the global financial crisis: causes, policy response, and outlook

The Global Financial Crisis: The Global Financial Crisis: Causes, Policy Response, and OutlookCauses, Policy Response, and Outlook

Max Alier *Max Alier *Resident Representative in UkraineResident Representative in Ukraine

* The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.* The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

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Main MessageMain Message

Despite recent economic indicators showing signs of an Despite recent economic indicators showing signs of an incipient recovery, it is too early to say that the economy is incipient recovery, it is too early to say that the economy is “out of the woods”. A number of issues still need attention and “out of the woods”. A number of issues still need attention and an adequate solution to these issues will be key in determining an adequate solution to these issues will be key in determining how fast and how strong we emerge from the crisis. In how fast and how strong we emerge from the crisis. In particular, restoring solvency of the financial system is key.particular, restoring solvency of the financial system is key.

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OutlineOutline

A Crisis in the MakingA Crisis in the Making

Macroeconomic Policy ResponseMacroeconomic Policy Response

Bringing the Financial System to a Sound Footing: Dealing with Bringing the Financial System to a Sound Footing: Dealing with Bank InsolvencyBank Insolvency

OutlookOutlook

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The root cause of the global financial crisis can be traced back The root cause of the global financial crisis can be traced back to the optimism bred by a long period of high growth, low to the optimism bred by a long period of high growth, low interest rates, low volatility, and policy failures in:interest rates, low volatility, and policy failures in: Financial regulationFinancial regulation Macroeconomic policiesMacroeconomic policies Global ArchitectureGlobal Architecture

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The global financial crisis brought to an end the longest period The global financial crisis brought to an end the longest period of strong global economic growth on record. of strong global economic growth on record.

Broadly speaking it was “healthy” growth:Broadly speaking it was “healthy” growth: High productivity growthHigh productivity growth Low inflationLow inflation Low long-term and short-term interes ratesLow long-term and short-term interes rates

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A Crisis in the MakingA Crisis in the MakingWorld Output Growth 1983-2007

(In percent)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

World CPI Inflation 1983-2007(In percent per annum)

0

5

10

15

20

25

30

35

40

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However, these benign conditions fed the build up of systemic However, these benign conditions fed the build up of systemic risk. Low interest rates, together with increasing and excessive risk. Low interest rates, together with increasing and excessive optimism about the future, pushed up asset prices, from stocks optimism about the future, pushed up asset prices, from stocks to housing prices. to housing prices.

Low interest rates and limited volatility prompted a search for Low interest rates and limited volatility prompted a search for yield and underestimation of risks leading to the creation and yield and underestimation of risks leading to the creation and purchase of ever riskier assets.purchase of ever riskier assets.

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The magnitude of the crisis and the clear threat of a global The magnitude of the crisis and the clear threat of a global financial meltdown prompted a strong policy response financial meltdown prompted a strong policy response characterized by an unprecedented level of policy coordination characterized by an unprecedented level of policy coordination across the globe involving industrialized countries as well as across the globe involving industrialized countries as well as emerging market economies.emerging market economies.

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World Ouput, Trade Volumen, and Commodity Prices(Percentage change)

-40

-30

-20

-10

0

10

20

30

40

2005 2006 2007 2008 2009

-15

-10

-5

0

5

10

15

GDP Growth(RHS Axis)

Commodity Prices(LHS Axis)

Trade Volumes(RHS Axis)

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Fiscal policy was loosened to offset the decline in private Fiscal policy was loosened to offset the decline in private demand prompted by the balance sheet effect resulting from demand prompted by the balance sheet effect resulting from the asset price correction, as well as, the deterioration in labor the asset price correction, as well as, the deterioration in labor market conditions.market conditions.

Monetary policy was rapidly loosened, including by using non-Monetary policy was rapidly loosened, including by using non-traditional instruments, to ensure an adequate level of liquidity traditional instruments, to ensure an adequate level of liquidity in the financial sector and to prevent a collapse of the payment in the financial sector and to prevent a collapse of the payment system.system.

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Bringing the Financial System to a Bringing the Financial System to a Sound FootingSound Footing

Beyond the near-term liquidity support needed to preserve the Beyond the near-term liquidity support needed to preserve the financial system, major challenges lie ahead:financial system, major challenges lie ahead:

Dealing with solvency problems and restoring credit flows.Dealing with solvency problems and restoring credit flows. Improving regulatory and oversight frameworks to prevent a Improving regulatory and oversight frameworks to prevent a

repetition of current crisis.repetition of current crisis.

I would like to focus on the first issue. In particular, on the I would like to focus on the first issue. In particular, on the frameworks to deal with bank insolvency and debt frameworks to deal with bank insolvency and debt restructuring.restructuring.

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Bringing the Financial System to a Bringing the Financial System to a Sound Footing: Bank InsolvencySound Footing: Bank Insolvency

The primary objective of the bank insolvency framework is to The primary objective of the bank insolvency framework is to safeguard the stability of the financial system. safeguard the stability of the financial system.

Why a special bank insolvency regime?Why a special bank insolvency regime?

A special bank insolvency regime, separate from the corporate A special bank insolvency regime, separate from the corporate insolvency, may facilitate timely action and provide for insolvency, may facilitate timely action and provide for consistency between the supervisory and insolvency-related consistency between the supervisory and insolvency-related functions of the banking authorities. It is particularly useful functions of the banking authorities. It is particularly useful where the corporate insolvency regime is weak and ineffective.where the corporate insolvency regime is weak and ineffective.

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““Insolvency proceedings” refers to all types of official action Insolvency proceedings” refers to all types of official action involving…involving…

the removal of management and/or the imposition of limits the removal of management and/or the imposition of limits on/suspension of, the rights of shareholders; on/suspension of, the rights of shareholders;

assumption of direct control by the banking authority or other assumption of direct control by the banking authority or other officially appointed person;officially appointed person;

……over a bank that has crossed a threshold for the over a bank that has crossed a threshold for the commencement of insolvency proceedings.commencement of insolvency proceedings.

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Types of bank insolvency proceedings:Types of bank insolvency proceedings:

Official administrationOfficial administration: the purpose is to protect the bank’s : the purpose is to protect the bank’s assets, assessing its true financial condition, and conduction all assets, assessing its true financial condition, and conduction all the necessary restructuring operations, or placing the bank in the necessary restructuring operations, or placing the bank in liquidation.liquidation.

Liquidation proceedingsLiquidation proceedings: the purpose is to maximize the value : the purpose is to maximize the value realization of assets, and an orderly and equitable distribution of realization of assets, and an orderly and equitable distribution of proceeds to creditors. Liquidation results in dissolution of the proceeds to creditors. Liquidation results in dissolution of the bank as a separate legal entity.bank as a separate legal entity.

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Bank restructuring operations should:Bank restructuring operations should:

minimize the disruption of the financial system;minimize the disruption of the financial system; limit the costs to depositors, other creditors, and taxpayers;limit the costs to depositors, other creditors, and taxpayers; aim at addressing the causes and not just the symptoms of bank aim at addressing the causes and not just the symptoms of bank

insolvency.insolvency.

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Types of bank restructuring operations:Types of bank restructuring operations:

Mergers and AcquisitionsMergers and Acquisitions Purchase-and-Assumption TransactionsPurchase-and-Assumption Transactions ““Good-bank/Bad-bank” Separation and Bridge BanksGood-bank/Bad-bank” Separation and Bridge Banks Publicly Assisted Bank RestructuringPublicly Assisted Bank Restructuring

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Systemic Banking CrisesSystemic Banking Crises are characterized by financial sector are characterized by financial sector distress of such a magnitude that it has an adverse in effect on distress of such a magnitude that it has an adverse in effect on the real economy, and usually include:the real economy, and usually include:

Severe financial problems in a large part of the banking system.Severe financial problems in a large part of the banking system. A system-wide loss in bank asset quality.A system-wide loss in bank asset quality. Widespread loss of credit discipline.Widespread loss of credit discipline. Danger of collapse of the payment and settlement systems.Danger of collapse of the payment and settlement systems.

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Response to systemic banking crises:Response to systemic banking crises: should aim at: should aim at:

Protecting the payment system.Protecting the payment system. Limiting the loss of depositor and creditor confidence.Limiting the loss of depositor and creditor confidence. Restoring solvency, liquidity, and stability of the banking system.Restoring solvency, liquidity, and stability of the banking system.

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OutlookOutlook

There are nascent signs that the world economy has bottomed There are nascent signs that the world economy has bottomed out. Credit and trade flows are resuming.out. Credit and trade flows are resuming.

Particularly encouraging are developments in EMs, in particular Particularly encouraging are developments in EMs, in particular in Asia and Latin America.in Asia and Latin America.

The IMF has started to revise The IMF has started to revise its output growth projections.its output growth projections.However, the recovery is stillHowever, the recovery is stillfragile and large reform agendafragile and large reform agendalies ahead to put the world lies ahead to put the world economy on a strong footing.economy on a strong footing.

World Output 2007-2014(In percent)

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2007 2008 2009 2010 2011 2012 2013 2014

WEO April 2009

WEO October 2009

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Thank youThank you

the global financial crisis: causes, policy response, and outlook

Documents

financial system

outlinea crisis

makinga crisis

financial sector

bank insolvencyoutlooka

global financial meltdown

policy failures

monetary policy