Building a Financial Sector from Scratch: Analysis of Non-Performing Loans in CESEE
To better understand the challenges to building a financial sector, we analyze non-performing loans in eight CESEE countries from 1989 to present. First, we observe the obstacles that state-owned banks face while they adjust from a centrally planned to a market economy and develop the human capital necessary for effective financial intermediation. Privatization to foreign owners resolved these problems by creating hybrid banks that carry both domestic client knowledge and foreign risk management practices. However, the introduction of foreign players fueled strong credit growth, both corporate and retail, that increased the vulnerability of the region and resulted in NPLs following the financial crisis. Despite this, today the banks, not the government, are in charge of the financial sector. Differences between the hybrid and the domestic banks continue to exist. Evidence suggests that foreign banks have better risk management practices and thus incur lower levels of NPLs. Because these hybrid banks, which have more enhanced human capital, dominate the CESEE financial sectors, the financial problems today are not as dire as they were in the 1990s.
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