Transcript Managing systemic banking crisis. Slides to presentation

MANAGING SYSTEMIC BANKING CRISES
Luis Cortavarria
International Monetary Fund
Monetary and Financial Systems Department
Banking Problems Worldwide 1980–2003
Banking Crisis
Significant Banking Problems
No Significant Banking Problems/Insufficient Information
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Crisis Management:
Complexity vs. Simplifications
 Banking crises are chaotic events:
 They emerge suddenly.
 They are intertwined 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.
 Challenge:
 Design a comprehensive program consistent with local
conditions without time and information.
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Crisis Management Framework
 Treatment of systemic crises differ from
treatment of individual bank failures.
 Tools appropriate for one may aggravate the other.
 Systemic crisis management—three stages:
 Crisis containment
 Bank restructuring
 Asset management
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Stage One:
Crisis Containment
 Containment must be an immediate priority.
 Reforms not effective in face of generalized
panic
 Measures cannot last forever
 Available tools:
 Emergency liquidity assistance
 Blanket guarantees
 Immediate bank intervention
 Administrative measures
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Stage One:
Crisis Containment
 These tools are controversial.
 Legitimate concerns about costs and misuse.
 How to avoid pitfalls?
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Emergency Liquidity
 Aim
 Restore depositor and creditor confidence.
 Pitfalls
 Macroeconomic pressure
 Increase monetary aggregates
 Can support insolvent banks
 Losses to the central bank
 Prone to abuse
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Emergency Liquidity
 Options
 Sterilize liquidity injections
 Introduce liquidity triggers
 Enhanced supervision of recipient banks
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Blanket Guarantee
 Aim
 Stabilize creditor fear, give time to design policies
 Pitfalls
 Not credible if government fiscal position is weak.
 High cost in case of large solvency.
 Moral hazard if prolonged, if no restructuring.
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Administrative Measures
 Aim
 Stop liquidity outflows when confidence is not
restored.
 Types:
 Deposit freezes
 Deposit restructuring
 Capital and exchange controls
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Administrative Measures
 Pitfalls
 Extremely disruptive to:
 Payment system
 Economic activity
 Private sector confidence
 Exemptions
 Unwinding process
Must be viewed as a final, desperate measure to
stop runs if all other tools have failed
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Stage Two:
Bank Restructuring
 Aim
 Restore banking system profitability and solvency
 Steps
 Diagnosis and triage
 Restructuring the banking system:
 Resolution of unviable banks
 Restructuring of viable but undercapitalized banks.
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Diagnosis and Triage
 Aim
 Identify banks in need of restructuring/resolution
 Pitfalls
 Data limitations
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Diagnosis and Triage
 How can pitfalls be addressed?
 Use concept of “medium-term viability” in
addition to solvency.
 Require banks to produce forward-looking
business plans:
 common assumptions and worst-case scenario
analysis; and
 stress tests and simulations to confirm viability.
 Audits
 Classify banks
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Bank classification:
Sound
and solvent
Undercapitalized
Insolvent
but viable
Insolvent and
nonviable
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Bank diagnosis:
Yes
Viable?
No
Bank
Resolution
Continue
under MOU
No
Fail?
Yes
Shareholders
Recapitalize
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Bank Restructuring
 Aims:
 Remove unviable banks from the system.
 Return viable banks to profitability.
 Options:
 Private sector
 Public sector
 Combination
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Bank Restructuring
 Pitfalls
 Delays
 Excessive forbearance
 No losses imposed on shareholders
 Partial resolution (while “praying for redemption”)
 Limitations in the legal framework:
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
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
Inability to wipe out shareholders
Restrictions for sale of assets
P & A transactions
Lack of protection for supervisors
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Bank Restructuring
 How can pitfalls be addressed?
 Planning—think through how crises will be
managed.
 Aim for least cost-restructuring outcome:
 Private sector solutions
 Restricted public sector-assisted solutions
 Single authority to oversee crisis management
 Strengthen legal and regulatory system (difficult
during a crisis).
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Bank Restructuring
 Ensure political consensus (possible but difficult)
 Avoid inadequate tools
 Proper communication
 Accountability
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Bank Restructuring
 Limitations to this approach
 If misused, costly, can cause moral hazard.
 Alternatives have been proposed:
 Allow illiquid banks to fail one by one.
 Apply depositor haircuts on restructured banks.
 Rarely used in practice.
 Does irreversible damage to potentially healthy sections.
 May not be least cost: economic costs > fiscal costs
 Very high social and political costs.
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Stage Three
Asset Management
 Aim
 Allow banks to focus on banking.
 Options:
 Private asset management companies (AMCs)
 Centralized (public) AMCs
 Difficulties:
 Weak market demand for distressed assets
 Weak property rights
 Unrealistic expectations about recovery rates
 Weak legal frameworks
 Poor loan documentation
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Conclusions
 Crisis management is a balancing act.
 Need to act quickly under extreme uncertainty.
 Lessons from past crises must be combined with deep
country-specific knowledge.
 Planning is key to successful crisis management.
 Bank restructuring is a long and painful process.
 Strategy should be comprehensive.
 Clear independence of the banking authorities.
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Thank you
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