Financial Sector Development in Southeast Europe — The Roles of EU Accession and Basel II

Abstract

Recent research has stressed the importance and strength of the link between financial sector development and economic growth in most countries (Levine et al. 2000; Wachtel 2001; Berger, Hasan and Klapper 2003). However, the connection seems empirically weak in transition countries (Berglof and Bolton 2002) and Southeast Europe (SEE). Indicators of banking system development, such as credit to the private sector as a percentage of GDP, have deteriorated as economic growth has improved (Mehl and Winkler 2002). This paradox is probably more apparent than real. Transition countries necessarily had to “clean up” portfolios of bad assets accumulated under communism and the first years of transition in order to stabilise their financial systems and their economies. Thus, it is reasonable to presume that, as in most countries, further economic development in SEE requires further financial development. Even if financial sector development may not have a big impact on growth, due to various other factors impeding business expansion, sensible financial sector policies and further progress in financial development should minimise the likelihood of financial sector instability that could damage growth. Two external factors influence policy issues relating to financial development: the EU accession process and the Basel II Accord. The approach taken by the SEE countries to these policy issues is discussed here in the broader context of how these countries can achieve the desired goals of financial development and economic growth in general. Of course, the SEE countries are economically and politically heterogeneous: there certainly is no one-size-fits-all approach to the issues raised here. The basic themes of this paper are two-fold. First, progress towards EU accession should bring greater political stability to SEE countries and raise investor