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The Global Financial Crisis: Causes, Policy Response, and Outlook Max Alier * Resident Representative in Ukraine * The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

3 Main Message Despite recent economic indicators showing signs of an incipient recovery, it is too early to say that the economy is “out of the woods”. A number of issues still need attention and an adequate solution to these issues will be key in determining how fast and how strong we emerge from the crisis. In particular, restoring solvency of the financial system is key.

4 Outline A Crisis in the Making A Crisis in the Making Macroeconomic Policy Response Macroeconomic Policy Response Bringing the Financial System to a Sound Footing: Dealing with Bank Insolvency Bringing the Financial System to a Sound Footing: Dealing with Bank Insolvency Outlook Outlook

5 A Crisis in the Making The root cause of the global financial crisis can be traced back to the optimism bred by a long period of high growth, low interest rates, low volatility, and policy failures in:  Financial regulation  Macroeconomic policies  Global Architecture

6 A Crisis in the Making The global financial crisis brought to an end the longest period of strong global economic growth on record. Broadly speaking it was “healthy” growth:  High productivity growth  Low inflation  Low long-term and short-term interes rates

7 A Crisis in the Making

8 However, these benign conditions fed the build up of systemic risk. Low interest rates, together with increasing and excessive optimism about the future, pushed up asset prices, from stocks to housing prices. Low interest rates and limited volatility prompted a search for yield and underestimation of risks leading to the creation and purchase of ever riskier assets.

9 Macroeconomic Policy Response The magnitude of the crisis and the clear threat of a global financial meltdown prompted a strong policy response characterized by an unprecedented level of policy coordination across the globe involving industrialized countries as well as emerging market economies.

10 A Crisis in the Making

11 Macroeconomic Policy Response Fiscal policy was loosened to offset the decline in private demand prompted by the balance sheet effect resulting from the asset price correction, as well as, the deterioration in labor market conditions. Fiscal policy was loosened to offset the decline in private demand prompted by the balance sheet effect resulting from the asset price correction, as well as, the deterioration in labor market conditions. Monetary policy was rapidly loosened, including by using non- traditional instruments, to ensure an adequate level of liquidity in the financial sector and to prevent a collapse of the payment system. Monetary policy was rapidly loosened, including by using non- traditional instruments, to ensure an adequate level of liquidity in the financial sector and to prevent a collapse of the payment system.

12 Bringing the Financial System to a Sound Footing Beyond the near-term liquidity support needed to preserve the financial system, major challenges lie ahead:  Dealing with solvency problems and restoring credit flows.  Improving regulatory and oversight frameworks to prevent a repetition of current crisis. I would like to focus on the first issue. In particular, on the frameworks to deal with bank insolvency and debt restructuring.

13 Bringing the Financial System to a Sound Footing: Bank Insolvency The primary objective of the bank insolvency framework is to safeguard the stability of the financial system. Why a special bank insolvency regime? A special bank insolvency regime, separate from the corporate insolvency, may facilitate timely action and provide for consistency between the supervisory and insolvency-related functions of the banking authorities. It is particularly useful where the corporate insolvency regime is weak and ineffective.

14 Bringing the Financial System to a Sound Footing: Bank Insolvency “Insolvency proceedings” refers to all types of official action involving…  the removal of management and/or the imposition of limits on/suspension of, the rights of shareholders;  assumption of direct control by the banking authority or other officially appointed person; …over a bank that has crossed a threshold for the commencement of insolvency proceedings.

15 Bringing the Financial System to a Sound Footing: Bank Insolvency Types of bank insolvency proceedings:  Official administration: the purpose is to protect the bank’s assets, assessing its true financial condition, and conduction all the necessary restructuring operations, or placing the bank in liquidation.  Liquidation proceedings: the purpose is to maximize the value realization of assets, and an orderly and equitable distribution of proceeds to creditors. Liquidation results in dissolution of the bank as a separate legal entity.

16 Bringing the Financial System to a Sound Footing: Bank Insolvency Bank restructuring operations should:  minimize the disruption of the financial system;  limit the costs to depositors, other creditors, and taxpayers;  aim at addressing the causes and not just the symptoms of bank insolvency.

17 Bringing the Financial System to a Sound Footing: Bank Insolvency Types of bank restructuring operations:  Mergers and Acquisitions  Purchase-and-Assumption Transactions  “Good-bank/Bad-bank” Separation and Bridge Banks  Publicly Assisted Bank Restructuring

18 Bringing the Financial System to a Sound Footing: Bank Insolvency Systemic Banking Crises are characterized by financial sector distress of such a magnitude that it has an adverse in effect on the real economy, and usually include:  Severe financial problems in a large part of the banking system.  A system-wide loss in bank asset quality.  Widespread loss of credit discipline.  Danger of collapse of the payment and settlement systems.

19 Bringing the Financial System to a Sound Footing: Bank Insolvency Response to systemic banking crises: should aim at:  Protecting the payment system.  Limiting the loss of depositor and creditor confidence.  Restoring solvency, liquidity, and stability of the banking system.

20 Outlook There are nascent signs that the world economy has bottomed out. Credit and trade flows are resuming. Particularly encouraging are developments in EMs, in particular in Asia and Latin America. The IMF has started to revise its output growth projections. However, the recovery is still fragile and large reform agenda lies ahead to put the world economy on a strong footing.

21 Thank you

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