INTRODUCTION

The transition economies considered here all inherited similar financial structures from the regime they succeeded. In fact, the common feature of the prereform period was the absence of financial markets, and the irrelevance of financial variables to the workings of the real economy, in particular the enterprise sector. Monetary transactions and holdings were the prerogative of the domestic sector. In the enterprise sector, money served only as an accounting unit.

Previously Centrally Planned Economies (PCPEs) were in a peculiar situation at the time reforms began. Price liberalization and market reforms certainly represented a major structural shock for these economies, and led inevitably to instability in both absolute and relative prices. In addition, soft budget constraints had to be eliminated in order to ensure that liberalized firms had a realistic incentive structure. In such a context, the functioning of a system involving banks and nonbanking intermediaries is unavoidably subject to high risks. The viability of firms that had, in the past, operated under soft budget constraints and government interference could not easily be established under the new regime. Informational problems were compounded by the lack of banking skills – indeed by the need to build a banking system from scratch. Therefore, the scope for efficient financial intermediation by banks in transition economies was bound to be limited. This may explain the low degree of financial depth (as measured for instance by the ratio of broad money to GDP) that has characterized all of the transition economies.

Some authors actually recommended that these economies start with low financial depth, in order to keep the intermediation role of banks to a minimum at the beginning of the transition period (McKinnon 1991).