To understand the transformation of banking in the post-communist transition, we examine the cost efficiency of 289 banks in 15 East European countries. We find that banking systems in which foreign-owned banks have a larger share of total assets have lower costs and that the association between a country’s progress in banking reform and cost efficiency is non-linear. Early stages of reform are associated with cost reductions, while costs tend to rise at more advanced stages. Private banks are more efficient than state-owned banks, but there are differences among private banks. Privatised banks with majority foreign ownership are the most efficient and those with domestic ownership are the least.

When should regulators close a financially ailing bank? FDIC practice in the US has moved in the direction of early closure. In contrast, banking regulators in Japan continue to follow a more patient approach. This paper analyses a series of models in which closure rules and bailout policies arise endogenously through the interaction of (i) regulators' attempts to minimize discounted, expected bankruptcy costs, and (ii) equity-holders' incentives to recapitalise banks. We characterize subsidy policies for distressed banks that implement socially optimal closure rules at minimum financial cost to regulators and which reduce moral hazard.

This article shows (1) how entry and exit of firms in a competitive industry affect the valuation of securities and optimal capital structure, and (2) how, given a trade-off between tax advantages and agency costs, a firm will optimally adjust its leverage level after it is set up. We derive simple pricing expressions for corporate debt in which the price elasticity of demand for industry output plays a crucial role. When a firm optimally adjusts its leverage over time, we show that total firm value comprises the value of discounted cash flows assuming fixed capital structure, plus a continuum of options for marginal increases in debt.