Financial Sector Development in SEE: The Roles of EU Accession and Basel II

This paper discusses the effects that the European Union (EU) accession process and the Basel II accord will have on South East European (SEE) countries. The paper explores SEE countries' approach to these issues in the broader context of how SEE countries can achieve financial development and economic growth in general.

The paper argues that:

• The EU accession process brings the advantages of greater access to resources through FDI, improved access to capital markets and official assistance;
• However, presence of foreign banks will pose regulatory problems, and greater capital inflows may increase volatility and the risk of "sudden stops" and macroeconomic instability;
• With Basel II, the challenges are whether, when and how to adopt it. Also, supervisors will face the challenge of adapting supervisory practices to their local circumstances.

The author probes these issues in different sections:

• Section 2 discusses what kind of financial sector SEE countries can aim for, and how public policy, in particular banking supervision, can contribute to the development of such a financial sector;
• Section 3 analyzes EU accession in terms of financial sector development needs;
• Section 4 examines issues raised by Basel II for SEE:
  • Basel II proposes important changes in supervisory practice,
  • The paper argues that the Standard approach of implementing Basel II is relevant for SEE, especially its focus on operational risk.
• Section 5 concludes by stating that SEE countries should tailor their responses to EU accession and Basel II to their own financial goals and economic and political environments.