Banks, capital markets, and corporate governance : lessons from Russia for Eastern Europe

The financial sector should be active in enterprise restructuring in the transitional economies, and should help channel resources to the private sector. What will best help the sector achieve these tasks: gradual reform or radical reform? Liberalization and privatization are the most urgent tasks transitional economies face. But for market reform to succeed, reforms of banking and capital markets must keep pace with enterprise reform and privatization. Central and Eastern Europe have pursued a gradual approach to financial reform, splitting the former state bank (or monobank) into a central bank and several large state-owned commercial banks, eventually to be privatized. Russia has taken a more radical approach, creating many new private commercial banks that have already taken over most of the business from state banks. The reform of banks and capital markets in transitional economies should not be modeled too closely on patterns in western economies, with their large institutions, complex financial instruments, and extensive regulation. A simpler process in required, compressing in a short period the historical development of financial systems - starting with small banks and accepting imperfect regulation and supervision as a fact of life. Systemic risks remain manageable if financial institutions are small and numerous enough. A system with many private banks is more likely to produce a financial sector that plays an active role in enterprise restructuring, channels resources to the private sector, and thus accelerates restructuring and economic growth. Historical comparisons confirm the benefits of such a liberal, weakly regulated banking system.