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Eastern Europe: Weak Banking Regulations Threaten Currencies, Economies, Says EBRD

Prague, 5 November 1997 (RFE/RL) -- The European Bank for Reconstruction and Development (EBRD) says the likelihood of currency crises in Eastern Europe is being magnified by the region's weak banking regulations.

In its latest Transition Report, the EBRD says unregulated lending practices can set off a chain reaction that leads to rapid currency devaluations, high inflation and an overall decline in a country's productivity.

The report sites recent failures of banks in Bulgaria and the three Baltic states as negative examples that other countries must heed -- failures that had massive consequences for the banking sectors and the economies of those countries as a whole.

Before Bulgaria's crisis in 1996, many banks in the country had become dangerously entangled with secretive private financial-industrial groups and unprofitable state enterprises. The loss-generating state firms and corrupt private companies continued to receive loans despite their inability or unwillingness to pay the money back.

The EBRD says regulators in many former communist countries have secretly cooperated in the unsound lending practices of banks. It says several states have had to bail out banks that became insolvent because of the widespread practice of issuing bad loans. This put an enormous strain on the state budget.

While a handful of corrupt officials and businessmen may profit from the practice in the short-term, the majority of people in a country ultimately suffer the brunt of such economic crises.

In Bulgaria's case, many people's entire life savings were eroded in a matter of a few weeks by hyperinflation and the rapid devaluation of the lev currency.

Ironically, while pensioners and unpaid workers were forced to forage for survival, some of the banks responsible for setting off Bulgaria's economic crises may have actually benefited from it. That's because the lev's devaluation reduced their non-performing loan portfolios to a pittance in terms of hard currencies like the U.S. dollar or the German mark.

The EBRD warns that when banks deplete their currency reserves through bad loans, they also can transmit their problems to healthier banks by borrowing on the interbank market.

The latest Transition Report explains that banking crises spread to foreign exchange markets when depositors lose confidence in savings institutions and start to look for alternatives for storing their money. A general loss of confidence in a country's currency also fuels inflation and upsets macroeconomic forecasts. The EBRD notes that this has occurred in Bulgaria, Estonia, Latvia and Lithuania since 1993.

The EBRD says most countries in eastern Europe and the former Soviet Union have not yet been affected by systemic crises because government bailouts have played a relatively small role in their economies.

But the Transition Report for 1997 warns that much needs to be done to establish solid banking principles and appropriate bank supervision in the region to stop future bank hemorrhages.

The report concludes: "The financial sector weaknesses in the region hold more potential upsets in store for both forecasters and policy makers."