Banking Reform and Development in Transition Economies

While development of sound, market oriented banking systems is fundamental to the transition, bank intermediation remains stunted after a decade or more of reform. This paper examines the impact of banking reform and other factors on banking development in transition economies at both the aggregate level and that of individual banks. A unique contribution of the paper is the analysis of a new panel data set of 515 banks in 16 transition economies for the years 1994-99. The analyses show that progress in banking reform is sine qua non of banking development. However, even where banking reforms have advanced with liberalisation of interest rates and development of prudential regulation and supervision, the real expansion of bank loans has failed to keep pace with output growth. There is significant evidence that foreign-owned banks and those with higher capital-asset ratios are expanding more rapidly than have other banks and that the larger, more dominant institutions are growing more slowly. However, privatised and ab initio private banks have expanded at about the same rate of state-owned banks. This result contrasts sharply with evidence on influence of ownership on the performance for non-financial enterprises in transition economies. Taken together, the findings point to the need for policies that can strengthen supply response of banks to progress in banking reforms. These measures include the more effective regulation of the entry and exit of banks, improvements in their corporate governance and removal of obstacles to foreign entry.