The paper deals with the question whether banks in the Baltic States are in a position to exert a positive in¯uence on enterprise performance. Eective, market-driven corporate governance by banks is discussed along the following four questions: are banks sound enough, large enough, strong enough, and skilled enough to have an impact on improving the eciency of ®rms? Data on ®nancial sector in the Baltics compared with other formerly communist Central European countries that signed associated agreements with the European Union (Bulgaria, Czechia, Hungary, Poland, Romania, Slovakia, and Slovenia) forms the basis of analysis.
It is argued that the widespread banking crisis in the CE-10 is not a consequence of communist heritage any more, but of weak, slow, and sometimes contradictory policies of the post-communist governments.
While `bad debt' constitutes the banks' most visible problem, it is argued further that two other problems really endanger the reform processes not only of the ®nancial sector in the Baltics, but of the entire reform countries' economies: ®rstly, the size of these ®nancial markets is about equivalent to the rounding error of US ®nancial statistics, causing an inherent volatility bomb. For investors, this implies diversi®cation strategies, short-termism and risk-adjusted-ROI goals. For the respective regulators, this recommends co-ordination strategies for the various capital markets, and setting up ®nancial markets that serve not only a small number of speculators but industry and population at large.
Secondly, using a stakeholder approach it is argued that strong tendencies prevail for non-prudent banking. Therefore, supervisors, foreign investors and bankers should analyse the `degrees of freedom' of local bank owners and bank managers by dependence analysis. For supervisors and regulators it is also important to consider the links between reliable corporate governance practices, foreign direct investment and the stability of the countries' currencies.