Banking reform and development in transition economies

While development of sound, market-oriented banking systems is fundamental to the transition, bank intermediation remains stunted after a decade or more of reform. This paper examines the impact of banking and enterprise reforms and other factors on banking development in transition economies at both the aggregate level and that of individual banks. A unique contribution of the paper is the analysis of a new panel data set of 515 banks in 16 transition economies for the years 1994-99. The analyses show that progress in banking reform is the sine qua non of banking development. However, even where banking reforms have advanced, the real expansion of bank loans has failed to keep pace with output growth. There is significant evidence that privatised banks and those with higher capital-asset ratios are expanding more rapidly than state-owned banks and ab initio private banks. While foreignmajority ownership of a bank is associated with neither stronger nor weaker real growth in its customer loans, a greater presence of foreign banks in a banking system has a positive spillover effect in spurring the real expansion of loans. These results contrast with evidence from the transition economies of relatively strong growth performance by ab initio private and foreign-owned enterprises in the non-financial sectors. Taken together, the findings point to the need for policies that can strengthen supply response of banks to progress in banking and enterprise reforms. These measures include the more effective regulation of the entry and exit of banks, removal of obstacles to the expansion of foreign-owned banks and the transfer of technology and banking skills that expand access to finance, particularly by small and medium-sized enterprises.