Money, Banking and Remittances.

The Case of Moldova

Author:
Ion M ALACI

Supervisor:
Dr. Mariola P YTLIKOVA

March 30, 2012

Contents
1

Introduction
1.1 Why analyze the financial sector? . . .
1.2 Why the Transition Economies Matter .
1.3 The purpose and the aim of the research
1.4 The structure . . . . . . . . . . . . . .

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A Survey of Existing Literature

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2.1 The role of the banking sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.2 The banking sector and the economy . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.3 The remittances and the economy . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Evolution of Moldovan Economy after 1991

3.1 Background information on the transition process . . . . . . . . . . . . . . . . . .
3.2 The Moldovan Banking Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.3 Final remarks on the banking sector . . . . . . . . . . . . . . . . . . . . . . . . .

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Banks, Monetary Policy and Remittances: a VAR Approach

4.1 Brief considerations on the VAR model . . . . . . . . . .
4.2 Description of Data and Main Assumptions . . . . . . . .
4.3 Granger causality . . . . . . . . . . . . . . . . . . . . . .
4.4 Running the Unrestricted VAR . . . . . . . . . . . . . . .

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Conclusions

45

Annexes
6.1 Summary Statistics: 1Q2000 - 4Q2011 . . . . .
6.2 AR Test . . . . . . . . . . . . . . . . . . . . .
6.3 VAR Lag Order Selection Criteria . . . . . . .
6.4 Pairwise Granger Causality Tests: 8 and 12 lags
6.5 Residuals Test . . . . . . . . . . . . . . . . . .

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1
1.1

Introduction
Why analyze the financial sector?

In the light of the most recent financial crisis and the severe economic recession that followed,
there are several important issues that emerged to the surface and are now being widely discussed
and analyzed.
The first takeaway is that a well-functioning and efficiently-organized financial system plays
an important role in the modern economy. The validity of this statement has been verified and
confirmed by Western Governments actions to stabilize their financial sectors in order to mitigate
the effects of the economic downturn. The developing countries and the transition economies have
adopted a similar position. More than that, international financial institutions (IFIs) such as the
International Monetary Fund (IMF) or the World Bank (WB) have supported such actions. In addition, as we shall further see in this paper, various empirical studies have emphasized the positive
link between the financial sector and the proper functioning, development and growth of an economy. Thus, studying the interaction between the financial sector and the policies conducted by the
government can provide useful insights regarding the development of a country.
Secondly, the recent economic recession has proved once again that the markets do not always efficiently react to shocks. Financial markets are a good example of this. Despite having
strong mathematical foundations and sophisticated models at the core, one would think that financial markets are infallible almost by their nature. Financial theory assumes that the agents receive
the information, rationally process it and then efficiently incorporate it into their decisions. This
is however by far not the case and newer approaches have started to include additional variables
into their models that are not only unusual, but also seem contradictory. Thus, drawing on such
disciplines as psychology of market participants or local specificity of a market, the new financial theory attempts to explain the inefficiencies that cannot be explained by pure mathematical
finance and economics. A good example is the increasing emphasis on models that are inspired
by behavioral finance. Given that not all the countries have been similarly affected by this shock,
it is of great interest to study the specifics of the financial sector in a country. A good example
in this sense is the use of reserve requirements as a tool for conducting monetary policy. Since
the emerging markets do not have well-developed capital markets, central banks cannot rely to
the same extent on conducting monetary policy via open market operations. Hence, changing the
reserve requirements becomes an important tool in these countries. Other examples include access
to information, political environment, corruption, under-developed or restrictive institutions.
Thirdly, individuals and firms can have various sources of sources of funds. For example, firms
can finance their investments out of retained earnings, debt (via corporate bond markets), equity
(equity markets) and bank loans. Hence, the typical micro approach defines banks as financial intermediaries (FIs) that link the deficit spending units (DSUs) to the surplus spending units (SSUs)
2

while providing the public with a wide range of financial services (Burton and Lombra, 2002).
According to the same authors, DSUs are typically firms or households for which spending on
consumption and investment usually exceeds the income while SSUs are net lenders. Under this
approach, through the very nature of their role, the banks have both direct and indirect on the economy. However, the opposite argument can also be true: FIs could be directly affected by existing
economic conditions or the economic policies implemented by a government.
The above-mentioned arguments clearly suggest that the financial sector plays an important
role and that analyzing its dynamics within a specific country or region can provide important
insights into the dynamics of economic development of that particular country or region.
1.2

Why the Transition Economies Matter

In addition to the above-mentioned ideas, another important issue to consider is that traditional
financial theory is rooted in the developed markets and there are now debates about the applicability
of many assumptions to real life. The problem becomes even more complicated when applied to
emerging markets or transition economies where high levels of risk and volatility are just two of
the many factors that limit the applicability of the traditional approach. Along this line, Sabal
formulates four main reasons that make information processing unclear (Sabal, 2002):
Economic volatility and interconnections among phenomena,
Particular conditions affecting each situation,
The uncertain period of time required for causes to translate into effects and
Differences in the availability and interpretation of information.

In other words, we see that interconnection (e.g. the close link between the economic sector and
the government) and actors bounded rationality play a major role when making a financial decision. Moreover, the same author identifies additional four characteristics that do not comply with
the rational actor assumption: (i) shifting preferences, (ii) shifting information processing, (iii)
shifting interpretations of information and (iv) perception of risk and group pressure (Sabal, 2002).
So why then analyze the transition economies? The answer is straightforward: they allow us
to observe and test the above-mentioned characteristics. Having experienced the socialist regime
for over 50 years where the government planned and dictated the economic policy, these countries
have widely embraced the idea of free markets once the Soviet Union ended. The difficult transition period that followed has been characterized by two crises in the 1990s with a dramatic decline
in GDP, high unemployment followed by a large number of emigrant workers and hyperinflation
(with 4-digit figures at its peak). The leaders in these countries were both unprepared and overwhelmed by various factors which has led to many policy decisions that the economists still debate
about. Some countries were able to overcome this period by remaining outside the Commonwealth
of Independent States (CIS) and ultimately joining the European Union (EU) in the early 2000s,
while the others formed the CIS and tried a more gradual shift to free markets. Although there are

still debates about which path was more successful, the fact remains that the current CIS members
are still facing the transition it is unclear when this period is going to end.
On the other hand, although the financial sector is not as developed in these countries relative
to the Western world, these markets have suffered relatively less during the most recent financial
crisis. Their main shortcoming has thus turned to be their main advantage: by not having developed capital markets and being primarily dependent on collateral-based lending practiced by their
commercial banks, transition economies has been somewhat less exposed. In addition, because
inflation rates are of great concern in these countries, the central banks actively use reserve requirements.
Among the economies in transition, despite being representative of other CIS members, the
Republic of Moldova represents an interesting case for research primarily for two major reasons.
First, Moldova is the poorest country in Europe that still faces a difficult transition period. It has
gone through all the difficulties of the 1990s, it has experienced a Communist government during
the 2001 2009 period and it currently is facing political instability. Despite these facts, according
to the most recent report from its government, Moldova has registered one of the highest growth
in Europe (along Georgia and Turkey).
Second, Moldova is among the countries with one of the highest level of remittances transfered
from abroad by its workers (unofficial numbers estimate that nearly one third of the 3.5 milling
population is abroad, Transnistria excluded). The share of remittances in the GDP has constantly
increased since the late 1990s and the amount remained high even during the most recent economic
recession of 2008 2011. For example, according to data from WB, in 2009 remittances represented 31% of Moldovas GDP (WB, 2011). This is a significant increase relative to 1998 when
the share of remittances was only 8% (the peak value was reached in in 2007 when this share was
36.6%), placing Moldova in the top of the list (this position being shared with Tajikistan). WB
also estimates that during the last 7 years, Moldovans sent back around $8 billion. The most recent
estimates show impressive numbers ranging between $1.2 and $1.4 billion for 2009 only. These
figures are based on remittances sent via official channels such as bank wires and rapid money
systems (e.g. Western Union).
Finally, as all the former Soviet countries, Moldova has never had a developed financial sector
in the Western understanding of this term. The capital market is virtually inexistent due to several
factors including lack of appropriate infrastructure, high level of uncertainty due to corruption etc.
Most of the relevant institutions are still relatively new in the sense that many laws and financial
institutions are under 20 years old. Finally, with a population of little over 3 million (excluding
Transnistria), most of which being concentrated around large urban centers, it has a large number of financial institutions, including 15 commercial banks and several hundreds of savings and
deposits associations (SDAs). All these have impacted the credit market in various ways and it
would be an interesting exercise to analyze how the market was set up and how it has evolved into
4

its current organization.

1.3

The purpose and the aim of the research

The purpose of this paper is twofold. First, as we saw above, analyzing the interaction of the
financial sector in a transition economy can provide important insights about development of the
country. Thus, I will look at the development of the banking sector starting with the early 1990s
and finishing with the most recent events such as the raider attacks that took place in 2011. The
broad question I seek to answer is how the development of the financial sector took place and does
is have any effects on the evolution of the Moldovan economy (or vice versa).
Second, as mentioned above, remittances represent a major point of focus for the Moldovan
government and for the international organizations present in Moldova. For example, the Financial
Literacy project implemented by International Organization for Migration (IOM) and International
Labour Organization (ILO) or Governments PARE 1 + 1 project aim specifically at attracting
the remittances into the economy (diverting them away from consumption into productive activities). Most of the existing literature focuses only on recommendations, taking the willingness and
preparedness of the Moldovan banks to absorb the remittances as given. The empirical question of
interest in this sense is whether the remittances affect the economy or the financial sector.
Based on these two idea, the main goal of my research is to analyze the interaction between the
main macroeconomic, monetary, remittances and financial sector indicators. In this sense, I have
collected quarterly macro level data for the 2000 2011 period and I will analyze this interaction
by running an unrestricted vector autoregression (VAR) to look at several macro level effects and
tendencies. In other words, taking such variables as real GDP, discount rate, reserve requirements,
the volume of loans in the economy, M2 and the volume of remittances, I will look at Granger
causality and impulse response functions to test whether shocks to this variables have long- and/or
short-term effects. In conclusion, the thesis would not only fall into the existing policy and research efforts, but would also complement them by suggesting several recommendations based on
the analysis of this interaction.
1.4

The structure

In this paper I focus on the interaction between the banking sector, the level of remittances and
the monetary policy, with the ultimate goal of analyzing the economy-wide tendencies. In this
sense, I begin by reviewing the theoretical concepts covering the main features of financial markets in transition economies, (commercial) banking competition and attraction of remittances into
the economy. A great part of the literature on banking emphasizes on the role of monetary policy
in creating and controlling the level of reservable deposits and hence of the supply of loans. It
is thus the open market operations of central banks that determine the amount of deposits which
directly determine the supply of loanable funds. Another approach argues for switching the focus
from deposits to banks financial strength and their ability to raise funds externally. In this case, it
5

is the cost of external funds that is important to loan supply rather than the total funds available. It
still remains unclear how the remittances impact the banking sector and the monetary policy.
The literature on migration and remittances is very broad, covering a variety of issues including
motives for migration, the motive behind remittances, their uses and certain effect on the economy.
The majority of the literature assumes that remittances have a positive effect on growth, however,
there have been few studies that have tested this relationship. There are few studies that actually
relate the amount of remittances to monetary policy and the banking sector.
In this context, the second section presents a brief description of the Moldovan economy and
of its banking sector. In this section I focus on the most important factors that have shaped the
Moldovan sector as it is today. I will show that it is not the lack of products or outreach, but rather
the dramatic effects of the crises that took place in the 1990s that have prevented the individuals to keep their excess funds in banks. In other words, there was an unfortunate combination of
hyperinflation, over 10 banks that failures and a collapse of output (leading to less employment
opportunities etc.) have negatively affected the development of this sector and that it was only
after the year 2000 that banks started to develop in a competitive way. In addition, the NBM was
able to conduct are more efficient monetary policy.
In the last section run an unstructured VAR to analyze the macroeconomic tendencies using
macroeconomic variables (GDP, CPI), monetary policy tools (M2, reserve requirements, the discount (base) interest rate and the exchange rate), the amount of loans in the economy (which acts
as a proxy for the financial sector) and the amount of remittances. This section also explains the
rationale for employing the VAR approach, the choice of variables and describes the data. I also
discusses the main findings and compare the results to the existing research. I also discuss the
implications of the outcomes in the same section.
This paper ends with a concluding section containing the main findings and lays the ground for
possible alternatives to and/or shortcomings of my approach.

2
2.1

A Survey of Existing Literature

The role of the banking sector

Interestingly enough, it is not only the impact of the banking sector that has been widely debated,
but also the basis for its existence has generated several interesting debates among economists.
In this sense, some economists have argued that, under certain assumption, in a Arrow-Debreu
economy, banking is redundant (Freixas and Rochet, 2008). The authors begin with very simple
assumption where a bank transforms the cash from its deposits into loans. In this way, the bank
has the role of taking a very liquid asset (cash) and transforming it into a long-lived asset (loans).
The figure below illustrates a simple economy:
Figure 1: A Simple Model

Households (subscript h) have savings (S ) and have the choice between depositing them at a
bank (D+ ), buying bonds from banks (Bb ) or equity from firms (Bf , subscript f denoting firms).
On the other hand, firms need cash for investment projects (I) so they can selling bonds and equity or borrowing from the bank (L ). Banks lend (L+ ) to firms by selling bonds and equity and
accepting deposits from households.
Next, the authors assume that there are two periods and that households have an certain initial
endowment (1 ). In the first period, the representative household decides what fraction to consume, deposit and invest. In the second period, household consumption is defined as the return
on investments from equity (f ), bonds (B ), and deposits (rD ). Thus, the consumer wants to
maximize its utility u(C1, C2) such that:
C1 = 1 Bh Dh
C2 = f + B + (1 + r)Bh + (1 + r)Dh
On the other hand, firms want to maximize f . If rL is the rate charged on bank loans and Lf
is the loan amount then we get:
f = pf (I) (1 + r)Bf (1 + rL )Lf
7

I = Bf + Lf
The authors find the partial equilibrium solution to the consumers problem such that the return on
bonds equals the return on deposits: r = rD , while the firm takes the return on bonds equal to the
return on loans: r = rL . In the general equilibrium case, we have that r = rD = rL and all markets
clear. Banks profit is given by
b = rL Lb rBb rD Db
Lb = Bb + Db
Here, it must be the case that b = 0. Thus, firms will be indifferent between their funding
source while households are indifferent to their mix of asset holdings. Therefore, bank loans are
simply redundant substitutes for bonds.
In the real world this of course does not happen. Various studies show that banks provide unique
and necessary services. For example, it has been argued that banks offer services and products that
are not easily replicable in financial markets (Gorton, 2002). Another empirical study found that
the share price of firms is negatively affected by the failure of firms primary bank (Slovin et al.,
1993). Similarly, an announcement of a new or an extended bank loan to a firm leads to a positive
return on firms equity while announcements of other security types do not generate such a large
return (James, 1987). In addition, Kashyap et al. (2002) provide an illustration of informational
advantages in specializing in taking deposit taking and lending.
For the banks to have a unique role in the economy, there must be some financial friction which
prevents or limits the direct trading. The common idea is that once agents holding private information publicly reveal it, a better outcome is achieved. Various economists have introduced such
concepts as asymmetric information (Sharpe (1990), Lucas and McDonald (1992), DellAriccia
(2001)), moral hazard (Boot and Thakor (2001), Bizer and DeMarzo (1992), Boyd et al. (1998))
or adverse selection (Jaffee and Russell (1976), Stiglitz and Weiss (1981)).
At theoretical level, in an earlier paper, Leland and Pyle (1977) show that signaling can be
employed to overcome these frictions. More recent work has emphasized on the use of mechanism
design models. Yanelle (1997) has criticized the traditional approach for assuming one intermediary and for suggesting solutions that cannot be applied in a competitive market framework since
under a double-Bertrand competition (Game 1 - Compete for loans, then deposits, Game 2 - Compete for deposits, then loans), the findings are not solid. Debraj (1998) explains these shortcomings
in a more applied (both theoretical and practical) framework of developing markets where due to
various real-world factors, all of the above-mentioned factors come into play and may lead to
inefficient market outcomes.

2.2

The banking sector and the economy

The interaction between FIs and the economy has been extensively analyzed by various scholars.
One body of research identifies two possibilities for how this interaction occurs. First, there is a
top-down direction where borrowers balance sheets and hence their ability to borrow is directly
affected by changes in monetary policy. Second, monetary policy changes can amplify the financial
frictions arising due to the problem of asymmetric information. As a result, the search for new
lenders becomes more costly, ultimately affecting the borrowers demand for loans. Although
the literature does not clearly identify which of these two channels are more substantial, several
authors suggest that the credit channel simply parallels the interest rate channel, implying a 2-way
street.
First, Bernanke and Blinder (1988) provide the basis for the credit channel theory by taking the
IS LM framework as their starting point and expanding it by incorporating money, bonds and
bank loans into their model:
Ld = L(, i, y)
This tells us that the demand for bank loans is a function of interest rates on loans and bonds
( and i accordingly) and of aggregate output (y). In addition, in this model, GNP reflects the
transactions demand for credit. As FIs, banks take deposits (D) and are required to keep a fraction
( ) as reserves which can either be held as excess reserves (E), be used for purchasing bonds (B)
or made available as loans (L). In addition, the banks face an adding up constraint given by:
B + L + E = D(1 )
Banks want to maximize returns on their asset portfolios such that the supply of loans is a
function of , i and :
Ls = (, i)D(1 )
Finally, the market clears when the supply of loans equals the supply of deposits:
Ls = Ld
With these assumption, an increase in the supply of loans leads to a decrease of the interest
rate charged by banks on loans. However, this has the opposite effect on the interest rate on bonds
and on output which also increases. Additionally, an increase in the demand for loans exactly the
opposite effect: the interest rate on loans increases and reduces output. Based on the adding up
constraint, the reserves and the supply of loans are positively correlated (Bernanke and Blinder,
1988). Together these results suggest that the monetary policy directly affect the supply of loans
and the total output (where the latter is influenced indirectly).

This model also leads to the question of why would the reserves be valued by banks. Romer and
Romer (1990) present two scenarios where economic activity is influenced by changes in interest
rates. Under the money view, banks have to maintain reserves to meet their customers transactions
demands. Deposits are fixed in their nature and a decrease in reserves would reduce the transactions reserves. Consequently, the banks would be more likely to hold reserves and not to lend. The
resources that are eventually used as loans are more costly, decreasing output (and slowing down
the economic growth) as a result of a decrease in bank loan supply. On the other hand, the lending
view is characterized by asymmetric information in the credit markets. In any lending relationship,
only the banks with credible information about their clients will lend. With information asymmetries, a customer that can obtain a loan from one bank may not be able to borrow from another bank.
Thus, a decrease in the amount of reserves would lead to a reduction in the supply of loans. Banks
with credible information that can use their resources for lending will be able to bid up the price.
This would pressure the interest rates up leading to less economic activity. Thus, it is the asset side
that affects the interest rate charged on loans. Romer and Romer provide evidence supporting the
money view. Their results suggest that there are independent movements in the money view which
however do not exceed the expected movements in the lending view (Romer and Romer, 1990).
There is also strong evidence that money leads output changes. However, these results are not fully
conclusive suggesting endogeneity in the relationship between money and output.
Other models investigating the money and the lending views have provided more robust (but
still inconclusive) findings. Bernanke and Blinder (1992) used a VAR approach to show that a
decrease in bank reserves can affect the asset side of the balance sheet. They found that bank
loans were specifically affected a lag. Two years after a tight money shock, the entire decline in
reserves was caused by the change in bank loans. The slow change in the bank loan portfolio can
be attributed to their contractual nature: it creates difficulties of the loan conditions in place are
altered (Bernanke and Blinder, 1992). The authors also conclude that changes in bank loans are
correlated with unemployment movements suggesting the importance of the lending channel as a
transmission mechanism.
We further look at the literature analyzing the determinants of the demand for loans. Under this
approach, the first things that firms would consider is the cost of the external funds which is widely
known in the corporate finance literature as external finance premium. The theory of finance
tells us that the internal funds (such as retained earnings) are preferred by firms (Brealey, 2006).
However, if firms opt for external funds, they usually go with the safest security first (typically
debt) while equity is usually issued last (Meyer, 1988).
Further, Bernanke and Gertler (1989) show that the external finance premium is correlated with
the business cycle. According to the same source, a firms balance sheet (defined as its net worth)
determines of the cost of funds for this firm. The net worth is typically pro-cyclical: it is low at
the bottom of the business cycle, making external funds pricey. On the other hand, the external
10

finance premium is counter-cyclical: the firms expect a high cost of external funds at the bottom
of the business cycle.
This issue has been further discussed by Bernanke et al. (1996). The authors show that a high
cost of external funds during the bottom of the business cycle requires the firms to abstain from
investment. Consequently, generates a decline in output (the financial accelerator effect). According to the same paper, large changes in investment spending happened after monetary policy
movements that had little effect on long-term interest rates (Bernanke et al., 1996). Here, some
additional explanations are necessary.
There are two ways in which the monetary policy can affect the cost of external financing.
Based on Bernanke et al. (1996), the balance sheet channel is linked to a change in interest rates
that directly affects a borrowers balance sheet. Thus, a restrictive monetary policy pushes the
interest rates up and increases the cost of debt service. Hence, borrowers net worth worsens, increasing the external finance premium and preventing new investments. The same authors further
explain that, the bank lending channel is linked to the transactions cost when bank credit is reduced
(i.e. when the supply of bank loans decreases, the firms are no longer able to borrow from their
lender of choice and must look for new borrowers). Because of informational asymmetries, it is
costly for the firm to provide the appropriate information, driving up the cost of external funds
(Bernanke and Gertler, 1989). It is straightforward to see that this is very similar to what we saw
above in the paper by Romer and Romer, except that now the change of the external finance premium (and not the interest rate) plays an important role.
Finally, Gertler and Gilchrist (1994) show that small firms react more dramatically to tightening monetary policy than large firms (i.e. small firms represent the majority of the decline in
output). This happens because large firms have better access to various types of credit and hence
have an easier way to address this situation.
More recently, there have been various attempts to separate the loan demand effects from the
monetary transmission mechanism. One example is Kashyap and Stein (2000) who develop the
following measure of balance sheet strength (i.e. banks liquidity) defined as:
Bit =(Securities Held + FED Funds Sold)/(Total Assets)
According to this approach, a high ratio would point to a more efficient response to an external
shock (Kashyap and Stein, 2000). To analyze the lending volume, the authors use total loans and
the level of consumption and investment (C&I) loans because liquidity can vary based on the type
of loans. Also, smaller banks tend to have a high concentration of such loans in their portfolios.
The authors find that monetary policy affects small banks with less liquid balance sheets. In particular, a tighter monetary policy will lead to a decrease in economic activity because of higher
interest rates. Consequently, banks will experience high loan losses and capital reductions because
of reduced supply of loans and of lending activity.
11

Kishan and Opiela (2000) extend the above-mentioned approach by including the capital leverage ratio which is important in assessing the policy impact. According to them, bank capital is
important for how much risk the banks are willing to take and to how the loan portfolio is distributed. In addition, it reflects a banks financial standing and serves as a key sign to investors
who are willing to supply the bank with (external) funds. This paper supports the idea that the
1990 1992 credit crunch was a result of low bank capital and the implementation of risk-based
capital guidelines (Kishan and Opiela, 2000). The authors also show that less capitalized (smaller)
banks are most affected by a changes in monetary policy. This happens because smaller banks
are unable or unwilling to raise additional funds to make up for the drop in reservable deposits
with time deposits (which usually happens during a restrictive monetary policy move). Thus, less
capitalized banks are more responsive than well-capitalized banks. This result is in line with the
above-seen bank lending and balance sheet channel views. This paper also argues that if monetary policy leads to changes in balance sheet health, poor capitalization can occur. In other words,
weak economic activity generates losses in the loan portfolio which decreases the capital level of
banks (Kishan and Opiela, 2000). Kishan and Opiela (2000) also analyze the correlation between
loan delinquency rates (non-current loans divided by total loans) and bank capital. They find an
no inverse correlation and regard this as an evidence of the bank lending channel. This approach
contradicts the idea of Romer and Romer according to which banks would compensate a decrease
in reservable deposits by attracting larger time deposits.
Gambacorta and Mistrulli (2004) also analyze the issue of capital and lending arguing that with
long-term assets matched to short-term liabilities, banks are exposed to interest rate risk. A restrictive monetary policy would reduce a banks profitability, making external funds difficult to obtain.
Banks would be forced to reduce lending to meet capital requirements (which does not have to be
binding). According to this approach, banks capital serves as a signaling mechanism for potential
investors: they require premium in return for providing external funds and banks with higher levels
of capital can secure these funds at a lower cost (Gambacorta and Mistrulli, 2004). The authors
find this effect to be very important and point to a separate bank capital channel. Assuming that
the bank equity market is imperfect, that banks are subject to interest rate risk, and that banks must
meet regulatory capital requirements, the authors provide with the following explanation. Tighter
monetary policy raises interest rates. Because of the matching problem between assets and liabilities, rates on short term liabilities are reset before the rates on longer term assets. Consequently,
banks will incur losses as a result of this matching problem and will see lower profitability and
capital levels. It is straightforward to see that lending will be reduced in order to maintain adequate levels of capital (which serves as a signal). Gambacorta and Mistrulli (2004) also find that
well capitalized banks respond better to changes in monetary policy and have smaller changes in
loan volumes. Further, the capital becomes important for banks relying uninsured forms of financing and experiencing matching problems. These results complements the balance sheet channel
12

described above.
Altunas et al. (2009) address the issue of bank risk based on the recent developments in financial innovation (more specifically the originate-to-distribute model of lending). This approach
makes the typical indicators on liquidity, capitalization, and size obsolete because they are not
effectively account for risk. Instead, this paper suggests expected default frequency (that offers a
forward looking measure of banks standing) to be used when modeling bank risk. The main finding suggest that risk important in determining the supply of loan and the buffer from the effects
of monetary policy. This implies that low risk banks will attract deposits easier. However, this
ability is pro cyclical. In addition, this paper supports the findings of Kishan and Opiela (2000)
according to which well capitalized banks are able to survive the economic downturns better. The
shortcoming of this approach results however from the difficulty of separating the supply and the
demand factors from each other (Altunas et al., 2009).
On the other hand, Ashcraft (2006) suggests that the presence of many large and liquid banks
can offset the downturn in lending by small banks. In addition, imposing constraints has negative
effect if firms cannot replace bank loans with nonbank sources. Thus, the monetary policy affects
banks based on their individual financial constraints while total supply of loans is unaffected so
that economic output is unchanged due to the bank lending channel. According to this approach,
large multi bank holding companies are protected very well from the effects of monetary policy.
Such organizations typically own small banks to protect them from monetary policy changes. If
this is the case, if the parent holding company is a source of strength to the bank, then the lending
channel approach is irrelevant (Ashcraft, 2006).
Disyatat (2010) argues that it is irrelevant to analyze changes in reservable deposits because,
contrary to the papers reviewed above, it is the bank lending that drives deposits and not vice versa.
In addition, there are always sufficient funds to meet the demand for loans and it only banks willingness to lend that can affect supply of loans hence, there are no actual constraints (except for the
regulatory capital requirements) to the supply of funds so long as the interbank system is working
correctly (Disyatat, 2010).
So far we looked at how the financial sector influences the economy. However, there have also
been debates about the direction of causality in this relationship. More specifically, the scholars
addressed the question whether it is the development of the financial sector that drives economic
growth or is it the other way around. It is worth mentioning that the majority of literature has
been focused on the banking sector and there is very little literature on stock markets (Levine,
1996). Bagehot (1873) is one of the first who emphasized the importance of the banking sector to
economic growth and innovation. According to Levine (1996), during the 1920s, J. Schumpeter
subscribed to the same idea, while during the 1950s, J. Robinson argued that banks responded positively to economic growth. Other scholars have argued that economists overstressed the role of the
financial systems (Lucas Jr., 1988). Finally, there have been arguments that the level of financial
13

intermediation is a good predictor of long-run rates of economic growth (Levine, 1996). However,
the same author explains that research only shows that these two factors are closely linked and
there is no well-established direction of causality.
Cetorelli and Gambera (1999) argued that looking at the degree of concentration in the banking
sector is important. More specifically, this study suggests that extent of bank concentration on has
a non-trivial impact on industrial growth: bank concentration has a first-order negative effect on
growth. this result supports the theoretical prediction that higher bank concentration results, on
average, in a lower amount of credit available to firms (Cetorelli and Gambera, 1999). In the same
time, according to the same authors, there is evidence that bank concentration has a heterogeneous
effect across industries: it has positive effects on sectors that are more dependent on external funds.
This is in line with the models arguing that concentration of market power in the banking sector
develops the lending relationships and enhances firms growth (Cetorelli and Gambera, 1999).
FitzGerald (2006) also argues from the micro level suggesting that the financial sector is positively related to economic growth. More specifically, FitzGerald argues that:
The contribution of the financial sector is important, but so is the institutional framework,
Financial development (from commercial banking to capital markets) is not related to higher economic growth
Financial liberalization leads to more efficient and liquid financial intermediation, but does not lead
to higher levels of domestic savings or investment and
The efficiency gains (investment allocation) can be reduced by instability resulting from short-term
foreign capital flows.

On one hand, these findings suggest that the role of commercial banks as FIs in developing countries needs to be reappraised (FitzGerald, 2006).
On the other hand, other economists have argued that financial innovation (i.e. creation of new
financial instruments, markets and institutions) has often played a vital role for the growth and
the survival of the financial services industry, while the relevant financial institutions (defined as
organizations and laws, industry practices etc.) have been evolving at a rapid pace not only in the
West, but also in the developing countries and transition economies (Burton and Lombra, 2002).

2.3

The remittances and the economy

There has been a substantial body of literature on remittances covering a wide range of topics,
beginning with what causes worker migration and subsequently remittances and finishing with
the effects the remittances have on poverty reduction, consumption, industry, the economy and
growth. A great body of literature studies the effects of remittances in Africa and Latin America, while Eastern Europe is not as widely studied. Researches usually look into the originating
countries, the social groups to which migrant workers belong in their home countries, the motives
for leaving the country (including better opportunities, higher wages versus unemployment and
14

poverty) and perspectives of returning to home countries (permanent migration versus temporary
stay). In this context, examples of recent studies include Haas (2005) and Davies (2007).
There have been many studies looking at the motives behind the transfers to home countries.
Surprisingly, all of them have suggested different (often opposite) results. From a microeconomic
perspective, Lucas and Stark (1985) proposed several hypotheses on the migrants utility functions
including pure altruism where the migrants utility is a function of their own and their family members consumption. The second type was pure self-interes where the migrants where motivated to
make transfers hoping to inherit assets from their families, to either invest in or to consume assets
at their places of origin. Finally, there are the tempered altruist - enlightened self interest migrants
which is a complex hybrid of the first two which also includes inter-temporal arrangement, the idea
of risk and other several factors.
More recently, Yang (2006) also emphasized on the motives for migration arguing that migrants with life-cycle motivation react differently to economic changes in the host or home country
than migrants with target-earning motivation. The first group consists of migrants who stay in the
host country as long as their marginal benefit from higher savings in the host country balances the
marginal disutility of working there. Consequently, they will stay longer if the economic conditions improve in the host country. The second group is composed of migrants aiming to accumulate
a certain amount of wealth and, after their target is met, they return to home country.
According to the same author, migrant workers can also be categorized based on their wages.
The high wage earners are typically skilled educated workers from households that do not face borrowing constraints and are capable of investing above the minimum investment threshold (Yang,
2006). On the other end are the low wage earners represented by low skilled workers who had to
finance the process of migration by either selling assets or borrowing. Since their wages are too
low, they do not consider investment in their home countries (e.g. small business). The third group
is in the middle, the middle wage earners: they have also borrowed or sold assets to migrate, but
they are considering investment at home. According to this approach, this last group is represented
by target-earners while the other two groups are composed of life-cycle migrants (Yang, 2006).
As pointed above, the studies yielded mixed results, neither supporting, nor rejecting these
theories. In an early study, based on monetary data, Johnson and Whitelaw (1974) found that
nearly 96.2% of urban-rural remittances were channeled to supporting family and friends in Kenya
(Mukras et al. (1985) and Schiopu and Siegfried (2006)). In their study of Botswana, Lucas and
Stark (1985) found that altruism alone was not sufficien to explain the transfers.
Based on evidence from South Pacific, Poirine (1997) found that the implicit loan theory seems
to better explain remittance behaviors, flows and uses relative to the altruistic or self-interest
theories. According to Schiopu and Siegfried (2006), this is indicative of a U shaped relation
between a familys pre-transfer income and remittances. In other words, poor households do not
have sufficient resources to cover the costs of migration while wealthy households do not have in15

centives to send a family member abroad to increase family income (Schiopu and Siegfried, 2006).
The same authors conclude that, given that the wealthy can invest more in education, remittances
should first increase and then decrease in the migrants skill level. In addition, others argued that,
remittances are merely compensatory transfers between family members who lost skilled workers
due to migration. Here, we can mention studies by Adams (1991) and Adams (2006).
Agarwal and Horowitz (2002) analyzed the households with multiple versus single migrants
under altruism and risk sharing approaches and found signifficant differences in remittance behavior of multiple and single migrants. Their study supports the altruistic incentive to remit.
Finally, within Yangs framework, Bojras (1989) found that high wage earners were less likely
to return, while Dustman (1996) found evidence that this group is very likely to return. Constant and Massey (2002) found no significant relationship. Yang (2006) explains these results by
claiming that the dependent variable does not capture such important aspects as family ties, job
opportunities in the home country etc.
Typically, from a macroeconomic approach, international migration of workers tends to occur
when there is an increase in demographic and wage differentials between the host and the home
country, being further augmented by the evolution of communication and transportation services
(Bojras and Bratsberg, 1996). In the same time, worker migration is not necessarily an one way
process: factors such as job loss, improving conditions in the home country (leading to better opportunities) or imperfect (initial) information about the opportunities in the host country persuade
the migrants to return. Other authors have added such variable as the preference to consume at
the country of origin as another factor influencing the decision to return (Hill (1987) and Djajic
and Milbourne (1988)). Recognizing that many developing countries see migration as a solution to
poverty, based on the example of the Philipines, Theoharides et al. (2010) found that migration to
host countries is directly related to the economic conditions in that country, such that a 1% increase
in the real GDP of the host country increases migration inflow by 0.97%.
There many studies that have analyzed the effects of home and host country conditions on the
flow of remittances. Mouhoud et al. (2008) cite El-Sakka and Mcnabb (1999) who found that
remittance flows are highly responsive to the differential between the official and black market
exchange rates, to the differential between domestic and foreign interest rates (negative effect) and
domestic inflation (positive effect). According to the same source, this is indicative of the fact that
imports financed through remittance earnings have a very high income elasticity, suggesting that
these imports are consumer durables and luxury goods (Mouhoud et al., 2008). Finally, the same
paper emphasizes on El-Sakka and Mcnabb findings about the effects of inflation suggest that
altruistic motives are dominant in the remitting decision. Vargas-Silva and Huang (2005) found no
significant effect of home country economic conditions on remittances. Gupta (2005) found that
most of the macroeconomic factors are insignificant in explaining the behaviour of remittances
around the trend over time. Only migrants earnings and source country economic activity had
16

a singificant impact, remittances being higher during periods of low economic growth in India
(Gupta (2005) and Mouhoud et al. (2008)). Schiopu and Siegfried (2006) also present a brief
overview of studies that have found that level of economic activity in the host and the home countries, the wage rate, inflation, interest rate differentials, or the efficiency of the banking system
along with such institutional factors as political stability and consistency in government policies
and financial intermediation significantly affect the flow of remittances. Ultimately, Schiopu and
Siegfried (2006) however conclude that, the evidence on most macroeconomic determinants is
mixed, the effects of the interest rate differential, the black market premium, domestic income and
inflation being inconclusive.
In the same time, Fayissa and Nsiah (2008) emphasize on the fact that not that many scholars
have analyzed the actual effects of remittances on the macroeconomy of the home country and,
consequently, on its growth. The main reason behind this is that, as seen above, several authors
have argued that remittances are mainly used for consumption and have minimal impact on investment while others have claimed that they are widely viewed as compensatory transfers between
family members who lost skilled workers due to migration (Fayissa and Nsiah, 2008).
Stahl and Arnold (1986) argued that, when used for consumption, the remittances may positively impact growth through a possible multiplier effect. On the other hand, Barajas et al. (2009)
found no evidence of a relation between workers remittances and economic growth. Fayissa and
Nsiah (2008) and Stahl and Arnold (1986) argued that remittances respond to investment opportunities in the home country and to charitable or insurance motives. The same two papers explain that
migrants can invest remittances in small businesses, real estate or other assets in their home countries because they know their home markets better than in their host countries. Another motive for
such investments is expectation of future returns. Fayissa and Nsiah (2008) argue that remittances
are mostly profit-driven and increase when economic conditions improve in home countries. This
phenomenon particularly occurs where the financial sector does not meet the credit needs of local
entrepreneurs (Stahl and Arnold, 1986).
Cooray (2010) briefly describes several studies that found that remittance inflows into the low
and middle income economies have been found to reduce poverty, provide capital for micro enterprises, reduce output volatility and lead to exchange appreciation. In his own study, the same
author examines the impact of migrant remittances on financial sector size and efficiency through
the government ownership of banks channel. The results of this study suggest that remittances lead
to increases in the volume of credit disbursed, the volume of bank deposits and liquid assets in the
banking sector. In particular, remittances lead to a fall in overhead costs and net interest margins
(Cooray, 2010). In addition, the same author argues that remittances lead to an increase in deposits
(and consequently in credit disbursed) and liquid assets. For this reason, the study concludes that
remittances provide financial access to the rural poor. The same author explains that his findings
are in line with other studies that have found that remittances can promote economic growth in the
17

developing economies by enhancing financial sector development, particularly in financially less

developed economies. However, some of these studies have pointed out that the financial system
in home countries have to be developed (Cooray, 2010). Finally, authors like Alberola and Salvado
(2006) have argued that banks have the ability to offer lower remittance transmission fees relative
to smaller money transmitter operators and hence to increase the volume of remittances into recipient countries while Freund and Spatafora (2008) argued that formal transmission channels such
as banks are more expensive compared to informal transmission channels (Cooray, 2010).
Another part of the literature on remittances is comprised of reports, surveys and other similar
publications by international organizations such as WB, IMF and IOM and various institutions
from home countries. Most of this work adopts the above-mentioned approach and is based on
generally available macro- and microeconomic data and on surveys conducted at regional and
local levels (including communities and villages). These surveys attempt to identify reasons for
migration, places of employment (since often workers are employed illegally in the host countries),
transmission channels (official versus unofficial channels to send the money to home countries),
main uses of remittances (investment versus consumption) and future plans of these workers (permanent versus temporary migration). However, policy recommendations typically assume that
remittances have a positive impact, especially if attracted into the economy via the financial sector.
However, this approach has been criticized for the underlying assumption that remittances are
by default a potential driver of growth. Chami et al. (2005) develop a model to analyze the causes
of remittances that allows the to test whether remittances behave like capital flows. They show
that altruistically-motivated remittances are sent to compensate their recipients for bad economic
outcomes and thus have a negative relationship with income growth. On the other hand, capital
flows such as FDI are profit driven and are positively-correlated with GDP growth (Chami et al.,
2005). The results of this study suggest that remittances are compensatory in nature and it is not
clear what impacts these transfers (and the policies similar to the ones presented above) may have.
In addition, the same authors suggest that if remittances are used as a substitute for labor income,
then they lead to a reduction of labor supply and labor market participation, which ultimately can
even adversely affects output. Chami et al. (2005) also point to the incentive effects on governments in the recipient countries who may view such transfers as stable source of insurance. In this
sense, Abdih et al. (2008) found that remittance inflows can lead to a decline in institutional quality. In this context, some authors have even called for ignoring the remittance euphoria because
unattractive investment environments and restrictive immigration policies which interrupt circular
migration patterns prevent the high development potential of migration from being fully realized
(Haas, 2005).
I will further describe briefly the research that focuses on Moldova. In this sense, has been
relatively modest. The existing studies assume that remittances have a positive effect on growth
(at the cost of social effects) and therefore focus on social aspect of migration and on policy rec18

ommendations to attract the remittances into the economy. They find that increasing consumption,
absence of a job and poverty were the main factors that determined the migrants to go abroad.
Also, according to these surveys and reports, most of the recipients are from rural areas (numbers
fall in the 50% 60% range). Here, I could mention Orozco (2008), Scutaru (2008b), MCCEE
et al. (2008), Cuc et al. (2005) and Hristev et al. (2009).
Some authors have argued that overall remittances do not directly lead to faster growth, but
rather they increase the certain households income (Marandici, 2008). In other words, remittances
can positively affect growth only if, on aggregate, a certain critical number of households benefits
from higher incomes which then represents development. The same author calls for an analysis of
the entire range of economic, political and social costs of remittances because the narrow focus on
higher household incomes and poverty alleviation does not include all aspects of development.
Still, it is surprising that the impact of remittances on growth has been only partially studied.
Even the studies that present figures are mostly descriptive. In other words, very few authors have
attempted to measure the effects remittances.
At this point, I am aware of only two empirical studies that have done research in this area. The
first study analyzes the impact of remittances on savings (through bank savings accounts) and finds
that remittance-receiving households tend to use formal financial services more than non-receiving
families leading to a faster financial sector development (Avila and Schlarb, 2008). In regard to
this finding, it is important to mention that essentially there are two ways of getting remittances:
via a formal (all the Moldovan banks offer money transfer services) and informal channels, this
explaining to some extent the results.Further, the same study found that remittances tend to increase household savings even more than bank accounts, which constitutes a key potential for the
development of the financial sector.
Another study looks at the factors that account for the receipt of remittances across households
and finds that a combination of household, migrant characteristics and some community level variables are the key elements in explaining the remittance behavior in Moldova (Piracha and Saraogi,
2011). According to the same source, altruism and investment are the two main motives behind
remittance flows to Moldova.
In this context, the study of the market of financial services and products by Scutaru (2008b) is
helpful in understanding the opportunities the beneficiaries of remittances have vis-a-vis the banking sector. By offering an extensive overview of the loans and deposits products, this report argues
that the Moldovan banks offer an extensive variety of services that are able to cover all the demand
from customers and that there are other factors that prevent the attraction of remittances into the
economy through the banking sector to reach higher levels. Orozco (2008) argues that the banks
should work on:
Communication - better promotion of their products and increasing outreach to cover the customers
from rural areas

19

 Education/literacy - increasing customers knowledge about the role and the functioning of the banking sector
New products - including other products that are currently available in the developed countries and
are not offered in Moldova yet
Target ratios - use of quantitative measures to reward the bankers
Partnerships with non-banking institutions - working with NGOs or other organizations that have
better outreach

Scutaru (2008b) subscribes to this position, however he emphasizes of the issue of trust: given that
the majority of population lost their lifetime savings during the crises of the 1990s, high uncertainty
(about inflation levels or government policies among other things) levels, confusion between the
role of deposits (savings versus investment) and distorted prices (especially of real estate) prevent
the Moldovans to opt to direct most of the remitted amounts to banks or to invest even more in
small businesses.
Scutaru (2008b) argues that effects of the remittances on the Moldovan economy are highly
debated. According to this source, the supporters claim that these amounts lead to economic growth
while the opponents emphasize the ways the remittances are used (i.e. primarily consumption) and
the market distortions that they generate, including their effects on prices and wages.
Finally, Culiuc (2006) argues along the same lines, Figure 2 summarizing his view on this
issue (where RER is the real exchange rate, CB is the central bank and NTG represents non-traded
goods).
Figure 2: The Effects of Remittances on the Economy

20

3
3.1

Evolution of Moldovan Economy after 1991

Background information on the transition process

I begin this section with some general background information about the process of transition and
then I shift my focus to the case of the Republic of Moldova. One of the most common definitions
of transitions states that it is a systemic movement from socialist economic system to market economy. This implies the functioning of markets moves to a non-forces interaction, new institutions
and actors emerge (or are created).
The transition from planned to market economy has been both painful and relatively long for
almost all of the former socialist economies. Some countries overcame the this period faster, joining the EU and being considered today as success stories (e.g. Poland, Czech Republic and the
Baltic States). Other countries are still facing transition.
There have been many studies about costs, the winners and the losers, the dynamics of economies
etc. Because they fall outside the scope of this paper, I only touch upon the most important points
and present selected statistics for illustrative purpose only. In this sense, a widely-cited paper is
Bruno (1993) who summarizes the phases of transition as follows:
Liberalization (prices and markets) leading to dramatic fall in growth rates
Hyperinflation and negative growth following the liberalization process,
Stabilization measures including fighting inflation, tight monetary and fiscal policy, checking the
collapse of output
Structural adjustment (privatization and restructuring) leading to positive growth figures and low,
normal inflation rates.

Melom et al. (1996) also emphasized that resumption of grow required stabilization which in turn
requires extensive liberalization. The same study argued that output contraction that occurred
during the early stage of transition accompanied by limited external financing and by very large
depreciations of the real exchange rate represented major barriers for stabilization. Finally, the
same authors provided arguments according to which, slower pace of reform did not strengthen
the fiscal position of slower reforming countries since their consolidated fiscal and quasi-fiscal
deficits were relatively high.
The failure of the centralized monetary and lending system that occurred after the disintegration
of the Soviet Union has literally paralyzed the economic structure of all the former member states
(Grigorita, 2005). It was in this context that the transition economies had not only to face the failure
of the old regime, but also to build new institutions from scratch. Further, turning our attention to
the CIS countries, it is important to note that, following the violent events that took place in 1990
1991 (the attempted coup detat in Russia), the economic conditions have dramatically deteriorated
not only in the Russian Federation, but also throughout the other USSR members. Needless to say,
as illustrated by the following graphs, the effects of this period have had a disastrous effect on the

21

former socialist economies.

Figure 5: Central Europe vs. Baltic States and CIS
A. GDP

B. Industrial Output

C. Inflation

We now turn our attention to the case of Moldova. The table below illustrates the evolution of
the Moldovan real GDP for the 1989 2010 period. It is important to mention that even until
today Moldova has not been able to achieve the reference level of 1989. In addition, the effects
22

both crises of the 1990s are easily observable. Starting with year of 2000, the Moldovan GDP has
registered a steady increase, with the exemption of the 2008 2010 period when growth was also
affected by the effects of the financial crisis and the global economic recession that followed.
Figure 6: The Evolution of the Moldovan GDP

The graph below illustrate the inflation levels. On 29 November 1993, the Moldovan national currency (Leu - MDL) was introduced. This allowed the NBM to promote an independent monetary
policy. As a result, as seen from the graph, the hyperinflation of the early 1990s was dramatically
reduced. In 1995, Moldova registered the lowest level of inflation in the CIS. During 1998 1999,
the inflation escalated again as a result of the Russian crisis. In 2009, the inflation level reached an
all time low due to deflation that resulted from the global economic recession.
Figure 7: Inflation Rate between 1992-2010

The table below summarizes the most important steps taken by Moldovan government between
1991 and 2003.
23

Table 1: Economic Policy between 1991-2003

Year

Month

Action

1991

June
August

Two-tired banking system established

- Independence from Soviet Union declared

January
1992

February
June
September
March

1993

1994

April
November
July
January
March

1995
June

1996

January
June

1997

July
August
September

1998

January
February
June
August
October
December

1999

April
May
July

- Most prices liberalized

- State trading monopoly abolished
- Competition law adopted
- New tax system introduced
- Exchange rate unified
- Cash privatization begins
- Privatization with patrimonial bonds begins
- Most quantity controls on exports removed
- New currency (Leu) introduced
- Securities and Exchange Commission established
- VAT introduced
- Treasury bills market initiated
- Full current account convertibility introduced
- Stock exchange established
- Trade in listed shares begins
- Enterprise restructuring agency established
- New Central Bank law adopted
- New financial institutions law established
- First sovereign Eurobond issued
- New VAT law enacted
- Bankruptcy law amended
- New land law adopted
- Independent energy regulator established
- New privatization law adopted
- International Accounting Standards introduced
- Nationalized cadaster introduced
- Credit auctions abolished in favor of open market operations
- Most tax and duty exemptions removed
- Restrictions on holding more than one bank account abolished
- VAT and income taxes amended
- Law on energy sector privatization adopted
- Pension reform launched
- All remaining trade restrictions removed
- Moldovagaz privatized
- Legislation on breakup of collective farms approved

January
February
May
June
July
August
December

- Minimum bank capital requirements raised

- Electricity distribution companies privatized
- IMF EEF program expires
- Regulation on bank mergers approved
- Parliamentary republic introduced
- Independent telecommunications regulator established
- Poverty Reduction and Growth Facility program agreed with IMF

2001

June
November

- WTO membership granted

- Bankruptcy and pledge law amended

2002

October
November

- Eurobond restructured
- Supreme court rejects challenge to power privatizations

2003

January

2000

- Tariff re-balancing program in telecommunication sector commences

Source: EBRD Transition reports 1998-2011

Here, some comments are necessary. First, to privatize housing and industry, the government issued vouchers to residents based on the number of years they had worked for state enterprises.
24

Residents exchanged the vouchers for ownership shares in enterprises or for housing. Second, by
1997 the majority of former state enterprises were in private hands. Further, Moldova was among
the first of the former Soviet republics to allow private ownership of farmland (Grigorita, 2005).
In conclusion of this subsection, it is worth to mention briefly the main characteristics of the
Moldovan economy. The industry is dominated by food processing since the country has traditionally specialized in frozen and canned vegetables.
Moldova is also well known in the CIS for its production of wines, sparkling wines and brandy
produced from its grape harvest . Other industries use locally grown sunflowers and soybeans to
make vegetable oil, and beets to process raw sugar. During the Soviet era, manufacturing plants
were developed to produce military equipment and consumer goods, and Moldova was a significant producer of carpets, home appliances (refrigerators and washing machines) and TV sets.
Further, Moldova has very little natural resources. Some small oil and natural gas reserves have
been discovered, but it continues to import most of its fuels from the Russian Federation.
Moldovas principal trading relations are with Romania and former Soviet republics, mainly
Russia and Ukraine. However, according to the most recent report from the Moldovan government, exports to the EU have crossed the 50% threshold. Food and agricultural products account
for about one-half of Moldovas exports, while the leading imports are fuel, electricity, and mineral
products. Moldova also has a metal-refining industry, almost entirely dependent upon imported
raw materials and fuels. More than one-quarter of Moldovas industrial plants are in the disputed
Transnistrian region.
3.2

The Moldovan Banking Sector

Surprisingly, there is little detailed literature on the development of the Moldovan banking sector.
Grigorita (2005) offers probably the only overview of the development of the Moldovan banking
sector starting with the 1800s and finishing with 2004. Another studies focusing specifically on
this topic are MCCEE et al. (2008), Scutaru (2008a), Scutaru (2008b), Orozco (2008) and Scutaru (2007). Extensive descriptive statistics is regularly reported by the Moldovan National Bank
(NBM), the National Bureau of Statistics and by the Logos Press newspaper. Consequently, this
section is primarily based on the above mentioned literature
In this context, in the CIS, the period between 1991 and 1995 was characterized by member
states establishing individual banking sectors. Moldova was not an exception for this. Similarly
to the other former Soviet republics, the formation of the banking sector included such important
actions as decentralization of lending resources, termination of state monopoly over the banking
operations and introducing competitive forces into the organization of the banking sector (Grigorita, 2005). Consequently, in 1991, the Moldovan state established a 2-layer banking system
where NBM played a central role (but with no commercial banking activity). The NBM was
reorganized by the Presidential decree Regarding the National Bank of Moldova dated 4 June

25

1991, from the Republican Bank of Moldova of the State Bank of USSR into the National Bank
of Moldova. On 11 June 1991, the Moldovan parliament passed the the NBM law while on 12
June 1991, the institution adopted the Law on Banks and Banking Activity Grigorita (2005) and
Scutaru (2008a).
Further, in 1995, as a result of various factors that needed to be adjusted, the Parliament adopted
a new NBM law (nr. 548-XIII), dated 21 July 1995, presented on 11 September 1995 and signed
by the President (Decree nr. 85-p, dated 19 September 1991) (Grigorita, 2005).
Other legal documents that are relevant for the banking sector are:
The Civil Code (dated 22 June 2002), Chapter XXIV:
Section 1 (articles 1222-1227): bank deposits, deposit contract, interest rates
Section 2 (articles 1228-1235): current accounts and the amounts placed on these accounts
Section 3 (articles 1228-1265): the procedures related to lending
Section 4: bank guarantees
Section 5: payment order
Section 6: payments using checks
Section 7: payments using bills of exchange
Section 8: payments using letters of credit
Section 9: documentary collection of payment
Section 10: payments using bank cards
Financial Institutions law (nr. 550-XIII, 21 July 1995, OJ nr. 1, 1 January 1996) addressing all the
activities of the banking sector including authorization and conflict resolution.
Regulation on the opening, modification and closing of bank accounts at authorized banks in the
Republic of Moldova (nr. 297, 25 November 2004)
Regulation on conditions, methods of issuing and circulation of certificates of deposits an bills of
exchange (nr. 94, 31 March 2005)
Regulations on cash operations (nr. 200, 27 June 2006, OJ nr. 120-123/441, 4 August 2006)
Regulation on cash operations (nr. 47, 25 February 2000)
Regulation on bank cards (30 June 2005, OJ nr. 36-38, 4 March 2005)
Law on deposit guarantees (nr. 575-XV, 26 December 2003, OJ nr. 30-34/169, 20 February 2004),
establishing the creation of the Deposit Guarantee Fund
Law on Bankruptcy (nr. 632-XV, 14 November 2001, OJ nr. 139-140/1082, 15 November 2001)
Law on Savings and Credit Associations (nr. 139-XVI, 21 June 2007)
Law of Microfinance Organization (nr. 280-XV, 22 July 2004)
Law on Pledge (nr. 449-XV, 30 June 2007)
NBM Regulation on lending activity by banks operating in Moldova (nr. 153, 25 December 1997)
NBM Regulation on provisions for loan losses (the risk fund) (nr. 164, 22 July 1998)

The first layer is represented by the NBM which is subordinated to the Moldovan Parliament. It
functions as a central bank and as a issuing bank. NBMs main attributes are:
Organization of circulation of money, issuing of bank notes and setting the exchange rate

26

 Lending to commercial banks and other lending institutions

Arrangement of inter-bank payments
Authorizing, regulation, supervision and control of banking institutions
Management of states foreign currency reserves
Representing Moldova in its relationships with other CBs and IFIs

The second layer is represented by the Moldovan banking sector (i.e. the system of commercial
banks). The Moldovan banks conduct local and international operations and can specialize in
certain activities. Their specter of activities is typical for commercial banking and therefore will
not be covered in this section. Instead, I shall focus on main developments that has shaped the path
for the Moldovan banking sector as it is today.
Table 3: Bankruptcies in the Moldovan banking sector
Name

Type of capital

License granted

Reorganized/License withdrawn

Topaz-bank

private/local

21 November 1991

18 September 1992

private/local

1990

21 May 1996
OJ. nr. 31, 23 May 1996

foreign

21 February 1994

10 September 1996
taken over by Victoriabank

private/local

N/A

23 December 1996
OJ nr. 81-82, 19 December 1996

private/local

1990

03 February 1997
OJ nr. 7, 31 December 1997

private/local

1991

16 December 1997
OJ nr. 84-85, 18 December 1997

private/local

14 July 1994

03 July 1997
OJ nr. 62-65, 09 July 1997

private

17 January 1994

18 March 1999
OJ nr. 26, 18 March 1999

private/local

1995

17 June 1999
OJ nr. 62-64, 17 June 1999

foreign

11 September 1996

04 November 1999
OJ nr. 120-122, 04 November 1999

private/local

20 December 1991

23 November 2000
OJ nr. 147-148, 23 November 2000

foreign

N/A

21 July 2007
OJ nr. 86-88, 27 July 2007
taken over by Mobiasbanca

foreign

11 May 2000

25 July 2002
OJ nr. 110-112, 01 August 2002

private/local

20 July 1993

19 September 2002
OJ nr. 131-133, 26 September 2002

foreign

15 October 1998

19 September 2002
OJ nr. 131-133, 26 September 2002

N/A

05 July 1997

Decision of auto-liquidation was

authorized by shareholders on 29 June 2005

N/A

8 August 1994

19 June 2009
OJ nr. 131-133, 26 September 2002

CB Basarabia
Filiala Dacia-Felix SA
Cluj-Napoca din or. Chisinau
BCA Capital-Bank
BCA Intreprinzbanca
BCA Bancosind
BCA Bucuriabank
BCIA Vias
BC Guinea SA
Banca Internationala de
Investitii si Dezvoltare MB
BCI Oguzbank SA
Bankoop-Banca Generala de
Credit si Promovare SA,
Sucursala Chisinau
BC BTR Moldova SA
Banca Municipala Chisinau SA
International Commercial
Bank (Moldova) SA
BC Businessbank SA
BC Investprivatbank SA

Source: Grigorita (2005) and NBM

27

Although Moldova is a small country (with a population of 3.6 million and an area of 33.9 thousands km2 ), the number of Moldovan banks has been traditionally extremely high considering
relative to its size. Table 2 below illustrates this point.
Table 2: Number of Moldovan banks (1993-2011)
Year

Nr. of banks

Foreign banks (branches)

1993

22

1994-1995

21

1996-1997

22

1998

23

1999

20

2000

19

2001

19

2002-2005

16

2006

15

2007-2008

16

2009-2011

15

Source: Grigorita (2005), Scutaru (2008a) and NBM

At the end of the 1990s, the number of banks has decreased to 16. This was a result of increased
competition, crisis and increased capital requirements (Grigorita (2005) and Scutaru (2008a)). The
newest player on the market is ProCreditBank which started its operations as a bank in 2008 (preliminary license received in December of 2007) while prior to that, it operated as a non-bank
financial institution (Scutaru (2008b)).
The most recent bankruptcy, Investprivatbank, occurred in 2009 when NBM withdrew the license based on banks insolvency due to over investment in real estate loans. Table 4 summarizes
the bankruptcies in the banking sector based on Grigorita (2005) and the NBM Annual Reports for
2005 and 2007.
More recently, the banking sector came into attention due to the so-called raider attacks. These
attacks are defined as (fraudulent) legal actions taken to take over control over a target company
as well as to exercise the administrative or law-enforcement pressure on the (rightful) owners. The
recent incidents had extensive cover in the media throughout the CIS member states, being common during the 1990s and, to a certain degree, less common nowadays. The Moldovan press has
also extensively covered these recent incidents media during the summer-fall of 2011. Because of
still on-going investigations and because a discussion of these actions falls outside of the scope of
this paper, it is too soon to get into more details at this point.
Currently, there are 15 banks on the market (see Table 4 based on Grigorita (2005)). The total
number of bank outlets is 1160, out of which, there are 293 branches and 867 agencies. In addition
to banks, there is a large number of savings and credit associations (SCAs).
Orozco and Kabulova (2007) identify nearly 530 SDAs and explain that these are organized
as non-profit organizations where only the members can make deposits or take loans. Further, the
28

profit earned by the SDA can only be used for operational expenses, saved as a reserves or capitalized. Their activity is supervised by the State Supervisory Board (and not by NBM) which is a
state agency subordinated to the Ministry of Finance (Orozco and Kabulova, 2007).
Table 4: The list of Moldovan banks
Nr.

Name

Type of capital

1.

Banca de Economii SA

mixt, local:
state and private

2.

BC Moldova-Agroindbank SA

3.

BC Moldindconbank SA

mixt,
local and foreign

mixt,
local and foreign

Authorized / reorganized
1940, organized as a savings house
1987 - reorganized as Banca de Economii
Republicana a URSS
2011 - Ministry of Economy approved a roadmap
for privatization
1987 - organized as Banca Agroindustriala
Republicana a URSS
1991 - organized as BC Moldova-Agroindbank SA
1992 - reorganized as Banca de Economii
1959 - organized as Banca Republicana a
Bancii de Constructii a URSS
1987 - reorganized as Banca Republicana a
Bancii Industriale si de Constructii a URSS
1991 - reorganized as Banca de Industrie
si Constructii SA
1987 - organized from Banca de Comert Exterior a
URSS into Banca de Relatii Comerciale Externe
a URSS, Vneseconombank
1994 - reorganized as BCA Export-Imoprt
1994 - authorized by NBM to organize as a SRL
1996 - reorganized into a closed SA
2006 - became part of the Italian group Veneto Banca

4.

BC Eximbank
Gruppo Veneto Banca SA

foreign

5.

BC Victoriabank SA

mixt,
local and foreign

1990 - authorized

6.

BC Mobiasbanca
Groupe Societe Generale SA

mixt,
local and foreign

1990 - authorized
2008 - became of the French group Societe Generale

7.

BC Comertbank SA

mixt,
local and foreign

1990 - authorized as Moldtorgbank

1991 - authorized as BC Comertbank SA

8.

BC Banca Sociala SA

mixt,
local and foreign

1987 - organized as Banca Sociala a Fondului

Locativ Republicana a URSS
1991 - reorganized as Banca Sociala BCA

9.

BC Universalbank SA

mixt,
local and foreign

1994 - authorized

10.

BC EuroCreditBank SA

mixt,
local and foreign

1992 - organized as Petrolbank

2002 - reorganized as BC EuroCreditBank SA

11.

BC Energbank SA

mixt,
local and foreign

1997 - authorized

12.

BC BCR-Erste SA

foreign

1998 - authorized
2006 - became part of the Austrian group Erste

13.

BC Unibank SA

foreign

1993 - authorized

14.

BC FinComBank SA

mixt,
local and foreign

1993 - authorized

15.

BC ProCreditBank SA

foreign

2007 - authorized

Source: Grigorita (2005) and NBM

29

3.3

Final remarks on the banking sector

Scutaru (2008a) analyzes the evolution of the Moldovan banking sector applying the Strategic Position and Action Evaluation (SPACE) approach and argues that the 1990s have been characterized
by an aggressive strategy while the period between 2000 and 2007 was characterized by competitive environment. The SPACE matrix plots calculated values for the competitive advantage (CA)
and industry strength (IS) dimensions on the X-axis while the environmental stability (ES) and financial strength (FS) dimensions are represented on the Y -axis. According to Scutaru (2008a), the
evolution of Moldovan banking sector is best illustrated by Figure 8. According to the same source,
the following factors played an important role in the direction the banking sector has developed:
Th hyperinflation of the 1990s negatively impacted the demand for banking services (deposits, loans)
Uncertain economic conditions have prevented large international banks from investing in Moldova
during the 1990s
Relatively low entry barriers have led to a large number of competitors during the 1990s, but the
economic conditions have reduced their number towards the early 2000s
The extreme fragmentation of the early 1990s has determined an aggressive direction
The NBM heavily guards the system in order to impose discipline in this strategic sector
The Moldovan state is involved in the financial sector by holding the majority shares in a large bank
(Banca de Economii) and by being involved in the market for insurance services
During the early 2000s, the banking finally stabilized, characterized and encouraged in the same
time, by a higher degree of stability and sustained development, this determining other foreign actors
to enter the market (Societe Generale, Veneto Banca, Raiffeisen, ProCreditBank etc.)
High competition on small and static market shifted the direction towards a competitive one

Figure 8: The Evolution of the Moldovan Banking sector

30

This result is in line with the data from the BNM. Based on its annual reports for 1999-2010, Table
5 illustrates the evolution of the main indicators (assets, liabilities and capital) between 1998 and
2010. It is interesting to note that before 2000, the amount of deposits from businesses exceeded
the amount from individuals pointing to the fact that the crises of the 1990s have not only shaken
populations trust in the banking sector, but the banks did not regard this market as attractive.
Figure 9: Banking Sector: Main Indicators

As the economy stabilized and with remittances starting to increase, the banks started to focus on
this market more (Grigorita (2005) and Scutaru (2007)).
At the end of this section, it is useful to present the conclusions through the framework of the
5-forces analysis (also known as Porters Five Forces Model).
Market competitors / Intensity of rivalry: we talk about how intense is the competition.
Thus, there are 15 banks, several financial non-banking institutions and 530 SDAs competing on a
small market (including a small population facing a large emigration problem, worker remittances
exceeding $1.3 billion per year) (Orozco and Kabulova (2007) and Orozco (2008)). In addition,
Moldova is the poorest country in Europe, with most of its economic activity is concentrated in the
capital (Chisinau) and 2-3 larger towns (Balti, Cahul, Ungheni). The average salary is around $200.
In this situation, the number of corporate clients is also relatively small, therefore, the Moldovan
banks face a fierce competition. All the studies on the Moldovan economy that have been mentioned above support this idea (one example is MCCEE et al. (2008)).
Threat of new entrants: we look at how easy is for new competitors to enter a particular industry. In case of Moldova, I believe that entry in the banking sector is difficult due to small size
of the market and its over saturation. In addition, after facing two severe crises during the 1990s
and after the most recent economic recession, NBM is enforcing relatively strict rules (especially,
as seen above, it was the capital requirements that has determined several banks to cease to exist
around 2000) (Grigorita, 2005). Finally, banking per se requires high level of investments required
31

(building the physical and software infrastructure). I believe that, as seen above, the most likely
path for new entrants is to to acquire an existing bank (Scutaru, 2008a). Thus, from this point I
believe that the Moldovan banks are protected and the only threat is competition among themselves
(even if a player is acquired by an international actor).
Substitutes: we look at how easy is to substitute the products/services provided with other
produced by similar actors. Given the high level of competition, I believe that the Moldovan banks
actually can improve their standing vis-a-vis this aspect. We saw above that (Avila and Schlarb,
2008) argued that households receiving remittances were more likely to use the banking sector.
However, I also mentioned that this is more likely because of the rapid money transfer services.
In this sense, banks compete with the Moldovan Post office too (which has better outreach thank
banks). As pointed by Scutaru (2008b) and Scutaru (2007), competition on interest rates for deposits is common. For these reasons, I believe that client loyalty is relatively low. Finally, because
the market is small, corporate clients have slightly higher bargaining power. On the product side,
the offer of services is not complete as is in the West, some of the products (such as direct debit,
electronic management of accounts etc. is not available yet)therefore the majority of services are
standard. This makes the switching costs be very low. The only time when it is rather difficult
to change the bank is when the loans are secured by pledges (for example, real estate), but still,
clients can do it.
Bargaining power of suppliers: in case of banks, in line with the literature reviewed in the
first section, I assume that the suppliers are those who provide funds to be used for lending. In
case of Moldovan banks, deposits from individuals and legal entities represent one source. However, due to a small market with many competitors, it is the banks that will seek to accommodate
the potential client increasing their bargaining power (especially with large corporations such as
Orange, La Farge, Moldcell (Turkcell-Telia Sonera) and, of course, large state actors. The international sources are money that come IFIs such as EBRD, IFC, BSTDB, EFSE, FMO or WB. These
suppliers offer long term resources and are extremely powerful when negotiating the loan agreements with the local banks. Due to high country risk, the are able to impose very strict prudential
conditions.
Bargaining power of buyers: the beneficiaries of banks services. In this case, the same logic
as before applies: local banks are fiercely competing for clients using interest rates. Large corporations and state actors are favored due to their size (large loans, salary projects etc.).

32

Banks, Monetary Policy and Remittances: a VAR Approach

4.1

Brief considerations on the VAR model

In this last section, I look at how the main macroeconomic, monetary, remittances and financial
sectors indicators interact based on the quarterly data for the 2000-2011 period. I will focus on
several macro level effects and tendencies.
Technically speaking, the VAR model is a system of equations that are jointly solved in order to
estimate the models parameters (Enders, 1994). Below is a representation of a nequation VAR:

x1t
x2t
...
xnt

nx1

A10
A20
...
An0

nx1

A11 (L) A12 (L) ... A1n (L)

A21 (L) A22 (L) ... A2n (L)
...
...
...
...
An1 (L) An2 (L) ... Ann (L)

nxn

x1t1
x2t1
...
xnt2

nx1

1t
2t
...
nt

nx1

Here, the second matrix is composed of the parameters representing the intercept terms. The
large nxn matrix is the polynomials in the lag operator (where L the lag operator such that
yt1 = yt L) and the last matrix is composed of white noise. Also, aij (1), aij (2) represent the
individual coefficients of Aij (L) and the variance covariance matrix being represented by .
The advantage of a VAR over structural or other model forms is that determining endogeneity may be difficult. It is often hard to determine if money changes output directly or changes in
money are determined endogenously. The VAR model allows each of the variables to be jointly
endogenous while each individual equation of the system considers each variable as an exogenous
component of the other variables Enders (1994).
According to Enders (1994), this approach has several shortcomings. First, the impulse response functions usually match economists prior beliefs (based on their theoretical background).
Further, one of the typical results includes a price puzzle where CPI seems to go up after an increase in the base (discount) rate, instead of down as anticipated. This problem is usually avoided
by using a commodity price index instead of the CPI. Thirdly, a more serious drawback is that
the VAR approach does not consider forward looking measures. Both of these complaints impose
a prior belief on what the response of monetary policy should look like (Enders, 1994). A third
shortcoming is that residuals (that represent shocks) do not generally look like those in the historical record and are not easily reconciled with past interpretations. The residuals also vary by
specification. This is less of a problem when looking at how the economy responds to a shock,
but becomes important when we want to know the casual impact of a shock. Thus, at best the
VAR identifies only the effect of policy given an exogenous shock (the endogenous response of a
policy to a shock cannot be determined). However, this exact question is what the economists are
typically after.

33

Granger causality is a statistical property that results when lagged changes in a variable X
have statistically significant power to predict the level of variable Y . Sims (1972) was one of
the first who employed this tool to find that money Granger caused nominal GDP changes (more
specifically, Sims found that lagged values of money levels were helpful in predicting the levels of
GNP). Mathematically, we are testing if the coefficients ai are equal to zero, given the following
regression:
X
X
X
yt = y0 +
ai mti +
bi yti +
ci zti + t
i=1

i=1

i=1

Using the above mentioned example of the nequation VAR, if all the variables in the VAR
are stationary, to test for Granger causality, one would perform a stanard F-test of the restriction:
a21 (1) = a21 (2) = a21 (3) = ... = a21 (p) = 0
Sims original results were however sensitive to how the model was specified. Thus, one
shortcoming of the Granger causality method is that it makes no prior assumptions and it depends
on specifications. For example, there is no assumption about how money affects output.
4.2

Description of Data and Main Assumptions

For the empirical part, I use the quarterly data from IMF database and from the NBM (1Q2000 4Q2011). Reporting is done in national currency (mil. MDL), but I have transformed the amounts
into their USD equivalents. I chose the American currency because Moldova officially addresses
the rate of the dollar, while the exchange rate for European currency is set according to supplydemand. There is another advantage of using the dollar: it allows comparisons to figures before
1999 when the European currency was introduced. Finally, I used the the exchange rate at the end
of the year.
To measure the output I use real GDP. Usually, industrial output is preferred, however, it was
not available and it remains as an option for a future research. Further, I have seasonally adjusted
the GDP using the method of moving averages. CPI is used as a measure of prices.
The indices related to monetary policy are M2 (already reported in a seasonally-adjusted form),
the level of reserve requirements and the discount (base) rate.
To test whether the amount of remittances impacts the banking sector and the overall economic
activities, I included the amount of loans. The rationale was the following: banks are assumed
as FIs, therefore, the level of loans is already inclusive of the level of deposits. This is in line
with the literature described in the first section. In other words, if remittances are deposited, the
banks will have higher amounts available for lending. In addition, if remittances lead to higher
economic activity (investment), I assume that the amount of loans should increase given that this is
a traditional source of funds for investment. For simplicity I assume no external sources of funding
for Moldovan banks (such as EBRD, WB etc.).
34

Figure 10: Evolution of Exchange Rates

Figure 11: Raw Data

35

Finally, I operate with log transforms for GDP, M2, amount of loans and of remittances according
to the following principle (see Annex 6.1 for summary statistics):
Y
log
Y

Yt+1
Yt


= log(Yt+1 ) log(Yt )

Based on the figure above, it is straightforward to see that before 2008 Moldova was targeting inflation (illustrated by an increase in the discount rate (drate) and reserve requirements (rr)).
Around the same time, there were pressures on the local currency due to the fact that remittances
were at their peak. As it was mentioned in the beginning of the paper, they accounted for 34% of
the GDP, placing Moldova at the top. NBMs actions at that point were to sterilize the influx of
foreign currency by buying it from the market and maintaining the exchange rate. These actions
are described in the NBM annual reports for 2007 and 2008. In addition, around the same time,
NBMs reserves in foreign currency peaked. Finally, it was an election year (elections were scheduled to take place in April of 2009) and a depreciation of MDL would have led to a fall in the polls.
However, although there have been arguments that Moldova would not be affected by the 2008
crisis, it is clearly seen from the data that it was not so. The the recession that followed the crisis of
2008 has negatively impacted the Moldovan economy. Not only there is a fall in the GDP, but also
in the amount of the remittances, which is expected given that the workers from abroad are primarily employed by such sectors as construction and services which are very sensitive to cycles (Cuc
et al. (2005)). NBM engaged both its most effective tools (base rate and reserve requirements) to
stimulate the economy.
4.3

Granger causality

The table below lists selected results for 8 and for 12 lags. More specifically, I will look results
with probability less than 0.05 (complete results are listed as an annex).
Table 5: Granger causality
8 lags
H0

Probability

Level

RR does not Granger Cause CPIINDEX

0.0010

1%

RR does not Granger Cause DRATE

0.0141

1%

DRATE does not Granger Cause RR

0.0171

5%

GDP does not Granger Cause LOGM2

0.0187

5%

RR does not Granger Cause LOGM2

0.0206

5%

CPIINDEX does not Granger Cause MDL/USD

0.0215

5%

MDL/USD does not Granger Cause CPIINDEX

0.0291

5%

LOGLOANS does not Granger Cause DRATE

0.0297

5%

RR does not Granger Cause GDP

0.0307

5%

MDL/USD does not Granger Cause LOGLOANS

0.0478

5%

LOGM2 does not Granger Cause CPIINDEX

0.0481

5%

36

12 lags
H0

Probability

Level

RR does not Granger Cause CPIINDEX

0.0098

1%

LOGREMIT does not Granger Cause CPIINDEX

0.0195

5%

MDL/USD does not Granger Cause LOGLOANS

0.0322

5%

RR does not Granger Cause LOGM2

0.0357

5%

First, these results tell us that the remittances do not Granger cause the amount of loans. More
than that, the remittances only Granger cause the CPI index. This is an interesting result because
is essentially tells us that the Moldovan banking sector and the GDP are affected by other variables rather than the amount of remittances. This table supports the literature that suggested that
remittances are primarily sent to make up for bad economic performance and lack of employment
opportunities in the home country rather than for investment.
Second, these preliminary results show that NBMs measures to increase the amount of money
in circulation Granger cause the CPI index. Thus, reserve requirements (both, with 8 and 12 lags),
M2 (with 12 lags), amount of loans (with 8 lags) lead to an increase in the money in circulation
and Granger cause the CPI index. Based on section 1, this result is in line with the quantitative
theory of money and M. Friedmans argument that inflation is a monetary phenomenon (Friedman,
1968).
In the same time, we see from the first table that the discount interest rate and the reserve requirements are intertwined, each Granger causing each other. A possible explanation for this is
that both instruments are commonly used by the NBM as tools for conducting monetary policy, especially in the periods immediately before and after the crisis of 2008 (as part of inflation targeting
and stimulation of economy accordingly).
We further observe the same relationship with the exchange rate and CPI index: both are also
intertwined. This can be explained as follows: due to high level of remittances (that eventually
need to be exchanged into local currencies), there are pressures on the NBM to either sterilize
or to meet the demand by printing more money. If this is the case, then the same argument can
be used to support the finding that remittances Granger cause CPI index (with 12 lags). On the
other hand, since Moldova has been heavily dependent on consumption of goods from abroad, it
has been exposed to the effects of inflation from abroad.
Another interesting result is that reserve requirements Granger cause the growth of GDP. This
is somewhat contradictory to the theory on neutrality of money. However, it does fall into the findings of Bullard and Keating (1995) who found a positive relation for the low inflation countries.
Moldovas tendency towards strict inflation targeting might have triggered this result. Another
possible explanation is that reserve requirements are widely used to either cool down or to heat
up the economy and, therefore, NBMs action (or reaction) can affect the GDP in a similar way
as a decrease or an increase in the base rate would.
In conclusion, it seems that NBM has retained its ability to conduct an independent monetary
37

policy, with the Moldovan financial sector continuing to act as an intermediary. These findings
make economic sense, but there are some more things that need to be either corrected with the use
of other variables such as industrial output and a measure of prices that is less sensitive that the
nominal indicator. In other words, we might have the case where the results are dependent on the
way the model is specified.

4.4

Running the Unrestricted VAR

In this subsection I present the results of the unrestricted VAR. As we saw above, the VARs have
been criticized for not assuming any prior theoretical basis. In this sense, I assume the following:
open economy, the monetary policy variables are more likely to change first (directly impacting
the amount of loans), followed by exchange rate,the real GDP and the prices (which I assumed to
be sticky). In regard to these assumptions, recall that NBM has price stability as one of the main
goals. In addition, it addresses the MDL/USD exchange rate. Finally, remittances are connected
to workers host countries economies. However, the causality could go both way (bad economic
conditions in home country could lead to higher inflow of remittances). In this specific case, the
data does not support this.
Based on these fact, I operate with the following Choleski decomposition (the variables slowest to respond to shocks are listed first): growth of remittances (logremit), prices (cpiindex), GDP
(gdp), exchange rate (mdl/usd), the amount of loans in the economy (logloans), M2 (logm2), discount rate (drate) and reserve requirements (rr). The AR test shows that there are no characteristic
roots of 1 or more (see table of VAR lag order selection criteria the in Appendix).
I further looked at the residuals to make sure that they are well-behaved. As seen in from the
the figure in the Appendixes, residuals look random, they go through swings of being positive and
negative, suggesting autocorrelation. Also, since they are not large in the first period and small
in the second period, they do not suggest heteroskedasticity. Finally, there are only few that fall
outside the dotted lines, especially during the 2007-2008 period (if that would have been the case,
it would have suggested non-normality).
We now turn our attention to the impulse response functions. The figures below illustrate only
the results where the effects are significant. Here, a technical technical remark is needed. In these
figures, the horizontal axis represents the number of quarters since the shock to the variable while
the vertical axis represents its effect on the variable of interest relative to what its value would have
been in the absence of that shock. The dotted lines represent 95% confidence intervals. An effect
is significant if the confidence interval does not contain the horizontal axis (zero).
We begin by looking at the response of the volume of loans. It is expected that, with no external
funding, the influx of money from remittances would be absorbed by the banks and put up for lending, leading to an increase in the total amount of loans. The trade off is that there are inflationary

38

pressures and NBM would be very likely to try address this issue by increasing the discount (base)
rates and the reserve requirements.
What the results however show us is that the amount of loans only significantly react to changes
in the discount rate and in the GDP. In addition, it responds to changes in the exchange rate (this
issue will be discussed later). In fact, none of the variables is not directly affected by remittances.
It turns our that the exchange rate plays a more important role.
Figure 12: Amount of loans

Figure 13: Reserve Requirements

39

We next look at the GDP. The results seem to be largely in line with Ganev et al. (2002) who found
some indication that changes in the exchange rate affect output rather than the discount rate. The
trend however is in line with Ghosh (1996) who found that credit growth boosts output quickly,
but more as a small and transitory effect, and that its eventual effect is to push output below its
original level. Consequently, reserve requirements have similar effects.
Regarding the effects on GDP, Starr (2005) argues that the exchange rate is an important monetary policy tool in the CIS countries. The same author explains that the CIS countries are relatively
open and changes in the competitiveness of domestic versus foreign goods both at home and on
world markets may have important effects on domestic production. This is also supported by Figure 16 which shows a positive effect on the amount of loans. Hence, as seen from Figure 14, the
Moldovas GDP reacts to changes in exchange rate, but in longer run. Finally, as seen form Figure
13, the reserve requirements also react to the exchange rate while the discount rate does not. This
second result is a little surprising surprising given that NBM does employ this instrument to boost
or reduce economic activity.
However, as seen from Figure 16 below, there is also a reverse relationship between GDP and
the exchange rate. The same applies to the amount of loans and to the discount (base).
Figure 14: GDP

40

According to the economic theory, a key monetary policy tool is the interest rate which is set by
the monetary authority / central bank. This is of course true for the advanced economies where this
is the main instrument. However, the effects of this monetary policy instrument tend to be unclear
in CIS countries (Starr, 2005). This issue has been emphasized throughout this paper on several
occasions.
Figure 15: Discount Rate

Figure 16: Exchange Rate

41

Starr (2005) also explains that in CIS countries, credit markets tend to be thin and segmented and
that the share of credit-sensitive aggregate spending small. Consequently, central banks ability to
use the interest-rate may be reduced and hence it may not be able to stimulate demand during a
recession and vice versa (Starr, 2005). As seen above, my results generally fall in line with this
argument.
An important result from this exercise is that the effects of exchange rate are important, affecting most of the variables. Starr (2005) explains that CIS countries typically have a managed
float type of exchange-rate regime where governments intervene in foreign exchange markets to
manage high-frequency fluctuations and to limit real appreciations. This is seen in Figure 17 where
the exchange rate also impacts M 2 in the long run.
This last effect can be a result of the fact that as the Leu depreciates (increasing the value of the
rate), there will not only be a higher demand for Moldovan goods (hence an increase in production and GDP), but also for Moldovan currency from the beneficiaries of remittances who would
consume more.
Figure 17: CPI

In case of prices (Figure 17), the effects of the exchange rate can also come into play because of
Moldovas reliance on foreign sources of energy and its recent spike in the level of consumption.
42

The latter has been widely debated among the Moldovan economists (as we saw in the first section),
some arguing that it is a direct result of increasing levels of remittances.
Figure 17 shows that CPI significantly responds only to the level of reserve requirements. As
mentioned above, the effects of manipulating the interest rate are not always clear and therefore the
central banks in the CIS countries can use other tools. In particular, NBM has used this instrument
a intensively (immediately before and after the crisis of 2008) and it turned out to be an effective
tool. Again, this result is not surprising given that the Moldova does not have a developed capital
market and its banking sector plays a major role.
Figure 18: Volume of Remittances

Generally speaking the variables related to the monetary policy and to the financial sector can
explain the fluctuations in prices in the CIS countries. The effects of money can be modest given
that these countries have more flexible prices and wages, low monetization, thin credit markets
and domestic interest rates that are not usually determined independently of world capital markets
(Starr, 2005).
Finally, based on the arguments presented above, the effects on M2 are generally not surprising,
being affected by shocks to GDP, the base rate and the exchange rate.
In conclusion, these results generally are in line with the existing literature. However, there
are also several things that should be considered. First, there it is possible that there is an issue of
endogeneity that is not captured by the unstructured VAR. This can be seen from the fact that the
amount of loans also reacts both to GDP and to the discount (base) rate. Second, although scholars
have argued that GDP does not seem to react to an increase in money, this may be an issue of an
inaccuracy that is also not captured by the model. These technical issues need to be addressed
within a more sophisticated structured VAR or a log-difference time-series model.
There is also a surprising result regarding the volume of remittances (Figure 18) which shows
that they move in the same direction as the discount rate. This could be indicative that with a higher
discount rate and less money available for lending, bank attempt to collect more deposits and hence
target the beneficiaries of remittances. However, this would require further investigation.
43

Figure 19: M2

44

Conclusions

As seen from this paper, the financial sector plays an important role in the economy. I have also
shown that there are ongoing debates on what are the overall effects of this sector on the economy
and on growth. Further, there also debates on the transmission mechanism and even on the direction of causality (banking sector versus institutions).
We have also seen that remittances represent an important amount of money for the home
countries and that there are on going debates about their effects and on how they should be used.
Nevertheless, remittances are closely linked to the financial sector and to the way a countrys monetary authority conducts its monetary policy.
This problem is further complicated by the fact that the the home countries are mostly developing or transition economies which tend to have underdeveloped financial markets. Although their
banking sectors seem to be able to absorb the remittances (they all offer deposit services), there
seem to be other factors that prevent this process
I chose a transition economy, Republic of Moldova, which not only fits into the descriptions
of a transition economy, but also benefits from a large amount of remittances which are primarily
directed into consumption. There have been several studies about the policy implications of these
amounts, but there are surprisingly few that have actually tried to measure the impact empirically.
The studies do however argue that the banking sector has overcome the problems of the 1990s
when the country was hit by two extremely severe crises (the collapse of USSR and the Russian
crisis of 1998). Beginning with the year 2000, the banking sector has stabilized and has switched
its evolution into a competitive path, similar to the Western example (less the capital markets). For
this reason, one should expect that, if remittances are indeed similar to foreign flows, then there
should be no problem in attracting them into the economy. In this sense, section 2 represents an
analytical overview of how the monetary authority, the Moldovan National Bank and the entire
banking sector was set up, followed by the main evolutions in this sector.
However, as we saw from the third section, when I run an unstructured VAR based on the data
from the IMF, the amount of loans was not affected by the amount of remittances. More than that,
the remittances did not have any significant effects on any of the variables (both monetary policy,
banking or output). My results pointed to the fact that it is the exchange rate that plays the most
important role. These results were generally in line with the literature on the monetary policy and
the effects of money in the CIS countries.
There are of course several issues that can be further
explored. First, there is the methodological issue related to the use of VAR models. As I mentioned in the last section, running a structured VAR could provide different results. In addition,
employing other time-series techniques can overcome the shortcomings of the unstructured VAR.
Second, using other variables could also provide different results. In this sense, I could suggest
using industrial output, a commodity price or a GDP deflator.

45

Finally, performing a thorough study of the evolution of the banking sector and of the influence
of remittances on this industry and on the economy as a whole is important because most of the
existing policies take the positive effect of both as default. Thus, the local governments along with
many international organization dedicate a lot of resources to these policies and it is extremely
important to ensure that there is no other alternative that could have led to better results that would
have benefited the home country to a greater extend.

46

6
6.1

Annexes
Summary Statistics: 1Q2000 - 4Q2011
Variable

Observations

Mean

Std. Dev.

Min

Drate

47

13.698

5.803

Max
30

logGDP

46

6.602

0.620

3.308

7.523

logM2SA

47

6.575

0.874

5.054

7.736

CPIINDEX

47

108.092

34.493

57.466

165.265

MDLUSD

47

12.409

0.989

9.921

14.503

RR

47

12.586

3.471

22

logLoans

47

6.639

0.931

5.106

7.835

logREMIT

46

4.293

1.005

2.229

5.745

6.2

AR Test

6.3

VAR Lag Order Selection Criteria

47

6.4

Pairwise Granger Causality Tests: 8 and 12 lags

48

6.5

Residuals Test

49

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