Institution building
Category: Bank Management
Exchanging goods on the spot against money involves high transaction costs. In order to save these costs, economic agents write contracts with each other that link the provision of a good or service today with the payment of some money tomorrow. If enforcement of these contracts is not ensured, people must fear that they do not receive the money for some good they provided, and will consequently only deliver if the customer pays on the spot (in the former SU, customers must often even pay in advance). Then, transaction costs increase, and the volume of goods exchanged decreases. This is, indeed, one of the reasons for the massive fall in production that has been observed in transition countries. The state must provide an efficient legal system, courts and police in order to prevent these efficiency losses.
Moreover, a system of social security is needed in order to prevent social unrest that may result from painful restructuring measures (see stabilization). Finally, the public sector, especially the tax administration must be reformed, in order to be able to raise the money needed to stabilize the budget and finance the public institutions.
In many countries of the former SU, public institutions have not been reformed at all. Legal insecurity has led to the emergence of mafia-like structures with devastating effect on the investment propensity of firms, especially of foreigners, who fear that their investments may be expropriated by a government that does not keep its promises, for instance, in respect to profit re-patriation, or by the mafia. In general, the lack of a clear regulatory framework for banks is a severe hindrance to more efficient bank operations (we discuss this topic in 2.2.2)
Quite naturally, the creation of a well-functioning regulatory environment is the single most important institutional reform for the banking sector. The following shortcomings must be rectified soon:
high concentration: some few state banks and privatized banks control large parts of the funds;
large degree of sectoral specialization: many major banks just serve one sector of the economy;
unregulated numerical growth of private commercial banks: minimal capital and risk coverage requirements are either not imposed or not enforced;
lack of transparence of licensing and competition policy: instituions abuse their power in order to extort bribes;
bad loans (see next page).