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Lessons from the Russian Meltdown: The Economics of Soft Legal Constraints

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  • Enrico Perotti

Abstract

On August 17, 1998, Russia defaulted on its domestic public debt, declared a moratorium on the private banks' foreign liabilities, which was equivalent to an outright default, and abandoned its exchange rate regime. The depth of the Russian meltdown shocked the international markets, and precipitated a period of serious financial instability. It is important to understand the roots of such a crisis to learn about possible lessons on both issues of bank supervision and international stability. While the visible cause of the crisis was an unsustainable fiscal deficit couples with massive capital flight, the critical question concerns the origin of such circumstances. This paper argues that the structure of individual incentives in the Russian legal context, compounded by the exceptional support granted by international institutions to Russia, explains the cycle of nonpayment, capital flight and fiscal unbalances leading to the dramatic 1998 crisis. We offer an interpretative model of noncompliance, cash-stripping and rational collective nonpayment, which led to the fiscal and banking crisis and ultimately to a complete meltdown. In our view, the banking sector was already insolvent prior to the crisis, and contributed directly and indirectly to it. The last section of the paper puts forward a radical medium-term policy proposal for a stable banking and payment system for Russia. Russia needs to create a basic foundation for savings and intermediation by asset restrictions and market segmentation, crude but effective rules used in all underdeveloped systems to restrain asset stripping and opportunism. Concretely, we propose a cautious extension of deposit insurance away from the monopolistic Sberbank and towards a narrow banking layer. The proposal also proposes to restore charter value in the commercial banking sector.

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  • Enrico Perotti, 2001. "Lessons from the Russian Meltdown: The Economics of Soft Legal Constraints," William Davidson Institute Working Papers Series 379, William Davidson Institute at the University of Michigan.
  • Handle: RePEc:wdi:papers:2001-379
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    References listed on IDEAS

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    1. Berglof, Erik & Roland, Gerard, 1998. "Soft Budget Constraints and Banking in Transition Economies," Journal of Comparative Economics, Elsevier, vol. 26(1), pages 18-40, March.
    2. Katharina Pistor & Martin Raiser & Stanislaw Gelfer, 2000. "Law and Finance in Transition Economies," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 8(2), pages 325-368, July.
    3. Marin, Dalia & Schnitzer, Monika, 2005. "Disorganization and financial collapse," European Economic Review, Elsevier, vol. 49(2), pages 387-408, February.
    4. Franco Modigliani & Enrico Perotti, 2000. "Security Markets versus Bank Finance: Legal Enforcement and Investors' Protection," International Review of Finance, International Review of Finance Ltd., vol. 1(2), pages 81-96.
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    Cited by:

    1. Perotti, Enrico C & Volpin, Paolo, 2004. "Lobbying on Entry," CEPR Discussion Papers 4519, C.E.P.R. Discussion Papers.
    2. Karas, Alexei & Pyle, William & Schoors, Koen, 2006. "Sophisticated discipline in a nascent deposit market : evidence from post-communist Russia," BOFIT Discussion Papers 13/2006, Bank of Finland, Institute for Economies in Transition.
    3. Dalia Marin & Haizhou Huang & Chenggang Xu, 2004. "Financial Crisis, Economic Recovery and Banking Development in Russia, Ukraine, and Other FSU Countries," IMF Working Papers 04/105, International Monetary Fund.
    4. Perotti, Enrico C. & Suarez, Javier, 2002. "Last bank standing: What do I gain if you fail?," European Economic Review, Elsevier, vol. 46(9), pages 1599-1622, October.
    5. Enrico Perotti & Marcel Vorage, 2010. "Bank Ownership and Financial Stability," Tinbergen Institute Discussion Papers 10-022/2, Tinbergen Institute, revised 11 Sep 2010.
    6. Alexei Karas & Koen Schoors & Laurent Weill, 2010. "Are private banks more efficient than public banks?," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 18(1), pages 209-244, January.
    7. Simplice A., Asongu, 2011. "Finance and inequality: exploring pro-poor investment channels in Africa," MPRA Paper 34994, University Library of Munich, Germany.
    8. Berglof, Erik & Claessens, Stijn, 2004. "Enforcement and Corporate Governance," Policy Research Working Paper Series 3409, The World Bank.
    9. Simplice A. Asongu, 2013. "Investment And Inequality In Africa: Which Financial Channels Are Good For The Poor?," The African Finance Journal, Africagrowth Institute, vol. 15(2), pages 43-65.
    10. S. CLAEYS & G. LANINE & K. SCHOORs, 2005. "Bank Supervision Russian Style: Rules vs Enforcement and Tacit Objectives," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 05/307, Ghent University, Faculty of Economics and Business Administration.
    11. Alexei Karas & William Pyle & Koen Schoors, 2010. "How do Russian depositors discipline their banks? Evidence of a backward bending deposit supply function," Oxford Economic Papers, Oxford University Press, vol. 62(1), pages 36-61, January.
    12. Claessens, Stijn & Perotti, Enrico, 2007. "Finance and inequality: Channels and evidence," Journal of Comparative Economics, Elsevier, vol. 35(4), pages 748-773, December.
    13. Enrico Perotti & Paolo Volpin, 2007. "Investor Protection and Entry," Tinbergen Institute Discussion Papers 07-006/2, Tinbergen Institute.
    14. Huang, Haizhou & Marin, Dalia & Xu, Chenggang, 2004. "Financial Crisis, Economic Recovery, and Banking Development in Russia, and other FSU Countries," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 79, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    15. Arnaud Bourgain & Patrice Pieretti & Skerdilajda Zanaj, 2009. "International Financial competition and bank risk-taking in emerging economies," CREA Discussion Paper Series 09-08, Center for Research in Economic Analysis, University of Luxembourg.
    16. Pieter H.M. RUYS & Jan BRUIL & Henry DIX, 2007. "Modes Of Governance In The Dutch Social Housing Sector," Annals of Public and Cooperative Economics, Wiley Blackwell, vol. 78(3), pages 381-413, September.
    17. Claeys, Sophie & Lanine, Gleb & Schoors, Koen, 2005. "Bank supervision Russian style : rules versus enforcement and tacit objectives," BOFIT Discussion Papers 10/2005, Bank of Finland, Institute for Economies in Transition.
    18. Marin, Dalia & Huang, Haizhou & Xu, Chenggang, 2002. "Financial Crisis, Economic Recovery and Banking Development in Former Soviet Union Economies," Discussion Papers in Economics 27, University of Munich, Department of Economics.
    19. Abdur Chowdhury, 2003. "Banking Reform In Russia: A Window Of Opportunity?," William Davidson Institute Working Papers Series 2003-601, William Davidson Institute at the University of Michigan.
    20. A. Karas & K. Schoors & G. Lanine, 2008. "Liquidity matters: Evidence from the Russian interbank market," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 08/520, Ghent University, Faculty of Economics and Business Administration.
    21. Simplice Asongu & Vanessa Tchamyou, 2015. "Inequality, Finance and Pro-Poor Investment in Africa," Working Papers 15/052, African Governance and Development Institute..
    22. Ruys, P.H.M., 2005. "The Governance of Services," Discussion Paper 2005-024, Tilburg University, Tilburg Law and Economic Center.
    23. Abdur Chowdhury, 2003. "Banking reform in russia: winds of change?," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 6(2), pages 89-103.
    24. Huong Dang, 2014. "How dimensions of national culture and institutional characteristics influence sovereign rating migration dynamics," ZenTra Working Papers in Transnational Studies 42 / 2014, ZenTra - Center for Transnational Studies.
    25. Perotti,Enrico C., 2004. "State ownership - a residual role?," Policy Research Working Paper Series 3407, The World Bank.

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