Financial Sector Development in Transition Economies: Lessons from the First Decade

Abstract

Broadly speaking, the role of the financial sector in all economies is to channel resources from primary savers to investment projects. The importance of this financial sector role has received much attention in the recent literature on economic growth. A strong consensus has emerged in the last decade that well-functioning financial intermediaries have a significant impact on economic growth. Modern economies have a wide range of market-oriented institutions for facilitating this process. In planned economies, this process was conducted by administrative arrangements and there were few market-oriented elements of the financial sector. The only ubiquitous financial institutions in the pretransition planned economies were banks, which acted as recordkeepers for the planning process and payment agents among state entities rather than as financial intermediaries. Although these banks had the appearances of real banks, they did not function as banks would in a market-oriented economy. Thus, the first step in the transition process for the financial sector is the development of market-oriented financial sector institutions. Given the unique problem faced by the financial sectors in formerly planned economies, many observers expected that the transition process would extend over many years. In fact, many transition economies have made remarkable process in the first decade of transition. Although financial sectors are far from perfect, the elements of market-oriented intermediation are already the rule rather than the exception throughout the transition world. Although banks are the most visible and often the dominant financial sector institutions, they are only one part of the process of financial intermediation. Financing arrangements that allocate resources in a market economy fall along a broad and long continuum. Financing starts with the entrepreneur, who collects the savings of friends and family, and extends to the large firm that raises capital in a variety of ways, ranging from the issuance of publicly traded