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Defined in this paper as the exercise of resolution powers, set out in a country’s resolution regime, including or to be accompanied by an insolvency or liquidation proceeding (for example, to wind up parts of the failed bank).
For example, Claessens and others (2010), among many other studies.
While tempting to describe these as phases, they need not be sequential. If the authorities are well-prepared, as described in Part I, shocks that would have triggered a systemic crisis in the past may not do so in the future.
IMF (2014) summarizes the key gaps as inadequate resolution powers and tools, inadequate cross-border cooperation frameworks, and inadequate mechanisms for loss allocation.
Moral hazard occurs when an agent increases risk without facing the full consequences, which in part or in full will be borne by another agent, such as a government bailing out the creditors of a failed bank.
Financial activities provided by the bank critical to the real economy and financial stability.
Stylized representation only—the order of tools is for illustrative purposes.
Any role for government officials (for example, from the Ministry of Finance) in individual resolution decisions should be limited to cases that involve the use of fiscal resources
Including suitably long contract terms (for example, longer than the electoral cycle) with limited grounds for dismissal.
Many resolution authorities are unlikely to face enough bank failures to justify maintaining the in-house capacity to liquidate banks and should outsource to third parties with the appropriate expertise and capacity.
Deposit insurance increased from €20,000 to €100,000 in the EU by end 2010, and from $100,000 to $250,000 in the US in October 2008 (on a temporary basis subsequently made permanent).
Substituting the DIS to receive recoveries from the liquidation in place of insured depositors protected by the DIS.
For example, under the US Federal Reserves Term Auction Facility, longer-term liquidity was made available to a wider set of counterparties against a wider list of collateral (normally reserved for the overnight discount window).
Larger UK banks committed, after moral suasion from the Bank of England, to draw upon the Special Liquidity Scheme (created in the GFC) for a minimum amount and for a minimum duration (at least three years).
The Hong Kong SAR authorities announced a new Resolution Facility in August 2019, available to a bank placed into resolution, with any losses being recoverable from the industry via a levy.
”Coordination” and “cooperation” are not used synonymously in this paper. Coordination is deemed the deliberate unity of action by authorities in the pursuit of a common purpose; cooperation a more voluntary, less-formal effort.
As enshrined in international standards—Core Principle 2 of the Basel Core Principles, Key Attribute 2 of the resolution standard, and Principle 11 of the deposit insurance standard.
In some countries, such as the US and Canada, the institutions themselves prepare the resolution plans, which the resolution authorities review.
For details, see IMF (2014).
When the central bank conducts due diligence on (pools of) collateral in advance.
Resolution authorities in the United States have conducted such exercises with UK and EU officials.
For example, during the GFC, the Term Auction Facility expanded the US Federal Reserve’s counterparties well beyond the normal small group of (nonbank) primary dealers (Dobler and others 2016).
In 2007, the guarantee on the UK’s Northern Rock had to be expanded twice from existing retail deposits to new retail deposits, and then to wholesale deposits within about three months of first being issued.
With similar effects, starting in 2009, some euro area governments guaranteed bank bonds to help solvent systemic banks generate eligible collateral for central bank liquidity. Acceptance of these bonds as collateral in Eurosystem operations was restricted in 2012 and discontinued in 2015, although they remain eligible collateral for ELA from national central banks.
Dell’Ariccia and others (2018b) estimate the conditional probability of a sovereign debt crisis occurring when a banking crisis emerges at 51 percent.
Examples include the Asset Protection Scheme in the UK and the Asset Guarantee Program for Citigroup and Bank of America in the US.
Exchange restrictions (and multiple currency practices) can be introduced only with prior approval of the IMF Executive Board, for balance of payments (BOP) reasons and must be temporary and applied without discriminating among IMF members. Multiple currency practices can also be approved for non-BOP reasons, if they do not impede the effective BOP adjustment of the country and do not discriminate between IMF members.
If a valuation needs to be performed without adequate information, resolution authorities should add a prudent margin to the loss estimate.
Regulatory forbearance arises when the supervisory authorities opt not to enforce prudential regulations, hoping that more favorable economic conditions will materialize and help gradually resolve problems. Forbearance can be informal, that is, turning a blind eye to violations, or formal, that is, an agreement to waive certain prudential rules for a limited period. Timebound formal forbearance may be necessary on an exceptional basis, for example, in response to a natural disaster or as part of a systemwide restructuring plan in a systemic crisis.
For a sample of US banks, Cole and White (2017) estimate that resolution costs increased by 37 percent compared to an assumed counterfactual of resolution at an earlier juncture.
As opposed to contractual arrangements with write-of or conversion features such as contractual contingent convertible instruments (CoCos), which can be triggered outside of resolution.
For example, at the onset of the 2008 banking crisis in Iceland, the authorities announced they would recapitalize a large bank. This triggered a sovereign downgrade as Iceland’s external reserves covered only a small fraction of banks’ foreign liabilities. All banks in Iceland subsequently faced foreign funding and deposit outflows, and margin calls.
Common loan restructuring tools include extending the maturity, reduced-interest loans, debt-for-equity swaps, repayment reduction through “warehousing” a portion of the debt, and write-offs of portions of the debt (typically based on repayment performance for the remainder of the debt).
”Hybrid” procedures are those for which the involvement of the judiciary or other authorities is an integral part of the procedure, but those procedures are less intensive than in formal insolvency proceedings.
See Pomerlano and Shaw (2005) and Laryea (2010) for a description of these approaches.
For a discussion of public support to mortgage modifcation programs, see Laeven and Laryea (2009).
The ability to establish an AMC as an asset separation tool is one of the Key Attributes resolution powers.
For example, in 2016 Spain compelled banks to lower collateral valuations, depending on the type of collateral and the length of time a loan is past due.
AMCs established during the Asian crisis, such as in Malaysia, allowed banks to amortize the initial impact on capital over several years. This is no longer possible under the International Financial Reporting Standards.