Banking in Transition Economies: Does Efficiency Require Instability?

Posted: 25 Aug 1998

See all articles by Gary B. Gorton

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Andrew Winton

University of Minnesota - Twin Cities - Carlson School of Management; Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Abstract

Efficient banks are essential for capitalist economies, yet bank failures result in costly externalities, leading to a potential conflict between the risk choices of private agents that own banks and socially optimal choices. This conflict is particularly severe in transition economies. Evidence suggests that these economies have banking systems which are both prone to failure and inefficiently small; established banks suffer from an overhang of bad loans, and implicit subsidies often favor continued lending to inefficient state-owned enterprises (SOEs). If a regulator seeks to impose higher capital standards to reduce the odds of bank failure, privately-held banks may instead exit the industry, shrinking a system that is already inefficiently small. If loans to SOEs are subsidized so as to mitigate repercussions from their failure to workers and to banks, established banks may prefer such loans over riskier unsubsidized loans to entrepreneurial firms. Encouraging entry into banking may mitigate this problem, but the new banks will be quite risky and prone to failure. The upshot is that, in transition economies, achieving an efficient banking system is likely to require significant instability.

JEL Classification: G21, P21

Suggested Citation

Gorton, Gary B. and Winton, Andrew, Banking in Transition Economies: Does Efficiency Require Instability?. Journal of Money, Credit, and Banking, Vol. 30, No. 3, Part 2 (August 1998). Available at SSRN: https://ssrn.com/abstract=118548

Gary B. Gorton (Contact Author)

Yale School of Management ( email )

165 Whitney Ave
P.O. Box 208200
New haven, CT 06511
United States

HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yale University - Yale Program on Financial Stability

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States

Andrew Winton

University of Minnesota - Twin Cities - Carlson School of Management ( email )

321 19th Avenue South
Department of Finance
Minneapolis, MN 55455
United States
612-624-0589 (Phone)
612-626-1335 (Fax)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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