Bank Governance and Financial Stability in CESEE: A Review of the Literature

This article explores the interrelationship between bank governance and financial stability in general and in the ten Central, Eastern and Southeastern European EU Member States (CESEE MS) in particular. Agency theory is used to illustrate that banks are engaged in multiple agency relationships. Within a conceptual framework, five main dimensions of bank governance are identified and analyzed, namely internal, external, corporate, institutional and international governance. Based on the pertinent literature, we subsequently review the agency problems the CESEE MS faced in their banking sectors on their way to installing efficient and sound banking systems in the 1990s. Their experience holds important lessons for the completion of banking reform in less advanced transition economies. Most importantly, banking sector restructuring should go hand in hand with a redesign of the incentive structures for all the relevant actors in the system. This seems to be a prerequisite for achieving and maintaining financial stability and improving the efficiency of capital allocation and economic growth prospects. Overall, the CESEE MS experience also provides useful insights for dealing with the ramifications of the current global financial crisis.