For the past six years, the central banks of the Baltics, Russia, and other countries of the former Soviet Union have undertaken ambitious programs of reform.1 The reforms have focused first on stabilizing monetary policy and then on achieving a market-based determination of interest and exchange rates. The reform of central bank operating procedures has been a key piece of the program. Central banks in the 15 countries have been encouraged to manage banking liquidity through market operations with indirect instruments. There have also been closely coordinated reforms to foster foreign exchange markets, interbank money markets, government securities markets, and to strengthen various central bank functions, including the payment system, central bank accounting and internal audit, and banking supervision and restructuring. This volume examines the progress the 15 countries have made in transforming their financial systems, and highlights the substantial progress achieved by central banks in most of the countries.

For the past six years, the central banks of the Baltics, Russia, and other countries of the former Soviet Union have undertaken ambitious programs of reform.1 The reforms have focused first on stabilizing monetary policy and then on achieving a market-based determination of interest and exchange rates. The reform of central bank operating procedures has been a key piece of the program. Central banks in the 15 countries have been encouraged to manage banking liquidity through market operations with indirect instruments. There have also been closely coordinated reforms to foster foreign exchange markets, interbank money markets, government securities markets, and to strengthen various central bank functions, including the payment system, central bank accounting and internal audit, and banking supervision and restructuring. This volume examines the progress the 15 countries have made in transforming their financial systems, and highlights the substantial progress achieved by central banks in most of the countries.

The chapters were originally prepared as sections of a background paper for the eleventh and final coordination meeting (May 1998) of 23 cooperating central banks and other major and international and regional institutions that have been providing technical assistance to the central banks of the 15 countries since early 1992. The donors have met regularly since 1992 to evaluate the progress of reforms, assess the effectiveness of technical assistance activities, and review staff resource commitments under the technical assistance program.2 At the 1996 high-level coordination meeting, participants agreed that most of the central banks in the 15 countries were reaching the stage where comprehensive technical assistance and advice from multilateral and bilateral donors on central banking functions were no longer needed. Therefore, the group decided to target the 1998 meeting as the final or “sunset” meeting of high-level representatives. Nevertheless, the group also recognized that there would be a continuing and substantial need for more specialized technical assistance in a number of areas, and that a few countries would require close support. Thus, there might be a need for a new, streamlined framework for future coordination efforts. This volume discusses remaining issues and points to areas where further reform is needed.

The structure of this book is similar to background studies prepared for previous years’ coordination meetings.3 Specifically, the book reviews the central banks’ progress during 1997 in moving closer to achievement of their medium-term objectives, as well as the technical assistance and support that have fostered this process. In addition, it also evaluates more broadly the cumulative progress that has been made since the start of reform in the early 1990s, and attempts to assess both the scope and sequencing of further reform measures needed to help each country meet international standards or best practices.

As in previous years, this background study attempts to rank, on a scale of I to III, the degree of progress that each country has achieved in the main central banking areas surveyed here. A ranking of (I) signifies limited progress; (II), moderate progress; and (III), substantial progress. An overall ranking based on the individual rankings for the key functional areas is also included. The same caveat as in previous years’ ranking exercises applies—measuring the rate of progress necessarily involves qualitative assessments, and the assigned rankings must therefore be treated with appropriate caution. Countries judged to have made “substantial progress” in financial system reform compared to their peer group in many cases still have further work to do in order to conform to best international practices and standards. Nevertheless, the rankings provided here are intended to assist the coordinating central banks and technical assistance donors in drawing broad conclusions about the effectiveness of their past efforts, the extent of the further reform measures needed in each country, and the associated technical assistance requirements. The rankings are partly based on comprehensive questionnaires that were addressed to the authorities in all recipient countries, in conjunction with the IMF’s ongoing contacts with the authorities in the course of technical assistance and other country work.

Summary of Findings in Key Functional Areas

Overall, good progress has been made in most central banking areas, although results have differed significantly among countries.

Monetary Operations and Government Securities Markets

Since 1992, most of the 15 countries reviewed in this book have made important progress toward establishing efficient market-based financial instruments, although further reforms are still needed to achieve basic goals of well-functioning, short-term interbank and government securities markets. Interest rate controls have been abolished, so that deposit and lending rates are now market-determined in most of the countries. The basic structure of interbank markets has been put in place, but liquidity in these markets remains thin in many of the countries, owing to the varying credit quality of financial institutions and the lack of trust between commercial bank counterparties, the unfamiliarity and inexperience with short-term liquidity management at commercial banks, and uncertainties surrounding payment and settlement services between banks. To address this lack of interbank development, many countries are introducing repurchase agreements as the basis for interbank trading. Primary markets for government securities have been established in most countries, although market participation in primary auctions has been mixed. The maturities of government securities remain primarily short-term, partly because of continuing concerns over inflation risk. Secondary markets in government securities have been slower to establish and develop in many countries, but there is reasonable depth and liquidity in Kazakhstan, Latvia, and Russia.

Most of the 15 countries have begun to exercise monetary control through indirect, market-based instruments. Only a few resort to direct monetary instruments and controls. Bank-by-bank credit ceilings have been eliminated in all countries, and limits on cash withdrawals by depositors are now maintained only in Turkmenistan and Uzbekistan. Directed credits, often at below-market rates, still exist in some countries (Belarus, Turkmenistan, and Uzbekistan). The design of indirect instruments and market-based central bank standing and discretionary facilities has progressed significantly in many countries, but thin interbank markets have hampered the monetary transmission mechanism, and in some cases central banks need to streamline the number of instruments and facilities used. While most of the countries are employing monetary programming techniques, the application of these methods has been hampered by deficiencies in their central bank’s short-term forecasting and liquidity management techniques. This stems largely from coordination problems, both within central bank departments and between the central bank and the finance ministry or treasury, in producing accurate short-term forecasts of government cash flows.

Two of the Baltic countries—Estonia and Lithuania—operate currency board arrangements, and thus are precluded from active monetary operations. Kazakhstan, the Kyrgyz Republic, Latvia, and Russia have made the most progress overall in introducing market-based monetary policy instruments and establishing interbank and secondary markets for financial instruments.

Following the initial stages of reforms in early 1992, the combination of rapid monetary expansions, limited supplies of goods, and government controls on prices induced sharp increases in real money balances. This in turn fueled spiraling inflation rates when prices were liberalized, and the value of those balances subsequently fell from late 1992 through 1994. The first steps toward macroeconomic stabilization brought about a leveling out in the real value of monetary aggregates, albeit at levels well below those in developing countries. Dollarization, although difficult to measure, has also been a significant factor in most countries through the period since liberalization began. These circumstances have been associated with instability in money demand relationships that have hampered the application of monetary management frameworks based on standard monetary and liquidity programming techniques.

Future efforts need to focus on fostering more liquid interbank money markets and secondary markets for government securities, improving the effectiveness of monetary operations using indirect instruments, and providing more complete financial markets. The streamlining of central bank operations through fully collateralized instruments such as repurchase agreements or Lombard-type facilities, and the gradual development of more stable money demand relationships, including banks’ demand for excess reserves, will enhance the monetary transmission mechanism and the implementation of medium-term policies directed toward price stability. Monetary policy, of course, is but one element that can contribute to good overall macroeconomic performance. Other supporting structural policies, in both the financial and real sectors, play crucial roles in the monetary and broader macroeconomic setting.

Foreign Exchange Markets and Official Reserves

Progress toward the efficient market-based determination of exchange rates is well advanced in most of the countries, including the areas of current account convertibility, and to a lesser extent, capital account convertibility; interbank market development; and central bank foreign exchange operations. Two-thirds of these countries are judged to have made substantial overall progress in this area. The three Baltic countries formally peg their currencies (Estonia to the deutsche mark and Lithuania to the U.S. dollar through currency board arrangements, and Latvia to the IMF’s special drawing right, or SDR). Five others (Russia and Ukraine, with exchange rate bands, and Georgia, Tajikistan, and Turkmenistan) operate de facto exchange rate pegs. The remaining seven countries operate regimes with varying degrees of flexibility, from those where the exchange rate is determined mainly in the interbank market with negligible official intervention, to those where the central bank is the market-maker and sets the rate. Exchange rates have been unified in all but two countries (Uzbekistan and Turkmenistan), and all but four (Belarus, Tajikistan, Turkmenistan, and Uzbekistan) have achieved current account convertibility. Furthermore, capital accounts are relatively unrestricted in five countries (the three Baltic countries, Georgia, and Kyrgyz Republic), with gradual liberalization continuing in several others.4 While auction mechanisms were implemented at the start of the reform process, they are gradually being phased out in favor of over-the-counter interbank trading arrangements, which decentralize the allocation of foreign exchange. Over-the-counter markets also support a variety of exchange rate regimes, from fixed to freely floating rates.

Although many of the countries have institutional arrangements in place for an efficient foreign exchange market, activity often remains thin, owing partly to counterparty concerns in the interbank foreign exchange market. Enhancing the liquidity of interbank trading remains a priority for future reform and, as in the domestic interbank money and securities markets, depends crucially on better counterparty information and more generally on strengthening banking sector soundness. Eliminating surrender requirements in those countries that have not already done so, and improving the foreign exchange payment system to minimize settlement risks, are other key elements that need to be addressed in coming years. Countries may also need assistance in developing contingency strategies to deal with volatile capital flows and the orderly liberalization of capital account transactions. Technical assistance in dealing with volatile capital inflows may involve the design of flexible market-based exchange arrangements, including an exit strategy from a peg regime, and advice to enhance the coordination of monetary and exchange rate policies. These developments, which result from globalization, liberalization, and financial innovation, call for an integrated approach to technical assistance in capital account liberalization; that is, one that emphasizes the linkages between liberalization and the need for sound financial markets and institutions and appropriate macroeconomic policies.

Bank Supervision and Restructuring

The process of financial market liberalization and reform that began early in the decade was the impetus for a rapid expansion of the number of banks operating in the Baltics, Russia, and other countries of the former Soviet Union. Many banks prospered during this early period of high inflation and currency depreciation, through intermediation in relatively safe government bonds or through speculative activity in a depreciating currency, rather than through traditional banking business, which would have fostered credit extension and financial deepening. The basic legal frameworks for bank intermediation, accounting and judicial infrastructures, and banking supervision and regulatory regimes did not keep pace with this development. Large macroeconomic imbalances soon followed, and a number of banks came to the brink of insolvency in the mid-1990s. In virtually all countries under review this near collapse led to broader systemic problems in the banking sector, which will require considerable amounts of human and financial capital and technical assistance to correct. These problems in some cases will take years to address.

Consolidation and recapitalization of the banking system are now well under way in many of the countries, with almost all taking important initiatives in systemic reform, supported by much multilateral and bilateral technical cooperation. Bank restructuring, however, is not yet complete. Further enhancement to supervisory capabilities will be needed to keep pace with the financial deepening and the increases in bank intermediation that should flow from sustainable economic expansion in coming years.

Twelve of the countries have conducted broad diagnostic reviews of their banking systems as the first step toward developing comprehensive bank restructuring plans. About half the countries have adopted overall bank restructuring policies, while the others have dealt with these issues using a bank-by-bank approach. Key elements have included the strengthening of bank licensing requirements, recapitalization, both through shareholder capital and retained earnings or dividends, and, for the remaining state-owned banks, through government recapitalization or privatization plans and the tightening of provisioning rules. Through application of firm licensing and exit policies, as well as mergers, the banking system is undergoing a sizeable consolidation, resulting in a marked reduction in the number of banks. Until now, however, much of the consolidation and restructuring efforts have been directed toward smaller banks. In the near future, some countries, particularly Moldova, Russia, and Ukraine, will need to redirect these efforts toward problem banks, including the large formerly state-owned banks. While two-thirds of the countries have delegated the responsibility of dealing with problem banks to a central authority, only two (Kyrgyz Republic and Lithuania) have chosen to create asset management agencies to deal with insolvent banks.

The legal framework for effective banking supervision is now established in all 15 countries and has been supported by considerable technical cooperation over the past five years. Much progress has been made in the implementation of banking supervision standards in most of these countries; but further groundwork must be established in Belarus, Tajikistan, and Uzbekistan. Most countries have raised minimum capital requirements to acceptable levels to create new banks. At the same time, capital adequacy requirements have been considerably strengthened, although these could be further reinforced beyond the suggested minimum Basle ratios, which are designed for internationally active banks in well-established markets. Asset qualities have improved in the majority of the countries, with nonperforming loans now reported at around 10 percent of total assets on a simple average basis, although there are wide variations in the estimates across countries.

Major concerns persist about the accuracy, comparability, and quality of commercial bank accounting data in many countries—key priorities for reform. The lack of consolidated accounts and supervision on a consolidated basis according to international accounting standards (including off-balance sheet items), as well as the enhancement of off-site analysis and on-site inspection programs are other elements of banking supervision that require strengthening.

Payment System Operations and Policies

Most of the countries have made impressive strides in improving their domestic payment systems, although much remains to be done to develop diversified consumer-oriented payment services of a standard comparable to those in mature market economies. Nevertheless, more than half the countries have made substantial progress in addressing the strategic issues of payment system policy and design, and only one—Tajikistan—has lagged substantially behind. There is some evidence of the salutary effect of payment system improvements on domestic intermediation and financial deepening—as reflected in lower currency-to-GDP ratios—although of course the contributions of monetary policy and sounder banking systems are integrally involved. Central banks of the Baltics, Russia, and other countries of the former Soviet Union have themselves played a leading role in the development of payment systems, including offering clearing services. In some cases (Kazakhstan, Russia, and Ukraine), the central bank has implemented pricing policies for its services to encourage involvement of the private sector in the design, development, and management of an efficient payment system.

Good progress has been achieved in consolidating settlement accounts at the central banks, to enable commercial banks to manage their day-today liquidity more effectively, although in some countries banks have only achieved, or are aiming for, regional rather than national account consolidation (Georgia, Russia, and Tajikistan), while in two others (Azerbaijan and Uzbekistan), bank account holdings are still highly dispersed.

The introduction of systemic risk controls in support of financial stability has been a key element in the recent efforts of these countries. Settlement discipline has been promoted through strict limits on access to central bank credit. Such limits also play an important role in the development of well-functioning interbank markets, although trading in this area remains thin in most countries because of solvency concerns and credit tiering among commercial banks.

Where substantial progress has been made in payment system policies, technical assistance will increasingly need to focus on specialized topics of evolving systems and technology. The development of specialized large value transfer systems, which are seen as a cornerstone for broader financial market evolution, is such a topic. These transfer systems are in embryonic stages in most of the countries, many of which are planning real-time gross settlement systems, with built-in links to delivery-versus-payment systems for domestic securities markets. Real-time gross settlement systems are now operating in Kazakhstan and Belarus, and a pilot system is being tried by a limited number of Russian banks in the Moscow region. Further work remains to be done to consolidate the legal basis underlying payment system arrangements, including bankruptcy and collateral laws, and, importantly, to expedite the execution of these laws through the courts. Another important area where reform is needed is in the containment of foreign exchange settlement risks.

Central Bank Accounting and Internal Audit

Two-thirds of the countries have made substantial progress in implementing central bank accounting and audit reforms. Central banks in 11 countries—Armenia, Azerbaijan, Belarus, Estonia, Georgia, Kazakhstan, the Kyrgyz Republic, Latvia, Lithuania, Moldova, and Ukraine—have introduced, or are about to introduce, accounting systems and policies and procedures that are broadly consistent with International Accounting Standards (IAS). Much improvement has also been made toward full public disclosure of transparent accounting information, essential to building broader confidence in the financial sector. In nearly all these countries, the central banks’ books have been subject to varying degrees of independent assessment by internationally recognized external auditors. Internal audit reform has occurred at a somewhat slower pace, although most countries recognize the need for improvement in this area. All countries have adopted a new chart of accounts, except Tajikistan, where a new chart is under consideration. Countries that are considered to have made moderate progress (Turkmenistan and Uzbekistan) have adopted a new chart of accounts, but these statements have not yet received a “clean” opinion by independent external auditors.

In the area of central bank accounting, the priorities for reform in the most advanced countries will be to enhance financial management control and information systems. Improvements in these two areas will permit more efficient use of central bank resources, establish policies to maintain central bank financial soundness, and allow the central bank to play a leadership role in establishing full and transparent disclosure standards, which, in turn, will promote general financial discipline in the financial system. Some countries still have gaps in their basic knowledge and application of accounting policies, including adoption of the accruals principle, valuation of assets, and the preparation of a full set of financial statements (in some cases preparation is impeded by conceptual or political obstacles to reform). Other relevant issues that will require further reform in all 15 countries, and in some instances additional specialized technical assistance, include the development and implementation of accounting policies for new financial instruments, especially off-balance sheet items; more structured staff training and development; management of new technologies and information systems; and harmonization of central bank and financial sector accounting and reporting standards.

Legislative Framework

Before 1991, the U.S.S.R. operated a monobank system in which savings were pooled and credit was allocated on the basis of centralized planning. Since 1992, all 15 countries have made considerable progress toward the creation of the legislative framework for a two-tiered banking system comprising an autonomous central bank and commercial banks that compete with each other and with other financial intermediaries. In these countries, the basic legal frameworks are now in place to enable the effective operation of a modern central bank with clear policy objectives and the political and operational autonomy to achieve those objectives. Eleven of the countries under review have made price stability the primary objective of central bank legislation, either explicitly or implicitly, through linking the currency to an anchor currency. Of the remaining countries, Azerbaijan, Russia, and Turkmenistan include price stability as one among multiple objectives, while Ukraine designates monetary or currency stability as one of its objectives.5

Legislative measures to ensure political and economic autonomy have also been built into laws governing central banks. The laws generally guarantee that the term of office for the central bank governor and for board members is longer than the election cycle, and in some cases include a double-veto arrangement for appointments. Provisions to assure the financial soundness of the central bank, including clear rules on the transfer of central bank profits and the responsibility of the government to recapitalize the bank in the event of losses are also provided. As a counterpart to the provisions granting central bank autonomy, provisions are also imposed on the central bank to ensure that it is accountable to the government and the public for its policies and actions. A key element of accountability is the publication of regular reports that make the policies and operations of the central bank more transparent, including officially audited financial statements that conform to IAS.6 While most central bank laws in the 15 countries include these basic elements, Estonia, Latvia, Lithuania, and Ukraine are currently examining ways to strengthen aspects of central bank autonomy and accountability. Belarus is also reviewing its central bank legislation, although it appears that some current proposals would weaken the autonomy of its central bank, the National Bank of Belarus.

Much of the legislative framework required for the efficient allocation of savings and the operation of financial markets is beyond the immediate purview of the central bank. The central bank has no influence over such basic laws as those governing property rights and contracts, bankruptcy, and the use of collateral, including the registration of liens. Furthermore, the laws that underpin financial markets and transactions must be supported and enforced through an efficient judicial process. These basic institutional and legal measures, once firmly established, will clarify the rights and obligations of counterparties to financial transactions. The confidence in market-based transactions will contribute to domestic financial deepening and currency stability, foster the establishment of fully market-determined interest rates through more liquid financial instruments and complete capital markets, and facilitate the application of indirect instruments of monetary policy. Other key impediments remain, however, including weaknesses in the payment system, unclear accounting standards, and bank unsoundness, that will slow the pace of overall financial market development to varying degrees in each of the countries.

Country Rankings

While all of the 15 countries covered in this book seek a fundamental transformation of their economic and financial systems over the medium term, inevitably, during the last six years, progress in the various key areas of central banking reforms has differed across countries. To help countries in determining the appropriate sequencing of further reforms, and to assist both recipient and donor central banks and institutions in identifying priorities for further technical assistance, the IMF has updated its rankings of each country’s progress in the key areas of reform and for each country’s financial system as a whole.

Countries are ranked by degree of progress: (I) limited, (II) moderate, and (III) substantial. The rankings are intended to provide a rough assessment of the relative progress made by each country from the end of 1991 to the present. Analogous exercises were conducted for three previous coordination meetings of technical assistance providers (1994-96), but an additional category covering central bank legislation has been included this year. Because of additional information and the methodology employed, including the additional legislative category, the individual and overall rankings presented in this report may not be strictly comparable to the earlier ones. In particular, a country may have registered steady progress since the earlier reviews, but may still be ranked in the same category. Moreover, a lower ranking would not necessarily indicate backtracking by the country, but might reflect lower-than-average progress compared with the peer group.

Of course, measuring this medium-term progress necessarily involves qualitative assessments, especially as to how far each central bank has moved toward implementing new market-based instruments and procedures of monetary policy, and how financial markets have responded. The assigned rankings must therefore be treated only as a rough indicator of areas that should receive priority in order to maintain the momentum of structural transformation in each country. A substantial ranking (III) does not imply that the country has fully achieved international standards or best practices in that area, and further actions, and possibly technical assistance, may continue to be needed. Finally, the rankings for each country reflect the pace of structural changes toward a market-based financial system and are not intended as an assessment of countries’ overall macroeconomic and financial policy stance.

The rankings listed in Table 1.1 summarize the progress made up to the end of 1997 in seven major functional areas: central bank legislation; monetary operations and government securities markets; foreign exchange operations and official international reserve management; banking supervision; bank restructuring; payment systems; and central bank accounting and internal audit. They are based on technical criteria outlined later in this book. The overall ranking is derived by aggregating those in each individual category. Specifically, countries that have at least four ratings of III and no rating of I have been accorded an overall rating of III. Countries that have three or more ratings of I have been given an overall rating of I. The other countries have received a rating of II. Each of the functional areas is given equal weight.

Table 1.1.

Progress on Central Banking Reforms: Country Rankings, 1997

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Note: *Denotes currency board arrangements; the rankings denote the following: (I) limited progress; (II) moderate progress; and (III) substantial progress.

Central banks in the Baltics, Russia, and the other countries of the former Soviet Union have recognized that implementation of the key central banking reforms discussed in this book will improve monetary control, strengthen financial intermediation, and lead to improved overall macro-economic performance. During the past few years, the reforms undertaken in these countries have been instrumental in bringing about price and foreign exchange market stabilization, although for some countries, the resumption of steady economic growth still lies ahead. It is not an easy matter to link reforms and improved economic performance with precision, but several recent empirical studies point to broad linkages between progress in structural reform and improved economic performance.7


The Baltics, Russia, and other countries of the former Soviet Union include Armenia, Azerbaijan, Belarus, Estonia, Georgia, Kazakhstan, Kyrgyz Republic, Latvia, Lithuania, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.


The cooperating central banks include those of Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Iceland, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.


The background papers for the 1996 meeting were published in V. Sundararajan, Arne B. Petersen, and Gabriel Sensenbrenner, Central Bank Reform in the Transition Economies (Washington: International Monetary Fund, 1997). The background papers from the 1997 meeting were collected in Malcolm Knight and others, Central Bank Reforms in the Baltics, Russia, and Other Countries of the Former Soviet Union, IMF Occasional Paper No. 157 (Washington: International Monetary Fund, 1997).


In addition, Armenia’s capital account is also presently unrestricted, but the regulations explicitly allow for the reintroduction of capital controls.


A revised central bank law that includes price stability as a primary objective has been prepared for parliamentary discussion in Ukraine.


IAS are promulgated by the International Accounting Standards Committee, composed of over 120 professional accounting bodies in 91 countries. The organization establishes the standards for the presentation of financial statements.


These include: J. Sachs and W.T. Woo, “Structural Factors in the Economic Reforms of China, Eastern Europe, and the Former Soviet Union,” Economic Policy: A European Forum, Vol. 9, No. 4 (April, 1994), pp. 101-45; M. Selowsky and R. Martin, “Policy Performance and Output Growth in Transition Economies,” American Economic Review, Papers and Proceedings, Vol. 87 (May, 1997), pp. 349-53; and E. Hernández-Catá, “Liberalization and the Behavior of Output During the Transition from Plan to Market,” Staff Papers, Vol. 44, No. 4 (December, 1997), pp. 405-29.