Financial markets in the Baltic States: fit for the EU?

The paper deals with the question whether banks in the Baltic States are in a position to exert a positive influence on enterprise performance. Effective, market-driven corporate governance by banks is discussed along the following four questions: are banks sound enough, large enough, strong enough, and skilled enough to have an impact on improving the efficiency of firms? Data on financial sector in the Baltics compared with other formerly communist Central European countries that signed associated agreements with the European Union (Bulgaria, Czechia, Hungary, Poland, Romania, Slovakia, and Slovenia) forms the basis of analysis. It is argued that the widespread banking crisis in the CE-10 is not a consequence of communist heritage any more, but of weak, slow, and sometimes contradictory policies of the post-communist governments. While 'bad debt' constitutes the banks' most visible problem, it is argued further that two other problems really endanger the reform processes not only of the financial sector in the Baltics, but of the entire reform countries' economies: firstly, the size of these financial markets is about equivalent to the rounding error of US financial statistics, causing an inherent volatility bomb. For investors, this implies diversification strategies, short-termism and risk-adjusted-ROI goals. For the respective regulators, this recommends co-ordination strategies for the various capital markets, and setting up financial markets that serve not only a small number of speculators but industry and population at large. Secondly, using a stakeholder approach it is argued that strong tendencies prevail for non-prudent banking. Therefore, supervisors, foreign investors and bankers should analyse the 'degrees of freedom' of local bank owners and bank managers by dependence analysis. For supervisors and regulators it is also important to consider the links between reliable corporate governance practices, foreign direct investment and the stability of the countries' currencies. The conclusion is drawn, that due to asymmetric information, small high-risk 'bubble' markets and uncertain bank privatization, capitalization and supervision, it is not easy to see how banks which have difficulties to manage themselves can exert a positive influence on the management of corporations and increase the efficiency of firms. However, even if the more general answer is negative, this does not imply that individual banks or financial institutions are not in a position to positively influence enterprise performance. © 1998 John Wiley & Sons, Ltd.