Financial Sector Reform and Banking Crises in the Baltic Countries
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Islam argues that externalities in financial markets, not the relevant question. T he question is instead implicit and explicit guarantees on financial transactions, whether there is reason to expect a significant weakening and information asymmetries in financial markets that of the currency, possibly as a result of a change in policy may exacerbate contagion provide a rationale for a stance. Large real exchange rate appreciations have been government role in managing the risk associated with among the main reasons for runs on currency; cross-border capital flows. Governments can macroeconomic policy needs to be aimed at managing complement private sector risk management with these. With a fixed exchange rate regime, :3exibility must measures that help deal with the volatility of capital be maintained elsewhere in the economy. Policymakers flows. These measures include those that control the type may need to make tradeoffs between price and output and volume of capital flows and those that help investors stability once market jitters have set in. There is no single make better investment decisions and that may reduce right answer to the question of which to emphasize more herding behavior, such as better information provision. at a given time; it depends on a country's circumstances. The main instruments that have been tried or recommended since the onset of the recent financial Risk management in the financial sector crises can be grouped in several categories. The health of the financial sector is relatec. to the government's fiscal position, its macroeconomic policies, Debt management and financial crises. The regulatory and supervisory The composition, maturity structure, and level of frameworks in developing countries need t:o be adapted external debt have played an important role in financial to the special features of these :narkets. Many developing crises. High short-term debt relative to liquid assets has countries are subject to frequert trade and capital been found to be consistently correlated with financial account shocks while lacking the means to deal with crises in recent times. Governments can affect the level these shocks, such as adequate insurance markets. This of debt (including private debt) and its composition, situation may call for policies t.lat not only affect the though the mix of policies they use will vary. Prudential incentives of lenders but also hi;ep manage risk more regulation in the financial sector, corporate sector directly. Examples of such policies include maturity and regulation, and restrictions on capital movements have liquidity requirements. all been used with varying success to change the level and composition of external debt. Information and transparency More disclosure of information and improvements in the Other nmacroeconomic policies quality of that information could reduce the volatility Most countries that have suffered macroeconomic crises that arises from herding beiIav or. Ex ante, they may also have had fixed exchange rate systems; some have not. have a b...
Islam argues that externalities in financial markets, not the relevant question. T he question is instead implicit and explicit guarantees on financial transactions, whether there is reason to expect a significant weakening and information asymmetries in financial markets that of the currency, possibly as a result of a change in policy may exacerbate contagion provide a rationale for a stance. Large real exchange rate appreciations have been government role in managing the risk associated with among the main reasons for runs on currency; cross-border capital flows. Governments can macroeconomic policy needs to be aimed at managing complement private sector risk management with these. With a fixed exchange rate regime, :3exibility must measures that help deal with the volatility of capital be maintained elsewhere in the economy. Policymakers flows. These measures include those that control the type may need to make tradeoffs between price and output and volume of capital flows and those that help investors stability once market jitters have set in. There is no single make better investment decisions and that may reduce right answer to the question of which to emphasize more herding behavior, such as better information provision. at a given time; it depends on a country's circumstances. The main instruments that have been tried or recommended since the onset of the recent financial Risk management in the financial sector crises can be grouped in several categories. The health of the financial sector is relatec. to the government's fiscal position, its macroeconomic policies, Debt management and financial crises. The regulatory and supervisory The composition, maturity structure, and level of frameworks in developing countries need t:o be adapted external debt have played an important role in financial to the special features of these :narkets. Many developing crises. High short-term debt relative to liquid assets has countries are subject to frequert trade and capital been found to be consistently correlated with financial account shocks while lacking the means to deal with crises in recent times. Governments can affect the level these shocks, such as adequate insurance markets. This of debt (including private debt) and its composition, situation may call for policies t.lat not only affect the though the mix of policies they use will vary. Prudential incentives of lenders but also hi;ep manage risk more regulation in the financial sector, corporate sector directly. Examples of such policies include maturity and regulation, and restrictions on capital movements have liquidity requirements. all been used with varying success to change the level and composition of external debt. Information and transparency More disclosure of information and improvements in the Other nmacroeconomic policies quality of that information could reduce the volatility Most countries that have suffered macroeconomic crises that arises from herding beiIav or. Ex ante, they may also have had fixed exchange rate systems; some have not. have a b...
Tang, Zoli, and Klytchnikova look at strategies for and low levels of intermediation. The Baltic states appear dealing with banking crises in 12 transition economies-to have struck a good balance, incurring modest fiscal five from Central and Eastern Europe (CEE): Bulgaria, costs while making their systems sounder and more the Czech Republic, Hungary, Macedonia, and Poland; efficient. the three Baltic states: Estonia, Latvia, and Lithuania;The findings suggest the following: and four countries from the Commonwealth of -Operational, financial, and institutional restructuring Independent States (CIS): Georgia, Kazakhstan, the should be undertaken in parallel. Kyrgyz Republic, and Ukraine.* Financial restructuring should involve adequate Three types of strategies were used to deal with the recapitalization to deter moral hazard and repeated crises. The CEE countries generally pursued extensive recapitalization. restructuring and recapitalizing of banks; most CIS * Operational restructuring should entail privatization countries pursued large-scale liquidation; and the Baltic to core investors (particularly to reputable foreign states generally pursued a combination of liquidation and banks). restructuring.* The enterprise problems underlying banking The strategy pursued reflected macroeconomic problems must also be addressed. conditions and the level of development in a country's e Fiscal costs were reduced when governments dealt banking sector. There were more new banks in the only with bad debt inherited from the socialist period; former Soviet Union (FSU-the CIS and Baltic states), when small banks that held few deposits were allowed to but they tended to be small, undercapitalized, and not fail, where the social costs of such failure were low; and deeply engaged in financial intermediation.when only banks that got into trouble because of The CEE countries generally incurred higher fiscal external shocks were rescued while those suffering from costs than the FSU countries but ended up with sounder, poor management were liquidated. more efficient banking systems, with many of the * The government, not the central bank, should recapitalized banks being privatized to strategic foreign undertake bank restructuring. Central bank refinancing is investors. The CIS countries pursued a less fiscally costly not transparent and could lead to hyperinflation. approach but have been left with weak banking systems This paper-a product of the Poverty Reduction and Economic Management Sector Unit, Europe and Central Asia Region-is part of a larger effort in the region to review lessons of experience in transition economies. Copies of the paper are available free from the World Bank,
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