How small are the banking sectors in central and Eastern European countries really?

Abstract

PurposeThe purpose of this paper is to present an analysis of the size of the banking sectors in central and Eastern European (CEE) countries. The banking sectors' ability is focused to provide financial intermediation between savers and investors in the economy.Design/methodology/approachThe existing literature on banking in transition economies argues in unison that banking sectors in CEE countries are too small and do not provide sufficient levels of financial intermediation. In this paper, a common drawback of the existing measures used to indicate the size of CEE banking sectors is detected: they all relate the volume of bank intermediation to gross domestic product (GDP). It is argued that since transition economies have a low stock of financial wealth relative to economic activity, a more objective measure of the size of the banking sector is the ratio of bank assets to a proxy of the stock of financial wealth rather than to GDP.FindingsThere is evidence that the estimation of the size of the banking sectors relative to GDP produce downward biased measures for the ability of CEE banks to intermediate available financial resources. When the size of the banking sector is measured relative to financial wealth, the gap between the developed European Union banking systems and those of the CEE countries is not as severe as argued in studies based on the traditional approach of measuring the size of the banking system with respect to GDP.Practical implicationsUsing the downward biased measure of financial system development to stress the underdevelopment of the financial intermediation in CEE may produce misleading policy recommendations, e.g. recommendations in the direction of rapid financial system expansion by lowering barriers of entry for new banks. The authors' new measure presents an alternative that should be considered by policy makers in the design of measures promoting financial system development.Originality/valueThe paper challenges the existing consensus on severe underdevelopment of the CEE banking sectors. It presents a new approach of accessing financial system development in emerging economies.