- David Hoelscher
- Published Date:
- October 2006
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Antony Rowe Ltd, Chippenham and Eastbourne
David S. Hoelscher and Stefan Ingves
Edward J. Frydl and Marc Quintyn
Steven A. Seelig
Michael Andrews and Mats Josefsson
George G. Kaufman and Steven A. Seelig
Ross B. Leckow
Dong He, Stefan Ingves, and Steven A. Seelig
Charles Enoch, Anne-Marie Gulde, and Daniel Hardy
List of Tables
List of Figures
List of Boxes
List of AbbreviationsABS
Asset management companyAMD
Additional market disciplineAMU
Asset Management UnitBCC
Bank Consolidation CompanyBDNI
PT Bank Dagang Nasional IndonesiaBI
Bank for International SettlementsBITI
Bank of Investment and Technological InnovationBNB
Bulgarian National BankBNI
Bank Negara IndonesiaBOK
Bank of KoreaBOL
Bank of LithuaniaBOP
Bailout pressureBR day
Bank restructuring dayBRSA
Banking Regulation and Supervision AgencyBTO
Been taken overCAB
Central Asian BankCAMC
Centralized Asset Management CorporationCAR
Capital adequacy ratioCBA
Currency board arrangementCBT
Central Bank of TurkeyCD
Certificate of depositCEO
Chief Executive OfficerCOD
Consumer price indexDBCP
Deutsche Bank Capital PartnersERP
Early retirement programEU
U.S. Financial Accounting StandardsFDIC
Federal Deposit Insurance CorporationFDICIA
FDIC Improvement ActFLC
Fondo Bancario de Protección al AhorroFRA
Thai Financial Sector Restructuring AgencyFRN
Floating rate notesFSC
Financial Supervisory CommissionFSS
Financial Supervisory ServiceFX
U.S. Generally Accepted Accounting PrinciplesGBII
IMF/WB Global Bank Insolvency InitiativeGDP
Gross domestic productHSBC
Hong Kong and Shanghai Banking CorporationIAS
International Accounting StandardsIBRA
Indonesian Bank Restructuring AgencyIFRS
International Financial Reporting StandardsIMF
International Monetary FundISO
International Organization for StandardizationITCs
Investment trust companiesJVs
Korea Asset Management CorporationKBA
Korea Board of AuditKDB
Korea Development BankKDIC
Korea Deposit Insurance CorporationKEB
Korean Exchange BankKFB
Korea First BankLOI
Letter of intentLOLR
Lender of last resortLTL
Mongolian Asset Realization AgencyMHC
Moral hazard costMOF
Ministry of financeMOFE
Ministry of finance and economyMOU
Memorandum of understandingMPB
Ministry of planning and budgetNPA Fund
Nonperforming Asset Management FundNPL
Net present valueOECD
Organization for Economic Cooperation and DevelopmentP&A
Purchase and assumptionPCA
Prompt corrective actionPD
Payment delay timePFOC
Public Funds Oversight CommissionPV
Resolution Trust CorporationSB
Savings Deposit Insurance FundSKr
State Savings BankTBTF
Too big to failTDB
Trade and Development BankTL
This book would not have been possible without the contribution of many people, both within the Monetary and Financial Systems Department (MFD) and in other departments of the International Monetary Fund. The guidance and supervision of the department’s activities by the Director of MFD, Mr. Stephan Ingves, was critical to ensuring the highest quality of the final product. Special thanks are also due to Carl-Johan Lindgren, Deputy Director responsible for the division during 1998–2003 and to Jonathan Fiechter, current Deputy Director of MFD, for their support and assistance to the division as it dealt with numerous crises across the world. The editor also acknowledges each author’s contribution to this volume. Early drafts of these papers have been presented at staff seminars and, therefore, have received extensive commentary and reviews by a large number of Fund staff. Moreover, the individual chapters have benefited from the comments of reviewers too numerous to mention here. Rather, the contributions are recognized in the individual chapters of the book. We would like to pay special thanks to Ms. Sandra Otero de Solares for her excellent editorial work and her efficient assistance in organizing the book. Finally, the editor would like to acknowledge the work done by Sean Culhane in the IMF’s External Relations Department in advising and arranging for publication of this volume.
The International Monetary Fund occupies a unique position among international financial institutions because of its universal membership. This vantage point allows Fund staff to view developments in the economic and financial systems of all of its 184 members. In recent years, the Fund’s role in financial sector surveillance has expanded significantly, with the traditional analysis of macroeconomic developments being complemented with analyses of the role of the financial sector (both banking and nonbanking institutions) in achieving and maintaining economic stability.
In the face of systemic financial crises, the Fund’s role is to assist national authorities develop and implement comprehensive economic policies. For individual countries, systemic crises are rare. However, given the broad nature of the Fund’s membership, Fund staff is frequently assisting one or more countries each year in addressing financial crises. What is a rare occurrence for the authorities of one country can be a common experience for Fund staff specializing in managing systemic crises. For that reason, the Fund established, in 2000, the Systemic Issues Division, a division within the Monetary and Financial Systems Department. Division staff have specialized knowledge of techniques for managing systemic crises. They recognize both the broad principles that can lead to an efficient resolution of systemic crises and, at the same time, can recognize how to mold those principles to meet the specialized and specific needs of individual countries. They are experienced at tailoring their policy advice to the circumstances of individual countries, avoiding “off-the-counter” or “cookie cutter” approaches to crisis resolution.
An additional mandate of the Systemic Issues Division is the dissemination of information and lessons learned. This book forms a part of the ongoing efforts of the Fund to explain the standards and principles that guide its work in crisis management. The chapters in this volume concentrate on bank restructuring and bank resolution. Chapters cover both theoretical approaches and practical lessons learned from the implementation of these approaches. Many of the contributions in this book have appeared as internal papers, used to share experiences among Fund colleagues. This collection is aimed at sharing staff experiences with a broader range of readers. In the long run, we hope that these efforts result in a robust discussion of principles and techniques and that national authorities find these efforts helpful.
Monetary and Financial Systems Department
David S. Hoelscher
Banks fail, and bank failures can cause distress among creditors, losses for both owners and creditors, and, in the extreme, can threaten financial stability. Losses from bank failures must be distributed. The impact of that distribution on economic activity will depend, in part, on the conditions of the bank and, in part, on the role of the bank in the economy. If the bank is not deeply insolvent or if it plays a limited role in financial intermediation, the impact of the bank’s failure is likely to be minimal. If the bank is deeply insolvent and plays an important role in financial intermediation, or the failure occurs during a period of financial uncertainty where contagion is a danger, the impact of the failure may be larger.
Well defined tools are available for addressing the failure of an individual bank. The narrow solution is the immediate closing of the bank and initiation of liquidation proceedings. Staff is laid off, insured depositors paid out, and other depositors and creditors receive a portion of the liquidation proceeds. Alternative measures, that may be less disruptive, include merger and sale of all or part of the bank’s assets and liabilities. In this latter case, the bank may be closed as an institution but the profitable banking business is transferred to other sound institutions.
Resolution of a systemically important bank or resolution of a bank in the midst of a systemic crisis poses particularly difficult problems. Banking systems can be chronically weak, reflecting entrenched unsafe and unsound banking practices or structural weaknesses in the institutional framework. These conditions can persist for a considerable period until a systemic crisis is triggered by sudden loss of creditor confidence. Such loss of confidence may be triggered by a variety of economic or political developments, beginning a difficult and often chaotic period. The steps for managing systemic crises involve more than bank resolution issues but a complex set of policy decisions aimed at containing the crisis, resolving failed banks, rehabilitating weak banks and resolving assets of failed banks. Hoelscher and Ingves discuss this broad framework for systemic crisis resolution in Chapter 1.
Once the authorities turn to bank resolution and bank rehabilitation, strategies are designed on a case-by-case basis. Faced with a bank failure, authorities must select the appropriate technique for the resolution of a failed bank. Seelig (Chapter 3) surveys the alternatives, discusses the pros and the cons of the most common approaches to bank resolution, and provides some guidance on determining when an approach is appropriate. A systemic crisis poses particular difficulties for the authorities. A number of resolution techniques may not be available to the authorities or may be inefficient and relatively costly. They must first contain the crisis and then turn to bank-by-bank resolution. Several chapters describe the limitations that arise imposed when a country enters a systemic crisis and how the strategy followed will be influenced by the conditions of the bank or banks, the financial position of the shareholders, and the medium-term prospects of the bank’s core client group. (See, for example, Andrews and Josefsson in Chapter 5.)
The first step in developing a bank restructuring strategy is the diagnosis of the financial condition of individual banks. The size and distribution of bank losses must be identified. As supervisory data may be outdated and not reflect the full economic impact of the crisis, supervisors may attempt to update available information based on uniform valuation criteria. The supervisors will also examine information on banks’ ownership structures (public or private, foreign or domestic, concentrated or dispersed) to help determine the scope for upfront support from existing or potential new private owners. Alternatively, scope may exist for the use of international auditors (Andrews and Josefsson identify the pros and cons of such assistance in Chapter 5).
One of the most difficult decisions to make must be made quickly—which resolution strategy is most appropriate. An immediate decision is what to save—the bank as an institution or to unwind the bank and save the profitable business. Intervention has both costs and benefits and the policy decision is how to balance both. The question is whether the bank is sound and viable over the medium term or whether only a subset of its assets (and key clients) can reasonably be expected to perform. Frydl and Quintyn in Chapter 2 provide a theoretical framework for assessing the relative sizes of such costs and benefits as a guide to policymakers. The policy choice must include issues of burden sharing, market signals for other banks, and concerns about contagion of banking distress to other, sound banks are among the factors that influence the choice of techniques. Andrews and Josefsson (Chapter 5) complement this theoretical framework with a discussion of the principles and guidelines that have been used in practice.
Rapid determination must be made concerning the shareholders’ willingness and ability to resolve the bank’s underlying weaknesses. Assessment of such willingness can be facilitated by requiring presentation of business plans showing a bank’s medium-term viability. A bank can be considered viable if (i) it can remain profitable and earn a competitive return over the medium term; and (ii) the shareholders are committed and able to support it. Supervisors may require that banks produce forward-looking business plans using common economic assumptions and that include time bound, measurable targets for monitoring purposes (see Hoelscher and Ingves, Chapter 1). While such plans may be relatively easy to develop, they must contain quarterly qualitative targets that permit the supervisors to measure progress and continually evaluate the bank’s medium-term viability.
The tools used by supervisors must be clearly outlined in the legal structure. As described by Leckow in Chapter 7, the legal and regulatory framework for bank intervention and bank resolution determines the framework within which the authorities may act. While modification and reform of this legal framework is frequently undertaken before the crisis, modification during a crisis is substantially more difficult. Typically, this legal framework should give supervisors the authority to differentiate between banks that are (i) viable and meeting their legal capital adequacy ratio and other regulatory requirements; and (ii) viable but undercapitalized. In the latter classification, an additional assessment will be needed to determine whether the existing shareholders can recapitalize their bank within an acceptable period or if the use of public funding should be considered. Shareholders of undercapitalized banks must agree to a monitored recapitalization and restructuring plan with time bound targets. Failure to meet the targets would be cause for intervention and resolution of the bank. The plan should also include sufficient restrictions on bank operations as to establish incentives for shareholders to over perform in their restructuring.
Private sector solutions are often the most efficient and cost effective approach. In these solutions, the shareholders retain responsibility to recapitalize and restructure their bank. Under some circumstances, however, particularly in the midst of a systemic crisis, shareholders may be unable to recapitalize fully their bank immediately but they are fit and proper and the bank is deemed viable. Experience has shown that, under some circumstances, banks may be allowed to remain in the system under strict conditions. The bank’s recapitalization could be phased in, with tight monitoring and requirements, including the suspension of dividend distributions until the required level of capital has been restored.
Experience has also shown that public sector support may be an effective complement to the restructuring efforts. Public sector support for the resolution process may be warranted to limit the costs to the real economy of too large a number of banking failures. Public sector assistance can use a variety of techniques. One option is to assist in joint public–private recapitalization programs. These programs can give the shareholders time to mobilize needed funds but also introduce distortions in the market. As described by Josefsson (Chapter 14), these programs can be designed to ensure that the appropriate incentive structure is established to avoid misuse. The public sector can also assist in the financing of the recapitalization program but care must be taken. Andrews (Chapter 4), discusses the techniques of issuing government banks to finance recapitalization but points out that some options will actually leave the banks facing serious risks.
Asset management and resolution is a critical part of the bank restructuring process. For banks that have been intervened and are in the process of resolution, proper management of the bank’s assets is a critical and complex process. Successful management of the assets can be an important element in maintaining a functioning financial sector with proper incentives for continued financial intermediation. Broadly, there are two options for asset management. Existing banks can undertake loan restructuring and loan workouts or problem assets may be removed from the bank and transferred to an asset management company (AMC). Song (Chapter 8) outlines some of the techniques for loan restructuring and the prudential treatment of such loans. He surveys country practices in classification and provisioning of restructured loans and proposes “good” practices. Alternatively, the authorities may decide to remove the assets from the bank and transfer them to a separate AMC. Ingves, Seelig, and He (Chapter 9) discuss the role of AMCs in bank restructuring and specifies several policy lessons learned from international experience.
As described above, implementation of bank restructuring can be chaotic and difficult, with restructuring practices being adopted to local conditions. For this reason, country experiences are as important as descriptions of best practices being complemented by descriptions of case studies. In this context, examples of bank restructuring experiences are provided for Korea (Kang, Chapter 10 and He, Chapter 14), transition countries (Enoch, Gulde, and Hardy, Chapter 11), and Indonesia (Enoch, Chapter 12).
Notes on Contributors
Michael Andrews Head of consultancy, A. Michael Andrews and Associates.
Charles Enoch Deputy Director of IMF’s Monetary and Financial Systems Department.
Edward J. Frydl Senior Economist of the Financial Systems Surveillance Division II, Monetary and Financial Systems Department, IMF.
Anne-Marie Gulde Advisor of IMF’s African Department.
Daniel Hardy Deputy Division Chief of the Financial Surveillance Policy Division, Monetary and Financial Systems Department, IMF.
Dong He Division Head, External Department, Hong Kong Monetary Authority.
David S. Hoelscher Assistant Director of the Monetary and Financial Systems Department, IMF.
Stefan Ingves Governor of the Riksbank, Sweden.
Mats Josefsson Advisor of the IMF’s Monetary and Financial Systems Department.
Chungwon Kang Was a visiting scholar (banking) at the IMF (2003).
George G. Kaufman Professor, School of Business, Loyola University, Chicago, II.
Ross B. Leckow Assistant General Council, IMF.
Marc Quintyn Advisor and Technical Assistance Area Chief, Monetary and Financial Systems Department, IMF.
Steven A. Seelig Advisor of the IMF’s Monetary and Financial Systems Department.
Inwon Song Senior Financial Sector Expert, Financial Supervision and Regulation Division, Monetary and Financial Systems Department, IMF.