these countries may have experienced an increase in capital in‡ows which could have come to fuel the credit boom in some of our sample countries. To account for capital in‡ows received by the domestic banking system we include the foreign exchange reserves held at the central bank, scaled by GDP.<sup>9</sup> Last, banking crises are accounted for, by including a dummy that takes value one in crisis inception years and the following two years,<sup>10</sup> with a negative e¤ect expected on credit to GDP.

The analysis uses quarterly data covering the ten countries listed in Appendix 1 over the period 1995-2005; as set out above, the sample is chosen such that it comprises all countries that were part of the former Eastern European bloc and that now are members of the European Union.<sup>11</sup> During the sample period, seven of these countries reformed their payment systems, with two countries (Poland and Czech Republic) having completed payment system reforms before the start of the sample period and one country (Romania) embarking on major reforms only at the very end of the sample.<sup>12</sup> These countries are included to achieve greater e¢ciency in the measurement of the e¤ect of control variables. Appendix 2 contains the list of variables used and the corresponding sources.

Summary statistics for all variables used in our tests are reported in Table 1. The descriptive statistics reported in the ...rst panel con...rm an increase in ...nancial intermediation over the sample period accompanied by a decline in the currency over demand deposits ratio and a small increase in the excess reserves over total deposits ratio.<sup>13</sup> The second panel reports a correlation matrix for a number of control variables. The correlation is high among some of these variables. Our approach is therefore to check the robustness of our results to the inclusion of alternative sets of control variables.

We go on to investigate the determinants of the trend in ...nancial intermediation by estimating equation (2). The main results are reported in Table 2. The speci...cations shown include control variables lagged by two periods<sup>14</sup> (i.e. half a year), in addition to the full set of country ...xed e¤ects, country-speci...c trends, year e¤ects and seasonal e¤ects.

9We also experimented with a broader measure of in‡ows including foreign direct investment, portfolio ‡ows and debt liabilities. This variable tended not to be signi...cant.

> 10Banking crises are identi...ed using the Caprio-Klingebiel World Bank dataset (2003) at www1.worldbank.org/...nance/html/database_sfd.html. According to this source, banking crises ocourred in the following countries (with crisis inception years in brackets): Bulgaria (1996), Latvia (1995), Poland (1993), Lithuania (1994).

> 11Bulgaria and Romania joined the European Union in 2007. All other sample countries joined in 2004. Slovenia has – in 2007 – also joined the euro.

12The series used are not available for a su¢ciently long period prior to reform in Poland and the Czech Republic (notably quarterly GDP).

> 13Credit to the private sector includes credit in both domestic and foreign currency. Payments technology may a¤ect the use of domestic currency transactions accounts by residents. The monitoring of these accounts can in‡uence the decision to grant credit, independent of the denomination of the debt. Moreover, while changes in domestic currency payments technology may at the margin favour domestic credit over foreign currency credit, for lack of data we are unable to explore whether payment system reforms might have brought about changes in the currency composition of the credit extended.

> 14We will later test the robustness of our results to alternative numbers of lags.

10