Bank Restructuring and Soft Budget Constraints in Financial Transition
This paper analyses in a formal model the problem of achieving financial discipline in a transitional economy with bank-intermediated finance. Even if banks have no intrinsic interest in refinancing unprofitable firms, they may still exploit the softness of government. By gambling for government bailouts, banks contribute to softening the budget constraints of enterprises. We show that the poor quality of loan portfolios, the absence of collateral and low bank capitalization are key elements explaining soft budget constraints and repeated bank bailouts in transitional economies. Bank reserves help in hardening budget constraints, but high initial levels of capitalization are necessary to mitigate potential negative effects of a credit crunch for enterprises. We show that the trade-off between hardness and enterprise liquidity is more severe when loan portfolios are of poor quality. A similar trade-off arises if a bank invests in screening or monitoring projects to improve the quality of portfolios. Under certain conditions the government should make capitalization contingent on banks investing in monitoring and screening in order to obtain hard budget constraints rather than to let banks use reserves for such investments. We further show that transfers of all non-performing loans to a separate institution, a hospital agency, is never optimal, whereas partial transfers may serve to harden budget constraints.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
|Date of creation:||Nov 1995|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
|Order Information:|| Email: |
When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:1250. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.