February 1995 In Central and Eastern Europe, banks are less active than planned in enterprise restructuring. Corporate restructuring is not normally a major part of commercial banking -- to ask banks to restructure their weakest clients is to direct attention away from lending to their strongest clients, which should be their core business. Enterprises are thus being restructured not by banks or government agencies but by brutal market forces. Many countries in Central and Eastern Europe assigned banks the responsibility for restructuring enterprises. Such restructuring had five components: * Triage of enterprises into three classes: viable, viable with debt relief, and nonviable. * Work with management of overindebted firms on a restructuring plan beforegranting debt relief. * Trigger the bankruptcy-liquidation process on nonviable firms. * Fund new investments needed as part of physical restructuring. * Provide corporate governance through representation on boards of directors. The initial information is that banks are performing these roles only to a limited degree. Signals are mixed on how vigorously governments want banks to pursue bankruptcy proceedings. With little opportunity to recover funds, banks are accepting even dubious restructuring programs from enterprises. But banks, except under government directive, are avoiding making new loans to loss-making enterprises. Together with a cut in fiscal subsidies, this is imposing a harder budget constraint on the enterprises. Nonviable enterprises seem more likely to starve to death than to die through execution. Corporate restructuring is not a normal part of commercial banking. To ask banks to restructure weak enterprises is to direct their attention away from what should be their core business: lending to strong enterprises. In fact, banks are under attack for being excessively conservative. Enterprise restructuring is taking place in Central and Eastern Europe driven by the disintegration of regional trade relations, sharply higher input prices, falling domestic demand, inflation, and other economic dislocations in combination with the harder budget constraint. Thus far the restructuring has been more downsizing than making new investments. This paper -- a product of the Financial Sector Policy and Institutions Unit, Financial Sector Development Department -- is part of a larger effort in the department to study the role of banks in restructuring.