23 sources. One option governments can consider for strengthening banks' capital position is expost rather than ex-ante recapitalization. Experience, including that of Hungary, Japan, and Thailand has shown that recapitalizing banks ex-ante does not necessarily ensure that restructuring will take place, and may create considerable moral hazard. Ex-post recapitalization links government support to a financial institution's progress in debt restructuring. The most explicit form of ex-post recapitalization would be to implement a loss sharing rule by which the government would cover a certain percentage of the loss arising from corporate restructuring deals.

To put bite into the incentive framework for restructuring, governments need to tighten provisioning and classification rules for bank loans if these rules are not in line with international best practice and also adjust rules for corporations. It often also means requiring financial institutions to apply those rules uniformly to standard, restructured, or rescheduled loans and to ensure that classification is based on a borrower's demonstrated ability to repay.

Implementing tougher accounting requirements often present a trade-off for governments. Requiring financial institutions to more realistically mark their assets to market and to provision restructured debt properly has short-term repercussions on financial institutions' capital positions and often increase their capital needs. Yet, international experience shows that meeting these upfront costs early on improves banks' incentives for loan recovery and proper restructuring and may thus yield significantly lower fiscal costs ultimately (Honohan and Klingebiel 2000).

Effective insolvency systems facilitate the rehabilitation of enterprises and also provide an efficient mechanism for the liquidation of those enterprises that cannot be rehabilitated. In addition, rehabilitation procedures may help overcome coordination problems of different creditors if they allow courts to impose restructuring agreements over the objections of creditors. Moreover, in economies undergoing transition, making state-owned enterprises subject to insolvency laws sends a clear signal that there is a limit to the amount of public financial support the firms can count on.

A question, however, here is whether indeed rehabilitation can be achieved most effectively through the application of a formal procedure. In a systemic crisis in particular, many countries rely on liquidation proceedings as the principal mechanism for rehabilitating enterprises. The very existence of liquidation proceedings create incentives for an out-of court restructuring and because an enterprise can be sold as a going concern liquidation can provide an effective vehicle for rehabilitation (Hagan 2000; International Monetary Fund 1999).

If bankruptcy procedures are lengthy and weak, debtors have incentives to ride out the economic downturn without diluting ownership which may inhibit deeper restructuring. Well functioning legal procedures and good access to courts are therefore crucial. Even if an adequate bankruptcy law exists, cross-country experience shows that effective implementation of the framework is even more important. In particular, given the complexity and the urgency of insolvency proceedings, effective implementation requires judges and administrators who are efficient, ethical and adequately trained in commercial and financial matters (Hagan 2000; International Monetary Fund 1999).