Regulating Banks in Central and Eastern Europe

Banks are crucial for the availability of credit in the economy. A well-capitalized and liquid banking system can provide citizens with affordable loans to buy a home or attend university and businesses with credit to invest in state-of-the-art technology or expand their business network. When a bank fails, however, the authorities need to step in and unwind the bank’s assets in an orderly manner to prevent a broader de stabilization of the country’s financial system. Moreover, most countries have a deposit guarantee fund that can be used to reimburse deposits in the failed bank, up to a stipulated limit. Even before the authorities have unwound the troubled bank, banking sector supervisors start investigating the reasons for the bank’s collapse. Often, they come across poor risk management practices within the bank and gaps in the country’s regulatory framework that allowed the large build-up of risks to begin with. In response, supervisors issue stricter guidelines and, depending on their legal competencies, patch up the legal gaps or signal to lawmakers the changes that need to be put in place.

Chapter 2 examines the economic reform path and bank privatization variables in my analysis. I reconstruct the path of banking sector reform in the four cases since the early 1990s. In particular, I discuss the timing of banking sector privatization and the extent to which foreign banks were allowed to enter the domestic market. We will return to these independent variables in Chapter 4, which analyzes the most important determinants of banking sector regulatory approach during the period of rapid credit growth in the region, 2000–2008.

During the period 2000–2007, Central and Eastern Europe was among the fastest growing regions in Europe (Lamine 2008; Bohle 2013; Myant et al 2013). The economic boom was most visible in the states that were well on track to join the EU such as Estonia, Hungary, and Slovenia. As their banking systems channeled foreign capital into the economy, more resources became available for consumer and business loans. Driven by high demand for new housing and office space, prices in the real-estate sector grew exponentially. Chapter 4 examines the variation in regulatory approaches adopted by banking sector supervisors in the four cases during this period of rapid credit growth. Drawing on an explaining-outcome process tracing approach (Beach and Pedersen 2013), I probe which of the four independent variables presented in Chapters 2 and 3 account for the observed regulatory approach in each case.

This book has investigated the choice of regulatory approach by banking sector supervisors in Central and Eastern Europe. Even though countries in the region received largely the same policy advice from international actors such as the IMF, the BCBS, and the EU, we observe variation in the regulatory approaches implemented during the credit booms in the early and mid-2000s. I sought to understand the domestic variables that influenced the choice of regulatory approach based on a most similar systems comparative case-study design. Bulgaria, Estonia, Hungary, and Slovenia are most similar systems with respect to their structural position in the global economy. As recent members of the EU, all four countries have been influenced by the common European regulatory framework in banking and finance. Yet the four cases offer variation in their banking supervision approaches over time as well as in important domestic variables such as economic reform path, bank privatization and level of foreign ownership, institutional structure of banking supervision, and party politics.