The Baltics -- Banking Crises Observed

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 th...