Into the Void: Governing Finance in Central & Eastern Europe

Twenty years after the fall of the iron curtain, which for decades had separated East from West, many countries of Central and Eastern Europe (CEE) are now members of the European Union and some have even adopted the Euro. Their readiness to open their borders to foreign capital and their faith in the viability of market self-governance as well as supra-national governance of finance is both remarkable and almost unprecedented. The eagerness of the countries in CEE to join the West and to become part of a regional and global regime as a way of escaping their closeted socialist past has both benefited and harmed them. There is little doubt that joining the EU and opening to the rest of the world has helped transform these economies at a pace that otherwise would have been unthinkable. Yet, as the global financial crisis reveals, these countries have also remained exceptionally vulnerable to shocks, including those that originate beyond their sphere of influence. This paper looks for explanations in the governance of finance, i.e. the allocation of de jure and de facto responsibilities over financial systems. It argues that as recipient countries of massive capital inflows CEE countries have largely relinquished policy tools to protect their economies and societies against a financial melt down or to respond effectively in a crisis. The policy choices they made – opening their boarders to capital inflows, limiting regulatory oversight by relying on home country regulators of foreign banks, etc. – were aimed at integrating them into the European and the global financial systems. A frequently overlooked side effect of these policies’ cumulative effect has been that they find themselves once more on the periphery – dependent on the goodwill of multilateral organizations over which they have little sway. The paper discusses two strategies to improve the governance of finance in CEE: A European regulator and the assertion of effect-based regulatory jurisdiction over foreign bank activities