The banking sector has been a consistent source of concern in transition economies. A substantial literature provides detailed advice for providing the foundations for sound banking in the transition and for avoiding difficulties – including Fabrizio Coricelli and Alfredo Thorne (1992), John Bonin and Istvan Szekely (1994), Gregory Udell and Paul Wachtel (1994), John Bonin, Kflmfn Mizsei, and Paul Wachtel (1996), and Jorge Roldos and Kenneth Kletzer (1996).

Consider, for example, the following recommendations of Bonin et al. They propose that capital requirements should be increased both for new bank licenses and for existing banks that were created under the laxer regime to encourage mergers and takeovers of undercapitalized small private banks. That is, there is a fear for the viability of undercapitalized banks. They further propose that the supervisory structure must be strengthened to the point where it is competent to exercise effectively discretion over who should be allowed to set up a bank. The supervisory agency must offer adequate compensation to attract capable and competent personnel. This recommendation reflects the fear of bank failure due to opportunistic behavior or incompetence of bankers. Bankers should be qualified to evaluate the prospects of borrowers and should be honest. Those monitoring the bankers should also be competent and honest, which requires a remuneration structure that makes employment by the regulatory authority attractive and succumbing to bribes unattractive. Further, the “hole” or negative net worth arising from marketing to market the asset portfolio should not be filled solely by public funds without strong assurances that management practices and personnel will behave prudently in the future (e.g., removal of current management and provision of proper incentive contracts).