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