The politics of bank ownership and currency policies in Central and Eastern Europe

This paper argues that state-owned, private domestic, and foreign banks have different preferences for exchange rate policies. More specifically, I posit that governments will be less willing and able to maintain fixed exchange rate arrangements in closed banking systems dominated by government-owned banks than in globalized banking systems with a large presence of foreign banks. The article’s principal claim rests on the notion that ownership structure of the banking system empowers different types of banks, affects their interests, and shapes the responsiveness of government politicians to bank demands. The bank ownership types further influence the stability of the domestic monetary system and financial regulation that are of paramount importance in the determination of exchange rate regimes. An empirical investigation of data on exchange rate regimes for 25 Central and Eastern European countries provides strong support for the theory. The results are robust to alternative estimation techniques, instrumental variable analysis, and the inclusion of several economic and political variables.