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The study reviews the performance of four transition countries - Albania, Azerbaijan, the Kyrgyz Republic, and Moldova - in the areas of private, and financial sector development, identifying both their achievements, and challenges, to extract beneficial reform efforts, and alternative approaches, setting the pace for sustainable growth. These countries were selected because they are among the poorest in the region, whose problems are seemingly intractable, and have been largely detached from the international marketplace until the transition began. Thus, in terms of history, resource endowment, and proximity to markets they are viewed as "late reformers" in economic development, and competitiveness, despite policy reforms. Enterprise arrears, and soft budget constraints have been a significant problem in many transition economies, more often than not, manifested as some fiscal tightening occurred to offset budget constraints. Hence, a core challenge of the transition is to reduce the role of government from all encompassing presence, towards a professionally managed model, and one which provides high service delivery, strengthens civil institutions, and plays an effective regulatory role in a market economy. This requires improved financial discipline, reasonable fiscal policy, and structural adjustment, while privatization that promotes concentrated outsider ownership, and foreign participation, should be favored.

Many of the distortions in poorly performing economies do not originate in the banking sector, but where state banks still control a large share of the resources in the banking system, they continue to pose a risk to macroeconomic and fiscal stability. State banks are typically vehicles for patronage that worsen the prospects for competitive market development. Alternatively, these state banks can be ineffective shells that fail to perform a useful intermediation role once the government imposes effective hard budget constraints and a modern supervisory system. The most problematic state banks have been agricultural and industrial banks, whose original role was to finance state farms and industrial enterprises that employed large numbers of people and served as the backbone of the socialist economic mode. Banks now show stronger growth in deposits and capital in many countries in Central and Eastern Europe and the Baltics, suggesting that these countries have put into place structures that have helped to restore confidence in banking systems among creditors, investors, and the public. Recommended strategies are that Governments need to design strategies to reduce state banking in order to help create a stable banking environment. Governments should take measures to improve the business environment as part of a broad overall strategy to strengthen the financial system and end state ownership of banks. Such measures include providing support to improve corporate governance, reform judicial systems, build registries of collateral, reinforce creditors' rights and contract enforcement, modernize accounting and auditing practices, reduce administrative obstacles to business registration, and modernize bankruptcy laws.