Seminar on Bank Resolution

Crisis Management and Extraordinary Measures

Luis Cortavarria-CheckleyOctober 26-27, 2009

How a systemic banking crisis can be defined?

Loss of confidence by creditors in quality and/or stability

in a substantial portion of a banking system

An event, serious enough to generate significant

negative effects on the real economy

Disruptions affects payments system, credit flows,

economic growth and destruction of asset values

§ 2

How does a non-systemic banking problem

differ from a systemic crisis?

Non-systemic events do not create generalized panic

Problems are concentrated in a small group of banks

No significant risk arising from imposing losses on depositors

Broadly the system is solvent, liquid and well-run

Bank resolution does not need public support

The bank supervisor may lead bank resolution

However, mismanagement of non-systemic banking problem may become systemic

Are banking crises old fashion events?

§ 4

Crises Come in Waves and Are Costly

Cost of Banking Crises in Advanced and EM Countries(Size of bubble represents gross fiscal cost as percent of GDP)

-20

-15

-10

-5

0

5

10

15

1975 1980 1985 1990 1995 2000 2005Starting date of crisis

Change in O

utp

ut

1/

Japan 1997

(fiscal cost: 14%)

Finland 1991

(fiscal cost: 13%)

Sw eden 1991

(f iscal cost: 4%)

US 1988

(fiscal cost: 4%)

Korea 1997

(fiscal cost: 31%)

Source: Laeven and Valencia (2008)

Note: 1/ Minimum real GDP grow th during crisis (percent of GDP)

Norw ay 1991

(fiscal cost: 3%)

Israel 1977

(fiscal cost: 30%)

Spain 1977

(fiscal cost:

6%)

Tequila

crises

ERM

crises

Debt crises Asian

crises

CAUSES OF BANKING PROBLEMS

§ 6

Banking Problems: Causes

Macroeconomic, political, or microeconomic…

or a combination of the three

§ 7

Macroeconomic Causes:

Macroeconomic imbalances build up strains in the banking system

Rapid credit expansion, asset price inflation

Large capital inflows

Inflexible exchange rate regimes; incentives for unhedged forex borrowing

Short-term forex debt vulnerable to capital outflows and depreciation

§ 8

Microeconomic Causes:

Poor banking practices

Unquantified risk taking

Lax lending practices

Inflated collateral values

Connected, insider, lending

Maturity and currency mismatches

High corporate leveraging

Weak risk control systems

Lead to balance sheet deficiencies (mismatches, poor credit risk assets, etc)

Banks with such deficiencies are vulnerable to any shock§ 9

Lax lending practices

§ 10

Lax lending practices

Microeconomic Causes:

Weak Supervisory Framework:

Weak prudential rules

Weak supervision and enforcement

Government authorized forbearance

Room for supervisory arbitrage

Lack of coordination among supervisors

Supervisory bodies not independent from political and industry pressures

Lack or insufficient resolution tools

Poor banking practices in combination with weak regulatory framework= TIME BOMB

§ 11

What to do in case problems are found

in a banking system?

Experiences in several countries have shown

that:

If detected and addressed early, most problem banks

do not fail, however, experiences have shown that most

failed banks were classified as problem banks well

before their resolution

§ 13

Deferring Action Costs Money

Action

Taken

Elapsed Time

Res

olu

tion

Co

st

Problem

Discovered

Options

Reviewed

• Fix the Underlying Problems

But, bank assets deteriorate rapidly

A major repair may be necessary

If a crisis is imminent, it is wise to seek to

manage it in an orderly fashion Destruction of value (banks)

Collapse of confidence:

Individual bank

Banking system

Currency

Economic disruption:

Payment system

Borrowers/customer relationship

RESOLUTION OF SYSTEMIC BANKING CRISES

§ 19

―For every complex problem, there is a solution

which is simple, neat, and wrong.‖

H. L. Mencken

§ 20

Resolution of Systemic Banking Crises:

Banking crises are chaotic events:

They may build up gradually, but commonly emerge suddenly

They are interlaced with political and social problems

Crisis management in this environment is complex:

There is no time

Conditions of banks are unknown

There are legal and institutional limitations

§ 21

Resolution of Systemic Banking Crises:

Challenge:

Design a comprehensive strategy within limited time

and information

Treatment of systemic crises differ from treatment of

individual bank failures in stable periods

Tools appropriate for one may aggravate the other

§ 22

Systemic Crisis Management

Phase 1 – Contain Crisis

Phase 2 – Restructure Banks

Phase 3 – Manage Impaired Assets

Phase 4 – Exit from Crisis Mode

Phase 1 – Contain Crisis

Irrespective of origin, a crisis first emerges as a

liquidity problem in one, or some, or all banks

Liquidity problems and deposit withdrawals are

symptoms of underlying problems

Liquidity is rarely the driven factor

§ 24

Indonesia

Japan

§ 25

§ Uruguay

§ 26

Argentina

§ 27

UK

§ 28

USA

Phase 1 – Contain Crisis

There is need of preserve/restore market confidence

Avoiding panic individual

bank/widespread

decisive action

clear public statements

§ 31

Phase 1 – Contain Crisis

Phase 1 – Contain Crisis

Establish credible macroeconomic policies

Announce extraordinary measuresProvide needed liquidity

All countries have done this

Short maturity, collateral, penalty rates but need for flexibility

Open market operations successful in sterilizing injections

Protect depositors Most countries have done this

Blanket guarantees successful but may be costly

Depends on size of financial hole and restructuring alternatives

Cover all liabilities except subordinated debt and equity

Announce medium-term restructuring program

Phase 1 – Contain Crisis

Extraordinary Administrative measures—third line of defense

Better to avoid due to disruptions and long-lasting damage to depositor confidence

But, may be needed when other options not available/have not worked

Bank holidays

Restrictions on deposit withdrawals

Rescheduling of time deposits

Capital controls

Phase 2 – Restructuring

Phase 2 – Restructure Banks

Diagnosis, focus on medium-term viability

Recognize losses upfront

Preserve viable, undercapitalized banks:

request time-bound recap/restructuring plans

close oversight and prompt corrective actions

Resolve insolvent, unviable banks:

not all institutions have franchise value

intervene & close or find merger partner

Phase 2 – Restructure Banks

Strategies: Public Sector Solutions

Deposits in resolved banks could be transferred to

remaining sound banks (public or private)

Other forms of public sector assistance are:

• Joint recapitalization schemes

• Nationalization (which should be temporary)

§ 36

Use of Public Money for Recap

Rationale: To encourage private sector contributions

(investor of last resort)

Principles and safeguards: All losses recognized/absorbed by existing shareholders

Match private injections with government funds

Government shares could have preferred status

Government representation in Board

Require operational restructuring/asset workouts

Sweeteners (option to buy back government shares)

Allow convertibility of state contribution: from Tier 2 capital to

Tier 1 capital, if CAR falls below given ratio

Phase 3 – Manage Impaired Assets

Phase 3 – Manage Impaired Assets

Resolution of debt overhang needed to restart

supply and demand of credit

Corporate debt restructuring often neglected

Issues in institutional framework

speed versus value

centralized versus decentralized

legal reforms (bankruptcy/foreclosure)

out-of-court debt restructuring (London approach)

Phase 4 – Exit from Crisis Mode

Exit from blanket guarantee if applied

Exit from government ownership of banks

Sale of assets taken over

Overhaul of regulations to not repeat mistakes

Continue corporate restructuring to avoid ―second-wave crisis‖

Lessons

I. Crisis ResolutionAbout strategy

II. Crisis ManagementAbout approach

I. Lessons—Crisis Response

1. Adopt comprehensive response

2. Secure confidence of creditors/depositors

3. Ensure upfront loss recognition

4. Facilitate recapitalization

5. Remove nonviable institutions

6. Do not ignore debt restructuring

0.0

0.2

0.4

0.6

0.8

1.0

Deposit freeze/Bank holiday

Blanket guarantee

Extensive liquidity support

Regulatory forbearanceBank closures/Mergers

Nationalizations/State

recapitalization

Bank restructuring agency

Asset management company

1980-1993

1994-2006Source: 40 past systemic banking crises, Laeven and Valencia (2008)

Resolution Instruments in Past Crisis Episodes

(Proportion used per systemic banking crisis)

Historically, evolution toward more

centralized/comprehensive approaches

II. Lessons—Crisis Management

A. Confront key questions early on

B. Ensure adequate communication policy

C. Generate political support

D. Plan for uncertainty

E. Plan for failure

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

Blanket

guarantee

Extensive liquidity

support

Regulatory

forbearance

Bank

closures/Mergers

State recap AMC

1980-1993

1994-2006

Source: 40 past systemic banking crises reported by Laeven and Valencia

(2008)

Extraordinary Measures in Past Crisis Episodes

(Proportion used per systemic banking crisis)

Selected Banking Crises Costs

(In Percent Of GDP)

Crisis Period Gross Outlay Recovery Net Cost Assets 1

Chile 1981-83 52.7 19.2 33.5 56.1

Ecuador 1998-2001 21.7 0.0 21.7 41.3

Finland 1991-93 12.8 1.5 11.2 109.4

Indonesia 1997-2002 56.8 4.6 52.3 95.1

Korea 1997-2000 31.2 8.0 23.1 72.4

Malaysia 1997-2000 7.2 3.2 4.0 130.6

Mexico 1994-95 ... ... 19.3 40.0

Norway 1987-89 2.5 ... ... 91.9

Russia 1998-99 ... ... 0.0 24.9

Sweden 1991-93 4.4 4.4 0.0 102.4

Thailand 1997-2000 43.8 9.0 34.8 117.1

Turkey 2000-2002 29.7 1.3 30.5 71.0

United States 1984-91 3.7 1.6 2.1 51.4

Venezuela 1994-95 15.0 2.5 12.4 28.3

Source: IMF.

1 Assets of deposit money banks in the year before the first crisis year.

§ 46

Extraordinary Measures in the

Current Crisis

Liquidity Recapitalization

No

Change

Establish,

Increase or

Expand

Wholesale

borrowing

Amount

Committed (bn

of US$)

Strengthened

Measures

Capital Plans

Established

Capital

Committed

(bn of US$)

Capital

Injected

(bn of US$)

Asset Purchase

Plans or

Guarantees Amount Committed (bn of US$)

Argentina √ √

Australia √ √ unannounced √ √ 16/

3

Brazil √ √

Canada √ 19/

√ 14/

unannounced √ √ 20/

115

China √ √ 1/ 19 19

France √ √ 425 √ 53 33

Germany √ √ 531 √ 11/

106 53 √ 10/

0

India √ √

Indonesia √ √

Italy √ /3

√ unannounced √ 4/

16

Japan √ √ √ 5/

124 1 √ 21/

217

Korea √ √ unannounced √ √ 15 3 √ 13/

30

Mexico √ √ unannounced √

Netherlands √ √ 266 √ 18/

30 28 √ 24/

32

Russia √ √ unannounced √ √ 25/

31 17

Saudi Arabia √ 22/

√

South Africa √

Spain √ √ 15/

218 √ 23/

√ 6/

132 √ 6/

0

Turkey √ √

United Kingdom √ √ 17/

379 √ √ 7/

138 56 √ 12/

62

United States √ √ 9/ 789 √ √

8/ 700 248 √ 2

104

Total 12 9 12 $2,608 16 10 $1,364 $458 9 $562

Deposit Insurance Debt Guarantees

Containment Resolution

Source: Various government announcements and information on official websites. Average exchange rates for September - June.

Asset Management Strategies

Table 1. Overview of Policy Measures for Banks—G-20 Countries

As of June 30, 2009

Figure 1. G-20 Financial Crisis Program

Status

0

5

10

15

20

25

Policy

Coordination

Depositor

Protection

Debt

Guarantee

Publicly

Announced

Diagnosis

Restructuring

and

Recapitalization

Asset

Management

Announced Underway Completed

Nu

mb

er

of

Co

untr

ies

Source: Stocktaking note of the G-20 responses to the Global Crisis, September 2009, IMF staff

Table 2. Cost of Public Sector Support

Source: Stocktaking note of the G-20 responses to the Global Crisis, September 2009, IMF staff

Injected Committed InjectedDebt

Guarantees

2/

Capital

1/

Asset

Protection Total Capital

(In billions of US dollars) (In percent of GDP)

Argentina

Australia 3 3 0.3

Brazil

Canada 115 115 2.1

China 19 19 19 0.2 0.2

France 425 53 478 33 18.7 1.3

Germany 531 106 638 53 19.9 1.6

India

Indonesia

Italy 16 16 0.8

Japan 124 217 341 1 1.7 0.0

Mexico 0

Netherlands 266 30 32 328 28 42.4 3.6

Russia 31 31 17 2.3 1.2

Saudi Arabia

South Africa

South Korea 15 30 45 3 5.8 0.4

Spain 218 132 349 24.3

Turkey

United Kingdom 379 138 62 579 56 26.7 2.6

United States 789 700 104 1,593 248 11.4 1.8

Total 2,608 1,364 562 4,534 458 6.8 0.7

Source: Table 1

Committed

Thank You