The Evolution of Bank Credit Quality in Transition Theory and Evidence From Romania

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Abstract
The paper offers a theoretical model of bank lending quality in a transition economy. The model obtains that under active bank monitoring the correlation between lending and arrears should decrease over time. This empirical measure allows us to assess whether banks impose financial discipline, or act as temporary buffers for losses. We run the test on a sample of Romanian state-owned enterprises over 1991-1994. We find evidence that, contrary to the findings of Pinto and van Wijnbergen for Poland, lending criteria for Romanian banks show few signs of improvement. Most worrisome is the stability of the relation between bank credit and financial arrears, which increases in strength over the period both statistically and in terms of economic impact. Bank credit is negatively correlated with profitability; however, there is evidence that better firms reduce their credit demand as real rates rise. Banks appear to be particularly soft towards the worse performing, larger and more insolvent enterprises. There is evidence of a policy shift in 1993-1994 with banks refinancing trade arrears, perhaps following IMF pressure against further central bank bailouts. Overall, the evidence suggests a largely passive attitude of banks towards the worse borrowers and limited reallocation of credit to better users. We are currently engaged in an expansion of the sample size and time period, both necessary before a final judgement may be made on the overall state of Romanian banking.