Transcript starting over safely: rebuilding banking systems

STARTING OVER SAFELY:
REBUILDING BANKING SYSTEMS
Gerard Caprio and Patrick Honohan
Prepared for the Conference “The Financial Sector PostCrisis: Challenges and Vulnerabilities”
Brookings Institution, Washington, DC, April 26-27, 2005
Outline
• Features of recent crises
• Post-containment resolution policy (short term)
• Infrastructure-building (medium term)
Varied sources of crises
• Unstable macro conditions
– positive feedback loop
– but banking often not causal
– unhedged positions a special feature
• Unraveling of government impositions
– China, Vietnam, Zambia, etc.
• Management failures
– “diverted deposits” fraud
Four distinctive features of recent
resolutions
• Skewed distribution of losses
– not all banks fail: the fittest survive
• State-owned as well as private bank losses
– Even in macro-related collapses,
• Turkey=50%, Indonesia=46%
• Information emerges slowly
– One-shot resolution is rare: it’s not over ’til it’s over
• Currency depreciation has often been central
– Sometimes a trigger, sometimes a resolution tool
Post-crisis systemic performance (1)
There is no universal pattern
• GDP growth tends to be adversely affected
– But could be misleading to interpret as causal
• Inflation more often slows than accelerates
• Nominal interest rates more often fall than increase
GDP growth before and after
10
China
8
Vietnam
6
Lithuania
Ukraine
Cameroon
Latvia
4
After
Costa Rica
Swaziland
Malaysia
Thailand
Bulgaria
CAR
2
Yemen
Korea
Paraguay Argentina
Ecuador
Jamaica
Venezuela
Burundi
Zimbabwe
0
-2
Congo DR
-4
-20
-15
-10
-5
0
Before
5
10
15
Inflation before and after
1.8
1.6
1.4
1.2
After
1.0
0.8
0.6
0.4
Zimbabwe
0.2
Congo DR
Russia
0.0
0.0
0.2
0.4
0.6
0.8
Bulgaria
1.0
-0.2
Before
1.2
Brazil
1.4
1.6
1.8
Post-crisis systemic performance (2)
• Bank lending does tend to be compressed after
crises, even when financial depth increases.
• Long-lived macrodoubts, sometimes fuelled by the
crisis, can cause dollarization to jump.
• Shrinking intermediation spreads have been
correlated with falling concentration rates.
Bank credit to pvt sector before & after (% GDP)
1.6
1.4
China
1.2
Korea
1.0
After
Malaysia
Thailand
0.8
0.6
Croatia
Vietnam
0.4
Ukraine
0.2
0.0
0.0
Philippines
Bulgaria
Indonesia
Ecuador
Mexico
Venezuela
0.2
0.4
0.6
Before
0.8
1.0
1.2
1.4
Deposit dollarization before and after
100
Bolivia
90
80
70
Paraguay
60
After
Ecuador
Bulgaria
50
Zambia
40
Vietnam
30
20
10
0
0
20
40
60
Before
80
100
Spreads (loan-deposit rates) before and after
70
Zimbabwe
60
50
After
40
Paraguay
30
20
Zambia
Croatia
Jamaica
Ecuador
Lithuania
10
Argentina
0
0
10
Ukraine
Bolivia
Bulgaria
Latvia
20
30
Before
40
50
Post-containment resolution issues:
Common ground (1)
• Transparent resolution policy; speed of action;
deal also with corporate distress.
• Merits of an all-private resolution; avoid full
socialization of losses
– shareholders & subordinated claimholders should pay
– Recaps should be with tradable/bankable instruments,
not vague IOUs
Post-containment resolution issues:
Common ground (2)
• Actual practice follows the consensus -- with
implementation deficiencies:
– Insiders allowed to loot
– Unsuitable new shareholders
– Too optimistic on asset recoverability
(mistaken attempt to protect the budget)
Post-containment resolution issues:
Points of contention
• Capital and ownership
– Also: when to recapitalize state-owned banks
• No monopoly for AMCs?
• Real value of deposits/exchange rate policy
Capital and ownership: options
• Relying on existing shareholders
– But risk of self-dealing and looting
– Leaves State in poor bargaining position
– Preserves existing power structures (cf Rajan-Zingales)
• Seeking domestic merger partner
– 2 weak banks = 1 strong one?
• Finding other local owners (where?)
• Nationalization (only temporary solution)
• Foreign buyers
Recapitalizing state-owned banks
• Fox and chickens
• Wait until governance is right
• This surprisingly is not yet part of the
conventional wisdom
AMCs
• Can assets find a ready market?
• Loss of information capital may be important
• Recovery experience not great
Real value of deposits
• Depositor confidence is important, but also need
to set system on sustainable path
• Nominal losses for local currency deposits
(Argentina), FX deposits (Argentina, Russia); real
losses from deval (Turkey, Indonesia) -- impact
on financial depth surprisingly low
• Devaluation and dollarization: endogenous and
official
Monetary depth, selected countries 1990-2003
0.7
0.6
share of GDP
0.5
Argentina
0.4
Indonesia
Russia
0.3
Turkey
0.2
0.1
0
1990
1992
1994
1996
1998
2000
2002
Reshaping the sector
for the medium term
• Stability through development
• Global finance and small financial systems
• Excessive reliance on banks and poorly structured
debt finance
• Bank regulation and supervision
• Financial sector standards, growth, and crisis
prevention
Stability through development
• Financial systems that do not provide broad access
to financial services are not stable
– Preferred credit schemes can erode “credit culture”
– Diversified portfolio of loans is more stable
– Why can’t developing country banks make loans at a
marginal cost of pennies?
Global finance and small systems
• Insufficient diversification a leading cause of
crises
– Requires more foreign entry, regional banking, and/or
investment abroad
– Should the World Bank become a global bond fund?
– Can credit default swaps help (soon)?
Reducing reliance on banks/debt
• Underdeveloped financial infrastructure creates a
bias for a bank debt finance
• Underpriced deposit insurance further skews the
playing field
• Tax policy often reinforces the bias in favor of
debt relative to equity.
Rethinking regulation
• Technical view of regulation has produced Basel II,
reliance on complex approach backed by supervisory
discretion
• Neither speaks to elements of developing countries. Better
risk management is desirable but…
– Where are the data?
– Where are the skills?
– Do developing countries want their best and brightest in
bank supervision?
Institutional Environment
Democratic, Political Structure/System
Media
Market Structure
Judicial, Legal,
Regulatory Environment
The Public
Politicians
Regulators and
supervisors
Corruption
Banks
Corruption
The Market:
Depositors,creditors,
rating agencies
Borrowers,
counterparties
Technology, Information Infrastructure
Financial Regulation: an institutional view
Better than Basel
• Emphasize market monitoring
• Put supervision in a supporting role
– Verifying the information that is disclosed
– Penalizing those disclosing inaccurate or misleading
information
• Building solid infrastructure in the financial sector
needs to be a priority
Beyond financial sector standards
• Standards virtually a tautology
– If you had them, you would be developed; if not
developed, you must be missing some.
– Standards give no priorities; no country could really
change their compliance overnight with all standards
– Their impact on the ground depends on the institutional
environment in which they are planted
– Rich got rich without them!