The Baltics -- Banking Crises Observed

Abstract

The authors compare the banking crises experienced in Estonia, Latvia, and Lithuania, examining the causes, effects, and policy responses. Estonia and Lithuania reconstituted the specialized Soviet banks as national state banks and began to privatize them. Latvia, by contrast, reconstituted the savings bank, then privatized branches of the remaining banks. 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 the competition needed to drive down deposit and lending rates, and provide the capital needed to support the emerging private sector. Little though was given at first to the implications of this policy for banking safety and supervision. The following conclusions, drawn by the authors, may have implications for banking reform in other former Soviet republics, especially the smaller ones: 1) some banking distress is inevitable; 2) banking distress may be desirable; 3) banking crises die down relatively quickly; 4) when crises arise, authorities should respond firmly and promptly; 5) corruption and weakness should never be rewarded; 6) banking crises should be prepared for; and 7) supervisors should send strong signals to bankers about appropriate banking behavior.

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