regulations for the banking sector than for their enforcement<sup>8</sup> . The same survey found that the _CIS_ countries were rated lower in both extensiveness and effectiveness than the _CEEs_ and the _Baltics._ Among the _CEEs, Hungary, Poland_ and _Bulgaria_ were rated higher in both counts than the _Czech Republic_ and _Macedonia. Estonia_ was rated the highest among the Baltic countries.

The issue of effectiveness of financial sector legal framework is closely related to the quality of banking supervision. As in the case of strengthening prudential regulations and introduction of international accounting standards (IAS), improvements in the quality of banking supervision took place in the aftermath of banking crises or after the initiation of financial sector reforms to address banking distress. However, the lack of financial resources and technical expertise have made the implementation of effective banking supervision problematic. Countries that are most advanced in terms of legal reform in the financial sector _(Hungary_ and _Poland)_ are planning to introduce bariking supervision on a consolidated basis, which is important to prevent excessive credit risk exposure and inadequate capitalization in the financial institutions not covered by the regulations.

In sum, a strong institutional framework is a key element for a sound banking sector. The strengthening of the institutional framework in the aftermath of banking crises in the sample countries have helped produce positive results of bank crisis resolution in all of them (see section 6 for results of crisis resolution). By the same token, the greater extensiveness and effectiveness of financial laws and regulations in the _CEEs_ and the _Baltics_ compared with the _CIS_ are accompanied by stronger banking systems in the first two country groups compared with the last one.

# 3.2 **Operational Restructuring**

_Operational restructuring_ of banks is aimed at improving their corporate governance. It deals with the flow problems in banks caused by non-perforning loans and high operating costs. Operational restructuring can take two forms: bank closure and liquidation; or bank restructuring, which could entail change of management or privatization.

The experience of the twelve countries under consideration was that **the** _CEE_ countries generally **restructured banks rather than close them,** whereas **the** **_CIS_ countries tended to favor the liquidation approach. The** **_Baltic_** countries pursued a combination of liquidations and restructuring.

The strategy adopted by the authorities for resolving banking crises seem to depend, in part, on two factors: (i) the development of the banking sector, including the degree of financial penetration; and (ii) macroeconomic conditions. The impact of these factors on the operational restructuring strategy pursued in the different country groups is discussed next.

The _CIS_ and the _Baltics._ At the onset of transition, the banking systems in the _CIS_ and the _Baltics_ were developed mainly through liberal entry of new banks in combination with the spontaneous breakup and privatization of state banks, and in some cases liquidation of old banks. This approach was not always a deliberate choice, but happened spontaneously when the former Soviet Union collapsed. The result was an explosion of the number of new banks that entered the system (in absolute terms and in

> 8 EBRD Transition Report, 1998. Academic and practicing lawyers and other experts familiar with the financial laws and regulations of the region were surveyed. The survey questions were based in part on the core principles developed by the Basle Committee, including questions on: banking regulations and supervision; minimum financial requirements (capital adequacy standards) and criteria for banking operations; use of internationally acceptable accounting standards; and ability of banking regulators to engage in enforcement and corrective action.

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