Luis Cortavarria

1
MANAGING SYSTEMIC BANKING CRISES

• Luis Cortavarria
• International Monetary Fund
• Monetary and Financial Systems Department

2
Banking Problems Worldwide 19802003
Banking Crisis
Significant Banking Problems
No Significant Banking Problems/Insufficient
Information
3
(No Transcript)
4
Crisis ManagementComplexity 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.

5
Crisis Management Framework

• Treatment of systemic crises differ from
  treatment of individual bank failures.
• Tools appropriate for one may aggravate the
  other.
• Systemic crisis managementthree stages
• Crisis containment
• Bank restructuring
• Asset management

6
Stage OneCrisis 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

7
Stage OneCrisis Containment

• These tools are controversial.
• Legitimate concerns about costs and misuse.
• How to avoid pitfalls?

8
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

9
Emergency Liquidity

• Options
• Sterilize liquidity injections
• Introduce liquidity triggers
• Enhanced supervision of recipient banks

10
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.

11
Administrative Measures

• Aim
• Stop liquidity outflows when confidence is not
  restored.
• Types
• Deposit freezes
• Deposit restructuring
• Capital and exchange controls

12
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

13
Stage TwoBank 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.

14
Diagnosis and Triage

• Aim
• Identify banks in need of restructuring/resolution
  
• Pitfalls
• Data limitations

15
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

16
Bank classification
Sound and solvent
Insolvent and nonviable
Undercapitalized
Insolvent but viable
17
Bank diagnosis
Viable?
Continue under MOU
Fail?
Yes
No
No
Yes
Bank Resolution
Shareholders Recapitalize
18
Bank Restructuring

• Aims
• Remove unviable banks from the system.
• Return viable banks to profitability.
• Options
• Private sector
• Public sector
• Combination

19
Bank Restructuring

• Pitfalls
• Delays
• Excessive forbearance
• No losses imposed on shareholders
• Partial resolution (while praying for
  redemption)
• Limitations in the legal framework
• Inability to wipe out shareholders
• Restrictions for sale of assets
• P A transactions
• Lack of protection for supervisors

20
Bank Restructuring

• How can pitfalls be addressed?
• Planningthink 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).

21
Bank Restructuring

• Ensure political consensus (possible but
  difficult)
• Avoid inadequate tools
• Proper communication
• Accountability

22
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 gt fiscal
  costs
• Very high social and political costs.

23
Stage ThreeAsset 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

24
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.

25
Thank you