luis cortavarria international monetary fund monetary and financial systems department managing...
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Luis CortavarriaLuis CortavarriaInternational Monetary Fund International Monetary Fund
Monetary and Financial Systems Monetary and Financial Systems DepartmentDepartment
MANAGING SYSTEMIC BANKING MANAGING SYSTEMIC BANKING CRISESCRISES
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Banking Problems Worldwide 1980–2003
Banking Crisis
Significant Banking Problems
No Significant Banking Problems/Insufficient Information
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Crisis Management:Crisis Management:Complexity vs. Complexity vs. SimplificationsSimplifications
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 Crisis Management FrameworkFramework
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:Stage One:Crisis ContainmentCrisis 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:Stage One:Crisis ContainmentCrisis Containment
These tools are controversial. Legitimate concerns about costs and
misuse. How to avoid pitfalls?
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Emergency LiquidityEmergency 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 LiquidityEmergency Liquidity
Options Sterilize liquidity injections Introduce liquidity triggers Enhanced supervision of recipient
banks
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Blanket GuaranteeBlanket 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 MeasuresAdministrative Measures
Aim Stop liquidity outflows when confidence
is not restored.
Types: Deposit freezes Deposit restructuring Capital and exchange controls
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Administrative MeasuresAdministrative 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:Stage Two:Bank RestructuringBank 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 TriageDiagnosis and Triage
Aim Identify banks in need of
restructuring/resolution
Pitfalls Data limitations
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Diagnosis and TriageDiagnosis 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:Bank classification:
Sound and solvent
UndercapitalizedInsolvent
but viableInsolvent and
nonviable
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Bank diagnosis:Bank diagnosis:
Yes
No
Bank Resolution
Viable? Continueunder MOU
Fail?
Yes
ShareholdersRecapitalize
No
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Bank RestructuringBank Restructuring Aims:
Remove unviable banks from the system.
Return viable banks to profitability.
Options: Private sector Public sector Combination
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Bank RestructuringBank 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
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Bank RestructuringBank 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 RestructuringBank Restructuring
Ensure political consensus (possible but difficult)
Avoid inadequate tools Proper communication Accountability
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Bank RestructuringBank 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 ThreeStage ThreeAsset ManagementAsset 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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ConclusionsConclusions
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 youThank you