By Michael Pomerleano

Reliance on capital inflows combined with forthcoming changes in European banking regulations leave central and eastern Europe countries extremely vulnerable.

Capital inflows were larger in emerging Europe and fell more severely during the crisis than in other emerging economies. A substantial share of these flows were cross-border loans from western European parent banks to their emerging European affiliates.

These inflows created macroeconomic and financial sector vulnerabilities — larger current account deficits, rapid credit growth, worse fiscal positions, and heavier indebtedness (often in foreign currencies) of households in a large part of the region.