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. Last Updated: 07/27/2016

Where the EBRD Leads, Investors Follow

One would expect a private equity firm that posted annual returns of 39 percent over three years, net of fees, to pay large bonuses. It would probably have palatial offices as well. But the private equity firm in question, the European Bank for Reconstruction and Development, is owned by the public sector. It has made these returns while helping former communist countries adopt a market economy. Its success should therefore be celebrated.

The overriding message in the bank's latest transition report is "mission accomplished." The central European countries it was set up to assist, including Poland and Hungary, are now full-fledged members of the European Union. The market can provide sufficient debt and equity for growth. The EBRD's job is done.

That job should not be understated in retrospect. In the early days, the United States was highly skeptical of a French project. But the bank has invested where others would not and created whole new markets. In private equity, for example, EBRD investments as a "fund of funds" have led to a new sub-sector of the buyout business focused on Central and Eastern Europe.

But now that subsidized finance is no longer needed in Central Europe, the bank has to decide what to do next. Its answer is to look south and east, to Russia, the Balkans, Central Asia and the Caucasus. It is a good policy. There is no room for another multilateral lender in Europe. But there are plenty of places where the EBRD can make use of its unique skills.

Investing further eastward will bring new challenges. Mongolia is a long way from the EBRD's headquarters in London. One option is more air miles and a new set of hotels for London-based bankers. But a better alternative is to shift jobs from London and put people on the ground. The bank recently opened an office in Georgia.

Another problem is costs. In Poland, with a relatively wealthy population of 38 million, $10 million deals are easy to come by. But in Kyrgyzstan, with a much poorer population of 5 million, the average deal size is lower. A banker's time, however, costs exactly the same.

The bank will therefore have to find ways to control costs. One route is to invest via local institutions: lending. Employing local staff will help. The EBRD may also want to hire more bankers from Central European countries who have experience of a transition economy and are still not paid at London or New York levels.

Fifteen years ago, when the Iron Curtain came down, it was hard to turn a profit in Central Europe. Now, where the bank leads other investors will follow. Just look at the mouthwatering returns from investing early.

This comment appeared as an editorial in the Financial Times.