CEPR Policy Paper 9: Lessons from the Russian Meltdown: The Economics of Soft Legal Constraints

On 17 August 1998 Russia abandoned its exchange rate regime, defaulted on its domestic public debt and declared a moratorium on banks? foreign liabilities. This was equivalent to an outright default. The depth and speed of the Russian meltdown shocked the international markets and precipitated a period of serious financial instability. There are important lessons to be learned from this episode on issues of bank supervision and international stability. Enrico Perotti locates the underlying cause of the crisis in the structure of individual incentives in a context of capture of state decisions by special interests. The author concludes with a radical policy proposal for a stable banking system for Russia, based on a segmented, narrow banking sector, concentration on commercial banking and a cautious extension of deposit insurance.