Comment on Banking in Transition Economies: Does Efficiency Require Instability

Abstract

Transition economies have been a very interesting laboratory of financial reform. While obviously some differences existed among these economies at the start of transition, there was, in terms of financial sector development, much commonality. Under central planning, banks were the passive recipients of household savings, since bank deposits were often the only asset households could hold. Banks were mere accounting agencies, keeping track of the financial transactions that resulted from planned allocations. Normal banking skills, including risk management, project screening and selection, and a diversified menu of instruments to attract savers, were absent. The other components of a financial system were rudimentary, and in most countries nonbank finance simply did not exist. Initially, one bank performed all lending. Early attempts at market reform in most countries saw this divided into a two-tier system, comprising one central bank and a number of commercial banks, often specialized by sector. But this had very little effect on banks' behavior. Since then, transition economies have pursued quite different financial reform paths, and have adopted and experimented with a range of reform approaches for the financial sector, with, at least at face value, quite different outcomes. There is thus potentially much to be learned from the outcomes for financial reform in these countries and in general. So far, much of the learning has been done without the benefit of an analytical model. This paper is therefore very useful as it can help provide this and thus guide the analysis of outcomes and further policy making. The paper is one of the first attempts to apply some of the recent models of financial intermediation for developed countries to transition economies and as such it provides much insight. My comments on the paper are in three parts: the description of the banking systems and reform in transition economies; the model, its assumptions, and applicability to transition economies; and the lessons for policy and empirical work. The descriptive part of the paper provides useful background for the issues at hand. It provides the macroeconomic, financial, and institutional development context in which financial reform took place. It highlights the unique linkages between enterprise restructuring and financial reform in transition economies, and the large differences in macroeconomic developments among countries since the onset of transition.