Until the late 1980s, the financial sector of the transition countries was characterized by a banking system in which the central bank dominated the financial sector. The savings bank collected savings deposits from households at low interest rates, which were then placed at the Gosbank. According to the credit plan approved by the Planning Authorities, the Gosbank set policy guidelines determining the volume and allocation of credit to different sectors (the credit plan), and the volume and allocation of cash issuance (the cash plan). Funds were then passed to the specialized banks (such as the agricultural and industrial banks), which represented different sectors for on-lending to individual enterprises. Interest rates had no role in the allocation of credit.

Until the late 1980s, the financial sector of the transition countries was characterized by a banking system in which the central bank dominated the financial sector. The savings bank collected savings deposits from households at low interest rates, which were then placed at the Gosbank. According to the credit plan approved by the Planning Authorities, the Gosbank set policy guidelines determining the volume and allocation of credit to different sectors (the credit plan), and the volume and allocation of cash issuance (the cash plan). Funds were then passed to the specialized banks (such as the agricultural and industrial banks), which represented different sectors for on-lending to individual enterprises. Interest rates had no role in the allocation of credit.

As the transition countries embarked on market reforms during 1991–92, two-tier banking systems emerged with the creation of central banks and the transformation of the specialized banks into notionally autonomous commercial banks. Concurrently, in large part due to lax licensing policies and practices, most of these countries experienced a large increase in the number of commercial banks, as well as in the number of branches of the existing banks.

The initial reforms paralleled those introduced in Eastern European countries slightly earlier. The outcome, however, has been different. Five years following the initial reform measures, the broad trends in the Baltic and CIS countries demonstrate that the intermediation role of the banking sector has declined sharply. Even the Baltic states, which were able to contain inflation by early 1993 and which established monetary control relatively quickly, still continue to have low intermediation ratios. Another development has been a sharp decline in the volume of central bank refinance credit to the banking sector, in part reflecting the reduced role of the central bank in intermediating the flow of funds among banks. The general trends can be summarized as follows (see Figure 2 and Table 6):

  • The ratio of broad money to GDP in the Baltic and CIS countries in comparison with the Eastern European countries is very small (25 percent to 55 percent).

  • The volume of bank deposits as a percent of GDP declined from over 80 percent in 1991 to less than 25 percent in the Baltic countries and to less than 7 percent in the CIS countries by 1995.

  • The ratio of bank credit to GDP fell from over 65 percent in 1991 to less than 15 percent by 1995.8

  • The share of government-guaranteed loans in total loans is about 15 percent (1995).

  • The ratio of central bank credit to banks to GDP declined from almost 60 percent in 1991 to less than 7 percent by 1995, reflecting the abandonment of central planning.

Figure 2.
Figure 2.

Financial Sector Indicators, 19951

(In percent)

Sources: Country authorities; and IMF, International Financial Statistics.1 Countries with similar ratios are grouped together as an unweighted average.
Table 6.

Structure and Performance of the Banking Sector

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Source: Central banks.

The definition and measurement of nonperforming loans vary across countries and the percentage given is therefore not directly comparable.

Furthermore, for most of the countries, the current overall financial situation is one with a significant danger of banking crisis. Two exceptions are Estonia and Latvia, both of which have already experienced and made progress in resolving banking sector problems. The ratio of nonperforming loans to total loans varies from 14 percent to 63 percent. It is possible that the situation is worse than these figures indicate, as the overall health of the banking system is difficult to gauge because many countries are only currently developing internationally accepted loan classification systems and new accounting practices. The ratios are high in comparison with the ratios of nonperforming loans to total loans in other countries that have faced banking crises. For example, prior to the onset of banking crisis, the ratio reached 9.1 percent in Argentina (end of 1980), 9.3 percent in Finland (end of 1992), 10.6 percent in Mexico (September 1994), 6.4 percent in Norway (end of 1991), 7.2 percent in Sweden (end of 1992), and 9.3 percent in Venezuela (end of 1993).

Macroeconomic Conditions

Although all transition countries experienced sharp declines in real GDP and major terms of trade shocks, the economic performance of the countries varied significantly following the breakup of the Soviet Union. The Baltic countries were able to contain inflation by early 1993; however, most other countries experienced high and volatile inflation well into 1994. Some countries, such as Armenia, Georgia, Ukraine, Tajikistan, and Turkmenistan, experienced hyperinflation during 1993–94. In most cases, high inflation erased the real value of old, nonperforming loans.9

The negative real interest rates paid on deposits at a time of very rapid growth in cash balances were associated with significant changes in the asset portfolio of individuals. As a result, holdings of foreign currency cash and of real assets increased significantly, while domestic currency deposits declined in real terms. Negative real interest rates, together with the rapid depreciation of the exchange rate, encouraged a marked disintermediation of the banking sector.

At the same time, there was initially a significant acceleration of credit growth and a concomitant rise in risk taking by banks during 1992–93. Except for the Baltic countries, which established firm monetary control relatively quickly, the credit expansion was initially fed by central bank refinance credit issued at the government’s direction, inefficiencies in the payments system that facilitated overdrafts to be drawn on the central bank by the commercial and state banks, and by lax enforcement of reserve requirements, which continue in many countries.

Recent efforts to contain inflation, by tightening monetary and fiscal policies, exposed underlying weaknesses in the banking sector. By the end of 1995, most countries had achieved major declines in inflation and stabilized their exchange rates (except Tajikistan and Turkmenistan) and banks could no longer mask the strongly reduced cash flow from their nonperforming assets. Also, stabilization of the exchange rate led to sharply decreased profits from foreign exchange speculation.

The resulting banking distress in many of the CIS countries has affected the authorities’ ability to formulate and conduct monetary policy. Transmission of monetary policy has been hampered by the problem banks’ inability and unwillingness to adjust their reserves or lending in response to monetary policy decisions. Market-based liquidity facilities have been distorted as problem banks are willing to borrow at any price to continue their operations. As a response, some countries have restricted access to credit auctions by banks that do not comply with prudential standards. In some cases, monetary control has been impaired by direct support to banks through overdrafts on their central bank clearing accounts. Furthermore, due to the problems in the banking sector, real interest rates have often remained extremely high despite the declines in inflation, as banks prevented nominal lending rates from falling in order to increase margins. Annualized interest spreads between deposit and lending rates in some cases exceeded 50 percent. This represented a high and unsustainable cost of financial intermediation that viable enterprises could not afford to pay. An implication is that the high lending rates were sustained by distress borrowing by potentially insolvent enterprises.

These developments suggest that an orderly program of bank restructuring to resolve the weakness in the banking sector is necessary to achieve further progress in stabilization and market-based monetary and exchange management. Such progress will also create an environment conducive to the development of an efficient financial system, thereby improving resource allocation and growth prospects.

Successful implementation of bank restructuring will have to be supported by restructuring of enterprises. Following the introduction of market- oriented reforms, governments initially prevailed on the banking system to continue extending credits to loss-making state-owned enterprises. This exacerbated the deterioration in banks’ portfolios. The subsequent introduction of hard budget constraints has led to dramatic cuts in subsidies to former state-owned enterprises and has resulted in debt-servicing difficulties for these enterprises. This, in turn, has sharply reduced the value of the asset portfolio of banks that had been involved in lending to these enterprises and also increased interenterprise arrears. Thus, a bank-restructuring operation without parallel efforts on enterprise restructuring will be incomplete and will not be fully effective.

Institutional Framework

Developing a proper institutional framework for banking soundness is critical to fostering growth and efficient financial intermediation. Individual country experience is extremely diverse. As shown in Table 7, some countries have made progress in institutional development. In many countries, however, it has been difficult to promote safe and sound banking practices owing to the absence of a suitable legal framework, including clear rules regarding property rights. Furthermore, the court systems in many countries have yet to develop sufficient expertise in financial matters to be able to adjudicate financial cases in a reliable way. These problems are evident in serious deficiencies in the area of loan collection and bankruptcy, inadequate rules on loan contracts, insufficient safeguards against conflict of interest between banks and their shareholders and other related parties, and inadequate rules on security and collateral. Moreover, commercial bank accounting practices are still largely based on the old Gosbank chart of accounts. Loan-valuation procedures are in their infancy and are seriously hampered by the lack of functioning asset markets.

Table 7.

Institutional Framework for Bank Supervision, 1995

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Source: Central banks.

Including branches and subsidiary financial enterprises.

Nonetheless, progress has been achieved in the past years in building the requisite framework. Much of the legal framework, including central bank and banking laws, has been put in place, and the supervisory and regulatory systems are being improved upon. The civil law framework necessary for safe and sound banking is also being built, in the form of civil codes, including laws on contracts, security, and collateral, as well as loan recovery. Bankruptcy laws are being enacted, including separate legislation for banks. Work is progressing on the reform of the accounting systems, for central banks as well as for commercial banks.

Banking Practices

Although experience has differed considerably from country to country, and generalization as a result is a hazardous exercise, the banks typically have found it difficult to adopt market-oriented credit policies. Credit decisions by and large have been taken on the basis of implicit or explicit government guarantees, political connections, and relationships between the banks and their large shareholder depositors, rather than on the basis of the payment capacity and viability of the borrower. This has led to poor loan discipline and lax collection efforts. Increasingly, banks have been turning to the interbank market to maintain their cash flows, thus increasing the risk of contagion. This has underscored the need for prudential rules on interbank exposure.

Financial analysis of borrowers, cash flow analysis, and computation of basic profitability, efficiency, and liquidity ratios are at best underdeveloped and inconsistently applied. Loan documentation often proves to be inadequate. Loans are frequently rolled over at maturity rather than repaid. Internal controls in banks are weak. Many banks are unable to exercise sufficient control over the lending practices of their branches, which have had, in practice, far more autonomy than bank branches in market economies.

These practices are due, in part, to the lack of management and banking skills and, in part, to the lack of reliable financial data on borrowers. Therefore, any strategy for addressing the systemic banking problems should be complemented with operational restructuring measures to improve accounting, loan evaluation, and financial disclosure standards, and to strengthen banks’ policies and practices, especially with regard to lending. To prevent the recurrence of banking system distress, it will be necessary to ensure that banks operate profitably and on commercial principles and have strong management and internal control procedures.

Banking Supervision

In contrast to other areas of institutional and banking development, more has been accomplished in the area of banking supervision. In part, this reflects an intense technical assistance effort on the part of the IMF, the cooperating central banks, and other international institutions. As noted in Table 7, much of the legal framework necessary to support an effective banking supervisory framework has been put in place and is being improved upon further. Central bank laws generally provide banking supervisory authority to the central bank. In those countries that have revised them, banking laws lay out the instruments necessary for effective supervision, such as adequate licensing requirements, regulatory authority, enforcement powers, and authority to withdraw licenses and close banks.

Most central banks have created separate banking supervision departments and are increasingly providing these with more and better-trained staff. This is a notable achievement, considering that central banks have continuously lost trained staff, who have left to take up more lucrative positions with commercial banks. Licensing regulations have been tightened, regulations on risk diversification have been introduced, and increasingly, limits on lending to shareholders and other insiders are being adopted. Minimum capital requirements for banks have been increased across the board, which has forced a consolidation process of mergers or closures of small undercapitalized banks. An important development has been the increasingly widespread introduction of loan classification and provisioning regulations. Combined with more adequate accounting practices, these regulations will greatly enhance the capability of the banks themselves, and the supervisors, to obtain a reliable view of the financial condition of the banks. In about half the countries, loan-loss provisioning is now treated as a tax-deductible business expense.

Nonetheless, it is necessary to take additional measures to make banking supervision more effective. These include further reduction of limits on single borrower lending and lending to shareholders and other insiders, in line with international standards. Monitoring and enforcement of implementation, and the application of corrective measures when noncompliance must be strengthened. For proper implementation of loan classification and provisioning regulations, effective on-site inspections are indispensable. Currently, such inspections are still too infrequent and place too much emphasis on checking formal compliance with rules and regulations, rather than on assessing the quality and real value of the banks’ loan portfolios.

In many countries, additional regulations are needed, for example, on limits on interbank lending. The decrease in bank financial intermediation has led to reduced lending and borrowing opportunities for banks, which have become increasingly dependent on the interbank market, often funded to a large extent by a single institution, the state savings bank. The events in Moscow in August 1995 have illustrated the dangers of excessive dependence on the interbank market. The dependence on the interbank market has, in some cases, reflected the weaknesses in the payments system and the reliance on correspondent banking arrangements to effect domestic settlement. Additional regulations to limit interbank exposure, therefore, should be couched in the context of accompanying payments system improvements. The risks of open foreign exchange positions have also become evident. After a period when open foreign exchange positions meant speculative profits for the banks, the risk of speculative losses has become real. Prudential limits on open foreign exchange positions are, therefore, necessary. Rules are needed on accrual of income, specifically with regard to interest payments, as well as on cessation and reversal of the recognition of accrued income when a loan becomes nonperforming.

Perhaps somewhat ironically, improvements in bank supervision and loan valuation have had the effect of exposing latent banking sector problems—to the point of making them appear to be worse in those countries that have progressed the farthest in achieving supervisory reforms than in countries where progress has been more modest. This, of course, is merely an illusion. More important, the strengthened banking supervision framework forms an improved basis from which to start a workable bank restructuring strategy.

Elements of a Systemic-Restructuring Strategy

Accelerating the restructuring of the banking sector in the transition countries is becoming a critical issue for monetary control and the recovery of the economy. If an efficient financial system is to develop, banks must begin to more effectively mobilize savings, substitute financial instruments for the use of cash and foreign currency in transactions, and channel resources into more productive activities. These objectives are attainable only in an environment of low inflation and where hard budget constraints on enterprises are enforced. Thus, the ability to sustain such an environment will be an important determinant of the success of the restructuring strategy.

Given the prevailing conditions in the transition countries, it would seem that the most important need at this time is to reform the large specialized banks, either by rehabilitating or liquidating them. It should be recognized that ad hoc liquidity injections or an inappropriately designed lender-of-last-resort function may lead to protracted structural lending by the central bank and exacerbate the moral hazard problems. As incremental or ad hoc policies are likely to trigger a general lack of confidence in the banking system and may lead to a run on deposits and deeper insolvency, an agreed comprehensive strategy must be articulated.

The design of the strategy depends critically on the agreed degree of government involvement in the bank-restructuring process. If the government is to play an active role in bank restructuring, including the use of public funds, the following issues need to be addressed. The significance of these issues is evident in the experience in bank restructuring in Eastern Europe and elsewhere.

First and foremost, the development and implementation of such a strategy will require a well-defined institutional setting. Depending on the circumstances, existing institutions (i.e., central bank, ministry of finance) may take the lead or a special agency or task force for bank rehabilitation may need to be formed. Guided by the budgetary resources available for bank rehabilitation and the implementation capacity of the restructuring institution, it will then be critical to reach consensus on certain strategic issues. These issues include the formation of a view on (1) the future structure and performance of the banking system, including the policy framework to ensure a competitive and viable system; (2) exit policy; (3) the treatment of loss sharing among involved parties, such as depositors and other creditors, borrowers, and shareholders with particular emphasis on avoiding moral hazard problems in the design of the strategy; (4) institutional arrangements for loan recovery and loan workout; (5) the use of public funds and the conditionality measures associated with their use, including a phasing of measures to achieve compliance with prudential standards and supervisory requirements; and (6) in some cases, transitional arrangements to ensure that basic financial services can be provided to the economy without disruptions.

The role of diagnosis in this exercise is crucial. In particular, it will be necessary to form a view about the core banking system that needs to be saved in order to maintain payment services and to ensure the continuation of credit allocation and other essential functions of the banking system.

A view should be formed about the role of depositor or creditor guarantees during the restructuring process. In case comprehensive depositor guarantee is introduced in a crisis to replace the absence of a limited deposit insurance scheme, its subsequent reduction or elimination should be considered. It may be necessary to stem or prevent an incipient run on the banks either by paying out a proportion of the deposits or by imposing a moratorium. However, if the depositors are not households, but rather state-controlled enterprises, different approaches can be taken on the disposition of enterprise deposits in order to prevent a sudden withdrawal of deposits. Arrangements will also need to be made to assure that borrowers will continue to service their debts to the banks.

The rights of shareholders with regard to governance over the bank most likely will need to be suspended or annulled. Their shares will, in most cases, have lost all their value. Arrangements will need to be made to prevent that they profit from any form of rehabilitation or recapitalization of the bank.

A comprehensive strategy should provide a minimum adequate financial structure and should reassure that remaining institutions are viable. If the restructuring effort leads to the elimination of a large part of the existing banking sector, care must be taken that basic financial services can be provided to the economy.

It would be necessary also to devise institutional arrangements for loan recovery and workout and asset management (this may include arrangements for enterprise restructuring). The bad loans can be left in banks’ balance sheets and the individual banks can set up workout units to deal with nonperforming loans (decentralized approach) or an asset-management agency can be set up to assume bad assets from the banks (centralized approach). If the latter approach is chosen, the asset-management agency will need to have corporate status and will need to be adequately capitalized to finance the assumption of the assets.

An alternative approach is to force restructuring through obligation to achieve, within a given time frame, capital and prudential requirements and for letting the “market” mainly work out the restructuring process while introducing temporary limits on the ability of unsound banks to increase the size of their balance sheet and exposure to depositors. However, a bank that is required to invest deposits in treasury bills, for instance, or other safe assets, provides the same payment services as other unconstrained banks.

Whichever degree of government involvement is chosen, a firm exit policy should be a key element of a restructuring strategy. While it is not an instrument to restructure a particular bank, exit is an important instrument in restructuring a banking system. For any bank, a determination to close or to save must be made before merger, twinning, or different forms of restructuring are considered. This determination would typically occur in the conservatorship imposed on a bank as part of a spectrum of enforcement actions.

Finally, the strategy should include concomitant reforms and incentives to promote efficient working of the financial system, as well as establish a self-correcting mechanism to minimize the recurrence of banking system distress. First, it is necessary to ensure that banks operate on commercial principles and have strong management and internal control, supported by adequate official oversight. Privatization and foreign ownership could be an important method of achieving these objectives; however, for privatization to improve governance, appropriate conditions—fit and proper owners and managers, strong lead investors—must also be present. Moreover, appropriately qualified investors, if available, may have limited interest in taking over financially troubled or insolvent banks. Therefore, restructuring of problem state-owned banks is likely to be an important precondition for successful privatization. Second, to minimize recurrence of distress, banking system restructuring will need to go hand in hand with enterprise restructuring and measures to strengthen the legal and regulatory framework for banking and loan recovery. Otherwise, as shown by the experience of Eastern European countries, the success of bank restructuring will likely be limited.

Experiences with Bank Restructuring

The situation in most transition countries has not yet reached the stage of an acute crisis, nor have there yet been closures or interventions in the large banks. The exceptions are Estonia and Latvia, which have already experienced banking sector problems and reacted to effect the necessary liquidation and rehabilitation of the large banks. However, the problems in the banking sectors in the other transition economies can be considered systemic in nature. In most of these countries, the five largest banks account for more than 75 percent of the total nonperforming loans. Moreover, as these banks are often closely linked through interbank loans and deposits because of their trading, failure of an individual bank may lead to contagion effects and hence trigger a systemic banking crisis.

Most countries have undertaken certain restructuring measures usually directed at the small banks involving increases in minimum capital and its enforcement through license withdrawals, liquidation procedures, and mergers (see Table 8). However, only 2 of the 12 CIS countries, namely, Kazakstan and the Kyrgyz Republic, have embarked on a systemic-restructuring strategy that includes particular measures to deal with the formerly specialized banks that dominate the financial system. In addition, each of these countries has made progress in enterprise sector reform, which has helped to ease loan problems in the banking sector. Russia has also begun to move more decisively and has closed some medium-sized banks.

Table 8.

Bank-Restructuring Measures, 1995

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Source: Central banks.

Participants include the central bank, Ministry of Finance, and commercial bankers.

In the appraisal stages.

Econonomic Analysis Division of the Bank Supervision Department.

Government guarantees.

Most other countries appear reluctant to close the large banks. In Moldova, measures are being designed to rehabilitate the large banks by means of financial and operational restructuring. In Azerbaijan, there has been substantial liquidity support to the Savings Bank (about 1 percent of 1995 GDP). In Belarus, in late 1995, the State Savings Bank and Belarus Bank were merged; both were experiencing serious difficulties, and the merger resulted in a weaker institution and increased concentration. As the deposits of the merged bank are guaranteed by the government, this has led to an increase in the financial responsibility of the government. Subsequently, in February 1996, the six largest banks in Belarus were reportedly nationalized. In Georgia, the three formerly specialized banks (State Savings Bank, Eximbank, and the Industrial Bank) were merged during the second half of 1995. The resulting bank became the largest bank in Georgia in terms of branches and assets (accounting for 70 percent of total assets of the banking sector). However, this bank’s balance sheet growth has been blocked, and its management has had to submit a restructuring plan, which if not workable by the end of 1996 will entail liquidation.

In Belarus, the decisions to merge banks appear to have been politically motivated and occurred without consultation and formal concurrence of the supervisory authority. In Turkmenistan, too, the President authorized the licensing of a special agricultural bank, which is to have a network of 53 branches, in an attempt to restructure the Agroprombank. This created a major increase in the supervisory burden on the Central Bank of Turkmenistan. In view of the severe staffing constraints in banking supervision, this may pose dangers to the effective exercise of supervision over the banking sector.

Thus, in most of the CIS countries, banking sector problems have been dealt with as and when they surfaced, and a systemic approach to bank restructuring has not yet emerged, in part because the magnitude and nature of the problem are not fully transparent. As a first step, these countries are beginning with a diagnostic study to establish the magnitude and the nature of the problems in the banking sector. Two sources of information generally used to establish an approximate indication of the extent of financial distress in the system are monthly off-site supervision reports collected by the central banks and on-site portfolio audits. The gap between the value of existing specific provisions and general loan-loss reserves of the banks and the size of their reported overdue loans (principal plus interest) provide a first approximation of the potential reserve deficiency. However, the diagnostic exercise for the transition countries is constrained by the weak accounting practices associated with the Gosbank accounting standards.

As discussed earlier, most countries have made progress in improving the legal framework for bank resolution and related actions. However, much work still needs to be done in this area to establish the framework for the effective functioning of the banking system. The importance of a well-functioning legal and court system is clearly illustrated in the case of Moldova, where the national bank is experiencing major legal difficulties in closing an insolvent bank, notwithstanding clear authority to do so in the new law.

Fewer than half of the countries have initiated formal deposit insurance schemes; however, in many countries, there seems to be an implicit government guarantee on deposits of the large banks. Household deposits at the state-owned banks, in particular at the former Savings Bank, are government-guaranteed by law in Belarus, Lithuania, Russia, Ukraine, and Uzbekistan. In the case of the Kyrgyz Republic, the government has implemented payoff plans to compensate the depositors and other creditors of the majority state-owned banks.

So far, only Kazakstan has established an institutional framework to recover nonperforming loans. Since early 1995, the directed credits that are nonperforming are being carved out from bank balance sheets. Most of the credits were withdrawn from the commercial banks and converted to long-term state debt of the government vis-à-vis the national bank (domestic credit) or held off-balance sheets by the Eximbank (foreign credits). In the Kyrgyz Republic, the government is in the process of establishing an independent legal entity to take control over and dispose of some of the assets and liabilities of the former state-owned banks. This institution will be established as an autonomous unit within the Enterprise Reform and Resolution Agency framework, which deals with many of the state-owned enterprise borrowers of the problem banks.

Another approach is that of Georgia, which is adopting a more “market-based” approach to restructure its banking system. A key element is the implementation of a bank certification program objective that is to establish proper programs to bring banks into compliance with the prudential standards. Failure to gain certification will be accompanied by strict limitations on balance sheet growth.

As a systemic-restructuring strategy will take time to design and implement, several countries such as Armenia, Azerbaijan, and Uzbekistan, have implemented a package of short-term stopgap measures. These include measures to curb the activities of problem banks and limit ad hoc injections of funds by the authorities. Azerbaijan and Uzbekistan have prohibited the banks that do not comply with prudential regulations from participating in the interbank market or credit auctions.

Bank-Restructuring Efforts

Bank-restructuring efforts are being supported to varying degrees in most of the transition states by the IMF, the World Bank, and other multilateral and bilateral donors.


In Armenia a de facto restructuring of the banking system has been going on since 1994 as reflected in the decline in the number of banks from 52 to 35. The sharp decline is a result of increased minimum capital requirements and the stricter enforcement of prudential regulations. The banking system is highly concentrated; the four former specialized banks account for about 65 percent of the total assets of t he banking system (see Table 6). A majority of the loan portfolio of these banks has been extended to state-owned enterprises of which about 20 percent is due to shareholders of the banks. The relatively poor performance of the former state-owned banks is very apparent as these banks account for about 90 percent of total nonperforming loans; the ratio of nonperforming loans to total loans is estimated at 33 percent.

The authorities are concerned about the fragility of the banking system and its potential adverse effects on the achieved economic stabilization efforts. As a first step, the Central Bank of Armenia is undertaking a detailed audit of all banks, with particular emphasis on the largest four and the Savings Bank. This work is designed to evaluate the quality of bank portfolios to confirm the appropriateness of the banks’ decisions on loan-loss provisions and write-offs and enable the authorities to assess the quality of bank management and control systems. The exercise started in March 1996 and is currently ongoing.

At the end of 1995, the central bank had introduced loan-loss provisioning rules in conjunction with tax deductibility regulations. In addition, in December 1995, to avoid undercapitalized commercial banks being stripped of capital, it issued a resolution to all banks recommending the stopping of dividend payments from unrealized gains by banks that do not meet prudential regulations.

The central bank has been directly involved in bank closures. In one case, the closure process lead to substantial political pressure against the central bank. Although it has been very forceful in denying responsibility for depositor protection, moves have been made toward introducing a limited depositor protection scheme. The State Savings Bank (SSB) offers full depositor protection; however, SSB deposits are worth an average of 60 cents each, because of their conversion from rubles into drams at the official exchange rate at the time of the introduction of the dram in late 1993.

An important component of the bank-restructuring program is the clarification and improvement of the legal framework in which banks operate. In this context, the government on June 30, 1996 passed the Law on Banks and Banking and a Law on Bank Insolvency.

As a systemic-restructuring strategy will take time to design and implement, the Armenian authorities have implemented a package of short-term stopgap measures. These actions, which extend the restrictions already imposed by the central bank on a few banks, are designed to curb the activities of banks that are already facing difficulties and prevent ad hoc injections of funds to such banks from undermining the objectives of a longer-term strategy.


As of March 1995, there were 180 banks in Azerbaijan compared with 211 at the end of 1994. Since the end of 1994, 28 were closed by the national bank, and 7 were merged. The share of the former state-owned banks accounts for about 80 percent of the total assets of the banking system (see Table 6).

The ratio of nonperforming loans to total loans is estimated at 34 percent; the formerly specialized banks account for about 90 percent of total nonperforming loans. This situation occurred because of (1) lack of motivation to collect arrears due to the institutional weakness in the legal framework for recovering debts (inadequate bankruptcy laws and absence of means of enforcement); (2) the inadequate system for establishing provisions or reserves to offset loan losses when they occur, limiting the possibility of writing off unrecovered bank loans; and (3) the collusion between banks and borrowers, mostly in the state enterprise sector.

As a first step to identify the size and the nature of problems in the banking sector, the Azerbaijan National Bank has conducted three on-site inspections of selected branches of three of the formerly specialized banks. The on-site inspections revealed serious violations, including collusive behavior of managers of different branches, numerous violations of prudential and administrative regulations and banking practices, and even criminal offenses. The national bank is currently undertaking a systematic evaluation of the condition of the rest of the banking system.

Based on information collected at the Savings Bank, the situation was characterized as extremely difficult. In October 1995, the Ministry of Finance granted a loan of manat 50 billion ($11 million) to the Savings Bank and reserved funds to extend another loan of manat 45 billion ($10 billion), for a total of about 1 percent of GDP. The authorities are considering limiting the Savings Bank to a very narrow concept of banking and constraining its activity to collecting deposits and insuring that these deposits are invested in safe, liquid, and sufficiently profitable assets.

The authorities are committed to develop an overall strategy for the restructuring of the banking system in the immediate future. A key element of the recommended strategy involves creating a reasonable prospect for the healthy development of the banking sector in the post-restructuring phase.


In Belarus, the number of commercial banks had approximately doubled at the end of 1994 and the beginning of 1995 (from approximately 25 to 50 banks). In October 1994, the National Bank of Belarus had drastically increased the minimum capital requirements and intended to introduce these increases according to a strict timetable. During 1995, a system for classifying loans and provisioning was implemented, leading to additional pressure on banks’ capital. Subsequently, four mergers have taken place between banks, three banks have been liquidated voluntarily, and one forcibly. Licensing policies have been tightened, and four applications refused.

During late 1995, a presidential decree was issued, ordering the merger of the State Savings Bank and Belarus Bank, a prominent commercial bank. Both were experiencing serious difficulties, and the merger resulted in a weaker institution. This has led to a sharp increase in the financial responsibility of the government as the state guarantee cannot be withdrawn from the new entity. In general, a comprehensive strategy to deal with the problems of the banking system is still in its infancy, although efforts are under way to develop a plan in the near future. There has been some tendency to opt for direct intervention in bank management, and proposals have been made to increase the share of the state in the banks’ capital. In addition, the national bank has occasionally not always been able to play an independent role in assessing the problems in the banking sector and proposing solutions.

A serious diagnosis will need to be undertaken assessing the financial situation of the banks, verified by on-site inspections. Experience from such inspections had shown that banks tend to classify bad loans in lighter categories than warranted, thus applying lower provisioning percentages. Although national bank estimates show that only approximately 9 percent of the loans are nonperforming, World Bank estimates show that merely on the basis of overdue criteria, the nonperforming loans probably outstrip capital. According to unofficial estimates between 35 percent and 40 percent of the payments in the economy are in arrears.


As of March 1995, there were 101 licensed banks in Georgia compared with 223 at the end of 1994. The significant drop is due to the higher minimum capital level now required for banks. Of the 122 whose licenses have been revoked by the National Bank of Georgia, 50 are in final process of liquidation, and 72 are still subject to standing liquidation committee resolution. The three former state banks that were merged without the consent of the national bank continue to dominate the banking industry with about 70 percent of total assets (see Table 6).

The Georgian banking industry remains desolate. While most private commercial banks remain solvent albeit inactive, a major bank appears to operate with negative real capital. The knowledge of safe and sound banking principles appears limited. In general, banks still accrue interest on delinquent loans and do not responsibly deal with problem assets. Moreover, capital is overstated particularly when the fixed assets account is added to capital for calculating the leverage ratio. The general public continues to lack confidence in the banking sector.

The ratio of nonperforming loans to total loans is about 30 percent; the former state-owned banks account for the bulk of total nonperforming loans. These banks appear to operate under severe capital constraints and with limited knowledge of safe and sound banking principles. All of the former state banks, however, are currently undertaking independent audits by internationally accepted accounting firms. The recommendations of the audits will likely bring to light the imminent need to raise additional capital, adhere to prudential banking principles, and adopt appropriate accounting standards.

The national bank has improved its bank supervisory efforts. Reporting exceptions and prudential standard violations are checked and followed up, thus creating a more disciplined banking environment. The liquidation process, through standing liquidation committees, has been implemented. The national bank is also in the process of establishing an appropriate legal framework and reliable account systems and taking measures to enhance the functioning of the payments system. A new commercial bank law was enacted in February 1996. Also, legislation that reaffirms the national bank’s independence is to be enacted by the end of June as one of the structural benchmarks for the IMF’s Enhanced Structural Adjustment Facility (ESAF) program.

Three key principles guide the restructuring of the Georgian banking sector: (1) the strategy should accelerate the differentiation between viable and nonviable banks; (2) only the viable banks, in compliance with minimum prudential regulating requirements, should be allowed to expand their balance sheets; and (3) banks should be encouraged to organize their own strengthening and upgrading programs and not rely on government budget funds. The essential approach to restructuring being proposed is case by case and based upon the strengthened enforcement of prudential standards, including bank certification. The certification of the former state banks is a midyear performance criterion under the ESAF program.

The national bank has started the implementation of a bank certification program for the handling and treatment of problem banks. The objective of the bank certification program is to establish proper programs to bring banks into compliance with the national bank’s prudential banking standards and to regulate the balance sheet growth of those banks that do not receive national bank certification. Failure to gain certification is accompanied by strict limitations on balance sheet growth. It is also recommended that because of current weaknesses in reporting, certification would require on-site verification of banks claiming to be in compliance with prudential standards.

Under the proposed approach to restructuring, individual banks will need to address their problem loan portfolios through the establishment of bank specific workout units supported through technical assistance.


In Kazakstan, the authorities have now put in place the final elements of a systemic bank-restructuring program. Much progress has been made with problem banks. The number has been reduced from some 190 in late 1994 to 129 in February 1996, as about 50 banks were liquidated and about 10 were merged with other banks. The five formerly specialized banks account for about 45 percent of total assets; however, their share in new lending is considerably lower. The ratio of nonperforming loans to total loans is about 35 percent, and the large part of it is due to the formerly specialized banks.

Banks have been classified as (1) sound banks; (2) problem banks to be liquidated, allowed to fail, merged with other banks, or converted into nonbank intermediaries; and (3) problem banks that could be rehabilitated or considered for rehabilitation particularly in light of their importance in the banking sector. With respect to the latter group, being developed are bank-by-bank restructuring strategies for those to be rehabilitated, as well as institutional arrangements for loan recovery.

Since early 1995, the nonperforming loans that had been instructed by central or local authorities are being carved out from bank balance sheets. Part of this credit is transferred to special institutions, namely, the Rehabilitation Bank, the Agricultural Support Fund and Exim/Development Bank; as to the rest, further guarantees are issued to the banks. Rehabilitation programs for banks, as well as organizational arrangements for loan recovery, are being worked out. A financial sector adjustment loan from the World Bank was approved on June 25, 1996.

The government has not injected new state capital into the banks. Recapitalization is expected to come from internal earnings and from new capital contributions by existing shareholders. Such capital contributions, however, are facilitated by provision of tax relief through increasing the amount of loan-loss provisions that banks can deduct from profit for tax purposes. The National Bank of Kazakstan is planning an increase in the interest rate paid on required reserves, which were reduced from 20 percent to 15 percent of all deposits on May 1, 1996.

Progress has also been made in the regulatory and legal framework. Major organizational changes have been made in the supervision department of the national bank; the prudential norms have been recently refined; as of December 1995, loan-loss provisioning is now fully taken into account in expenses before taxes. The national bank is in the process of implementing a new chart of accounts for commercial banks that is more in line with International Accounting Standards. In addition, draft regulation on conservatorship has been written.

Kyrgyz Republic

The banking system of the Kyrgyz Republic is dominated by four former state-owned specialized banks that account for about 80 percent of the total assets of the banking sector. These banks are highly insolvent and account for about 95 percent of nonperforming loans. The ratio of nonperforming loans to total loans is 63 percent, the highest reported among the transition countries.

A systemic bank-restructuring strategy has been developed, supported by a financial sector adjustment credit from the World Bank. The main elements are to restructure or liquidate the four former state-owned specialized banks, establish a rural finance strategy, establish a legal entity to recover nonperforming loans, and develop a sound legal and regulatory framework. Progress has been made on all fronts. The action programs for the restructuring and liquidation of the specialized banks have been finalized. This program calls for the liquidation of two of the specialized banks with the government assuming the costs of protecting the depositors and other creditors in full. The liquidation of the Savings Bank has already been initiated, and the government as the sole owner of the bank is in the process of implementing a deposit payoff plan with financial assistance from the World Bank.

The other two specialized banks will be substantially downsized by writing off all loans classified as loss. The latter two banks will absorb the cost of the resolution of their nonperforming loans as well as the funding and investment costs to bring the institution into compliance with international banking practices. If either of the banks is unsuccessful in raising the required capital, then the national bank will place the institution into legal conservatorship. The national bank would complete the recapitalization through a national bank bond issue and sell the entire institution to new private investors. If the sale is not successful then the national bank would liquidate the bank. At that stage, the government would have to make a decision as to whether depositors and other creditors will be protected and if so whether they would be fully or partially protected for the amount of their claims.

Three of the small banks have been liquidated. The national bank is discussing with those that do not meet minimum capital requirements how to alleviate the situation. If they are not able to raise capital they will be liquidated. Some banks have been able to raise foreign capital.

The government is also in the process of establishing a legal entity, the Debt Recovery and Resolution Agency (DERRA) to take control over and dispose of the assets and liabilities of the former state-owned banks as an agent of the national bank with a mandate of a three-year term. The nonperforming loans of these banks will be transferred to the DERRA’s Debt Recovery Unit. DERRA will be established as an autonomous unit within the Enterprise Reform and Resolution Agency (ERRA), which deals with many of the state-owned enterprise borrowers of the problem banks.

Important steps have been taken to establish the proper legislative framework. Laws on Banks and Banking and on Pledge (Collateral) had been submitted to the Parliament by the end of 1995. An amendment to the Bankruptcy Law to permit the national bank to place banks into receivership and liquidation without court involvement is being drafted.


In Moldova, the banking sector consists of 21 banks, 5 of which are formerly specialized banks. The sector is heavily concentrated, with the six largest banks accounting for approximately 84 percent of the assets and 72 percent of regulatory capital. In December 1994, the National Bank of Moldova implemented new regulations for loan classification and provisioning for bad loans. Audits of the larger banks suggested substantial weakness of these banks, with clear consequences for the soundness of the entire system. In February 1995, the national bank entered into recapitalization agreements with the ten banks that reported negative capital. Several factors indicate that the condition of the remaining 12 banks may also be quite weak.

Financial reporting of the banks is still based on the Gosbank system, making a realistic assessment extremely difficult; however, from June 1996, large banks will use reports broadly adapted to international financial standards. Loans are also not yet classified very accurately, due to a lack of experience in loan assessment. Loans that are rolled over are currently not considered to be nonperforming. Furthermore, approximately 15 percent of all loans are government guaranteed.

The national bank has strengthened banking supervision, by means of the issuance of new prudential regulations, the introduction of new laws providing greater powers for the national bank, the inclusion of a banking resolution unit within the national bank, and the submission by selected banks of plans for recapitalization and credit improvement. A focused program of on-site bank inspections is in place.

The national bank estimates that classified loans in November 1995 were 96 percent of total capital before provisioning. Taking into account possible inaccuracies in loan classification, the total of such loans could exceed total capital before provisioning.

The national bank has basically adopted a bank-by-bank strategy for the resolution of the problems. There is a clear policy not to close the large banks. Measures are being designed to rehabilitate them, by means of financial and operational restructuring. With regard to the small banks, the national bank is overseeing the recapitalization or voluntary liquidation of undercapitalized banks. In the case of one small bank, the arbitration court in Moldova initially blocked the national bank’s attempt to take possession of the bank and invalidated the revocation of the bank’s license by the national bank, on unclear procedural grounds, notwithstanding clear authority granted to the national bank in the new law. Banks that do not meet the requirements and are not willing to sell or merge will be encouraged to liquidate voluntarily. The national bank may also take steps to put banks into receivership if necessary.

The large commercial banks, the majority of which are the formerly specialized banks, will be treated in the same manner as the small banks, although outright closure may be avoided. The strategy for the large banks includes assessing which banks are viable and which are not. Remedial and restructuring plans are being developed for the viable banks. The viable banks will need to receive technical assistance in improving their operations, for instance in the form of twinning. Workout units will need to be established within the banks to deal with bad loans.

Russian Federation

The number of banks in Russia increased sharply in 1994 and continued to grow during the first eight months of 1995, although growth slowed substantially, and the number has started to decrease. As of January 1996, the number of banks was 2,268. The decrease in growth was a result of tighter licensing policies, including an increase in minimum capital requirements for banks to an equivalent of ECU 1 million. In real terms, there was an actual contraction of the total assets in the sector in the period January-August 1995. The ten largest banks, all based in Moscow, account for approximately 50 percent of total assets.

To date the Central Bank of the Russian Federation has addressed the difficulties of the banking sector bank by bank. The revocation of bank licenses has been stepped up, although actual liquidation has been slowed by inadequate legislation. The central bank is also making a comprehensive assessment of the banking sector and is in the process of devising an overall strategy to deal with problem banks.

The central bank is committed to developing a strategy for dealing with the impending systemic difficulties in the Russian banking sector. It intends to intensify the prudential supervision of the individual banks and, with the participation of the government, form a Restructuring Committee to prepare an overall strategy for bank restructuring and to oversee its implementation. The central bank is also committed to establishing criteria to classify banks into those that are solvent, those that would be rehabilitated by their own efforts using traditional sanctions, and those that need rehabilitation using public funds. Plans are being developed for the operational and financial restructuring of the banks that can be rehabilitated. Institutional arrangements for loan recovery and loan workouts are also being considered. Coordination with enterprise-restructuring efforts will be ensured.

The authorities need to evaluate the state of the banking system and calculate its shortage of capital. Sources of finance for the capital deficit should be the initial shareholders of the banks, other private sector contributions (e.g., in the form of mergers), debt relief, losses to depositors, and in the last instance government sources. Any support given to banks in the context of the restructuring operation should be transparent and avoid as much as possible distortions in the competitive position of the banks.


The banking sector in Tajikistan consists of 19 banks. The system is still in the early stages of development, and banking supervision still needs substantial strengthening. The banking sector is strongly concentrated where the four largest banks hold 60 percent of total capital and 41 percent of the assets.

The figures on the condition of the banking system are scarce and are subject to substantial change over time. According to the estimates of the National Bank of Tajikistan during September 1995, overdue loans amounted to 20 percent of total capital. However, uncleared settlements in the system amount to TR 3.1 billion. A considerable proportion of this payment float can be considered overdue payments. In February 1996, nonperforming loans were estimated by the national bank to be 46 percent of total capital.

There is no system for loan classification and provisioning in place at this time. However, in view of the fact that the capital adequacy ratios (Tajikistan uses a simple gearing ratio of 5 percent of assets) are already very low, ranging between 0.2 percent and 2.8 percent, widespread insolvency is probable, once the banks are properly valued. A strategy for assessing the true condition of the banking system, and for dealing with the problems that are expected to arise, is yet to be formulated.


As of March 1996, 15 commercial banks, including 2 branches and a subsidiary of a foreign bank, operate in Turkmenistan. During 1994, a moratorium had been imposed on the licensing of new banks. After the moratorium was lifted, stricter licensing policies were applied, resulting in the rejection of four applications out of six in 1994.

In addition, the Agroprombank was restructured and divided into 53 separate banks, increasing substantially the supervisory burden of the Central Bank of Turkmenistan. Such a burden may pose dangers to the effective exercise of supervision over the banking sector, in view of the severe staffing constraints in banking supervision.

Very few data are available on the quality of the assets of the banking sector and its capitalization. The inspectors of the central bank have received guidelines on the classification of loans; however, an integral system for loan classification and provisioning has not yet been introduced.

As there is no clear view at this time of the true level of capitalization of the banks, it is not possible to properly diagnose the state of the banking system. Developing strategies for the improvement or restructuring of the banking sector would therefore be premature.


The extended period of near-hyperinflation in Ukraine, from 1992 until the beginning of 1995, took a heavy toll on the banking sector. Large-scale disintermediation occurred, as well as currency substitution into dollars. Demand and time deposits in local currency fell from 40 percent of GDP in 1992 to 2 percent by the end of 1995.

There are currently about 200 banks in Ukraine. The five largest account for approximately 70 percent of total assets. The smallest 100 account for not more than 1 or 2 percent of the sector. Provisions are currently not tax deductible, although the income tax rate on bank profits has been reduced. As of May 1996, the total amount of loans overdue and in default was estimated at 80 percent of total banks’ capital.

There is no evidence of an overall strategy for the rehabilitation of the banking sector. Measures are continually being undertaken to improve the legal and regulatory framework. A system for loan classification and provisioning was implemented in mid-1995. Substantial technical assistance is given in the areas of banking supervision and accounting. The National Bank of Ukraine has increased minimum capital requirements, leading to a substantial decrease in the number of licensing applications. In 1995, the national bank intervened and delicensed 22 banks.

Household deposits at the state-owned banks are government guaranteed by law. The authorities are legally required to develop a more generalized depositor scheme. Recently, a regulation was put in place on contributions to a deposit protection fund at the national bank.


As of June 1996, there were 28 banks in Uzbekistan, including 2 state-owned banks, 24 banks with some state participation, and 2 private commercial banks with foreign participation. The banking sector continues to be dominated by a few large state banks.

The financial market in Uzbekistan is still subject to certain restrictions and distortions. Onerous reserve requirements exist, obliging banks to surrender up to 25 percent of their liabilities as precautionary reserves.

Debt-recovery mechanisms, which were not functioning until recently, are now being put in place. A bankruptcy law has been put in place, and legislation on the mortgage of real estate has been promulgated; however, a law on collateral does not exist. Market-oriented accounting standards need to be adopted and implemented.

Overdue loans of the banks were estimated at almost 10 percent of total loans, as of October 1, 1995. This amount exceeds the amount of paid-in capital of the banks. It is estimated that the actual losses will be considerably larger. Much overdue interest is capitalized, and loan-loss provisioning based on overdue periods does not take into account losses expected in the future.

The World Bank has advised a strategy the cornerstone of which is the establishment of a proper legal and business environment for the banks, free from incentive distortions. Specifically directed at the banks, the first requirement is a diagnosis of the financial condition of the banks. The next phase would be their financial restructuring. In view of the dominance of the public sector in the banking system, public funds will need to be invested in this restructuring. This may take place in the form of providing performing assets to the banks, in exchange for the carved out bad assets. The last phase is the operational restructuring of the banks. This would entail removing several layers of management, the development of a new business plan, and the development of banking skills in the bank.

Several immediate measures until a systematic strategy can be implemented are under consideration. These include limiting the activities of the large banks for a certain period of time, for example, 18 months; prohibiting dividend payments and participation in interbank borrowing or credit auctions; refusing new household deposits; funding additional lending from cash flow from repayments on loans and other internal sources; and reducing the reliance on central bank funds. During the initial period of austerity, a business plan should be developed for the future. At the same time, the banking supervision capacity of the central bank should be strengthened.

The Baltic Countries


Following the adoption of a currency board arrangement in June 1992, as part of its financial sector reform program the Bank of Estonia (BOE) achieved substantial progress in increasing the efficiency of the payments system. By the end of August the delay in clearing domestic payments was reduced to a two-day maximum. These developments, however, led to the unveiling of solvency problems in the two major banks and a smaller bank. The BOE’s initial response was to extend emergency credit to the largest of these banks. As it became clear that such credit would be insufficient the banks were forced to close and a task force for each bank was formed to examine the bank’s financial position.

Based on the initial assessment of the task forces it was decided that sufficient liquidity was available at each bank to permit partial access by depositors to their claims. During the end of 1992 and early January 1993, the authorities, in consultation with IMF staff, developed a comprehensive bank-restructuring strategy. The smaller bank was liquidated, and depositors were compensated with the receipts from the liquidation of the bank’s assets.

The two large banks were recapitalized through placement of government bonds, merged, and opened as a new bank wholly owned by the government, the National Estonia Bank. Prior to its operation as a new entity the national bank received liquidity from the BOE to permit opening the branches of the two former banks. The closure of banks in 1993 did not have systemic consequences as there were no contagion effects to trigger a run on deposits. In effect, there was a shift in banking business toward other healthy banks.


As in other transition countries, following the financial sector reforms in early 1990s the number of banks grew rapidly mainly due to lax licensing requirements. However, the evolution of the Latvian banking sector differs significantly from that of the other countries. In particular, the new commercial banks’ share of total bank assets grew from 47 percent to 85 percent in two years and accounted for 89 percent of total bank credits at the end of 1994 compared with only 23 percent two years earlier. In part this reflects the sale of former branches of the Bank of Latvia to commercial banks.

Of these banks, Bank Baltija’s assets grew from about $25 million in January 1993, to almost $500 million in early 1995; it became the largest bank in Latvia. The bank developed a large network of branches and competed aggressively with the Savings Bank by offering very high interest rates. When the Bank of Latvia obliged all banks to present financial accounts audited on the basis of International Accounting Standards, Bank Baltija refused to give its auditors full access to all documentation. In spring 1995, when the public became aware that Baltija was in difficulty, deposit outflows picked up. Initially, the Bank of Latvia provided a small amount of liquidity support, but when it became clear that the situation of the bank was largely due to fraud further support was denied. Bank Baltija was declared insolvent by a court in July 1995; it was closed and has remained closed despite the attempts of creditors to review this action in the courts. Besides Bank Baltija, approximately 15 smaller banks have been closed during 1994 and 1995 and liquidated according to law, without interference from the authorities. In the middle of the crisis, laws were drafted to deal more systematically with bank problems, including a Law on Rehabilitation. However, when the proposal reached Parliament it was never enacted, as there were signs that the bank crisis might be over.

No deposit protection was in place in Latvia when the bank crisis started. To restore confidence in the banking system, the government initially announced that household depositors would be compensated. The planned compensation included a ceiling of LVL 500 ($1,000) per depositor, with an immediate cash payment of LVL 200 and the rest in three installments of LVL 100 during the subsequent three years. Only limited payments have been made under this scheme, and it appeared early in 1996 that the new government would limit compensation to the amounts actually recovered in liquidation.


The banking system in Lithuania is highly concentrated. The five largest banks account for three-fourths of the total assets of the banking system. At the end of 1994, 28 banks were licensed to carry out banking activities, but as of March 1996, 14 had had their licenses withdrawn and entered into bankruptcy proceedings.

Three of the four biggest banks are state controlled and the rest privately owned. A far-reaching system for deposit protection is in place (however, no insurance fund has been established yet, thus making the government the insurer of the deposits). According to a decision taken by the Parliament when the bank crisis surfaced, individual depositors of the 14 banks that are to be liquidated will be protected up to Lt 2,000 ($500).

In late 1995, the authorities suspended the operations of the three largest banks with solvency problems. Subsequently, one of the banks has been allowed to resume operations (without government support), one is being restructured by the government, and one is still seeking nongovernment investors for its rehabilitation. A special asset-management company is being set up—owned by the government—to which nonperforming assets from banks receiving public support will be transferred. It is proposed that banks receiving public support will be initially nationalized, and existing shareholders will lose all their rights and the full value of their shares.