This paper examines the use of counter-cyclical regulatory tools in Central and Eastern Europe to ensure domestic financial stability. It also probes the limits of this supervisory approach. Some banking sector regulators in Central and Eastern Europe used counter-cyclical measures during the credit booms in the region in the early and mid-2000s. I investigate whether those measures produced the intended effects, focusing on four countries which implemented counter-cyclical measures to varying degrees: Bulgaria, Estonia, Hungary, and Slovenia. The Bulgarian Central Bank has applied consistently a risk-averse approach and has intervened with counter-cyclical measures such as requiring higher provisions against bad loans and putting in place mandatory limits on the rate of credit expansion. In Estonia too, the Central Bank has used a risk-averse supervisory approach since the beginning of transition despite the overall free-market orientation of Estonian governments. In the Hungarian case, until 2007, the supervisory approach was predominantly market-based and relied on improved information provision about financial risks to banks and customers. In Slovenia, the Central Bank took measures to build higher provisions during the period of rapid credit expansion and closely monitored liquidity. However, Slovenia has been affected negatively by the quick reversal of cheap credit from the international capital markets after 2008. Since 2010, the government has repeatedly provided capital injections to the domestic banking sector in an effort to stabilize it.
I argue that counter-cyclical regulatory measures can only mitigate risks in the short-term. My analysis shows that their effectiveness is rather limited unless the ruling government and private sector actors synchronize their actions with those pursued by bank regulators. For example, the Hungarian case demonstrates that if a government wants to encourage economic growth and has political channels to steer supervisory policy, it can easily counteract any measures intended to cool off credit booms.
