In the mathematical approach to modeling meteorological phenomena (as well as in other areas amenable to applications of nonlinear dynamics), the importance of initial conditions is taken for granted. Systems formerly thought to be random or “chaotic” now are better understood by applying nonlinear models that highlight, among other factors, the key role played by initial conditions and the effects of infinitesimally small deviations from these conditions on future developments. Unfortunately, the ability to measure and collect data is far less advanced in the analysis of banking than in that of hurricanes. At least in part, this difference has some behavioral origins: Insofar as scientists are aware, air molecules have no incentive to deceive observers as to their natural properties. Unfortunately, life is not so straightforward in the world of banking, nor for that matter, in much of economics. Notwithstanding these measurement problems, it nonetheless is quite plausible that initial conditions matter a great deal in determining the impact of economic reforms on a given system, and in the present case of financial sector reforms.

The preceding chapter shows the effects of information asymmetries and limited enforcement ability on the frictionless and perfect information model in which many economists have been schooled, and was intended to help in the conceptualization of the reform process. The present chapter focuses on banks, the linchpin of most financial systems, and on how their condition at the time reforms are initiated can influence the evolution of the financial sector and the economy thereafter.