Report on the Paper:
Eastern Europe's Experience with Banking Reform by Alfredo Thorne

September, 1993, pp 959-1000

Thomas Jared Denslow

Reforming the banking system is essential to the economic transition in Eastern Europe. This, like the efforts at privatization, has been a formidable task. In Romania, the process has been especially slow. Although in recent months, the government has shown more willingness to implement the needed measures. In his article in the JOURNAL OF BANKING AND FINANCE, Alfredo Thorne describes the current crisis in Romania's banking sector, relating it to the policies of the former communist regime and suggesting possible remedies to insure macro and micro economic stability.

The place of banks in communist Romania was negligible. The three types of banks, commerce, savings and specialty, had merely passive roles in the economy, conducting business only in the manner outlined by the central planners. Thorne points out the obvious and fundamental problem of adjustment from the former system to a market economy, but, in addition to the transitional conundrum, financial considerations also pose a significant threat to the solvency and future of banking in Romania. Among these problems is the tremendous amount of non-performing loans, in some cases amounting to half of a bank's portfolio and constituting more than 34% of all bank's portfolios.

Under the former regime, bank's were forced to make loans to loss-making enterprises, a policy which now is undermining the financial stability of the whole country. The situation was worsened by the fact that banks had no control over the enterprises that were indebted to them because privatization lagged and the rules for bankruptcy in these situations, or any for that matter, was unclear. The government has since guaranteed 90% of these loans but has been reluctant to make good on its offer.

Despite the weak financial position of the banks, most have made some, if small, profits over the last two years. However, the fundamental problems independence, inefficiency, and regulation. Thorne discusses these issues and places their roots in policies of the pre-reform era. The lack of regulation is an obvious problem, he states, but there is not an easy solution. Proper regulations are difficult to devise but even more difficult implement when the objects of the regulations cannot yet function in them. The problem of sequencing, then, leads Thorne to his next issue, that being efficiency.

First, knowledgeable managers with the proper incentives are essential. This fact, however obvious, provides no solutions when the managerial pool is deficient even in the basics of market economics. Incentives, Thorne argues, is the best way to distill the best financial managers who are so important. But the ability of managers win such incentives is contingent upon their being able to do just that, perform.

Under the former system independence was impossible, and that fact persists today because of the overly interdependent nature of the Romanian economy. The network of "good ole boys" and real financial obligation negates any attempt at market-style management. Thorne therefore suggests that privatization of the banks is essential to the reform process.

In all three of his major points, Thorne is correct. Indeed, the Romania government has recently taken steps to privatize the existing banks and adequately regulate the new ones. Previously, the state-run banks, in order to accommodate the wishes of their owners, the state, continued to make loans to failing state enterprises. The most detrimental result of this activity was that new business was crowded out of the credit market. To fill the void, new banks have begun to spring up in Romania. The number of banks in Romania has increased from ten to twenty-six in the last three years.(1) The emergence of these new and possibly unstable banks poses a new and dangerous threat to the economic future of the country. Reacting to pressure from the liberal opposition in parliament, Pres. Iliescu has recently initiated a program to privatize the largest of the state banks.

This his a helpful step forward, but Romania is now paying the price of its gradualist approach to economic transformation, only doing now and in a piece-meal fashion what should have been done four years ago.

  • (1) Eremia,M.1994. "Romanian Big Bank in Private Hands Next Year".THE REUTER EUROPEAN BUSINESS REPORT.Nov.7,1994



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