The Baltics - Banking Crises Observed

44 Pages Posted: 20 Apr 2016

See all articles by Alex Fleming

Alex Fleming

World Bank - Europe and Central Asia Region

Lily Chu

World Bank - East Asia and Pacific Region

Marie H. R. Bakker

World Bank

Date Written: September 1, 1996

Abstract

Lessons learned from banking crises in three Baltic republics - crises that all developed in the context of simultaneous transition and adjustment, putting tremendous strain on banks and their enterprise borrowers.

Fleming, Chu, and Bakker compare the banking crises experienced in Estonia, Latvia, and Lithuania, examining the causes, effects, and policy responses. The starting point for the three banking systems was the same: They inherited the monobank system of the former Soviet Union, with specialized state banks serving specific branches of the economy. They quickly established a central bank at the core of their banking system. They were weak in bank management and lacked staffs with modern banking skills, and no system had an appropriate legal, regulatory, or supervisory framework governing the banks. In some instances fraud and corruption prevailed, encouraged by the relatively permissive regulatory and supervisory environment for banks that existed in the Baltics. All had to decide what to do with the remnants of the Soviet banking system at the same time that they encouraged the growth of the new private banking sector.

Estonia and Lithuania reconstituted the specialized Soviet banks as national state banks and began to privatize them. In some instances the state retains an ownership stake. In Lithuania the state may increase its ownership share as part of a rescue effort for some former state banks. Latvia, by contrast, reconstituted the savings bank, then privatized branches of the remaining banks. The residual branches were merged into one bank, rehabilitated, and then subject to formal privatization. The savings bank is now being privatized.

In the early stages the three private banking systems were similar and grew rapidly. All three have had liberal policies toward licensing new commercial banks, believing that more banks would generate the competition needed to drive down deposit and lending rates, and provide the capital needed to support the emerging private sector. Many new private banks were established by enterprises that wanted access to cheaper funding than was available from other banks. Little thought was given at first to the implications of this policy for banking safety and supervision.

The conclusions drawn by Fleming, Chu, and Bakker (in brief, below) may have implications for banking reform in the other former Soviet republics, especially the smaller ones:

Some banking distress is inevitable. Banking distress may be desirable. Banking crises die down relatively quickly. When crises arise, authorities should respond firmly and promptly. Corruption and weakness should never be rewarded. Banking crises should be prepared for. Supervisors should send strong signals to bankers about appropriate banking behavior.

This paper - a product of the Enterprise and Financial Sector Development Division, Europe and Central Asia, Country Department IV - is part of a larger effort in the region to distill the lessons of the first five years of transition.

Suggested Citation

Fleming, Alex and Chu, Lily and Bakker, Marie H. R., The Baltics - Banking Crises Observed (September 1, 1996). Available at SSRN: https://ssrn.com/abstract=614961

Alex Fleming (Contact Author)

World Bank - Europe and Central Asia Region

1818 H Street
Washington, DC 20433
United States

Lily Chu

World Bank - East Asia and Pacific Region

Washington, DC 20433
United States

Marie H. R. Bakker

World Bank

1818 H Street, N.W.
Washington, DC 20433
United States

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