Summary: One legacy of central planning, says the author, is that the financial systems in the transitional economies are even less developed than in many developing countries. He contends that the main goal of financial reform in these economies should be to make passive financial systems active - to make financial systems participate actively in the economy, as they do in market economies. For this to happen, the transitional economies must develop banking systems that allocate credit efficiently. Commercial banks must screen borrowers and monitor and discipline enterprises. The role of the government or the central bank should be limited to regulation and supervision. Most transitional economies have adopted a gradual approach to reforming their financial systems, maintaining the banking system's passive role. But banking reform in Eastern Europe cannot wait for enterprise restructuring and privatization, because both banks and state enterprises are burdened with inherited bad debts that endanger their solvency and hence that of the economy. The financial restructuring of banks and enterprises should be undertaken simultaneously, says the author, and should start early in the transition. Commercial banks should play an active role in the financial restructuring of enterprises. Governments must take responsibility (through the budget) for the debts of nonviable enterprises in a transparent manner and for the recapitalization of banks after their clean-up. Otherwise the healthy segments of the commercial sectors will have to carry the burden of financial restructuring, which will slow down the transition. Early in the transition, attention must also be paid to improving the system of payments, demonopolizing banking, changing the structure of ownership (including privatization), and introducing market-based financial legislation. The speed of financial reform will depend greatly on the availability of skilled banking professionals, on access to technical assistance from abroad, fiscal constraints, and of course on specific country circumstances. For example, for most countries of the former Soviet Union - except, for the Baltic states - a prerequisite to successful financial restructuring is macroeconomic stabilization and the reduction of high inflation rates. The most important lesson from countries further along in reform is that financial reform should not be delayed but should start as soon as possible. Delays reduce living standards (burdening the healthy parts of the economy with direct taxes or high financial costs), discourage small-scale entrepreneurs, inhibit the entry of new forms, and cause the economy to stagnate further.
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