Book
Share
Front Matter

Front Matter

Author(s):
David Hoelscher
Published Date:
October 2006
    Share
    • ShareShare
    Show Summary Details

    © International Monetary Fund 2006

    All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

    No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP.

    Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

    The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988.

    Nothing contained in this book should be reported as representing the views of the IMF, its Executive Board, member governments, or any other entity mentioned herein. The views expressed in this book belong solely to the authors.

    First published 2006 by

    PALGRAVE MACMILLAN

    Houndmills, Basingstoke, Hampshire RG21 6XS and

    175 Fifth Avenue, New York, N.Y. 10010

    Companies and representatives throughout the world

    PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St Martin’s Press LLC and of Palgrave Macmillan Ltd.

    Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries.

    ISBN-13: 9780230019003 hardback

    ISBN-10: 0–230–01900–5 hardback

    This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources.

    A catalogue record for this book is available from the British Library.

    A catalogue record for this book is available from the Library of Congress.

    10 9 8 7 6 5 4 3 2 1

    15 14 13 12 11 10 09 08 07 06

    Printed and bound in Great Britain by

    Antony Rowe Ltd, Chippenham and Eastbourne

    Contents

    List of Tables

    1.1 Fiscal Costs of Selected Banking Crises

    2.1 Comparisons of Initial and Final Fiscal Costs of Bank Restructuring

    2.2 Government Intervention Techniques and Their Fiscal Implications

    2.3 Economic Benefits of Intervening in a Banking Crisis

    2.4 Economic Costs of Intervening in a Banking Crisis

    2.5 Fiscal Costs and Benefits of Government Intervention in the Swedish Banking Crisis

    2.6 Parameters and Variables Used to Calculate Benefits and Costs of Intervention in the Swedish Banking Crisis, 1991-Q3 to 1993-Q4

    2.7 Estimates of Benefits and Costs of Intervening in the Swedish Banking Crisis

    3.1 Easy Bank—Prior to Examination

    3.2 Easy Bank—Correct Balance Sheet

    3.3 Failed Banks

    3.4 Acquiring Banks

    3.5 Acquiring Banks and Liquidation

    3.6 Acquiring Bank and Failed Bank Liquidation

    3.7 Acquiring Bank and Liquidation for Whole Bank Transaction

    3.8 Failed Banks Liquidations

    4.1 Banks and Government

    5.1 U.S. Prompt Corrective Action

    5.2 Bank Closure Options Available to Deposit Insurers

    6.1 Funds Availability of Insured Deposits

    6.2 Funds Availability of Uninsured Deposits

    9.1 Considerations for Decentralized Asset Management

    10.1 Seoul Bank: Historical Summary Table

    10.2 Recapitalization of Korean Banks–December 2000

    10.3 Korea: Government Financial Support

    10.4 Seoul Bank: Early Retirement Program, September 2000

    10.5 Seoul Bank: Disposition of Nonperforming Loans

    10.6 Nonperforming Loans in Korean Banks

    10.7 Retail Loan Growth in Korean Banks

    10.8 Seoul Bank: Profit and Loss

    10.9 Seoul Bank: Balance Sheet

    10.10 Comparison of Seoul Bank and Korea First Bank

    10.11 Key Management Ratios of Seoul Bank and Korea First Bank

    11.1 Bulgaria: Selected Economic Indicators, 1993–98

    11.2 Bulgaria: Economic Standing of Banks at the Outset of the Banking Crisis

    11.3 Bulgaria: Loan Portfolio of the Banking Sector by Ownership Group (April 1996)

    11.4 Economic Standing of the State Banks

    11.5 Lithuania: Selected Economic Indicators, 1993–98

    11.6 Lithuania—Indicators of Financial Sector Soundness and Market Development

    11.7 Mongolia: Selected Economic Indicators, 1993–98

    11.8 Mongolia: Structure of the Banking Sector

    11.9 Mongolia: Estimated Bank Losses and Their Allocation

    13.1 Nonperforming Loans at Financial Institutions

    13.2 KAMCO Purchase of Nonperforming Loans from Financial Institutions

    13.3 KAMCO Nonperforming Loans Portfolio

    13.4 Nonperforming Loan Acquisition by Type of Loans

    13.5 Nonperforming Loans Acquisition by Type of Seller

    13.6 Bonds Issued by NPA Fund

    13.7 Pricing of Nonperforming Loan Purchases

    13.8 Resolution of Nonperforming Loans by KAMCO

    13.9 Operating Expenses of NPA Fund

    13.10 Balance Sheet of the NPA Fund

    List of Abbreviations

    ABS

    Asset-backed securities

    AMC

    Asset management company

    AMD

    Additional market discipline

    AMU

    Asset Management Unit

    BCC

    Bank Consolidation Company

    BDNI

    PT Bank Dagang Nasional Indonesia

    BI

    Bank Indonesia

    BIS

    Bank for International Settlements

    BITI

    Bank of Investment and Technological Innovation

    BNB

    Bulgarian National Bank

    BNI

    Bank Negara Indonesia

    BOK

    Bank of Korea

    BOL

    Bank of Lithuania

    BOP

    Bailout pressure

    BR day

    Bank restructuring day

    BRSA

    Banking Regulation and Supervision Agency

    BTO

    Been taken over

    CAB

    Central Asian Bank

    CAMC

    Centralized Asset Management Corporation

    CAR

    Capital adequacy ratio

    CBA

    Currency board arrangement

    CBT

    Central Bank of Turkey

    CD

    Certificate of deposit

    CEO

    Chief Executive Officer

    COD

    Collection Department

    CPI

    Consumer price index

    DBCP

    Deutsche Bank Capital Partners

    ERP

    Early retirement program

    EU

    European Union

    FAS

    U.S. Financial Accounting Standards

    FDIC

    Federal Deposit Insurance Corporation

    FDICIA

    FDIC Improvement Act

    FLC

    Forward-looking criteria

    FOBAPROA

    Fondo Bancario de Protección al Ahorro

    FRA

    Thai Financial Sector Restructuring Agency

    FRN

    Floating rate notes

    FSC

    Financial Supervisory Commission

    FSS

    Financial Supervisory Service

    FX

    Foreign exchange

    GAAP

    U.S. Generally Accepted Accounting Principles

    GBII

    IMF/WB Global Bank Insolvency Initiative

    GDP

    Gross domestic product

    HSBC

    Hong Kong and Shanghai Banking Corporation

    IAS

    International Accounting Standards

    IBRA

    Indonesian Bank Restructuring Agency

    IFRS

    International Financial Reporting Standards

    IMF

    International Monetary Fund

    ISO

    International Organization for Standardization

    ITCs

    Investment trust companies

    JVs

    Joint ventures

    KAMCO

    Korea Asset Management Corporation

    KBA

    Korea Board of Audit

    KDB

    Korea Development Bank

    KDIC

    Korea Deposit Insurance Corporation

    KEB

    Korean Exchange Bank

    KFB

    Korea First Bank

    LOI

    Letter of intent

    LOLR

    Lender of last resort

    LTL

    Lithuanian litai

    MARA

    Mongolian Asset Realization Agency

    MHC

    Moral hazard cost

    MOF

    Ministry of finance

    MOFE

    Ministry of finance and economy

    MOU

    Memorandum of understanding

    MPB

    Ministry of planning and budget

    NPA Fund

    Nonperforming Asset Management Fund

    NPL

    Nonperforming loan

    NPV

    Net present value

    OECD

    Organization for Economic Cooperation and Development

    P&A

    Purchase and assumption

    PCA

    Prompt corrective action

    PD

    Payment delay time

    PFOC

    Public Funds Oversight Commission

    PV

    Present value

    RB

    Reconstruction Bank

    RTC

    Resolution Trust Corporation

    SB

    Savings Bank

    SDIF

    Savings Deposit Insurance Fund

    SKr

    Swedish kronor

    SSB

    State Savings Bank

    TBTF

    Too big to fail

    TDB

    Trade and Development Bank

    TL

    Turkish lira

    Tog

    Mongolian togrogs

    W

    Korean won

    Acknowledgments

    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.

    Foreword

    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.

    Ulrich Baumgartner

    Acting Director

    Monetary and Financial Systems Department

    IMF

    Preface

    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.

      You are not logged in and do not have access to this content. Please login or, to subscribe to IMF eLibrary, please click here

      Other Resources Citing This Publication