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Banking reform in transition countries

  • Claessens, Stijn

In reforming the financial sector in transition economies, one important debate is whether governments should try to reform existing state-owned banks (the rehabilitation approach) or whether a new private banking system should be allowed to emerge (a new entry approach). Or should there be a mix of the two approaches, in which the state bank activities are restricted while a parallel private banking system develops? The authors'cross-country comparison of banks'institutional development in 25 transitional economies suggests that progress can be faster under the new entry approach, especiallyrelative to initial conditions. Progress under the rehabilitation approach appears to be inhibited by poor incentives. In most countries, even those with a good banking infrastructure and a large segment of good banks, a two track process has evolved, with differences between weak and strong banks. Weak banks have moved little beyond central planning. Regression estimates suggest that slow progress of weak banks is associated with: cover concentration, government preferential treatment, and limited new banks entry. The causality direction is often unclear. Policies and structural conditions can affect bank quality. The role of banks will remain limited in many transition economies due to weak legal infrastructures, much uncertainty and inside information, and problems associated with highly leveraged financial intermediaries - including fraud, political interference, and implicit guarantees. In the short run, self-finance and intermediation among enterprises and through nonbank financial institutions may prevail.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1642.

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Date of creation: 31 Aug 1996
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Handle: RePEc:wbk:wbrwps:1642
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  1. Franklin Allen & Douglas Gale, 1994. "A welfare comparison of intermediaries and financial markets in Germany and the U.S," Working Papers 95-3, Federal Reserve Bank of Philadelphia.
  2. Demirguc-Kunt, Ash & Levine, Ross, 1996. "Stock Market Development and Financial Intermediaries: Stylized Facts," World Bank Economic Review, World Bank Group, vol. 10(2), pages 291-321, May.
  3. Ronald I. McKinnon, 1991. "Financial Control in the Transition from Classical Socialism to a Market Economy," Journal of Economic Perspectives, American Economic Association, vol. 5(4), pages 107-122, Fall.
  4. Dimsdale, Nicholas & Prevezer, Martha (ed.), 1994. "Capital Markets and Corporate Governance," OUP Catalogue, Oxford University Press, number 9780198287889.
  5. Caprio, Gerard Jr. & Summers, Lawrence H., 1993. "Finance and its reform : beyond laissez-faire," Policy Research Working Paper Series 1171, The World Bank.
  6. Gerard Caprio, Jr., 1995. "The role of financial intermediaries in transitional economies," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 42(1), pages 257-302, June.
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