Bank lending in transition economies
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AbstractBank privatization and tighter credit enforcement are believed indispensable to facilitate the Eastern European transition process. We analyze lending by value-maximizing banks, the only source of capital in the transition, faced by non-performing loans to the state-owned sector. We show that banks have a perverse incentive to fund former debtors, although less efficient and more risky than private firms, because they gain the potential repayment of previous debts. This leads to a lower productivity of investment and a greater concentration of risk; the expansion of more efficient private firms is delayed, leading to a slower recovery and a greater risk of financial crisis.

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