POLICY RESEAR-H -WORKING PAPER 184ZI

# Summary finldings

Nearly 100 countries have experienced bank_ insovenCies -n the past 20 years. Weakness in the financial sectors of many countries is reflected in the size of the insolvencies inm mnany.- cases, the cost of bailout exceeded 15 percen, of _GDP_ and the tact that these crises ofretn recur Because a strong finaucial se^to-r is importanr for econom-ic _grn"m'hd_ the World Banak has increasmngly graneEd s>a-ns witi conrtiors atached to achieve specific financia<sup>l</sup> _s-c1 or_ r-o The Bank often employs TInr acia1 sector adjustment loa:n§ (FSALs) or, in nporer c .untries, credits (FSACs). ;ESALs are generaliy more cormreinensive than other types of interventorns and tee d tn concentra<-e _orn_ t"e reform areas most closely linked to the opera.iorns ot deposit banks. Since 1990, **t.eir** main focus has shivted from im-proving prudenafli-i regularions anr corr'cring interest rate distortions to privatizang anc re--api alizing banks.

Cull exa-rninmes whether (1) inital condisions in a rec,pienr eoutrry explain a suhs Lar-ial amotunt of the variation -7 i ttrven'iGn outconnes (as neasured by posti.ter"ienstlfinnancial deepenrng) and ' **_tI_** whether the changmrg na-"re or mterventisns has had implications for the.r success. He fh-.s tha.

t'Fhe decine 'n posr-i-e-rvent-ion nerformrance since I1T99 cannot be attfibDutCd solely to initial m-acroeconcr.ri _and fnrancual_ seccor conditions in the recipient country_a_ Wvner inial mnacroeconoirnc and financial sector conditions 'vere controlled for, certain types of reform, espec'aoy those dealing with prudential regulations, were associazced w'th relative'y large increases in the ratio of Mrr;ney suDDIV _'M12)_ to GDP. Those dealing with recatital±za _n-_ have also been relatively successful, espe. ially hen they also tackled prudential regulation or bank;i supe:rgsion. Those that focused on supervlisior did no,r on average, substantially outperform -hose _ti4t d-d not_ focus on supervision. And reform focused on aonk privatization was associated with much less fi r,ncal deceping three **years** after the intervention. In addiion to reformr airned at institutional strengthcnin r.i, Jh reforrn environment itself had a substantial impact on intervention outcomes. Financial deepering ewas posinvei associated withr macroeconomic srabihicy ¢lUow i.nflt. ar.d an initially underdeveloped financial sector.

-As the Bank s ooaerationai directives suggest, some macroccornom;c stability is important for the success of _tWo_ c-or 1nteHveOtionls especially those that incorporat i rest ate liberalization.

'%Ihile -, r;ay bIe nes. tno ove more aggressively on inancial rerormn when mracroeconomic circumstances are favo;--HeI "visible" reform (such as privatization or n-;rest _-ae_ -eegulation) should be slowed rather than a anco e i rn less rortunate circumstances. By contrast, less v si le institu,rion-huilding efforts should be 3o-rntued regardless ot macroeconomic conditions.

This paper - a oroduct of the Development Research Goiup - is oart of a larger effort in the groun to evaluate the effectiveness of World Bank lending. Copies of the paper are available _free_ fromr the W9i,orid _Bank,_ 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room N9-030. telephone 202-473-7/644, fax 202-5221155. internet address psintsmaboagye@worldbank org. Aug-ust 1997. (S4 pages) _The Po Research Rcy Workinlg Paper Series disseminates the findings of vvook in progress to encourage the exchange of ideas about aeveiop'nent issues. An objective of the series is toget theyfindings out qtiickly, e-ven fi the Preseniations_ **_are_** _iess than fully polished._ **_The_** _i,t-cpers carry the n ames ofthe authors and should be cited accordinglyi. The findings, interpretations, and conclusions expressed in this paper arc entirely those of the authors. They do not necessarily represent .ke liew of the 'World Bank. its Executive Directors, or the coumv;es ghey reresern._ Produced by the Policy Researchn Disserminatlon Center