Abstract

Systemic financial crises have become a common, albeit infrequent, feature of the global financial landscape. Since 1980, nearly every country has been affected by serious financial distress or systemic financial crises. Resolution of such crises requires a complex mix of macroeconomic and financial sector policies. One important element in the mix is the restructuring and resolution of problem banks. Considerable experience has been gained in this area in the past decade. This volume outlines the theoretical insights gained and the practical lessons learned. For more information on how to purchase this title, please visit http://www.palgrave.com/economics/imf/index.asp.

Frontmatter Page

© International Monetary Fund 2006

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Contents

  • List of Tables

  • List of Figures

  • List of Boxes

  • List of Abbreviations

  • Acknowledgments

  • Foreword

  • Preface

  • Notes on Contributors

  • I. Overview of Crisis Resolution and Bank Restructuring Policies

    • 1. The Resolution of Systemic Banking System Crises

    • David S. Hoelscher and Stefan Ingves

    • 2. The Benefits and Costs of Intervening in Banking Crises

    • Edward J. Frydl and Marc Quintyn

  • II. Options for Bank Restructuring

    • 3. Techniques of Bank Resolution

    • Steven A. Seelig

    • 4. Issuing Government Bonds to Finance Bank Recapitalization and Restructuring: Design Factors that Affect Banks’ Financial Performance

    • Michael Andrews

    • 5. What Happens After Supervisory Intervention? Considering Bank Closure Options

    • Michael Andrews and Mats Josefsson

    • 6. Post-Resolution Treatment of Depositors at Failed Banks: Implications for the Severity of Banking Crises, Systemic Risk, and Too-Big-To-Fail

    • George G. Kaufman and Steven A. Seelig

    • 7. The IMF/World Bank Global Insolvency Initiative—Its Purpose and Principal Features

    • Ross B. Leckow

  • III. Options for Asset Management

    • 8. Prudential Treatment of Restructured Loans

    • Inwon Song

    • 9. Issues in the Establishment of Asset Management Companies

    • Dong He, Stefan Ingves, and Steven A. Seelig

  • IV. Country Experiences

    • 10. From the Front Lines at Seoul Bank: Restructuring and Reprivatization

    • Chungwon Kang

    • 11. Banking Crises and Bank Resolution: Experiences in Some Transition Economies

    • Charles Enoch, Anne-Marie Gulde, and Daniel Hardy

    • 12. Interventions in Banks During Banking Crises: The Experience of Indonesia

    • Charles Enoch

    • 13. The Role of KAMCO in Resolving Nonperforming Loans in the Republic of Korea

    • Dong He

    • 14. The Public Sector Recapitalization Program in Turkey

    • Mats Josefsson

  • Index

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 Figures

1.1 Options for Asset Management

2.1 Structure and Evolution of a Banking Crisis

2.2 Fire Sale of Marketable Assets by Banks

6.1 Additional Market Discipline and Bailout Pressure as Functions of Depositor Payment Delay Time

11.1 Mongolia: Real Monetary Aggregates

11.2 Mongolia: Bank Liquidity

13.1 Nonperforming Loans of the Financial Sector

13.2 Purchase Price Through Time

13.3 Nonperforming Loan Resolution Through Time

List of Boxes

5.1 Principles for Dealing with Weak Banks

5.2 Procedures for Supervisory Intervention and Takeover of a Bank

5.3 Indonesia: Doing It Wrong and Doing It Right

5.4 Assessing the Financial Condition of Banks

9.1 Advantages and Disadvantages of a Centralized Public Asset Management Company

13.1 Recovery of Public Funds for Financial Sector Restructuring

13.2 Loan Classification and Estimating the Size of Nonperforming Loans

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.