“Financial system development progress in Western Balkans”

Financial system supports economic growth, while its regulatory framework provides stability for investors. Developing countries with bank-oriented financial systems are not attractive to investors, so prolonged status quo leads to economic deterioration. This is particularly the case with some of the most underdeveloped areas in Europe: Western Bal-kans. It is essential the developing countries in this region consider steps towards financial liberalization, which will help open the borders for capital flows and attract new investments. The main goal of this paper is to review and present the available information related to the banking system development in Western Balkans in terms of ownership structure, capital adequacy, loan and asset performance, return on investment and liquidity. These indicators should provide a clearer picture of the current financial systems in Western Balkans economies and their development progress – useful for comparison with other developing regions and financial transformation and liberalization efforts.


Introduction 
A well-functioning financial system plays a crucial role in the transformation process from a centrallyplanned economy towards one that is market-oriented.It is essential that developing countries consider steps towards financial liberalization or deregulation, which will help open the borders for capital flows and attract new investments and ideas.While financial liberalization does not guarantee quick economic growth for developing countries, it helps increase the chances for progress and creation of opportunities for financial development.
Empirical research conducted for this paper reflects on selective history and current state of relatively young financial systems of some of the most underdeveloped countries in Europe, namely Albania, Bosnia and Herzegovina, Croatia, Macedonia, Montenegro, and Serbia.In addition to their struggle for economic growth, these countries are also trying to qualify for the EU membership (Croatia achieved this goal in 2013).The research focuses mainly on the banking sector, as the capital markets in these countries are still lacking sufficient depth for a proper investigation.
The paper focuses on the empirical analysis of financial liberalization in the Western Balkans region in the light of the latest global financial crisis.It is the aim of this paper that other developing countries would bene- Emira Kozarević, Nedžad Polić, Amela Perić, 2017.Emira Kozarević, Associate Professor, Tuzla University, Department of This is an Open Access article, distributed under the terms of the Creative Commons Attribution 4.0 International license, which permits unrestricted re-use, distribution, and reproduction in any medium, provided the original work is properly cited.fit from the experience and lessons learned from these countries, while taking into account any relevant similarities and differences.Ultimately, all developing countries thrive to become more attractive to investors, which requires stable economic conditions and clear regulatory framework, delicately balanced with expected flexibility, reliability and transparency.

Banking system transformation and liberalization
Developing countries have learned through their own history and the evidence from around the world that, in order to start liberalization processes, it is essential to first ensure adequate regulation of their financial systems in line with country-specific requirements and circumstances.It is often wrongly assumed that economies with greater connection and dependencies on international trade require stronger liberalization.It is important to recognize that, when it comes to financial systems and economy, each developing country follows their own practices, processes and traditions and should also find the most appropriate liberalization model that suits their circumstances.
The most recent financial crisis experience has contributed to an interest in the issue of the financial liberalization not only in the developed part of the world, but also in the developing countries, such as the Western Balkans region.Developing countries in this region are keen on moving towards economic liberalization and catching up with the rest of the Western Europe in their efforts to become equal partners in the European integration process.While the developing countries of Western Balkans are considered to have the geographic advantage in comparison to some more remote regions of the world, it is important to understand each country's specific history, culture, customs, events and situations that impacted on their progress towards global integration and liberalization.
The effects of financial freedom and ownership structure on economic growth have been popular topics among economic researchers.Some researchers attempted to perform calculations to predict the effects of openness on growth (Bremus and Buch, 2016, p. 16), or evaluate fragility during financial crisis (Ashraf, Ramady et al., 2016, p. 65), while some focused on the effects of leverage and liquidity on earnings and capital management (Gombola, Ho et al., 2016, pp. 35-58) or researching equilibrium calculations for competitive conditions (Dal Colle, 2016, pp.2-9).Turkey went through major liberalization efforts in 1990s, resulting in continuous changes in the financial sector over the next two decades, namely related to competition structure, involvement of foreign banks and response to the global financial crisis.The empirical study conducted on data covering 1990-2014 period not only showed the positive relationship between competition and economic growth, but also highlighted some negative effects associated with liberalization.For example, the share of consumer loans within total loans granted by banks rose from 2% in 2001 to around 40% in 2014, but these loans were mainly used for consumption rather than real investments, thus, affecting the economic growth (Celik andCitak, 2016, p. 1754).
The study conducted by Lin, Doan et al. (2016, p. 32) focused on the analysis of liberalization in Asia and determined that foreign presence improves bank efficiency, primarily in countries with high financial freedom.They also found that assessing the effects of financial freedom and the changes in bank ownership structure on the efficiency of financial institutions is particularly interesting in the context of the latest global financial crisis due to increase of the prominence of systemic risk.This study further emphasized the importance of designing an appropriate bank regulatory and supervisory framework in the design of privatization and liberalization programs to help maintain the efficiency and stability of banks.
Analysis of Pakistan liberalization experience (Bonaccorsi di Patti and Hardy, 2005, pp.2402-2403) showed that sometimes immediate impact of liberalization reforms fails to produce results, especially when there is a time lag between regulations and the practical applications of those regulations to banking and financial processes, for example, in loan assessment and provisioning.Garriga (2016, pp. 19-20) agrees that the longer the time elapsed since the last prudential regulation reform, the more vulnerable the country is to banking crises; and adds that the countries at lower levels of liberalization of the financial system are even more vulnerable to banking crises than those that have progressed further in their liberalization efforts.Understanding this vulnerability helps with the efforts of achieving positive growth effects of liberalization without increasing the risk of a banking fragility (Hamdaoui, Zouari et al., 2016, p. 644).
The latest global financial crisis experience also highlighted the effects of risk-taking behavior, especially with regards to the impact that ownership concentration and income diversification have on the financial stability of banks.The study conducted by Ashraf, Ramady et al. (2016, p. 65) into experience in the GCC1 region found that the fragility of the financial system and elevated risk-taking behavior of banks became more pronounced especially for banks located in the more financially open and globally integrated economies.
Developing countries find themselves in various stages of the transformation process from socialist banking (characterized by state ownership) to a market-oriented system.Privatization of state-owned banks, establishment of new private banks and the arrival of foreign banks are common characteristics for all countries under this transition.Kapor (2005,  The first socialist country to develop a financial system in the 1990s was former Yugoslavia, through separation between commercial and central banking.After the dissolution of Yugoslavia, with hyperinflation and decline of economy due to war devastation, the financial system was completely destroyed.Introduction of effective banking supervision, application of regulations with international standards and practices, state capital privatization, and introduction of foreign capital were very important elements of the transition process for all Western Balkans countries. A very important factor for an economy is clear and established exchange rate policy.For Montenegro, it meant introducing "euroization", and for Bosnia and Herzegovina, it was the establishment of a currency board.Croatia             into foreign currency on the national foreign exchange markets.Reduction or further withdrawal of these assets abroad will further accelerate the depreciation.Available foreign exchange reserves in central banks are relatively small when compared to their value on banks' balance sheets (Živković, 2011, pp. 67-68).

Concluding remarks and future research
This paper examines the progress of financial systems development in Western Balkans as one of the least developed European regions, considering the impact of the latest financial crisis.
The paper presented a dataset from the Western Balkans region for the period before, during, and after the financial crisis, showing some common trends, as well as differences between the countries, which need to be taken into consideration when planning the next macroeconomic steps associated with liberalization or deregulation.Despite different organizational models across the Western Balkans countries, the data show strong similarities when it comes to trends associated with capital flows, return on equity, ownership structure, loans, etc.
It is recommended that further research is conducted by each developing country into how available lessons can be effectively utilized when making decision associated with liberalization, taking into consideration not onlycommon with economies that provided the lessons, but also the specific features unique to the developing countries and their respective cultures, financial and political setup, traditions, and development level.Developing countries should continuously research and apply available quantitative and qualitative methods in monitoring and managing their financial and banking system transformation progress.
And, finally, a practical recommendation for developing countries is to promote effective financial education for all subjects associated with liberalization process  policy makers, industry leaders, and public in general.
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