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Managing Systemic Banking Crises David S. Hoelscher Systemic Banking Issues Division MFD/IMF Introduction 1. Recent systemic banking crises have emerged in Argentina, Ecuador, Mexico, Turkey, and Uruguay. 2. These recent crises introduce new challenges not seen in the Asian banking crises of the late 1990s. 1. What identifies systemic banking crises? A banking crisis is systemic when a loss of confidence the financial system is sufficiently large to have an impact on the real economy. The real effects arise from disruptions to the payments system, reduction in credit, and loss of asset value. A key feature is the impossibility of distinguishing viable from nonviable banks. Fiscal Costs of Systemic Crises (In percentage of GDP) Indonesia 1997-present Chile 1981-1983 Thailand 1997-present Turkey 2000-present Korea 1997-present Ecuador 1998-2001 Mexico 1994-1995 Venezuela 1994-1995 Finland 1991-1993 Malaysia 1997-2001 Sweden 1991-1993 Gross Cost United States 1984-1991 Net Cost Norway 1987-1989 0 Sources: IFS, WEO and national authorities. 10 20 30 40 50 60 2. Triggers of crisis Banking distress can persist for considerable time. A crisis can be triggers by any number of events – economic developments – political factors – just bad luck Irrespective of origin, a crisis first emerges as a liquidity problem in one, or some, or all banks 3. Stylized Phases of Crisis Management Phase 1 – Crisis Containment Phase 2 – Bank Restructuring and Resolution Phase 3 – Management of Impaired Assets 3. Phase 1 - Containing the Crisis Objective: Stabilize bank liabilities and protect the payment system Measures: • Provide liquidity support to illiquid institutions • Sterilize support with appropriate monetary policy • Protect depositors (establishing a blanket guarantee has proven successful in some circumstances) • Once depositors protected, remove nonviable banks • Announce a medium-term restructuring program • If all this fails: resort to administrative measures as a very last resort 4. Phase 2 - Bank Restructuring Objective: Restore viability and efficiency of the sector Measures: – Diagnosis – Legal and institutional reform – Resolution of weak banks Phase 2 - Bank Restructuring (2) Diagnosis - A medium term perspective needed - Need to evaluate banks based on uniform criteria - Special audits have been tried with mixed results - Classify banks into viable and nonviable banks. Phase 2 - Bank Restructuring (3) Institutional and legal arrangements – A single, high level authority is needed to provide political support and coordinate efforts – Where possible, existing institutions should be charged with implementation – Where institutional or legal reforms are needed, quick progress is needed. 4. Bank Restructuring (4) Bank Resolution Viable, undercapitalized banks: Shareholder responsible for recapitalization Present time-bound restructuring plans Be subject to intensive reporting and monitoring Insolvent, unviable banks: Should be intervened and resolved quickly. The bank may be resolved, but the banking business preserved. Deposits should be transferred to sound banks. Should be passed to agency responsible for resolution. Resolution options guided by “least cost” criteria. 4. Bank Restructuring (5) Use of public funds for recapitalization: • May be justified under special circumstances • Should be last resort • Could be designed to encourage private sector contributions 5. Phase 3 – Management of Impaired Assets Objective: Ensure orderly management of weak bank assets Dealing with impaired assets - centralized versus decentralized - speed versus value 6. Recent Challenges Dollarization Sovereign Debt Restructuring Dollarization Issues – Complicates management of deposit runs – Increases credit risk – Reduces effectiveness of policy tools (LOLR, blanket guarantees) Measures – Increase liquidity coverage for dollar deposits – Obtain foreign credit lines to support international reserves – As a last resort, administrative measures may be only option Sovereign Debt Restructuring Few cases to analyze Impact depends on unknowables – Bank exposure to the sovereign – Currency denomination of debt – Terms and modalities of restructuring Any strategy for sovereign restructuring must include explicit consideration of the impact on the financial system. 7. Conclusions and Lessons 1. Supportive legal and institutional framework should be in place before crisis hits 2. Make sure official safety nets are designed correctly (LOLR, blanket guarantee) 3. Aim for quick resolution, when momentum is there 4. Transparency in government actions is essential 5. Last but not least: Need for political leadership and coordination