Journal Issue
Working Paper Summaries (WP/94/1 - WP/94/76)

Working Paper Summaries 94/24: Systemic Requirements for Monetary Stability in Eastern Europe and the Former Soviet Union

International Monetary Fund
Published Date:
August 1994
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This paper draws lessons from banking reform in the more advanced post-Communist economies (PCEs), in particular Hungary and Poland, for the “second wave” of reformers (the countries of the former Soviet Union and some of the Balkan states). It considers whether the current generally accepted “main sequence” of banking reform in PCEs is suitable. This “main sequence” consists of: (1) splitting up the traditional Soviet-type monobank into a number of state-owned commercial banks (SCBs); (2) liberalizing entry by private (mainly domestic) banks; and (3) trying to privatize the SCBs. The “main sequence” assumes that commercial banking skills (above all, credit allocation) and central banking skills (above all, bank supervision) can be developed sufficiently rapidly that the banking system in PCEs will cease making bad loans. If, as one suspects, such skills can only be developed over a long period, then newly created bad loans are likely to continue causing monetary instability for a long time.

An alternative path to monetary stability is the retention (or reintroduction!) of 100 percent reserve backing of banks deposits in the form of liabilities to the central bank; the banks would take over from the state monobank the payment system function. Entry into the payments industry should be fairly open (subject to the 100 percent reserve requirement), and the parts of the monobank providing payments services should be privatized. To cover their costs they could either charge for their services or receive a modest interest payment on their reserves. Bankers could then concentrate on creating an efficient payments system, which is probably what a PCE needs most in the first phase of transition. The allocation of capital would become the sphere of new, non-bank institutions outside the payments system; capital would also come from informal markets and plough-backs.

In addition to a stable banking system a stable monetary system also requires an anchor linking the domestic currency to foreign currencies. Adopting a fixed exchange rate is insufficient in itself to achieve this, particularly in the absence of central banking skills. Some kind of “monetary rule”, providing an automatic link between the money supply and reserve holdings of an outside asset is necessary. The paper therefore considers what kind of monetary rule is suitable for PCEs at various levels of development of their banking systems.

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