing coopera-

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tion with respect to technology and data sharing between banking institutions thousands of miles apart. The Chinese government has been deeply concerned about “financial security” and has been successful in developing its own homegrown card system to challenge the advance of multinationals not only domestically but also internationally. In China as well as Vietnam, top managers of state-owned banks are still appointed with communist party consent, because large banks are to serve the economic policies of the central and local government. The Vietnamese card market is the least developed of all the countries in our sample. Its retail banking covers an even smaller percentage of the population than the banking system in China, its IT infrastructure is even more inadequate, and for historical reasons, until recently, foreign and especially American capital mostly shunned the country. In Chapter 8, which serves as a conclusion, we summarize our arguments, highlighting the problems that market makers in all of the countries faced, but emphasizing the differential successes and sometimes different paths and sequences of events that accompanied the development of card markets in the eight countries. We also note that in several of the countries, most unambiguously in China, the central purpose of the card market shifted from providing a tool of convenience to customers to offering an instrument of economic control for the state. We then revisit theoretical issues of social order and market emergence, and discuss the implications of our work for the study of globalization, postcommunist transitions and markets.

two

The Transition from a Communist to a Market Economy

The card markets in our eight countries developed against the backdrop of the largest effort of market building in recent history—the transition from a centrally planned economy to a market economy that began after communism collapsed in Europe in 1989. During the height of the Cold War, official communist orthodoxy considered markets to be not just exploitative, alienating and the ultimate source of inequality and injustice, but also irrational and chaotic. They were condemned as wasteful and inefficient, because competition, it was claimed, creates needless duplication. Markets are also the very core of capitalism, which socialism was supposed to have surpassed. Although markets were not completely absent under communism—one could find simple markets in agricultural produce, home repair or foreign currency—they were rudimentary, marginal and, if not illegal, always in danger of criminal prosecution.1 Anyone involved in a market could easily be saddled with the label profiteer (spekulyant), parasite, or capitalist roader. 25

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As communist economies began to slow down in the late 1950s and moved off an extensive growth path, on which the GDP was increased primarily by putting more people to work and using more natural resources, and into an intensive phase, in which the same resources had to create more output, communist governments began to consider changing their rigid systems of central planning. In a few of the Central European countries—Poland and Hungary are prime examples—experimentation with limited market mechanisms, as opposed to full markets, began as early as the 1960s. Market mechanisms involved giving some autonomy to enterprises by trying to steer them with material incentives rather than with direct commands, to make central control more effective. Although there was retrenchment in the 1970s, these two countries never fully renounced the idea that market mechanisms could help their centrally planned economy. In 1978, China too began its long march to a market economy by letting peasants sell their surplus produce on local markets, and it soon established special economic zones. Next, the Soviet Union and Vietnam launched their market reforms, in the middle of the 1980s. Perestroika—restructuring—was initially an attempt by Gorbachev’s leadership to enhance the Soviet system of centralized redistribution, but by the second half of the 1980s it drifted in the direction of supplanting some aspects of central planning with market forces. The Vietnamese initiated a program of Đổi Mới—renovation— which accepted private enterprises (under close state supervision) as part of its socialist economy. Two other countries in our sample, the Czech Republic, then part of Czechoslovakia, and Bulgaria, took a more rigid position. The Czech leadership came to power by crushing economic and political reforms in 1968; it was therefore hard for them to embrace changes they had acted to expunge. Bulgaria tried but abandoned reforms after its 1981 New Economic Model proved to be a failure. Yet by the second half of the 1980s, even these two countries fell in line behind the Soviet Union, which was pursuing its perestroika, and both loosened state control of the economy.

The Three Groups The 1990s transition played out differently in Central Europe, East Europe and Asia. The economies of the three Central European countries comprising our first group—the Czech Republic, Hungary and Poland—were

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more developed than those of the other countries we have examined, and in all three of them the communist party lost its grip on power. The Czech Republic, which split from Slovakia in 1993, has about ten million inhabitants, as does Hungary. Both have relatively small markets and have always been quite open to trade with other countries. Poland is bigger, with a larger internal market. It is almost twice the size of the other two countries combined and is now the sixth largest country in the European Union. These countries quickly integrated into the Western world, becoming members of the Organisation for Economic Co-operation and Development (OECD) and the World Trade Organization (WTO) in 1995.2 They have been part of NATO since 1999 and of the European Union since 2004. The poorer East European countries had a slower start. Bulgaria is the smallest, in terms of population, of our eight countries, with a little more than 7 million people. Russia and Ukraine, both created at the breakup of the Soviet Union, are much larger. The population of Ukraine is close to 45 million, and by territory it is the largest country in Europe after Russia and France. Russia covers the largest land mass of any country in the world, spanning nine time zones. With more than 140 million people, it is larger than our other five European countries combined. In all three of the East European countries, the communist party relinquished power, but at least initially the postcommunist governments did not make a clean political break with the past. Bulgaria was the first to sign on to the WTO, in 1996, and it entered NATO in 2004 and the European Union in 2007. Ukraine did not join the WTO until 2008, and Russia joined only in 2012. None of these three countries is a member of OECD, although Russia was invited in 2007. Finally, our third group, the two Asian countries, took a different path altogether. China is the world’s largest country with 1.3 billion inhabitants. Vietnam, with its culturally disparate Southern and Northern parts reunited in 1976 after the Vietnam War ended, is the thirteenth most populous country in the world, with 87 million people, a number that, unlike in the other seven countries, is rapidly growing. In 1990, both China and Vietnam were much poorer than the other six countries. Despite ongoing market reforms, political power in these two countries remains in the hands of the communist party, which is why there is some debate over whether they can be labeled postcommunist. Both joined the WTO—China in 2001 and Vietnam in 2007—yet their governments have been stalling full integration in favor of protecting domestic industries from global economic forces.

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The Transition Debate Even though the countries in the three groups are different, they faced similar problems at the outset of transition. It was clear from the start that markets would not simply spring into action once prices were freed and property was privatized, but just how much and what kind of help markets needed was discovered by trial and error over time. This realization—that markets are not the natural form of economic interaction that emerge from our universal human character but are carefully built, and only once they are there can actors perceive them as natural—was the main lesson of the transition.3 Academic discussion on the market transition revolved around how to manage the shift from a centralized, planned economy based on state owner­ ship to a market system resting on private property. The policy debate focused on the European postcommunist countries. China and Vietnam rejected direct advice from Western experts, with China’s leadership firmly insisting that because China was unique due to its size, importance and history, so was its path to economic growth.4 Vietnam maintained a more peripheral role, reflecting its lighter weight in the global economy. Propelled by neoliberalism and its profound faith in self-constructing and self-regulating markets, leading economists initially advocated a one-sizefits-all solution applicable to all markets in all countries, a shock therapy opposed by gradualists that included rapid privatization, fast liberalization of prices and trade, and immediate stabilization by fiscal and monetary austerity.5 Starting from the functional rules of the market, this advice was developed by deducing generative rules from a stylized understanding of how markets function. If markets are driven by self-interested competition, privatization—the creation of private property, one of the preconditions of a market—can be best conducted by competitive auctions. If price signals are distorted and thus mislead market actors, prices are simply freed by removing state subsidies and taxes across the board. If competition is hampered by trade tariffs, they are just to be lifted wholesale. The cognitive gap created by the missing generative rules was covered over by fears of political obstruction by the old elite and by the conviction that different parts of the economic system were tightly related. Taking too much time to build markets was seen as potentially jeopardizing the transition because it would give time for communists and antimarket forces to regroup. Relying on the state

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to produce the preconditions of markets was seen as running the risk of permanently empowering state bureaucrats. Starting reforms in only one sector of the economy or proceeding in a piecemeal fashion was equally problematic because all of the elements of the command administrative system were seen as interdependent and therefore meant to vanish simultaneously. The so-called market transition debate was the process of coming to terms with the fact that the self-creating market is a myth, and that the generative and functional rules of the market are separate and can even point in opposite directions. If privatization is aimed at achieving markets operated by private enterprise with only a light touch from the state, the state must at first have a strong hand in order to avoid corrupt appropriation and mismanagement. To free markets from the legacy of communist-era overregulation, new, market-friendly regulations must first be put in place. To get competition going, some actors might initially need protection from challengers so that there will be enough actors to compete. These regulations vary from market to market, but all of them involve setting up generative rules before functional rules can take effect. The logic of market reforms was ultimately driven by the need to create new market actors and to establish cooperation and valuation. The thrust of privatization was to create new, independent owners whose self-interest would be in line with the economic success of their businesses. Trade liberalization aimed at bringing in existing actors, mostly from abroad, to widen radically the circle of suppliers. The importance of cooperation was initially overlooked by the theorists of the market transition. Their main push was to sharpen competition primarily by the creation of new players and deregulation, as well as by putting an agency in charge of rooting out anticompetitive practices. Yet no one objected to the rise of industry associations or chambers of commerce, which are standard in developed capitalist countries. From the perspective of the economists who debated how best to guide the transition, value was not a central concern. Most of them believed in what Austrian economist Friedrich Hayek called the “marvel of the ­market”—that the free play of supply and demand will establish in the best way possible the true value of any commodity in the form of a single price.6 Nevertheless, theorists understood that not everything is priced directly by the market, and they agreed that new, Western-style accounting methods should be introduced, at both the enterprise and the national level, to properly measure such values.

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As the debate moved on to the details of market creation, there were ferocious clashes over the mode and pace of market construction and the proper sequencing of policies. Advocates of shock therapy and gradualism fought pitched battles,7 with shock therapy advocates claiming Poland’s success and gradualists citing China’s success as support for their respective positions.8 There was wide disagreement over the role of the state, over how it should privatize enterprises, regulate their activities and tax or subsidize various industries. But there was a remarkable consensus that the main goal was to optimize production, which until that point was largely carried out by inefficient, outmoded and poorly incentivized state-owned enterprises with soft-budget constraints on inputs and little accountability for the quality of outputs (formally, only quantity mattered for plan fulfillment).9 Theorists of the transition operated with a clear supply-side bias: they paid close attention to the creation of new goods and services and trusted that what was produced would be consumed by someone who could afford it. Market creation therefore meant the building of its supply side, and the transition to a market economy was thought of as aligning supply with existing demand. It was assumed that if incomes derived from production reflect the productivity of workers, the resulting income distribution will offer a pattern of demand optimal for absorbing what was produced. Ignoring consumers as a theoretical problem is a major omission, because building demand for a product is a key part of market building, a point few entrepreneurs would argue with. Finding customers, convincing them that the product is worth buying and using—in other words, marketing the product—is as essential for market emergence as developing the product. There were several reasons why researchers did not think of consumption as an important theoretical challenge that needed the same thought and consideration as production. First, state socialism left behind a large pent-up demand for consumer goods and as a result the question of how to motivate former communist citizens to become savvy capitalists—entrepreneurs starting their own companies or investors buying the stock of newly privatized enterprises—seemed much more pressing than the problem of how to turn them into willing consumers. As Hungarian economist János Kornai pointed out, socialist economies were supply constrained, and demand seemed infinite.10 The second reason for overlooking the creation of consumers was the fact that most of these economies, especially those in Central Europe and China, quickly embarked on an export-led growth strategy.11 Producing for

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consumers in other countries made the need to organize a viable consumer market at home less urgent. Third, many of the goods and services produced were consumed by other producers down the production chain. Because these consumers were producers as well, they could be subsumed under the supply-side approach of the market transition literature. The final reason was purely ideological. Influenced by neoliberalism, scholars assumed that demand was given—exogenous—and therefore unproblematic: people’s wants and desires derived either from human nature or from very general historical conditions. Tastes were facts on the ground and de gustibus non est disputandum.12

The Communist Legacy Communist consumers lived in an economy where most goods and services were in short supply.13 Whether the product was housing, vacation tours, jeans, cars, sausages, toilet paper or household durables, there were always more people with money interested in buying them than there were items available. This situation was a result not only of insufficient production and irrational distribution across the geographic areas, but also of an imbalance between the value of all goods in the consumer distribution system and wages paid, with the latter outpacing the former. In market economies, such an imbalance is corrected by rising prices. In socialist economies, prices could not rise because they were fixed by the socialist government. The problem of constant shortages was instead solved through rationing. Some goods, such as automobiles, were not sold through open retail trade but instead allocated to citizens by the government or through the workplace or elaborate systems of queues one had to enter. Accessibility rather than affordability was the biggest challenge for socialist citizens, because access was a resource that money could not usually (or easily) buy. Access to rare consumer goods worked as an instrument of social control: gainful employment was not only a source of income but also a rationing channel, where position (seniority), performance (productivity) and political loyalty were used as grounds for eligibility. Sometimes this system could even lead to a peculiar form of inequality, where the earnings of select groups of citizens (political elites, ­exemplary workers, high-profile artists or writers) could be quite similar to the wages

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of ordinary people, yet their money was worth more because the former could access better-stocked shops, jump to the head of the line or spend their money bypassing retail altogether.14 Thus, priority access was far more important than the amount of money one earned.15 Therefore, the socialist economies of shortages, particularly in East Europe, were also “economies of favors,”16 which by late socialism led to widespread reliance on informal networks, nepotism and corruption to procure sought-after consumer goods and even free resources that were supposed to be allocated on the basis of need or merit, such as acute care hospital beds and college admissions. On a macro scale, shortages and rationing led to “monetary overhang”—a situation in which the monetary mass in the hands of citizens was larger than the value of goods and services produced—and, as a result, to forced savings.17 Under these conditions, consumer credit was very limited because it would have injected additional purchasing power into an economy that already had more money chasing goods than the worth of goods available.18 The entire socialist financial system was strongly controlled by the communist state and was subordinated to the needs of central planning. There was a state monopoly on financial services in each of the countries in the form of a large monobank that handled all financial transactions and monetary activities through specialized divisions focused on attending to particular tasks. The monobank acted as a central bank: it was in charge of the domestic currency, including establishing the exchange rate of the national currency against other currencies. One of its divisions handled foreign trade, another handled large investment projects, a third construction, and a fourth agriculture, each working with companies. Another division provided retail services to individuals and households through a system of retail branches sprawled across entire countries’ territories. Customers of these retail branches were subject to uniform rules, and to uniform and virtually unchanging interest rates on their deposit accounts. The functions of retail banking were also performed by another state service with an even more expansive network of local branches—the post office. Similar to Western Union, which piggy­ backed its money transfer business onto its existing telegraph communication service in nineteenth century United States, the socialist post office used its telecommunication capacities to provide money transfer services in an era when banking involved pens and thick ledgers. Personal checks never took hold in socialism, and sending money across geographic distance involved taking cash to the local post office and either telegraphing the recipient to

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come and collect the money from their post office branch or having the cash delivered to the recipient’s home along with the mail. Under socialism, payment by ordinary people was rendered in cash, the bills and coins immortalizing each country’s national heroes. This method was never challenged by any other payment means until the arrival of plastic cards in the early 1990s. The exchange rate of the country’s currency was closely controlled by the government, and people holding foreign currencies (where it was allowed) had to keep them in specialized bank accounts, effectively lending their dollars, marks and francs to the state, which sought full control of the payment system of its own economy. The cash-based payment system of each socialist country, all the talk of proletarian internationalism notwithstanding, was the epitome of its national sovereignty. There was a primitive form of consumer lending for big-ticket items such as furniture, household durables, jewelry and furs, but it was largely devoid of uncertainty or risk. The interest on these installment loans was centrally set and payments were often arranged to be deducted directly from one’s pay (and if not, they certainty could be deducted if the installments were not paid on time). Collecting payments essentially involved the state transferring money from one of its pockets to another, because the bank, the retailers and most employers were state-run companies. Yet unlike state enter­prises, which could always ask the state to lend them more money, households overall had to live under hard budget constraints and could rarely spend more than they took in. What was glaringly missing in socialist banking, then, were market actors—most notably commercial banks, the main actors on the supply side of payment card markets. Although retailers and households—the two groups of customers in payment card markets—were not absent per se, they were nevertheless utterly unprepared (and, as we demonstrate later, initially greatly unreceptive) to participate in payment card markets. Both preferred cash to cards, often balking at the cost and risks involved. In addition, because the socialist financial system was ruled through central planning, it had not developed any forms of cooperation found in financial markets (such as banking associations, credit bureaus and systems of mutual clearance). Last but not least, the centrally determined prices of goods and services also precluded the development of market-based systems of valuation of commodities by both producers and consumers. Because of shortages, almost everything found buyers.

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To sum up our discussion so far, in socialism, banking services were provided to households on a noncompetitive and no-risk basis, consumer demand chronically outpaced production, and consumer credit was rudimentary, because millions of communist citizens accumulated cash they could not readily spend, whereas cash—the only known means of payment—was typically less important than having access to goods, either through formal state-procured rationing or through mutually beneficial connections with the “right people.” In the rest of this chapter we discuss the emergence of the first market actors (commercial banks) and the macroeconomic conditions that influenced the demand for cards. The problems of cooperation and valuation are addressed in subsequent chapters.

Creation of Commercial Banking two-tier system

The development of the new financial system began in all eight countries in the 1980s through the creation of the main actors of financial services: commercial banks. In retrospect, this was not the only possible trajectory for these countries. There were other actors who could have assumed more important roles at the beginning, such as credit cooperatives, home savings associations, consumer finance companies, investment brokerages, or credit card companies. These more specialized actors, however, emerged only later and had to adjust to a field already dominated by commercial banks. As we show in later chapters, commercial banks turned out to be the main players in the creation of payment card markets. Depending on the rules of entry, some countries ended up with a crowded field of commercial banks while others kept strict control over banking licenses (Figure 2.1). Russia has had the most liberal rules for licensing banks, as did Bulgaria until its financial crisis in 1996.19 Ukraine was less permissive than its larger eastern neighbor, but it still allowed entry of more than twice the number of banks one finds in Poland, even though Ukraine’s population is not much larger. On the other end stands China, which has about the same number of commercial banks as Ukraine, with a population that is almost thirty times as big. Vietnam has also been tightfisted with banking permits, even after 1994, when it began to open up to the Western world.

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Figure 2.1  Average Number of Banks in Each Country Between 1990 and 2011 (Logarithmic Scale).

The transition process started similarly in all eight countries: the staterun monobank was broken up and a two-tier system was built, with the central bank as the first tier and a number of specialized state banks as the second. This system later served as the basis for creation of commercial banks. In the six European postcommunist countries in our investigation, the retail market for financial services began with the dominance of a single giant savings bank, originally the retail arm of the socialist monobank. In socialist Hungary, the bank that managed domestic banking for individuals was Országos Takarékpénztár (National Savings Bank) or OTP. The socialist OTP was not a business but a government agency that, in addition to managing household financial needs, also performed educational functions in order to install proper financial habits in citizens. It also—possibly with the opposite effect—administered the state lottery, the national football pool and other forms of state-sponsored gambling. Similarly, in communist Czechoslovakia, it was Česká spořitelna (Czech Savings Bank) or ČS that dominated the retail market in the Czech lands, and in the Slovak lands it was its sister bank, Slovenská sporiteľňa (Slovak Savings Bank). In Poland, Powszechna Kasa Oszczȩdności (General Savings Bank) or PKO, was in charge of most retail banking. A second, albeit much smaller bank, Bank Pekao, played a limited but important role as the foreign currency bank. In the 1970s and 1980s, Bank Pekao handled remittances sent

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by foreign-based Poles to their families back in Poland, and by 1990 it developed a network of offices in all the major cities in the country, serving a sizable clientele. The Bulgarian socialist retail bank was Darzhavna Spestovna Kasa (State Savings Bank) or DSK. It too started out as the country’s largest retail bank, although its sluggish management soon lost ground to the more dynamic former foreign trade bank, Bulbank. In the Soviet Union, the reorganization of the monobank system in 1987 produced a giant retail bank, Sberbank (Savings Bank).20 Up to today, Russia’s Sberbank has never lost its decisively dominant position in the postcommunist banking system (nor in retail banking in particular). In Ukraine the situation was different from that of Russia and the other East European countries, because as Ukraine gained independence in 1991, most of the assets and liabilities of Soviet Sberbank were transferred to the Russian Sberbank leaving its Ukrainian counterpart, Oshchadbank, with relatively little money. As a result, Ukraine has never had a decisively giant bank,21 Oshchadbank being comparable in size to a few of the largest banks, most of which are descendants of the branches of specialized state banks formed on the basis of the old monobank system. In Vietnam and China, during socialism there was no dedicated retail savings bank. In Vietnam, in the early days of socialism, right after reunification in 1975, banking reflected the gap between the predominantly rural population and the more affluent people in the large cities of Hanoi and Ho Chi Minh City. Agribank (the Vietnam Bank for Agricultural and Rural Development) serviced the countryside while Vietcombank dominated in the urban areas. In China, the People’s Bank of China handled most banking transactions until 1984, when it became the central bank. Subsequently, the Agricultural Bank and the rural credit cooperatives served the countryside and various state-owned banks, either newly formed or reactivated, served in the cities, where individuals connected with them through their work units. Although there was no giant retail bank in either country at the beginning of the transition, in Vietnam, where the state exercised less control, Vietcombank was able to parlay its initial urban advantages into becoming, at least for a time, the country’s leader in retail services. In addition to having giant retail banks, Hungary and Poland had expansive networks of rural credit co-ops (similar to those in China and Vietnam) that survived during communist rule. In Poland, credit co-ops were unified

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in 1975 under a single organization named Bank Gospodarki Żywnościowej (BGZ), whereas in Hungary they remained local until 1989. These rural savings and loans had a particular clientele—peasants and rural workers whose financial service needs centered on agricultural production and small-scale construction. After 1989, sitting on a loyal, and mostly older, clientele, rural co-ops were under no pressure to venture into new areas of financial services, even if a few local branches did show some signs of entrepreneurial spirit. In the countries where giant retail banks dominated (Russia, Hungary, the Czech Republic, Poland and Bulgaria), at the onset of market reforms they had the vast majority of the residential accounts in their respective countries. These accounts offered them a large amount of information that new­comers did not have. They did not have to worry about losing their clientele, because most of their customers were captive by sheer inertia. People were used to the state savings bank and trusted it because of its size and because of the general belief that the state stood behind it even when it was no longer a state institution. Size also meant convenience. Through their large network of branches, the giants could provide easier access than small upstarts. In all of our European countries, with the exception of Ukraine, initial bank reforms aimed at eliminating this monopoly, but shrinking the immense advantage of the giants turned out to be more difficult than expected.22

market concentration

Finding a foothold next to the national giant was difficult. Between 1995 and 1999, industry concentration measured as the total assets held by the top three banks was 72 percent in the Czech Republic, 57 percent in Poland and 53 percent in Hungary.23 In Hungary, OTP was by far the largest bank, and the second and third (Kereskedelmi és Hitelbank, or K&H, and Magyar Kereskedelmi Bank, or MKB) followed at a distance. In the Czech Republic, the top three banks (Československá obchodní banka or ČSOB, ČS and Komerční) were close to each other in size; hence they had a large share of the total. In Bulgaria, before the 1996–1997 crisis, DSK held around 75 percent of deposits made by households. In Russia, the top five banks controlled 38 percent of combined assets in 1997; of these, 25 percent were held by Sberbank, and the other thirty largest banks held 67 percent of total assets. Ukrainian National Bank does not report banking industry’s assets prior to

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2003, but in that year, the top three banks controlled 27.5 percent of combined banking assets and, as in the Czech Republic, the largest banks are similar in size, bringing more balanced competition in Ukraine than in Russia. The concentration looks more pronounced if we look at retail banking only. As late as the mid-2000s, in Poland, PKO had a 35 percent share of the retail market, followed by Pekao with 18 percent, and Bank Zachodni ­Wielkopolski Bank Kredytowy (BZ WBK), with 9 percent, was a distant third. In Hungary, OTP had 38 percent of household loans and 44 percent of all deposits, followed by K&H with 10 and 14 percent respectively. ČS had more than 5 million customers, which was very high in a country of ten million where people rarely held accounts in multiple banks. This concentration has been slowly eroded by privatization and the entry of foreign-owned banks with deep pockets, but it took time for it to play out. DSK used to claim more than 90 percent of the consumer credit market in Bulgaria in the 1990s; its share dropped to 47 percent by 2003 and to 30 percent by 2011.24 Russia’s Sberbank controlled 79 percent of household deposits in 1997. This number went up to 85 percent in the aftermath of the 1998 banking crisis, and then down to 55 to 65 percent in the years of robust economic growth of 2002– 2007. In the past few years, this number has hovered just above 50 percent.25 In China, the big four banks—the Bank of China (not to be confused with the People’s Bank of China, the central bank), China Construction Bank, Industrial and Commercial Bank and the Agricultural Bank—accounted for 85.6 percent of all consumer loans as late as 2002.26 In Vietnam the situation was similar, and in 2005, 74 percent of the deposits and credit belonged to the five large state owned banks.27

p r i vat i z at i o n

The privatization of the banking sector happened in different ways in the eight countries, but in the end the four European Union members emerged with banking systems owned predominantly by foreign financial institutions, while in Russia almost half of the combined banking assets belong to state-owned banks and only about a quarter are foreign owned (down from 31 percent in 2009). In Ukraine, the majority of banking assets are owned by domestic capital, and the share of foreign capital recently grew to 35 percent.28 In the two Asian countries, all important players remain in state hands.

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Privatization was how the European countries populated the market for financial services. Each country passed laws on financial institutions in the early 1990s that defined how banks and other service providers could be formed and the types of activities that were allowed to different types of actors. In Central Europe (Hungary, Poland and the Czech Republic), the rules of bank creation were quite strict. Legislators tried to avoid having companies create their own banks and tap them for funds to make up for losses in their main line of business. This was an important concern in the early 1990s, when most large enterprises, still under state ownership but soon to be privatized or liquidated, had accumulated large amounts of debt. Lawmakers did not want to see big firms setting up banks, taking deposits from others and using that money to support the company. To separate banks from other businesses, the laws also cordoned off a set of services that only the banks could provide and other businesses could not, such as lending. This restrictive approach left only a few doors open to the creation of private banks. Because after decades of communism few domestic individuals or even groups had enough resources to start a bank and because domestic companies were excluded from banking, new banks could be created almost exclusively by foreign capital only. To privatize the banks that the state carved out of the monobank system was also a challenge. They were sold either to foreign investors or to micro-investors at home who would each buy a small amount of stock in the bank. Hungary, having piled up a large foreign debt under the last two decades of communism, privatized its newly created state banks by selling them to foreign financial institutions and used the revenue to pay off its debt. By the end of the 1990s, two thirds of Hungary’s banking assets were in foreign hands, and in a few years all major banks were foreign owned except the largest, OTP, which was taken to the Budapest Stock Exchange in 1995. The state retained 25 percent plus one vote, and other Hungarian institutions, such as municipalities and the social security fund, held sizeable blocks of shares. Because OTP was a success, its CEO could play these institutions off against the state by acquiring an agreement from the owners that removing him would require a vote of 75 percent plus one.29 This gave the bank’s management considerable independence. Poland also had to contend with a large foreign debt but had the option of renegotiating much of it, and consequently the pressure to sell was less urgent than in Hungary. The Poles took their time and by the late 1990s their

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banking system was still dominated by domestic banks. In 2000, however, in just one year, the share of foreign ownership rose to more than 70 percent, after Pekao was sold to an Italian-Austrian consortium and BZ WBK was purchased by an Irish investor. In 2004, PKO, just like OTP, was taken to the stock market, but the state treasury kept 51 percent of the shares. The Czechs initially took an altogether different route. Their banks were partially privatized through their voucher privatization program, which handed tiny packets of shares to hundreds of thousands of Czech citizens. The state, holding on to a large share of these banks, took over their bad debts and deposited them in a new “bad” bank (Konsolidační Banka) created as a dumpster for toxic assets. The Czech banking system was considered the best and healthiest in the region until 1997, when it was revealed that the banks were saddled with new bad loans covered up by accounting tricks. A series of bank failures that followed brought about a second wave of privatization, which started in 1998 when the collapse of one of the larger banks, Investiční a poštovní banka, forced the Czech government to sell it to a Japanese investment firm.30 This development opened the door to what earlier Czech governments wanted to avoid: the acquisition of all the major banks by foreign financial institutions. Soon all the other big banks—ČS, Komerční and ČSOB—were put up for sale as well. In 2000, ČS was bought by the Austrian Erste Group, which also purchased the Slovak savings bank, the Hungarian postal bank and a major bank in Croatia. In Bulgaria, as in the former Soviet Union, banking regulation was more lax, leading to the situation that Central European countries were able to avoid—creation of a large number of small, undercapitalized (“pocket”) banks by companies—whether still state owned or already privatized— sometimes to circumvent state bureaucracy, other times to siphon off enterprise assets to benefit managers and shareholders. In Bulgaria, a large number of small state-owned banks were founded as a result of the continuous reform of the monobank system there: sixtyone state-owned banks were licensed in 1990 alone, bringing the total number of registered banks in Bulgaria to seventy. Privatization of the banking sphere in Bulgaria was postponed, however, and for most of the 1990s, state banks, with the strong encouragement of the government, continued their socialist-era practice of financing loss-making state-owned enterprises, and the share of nonperforming loans grew faster than the volume of lending. In 1992–1996, the Bulgarian state initiated a series of consolidations of small

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undercapitalized banks into several bigger ones in the hope that this would improve their financial viability and future chances of being privatized. As a result, the number of banks went down from seventy to thirty-five. But these measures did not strengthen the banking system, and in 1996 Bulgaria was engulfed in a devastating financial crisis that bankrupted fourteen of the thirty-five banks and demonstrated in no uncertain terms that a major reform was long overdue. The subsequent measures involved the establishment (under pressure from the International Monetary Fund) of a currency board that fixed Bulgarian currency to the German mark (and starting in 1999, to the euro), and the sale of all six state-owned banks during 1999– 2003 to foreign financial groups.31 DSK, the former socialist retail giant, was the last among them to privatize; it was sold in 2003, with an unusual twist, to another former socialist giant, the Hungarian OTP bank. In 2008, more than 90 percent of the banks in Bulgaria were in foreign hands, and a few were part of big international financial groups. Only one Bulgarian bank was state owned, and it controlled less than 1 percent of Bulgaria’s total banking assets.32 In the Soviet Union, private commercial banking began in 1988, when a series of new laws—notably the Law on Cooperation—opened possibilities for private entrepreneurial activity. That year, only 25 banks were founded in the whole of the Soviet Union, but by the end of 1990 there were already about 300 banks, most of them private. From that point on, the number of banks increased exponentially. By the end of 1991 there were 1,360 in Russia, and by 1995, 2,500.33 In 1994 alone, more than 500 new banks were licensed by the Bank of Russia. Currently, the number of licensed banks in Russia stands at fewer than 1,100, following a steady stream of closings due to bankruptcies throughout the 1990s as well as more recent mergers and acquisitions. Ukrainian banking grew in a similar fashion, though at a less dramatic speed. In 1991, the year of Ukrainian independence, there were 76 banks, and by 1995 there were 230.34 Capital requirements for these newly founded banks were very low—comparable to the price of a two-bedroom apartment in a large city.35 Low entry barriers encouraged bank creation by individuals with no banking experience or even basic knowledge of finance, resulting in hundreds of small undercapitalized and unstable banks ready to crumble at the first signs of financial trouble. Indeed, banks failed just as frequently as they were founded. In Ukraine, four banks that during the

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early 1990s were among the ten largest in the country were liquidated by 1995. The following year there were a total of forty-five bankruptcies (approximately 20 percent of all registered banks were liquidated in just one year).36 By 2000, the population of Ukrainian banks dipped to 188, and has not changed dramatically since then. The arrival of foreign banks brought new capital and know-how to consumer credit and forced the postcommunist giants to innovate. For understandable reasons, the giants tried to hold on to their initial advantages as long as they could. They dragged their feet on most measures that required cooperation if cooperating would give their competitors some advantage, as we discuss later.

Macroeconomic Conditions In the 1990s, there was no significant demand for payment cards in postcommunist countries. The use of cards needs a certain level of affluence (after all, one typically must pay for the convenience they deliver), and economic recession in the European countries made most people even poorer than they were during socialism. The two Asian countries experienced robust growth, but they started out much poorer, and initially only the elites were affluent enough to find cards appealing. Merchants too understood that pushing prices down is more important than offering people the opportunity to pay with plastic, and many waited for a larger crowd of consumers to carry cards and make it worthwhile to accept them for payment.

t h e va l l e y o f t e a r s

In postcommunist Europe, the collapse of communism ushered in a period of severe economic hardship. In peace times these countries had not seen a recession this deep since the Great Depression (Figure 2.2).37 Hungary, the Czech Republic and Poland lost 15, 12 and 5 percent, respectively, of their GDP.38 Poland implemented the most hardline shock therapy policy, starting in 1990; it is also the country that reached its pre-transition GDP the fastest, by 1994. The Hungarians and the Czechs, both of which hit rock bottom in 1993, took ten years to reach that milestone.

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Figure 2.2  GDP per Capita in the Eight Countries 1988–2010 at Constant 2000 USD. Source: World Bank.

The Bulgarian economy showed positive growth in 1994–1995, then suffered a devastating crisis in 1996–1997, and started to grow again in 1998. At its nadir, it was at only 82 percent of its 1990 value, and it caught up with pre-transition figures only by 2001. The trajectory of Russia and Ukraine was even worse. The two economies were steadily contracting until 1996. By this time they had already lost 42 percent and 57 percent of their GDP, respectively. Russia’s GDP finally reached its 1990 level in 2007, and Ukraine has not accomplished this goal yet; its highest GDP since the start of the transition was registered in 2008 and was only 74 percent of its 1990 level. In the early 1990s, in Russia and Ukraine, reduced incomes were compounded by wage arrears—chronic nonpayment of wages, sometimes spanning months. Although they were still counted as officially employed and receiving pay, these people were left to fend for themselves, with the hope that their employers would resume salary payments at a later date. In some cases, they were given compensation in kind and had to barter goods produced by their company, from tombstones to underwear, for items essential for their survival.39 But as the pie shrunk and then grew again, the incomes in postcommunist societies became more unequal, so while a small portion of the population gained ground, others lost even more than one may surmise from the ag-

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gregate data (Figure 2.3).40 In the six European countries, income inequalities were driven by two forces. First, wages and salaries began to diverge as socialist wage regulations were abandoned and markets started to differentiate more sharply among individual workers, workplaces and sectors of the economy. In addition, substantial rent income also became available to a narrow segment of the population that was able to acquire property through privatization. Over the decade of the 1990s, the top quintile of income distribution across the postcommunist region increased its share of all income, while the other quintiles got less. Even when the countries eventually returned to their earlier overall levels of economic well-being, judged by their per capita GDP, the majority of households still had not. Shrinking incomes, however, were only one of the factors meting out economic hardship for the majority of the population. Dwindling state services were the second factor. The end of socialism also meant reduction in the public resources and welfare benefits that were central to socialism, such as free health care and education, generous maternity and disability leaves, subsidized housing, day care and vacations. Some of these benefits were abandoned entirely, many were scaled back, and now these services had to be paid for by individuals and families out of pocket. In other words, it was not just that incomes shrunk, but also that expenditures grew.

Figure 2.3  Percentage of Total Income Share Held by the Richest 20 Percent in the Late 1980s and the Second Half of the 1990s. Source: World Bank.

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Moreover, the ability of the state to collect taxes in all of these economies, where significant parts of economic production were generated informally, was considerably reduced. This dealt a substantial blow to the capacity of the state to fund even those services it intended to continue to offer. Just as the recession hit some people more than others, the thinning of public services affected some groups more deeply than the rest. The retreating welfare state had to refocus its diminishing resources on the poor, means-testing people to gauge their eligibility. The working and middleclass people, not qualifying for these programs and left to their own devices, were often unable to afford the goods and services produced by resourceful postcommunist entrepreneurs and foreign companies eager to exploit postcommunist markets. Aggregate figures of household consumption saw a painful drop in the 1990s and then a slow crawl back overall by the decade’s end (Figure 2.4). By all accounts, the 1990s was a difficult period for starting card markets in postcommunist Europe. Polarization of incomes in postcommunist European countries narrowed the potential demand for bankcards by concentrating gains on a small elite and shortchanging others. By making the majority of the people de facto poorer, the recession pushed them out of the economic bracket in which one could consider paying for the convenience

Figure 2.4  Household Consumption per Capita 1988–2011 at Constant 2000 USD. Source: World Bank.

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of carrying a payment card or using a credit card to borrow. It also created uncertainties that were new to people who had grown up under the relative economic security of the old socialist system. In times of large societal changes, uncertainty becomes inevitable and highly visible. The past ceases to be a reliable guide to the future, because the very point of large-scale transformations is to break with the past and create new conditions. For most people, the biggest source of uncertainty was the restructuring of the economy, the process by which ailing, large, cumbersomely bureaucratic and inefficient enterprises were transformed into leaner and more productive ones by closing down many firms and firing many workers. As a result, unemployment, virtually unknown under communism, shot up dramatically (Figure 2.5). In Poland and Bulgaria, it has been in double digits for most years since 1990, dropping below 10 percent in Bulgaria only in 2006. Russia and Ukraine saw numbers above 10 percent in the late 1990s; the rate dropped somewhat in the new millennium. In Hungary, after a spike in 1993, unemployment stabilized below 10 percent and then started to climb again after the world economic crisis set in, in 2007–2008. In the Czech Republic, for the most part unemployment managed to stay in the single digits. But job loss in the region was even bigger than official unemployment figures suggest, because many people disappeared from the labor

Figure 2.5  Rate of Official Unemployment 1992–2010 (Percentage of Total Work Force). Source: World Bank.

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force without being counted or registered as unemployed. Some were let go into early retirement,41 others fell out of the official economy and into the shadow one, and the rest postponed entering the labor market by extending their time as students.42 Labor force participation, which includes both people working and those counted as unemployed, dropped in all six countries and bottomed out in 1998 for Hungary and Russia, in 2003 for Bulgaria and Ukraine, and only recently for Poland. For the Czech Republic, the slow downward trend has yet to stop. For people who kept their jobs and got paid, there was yet another source of uncertainty. Reflecting the instability and poor performance of the economies in which they worked, they had to cope with inflation, sometimes on a spectacular scale (Figures 2.6a and 2.6b).When Poland took its plunge into the postcommunist economic transformation, it suffered inflation of 640 percent in 1989 and 249 percent in 1990,43 and even though this number dropped to 55 percent the next year, it never fell below 10 percent until 1999. Hungary and the Czech Republic were more fortunate. Both began with inflation rates in the high 30s. The Czechs were successful in stabilizing prices quickly, but it took the Hungarians until 2000 to do the same. The most devastating price rises occurred in East Europe. Bulgaria, during its crisis of 1996–1997, experienced inflation of almost 1,000 percent, but its reforms in response to the crisis created price stability by 1999. In Russia, an inflation peak of about 800 percent was registered in 1993, and after that it declined steadily. Some of the gains were lost during the banking crisis of 1998, when inflation rose again to more than 80 percent, but since then it has been hovering around 10 percent. Ukraine was hit with the highest inflation among these countries. Its move to independence and the creation of its own currency, the karbovanets, brought on a hyperinflation of 4,700 percent in 1993. In 1996, the karbovanets was replaced by the hryvnia at the rate of 100,000 to 1. The following year, inflation was only 16 percent, but it has been fluctuating ever since, climbing back to 25 percent as recently as 2008. Inflation makes people unsure how much their money will be worth even in the near future and whether they will be able to make up for price hikes with higher wages. From a rational standpoint, customers should be expected to spend more when money is losing value and prices are rising. Their money will be worth less tomorrow, so spending it now lets them buy things they will not be able to afford in the future. In theory, the same goes

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Figure 2.6a  Inflation in China, the Czech Republic, Hungary and Poland (GDP Deflator). Source: World Bank.

Figure 2.6b  Inflation in Bulgaria, Russia, Ukraine and Vietnam (GDP Deflator). Source: World Bank.

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for borrowing: high inflation should make customers interested in borrowing more because expecting even higher inflation in the future will make their loans easier to repay (given that they have confidence in their ability to make their earnings keep up with inflation). As is often the case, the rational model is misleading.44 In times of high inflation, uncertainty erodes consumer confidence so much that people end up spending more conservatively on consumer items. They are also less likely to take out loans that will carry high interest rates even if they expect inflation and interest rates to rise even further tomorrow.45 Lenders are also implicated here: they respond to inflation with interest rates so high that borrowing is deterred.46 To sum up, the macroeconomic instability of the 1990s put consumers on shaky ground. Seeing their living standards worsen and inequality set in amid newly emerged uncertainties about jobs and social benefits, they worried about the future and did not see any use for cards, which many perceived as a luxury product they had lived perfectly well without in the past. European countries thus had to start spreading cards—and especially the more expensive credit cards—among a narrow elite group first, and as the countries’ economies began to turn around, they moved the cards downmarket (which often still required more than gentle persuasion).

the ascent of smiles

While East and Central European countries were shedding tears as they tightened their belts, China and Vietnam had every reason to smile as far as economic growth figures were concerned: in the previous twenty years they had experienced rapid growth, 10 and 7 percent, respectively, on average each year in the 1990s and into the next decade. This enviable growth should be attributed not only to policies but also to initial conditions—the fact that both started from a much lower base than any of the European transitional economies, Vietnam even more so than China. Nevertheless, their gradualist, state-led model of transition has been frequently brought up as exemplary compared to the sometimes out-of-control reforms in East Europe, which were accompanied by hyperinflation, robber capitalism and inevitable 180-degree policy changes due to political pluralism. Even after more than two decades of robust economic advancement, the GDP per capita of the two Asian countries is below those of the European countries, although China

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caught up with and overtook ailing Ukraine a short time ago (Figure 2.3). Overall, China and Vietnam are still far from being affluent. Growth rates aside, however, China and Vietnam resemble the rest of the countries in our sample in that their inequalities also grew during this period, particularly along the urban-rural divide.47 Despite being relatively poor, both countries harbored a growing urban middle class that lived at a level comparable to that of people in the more developed postcommunist countries. By the early 2000s, Vietnam urbanites were earning and spending twice as much as rural folk, and this ratio kept constant over the following decade.48 The lives of the residents in Ho Chi Minh City (formerly Saigon) and to a lesser extent in Hanoi, the capital, resembled those of urban residents in more developed Asian countries; they wore the same knock-off designer clothing, coveted the same electronic gadgets and watched the same Korean soap operas on television as people in Kuala Lumpur or Jakarta. In China, which began its reforms earlier and grew faster than Vietnam, the difference between urban and rural incomes was even larger, with close to a one-to-three ratio by 2002.49 In Asia, however, growing inequalities had the exact opposite effect on payment card markets than in Europe. Rather than limiting initial demand for cards to small groups of elites, inequalities in Asia created what amounted to a two-lane highway of growth. The Chinese and Vietnamese populations were initially too poor to have any use for payment cards. Economic development was necessary to claim a prosperous enough middle class. Although economic growth was rapid overall, it was faster still in cities, where it began from an already higher base around 1990. That meant growing differences between a slowly but steadily developing countryside and the rapidly rising cities, and this spectacular development delivered a metropolitan market by the 2000s that in principle could have been interested in using plastic. These urban markets were of quite substantial size. In Vietnam about a fourth and in China about a third of the population lived in cities in 2000.50 Since then, the numbers have grown to 30 and 50 percent respectively. The Vietnamese urban market is larger than the population of Hungary and the Czech Republic together, while there are more urban Chinese than all the people in the European Union. Because of the spectacular dynamics of their economic development, unemployment has been low in the two Asian countries. Inflation in China and

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Vietnam also has been low and under control since 1996, except for a spike in Vietnam in 2008, when rising commodity prices temporarily pushed the rate above 20 percent. Yet, as we will show, memories of inflation dating to the 1980s did have a negative effect on Vietnam. By and large, China and Vietnam followed a deliberate, gradualist and ultimately successful path, with a great deal of stability in growth. China has a less divided and more effective government and has been more successful than Vietnam, as its higher growth rates demonstrate. This was reflected in the creation of China’s payment card market as well.51

Conclusion The goal of this chapter was to introduce our eight countries and to put their nascent card markets in the wider historical context of their communist past and their market transitions. Emerging from the communist system of monobank finance, a system that relied on a mixture of administrative allocation and cash purchases and that allowed only the simplest and most limited forms of consumer credit, the market had to create its main actors—commercial banks—and set up cooperative arrangements through banking associations and interbank information exchange. It also had to establish the value of bankcards, and this turned out to be extremely difficult during the last decade of the millennium. In Asia, cards seemed to arrive too early in the countries’ development trajectories, because China and Vietnam still did not quite have an affluentenough middle class. In Europe, the problem was similar; the moment to launch card markets was not an opportune one, but this problem was manifested differently. In the Central and East countries in the 1990s, consumers worried about their declining living standards and new experiences of uncertainties related to inflation, the threat of unemployment and contraction of welfare state that used to provide comprehensive and free or heavily subsidized social services. Except for a small elite group who benefitted during the recession, and frequently viewed cards as status symbols, most of the population had no reason to be the least interested in a new payment instrument. Banks—the ones that introduced and pushed cards—were at times illequipped for this task. Socialist banking left a profound legacy in the form of retail giants that captured a large portion of household accounts, more

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often than not resisted innovation and balked at the idea of cooperating with smaller banks. The states differed in their policies on the banking industry: some encouraged the creation of a large number of new domestic banks, often to the detriment of the stability of the banking system and consumers’ trust in banks; others quickly or eventually opened their banking spheres to foreign investment, in some cases after several rounds of bank failures and expensive bailouts; yet others staunchly insisted on preserving state control in the banking sphere, viewing financial services not as a market but as an arm of the state monetary system. The 2000s saw a steep rise in card ownership and use as problems of valuation and cooperation were eventually solved (the latter with the help of the state or the monopoly power of large foreign card networks). In the next two chapters we present the particular puzzles that payment and credit card markets were faced with in the process of constructing markets for cards. The first two puzzles, two-sided markets and standardization, discussed in Chapter 3, are related to the payment function and therefore plague both debit and credit cards. Three more puzzles—information asymmetry, information sharing and market origination and expansion, explored in Chapter 4—are tied to the credit function and affect credit cards only.

three

Payment Puzzles

Starting a payment card network is quite difficult, a point easily overlooked today in countries like the United States, where cards are now ubiquitous. Functionalist perspectives, such as the standard equilibrium analysis in economics, often begin from functioning markets and focus on the factors that reproduce them. Our historical approach leads us to ask a different question: How do markets come about in the first place? Our focus is on the rules and mechanisms that generate markets as distinct from those that keep them going. As we show, generative and functional rules are quite different from each other, and certain factors and mechanisms can be paramount in the genesis of the market but play little or no role in its maintenance, and forces that are central in the day-to-day functioning of markets are insufficient to bring the market to life. In this chapter, we first briefly explain the mechanics of a card market, including the rights and duties of the market’s key actors. We then move on to discuss the problems experienced by developing credit card markets 53

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that originate from the card’s function as a payment mechanism. As a means of payment alternative to cash, cards require that a complex system be in place, a system even more complex than the one supporting universal acceptance of a national currency. We discuss here two puzzles that market makers face. The first is how to recruit two types of customers—individuals to carry cards and merchants to accept them—simultaneously and in a complementary fashion. The second puzzle is how to standardize card technology across multiple card issuers. Failing to achieve complementary growth would stall the market entirely, while inability to standardize would result in a market fragmented by several incompatible card brands. The first puzzle is a valuation problem, the second is a problem of cooperation. We conclude with a brief review of how these problems were solved in the United States and in the transitional countries.

How the Card Market Works An entry point to the system is when an individual signs up with a card issuer, usually a bank, to become a cardholder. The issuers of debit cards are typically banks where individuals keep their money. In this case, the issuer requires the cardholder to retain a certain amount of money in an account controlled by the issuer and from which each charge is promptly paid. Credit or charge cards, which we discuss in the next chapter, do not demand a deposit account and can be issued by specialized card companies, such as American Express, in addition to banks, and the cardholder is regularly billed by the issuer to pay the charges. A charge card requires monthly payments in full; credit cards allow paying a small proportion of the overall bill each month (a minimum payment) while interest accumulates on the unpaid portion of the bill. Cards are an alternative means of payment meant to be used instead of cash to make purchases in shops, restaurants, hotels, and other merchant locations. To be able to accept and process cards, a merchant contracts with an acquirer—usually a bank other than one that issues cards—which enrolls the merchant in the system, provides it with the necessary card-accepting equipment, sets up communication lines for authorizing card purchases and passes on the merchant’s claims to other banks for processing and account settlement. Acquirers can do these functions in-house or outsource them to

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third parties, which usually charge per-transaction authorization fees and per-account and per-year processing fees. When a cardholder hands over the card to a cashier, the information from the card that identifies the user and the account, along with information about the transaction and the merchant, is sent to the acquirer. The acquirer verifies that the merchant is one of its own and forwards the information through a series of intermediaries to the issuing bank, which determines whether the card is valid and the cardholder is authorized to spend the amount to be paid. If everything is in order, authorization flows back through the acquirer to the merchant, who now knows it can accept the card for payment. Whereas a cash transaction involves only two actors—the customer and the merchant—paying with a card is a much more complex operation, involving an additional host of actors (the acquirer, the issuer, and possibly a few others who provide back-office support for the acquirer and the issuer). All of the intermediaries need to be paid. For this reason, paying with cards is considerably more expensive than paying with cash or even by check.1 It is typically the merchants who pay the lion’s share of this additional cost. When the card is authorized by the merchant, the cardholder is charged, either from the deposit account or from the credit line, and this money is passed by the issuer to the acquirer. The acquirer then passes the money on to the merchant, minus the merchant’s discount—1 to 3 percent of the purchase value depending on the card, the transaction and the contract between the acquirer and the card network. The acquirer keeps a small portion of the merchant discount while the larger portion, called the interchange fee, goes back to the issuer. The issuer also collects the money from the cardholder, immediately and automatically for debit cards and sometime later for charge and credit cards. So, if the merchant sells $100 worth of goods, he may be reimbursed only $97, and the $3 is split between acquirer and issuer, with the issuer getting a larger chunk. Regardless of whether the card is processed through a multinational or through a local card processing company, the processor who at minimum services the electronic pathways of communication through which the card information travels must also be paid. The processor receives payment from both the acquirer and the issuer, usually in the form of a flat user fee. Thus the acquirer makes money from its share of the merchant discount; the issuer makes money by collecting the interchange fee plus whatever it charges the cardholder in the form of an-

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nual fees, interest, penalties and so on; the processor collects a subscription fee from the issuer and the acquirer; and card networks collect membership dues from member banks. In spite of being two of the most successful corporate brands, Visa and MasterCard have until only recently been nonprofit associations, essentially clubs of (profit-seeking) banks. Their main job has been to set and enforce the rules (such as interchange fees), resolve disputes and maintain their brand through advertisements.2 Just as in any club, banks must fulfill some requirements to join. For instance, they must have a certain rating that indicates that their operations are sound. If a bank does not make the grade, as happens in some of the postcommunist countries, it can still join Visa or MasterCard as an associate member with limited rights if it can find a guarantor (usually a larger and better-rated bank) to vouch for it. Until recently, both Visa and MasterCard were owned by their partner banks that had full membership status. This, however, is changing. Visa went public and started selling stock in March 2008. MasterCard, which began with the same nonprofit model, separated membership and ownership by putting itself up for sale two years earlier, in 2006. So far, however, these public offerings have not resulted in any significant changes besides the fact that both Visa and MasterCard stock is now traded on the New York Stock Exchange. American Express, Discover and Diners Club are not clubs but for-profit corporations. Their unitary system is similar to the one just outlined except a single company is the acquirer, the issuer and the processor rolled into one. Recently, American Express moved toward a hybrid system when it started to franchise its brand to interested banks. These companies issue charge cards and credit cards, never debit cards, because they do not keep or manage deposit accounts. In countries where the law prevents nonbanks from issuing cards, such as Russia and Hungary, American Express and ­Diners Club were forced to change their formula and set up card dissemination through local banks.

Competition with Cash The most serious rival to payment cards is cash. When cash rules, cards have a hard time gaining ground. In the United States, cards were first positioned as safer alternatives to checks, making smaller merchants particularly

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interested in accepting them. The merchant discount could therefore be viewed as a price to pay for assurance that the issuing bank stands behind the payment. In transactions involving personal checks, no such guarantees are given: if the checking account does not have sufficient funds, the check is bounced and the merchant that accepted it incurs the loss. In socialist shortage economies, cash did not play the same role it does in market economies: access to consumer goods and favors were more important than cash on hand, resulting in monetary overhang and forced savings. Hyperinflation in the early 1990s wiped out the savings and solved the overhang problem. Market reforms and trade liberalization saturated markets with consumer goods, eliminating the importance of access and elevating cash to the supreme position. But the more central cash is to consumer payments, the more difficult it is for cards to elbow it aside, and vice versa. A Russian example is a case in point. There was a brief period in the mid-1990s when many smaller Russian towns were faced with the problems of wage arrears, shortage of cash and even occasional reliance on payment of wages in an enterprise’s own output. These circumstances spearheaded introduction of payment cards by local governments as a way to reduce social tension and provide local populations with access to consumer goods. Cards were welcomed out of necessity—because cash was not available.3 The 1990s also brought another challenge to cards, however: the growth of an informal economy with exclusive reliance on cash, which to this day is a barrier to card issuance and acceptance in many of the postcommunist countries, particularly in Russia, Ukraine and Bulgaria. We address this challenge in Chapter 6, where we focus on the three East European card markets.

The Puzzle of Two-Sided Markets The success of the payment card depends specifically on how competition with cash plays out in two groups of clients: those who use the cards as payment (the cardholders) and those who accept the cards as payment (the merchants). In fact, the payment card is nothing more than a platform where these two groups can meet for business. The value of a card for a cardholder depends on how many merchants are willing to take it as a means of payment, and the value of a card for a merchant depends on how many people have and want to use cards. This

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is why credit card markets are called two-sided markets: the card company must sell its product to two sides that are interdependent.4 Two-sided markets are not uncommon. Card companies are in a position similar to real estate developers, who need both residents and businesses to build a new community; to advertising directories, which must attract both advertisers and readers; and to art galleries, which have to get artists to sign up and art collectors to come and buy art. Universities too must compete, for both faculty and students. The challenge is to attract two crowds simultaneously.

critical mass

Two-sided markets raise not one but two problems. The first challenge is that it is difficult to get the market going because in the beginning neither cardholders nor merchants get much for their money. Only when a critical mass is achieved on both sides will it be worth it for individual consumers and retailers to buy into the card system. Suppose you are a developer and want to build a new upscale community in the Arizona desert. The nearest city is an hour away by car and you are building pricey homes. You will need residents who are willing to settle there, but you will also have to have other things. You can build a golf course and put in trees, but to make the place really attractive you will also need cafes, bookstores, movie theaters, and a large number of good restaurants of various kinds—in other words, you will need many businesses that will make the community an attractive place to live. Developers often build commercial space in addition to residences, but that space still needs to be leased to retailers. You will need at least a few thousand residents to attract more than the usual supermarket next to a gas station plus a Dairy Queen and a diner. To draw more than a handful of residents, you will have to have at least some attractive cafes and restaurants already in place. Worse yet, in your business, time is of the essence. You borrowed a lot of money to build this place and you cannot have the houses sit empty for long. But no cafes may mean no home sales, and weak sales and no critical mass of affluent residents will not attract good coffee shops. The same is true for other two-sided markets: to be attractive to prospective advertisers, directories need to already have a wide customer base, but consumers will not want directories unless they contain a large number of informative advertisements and coupons. Seasoned art

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collectors will not visit a gallery that has not represented valued artists, but well-respected artists are unlikely to sign up with a gallery that is unknown or untrustworthy to buyers of art. Left to their own devices, each side will just sit and wait for the other side to act first, and nothing will happen. All two-sided markets are by no means similar in every respect. For instance, although affluent retirees buy homes independently of one another in areas that cater to people with socially active lifestyles and rarely consult the roster of residents who already live there, professors about to join a university department do care who exactly their colleagues are going to be, and certain professors will attract not just students but other professors as well. Therefore, when starting a new campus, hiring someone famous is usually a good first step.5 The same is true in the art world, where wellknown artists are an attraction not only for art collectors but also for other artists who may consider it important to exhibit their work alongside other famous works of art. In other words, two-sided markets can differ from one another, and their generative rules will not be the same, but all of them must somehow solve the problem of critical mass on both sides.

balance

The problem of critical mass is compounded, however, by a second puzzle of two-sided markets: the problem of balance. The two sides may not be equally inclined to join. To continue the real estate development analogy, homebuyers and businesses may not be equally motivated to relocate. Some people will come in any case. They will like the vista of the desert, the floor plan of the houses and the large yards: they will be the optimists who believe that in a few years the community will flourish. But businesses unimpressed by the beauty of the landscape will not open until they see there are enough potential customers. To entice them, you will build them premises and give them a discount on their leases or pay for their utilities. But now they will cost you money and the more successful you are in bringing them to your community, the more you will have to pay. One possible way to recoup the money is to charge a bit more for the homes. After all, with more and better retailers around, the development becomes a more appealing place to live. And the extra money can then be passed on to the cafes and bookstores as additional perks. Higher home

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prices, however, may reduce the number of residents, and now even the optimists will think twice before buying here and may instead choose a more affordable town. Then you will have to pay businesses even more to set up shop in your community in order to attract homebuyers. In short, you will need to find a balance between the incentives extended to the two sides. Therefore, there has to be a mechanism that effectively transfers a part of the house prices to the businesses. If the developer builds and leases both the business and the residential property, this transfer is trivial. It is just an internal accounting exercise. Businesses do that all the time. Grocery stores give discounts on milk but charge more for cereals, along with the bread and the oranges. Because it goes to the same cash drawer, the stores will break even and perhaps even do better if people who would have gone elsewhere to shop are lured in by cheap milk and buy a lot of other things at regular or increased prices. If, however, there is one service company that deals in residential and another in commercial real estate, then without some transfer, the residential developer will make money and the commercial developer will operate at a loss, which will ultimately affect the residential developer as well because few homebuyers will want to move into a neighborhood with hardly any retail and service venues. For both developers to stay in business, the residential company must transfer some of its income to the commercial company. The latter can then use this additional revenue to get more business, which will in turn benefit the residential side. In a simple competitive market, the price mechanism will not produce the desired outcome but will result instead in a market failure: the community will not be built or it will be a financial disaster. Economists say the price is wrong because it does not internalize costs and benefits. This means two things: First, the extra efforts of early real estate developers will benefit later ones because getting the first residents and cafes costs a lot, because they have to be given a very good deal to join. Second, the extra efforts of commercial real estate developers will benefit residential developers more than the other way around, because, as in this example, businesses are more reluctant and need an even better deal than homebuyers to locate to a new area. Cardholders and merchants are like homeowners and cafes, and the card companies’ job is to hook them up. Each side has to reach a certain absolute number for the business to get going. If there is only a single shop in town that accepts payment cards, few people will be eager to get a card. If the vast majority of customers want to pay with cash or are indifferent about paying

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with a card or cash, merchants will not forfeit a percentage of their income to be able to accept cards, because selling on cards costs money. In the credit card market, it is harder to convince individuals to switch from cash to cards and easier to get businesses to accept cards in lieu of cash. This is because merchants compete for customers, and if one merchant does not accept cards while others do, that merchant can lose clients. This possible outcome gives them an additional incentive. Therefore, when they make a decision to sign up to accept cards, merchants look not only at their customer base but also at other merchants: do they already accept cards or not? If they do, pressure is put on all merchants to also find an acquirer (a bank that will process store card transactions) and join the system. Although it may be equally difficult to sign up the very first merchants and the first cardholders, after at least a few merchants have already accepted cards, the pressure of competition will aid card acquirers in attracting other merchants. The same is not true for customers. The fact that your neighbor has a payment card might make you more interested in getting one if it is perceived as prestigious to be a cardholder.6 But even in this case, one would not feel pressure to actually use the card to pay for purchases rather than just have it in one’s wallet and brag to others about it.7 This difference between merchants’ and prospective cardholders’ motivations to join the card market has to do with what cognitive psychologists call the asymmetry of loss avoidance: people are more motivated to avoid an actual loss than to achieve the same future gain, all else being equal.8 The hurt of losing $50 is larger in magnitude than the pleasure of gaining $50. If merchants believe that by not joining the payment card system they will lose potential sales, they have a more powerful incentive than getting a new service, which is the reason cardholders sign up. This is why nascent card markets must push stronger on the consumer side. This is why the interchange fee, the compensation of the issuing bank, which faces a harder task than the acquirer, is the largest part of the merchant discount. To the extent that issuers put greater effort into recruiting than acquirers, it is necessary to make the portion of the merchant discount that issuers get (the interchange fee) substantially larger than what is taken by acquirers. However, this disparity may be justifiable only in the case of nascent card markets. The vigorous, often passionate debate in the literature9 over the proper size of the interchange fee is then myopic in that it often fails to distinguish between emerging and mature markets, conflating generative and functional rules. A sizable interchange fee may be necessary

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to generate the market, but it becomes a source of rent and inefficiency in a market that is already up and running. Once there are enough cardholders, a high fee pocketed by acquirers simply pushes prices up for every­one, and it is time to cut it drastically. As discussed in more detail in Chapter 5, this is precisely what the European Union decided to do in 2007.10

The Puzzle of Standardization In most countries, there is a single currency and when cash is used as a means of payment the only aspect of a banknote or coin that matters is its value. The bills are fully fungible, and it does not matter in the least which particular note is used. Bills of the same denomination are all alike.11 This is not surprising because there is a single issuer. Cash can be printed or minted only by the state, and anyone else who tries is dealt with harshly. Payment cards, however, are issued by thousands of banks in the United States alone. In principle, each card could be different, with its own size, shape and technology. In fact, all cards look almost identical, all fit into the same slot, all have a magnetic stripe and all have it at exactly the same place: across the back of the card below the middle.12 Each card can be inserted into readers in four different ways, but only one way is correct, making it a universally frustrating experience for all of us. But when we succeed, all cards can be read by the same automated teller machine (ATM) or point-ofsale (POS) terminal. In principle, we could see a battery of card readers, each based on a different technological platform, on each checkout counter, but usually we do not. Moreover, once a card is read, it is processed by the same machines, using the same technical codes and conventions for all cards, even if the databases—the ones that store the information necessary for authorization and settlement—are different. In fact, the same technological system can take care of the payment after the card is used by the merchant, regardless of which bank issued the card. The information is routed differently depending on whether the card is a Visa, an American Express card, a credit card or a debit card. So not everything happens exactly the same way, but the user interface is the same, and cards of the same brand are processed in the same manner regardless of the card’s issuer or the merchant’s acquirer. This is a remarkable system because it requires all issuers to agree on a series of common standards. Standards are very powerful once they are in

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place and they have their own inertia and ability to enforce themselves.13 The hardware and software that are based on these standards and that make the card system work require a huge investment, but once they are developed and implemented, they are inexpensive to operate. They have enormous economies of scale. Once all POS machines accept only cards of a certain size and type, and once card processing uses only certain software, newcomers to the card market have little choice but to submit to the common technology unless they are willing to develop and deploy their own at great expense. In the beginning, when a market is just being established and technology is still up for grabs, many different standards are possible and competitors must somehow commonly settle on one of them. In fact, the history of technology is replete with vicious fights over standards, be it the recent war between the HD DVD and Blue Ray formats, the epic struggle between IBM and Apple, or the once famed but now long-over battle that videocassette maker Sony and its Betamax format lost to Matsushita, the creator of the VHS cassette.14 Seeing one’s standards adopted as community norms carries rewards. If a standard is proprietary, as with most technologies, its owner can shut out competition or collect rent for using the standard. Even if it is an opensource standard—for example, the metric system—it is beneficial to have others adopt your standard rather than you adopting theirs. Switching is costly, which is why the United States still uses miles and inches rather than kilometers and centimeters. For consumers of technology, the switch requires an adjustment in mental disposition, skills and practices. This is one of the main reasons that the QWERTY keyboard has never been replaced despite the availability of viable alternatives. It was originally designed to slow typists down because typing too fast on the original machines frequently led to keys sticking together. Subsequent improvements to hardware and eventual production of computers solved the problem of stuck keys, but by that time, scores of professional typists and lay users had already adopted the layout, memorizing and internalizing it to the extent that it became as natural to them as riding a bike. The QWERTY keyboard became locked in and virtually impossible to change, even though other layouts can make typing faster and more convenient.15 For payment cards, the magnetic stripe, invented in 1960, is becoming the equivalent of QWERTY. When chip technology emerged in the 1980s,

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everyone recognized that cards with a small embedded microchip are safer than cards carrying vital information on a magnetic stripe, because a stripe is much easier to counterfeit; it also holds much less information than a chip. In the United States, the magnetic stripe technology was introduced first, however, and is still dominant.16 The puzzle of standardization, of how competitors come to agree on a common technology, is closely related to the puzzle of the two-sided market. Both puzzles are based on the fact that some things work better and attract new users when many people are already using them. This effect is often filed under the label “network externalities,” because as a network of users grows, each new member makes the service or good more valuable for the next member.17 As a result, as with all path-dependent processes, both puzzles are hard to solve because early adopters will not yet enjoy the advantages of having others on board, and solutions to both of them will be hard to change once they pass a certain point. Standardization requires critical mass in one group, two-sided markets need a critical mass in two complementary groups and the proper balance between them. Not only do the puzzles of two-sided markets and standardization belong to the same category of problems, but in card markets their solutions are also related. Specifically, solving the standards problem for payment cards will make the solution to the two-sided market puzzle easier. Markets that have coexisting incompatible standards are essentially fragmented into separate clusters, each with its own standard, and each facing its own two-sided market problem. In card markets, only those merchants that accept the card of a particular standard matter when potential cardholders are considering signing up for the card. So when different card issuers are pushing for cards that use incompatible technologies, they inevitably undermine each other’s efforts in attracting the critical mass of merchants and cardholders. Compatibility, on the other hand, creates bigger pools of both. It also helps potential users actually make the switch from cash or checks to cards. If merchants can buy only one machine to fit a single system, they will be more willing to adopt electronic payments. In a similar fashion, if consumers find that the card is accepted by all POS machines, not just those of their issuer, they will be more likely to want it and use it. If we imagine the card payment as passing through a chain stretching from merchant to customer, the two-sided market is the puzzle of how to create the largest numbers on both ends. The standards problem is how

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to channel the largest number of transactions through a single chain linking the two extremities. The first puzzle is concerned with the marketing and selling, the second with the servicing of the card.

Creation of the Payment Card Market in the United States How were these problems solved in the United States? How did the current card-based payment system emerge? Payment cards have been around since 1914, when Western Union introduced a paper charge card that identified the customer and the account from which the charge was later deducted. By the time the legendary founder of Diners Club, Frank X. McNamara, came up with the idea of a card to pay for meals in several unrelated New York City restaurants in 1949, payment cards were already being issued by merchants, such as department stores, gas stations and hotel chains, to their own customers. Cards helped stores to extend store credit to customers. All cardholders had to do was show the card, which instructed the shop owner where to chalk up the charge, allowing them to “buy now, pay later.” This system worked well as long as people stayed in one place and made their purchases in a single store. Hotel and store chains could allow for some limited mobility of customers. A card issued by Shell Oil, for instance, would be honored at Shell stations across the country. Still—and this was one of the main reasons such cards were attractive to merchants—they chained their holders to a particular vendor. With the post-World War II economic boom in full swing and more and more people traveling on business, the limitations of the one-merchant one-card system became obvious. McNamara’s invention was a two-sided market that released the consumer from the clutches of a single retailer. He conceived and implemented the Diners Club card not as a credit card but as a charge card. Its balance had to be paid off at the end of each month and there was no interest charge. The card’s main target was the traveling businessman, who could better keep track of his expenses with the monthly statements he received. But more than just an instrument of accounting convenience, the card became the basis of a new payment system. Although the Diners Club card has never been a credit card, there were at least two reasons it became known as such. First, charge cards do extend limited credit for the duration of the billing period, even though they do not

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charge interest. Because the charge card was partly rooted in store credit, calling charge cards credit cards was an easy slippage. The source of the term credit card was the futuristic novel Looking Backward: 2000–1887 by Edward Bellamy. Written in 1881 and published six years later, the novel describes how Bellamy imagined the world would be by the end of the twentieth century. One of the features of his utopian society was the credit card, which replaced cash entirely: A credit corresponding to his share of the annual product of the nation is given to every citizen on the public books at the beginning of each year, and a credit card issued him with which he procures at the public storehouses, found in every community, whatever he desires whenever he desires it. This arrangement, you will see, totally obviates the necessity for business transactions of any sort between individuals and consumers.18

In fact, Bellamy, a socialist, saw the credit card not as just the end of money but as the end of commerce. It is an irony of history that Bellamy’s socialist idea was never seriously entertained by socialist countries but that a form of it did emerge in capitalist economies. Notice that the “credit” in Bellamy’s credit card had nothing to do with borrowing; it referred to the wages of the person. The publicists of Diners Club at its founding, the Simmons brothers, were strongly influenced by Bellamy’s idea of a nationwide payment card and kept Bellamy’s term.19 The confusion between payment and credit cards has been with us ever since, and in most postcommunist countries any plastic payment card is called a credit card by the public and the popular press. To get its two-sided market started, Diners Club distributed its payment cards to consumers for free and charged restaurants and other establishments a 7 percent merchant discount.20 Several large companies resisted accepting credit cards precisely because they already had their own cards and they did not see the benefits of the new card that would cost them 7 percent of each transaction. The CEO who replaced McNamara, Alfred Bloomingdale, could not even sign up the famous department store his grandfather had founded in New York. However, in major cities some smaller establishments that could not issue their own cards did sign up, mostly through personal connections with the founders. Yet even they often found the 7 percent merchant discount excessive. At one point, Milwaukee restaurant owners revolted and demanded that it be lowered. They were not successful: competition and lack of organization prevented them from dictating

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their conditions to the issuers, and from resisting the card altogether. To the great benefit of Diners Club, small merchants suffered from a classic collective action problem: once a few key merchants at a local market got on board, others could not stay ashore or jump ship. Those who refused cards risked losing customers. That is how Matty Simmons, then vice president of ­Diners Club, described their predicament: If all the better restaurants in a city dropped out, their customers would simply have to pay cash. One or two restaurants leaving alone would be at a competitive disadvantage: they would not be able to offer the convenience and service of the credit card to be found at another establishment. A successful organized boycott could literally have us at the mercy of the restaurant owners and could spread throughout the world.21

Resistance notwithstanding, more and more merchants were coming on board, convinced that cards would increase their sales.22 And the sales did increase, because the free cards gave customers several benefits. First, they were convenient. They also produced useful receipts. Most initial users were traveling businessmen who used cards to pay their business expenses. A single monthly bill payable to the card company made it easy for them to write their expenses off their taxes or to get reimbursed by their employer. These benefits alone, however, would probably not have been sufficient to attract an average cardholder, so the founders decided it was also necessary that cardholders be given the service for free and the entire cost of the system was shifted to the merchants. Indeed, initially the card was free, and the annual fee introduced a year later was only a nominal amount. Its main function was to weed out nonusers who received their unsolicited cards in Diners Club’s mass mailing campaigns. To make the card more appealing to merchants, Diners Club produced a newsletter, the Diners Club Magazine, which it sent with the statements to its cardholders. It featured restaurant reviews penned by the Simmons brothers that gushed about businesses that had already joined the system. Thus Diners Club rewarded its merchant clients with free advertising. It was also important that Diners Club’s initial customers were mostly well-heeled businessmen whose patronage was highly valued by better restaurants and whose habits and needs were well understood by Diners Club’s leadership, who were well-off businessmen themselves. It was no coincidence, therefore, that Diners Club began in New York City. Just like the electrical industry, which had also needed a critical mass of

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customers in order to take off several decades earlier,23 Diners Club banked on the largest and most densely populated metropolis in the United States. Producing the critical mass was easier in a city abundant with restaurants and office buildings, all in close proximity to one another. The first dining establishments that were signed up to accept Diners Club cards were the ones whose owners the founders knew personally. On the other side of the two-sided market, McNamara began recruiting customers by pushing fliers under office doors in the Empire State Building, where ­Diners Club had set up its own office. The first two hundred card owners were also friends and acquaintances of the founders, and all well connected in the New York business world. Once the initial social networks were exhausted, Diners Club mailed out thousands of unsolicited free cards using various subscription lists to reach out to a much larger group of New York City merchants and businesspeople. Heavy publicity did the rest and helped Diners Club cards to get beyond New York’s boundaries.24 Although merchants were pressured to accept cards if their competitors did, there was no equivalent pressure on individuals to become cardholders. Even though Diners Club tried to advertise the card primarily as a prestige good, not just as a product of convenience, status pressure on customers was much weaker than the competitive pressure on merchants. The card’s ultimate success depended on Diners Club’s ability to redistribute costs and benefits between the two sides of the market through the interchange fee, making merchants subsidize most of the issuing banks’ operating costs. The critical mass problem was therefore solved with the help of the uniquely high density of restaurants and potential cardholders in New York, the social ties of the founders, unsolicited distribution and relentless advertising. The balance problem was resolved by transferring the costs of card issuing and operation to the merchants. The original Diners Club card was not at all like the card we know today. In fact, it was a small booklet shaped like a business card with a cardstock cover printed with the holder’s name, account number and address and a signature line.25 The subsequent pages of the booklet listed the establishments that accepted the card. The information had to be copied by hand by the retailer. In 1928, Charga-Plates—small metal cards on which the information was embossed—came into use. With the help of a layer of carbon paper, one could transfer the necessary information from the card to the payment slip mechanically by pressing the carbon paper and the slip

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against the uneven surface of the card. Although Charga-Plates reduced the mistakes that often occurred while merchants copied the information, and ensured that the information was legible, they were relatively heavy. The plastic card, introduced by American Express in 1958, had all the advantages of the Charga-Plate but was much lighter. American banks were also eyeing the card business. Several of them tried setting up their own card systems in the late 1940s and 1950s, before the appearance of the first true and widely accepted credit card, the BankAmericard, later renamed Visa, in 1958. Banks wanted to expand the market beyond the select circle of businesspeople and establish the payment card as a mass product and a tool to access credit. Many of the early adopters of cards quickly abandoned the business, but those that stayed had to solve the problem of standardization. At the very least, card issuers needed to agree on a card format, on how to identify the cardholder, and on a design for merchants’ charge slips. At that point it was not yet a question of technological compatibility, because transactions remained paper based, but an issue of consumer and merchant recognition and overall processing efficiency. Efforts toward standardization came from three sets of actors: (1) large card issuers attempting to develop their card brands, (2) associations of banks or other card issuers and (3) the state. Some of these efforts were directed specifically at standardizing card processing, others were part of a more general process to standardize interbank operations. During the 1950s, several banks attempted to establish large card systems either by involving their own branches or by relying on other banks.26 For instance, Florida National Bank established the first statewide card operation in 1957. Bank of America followed suit in California. In 1966, Bank of America started to franchise its BankAmericard brand to other banks throughout the country. In these cases, the leading bank developed and imposed its standards on other banks. The bigger the system became, the easier it was to attract subsequent participants. To counteract the actions of large card issuers such as Bank of A ­ merica, smaller banks organized to form associations that supported alternative brands and helped standardize cards and card processing. The Charge Account Bankers Association, founded in 1954, purchased large quantities of similar cards and initiated standard accounting and processing procedures.27 Several other card associations (among them the California Bank-

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card Association, later renamed Western States Bankcard; the Midwest Card Group; the Eastern States Bankcard Association and the Interbank Card Association) adopted the Master Charge logo. The standardizing efforts in the American credit card market were happening in two parallel fashions—separately among banks belonging to the Interbank Card Association, and among those that acquired BankAmericard franchises from Bank of America. These groups were the precursors of the MasterCard and Visa networks. Their efforts were directed at standardizing the rules of interchange and regulations dealing with fraud. The separation between the two groups of banks was aided by antiduality provisions that at that time limited issuing banks to only one card brand (in the case of Bank­Americard, this rule was part of its bylaws). Merchants also typically accepted cards from only one issuing bank. In 1974, the U.S. Justice Department issued an opinion suggesting that this practice might in fact violate antitrust laws, particularly in the light of emerging debit card systems and electronic fund transfers. As a result, the two card associations faced the need to develop standards for a national interchange system.28 In addition, as early as 1968, various actors in the credit card market— which included, in addition to card issuers, the manufacturers of cards, card equipment and printed forms—addressed the need to establish uniform standards with the American National Standards Institute. Standards were issued in 1971 and revised in 1973. They established the size of the card, the location of the signature panel, the features of the magnetic stripe, the look of the embossed characters on the face of the card, various encoding protocols and, most famously, the uniform way of numbering accounts. The latter feature was supposed to facilitate the interchange of credit card slips. These standards were to be applied to all plastic cards, including American Express, Diners Club and merchant-issued cards.29 It is unclear from available accounts whether the standards that were adopted benefited some banks or some associations more than others. Never­ theless, one thing is clear: the establishment of universal standards was aided by the fact that it happened in an era before different card issuers and merchants’ banks had a chance to invest in expensive computer-based card-processing technologies. In the early 1970s, computerization began to transform the card industry.30 In 1971, electronic POS machines and ATMs inaugurated the magnetic stripe. By that time, the key standards were already firmly in place.

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Postcommunist Solutions to Payment Puzzles When payment cards were introduced in the postcommunist region, they managed to help solve several problems of monetary exchange that were either a legacy of socialism or characteristic of the transitional period. While individual consumers and merchants resisted adopting this new product, banks, employing organizations and the state quickly figured out the advantages that payment cards brought to various monetary transactions. Prior to the arrival of cards, workers’ salaries in all the countries had traditionally been paid in cash. Payment cards were introduced on a mass scale in connection with salary projects, which furnished workers with bank accounts and direct-deposit schemes. These arrangements made payment of compensation easier and less expensive for employers. In ­Russia and Ukraine, factories and plants no longer needed to transport cash salaries to their premises, and store and distribute them to workers individually while the rest were patiently queuing behind them, their duties put on hold. Workers, who had no choice but to take the card, were also believed to benefit; they could now withdraw cash gradually and in private rather than receiving it all at once in front of their coworkers, or they could even use the card for noncash transactions in factory cafeterias or in some local retail stores.31 The workers themselves were less convinced of these benefits. In Central Europe, bank cards were pushed mainly by the new owners of privatized enterprises. With the quick arrival of foreign capital, foreign owners familiar with the advantages of payment cards were interested in enjoying their benefits in Central Europe as well. Multinational companies such as General Electric and British Petroleum that came to the region often preferred to continue banking with foreign banks they knew and trusted. Multinationals also demanded charge cards for their top executives and managers, who frequently traveled abroad for meetings or training sessions. While salary projects provided recently formed local banks with an easy way to attract capital quickly and widen their customer base, foreign banks found the salary projects of their clients a convenient springboard for plunging into the pristine waters of postcommunist retail banking. Ultimately, salary projects helped to set the stage for the eventual development of credit card markets in the region.

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A particularly prominent role in promoting salary projects was played by transitional states. Despite ongoing privatization efforts and the creation of new private firms, the state remained the biggest employer in areas such as education, health care, defense, the postal service, the national railroads and government bureaucracy. If banks wanted to increase the number of cardholders, it was logical to go after the state and its employees. Thus, in addition to being applied to workers at steel-rolling plants and confectionary factories, salary projects were also administered to groups of doctors, teachers, university professors, government bureaucrats of all ranks and stripes, soldiers and members of parliament as the state contracted with a few lucky banks to disburse the salaries of state employees. Later the idea was even transformed into “social benefits” cards and issued to college students, retirees and other categories of citizens who received various forms of welfare provision. It is ironic that the initial success of plastic cards—payment instruments that were developed in the depths of the capitalist economy and that promised to bring postcommunist citizens into global capitalist markets—relied so heavily on socialist legacies. What made salary projects such a powerful tool in solving the puzzle of two-sided markets was that the decision to carry a salary card was not made by the consumers. It was their employers who decided to enter into agreement with the banks to have the salaries of everyone on the company’s payroll directly deposited to the bank and to issue a card, whether employees wanted it or not. This coercion was not unlike the socialist tradition of employer paternalism. In socialist economies, workers typically had long tenures at their enterprises. Turnover was limited by restrictions on geographic mobility, but to encourage retention even further, enterprises took care of their workers by providing them with in-house health care, day care and summer camps for their children, discounted vacation and resort passes and low- or no-interest loans. This kind of paternalism was especially prominent in China, where it was called the “iron rice bowl” policy, as well as in Russia and Ukraine. Even in the more developed Central European communist countries it had played some role. Using the workplace to issue plastic cards therefore drew on a long communist tradition. Armed with salary project agreements, postcommunist banks could issue cards at a much higher speed than McNamara’s charge card project. None of the postcommunist salary cardholders had to be cajoled one by one: as long as the bank was able to appeal to the company, the employees were

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coerced into becoming cardholders. Companies had a lot to gain from salary projects, and the bigger the company and the more people it employed, the more new cardholders the bank could sign up at once. In China, at least initially, multinational payment cards had a peculiar niche. Because the Chinese interbank system of claims settlement was tardy and unreliable, entrepreneurs often decided to settle their wholesale purchases using their personal Visa cards. In the early years of the Chinese card market, therefore, Visa could benefit from the backwardness of Chinese banking. The future of the payment card market in China was also laid by anticipation of the 2008 Olympic Games together with the already growing tourist industry. The influx of millions of foreign tourists compelled the Chinese government to orchestrate a big push to expand its own national payment card network, called UnionPay. In Central Europe, tourism was also a factor. Merchants in Hungary, which by the 1980s was already one of the most frequently visited destinations in the region, and in the Czech Republic, where tourism exploded in the 1990s, had to accommodate foreign visitors who wanted to avoid handling strange-looking banknotes obtained from moneychangers charging obscenely high commissions. Because most of these foreigners came armed with Visa, MasterCard and American Express cards, these cards’ logos were soon prominent in the hotels, restaurants and shops of the main tourist destinations of Budapest, Lake Balaton, Prague and Karlovy Vary. In Poland, the crowds of tourists were complemented by a large number of Poles who worked abroad and needed to access their foreign bank accounts during their visits home. The standardization puzzle was also solved in ways peculiar to postcommunism. In some countries, such as China and Bulgaria, the state stepped in and created the common technology that became the infrastructure of the card system. In other countries, the banks had to find ways to cooperate and the success or failure of these attempts depended on the structural characteristics of those markets, a point we return to later. Upon scrutiny, we will see that, left to their own devices, banks in Russia, Ukraine, Vietnam and Central Europe had great difficulty solving the standardization problem on their own. By and large, the problem of standardization in Central Europe was resolved ultimately by the entry of the multinationals, which forced their processing system on these markets. In Russia and Ukraine, market actors and policymakers hotly debated the possibilities of creating national

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payment systems based on one of the domestic brands. However, with the passing of time and the dominance of international over local brands, it became less likely that any domestic brand, even if backed by the state, could successfully resist the ever-expanding presence of MasterCard and Visa cards in those markets. To sum up, the two-sided market puzzle was solved in postcommunist countries in ways that were unthinkable in the United States. Mobilizing the remnants of socialism, postcommunist states intervened forcefully, mostly denying rather than offering choice to consumers. In the process, they generated millions of cardholders, which helped the consumer side of the market—the one that needed the bigger push—enormously. This success gave card acceptance value in the eyes of merchants. With merchants on board, cards also became more valuable to consumers, although much less so than expected. In Vietnam, where the state took a much longer time to step in, the payment card system developed much more slowly and depended much more on the resourcefulness of urban banks in Hanoi and Ho-Chi-Minh City. The standardization puzzle—how to force banks to cooperate by accepting a common card-processing system—got resolved either by state intervention or by the conquest of the multinationals. The state deployed its political power and the multinationals employed the market power of the duopoly of Visa and MasterCard. Where neither of the two mechanisms was available, as in Vietnam or in Central and East Europe for the first few years of the market, important banks refused to cooperate and the lack of standardization posed a serious obstacle to market development.

four

Credit Puzzles

The previous chapter focused on the problems of developing markets for payment cards, but credit cards are much more than just a means of payment. They also provide their owners with access to small multipurpose personal loans, whenever cardholders need it and wherever cards are accepted. As personal loans, credit cards pose a problem of uncertainty for card issuers, who lend money and want assurance that the loan terms will be honored. In this chapter we analyze a particular shape taken by the puzzle of uncertainty—­ information asymmetry—and we discuss methods that card issuers can use to solve it. A common method of solving the information asymmetry puzzle is for card issuers and lenders to share information about their past and present cardholders and borrowers. Yet despite the obvious benefits of this solution for the market as a whole, individual lenders typically resist such sharing. We address this resistance as another puzzle—that of information sharing. Finally, because markets are dynamic creations, past data, even if pulled together, are valuable for predicting the future behavior of current c­ ardholders 75

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only as long as the future is not believed to be very different from the past. This belief, which should not be taken for granted, leads to two additional problems: market origination and expansion. Information asymmetry is a problem of valuation. The lender must figure out the riskiness of the customer, which establishes how much the borrower has to pay so that the loan is worthwhile for the lender. Market expansion exacerbates information asymmetry and the valuation problem because, as the market expands, credit will be offered to new groups of customers, whose riskiness is not yet known and cannot easily be predicted. Information sharing is a problem of cooperation. We conclude the chapter with a brief discussion of how these puzzles were solved in the United States and in our group of transitional countries.

The Puzzle of Information Asymmetry Granting someone credit is always fraught with uncertainty. It is not just that lenders, be they banks or individuals, cannot be certain their loan will be repaid—on time and with interest; it’s that they cannot even trust borrowers to provide all the information needed to make a rational decision about giving out and pricing those loans. Borrowers want to get the loan and therefore disclose information strategically so they can get the best possible deal. Economists call this conundrum information asymmetry.1 The problem arises from the fact that the lender knows less than the borrower about two key pieces of information: how determined each borrower is to repay the loan and what the borrower’s resources are likely to be in the future. In lending these are called character and capacity. Because there is no easy way for lenders to find these things out, they must fall back on experiences they had with similar borrowers in the past. Assuming that the past is a useful guide to the future, lenders can calculate a probability that each loan applicant will or will not pay by looking at how similar ­borrowers repaid their loans in the past. This probability—a number between zero and one— will guide them in setting the price for the loan. The higher the probability (or risk) that the customer will default, the higher the price the customer should pay for the loan. This is true up to a point, because credit will be unavailable—rationed—for very risky borrowers.2 Thus the rational lender, like most of us, will let past experiences with similar people drive his judgment. In each reference group there will be good

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and bad borrowers, and the probability that an applicant is a bad customer could simply be the proportion of bad customers in that group. But the social world is rarely black and white. There are other kinds of people besides those who always pay in an exemplary fashion and never default and those who take the loan and immediately disappear with the money. For instance, a borrower who stops paying after having paid back most of the loan because he unexpectedly lost his job is neither “bad” nor “good” but somewhere in between. Another way of thinking about the information the lender is looking for is that he wants to find out the extent of the applicant’s creditworthiness, not just whether he is creditworthy or not. So there may be a continuous distribution of creditworthiness in the group, just as there is a continuous distribution of height, weight and age, and the lender’s best bet will be to assign the applicant the average creditworthiness of his reference group.3 In other words, every applicant who is sorted into that imaginary group will be charged the same rate, irrespective of whether he is actually above or below the average. This is precisely how we make decisions in many situations. Just like lenders, who are not able to distinguish between better and worse borrowers until after the loans have been issued, we cannot tell precisely how long the light bulb we are about to buy will last. But if the light bulb is from a brand with a longer average life than other brands, we are willing to pay more, even if we know that some bulbs of that brand will actually do worse than some bulbs of a cheaper brand that on average lasts fewer hours. Such average pricing is problematic, of course; after all, unless worse customers are charged a higher than average interest rate and better customers a lower one, the former will end up paying less than they should and the latter will be overcharged. The very worst customers in any given group will be undercharged in the extreme. Some of them may not even intend to pay anything back, in which case they will pay nothing at all unless there is some upfront loan origination fee. The very best customers will pay more than they should, and be charged as if they had just average creditworthiness, even though their creditworthiness is better. This is how the lender makes up for the losses caused by bad borrowers. In fact, good customers are made to pay for the losses caused by bad ones. How lenders choose their borrowers and how they price their services will affect the borrowers’ behavior. Better clients, those who end up overpaying, may drop out of the application pool because they find borrowing too expensive. If they do drop out, their departure will lower the average

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quality in the group of prospective applicants, and the old price will no longer cover the losses caused by the worse customers. This will prompt the rational lender to raise the interest rate for everyone in the group. Faced with more expensive loans, some more of the better customers in the pool may drop out, leading to an even higher concentration of poor risks and prompting the lenders to raise interest rates even further. This rate spiral can continue until only the very worst borrowers remain because they don’t mind being charged even unreasonably high prices. After all, they are not planning on paying anything anyway. This mechanism, by which the good applicants gradually abandon the market, leaving only the worst ones in the pool, is called adverse selection. Because of adverse selection, the market fails to reach an equilibrium price that would keep supply and demand in balance. In fact, in theory at least, it leads to the total destruction of the entire market.4 Unlike in the classical scenario of price-demand interaction, where an increase in price lowers demand in a way that makes further price increases less likely, moving the market to a stable equilibrium, here raising prices alters demand in a way that necessitates further price increases in an upward spiral.5 In addition to changing the composition of the applicant pool in the direction of more bad risks, rising interest rates also change the behavior of people who receive the loan. As borrowing becomes more expensive, the likelihood of people being able to meet their obligations, regardless of their initial abilities or intentions, decreases. It is harder to repay an expensive loan than a cheap one. Again, but now through a different mechanism, raising prices results in worse customers, and worse customers call for even higher prices. This factor is called moral hazard because it achieves its effect not through self-selection before the loan is awarded but by changing people’s creditworthiness from better to worse after the loan is already extended.6 It is not only the lenders who are afflicted with the information asymmetry problem. In fact, information asymmetry is a two-way street. Anyone who has applied for a much needed loan and felt anxious about the outcome knows that lenders are not the only ones facing uncertainty in this ­encounter. The borrower often does not know how his application will be judged and is frequently flummoxed by the complexities of the transaction as he is faced with a lender with highly specialized knowledge that borrowers do not possess.7 The current subprime mortgage crisis illustrates with many examples that some people default as a result of being suckered into

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loans they would not have taken had they fully understood the terms. So, while borrowers know more about how likely they are to repay the loan, lenders know more about the fine print of the deal.8 The preponderance of the asymmetry nevertheless afflicts the lender as long as borrowers are willing and able to walk away from their loan obligations. To sum up, lenders face the problem of information asymmetry that they cannot simply solve through the price mechanism by charging riskier customers more. To handle uncertainty, they rely on solutions that fall into two general categories. First, they try to predict as best they can who will turn out to be a good client and who a bad one, which involves a process of screening. Or they develop measures to influence the behavior of borrowers in the hope of improving the odds of successful loan repayment. These latter strategies range from requiring collateral, which would be repossessed by the lender if the borrower failed to repay, to a credible threat of sanctioning, which would both punish those who had already defaulted and deter those who may just be contemplating doing so.9

collateral

For centuries, pawnshops were the main source of credit where people would deposit something of much larger value than the loan they sought. The pawnbroker then advanced the loan and if the loan was not paid back, the broker had the collateral, which he could sell. In the absence of means to predict what borrowers will do, collateral acts as both a way to control their behavior and as compensation to the lender if control fails to prevent default. But modern lenders do not want to deal with a gaudy collection of gold watches, jewelry, pianos, tableware or furniture of uncertain resale value and with tremendous transaction costs for storing and selling. The collateral they do accept, such as real estate or automobiles, are assets the lender does not have to take into physical possession because they cannot be hidden easily by their owners and can be collected with relative ease if necessary. Even then, repossessing a home or a car and selling it is costly, and lenders often require even more liquid collateral, such as cash or stock deposits. This reveals the main disadvantage of the collateral: it takes the credit out of lending. If you must deposit money in order to secure a loan less than or equal to this deposit, why should you borrow at all? Why not just use the

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security deposit for the purpose for which the loan is needed? In fact, the deposit turns lending upside down: it is a loan from the borrower to the lender. Moreover, unlike installment credit, where the durable item purchased on credit acts as collateral, credit cards do not make such an option possible. The fundamental difference of loans extended through credit cards is that they are relatively small and are of general purpose. American credit cards are typically used for such day-to-day needs as food or concert tickets—items that are of small value and consumed quickly. This is not to say that credit cards cannot be collateralized, but the collateral must then be something unrelated to what the credit card buys, as illustrated by home equity credit cards.

sanctioning

The bank may not know who will be a good client and who will be a bad one, but it can mete out some sort of punishment to all those who it finds out do not pay. If the penalty is high, bad behavior becomes costly, sending the clear message to existing borrowers that not paying properly is not worth the gain. This penalty will deter default. Indeed, banks impose penalties on people who skip payments, and they do try to catch deadbeat borrowers, and if all fails they can even take them to court. The trouble is that punishment is costly, not just for the delinquent borrower but also for the lender. In the United States, banks sell defaulted credit card accounts to collection agencies at huge loss—for around one cent on every dollar outstanding. Yet because the sums involved are relatively small (at least for the bank, and compared to mortgage or corporate lending) sanctioning bad clients makes sense only if it also acts as a deterrent to others, so that one act of punishment keeps in line many would-be nonpayers.

screening

To reduce the need for sanctions, lenders must therefore screen customers to avoid as many bad apples as possible. By knowing as much relevant information about an applicant as they can, lenders are able to sort applicants into more homogenous groups. But even with the finest slicing, it is of course impossible to create groups of borrowers in which everyone will have

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exactly the same risk quality and no one will be above or below the group average. If the lender can get close to this ideal, the difference between the assessed and actual creditworthiness of clients will be small enough that applicants will not be able to tell if they are over- or undercharged. In this case, best customers will have no reason to leave the pool, and the worst borrowers will be easy to exclude. The information asymmetry argument assumes that borrowers know precisely how creditworthy they are except they don’t tell that to the lender. Of course people are not that knowledgeable.10 Some will be overly confident about their probability of repaying, others may underestimate how good customers they are. Some may take the loan determined to pay it back but then change their minds, and others may borrow thinking it is free money but then realize the consequences of not paying. For adverse selection to disappear, people don’t have to be identical; it is enough that most people are within a range where they cannot really tell if they are paying the right amount. In that case, people who decide not to borrow will be randomly, and not adversely, selected from the pool.11 In real life, the character of the applicant is not a quality that can be directly observed, nor is it the only thing that determines what happens to the loan; the debtor’s capacity to pay—when the payment is due—is at least as important. Lenders must surmise character from observable traits, just as they must infer capacity to pay from various indicators. This is without a doubt made more difficult by a borrower’s interest in misrepresentation, but even an honest client is not easy to evaluate, because the future we want to know is never a simple extension of the past that we can know. Identifying correctly what signs to look for to assess an applicant is the holy grail of credit screening.

Puzzle of Information Sharing by Unequals Thus, to fight information asymmetry and make better predictions, lenders need more information about potential borrowers, but they cannot simply ask the applicants. Prospective borrowers are strategic: a few of them may be crooks and would lie to get the loan with no intention of paying a penny; many others have every intention of paying it back but, to improve their chances of qualifying for a loan on better terms, they may embellish their

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past to the lender. To get information that is truthful and unbiased, lenders need to look for it elsewhere. Although there are many places where lenders can find useful information (borrowers’ employers, their circle of friends, their landlord, their utility company, even their neighbors), the most relevant data—the facts about their actual credit behavior—are available only from one type of source: other lenders. By sharing information, lenders can warn each other about bad customers and pool their experience to make better, more accurate probability calculations.12 In a market, however, lenders are in competition with each other. Those who are able to estimate borrowers’ creditworthiness more accurately can offer prices that are more competitive and lose less money on loans that go bad. The competitive edge of lenders is, to a large extent, their ability to assess applicants better than others. Getting more information directly benefits each lender, but giving up valuable information benefits their r­ ivals. Whether or not lenders cooperate on sharing information with each other, and the extent of their cooperation, will therefore depend on how they perceive the delicate balance between the advantages of receiving and the disadvantages of releasing information. Lenders share information in three ways: through honors lists, blacklists and full reporting systems. In the 1920s, after the shock of World War I and one of the worst inflations ever to devastate a developed economy, German merchants and utility companies created a list of good borrowers. Customers who met their installment obligations and paid their utility bills promptly were put on a list so they could be eligible for other services.13 This honors list was possible because the businesses that contributed to the list were mostly not in competition with the other businesses that used the list. In fact, in many cases they complemented each other, the way the business of an electricity company complements that of a warehouse that sells electric appliances on credit. The success of one business helped the others succeed. Even when German companies were in competition, such as those selling electric lamps, they did not compete primarily on their ability to spot creditworthy customers, because they were not financial institutions; but if they competed at all, they did so on the quality and price of their lighting fixtures. They lent money only as a means to sell a particular product or service. Such honors lists are very rare today. A much more common form of sharing information is by creating a list of bad borrowers. Such a blacklist

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benefits lenders by helping them avoid bad risks—people who in the past did not honor their obligations. It is a form of sanctioning bad borrowers that is performed by all other lenders who refuse the applications of such borrowers or charge them significantly more. For the borrowers, the blacklist acts as a deterrent, encouraging them to pay up or else their misdeeds will be made known to other lenders. Although the blacklist benefits all potential lenders, it does not compensate the lender who got burned by the unpaid amount. For that lender, learning that someone is a bad borrower is a knowledge bought at considerable expense—the defaulted amount plus other costs—which is not shared by other lenders. Sharing that information with other creditors is therefore a gift to potential competitors, and although rational lenders are interested in learning about other lenders’ bad borrowers, they may resist sharing information about their own. The deterrence effect, however, occurs only if all the lenders submit information to the blacklist. Then the delinquents have nowhere to turn, and this threat acts as a strong incentive for existing borrowers to continue paying. In the beginning, when only a few lenders contribute to the blacklist, there is little to be gained from contributing to the list: the information is sparse and the deterrence effect is weak. Keeping rather than sharing information is the rational thing to do. If the system takes off nevertheless, after a certain point keeping information from others becomes irrational, because all the bad clients will gravitate to the few banks that stay outside the system.14 Moreover, joining a large system also gives the new member a cornucopia of information that can be analyzed for marketing and other purposes. This discussion illustrates the point that starting a blacklist is difficult in the same way it is difficult to start a two-sided market or establish a standard, except that here the threshold is even higher in relative terms. If ­almost everyone is in the system, the incentive to join is very strong; if only a few belong, the incentive is weak or nonexistent. Finally, creditors can share comprehensive information (both good and bad) about borrowers, including loans their clients obtained in the past, how they repaid them, and the current indebtedness of the applicant. When both good and bad information is collected, previous nonpayments fall into perspective, allowing lenders to acquire a more subtle picture of the applicant’s creditworthiness. It makes a difference what the lender knows about the borrower: that the borrower was late on a recent loan payment, or that this was the only late payment in an otherwise spotless ten-year borrowing

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c­ areer. After all, one missed payment with dozens of punctual ones deserves a different consideration than one without. The full record also informs the would-be lender of how thinly stretched the applicant is. A person carrying a large debt already, even if the client services the debt properly, will be riskier than the one who currently owes nothing. A full reporting system also encourages people to borrow and to pay loans off. When only negative information is collected, good borrowers and people who never had a loan (maybe because earlier lenders found them not to be creditworthy) are indistinguishable. When both negative and positive data are reported, being a good borrower means having a record of borrowing and repaying; bad risks are those who defaulted in the past or never borrowed: at best their creditworthiness is unknown, at worst it is poor. This puts pressure on people to get into the system and to borrow in order to build their credit history even if they don’t really need a loan currently because once they need it they must have a (good) credit record. The great disadvantage of the full reporting system for lenders is that they effectively offer up their good customers to other lenders for cherry picking. To put it differently, this form of sharing increases competition among lenders for good clients, which clients probably appreciate but lenders don’t. Many consumers also feel that by releasing their credit history their rights to privacy are violated. They feel the blacklist is more defensible because it hurts only those who were derelict and thus forfeited their privacy. A real challenge to establishing an interbank information-sharing system, whether an honors list, a blacklist or a full reporting system, comes from a big lender with a disproportionately large share of the market.15 Such a lender will not be interested in information sharing because it will have a lot of data of its own and will receive comparably little new information through an information-sharing arrangement. Banks with small market shares, on the other hand, will benefit the most, but they will have less to contribute. In fact, if big banks have the same rate of defaulting customers as small ones, they will have more bad customers in absolute terms. This means that when they terminate these customers, there will be a large number of bad clients on the market looking for credit. The big bank will know who they are and will avoid them, but the small banks, if there is no information sharing, will not be able to tell them from any other new client. This disparity further increases the big bank’s advantage, because small banks will

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choose from a pool heavily polluted by the big lender and will end up with a higher default rate while the big lender picks from a pool only slightly polluted by the few rejects of the small banks. Thus the paradox of information sharing is that the larger a lender is relative to the overall market, the more it can contribute to the common pool and the less it is in its interest to do so. And the smaller a bank is, the less information it has to offer to other banks but the more motivated it is to share whatever it has. It thus follows that if lenders compete, establishing information-sharing arrangements is easiest when there are many small lenders and no big one.

Puzzle of Market Origination and Expansion When the market and the product are new, and lenders serve their first customers, the uncertainty they face is intense. Lenders cannot scrutinize applicants’ credit histories because they have none. They cannot compare applicants to earlier clients because there have been none. This is a problem of market origination. Lenders have to look at how applicants behaved in older markets for similar goods or services and try to extrapolate from there to the new one. In fact, credit is a matter of degree. Whenever time passes between the sale and the payment, some credit is always extended.16 The restaurant that allows us to eat first and pay after we have finished our meal is extending a miniscule amount of credit, with the risk of us leaving before the check arrives. The utility company that lets us use water and electricity and demands payment only at the end of each pay period is granting credit too. Any time consumption is continuous and payment is periodic (as with water, electricity and gas for heat), or the purchase is more frequent than the payment, credit is extended. The charge card is similar to utilities in that consumption happens first and payment comes in lump sums over regular intervals. True credit cards in the United States expanded this germinal form of lending by offering revolving credit. Because charge cards already extended some, albeit limited, credit, information about how people handled their charge cards could help predict how they would use their new credit card, keeping in mind the important difference, that credit cards offered cardholders, for the first time, general-purpose credit without collateral on a continuous, revolving basis, giving them much more discretion in how to handle their

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debt. The lesson that can be learned from markets for similar goods is a matter of degree. The history of payments on charge cards is more useful than the history of utility bill payments. Once the market gets off the ground and lenders try to sell the product to more customers, they still face the problem of market expansion. Although information on borrowers’ histories accumulates, it has ­limited value because it tells lenders only what happened to loans that were granted; it can say nothing about how people who applied but were turned down, or who never applied in the first place, would have performed had they received the loan. Because lenders know little about their customers, at least at the beginning, if they try to avoid bad ones they are likely to turn down or overlook perfectly good clients who would have been excellent borrowers. In other words, when lenders look at their data, they see the errors they made in granting loans to bad risks, but they know nothing about the opportunities they missed. They face the problem of counterfactuals: not knowing what could have happened but did not. If banks don’t care about the people who have not yet borrowed and are content to lend to the same narrow circle of people, this is a hypothetical problem; but when banks start a new credit market or expand an existing one to encompass a larger clientele, their goal is precisely to get the uninitiated to borrow. People who have never applied or who have applied but were turned down are the very target of such market-construction efforts. To put it differently, banks may be able to tell the probability of loan default given that a person was granted a loan, all else being equal; but they cannot tell the probability of a loan going bad given that a person applied (or would have applied) for it, precisely because the data on those who were rejected (or did not even apply) does not exist. Moreover, the problem is amplified if the people who apply now are very different from the ones who applied in the past—representing different social groups, with different means, income trajectories, financial culture and so on. How new customers would use (or abuse) a new product is largely unknown. Worse yet, new products are adopted in a nonrandom fashion. The first people drawn to credit cards are different from those who adopt them later, and those who adopt them later are unlike those who are the last to get them. Furthermore, the people to whom lenders, at the beginning, want to issue credit cards (the most lucrative customers, the cream of the crop) are different from those whom lenders accept only when everyone

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else has been brought into the market. Although the novelty of the product may wear off quickly, the expanding market is continuously moving into new segments of consumers. Even within the same country, because the market must capture new social terrains, old information is rendered of limited value. Starting business in another country, with a different economy, society and culture—the very essence of globalization—presents the same problem but on a much larger scale. This is why the lessons learned about customer screening in other countries are not worth much for judging individual clients in a different country. Thus the dynamic credit card market presents two additional ­dilemmas: the puzzle of market origination—the problem that follows from the novelty of the product—and the puzzle of market expansion—the dilemma that comes with new customers. Both puzzles are made even harder to solve when the political, economic and technological environment is changing fast, as happened in the postcommunist transition, altering forces that influence cardholders’ ability and willingness to pay their card debts.

Creation of the Credit Card Market in the United States Credit has always been more than a simple economic transaction organized by the straightforward play of supply and demand, and at least since Hammurabi in the second millennium BC it has been highly regulated by laws and moral prescriptions.17 Spending money one has not earned yet has been frowned upon in many cultures. Even in the United States, the birthplace of modern consumer credit, powerful cultural trends objected to consumer borrowing initially. Protestantism, partial to ascetic accumulation, took a particularly dim view of consumer credit, equating it with begging and disgrace, which is reflected in numerous proverbs of that time, such as “To borrow, or beg, or get a man’s own, it is the very worst world that ever was known,” or “Beware of borrowing: it brings care by night and disgrace by day.” Yet credit in the United States, a country populated by immigrants, was for most people unavoidable.18 European immigrants, arriving with few possessions and leaving behind land, real estate, livestock, family and social ties accumulated over generations, needed credit to start their new lives. Economic development in the United States, more than elsewhere,

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depended on credit, and some retailers were willing to hold open-book accounts for their regular or most valuable customers. In fact, it was merchants rather than banks who spearheaded the development of the consumer credit market in the United States, through such openbook accounts and department store cards. Banks, on the other hand, for a long time shunned small-scale consumer credit.19 Strong anti-usury laws were on the books in most states and limited the rate of interest that lenders could charge their clients, making the credit business not lucrative. And though in many cases banks managed to evade these laws, coupled with moral objections to consumer lending and borrowing, they limited the spread of bankprocured consumer credit until well into the twentieth century. Merchants were entirely unaffected by usury laws because they could simply raise prices on their products to cover the risk of delinquency. As a result, merchants often exhibited two prices: one for full payment and another for purchase by installment, and the difference covered the losses from nonpayment.20 Consumer credit did not become a respectable pursuit until the twentieth century. Starting with merchant-procured store credit, it proceeded further with installment credit provided by banks to finance the purchase of the first mass-produced consumer durables. Early products, such as the piano and the sewing machine, were followed in the first decades of the twentieth century by the automobile and, with the availability of electricity, a series of electrical appliances. The growing popularity of consumer credit was accompanied by a cultural shift: from viewing borrowing as morally corrupt to considering prompt and responsible repayment as a virtue. 21 The boom in consumer credit in the 1920s was cut short by the Great Depression, and only after World War II did it regain its momentum. Mortgage lending stood halfway between the industrious business credit and the frivolous consumer loan and occupied a moral category of its own. Owning one’s home was a dream endorsed by American culture in ways that possessing cars or washing machines was not. Still, by the time the first credit cards appeared in the United States in the late 1950s, consumer credit was well entrenched, even if most of it was given to buy consumer durables and therefore was lent against some collateral—the durable item that in principle could be repossessed. With the rise of credit, lenders inevitably had to face the problem of information asymmetry and the resulting problems of adverse selection and moral hazard. The solution came in the form of credit bureaus that col-

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lected information from lenders and offered it to other lenders who wanted to know about the past behavior of a prospective client. Here again, merchants rather than the banks pioneered the concept of credit reporting. The first modern credit-reporting company, Lewis Tappan’s Mercantile Agency, was set up by merchants, though initially it facilitated commercial rather than consumer lending.22 Why merchants and not banks? On the one hand, this was a consequence of the banks’ much later entry into consumer lending: even when the trade association of credit bureaus, Associated Credit Bureaus, Inc. (ACB), was formed in 1906, banks were still not interested in consumer lending, and consumer credit was a technicality of the retail business. On the other hand, perhaps, lenders’ resistance to information sharing is to blame. They compete on their ability to lend well and to avoid people who turn out to be bad risks. For merchants, however, credit was just one way of selling more of their goods—only a means to an end. The ACB attained full coverage by 1960, which was still in the era of paper files and filing cabinets. It had by then developed a standardized system of reporting. Computerization of the ACB started only in 1965, in its Los Angeles affiliate. The same year, Credit Data Corporation set up its own computerized database by persuading several California banks to contribute data to its system. From the 1960s on, local credit bureaus were bought by large corporations specializing in data management.23 The merging of merchant and bank data resulted in a system of credit reporting dominated by three giants—Experian, Equifax and TransUnion—each covering virtually the entire market. The key factor that helped Credit Data Corporation obtain data from banks despite their usual resistance to data sharing was one unique feature of the American banking system—its extreme fragmentation. After the ­McFadden-Pepper Act took effect in 1927 and then, six years later, after the Glass-Steagall Act was passed, banks’ ability to set up branches was strictly limited and they could not serve markets beyond the borders of the state where they were headquartered.24 This ban on interstate banking, which was rooted in historical accidents,25 brought about a banking structure that was unique to the United States, where the vast and ever more integrated market was served by tens of thousands of small banks.26 The ban meant that banks did not compete nationally and did not have as much of a problem sharing information on their customers with banks located elsewhere.

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The current comprehensive system of credit reporting therefore grew out of unique historic circumstances that made the puzzle of information sharing easier to solve. Consumer credit reporting was developed first by merchants, who viewed credit as a means to better sales, not as their main line of business. When banks joined, the cost of information processing was rapidly declining, and there was no large player in the U.S. consumer credit market. All of the small lenders stood to gain from a system in which they contributed only a small share of their information but received a lot. Because of the ban on interstate banking, lenders could not compete very well across state lines. For a California bank, for instance, getting information about the credit history of someone who had recently relocated from Utah or Michigan was of great value and raised no issues of commercial rivalry with Utah or Michigan banks. A series of regulatory changes, however, recently altered the structure of the consumer finance market. Increasing deregulation in the 1980s and the eventual repeal of McFadden-Pepper and Glass-Steagall in the 1990s27 started a process of concentration in the lending industry that cut the number of retail banks in half during the last two decades of the twentieth c­ entury.28 In the credit card market a similar concentration occurred. By 2003, the top three issuers of credit and charge cards accounted for almost half of the market, and the top ten for 86 percent.29 In 1999 some of the biggest lenders decided to stop supplying information on car, personal, mortgage and other loans on the then hotly contested subprime market to the three big credit bureaus, a move later followed by card issuers, including Citigroup and Discover.30 Because US banks share information on a voluntary basis, this defection was not illegal. However, it not only alarmed the three bureaus but also raised concern in various regulatory agencies. In the end, the crisis was solved by a mixture of threats from regulators and a new bureau policy that excluded lenders who were delinquent in providing information from access to bureau files for prescreening customers—a practice whereby lenders look at credit files to decide whom to solicit with loan offers. Yet the calamity underscored the increased fragility of information sharing brought about by the growing concentration of consumer lending in the United States. Market origination and expansion in the United States could thus rely on a long history of consumer credit and credit reporting. Early credit card issuers could consult applicants’ history of using credit, including the charge card that was similar to the new product.

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Postcommunist Solutions to the Credit Puzzles The problem of how to manage information asymmetry was central to the communist system. Communist governments were in a constant state of frenzied paranoia that their subjects were hiding information from them— whether these subjects were managers obscuring the true productive capacity of their industrial facilities, or common folk who the governments feared might be concealing their true level of loyalty to the regime. To exercise better control over citizens, the governments engaged in regular and relentless information gathering about numerous aspects of people’s daily lives. To get anything done in a socialist state (from enrolling one’s child in school to exchanging one’s apartment or applying for a trip abroad), common people had to collect and provide an endless number of documents to the appropriate authorities.31 Information gathering was carried out and administered on behalf of communist governments by an elaborate network of institutions headed by the secret police but including apartment building administrators, post offices, regional policlinics and working collectives.32 The consequences of screening people’s loyalty to the regime is of course quite different from screening their creditworthiness. The choices of citizens of communist states were much more limited, just as the state had much greater and more wide-ranging power than the lender with a very narrow and well-defined interest. Still, the basic weapons that communist states had against information asymmetry—control and screening—were the same as those that lenders use. A series of sanctions punished anyone who stepped out of line and sent a message to all other would-be rule ­breakers33 while a huge state apparatus was gathering information about citizens to preempt any form of undesirable activity. Socialist lenders did not face the usual dilemma of whom to lend to. Most residential banking under communism was conducted through a state-owned savings bank, although in Central Europe one would also find rural savings cooperatives serving the rural populations. Formal lending was ­limited.34 Personal loans were offered for emergencies and for big-ticket items, but it was employers who had to request such credit on behalf of their ­workers.35 Monthly installments would then be automatically deducted from the person’s paycheck, with the employer acting as a de facto guarantor of repayment. The role of employers in extending consumer credit to their workers

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and guaranteeing repayment exemplifies socialist employer paternalism, which reemerged in the postcommunist period in the form of salary projects. Such credit provision was an extension of the welfare state and helped people to optimize consumption and compensated for universally low wages.36 Despite these forms of formal borrowing, a strong aversion to borrowing and living in debt was commonly present in socialist societies. In general, the culture in these countries frowned upon spending more than one had earned, and the communist ideology in particular, just like Protestant Puritanism that dominated American culture in earlier centuries, emphasized saving, thrift and financial prudence. However, unlike the United States, where a culture of consumer credit and a taste for borrowing already existed by the time the first credit cards were issued, postcommunist countries had little experience with retail banking in general and consumer loans in particular, and people were unconvinced about the value of going into debt to afford consumer goods.37 The end of communism in East and Central Europe and the start of market reforms in China brought significant changes. In contrast to the United States, where credit cards first appeared during the stable, robust growth of the 1950s and 1960s, the first postcommunist decade experienced tectonic transformations in the economy and society. These transformations exacerbated information asymmetry-related uncertainties in two ways. First, formal consumer credit was new, but apart from this, the past that the postcommunist transformation wanted to leave behind was no longer of much use to foreseeing the future. Who was creditworthy and thus a valuable customer during the transition could not be inferred from experiences in an era that no longer existed. Second, the transition itself created a flux and chaos in most of these countries. Shifting laws, financial crises, sudden jumps in unemployment and inequality, high inflation, the collapse of banks, pyramid schemes and policy miscalculations all created an environment with little stability or predictability. While uncertainty increased manifold, lenders’ ability to screen and control was significantly diminished. The communist state was dismantled, and the capacity of the postcommunist state to gather information about its citizens was at that point severely limited. Telling good credit risks from bad ones was difficult. Besides, many countries passed very strict privacy laws regulating the sharing of private information about citizens with third parties and requiring the client’s explicit consent every step of the way. These

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laws did not have to be strictly enforced (for example, private information of all kinds, including borrowers’ personal data, have been illegally but widely available for sale in Russia’s open-air markets). But where such laws were on the books, they stood in the way of developing formal interbank ­information-sharing mechanisms. The transition also radically changed the relations among banks, the state and employers. Whereas the communist states backed communist-era retail banks, private banks of the 1990s could not count on such support. They could not expect that the state would help them collect bad debts, so they had to lend wisely. Employing organizations also could hardly be required to cooperate with banks. Some of them (for instance, state or municipal organizations and large recently privatized industrial enterprises) may have preserved paternalistic relations with their workers and eagerly participated in salary projects, in which they brokered agreements between banks and individual consumers. But other employers, most notably recently founded small private companies, did not subscribe to this philosophy: they neither considered themselves responsible for providing access to credit to their employees nor were willing to serve as guarantors by ensuring employment and restricting borrowers’ mobility. As geographic and job mobility increased, lenders’ capacity to control borrowers seriously weakened. In theory, lenders could resort to punishing bad borrowers. But here too the resources were limited. The courts, overwhelmed with new laws and a deluge of conflicts that now had to be channeled through the judicial system, were unprepared to handle the enormous new caseload, particular with respect to credit cards—a completely new financial instrument. As a result, defaulting borrowers were let off the hook because lenders were hesitant to start a legal proceeding that could last many years. To sum up the argument so far, postcommunist lenders faced a harsh reality. Screening credit applicants was difficult because people had no prior credit histories, and quickly changing circumstances made past experience irrelevant in predicting future behavior. Increased mobility and change in the relationships among lenders, the state and employing organizations weakened the capacity of lenders to control borrowers’ behavior. Lenders could not rely on punishment either because the overall inefficiency of the courts made the threat of a sanction an empty promise. How did postcommunist banks approach the problem of information asymmetry in such circumstances? Their initial strategy was closely linked

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with the particular way in which credit cards were introduced in the postcommunist world. Whereas in the United States credit cards were initially aimed at the mass market and were introduced because it was believed the elite market had been exhausted by charge cards, in the postcommunist world the credit card appeared first as an elite product targeted at the most affluent. Consequently, the problem of information asymmetry could be solved by methods lenders had used for centuries in small markets: taking advantage of social networks and personal ties. The first credit cards were issued to people whom bank managers knew personally or to those who occupied important positions in politics and business and had a public reputation they needed to maintain. Personal ties and public reputation did double duty: they supplied information about borrowers that was unavailable for ordinary citizens and they facilitated sanctioning. With their public standing at stake, borrowers had a lot to lose if they did not live up to their financial commitments. Banks compiled VIP (very important person) lists that included elite members the bank wanted and targeted as customers. Some of these important people were the top managers of companies the banks served who wanted not just debit or charge cards but also credit cards. VIP lists also included top politicians, businessmen, celebrities in sports and entertainment, and others. This small elite market, however, was soon saturated with credit cards and banks had to face the puzzle of market expansion. To expand the market beyond the small group of elites, several banks tried asking for collateral. For instance, some required a security deposit as a condition for receiving a card, but the size of the deposit was often greater than the credit the card extended. Hardly surprising, this policy made little headway. A more promising direction was to expand the circle of credit cardholders by mining the client base that postcommunist banks already had. Trying to sell an additional service to people who already had an account with the bank let banks observe the financial behavior of the future cardholder. They could see the amount of funds the client had, the regularity with which deposits arrived to the account, and the payment habits of the client (whether she paid her bills from her bank account and so on). On the basis of this information, banks could identify a group of good customers who could first be offered a debit card with overdraft protection, then a credit card with a modest credit line, and an ever growing credit line if the client was deemed deserving. Screening therefore happened through an

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iterative process, and creditworthiness was established in a gradual manner, shifting from debit to credit card. Selling credit cards to existing clients had the additional advantage of enabling easier control. People with other accounts in the bank were already roped in and could not easily disappear when the bank needed to pressure them to pay. And if all else failed, the client’s other accounts could be used to compensate the bank for the amount of the unpaid balance. In salary projects, the employer could also be enlisted by the banks as support. The resulting market, however, was a distinctive one. The road to a credit card in postcommunism led through a long-term engagement with a particular bank. The gradual process just described locked clients into a single bank, making competition among issuers of credit cards virtually impossible. In the absence of widespread information sharing between banks, the client’s credit history had to be built with each bank, and if the client left for another bank, he or she would have to start all over again. Although banks were happy to keep their clients trapped, they suffered from the glacial pace of card issuing and being limited by the size and quality of their existing client base. There was therefore pressure to make credit histories portable through information sharing among banks. Setting up an information-sharing arrangement was especially difficult in postcommunist countries because the banking system was highly concentrated. In each country, the successor of the communist savings bank had the lion’s share of the market and customers, and it was reluctant to cooperate and give up its advantage to small upstart banks. At the same time, a credit bureau that did not use data from these big banks would hardly be useful. In the United States, the fragmented banking structure made information sharing relatively easy to achieve and the problem was solved by creating private credit registries through a market-driven process. Postcommunist banking inherited a concentrated market structure, and the giants were not interested in sharing because they would have to put in a lot of information and take out only a small amount that they did not already have. Here cooperation had to be imposed. Strong privacy laws initially led many countries to adopt only a negative information-sharing arrangement, which is a weaker and more limited version of interbank information sharing. The creation of a full-record (both negative and positive) credit registry turned out to be a real challenge. ­Although all of the countries in our sample eventually succeeded in creat-

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ing full-record consumer credit registries, several of them accomplished this only after numerous setbacks, and all of them did so only in response to outside intervention. In the following chapters, we compare the developmental paths of credit card markets in all of the eight countries and analyze in detail the reasons for the differences.

five

The Construction of Card Markets in Hungary, Poland and the Czech Republic

The calling card of money. Its owner presents it at purchase and with it presents himself. The Duna Credit Card offers every adult Hungarian citizen convenience and safety. [ . . . ] Duna Credit Card: The currency of trust. advertisement, november 1989

This was the ad for the first Hungarian bank card accepted nationwide, issued by Dunabank in early November, 1989, a few days before the fall of the Berlin Wall. The advertisement heralded a new era. Bank cards were not entirely new. As elsewhere in the Soviet bloc, a few payment cards had been scattered among the very top party and government officials in Communist Hungary, to be used mostly on foreign trips as part of a fat package of rare privileges. But now, for the first time, the card was being offered to “every adult Hungarian citizen.” The issuer, rather than dispensing a favor, was pleading with ordinary people to avail themselves of this new product and service. The new commodity aimed at the masses was meant to exude exclusive style and privilege, not the sort that was associated with communist cadres, but the kind linked in the collective imagination with Western affluence and consumerism. The gesture of nonchalantly presenting a small colorful card that, in contrast to the humiliation of nervously fumbling with notes and coins, elegantly disre97

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gards the pain of being separated from one’s money, signified a person of means and high status. Peddling the uncommon to commoners, turning a rare luxury into goods that anyone can purchase—in the process using and spending its exoticism that attracts customers in the first place—is what markets do well, but as we show, even this very task—the democratization of finance—posed particularly thorny problems in the development of credit card markets. Unlike most of its followers, which were “credit cards” only in name and functioned as debit cards, albeit sometimes with an overdraft limit, the Duna Credit Card extended an actual credit line equal to twice the average monthly wage, or 20,000 Hungarian forints (HUF). Just as for any real credit card in the United States, the debt could be rolled over after submitting the 1 percent minimum payment, but the interest rate was high and there was a .5 percent fee on the value of each transaction as well. In addition to paying the annual fee, the cardholder had to pay a 2 percent supplementary charge every year for the unused part of the credit line. There were additional fees for cash advances and monthly statements. In the absence of ATMs,1 the first owners of the card had to go to one of the seven branches of Dunabank or to one of the many post offices around the country to withdraw cash. This was less convenient than having “cash machines” on every other street corner; but with many state-owned gas stations and large retail chains accepting the card, it was a start. Although the first credit card was no different than what American or British banks were offering at the time, the bank card market, and credit cards in particular, made little headway for another decade. The appearance and use of debit and credit cards in Hungary and elsewhere was neither an obvious nor a natural development. Having the product and all the technology available was not enough; the market as a social structure had to be constructed before credit cards could take off. In the Czech Republic, the first mass-marketed cards appeared in 1989. Issued by Česká spořitelna (the Czech Savings Bank or ČS), they were little more than ATM cards with an actual person and not a machine handling most transactions. The first real payment cards, sporting the Visa Classic logo, appeared in 1990. It was offered by Živnostenská Banka, the bank that was in charge of foreign currency transactions under socialism. Živnostenská was considered the pioneer in the Czech card business because in 1988 it

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created a special store card for the Tuzex network of shops, where, during the meager years of the communist shortage economy, people could buy imported goods with special vouchers, drawing on their Western currency Tuzex accounts.2 The Polish counterpart of Živnostenská was Bank Pekao, which handled the foreign currency transactions for all of Poland and the accounts of those Poles living or working abroad. Pekao issued the checks that let Poles shop in the Polish version of Tuzex stores, called Pewex. Pekao introduced the first ATM cards in the 1980s to make it easier for people to retrieve zlotys (Poland’s national currency) from the hard-currency accounts that grew rapidly in the 1980s when Poles, with official blessing, flooded Western countries as guest workers. Although foreign-issued cards were accepted from the 1960s on in exclusive restaurants and hotels operated by the state company Orbis, the first domestic card was issued only in 1991, a Visa debit card, linked directly to the customer’s savings account. The first credit-granting card did not debut until two years later. After a slow start in the late 1980s to early 1990s, it took several years in all three countries for banks to begin issuing individual and corporate credit cards to customers in substantial numbers. On the supply side, there were institutional, macroeconomic and infrastructural preconditions—such as the POS and ATM networks and the network of information collection and processing—that had to be put in place. On the demand side, banks first and foremost had to convince people that they wanted this service. For most people, it was far from obvious that they needed a bank card, let alone a credit card. As the Dunabank advertisement intent on reassuring future customers correctly anticipated, most people were uncertain whether they could trust this new currency, and even after an army of cardholders was created with some help from governments and large employers, banks had to educate customers in the proper use of these new financial products. We address these preconditions in this chapter.

Getting Competitors to Cooperate In Czechoslovakia, Hungary and Poland, just as in all ex-Soviet bloc countries, postcommunist retail banking began with the towering dominance of

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the successor of the communist savings bank. ČS, OTP and PKO were all sitting on a large, mostly inert clientele who felt safe banking with their national giant and enjoyed the convenience of its wide branch network. This concentration made it very hard for new banks to find a foothold. It meant serious obstacles not just to competition in retail finance but also to the cooperation necessary for card markets. Although over time this concentration eroded, it happened only gradually. From the outset, banks realized they had some common concerns. In 1989, the Hungarian banks formed their national banking association, followed by the Czech banks in 1990 and the Polish banks a year later. The main function of these associations has been to represent and lobby for their member banks’ common interests, but they were also designed to serve as forums where members can develop common positions on various issues, and their publicly stated purpose was and remains supporting cooperation between banks, creating new interbank institutions, organizing education and research on topics of common concern, facilitating interbank agreements, setting standards, creating self-regulatory systems and developing ethical guidelines. The Czech and Polish associations mention explicitly in there statutes that they wish to promote the bank card market. The associations were also set up to represent their members in international federations. Despite the lofty goals, the associations have been modest affairs with humble offices and small staffs, with most of the work being carried out in committees formed by the members delegating their own employees to do the job. The associations gave special consideration to bank cards. The Hungarian Banking Association has had a bank card forum, the Polish Bank Association formed a board of card issuers, and the Czech Banking Association created the Commission for Payment Traffic and Payment Instruments, which works on card-related issues. Of the three countries, only the Czechs have a bank card association that was founded in 1991, to which we return later in the chapter. The bank associations, let alone the organizations they created to address the problems of the card market, have never had real power over their members, however. Members could choose on what issue and in what way they wanted to work with others and when to go it alone.

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The Payment Card To forge a payment card market, both its supply side—everything that banks need to be able to issue cards—and its demand side—people’s desire to have and use cards—had to be crafted. Efforts to build each side encountered substantial difficulties.

t h e c r e at i o n o f s u p p ly

Unlike in the United States, where the bank card began as a charge and credit card, during the 1990s in Central Europe most cards were ATM cards first and then debit payment cards, with very limited or no credit function. To create the payment card markets, banks had to solve the two-sided market and the standardization puzzles. They had to assemble a large-enough network of merchants who accepted their cards on uniform terms, and a physical infrastructure that could handle the authorization and processing of transactions. Where there are many small banks, all benefit from cooperation because none of them can create a network and infrastructure that is large enough to be viable, and even if they could, it would be impossible to run a national market with merchants signing up with every bank, each with its own rules and machines. Yet when there is one bank that holds a large share of the retail banking market, there is the temptation for the dominant bank to build its own system and force the other issuers—if they survive at all—to use it for a fee.

Payment Card Infrastructure: The Standardization Problem In Hungary, OTP issued the first ATM cards in 1989, but the program was a small-scale affair with only two machines and a few hundred cards, and it did not grow much in the following years. Nevertheless, by 1992, OTP decided it wanted to control the still fledgling payment card market and began to promote its own system aggressively, trying to push other, smaller banks to sign up and use its services. At that time the vast majority of cards were ATM cards, good only for withdrawing cash. Only Dunabank and

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­ udapest Bank issued payment cards in Hungarian forints while a handful of B banks offered international cards by American Express, Visa and Eurocard (which later merged with Mastercard to become Europay-MasterCard), but only to people with accounts in US dollars or some other major Western currency. During the early years of the transition, consumer finance was merely a sideshow for the banks. Their efforts were largely concentrated on coping with mounting enterprise debt that piled up quickly as one s­ ocialist-era factory after another went bankrupt. The entire banking sector was engulfed in a deep crisis.3 The government had been eager to privatize the banks, which now looked much too troubled for anyone to buy. The government therefore intervened and imposed on the banks a series of reforms, including the revamping of interbank clearing of transactions. This system, which handles the movement of money among banks, was in Hungary entrusted to a company called GIRO. GIRO created a subsidiary, GIRO BankCard (GBC), to process card transactions, then a very small part of interbank business. GBC applied successfully for a World Bank loan to carry out its mission. The World Bank, however, set a condition for releasing the money: all banks in the card business had to use the system. The World Bank was not interested in supporting particular banks; it wanted to help the construction of a national infrastructure. OTP balked. The new system would have made it all but impossible for OTP to carry out its own design, forcing it to cooperate with the other banks. As OTP pulled out, GBC, unable to meet the World Bank’s condition, had to return the loan. As one of the founding managers of GBC put it with frustration, “From the GIRO’s perspective, OTP has been a very negative player” [H #3].4 A year after the World Bank project failed, OTP introduced its own new and expanded system, capable of handling large volumes of transactions, and offered it to the other banks, but they declined. OTP came out with its own strange hybrid payment card: a card with a checkbook. The owner would show the card for authorization and then write a check. This was not very different from how other payment cards worked when slips of paper were imprinted with the information embossed on the card, except here the customers had to carry the slips, which were already printed with their name and card number. The success of the check card was decidedly modest. In a country where most people never saw a personal check let alone wrote one, having to carry the booklet and then fill out the required information put a burden on the customer that few saw as necessary. OTP managed to enroll

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only two other banks into its card network. By then, GBC, with the help of the Hungarian National Bank, constructed a card-processing system without the World Bank loan and without OTP’s participation. The battle between the two domestic card networks took a new turn in 1996, when the Hungarian currency became convertible. Now that forints could be freely exchanged for US dollars or German marks, people with domestic accounts could receive an international card and more and more banks started to issue ones with Visa or MasterCard logos. These cards had to be compatible with the systems maintained by the two multinationals, and both OTP and GBC had to be able to process them. This meant that OTP had to accept cards issued by GBC affiliates just as GBC had to take OTP cards, as long as they carried the international logos. Getting an internationally branded card therefore meant not just that one could use the card abroad but also that it could be used more widely domestically. Thus the number of exclusively OTP and GBC cards began to dwindle, and the two international systems have emerged as the new standard. In the Czech Republic, events followed a similar path. The Czech exSoviet savings bank, ČS, began, just as OTP had, with a small ATM card program before the fall of communism. The size of their network reached three hundred machines by 1993. Just as in the Hungarian case, in 1991 in then Czechoslovakia there was an attempt to challenge the dominant market position of the socialist-era giant and create a multibank card network. This initiative, however, did not come from the government, as the Hungarian GBC did, but from the Czech Bankcard Association (CBA)—a voluntary professional association recently organized by several smaller Czech banks. As the president of CBA recalled with a touch of nostalgia, We were all educated in socialist schools and started to work in socialist companies . . . , we liked cooperation. So there were no problems of this kind in the beginning. The market was not so competitive as it is now. We got very easily agreement concerning the common infrastructure, security and statistics. [ . . . ] There was one problem and that was Česká spořitelna in those times. Because Česká spořitelna, due to their earlier experiences with cards—one or two years earlier they started—they already had built their own center. [C #2]

CBA declared its dedication to the promotion of cards, to cooperation on fraud and on gathering market data and to collaboration with the large international card companies. To build the system of card authorization, CBA

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hired a private company, MUZO, a software firm that worked for the foreign trade ministry. MUZO had no experience in the card business and had to turn to Eurocard and MasterCard for help.5 Thus the CBA network was, from the very beginning, compatible with one of the two big inter­national networks. In the meantime, like OTP, ČS decided to push forward with its own system, but soon found that it was missing out on tourists who flooded the country following the heady days of the Velvet Revolution that brought down communism in Czechoslovakia, and who could not use their international cards with the ČS’s proprietary machines. ČS then sought out the other large multinational, Visa, as a partner. For a time there were two parallel and incompatible systems: one operated by ČS with Visa and another operated by CBA in partnership with MasterCard. In 1996, the second largest bank, Československá obchodní banka (ČSOB), a stalwart of CBA, decided to add Visa cards to its MasterCard product line. Its dual membership in the two large networks was soon followed by other banks, and the two systems were forced to connect and join in one large network that still stands on two pillars. Poland was early in adopting international cards. It was viewed as a particularly appealing market due to its large size and the early convertibility of the zloty. The first Visa payment card issued by Bank ­Inicjatyw Gospodarczych was followed in 1993 by the first card in the region that allowed international use, issued by Pekao, which had already offered Visa Classic ATM cards. In 1995, Pekao introduced the first domestic Polish credit card.6 But there was little coordination between different card ­issuers until 1994, when the Polish Bank Association established the Bank Card Issuers Board (RWKB). At the same time, Visa Forum Poland and Europay Forum Poland were founded with the goal to “exchange experience and prevent unfair or harmful competition.”7 Even as late as 1997, there were fifteen different ATM systems in operation, and banks negotiated a jumble of bilateral agreements to patch systems here and there to make them compatible. That year, PolCard, a company owned by a few banks, was hired to integrate the systems. Currently most banks are on the PolCard system, except Pekao and Bank Zachodni WBK, which have their own card infrastructure. All of these systems, however, are linked to Visa and MasterCard. The creation of a common processing system is difficult in a market where the size of the players is uneven. Large banks have less incentive to cooperate than small ones, and giants will try to force their own solutions onto the rest of the market. Of the three countries, Hungary had the most

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powerful central player, OTP, and Poland’s PKO was the weakest relative to other banks and was also under the closest state supervision, which curbed its ability to exercise its power of size. Cooperation among the smaller banks was the most robust in the Czech Republic and the most anemic in Poland. In none of the three countries was full cooperation feasible, however, and in the end the standardization problem was solved by the complete takeover of payment card markets by the international brands.

Fighting Fraud As standardization developed, fighting fraud also turned into a task demanding that banks work together. Cards can be abused by thieves of all kinds, but stealing cards from people’s pockets or purses was not the typical method of criminals. In the early days of imprinters, it was enough to steal the carbon paper and thereby the card number on it. Then one could manufacture a copy of the card (called “white plastic”) and use it. This fraud was limited by the fact that it had to involve the merchants, and most of them were interested in protecting their reputation. With the spread of ATMs, swindlers could cut the merchants out of the loop. One simple trick was to tamper with an ATM so that a card would get stuck inside. When the befuddled client could not retrieve the card, the thief, disguised as another customer waiting in line, would offer advice and ultimately help with entering the PIN. The card, of course, would stay in the machine, at which point the owner would give up and leave to report the problem. This was when the thief would retrieve the card and, armed with the PIN, begin the spree of spending the card owner’s money. The most common fraud deployed a more sophisticated technique called skimming, a process of obtaining electronically the information stored on the card’s magnetic stripe and acquiring its PIN. As laptop computers became widely available, credit card rings, often working on an international scale, would install their own electronic card readers in ATMs that would record the data from the magnetic stripe and, with the help of a small camera aimed at the hand of the card owner, the PIN. The thieves would then produce an exact replica of the card, often in multiple copies, and use them or sell them on the black market. The advantage of this method was that the owner would suspect nothing until the card bill arrived. In 2000, in Hungary, the only country that reported detailed figures, 60 percent of all loss to fraud was due to skimming.

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Paradoxically, standardization helped not just banks and customers but also criminals. Banks using the same technology meant that fraudsters did not have to crack multiple systems. The same equipment and technology could be used to forge most of the cards. Because card counterfeiters could strike any issuer, cooperation among the banks to prevent fraud became a necessity. Early on, card managers tried to deal with the problem by reporting fraud to the police, but the police knew little about card technology and had to rely on the banks to catch the criminals. Soon an informal network developed among banks to alert each other of larger frauds. When the inter­ national card companies appeared on the scene, they set up a card fraud forum in each country, and thus cooperation acquired a formal framework. In Hungary, the fraud forum met every three months; elsewhere fraud hunters convened with less regularity. At the forum the discussions were framed by the uneasy balance of cooperation and competition. Professionals discussed mostly general trends in fraud, new methods of fraud prevention and detection or current major cases of fraud, always careful not to reveal too many details about their own internal procedures.

the creation of demand

Getting Merchants on Board Initially, merchants in the region were uninterested in payment cards. Teaching them the value of the card for their business was not easy because, understandably, the idea of paying a fee on each purchase did not appeal to them. In 1995, in Poland, fewer than twenty thousand establishments accepted payment cards, which, relative to the country’s population of thirty-eight million, was very low.8 Most of these shops were in the tourism industry. Tourism was the initial force behind the spread of card acceptance in the other two countries as well. In Hungary, a country of ten million, by 1994 only six thousand shops accepted bank-issued payment cards, and most served tourists.9 The Czechs were ahead, though not by much. In 1995, 8,200 establishments honored payment cards in a country about the same size as Hungary.10 As the director of the Czech Card Association put it, In the beginning it was not very easy, of course, because [the merchants] were not informed. We had to do a lot of education. It became easier when foreigners, as tourists or businessmen, were coming in the Czech Republic

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in higher numbers. So the merchants realized that the foreign people want to pay by card, and if they can’t, the business is lost. . . . In many cases, when the merchants told us “get out! I will never accept cards,” a few weeks [later] they came to the bank and asked, “Please give me a terminal or imprinter because I am losing business!” [C #2]

In Hungary the payment card faced an additional obstacle. The country’s main tourist attraction, the warm lake resort Balaton, draws tourists only during the summer. As a card pioneer of one large bank explained in 2004, I am suffering at Lake Balaton because they do not accept cards. The shops are open four months a year, and for those [ . . . ] we don’t give a terminal, we give them an imprinter, which does not accept Maestro, does not accept Visa Electron . . . [because those are flat and without the raised letters and numbers the imprinter cannot read them] . . . and if I give him a terminal for four months, it is only trouble for me. I have to send out maintenance, bring in the terminal after four months, then store it, bring it out again in May, write a new contract, install it. This is how things are at Lake Balaton. The rest of the country does not count, because not counting hotels and [international retail] chains, there is not enough turnover and therefore no demand for it. [HB #6.1]11

Many merchants had another good reason to resist payment cards. Paying with cash is anonymous, but electronic payments are easy to trace and that makes avoiding paying taxes on them more difficult. When this Hungarian bank tried to persuade a successful restaurant in Budapest to accept payment cards and install a POS, the owners told the bank “point blank that they cannot generate the extra 2.5 percent [interchange fee], and they cannot generate it, not because [the fee is high]—the restaurant is very profitable—but because they cannot afford to show to the tax authorities the turnover that they make” [HB #6.1]. Initially banks were giving POSs to merchants for free, not just because they wanted their business but also because they were eager to fully control the machines. Their main concern was that a merchant might get ahold of the customer’s card information by fiddling with the software and then use it fraudulently or even sell it to criminals. By giving terminals to merchants for free, banks could ensure that the merchants used a machine that the bank knew well. This simplified their monitoring, maintenance and development. Banks also approached large, mostly foreign-owned retail chains to issue co-branded cards. These stores could not hide their income from the tax

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authorities and the anonymity of cash had much less appeal to them. They also saw the co-branded cards as a way to train loyal customers. Co-branded cards could be used anywhere cards were accepted, but by giving out various rewards, such as points that could be redeemed on purchases, the chain stores could persuade people to return over and over. The foreign owners of these stores were familiar with payment cards; they already accepted them in their stores in Western Europe, where they were a routine part of their operations. The transparency that deterred small retailers was an advantage for the central management of these chain stores, because it made it easier to monitor payments in their sprawling retail empire. Moreover, co-branding provided a form of advertisement. Putting the name of the company on the card kept the brand ubiquitous. Finally, it also helped that banks were willing to cut interchange fees for many of these large retailers.

Selling Cards If merchants were reluctant to enlist, the population was equally unenthusiastic about what seemed to them an unnecessary expense. There was the old well-entrenched habit of using cash. Metal and paper gave material reality to money. It was easy to tell how much one was paying by looking at the size, amount and color of cash. The difference between ten and ten thousand zlotys was immediately obvious if one looked at the two amounts in cash, but barely noticeable when one paid them electronically. Even when forced to use cards, most people used them to get cash from their bank account through the ATM, thus treating the card as an inconvenient obstacle standing between them and their money. As late as 2005, in Poland 70 percent12 and in Hungary 55 percent13 of all transactions were cash withdrawals, and in 2003 in the Czech Republic it was 70 percent.14 The card chief of one of the leading Hungarian banks complained in 2005 about a young colleague who had just been hired in the card department: “He is a college student, a senior, and has just started working in our bank, and he has never in his life paid with a bank card. He takes the money out of the ATM. He is a senior at the school of economics. I really don’t get it . . . this is absolutely a cultural issue” [HB #3.1]. It wasn’t only the novelty of cards and the habit of relying on cash that made people reluctant to embrace this new way of spending. Using payment cards incurred various fees, including an annual fee and a transaction fee for each withdrawal. To get people to pay for something (the use of their own

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money) that is also available free of charge was not a particularly attractive proposition. An even bigger anxiety was the fear that if the card was lost or stolen its owner was liable for the entire amount of damage. Even if one was a victim of one of the sophisticated frauds, the banks washed their hands and shoved all responsibility onto the cardholder. In 1996, the top card manager of OTP summarized, in a condescending tone reminiscent of socialist bureaucracy, what was more or less the general position of the banks even many years later: One must recognize that using bank cards is extremely convenient, but it is also extraordinarily dangerous. Bank cards represent a new lifestyle, which includes having to pay attention to whether someone has stolen your little plastic card. Unfortunately, in Hungary this [new] behavior is not common at all. In fact, sometimes a client who’s in a hurry or distracted forgets his card or money in the ATM on the street.15

People had to accept the risk and change their lifestyles in order to minimize the danger. To add further harm to injury, most banks initially attached a twenty-four- to seventy-two-hour waiting period after the stolen card was reported during which the cardholder was still responsible for any loss. No wonder people would rather stick with cash, because if it was stolen, the loss was limited to the amount taken. Mistrust and anxiety about the use of cards was pervasive. It was not until the European Union began to address the problem that banks instituted, reluctantly, a reasonable limit on customer liability for unauthorized charges. Starting in 2000, EU regulations asserted with increasing emphasis (culminating in the Payment Services Directive initiated by the European Commission and passed by the European Parliament in 2007) that cardholders should not be made responsible for unauthorized use of their cards unless they acted fraudulently or with gross negligence. The European Union set a 150-Euro limit on the liability of the customer. Bankers in Central Europe protested these rules, predicting an avalanche of fraud, but eventually, as new members of the European Union, they could not ignore the growing pressure. In 2002, the Polish legislature passed a law that required banks to adopt the EU rule for all electronic payment instruments. Hungary followed suit in 2006, establishing a similar limit and prohibiting charges after the theft was reported. The Czech banks introduced the rule only in 2009, but in anticipation of the increase in mischief, they also raised their fees.

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The European Commission recognized that the card market was limited by consumer anxiety over the safety of using the card; it also understood the banks’ dilemma, that although having a uniform and low maximum liability would benefit the market as a whole by expanding radically the number of cardholders, no bank would introduce this rule on its own, fearing that it would attract all the distracted, forgetful or devious cardholders. The regulation was intended to solve this collective-action problem, but there was an additional flaw. Charging the customer was irrational in the sense that she was not the one who could do most to combat fraud.16 Skimming and counterfeiting, for instance, are fought much better by card issuers, who by the early 2000s could spot unusual activities promptly and cancel a card without delay. Better yet, they could switch to chip cards, which are much harder to counterfeit. In a rational system, the penalty is meted out in a way that minimizes overall misconduct and therefore should penalize those who can do most to avoid or mitigate the damage, that is, the banks, who had no incentive to make serious efforts to control fraud as long as customers were shouldering most of the cost. The Commission foresaw correctly that shifting the liability to banks would not significantly increase the relative frequency of bad behavior by customers while it brought on board a large number of new cardholders.17 At the same time, the limit would give an incentive to issuers to make changes that would cut down on fraud.

Making the Currency Convertible One way socialist economies were separated from the world economy before 1989 was that their currencies were nonconvertible. The socialist state controlled the exchange rate of its currency by prohibiting its direct sale and purchase. Citizens were not allowed to buy foreign currency except for the limited amount made available when they traveled. That meant their zlotys, forints and crowns were useless abroad and could be spent only inside their own country. Any card linked to a nonconvertible currency depended on the network of domestic merchants that accepted the card and was useless beyond the country’s borders. The first currency that abandoned its strict controls was the Polish zloty. Since the early 1980s, the US dollar had been widely used in the Polish unofficial economy and had acted as a second currency. In 1990, the zloty became freely convertible. The Czech crown followed suit in 1995 and the

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Hungarian forint in 1996. The convertibility of the national currency gave another reason for people to get a bank card. Even if they could not find many shops in their own country where they could pay with a card, they could use the plastic on their foreign trips. With foreign shops available, the number of places where their cards were accepted suddenly expanded. Moreover, Western countries—fearful of East tourists arriving without enough money, sleeping in parks and other public places, panhandling and worse—had demanded that tourists show a certain amount of cash at the border. Now that the money in one’s bank account could be freely used abroad, it was enough to show a bank card that would work in the country of destination. The payment card became a needed companion to the passport. All of this assumed that the card could be used in international systems. Banks reluctant to team up with domestic competitors in creating a common domestic network were happy to join the existing multinational ones. From the bank’s perspective, there was a big difference between the two. International access was simply an additional service offered with the card, making it more attractive and competitive in the domestic market. Because retail banks competed only within their home countries, cooperating with foreign banks abroad was easy and, eventually, as we explained, made unavoidable the much harder cooperation with domestic competitors on standardizing card acceptance.

Issuing Bank Cards to Employees Getting people to embrace bank cards took more than just easing their anxieties about card loss or offering convenience on foreign trips. It took direct intervention. Large companies, now under foreign ownership, began to pay their employees through bank transfer. Because in the early 1990s foreign businesses did not trust local banks, many brought with them their own banks, those they knew well and with whom they were accustomed to doing business. These foreign banks, intent on entering the newly emerging markets of the region, offered not just corporate financing for the foreign firms but also charge cards for their management, and if they could they extended their services to employees as well. Foreign-owned companies often opened accounts for their workers in their “housebank,” and paid their salaries by directly depositing the money in their accounts. Workers, who were used to standing in line at the beginning of each month in front of a small window

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at their company’s payroll office to collect wads of banknotes, now received their salaries by taking a trip to the bank and withdrawing the money either after queuing up at another small window or in front of an automated teller. Whether they liked it or not, workers had to own a bank card. People did not appreciate becoming involuntary cardholders. In one survey, taken in the summer of 1998 on a representative sample of Hungarians, pollsters found that half of the cardholders carried the card only because they had to have it to get access to their salaries, and only 47 percent took out the card voluntarily.18 A similar survey a few months later presented findings that were no different.19 The idea of a salary card to access directly deposited wages was adopted by the Hungarian state. In 1996, a government decree mandated that state budgetary institutions pay their employees through bank transfer as part of the modernization of the treasury. All teachers, doctors, bureaucrats, police and military—750,000 workers altogether—were supposed to get a bank card in January 1997 but it took another two years until the plan was implemented because the banks were reluctant to forgo the various charges and the trade unions fought the bank fees they saw as a de facto paycut. The number of merchants with card readers also grew as the state decided to make smaller government purchases using bank cards. The bank that won the right to issue these purchase cards was OTP. The Polish and Czech states were not so forthcoming, although eventually they did join the fray. In those countries, large employers were leading the way, essentially outsourcing a part of their payroll to banks at their workers’ expense. For multinationals, which were already accustomed to paying their workers by bank transfer, this was an easy transition. Forcing people to accept bank cards required less effort in the private sector, where it was a simple management decision, unencumbered by strong unions and political overtones. In the state sector, organized resistance was much stronger.

single euro payment area

When they joined the European Union in 2004, the Central European countries also joined the Single Euro Payment Area (SEPA). The SEPA was created in 2002 (and has been promoted since then) by the European Payment Council (EPC)20 to establish a unified payment system in the Eu-

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ropean Union, essentially to solve the problem of standardization. After launching the euro, the EPC turned its attention to electronic payments.21 After two other payment schemes, covering electronic wire (credit) transfers and direct debits,22 were introduced, the SEPA Card Framework (SCF) took off in 2011. SCF is a SEPA payment scheme—a set of rules and standards for executing payment card transactions. In essence, a SEPA payment scheme can be compared to other frameworks which prescribe standardised processes to be observed by actors operating in network industries: such standardisation—or integration—initiatives enable the provision of services by service providers in a two-sided market also across traditional boundaries (for example, national borders). An example of such integration initiatives are standardised railway tracks allowing a multitude of commercial railway operators to move their trains across borders. Similar examples of standardisation in network industries can be found in the areas of telecommunication, television or radio.23

The goal of the card scheme is to create an infrastructure or platform that allows customers to use their cards for payment in any establishment anywhere in the SEPA area that accepts cards or for withdrawing cash from any ATM. “There should be no differences whether they use their card(s) in their home country or somewhere else within SEPA,” the official plan announced, and the distinction between international and domestic cards, at least within the zone of the participating countries, would disappear.24 The SCF would also bury the magnetic stripe “six feet under”25 and introduce a new card authorized using both a chip and a PIN. As of 2012, the SEPA system would issue “chip only” cards. The new chip system is built around the EMV standard, named after the first letters of Europay (since bought by MasterCard), MasterCard and Visa, and it is the system used by JCB ( Japan Credit Bureau) and American Express as well. The hope of the SCF is that standardization will bring about more competition. By making EMV the general standard and making the system open and transparent, and by separating the management functions, such as issuing and acquiring, from processing, the EPC would like to lower the barrier to entry into the card market for those wishing to offer cards and related services. In principle, the new EMV-based card system would be available to any bank without joining Visa or MasterCard. Just as television stations are not involved in the operation and maintenance of satellites or cable systems, banks that issue payment cards would not engage in card processing. And

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just as any station can broadcast on any satellite or cable because transmission follows the same protocol everywhere, any card should be able to operate within any processing system because all systems will be using the same technology. The original SEPA plan anticipated that it would make domestic cards more viable, but Eurosystem, the monetary authority of the Eurozone,26 has taken a less sanguine view. It believes that card markets are inherently oligopolistic and foresees only three possible outcomes. The first is that national schemes would all be displaced by Visa or MasterCard, because joining one of the two multinationals would be the fastest and easiest way of complying with SEPA requirements. After all, the technical standards that SEPA demands from all banks are the ones the multi­nationals developed and use. This outcome would be the opposite of the stated intention of SCF. The second possible outcome is that domestic issuers would co-brand their cards with both Visa and MasterCard. This move would perpetuate the present situation of the multiplicity of local schemes, with international capability tacked on. The third possibility, the one that Eurosystem prefers, would be a new European brand that would give competition to the international giants as an equal third player, and that would emerge either as a domestic brand, then grow into an all-European and then an international brand, or as an alliance of domestic brands.27 As the European Central Bank put it, it is interesting to note that, whereas the emergence of at least one European card scheme is still not guaranteed, countries such as Russia and India plan to follow the example of China, which introduced its own card scheme, China Union Pay, in 2002. While the political, economic and competitive environment, compared to the EU, is, of course, very different, the main reasoning behind these initiatives holds also true for the European ambition, that is the aim to have more efficiency and greater choice for users by fostering competition and also to actively address the specific requirements of its own payments market.28

Standing closer to banking interests, the EPC, while endorsing competition “between all participants,” was less enthusiastic about creating a new all-European brand. As its press release carefully stated, “In an environment where there are already competing schemes, the EPC did not believe that its role was to develop a new European card scheme which would replace or compete with existing payment card schemes.”29 Currently only three initiatives exist for establishing a European brand, and all are still in a very early stage.30 According to one expert, “Although

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all parties agree that a European card scheme would be a welcome new entrant in the payments market, no significant progress has been noted for years. Banks await new card schemes to arrive. . . . Everybody is waiting for everybody.”31 European hostility toward MasterCard and Visa grew when the two card issuers went public in 2006 and 2008, respectively, abandoning their status as bank cooperatives and becoming publicly held for-profit corporations. It was feared that the shift from a membership-driven to a shareholder-driven organization would lead to excessive price increases. The main concern of Eurosystem was the multilateral interchange fee charged by Visa and ­MasterCard.32 Because it is charged by an issuing bank to an acquiring bank for each sales transaction, the interchange fee makes issuing cards more lucrative. Because the acquiring bank passes the interchange fee on to the merchant and the merchant increases prices in order to transfer the charge to the customers, the interchange fee results in higher prices. In 2007, reversing a 2002 ruling for Visa, the European Commissioner for Competition ruled that the interchange fee in the form in which MasterCard had implemented it was a violation of European antitrust laws. In 2009, Visa received the same injunction. The Commissioner argued that although the interchange fee itself is not illegal, it is excessive because the two multinationals failed to prove that at its current level it had any positive effect on innovation or efficiency or that it benefited consumers in any way. In effect, she argued that whereas high interchange fees could have been justified when the market needed to enroll the first cardholders, in its current, mature phase it was unnecessary. Interchange fees may have been needed to generate payment card markets, but they are not necessary to keep it running. This ruling forced both Visa and MasterCard to cut their interchange fees substantially.33 On this score too, EPC was skeptical, because its constituency, the banks, were beneficiaries of the interchange fee. It criticized the Commissioner’s decision as a source of uncertainty that upset well-oiled business routines. Overall, the SCF has proved to be the weakest link in the SEPA program. Customers do not comprehend the arcane technicalities of SEPA and are not clamoring for standardization, even though in principle they would be the main beneficiaries of greater competition.34 The issuers are not keen on paying the cost of exchanging their cards for the more expensive chip card. Besides, they enjoyed the hefty interchange fees while they lasted, and they do not welcome competition. Acquirers are reluctant to throw out the old

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POS machines and replace them with costlier ones. To get more buy-in from industry, in 2008 the EPC created the Cards Stakeholder Group, a consultative body that meets and discusses card standardization issues on a regular basis. The card framework has been moving forward slowly. SEPA is an example of an attempt to support local brands against the multinationals through standardization and antitrust intervention. In principle, politically initiated international standardization could produce a payment market that works like railways: a collection of national networks woven together by a set of common rules and standards of interoperability. ­Because it is unlikely that each country would want to operate a national monopoly that handles the entire system from card issuing and acquiring to processing, a more appropriate analogy would probably be a long-distance bus service in which many local bus companies would operate, offering services at home but also some abroad, while other companies would maintain roads and gas stations. Common standards would guarantee that any bus could drive on any highway and fill up at any gas station. Yet as SEPA seems to suggest, when domestic markets are already dominated by multinationals and local banks actually benefit from the monopoly power of international giants through their share of the interchange fee, and when technological change can be achieved more easily through old organizational structures, the inertia against restructuring the market may be too big. Another lesson of SEPA is that whereas cooperation was needed to create the payment card market in postcommunist Europe, cooperation is equally necessary to make the existing markets more competitive, even more marketlike. Competitive markets are created not by market competition but by heavy-handed political intervention, if at all.

The Credit Card Whereas in the United States the bank card market began with credit cards and only now are debit cards becoming more popular, in these three Central European countries, like almost everywhere else, debit cards arrived first and only recently have credit cards begun to take off. American-style credit cards are still few in Central Europe, but their numbers are growing quickly. Today, the credit card markets in the region are dominated by Visa and MasterCard, and most banks offer either one or both international brands.

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debit versus credit cards

The difference between debit and credit cards was less cut and dried when fast information technology was unavailable, which is one of the reasons the US market began with credit cards. If charges on debit cards are immediately deducted from the client’s account, the debit card offers no credit and its issuer does not have to grapple with what we labeled credit puzzles. If, however, there is a delay between the payment and the clearing of the transaction—if the deduction is not instantaneous—de facto credit is extended to the customer. The customer buys now and pays later. This was the case when cards first appeared in the United States, well before phones and computers were enlisted to process transactions electronically. In the 1990s, information technology in Central and East Europe was only a little faster than what it was in the United States forty years earlier. In those early days, when a Hungarian, Polish or Czech shopper paid with a debit card, the cashier would pull out a ring binder where the bad cards for each system were catalogued in a “stop list” and compare the card to the list, and if it could not be found there, the cashier would put the plastic card into an imprinter. After transferring the information embossed on the card onto the sales slip by rubbing over the carbon paper laid over the card, and after obtaining the customer’s signature, the purchase was complete, but the merchant would have to wait days or weeks to receive the money. The sales slip would have to be mailed to the merchant’s bank, where it was hand processed; then the invoice was sent to the customer’s bank, which only then would deduct the purchase price. While the merchant waited, the debit card raised the same kinds of questions that credit cards raise. Take the issue of overdraft. The stop list of bad cards, refreshed only once a month or even less frequently, could show if the card was valid, albeit only with delay, but it provided no information on whether there were sufficient funds in the person’s account or credit line to pay for the purchase. Soon telephones were enlisted to check on funds, but the authorization inquiry was long and cumbersome and made the customer wait long minutes while the transaction was cleared. Phone lines were slow and unreliable, and banks did not have the capacity to update in real time the database used by the authorization system. As several banks began to use the same system, authorization required an additional step of acquiring and merging data from different banks. Originally the data from the banks was

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delivered on five-and-a-quarter-inch floppy disks to the central computer by couriers. So, for a long time, Polish, Czech and Hungarian cardholders received credit on their debit cards, and card issuers therefore had to tackle a limited form of the credit puzzles even before the use of actual credit cards began to spread, and they had to screen their debit card clients carefully. With the improvement of technology, and the possibility of real-time authorization and immediate debiting of the cardholder’s account, debit cards largely lost their credit function, although several of them have kept offering a small credit line as overdraft protection.

creation of demand

Although people were not keen to embrace the debit card, they were even less eager to welcome its more exotic cousin. When we asked banks in 2004 what was the biggest difficulty they faced in the credit card business, most pointed to people’s lack of interest. One clue why people showed so little enthusiasm could have been the fact that several of the card bosses themselves shunned credit cards. When we asked the director of one of the large card operations in the Czech Republic whether he himself owned a credit card, he gave a response we heard from many others: No, no. Because . . . I have a couple of cards, of course, it’s my job, but you know, I don’t need it. I have one card but it is a charge card, it is Diners, and I have it more because of my friend [who works for] Diners Club than [because] I need it. Interviewer: So do you pay cash? No, no. I have cards. I have debit cards. Because of my income and balance on my account, I really don’t need credit cards. [CB #5.1]

His colleague, the chief risk manager, a man in his early forties, explained to us in a later interview why he too did not own a credit card: “Those are for young people” [CB #5.2]. But some younger credit officers also went without credit cards. A young Czech loan officer we interviewed in a different bank in the presence of his boss gave the following answers: Interviewer: Would you qualify for the loans you are assessing? Would you get a loan from yourself?

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Loan officer: Yes, I think so. Interviewer: Would you get a credit card? Loan officer: I think I am a good client Boss: You don’t have a credit card. Loan officer: I don’t have a credit card. Boss: We have to change that [laughter]. Interviewer: Why don’t you have a credit card? Loan officer: Because I did not need it [giggle]. It could be stolen from my pocket; it’s very easy for a thief. Interviewer: But isn’t there a limit of liability? Loan officer: Yes . . . but I have a debit card for my account, I have overdraft on my account, that’s just like a credit card. But if it will be necessary I will take a credit card. I don’t think I am such a bad client. I would get it here. [CB #3.2]

For this young man, credit is a protection against accidentally overspending, not a way to buy things while knowing you don’t yet have the money to pay for them. By no means did all card managers feel averse to their own product. Some had an almost evangelical enthusiasm for credit cards and saw their mission as creating a “modern” market of financial services, which meant a market like the one in the United States. Yet the fact that several of them elected not to have a card does raise the question of why people should want a credit card in the first place. There are plenty of reasons to doubt the desirability of credit cards. It is not clear why anyone with any savings would choose to pay high interest to borrow rather than spend savings that produce much lower interest.35 Even in the United States, where people have had a much longer history with cards and consumer credit, many overestimate how promptly they will pay off their entire balance, expecting never to revolve their debt and then doing it anyway and paying a lot more interest than they anticipated. People also often underestimate the costs of borrowing by not fully understanding all the charges.36 Moreover, credit cards encourage overspending, a point that merchants may appreciate but customers come to regret.37 The fact that many bankers themselves preferred debit and charge cards over credit cards suggests that the willingness to use credit cards is rooted more in culture than in individual rational calculation. This was evident in the way bankers perceived their task in creating demand for their product

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and identified the main obstacle they had to conquer in finding a sufficient number of cardholders. As one Hungarian bank official stated it plainly, “We say that the main difficulty is culture. Simply, people must be taught to use the credit card and to enjoy its advantages” [HB #3.3]. The card was not addressing an existing preference. People’s preferences had to be tinkered with for the product to be a success. As amateur sociologists, bank managers had their own analysis of this cultural aversion to credit. The director of the card department in a Polish bank gave an explanation we heard repeatedly in different forms: We are at the beginning of the road. It is a product that . . . is starting to live and starting to be popular. And it is also a little bit against the . . . ummm . . . not only Polish, because it’s all Slavic countries, rather Christian countries—against this mentality. It is not like Protestant countries like the United States where it is normal to live on credit, so you work and earn to pay for your credit. In Poland this is the opposite. We live and earn to pay any expenses . . . first money, then expenses, and to change this mentality into more an American or English way. It’s a quite difficult job, this is the most difficult job. [PB #5.1]

According to this analysis, the cultural divide between the United States and Central Europe runs deep. Central Europeans are more conservative. They insist on earning first and spending later—which ironically are precisely the virtues that were celebrated in the United States until the cultural shift that accompanied the rise of mass consumer credit began after the First World War.38 A third executive from a different Hungarian bank gave his own gloss on this theme: We should somehow get people into the habit. I say this from a business perspective, that they can spend more than what they have in a given situation, that they should not start from a Prussian financial culture that I first get something and then I spend from that and probably save too, and maybe if I need something I take a loan. By the way, I don’t know if this is good or bad, whether the Anglo-Saxon [culture] is good or bad, but from the perspective of profitability, we think it is better if there is a credit line. I spend from it and afterward I look at my statement and [ . . . ] decide if I want to revolve it. [HB #5.3]

To create this market, banks had to change minds and habits and not just interest rates or annual fees. Persuasion is the essence of marketing, but Cen-

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tral European bankers had to do more. They had to educate people, and not just about how to use the card, but also that they want to have one. One Austrian official of a then-German-owned Czech bank explained that he required new cardholders to contact their call center after they got their credit card to get instructions on its proper use. Cardholders had to be convinced to borrow. Just charging them higher fees on cash transactions was not enough: At the beginning, when we started, people hadn’t known this product. They were not thinking, they took the money immediately from the ATM machine. And they were thinking this was the object of this product! But it is completely different. This was wrong and then we had to stop and if somebody was taking our cards, he had to call into the call center, [and] we had to explain to him the product. [CB #3.1]

To persuade and educate people, banks also rolled out advertising campaigns. From billboards to television ads, people could see happy and prosperous cardholders enjoying the advantages offered by credit cards. Famous actors were hired to hawk the cards along with other services the banks offered. Banks also created marketing alliances not just with large retailers but also with football clubs, gas stations, various professional associations, national airlines, insurance and mobile phone companies, and so forth. ­Co-branding—putting the partner’s logo on the cards—gave banks access to the clients of its partners, while benefits offered by the partner gave additional incentives for people to get the card.

t h e s u p p ly o f c r e d i t

The Elite Market If people could be persuaded to want credit cards, the lenders still had to figure out which applicants should get them. To solve the puzzle of information asymmetry and avoid dodgy borrowers, banks issued their first credit cards to their elite customers, who seemed a safer bet. Starting with an elite clientele had many advantages. Demand among the well-to-do was higher because they often traveled abroad and they appreciated the convenience of being able to pay with the card on their foreign trips. Moreover, as they interacted with Western partners who had credit cards, these clients were very aware of the product and were tuned in to its symbolic value. One of the

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Polish pioneers of credit cards recounted the response of a Polish businesswoman when asked why she wanted to have a credit card: No matter how much the card costs, I have to have it. Why? Because I have a million-dollar contract in Germany, and whenever I go to them and invite them to lunch or dinner, and I see in their eyes when I am paying with bills at the restaurant, they say, Jesus Christ! We have signed a contract with somebody who is not trusted by any bank. [PB #5.1]

Because elite customers were less price sensitive, their cards could be priced higher. For the elite, the credit card was a token of financial well-­ being and prestige. In this respect, high price was even a plus. Just as sporting a diamond ring, carrying an expensive credit card signaled financial success by the very fact that not everyone could afford one. The credit puzzle was also easier to solve: elite customers were less likely to default due to lack of funds, and if they did, they were easier to find. All banks wanted a slice of the elite market and kept a roster of their most valued customers, which was often referred to as the VIP list. The VIP list included high net worth clients but it had a much broader purpose. The head of the card division of another Hungarian bank described the VIP list as follows: One does not necessarily have to have a large deposit. The client may have less money in his account than me or you, but he has a societal reputation in Hungary, which makes him important for the bank. . . . Those include actors or strategically important clients, like managers or employees of the Hungarian National Bank—which is to some extent a conflict of interest at some level—or employees of the World Bank [in Hungary] . . . Sometimes I approach people . . . [saying] . . . “Be my special client!” that is, I immediately offer you that I will treat you as “image” if you come as a client. [At other times] we first seek out the leader to be our individual client, hoping that he will bring his company to us, or the other way around. [HB #4.1]

VIPs delivered something more than just payment for the service they got. They brought “image,” not just in the form of celebrity endorsement but also as influence on local opinion, and they could also deliver political support and additional business. Politicians were on the VIP list of most banks, and VIP members were frequently known personally by bank directors. One Czech branch manager in a town an hour west of Prague showed

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us a picture of himself standing next to the local mayor, who had gotten his credit card from his branch. “The mayor of K. is my friend and he is OK,” he said with a broad smile [CB #5.4]. Some international banks felt awkward about the VIP list, perceiving it as a form of corruption, a point conceded by the Hungarian card manager quoted earlier. One of the largest US banks in Central Europe made it a policy not to have a VIP list and refused to issue credit cards to elected politicians, with the justification that their tenure in their jobs, and therefore their finances, were certain only until the next election. But this was the exception in the region, and most banks were eagerly courting people of power and influence. That VIPs were not always profitable could frustrate bank managers, even if they understood their “strategic” importance. A director of an international bank in Poland spoke with exasperation about a VIP list member whom they put on their list as a defensive move: “this journalist, he makes little money but can cause a lot of trouble . . . ” [PB #7.2]. When banks with VIP lists were asked how they would treat VIPs if they were to lose their status, the typical and unsentimental answer was that the person would be reevaluated as a regular customer. In these elite markets, the key problem of information asymmetry was solved by personalized trust. Top bank managers, themselves members of the national or local elite, had informal ties through which they could obtain additional information about their VIP customers. For some famous clients, useful information could be gleaned from the media and other public sources. It would seem that an important factor guarding banks against bad credit behavior was the VIP’s reputation, which could be spoiled if he or she were to act irresponsibly as a borrower. Yet skipped payments by VIP clients never drew loud condemnation from the banks, and resulted in legal action only in exceptional cases involving large amounts. After all, VIP clients had the power to retaliate. In a public battle, a bank’s reputation would have been as much on the line as its VIP customer’s. It was more important that the visibility of VIPs made it hard for them to hide from their personal customer representatives, who would respectfully but persistently coax and cajole them if they fell behind on their payments. Most, however, paid up, and delivered other intangible benefits for the bank.

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An internal document of a large Hungarian bank from 2001 revealed that the following professionals were to be granted preferential treatment if they applied for credit and, by extension, for credit cards: •

Public figures (in social, political and cultural areas)

•

Doctors and pharmacists

•

Lawyers, judges and notaries

•

Top managers of banks, credit institutions, insurance companies, and armed forces, and mid- and higher level managers in state administration

•

Teachers

•

Engineers

•

Public employees and civil servants

•

Employees of banks, credit institutions and insurance companies.39

Additional positive consideration could be given to applicants “on the basis of the personal experiences of bank employees with the applicant (fairness, trustworthiness etc.).” Curiously, the list does not include wealthy entrepreneurs and top managers of factories or other private enter­prises outside the financial service sector. Although those did end up on the VIP lists, they got there on the strength of their wealth and needed no assistance from internal policies. This roster of preferred social groups also included people who were a cut below the national elite, but who could garner prestige in their local communities and, equally important, whose occupation secured a steady income (teachers, doctors, pharmacists, public employees, civil servants and engineers). These people got preferential treatment when their application was assessed, but they did not necessarily receive personalized service. They were “preferred” but not quite “very important.” Although VIP customers may have made the bank as a whole more profit­ able, they did not turn credit cards into a money-making enterprise. Even if they used the card copiously and revolved on large balances, because of their small numbers, elite clients could not support the cost of running a credit card operation. The large fixed cost of issuing credit cards required either a cross-subsidy from other operations for each client, or a larger customer base that could take advantage of economies of scale. The addition of these less exclusive groups reflected the need to extend the base.

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Relational Banking A few lenders chose the first option; they put the credit card into a mix of services that included ones that were profitable and could pay for the losses incurred by the credit card operation. Some banks, mostly those headquartered in Germany, embarked on a strategy of selling credit cards as a portfolio of services, building a complex relationship with their small but well-heeled clientele. The manager of the Polish subsidiary of a large German bank explained the bank’s strategy this way: We don’t want to have the consumer loan lines [for people coming] from the street. They are just coming with the salary statement and earning two thousand zloty and need ten thousand. If you want to have a relationship with the bank—deposits, accounts, investment funds, whatever account— then you are a potential client for us; otherwise this will be automatically reflected in the pricing and we will not decline this in the beginning but we will charge more in case you just ask for one single product. Interviewer: Isn’t this elite market already overbanked? I don’t think so. [ . . . ] this is really an emerging market [ . . . ] I think this model we developed [ . . . ] can be successful. For each client a relationship manager would be assigned and a contact person in the bank [would be] developing financial concepts for you. They are not to grant any loans that do not fit your personal situation or provide you with some other product and later find out it is wrong [for you]. [PB #4.1]

In relational banking, the credit card is just a hook to draw clients in: In case the client enters the bank [and says], “ahh, I [must] have everything from you, otherwise I do not get the card,” this system for sure does not work. Especially for the small and medium-sized enterprises, you need a kind of anchor product. You provide them the credit line to the account and he has to provide the turnover to this account and then come to a deeper and deeper relationship with that client. And then you can develop some models [ . . . ] for the company, and hope to develop the business together with the bank. [ . . . ] For sure, in the first stage, we can accept this standalone credit or charge card, but with the intention to develop the relationship. [ . . . ] Not to get this one thousand zloty [fee that] the client wanting a charge card [pays], but to see from the early beginning what else you want to do with this client. [PB #4.1]

Relational banking kept the personalized tools of VIP banking and though it cautiously extended them somewhat beyond the top elite, its main

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direction of growth was intensive; the goal was not to have more customers but rather to get existing customers to buy more services. Although some of the banks favored this strategy, the majority decided instead to follow the path of extensive growth; they wanted a wider clientele even if those customers asked for only a single product, such as the credit card.

Moving to a Mass Market Solving the Information Asymmetry Puzzle  Lending to a large number of strangers amplifies the problem of information asymmetry that creditors face. Some banks initially tried to avoid the information asymmetry puzzle and protected themselves against nonpaying borrowers by requiring a substantial collateral: a security deposit equal to or even larger than the credit line on the credit card. This turned out to be not so popular because it made obtaining a credit card very expensive. It was not just that one had to pay the various upfront fees (initiation fee, application fee, annual fee and so on), but one also had to part with—even if only temporarily—a larger sum of money that would be kept by the bank for security. In fact, with the large security deposit it is the client who lends to the bank and not the other way around, which is why some banks pay interest on security deposits. To require a less liquid asset, such as real estate or a car, to serve as collateral would have forced banks to evaluate and, in the event of a default, repossess, care for, or store and then sell objects they knew little about. Therefore their next idea was to require cardholders to deposit their paychecks directly into an account that the bank controlled and could garnish if necessary. If the card applicant already had a payroll account with the bank, this was a reasonable solution, but people still had to sign an authorization that empowered the bank to take money forcibly from the account in case of nonpayment or default, and that made many clients uncomfortable. In any case, as we have seen, people did not like the idea of not getting their salary in cash. The thought of the bank grabbing their money made them even less enthusiastic. If banks wanted to compete for and gain customers in a feeble market, they could not rely primarily on collateral. Screening Customers  Banks could not circumvent the information asymmetry problem by perfectly insuring themselves against nonpayment, so they

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had to face the puzzle directly. They had to evaluate customers; they had to predict with some accuracy, on the basis of the information available to them, who would and who would not pay. By making the right predictions, banks could minimize their failed loans. But first they were faced with an obstacle: the information available about applicants was sparse, unreliable and often biased, that is, it was asymmetrical. Second, they faced the problem of the counterfactual: they could not know how people they rejected or scared away would have behaved had those people been granted the loan. Maybe they would have been just as good customers as others. Banks found out—albeit too late—about the mistake they made by giving someone a card who turned out to be a bad client, but they could never find out the other type of mistake: when they had refused a good customer. When banks crave new customers, avoiding this second type of error is vital. Under pressure to increase the number of their credit cardholders and move beyond their elite clientele, the banks set out to follow a number of strategies, often simultaneously. The first one, similar to relational banking except for its wider scale and shallower depth, was to scour their customer records, find their good clients and offer them a credit card. Cross-selling credit cards to existing clients was advantageous because banks already had some information on potential cardholders. The bank knew how much these clients saved or deposited and how regularly they received payments to their accounts, and if they borrowed money from the bank, the bank knew whether they paid on time. Besides, if customers had savings or checking accounts, the bank could hold these as collateral in case of trouble. Yet the strategy had limitations. Given the history of retail banking in these countries, the banks, except for the national giants, did not have large enough clienteles. For most banks, the task was precisely to expand into new circles of customers. Even the giants, with their enviable customer base, did not fare much better. Their problem was that their sprawling branches kept their records in paper files and in various, often incompatible formats. Developing a digitized customer database took the big banks a long time and during their first decade they ran their retail operations without a unified customer database. OTP, for instance, did not have its own system up and running until 2001, and even in 2004 it was still populating its database with only new trans­ actions, because it ultimately gave up on moving the account histories kept in its many offices on quadrille-ruled booklets to its new system. ČS started to

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develop its own centralized client registry in 2000, the year it was bought by Erste, an Austrian bank, and Poland’s PKO was still building its unified system as late as 2004. Still, even without a unified system, big banks could take advantage of their large size by farming out the promotion of their cards to the branches where the data sat. Yet even if banks had records, those records had little to say about how people handle a product, the credit card, that they had never before encountered. With consumer loans being sparse and credit cards still a rarity, the history of being a bank depositor had dubious relevance for predicting how customers would treat their credit card obligations. The second strategy drew on the banks’ corporate clients. While the first strategy expanded services to existing individual customers, the second strategy offered new services to existing corporate clients, roping in new cardholders through companies that already did business with the bank. Having already offered credit cards to corporations’ top managers, the banks began to move down the corporate hierarchy, reaching mid- and lower-level employees. Because the bank was already in charge of the company’s payroll, it could monitor the employees’ incomes almost in real time. Because they held the company’s accounts, they had a good sense of the financial stability of the business, which was one of the predictors of the employees’ ability to pay. Moreover, in the case of defaulting clients, banks had the company track them down and persuade them to pay up. An example is a large U.S. bank that had arrived in the Czech market just a few years earlier. It had a special plan: We call it [OurBank] At Work, which is a special program . . . we approach our [corporate] client with a holistic solution, so not just a consumer or corporate [solution], or something like that, but everything together. Every single financial need of the employee as well. In these cases we know much more about the employer and we know something about the profile of the employees they have. [CB #4.1]

This program, followed also by its Hungarian and Polish branches, produced about one quarter of the bank’s Czech cardholders by 2004. Both the first and the second strategy had natural limits. The pool through which the banks could sift was not wider than the bank’s existing client base in the first case, and limited to all the employees of its corporate clients in the second. Most banks therefore had to turn to a third strategy often deployed alongside the other two: they began to seek credit card applicants from the street.

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The Austrian CEO of a German bank in the Czech Republic explained why it had to rely heavily on customers who came in from the street and wanted only a credit card: Here we have this American-British system and in Austria we have this Continental European system where you always have to have a linkage between a current account and a credit card. [In the Czech Republic] we have decided to go into [the] retail market and to offer a credit card as a separate product. [ . . . ] There was no question to do it in the same way as in Germany because [ . . . ] we had no clients. [CB #3.1]

Targeting new customers with no prior connection to the bank exacerbated information asymmetry and required an entirely different approach to screening. Banks had to devise a method to judge strangers. The credit card world, and the international companies in particular, offered a solution: statistical scoring. Statistical scoring takes data available at the time of the application and combines them to give the best prediction of how that applicant will behave in the future. This process requires a weight (a multiplier) for each predictor that is derived from a statistical equation calculated from data for people who already had the chance to prove how they pay their debt. Those weights are employed to calculate the probability that the new client will do well in the future. In essence, statistical scoring tells the lender, on the basis of mechanically combining a large number of observations from the past, how people who are similar to the applicant tend to behave and offers that calculation as the best prediction of how the prospective new client would do if the loan were granted. The U.S. firm Fair Isaac Corporation (now FICO), the inventor of this automated technology, together with the multinational credit information service provider Experian and other Western companies, arrived early in the region to convince the banks about the usefulness of statistical credit scoring, hoping to sell the technology. Many banks consulted them, and even bought starter kits, but once they grasped the basic principles, the banks decided to develop their own automated scoring systems, or if a bank was bought by an international financial institution, it adopted the technology of its new parent company. Along with marketing, screening customers was considered by managers to be the core of what banks do. Deciding who to lend to is what makes an organization a bank and what may give it a competitive advantage. Although banks outsourced many functions, from

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card manufacturing to card activation and even authorization and collection, they always kept applicant screening in-house. During our research, we found that most banks in Central Europe used their own versions of credit scoring, even though, as we show, it was not the only, and often not even the most important, basis of their decisions. The issue of screening customers while trying to expand the market takes us back to the problem of the counterfactual, that is, the problem of not having information about what could have happened but did not. As most banks tried with great determination to minimize the number of failed loans, they faced the following paradox: the more successful banks were at lending only to those who would surely pay, the less they learned about how to tell good borrowers from bad ones, simply because their success kept out the latter. Not knowing what bad borrowers were like made it impossible for them to figure out which characteristics of the good borrowers predicted their good behavior. This knowledge could be obtained only by carefully comparing good and bad customers, and information on the latter was missing.40 Not knowing whether all the rejected applicants would have been bad borrowers if they had been given loans also amounted to incurring opportunity costs, because lenders lost potentially good customers and forewent profits. In addition to not knowing about the rejected applicants, banks also knew nothing about the people who had not yet applied, and given the pressures of market expansion, they were very eager to recruit them as new customers—so eager, in fact, that several banks hired market research firms to run surveys that asked consumers how they felt about credit and about credit cards in particular. These surveys were expensive, and bank managers were privately quite skeptical about their usefulness, pointing out that the surveys were all about talk, opinion and hypothetical situations. When asked why they did not experiment instead and give credit cards to a wider segment of the population, then see how they actually behaved, and then spend the money now paid to consumer surveyors to cover the loss from nonpayment, managers explained that the first expense falls under marketing and the second under risk management, and as such they are two different things. They pointed out that money spent on market research is a form of development deemed beneficial for the bank, while loan failures are an indication that the bank is doing a bad job and would harm its reputation. What they failed to appreciate was that learning from mistakes inevitably meant first making mistakes, something that banks desperately tried to avoid.

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Legal Doubts About Automated Screening  In legal terms, credit scoring falls into the category automated individual decision: a decision made in a mechanized way and concerned with a particular individual as opposed to some statistical category of people. Automation is an important advantage in retail lending, in which a lot of customers borrow relatively small amounts of money. In the United States, credit scoring emerged as a solution not to the difficulties of handling a mass of customers but to antidiscrimination suits filed against lenders in the 1960s and early 1970s. The Equal Credit Opportunity Act of 1974, and the subsequent Regulation B added by the Federal Reserve, stipulated that using empirically derived and demonstrably and statistically sound methods in credit decisions made lenders immune to law suits.41 The law did not just accept but also encouraged automated individual decision making. Since then, credit scoring has been viewed as an objective and scientific method of making decisions about loan requests, superior to human judgment, which was deemed to be prone to errors, mistakes and prejudices of all types. Taking human discretion out of credit decisions was a way to protect individuals who wanted to borrow. In 1995, the European Commission issued a directive on data protection that all member states had to adopt. The directive took a markedly dimmer view of automated individual decisions. It prohibited imposing on an individual decisions that are “based solely on automated processing of data intended to evaluate certain personal aspects relating to him, such as his performance at work, creditworthiness, reliability, conduct, etc.” if the outcome is negative.42 The directive made it clear that the Commission aimed to protect individuals because taking human discretion out of decisions of consequence threatens people, a position diametrically opposite to the one upheld by the American legal system. Rather than providing an objective and fair process, as a communication from the Commission in 1990 put it, “the use of extensive data profiles of individuals by powerful public and private institutions deprives the individual of the capacity to influence decision-making processes within those institutions, should decisions be taken on the sole basis of his ‘data shadow.’”43 Two years later the Commission elaborated further: The result produced by the machine, using more and more sophisticated software, and even expert systems, has an apparently objective and incontrovertible character to which a human decision-maker may attach too much weight, thus abdicating his own responsibilities. [ . . . ] the use of scoring

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techniques with a view to lending to an individual is possible, if positive decisions to lend are based solely on automatic assessment of the risks; but where the score is negative the legitimate interests of the data subject must be safeguarded, for example by deferring a final answer until the organization has been able to carry out a “flesh-and-blood” study of the case.44

Automated individual decision as a legal concept was absent in the three countries until they joined the European Union in 2003 when, following a 1995 EU directive on the topic,45 they had to put laws protecting data privacy on the books. Each country adopted the directive somewhat differently. The Polish law followed the directive most closely.46 With the consent of the customer, the law allowed credit scoring to be the sole arbiter of an application if the loan was granted; otherwise, humans in the bank had to review the case. The wording also implied the need for people to consent to the use of their personal data. The Czech law flatly banned mechanized judgments, but it allowed for exceptions when the decision was favorable or when such judgment was explicitly requested by the person involved.47 The Hungarian law went the furthest. Not only did it stipulate that automated individual decisions were illegal without a specific law authorizing such decisions or the expressed consent of each person to be judged, but it also demanded that people be given an opportunity to “express their point of view.” Moreover, it required that the mathematical method and its meaning be disclosed to the person if that was requested.48 To comply with this last requirement was unthinkable. Banks treated scoring algorithms as proprietary technology that they wanted to shield from competitors; moreover, they were also worried that once the algorithm was out, people would begin to game the system by tweaking their answers to get the results they wanted.49 The banks did not see the law as an impediment to scoring, however. They reasoned that credit is a contract and when people sign the loan documents, they agree to be scored. The Hungarian banks chose to ignore their duty to disclose their models upon request, but there were no such legal requests that we are aware of. Credit Cards with Some Credit Scoring  Credit scoring was rarely the only thing that banks used to decide creditworthiness. They mostly followed the EU directive because, for their own reasons, they too did not trust scoring. They used scoring as one piece of evidence to be weighed together with

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other information by the lending officer. In one Polish bank, this was how the decision was described: Interviewer: Is there information that comes from personal contact? In some banks, you fill out this questionnaire but then the salesperson or the officer fills out another questionnaire about this interaction. . . . Of course the customers have direct contact with the credit officer, and in our scoring system there is a special group of fields where he can move this information you are talking about. So he can give this information to us, to headquarters, that this customer was drunk as he came in to fill out his application. [ . . . ] He can put [down] this information: “The customer is known in our branch,” that “he got three or four loans and all are [being] paid on time.” Interviewer: Is this something that enters into the formal scoring system? No, no. It is not entered into the formal scoring system. This information is something that is used [in conjunction with scoring]. . . . Interviewer: So the credit analyst looks at the score and looks at this extra information. . . . Yes, and looks for information from BIK [Biuro Informacji Kredytowej S.A., the credit bureau] and from the application and makes a recommendation. [ . . . ] in Poland, [the phrase] is often used: a “gray zone.” [ . . . ] We call this the “gray zone,” when we divide [applicants into] good and bad, there is this gray zone. [ . . . ] So this is a problem and these loans are verified by credit analysis. [PB #1.1]

In this bank, the officer in the branch who had contact with the applicant sent the applicant’s file to the credit analyst in the central office. The credit analyst calculated the score from the file, then made a judgment based not just on the score but also on the credit bureau report available in Poland and the branch’s written comments. In most cases, the credit analyst’s judgment was not final; it was just a recommendation to the branch. The analyst’s judgment was aided by certain rules. The rules gave clear guidance on the low and high end of the scoring scale: the best and worst customers were easily sorted. The middle group was the “gray zone” where the analyst had to use expert judgment. The percentage of applications automatically rejected in this bank was only 3 to 5 percent. But there were no automatic accepts. The rest of the cases, together with the recommendations, were handed over to the branch, which could now make its own decision. In this bank, about 70 percent of

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the cases came with a positive recommendation, but 90 percent got accepted. Thus, for 20 percent of the applicants, the local branch overrode the decision of the credit analyst, whose judgment was already influenced by the branch’s comments. This high acceptance rate was thought to be normal because [at the] branch the credit officers make interviews with the customers before the application fee is paid. So the customer goes to the branch, says that he has this salary, these education levels and so on, and the credit officers say, yes, you can apply for the credit. So, the really worst customers are rejected in this first interview before they fill out the application. This is, I think, a common situation in every bank. [PB #1.1]

The reason for the low rejection rate was that the preliminary selection was made by the branch officers, who tried to anticipate the central office’s final decision, because sending up too many automatic rejects would have reflected badly on the branch. The branch officers were not told the applicant’s score, however, and the actual model weights were top secret, known only to a select few in the risk management department. The risk managers did not want the local officers, who were interested in selling cards, to help applicants get a higher score by tailoring and shaping their answers according to the model. They wanted accurate information because a large part of the information provided by the applicant, including some pieces that were weighted heavily, such as education, was not independently verified. In this bank, the risk managers in the central office, whose job was to worry about bad loans, were wary of the local officers in the trenches, whose job was to push the product, but they let them make the decision, for several reasons. First, there was a sense that the local people knew their customers better than the people sitting at the headquarters. Second, there was the same problem of counterfactuals discussed earlier: if the decisions were based exclusively on scoring, the scoring model could not be properly validated, because one would never find out about false negatives—the people rejected by the model but who nevertheless may have been good customers. It was common practice to allow the scoring system to decide for the lowest and highest scores and to use human judgment in the “gray zone.” Another, smaller Polish bank gave the following estimate for its gray zone: [With] our scorecards at the moment, we would get an automation of about 50 percent of the applications. In round figures, about 20 percent would be

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automatically declined, 30 percent would be automatically sanctioned, and the other 50 percent [would be] sent for lender review. We have a number of credit analysts who literally review them using the prompts that are built into our review rules. [PB #6.1]

One bank, in Poland, that has gone the furthest among those in our sample in mechanizing the entire lending process, centralized its credit assessment in a single office in the bank’s headquarters. The heart of the system was the “decision engine” attended to by three young officers. The “engine” was a computer algorithm that included all the considerations the bank could formalize. The algorithm was quite complex. For people who were already clients of the bank and applied for a credit card, the engine had a simplified process, sorting them into five groups on the basis of the financial services they had been receiving from the bank: (1) mortgage holders, (2) those with credit older than six months, (3) those with multiple accounts, (4) those with a direct deposit account and (5) the rest. (The first four groups were all clients in good standing.) The engine included a separate scoring process that was used mainly for new customers, but existing customers—for instance, those who had only a short history with the bank and no substantial blemish on their record—could be scored in that way as well, if scoring data were available and the score led to a more favorable decision than the other method. The engine used about ten variables to construct the credit score. The credit score, however, was only one of four factors programmed into the decision model. The model also included, as a separate consideration, information from the credit bureau (BIK) about the person’s credit history obtained from other lenders participating in the registry. As a third criterion, the engine took into account whether the person was in any of the desirable target groups devised by the marketing department, such as college students in specific majors. This criterion created difficulties, because the categories useful from a marketing perspective were not always readily available in the system that contained the information from the application form, which had to be short and unobtrusive so as not to scare away prospective customers. Finally, a set of conditions was included by the risk department that picked out groups considered either high risk or especially reliable by its experts. A series of logical rules adjudicated these four criteria, and the system handed down a final decision in 65 percent of the cases. The rest were given over to the credit analysts, who then had to decide “manually.”

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When a risk manager was asked why the manual adjustments were needed, and why the bank could not just simply include all these factors in a single scoring model, the answer was a series of examples involving special circumstances in which the scoring model would be in error. For example, the scoring system usually assesses higher level of risk for young customers, for males, for people who rent a flat and not own a flat, people who work only for a short time, and usually all these characteristics [are] separately considered as predictors of bad behavior. But it could happen that we have an applicant who rents a house, has worked only for a short time, he is a consultant, he is usually [a] very, very good customer, reliable customer, but it is not possible to asses him a risk, a score; in this particular case the score is simply not a good way to assess the risk. Interviewer: But in principle you could add this as another variable or variables in the model. In fact, we could build a model that would have only cases, not characteristics but cases. We could consider all the possible cases and this would be the best model. For example, if we had ten characteristics and each of these characteristics had five possible arguments, we would have five . . . such a huge number of observations [would be] needed that it is not possible to calculate it in a statistical way. It would be the best model, but it is not possible to do. So we have to have a simplified score card and then [we need to add] changes to perform better. [PB #3.2]

In fact, the best model would assess each person individually using a unique combination of the values of the predictors. This would of course make statistical analysis and calculation of probabilities impossible. Without making the connection himself, the risk manager essentially restated the EU concern that the actual person is complex and unique and should not be mistaken for his “data shadow.” Most Central European risk managers were acutely aware of the limitations of credit scoring. The closer we got to the people who were responsible for the technical details of the technology, the more skepticism we found about its ability to tell good customers from bad ones. Just what should count as an indication of a bad customer was also less than straightforward. Most banks in the region defined a customer as bad if he or she missed one or more consecutive required minimum payments after the thirty- to forty-five-day grace period. Consequently, scoring ­models sorted people into two groups: those who always paid promptly, defined as good customers, and those who missed at least one minimum payment,

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counted as bad ones. New customers were then judged on the likelihood of missing at least one payment in the future. This makes perfect sense if the bank’s main aim is to deal only with fastidious people. Yet people miss payments for all sorts of reasons, and only very few of these people actually default—fail to pay at all or, as banks put it, remain delinquent beyond 90, 120 or 180 days. Those who miss a payment or two pay fines and interest on the outstanding loan, and are much more profitable for the bank than those who always pay off their card debt on time. Even people who eventually default may turn an overall profit for the lender if the fees, fines, penalties and interests make up for the unpaid portion of the loan (plus interest and the cost of trying to recover it). As the risk manager of a large Czech bank put it, “The best clients we have are those close to the cutoff point. They have the best return, they yield the best profitability, they have huge margins even if we use risk-adjusted prices. We like them very much” [CB #1.1]. The scoring model gives low scores to the most profitable customers and high scores to the least lucrative clients, who pay in full before the end of the grace period. Scoring thus counsels against taking those with the best profitability, and rewards the general bourgeois values of punctuality, prudence, and reliability. Moreover, concentrating on payments missed on a particular loan ignores that people often have multiple relations with the bank. They may miss payments on their credit card but make money for the lender by paying their mortgage or car loans. The account in trouble may be just one element in a portfolio of services. Punishing a missed payment on one account with a fine may make it harder for the customer to meet the obligations on others. Judging accounts in isolation is clearly not the most rational way to evaluate customers. Except for the “high networth clients”—a small subset of the VIPs whose entire business with the bank is evaluated—banks did not consider the predicted overall profitability of the customer. The scoring system therefore raises a series of questions: Why look at a single service and not at all the services a client takes from the bank? If the focus is on a single service (such as the credit card), why consider payment habits and not profitability? And if it is payment habits that the lender chooses to use to evaluate a future customer, why do banks use punctuality as opposed to default? When asked these questions, many bankers offered the view that not paying is a moral flaw. As one banker who managed scoring for the ­Polish credit bureau put it with passion, “When

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someone has a negative [credit] history, [he should be] out of society! This is a very heavy penalty, you can say. You can say it is human etc. It is human not to pay the bills? Why is it normal not to pay the bills? This is destroying the economy” [PB #1.2]. From this perspective, credit scoring looks much more like an educational tool, aimed at inculcating proper values in citizens, rather than an instrument of profit making. Others pointed out that they were simply following international industry standards. Doing what large US banks do might not have protected them from inefficiencies, but it probably shielded them from culpability for those inefficiencies. For the risk managers who were in charge of developing the scoring methodology, it was necessary to find a simple, well-defined outcome that was numerous enough for their statistical models to work. Missed payments fit these requirements because they were easier to measure than profitability and they were more numerous than default. Because many risk managers came with degrees in statistics, physics or math, they found profitability to be an important but elusive concept that they considered to be the primary responsibility of the marketing people with business degrees. They saw their job as providing security for the bank by avoiding massive losses. With default rates mostly under 2 percent, they had to find a way around the difficulty of modeling rare events. Missed payments were four to ten times more common than default, which made statistical models easier to fit, but of course they also meant that the vast majority of the delinquencies got happily resolved eventually, and the model predicted something other than what it was supposed to.

Marketing Versus Risk Management Creating a mass market for credit cards put banks under contradictory pressures: they had to sell as many cards as was humanly possible, but at the same time they also had to weed out risky applicants. Banks could have handled this internal conflict in several ways. In principle, they could have developed a system in which loan officers would have been rewarded for enrolling new clients but punished if the ­client turned delinquent. By holding loan officers directly responsible for the bad clients they approved, the bank could have created a commission system in which incentives reflected both success and failure, creating a balance. Yet no bank chose this option, for several reasons. First, loan of-

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ficers good at coaxing reluctant prospective customers were not necessarily the same people who could best evaluate their creditworthiness. Moreover, if the bank wanted to expand, penalties for bad clients would have curbed the enthusiasm of the sales force, making it overly cautious and stifling the effort. At best, the card officers would have bombarded a small circle of affluent people who seemed safe and thereby kept the credit card an elite product. In some cases, the enthusiasm of the salespeople indeed left much to be desired. An Indian card manager of a large U.S. bank that hoped to establish its retail operation in the Czech Republic by blazing the trail in credit cards employed about a hundred salespersons whose job was to find prospective clients, meet them face-to-face, mostly at their workplace, explain to them the value of the product and get them to apply. He complained, [The] biggest difficulty that I would say here is actually selling. Surprisingly. So we have found it very difficult to [ . . . ] recruit sales agents who are sufficiently motivated to go and sell these products door to door [ . . . ] For some reason salespeople over here seem to be very content, if you will, with their base salaries. So they are like, “OK, I will only get you the applications that I’m sure will get approved, that are well within the bounds you have assigned. If I get one that’s fine, and if I don’t get any that’s fine too.” [CB #4.1]

The sales agents were paid a base salary that was slightly above minimum wage, as well as a tiered commission that paid an amount based on the total number of new contracts they delivered that month. The more clients they brought in, the higher their commission per customer was. Even with this incentive system, the U.S.-Czech bank’s sales force delivered a lackluster performance. Penalizing sales agents for the bad clients they brought in would most likely have made them even less enthusiastic about their task. Banks chose a different solution. To establish the value of each customer, they organizationally separated sales from risk management and centralized the latter in a single department, staffed with risk specialists whose sole job was to protect the bank from lending to risky clients. Foreign owners would often go so far as to bring in foreigners to mind their risk department. These expatriates rarely spoke the local language and knew little about local culture, but they were versed in the statistical techniques of risk management. At one point in the middle of the first decade of the 2000s, all but one of the big Czech banks had their credit card risk portfolio managed at the top by foreigners.

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Trusting resolution of the information asymmetry problem to the risk managers and isolating them from marketing, however, relieved salespeople of the pressure to judge applicants and turned them into the applicants’ advocates. A German-Czech bank that decided against face-to-face persuasion and followed the more typical path of sending promotional mail and placing commercials in the media to recruit new cardholders found that “if you gave the sales force the possibility, then everyone would be a VIP” [CB #3.1] and would automatically be offered a credit card. Risk management first sought to guide loan officers with a set of rules, but these rules would constantly run up against reasonable exceptions. The main problem with the rules was their discursive nature. They had to be accompanied by a causal explanation justifying why this and not that type of person would be more likely to pay back their loan, and it was always easy to challenge those rules with anecdotes or common sense arguments. Much of this challenge came not from the unsuccessful applicants but from the bank’s salesforce, who were eager to sign up new cardholders. Worse still, the rules had to come from some knowledge of how to recognize good borrowers and distinguish them from bad ones, a knowledge that was scarcely available even to the salesforce, who met and dealt with the clients, and it was inaccessible to the risk managers in the central offices, who rarely if ever encountered a credit card applicant. Rules were therefore soon replaced by statistical prediction. Risk managers did not have to argue why it is necessary to collect a certain piece of information from the applicant. All they had to claim, essentially, was that this information was predictive in the aggregate, that in the statistical model the variable had a significant net effect. Leaving behind causal explanations, they spoke about probability distributions in which no single case can disprove or prove anything. Whereas marketing could not see the forest for the trees, risk management claimed to have a map of the forest: If we ask, what was the reason that this client did not pay, this is a good question for a corporate client but not for a customer, who simply may have gone for a long holiday and forgot to pay an installment. We don’t inquire about that. We simply focus on aggregates, certain measures, that are appropriate for this kind of portfolio analysis. [ . . . ] Given the data we have, we can generate the full probability distribution of default. [PB #1.1]

Off the record, salespeople often talked about risk managers—many of whom had degrees in mathematical sciences or were simply fresh out of ­college—as interlopers, lacking specialized knowledge and understanding

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of the card business. Many top card managers viewed the incipient card business with evangelical zeal and saw themselves as pioneers thwarted by the overly cautious risk people. Risk managers, on the other hand, casting themselves as beacons of rationality and science, spoke disparagingly in private conversations about the salespeople, who they said were unable to comprehend even the simplest mathematical models underlying risk calculation. If sales leaders were evangelists for bank cards, risk bosses were on a mission to rationalize lending. One Hungarian manager captured the “epic battle” between the two departments succinctly: marketing has the motto “no risk, no business,” while risk management subscribes to the adage “no business, no risk.” On record, both talked about their conflict as “normal” and “inevitable,” as striving for the proper “balance,” but the tension was palpable.

Sharing Credit Information To screen new customers, banks needed to know something about the applicants’ record of paying off their loans, which required information sharing among lenders. In Central Europe, where the market for consumer credit was highly concentrated, this was an especially difficult task because those who were most central to the effort, the ex-communist savings banks, were the least motivated to join in and had the most political and economic clout to oppose any effort to create a credit registry. As one of the managers of the Czech Credit Bureau summed it up, the largest [obstacle] that we saw and that probably exists everywhere in the world was market concentration, because if there are large banks who control a large part of the retail market at the moment, they are very unwilling to share their data with the rest of the market. That is natural. In the Czech Republic, the largest bank holds 42 percent in terms of retail lending, and that was an issue for them. [CB #4.1]

In Hungary, until recently, only a blacklist type of reporting process existed for individual customers. The reporting system (Bankközi Adós- és Hitelinformációs Rendszer or BAR) was created in 1995 in the wake of a deep banking crisis as part of a massive bailout package, and the banks were in no position to protest or ignore the directives they received from a nervous state administration. How little importance consumer lending carried in those days is expressed by the fact that the system was designed almost

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entirely with corporate lending in mind. A register for consumers did get established, but whereas for companies there was full reporting, for consumers only records of nonpayers were reported by their lenders. More than a decade after the register’s inception, Hungarian bank professionals claimed that even this negative consumer list was incomplete and that the largest player, OTP, reported “irregularly.” The largest bank itself had a low opinion of the list. Indeed, data quality was a concern. Using names as identifiers, the list could easily confuse people with common names. Moreover, the system was originally written using English letters and ignoring Hungarian diacritics, thus creating even greater confusion. Many lenders elected not to use the list when they made offers to customers with whom they had already had a satisfactory experience of some sort. In certain situations, such as when issuing purchase credit on the spot through a retailer, lenders had to weigh time constraints against information of dubious quality and frequently made their credit decisions without consulting the list. The Hungarian Banking Association was keen to create a full-reporting credit bureau that includes positive information along with the negative. Its efforts were hampered, however, not just by the giant OTP, which had little reason to give up its enormous stash of information, but also by data privacy considerations. Hungary’s Commissioners for Data Protection were strong opponents of maintaining a full reporting system without explicit consent from customers. The Commissioners asserted that banks must seek written agreement from applicants, occasionally even questioning whether voluntary consent is possible at all under duress of financial hardship. Banks that otherwise would have supported such a full-reporting registry balked at the idea of requesting a waiver from clients, because they thought this would scare customers away and send them to those banks that would not require such a waiver.50 In line with the EU-inspired law, one Commissioner insisted that not only was consent necessary to collect information from people, but it was also necessary for customers to agree separately to any form of processing of their data if it resulted in new information that referred to them individually.51 The registry could compute statistics describing large groups as a whole, but they could not calculate anything that would attach to individuals. This requirement made it impossible for BAR to produce a score or index summarizing the creditworthiness of each person in the system. For

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a negative list, this index would have been a measure of how many offenses the person committed and how bad they were—a simple summary that would have created little concern. In a full-information system, however, that score would be more complex. Statistical algorithms would combine a large amount of information, including the type and size of the loan, its length, whether there was any early—not just late—payment, current balances, and so on. The managers of the registry argued that an index simply rearranges mathematically existing information that people already agreed to disclose. The Commissioner countered that if the index represented no new information about the individual, there would be no point in calculating it for each person. For good measure, he also invoked the ban on automated individual decisions. Why the Commissioner did not protest credit scoring by lenders (as opposed to registries) is not entirely clear, though it is probably because lenders can always claim they never rely on statistical models alone, whereas credit bureaus that have no direct connection to borrowers cannot easily make this claim. The Hungarian government was finally persuaded by the global debt crisis that a full-reporting credit registry was a way of controlling runaway consumer indebtedness. Tens of thousands of Hungarians borrowed in foreign currency and saw their payments balloon as the Hungarian forint depreciated against the Euro and more dramatically, against the Swiss franc. A credit registry that allows lenders to monitor how much people owe now seemed convincing despite arguments from the Commissioner that the countries that ran up the largest consumer debt—Britain and the United States—have full-reporting systems, whereas countries such as France that kept consumer debt under control use only a blacklist. The Hungarian legislature passed a law on credit registries in 2011. The new law envisions the registry as a private enterprise and, in principle, ­allows for competing credit bureaus. A mandatory condition for a company that wants to run a registry is that it must have at least 70 percent of its data suppliers signed up before it can get the license. By mandating that all lenders participate, the law dictates that big banks must provide information to the credit bureau. Individual borrowers must give written consent for the registry to release their information, but not if the information is negative. Indeed, the law is advertised as giving people a chance to let lenders know they have been good customers. This is technically true: through the negative list, lenders already had access to bad information; what the

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full-reporting registry adds is the nonnegative data. The registry includes only information about lending contracts and the corresponding payment history, plus the usual information necessary to identify the borrower. It does not include sociodemographic information such as profession, position or type of activity for the self-employed, nor does it contain income data. When the law was passed, the government sacked the Commissioner, and with the help of the ruling party’s majority in the legislature, it redefined the jurisdiction of the Commissioner’s office, stripping away its adversarial position and making it essentially a government agency.52 In the Czech Republic, the Czech National Bank initiated the creation of a credit bureau and in 1998 the government amended the 1992 law on banking, making it possible to share information among banks without clients’ consent.53 This amendment, however, led to various legal challenges on the grounds of privacy rights to personal data. The Law on Personal Data Protection of 2000 did not challenge the earlier law, and the objections of the Office for Personal Data Protection had little effect. Seven banks, including the four big ones, founded the Czech Credit Bureau in 2000, but it did not start operating until 2002. The effort was led by GE Capital, a new upstart, and ČSOB. ČS, the largest retail bank, was strongly against a full-reporting system until 2000, when the Erste Group of Austria bought ČS and the new owner, who had used information from fullreporting credit bureaus routinely in other markets, reversed the bank’s position. Its experience in Austria had convinced Erste that having both good and bad information was valuable in risk management. Because of the early legal challenge, in the Czech system, as in Hungary, the scope of data collection is narrow. Some banks are still reluctant to join. Živnostenská, with its large elite clientele, had been unenthusiastic, fearing that the credit bureau would enable other banks to poach its lucrative customer base. When Živnostenská was taken over by UniCredito Italiano, the new owners made the strategic decision to expand their retail lending and move from providing elite, relational services to serving a mass market, and subsequently Živnostenská also joined the credit bureau. When the country entered the European Union and its data privacy laws were brought in line with EU directives, the CCB was already up and running with the support of all the big and most of the smaller banks. Some banks waited to see if privacy concerns would undermine the CCB, but it was soon clear that privacy advocates would not be able to overturn the section of the banking law that gave banks wide discretion.

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In Poland, a full-reporting credit bureau started the earliest. BIK was founded in 1997 and began accepting data in 2001. It is owned by several banks and the Polish Banking Association. More than half of Poland’s banks are members, including PKO and many other large banks. The second largest, Pekao, however, had resisted the creation of BIK and was not supplying data as late as mid-2004, citing data processing problems. Initially, the biggest contributors received a discount on each inquiry, but this soon ended. The data being gathered by BIK is quite extensive because the Polish law passed in 1997 that allowed for data sharing among banks did not stipulate its content. The registry includes not just the usual credit information but also sociodemographic data, such as income, education, profession and employment history, although banks can choose not to provide this information. Each time a new loan begins, these sociodemographic variables are updated by the lender from the application form. Unlike in the Czech Republic, Poland’s data protection law did not exempt banks from customer consent. Just as in Hungary, applicants must sign a waiver letting lenders share their positive information. Store-related credit providers and most cooperative banks tended to opt out of the system. The former did because they found the 1 euro charge per inquiry too expensive. Cooperatives, on the other hand, operating in villages and small towns, felt they knew their customers well enough not to need BIK’s report. There were various problems with the records here as well. As in Hungary, some had to do with diacritics and various ways to abbreviate names. Others were related to mistakes committed by other bureaucracies, such as the Interior Ministry, which occasionally assigned erroneous ID numbers to individuals.54 BIK offers credit scoring that evaluates people’s creditworthiness on the basis of their credit history as well as another score that predicts the likelihood that they would take on new credit products. The latter score is used in the marketing of financial services. In Poland and the Czech Republic, the national giants gave up resisting the credit registry earlier than in Hungary. In Poland, PKO stayed in state hands and could not follow its selfish interest the way private banks could. It was also quickly losing its unique, dominant position, mostly to Pekao, which rose to prominence thanks to a historic accident: to relieve political pressures, in the 1980s the liberal policies of the unpopular military communist government allowed Poles to take jobs abroad, and thus created the

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need for a large bank for foreign remittances. By 1990, Pekao had branch offices nationwide. In the Czech Republic, ČS was privatized, partially, by mass privatization early on. This allowed ČS a measure of independence from the state that PKO never had. Its top management could thus follow the bank’s narrow self-interest and obstructed information sharing until the bank was finally sold to an Austrian financial institution and compelled to integrate into the institutional structure of its parent company. By then, ČS’s initial advantage was shrinking as foreign and other domestic banks began to eat into its market share. In both Poland and the Czech Republic, the full-reporting system was legislated into existence before the countries joined the European Union and signed onto EU data protection standards. In the Czech Republic, earlier laws had explicitly waved the need to ask for consent; in Poland, laws allowed the gathering of an unusually wide array of data. In Hungary, OTP was strong enough to resist data sharing longer. Just like ČS, it was partially privatized to small domestic shareholders, giving management large discretion, but not before the government required the creation of a blacklist for consumers. Subsequently, OTP was very successful at expanding into a regional, multinational powerhouse by acquiring the postcommunist savings bank DSK in Bulgaria, as well as many others, and it currently owns subsidiaries in Russia, Ukraine, Slovakia, Romania, S ­ erbia and Croatia. While its market share in Hungary was declining, OTP’s political clout remained considerable. OTP was able to fend off efforts to create a full-reporting system. In 2003 it received unexpected support from the law on data protection that Hungary had to adopt to enter the EU and it could hold out until Hungary was engulfed by the global debt crisis.

Enforcement and Collection One of the reasons why selecting the right customers upfront is so important to banks in credit card markets is that recovering losses after the fact is very costly. The amounts are small, people can hide and have certain rights, and banks are reluctant to expose themselves as bullies. Going through the legal system is expensive and time-consuming. In these countries it takes several years to receive a final judgment that can be collected on.

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Although screening is indispensable, the entire process, credit scoring included, to some extent misconstrues why people default on their loans. When payment is missed or a default happens and it finds its way into the credit registry and scoring models, the key assumption is that the individual’s characteristics are the only information relevant to knowing why it happened. Nonpayment is seen as a choice made by the individual borrower. It is not just that this approach makes no distinction between factors within and beyond the debtor’s control. What is also missing is the recognition that lending is a relationship, and the bank’s decisions—the conditions it sets for the loan, the way it manages the loan—can be as consequential for the fate of the loan as the decisions the borrower makes. Screening out bad customers is important, but many borrowers do not apply with the ill intent of never paying. In most cases, borrowers lose their will or ability to pay only after they get the loan, and then how the bank responds is crucial. In fact, banks are intensely aware of the importance of managing the loan properly. Initial failures in the credit card market are often the result of insufficient appreciation of customer relations that include, along with helping the applicant to select the proper loan, monitoring and collection. Monitoring credit card activity was a challenge in the 1990s, when most transactions were carried out with the help of imprinters. Because paper moved slowly, it took many days for banks to see a transaction in their own system. This situation created opportunities for people to exceed their credit limit, and banks often did not know about fraudulent use of a card until the unauthorized user had already racked up a large debt. By the mid-2000s, most banks in the region had installed an electronic monitoring system, mostly as they joined the international card companies. The banks could now see transactions within minutes. Many were also now offering clients the ability to monitor their own transactions. Each time a person uses her card, she can receive a short text message on her mobile phone. This service gives a measure of protection against fraud by unauthorized users, and enables card issuers not just to detect wrongful use but also to cancel cards on very short notice. When cardholders fail to make their monthly payments, banks follow a detailed script. A typical process is that in three to five days the bank’s collection department tries to contact the client either by phone or by a short text message. According to our interviews, the majority of people pay after the first contact, in which case the bank can overlook the error and report

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the account as continuously current. If that fails and the minimum payment is not delivered, the bank sends a letter. If it is not responded to within a few days, they suspend the card and send another letter. Many banks charge the delinquent client for each letter, on top of a penalty and the interest that keeps accumulating. The amount of time before cancellation varies. Some banks spring into action immediately. Others give the debtor more time. Delivering the data to the registry, however, is uniformly regulated in each country. When there was only a blacklist, delinquent payers in Hungary were put on the list after ninety days, but only if they owed more than the monthly minimum wage and their delinquency was continuous. This is still the rule for people who opt out of the full-reporting credit registry. In Poland, those who refuse consent have to not pay for sixty days, and thirty more days must pass after receiving written notice to be entered in BIK’s involuntary blacklist. The behavior of those who consent in Hungary and Poland, as well as that of all Czechs, is reported every month to these countries’ national credit registries. Banks also increasingly generate a different kind of score. Unlike the credit score calculated at application, the recovery score tries to predict default on the basis of all the data the bank has available on the client, including the way the borrower behaves with the loans after receiving it. This score indicates the likelihood of recovering the entire loan even if the client misses payments, and it helps loan officers manage the loan. One Czech bank updates its records every day: We have now an internal behavior scoring on the scorecard and we are doing these on a monthly basis. [Nothing] happens [ . . . ] except if the client is in collection, then we are checking this [ . . . ] score. For [the] worst cases, we cut [the card] off immediately. For a good guy, we are saying this is only an exception; he has forgotten or something else and therefore we do not cut [him] off, we are waiting ten days [ . . . ], and for the rest we block the card immediately. [CB #3.1]

This score can also be used to decide whether to renew a card or increase or decrease its credit limit, but also to fine-tune the bank’s actions when a payment is missed. If the model suggests that the missed payment is just an error, the bank will act with more restraint and amicability. If the debt is not very large, banks can offer to convert the credit card debt into a nonrevolving personal loan to be paid off in installments over an extended period. If the debtor is unwilling or unable to take this offer,

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banks use other accounts the client may have with the bank to pay off the debt, provided they have secured the client’s consent. If all else fail, banks sell the debt to a factoring or collection agency. Many banks own such an agency themselves as a subsidiary. Now the debt is off the bank’s books, but the bank is still pursuing the offender. Debt on cards is rarely large enough to make it worthwhile to take the cardholders to court. If the card debt is part of a larger sum owed to the same bank on other lines of credit, then legal action is considered, but banks in Central Europe have felt that it takes too long to get a final judgment that can be executed. Personal bankruptcy protection was instated in the Czech Republic in 2007. It protects debtors with consumer debt by allowing them to discharge as much as 70 percent of their obligations.55 In Poland, consumers get no bankruptcy protection, so most credit card debt cannot be discharged. Since 2009, sole proprietors can file for bankruptcy, but not as consumers. In Hungary there were several attempts to push through legislation allowing private entrepreneurs and consumers to request bankruptcy protection, but so far the banks have fought this measure successfully.

Conclusion In Central Europe, building a two-sided market was a hard task and took more than a decade to achieve. To solve the puzzles of two-sided markets, standardization, information asymmetry, information sharing and market origination and expansion, banks had to cooperate in a fiercely competitive market. This was made especially difficult by the presence of one large bank in each country. In all three countries the final result was a card market dominated almost exclusively by the two large international companies: Visa and MasterCard. Domestic brands disappeared, except in Poland, where PolCard still issues its own cards through domestic banks, claiming no more than 5 percent of the entire market. The triumph of Visa and MasterCard was largely due to their ability to help solve the puzzles with which the banks were struggling. Linking issuers to a large network, offering early cardholders a large number of shops where they could use their cards, even if those shops were abroad, and providing merchants with a sizable clientele, even if they tended to be foreign visitors, gave a needed push to the market to take off. By forcing standardiza-

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tion on reluctant banks and pressing technologies onto lenders to manage information asymmetry and conduct their card business, the two multinationals played an important role in the rise of payment and credit cards. So did the state. In Hungary it delivered a large clientele for the banks at a crucial point in the development of the market and was instrumental in solving the problem of information sharing when lenders were unable to come to an agreement for two decades. In Poland, the state, which kept active ownership of PKO, did not let the national giant obstruct data sharing. In all three countries, large corporations outside the financial sector played a key role in pressing cards on customers. When recently the European Union, through SEPA, began to push for further standardization in order to increase competition, trying to force Polish banks to accept Hungarian or Czech cards without the Visa or MasterCard logo and enabling any European citizen to get their payment card in any European country, whether the Czech Republic, Hungary or Poland, or any other, the banks balked. It is unclear if this political intervention in market creation will be successful, and unclear how much political pressure the European Union will be able to exert, especially given its economic turmoil. Its power is especially doubtful in Hungary, where since 2010 the government has been intent on reclaiming national sovereignty over its banking system, snubbing EU regulators and the IMF. Unlike in the United States, where regulations aimed at curbing discrimination in lending shaped the market, in Central Europe concerns about data privacy influenced market development. Discrimination in the United States was a violation of basic rights, whereas in Central Europe access to credit was not a right but a free business decision by lenders. Whereas in the United States mechanization of credit assessment, a key technology in making credit card markets profitable, was seen as a way of protecting borrowers, in Central Europe, following EU directives, it was considered a threat. In the next chapter we continue the discussion of how market puzzles were solved in emergent card markets but focus on three East European countries: Bulgaria, Ukraine and Russia.

six

Russia, Ukraine and Bulgaria

Banks are offering supermarkets to install POS terminals, promising more clients and bigger purchases per client, but merchants still resist. One of the reasons is that many, even big chains, prefer to work for cash as it helps them evade taxes. [ub#11.1]

This was a frequent complaint from banks in the East European countries: merchants refused to accept cards because every card transaction generates an electronic information trail and they feared unwelcome transparency. In such a situation, it does not matter whether banks are successful in peddling cards to individuals. No matter how many consumers have cards, a market will not launch if merchants have a strong preference for cash. More generally, this problem underscores the extent to which the growing number of cards in cardholders’ hands is a misleading indicator of market growth. East European card markets are not what they seem at first glance. Card acceptance lags significantly behind card issuance. A large portion of the millions of cards issued to postcommunist consumers are actually “dormant”: they were offered via salary projects or in connection with a consumer loan, but they are never used or may not even have been activated. And the cards that have been activated are not used in the way intended: the majority of consumers stubbornly head to ATMs to withdraw cash, and only then visit shops. 151

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Payment Puzzles problem of demand

In the United States, payment cards came to replace cash and checks, which had existed much longer and with which both consumers and merchants are much more familiar. This is precisely how Visa evaluates its success globally—by the ability of its cards “to displace consumers’ use of cash and checks.”1 Personal checks never took hold in the former Soviet bloc countries, and when the cards started arriving, they were met with only one competitor—cash—but it was a mighty one. In Russia, card transactions account for only 7 percent of the volume of total consumer transactions.2 Ukrainian and Bulgarian estimates are also less than 10 percent. Not only had cash been the sole payment mechanism known to postcommunist consumers, but it was also widely preferred because informal and illegal transactions were conducted in cash. A widespread underground economy was a staple feature of advanced socialist societies. The transitional period only intensified the scale of informal economic dealings.3 Although many forms of economic activity that were previously prohibited or condemned were legalized with the fall of communism, there are still numerous incentives for businesses or individuals to keep a portion of their economic activity in the shadows. Even though the underground economy is strong in all postcommunist countries, its size is estimated to be significantly bigger, and tax avoidance is much more rampant, in Russia, Ukraine and Bulgaria than in the Central European countries. Recent official estimates of Russia’s gray economy place that number around 25 percent of the GDP: apparently a quarter of Russia’s regional economy continues to operate off the books.4 Western and opposition journalists quote higher numbers. For instance, according to one large comparative study, the size of the shadow economy decreased in the second decade of the transition (from 1999 to 2007) in all of the countries in our sample: in Ukraine, from 53 percent of official GDP in 1999 to 47 percent; in Russia, from 47 to 41 percent; and in Bulgaria, from 37 to 33 percent.5 By contrast, these estimates are considerably lower in Central European countries: a reduction from 25 to 24 percent in Hungary, from 28 to 26 percent in Poland and from 19 to 17 percent in the Czech Republic. Another report that analyzed only the Russian shadow economy claims that the volume paid in bribes and kickbacks by businesses, including deals cut with bureaucrats in exchange for protection, reached $316 billion in 2005, nearly half of Russia’s

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official GDP, and up from $33 billion in 2001.6 Economies in which a large portion of economic transactions occur informally resist the transparency that cards inevitably bring. As we discuss later, in East Europe, when firms want to keep a portion of their capital turnover in cash, they may pay a part of their employees’ salary in cash, making the workers appear more cash poor in the eyes of the lenders than they really are. Retail firms, meanwhile, may resist accepting cards altogether.

Two-Sided Markets The main way to mass-distribute cards in all three of the countries we discuss in this chapter was via salary projects. From the bank’s standpoint, the salary project is a highly attractive way to recruit new cardholders, because its operating expenses are low (no need to invest in branch expansion or advertising) and the return is high (cardholders are signed up en masse). This issuing strategy revealed the remarkable “practical smarts” of card issuers. They relied on the socialist legacy of employment paternalism. Banks used their existing interorganizational ties with companies to issue cards to the companies’ employees or, conversely, used salary projects as bait to turn those companies into the bank’s corporate clients. Just as Hungary did, the Russian, Ukrainian and Bulgarian states assumed a particularly important role in this process as they made their employees and the recipients of various social benefits available for banks’ salary projects. These included the millions of retirees and university students who were issued cards when their pensions and stipends were transferred to direct deposit payments. The fact that scores of workers across the postcommunist region were turned into holders of salary cards without being asked or given a choice of bank highlights the role of coercion in building demand and developing markets for new products.7 Yet there are formidable challenges to the spread of electronic noncash transactions in a country where a large portion of economic activities are informal, unregistered or illegal, because the use of payment cards threatens to bring these shadow transactions out into the open. According to our respondents, merchants resist the acceptance of cards precisely for this reason. Recall the case, discussed in the previous chapter, of the successful Hungarian restaurant that did not want to reveal the size of its sales turnover to the tax authorities. In contrast to Hungary, Poland and the Czech Republic,

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where unregistered transactions are mainly the lot of small or medium-size companies, in East Europe cash is preferred in the entire economy. As was explained to us in one of our interviews, many supermarkets receive produce from their suppliers without any papers: they pay the suppliers in cash, and they want customers to pay cash as well. There is little market pressure on the merchants to start accepting cards. Bankers complain: Market competition has not reached the point where stores would start fighting for customers. A popular chain supermarket, Billa, refuses to accept cards. [If it did,] this would help promote cards and turn them into a truly mass product. [ . . . ] Supermarkets should start accepting cards; this would allow shifting public consciousness from cards as an instrument of receiving salaries to cards as a means of payment. [UB #11.1]

In Central Europe, supermarkets were in the forefront of accepting payment cards, and foreign-owned retail chains were especially quick to recognize the advantages of electronic payment. In East Europe, by contrast, foreign-owned supermarkets put up considerable resistance. Germanowned European supermarket chain Billa did not accept cards in Ukraine until mandated to do so by recent legislation. In Russia, another popular, French-owned supermarket chain, Auchan, made a decision only in 2011 to start accepting MasterCard and Visa cards. This happened ten years after the first Auchan store opened in Russia. Explaining their resistance, Auchan pointed to the high merchant discount—a percentage of each purchase that merchants have to pay to the bank for processing transactions.8 This concern was echoed by one of our respondents in Ukraine: There are problems signing merchants up. They are not well educated about the benefits of noncash transactions, and many often complain about the discount rate they have to pay to the acquiring bank. As a result, there aren’t enough places where cards are accepted. [UB #12.1]

Although salary agreements between banks and companies coerced individuals to become cardholders, those cardholders were not eager to become card users, preferring instead to withdraw cash before going shopping. Pressures of the unofficial economy aside, merchants did not see any reason to sign up for card acceptance because they continued to believe, correctly, that consumers preferred cash. Yet coercion, in the end, turned out to be a really powerful instrument for building demand and developing markets. In addition to promoting cards

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among state employees and recipients of state benefits, governments—interested in fighting the underground economy in the hope of improving tax collection—have been actively pushing card acceptance.9 As early as 1998, one of Russia’s radical populist politicians, Vladimir Zhirinovsky, penned a book promoting the idea of delegitimizing cash altogether and moving exclusively to electronic payments in an attempt to defeat such illegal markets as drug dealing and prostitution.10 Since then, Zhirinovsky has not abandoned his idea, and he evoked it again in a recent interview with a Russian news agency, RIA News. In response to the question of whether it is possible to fight corruption in Russia, he said, “It is possible. We need to switch entirely to cashless transactions. There should be only electronic money and bankcards. One would use only cards to pay everywhere—in stores, in hair salons, and in pharmacies. Then there would be nothing left for bribes, there would be no cash.”11 Zhirinovsky’s idea casts payment cards in a completely different light. From this perspective, payment cards are neither a potentially profitable commodity nor a financial service delivering convenience and credit to individual customers; nor are they a means to ensure the triumph of the socialist idea of fairness, as Bellamy proposed in his novel Looking Backward.12 Instead, they are a form of national currency, a pillar of the country’s payment system and, most important, a weapon in the hands of the state to fight against the moral degeneration of the nation. In 2007, a Russian parliamentary group initiated a draft law that would have required retailers with a sales turnover above a certain threshold to install card terminals and accept cards alongside cash. This initiative did not result in any legislation, but the idea was revived again in 2011, this time by the Ministry of Economic Development. The latter initiative suggested establishing an upper limit for cash transactions between individuals and organizations and mandating card acceptance in retail locations, pointing to the fact that 20 percent of retailers in large cities and 80 percent across Russia are not yet equipped to accept cards.13 In addition, the Russian Ministry of Finance put forth a proposal that all employers, with the exception of very small ones, must pay salaries electronically starting in 2013. Furthermore, in a move resembling Zhirinovsky’s idea, Russia is launching a universal electronic card that will eventually be issued to every Russian resident. The card combines the functions of an ID, social benefits and banking card, and can be used to pay for municipal services.14

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Ukrainian lawmakers have already managed to mandate card acceptance by retailers in a series of laws and Cabinet decrees starting in 2004. An amendment to the law “on payment systems and the transfer of monetary means in Ukraine” and subsequent Cabinet decree required all Ukrainian merchants in the three regional centers (Kiev, Simferopol and Sebastopol) to install POS equipment and accept cards by July 1, 2007. By January 1, 2008, this requirement was extended to merchants in all towns with a population over 25,000, and by 2009, to the rest of the smaller settlements. But the Achilles heel of these mandates was the absence of any credible sanctions. As a result, by 2010, many retailers had not complied. This situation prompted the Cabinet to issue yet another decree in 2010 mandating all merchants, including small businesses, located in towns with a population of more than 25,000 (that’s 110 towns and cities), to accept cards for payment by December 31, 2011.15 In establishments with more than one cashier, no less than 50 percent of all cash registers were to be equipped with card-accepting POS terminals.16 In Bulgaria, in an attempt to align their interests with those of the state, several Bulgarian banks—members of Visa Europe—approached the Bulgarian government with five measures designed both to reduce the size of the shadow economy and, at the same time, to give a boost to the payment card market,17 including a requirement to conduct electronically all salary payments, payments to public services and payments above a certain size, as well as to equip all merchants with POS terminals. These appeals, for the most part, remained unanswered; currently there is no mandate for Bulgarian merchants to accept cards for payment. But even when mandated, merchants have continued to resist accepting cards. In Ukraine, although large stores have generally complied with the new law by installing POS terminals, cashiers may still refuse to accept cards, claiming, for instance, that the terminal is not functioning. “We are only accepting cash,” the cashier of Kiev supermarket Silpo said sternly in response to being asked whether a payment card can be used. “We have a POS terminal installed, but it does not work now,” explained another cashier of a large shopping center.18 This may in fact be true because the poor quality of telephone lines used for authorization can make transactions difficult or downright impossible. Merchants predictably balk at the size of the merchant discount. Although Ukrainian National Bank has recently demanded (twice!) that banks lower merchant fees to 2 percent, some banks are willing to ­acquire merchants only if paid 3 to 5 percent. According to a poll con-

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ducted by the Ukrainian Interbank Payment Systems Member Association (EMA), in four Ukrainian cities, including the capital, more than 70 percent of cardholders believe that the number of stores equipped with POS terminals is not adequate. Cards are most commonly used in large super­markets, specialized building supply stores, and home durables and shoe stores, while card acceptance in small food stores, cafes and gas stations is trailing behind.19 Due to the increased competition between acquirers, many banks now offer to install POS terminals free of charge for the merchant. Nevertheless, according to the press secretary of PrivatBank, leader of the Ukrainian card market, merchants continue resisting and “it takes a long time to convince a merchant to install a POS terminal, sometimes up to a year.”20 As a result, the balance has been off: while banks have been successfully pushing cards onto individuals, the number of card-accepting merchants has lagged. Moreover, the kinds of retail locations where bank cards are most likely to be accepted are not the ones that most salary cardholders frequent. Banks themselves acknowledge this problem, noting also its effect on costs: “Historically, cards were introduced in high-end stores since banks were not putting POS terminals just anywhere. But the cost of operating a card program is high if the volume is low” [UB #12.1].

p r o b l e m o f s u p p ly

Standardization The problem of lukewarm demand for and at times outright resistance to the spread of payment cards and the related challenge of building a two-sided market were addressed in a similar way in all three countries: with the assistance of employers and the state, the banks coerced workers and recipients of social benefits to become cardholders and even lobbied for the passing of the laws that mandated card acceptance among retailers. The second of the payment puzzles, the puzzle of standardization, merits a particularly detailed discussion because the three countries varied significantly in the way in which this puzzle was manifested and in the steps they took to solve it. We have seen that the emerging payment card markets are very competitive: issuing banks compete for access to large enterprises, and far from being resigned to their fate, newly founded commercial banks compete with former socialist giants. Nonetheless, as much as competition defines pay-

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ment card markets, they are also defined by the imperative of cooperation, particularly when it comes to technology standards. In card markets, standards are represented by card brands and technology. Among the three East European countries, only in Bulgaria is the war of the brands now over, with the decisive victory of the international cards, Visa and MasterCard-Europay. The Bulgarian domestic brand Borica dominated initially, but it was first replaced with co-branded Borica-MasterCards, and then recently phased out completely. In Russia and Ukraine, international cards now dominate (in Russia, since only 2003), but there is a continuous appeal by the states to establish a domestic card network, one that can successfully compete against the current hegemony of card multinationals, and the Russian and Ukrainian states have been actively pursuing this goal. Bulgaria  In Bulgaria, three banks—the First Private Bank, the TouristSportBank and the BalkanBank—pioneered their local card brands beginning in 1992. The first two issued cards based on magnetic-stripe technology, and the cards by the third used a microchip. All three banks operated independent networks, but their card programs were short-lived because all three banks went bankrupt in 1996–1997 during the country’s financial meltdown. The Bulgarian state recognized early the need to establish a unified system for card payments. In 1993, through the Bulgarian National Bank (BNB), it created the card network Borica Ltd., which served the entire banking system. Borica was to become both a national card processing system and a domestic debit card brand. Owned fully by BNB, Borica started operation in 1995 and initially enrolled primarily state-owned banks.21 By issuing its regulation called “Payments Initiated by Bankcards” in 1995, BNB secured for Borica a monopolistic position in card payments authorization. For a certain period, the advantages of having one operator, one clearinghouse and one system of POS and ATM terminals were considerable. Many banks were still in poor financial condition, so they could lease the ATM and POS terminals from Borica. In 1996–1998, Borica joined the networks of MasterCard, Visa and American Express, and thus all domestic and international cards became compatible with the existing ATM and POS network. But neither this advantage nor the introduction of the first electronic payment system for cards bearing the Borica logo were sufficient to popularize their use, and in 1999 there were fewer than three hundred ATMs and fewer than five hundred POS terminals, most of them concen-

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trated in Sofia bank offices; and fewer than three hundred thousand cards had been issued. Bank privatization gave Borica an initial advantage. The number of B ­ orica cards spread rapidly, with an average annual growth of more than 60 percent for the period 2000–2005.22 But large banks, now foreign-owned, soon started replacing Borica cards with co-branded Borica-Maestro cards, then abandoned the Borica brand altogether. By 2005, the majority of Borica cards were co-branded and Borica as a domestic brand began to fade. Although it capitulated as a card brand, Borica remains the largest card processor in Bulgaria. Since Bulgaria joined the European Union in 2007, it is obliged, like the Central European countries, to apply the SEPA Card Framework. In 2011, Borica merged with the IT company Bankservice, owned by the BNB and twenty-six other banks. It is now implementing SEPA. Russia  In Russia, the very first bankcards bore the international card logos of Visa and MasterCard. They were issued as part of small programs by two state banks, Vneshekonombank and Sberbank, in 1988 and 1989, respectively. Vnesheconombank’s first program issued Visa cards to the members of the Soviet Olympic team who were on their way to Seoul for the summer Olympic Games. The following year, Vneshekonombank issued another handful of Eurocards (later MasterCard) to top members of the Soviet political bureau and their wives. Sberbank’s 1989 program put about five thousand Visa cards in the wallets of ordinary Muscovites as part of a pilot program to test a system of noncash payments. The program was administered by the main branch in one of Moscow’s city districts. But the honor of being the first bank to carry out a mass commercial program of card dissemination in Russia belongs to a private commercial bank, Kredobank. This program issued Visa cards and was launched in 1991, when Russia was still part of the Soviet Union. Just as in the case of Vneshekonombank, the cards were intended for elite rather than mass clients, particularly those who traveled abroad or worked for foreign-owned companies. During the four years that the card program existed, Kredobank issued ten thousand cards; the majority of those were debit cards. In retrospect, it made perfect sense for the Russian credit card pioneers to start issuing cards by joining the existing networks. They did not have to reinvent the wheel, and a domestic card-acceptance network (though of

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a severely limited nature) was already in place. Foreign credit cards have been accepted across the socialist camp in hard-currency stores and hotels catering to foreigners since the 1960s—first cards from American Express and Diners Club, and later, in the 1970s, from Visa and Europay, European partner of MasterCard. In addition, for those who traveled abroad, international cards opened a world of payment possibilities, with millions of merchants accepting these cards worldwide. Domestic card brands started to emerge in Russia in 1992. Several multi-issuer networks were founded, each with the ambition of expanding to become a national card brand. They were accompanied by single-issuer brands, most of which could be serviced only in the bank’s own ATMs. ­Experts estimate that as late as 2004 there were seventy single-issuer card networks operating in Russia, plus a handful of multi-issuer networks. Three of the multi-issuer brands that emerged in the early 1990s are still around: STB Card (founded in 1992 by SBS-Agro Bank), Union Card (cofounded in 1993 by two large commercial Moscow-based banks, Incombank and Avtobank) and Zolotaya Korona (established in 1994 in Novosibirsk as a regional interbank payment network and cofounded by the Siberian Trade Bank and Center of Financial Technologies). A few of the domestic card networks (Zolotaya Korona, Sbercart, Universal and OptimumCard) issued smart cards (based on microprocessor technology), hailed as “progressive” and as “cards of the future” in an implicit critique of the world dominance of Visa and MasterCard’s magnetic stripe technology. Why, in Russia, have the domestic brands emerged alongside the international ones? One reason for this surge is that in the early 1990s there were barriers to Russian banks joining international card networks. Many Russian banks did not qualify given their size and financial vulnerabilities, and others were effectively driven away by high membership fees and reserve requirements. In several cases when a few banks tried in earnest to gain membership, Visa and MasterCard resisted or purposefully made the process long and complicated, because they were concerned about Russia’s political and economic instability, high rate of inflation, frequent interbank nonpayments and bank failures. One such refusal—to grant principal membership in the Visa association to Stolichny Bank in 1992—allegedly motivated the bank’s oligarch owner to develop Russia’s first domestic card brand, STB Card, out of pure spite. The conflict was quickly resolved and Stolichny Bank was able to join Visa.23 But domestic card brands continued to proliferate, for

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two additional reasons—market competition and the peculiar role that cards played in transitional Russia in the 1990s. Russian banking in the early years of the transition was a very dynamic and very competitive industry. Although Sberbank remained by far the largest bank (even now it is the biggest retail bank in all of Central and East Europe), hundreds of new commercial banks were founded in the first few years following the legalization of private enterprise and the start of the transition. Competitive banks shared very little, preferring to develop their own technology, card acceptance and processing. Developing the bank’s own card brand was part of this mind-set. Besides, domestic card networks were much better suited than Visa and MasterCard to solving urgent problems that were peculiar to the Russian financial system of the 1990s: shortage of cash, particularly in the regions; chronic inter-enterprise nonpayment; and wage arrears. Employing organizations that were short on cash were particularly interested in issuing cards to their workers, who could use them to pay for purchases in local establishments such as stores and cafes. In cases of inter-enterprise nonpayment or wage arrears, cards could help in managing local systems of mutual clearing and in dissipating social tensions. International cards were viewed as unsuitable for these purposes, not least because they were more expensive. In the early to mid-1990s, when cash was scarce, employers and local governments considered cards a boon. But as cash became more plentiful, employers got progressively more concerned with hiding their capital turnover from the state and with minimizing taxes. However, rather than discontinuing salary card projects altogether, they directly deposited partial salaries and paid the rest in cash. They may have done this to maintain an air of legitimacy, because entirely cash-paying enterprises would attract unnecessary attention from the tax authority. For the next decade, until 2003, Russia’s domestic brands successfully resisted the onslaught of international brands by holding a larger combined market share. The trend was aided by a continuously small market share of foreign banking capital in Russia. At that time, the developing card market in Russia was serving two distinct types of cardholders: a small group of elites who carried international cards, valuing them as status symbols and using them when traveling abroad; and a much larger group comprising, by some estimates, 95 to 97 percent of cardholders who were ushered into the card market as part of salary projects.

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While domestic brands collectively dominated the international cards in Russia in the 1990s, the card market was severely fragmented between several domestic card networks, so each of them could capture no more than a small segment of the overall market. In other words, brand competition was not so much between domestic and international cards in Russia, but between different domestic brands as each tried to edge out all the others in a bid to become the national brand and the major opponent of the internationals. Why did the domestic networks fail to join forces and create a single national network? The dialogue about a national card payment system based on a domestic brand has been actively pursued since the early 1990s. A strong chorus of nationalist sentiments that put forward the calls to create a Russian payment card was in part fueled by the concern over the flow of private financial information outside of Russia since international card transactions are settled abroad. But there were also arguments made by technology experts and the business community. The techs argued that Russia, as a late-developer, had a unique opportunity to develop its card market based on the progressive smart card technology leapfrogging backward magnetic stripes. The business camp pragmatically pointed out that the vast majority of card transactions were (and still are) domestic, even local. The cost of inter­national cards for cardholders is two to three times more than the cost of domestic cards. Banks spend on average fifty to one hundred thousand dollars to join an international card network, and only about thirty thousand dollars to join a domestic one.24 The existence of several competing domestic brands made the creation of a national card brand complicated, because the domestic brands were not, for the most part, interoperable. Each domestic network developed its card technology standards independent of and in competition with the others, using different IT protocols, and consequently each had to develop its own merchant acceptance network independently as well. In the 1990s it was therefore not an uncommon sight in Russian stores to see several POS-­terminals, each for its own card brand, standing side by side at the checkout. In addition, banks had fears about other banks’ financial stability—a real threat, it became plainly evident, when several well-known interbank card systems failed or were seriously weakened following the financial difficulties experienced by their issuing banks in 1996 and 1998. There were several known attempts in the 1990s to unite Russia’s domestic card networks, but unlike PolCard in Poland, none of these were

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successful. If banks could not cooperate, the state was not strong enough to make them do so. Nor did the state have sufficient resources at the time to initiate and finance the development of a single standard.25 The situation changed after a 1998 crisis devastated Russia’s banking industry, including several domestic card networks whose viability was threatened. Unsure of their future, some banks were finally ready to put their differences aside and consolidate. In 2002, two of Russia’s largest domestic magnetic-stripe card brands, Union Card and STB Card, formally agreed to cooperate and combine their card payment networks, with the ultimate goal of developing a national payment system in Russia. Their alliance required some technological tinkering, and resulted in the establishment of 3,500 ATMs and 26,000 POS terminals. But they could not challenge the multinationals: in 2004, their combined market share was 800,000 cards behind MasterCard and comprised less than half of all Visa cards issued in Russia. Two more claims to create a national payment system were put forth by two other domestic networks, Zolotaya Korona and Sbercart. The former appealed to then-President Putin to assist in implementation of its conception of the “federal card.” The project was supposed to lead to the development of a national processing center and the issuing of a co-branded card that would act either as a domestic card (part of a national payment system) or as an international card, depending on where it was used. Not surprisingly, as the leading issuer of chip cards in Russia, Zolotaya Korona proposed that federal cards should also be based on chip technology. Sbercart, the card brand of Russia’s state-owned giant retail bank, Sberbank, was rebranded in 2008 under a new name, United Russian Payment System, to imply its continuing ambition to be the platform for the national card brand. The network now unites more than twenty banks. Except for Sberbank, all of them are small and medium-size regional banks. Perhaps in a bid to further strengthen its ambition, Sberbank announced in 2010 that all of its Sbercarts would be reissued with an embedded chip compatible with international standards. Most recently, a draft bill on the creation of a national card payment system has been submitted to the Russian Parliament for discussion. It proposes that cards issued as part of this program would be widely distributed chip cards and that they would combine many functions, including identification, social benefits, transportation payments, and so on. The two most likely contenders for the role of central bank in this network are two state-owned

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banks: Vneshekonombank and Sberbank.26 This proposal looks promising; the challenge is that, compared to how it was in the 1990s, the Russian card market is now dominated by multinational brands. This is largely a consequence of the 1998 crisis that dealt a blow to Russia’s largest banks, many of which were involved with domestic cards, and allowed multinationals to solidify their presence in Russia. Currently, more than 85 percent of cards issued in Russia bear the Visa or MasterCard-Europay logo. Domestic card payment systems have been almost completely squeezed out of the two largest markets—Moscow and St. Petersburg—reflecting these cities’ greater global integration. The Russian state may now have the necessary strength to orchestrate the creation of a national card payment network, as well as sufficient financial resources to pay for it. However, the current dominance of the international brands makes the creation of a domestic brand network more complicated than ever. If the Russian state fails despite its resolve and ample resources, it would mean that precious time has been lost and the development has been set on a path that is impossible to alter. If, on the other hand, the Kremlin succeeds in challenging the hegemony of Visa and MasterCard, it would be a tribute to the power of the state to redraw development trajectories set in motion by a path-dependent logic. What is certain is that the creation of a domestic card network in Russia will be an uphill battle. Ukraine  At first glance, the Ukrainian market does not look much different from the Russian one, with the international brands dominating but several domestic brands existing alongside, with a continuous debate about the need to create a national card payment system based on a domestic brand. As will be obvious, however, the development of the Ukrainian market has followed quite a different path. Unlike in Russia, in Ukraine domestic card brands never dominated. According to our interviews with banks and to information reported on banks’ websites, the first Ukrainian cards were issued in 1996–1997, five to seven years later than elsewhere in the region, and these were both international cards and single-issuer domestic brands. Despite the simultaneous emergence of both international and domestic brands, the latter left practically no trace on the future development of the Ukrainian card market. All of the domestic cards were proprietary brands of large domestic banks, and most were short-lived; with one exception, none of the leaders of the card market offered domestic brand cards in 2004.

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Why was the card market development trajectory in Ukraine different than the trajectory in Russia? First, in the 1990s, the Ukrainian banking market was not as concentrated as the Russian market. It lacked a giant retail bank because the Russian branch of Sberbank had inherited most of the Soviet bank’s assets and liabilities following the dissolution of the Soviet Union, leaving the branches of Sberbank in other former Soviet republics relatively small. The largest Ukrainian banks have been fairly similar to one another in size, and their relative rankings have changed frequently over the years, in part as a result of frequent tenders to service state budget accounts run by the Ukrainian Ministry of Finance.27 These circumstances provided for greater market competition than in Russia. In the past few years, one of the private banks (Privatbank) managed to assume a leading position, both as the largest bank and as the leader of the card market (of which it claims more than 40 percent). Besides, unlike their Russian counterparts, Ukrainian banks could not rely to the same extent on high profits from the resourcerich industrial sector, and thus were relatively weak during the formative period of the card market. All of these factors made joining the existing card network a more appealing prospect for Ukrainian banks than developing their own multibank domestic system. Because they also started a few years later than banks in Russia, they found a better established Visa and MasterCard network already functioning in the region. The hegemonic duopoly of Visa and MasterCard in Ukraine was left unchallenged until 2000, when seven medium-size banks founded a domestic card payment system. Ukrcard now claims forty banks as members, most of them medium or small, and none of them card market leaders.28 The same year that Ukrcard issued its first cards, the network was certified as a Member Service Provider for Europay. Two years later, in 2002, Ukrcard became a processor for Visa, but also started processing interbank transactions on cards issued by Ukrcard members. In other words, because of the timing, this domestic card brand was from the very beginning compatible and integrated with the international card networks. In 2004, the Ukrainian state initiated the creation of another domestic card brand: the National System of Mass Electronic Payments, or NSMEP. From the outset it was the intention of the Ukrainian state to make NSMEP the foundation for the country’s national payment network—thus not a commercial financial service, but rather a national institution. In 2007, NSMEP cards were issued by thirty-four mainly small

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and medium-size banks without large card programs. To date, NSMEP has distributed almost three million cards, which account for 10 percent of all cards issued in Ukraine; and it has established six thousand card-accepting terminals. Notably, just as in Russia, state-promoted NSMEP cards are chip cards, and unlike Ukrcards, they are incompatible with international card standards. The arguments in favor of a national card payment network based on a domestic brand are familiar ones: the vast majority of trans­actions using cards issued in Ukraine take place in Ukraine, but 95 percent of these domestic transactions are conducted using international cards, which are more expensive and raise privacy concerns, because transactions with international cards are processed outside Ukraine. 29 To promote NSMEP, Ukrainian National Bank claimed that wider adoption of this card would speed up payment settlements, increase the rate of noncash payments in Ukraine30 and attract significant cash resources of the population into banking circulation. Recognizing the inherent disadvantages of NSMEP as a latecomer, the Ukrainian state has been actively pushing the brand among both prospective cardholders and merchants. NSMEP cards are a preferred brand for state and municipal employees, recipients of social benefits and students at state universities. For instance, in 2006, in an attempt to move away from cash-based disbursements of stipends to college students, NSMEP member banks carried out a program of issuing NSMEP cards at seven universities across Ukraine. Eleven thousand cards were issued that year. By the end of 2010, more than one hundred thousand NSMEP cards were issued at almost fifty universities, and the intention is to further widen the program to include all other schools. The Student Card program is viewed as the first step toward implementation of a social card program intended to disburse the payments of other state-provided social benefits (such as pensions and unemployment, disability and maternity compensation). In 2006, the national post office (Ukrposhta) joined NSMEP as an acquirer, and NSMEP cardholders could now obtain cash, add cash to their card, or pay for services in Ukrposhta’s many branches. This is a particularly important move because post office branches are located all over the country, even in small villages, possibly giving NSMEP a leg up against traditional banks, which have to open new branches if they want to reach regional towns and rural areas. NSMEP has just signed an agreement with the Service Center of Mobile Payments to enable mobile phone users not

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only to pay their usage charges but also to use their mobile phones to manage their card accounts. Ukrainian National Bank believes that NSMEP cards should be very attractive to both consumers and merchants. According to the head of the bank’s Department of Methodology of Retail Payments, in 2006, annual per-card expenditures on NSMEP cards were already much higher than those on Visas and MasterCards—9,955 UAH (hryvnias) for ­NSMEP cards, 5,257 UAH for Visa cards and 5,231 UAH for MasterCards—­ illustrating consumer demand.31 He also argued that merchants should prefer NSMEP cards to international brands for two reasons: first, unlike ­magnetic-stripe cards (and the majority of Visas and MasterCards are magnetic cards), chip cards allow card payments to be processed off-line, which is quicker and cheaper; second, the merchant discount on trans­actions using NSMEP cards is 1 percent whereas for Visas and MasterCards it is two to three times more. For those merchants who do not appreciate the carrot, the state also has a stick. One of the recently passed laws mandating that retail establishments must take plastic cards alongside cash now includes a provision that each retail establishment has to accept at least three card brands. This mandate is no doubt another attempt to promote NSMEP cards alongside the ubiquitous Visas and MasterCards. If “POS-terminalization” is successful, the number of card terminals in retail locations is expected to increase by three to four hundred thousand. This effect is a perfect illustration of the ability of the state to use coercion to solve the “chicken or egg” problem: i­ndividuals are forced to own cards and merchants are forced to accept cards. These provisions could stimulate the development of the card market, but their success hinges on the readiness and desire of cardholders to use cards for payment. After all, they could continue using cards exclusively to withdraw cash, leaving the merchants’ POS terminals idle. Even if these provisions are successful, there is no reason to believe that domestic brands would benefit more than international ones. It is therefore unlikely that the state will effectively challenge the presence of Visa and MasterCard in Ukraine, particularly because more than 40 percent of cards in Ukraine are international brands issued by a single domestic private bank—Privatbank. ­Domestic brands may remain a niche product limited to providing state workers’ salaries and social benefits. Then the Ukrainian case would exemplify the role of timing and path-dependency in card market trajectories.

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Despite the state’s interest in creating a national payment system and upsetting the dominance of international brands, the early market advantage of those brands may have already been solidified.

Credit Puzzles As we discussed in the previous section, a common strategy for marketing cards was coercion via salary projects. Yet, although banks were able to force cards into consumers’ hands, and were hoping to mandate in the near future that merchants would be equipped to accept cards for purchases, they could not make consumers use those cards. This puzzle applied even more to credit cards. Similar to what we saw in Hungary, Poland and the Czech Republic, there was a perception among bankers that credit cards were not popular, and it was a struggle to promote them, not only because people refused to replace cash with electronic payments, or were opposed to the novelty of cards, but particularly because they resisted the ideas of credit and borrowing. Our respondents were unanimous in their assessments: Credit cards are not very popular, including those that provide credit in connection with salary cards. Few people use them to charge. [UB #12.1] The Russians are not used to living on credit . . . this is a particular characteristic of the Russian character. Credit is viewed as something negative. [RB #8.1] People are not aware. The credit card is more popular in other countries. [BB #4.1] [There is a] . . . low credit culture of the population . . . people are shunning . . . credit. [RB #3.1] Consumers are not ready to take loans. There was a period in Ukraine [­several years ago] when interest rates grew and borrowers were hit hard. Thus there is a common perception among the public that credit is bad. In the last year or two we are witnessing a consumer credit boom. But people are still afraid to use credit lines [on revolving cards]. [UB #13.1]

This last respondent makes a distinction between the installment loan and the credit card. The former is becoming more acceptable. There is evidence that the volume of consumer lending was growing very rapidly across the three countries starting in 2001; by 2003 there were indications that

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these countries were in the midst of a real consumer boom. Still, credit cards were not nearly as popular as loans. The following comment from a bank representative shows that this bank recognizes the difference but remains hopeful that the wider acceptance of credit cards will follow the path paved by consumer credit: In Ukraine, much of consumer credit is not tied to cards yet. People often end up getting loans from different banks to finance consumer goods. ­Customers did not make it to the banks yet, only to the stores. Once they got there, they realized they do not have enough money, and the merchants went to banks to ask them to provide clients with credit. On the other hand, people still do not trust banks much because they lost their savings in the past. [UB #6.1]

There is an essential perceived difference between installment loans and credit cards. The special-purpose consumer loans that are tied to particular big-ticket items, such as furniture or a computer, are a one-time means to a very defined, specific end, and thus feel more limited and justifiable. Credit cards, on the other hand, remove the means-end consideration by pushing the more radical idea that one always has the possibility of buying on credit, no matter what the purchase is—that it is a constant temptation—and for this reason people look at them with more trepidation. The consumer loan enables the purchase. The credit card engenders the consumer. This bank was gradually moving toward the credit card as a product that would naturally succeed small consumer loans: ”In the beginning we issued loans in the head office, then we started to issue through branches as well, now also in stores. The next stage is to offer credit cards—it is a universal instrument, which is not linked to any store, or any purchase” [UB #13.1]. As consumers are getting used to the idea of formal borrowing, the banks are faced with the reality of lending and the risks that it poses. It is becoming necessary for them to learn how to better screen prospective cardholders, to which we now turn.

information asymmetry

Mirroring the dual nature of the credit card—a payment instrument and a personal loan—Russian and Ukrainian banks frequently maintained two separate departments responsible for approving applications and servicing

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card accounts: plastic card departments32 supervised the technical side of the process (generating PINs and monthly statements, monitoring transactions and so on); credit departments focused on risk management (prescreening applicants, establishing the size of their credit lines and working with problematic accounts).33 In some cases, the process of applying for a credit card even involved filling out two applications to be processed simultaneously: one for a plastic card and the other for a consumer loan. In another case, the bank would issue a debit card immediately, but it would take the bank another three to six months to have the credit line approved. This period was informally considered a trial period for the new cardholder. According to our interviews in the three countries, overdraft cards (debit cards that allow for overspending and therefore provide a form of credit) and credit cards were issued in four types of circumstances: (1) to applicants of high status, including the status acquired through an informal recommendation; (2) to those who provided collateral; (3) to those whose monthly salary was directly deposited in the bank, a special case of collateral-secured cards; and (4) to those purchasing consumer durables in retail locations. All of the banks we interviewed reported that credit cards were first issued to people connected to the bank: the bank’s own employees, VIPs (for instance, top managers of the bank’s corporate clients) and those whom VIPs, including the bank’s own top managers, were willing to recommend personally. Indeed, just like banks in Central Europe, East European banks started their card programs in the 1990s from a small circle of people connected to the bank and only gradually widened their clientele to include strangers.34 Some of these select people were even able to get unsecured lines of credit, which were extremely rare at that time. These individuals’ positions within the network connecting them to the bank, their status (for VIPs) or the influence that others were willing to deploy on their behalf (in the case of personal recommendations) were accepted in lieu of tangible collateral or security deposits. For instance, one Bulgarian bank that started in corporate finance and then moved into the retail market did not offer credit cards to the general public but only to a select few—mainly managers and top employees of the bank’s corporate clients. Credit cards are only for select individuals. We usually know everything about them, and it’s not somebody who [applies for the] card[. . . . ]Usually the bank says, “We suggest the card to you.” This service is not included in the [usual] service of the bank.

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Interviewer: So how does one get a credit card? They say we are ready to offer you. Interviewer: The center says? No, no, the local office. We are ready to offer you this service. [BB #5.1]

Some banks stated outright that they did not issue unsecured (so-called blank) credits except to VIP clients or individuals connected to the bank through their employer—typically the bank’s corporate partner or a large corporate client. Other banks reported that they “don’t work with people ‘from the street,’” underscoring the importance of having a tie to the bank— through either a salary project, a tie mediated by the cardholder’s employer or a personal tie—as a basis for being issued a card. They were practicing a “preventive” strategy with the goal of minimizing late payments, defaults and fraud. Not surprisingly, such banks claimed that their default rate was close to zero: We give loans to those who will definitely pay. [UB #1.1] We do not have any defaults because credit cards are issued to people with whom the bank has stable relations. [RB #5.1]

“Stable relations” in this case gave the bank assurance that even if these cardholders had problems repaying the loan on time, they wouldn’t disappear or lie to the bank but would negotiate and work out an acceptable repayment schedule. A strategy that relies on social ties as a basis for issuing credit cards is obviously limiting, and had it not been for salary or social benefits projects, which now routinely offer overdraft options, such banks would have had very small card programs. High-status individuals were not only desirable cardholders but also sought-after recommenders who could lend their status to others. By and large, such recommendations are informal because they come from people “of such high caliber that formal written recommendations are not required,” as we were assured by a representative of one of the banks [UB #7.1]. Another stated: “Recommendations work if they are from members of the board and large-account clients” [UB #12.1], and yet another told us: “If the branch head writes that he knows the customer from grade school, this pretty much gives a guarantee” [RB #13.1], even though not a formal one.

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The list of people who can recommend and whose recommendations are taken into consideration is not formally compiled. Recommendations are therefore evaluated on a case-by-case basis, and the outcome of these evaluations can in principle be negative if the bank decides that the status of the recommender or the recommender’s familiarity with the applicant is insufficient. So, “simply being acquainted [with an employee of the bank] is not worth much” [UB #3.1], and mere “familiarity with bank management or employees is not considered” [RB #3.1]. If the recommendation cannot carry the day (usually because the guarantor is not of a high enough status), the bank may require a formal guarantee or even collateral. To those who cannot count on a high-positioned individual in their network (or on their employer) to recommend them, banks offer collateralized credit cards and overdraft debit cards. “Anyone ‘from the street,’ without any contacts with the bank, can get a card if they make a deposit,” we were assured in one Ukrainian bank [UB #10.1]; the size of the loan (the credit line) was set at 50 percent of the size of the deposit. Another Ukrainian bank echoed this position: “Credit cards are not issued to ‘people from the street,’ but this is an informal rule. In reality, if a person opens a big deposit account, why not issue them a credit card?” [UB #15.1] A large Bulgarian bank’s representative described the bank’s card-issuing process and explained the role of deposits this way: Interviewer: How does your bank decide who should be issued a credit card? In the general case, if you have a [directly deposited] salary in our bank or a [security] deposit, you will receive this card. There is no restriction. Interviewer: If I have a credit line of, say, 10,000 levas, then how much security deposit do I have to put down? Twelve thousand five hundred. Interviewer: That’s a lot of money to put down. But if I have 12,500 to put in my account, then I may not need credit from you. This is the world of our clients! [Laughter] [BB #3.1]

At first glance, this approach makes consumer loans and credit cards available to a larger, more inclusive group of potential customers who do not necessarily have to be affiliated with any organizational body, and their personal wealth trumps the lack of “right” social ties or organizational position. On the other hand, the requirement to keep in the bank a deposit

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that is significantly larger than the size of the loan that the bank is willing to offer must limit the scope of potential customers interested in such credit cards. As the Bulgarian bank representative indicated earlier, in the absence of a substantial deposit, credit cards can be secured by directly deposited wages. Some banks offered blanket overdraft coverage to everyone in an enterprise for which they administered a salary project. The most cautious banks asked the enterprise to formally guarantee the overdrafts, and companies are frequently willing to submit such guarantees on behalf of their employees. In one bank, for example, we were told that the enterprise was required to formally guarantee repayment, though if it could not, the risk of nonpayment could be insured by an affiliated insurance company (with an average premium of 1.5 percent of the amount of permitted overdraft). Some enterprises submitted a list of their top employees, requesting (and often formally guaranteeing) overdraft coverage for them. Finally, a handful of Russian banks have offered credit cards in connection with store purchases. For instance, Russkiy Standart has been promoting express loans offered in retail stores to shoppers eager to buy consumer goods but lacking enough cash. Successfully repaying such a loan leads to being automatically issued a credit card (an arrangement specified in the fine print of the loan’s application form). Russian Deltabank issues co-branded credit cards with IKEA, the Swedish home furnishings store. Ukrainian banks have been eyeing this practice. When we conducted our interviews, at least one of them, Pravex, was also offering express loans in retail locations, but they were not yet providing full-blown credit cards.

Screening Application  When individuals applied for credit cards in the head office or at a branch, the application process involved meeting with a credit officer, filling out a form (sometimes two—one for a card, the other for a loan) and supplying additional information (copy of a passport and, in some cases, even a note from a psychiatrist).35 This information was then forwarded to the higher-ups—such as a senior credit officer, head of the branch or credit committee, or a group of top managers of the bank—who would make the final decision.

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One of the key questions that the officer accepting the application has to answer is why the client is applying for the card. Applicants are asked the question directly, and the officer carefully listens for the explanation. It turns out that there are wrong reasons for card applications. A Russian banker we interviewed was quite adamant about this: First, we need to find out why the client needs a card. Are they going to use it for Internet purchases or travel? If the applicants say they need the card in order to transfer the money to another city (for instance, because they are moving to Moscow), this is an immediate rejection. We do not admit this [to the applicant], but the bank wants to avoid people who want to use the card mainly for cash withdrawals. Maybe this is money laundering. [RB #12.1]

This banker’s Ukrainian counterpart underscored the importance of transparency in even stronger terms: “It is very important to determine the goal of applying for the card. The banker is like a doctor: if you do not tell him everything, he will give you a wrong medicine” [UB #6.1]. The banks were particularly concerned about the possibility that some of their card applicants might in fact be “mules” hired to apply for the card, which would be used by someone else, most likely fraudulently. We were told, “In this case, bank representatives are trying to explain to this person that they bear full responsibility for card transactions, and they could lose much more than what they were promised to be paid for getting a card. In one such case, a foreigner brought three people in a row to apply for a card” [RB #1.1]. In a similar scenario, students were “hired” to apply for cards that were then taken by their “employer.” When the banks realized what was going on, the “employer” was gone, and although the students could be easily located, they had no money to pay.36 Because applications are submitted in person, bank officers have the opportunity to form a personal impression of applicants: Do they appear trustworthy and open or, on the contrary, do they seem to be hiding something? How are they dressed? (This question becomes shorthand for evaluating socioeconomic status.) Moreover, do their dress and overall appearance correspond with their stated occupation? Last but certainly not least, are they sober? The bank officers who accept applications are called credit inspectors, and in more than one of the banks they were referred to as “lay psychologists,”

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emphasizing their knack of assessing applicants. As we were told in one Ukrainian bank, The credit inspector studies the applicant as a psychologist, whether he is normal and sane, whether he lied in response to any of the application questions; [inspector] can ask about friends, acquaintances, business partners [of the applicant] [ . . . ] perhaps they have mutual acquaintances [ . . . ] the purpose is to figure out social status. . . . The credit inspector also looks at appearance, manner of speaking. [UB #1.1]

Given that many banks considered the credit card a combination of payment card and personal loan, it is not a surprise that they evaluated the applicants in a way similar to how applicants for personal loans are evaluated. Here is a scenario that was offered in another bank: “For instance, someone who claims to be a serious manager and is coming from work is dressed unlike ‘a serious manager who is coming from work.’ . . . So credit inspectors sometimes have feelings that they should not approve applications. They talk to people, and the clients often do not realize how much they have already said” [UB #15.1]. The role that such personal impressions played in the ultimate decision to issue a card differed between banks. Sometimes personal impressions were not required at all and were added purely at the discretion of the officer who accepted the application. In other cases this impression was required and there was a special place to record it on one of the bank’s internal documents, usually after the applicant left. Though not decisive, this impression would help the bank arrive at the final decision. As we were informed in one Ukrainian bank, “personal impression is not formalized, it is not mandatory, and it can be formed at the initiative of a credit inspector. . . . But in [another Ukrainian bank, where the respondent used to work prior to his current appointment] it was mandatory: the last line of the interview questionnaire was ‘personal impression,’ whether the applicant was well-mannered or not” [UB #3.1]. A Russian bank also required credit officers to record their impressions: Besides an electronic version of the application, there is a sheet where the final decision will be recorded. There is a place for comments there, and this is where the credit inspector can record his personal impression of the applicant after he leaves. We even developed a coding system for such information: whether the client was drunk or sober, whether he came alone or

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was brought by someone else. These comments are supposed to record any deviation from typical behavior.” [RB #13.1]

As the preceding quote indicates, some banks even went as far as assigning numerical scores to personal impressions and including them in point system calculations. We were able to obtain point system criteria (variables and their weights) from several Ukrainian banks, and two of them had a group of scores that, in addition to assessing the usual demographic and financial situation variables, evaluated applicants on the basis of the impression the applicants made on the bank officer who took their application. People were scored on these five decidedly judgmental variables:37 1. Communicative 2. Entrepreneurial 3. First impression [of the bank officer] 4. Interview-based opinion And the most subjective of all: 5. The looks (vneshnost’) Each variable could receive value one to three. In one of these two banks we were assured that evaluation of the applicant’s looks was important only for boutique products (not issued en masse), for instance, for “blank” (uncollateralized) credits; or when the intended use of the card was unclear; or in the case of a request for a particularly large credit line. An officer in another bank said that whereas the personal impression variable added about 5 percent to the overall number of points, physical appearance (“the looks”) contributed no more than 1 percent. Verification by the Security Department  Once application materials were accepted by a typical Russian or Ukrainian bank, they were usually passed to a security department. (Bulgarian banks followed a different procedure, which we describe later.) The security department of the bank plays a key role in verifying information submitted in a card application, as well as fighting fraud and handling late payments.38 The responsibilities of security departments include those handled by the risk management departments of Central European banks. The difference between the two is reflected in the name: security departments are typically given a much broader mission than risk management departments. Security departments are expected to

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ensure both the physical and the informational security of the bank, and in line with this broader mission their repertoire of methods may go far beyond intelligence gathering, estimation of risk and loan underwriting. They are widely known to be staffed with former officers of the army, the police and the KGB (siloviki).39 None of our Bulgarian interviewees reported that security departments were instrumental in card issuing in Bulgarian banks. They are also completely unknown in this form in Poland, Hungary and the Czech Republic.40 Security department verification in Russia and Ukraine pursued two main goals: to establish the applicant’s trustworthiness and to ensure that the cardholder can be held accountable in case of a problem. This is how a Russian banker explained the purpose of verification: “The goal of the bank is to collect as much information about the client as possible, in order to identify the person, and find him easily in the case of a default. We are making an evaluation of who can be trusted and who can’t. The most important goal is to identify those who purposefully distort information” [RB #11.1]. Establishing trustworthiness meant, first of all, weeding out crooks and preventing outright fraud. An officer of a medium-size Ukrainian bank described how they recently dodged the bullet thanks to the vigilance of their security department: We had a case recently: two well-to-do persons came in applying for cards. We refused them—there was something in them that we intuitively did not like. And we were right! They went to another bank, and that bank’s security department was not as vigilant. They were issued cards and defrauded the bank of 70,000 UAH [approx. $14,000 at that time] on below-floor-limit purchases and other things. They were that “talented.” [UB #1.1]

Establishing accountability includes evaluating whether cardholders are securely “anchored”41—in other words, whether they can be easily contacted if necessary: “It is important that the client be accessible, tied to a particular geographic territory. There should be something that would hold the client” [RB #12.1]. To test this information, security department personnel would call the applicant’s home and work phone numbers and ask to speak with the applicant to verify whether he could be easily reached. If they could not get the applicant on the phone after two or three attempts, the application would most likely be rejected. The need to anchor the cardholder and hold him accountable is why banks viewed salary cards—even those with a substantial overdraft—as a particularly low-risk option. Know-

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ing where a cardholder works and having a tie with the employer made the bank confident that the cardholder could be easily tracked. For the same reason, married applicants and those with kids were considered to be more reliable (and therefore more desirable) borrowers (characteristics that are illegal for American lenders and credit bureaus to consider). Calling the numbers provided on the application form has been a common verification method, but a few banks expressed concern that a criminal could easily pass this test. Referring to other banks’ point systems that quantify accountability and “anchoredness,” one of the interviewees raised this concern, mocking other banks’ gullibility: “They gave points if the telephone indicated in the application form was indeed the one associated with the workplace, and more points if people worked at their workplace longer. To check this, credit officers would call the work number indicated, but the applicant could have asked his friend to answer the phone and confirm that such and such indeed worked in the company for a certain number of years” [UB #13.1]. Data Analysis and Decision Making  Whereas most banks in Russia and Ukraine used a combination of expert judgment, simple rules and point systems in which each factor was assigned a point value by expert decision as opposed to statistical calculations, and occasionally even statistical scoring, the ultimate decisions were typically made by experts who relied on both rules and point systems. Decision making in Bulgarian banks was much more routinized and formalized, and typically relied on point systems and scoring. Rules were used to streamline and speed up prescreening. They also helped control the relatively inexperienced managers of regional branch offices. According to the manager of a Ukrainian bank, “Rules allow making a decision fast so they are used to offer mass products. They also allow the bank to trust its officers in the regional branches, whose skill level is lower than those in the head office” [UB #3.1]. Some rules were used as “stop factors,” that is, they were intended to immediately weed out unsuitable applicants, for instance, those below a certain age, with a criminal past, unemployed, drunk at the time of the application, and so on. Rules were developed by the bank’s experts (top managers, usually). At the same time, even straightforward rules could be flexibly applied. For example, even when a bank expected applicants to be at their current job no less than five years and to have a college degree, not meeting one or both of these requirements did not usually automatically disqualify applicants from further consider-

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ation: “If time at current job is less than five years, then it is important for an applicant to demonstrate having a car; if time at current job is less than one year, the fact of having a college degree and the college where it was obtained become particularly important” [RB #3.1]. In addition to being simple eligibility requirements, rules sometimes involved generalizations based on empirical evidence. Several Russian and Ukrainian banks gave us similar examples: If there is information about intensified fraud in a particular geographic region, the branch will change the rules to take this into consideration. [RB #13.1] In [one Ukrainian bank,] defaults on express credits were 28 percent in the Kiev region. As a result, the bank stopped providing them in Kiev [ . . . ] a large number of dishonest people, it is hard to verify information [ . . . ] now they only extend such loans in the regional towns of no more than one hundred thousand people. [UB #2.1]

Another Ukrainian bank agreed with the argument that smaller towns had a more trustworthy populace: “The further away [they are] from the capital, the more responsible and reliable the borrowers are, the better they pay back. In a big city, people are more ‘inventive,’ they think they can just refuse to pay and the bank would not be able to do anything. And some banks do not do anything, but others are trying to go after defaulters” [UB #3.1]. A few banks reported using point systems to attempt to quantify different borrowers’ characteristics. Although most banks referred to their point systems as “scoring,” the variables and weights used in these point systems were developed by bank experts on the basis of their experience and common sense rather than, as in true scoring, on the basis of statistical analysis of past data.42 For example, “if someone has a deposit, they should be given more points than the one who has a twenty-five-year working experience” [UB #10.1], but in the absence of any empirical data, it is not clear precisely how many more points having a deposit is worth. Several of the banks provided details of their point systems: they typically focused on social status, current financial situation and applicants’ history. Here is how one Ukrainian bank explains the mechanics of point calculations: The point system is divided into several parts [and] each is assigned a minimal passing score. The credit inspector moves to the next part if the previ-

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ous one received a passing score. Number of received points is multiplied by the weight of each factor[. . . . ] Same number of points can lead to different decisions. Points are just one element of the decision, but much is due to subjective factors[. . . . ] May be this is why we do not trust this model yet. After all, it has been based entirely on our mental constructs and stereotypes and not on any real statistical data. [UB #6.1]

Point systems were developed in-house and were sometimes based on similar tools used in other banks or inspired by presentations given by foreign developers of scoring models. But just as with rules, in Ukraine and Russia, point systems were used in a flexible way: they did not replace the human being as an ultimate decision maker and could be overridden. In one Ukrainian bank we were assured that “the point system exists, but it is neither a panacea nor a dogma. The client may earn a necessary number of points but be turned down by the security department. The opposite can also happen: the client might not reach a necessary cut-off point but be attractive to the bank on the basis of other factors [UB #6.1]. For this particular bank, the rules also existed to be broken: “If the question is about issuing a Gold Card we can violate the rules. If the person wants it, and is willing to pay for it, we should just go ahead and do it. We understand that the reason he wants it is because he would be ashamed not to have one in front of his buddies” [UB #6.1]. Other banks emphasized that standardizing consumer lending is in principle problematic: “In 50 percent of cases we need to approach clients individually. Size of credit line, interest rate—it’s all different” [UB #7.1]. Representatives of only two banks among the fourteen we interviewed in Ukraine claimed that their specialists were developing scoring models, but in 2004 they had not yet been used. Experian and a few other foreign vendors of scoring solutions repeatedly visited Ukraine to make presentations on the virtues of credit scoring, trying to get banks to buy their products. None of those interviewed admitted to purchasing anything, and many said these scoring systems were too expensive. Reflecting the fact that in the context of a developing economy labor is cheap compared to technology investments, one bank representative admitted that “banks are not ready to invest in scoring systems[. . . . ]It is expensive to buy ready-made solutions, yet it is difficult to develop them in-house[. . . . ]It is cheaper to hire ten people to dig a trench than to buy one excavator” [UB #6.1]. Nevertheless, most banks believed that in the future scoring would inevitably replace other methods of screening. At that point, however, even if

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quantification was used, it was considered by human experts alongside other information. In one of the interviews with a market analyst (not employed by the bank), we were told that one Ukrainian bank started using application scoring but stopped after three months because “they could not find clients that would pass application scoring in a satisfactory manner. They tried a member of the Parliament, but the system said, ‘No, should not be given a card’” [U #1]. In Russia, credit scoring generally was not used either, but a few banks were at the stage of developing a scoring model. A few claimed to use scoring models that on closer inspection turned out to be point systems. For instance, one Russian bank insisted they used a scoring model, not a point system, because the weights were not determined by experts but borrowed from other sources. However, they were unable to reevaluate the model because they had not yet issued enough bad credits. And given the insistence of most banks we interviewed that their default rate was negligible, it is not clear how (or how soon) the banks would be able to gather the necessary data. In both Russia and Ukraine, points and scores informed the ultimate decision but did not replace it. Decisions were still made by human experts— in Russia, typically by senior credit officers, heads of regional branches or heads of payment card departments; in Ukraine, by credit committees. ­According to one interview, the difference between Russia and Ukraine may have been a legacy of a recent Ukrainian National Bank policy: “Until recently, Central Bank insisted on credit committees. No manager could make decisions on his own. Now banks can delegate this decision to individual managers, but many banks are reluctant to change” [UB #4.1]. Credit committees, which are very rare in Central Europe when it comes to retail loans, typically included a deputy head of the board, a head of credit and risk management divisions—all in all, five to seven people. In banks with smaller consumer-lending operations, such committees made decisions about all applications for loans, both consumer and corporate (only a portion of consumer loan applications specifically concerned credit cards). In banks with larger retail programs, standard credit card applications, such as those related to salary projects or collateralized with deposits, were not evaluated by the credit committee; only nonstandard ones (such as “blank” or unsecured credit lines or loans to VIP clients) were. In addition to formally approving credit card applications, credit committees were also charged

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with developing and approving conceptual issues, including eligibility criteria, rules and point systems. In 2006, the largest Ukrainian card issuers started to widely market credit cards that no longer required potential cardholders to have a deposit in the same bank. (Russian Russkiy Standart had pioneered unsecured credit cards earlier, in 2001.) Such cards typically offer modest “baseline” credit lines—from 500 UAH (at that time, approximately $100) to 2,000 UAH ($400). But some banks offered much higher credit lines. One bank, for instance, offered uncollateralized credit lines up to three times the cardholder’s monthly salary, or even up to six times the monthly salary if it was directly deposited to the bank. A few of the largest banks also offered grace periods from thirty to forty-five days. This change in marketing meant that banks were suddenly faced with a large number of strangers with no ties to the bank. It challenged them to improve their methods of screening and controlling cardholders, to move from time-consuming case-by-case verification and decision making to more standardized methods that allowed processing applications and arriving at decisions en masse. For Bulgarian banks, on the other hand, making lending decisions based on credit scoring was commonplace. Here is an exchange to illustrate this point: Interviewer: And who makes the decision? We have a centralized credit unit here responsible for the decisions. Actually, the people aren’t making the decisions but they are using our software. Interviewer: Who signs off on the credit? The credit underwriter . . . you mean the approval of the customer? [ . . . ] the approval is in our centralized credit unit. Interviewer: How is the credit limit decided? It’s augmented in the system. It’s a combination of both the credit scoring and the income of the customer. Interviewer: So basically with the scoring you make the decision of whether the person gets the credit or not and then how much? Yes. Basically what the underwriter sees on the screen is the answer— approve, reject and the amount. [BB #4.1]

Income Data  One of the central challenges of pre-screening is getting around the problem of bad data. Income data are notoriously unreliable across the East European region because many employers pay only a portion of work-

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ers’ compensation officially while the rest is paid in cash or in some other form. This practice allows both employers and employees to lower their tax burden. According to a recent survey by Russian pollster VTsIOM,43 one third of Russians admit to being compensated for their labor with wages that are not officially recorded and taxed. The Bulgarian estimate by Visa Europe (not based on self-reports) is even higher—48 percent.44 Although some of those people are informally employed in baby-sitting, elder care or tutoring, the majority of them are officially employed by organizations that underreport their salaries to reduce taxes. Yet it is essential for the banks to know applicants’ income because the size of the overdraft credit line directly depends on it. Some banks work only with “white” income, requiring applicants to submit an official paystub from the employer. But many banks indicated they felt they had to find a way to work with customers whose incomes were unverifiable because denying them service outright would be bad business. Here is a discussion of this problem in one of the interviews: Another problem is when the person is getting, say, legally $50, and the rest in the envelope. . . . [Laughs] It is impossible to verify these envelopes, even though we understand very well that this person has an apartment, a car, etc. and it is perfectly clear they were not bought on a $50-a-month salary. Well . . . here everything has to be decided on an individual basis. We are starting to figure out who other family members are, maybe the guy’s wife is paid more and legally . . . everything is decided on a case-bycase basis. [UB #10.1]

Most banks have no other choice but to accommodate “gray wage” recipients and accept unofficial confirmation of one’s salary by the employer. For example, one bank reports that it issues about 40 percent of its mortgages to borrowers who receive unofficial pay.”45 One of our interviewees admitted that “hardly any bank today can afford not to consider ‘gray’ income” because this phenomenon is so widespread that refusing to consider it would amount to severely limiting the customer pool to employees of the state, municipalities and large foreign corporations, which tend to obey the tax code [RB #11.1]. The employer’s confirmation is accepted in a free format on official letterhead. However, not every organization is willing to supply such a document, because the difference between the stated sum and the one officially declared amounts to admitting tax evasion and can be used as

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evidence in an investigation by the tax authorities. Some organizations are only willing to provide a verbal confirmation but not a written one. With or without such an unofficial confirmation, banks can consider three other factors. First, lenders themselves can estimate borrowers’ real income on the basis of their job description (position), education, experience and the industry in which they are employed. Bankers assured us that they have a pretty good idea how much someone with a given position in a given industry is paid. Credit officers who analyze the applications compare the amount with available statistical data.46 This process serves the additional purpose of verifying applicants’ overall honesty. The one whose claimed income is significantly higher than the bank’s own estimate is immediately suspect. One of the important additional criteria is whether borrowers would easily find another job if they were to be fired or if their company were to close. This determination is based on how common the applicant’s specialty is. Consider, for instance, the difference between an attorney and a harp player. Given that they are equally good at what they do, the latter would probably have significantly more difficulty finding another orchestra to play in than the latter would have finding another law firm to work for. Here the bank evaluates borrowers on the basis of their labor market position, which presupposes that the lender has a thorough knowledge of the various labor market sectors and of demand for particular specialists. Second, lenders can consider other family members’ incomes on the basis of the expectation that relatives help each other informally. Although parents or adult children of the borrower will not be legally responsible for the outstanding balance, banks expect them to step in when necessary. This evaluation, however, takes us back to the original problem if relatives also receive a substantial portion of their income in “gray wages.” The expectation of informal help is fundamentally different from a formal obligation by a third party to pay if the borrower is unable to do so. In the case of a formal obligation, the third party serves as a legal guarantor; in addition to a relative, it could be anyone—a friend or even an employer. Third, and most important, lenders collect information about applicants’ current consumption or possessions as an indirect measure of their real income. Ownership of real estate, except for apartments that were privatized free of charge as part of a mass privatization of municipal housing, and owner­ship of an imported, recently manufactured car attest in the eyes of

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the bank to the borrower’s solid economic position and can compensate for the lack of sufficiently high officially paid income. Monthly mobile phone bills can be such a proxy, and some banks set a minimum required level for such charges.47 In traditional evaluations of borrowers, fixed monthly expenses (such as mortgage or rent, child care expenses, car payments, and so on) are subtracted from the monthly income to arrive at disposable income. Other things being equal, the larger the fixed expenses are, the smaller is the loan for which the borrower can be eligible. Here the logic works in the opposite direction. In the absence of income information, proof of substantial monthly expenses increases one’s chance of qualifying for a larger loan or a credit card. In more than one bank, credit officers asked prospective applicants where they took their vacations. The desirable response was “somewhere abroad.” Lying about this might not work, because credit inspectors were trained to probe further with questions about the specifics of foreign destinations, and they could see through a lie. One Ukrainian bank even tried to use applicants’ tastes as shorthand for elusive socioeconomic status. Bank officers routinely asked applicants which radio station they preferred. One radio station in particular, Radio Chanson, which plays light pop music, was typecast as a station particularly popular among blue-collar workers, taxi drivers and lumpenproletariat—the poorest layer of the working class. “So, whoever listens to it is not a critical borrower for our bank,” one of our respondents in this bank dismissingly concluded. When asked how the bank knew about this connection between one’s preference in music and one’s social status, our respondents (we interviewed several managers at the same time) unanimously insisted that we should listen ourselves and it would become obvious. To investigate applicants’ material possessions further, some banks went as far as visiting applicants’ homes. Citibank Russia, which pioneered this bold approach, widely advertised its first credit cards by saying that all applicants had to do was call and a Citibank employee would visit them at home and help fill out an application. What looked like an amazing customer service was just another trick to assess borrowers’ real incomes, as we learned from a conversation with a former Citibank employee. Citibank credit officers were trained to look around at the general condition of the residence, quality of furniture and consumer electronics while helping to fill out the application and answering questions. A mass market like the one for

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credit cards or small consumer loans can hardly be sustained in such a laborintensive and time-consuming manner, yet one can imagine this practice being firmly entrenched in the mortgage application process. The one clear downside of this strategy was that the bank did not openly position home visits as part of the screening process, so it could not verify whether the residence was really owned or occupied by the card applicant without revealing its intentions. In theory, only the address of one’s official registration with the police (the address stamped onto one’s domestic passport) could be easily verified, but a large number of people lived elsewhere, and the agreements between renters and landlords were frequently informal. The lavishly furnished home to which the loan officer was invited could turn out to be a Potemkin village. Our firsthand data are corroborated by other scholars’ findings. For instance, Shevchenko observes that Russian banks are not alone in their attempt to use consumption as an indirect measure of one’s income. She reports that Russian market research agencies “have switched to the policy of asking their respondents not about their income, but about their possession of consumer durables, such as video recorders, automobiles, computers, etc., considering this a more accurate measure of the respondents’ social class than a direct question about income.”48 Neither are Russian banks original in using ownership of real estate and foreign-made cars as an indicator of affluence. Russian pollster VTsIOM asked a representative sample of Russians in the late 1990s what attributes distinguish the rich. The top three categories were a foreign-made car, a large apartment and vacations abroad.49 It is important to note that when it comes to consumer credit, none of a borrower’s possessions is used as collateral. The bank does not have any legal claims to the borrowers’ apartments or cars and does not consider them a source of revenue from which an unpaid balance on a loan can be paid. Rather, they are perceived as market signals50—proxies of borrowers’ financial position in the absence of other, more direct ways of verifying income. But such signals may not be credible after all, because they may be too easy to fake. Consumption in Russia does not sit on a secure foundation of savings and investment as could be expected in a stable Western economy. In fact, if only consumer possessions are factored in, but not current indebtedness, what lenders may be observing is consumption purchased on credit. What is the downside of using consumption to handle the problem of “gray wages”? Russian banks perceive consumption as the tip of the ice-

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berg and extrapolate from this to the total size of borrowers’ income and wealth, but in the Russian context the tip of the iceberg may be all the ice there is. Although the rate of defaults on consumer loans prior to the latest financial crisis remained low (less than 2 percent, according to the Central Bank of Russia, across all banks and all kinds of credit), individual banks—­ notably the leaders of the consumer lending market—reported rates as high as 6.94 percent (Russkiy Standart), 7.85 percent (Finansbank) and a staggering 15 percent (Home Credit and Finance Bank).51 According to the deputy head of Russia’s Federal Antitrust Office, in 2006 defaults were growing at twice the rate of consumer lending.52

information sharing Other banks do not share information. Very few banks accumulate all credit histories of all clients; many do not even have technical capabilities to do so. And it is logistically difficult to get information from all 150 banks. [UB #11.1] When money making is concerned, banks are not very good friends, but when they are concerned about not losing money, they can be very good friends. [UB #3.1]

One of the key obstacles to the development of mass credit card markets, according to our interviewees, was the lack of credit bureaus and reliable information about potential clients. This and the low level of consumer credit culture were the two problems most commonly mentioned. Formal credit bureaus of the kind that exist in mature credit markets and assist lenders in screening prospective borrowers were not founded in any of the three countries until 2004–2005—quite late in that the very first cards had been issued there some ten to fifteen years earlier.53 Until this point, interbank information exchange about clients had taken place informally, between bank employees who often knew each other personally. This was usually done at the mid-management level, and typically through the banks’ security departments. Security departments have been staffed by former officers of the state security forces, and their shared alumni status has facilitated such information exchange. Many bank representatives, especially those from large banks, confirmed that they participated in such informal exchange: “Large . . . banks have specialists in security departments who work with cards and they all know each other,” we were assured

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in one Ukrainian bank [UB #3.1]. A Russian respondent used even stronger terms: “There are personal connections among managers, people recognize each other’s voices . . . they exchange information” [RB #8.1]. Others lamented that such an exchange might not be reliable even if it was based on preexisting social ties: “Security departments exchange info if they have personal relations, but without any guarantee that information is truthful” [UB #15.1]. Although a couple of Bulgarian banks confirmed a similar practice, one of the largest Bulgarian banks claimed that such information exchange was not going on: We require the customers to indicate if they have any obligations with our bank, or with another. We require them to fill it out, but I am not sure if we can check this information. . . . I would say that we don’t share with the other banks; maybe this is because of the competition, [we would not want to] be providing the other institutions with information. Maybe the way to [solve] . . . this problem is to implement credit bureaus. [BB #2.1]

Not only did this type of exchange run against the postcommunist region’s strict privacy laws, which were intended to protect the financial information of individuals, but it also challenged banks’ competitiveness, a concern expressed by the Bulgarian respondent just quoted. A vice president of one Ukrainian bank put it bluntly: “We cooperate with other banks only when it comes to defaults. If we call another bank to verify facts about Mr. Sidorov’s credit history, that other bank may simply offer Mr. Sidorov better terms” [UB #10.1]. Given the existence of formal laws limiting information exchange, and given the fact that sharing such information is a sensitive matter for banks, those engaging in it had to rely on a considerable degree of trust, and even then, as the earlier quote from a Ukrainian bank indicates, some information is better kept concealed. There were multiple downsides to these usually bilateral exchanges: they were entirely voluntary and depended on the existing social ties between specific banks; they were hardly systematic and the information transmitted may not have been comprehensive; moreover, sometimes this information could not be easily shared even between friendly banks because of incompatible standards or other technical barriers. In addition, formal blacklists were also organized. In Ukraine a formal interbank database of bad clients called the Exchange was created in 2001 by a card issuers’ association (EMA).54 It was primarily concerned with fraud

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and operated by sending periodic e-mail updates with lists of cardholders and merchants suspected or accused of fraud. In an attempt to standardize information (and perhaps legitimize the blacklist), EMA assigned each cardholder in the database to one of four categories (remember, it is a list of crooks; those who simply defaulted would unlikely be found there): suspicious, nonreliable, dangerous and very dangerous. For example, nonreliable clients were those who had more than twice lost or “did not receive” their cards, or those whose cards were more than twice “compromised” in an ATM or at a retail location. The categories were developed by EMA in collaboration with a few banks; but although EMA officers saw value in them, even suggesting that they be made part of regular monitoring of cardholders’ activities, they admitted that the categories were not entirely legitimate. Even the banks that participated in the creation of the categories later refused to use them. According to our interviews, the Exchange database was used by some Ukrainian banks, but its value was limited because the information it contained was neither complete nor updated and did not include late payments or defaults. A representative of one bank admitted that there were disincentives to sharing information with the database, even in the case of merchant fraud: “Banks do not want to share info about merchants; merchants are also clients of the bank, and banks do not want to spoil their reputation” [UB #1.1]. An officer in another bank stated the following: [The] Exchange database is not effective. One of the main problems is that information is not full or verified. Everyone is adding info at their own discretion. Banks can take this info into consideration but should act on it carefully. [ . . . ] Banks—members of Exchange—did not sign an agreement by which they should be held responsible for knowingly supplying false information. The system is strongly aimed at monitoring and fraud; it is useful for preventing fraud in particular countries, but for issuing credit it is not very useful. [UB #7.1]

Out of about 150 active banks in Ukraine, fewer than thirty were members of EMA in 2004. There was a further twist on the Exchange database, however. Although officially it was an organization that supported card issuing and acquiring by its member banks, unofficially it acted like a clearinghouse of fraud information to benefit all the banks: Officially, few banks submit into the EMA, but unofficially, there is exchange between banks with facilitation from EMA: banks unofficially let

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EMA know about cases of fraud, and EMA unofficially sends information to other banks, practically all of them, without naming the source. Now, banks that are interested in details have to contact, unofficially, other banks through personal contacts and try to find out more information. But it is not guaranteed that they would be successful. [UB #1.1]

The use of unofficial methods to prescreen applicants was ubiquitous, and banks vehemently defended it as inevitable when developing a market in the absence of formal credit reporting: “Since we have no credit bureaus [in Ukraine], we have to resort to these unofficial methods because otherwise how would we be able to lend to strangers? World Bank and Basel Committee recommend how to issue credit, but most of these recommendations are inapplicable to our situation” [UB #7.1]. There was a similar form of informal information exchange in Russia, and according to our respondents, “about twenty banks in all of Moscow [were] part of it, in addition to the fact that security department officers know each other well, and also exchange information” [RB #12.1]. There was also a fraud forum in Moscow that was mostly concerned with merchant fraud (it was run by the leading card-processing company). In Bulgaria, our respondents reported that even a fraud forum was not much help because it too was “mostly for [banks in the] acquiring business, and the information in it is primarily about bad merchants” [BB #2.1]. Another blacklist was organized by the Ukrainian National Bank in 2001—the Common Information System for Registering Delinquent Borrowers (or CIS List of Delinquent Borrowers). It is a volunteer system whose main goal is to increase the reliability of the banking system and strengthen confidence in banks. Upon joining the system, each bank is expected to provide regular information on clients who have failed to make payments on time. Virtually all of the registered banks are members, but many of our respondents said the resource is not very useful because both adding and obtaining information is time-consuming. (In 2004, inquiries were still made by a written request from the bank.) Prior to the legislation of formal credit reporting, banking communities in the three countries engaged in lively debates about what the new credit bureaus should look like. The crux of the argument centered on whether credit bureaus should be commercial organizations affiliated with Experian or other such multinational companies, noncommercial organizations organized and owned by banks (for instance, through the national bank associations) or organized and controlled by central banks. This argument over organizational

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forms and types of ownership concealed an essential tension of postcommunist banking—the one between the largest banks (market leaders who controlled enormous portions of the retail market in their respective countries) and the rest of the banks. Just as in Hungary and the Czech Republic, the largest banks in Russia, Ukraine and Bulgaria have been stalling the process of formalizing information exchange and establishing credit bureaus. Both Bulgarian DSK and Russian Sberbank continue to control the largest chunks of consumer credit markets in their countries (with 30 and just above 50 percent respectively).Ukraine is a notable exception: the Ukrainian equivalent of Sberbank, Oshchadbank, although it is a large bank, has never had as large a market share; and the role of renegade was played by privately and domestically owned Privatbank. Market leaders in the three countries doggedly insisted on protecting their market advantage by refusing to share their consumer data with smaller contenders. Just like Russia’s Sberbank, Ukrainian Privatbank resisted the mandate to share and eventually ended up organizing its own bureau rather than contribute its data to one of the several bureaus organized by several smaller banks, because it detested so much the idea of losing control over its enviable customer database to the rest of the market. In addition, banks also feared that other banks might free ride, that is, try to get information but avoid sharing the information they had: Banks are afraid to give more information than they will be able to receive back. [Our bank] can share information, but it is not clear whether we would be able to get anything back. The idea of a credit bureau is good, but its implementation has been very slow and stalled. It seems that banks after all are not very interested. . . . Credit bureau would become much more realistic of an idea if some organization would take an initiative, for instance, Central Bank. Banks do not want to lead the way, they are afraid of other banks free riding on them. [UB #12.1]

Yet another problem was the reliability and trustworthiness of information. Would banks be required to submit all the information on all of their clients, or would they be able to shield some information strategically, for instance, information involving their VIP clients? Moreover, who would be able to ensure that the information is truthful, and that the banks do not manipulate it to retaliate against certain clients? The problem is that the bureau has to be trusted by banks. How will the bureau guarantee that the information supplied is accurate? That no one

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supplied false information to punish a client, and that the information is comprehensive? For instance, if it is up to the bank to decide whether to submit information or how much to submit, then banks might hide negative information about their VIP clients [as a service to them]. [UB #11.1]

Hiding positive information about the bank’s best clients might be an even more attractive strategy, because those clients would be invisible to other banks competing for them: “The exchange of positive information makes no sense. Banks would have to give away their best clients to their competitors” [UB #4.1]. For these reasons, many of our interviewees argued that the credit bureau had to be created by the state, because only the state, they claimed, was the agent that could effectively mandate and enforce full disclosure of information on the part of all the banks. “Make us share information!” one exasperated interviewee pleaded, suggesting that incentives alone won’t work [UB #3.1]. Another interviewee was also in favor of a state-run credit bureau, arguing that banks would not trust their information to a privately owned bureau whereas “the state knows things anyway” [UB #4.1]. Yet another (Bulgarian) bank also argued that a bureau run by the central bank (and presumably based on a mandatory supply of information) would be better because it would draw in all the banks [BB #2.1]. But this was not a unanimous opinion. For instance, at least two banks argued that a state-run credit bureau would be either too slow and unwieldy or unable to guarantee information security. A private credit bureau would be preferable to a state-run one because a peculiar feature of state organizations is that they are not interested in fast and efficient work. A credit bureau will work well if it has a commercial interest. The state would be slowing down the process of producing credit reports. If the market expands and drives further the demand for credit reports, how would a state-run bureau respond? Where would they get additional funds to hire new people and expand? Will they rely on the state budget? But it is allocated only once a year. Will the banks have to wait until then? But an applicant wants to receive the card quickly. [UB #5.1] It is not clear who will use this information, whether competitors will be able to lure away our clients, whether tax authorities will have access. [The possibility of information leaks could not be ruled out because] Central Bank employees do not have very high salaries. [UB #6.1]

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Banks were rightly concerned about regulating access to clients’ financial information. They themselves guaranteed confidentiality to their clients, but they would be powerless to protect information from unauthorized use once it was passed to a third party. And though a few argued that the state would be in a better position to guarantee information security against third-party breach because of its apparent impartiality, others were concerned about protecting credit bureau data from the state and its coercive agencies. A representative of one bank even suggested that for this reason Ukrainians would rather share information with a foreign bureau than with the one affiliated with the Ukrainian state [UB #8.1]. Debates among Russian lawmakers on alternative credit bureau ­models, which echoed many of these concerns, spilled onto the pages of major ­dailies and now present historical evidence of the contested process of institution building that highlights conflicts between different visions of interbank information exchange. In brief, the Federal Law on Credit Histories,55 which went into effect on June 1, 2005, allowed the establishment of credit bureaus as commercial organizations that can form, process and store the credit histories of individual borrowers, entrepreneurs and firms, as well as provide credit reports and related services (for example, credit scoring). It mandated that starting on September 1, 2005, all credit-granting organizations in Russia should provide information on their borrowers to at least one bureau (conditional upon borrowers’ written consent). Russia’s Central Bank was to establish a central catalogue that would store a copy of every credit history’s title page and information about which bureau contained a full report. The idea was that a prospective lender, or a borrower who wishes to access his own credit history, would first contact the Central Bank catalogue to find out in which bureau the credit history is located. The law specified that credit bureaus could exchange information only with organizations that offer loans or installment credit (therefore, in addition to banks and credit unions, utility companies and mobile phone operators could also be legally involved in information exchange with credit bureaus).56 But credit bureaus were not legally permitted to exchange information with other credit bureaus, a point that some analysts argued to be a downside of the Russian system. After it became clear that multiple commercial credit bureaus were favored over a single public credit registry, the biggest battle focused on the issue of limiting each bureau founder’s share in the bureau’s capital. One of

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the sides to the debate argued to keep it at 10 percent, which would necessitate the cooperation of at least ten founders, most if not all of whom were expected to be banks. Proponents of this measure were well aware of the fact that one of the main barriers to interbank information sharing in Russia was precisely the unwillingness of banks to cooperate, and particularly the resistance of several market leaders, most notably the giant ­Sberbank. Their hope was that the legislation would leave banks (and Sberbank in particular) no other choice but to share information. Their opponents, on the other hand, argued that the 10 percent share limit would unnecessarily limit the number of bureaus, maybe even result in the creation of only a single bureau, a monopoly, because there could be only a limited number of banks interested in investing in such an expensive and long-term ­project.57 They argued that it was more important to provide opportunities for creating numerous bureaus that would compete with each other than to force cooperation between banks. The final version of the law limits each cofounder to a maximum 50 percent share in a bureau’s capital, making it possible for only two partners to organize a bureau. This measure indeed encouraged the creation of many bureaus. By 2012 thirty-two credit bureaus were registered in Russia, but the five largest held 95 percent of the collected credit histories.58 But the law did little to overcome the lack of cooperation between banks—a problem that has plagued Russian banking since the early 1990s. As was predicted, the three leaders of the consumer credit market—Sberbank, Russkiy Standart and Home Credit and Finance Bank—organized their own “pocket” bureaus, satisfying the letter of the law but not its spirit.59 In response to fears commonly expressed by banks that sharing information with other banks would allow the other banks to poach their best customers, current legislation limits what sorts of information about borrowers can be accessed through bureaus by prospective lenders. For instance, prospective lenders can find out only the amounts and repayment of loan applicants’ current and past credits, not about the banks that issued these loans. (Credit histories with complete information are available to borrowers themselves.) Credit bureaus were not an immediate hit: for the next several years following the legislation, Russian banks routinely complained that inquiries were filled too slowly and information was not comprehensive or upto-date, and most banks continued to rely on the tried and true screening

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methods discussed earlier. Nevertheless, credit bureaus may be gaining popularity after all. In just five years they accumulated a combined volume of credit records of forty-five million individual borrowers, which is more than half of the economically active Russian population (estimated at eighty million).60 The director of the National Bureau of Credit Histories reported that each month the bureau receives seven to eight hundred thousand credit histories (down from about one million before the 2008–2009 crisis). Besides information on past loans, credit bureaus now also provide information about borrowers who applied but did not get loans (because they either were rejected or voluntarily withdrew their applications). They also help in verifying applicants’ passport or driver’s license information.61 In Ukraine, three consumer credit bureaus were formed in the few years following the legislation.62 Both Russia and Ukraine make information sharing conditional upon the borrower’s permission. But unlike Russia, Ukraine did not mandate that each bank must sign an agreement with at least one bureau and start supplying information. The decision to start submitting information to a bureau is left entirely to the banks, which raises the question of whether, in the absence of a mandate, Ukrainian banks can overcome their resistance to information sharing and start supplying data to credit bureaus driven purely by market incentives. Another concern is the requirement of explicit agreement by borrowers. Will they agree to have their information shared? On the one hand, if they don’t, banks can simply refuse to lend to them. On the other hand, if Russian banks want to go around the mandate to share information, they can play up borrowers’ reluctance. Because there is no mandate, Ukrainian banks have even fewer reasons to supply information. Credit bureaus understand that this is a barrier. This is why the vice president of the Association of Ukrainian Banks, who was an active participant in the drafting of the current credit bureau legislation and head of one of the bureaus, had this to say: The question of getting borrowers to agree [to have information about them supplied to a credit bureau] is not simple. You know, first of all, it requires participation of the two sides. On one hand, bank personnel aren’t ready to talk to people in a way to entice their consent. I myself applied for a loan in one of the banks and a female employee who was processing my application said, “Antonina Borisovna, [ . . . ] do you want to sign consent to forward information to a bureau of credit histories?” And I replied, “And what for?” and she quickly responded, “Don’t be afraid! Of course, many

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are afraid, especially the lawyers and those that are rich. But you shouldn’t, we are not going to . . . nobody’s really . . . we won’t send in much of that information . . . nothing will happen to you. . . .” When a person hears something like this, he will of course get afraid. So we need to educate our people. They have to understand why the bank needs this consent—it will open a door, a door to all the information, and the consent is the key to this door. On the other hand, we need to work with the client too, so that he also understands what this gives him, that he can go to any bank, that this is his reputation. And of course if we do everything right, many clients will be willing to consent. You know that the client who is applying for a loan is ready to consent to almost anything, if we do our job well.”63

Bulgaria has organized two consumer credit bureaus so far: a public credit bureau, Central Credit Registry (CCR), founded by the Bulgarian National Bank in 1998;64 and a private one organized by Experian.65 CCR initially functioned solely as a data-gathering arm of the National Bank, collecting information primarily for statistical purposes. It started supplying information to lenders in 2006, following the demands of the IMF. Until 2012, it collected information only on loans over 10,000 lev ($6,000); therefore most credit cards were not included. The public registry has collected loan information regardless of the loan amount only since May of 2012.66

sanctioning and responsibility

All the banks we interviewed in East Europe reported zero or very low rates of default. Many praised their conservative lending strategies: “Default rate is very low, we issue to those people we think are reliable, besides almost all of credit lines require collateral, and we only take deposits as collateral. . . . We did not even have situations when we had to transfer funds from deposits to cover expenses, but sometimes clients forget to pay on time” [UB #8.1]. The typical course of action in the case of a missed payment is a phone call “to find out what is going on,” and “how things are,” because “some people simply forget.” If the client does not respond or does not pay, the next stage is a letter from the bank (some banks start charging increased interest rates on accounts that are overdue—as high as twice the standard rate), and finally, if the balance is not paid off in three months, the case is turned over to the security department. Depending on the amount, the bank

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decides what to do next: write off the loss if the debt is small; go to court, which may be expensive and is definitely time-consuming; or try to resort to the services of “tough boys”—informal debt collectors. One bank reported that they “worked with a client for two years, and then the client did not pay, sold everything and left abroad, and we could not find this person. The bank had to find . . . with the help of our security department . . . they use their own methods . . . this person’s relatives, and he ended up paying later” [UB #7.1]. A Bulgarian bank had a similar procedure but stopped short of sending informal debt collectors: “We chase the customer forever. First, we call; if he or she continues [not to pay], we send a letter, and then we send a lawyer” [BB #4.1]. Notably, in their case, the sequence kicks in even if the customer is only one day late in payment. Here is how one Ukrainian bank responded to the question of what happens when the client does not pay and what the bank can potentially do: We have not appealed to courts about unpaid credits, but with unsanctioned overdrafts we did. We had no more than twenty court cases concerning such defaults since 1998. Interviewer: How long does the court proceeding take? A very long time. About one year to get a decision . . . the accused party does not show up, the session is rescheduled, then they can appeal. . . . Interviewer: Does it make financial sense to the bank to appeal to courts? If we are talking about significant sums. At least $300–500. [UB #10.1]

Here is how a second bank responded: We have one case currently pending in the court system; it is a default. The first meeting was cancelled because the debtor did not show up. We are waiting for the second and the third, after which the judge will make a decision even if the debtor does not come. It might not make any economic sense to appeal to court, but this will teach the lesson to all other borrowers. It is not very expensive but time and energy consuming. It can take around six months. [UB #3.1]

Some banks emphasized that they would go to court only in the case of outright fraud, hoping that the customer who is late with payments will be willing to renegotiate the terms of repayment. For instance, a medium-size Ukrainian bank with a large card program reported that about 5 percent of credit cardholders experience late payments, but these are people who

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forgot to pay and when they are reminded they usually do. The bank had not gone to court in connection with unpaid balances, only in cases of fraud. Formally, the responsibility for a default is collective, and the bank officer who made the decision to issue a card that later led to a default is typically not required to compensate the bank. But a few of our respondents said this bank officer is expected to track the defaulter personally, to negotiate and make the defaulter pay. One of our respondents claimed that the management in a few Ukrainian banks would subtract the size of the default from the salary of the credit officer who gave the positive recommendation to issue the card. In one bank we were assured that personal financial responsibility by the branch manager was the “magic bullet” that helped the bank reduce defaults: “The bank used to have lots of defaults. Now heads of branches are financially responsible for defaults. They lose their personal income, the head office places a lower limit on their decision-making authority, and finally they can even be fired” [UB #13.1]. In another bank, we were informed that a credit officer with more than 4 percent defaults in a year would be fired without question. We never encountered this direct accountability of loan officers in Central Europe. In fact, in many banks, the separation of sales and risk management construed bad lending as a technical problem to be solved by the risk people, who should expect sales to be overly lenient. Even though there are companies that specialize in collecting unpaid debts, most East European banks claimed that their own security departments worked with late or nonpayers. Some reported using the court system but, as we have illustrated, most noted that this process was drawn out and would only be worth it to recover losses above a certain level or as a symbolic measure to warn potential defaulters. A representative of only one bank claimed that this bank took all cases of defaults to court and had decisions rendered quickly, usually within a month. (Other banks mentioned the special ties that this bank had to the Ukrainian court system, which must have assured quick and successful processing of its claims.) Ukraine has not legislated personal bankruptcy yet (neither has Bulgaria), but it has been intently following attempts to legislate it in Russia, where the Parliament passed a bill in its first reading in November 2012.67 It could be in effect in 2014. In the absence of such a law, lenders charge defaulted borrowers predatory interest rates and in principle can go after them indefinitely. Large lenders tend to rely on their own security in tracking the defaulters, while medium-size banks have been increasingly transferring

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or selling defaulted accounts to credit collection companies that have been springing up across East Europe. Credit collection is not regulated, and consumer protection advocates have been crying foul over potential abuses of borrowers’ constitutional rights.

Conclusion From the standpoint of the credit card as a means of payment, East European bankers were faced with the challenge of simultaneously recruiting cardholders and merchants. Their solution was coercive salary projects, particularly those blessed by the postcommunist states, which made millions of their employees and welfare benefit recipients available to banks as potential holders of salary and benefits cards. But salary cards turned out to be powerless in replacing cash. Instead of treating their cards as payment mechanisms, holders of salary cards stubbornly used them for cash withdrawals. Despite the growing number of cards in circulation and the expanding volume of card transactions, noncash payments as a percentage of the total volume of card transactions has not changed in these countries in almost ten years. Banks are trying hard to get people to use cards in stores: card purchases are free for cardholders whereas card withdrawals often are not (unless it is a salary card used to withdraw cash from the bank’s own ATM). Card acceptance is far from being universal, however, and it is better in larger cities, in larger and more expensive stores and in hotels and travel agencies. In part, banks are to blame: their eagerness to market cards via salary projects has not been matched by the development of the card acceptance network. Merchants have actively resisted too: even those places that do accept cards sometimes claim that their card terminals are not working, or they are taking a long time to process card payments, signaling to the cardholders that the next time they had better use cash. Merchants resist because of what they claim are high merchant discounts, but also because a portion of their turnover is conducted unofficially and in cash in order to minimize taxes and free resources for extralegal payments to state officials. Card acceptance and the traceability of electronic transfers would threaten this established way of conducting business. It seems that the only way to fight this resistance is by mandating card acceptance. Fifteen years ago, East European bankers hoped that using a

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salary project to coerce individuals to carry cards would help jumpstart the market. But it turned out that coerced card ownership was not enough. Now it is the merchants’ turn. The Ukrainian state already mandates card acceptance by all retailers. The Russian and Bulgarian states are hoping to follow suit shortly as well. Far from being interested in helping the card market per se (though banking associations have been lobbying their states to get involved), the states are taking aim at the “gray” economy, hoping that card acceptance will reduce unofficial transactions in retail and increase tax revenues. It is not clear how this would be achieved because, besides lowering the tax burden for companies and employees, unofficial cash is also used to bribe state officials, a phenomenon of staggering proportions in Russia,68 but not a trivial matter in either Ukraine or Bulgaria. The three countries differ significantly in whether they are dominated by international cards or provide any space for domestic brands. Multiple factors are at play here. The most obvious factor is the size of the market. Large countries like Russia are naturally more attracted than smaller ones like Bulgaria to the idea of developing a national payment system based on a domestic brand. But the size of the country is not sufficient to bring forth a national payment system if the state does not have the resolve and the resources to do so. The Russian state of the 1990s was not able to do this despite appeals by card professionals and several attempts to unite incompatible domestic brands, but since 2000, now that the Russian state is much more powerful and flush with petrodollars, it may finally be able to bring this goal to fruition. The early success of the Bulgarian domestic credit card brand Borica (the small size of the country notwithstanding) attests both to the key role of the state and to the card’s opportune timing (early in the game, with still no serious domestic brand competitors), but its decline is a tribute to the power of foreign capital and greater global integration within the European Union to favor international brands. When the state does not take charge, the multinationals may clean out domestic brands, particularly if the card markets are also fractured by the battle between the large postcommunist savings bank and a coalition of smaller private banks. The governments of small countries can resist the onslaught of multinationals, but strong states of larger countries can do so more successfully. Perhaps had Bulgaria been a larger market, the Borica brand may have proven more resilient. It is possible that the new EU card framework, SCF, is giving a new lease on life to Borica.

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Wrong timing is what may in the end prevent Ukraine from transforming NSMEP cards from a niche product into a truly national brand. Ukraine was too late in introducing NSMEP, which now has to fight the uphill battle against the overwhelmingly dominant international brands. Timing is also what makes the present task of the Russian state more difficult than it would have been before 2003, when international brands did not yet hold an advantage over domestic brands. But “more difficult” does not mean “impossible.” If Russia is successful, it will signal that a strong and resource-rich state at the helm of a large country can steer it away from any paths previously traveled. Unofficial economic transactions not only stall card acceptance among retailers but also undermine the spread of consumer credit (and credit cards). Individuals with unofficial cash salaries appear more income poor (and thus appear less desirable as borrowers and as holders of credit cards) than they really are in the eyes of the banks. Although most banks have recognized this and have devised methods to evaluate prospective borrowers, including card applicants, some of these methods appear outright dangerous—for instance, using consumption and lifestyle as a proxy for income, which is difficult to confirm because of “gray wages.” But consumption in a postcommunist society is not protected by accumulated wealth as is the case in more affluent societies, and it cannot serve as a reliable indicator of an applicant’s socioeconomic position. Consumption patterns may reflect conspicuous consumption, which is particularly common in societies that lack other markers of distinction besides brands and labels. If consumption is used as a sign of a person’s socioeconomic status, it can be easily forged and manipulated to deceive lenders. Credit reporting was finally legislated in Russia, Ukraine and Bulgaria in 2004–2005, after more than ten years of debates about what form it should take, who should participate and on what grounds, and who should pay for it. The major lesson from this period is that large banks that managed to accumulate a disproportionate amount of data tend to resist information sharing with their smaller competitors to the bitter end. With the exception of Ukraine, these bastions of resistance were former socialist retail banks underscoring the lasting legacy of the socialist monobank system. A usual refrain in this case is coercion. It was a common theme in our interviews in the three countries that the banks expected the state to march in and mandate information sharing. Only under pressure were the retail banking leaders expected to comply.

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In the case of at least three problems of emerging credit card markets— the problem of simultaneous recruitment of cardholders and merchants, the problem of standardization and the problem of information sharing—card issuers have appeared to be powerless in solving them: they are either defeated by the resistance of salary cardholders to using cards for retail payment and by the refusal of merchants to accept cards, or they are paralyzed by the inability of the banking community to control competitive tendencies in favor of greater cooperation over standards and information. The markets have not given rise to efficient solutions, and have had to wait for the states to make market participation mandatory for merchants and enforce the rules of information sharing. Establishing national payment systems in Russia and Ukraine when the markets are already dominated by international card brands is a Herculean task, and will be a test of the state’s ability to shape and direct market trajectories.

seven

Vietnam and China

In the previous two chapters, we have shown that self-interested market actors cannot solve the fundamental puzzles of card markets, and outside intervention is needed. In Central and East Europe, the state and multi­ national monopolies played leading roles in tackling the puzzles, though their success varied. Turning to two Asian postcommunist countries, Vietnam and China, we encounter communist states that, unlike those in Central and East Europe, did not relinquish power and managed to keep multinationals at arm’s length. In both countries, the plot unfolded in two acts—the first before and the second after they joined the World Trade Organization. They followed different trajectories and these led to different outcomes. The Vietnamese state let its banks take the lead and got involved in the card market only in a supporting role. Beijing, on the other hand, took the director’s chair. These differences are largely a consequence of the two states’ divergent histories and the countries’ different “weights” in the global economy. In China, the commu203

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nist state has been in power since 1949. Although its first generation of Communist revolutionaries was mostly gone by 1993, the Chinese state continued to pursue its policy of closely regulating the political and social spheres, and keeping tabs on the economy while carrying out market reforms. China’s size allowed it to dictate precisely how much global integration was desirable and in what form. For example, though China has generally been open to foreign direct investment, its banking remains one of the least liberalized industries, dominated by several large domestic state-owned banks that frequently act as an extension of the state.1 Vietnam’s situation, on the other hand, was overshadowed by its past and by the country’s much more modest size. Vietnam carries a legacy of being a nation divided between the freewheeling capitalistleaning South and the buttoned-up communist North. It was formally reunified in 1976 after the end of the war with the United States, but national unity remained a delicate balancing act. In addition, Vietnam remained largely a political outcast in the Western developed world until the 1990s due to the U.S. embargo imposed on the country following the conclusion of the Vietnam War. As a result, political elites remained deeply divided over globalization, so much so that the fate of Vietnam’s WTO membership was in limbo until 2005, when the top leadership, with some prodding from China, finally decided to make the political commitment.2

Vietnam Vietnam looked to the future during a 30th anniversary celebration of its victory over America yesterday, with a parade in which capitalist banks were more prominent than communist tanks. In a sign of the country’s changing priorities, there was no military display of firepower. Instead, many of this year’s floats were commercially sponsored. The biggest cheer was for a giant cash machine, topped by a revolving globe and flanked by a bevy of young women in green uniforms. Several floats were sponsored by local financial institutions—at least two featured the logo of a US credit card, and another showed women pushing heavily laden trolleys through a supermarket. For today’s Vietnamese, liberation now means owning a mobile phone and a moped. j o n at h a n wat t s , t h e o b s e rv e r , a p r i l 3 0 , 2 0 0 5 3

Retail banking in Vietnam got off to a difficult start haunted by the country’s recent history. If the war and the tanks had faded into the past by 2005, their aftermath was casting a long shadow. As a reminder of hyper-

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inflation in the 1980s, even cheap everyday items in the stores of Hanoi and Ho Chi Minh City (formerly known as Saigon) cost tens or hundreds of thousands of dongs and one still cannot buy a pair of US blue jeans unless one is a dong millionaire. Inflation—along with account confiscations in 1975 and various scams and scandals in the last two and a half decades, including the collapse of hundreds of credit cooperatives in 1991–1992— eroded the little trust that people had in the Vietnamese banking system.4 That perpetrators were severely punished, some of them by death, did not reassure the public. In fact, both the troubles and the retribution revealed that the central government was not fully in control of the financial institutions and was unable to prevent crooked bankers from misappropriating deposits. The outsized punishment was an acknowledgement that the only effective tool the state possessed to protect depositors was a massive retribution meted out after the harm was done. It could arguably work as deterrence, but the government was not equipped to step in before large damage was done. The reason that the key issue for the bank card market was not trust in people by banks but trust in the banking system by ordinary people was that payment cards, almost without exception, required a deposit account. The deposit account reassured the banks but made people apprehensive. Due to this deep, popular distrust, as late as 2009, only 17 percent of the population had a bank account.5 The situation in the countryside was markedly worse than in the cities. With more than 70 percent of Vietnamese living in rural areas, building the card infrastructure posed special challenges. Phone service was abysmal until 2005, when mobile communications began to take off. Paved roads were rare. The bank best positioned to serve this market, the Vietnam Bank for Agricultural and Rural Development (Agribank), was preoccupied with promoting agricultural development and directly addressing poverty. To get the card market off the ground, lack of trust and poor infrastructure had to be addressed simultaneously. As one of the pioneers of payment cards working for the Vietnamese branch of a large multinational bank observed, First, establishing infrastructure for . . . —let’s step back first. Why is a large chunk of transactions outside of this banking system? One very key factor is the lack of trust and if you have to address—you have to address right at the roots of this—it’s got to be a multipronged approach—you cannot just keep addressing this; you’ve also got to add infrastructure in to facilitate those transactions. [VB #5.1]

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payment puzzles

Just as in most of the countries in this study, the first payment cards were brought to Vietnam by foreign tourists. The number of shops that accepted cards was initially very limited. In 1990, foreigners could use their Visa cards in no more than twelve stores in Ho Chi Minh City. With Vietnam still under US embargo, the logistics were handled by Vietcombank in collaboration with a French bank that acted as the bridge to Visa International. ­Vietcombank, like Poland’s Pekao, was in charge of handling remittances from abroad and, by extension, managed the foreign currency accounts of Vietnamese citizens. It was thus the logical choice to provide the services tourists needed. Vietcombank had grown to be the largest and most innovative retail bank in the country, and by 2004 it controlled 95 percent of the urban card market. Encouraged by its initial exposure to the world of payment cards, it attempted to issue its own cards in 1993, but only a few hundred of them were taken by consumers, mainly by foreigners living in Vietnam. Only in 1994, after the U.S. embargo was lifted, did Vietnamese banks begin to join the international finance community. By then the Vietnamese banking system was dominated by four large state-owned commercial banks (SOCBs)—the Bank of Foreign Trade (Vietcombank), the Industrial and Commercial Bank (Vietinbank), the Bank of Investment and Development (BIDV) and the Bank for Agricultural and Rural Development (Agribank)—which held more than 80 percent of all the country’s banking assets; the rest were shared by joint stock banks, which issued shares mostly to state-owned enterprises and banks, a few joint-venture banks with some foreign ownership, small credit cooperatives and branches of foreign banks. In 1995, the Banking Modernization Project financed by the World Bank aimed to create a modern payment system with the payment card as an integral part. That year, four Vietnamese banks enrolled in the MasterCard network, and a year later they founded the Vietnam Bank Card Association (VBCA). Vietcombank issued the first MasterCard in Vietnam in 1996, followed by a joint stock bank, Asia Commercial Bank (ACB), its main competitor.6 ACB launched its own Visa card in 1997, and Vietcombank followed suit a year later. Until 2002, most cards were ATM cards. In June 2002 there were only 111 ATMs in the entire country, most of them in Hanoi and Ho Chi Minh City. Each bank that issued cards had its own machines. The ATM, a device developed in the United States to save on labor costs, made little sense in a

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country where cheap yet literate labor had been abundant. In 2002, a new ATM cost about US$30,000. The bank also had to pay a charge of $2,000 to $6,000 a year for renting the location. The machines then needed constant care and expensive foreign parts and were vulnerable to abuse of all kinds. ATM yearly maintenance in 2011 was around $24,000—equal to the annual wages of twenty tellers.7 Recall the sentiment of one of our Ukrainian respondents quoted in Chapter 6 that perfectly illustrates this dilemma (the Ukrainian banker was referring to the prospect of buying a scoring model to assist in consumer lending): “It is cheaper to hire ten people to dig a trench than to buy one excavator.” On the other hand, given the anxieties that the Vietnamese had about banks, providing customers with full access to their money—around the clock, seven days a week—was necessary to persuade them that banks were safe. For holders of payment cards, ATMs were central because, just as in the other countries we have discussed, few people paid with cards and instead used their plastic just to withdraw money. Those cardholders who were willing to dispense with the anonymity of cash ran up against the problem that even by the end of 2003 only nine thousand shops in Vietnam accepted payment cards, and a large number of them were expensive hotels and restaurants where only foreign tourists would go. These merchants accepted mostly international cards. The domestic card system in Vietnam, similar to those in the other countries we discussed, was fragmented among several competitive and often not interoperable brands, each of which came with its own system of rules and POS terminals. Installing several POS machines and working with multiple acquirers to get reimbursed for the purchases was an unattractive proposition for the merchants. They also resented the 3 percent merchant discount. If merchants decided to accept payment cards, they often added the 3 percent to the purchase price as a surcharge, which was against the law, as card contracts have spelled out to both merchants and cardholders. But banks never could enforce this rule. Had they tried, they would have found even fewer stores willing to sign up. As in most card markets, the intent of the no-surcharge rule was to spread the extra cost of card usage across all customers—both cash and card users. As this rule went unheeded, the entire cost of the merchant discount fell on cardholders, making cards even less attractive to them. The first cardholders were well-placed civil servants and people working for foreign companies and joint ventures in Hanoi or Ho Chi Minh City,

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but increasingly employees of stable companies joined the ranks as banks promoted the salary projects that were popular in East and Central Europe and enrolled enterprises to deposit their workers’ salaries with them. Interviewer: Are there new market segments that you are especially interested in? At present we are concentrating on the people working in companies. We also look for some of the rural areas too. Interviewer: When you say “companies,” these are big companies, right? Big or small companies, it’s OK because they have to transfer the money first and then we put it into the account. [ . . . ] We don’t care whether they have business with us or not. We want to do all the marketing to all. Whenever they want to do payments of the salary of the staff through the card, then they have to open the account with us. [VB #4.1]

This small joint-stock bank did not care if it had any other relationship with a company, but in many cases banks did handle the company’s payroll or the entirety of its finances. Banks also tried to target other segments of the new middle class: For debit card, we focus on students and housewives because it’s very popular. The minimum you deposit in our account may be a little, . . . we focus on some companies, some universities . . . some students study away from home so the parents have to send money for them to support them, for study, for living, and everything. . . . That’s why they have to . . . send money to the children in some other way. It is received by debit card by the students . . . it will be security for the money. Sometimes their parents also control what the children do with this money. [VB #3.1]

This bank’s focus on the new upper middle class families where the wife is at home and the children are in college far away seemed fanciful in 2004. They were—and still are—a very thin elite layer. Most banks were eyeing a wider market. They took aim at so-called “social classes A, B and C,” as they were referred to by marketing firms employed by Visa and MasterCard for the Asian region. These were households with estimated incomes over $250 a month, above the poor classes of D and E. Many banks considered the ATM and debit card to be the “first step” toward other services, including savings accounts, car loans, mortgages, and credit cards. A gateway product to retail banking, bankcards were an investment in building a clientele, an expense to be recouped later with other services. But despite all the efforts, the cards were unpopular in

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Vietnam and, by 2002, even the number of personal bank accounts began to decline. A few of the banks realized that part of the problem was lack of cooperation between card issuers, and they set out to unite their efforts in promoting cards. In March 2002, three of the four large SOCBs, together with ACB, reached an agreement on a national card network. (The fourth SOCB, BIDV, opted out and started negotiations on a separate system with two large foreign banks, the British HSBC and ANZ, a bank headquartered in Australia.) Yet, by late summer of 2002, the national card network agreement was broken off as the two largest banks and the two main competitors, Vietcombank and ACB, split from the group and started a network together. At the same time, a consortium of ten smaller, joint stock banks began negotiations about a card network and invited Vietcombank. When Vietcombank found out that it would get only an equal share in the consortium, it walked out of the negotiations. Similar to former socialist retail giants in other countries we discuss in this book, Vietcombank had 50 percent of the credit market and 70 percent of the debit card market in Vietnam. It also owned 160 of the 220 ATMs in the country, and it surely considered itself exceptional. Eventually, Vietcombank created its own network, called Smartlink, enrolling seventeen joint stock banks, but not ACB. By 2009 there were three more networks. Banknetvn was founded by Vietnam’s central bank, the State Bank of Vietnam or SBV. It signed up ACB along with all the other SOCBs and several other banks. In addition to Smartlink and Banknetvn, there was also a card alliance called the Vietnam Bank Card that united six financial institutions, including China’s UnionPay. Finally, there was a card association between Sacombank and ANZ. In 2007, SBV noted that “the lack of association between banks in card service caused quite a few discomforts to users”8 and issued a decision to unify the four networks under the umbrella of Banknetvn.9 The process did not start until 2008, when the two largest networks, Banknetvn and Smartlink, connected; and all ATMs were integrated only in 2010, at the last moment before Vietnam opened its banking to foreign competition, as it was required to do by its membership in the WTO. The linking of POS terminals followed months later. In fact, 2007, when Vietnam joined the WTO, was a year of feverish lawmaking designed to shore up the Vietnamese payment system and to give a boost to the bank card market. The country had three years before the

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gradually introduced WTO rules reached its financial services. The most important law the government passed that year required all state institutions to pay salaries through a bank account.10 As a consequence, by the end of 2007, the number of bank cards jumped from 3.5 million the year before to 8.3 million, and it reached 14 million the next year. By 2010, the number of cards grew to 30 million as more and more state companies and agencies complied with the law. Yet even three years after the law took effect, almost half of the state agencies still paid their workers in cash.11 Without a nudge from the state, private employers trailed even further behind. Nevertheless, since 2007, not only has the card market grown but its shape has changed considerably. By 2010, Vietcombank was no longer the largest card issuer. This title was taken over by the state-owned Agribank, the biggest bank in the country. Agribank took advantage of its wide network of branches in the countryside, which with recent improvements in telecommunication technology it could now integrate. It was followed by Vietinbank, the second largest bank, also state owned. Vietinbank used its ties to large state companies to enroll their workers and charge ahead of Vietcombank, which was now only a close third in terms of number of cards issued.12 The great expansion of ATM and debit cards, however, was costly for the banks and in 2008 the VBCA requested that the SBV approve an ATM fee. The proposal created a large popular uproar and was shelved. Bleeding money, the banks started to neglect their machines. The ATMs were often out of service and, not surprisingly, as the VBCA reported in 2011 with dismay, about half of the bank cards were unused. According to the VBCA, the cards remained inactive because many banks managed their card service as a means of grabbing customers or “promoting their brands,” paying no attention to the quality and efficiency of the card service itself. Banks also viewed the cards as a way to raise funds through the required minimum deposit.13 The various fees that were tacked on to every card transaction—except for money withdrawals under a certain amount from the bank’s own ATM—did not make cards more popular either. Therefore, the increase in the number of issued cards did not solve the main underlying problem—the problem that two-sided markets pose—that more cards did not bring in more merchants to start a virtuous cycle; in fact, more cards just made the banks’ losses bigger. They lost money on cards in the early years too, but those losses were small because the market was small then. Now that the market was larger and they had to invest in

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more ATMs and more POS terminals, and to issue and administer more cards, their losses ballooned. Cards were still seldom used as a means of payment. Cash continued to be king in Vietnam as it was in Russia and Ukraine. According to the SBV, 80 to 85 percent of consumer transactions in 2010 were in cash whereas only 5 percent were settled by plastic.14 The number of POS terminals per card was about one third of those in Hungary, and most of them were concentrated in the two biggest cities. In the countryside, POS terminals were hard to find except in some post offices. Moreover, even if a shop had a POS terminal, up to 29 percent of the transactions did not go through, depending on the network; Banknetvn, the largest network, had the worst rate of completion.15 And even when a payment was successful, there was the illegal surcharge to pay for using a card and not cash. It made sense for consumers to take money from a nearby ATM and bring the bundle of banknotes to the store, even if they had to pay a fee for the withdrawal, because that fee rarely amounted to more than 1 percent. And merchants preferred cash anyway because they wanted to avoid taxes. In 2012, banks began to streamline their ATM operations. They removed machines in low-use areas, consolidated ATMs in groups of three or four to cut down on rental and service costs, increased their reliance on interbank cooperation, letting the ATMs of other banks service their clientele.16 The latter change allowed everyone to collect ATM fees when they were not serving their own customers. Banks also raised other fees.17 By 2011, there were three cards for each one hundred Vietnamese residents. With a strong hand from the Vietnamese government, the Vietnamese banks were successful in turning a large portion of the population into cardholders, supplying one side of the two-sided market. But just as in East Europe, coercion did not get the banks far: cardholders resisted using their cards as a payment device, and with merchants being reluctant from the outset, a vicious cycle emerged. Because few people paid with cards, merchants were even more reluctant to sign up for a POS terminal, and even if they did, they insisted on charging the card-paying customers more to cover their merchant discount, which made consumers even less likely to pay with cards, which in turn rendered merchants even less enthusiastic about accepting cards for payment. A two-sided market must be built from both sides, otherwise, as the low usage of cards shows, even the side that was successfully pushed will atrophy. The expensive ATMs were unprofitable, and as banks began to neglect them, people began to close their bank accounts and give up their ATM cards.

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credit puzzles

Because the two-sided market is unbalanced in Vietnam and cards are not used for payment, launching a card that supplies credit is especially difficult. In principle, one can imagine a situation in which people would access credit as cash and use their credit cards as ATM cards, except they would draw against a credit line rather than an account with money in it. This situation would divorce the payment and the credit functions of the card. Although it is certainly a possibility, it would be very expensive for the banks because it would cut out an important source of the bank’s revenues—the merchant discount. This is why banks typically charge extra for cash advances on credit cards and, as we have seen in Central Europe, try to educate their customers not to do it. Even in 2012, the vast majority of the bankcards in Vietnam were ATM and debit cards and real credit cards were few and far between. In 2004, Vietcombank, then the largest issuer of cards, had half a million cards in people’s pockets, and one tenth of them were credit cards, mainly carried by the elite. They were real credit cards with revolving credit, but to get one, a person had to deposit 120 percent of the credit line. This made little sense to most customers, except those who planned to use the card abroad. In a foreign country, the credit card provided an extra sense of security. Even if the money in their current account was low, travelers could count on their credit line—essentially, on the money they had set aside as a security deposit. Three out of four of the owners of these credit cards were traveling businesspeople and students studying abroad. Some banks offered debit cards with overdraft possibilities. One example was a small bank headquartered in Ho Chi Minh City. To get a debit card, one had to open a deposit account and maintain a minimum balance of 50,000 dongs. To receive overdraft privileges, one had to file a second application. Interviewer: What do I have to do? Suppose I have a card and I want to get the overdraft. What do I have to do? You must . . . have collateral or you are working for a company that guarantees your payment. Interviewer: So the company can actually guarantee. . . . Yes—it depends on the company but, say, for example, your company pays the salary . . . through the card. You sign the contract with us for transferring the money from the company to the cards of the employees. Then in that case we don’t need the collateral. Maybe for some companies which are

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the regular customers of the bank we know the . . . company very well so we don’t ask for any guarantee from the company. It depends—we have different flexible policies. . . . Interviewer: And if I’m self-employed . . . not working for a company. . . . We ask for collateral. [VB #4.1]

The collateral could be a house or a vehicle, in which case the maximum overdraft allowed would be 70 to 80 percent of the value of the property. If it was a deposit account, it could be 100 percent. The maximum overdraft allowed at this bank was 50 million dongs—more than twice the annual income of an average urban Vietnamese. For employees the limit was tied to the ­salary. Yet for people without a company willing to vouch for them, the collateral itself was not enough from the bank’s standpoint. If things went wrong, the bank had to find the borrower to collect on an unpaid balance. Thus the applicant had to provide a certificate from the local residential committee to prove his address. The bank could also call the local police to find out about the applicant. Importantly, once the application began, the case was handed over from the card specialists, who were interested in expanding the clientele, to the credit department, whose job was to hold the line on defaults. The credit department met the applicant in person, verified some of the information he provided, made a personal judgment about his character and arrived at a decision—hardly a scenario sustainable in a mass consumer market. A few nonsecured cards were given by ACB to its VIP customers with a long record at the bank, but the market for real credit cards has failed to take off. In 2009, less than 1 percent of all cards issued in Vietnam were credit cards, and in 2011 the number was less than 3 percent, or under a million. Most of the credit cards bore an international logo, while the overwhelming majority of the debit cards were domestic. For some banks, consumer credit grew out of business lending. To get an auto loan or a mortgage, people had to present a written plan of payment, similar to a business plan. Interviewer: How about consumer loans like car loans and mortgage loans? Where there is no business—I am buying the house for myself, the car for myself. Even for the consumer loan you must have a plan—you show us how you can get money to cover the loan. So it is not based on the monthly salary or something like this. So it’s not enough to write on a form that my monthly income is 400,000. [VB #3.1]

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This model did not work very well for credit card loans. The size of such loans can vary day to day, and the purchase is not specified in advance, leading banks back to security deposits. There were a few exceptions to the general rules of creditworthiness. VIPs and bank employees could get a loan in some banks without a payment plan or collateral.

Information Sharing Banks could ease the need for collateral if they had a credit registry that would help them screen applicants and punish nonpayers. Information sharing in Vietnam should have been a simple affair, because the big banks were owned by the state. Indeed, after credit cooperatives were decimated in 1991–1992, the SBV established the Credit Information Center (CIC) as part of its credit department, and the CIC became independent in 1999. Created primarily for registering corporate credit, CIC kept track of larger loans given to companies as well as to individual entrepreneurs and farmers. In 2004, one bank manager explained the following: [For] individuals we don’t have [information sharing]. . . . Say . . . I work for another bank, but we are friends so you share with me the information, but we don’t have any official or government information system. But from time to time, the state bank has issued something like letters to banks to make a report about a certain customer. In the letter, the state bank may mention that recently this customer XYZ has committed a fraud with some bank in Ho Chi Minh City so all the banks in Vietnam have to report whether the bank has got such customer and what their operations are—or if the bank has found anything suspicious, or something about this customer, please ­report to the state bank. [VB #4.1]

Bankers did communicate informally about problem cases, but they found out about bad borrowers from the CIC only indirectly, when the SBV received a complaint and decided to investigate to find other victims. Information sharing did not make much progress until 2007, for three reasons. First, as long as most retail loans were secured by collateral, the need for exchanging data on applicants was less urgent. Second, when Vietcombank dominated the market, Vietnam ran up against the same problem as the other countries: the large player was uninterested in giving away information. The central government did not order the banks to start sharing until WTO accession forced its hand. Third, the Vietnamese state did not have the capac-

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ity or the inclination to play a proactive role in building credit markets. Its involvement has been mostly reactive, stepping in to put out fires. The main influence on information sharing came from the International Finance Corporation (IFC). Part of the World Bank, the IFC had been promoting the idea of private credit bureaus in Vietnam since 2005, but it made little headway until 2007. Once Vietnam joined the WTO, however, it could not ignore the IFC anymore. Seeing the writing on the wall, SBV began to build up CIC rapidly into a well-functioning public registry: the SBV annual reports claim that in 2009 the public registry contained credit files on 9.2 percent of adults, and in 2010 this number grew to 19 percent. CIC covered more than a quarter of all adults in 2011.18 Meanwhile, SBV started an unhurried process of deliberation on the legalization of private registries. Preparing the government decree took three years, and the new law stipulated that a private registry had to sign up at least twenty commercial banks, whereas each bank could supply information to only one registry.19 Given the total number of commercial banks, the decree allowed for a maximum of only two registries. The first registry was formed by eleven banks; they created a consortium called the PCB Investment Joint Stock Company in November 2007, but they could not get the bureau licensed until 2013. The founders included three of the four largest state-owned banks, the important exception being Agribank, the largest card issuer by 2010. Thus the first private credit bureau is owned primarily by state-owned commercial banks that dominate the registry. The manager of the databank is CRIF, an Italian company that also runs credit reporting in the Czech and Slovak Republics.

China “The establishment of UnionPay stands for the formation of a new industrial system—“joint stipulation of rules, joint popularization of business, joint expansion of market and joint standardization of orders.” u n i o n p a y c o r p o r a t e w e b s i t e 20

In China, just as in Vietnam, the banking system has been dominated by a few state-owned commercial banks created from divisions of the central bank, called People’s Bank of China (PBC). In 2000, the four large SOCBs—

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the Bank of China (BoC), the Agricultural Bank of China, the China Construction Bank, and the Industrial and Commercial Bank of China—had 71 percent of all deposits and 65 percent of all loans in China.21 Yet these four banks did not have the independence that their counterparts in Vietnam enjoyed. The state kept them on a tight leash. The first bank cards issued in China were issued in 1985 by the BoC, initially in the newly created coastal special economic zones. The Bank of China Card, later renamed the Great Wall Card, was originally a charge card with a security deposit.22 As in East and Central Europe, poor infrastructure at the time made it impossible to settle transactions quickly. Short-term credit was therefore unavoidable, yet barely tolerated. As a result, cards came secured and cardholders were required to pay off debt quickly. Two years later, BoC joined the two large international associations (Visa and MasterCard), and in 1988 it issued its Great Wall MasterCard, which could be used abroad. BoC was soon followed by the other three large SOCBs. The Industrial and Commercial Bank of China came out with its Peony Card, the China Construction Bank with the Dragon Card, and the Agricultural Bank of China issued its Jin Sui Card. However, these cards did not catch on as payment devices and remained only status symbols, because at the time only a few hotels and large department stores accepted them. Cards were often incompatible with the ATMs and POSs of other banks, and even the same bank could not easily process cards from its own branch located in a different city. By 1995, just fourteen million cards were in circulation in a country of more than one billion people, and the vast majority of those were charge cards.

payment puzzles

Problem of Demand Customers don’t need the cards; second, they don’t want to pay yearly fees; and they don’t understand that a credit card is a credit product. chinese bank card manager, 2004

Building a card system in such a vast country has been a particularly formidable task. Working in a large geographic area, the builders of the card infrastructure had to overcome multiple obstacles, including lack of phone

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lines, and the fact that there was neither sufficient professional knowledge nor an established culture of banking and formal borrowing in China. The Chinese government took a proactive role in market creation, although not until 2002 did it switch into full gear. First, it experimented with technology. In the early 1990s, the government decided to set up a bank card network service and built a national bank card network system center in twelve cities with the aim of linking all the banks electronically.23 Then the state got involved by making its employees available to banks as potential cardholders. Rather than getting customers themselves to apply for cards to be used as a convenient way to make purchases, banks issued a large number of cards to workers at various companies and organizations via salary projects, to be used both as an instrument for direct deposit of wages and for employee ID purposes.24 Just as in Vietnam and elsewhere, the workplace became the primary vehicle for card issuing and use in China, even though, due to the structure of the Chinese economy and society, a markedly smaller percentage of China’s population, compared to Europe’s, was urban and employed at large industrial enterprises. Therefore, salary projects did not penetrate the market as deeply in China as they did in former Soviet-type command economies.25 In 1995 the card market began to grow more rapidly, and charge cards were overtaken by debit cards, which proved to be much more popular, because they posed less risk for banks and were cheaper. The state was also working to increase card use more indirectly through state-run enterprises and government workplaces. Despite the seeming success of salary projects in distributing cards, cash continued to rule, both as a nod to a long-standing tradition and as a reaction to the lack of a widespread card-accepting network. In 2002, 97 percent of all consumer purchases were made with cash.26 Workers were coerced to carry cards, but just as in East and Central Europe and Vietnam, most used them for cash withdrawals, not to pay directly for purchases.27 Chinese cardholders often simply did not use their cards; a significant proportion of those issued were never activated. One reason for the large number of dormant cards was that despite the fact that banking and particularly retail banking was concentrated in the four largest state-owned banks, the financial services sector was very segmented in China. Most cards could be used only at branches of the issuing bank because the different issuers could not agree on common standards and conditions. The market was also segmented on the merchants’ end. Similar to

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what one would see in Russia and elsewhere in the 1990s, in China, as late as 2003, big stores that accepted cards had several POS terminals, each connected to a different network, sitting side-by-side on their retail counters. This situation was emblematic of the lack of standardization in the card market: different terminals accepted different kinds of cards because the competitive banks that issued or processed them could not agree on shared numerical codes. In China as in East and Central Europe, the social legacy of retail banking concentration was partly to blame because large socialistera state-owned banks refused to cooperate with smaller newcomers.28 Multinational card companies had always coveted the opportunities available in the Chinese market and were ready to integrate the multitude of systems under their own umbrellas. They jumped into wooing Chinese consumers as soon as it became feasible. In the 1990s, it became permissible for Visa and MasterCard to service foreign currency transactions, but not those in the local currency. Because they were shut out of all yuan-based payments, the multinationals were denied the leading role in the nascent market and soon found themselves locked in a peculiar position. Rather than serving a legion of consumers armed with cards and a network of merchants equipped with POS terminals, they acted as a surrogate interbank clearing system for transactions in foreign currencies. The domestic clearing system at the time was so slow that clearing transactions could take months. Naturally this was a hurdle for a rapidly developing private entrepreneurial sector. With the help of Visa and MasterCard, foreign businessmen and local entrepreneurs could settle accounts with their locally issued cards. In fact, at the time, Chinese-issued Visa cards boasted the highest per-card transaction volumes in the world because industrial deliveries were paid for by credit cards. The multinationals’ hopes of dominating the Chinese market only grew stronger when China signed onto the WTO in 2001. But again these hopes were not meant to be realized. China’s entry into the WTO posed a new challenge to the banking sector. As in Vietnam, China’s government was granted an official grace period to defer the liberalization of its financial industry until later—in this case, until 2006. Beijing used this time to build its system of defense in anticipation of aggressive competition from the multinational card companies. In early 2002, the central government launched China UnionPay Company (CUP), its national interbank card payment network. As it did with most of its economic innovation, the Chinese government began CUP with a

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local, pilot project that it then expanded nationwide. Initially CUP connected the card systems of the four main state-owned banks with eighty-one smaller ones in the large cities of Beijing, Shanghai, Guangzhou, Hangzhou and Shenzhen.29 Next CUP issued its own cards marked with its own red, blue and green logo. The three colors carry special meaning: red symbolizes “­aggressive,” blue means “extensive” and “deep,” and green signifies “safe” and “highly efficient.”30 The cards soon spread across the entire country. In early 2006 the government announced a plan to establish regional and national centers to process the settlement of checks, bank drafts and electronic payments for both commercial and domestic users.31 The Chinese government understood the importance of getting as many merchants on board as it could and as quickly as possible. In a move that generally followed the Chinese approach to market reforms—a combination of government coercion and market incentives—all payment card processing equipment in all stores was required to be made compatible with the UnionPay system.32 To its credit, UnionPay charged merchants less than Visa and took a smaller cut in conversion fees for foreign purchases. The 2008 Beijing Olympics was set as a milestone for having 30 percent of urban merchants accept CUP cards. Yet persuading merchants was no simple task. In 2004, only 3 percent of merchants, on average, were equipped to accept cards, with that number being higher, around 30 percent, in Shanghai, which had reached the Olympic target four years early.33 But even those shopkeepers who acceded to be paid with plastic at times resisted. For instance, in 2004, forty-six retailers who were handling almost 80 percent of all retail business in Shenzhen stopped accepting UnionPay cards under the pretext of machine maintenance, and another group of shops began to charge a UnionPay levy for those consumers unwilling to pay cash. Merchants objected to the relatively low 1 percent fee that UnionPay charged on purchases and demanded that it be cut in half.34 Supported by the China Chain Store and Franchise Association, more merchants in Guangdong, Nanjing, Shanghai and other large cities soon joined in the protest. After a few months, UnionPay backed down and reduced its charge. The newly minted Chinese cardholders had resentments of their own. They protested the various fees that banks imposed on them, and even the National People’s Congress got involved to protect customers from the banks and the monopoly power of UnionPay.35 Because many of them were forced by their employers to get a card,36 customers staged their own boycott.

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­According to a UnionPay official, only one in ten cards were active in 2008, the year of the Olympics.37 None of this stopped the fast expansion of UnionPay. In 2009, according to UnionPay, 2.13 million merchants, 2.88 million POS terminals and 930,000 ATMs were accepting UnionPay cards,38 and the China Daily claimed that most shops and restaurants in the larger Chinese cities were accepting cards for payment.39 If we compare this situation to Vietnam, the per capita figures for POS terminals were more than six times larger, and those for ATMs were almost seven times larger and the per capita merchant figure was fourteen times as much. By the end of 2012, Chinese banks had issued a total of 3.5 billion credit and debit cards across the country, an increase of 19.8 percent from a year earlier.40 As per capita card ownership was exceeding two, it was increasingly more difficult to sell another card. In just nine years, UnionPay had surpassed Visa in the number of cards issued and became the largest card issuer in the world.41 In 2011, UnionPay had 29 percent of the cards issued in the world (Visa had slightly more than 28 percent and MasterCard had 20 percent), but its global share of the number and total value of card transactions was still much less than the share of the multinationals, at 3 percent and 12 percent respectively.42 After the 2006 deadline set by the WTO expired, the multinational card companies began to demand, with growing impatience, the license for yuan-denominated transactions. As of 2011, international card companies were still not permitted to issue cards in the domestic currency, leading the United States to file a complaint at the WTO on behalf of Visa, MasterCard and American Express.43 In 2010, apparently disillusioned with the prospect of putting pressure on China via international institutions, Visa decided to use its market power to retaliate: it asked its member institutions to block transactions by Chinese shoppers who bought goods and services abroad using UnionPay’s system.44 The Chinese did not back down and mandated in 2012 that Citibank, as the first Western bank permitted to issue yuandenominated cards in China, must process purchases on Citibank cards through UnionPay rather than one of the foreign companies.45 Unlike in the East and Central European countries, where either there are no domestic brands at all (as in Hungary and the Czech Republic) or they are relegated to a niche dominated by multinational brands (as in Poland and, at this point, Ukraine and Russia), in China it is multinational card companies that play second fiddle to domestic cards, which are pro-

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tected and supported by the state and subsequently have a dominant market position. The Chinese state policy of creating a national card network is now being actively considered in Russia and Ukraine.46 The arguments in support of domestic brands are familiar ones—the vast majority of trans­ actions are domestic and do not require international cards; domestic cards are less expensive; and transactions that do not involve multinational networks are more secure because they keep information flows within national ­boundaries—but they are made infinitely more compelling by the sheer size of the Chinese domestic market. China does not have to join anyone else’s club. It can organize its own. The frustrated multinationals found themselves faced with a market they could not ignore because of its size yet could not conquer because of the state’s protectionist measures. China’s economic leadership has a different understanding of domestic financial services than the governments in Central Europe, and it has capacities that the Russian and Ukrainian states do not have. Mindful of what it considered to be the lessons of the Asian financial crisis of 1997 and the failed liberalization and crises of the Russian and Latin American economies, Beijing did not think of the payment card infrastructure as just another service best delivered by market actors. Instead, it viewed it as part of the country’s financial system, a lever necessary to control and steer economic development. It therefore insisted that the card system was to be under­stood in the wider context of national financial and economic security, as an instrument of facilitating inter-enterprise payments, controlling fraud, and improving tax revenues and the overall transparency of financial flows; as a way of modernizing China’s payments clearance system; and as a means to spur domestic consumption.47 The card market was a tool for economic progress. One Chinese scholar explained it this way: Bearing in mind the central position of financial institutions in modern economies, every nation wants their financial markets to constitute a significant means of realizing its social and economic objectives. Control of the financial system is an important aspect of governmental distribution of resources. Foreign financial institutions, however, are not interested in the long-term development goals of the host country and do not consider host country benefits when selecting projects. Once foreign institutions dominate a country’s financial system, it is difficult for the government to expedite its intentioned economic policies.48

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Another sentiment, echoing this one, comes from the Chinese banking industry. Quoting from an article published in the Shanghai Securities News on October 25, 2005, the South China Morning Post reported that two banking industry managers expressed their opposition to a recently publicized offer from a consortium led by Citigroup to buy an 85 percent stake in the loss-making Guangdong Development Bank: “The excess introduction of foreign capital into our financial institutions will easily lead to a loss of control over our economy and threaten national financial security. We must abandon policies that are making China’s economy a colony, like Latin America.” The South China Morning Post article explained that this criticism questioned whether “China should sell pieces of its financial institutions to foreigners, exchanging market share for technology, expertise and better corporate governance. It argued that introducing foreign capital was not the only way to create strong and well-run financial institutions and that the aim of the foreigners was to control China’s financial system and siphon off the profits and resources for themselves.”49 These views are not far from those of some Russian officials and industry representatives, but they are in clear opposition to the realities of several Central European markets, where banking is largely if not entirely foreign owned. What the Chinese example demonstrates is that, rather than capitulating, large countries led by strong states may go on the offensive. Size matters; this option is open only to countries with sufficiently large domestic markets. Had Bulgaria been a larger market, Borica, which initially had control of the market, may have proven more resistant to competitive pressure from multinationals. But in addition to size, ideology matters too. Unlike most of the East and Central European states, China has approached the bankcard market from an entirely different perspective. It views payment cards as an integral part of its financial system, which it in turn sees as an instrument of the government’s economic policy, not simply as an item of consumer convenience and source of profit, as seen by Visa and MasterCard. Both the multinationals and China share a vision of the various players (issuers, acquirers, processors) as a tightly coupled system and understand the need to force the players to cooperate, but they see the ultimate purpose of this system differently. UnionPay does not intend to rest on its laurels following its spectacular conquest of the domestic market. It has far-reaching global ambitions. As reported proudly on the UnionPay website in 2010, its headquarters were

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visited by then Chinese President Hu Jintao, who praised the company for developing the bankcard industry in China and encouraged it to “strive to establish UnionPay as one major bankcard brand worldwide.”50 UnionPay cards are now accepted in 143 countries, including the Czech Republic, Hungary, Poland, Russia and Vietnam. (Visa is accepted in 200 countries and territories.) Currently, more than sixty-five financial institutions in seventeen countries, including Japan, Russia and Singapore, issue UnionPay cards in their local currency.51 It is no surprise that Visa, MasterCard, American Express, Diners Club and JCB (a Japanese brand) now see UnionPay as a global rival.

credit puzzles Beijing retiree Yuan Yizhong cut up his son’s seven credit cards with a pair of scissors when he discovered that the twenty-nine-year-old had racked up huge debts that he couldn’t afford to repay. Yuan then used most of his life savings to repay about half of his son’s credit card bills of 200,000 yuan. “My son will get my house after I die, but I’m afraid it might not be enough,” Yuan said.

c h i n a d a i l y , a u g u s t 3 1 , 2 0 0 9 52

Despite the fast-growing issuance and acceptance of cards in China, there are formidable cultural obstacles that the credit card market and consumer lending more generally have to overcome. Consumer credit has historically been underdeveloped in China. Rooted partly in a cultural tradition of Confucian frugality, the Chinese save at a very high rate. Relatively low personal disposable income notwithstanding, collectively, by the end of 2009 they had accumulated an astounding US$ 2.86 trillion in savings.53 Chinese banking has traditionally resembled “a one-way street: aggregating savings deposits from consumers and lending the funds to businesses, primarily state-owned enterprises.”54 Credit for the purpose of spending was viewed particularly negatively, and banks were overwhelmingly viewed as deposit institutions, not consumer lenders. Just as it was common in the Soviet Union and Vietnam, borrowing happened mostly informally, within the extended family. In 2004, ­McKinsey & Company estimated that only 2 percent of China’s 1.3 billion people held revolving credit cards, and more than 80 percent of the volume

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of card purchases accounts for paying for upscale dining and hotels. These estimates were corroborated by the same-year data from CUP: the number of issued debit cards was 685 million and the number of credit cards was only 29 million. More than half of the cards were found to be used rarely, and the use of credit cards to pay for purchases was a very small amount of total credit card use. According to a study by a major Chinese bank, the average balance carried on a personal credit card in 2004 was only $2 for smaller regional banks and $7.50 for major national banks. Similar numbers for Visa and MasterCard report a purchase volume of $114 per card in 2004 or $1 per trans­action.55 This prompted high-level managers at McKinsey’s Shanghai office to complain that “more than half of Chinese cardholders today are unprofitable customers; a mere 2 percent classify themselves as ‘frequent revolvers’—consumers who almost always leave a balance on their credit card—while more than 85 percent of cardholders pay off their entire monthly bill.”56 The government initially contributed to promoting the credit card market, which it saw as a crucial mechanism for increasing domestic consumption, reducing corruption and increasing transparency of payments. 57 For instance, in 2005, a credit card intended especially for civil servants was reportedly issued to the employees of the Shanghai Foreign Affairs Office and the Shanghai Municipal Exchange and Cooperation Office with the stated purpose of reducing corruption and making spending on business travel more transparent.58 The number of credit cards issued in China grew by almost 200 percent between 2006 and 2008 (to 142 million), while the total transaction volume on credit cards reached 3.5 trillion yuan as enthusiastic banks started to peddle cards aggressively to everyone whose attention they could grab—from shoppers in malls to students in college dormitories.59 Almost 15 percent of all consumer purchases were paid for by cards in 2008, up from 4.8 percent two years earlier. Most shops and restaurants in major Chinese cities accepted cards as of 2009, a major improvement compared to the situation even three years earlier. Chinese banks’ marketing strategies closely resembled the card-issuing strategies of Russian, Ukrainian, Bulgarian and Hungarian banks, which also targeted natural communities of potential cardholders—employees through their enterprises, students through their educational establishments and retirees through their pension fund—to issue secured overdraft cards. In all of these countries, enterprises not only connected banks with a large number of potential cardholders

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who had no choice but to switch from cash salaries to directly deposited ones, but also helped reduce the banks’ uncertainty because the overdrafts were expected to be paid by the cardholder’s next monthly salary or stipend. Some Chinese banks, however, went overboard. For instance, China Daily reported that students at Xi‘an University were issued not debit but credit cards by a major Chinese bank without their consent or even knowledge but with the direct assistance of their university. In a move reminiscent of the unsolicited mailing of cards that was practiced at the dawn of the US card market, “the university had filled in the application forms without the students’ consent or signatures to help the bank achieve its credit card quota, resulting in more than 10,000 credit cards being issued to unwitting students.”60 This bank and others apparently pressured their employees to issue more cards to fill quotas. The Chinese leadership, however, learned from the dramatic 2003 South Korean credit card crisis that resulted from government policies aimed at increasing consumer spending and transparency by distributing cards indiscriminately so that ultimately 27 percent of the homeless in Seoul had a credit card.61 The government pulled the brake just in time. According to the People’s Bank of China, 4.97 billion yuan of credit card balances were at least sixty days late in the first half of 2009—more than twice the amount of the year before. This was a particularly serious issue in a country with no personal bankruptcy but with the widespread belief that parents are responsible for their children’s debts. According to a survey conducted by the ­Beijing Youth Daily, 11 percent of Chinese parents had already paid for the debts charged on the cards of their children (ages twenty-two to twenty-seven). As one of the bank managers commented, ”With credit cards, young people will quickly empty their parents’ pockets.”62 The China Banking Regulatory Commission instructed banks in 2009 to stop incentivizing new credit cardholders with gifts and requiring their staff to meet set quotas. The government also cracked down on issuing cards to those under eighteen. As a result, several banks scrapped or severely limited their credit card programs that targeted students.63 Most likely the government interfered just in time because by all accounts Chinese banks would not have been able to survive a crisis similar to the one in South Korea. In the words of the chief economist for MasterCard International in Asia, “A consumer-credit bubble would finish many of them. They have to get this right.”64 In 2010, per capita credit card ownership stood at 1.12 in Beijing and

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1.05 in Shanghai—more than one for each adult and child. The national average was 0.17, and there was one credit card for every ten debit cards. The national per capita of bank card ownership (including debit cards) that year was 1.78.65

Information Sharing The lack of credible, systematic credit information on individuals has been the major obstacle in the further development of the credit card market in China.66 Blacklists were used in China but seemed to be regional in nature and operated by the individual banks.67 Credit reporting, even to a larger extent than the card market itself, has developed into a state monopoly in China. Prior to the period of rapid growth in household lending, there had been no need to collect credit histories of individual borrowers because lending to enterprises dominated bank portfolios. In the late 1990s, however, such a need arose. Between 1999 and 2007, outstanding consumer loans grew from 0.14 to 3.28 trillion yuan, corresponding to an annual growth rate of 48 percent.68 In response to these changes, the Shanghai branch of the PBC created the first pilot credit reporting program—Shanghai Credit Information Services. That program gave rise to the first credit bureau in China, the Shanghai Credit Company, in 1999. The data were collected from fifteen local commercial banks, plus from organizations of public security, social service agencies and the court system, and included information on credit cards and fraud. In a year the company gathered data on 1.8 million debtors, including 1.18 million cardholders.69 From the start, the operation of the Shanghai Credit Company was limited to the city of Shanghai, and in practice it did not even cover all of the city’s districts. Nevertheless, this model was replicated in other Chinese cities. In 2001, a pilot credit reporting system was also set up in Shenzhen, where municipal government and the Shenzhen branch of the PBC were required to issue licenses to credit reporting agencies and rating companies. The first credit bureau in Beijing was founded in 2003 and was also local in its scope. The lack of a national repository of information remained the Achilles heel of the Chinese consumer credit market. Because information was not accumulated nationally, nothing prevented bad borrowers from seeking financing in a neighboring jurisdiction. After a series of local initiatives proved promising, the central govern-

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ment pushed for a national credit reporting system. In 2001, the PBC was instructed by the Communist Party of China’s National Congress to develop a national consumer credit information registry. In 2004, UnionPay made the first attempt to collect information on bad credit card and other consumer loans nationally.70 That same year, the PBC announced that a national credit reporting system “with Chinese characteristics” that had operated on a trial basis the previous year would be formalized into the PBC Credit Reference Center (PBC CRC).71 In countries where public credit registries exist under the auspices of central banks, their main purpose is regulatory and supervisory, and their greatest concern is to prevent systemic risk by making sure that none of the banks is lending imprudently. To this end, they typically collect information only from financial institutions. Private credit bureaus, on the other hand, consider it their mission to help lenders assess borrowers’ creditworthiness. As a result, they cast their net wider to include various nonbank organizations, such as utility and telecommunication companies, among their information suppliers. What is notable about Chinese credit reporting is that it combines the features of both public credit registries and private credit bureaus. PBC CRC collects information on all loans, irrespective of their size; and in addition to basic identifying information and credit history (both positive and negative), it also collects so-called off-bank information from utilities and telephone bills as well as court records and tax liens. Telecommunications companies are a particularly useful source of data: by the middle of 2007, the number of mobile phone users in China reached more than five hundred million, with 38.3 handsets for every one hundred people. The lion’s share of information comes from the four biggest banks, the rest from other banks, credit cooperatives, nonbank financial institutions and foreign lenders. In just one year after the nationwide expansion in 2005, PBC CRC collected data on 97.5 percent of the total consumer loan portfolio. The database saw more than a hundredfold increase in the number of inquiries in just the first two years after its inception: from 1,000 credit reports requested per day in 2004 to more than 110,000 inquiries per day in early 2006.72 As of August 2012, PBC CRC had information on 800 million individuals, with credit information on 280 million.73 The majority of the adult population has therefore already been captured by the registry.74 Given its position as an industry regulator, PBC mandates data sharing for all banks, but prevents them from supplying this information to anyone

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else but PBC CRC, particularly private bureaus: “The PBC states that this information is too important to be shared with private sector entities.”75 Combined with the fact that it costs banks nothing to inquire for information (unlike the submission of information, inquiries are voluntary), this limitation essentially locks private companies, including multinational credit bureaus, out of the credit reporting market in China. Although foreign banks can access PBC CRC information, they are prohibited from setting up their own bureaus and collecting information directly. Data privacy has not been a central concern of the Chinese government. The stated goals of the credit information system go far beyond guaranteeing the smooth operation of the credit card market or credit markets in general. PBC CRC files contain the personal ID issued to each individual by the Ministry of Public Security, making it easy to link the credit database with any government record, so the registry also serves as a database for administrative and law enforcement action of many kinds. In its 2010 report on financial stability, the PBC claimed that its system has not only already improved lending, but has also strengthened “law enforcement. Incorporating administrative punishment and credit related information into the credit information system, relevant agencies have leveraged on the credit information system most frequently used by commercial banks to enhance administrative efficiency and law enforcement, which also supplemented the incentive mechanism for enterprises and individuals to abide by law.”76 In other words, the credit bureau also serves as a way of reporting on lawbreaking in many areas other than lending and helps to find and punish illegal behavior. A year later the PBC wrote that the “PBC, in collaboration with related agencies, incorporated gradually the administrative punishment information in the areas of product quality, environment protection, social security and foreign currency. The credit reports generated by the enterprise and individual credit information system have become the core credit information, and the economic identification which could fully reflect the creditworthiness of enterprises and individuals.”77 The misdeeds of people (and companies) who, for instance, cheat on social security or break foreign currency rules, and get caught, are added to their credit report, and their entire record is available to the police, the tax authorities and other government agencies. The CRC database has shaped up to be the largest and most comprehensive database of this kind in the world, and one of the most powerful information resources in the hands of the central government.

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The Chinese credit bureau therefore has a much broader mandate than any of the other credit bureaus we have discussed.78 In 2009, a law was proposed to protect data privacy. The law would prohibit the gathering of personal information such as appearance, genetic data, fingerprints, blood type and disease history, a person’s ethnic identity, family, religious beliefs and political affiliation. It would also require written approval from individuals to collect information about them. Both ­individuals and corporations would have to consent to their data being given to a third party.79 The list of measures to protect the use of personal information sounds similar to the legal environments in which credit bureaus operate in the United States and Western Europe. It is surprising, then, that PBC CRC will be excluded from all of these requirements, which strongly suggests that the state is not willing to compromise on the scope of information it can collect through its credit registry. Yet even if these restrictions were to apply to the PBC CRC, the use of the unique citizen ID would allow the government to pool data from various sources. At the end of 2012, the law to regulate credit information management was still a draft.

Conclusion The two countries in Asia started the 1990s from a lower economic base and with a poorer population and worse infrastructure than their European counterparts, and they experienced much more vigorous economic development in the two subsequent decades. China, being an economic superpower and having a strong state, was able to set its own rules, while Vietnam, weaker and smaller, could not. The Vietnamese state initially let the big state-owned banks run the show and stepped in only as the WTO beckoned. To help the market along, it pushed state companies to enroll in salary projects, but it paid very little attention to the other elements of the card market. It did not force standardization nor promote card acceptance by merchants, and it was very late in helping with information sharing. It never fully reined in the large banks. All of this created an imbalance and bad dynamics: lots of cards with few places that accepted them, and at high cost for both card issuers and users. In China, the market was moving along until 2002 with some help from the government. After China signed on to the WTO, the state took mat-

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ters into its own hands. The central government thought of payment cards and the banking system in general not as another market for financial retail services but as the infrastructure of the economy and a governance tool. The payment card was reframed from being a cosmopolitan commodity that offers convenience to individuals to being a tool that provides the state control over money flow in the economy and over its citizens as economic actors. This perspective is reflected not just in the national card system it constructed but also in the credit information registry it has built, which may become one of its most powerful resources in keeping law and order. The new frame also demoted individual banks from being the protagonists of market construction and relegated them to executing central directives. In building UnionPay into a monopoly, Beijing encountered resistance on both sides. Both the cardholding public and merchants resisted, but the state acted with a mix of a powerful strategy and flexible tactical compromises. For this project to succeed, it had to shut out the multinational companies. Yet payment systems could not be a purely domestic affair. With an increasing number of Chinese traveling abroad and using their cards in foreign countries, UnionPay could not run an exclusively domestic operation. It had to offer services abroad to its domestic customers, and this put UnionPay on a path to becoming a competitor of the multinationals not just in China but also on the global stage.

eight

Conclusion

Imagine you’re going down the street and you see a billboard or an advertisement for a concert that you’re interested in. You simply write Mobito a message from your telephone with the simple code from the advertisement and specify the number of tickets and press send. Then comes the request for payment, you approve, and you get the tickets in your e-mail or directly to your phone. viktor peška, deputy chairman of mopet, czech mobile payments company founded in 20101

Developmental biologists design controlled lab experiments with the goal of understanding the mechanisms and processes that guide the development of organisms. Most social scientists are not as privileged, because our ability to design experiments is limited. For the most part, we stick to observations. Postcommunist transitions have provided researchers with an unusual opportunity to observe credit card markets develop from their inception, in conditions not unlike the ones in a lab experiment: a new, standard product (the credit card) is introduced simultaneously in several environments that share many important characteristics. The fact that both the trajectories of credit card market development and the resulting markets differed among the countries we studied, and in significant ways departed from the American blueprint, is a measure of the limitation of global pressures, a tribute to the varying power of local environments in shaping the course of market development, and evidence of the overall plasticity of markets. Closely following markets from their birth allows us 231

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to analytically separate mechanisms that help put markets into gear (we call them generative rules) from mechanisms that underscore how established markets function (functional rules). The undeniable advantage of focusing on markets in their early formative stages is the opportunity to capture generative rules that in mature markets become taken for granted and invisible. The unfolding of markets in the postcommunist world has been a process, spectacular in scale, that has taught us valuable lessons about what markets are and how they come about. The creation of card markets in the eight countries we studied began with an attempt to transplant the American born-and-raised credit card brands, Visa and MasterCard, onto postcommunist soil. The American card market acted as a performative ideal type: it both served as a template of understanding of what such a market should entail and promoted actively the replication of this type of market in these countries. American and other global actors played key roles in this process. The very first cards in all of the countries were linked to foreign exchange accounts, but they later inspired the emergence of various domestic and local card brands, with varying longevity. Multinational banks swept the banking systems in Central Europe and Bulgaria but were kept at bay in Russia, Vietnam and China, and to a lesser extent in Ukraine. Foreign credit bureaus, with the blessing of the World Bank, disseminated know-how on interbank information sharing, and in several countries they played an even more direct role in credit reporting by opening domestic credit bureaus in partnerships with local players. But in many instances local actors pushed back in response to globalizing pressures, and even in Central Europe, where governments put up little resistance to globalization, global forces had to act through nationstates and national institutions as retail finance everywhere remained for the most part confined to national boundaries. At one extreme, we find China, which refused to open up its financial sphere, despite formally joining the WTO and enduring continuous protests from Visa and MasterCard, and instead developed an independent national card system, UnionPay. In an ironic twist, UnionPay is now pursuing its own globalizing strategy of panAsian expansion. Russia’s goal in attempting to create a domestic payment card system was similar—subordinating consumer finance to the needs of national security and sovereignty in the face of increasing global pressures. Payment cards born as a financial service to deliver the small convenience of

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easy payment and quick access to credit by private vendors are now poised to become an instrument with which national governments can better control and monitor the economic activities of their citizens. With the help of cards, governments not only are able to disburse social benefits payments, from child support to pensions, and collect more taxes, but can also use card transaction data as a new source of information about citizens, and they can restrict how the poor use welfare payments or how entrepreneurs spend their government loans. Even in countries that have wholeheartedly embraced foreign influence, such as Hungary and the Czech Republic, governments have been experimenting with special-purpose payment cards, such as the Széchenyi card in Hungary, issued for small and medium-size businesses that participate in the government’s subsidized enterprise loan program, or the S-Card in the Czech Republic, launched to distribute welfare and disability payments. It is perhaps not surprising then that the final results in our eight countries turned out to be quite different from the original, US blueprint. For instance, the American market began with charge cards and soon moved to credit cards whereas debit cards emerged more recently and managed to overtake credit cards only a few years ago.2 In our eight countries, although all bank cards were persistently called credit cards in popular parlance, ATM and debit cards led the way and credit cards have taken root only with great difficulty. In fact, not even the payment function of these cards has proved as popular in these countries as in the United States or other countries such as Sweden. Whereas in the United States in 2010 less than a fifth of all consumer dollars were paid in cash,3 in the countries we studied, even in the most advanced markets, cash is still king and people use their cards more for cash withdrawal than for payment, frequently equating their cards with their demand deposits in the bank (referring to “storing money on cards,” “withdrawing money from cards,” and so on). The vast majority of cards in the United States, with the exception of corporate cards, were issued to individual consumers who either initiated an application or responded to a bank’s preapproved offer. In postcommunist countries, employers and the state helped banks to coercively mass-issue cards to employees and recipients of various social benefits. Even the ritual of using a card varies somewhat: in the United States, credit cards rarely require a PIN, but in the new markets, the PIN is de rigueur. The American market has also been slower to embrace smartcards that have a computer chip embed-

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ded in them, because so much has already been invested in magnetic stripe technology. The four EU countries in our sample have pledged to switch to chip-only cards in the near future, and the other countries are also charging ahead with the new technology. Designed to cross national boundaries effortlessly, cards are without doubt a formidable globalizing force, but a flexible and malleable one as well. Card markets, like cards, are plastic.

Differences in Outcomes and Development Trajectories If the countries we observed all look different from the United States, in many ways they also look different from one another. They vary by card penetration and use. Vietnam and Ukraine are on the low end, the Czech Republic and China are on the high end, and Hungary, Poland, Russia and Bulgaria are somewhere in the middle. In the Czech Republic and Hungary, Visa and MasterCard logos can be found on almost all debit and credit cards. In Poland and Bulgaria too, Visa and MasterCard dominate; but in Poland, PolCard survives for now, while in Bulgaria, Borica as an independent card brand has folded. In Russia and Ukraine, various local card brands survive despite the dominance of Visa and MasterCard, and the states continue to pursue the idea of creating national card payment systems. In Vietnam, international cards are rare, and most debit cards are domestic, proprietary cards of the issuing bank. In China, most cards carry the UnionPay logo and multinationals are effectively shut out, despite the WTO rules and admonishments. The creation of these eight markets also took different paths. In none of the countries was the market able to “build itself.” In all of them, third parties had to step in to define who the principal participants were and to force these actors to solve the payment and credit puzzles that the banks were not capable of solving on their own. Self-interested, competitive actors left to their own devices appeared to be powerless in bringing about necessary legal and organizational changes, despite most of them agreeing that these changes would benefit the market as a whole. In all of the countries, the state was a key player, although the degree of its intervention varied depending on its capacities and the political context. In some countries, banks also got help from the juggernaut of Visa and MasterCard and large private employers.

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cast of characters

One important role the state has played in the financial sector is that of gatekeeper. In financial services, the barriers to entry are high compared to most other markets. States decided on the cast of characters that could offer financial services. They determined what conditions actors needed to meet in order to enter the new market, and what part foreign players could play. In all of these countries, the state resolved to limit the list of players primarily to commercial banks, and to limit nonbanking institutions such as monoline credit card companies, consumer finance companies, gas station networks and telecommunication companies to walk-on roles, or as happened in many countries, it decided to keep them entirely off the stage. What counts as a commercial bank, what the requirements to charter a bank are, how much capital it must have, what services it must offer, what it can own, how it must operate, how it is supervised and so on are the rules that states have set and enforced according to their political goals and capacities. In all of the countries, the first commercial banks were created following the same recipe: they were the results of the disaggregation of the socialistera monobank into its various functions, and the subsequent transformation of those specialized financial institutions into well-rounded commercial banks. Except in China and Vietnam, where the population before 1990 was largely unbanked, these reforms gave socialist-era savings banks a large initial advantage in the postcommunist retail banking market. After the first banks were set up, the stage was populated with additional actors—newly licensed domestic banks or foreign institutions that either opened branches under their own names or acquired existing domestic banks. China has made the licensing of domestic banks very strict and resisted strongly the entry of foreign banks. In Vietnam, the state has pursued a similar approach. Both China and Vietnam were successful at holding the line on who can enter the market, but only the former was able to keep those on stage fully subordinated to its directorial instructions. Russia’s government has also been protective of its domestic banking industry, severely limiting the presence of foreign banking capital. Yet, in a surprising move, it allowed an almost unlimited proliferation of domestic banks in the late 1980s to early 1990s, with very low barriers of entry and very loose regulation, essentially letting the newly minted banks fight it out in the Darwinian world

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of free competition. Many of these banks were small, undercapitalized and short-lived, which undermined the people’s overall trust in banks and, ultimately, in the card system too. Ukraine set out on a similar path, although banks did not multiply there at the same frenetic rate as they did in Russia. In the first part of the 1990s, the Bulgarian government also made it much too easy to start a bank, until it suffered a catastrophic financial crisis and had to get in line to join the European Union.

cooperation

Where socialist-era retail banks dominated, they fiercely resisted cooperation with other, smaller and newer banks. The states were able to impose cooperation, but the degrees of their success differed depending on their ambitions and capacities. China, with its banks under tight state control and none of them significantly larger than the others, was an exception; cooperation did not even emerge as a problem. Beijing standardized card technology and infrastructure, and established a powerful credit registry, all part of a systematic strategy of market building. Vietnam did not have the capacity to follow ­China’s developmental approach and, until recently and partially reflecting its lower level of economic development, did not consider retail finance an important enough reason for the state to engage in proactive market building. The Russian and Ukrainian states initially had neither the interest nor the capacity to take the lead. Growing fascination with the Chinese model and the rise of economic nationalism, however, has propelled Russia and Ukraine down a similar course during the past several years. Both are now pushing to build their own version of UnionPay, but Ukraine trails significantly behind Russia, in both motivation and state capacity. Yet the already established presence of foreign banks and the big multinational card companies in Russia and Ukraine makes the development of an independent national card system much more difficult now than it would have been a decade ago. Despite the heavy involvement in card issuance and standardization, the Russian and Ukrainian states failed to effectively promote interbank cooperation on information sharing. Both countries legislated credit reporting, but effectively forwent the unique opportunity to force cooperation on the largest banks.

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Bulgaria began active state engagement by building its national card system, Borica, and then assumed a more passive role by focusing on measures required for the stability of its financial system as a whole. In Central Europe, the nation-states played a lesser role, with the Hungarian government the most active in the region and the Czech the least. Eventually they ceded some of their tasks to the multinational card giants. With EU accession, a new powerful political player came into play. In an attempt to integrate national card markets, the European Union is hoping to take advantage of its size and launch its own alternative to Visa, MasterCard and UnionPay.

e s t a b l i s h i n g va l u e

The value of debit and credit cards was not immediately obvious to either cardholders or merchants. Apart from experiencing inertia and being averse to giving up the anonymity of cash, cardholders did not want to pay for the right to use their own money, even though the first cards offered only simple debit and ATM functions. They were even more reluctant to borrow at high rates, and they were worried about unauthorized charges, especially, because at the beginning they were held fully responsible for them. Banks were unwilling to protect their customers from those losses, partly because it was costly, and partly because they felt it could create a moral hazard by encouraging people to act irresponsibly. Moreover, banks were caught in a classic dilemma: unless all of them adopted a policy of setting limits on their clients’ liability, those banks that did would attract a disproportionate number of careless or fraudulent customers. Merchants, even the largest ones in some countries, also resisted card acceptance: they did not welcome the transparency that made tax evasion more difficult, nor did they want to incur the merchant discount, and the additional hassle of card processing. The banks therefore initially advertised cards as an elite product, something that could make people look more like the prosperous Westerners whose lifestyles postcommunist consumers coveted. They pointed out to local merchants the appeal of foreign tourist consumers, a more convincing argument in the more affluent, Central European countries, where tourism was more robust. In the end, these markets resorted in large measure to coercion to break the reluctance of potential cardholders, and they mobilized the help of large employers. Under the umbrella of salary projects, banks opened accounts

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for workers and had their wages directly deposited while arming people with ATM and payment cards. In Russia, Ukraine, Vietnam, China and Hungary, the state played a particularly important role in this respect, making millions of its employees, as well as the recipients of various social benefits, such as students and the elderly, available to banks as cardholders. In Bulgaria, Poland and the Czech Republic, large foreign and domestic private employers also pitched in. But it quickly became clear that forcing people to own a card is not the same as getting them to use it. Many people had no intention of paying with their bank card and used it just to withdraw money at ATMs. This practice created the largest problem in Vietnam, where it resulted in serious losses for banks. Subsequently, coercive pressures were also put on merchants to accept cards. In China, Ukraine and Russia, the governments tried to foist card acceptance on merchants by legal mandate. Nevertheless, even in China, where the state had more power and where the market grew fastest, implementation of the mandate required additional, delicate negotiations with the stores. In Central Europe, large, mostly international retail chains also contributed to getting the necessary critical mass, but they played a lesser role in East Europe and Asia. Coercion created value by changing the terms of the calculation drastically. Salary projects altered the context of evaluating card ownership. Having a card was now tied to being an employee and being paid, and the value of one’s job became part of the value of the card. On the banks’ side, the thorniest issue of evaluation was the assessment of how risky customers were, because the customer’s projected future behavior is a key component of the price of the loan. It was especially difficult to make this judgment for credit card applicants. The puzzle posed by information asymmetry was overcome in different ways. In the United States, the main method was a sophisticated and highly automated screening process that relied on statistically derived credit scores; but this technology, though it now appears in all of the eight countries, played an important role in the 2000s only in Central Europe, and even there it never became the main instrument of assessing card applicants. Banks were much more likely to employ some form of liquid collateral, such as a security account, or to take strong sanctions against people who failed to pay. Employers were also central in all these countries as guarantors of conscientious card use. In Asia, Russia and Ukraine, they largely shouldered the

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responsibility for their employee’s cards, relieving banks of much of the usual risk of issuing cards. In Central Europe, employers aided banks in screening customers by supplying references, and with the written consent of the cardholder, employers helped banks recover losses by garnishing wages. Credit registries in Central Europe and China, just as in the United States, also offered an inexpensive way to punish defaulting customers. Collateral and sanctions narrowed the discretion of cardholders and the risk that banks were taking. This made the calculation of the cardholder’s value for the bank easier.

Globalization Stepping back from card markets, we now turn to some of the wider implications of our work, addressing theories of globalization, market transition and the market. Our research was partly inspired by the vast sociological literature on globalization. Globalization is best viewed as the totality of a large number of projects directly or indirectly aimed at the integration of nation-states into a transnational order. One of the most visible projects is allowing people to conduct economic transactions around the world by providing a means of payment in lieu of their domestic money. In the 1990s, sociologists were much impressed by the seemingly unimpeded sweep of global forces.4 In 1995, sociologist George Ritzer described the global spread of credit cards as the harbinger of the rise of American consumerism in the rest of the world.5 According to Ritzer, cards carry the rationalizing impetus of efficiency, calculability, predictability and control, along with displacement of personal relationships by nonhuman technology, a process he labeled McDonaldization, after the fast-food chain.6 As we have shown, the performative ideal type of the credit card market—its blueprint—indeed embodies many of these characteristics. Yet we have seen that this rationalization has fared differently in various countries, making more headway in Central Europe and much less in East Europe, Vietnam and China, and nowhere did it proceed by the sheer force of the market. The use of statistical credit scoring technology—the McDonaldization of consumer credit assessment—to deliver loan decisions in a mechanized fashion to serve a mass clientele quickly and at a low cost following a scientifically designed process—the way hamburgers are cranked out—was not

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fully victorious even in Central Europe. Where it was used, it was to aid human judgment or to identify extreme cases. Bad data and too few cases, exacerbated by banks’ unwillingness to share information, made automation difficult, just as running a McDonalds is impossible without reliable and ample supplies of standard-quality beef and potatoes. The need for market expansion posed a special problem for automating credit card decisions. Offering cards to new and riskier social groups meant that data from earlier transactions were of limited relevance. Mechanization was adopted, wherever it was, primarily for reasons of legitimacy and control. Using state-of-the-art decision-making technology shielded bank officers from blame if the decision turned out to be wrong. Mechanization, just as in a fast-food restaurant, also increased management’s control over the production process. By cutting the discretion of credit card officers and fully documenting each step in the computer system, managers could monitor lending closely, just as managers in fast-food restaurants can keep short-order cooks under permanent surveillance. Bank management, however, had to balance the contradictory pressures of increasing the customer base and reducing risk, a conflict often played out as a struggle between the marketing and risk management departments. In the EU member states, mechanization was also hampered by legal directives aimed at curbing automated decision making and protecting data privacy. The McDonaldization of banking thus ran up against serious obstacles. There were, of course, other ways to achieve the necessary control beside rational calculation. The history of the credit card illustrates the fact that rational calculation is unnecessary when more direct forms of control are available. If cardholders must have a security account or if their employer will help with collection or if nonpayers can be excluded from future lending, there is little need for fancy probability models to predict individual credit default. A growing body of research has pointed out the various ways that local conditions remain recalcitrant to the onward march of globalization. James L. Watson, for instance, has shown that even McDonald’s must adapt to local cultures.7 Students of the US card market have also noticed that developed countries have not copied the US blueprint. David S. Evans and Richard Schmalensee, commenting on European card markets, note that even though strong convergent forces have brought those markets closer to the US model, institutional differences persist. Ronald J. Mann has found

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that markets in Japan and West Europe show differences that seem to reflect the unique historical circumstances under which they developed.8 Because the debate between globalists and localists hinges on the differences and similarities between handpicked outcomes, it is an argument difficult to settle. There are three ways in which this comparative finalism hinders any resolution. First, there is no agreement on the level at which one must scrutinize similarities and differences. From a bird’s-eye view—looking at broad processes—globalization is much more plausible than from a worm’s perspective. Under a microscope, even two Big Macs can be shown to be different, just as a careful reading of two different credit card contracts in the same country may reveal differences. Second, even if debaters agree on the relevant level, it is unclear which differences matter and which do not. If McDonald’s does not sell beef patties in India, is that more important than the similarities of the production process or the physical space of the restaurant? If credit cards work the same way in Poland and Hungary, does it matter that Polish banks can rely on a credit bureau with full reporting while Hungarians, until recently, could not; or does it matter if some Polish cards are issued under domestic logos? Third, even if there is consensus about what the important differences are now, it is still uncertain whether they are temporary vestiges soon to be brushed aside by the triumphant march of globalization, or intractable obstacles in its path. How can we tell if the seeming predominance of domestic brands in countries such as China and Vietnam is temporary and will soon be squeezed out by multinationals, or a stable and defining feature of those markets? We move beyond this debate by offering a different methodology. In this book, we did not start from comparing existing card markets. Instead, we began with a set of problems or puzzles that these markets had to solve in order to triumph.9 All of these problems were understood by the main ­players—in our case, the banks, and in China, the state—who spearheaded the effort of market creation. We then followed these markets over two decades, showing how they developed differently and why. Thus the relevant level of focus is where the action of globalizing intent (in our case, market building) is concentrated. The important differences are the ones that pertain to the operability of the market, and our historical approach of describing the mechanisms unfolding in time can identify how elements are changing, even if changes are rarely a linear progression. Indeed, they can be reversed (for instance, as happened in Vietnam, where banks began to dis-

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mantle their ATMs, or in Russia and Ukraine, where the states are attempting to revert to domestic cards) or they can take unexpected turns (as they did in China at the turn of the millennium with the launching of UnionPay).

The Postcommunist Market Transition The literature on postcommunist market transition, another line of research that motivated our project, asks a question similar to the one preoccupying the literature on globalization: are the countries that abandoned communism headed toward a common destiny of market capitalism or will they create their own local variety of market economy? In this book, we shifted the focus of inquiry from national economies to markets for a specific product (the bank card). By asking questions about the national economy rather than about particular markets, the transition debate could easily dispose of two of our three questions—Who are the actors and how is value established? In the context of the national economy, the answer to each question is rather trivial: the actors are all economically active citizens, and value is prosperity broadly conceived. Although in the long run both turned out to be important questions—Who can be integrated into the economy? And what exactly does prosperity entail?—within the narrow time window open for the transformation of these economies, both of these questions could be overlooked. The third question, on cooperation, was either obscured by the transition literature’s preoccupation with competition—the element that had been missing from socialist economies and that was seen as the key ingredient to making markets work—or considered a matter for legislation, regulation or deregulation. In fact, much of the transition debate took the perspective of the state and construed the government as the principal actor entrusted with the general framework for all the specific markets that make up a national economy. In shifting our view to the market of a specific product, we did not lose sight of the state, but the main characters became different. At this level, our three questions became the appropriate guide for explaining market building. If one thinks of the national market as an aggregation of many markets, we can give a more nuanced, market-by-market answer to whether postcommunist countries create a new form of capitalism. Looking at particular markets, it is also easy to see that not only can the socialist past be a burden for market building, a hindrance to overcome, but it can also be of assis-

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tance. A large state sector in Hungary, a strong, commanding state in China, and the legacy of bloated socialist enterprises in Russia aided card markets in spreading payment cards. Through the lens of the payment card market, we can also appreciate the difficulties that these economies encountered, not just in supplying cards but also in creating demand for them. Markets never simply respond to existing demand; they have to shape it, train it, educate it, and occasionally conjure it up entirely from thin air. Only when homing in on a certain product can we recognize the enormous effort that entrepreneurs exert to establish the value of what they want to sell. Finally, the transition debate envisioned a national economy in which all markets follow the same logic of balancing supply and demand by setting prices based on competitive selfishness. The sagas of the card markets, however, show that for markets to arrive at this state, they have to solve a series of problems distinctive to their product and social context. Whom to let in, how to mix cooperation with competition and how to evaluate the product are peculiar to each market and predate the familiar drama of competitive, selfish, rational players.

Markets Economic models proclaim their ability to explain and predict the behavior of markets, but their analytical power is limited to stable markets, resting on certain assumptions made true, if true, by generative rules. But this stability is a matter of degree. Unlike textbook markets, markets in real life are unstable and constantly shifting, coming to rest for periods that may last decades, years, or only months or weeks. When a market reaches a level of stability, it appears normal and natural to its participants. It is then that an economic model of rational action can capture the logic of how markets operate. Such a model follows a marginalist approach: given the conditions, this is how the market players behave or ought to behave. We started with a set of five puzzles specific to credit cards that served as barriers to market emergence and development but could not be solved by competitive, self-interested actors: (1) the chicken-or-egg problem of twosided markets, (2) the dilemmas of cooperation involved in standardization, (3) the puzzle of strategic uncertainty created by information asymmetry,

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(4) the predicaments of information sharing among unequal players, and (5) the quandaries of market origination and expansion. The first, third and fifth puzzles thwarted the development of the market because they prevented banks and clients from developing ways to value and evaluate credit cards. The second and fourth puzzles stunted the market because their solutions required cooperation among banks that was not in the short-term selfinterest of the most influential players, who would rather have eliminated their rivals than created a competitive market. But solving these two puzzles also aided valuation. Standardization made cards more valuable for card owners, and information sharing made it easier for card issuers to evaluate potential customers and price card products. These five puzzles that market creators understood well but struggled with were resolved with more or less success in all of the eight countries. To the extent that markets depended on social forces and not just on economic incentives in solving these puzzles, the markets are socially embedded and market exchange is a form of social action. Understanding markets well involves retracing their development trajectory back to their point of origin because, as aptly argued by Greta Krippner, “congealed into every market exchange is a history of struggle and contestation that has produced actors with certain understandings of themselves and the world which predispose them to exchange under a certain set of rules.”10 Jens Beckert articulates a similar idea: “the development of the macrostructures prevailing in markets needs to be understood as a political, social, and cultural process which can be explained only by following the historical development of the evolution of specific markets.”11 Paradoxically, the more effective generative rules are in putting markets into gear, the less visible these social forces may eventually become and the more disembedded the market may appear. In other words, the better these puzzles are solved, the less actors have to think about them, the more they can take for granted the conditions delivered by generative rules and the more they may focus just on playing by the functional rules. No wonder generative rules get no credit. Instead, the myth of self-generating competitive markets is perpetuated further. In this book we make the case for the behindthe-scenes role of generative rules (which often work tirelessly on tasks of gargantuan proportions) in order to give credit where credit is due. Although limited in application, economic models are nevertheless very useful. First, as a descriptive device, they can shed light on the functional rules of a market if certain expectations are met about who the players are, what

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ways they are willing to cooperate and what the actors value. Those three factors are treated as exogenous, and they present the constraints within which markets function. If banks supply cards, if common card infrastructure and information sharing are available, if people value the convenience and liquidity that cards offer and if merchants see cards as either a necessity or an opportunity to boost their sales, then a card market can work. The analytic function of economic theories is not just to supply what Max Weber called an ideal type, a simplification and clarification of reality, and not only to reveal the necessary preconditions that markets require; it is also to provide cognitive coordination, a common language for participants to use in thinking about a market. Next, as a prescriptive tool, economic theories can help the coordination of action among market players. By prescribing what to do, they can narrow the universe of actions that people are likely to take, making markets more predictable. If credit scoring is considered the best practice in selecting credit card applicants, not only will banks abandon the use of credit committees, but they will also expect other banks to do the same. All lenders switching to numeric credit scores will allow them not just to compare clients within their own portfolio but, as the best methodology becomes established, also to anticipate how their clients will be evaluated by other lenders. Last but not least, as an ideological instrument, economic theories establish the market’s legitimacy. By laying out how rational actors in pursuit of legitimate goals may reproduce the market, and thus showing how a market is optimal given the circumstances, they shield the market from political and moral objections. For instance, they shift the focus away from discussing the social consequences of electronic surveillance, the income inequality underlying the need for consumer credit or the social costs of indebtedness. It is in this sense that economic theories protect these markets and contribute to their overall stability. Performativity of economics is laid bare here: for its theories to work, the market must be stable, and this very stability is advanced by those theories.

The Future Markets exist in time. They emerge and grow, but may later decline, disappear or morph into new markets. If you reach into your pocket, you are likely to find next to your wallet, containing your payment card, a cell

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phone. The pocket-size mobile phone is a more recent invention than the flat plastic rectangle. It began to spread only in the 1990s, when improved technology requiring less battery power made it possible to shrink large bricklike mobile phones into palm-size devices. Yet technology alone did not make the mobile phone market. Nor did it spring forth from people’s natural propensity for truck, barter and trade. Just as with the card market, building the market for cell phones had to overcome many challenges. Similar to getting people to use cards, getting more people to buy and use cell phones became easier the more phones were already in use. Yet, in contrast to card markets, where there are two distinct constituencies, the cardholders and the merchants, each with their own objectives and constraints, in the phone market the same phone user is alternately the caller and the recipient of a call. Standardization is another problem that the makers of card and cell phone markets have in common, as Europeans with their GSM phones and Americans with their CDMA devices experience when they are on the other continent. Furthermore, if mobile phone bills are paid days or weeks after the service was rendered, phone companies are essentially required to extend implicit credit and therefore face the same problem of information asymmetry that banks and other lenders grapple with. During the last two decades, cell phones have been spectacularly successful and now are ubiquitous in all of the eight countries we studied, and it is quite possible that in the not so distant future, the bank card in one’s pocket will be entirely replaced with a mobile phone as the new instrument of payment and, possibly, consumer credit. The process of mobile payments elbowing out credit and debit cards is spreading in Asia, but in Africa, where most people do not have a bank account and bank cards never took root, cell phones are already the payment instrument of choice. In Kenya, two-thirds of the adult population sends money through short text messages, supplanting bank cards with SIM cards. Money is credited on SIM cards either by their owners depositing cash at a telecom outlet or by receiving a transfer from another phone. One can pay by sending a message, thus debiting the SIM, and cash can be collected at a telecom outlet, where the amount is subtracted from the phone. In poor areas, several people, each with their own SIM card, can share a single handset. The system, called M-Pesa—M for mobile followed by the word for “money” in Swahili—is run by Safari.com, a telecom company that grew out of the state-owned Kenya Posts and Telecommunications Corporation.

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Since 2007, the government privatized Safari.com through public stock offerings and it is now a private corporation that operates as a de facto monopoly.12 It is unlikely that Kenya will ever build a payment market based on plastic cards with magnetic stripes, just as postcommunist countries never bothered with paper checks. As an emerging market for a new form of payment, the mobile payment market has to construct necessary infrastructure and define the players, cooperation and value in new ways. For instance, the use of cellphones makes it possible to bypass the banks altogether, as happened in Kenya, and to bring in new actors, from phone service providers to technology companies such as Google and Apple, each with its own system. Competition notwithstanding, the new actors need to agree on new technology standards for phone readers and for the interface between the phone and the hardware that processes the payment. The question must be settled of whether to exploit the regular phone connection by sending text messages, as in Kenya or as the Czech mobile payment company Mopet would have us do, or to use a contactless reader that communicates with the phone via a simple twodimensional barcode, through radio frequencies or using a version of Near Field Communication technology that reads a phone from a two-inch distance. Moreover, there must be cooperation on encryption and identification, and the players must agree on new rules of payment and data privacy. If mobile payment allows people to spend money they do not yet have, credit registries must be redesigned to accommodate new players. Last but not least, people and merchants must be convinced that this new payment instrument is useful for them and is worth the extra cost that they ultimately will have to bear. Smartphones will not be just a replacement for cards. They could allow for new functions that cards can never have: they may keep instant tabs on one’s account, register payment patterns, warn if items cost less online or in a nearby store and allow merchants to send instant coupons and reminders to their customers. Even small shops will be able to award loyalty points and keep tabs on customers at a low cost. Receipts can be issued electronically. Unlike cards, smartphones know where you are; they can take pictures, send and receive information and store much more than a handful of numbers; and they are integrated with the owner’s e-mail, web browser, spreadsheet and countless other applications. Because phone companies know where their customers are at any moment and have a complete list

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of their calls, finding nonpayers will be easier than it is for banks. If all that comes to pass, in a few years we may look at bankcards with the same sense of nostalgia or incomprehension that today we experience at the sight of cassette tapes or a rotary phone. When new markets are emerging is when entrepreneurial capitalism is in high gear. Even when market construction involves adapting a model that has been successful elsewhere and does not entail fashioning a market never seen before, entrepreneurs face much uncertainty and a series of interrelated puzzles. Markets stall unless these puzzles are successfully solved. Following markets from their inception and along their developmental trajectories makes visible the hands that craft markets and enable them to work.

Reference Matter

appendix 1

Data and Methodology

This book is based primarily on fieldwork the authors conducted in eight countries. We visited each country multiple times. Most of our visits took place in 2003–2005, with occasional follow-up visits later. The project was supported by a grant from the National Science Foundation and other agencies in the countries studied. Qualitative data were obtained from semi-structured interviews. In all eight countries, we interviewed bank managers responsible for payment card programs and consumer credit as well as security and risk management. At some banks we conducted multiple interviews to get both sides of the story—the selling of card products and managing risks. In some cases, we interviewed the same person more than once years apart. When we could, we also interviewed managers at the branch level to understand the practice of card promotion and client selection from the perspective of those who interact with customers. Because the banks requested strict confidentiality, when we quote a specific person, we cite the interview with a code. The first letter in the code refers to the country, the second letter, B, stands for bank interviews. The first number indicates which bank the person worked for, the second is the number of the individual with whom we spoke (we often interviewed multiple persons in the same bank). So, for instance, the code HB #1.2 refers to an interview with person number 2 in Hungarian Bank number 1. (The codes for nonbank interviews do not include the letter B or a bank number, only the country initial and one digit for the person.) Our sample of banks was based partially on stratified purposive sampling, supplemented by snowball and convenience sampling. Because no complete databases of card issuers existed in any of the countries when we were preparing for our fieldwork, in order to recruit banks into our project we compiled lists of card-issuing banks in each of the countries with the help of Visa International, national card associations and national banks. We also scoured bank websites for evidence of bankcard operations. Our lists included the largest banks, unless they stated they did not do retail business, as well as banks mentioned in periodicals in connection with their credit card programs. We recorded their ownership type and size, with the intention of interviewing a variety of banks. For the smaller countries, we contacted all 251

19

4: the national bank, UnionPay, the Shanghai credit bureau, and Sino Credit Consulting

29

1 workshop

# of other 5: the institutions national interviewed bank, the banking association, Borica, Alpha Research, and the Institute for Liberal Strategies

# of 21 individuals interviewed

Additional field data

China

# of banks 10 interviewed

Bulgaria

1 workshop

13

4: the national bank, the credit bureau, and the banking and card associations

5

Czech Republic

Table A1.1  List of Interviews and Field Data

3 workshops and a card conference

22

7: the national bank, the national banking association, the GIRO card processor, Bankinfo, Axa Insurance, ITCB, and Financial Research PLC

7

Hungary

24

5: a credit bureau, a card company, the national banking association, the Ministry of Finance, and a Visa regional fraud manager in Warsaw

12

Poland

Card security conference

21

4: a card company, the national banking association, a consumer research institute, and a Visa regional fraud manager in Moscow

14

Russia

29

2: a processing company and a card issuers association

15

Ukraine

2 workshops

16

4: the national bank, a bank IT company, the Visa regional manager in Ho Chi Minh City, and the Economic Research Unit of the Hungarian Embassy, Hanoi

9

Vietnam

9

4: Visa International in London and San Mateo, the Visa regional manager in Seoul, Global ­Vision Group in San Mateo, and Bankscope in Miami

Other

184

39

91

Total

252

appendix 1

data and methodology

253

of the banks on the list, and for the larger countries, we picked a sample of fifteen to twenty banks, making sure we included banks with domestic owners as well as those with foreign owners, state-owned banks, and both larger and smaller ones. We systematically contacted the selected banks. If we were turned down or experienced difficulties scheduling interviews, we replaced the bank with a similar bank from the reserve list if it was available. We supplemented our sample with banks recruited through snowball sampling, following up on leads and recommendations shared with us by our interviewees. We also interviewed a few banks that did not offer cards at that time. Most of the interviews were conducted by the authors themselves, except in China, where we collaborated with a prestigious research institute in Beijing, and in Russia, where some of them were conducted by Olga Kuzina, a sociologist from the Higher School of Economics. In China it was very clear from the beginning that banks there were much less accessible than banks elsewhere. Researchers from the institute completed nineteen interviews, and when we looked at them we found too much similarity across the banks. The responses were also highly scripted and reported on official policy as opposed to actual practice. Compared to the few interviews we carried out ourselves through local contacts in China, these interviews were not very informative, although they were conducted at some of the largest banks. Only later did we understand that in China we were looking in the wrong place to find the main actors of market creation. Whereas everywhere else it was the banks that played the lead role, in China, by 2004, the time of our nineteen interviews, the state had taken over. Asking questions of banks that had to carry out the game plan of the central government in Beijing was like asking disciplined soldiers about war strategy. At the time, we did not fully understand the strategy, nor did we comprehend the extent of the central government’s control. Anyone who has ever engaged in field research in different parts of the world knows that the quality of social interactions can vary considerably from culture to culture. Whereas Chinese banks appeared to us, American researchers, as highly disciplined, quite secretive and almost military-like organizations, bankers in Central Europe were mostly cordial, curious but matter-of-fact and highly professional; and in East Europe our interviewees were more personable, voluble and ready to offer their own opinions. In Vietnam, following the cultural divide between North and South—a trope we heard repeatedly from our Vietnamese friends—our respondents in Hanoi were somewhat formal and circumspect, and in Ho Chi Minh City, a little more easygoing. All eight countries, however, shared one important trait: personal connections and referrals were invaluable for getting a foot in the door. Apart from the banks, we also interviewed representatives of Visa International at their headquarters in London and their regional representatives in Poland and Vietnam, as well as national banking associations, card issuer associations, state officials, card processing companies, various card experts and IT professionals who supplied information systems for card operations.

254

appendix 1

The interviews in Poland, the Czech Republic, Bulgaria and Vietnam were conducted mostly in English and less often in the local language, and in Ukraine they were conducted in Russian. In Hungary, China and Russia we interviewed mostly in the local language. In Vietnam, a few interviews were conducted in Hungarian, because some of our interviewees had studied in Hungary during the socialist times and had learned the language well. We had native speakers helping us out in all our bank interviews when the native language was not used. Most of the interviews were recorded and later transcribed; where we could not record, interview data were reconstructed from our extensive handwritten notes. We supplemented our interviews with analysis of bank application materials and internal bank documents (for instance, memos designed to aid in assessing credit applications) where these were made available to us. We made use of macroeconomic and card market data obtained from central banks, and card statistics on five countries (the Czech Republic, Hungary, Poland, Russia and Ukraine) made available to us by Euromonitor International, as well as secondary data from specialized industry publications such as the Nilson Report and from the mainstream press. We got access to a series of proprietary market research data reports on consumer interest in and use of payment cards and consumer credit. We also interviewed a small convenience sample of cardholders in each country. In Hungary, the Czech Republic, China and Vietnam we held workshops for bank card managers. In the first two countries, the events were organized by the national banking association. In China, the central bank (the People’s Bank of China) organized and sponsored the workshop. In Vietnam, our workshops in Hanoi and Ho Chi Minh City were organized by the Center for Research and Consulting on Management, Hanoi University of Technology. At these workshops, we presented our preliminary findings and received input from our audience. Assistants took notes at these events. We also attended conferences and workshops held by others in Hungary, Ukraine and Russia.

appendix 2

Concentration in Banking Over Time

The most common figure used to show bank size is the amount of assets the bank holds, and the most common measure of market concentration in banking is the share of assets a bank or a group of banks holds. These figures must be disclosed to the regulatory agencies and they are comparable across countries. Measuring retail concentration is more difficult. The size of household deposits and loans and the number of clients are data that banks treat as sensitive business information, and national banks that gather financial data from other banks rarely disclose that information for individual banks. Yet during our fieldwork, we did receive approximate figures from banks or from banking experts for some countries.

255

256

appendix 2

Figure A2.1a  Concentration of Banking Assets in the Czech Republic in 1995. Source: Claessens 1998.

Figure A2.1b  Concentration of Banking Assets in the Czech Republic in 2003 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2004, “Trends in CEE Banking,” “Country Overviews,” “Market Players” and “Company Updates.”

concentration in banking over time

257

Figure A2.1c  Concentration of Banking Assets in the Czech Republic in 2011 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2011.

Figure A2.2a  Concentration of Banking Assets in Hungary in 1994 (Top Banks Named). Source: Neale and Bozsik 2001.

258

appendix 2

Figure A2.2b  Concentration of Banking Assets in Hungary in 2003 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2004, “Trends in CEE Banking,” “Country Overviews,” “Market Players” and “Company Updates.”

Figure A2.2c  Concentration of Banking Assets in Hungary in 2011 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2011.

concentration in banking over time

Figure A2.3a  Concentration of Banking Assets in Poland in 1995 (Top Banks Named). Source: Balcerowicz and Bratkowski 2001.

Figure A2.3b  Concentration of Banking Assets in Poland in 2003 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2004, “Trends in CEE Banking,” “Country Overviews,” “Market Players” and “Company Updates.”

259

260

appendix 2

Figure A2.3c  Concentration of Banking Assets in Poland in 2011 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2011.

Figure A2.4a  Concentration of Banking Assets in Bulgaria in October 1996 (Top Banks Named). Source: Yonkova, Alexandrova and Bogdanov 1999.

concentration in banking over time

Figure A2.4b  Concentration of Banking Assets in Bulgaria in 2003 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2004, “Trends in CEE Banking,” “Country Overviews,” “Market Players” and “Company Updates.”

Figure A2.4c  Concentration of Banking Assets in Bulgaria in 2011 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2011.

261

262

appendix 2

Figure A2.5a  Concentration of Banking Assets in Russia in 1995. Source: Claessens 1998.

Figure A2.5b  Concentration of Banking Assets in Russia in 2003 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2004, “Trends in CEE Banking,” “Country Overviews,” “Market Players” and “Company Updates.”

concentration in banking over time

Figure A2.5c  Concentration of Banking Assets in Russia in 2011 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2011.

Figure A2.6a  Concentration of Banking Assets in Ukraine in 1995. Source: Claessens 1998.

263

264

appendix 2

Figure A2.6b  Concentration of Banking Assets in Ukraine in 2003 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2004, “Trends in CEE Banking,” “Country Overviews,” “Market Players” and “Company Updates.”

Figure A2.6c  Concentration of Banking Assets in Ukraine in 2011 (Top Banks Named). Source: Raiffeisen Zentralbank Österreich AG 2011.

concentration in banking over time

265

Figure A2.7a  Concentration of Banking Assets in China in 1995. Source: Berger, Hasan, and Zhou 2009.

Figure A2.7b  Concentration of Banking Assets in China in 2003. Source: Berger, Hasan, and Zhou 2009.

266

appendix 2

Figure A2.8a  Concentration of Banking Assets in Vietnam in 1995. Source: Claessens 1998.

Figure A2.8b  Concentration of Banking Assets in Vietnam at the End of 2008 (Top Banks Named). Source: Moody’s Investors Service, Inc. 2009.

Notes

chapter one 1.  The card’s dimensions are three and three-eighths by two and one-eighth inches. The ratio of the longer to the shorter side is about the same as the ratio of the sum of the two sides to the longer one. 2.  Cards as a means of payment are now being challenged by the growing popularity of mobile payments that bypass physical form altogether. 3.  Swedberg, “Markets in Society.” 4.  Why this might not happen is discussed in the literature on path dependence. See Arthur, Increasing Returns and Path Dependence in the Economy; and Rona-Tas, “Path Dependence and Capital Theory,” p. 107. See also Solow, “Economic History and Economics.” 5.  Even the most extreme form of traditional economic theory would allow for the necessity of a state that enforces property rights. 6.  This split between generative and functional rules is reflected in the divorce between economics and economic history (see David, “Clio and the Economics of QWERTY”). 7.  Two of the earliest expositions of market failure are by Paul A. Samuelson, “The Pure Theory of Public Expenditure,” and Francis M. Bator, “The Anatomy of Market Failure.” There is a large literature on various forms of market failure (for example, Williamson, “The Vertical Integration of Production”; and Akerlof, “The Market for ‘Lemons’”), but since the early 1960s, mainstream economics has fought hard against the concept because it implies the need for outside intervention and state regulation. The criticism has drawn on the so-called socialist economic calculation debate that makes a strong case for the robustness of the market and the power of prices to inform actors (Hayek, “The Use of Knowledge in Society”). It also builds on the Coase theorem, which states that if there is a market for externalities with low or no transaction cost, markets will internalize externalities and in effect create their own optimal conditions of operation (Coase, “The Problem of Social Cost”). Another line of attack comes from evolutionary economic theories that posit that markets will find their necessary preconditions by trial and error over time (see 267

268

notes to chapter one

Alchian, “Uncertainty, Evolution, and Economic Theory”). For general criticism of the possibility of market failure, see Toumanoff, “A Positive Analysis of the Theory of Market Failure”; and for a collection of the most prominent interventions, see Cowen, Public Goods and Market Failures. Since the 1990s, and with even more force in the past decade, market failure as a concept has returned to economic analysis as a respectable tool (for example, Stiglitz, “Capital Market Liberalization, Economic Growth, and Instability”; Cowen, “Market Failure for the Treatment of Animals”). 8.  For more detail, see Swinbank, “Economics of Food Safety”; and Antle, “Economic Analysis of Food Safety.” 9.  For an exposition of the idea of embeddedness, see Polanyi, The Great Transformation; Granovetter, “Economic Action and Social Structure”; Lie, “Sociology of Markets”; Krippner, “The Elusive Market”; Krippner and Alvarez, “Embeddedness and the Intellectual Projects of Economic Sociology”; and Fligstein and Dauter, “The Sociology of Markets.” 10.  See Bernstein, “Opting out of the Legal System”; and Richman, “How Community Institutions Create Economic Advantage.” 11.  We argue not just that social construction is a metaphor but also that markets are de facto constructed, that is, they are made possible by intentional problem solving. See Abolafia, Making Markets, p. 8. 12.  Beckert, “The Social Order of Markets” and “The ‘Social Order of Markets’ Approach”; Aspers, Markets. 13.  Polanyi, “The Economy as Instituted Process.” 14. Fligstein, The Architecture of Markets, p. 18. 15.  Nonbank financial service companies cannot offer debit cards because they are not taking deposits against which one could use a debit card, but they can issue prepaid, charge or credit cards. The French consumer finance company Cetelem set up shop in the Czech Republic in 1996, a few months later in Hungary and in 1998 in Poland. In the Czech Republic, the government accepted the retail finance company as a card issuer. Two other companies in the Czech Republic—GE Capital (later GE Money) Multiservis, a part of the finance arm of the American company General Electric, and Home Credit, a domestic company—were also allowed to issue credit cards, although GE soon created its related bank, which has been promoting its own credit and debit cards. In Hungary and Poland, Cetelem had to register as a bank to be able to deliver credit through cards. In Hungary, Cetelem started a new bank, in Poland it bought one. In Bulgaria, Transcard, a monoline credit card company, was founded in 2002 with help from one of the big gas station chains. After some hesitation, the Bulgarian government allowed it to operate. 16.  European Payment Council, “EPC Response to European Commission Green Paper.” 17.  Rona-Tas and Hiss, “Forecasting as Valuation.” 18.  Kollock, “The Emergence of Exchange Structures.” 19.  For reviews, see Zukin and Maguire, “Consumers and Consumption”; and Zelizer, “Culture and Consumption.”

notes to chapter one

269

20. Norris, R. G. Dun & Co.; Olegario, A Culture of Credit; Carruthers and Cohen, “The Mechanization of Trust.” 21.  We also did fieldwork in South Korea, where, after 1998, banks were issuing cards aggressively, with encouragement from the government, which hoped to use credit cards to stimulate internal consumer demand and to move payments out of the gray economy of cash transactions and make them measurable and taxable. This resulted in a credit card crisis in 2003, when the government had to bail out several large credit card companies. 22.  Evans and Schmalensee, Paying with Plastic; Rochet and Tirole, “Two-Sided Markets”; Wright, “Optimal Card Payment Systems”; Brito and Hartley, “Consumer Rationality and Credit Cards”; Kahn and Roberds, ”Why Pay?” Caillaud and Jullien, “Chicken and Egg.” 23. Nocera, A Piece of the Action. 24.  Visa apparently changed its position when it announced the move to implement the Visa COPAC (Chip Off-Line Pre-Authorized Card) program for countries with poor consumer credit culture and insufficiently developed telecommunications infrastructure. Such cards store on their embedded computer chip all the information about the account and allow off-line transactions without needing each of them to be authorized. Russia was initially picked as a testing ground for the COPAC program. It is not entirely clear whether the pilot was completed in the midst of Russia’s 1998 economic crisis. The subsequent version of the COPAC program, called Horizon, was administered in Ghana in 2000, and now Visa’s Central Europe, Middle East and Africa (CEMEA) website reports that more than 5.3 million chip-based Visa cards were issued across the region, including in Russia and other Commonwealth of Independent States (CIS) countries. “Visa COPAC”; “Card Briefs”; and “The 21st Century Way to Pay.” 25. Weber, Economy and Society. “The construction of a purely rational course of action [ . . . ] serves the sociologist as a type (ideal type) which has the merit of clear understandability and lack of ambiguity” (p. 6). Although Weber is concerned here with social action in general, and we are interested in markets in particular, we can easily apply his concept to markets that are, as Weber points out, the “archetype of all rational social action” and that, in addition, entail competition and exchange (p. 635). For a detailed exposition of the relationship between economic theory and Weberian ideal type, see Swedberg, Max Weber and the Idea of Economic Sociology, pp. 193–195. 26.  Callon, “Introduction.” 27.  Garcia, “La Construction Sociale d’un Marche Parfait”; Callon, “Introduction”; Donald MacKenzie, An Engine, Not a Camera; MacKenzie, Muniesa and Siu, Do Economists Make Markets? Aspers, “Theory, Reality, and Performativity in Markets”; Santos and Rodrigues, “Economics as Social Engineering?”; Callon, “What Does It Mean to Say That Economics Is Performative?”; and MacKenzie and Millo, “Negotiating a Market, Performing Theory.” 28.  Some of the most important sources are Euromonitor International, Lafferty Group, and the Nilson Report.

270

notes to chapter two

chapter two 1.  See Rona-Tas, The Great Surprise of the Small Transformation. 2.  For a detailed discussion of the economic integration of the postcommunist countries that are now EU members (plus Croatia), see Bandelj, From Communists to Foreign Capitalists; and Epstein, “The Social Context in Conditionality.” 3.  There is an enormous literature on the transition of postcommunist economies to a market economy, including entire journals devoted to the subject. Some of the early classics are Lipton and Sachs, “Creating a Market Economy in Eastern E ­ urope”; Kornai, The Road to a Free Economy; Fischer and Gelb, “The Process of Socialist Economic Transformation”; and Blanchard, Dornbusch, Krugman, ­Layard, and Summers, Reform in Eastern Europe. For an overview of the debates, see Kolodko, From Shock to Therapy; and Hamm, King and Stuckler, “Mass Privatization, State Capacity, and Economic Growth in Post-Communist Countries.” On China, see McMillan and Naughton, “Elements of Economic Transition”; and Lin, Cai and Li, “The Lessons of China’s Transition to a Market Economy.” On Vietnam, see Fforde and De Vylder, From Plan to Market. 4.  In China we were told several times by bankers and state officials we interviewed that they thought the experiences of other countries were not relevant to their efforts to build their own payment card market. 5.  Lawrence Summers, then chief economist of the World Bank, put it this way: “There is a striking degree of unanimity in the advice that has been provided [by economists] to the nations of Eastern Europe, and the former Soviet Union. . . . Privatization, stabilization, and liberalization . . . must all be completed as soon as possible” (Summers, “Comment” pp. 252–253). This view dovetailed with the socalled Washington consensus, a term coined by economist John Williamson in 1989. The Washington consensus was a set of measures that economists thought were necessary for developing countries to adopt in order to achieve growth (Williamson, “What Washington Means by Policy Reform”). 6.  Hayek, “The Use of Knowledge in Society.” 7.  Murrell, “The Transition According to Cambridge, Mass”; Poznanski, The Evolutionary Transition to Capitalism. 8.  Jefferson and Rawski, “How Industrial Reform Worked in China”; McKinnon, “Gradual Versus Rapid Liberalization in Socialist Economies”; McMillan and Naughton, “How to Reform a Planned Economy.” 9.  Nee, “Organizational Dynamics of Market Transition”; Stark, “Recombinant Property in East European Capitalism”; Kolodko, “Transition to a Market and Entrepreneurship”; Djankov and Murrell, “Enterprise Restructuring in Transition.” 10. Kornai, Economics of Shortage. 11.  Rodrik, “Foreign Trade in Eastern Europe’s Transition”; Brenton and Gros, “Trade Reorientation and Recovery in Transition Economies”; Mitra, Selowsky and Zalduendo, Turmoil at Twenty. 12.  “There is no disputing about taste.” Stigler and Becker, “De gustibus non est disputandum.”

notes to chapter two

271

13.  Kornai (Economics of Shortage) dubbed socialist economies “economies of shortage.” 14.  Zaslavskaya calls the Soviet Union’s system of privileges in the distribution of goods “ruble inequality.” Zaslavskaya, “Chelovechesky faktor razvitiya ekonomiki i sotsial’naya spravedlivost.’” 15.  By the 1980s, this was less true in Central Europe. 16. Ledeneva, Russia’s Economy of Favours; Kenedi, Do It Yourself. 17.  Many socialist citizens had deposit savings accounts in a local branch of the state savings bank from which they could take cash. Savings accounts were also the only form of investment available for individuals: the bank paid a modest interest determined by the government. On monetary overhang, see Hofman and Koop, “Monetary Overhang and the Dynamics of Prices, Exchange Rates, and Income in the Transition to a Market Economy.” Lack of investment opportunities other than low-interest savings made popular various insurance and annuity policies. 18. Kornai, The Socialist System. 19.  Spendzharova, “For the Market or ‘For Our Friends’?”; Bonin, “Banking in the Balkans.” 20.  “Gosudarstvenny Bank SSSR,” Central Bank of the Russian Federation, at http://www.cbr.ru/today/history/gosbank.asp. Last accessed on September 6, 2013. 21.  The descendant of the Soviet Sberbank in Kazakhstan, Halyk Bank, just like the Ukrainian Oshchadbank, has never been as disproportionately large as the Russian one (it is the third largest Kazakh bank by assets). As in Ukraine, having a group of similar-sized banks rather than one giant bank dominating the scene influenced the banking system in Kazakhstan by making it more competitive. 22.  One early entry into retail banking in Hungary, the Czech Republic and Poland was their postal services, which created postal banks. Posta Bank in Hungary, Investiční a poštovní banka in the Czech Republic and Bank Pocztowy in Poland were launched to take advantage of local post offices as an instant nationwide system of bank branches. In fact, under different rules of entry, in each of these countries, the Post Office and not the banks could have evolved to become the main provider of payment card services. Given the way actors were defined, in Poland, to create Bank Pocztowy, the Polish post joined forces with none other than PKO, which became a minority owner. Bank Pocztowy has remained a small player in Polish retail banking. In the other two countries, the postal banks stayed independent and grew, but each eventually failed spectacularly, even bringing the country’s entire national banking system to the verge of collapse, and they were eventually bought out by other banks. 23.  Charts on the market concentration of commercial banks are in Appendix 2. 24.  Rona-Tas and Karagyozova. Unpublished. “The Bulgarian Credit Card Market.” 25. RosBusinessConsulting, at http://rating.rbc.ru/article.shtml?2009 /02/25/32317346. Last accessed on September 6, 2013. See also World Bank, “Russian Federation.”

272

notes to chapter two

26.  Jentzsch, “An Economic Analysis of China’s Credit Information Monopoly.” 27.  Vietcom Securities, Vietnam Banking Sector Report, 2010, http://vninvestment .files.wordpress.com/2012/03/vietnambank2011.pdf. Last accessed on November 6, 2013. 28.  National Bank of Ukraine. At http://news.finance.ua/ru//1/0/all/2010/06/22/ 201330. Last accessed on July 5, 2010. 29.  Gavra and Bogár, “Csányi Sándor portréja I-II.” 30.  The Czech Post Bank was ultimately taken over by ČSOB, which by then was in the hands of the Belgian KBC. 31.  Bulbank, at that time the second largest bank in Bulgaria, was purchased by the Italian UniCredit Group, and United Bulgarian Bank (UBB) was bought by the National Bank of Greece. Bulgarian Post Bank is now jointly owned by a subsidiary of the American International Group (AIG) and the private bank group EFG International. Express Bank was sold to the French bank Société Générale, and Commerical Bank Biochim was acquired by Bank Austria Creditanstalt. 32.  OECD, “Competition, Concentration and Stability in the Banking Sector.” See also Mirchev, “The Bulgarian Banking System and the EU Single Financial Market.” 33. Guseva, Into the Red. 34.  Dushkevych and Zelenyuk, “Ukrainian Banking Sector.” 35.  Dushkevych and Zelenyuk, “Ukrainian Banking Sector.” 36.  Baum, Caglayan, Schäfer and Talavera, “Political Patronage in Ukrainian Banking.” 37.  One exception was the famine in Ukraine in 1932–1933. It was a consequence of systematic measures to force the implementation of Stalin’s policy of collectivization in the countryside, which was met with fierce resistance from Ukrainian farmers. Official Soviet accounts determined collectivization to be a success, but it was later revealed to have caused suffering and famine resulting in several million deaths. By comparison, the postcommunist transition was a moderate affair, surprisingly lacking in violence and drama (Greskovits, The Political Economy of Protest and Patience). 38.  There is some debate about how the accounting system used under socialism can be made comparable to the currently used calculations that are based on market prices; the exact numbers are therefore in dispute. There are also alternative measures of economic output. What is not in dispute, however, is that there was a large drop in the GDP across the whole region. 39. Guseva, Into the Red; Woodruff, Money Unmade. 40.  For the reasons behind this rise in inequality, see Bandelj and Mahutga, “How Socio-Economic Change Shapes Income Inequality in Post-Socialist ­Europe.” Because the income figures rely on surveys that are notoriously unable to capture the very poor and the extremely rich, they are likely to underestimate any change in the income gap. 41. Vanhuysse, Divide and Conquer.

notes to chapters two and three

273

42.  Nesporova, “Why Unemployment Remains So High in Central and Eastern Europe.” 43.  The inflation rate in 1989 and 1990 in Poland is not easy to establish with precision and for this reason the 1990 figure is missing from Figure 2.6. Jeffrey Sachs, a key economic adviser to the Polish government at the time, claims it got reduced “from more than 50 percent per month in late 1989 to around 4 percent per month in mid-1990” (Sachs, “Shock Therapy in Poland,” p. 273). Because the inflation rate changed from month to month, most sources provide monthly figures. A 50 percent monthly rate, if sustained for an entire year, would result in an annual rate of 12,975 percent, and even 4 percent per month would translate to 160 percent annually. The numbers in the text are from Leszek Balcerowicz, the minister of finance whose famous plan stopped inflation (Balcerowicz, “Transition to the Market Economy”). 44.  If people acted according to how rational actor theories expect them to, hyper­inflation would be far more common, because higher spending would result in higher prices that would elicit even more spending, driving prices higher still in a vicious cycle. Yet hyperinflation is rare, and when it happens, it is the result of some external shock and not a run to spend and borrow. 45. Mueller, “Consumer Reactions to Inflation”; Katona, “Psychology and Consumer Economics”; Throop, “Consumer Sentiment”; Ludvigson, “Consumer ­Confidence and Consumer Spending.” 46.  Boyd, Levine and Smith, “The Impact of Inflation on Financial Sector Performance”; Fries and Taci, “Banking Reform and Development in Transition Countries.” 47.  Nguyen, Albrecht, Vroman and Westbrook, “A Quantile Regression Decomposition of Urban–Rural Inequality in Vietnam”; Yao, Zhang and Feng, “RuralUrban and Regional Inequality.” 48.  General Statistical Office of Vietnam. For income data, see http://www.gso. gov.vn/default_en.aspx?tabid=474&idmid=3&ItemID=12653; for consumption data, see http://www.gso.gov.vn/default_en.aspx?tabid=474&idmid=3&ItemID=12652. Last accessed on September 6, 2013. 49.  Sicular, Ximing, Gustafsson and Shi, “The Urban–Rural Income Gap and Inequality in China.” 50.  Chan and Hu, “Urbanization in China in the 1990s.” 51.  See Vu, “Economic Reform and Performance”; see also Kaufmann, Kraay and Mastruzzi, “Governance Matters VIII.”

chapter three 1.  In the United States, a $100 purchase costs $0.22 if paid in cash and $2.41 if paid by credit card (cited in Chakravorti and Emmons, “Who Pays for Credit Cards?”). Whether cash is more or less expensive than cards at the level of the entire economy as opposed to at the level of the transaction is a different issue. Here the calculations involve social costs not borne directly by those participating in the

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­ ayment transaction, such as the costs of printing, minting, storing and recycling p currency paid to the Central Bank, or taxes lost, and the costs borne by the parties but not related to the transaction such as interest forgone on cash holdings (a form of seigniorage). For an overview, including a survey of the international literature, see Turján, Divéki, Keszy-Harmath, Kóczán and Takács, “Nothing Is Free.” 2.  Evans and Schmalensee, Paying with Plastic. 3. Guseva, Into the Red. 4.  On two-sided markets see Rysman, “An Empirical Analysis of Payment Card Usage”; Armstrong, “Competition in Two-Sided Markets”; and Rochet and Tirole, “Two-Sided Markets.” 5.  In a country where, as in most parts of Europe, there is little mobility among professors and students, the two-sided market problem may not apply at all to universities. 6.  Having a card will then be an exercise in what sociologist Thorstein Veblen called “conspicuous consumption” (Veblen, The Theory of the Leisure Class). 7.  Unless issuing banks charge cardholders significant annual fees, banks do not profit from cardholders owning a card without using it for purchases. In other words, the ultimate goal of card issuers is to make consumers use cards in lieu of cash. In fact, this is precisely how Visa International gauges its success worldwide—by the extent to which cards are replacing cash transactions. 8.  Tversky and Kahneman, “Prospect Theory.” 9.  Wright, “The Determinants of Optimal Interchange Fees in Payment Systems”; Rochet and Tirole, “An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems”; Evans, Interchange Fees. 10. The 2007 intervention of the European Commissioner for Competition forced MasterCard and Visa to reduce their interchange fee substantially in the countries of the European Union. Predictably, such measures have been fought tooth and nail by the multinationals, who claim they will make it impossible for them to operate profitably. The years since have vindicated the Commissioner’s decision, as Visa and MasterCard have remained profitable. 11.  Here we purposefully paint a simplified picture of monetary transactions. We acknowledge an important cultural tradition in economic sociology of considering the different meanings of money depending on its sources, intended uses and other contextual factors. Carruthers and Espeland, “Accounting for Rationality”; Zelizer, The Social Meaning of Money. 12.  The size, shape and numbering of the card was originally set in 1985 (with subsequent revisions) by the International Organization for Standardization’s International Electrotechnical Commission, or ISO/IEC, by its 7810 ID1 rule. The size and location of magnetic stripes was set two years prior by the American National Standards Institute, or ANSI, by its standard X4.13–1983. 13. Farrell and Saloner, “Standardization, Compatibility, and Innovation”; David, “Clio and the Economics of QWERTY.” 14.  Besen and Farrell, ”Choosing How to Compete”; Gandal, “Compatibility, Standardization, and Network Effects.”

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15.  David, “Clio and the Economics of QWERTY”; Arthur, Increasing Returns. 16.  Several years ago, some US banks started issuing cards that had both a chip and a magnetic stripe, but they later abandoned them because they were more expensive to produce and were unnecessary because domestic merchants are overwhelmingly equipped with magnetic stripe POS terminals. In Europe, the Single Euro Payment Area (SEPA) has mandated that its member countries switch to chiponly cards. It took the political muscle of the European Union to begin the switch from the old to the new technology. As American travelers become less and less able to use their cards with stripes in Europe, they will experience directly what happens when standardization is incomplete. 17.  Katz and Shapiro, “Technology Adoption in the Presence of Network Externalities,” “Product Introduction with Network Externalities,” and “System Competition and Network Effects.” 18.  Edward Bellamy, Looking Backward 2000–1887, Chapter 9, p. 42. 19. Simmons, The Credit Card Catastrophe. 20. The 7 percent figure came from the owner of the restaurant where Diners Club founders used to have lunch. Mr. Major of Major’s Cabin Grill was asked how much he was willing to pay for such a card. Later he explained that he came up with the number by considering that travel agents at the time were receiving a 10 percent commission. See Mandel, The Credit Card Industry, p. 3. 21. Simmons, The Credit Card Catastrophe, pp. 40–41. 22.  Some merchant groups decided to issue their own cards. The American Hotel Association, the International Air Transport Association and the oil companies all tried in the 1950s to introduce their own payment cards as alternatives, but none succeeded. 23.  McGuire, Granovetter and Schwartz, “Thomas Edison and the Social Construction of the Early Electricity Industry.” 24. Simmons, The Credit Card Catastrophe. 25.  Stearns, “‘Think of It as Money.’” 26.  Phillips, “The Role of Standardization in Shared Bank Card Systems”; Kish, “Credit Cards Replace Cash.” 27.  Phillips, “The Role of Standardization.” 28.  Phillips, “The Role of Standardization.” 29.  Phillips, “The Role of Standardization.” 30. Chutkow, Visa; Hock, One From Many. 31.  Guseva, “Building New Markets.”

chapter four 1.  Akerlof, “The Market for ‘Lemons.’” 2.  Stiglitz and Weiss, “Credit Rationing in Markets with Imperfect Information.” 3.  The probability is also an average calculated for a quality that takes only two values: zero and one.

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4.  Akerlof, “The Market for ‘Lemons.’” 5.  Ausubel, “The Failure of Competition in the Credit Card Market.” 6.  Adverse selection and moral hazard work in many markets, including health insurance and the used car market. 7.  Warren, Testimony Before the Committee on Banking, Housing and Urban Affair of the United States Senate; Mann, Charging Ahead, Chapter 13. 8.  In an unusual twist, a Russian man has recently demonstrated that whereas lenders unilaterally write credit agreements, and may think they know more about the deal, crafty borrowers can make lenders vulnerable to the information asymmetry of the fine print. The forty-two-year-old resident of the town of Voronezh received an unsolicited credit card offer online, but instead of just signing the contract, he first scanned and edited the terms, then sent it back to the lender, who approved it without reading it. It turned out that the bank agreed to issue him a credit card with no interest, no credit limit and no fees, plus a steep penalty if the bank cancelled the card or changed the terms of the contract. The cardholder used the card for two years, and these details came to light only when the bank cancelled the card and sued for unpaid interest and other fees. The cardholder counter-sued and the case was reportedly settled. From http://m.now.msn.com/ dmitry-agarkov-outwits-russian-bank-by-writing-own-credit-card-terms. Last accessed on August 8, 2013. 9.  Guseva and Rona-Tas, “Uncertainty, Risk and Trust.” 10.  Borrowers’ ability to repay can be affected by unforeseen obligations such as the birth of a child or large health expenses, as well as loss of a job, divorce or a death in the family. 11.  In effect, the information asymmetry disappears. What the clients know but do not tell is now divided into a systematic element that results in the differences among the groups, and a random component, the differences inside each group. The systematic part is now known by the lender and the random element that remains will not lead to adverse selection. 12. Miller, Credit Reporting Systems and the International Economy; Jappelli and ­Pagano, “Information Sharing, Lending and Defaults.” 13.  Nagy, “Banki információs rendszerek Németországban.” 14.  We assume that only lenders who share their information can receive data from the common pool. In principle, contributing lenders can let others use their shared information for a fee. The problem is how much to charge for the usage. If the pooled information is puny, the price will be low because access to the pooled information will have small value for outsiders. Low prices will neither entice sharers to make the data available to others nor give an incentive to outsiders to start sharing. When the pool is big, the data will be much more valuable for those not reporting because without it they may be mobbed by the worst clients. So they can be charged exorbitant fees and they might as well join. 15.  Dell’Ariccia, “Asymmetric Information and the Structure of the Banking Industry”; Major, “Information Sharing Among Banks About Borrowers”; Gal-Or,

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“Information Sharing in Oligopoly”; Gehrig and Stenbacka, “Information Sharing and Lending Market Competition with Switching Costs and Poaching.” 16.  Arrow, “Gifts and Exchanges.” 17.  Gelpi and Julien-Labruyere, The History of Consumer Credit; Graeber, Debt. 18. Calder, Financing the American Dream. 19.  Hunt, “A Century of Consumer Credit Reporting in America.” 20. Calder, Financing the American Dream; Gelpi and Julien-Labruyere, The History of Consumer Credit; Hyman, Debtor Nation. 21. Olney, Buy Now, Pay Later. 22.  Lewis Tappan’s Mercantile Agency was founded in New York in 1841 and was soon followed by other, similar credit bureaus. These tended to be national in scope. See Foulke, The Sinews of American Commerce; Madison, “The Evolution of Commercial Credit-Reporting Agencies in Nineteenth-Century America”; Norris, R. G. Dun & Co.; and Olegario, A Culture of Credit. 23.  Klein, “Credit-Information Reporting,” p. 331. 24.  This ban was reinforced in 1956—-about when credit cards emerged—by the Bank Holding Company Act. 25.  McFadden-Pepper was originally intended to liberalize branching by allowing banks to set up branches in their cities, a right they did not have before. At the time, given the limitations on communication technology, a ban on banking beyond state boundaries was a reasonable limitation (Rose, Banking Across State Lines). GlassSteagall, written during the Great Depression, was, on the other hand, an attempt to reign in big banks and financial speculation. 26.  In the 1920s there were more than 30,000 banks in the United States. By 1940, decimated by the Great Depression, there were about 15,000. In 1980, there were still 14,407 banks in the United States. Between 1980 and 1998 this number dropped precipitously to 8,697 (Rhoades, “Bank Mergers and Bank and Banking Structure in the United States, 1980–1998,” pp. 23–24). Currently, the United States is still in the lead among large industrial countries in number of banks relative to the size of its population (Barth, Caprio and Levine, “The Regulation and Supervision of Banks Around the World, p. 7). 27.  The Riegle-Neal Act of 1994, which took effect in 1997, lifted the ban on interstate banking. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 opened new markets for banks, allowing them to engage in financial services other than retail banking, such as investment banking and insurance. 28.  Rhoades, “Bank Mergers and Bank and Banking Structure in the United States.” 29.  Nilson Report 802(January 2004):6. The Nilson Report provides market concentration in terms of outstandings, essentially the sum owed to issuers by cardholders. 30.  Fickenscher, “Lenders Hiding Credit Data and Regulators Object” and “Credit Bureaus Move Against Lenders That Withhold Info.” 31. Goldman, USSR in Crisis. 32. Shlapentokh, Public and Private Life of the Soviet People.

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33.  For instance, a previous criminal conviction was recorded on one’s labor card, severely limiting the availability of jobs to choose from, and often preventing the ex-convict from living in the most desirable cities. These practices varied, of course, to some extent by country and historical period. 34.  Neuhauser, “Two Channels of Consumer Credit in the USSR.” 35.  A small number of not employed borrowers, such as pensioners, could apply directly to banks (Potrebitel’skiy kredit). 36. Guseva, Into the Red. 37.  The form of borrowing that was much more widespread and popular in communist countries was borrowing informally from friends and family. For instance, evidence from the Soviet Union suggests that 75 percent of people regularly borrowed money from one another (Pavlov, “Razvitie kollektivizma v bytu rabochey molodezhi”), and 20 percent of large-city dwellers borrowed specifically from neighbors (Iankova, Gorodskaya semya).

chapter five 1.  The first Hungarian ATM was installed in 1989 not in the capital but in the small village of Nyúl in the northwest part of the country by the local saving cooperative. 2.  Each country had its own foreign currency shops. In Poland, Pewex; in Hungary, Konsumex; in Bulgaria, Corecom; in the Russian part of the Soviet Union, Beryozka (little birch tree); in the Ukrainian part, Kashtan (chestnut tree); and in China, the Friendship Store provided imported goods in exchange for hard currency. 3.  See McDermott, “Politics, Power, and Institution Building”; Tang, Zoli and Klytchnikova, “Banking Crises in Transition Economies.” 4.  For reasons of confidentiality, we cannot cite the names of our interviewees. Instead, we use a code described in Appendix 1. Here, for example, the first letter H refers to the country, Hungary, and the 3 refers to the individual we interviewed there. 5.  MUZO was hired because the banks thought its expertise in tracking a large volume of transactions would qualify it for the job. 6.  National Bank of Poland, “Rynek kart płatniczych w Polsce.” 7.  National Bank of Poland, “Payment System in Poland.” 8.  National Bank of Poland, “Rynek kart płatniczych w Polsce.” 9.  Heti Világgazdaság October 8, 1994. 10.  Czech Bank Card Association, “CR Bank Cards Development.” At http:// statistiky.cardzone.cz/download/history_since_1989.pdf. Last accessed on September 6, 2013. 11.  Here the speaker is employee #1 in Hungarian Bank #6 (HB #6.1). See Appendix 1. 12.  Prus, “Country of Region: Poland. Payment Card Market.” 13. Keszy-Harmath, A fizetési kártya üzletág Magyarországon. In 1999, this figure was 82 percent.

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14.  Calculated from the European Payment Cards Yearbook, 2004, Volume 2: Czech Republic. http://www.paymentcardyearbooks.com. 15.  Interview in Heti Világgazdaság, October 12, 1996. 16. Levitin, Private Disordering. 17.  Keszy-Harmath, “Visszaélések a bankkártya üzletágban.” 18.  Heti Világgazdaság, August 15, 1998. 19.  Figyelő, October 8, 1998. 20.  The SEPA includes thirty-two countries. It consists of all EU member states, regardless of whether they use the euro as their national currency; three countries that are members of only the European Economic Area (Lichtenstein, Iceland and Norway) as well as Monaco and Switzerland. 21.  Verdier, “Payment Card Systems in Europe.” 22. In 2008, uniform instruments for pan-European credit transfer (SEPA Credit Transfer or SCT) were adopted; a year later banks began to offer SEPA direct debit (SDD). Direct debit is when a biller withdraws funds from a payer’s account. 23.  At http://www.europeanpaymentscouncil.eu/content.cfm?page=what_is _a _payment_scheme. Last accessed on November 6, 2013. 24.  European Payments Council, “SEPA Card Framework,” p. 3. 25.  Ruttenberg and Hempel, “Time to Prepare the Eulogy.” 26.  The Eurosystem consists of the European Central Bank and the national banks of countries that use the euro. 27.  European Central Bank, “The Eurosystem’s View of a ‘SEPA for Cards.’” 28.  European Central Bank, “Single Euro Payments Area Seventh Progress Report.” 29.  European Payments System, “Questions & Answers.” 30.  European Central Bank, “Single Euro Payments Area,” p. 23. 31.  Vermeulen, “How to Migrate to SEPA.” 32.  Interchange fees are agreed upon either bilaterally, between one issuing and one acquiring bank, or multilaterally, by setting a general rule that is binding for all issuing and acquiring banks participating in a card scheme. 33.  This charge ranged between 0.4 percent and 1.05 percent for payments with Maestro debit cards, and between 0.80 percent and 1.20 percent for transactions with MasterCard consumer credit cards. The charge was subsequently reduced to 0.2 percent and 0.3 percent, respectively. Visa is currently charging 0.2 percent in Europe. The comparable rates in the United States average around 2.0 percent. A more skeptical view on the ultimate success of the cut is given in Evans, Interchange Fees. 34.  Santamaria, “Why change? Why me? Why now?” 35.  See Ausubel, “The Failure of Competition in the Credit Card Market”; Gross, “Do Liquidity Constraints and Interest Rates Matter for Consumer Behavior?”; Telyukova, “Household Need for Liquidity and the Credit Card Debt Puzzle.” 36.  Oren Bar-Gill, “Seduction by Plastic”; Block-Lieb and Janger, “The Myth of the Rational Borrower.” 37.  Prelec and Simester, “Always Leave Home Without It”; Soman, “Effects of Payment Mechanism on Spending Behavior.”

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38. Olney, Buy Now, Pay Later. 39.  Confidential internal document of HB #5. 40.  This is often referred to in the statistical literature as “selection bias.” Selection bias happens here in two steps. First, people select whether or not they apply for a loan. (Adverse selection emerges at this stage, but here is where bankers encounter the problem of people simply not being interested in the new credit product.) ­Second, the lenders select which applicant will get the loan. These two selections result in a clientele that is very different from the potential pool of applicants. There have been various attempts to correct mathematically for the bias created in the second step (for example, Greene, “Sample Selection in Credit-Scoring Models”; Thomas, Edelman and Crook, Credit Scoring & Its Applications; Siddiqi, Credit Risk Scorecards; and Hand, “Reject Inference in Credit Operations”) by using whatever lenders know about rejected customers from their applications to correct the data they have on accepted clients, but there has been no real statistical solution (see Hand and Henley, “Can Reject Inference Ever Work?”). 41.  Board of Governors of the Federal Reserve System, “12 CFR Part 202.” 42.  Directive EU 95/46/EC of the European Parliament and of the Council of October 24, 1995, Section 15(1). At http://eur-lex.europa.eu/LexUriServ/LexUriServ .do?uri=CELEX:31995L0046:en:HTML. Last accessed on September 6, 2013. 43.  The Commission’s communication on the protection of individuals in relation to the processing of personal data in the Community and information security, COM(90) 314 final—SYN 287, 13.9.1990, p. 29. 44.  Amended proposal for a Council Directive on the protection of individuals with regard to the processing of personal data and on the free movement of such data by the Commission of the European Communities, COM(92) 422 final—SYN 287, pp. 26–27. 45.  The EU directive in 1995 explicitly mentioned decisions about creditworthiness as an example of automated decision making. At http://old.cdt.org/privacy/ eudirective/EU_Directive_.html. 46.  Act of August 1997, amended in 2004 Article 26(A). 47. Act 101 of April 4, 2000, amended in 2004, Article 11/6. 48.  Act LXIII/1992, amended in 2003 Article 9(A). 49.  For what happens once credit scoring becomes more transparent and how that contributed to the US mortgage crisis, see Rona-Tas and Hiss, “The Role of Ratings in the Subprime Mortgage Crisis.” 50.  Rational models would suggest that people who are scared away by such consent have something to hide and banks should be happy not to get them as applicants. Good customers would be happy to signal their qualities by agreeing to sign such an agreement. Banks did not believe this was a realistic scenario. 51.  Péterfalvai, “Az adatvédelmi biztos beszámolója 2005,” pp. 447–449. 52.  In January 2012, the European Commission that has been highly critical of the termination of the Office of the Data Protection Commissioner started an infringement procedure to force the Hungarian government to reverse its decision.

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53. Section 38a (1) of the Act No. 21/1992 Coll., on Banks. 54.  In Poland, national IDs are not arbitrary but carry certain information about the person so mistakes can be highly consequential. 55.  Hajek, “The New Czech Insolvency Law.”

chapter six 1.  Visa Worldwide Association Report 2004, p. 30. At http://www.visa-asia.com/ ap/center/mediacenter/includes/uploads/Visa_Worldwide_Report.pdf. Last accessed on September 5, 2013. 2.  Euromonitor, “Financial Cards and Payments in Russia,” Country Market Insight, January 27, 2010. 3.  Schneider, Buehn and Montenegro, “New Estimates for the Shadow Economies All over the World.” 4.  “Dolya ‘seroy’ ekonomiki uzhe dostigla 25 protsentov.” At http://www.fed press.ru/77/polit/society/id_150272.html. Last accessed on September 4, 2013. 5.  Schneider, Buehn and Montenegro, “New Estimates for the Shadow Economies All over the World.” For alternative but similar estimates, see also Johnson, Kaufman, Shleifer, Goldman and Weitzman, “The Unofficial Economy in Transition”; and Lackó, “Hidden Economy an Unknown Quantity?” 6.  According to Moscow’s InDem Foundation, an independent polling group. Quoted in Matthews and Nemtsova, “The New Feudalism.” 7.  Guseva, “Incertitude et complémentarité.” 8.  Kreknina, “Auchan nachal prinimat’ bankovskie karty.” 9.  Improving the transparency of financial transactions and increasing tax revenues were among the main motivators behind the state-promoted growth of the credit card market in South Korea in the 1990s. The Korean market boom ended with a bust a few years later. Day, “South Korea Builds a House of Cards.” 10.  Zhirinovsky and Jurovitsky, Novye Dengi dlya Rossii i Mira. 11.  “Zhirinovsky: Nuzhno zapretit nalichnye den’gi.” At http://olymp2010.rian .ru/interview/20091211/198672515.html?id=. Last accessed on September 4, 2013. 12. Bellamy, Looking Backward. 13.  “Dlya krupnyh pokupok v magazinah potrebuyutsya kartochki, vvodyat limit nalichnyh raschetov.” At http://www.pervo.ru/news/stories/6394-dlya -krupnyh-pokupok-v-magazinah-potrebuyutsya-kartochki-vvodyat-limit-nalichnyh ­-raschetov.html. Last accessed on September 7, 2013. In January 2013, the Ministry of Finance planned to propose to the Cabinet a bill mandating that all merchants with an annual turnover above 60 million rubles must accept cards. At http://ria.ru/ economy/20130115/918244651.html. 14.  Elena Kukol, “Pervye elektronnye karty vydadut uzhe v avguste.” 15.  Ukrainian Cabinet Decree no. 878, from September 29, 2010. At http:// zakon2.rada.gov.ua/laws/show/878-2010-%D0%BF. Last accessed on September 4, 2013.

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16. “Operatsiya ‘terminal,’” February 21, 2012. At http://news.finance.ua/ ru//2/0/all/2012/02/21/270210. Last accessed on September 4, 2013. 17.  Maev, “The Shadow Economy Represents 37,7% of the GDP in Bulgaria.” 18.  “Karty v ruki.” At http://focus.ua/economy/6643. Last accessed on September 4, 2013. 19.  “Karty v ruki.” 20.  “Karty v ruki.” 21.  Bojinov, “Evolution and Present Status of Bulgarian Card Market.” 22.  Overall card growth was actually even higher, because two more independent networks of POS terminals were established in 2002 and 2003, the Transcard and Euro­Line networks, respectively. 23.  If Visa and MasterCard resisted initially, they did not do so for long. By the beginning of 1995, about twenty Russian banks had become members of Visa, and forty-two had acquired membership in MasterCard-Europay. 24.  Bruikov, “O ‘plastikovoy’ gordosti velikorossov.” 25.  Bruikov, “O ‘plastikovoy’ gordosti velikorossov.” At one point, the state did conceive of developing a single national smart card based on Sberbank’s existing card brand, Sbercart, but this project was never implemented. Again market actors could not agree, and the state could not enforce cooperation. Although they recognized the strengths of the project—smart card technology and Sberbank’s expansive branch network—private commercial banks opposed the measure, fearing it would give too much power to the state-owned retail giant. 26.  “Central Bank of Russia: National Payment Card System Will Be Open for Russian and International Payment Systems.” 2009. PLUS Journal 11(151). At http:// www.plusworld.ru/journal/online/art141220. Last accessed on September 7, 2013. 27.  Rather than permanently appointing one or several banks to service state budget accounts (that is, to disburse state salaries or finance capital improvement campaigns), the Ukrainian state in the 1990s held frequent tenders for these assignments among several large banks. In addition to receiving commissions, undercapitalized Ukrainian banks coveted these opportunities because they brought additional financial resources, even if temporarily. This practice helped preserve relative size parity among the Ukrainian banks in the 1990s. 28.  At http://www.ukrcard.com.ua. Last accessed on September 4, 2013. 29.  “Natsionalnoe platezhnoe prostranstvo: ostrye voprosy i neprostye otvety.” At http://fin2top.com/download-article/165. Last accessed on September 5, 2013. 30.  Only about 3 to 5 percent of the total volume of card transactions in Ukraine are noncash payments. Kravets, “Mistse ta rol NSMEP na kartkovomu rynku Ukrainy.” 31.  “Mify o NSMEP kak sredstvo manipulyatsii soznaniem.” 32.  The plastic card department could alternatively be called the department of payment methods, or its functions could be performed by a department of individual clients; in the latter case, it would cover all aspects of retail business, including cards. 33.  The credit department would work with all types of credit applications, of

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which credit card applicants usually comprised a small portion. The credit department was assisted by the security department, a necessary fixture in each Russian and Ukrainian bank we encountered but not in the Bulgarian banks; it carried out verification of application data and applicants’ profiles. Several banks indicated that their legal department also got involved in approving applications. In a large Ukrainian bank, credit cards were processed not by the credit department but by the department of individual clients, which would handle all credit applications from individuals. 34. Guseva, Into the Red. 35.  Ukrainians applying for loans (especially large and long-term loans) are sometimes asked to procure a note from a psychiatrist attesting to their sanity. In one bank we were told that this is done to make sure the applicant is able to work. Apparently applicants for external passports in Ukraine are also asked to bring such a note [UB #13.1]. Another respondent reasoned that whether the applicant is sane or not “is often apparent during the interview” [UB #6.1]. 36.  This scenario is discussed in Guseva, Into the Red. 37.  The similarities between the two banks were most likely explained by interbank job mobility. 38.  The typical bank security department performs a wide spectrum of services— from the physical security of bank ATMs and card processing (if done in-house) to the informational security of verifying loan applicants’ information, investigating fraud and collecting debt, as well as security entirely unrelated to card business— such as background checks on new employees. 39.  Mennicken, “Figuring Trust.” During one of our Ukrainian interviews, we asked our respondent who was employed in the bank’s security department. The officer’s response was “former employees.” He paused as if this was a perfectly sufficient response, but we had to probe further: “Of security forces?” (This category encompasses the military, the police and the secret service). He chuckled, and said yes [UB #3.1]. We did meet the head of the security department at that bank. He was a former officer of the KGB and acted terribly suspicious of us and our questions. (As a good security department officer, he must have always been on guard.) 40.  In these countries, security departments consist of only doormen, guards protecting the transfer of valuables, monitors of closed circuit surveillance cameras or night watchmen—people in charge of the physical safety of the bank and its operations. 41.  Guseva and Rona-Tas, “Uncertainty, Risk and Trust.” 42.  In one Ukrainian bank that developed such a point system we were told that their questionnaire with more than one hundred questions was tested on the bank’s own employees as well as on friends and acquaintances (altogether about one hundred people) to see how accurate it was and how many would pass. Some of the questions and their weights were fine-tuned as a result. 43.  “Serye zarplaty ostayutsya stolichnym yavleniem,” Kommersant, March 21, 2007. At http://www.kommersant.ru/doc/751825/print. Last accessed on September 5, 2013.

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44.  Maev, “The Shadow Economy.” 45. “Pressa o Banke—kommentarii.” At http://www.gorodskoi.ru. Last accessed on July 20, 2007. A more recent marketwide estimate is similar: 30 percent of mortgage borrowers receive unofficial income. “Ipoteka na chestnom slove: u 30% zayemshchikov net ofitsialnogo dokhoda.” At http://bankir.ru/novosti/s/ipoteka-na -chestnom-slove-u-30-zaemshchikov-net-ofitsialnogo-dokhoda-10047551. Last accessed on September 9, 2013. 46.  Official statistics are also not immune to the problems of estimating incomes. 47.  In one of the banks where we interviewed, prescreening criteria were formalized: the size of the documented “white” salary had to be at least 9,000 RUR (Russian rubles) ($346) and the mobile phone bill had to be no less than 1,500 RUR ($58) per month. 48.  Shevchenko, “In Case of Fire Emergency,” p. 150. 49.  Korostikova, “Bogatogo delayut chasy.” 50.  Spence, “Job Market Signaling.” 51.  Samotorova, “Bani na potrebu.” On the consumer credit trends in Russia, see also “Noveyshaya kreditnaya istoriya,” Delovoy Kvartal. At http://ekb.dkvartal.ru/ news/novejshaya-kreditnaya-istoriya-236607843. Last accessed on September 5, 2013. 52.  Prokop’ev, “Banki upovayut na ‘dedushkinu ogovorku.’” 53.  Credit reporting has been discussed in the banking community since the 1990s (as early as 1992–1993 in Bulgaria), but laws authorizing credit data collection by third parties were passed in Bulgaria and Russia only in 2004 (and went into effect in 2005) and in Ukraine in 2005 (and went into effect in 2006). 54. In 2004, it was renamed the Ukrainian Interbank Payment Systems Member Association “EMA.” 55.  Russian legislation database. At http://base.consultant.ru/cons/cgi/online .cgi?req=home. Last accessed November 1, 2010. 56.  One of the largest credit card programs in Bulgaria—Transcard—is led by a nonbank issuer and was able to challenge the hegemony of banks in the card markets. One of our Bulgarian respondents claimed that the reason Transcard was so successful was because it managed to access the database of the biggest Bulgarian mobile operator, something that most Bulgarian banks had not yet managed to do. 57.  At that time, there was already an initiative to create a credit bureau from a group that included the Association of Russian Banks (ARB) and several mediumsize banks. They were mostly interested in the 10 percent limitation, which would mean that Sberbank, with its enviable market share, would not be able to create its own pocket bureau but would have to join with the others. No doubt the group led by the ARB was counting on the participation of Sberbank, which was initially listed among the founders. Such was its role in Russian retail banking that whoever got access to its customer database would gain an immediate advantage. In a dramatic change of heart, however, Sberbank later reneged on its earlier promise and announced that it would only provide ARB’s credit bureaus with its database of negative information. See Guseva, Into the Red.

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58.  See, for instance, http://www.nbki.ru/press/pressabout/?id=332. Last accessed on November 8, 2013. As of 2011, R ­ ussia’s five biggest credit bureaus were as follows: (1) ARB’s National Bureau of Credit Histories (NBCH), organized with the participation of the American credit bureau TransUnion and the Italian CRIF; a large state-owned Russian bank, VTB; and more than a dozen commercial banks (http://www.nbki.ru/company). (2) Equifax Credit Services, organized initially as Global Payments Credit Services by Home Credit and Finance Bank together with Equifax and renamed in 2008; with more than fifty-two million credit histories reported on its website, it has emerged as a market leader (http://www.equifax.ru/ about). (3) Russkiy Standart, a pocket bureau organized by the leader of the markets for express credits and credit cards. (4) Infocredit, a credit bureau with a 50 percent ownership by Sberbank. (5) Experian-Interfax, organized initially as a joint venture between Experian and the Russian information agency Interfax; in 2009 its 50 percent share was purchased by Sberbank. In 2012, Infocredit and Experian-Interfax merged. The new bureau was named the United Credit Bureau (http://www.e-i.ru/ rbr.asp?rbr=2, last accessed on September 5, 2013); a 50 percent share was owned by Sberbank and 25 percent each by Experian and Interfax (http://www.group.interfax. ru/lnt.asp?lnt=1&id=532, last accessed on September 5, 2013). 59.  Home Credit and Finance partnered with the global credit bureau Equifax, Sberbank cooperated with three little-known financial companies, and Russkiy Standart did not even bother to find a real partner. Its credit bureau is co-owned by Russkiy Standart Company and an individual named Ilgiz Mukhametdinov, associate director of production of Russkiy Standart Vodka in St. Petersburg. At http://ko.ru/ articles/13075. Last accessed on November 7, 2013. 60.  Rossiyskaya Bizness Gazeta, June 8, 2010. At http://www.rg.ru/2010/06/08/ gody.html. Last accessed on September 4, 2013. 61.  Many of the loans, particularly those issued in stores without thorough verification while customers wait, were given to people who used stolen or fraudulent IDs. The lion’s share of defaults is on such illegitimately obtained loans. 62.  The three Ukrainian credit bureaus are (1) the Ukrainian Bureau of Credit Histories, founded on equal terms by Privatbank, the largest Ukrainian bank and leader of the retail banking market, and by a foreign company, BigOptima LTD (at http://www.creditinfo.com.ua/?PageID=1906 and http://www.ubki.com.ua/ index.html); (2) the First Ukrainian Bureau of Credit Histories, organized by the Association of Ukrainian Banks, two Ukrainian insurance companies and thirty banks that at the outset claimed 70 percent of the national retail lending market; and (3) the International Bureau of Credit Histories, founded on equal terms by the Ukrainian financial group TAS, the National Association of Credit Unions of Ukraine and the Icelandic Creditinfo Group, which since 2012 is owned by six partners, including the two original founders and Swedbank, in turn, owned by a Swedish financial group. 63.  From a presentation at the Ukrainian Card Forum organized by the Ukrainian Interbank Payment System Member Association “EMA,” June 2007.

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64.  At http://ime.bg/bg/articles/krediten-registyr/#ixzz1MorKqa4W. Last accessed on September 9, 2013. According to the Ordinance of the National Bank, “the Central Credit Register (CCR) is an information system for credit indebtedness of the persons served by the banks, organized and maintained by the BNB.” 65.  At http://www.experian.bg. Last accessed on September 9, 2013. 66.  Ordinances of the Bulgarian Central Bank. At http://www.bnb.bg/bnbweb/ groups/public/documents/bnb_law/instructions_reg22_bg.pdf. Last accessed on September 9, 2013. 67.  Glushenkova, “Highly Anticipated Bankruptcy Bill Still Under Debate.” 68.  Matthews and Nemtsova, “The New Feudalism.”

chapter seven 1.  Nee and Opper, Capitalism from Below. 2.  The higher level of corruption in Vietnam than in China also indicates the Vietnamese state’s relative weakness. Kaufmann, Kraay and Mastruzzi, “Governance Matters.” For data on corruption perceptions from 2001 to 2012, see Transparency International at http://www.transparency.org. Last accessed on September 4, 2013. 3.  Watts, “Vietnam Celebrates 30-Year-Old Victory over US.” 4.  For example, Schmetzer, “Capitalist’s Fall Teaches Vietnamese a Costly Lesson”; “In Vietnam Scandal on the Increase as Banking Sector Expands,” Deutsche Presse-Agentur, May 11, 1996; Watkin, “Bank Fraudsters Sentenced to Death”; ­Arthurs, “Vietnam Tries 59 over Bank Scandal.” 5.  “Moody’s Global Banking: Vietnam,” Banking System Outlook, August 2009. At http://vninvestment.files.wordpress.com/2012/03/vnmoody09.pdf. Last accessed on September 4, 2013. 6.  The other two banks were the smaller Firstvina Bank and the larger Eximbank. Firstvina is a joint venture of Vietcombank and a Korean bank. Eximbank is a joint stock company. Neither played a leading role subsequently in the creation of the card market. 7.  Ha, “Banks Attempting to Collect ATM Fee, for the Fourth Time.” 8.  State Bank of Vietnam, Annual Report 2007, p. 43. At http://www.polymernotes.org/annual_reports/VNM_2007.pdf. Last accessed on September 4, 2013. 9. Decision 3113/QD-NHNN, on the promulgation of the Development Plan of Unified Card Switching Center, December 31, 2007. 10. Directive 05/2007/CT-NHNN, on the salary payment through account to those who receive salary from the state budget, dated October 11, 2007, in accordance with Directive 20/2007/CT-TTg of the Prime Minister, dated August 24, 2007. See also Truitt, “Banking on the Middle Class in Ho Chi Minh City.” 11.  State Bank of Vietnam, Annual Report 2010, p. 33. At http://www.econo mica.vn/Portals/0/MauBieu/e56d07de44e75d10f6f116f9bda98179.PDF. Last accessed on September 4, 2013. In 2003, when we suggested the introduction of salary accounts for state employees, the governor of SBV was very skeptical that Hanoi

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would be able to enforce such a law. At that time, the general expectation was that Vietnam would join the WTO in 2005, two years before it actually happened. 12.  Vietcombank Securities, “Vietnam Banking Sector Report,” p. 8. Data are from VBCA. 13.  Tordesillas, “Half of Vietnam’s ATM Cards Remain Unused, Says VBCA.” 14.  Vietcombank Securities, “Vietnam Banking Sector Report,” p. 18. 15.  “Local Cardholders Still Use Cards for Cash Withdrawal,” VietNamNet Bridge, January 2, 2012. At http://english.vietnamnet.vn/en/business/18244/business -in-brief-1–2.html. Last accessed on March 18, 2012. 16.  “Banks Try to Slash Costs by Streamlining ATM System,” VietNamNet Bridge, March 23, 2012. At http://english.vietnamnet.vn/fms/business/20076/banks -try-to-slash-costs-by-streamlining-atm-system.html. Last accessed on September 4, 2013. 17.  Phong, “In Vietnam, Card Holders Bear 17 Kinds of Fees.” 18.  State Bank of Vietnam, 2010, 2011 Annual Reports. 19. Decree 10/2010/ND-CP, on credit information-related activities. 20. ”Overview.” UnionPay. At http://en.unionpay.com/comInstr/aboutUs/ file_4912292.html. Last accessed on September 4, 2013. 21.  Lu, Fung and Jiang, “Market Structure and Profitability of Chinese Commercial Banks.” 22.  Worthington, “Entering the Market for Financial Services in Transitional Economies”; Worthington and Deng, “Payment Cards in China.” 23.  Chen, “Payment System Developments in the People’s Republic of China”; Feng, Yong daikuan xiangshou jinsheng, quoted in Perkins, “The Credit Card Market in Mainland China.” 24.  “New Type of Credit Card Issued in Beijing,” Business Daily Update, December 16, 2003; Worthington and Deng, “Payment Cards in China,” p. 1549. 25. In 1994, 54 percent of the Chinese labor force employed in agriculture and 60 percent of state employees worked at small and medium-size enterprises (see Cao, Qian and Weingast, “From Federalism, Chinese Style, to Privatization, Chinese Style.” In contrast, in Russia in 1992, 82 percent of the workforce were employees of large enterprises (Gimpelson and Lippoldt, The Russian Labour Market). 26.  “Non-Income Factors Drive Chinese Consumption,” Cards International, November 20, 2003, p. 7. 27.  “Credit Card Business in China Faces Cultural and Financial Hurdles,” China Business Insider, May 28, 2002, p. 6. 28.  Lawrence, “Charging Ahead,”; “China Anticipates Vast Cards Growth,” Cards International, March 31, 2003, p. 33; Wei, “Plastic Kingdom.” 29.  China Daily, March 27, 2002. 30.  See the UnionPay corporate website at http://en.unionpay.com/comInstr/ brands/file_4600165.html. Last accessed on September 4, 2013. Compare to the meanings attributed to the logo colors used by Visa and MasterCard. On Visa cards the blue stands for the sky and the gold is a reference to the golden state, Califor-

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nia, where Visa originated. The red on MasterCard cards represents vitality and the ochre-gold stands for prosperity. 31.  “Central Bank Urges Non-Cash Payment,” Shenzhen Daily/Agencies, January 24, 2006. At http://www.chinadaily.com.cn/english/doc/2006-01/24/content _514994.htm. Last accessed on September 7, 2013. 32.  Consultation request by the Office of Ron Kirk, US Trade Representative, September 2010. At http://www.ustr.gov/webfm_send/2287. Last accessed on September 4, 2013. 33.  “Culture Clash for Chinese Cards,” Cards International, September 24, 2004. 34.  Although an EU regulation fixes the interchange fee (typically a large part of the merchant discount) at 0.2 or 0.3 percent, in Russia and Ukraine it can be as high as 3 percent. 35.  ”Fees Need Explanation.” China Daily, July 8, 2006. 36.  Lee, “Visa, MasterCard to Compete in—but Not with—China.” 37.  China Standard, August 13, 2008. 38.  UnionPay web site at http://en.unionpay.com/comInstr/aboutUs/file_501 74738.html. Last accessed on September 4, 2013. 39.  “China’s Banks Tighten Credit Card Policies,” China Daily, August 31, 2009. At http://www.chinadaily.com.cn/bizchina/2009-08/31/content_8979572.htm. Last accessed on September 4, 2013. 40.  ”Paying on the ‘Never-Never’ Skyrockets,” China Daily USA, March 18, 2013. At http://usa.chinadaily.com.cn/business/2013-03/18/content_16315802.htm. Last accessed on September 4, 2013. 41.  Visa claims to have issued about 1.9 billion cards worldwide by September 30, 2011, and 2.1 billion by March 2013, significantly fewer than did UnionPay. Visa statistics are from Visa’s corporate website, at http://corporate.visa.com/about-visa/ our-business/global-presence.shtml. Last accessed on September 4, 2013. 42.  Banking Automation Bulletin 291, August 2011, at http://www.rbrlondon.com /reports/b291_cards.pdf. Last accessed on September 4, 2013. 43.  South China Morning Post, September 17, 2010. 44.  South China Morning Post, June 4, 2010. 45.  Freedman, “U.S. WTO Case Against China ‘Major Reason’ for Citibank Nod.” 46.  India too is building its own national brand, called Rupay. The soon-to-be launched Rupay card will be integrated into India’s national ID program. Aadhaar, the Unique Identification Authority of India, will provide every resident with an identification number after undergoing fingerprint, facial-recognition and iris scans. The Rupay card will be linked to this identification number. Transactions will be authorized with the ID number and the fingerprint (Chibber, “India Payments Card Tied to ID Program”). Brazil opted for the opposite path. It decided to abandon its largest domestic brand, Cheque Eletrônico, in 2005. Now its market is more than 90 percent dominated by Visa and MasterCard (Central Bank of Brazil, “Report on the Brazilian Payment Card Industry,” p. 3).

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47.  Yong, “Economic Security.” For an overview, see Yeung, “China in the Era of Globalization.” 48.  Ye, “Financial Opening and Financial Security,” p. 565. 49.  O’Neil, “Debate Heightens Sense of Xenophobia.” 50.  At http://en.unionpay.com/comInstr/aboutUs/file_4912292.html. Last accessed on September 4, 2013. 51.  “Paying on the ‘Never-Never’ Skyrockets.” 52.  “China’s Banks Tighten Credit Card Policies.” 53.  Wu, “Encourage Spending, not Saving.“ 54.  Xu and Liu, “Consumer Credit Risk Management in an Emergent Market,” p. 87. 55.  Perkins, “The Credit Card Market in Mainland China”; “Visa & MasterCard Bank Cards in Asia/Pacific—2004.” With the modernization of the banking sector, the era of Chinese entrepreneurs using Visa credit cards to pay for their firms’ industrial deliveries in order to bypass the slow interbank clearing system has come to an end. 56.  Von Emloh and Wang, “In Pursuit of the Great Spenders.” 57.  Zhao, “Zhongguo geren xinyong zhidu jianshe de xiangzhuang, wenti yu zhengce jianyi.” 58.  “Credit Cards for Civil Servants to Spur Transparency,” Shanghai Daily, December 21, 2005. Reprinted by Xinhua News Agency. At http://news.xinhuanet. com/english/2005–12/21/content_3949965.htm. Last accessed on April 30, 2012. 59.  “China’s Banks Tighten Credit Card Policies.” 60.  “China’s Banks Tighten Credit Card Policies.” 61.  From a government study cited in “Business: Korea Goes Bust,” Newsweek, May 7, 2004. At http://www.thedailybeast.com/newsweek/2004/03/07/business ­-korea-goes-bust.html. Last accessed on September 4, 2013. 62.  Wei and Chien, “Chinese Learn Credit Card Perils the Hard Way.” 63.  “China’s Banks Tighten Credit Card Policies.” 64.  Karmin, “China Prods Its Consumers to Use Plastic.” 65. “2.4 Billion Bank Cards Issued in China,” People’s Daily Online, November 26, 2010. At http://english.people.com.cn/90001/90778/90859/7212439.html. Last accessed on September 4, 2013. 66.  Zhao, “Zhongguo geren xinyong zhidu jianshe de xiangzhuang, wenti yu zhengce jianyi”; “Overdraft Plagues Card Industry,” SinoCast, November 24, 2005. 67.  “China—Prospects for a Role on the International Stage—Liu Mingkang, Chairman and President of Bank of China, Talks to The Banker About Prospects for Banking Following China’s Accession to the World Trade Organization,” The Banker, June 1, 2002. We have not been able to confirm how widely and systematically blacklists were used in China or how up-to-date they were. 68.  Shen and Yan, “Development of Consumer Credit in China.” 69.  ”Private Credit Information Available,” China Internet Information Center,

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http://arabic.china.org.cn/english/2000/Aug/1252.htm. Last accessed on September 4, 2014. 70.  “China UnionPay to Share Bad Records of Bank Card Holders,” SinoCast China Business Daily News, February 24, 2004. 71.  Zhang and Smyth, “An Emerging Credit-Reporting System in China.” 72.  “Consumer Credit Database Established,” China Daily, January 17, 2006. 73.  PBC CRC also had information on 18.4 million enterprises, of which 8.8 had a credit record. These figures were reported by Cuiling Zhou, a manager in the Consumer Credit Reporting Department of PBC CRC, in her presentation “Credit Information Database in China” at the 4th Credit Reporting and Risk Management Training in Kuala Lumpur, November 2012, organized by the International Finance Corporation. 74. Since 2006, the PBC CRC has developed a consumer credit score called the China Score with the help of the Chinese Academy of Sciences and Fair Isaac Corporation (FICO), but it is yet to be implemented. 75.  Jentzsch, “An Economic Analysis of China’s Credit Information Monopoly.” 76.  China Financial Stability Report 2010, People’s Bank of China, p. 129. At http://www.pbc.gov.cn/publish/english/955/2010/20100917102952632398099 /20100917102952632398099_.html. Last accessed on September 4, 2013. 77.  China Financial Stability Report 2011, People’s Bank of China, p. 109. At http://www.pbc.gov.cn/image_public/UserFiles/english/upload/File/China%20 ­Financial%20Stability%20Report%202011.pdf. Last accessed on September 4, 2013. 78.  UnionPay also collects transaction data and mines it for various purposes. For instance, on the basis of the records of its urban cardholders, it periodically publishes a consumer confidence report. 79.  ”Xie Yu Credit Rule to Guard Personal Privacy,” China Daily, October 14, 2009.

chapter eight 1.  Thompson, “Shops Dial Up ‘Mobile Money’ Plan.” 2.  Federal Reserve System, “The 2010 Federal Reserve Payments Study.” 3.  Nilson Report 985(December 2010):10. 4.  For a review of the literature, see Guillén, “Is Globalization Civilizing, Destructive or Feeble?” 5. Ritzer, Expressing America. 6. Ritzer, Expressing America, pp. 152–153. See also Ritzer, The McDonaldization Thesis; and Ritzer and Melone, “Globalization Theory.” 7. Watson, Golden Arches East. 8.  Evans and Schmalensee, Paying with Plastic, pp. 59–60; Mann, Charging Ahead, pp. 117–118. 9.  Our approach is similar to what Haydu, in “Making Use of the Past,” calls sequences of problem solving.

notes to chapter eight

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10.  Krippner, Granovetter, Block, Biggart, Beamish, and others, “Polanyi Symposium,” p. 112. 11.  Beckert, “The Social Order of Markets,” p. 264. See also Gemici, “Uncertainty, the Problem of Order, and Markets”; and Beckert, “The ‘Social Order of Markets’ Approach.” 12.  See the Safari.com web site, at http://www.safaricom.co.ke. According to the Economist, 25 percent of Kenya’s GNP flows through M-Pesa (“Why Does Kenya Lead the World in Mobile Money?” May 27, 2013, at http://www.economist.com/ blogs/economist-explains/2013/05/economist-explains-18).

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Index

Page numbers followed by f or t indicate figures or tables, respectively. Aadhaar, the Unique Identification Authority of India, 288n46 Adverse selection, 78–79, 81, 88, 276n6, 276n11, 280n40. See also Information asymmetry Asia Commercial Bank, 206, 209, 213 Agribank (or VBARD, Vietnam Bank for Agricultural and Rural Development), 36, 205, 210, 215 Agricultural Bank of China, 216 AIG (American International Group), 272n31 American Express, 56, 69; logo, 73 ANSI (American National Standards Institute), 70, 274n12 Antitrust, 70, 115–16 ANZ, 209 ARB (Association of Russian Banks), 284n57, 285n58 Associated Credit Bureaus, Inc., 89 ATM (automated teller machine), 62, 98; in Bulgaria, 158; in China, 220; and fraud, 105; and inconvenience, 108–9, 210–11; in Russia, 163; standards, 70; in Vietnam, 207–8, 209, 211; withdrawal, 151. See also Cash; Cooperation ATM card, 70, 208, 212; in Czech Republic, 103; in Hungary, 101; in Poland, 99, 104; in Vietnam, 210. See also Cards Auchan (supermarket), 154 Automated decision making, 129, 131–32,

143, 182, 240, 280n45. See also Data privacy/protection Avtobank (Russia), 160 BalkanBank (Bulgaria), 158 BankAmericard program, 69–70 Bank associations, 33, 51, 69–70, 190, 200, 252tA1.1; in Czech Republic, 100, 104; Hungarian, 142; Polish, 100, 104, 145; Ukrainian, 195, 285n62 Bank Austria Creditanstalt, 272n31 Bank of China, 216 Bank Holding Company Act, 277n24 Bank Inicjatyw Gospodarczych (Poland), 99, 104 Banknetvn, 209, 211 Bank Pekao (Poland), 35, 99, 104, 145–46 Bank Pocztowy (Poland), 217n22 Bankruptcy, personal, 13, 22, 198, 225; protection, 149 Bankservice, 159 BAR (Bankközi Adós- és Hitelinformációs Rendszer, Hungary), 141, 142 Beckert, Jens, 244 Bellamy, Edward, Looking Backward: 2000–1887, 66, 155 Beryozka, 278n2 BGZ (Bank Gospodarki Ẓywnościowej), 37 BIDV (Bank of Investment and Development, Vietnam), 206, 209 BIK (Biuro Informacji Kredytowej S.A.), 133, 135, 145, 148 311

312

index

Billa (supermarket), 154 Biochim, Commerical Bank, 272n31 Blacklist, 82–85; and data privacy, 141–46; and delinquency, 148; formal, 188–90; involuntary, 148 Bloomingdale, Alfred, 66 BNB (Bulgarian National Bank), 158–59 Borica, 158–59, 200, 222, 234, 252tA1.1 Brazil, 288–89n46 Budapest Bank, 102 Bulbank, 36, 272n31 Bulgarian Post Bank, 272n31 BZ WBK (Bank Zachodni Wielkopolski Bank Kredytowy), 38, 40 California Bankcard Association, 69–70 Callon, Michel, 16 Card associations, 69–70, 209, 251; Czech, 100, 103, 106; Ukrainian (EMA), 157, 188–90; Vietnamese (VBCA), 206, 210 Cards: in Bulgaria, 158–59; in Central Europe, 98–106, 116–18; in China, 224–26; competing with cash, 56–57, 61; credit, 3, 66–71, 94–95; debit, 15, 117–19, 208–9; and elites, 121–24; and marketing, 10, 119–21, 138–41, 182, 224–25; and risk management, 138–41, 144, 176–77, 240; in Russia, 159–64; standardized, 70; in Ukraine, 164–68; in Vietnam, 212–14. See also ATM card; Card technology; Chip cards; Domestic cards; MasterCard; Visa Cards Stakeholder Group, 116 Card technology, 54, 106, 162, 236, 282n25; card size, 2, 274n12; and fraud, 105; magnetic stripe, 62–64, 70, 167; prepaid, 268n15; Russian, 163, 166; smart cards, 160, 162, 282n25; standardized, 115. See also Chip cards Cash, 108–9; anonymity of, 107; and ATM, 19; as impediment to cards, 152–57; and salary cards, 161, 199; in socialism, 33–34; switching to cards, 61, 64, 166–68 CBA (Czech Bankcard Association), 103–4 CCB (Czech Credit Bureau), 144 CCR (Central Credit Registry, Bulgaria), 196 CEMEA (Central Europe, Middle East and Africa), 269n24

Center of Financial Technologies, Russia, 160 Cetelem, 268n15 Charga-Plate, 68–69 Charge Account Bankers Association, 69 Cheque Eletrônico, 288–89n46 China Banking Regulatory Commission, 225 China Chain Store and Franchise Association, 219 China Construction Bank, 38, 216 Chip cards, 63–64, 110, 115, 269n24, 275n16; microchip, 64, 158; in Russia, 163, 166; in Ukraine, 167 CIC (Credit Information Center), 214–15 CIS (Commonwealth of Independent States), 269n24 CIS List of Delinquent Borrowers (Common Information System for Registering Delinquent Borrowers), 190 Citibank, Citigroup, 90, 222; in China, 220; in Russia, 185 Co-branded, 107–8, 158–59, 163, 173. See also Logo Coercion, 15, 155, 219; of cardholders, 72, 73, 153–54, 157, 167, 168, 211, 237; of information sharing by banks, 201; of merchants 200, 238; and value, 238. See also Salary projects; State mandating Collective action problem, 67; and limiting client’s liability, 109–10, 237 Competition, 9–11; and lenders, 82–84; and market transitions, 28–29, 242–43; and standardization, 113–16, 157–65 Competitive markets, 60, 116, 244 Consumer credit, 13; in Asia, 213, 223; aversion to, 120; in Central Europe, 91–92, 141, 186, 201; in China, 223; in Eastern Europe, 168–69, 201; in Russia, 186; and socialism, 32; in United States, 87–90, 119–20. See also Credit scoring Consumption/Consumerism: household, 45; and loan qualification, 184–87; as proxy for income, 201 Cooperation, 95, 236; and ATMs, 209– 11, 221; in Central Europe, 100–106, 116, 236, 242–45; in Russia, 41, 194; in Vietnam, 209. See also Information sharing

index COPAC (Chip Off-Line Pre-Authorized Card), 269n24 Corecom, 278n2 Corruption, 29, 32, 88, 123, 155, 224; bribes, 152, 155, 200, 269n21. See also Informal economy Court system, 12; to sanction nonpayers, 80, 93, 149, 197–98 Credit bureaus, 89–90; in Bulgaria, 196; in China, 226–29, 252tA1.1; in Czech Republic, 141, 144; full-reporting, 142–48; in Poland, 145; in Russia, 193–96, 285n58; trust in, 191, 192; in Ukraine, 191–95, 285n62; in Vietnam, 216 Credit cooperatives: in Asia/rural, 36, 205–6, 214, 227; in Central Europe, 145 Credit Data Corporation, 89 Credit registry: in Bulgaria, 196; in China, 227–29; in Czech Republic, 127–28; and data privacy, 95–96; in Hungary, 142–44; and information sharing, 214; in Poland, 136, 145; in Vietnam, 215 Credit reporting: in Central Europe, 141–46; in China, 226–28; in Eastern Europe, 190, 201; in United States, 89–90 Credit scoring, 90; automated, 129, 131, 182; “gray zones” of, 133–34; legalities of, 131–32, 142–45; models, 135–38; prescreening, 90, 190. See also Risk CRIF, 215, 285n58 Critical mass, 58–9, 64, 153, 238; and Diners Club, 67–68 Croatia, 40, 146 ČS (Čzech Savings Bank), 35, 37, 38, 40, 103–4; and privatization of, 146 ČSOB (Československá obchodní banka, Czech Republic), 37, 40, 104, 144 Cultural Revolution (China), 204 CUP (China UnionPay Company), 218–19 Currency convertibility, 103, 104, 110–11 Czech Credit Bureau a.s., 144 Czech National Bank, 144 Data privacy/protection, 240, 247, 280n52; in China, 228–29; in EU, 131, 142, 144–46, 150. See also Blacklist; Credit registry

313

Debt collection, 80, 146–49, 197, 199, 238n38 Deltabank (Russia), 173 Diners Club: corporation, 56; creation of, 14, 65–69; standards, 70 Domestic cards: in China, 218–21; in Czech Republic, 98, 103–4; in Hungary, 97, 101–3; in Poland, 99, 104; in Russia, 159–64; in Ukraine, 164–68; in Vietnam, 206–12. See also Cards Domestic card networks: in Hungary, 103; in Russia, 160–64 Dragon Card, 216 DSK (Darzhavna spestovna kasa, State Savings Bank, Bulgaria), 36–38, 41, 146, 191 Dunabank (Hungary), 97–99, 101 Duna Credit Card, 97, 98 Duopoly, 74, 165 Eastern States Bankcard Association, 70 Economics, economic theory, 4–7, 16, 21, 53, 244–45, 267n5, 267n6, 267n7, 269n25 EFG, 272n31 Elites: in Asia, 42, 50; and “democratization” of cards, 19, 94; in Russia, 161; in Vietnam, 204. See also Prestige; Status; VIP EMA (Ukrainian Interbank Payment Systems Member Association), 157, 188–90 Embeddedness, 7, 244 EMV (Europay, MasterCard and Visa), 113 EPC (European Payment Council), 112–16 Equal Credit Opportunity Act of 1974, 131 Equifax, 89, 285n58 Erste Group (Austria), 40, 144 EuroLine, 282n22 European Commissioner for Competition, 115, 274n10 European Economic Area, 279n20 European Union (EU): data protection in, 132, 142, 144–46, 150; European Payment Council, 112–13; regulations, 109. See also Single Euro Payment Area (SEPA); Standardization Eurosystem, 114–15, 279n26

314

index

Evans, David S., xvi, 240 Eximbank, 286n6 Experian Interfax Credit Bureau (or Experian), 89, 129, 180, 190, 285n58 Express Bank (Bulgaria), 272n31 Externalities, 7, 267n7; network, 64 Fair Isaac Corporation (FICO), 129, 290n74 Financial crisis: Asian of 1997, 211; Bulgarian of 1996, 34, 41; and effects on Hungary, 143, 146; global of 2008, 17, 143, 146, 187; Russian of 1998, 163, 164, 269n24; South Korean credit card crisis of 2003, 269n21 Finansbank (Russia), 187 First Private Bank (Bulgaria), 158 Firstvina Bank, 286n6 Florida National Bank, 69 Foreign investment/capital, 13, 22, 23, 39, 52, 71, 222, 235; in Asia, 204 Foreign-owned: banks, 38–41, 159, 229; retail chains, 107, 154 France, 143 Fraud: electronic monitoring of, 147; fighting, 110, 252tA1.1; merchant, 189–90; security department verification, 177–78; and standardization, 105–6. See also ATM; Blacklists; Card technology Free riding, 191 Friendship Store, 278n2 Functional rules, 4–7, 244; and market transition, 28–29 GBC (GIRO BankCard), 102–3 GE Capital Multiservis, 268n15 Generative rules, 4–7, 11, 244; and twosided markets, 59 Germany, 82, 125, 129 Ghana, 269n24 Glass-Steagall Act of 1933, 89 Globalization, 2, 11, 87, 204, 232, 234, 239–42 Gramm-Leach-Bliley Financial Services Modernization Act of 1999, 277n27 Gray income, 183–84, 186–87 Great Wall Card, 216 Halyk Bank, 271n21 Hayek, Friedrich, 29, 267n7 Hammurabi, 87

Ho Chi Minh City (Saigon) (Vietnam), 36, 252tA1.1; banking system, 74, 206–7, 214; inflation, 205; urbanites in, 50, 205 Home Credit and Finance, 187, 194, 285n59 Honors list, 82, 84 Horizon, 269n24 HSBC (bank), 209 Hu Jintao, 223 Hungarian Bank Association, see Bank associations Hungarian National Bank, 103, 122 ICBC (Industrial and Commercial Bank of China), 216 Ideal type, 12–13; American card as, 232. See also Performative ideal type; Weber, Max IFC (International Finance Corporation), 215 IKEA, 173 IMF (International Monetary Fund), 41, 150, 196 Incombank (Russia), 160 India, 114, 139; and Rupay, 288–89n46 Infocredit, 285n58 Informal economy, 47, 57, 153–57, 183, 286n21 Information asymmetry, 76, 78–79, 81–82, 88; and communism, 91–92; and issuing cards to elites, 121–23; and postcommunism, 93–94; and screening, 126–27, 129 Information sharing, 82, 84–85, 194; and credit registry, 214; and phone, 193, 227; state mandates in China, 227–29; state mandates in Hungary, 143; state mandates in Russia, 193–95; state mandates in Ukraine, 191, 195; state mandates in Vietnam, 214–14; in United States, 89, 95; and World Bank, 232. See also Credit registry; Honors list Inflation, 47, 48f2.6a,b, 50; in Asia, 205; hyperinflation, 47, 57; in Russia, 160; and World War I, 82 Insurance, 126, 271n19, 277n27; deposit insurance, 13, 22; and information asymmetry, 276n6; insurance company, 9, 121, 124, 173, 285n62 Interbank Card Association, 70 IPB (Investiční a poštovní banka, Czech Republic), 40, 271n22

index ISO/IEC (International Organization for Standardization/International Electrotechnical Commission), 274n12 IT (information technology), 23, 117, 159, 162, 252tA1.1 JCB (Japan Credit Bureau), 113, 223 Jin Sui Card, 216 K&H bank (Kereskedelmi és Hitelbank, Hungary), 37, 38 Kashtan, 278n2 Kenya Posts and Telecommunications Corporation, 246 Komerční bank, 37, 40 Konsolidační Banka, 40 Konsumex, 278n2 Kornai, János, 30 Kredobank (Russia), 159 Krippner, Greta, 244 Lake Balaton (Hungary), 73, 107 Law on Cooperation, 41 Legacies: of communism, 13, 31–34, 72–73, 95; socialist, 13, 72, 153 Legitimacy: of blacklists, 189; and mechanization, 240 Lewis Tappan’s Mercantile Agency, 89, 277n22 Logo, 73; and co-branding, 121; colors of, 219, 288n30; international, 165, 213, 219, 234; Visa and MasterCard, 98, 99, 103, 164 Mann, Ronald J., 240–41 Market building, 30, 236, 241–42 Market concentration: in Bulgaria, 260–61f2.4a-c; in China, 265f2.7a,b; in Czech Republic, 256–57f2.1a-c; in Hungary, 257–58f2.2a-c; market, 141, 255; in Poland, 259–60f 2.3a-c; in Russia, 262–63f2.5a-c; in Ukraine, 263–64f2.6a-c; in Vietnam, 266f2.8a,b Market expansion, 86–87, 240; and elites, 94 Market failure, 7, 78, 267–68n7 Market origination, 85, 87, 90 Market transition: debate, 28–31; postcommunist 242; and privatization, 28–30, 39–42, 93. See also Competition; Functional rules

315

Mass issue, 233 MasterCard: in Bulgaria, 158; in China, 216; in Czech Republic, 98, 104; in Hungary, 102, 103, 107; and membership, 56; origins of, 70; in Poland, 99, 104; resistance to, 115, 154; in Russia, 159, 160–61, 163; in Ukraine, 165, 167; in Vietnam, 206 MasterCard-Europay, 158–59, 164 Master Charge, 70 McDonald’s, McDonaldization, 2, 239–40 McFadden-Pepper Act of 1927, 89–90, 277n25 McNamara, Frank X., 65, 66, 68, 72 Mechanization of credit, 135, 150, 239–40 Member Service Provider, see Ukrcard Midwest Card Group, 70 MKB (Magyar Kereskedelmi Bank, Hungary), 37 Monobank, 32, 35–36, 39–40, 51 Mopet, 247 Moral hazard, 78–79, 88, 237, 276n6. See also Information asymmetry M-Pesa, 246, 291n12 Mobile payments, 166–67, 205, 246–47. See also Phone Multiservis, 268n15 MUZO, 104, 278n5 NBCH (National Bureau of Credit Histories), 195, 285n58 Neoliberal, neoliberalism, 28, 31 New Economic Model, Bulgaria, 26 Nilson Report, 254, 277n29 Nocera, Joseph, 14 NSMEP (National System of Mass Electronic Payments), 165–67, 201 Nyúl, Hungary, 278n1 OECD (Organisation for Economic Cooperation and Development), 27 Off-line authorization, 269n24 Oligopolistic, 114 Olympic Games, 73, 159 OptimumCard, 160 Orbis, 99 Oshchadbank (Ukraine), 36, 191 OTP (Országos Takarékpénztár, National Savings Bank, Hungary), 35, 39; and ATM cards, 101–2; and information

316

index

sharing, 146; and salary cards, 112; and World Bank, 102–3 Outsourcing, 52, 129 Paternalism, 93; employer, 13, 72, 92, 153 Path dependency, 64, 164, 167, 267n4 PBC (People’s Bank of China), 215, 226–28 PBC CRC (PBC Credit Reference Center, China), 227–29 PCB Investment Joint Stock Company, 215 Peony Card, 216 Perestroika, 26 Performative ideal type, 16, 232, 239. See also Ideal type; Weber, Max Personal data, 93, 132; Law on, 144 Pewex, 99 Phone, 12, 205, 216; and authorization, 117, 147, 156; companies in marketing alliance with card companies, 121; and information sharing, 193, 227; to manage account, 166–67; as means of screening, 177–78, 185; as payment instrument, 9, 166–67, 205, 231, 246–47 Plastic card market, 14 PKO (Powszechna Kasa Oszczȩdności, General Savings Bank, Poland), 35, 38, 40; and data sharing, 150 Point system, 176, 178–82, 283n42. See also Prescreening PolCard, 104, 149, 234 POS (point-of-sale) terminal, 62–64; in China, 218, 220; in Eastern Europe, 156–58, 162–63; in Hungary, 107; “terminalization,” 167; in Vietnam, 207, 209, 211 Posta Bank (Hungary), 271n22 Postal banks, 40, 271n22 Pravex, 173 Prescreening, 90, 170, 178, 190 Prestige: of cards, 61, 68; and elites, 122, 124. See also Elites; Status; VIPs PrivatBank (Ukraine), 165, 167, 191 Privatization, 28–30, 159; in Europe, 38–42. See also Market transition Protestantism, 87, 92, 120 Puritanism, 92 Putin, Vladimir, 163 QWERTY, 63

Rational behavior, 6–9, 47–49; of lenders, 78, 83, 141 Recovery score, 148 Relational banking, 125–26 RIA News, 155 Riegle-Neal Act of 1994, 277n27 Risk, no-risk lending, 33–34; calculable, and statistical scoring, 129–38, 136, 140–41, 143, 178–82; and valuation, 76–79, 137, 238 Risk management, 138–41, 144, 176–77, 240 Ritzer, George, 239 Romania, 146 Rupay, 288n46 Rural Credit Cooperatives (China), 36 Russkiy Standart, 173, 182, 187, 194, 285n58, 285n59 RWKB (Rada Wydawców Kart Bankowych, Bank Card Issuers Board, Poland), 104 Sacombank (Vietnam), 209 Safari.com, 246–47 Salary projects, 71–73, 92–93; in Asia, 208, 217; in Eastern Europe, 153, 161, 171, 173, 181; salary cards, 72, 112, 153, 161, 177, 199 Sberbank, 36–38, 159, 165 Sbercart, 160, 163, 282n25 SBS-Agro Bank, 160 SBV (State Bank of Vietnam), 209–11, 214–15 SCF (SEPA Card Framework), 113–15 Schmalensee, Richard, 240 SCT (SEPA Credit Transfer), 279n22 SDD (SEPA direct debit), 279n22 Security department (in Russia and Ukraine), 176–77, 187–88, 190, 197– 98, 283n33, 283n38, 283n39 Self-interested behavior, 9, 11; and privatization, 29. See also Rational behavior SEPA (Single Euro Payments Area), 112–16, 150, 159 Service Center of Mobile Payments (Ukraine), 166 Shanghai Credit Company, 226 Shenzhen (China), 219, 226 Shevchenko, Olga 186 Shortages, in socialist economies, 31–33, 57 Siberian Trade Bank (Russia), 160

index siloviki, 177, 283n39 Silpo (supermarket), 156 SIM (Subscriber Identity Module) card, 246 Simmons, Matty, 67 Slovenská sporitel’ňa (Slovak Savings Bank), 35 Smart cards, 160, 162, 282n25 Smartlink (Vietnam), 209 SOCB (state-owned commercial banks): in China, 215–16; in Vietnam, 206, 209 Société Générale, 272n31 Social networks, 32, 68, 223, 278n37; face-to-face, 139–40; informal network among banks, 106, 187, 190, 214; and personal ties, 94, 123, 170, 171, 184. See also Elites; Status Social order, 8–12, 230 South Korea, 9; and credit card crisis, 225 Standardization, 64, 69–70, 116, 157; in Central Europe, 101–5; and data protection, 146; and electronic payments, 112; in EU, 113–16; and postcommunism, 73; and two-sided markets, 64; in United States, 69; and World Bank, 102. See also Card technology; Competition; Fraud; Two-sided markets State employees, 72, 155; civil servants, 124, 207, 224 State mandating: of card acceptance in Bulgaria, 156, 199–200; of card acceptance in Russia, 155, 199–201, 238; of card acceptance in Ukraine, 154, 156–57, 167, 199–201, 238; of card issuing in China, 217, 238; of card issuing in Hungary, 112; of card issuing in Russia 153–55; of card issuing in Ukraine, 153, 166–67; of card issuing in Vietnam, 210; of chip technology in EU, 275n16; of information sharing in China, 227–29; of information sharing in Hungary, 143; of information sharing in Russia, 193; of information sharing in Ukraine, 191, 195 Status, 97–98, 175, 179; cards as symbols of, 97–98, 161, 216; socioeconomic, 174, 185; and VIPs, 170–72. See also Elites; Prestige; VIPs STB Card, 160, 163 Stolichny Bank (Russia), 160

317

Surveillance/monitoring: by banks, 107– 8, 128, 240; electronic, 147, 189 Swedbank, 285n62 Sweden, 233, see IKEA Széchenyi card (Hungary), 233 Tappan, Lewis, 89, 277n22 Taxes: avoidance of, 107, 151–53, 161, 183–84, 211; and the state, 28, 45 Tourism: in Central Europe, 73, 106–7; tourists, 73, 104, 106, 111, 206–7; travel, 65, 67, 121, 159–61, 212. See also Visa TouristSportBank (Bulgaria), 158 Transcard, 268n15, 282n22, 284n56 TransUnion credit bureau, 89 Trust, 7, 8, 10, 97, 99; in bank personnel, 178; among banks, 188, 205; in banks, 37, 52, 71, 111, 169, 205, 236; in cardholders/clients, 76, 122, 123, 124, 174, 177, 179; in credit bureaus, 191, 192; and credit scoring, 132–33; and stolen cards, 109 Tuzex, 99 Two-sided markets, 57–59; and Diners Club, 66, 68; and standardization, 101, 157; and valuation, 54 UK/Britain, 143 Ukrainian Interbank Payment Systems Member Association, see EMA Ukrainian National Bank, 37–38, 156–57, 181; and blacklists, 190; and card promotion, 166–67 Ukrcard, 165–66 Ukrposhta (National Post Office, Ukraine), 166 Uncertainty: and coordination, 9; and information asymmetry, 76, 78–79, 92, 243; in lending, 76–79, 85–87, 92–93; of loan repayment, 4, 75, 225; of novelty, 85, 248; and social change, 46–49, 51 UniCredit Group, Italian, 144, 272n31 Union Card, 160, 163 UnionPay, 73, 218–20, 222–23; in Russia, 236 United Bulgarian Bank, 272n31 United Russian Payment System, 163 Universal card, in Russia, 160 Valuation, 10, 244; and information

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index

asymmetry, 76; and two-sided markets, 54 VBCA (Vietnam Bank Card Association), 206 Vietcombank (Vietnam), 36; and cardholders, 212; and cooperation, 209; and tourists, 206 Vietinbank (Industrial and Commercial Bank, Vietnam), 206, 210 VIP, 170–72, 191–92, 213–14; lists, 94, 123–25. See also Elites; Prestige; Status Visa: in Bulgaria, 158; in China, 216, 218, 219, 220; and COPAC, 269n24; in Czech Republic, 98, 104; in Hungary, 102, 103, 107; and membership, 56; origins of, 69–70; as performative ideal type, 232; in Poland, 99, 104; resistance to, 115, 154; and rivals, 223; in Russia, 159, 160–61, 163; and tourists, 73, 206; in Ukraine, 165, 167; in Vietnam, 206 Vneshekonombank (Russia), 159, 164 VTsIOM, 183, 186

Watson, James L. 240 Weber, Max, 16, 245. See also Ideal type Welfare benefits: reduction of, 44, 45, 51; used to build card networks, 72, 199, 233 Western States Bankcard Association, 70 Western Union, 32, 65 World Bank: and Banking Modernization Project, 206; and GIRO Bank Card, 102–3; and information sharing, 232; and infrastructure in Hungary, 102–3; and interbank sharing, 232; International Finance Corporation (IFC), as part of, 215; on issuing credit, 190; and Lawrence Summers, 270n5 World Trade Organization (WTO), 27; and China, 218, 220; and Vietnam, 204, 209–10, 214–15 Zhirinovsky, Vladimir, 155 Zivnostenská Banka (Hungary), 98–99 Zolotaya Korona (Russia), 160, 163