One result of ignoring the true messiness of the transition from a command to a market economy is that governments are sometimes offered flawed policy recommendations and conclusions that are at odds with reality. Here is a framework for reflecting on certain features of bank behavior during the transition from a command to a market economy—and on public policy interventions for the sector often advocated by the International Monetary Fund, the World Bank, and other donor agencies.
The economic transition from a command to a market economy is a complex, messy process, during which the incentives of economic agents may be significantly different from incentives familiar to Western economies. As a result, attempts to transplant Western institutional and regulatory norms of good practice into transition economies may produce disappointing, even counterproductive, results.
Roe, Siegelbaum, and King show some specific characteristics of transition economies that are likely to have an impact on bank behavior and safety. They argue that these characteristics do not inevitably fade away as the transition proceeds; indeed, they may endure for an extended period.
This being so, Roe, Siegelbaum, and King propose a simple analytical framework designed to shed light on the characteristics of the banking sector during the transition. This framework relies on familiar theories of asymmetric information and the potential advantages banks have in mitigating both the adverse risk and moral hazard associated with imperfect information.
This framework suggests that the safety of an individual bank (and by extension the system) depends on three factors that evolve significantly during the transition:
Among their many conclusions:
Their analysis helps to account for several paradoxes observed in transition banking systems, including the relatively long-term survival of banks which by any objective standard are insolvent.
This paper is a product of Ukraine/Belarus Country Unit, Europe and Central Asia Region. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Diana Cortijo, room H2-023, telephone 202-458-4005, fax 202-477-3288, Internet address dcortijo@worldbank.org. The authors may be contacted at aroe@worldbank.org or psiegelbaum@worldbank.org. (55 pages)
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