Financial Sector Governance and Banking Insolvency

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Financial Sector Governance and Banking Insolvency

• V. Sundararajan
• Deputy Director
• Monetary and Exchange Affairs Department
• International Monetary Fund
• Policy Challenges for the Financial Sector in the
  Context of Globalization
• Washington DC
• June 5-7, 2002

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The Governance Nexus

•  

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What is Governance?

• Institutions and practices by which authority is
  exercised
• Arrangements by which incentives of managers,
  owners, and other stakeholders are aligned
• Principal - agent
• Principal - principal
• Principal - stakeholders

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• This presentation
• Looks at interaction between regulatory
  governance and
• corporate governance of financial intermediaries
  in
• Normal times
• Times of distress
• Times of crisis

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1. Corporate governance of financial
intermediaries
during normal times

• Is essential to implement effective corporate
  governance over the firms in which they invest
• How does this happen?
• Financial firms are owners and asset managers
• Debt as a controlling device
• Insolvency regime/creditor rights
• Conciliation/out-of-court restructuring
• Effective loan classification/loss provisioning
  as a foundation for corporate restructuring
• Role of capital markets
• Caveat emptor emphasis with strong disclosure
  regime
• Portfolio decision of asset managers/investors
• Take-overs/corporate control markets

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1. Corporate governance of financial
intermediaries during normal times

• Faces problems that are different from the
  corporate sector, because
• financial intermediaries have special attributes
  that intensify standard corporate governance
  problems (opaqueness, highly regulated,
  government ownership)

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1. Corporate governance of financial
intermediaries during normal times

• Therefore, regulators and supervisors need to
  provide right incentives to instill good
  governance practices in financial intermediaries
• How does this happen?
• Financial sector supervision
• Of internal controls and systems
• Intervention arrangements
• Voluntary code of good corporate governance,
  backed by authorities
• Regulations on ownership/fit-and-proper
• Listing rules, market abuse rules, market
  integrity regime

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1. Corporate governance of financial
intermediaries during normal times

• Disclosure, audit regime
• Prudential, customer, governance disclosure
• Consumer education
• Managerial incentives (Other regulatory agencies)
• Broader competition policy
• LOLR
• Deposit insurance

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1. Corporate governance of financial
intermediaries during normal times

• Good regulatory governance is important to
  provide
• incentives to the sector in a credible manner
• Components of good regulatory governance are
• Agency independence cum- accountability
• Transparency in actions and decisions
• Measures to ensure integrity of agency staff
• Through FSAPs, and the assessments of compliance
  with
• financial sector standards and codes, the IMF
  and the World
• Bank try to improve regulatory governance.

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Financial Sector Standards and Regulatory
Governance (RG)

• Regulatory Standards and RG
• Proper governance structure a precondition for
  effective regulation
• Operational independence
• Adequacy and legal protection of staff
  (integrity)
• Enforcement powers for supervisors
  (accountability)
• Clarity and transparency of regulatory process

• Transparency Code and RG
• Desirable set of transparency procedures to
  improve RG
• Accountability and its disclosure
• Integrity of the regulator and its disclosure
• Independent pursuit of regulatory policy and its
  transparency
• Regulatory operations transparency

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1. Corporate governance of financial
intermediaries during normal times

• Good regulatory governance is effective and
  sustainable only with good public sector
  governance
• Good public sector governance implies respect of
  the state for the institutions that govern
  economic and social interactions among them
• Absence of corruption
• Approach to competition policy
• Effective legal environment
• Effective judicial system
• Government ownership
• As long as political interference in the
  regulatory process is not costly for the
  politicians, regulatory governance can not be
  effective

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2. From normal times to times of distress

• When under stress, incentives for good financial
  sector governance tend to disappear
• Financial intermediaries tend to take actions
  that reflect poor governance, including
• attracting deposits with higher interest rates
• loosening risk management
• inflating collateral
• Many of these actions are meant to present a
  better balance sheet, and to avoid supervisory
  actions or intervention

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2. From normal times to times of distress

• In these circumstances, regulatory governance
  starts to
• matter significantly
• Danger for political (and industry) interference
  grows under these circumstances
• Supervisors need to anticipate steps and actions
• Supervisors need to enforce rules and regulations
  strictly
• Supervisors should not apply forbearance
• To withstand these threats, independence,
  accountability, transparency and integrity are
  needed

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2. From normal times to times of distress

• In sum
• Balance of importance between market discipline
  and supervisory oversight shifts to the latter
• Within supervisory toolbox emphasis shifts to
  intervention tools

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3. From times of distress to crisis management

• When distress turns into a full-fledged crisis,
  good regulatory governance becomes even more
  critical
• It could be argued that good governance
  frameworks established for normal times suffice
  for crisis management
• It is certainly so that good governance
  frameworks will pay off in crisis times

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3. From times of distress to crisis management

• However
• Crisis management requires exceptional measures
• Crisis management requires appropriate
  institutional arrangements
• Both requirements force us to revisit and
  strengthen
• regulatory governance frameworks under these
• circumstances

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3. From times of distress to crisis management

• Exceptional measures
• Measures need to be innovative, creative
• Outcomes unknown, unpredictable
• What could be exceptional measures?
• Emergency liquidity support, blanket guarantee,
  deposit
• freeze, closure of unviable institutions,valuati
  on of assets,
• recapitalization, AMCs
• Accountability and transparency as leading
  governance
• principles- Crises increase the level of
  uncertainty.
• Transparency is needed to reduce levels of
  uncertainty.

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3. From times of distress to crisis management

• Appropriate institutional arrangements
• Need for political leadership
• Budgetary impact
• Burden sharing--redistribution of wealth
• Breaking vested interests
• Institutional structure that supersedes
  individual agencies temporarily
• Governance structure that is independent,
  accountable, transparent, and with integrity,
  helps to
• Create credibility of crisis resolution actions
• Allows speedy decision making
• Avoids duplication and institutional overlap
• Reduce uncertainty

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3. From times of distress to crisis management

• Regulatory governance in crisis management
• Exceptional measures should be formulated and
  implemented in a transparent manner
• The four components of Regulatory Governance
  should underpin all exceptional institutional
  arrangements