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Financial reform lessons and strategies


  • Caprio Jr, Gerard
  • Atiyas, Izak
  • Hanson, James


The argument in favor of gradual - but sustained - financial reform is based on two factors. First, the development of borrower net worth will determine the health of the real and, ultimately, the financial sector. Thus, speeding up reforms when borrower net worth is subject to positive shocks - or slowing them when it is subject to negative shocks - appears sensible and appears to have worked better in practice. Second, the initial conditions of the banking sector - not just its net worth but its stock of human capital, the initial portfolio mix, and the internal incentive systems - will also determine the success of any reforms. Thus the speed of financial reform must be related to these conditions: rapid reform with unskilled bankers, unbalanced portfolios, and perverse"bank cultures"is a sure recipe for financial crisis. Of course, political factors can present unique opportunities to point an economy rapidly and permanently toward a more market-based system. And these opportunities should be seized. But where possible, financial reforms should consider links to the real sector and institutional development. The case for gradual reforms is not one for inaction, as the conclusions of this study suggest that financial reform is worth the effort and that, with due attention to the institutional environment, the lessons can be applied elsewhere. Authorities can do much to increase the market orientation of their financial system, with all its benefits, even without a big bang. They can eliminate the grossest interest subsidies, move toward market financing of government debt, and raise deposit rates at least to only slightly negativeor modestly positive levels, paying attention to budget realities. In several countries, authorities ended modest financial repression early in their reform efforts, while still retaining some controls. Of those that moved fastest on interest rate deregulation, Indonesia and New Zealand met most of the foregoing conditions, with some uncertainty about the health of the banks at the point of deregulation. But in both cases banks had a window of a few years before new entry was permitted, allowing them time to adjust before competition intensified. Caution regarding entry helped to limit the reduction in the franchise value of bank licenses, especially given the limitations on supervisory skills. And in both cases, deregulation coincided with falling world interest rates. Although an eclectic approach to financial reform is more difficult to manage than one of immediate, complete deregulation, it appears borne out by the country cases and the theoretical approaches reviewed here.

Suggested Citation

  • Caprio Jr, Gerard & Atiyas, Izak & Hanson, James, 1993. "Financial reform lessons and strategies," Policy Research Working Paper Series 1107, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1107

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    References listed on IDEAS

    1. Gelb, Alan H., 1989. "Financial policies, growth, and efficiency," Policy Research Working Paper Series 202, The World Bank.
    2. Caprio, Gerard Jr. & Levine, Ross, 1992. "Reforming finance in transitional socialist economies : avoiding the path from shell money to shell games," Policy Research Working Paper Series 898, The World Bank.
    3. Masahiko Aoki, 2013. "Toward an Economic Model of the Japanese Firm," Chapters,in: Comparative Institutional Analysis, chapter 18, pages 315-341 Edward Elgar Publishing.
    4. Caprio, Gerard, 1992. "Policy uncertainty, information asymmetries, and financial intermediation," Policy Research Working Paper Series 853, The World Bank.
    5. Caprio, Gerard, Jr & Levine, Ross, 1994. "Reforming Finance in Transitional Socialist Economies," World Bank Research Observer, World Bank Group, vol. 9(1), pages 1-24, January.
    6. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
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    Cited by:

    1. Isard, Peter & Mathieson, Donald J. & Rojas-Suarez, Liliana, 1996. "A framework for the analysis of financial reforms and the cost of official safety nets," Journal of Development Economics, Elsevier, vol. 50(1), pages 25-79, June.
    2. Deabes, Tosson, 2005. "The middle way between flexible and fixed exchange rates," MPRA Paper 1992, University Library of Munich, Germany.
    3. Visser, Hans & Herpt, Ingmar van, 1994. "Financial liberalization and financial fragility : the experiences of Chile and Indonesia compared," Serie Research Memoranda 0056, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.


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