The World Bank Bank Insolvency Framework and the Global Bank Insolvency Initiative Ernesto Aguirre, Manager of Banking Regulation June 20, 2002

Contents Bank Insolvency Framework vs Corporate Insolvency - Definition - Concept of Bank Insolvency - Starting Point - Objectives Importance of the Bank Insolvency Framework - Concept - Country Examples The Bank Insolvency Initiative - Objectives - Participants - Work Program - Contents

I.What is the Bank Insolvency Framework and how it differs from the general (corporate) insolvency framework.

Bank Insolvency Framework a) Definition Set of measures that should (have to) be taken by the State Authorities to confront actual/potential bank insolvency.

Bank Insolvency Framework b) Applicable concept of Bank Insolvency Insufficient criteria for triggering actions under the BI Regime: Balance sheet insolvency: Liabilities exceed assets Liquidity insolvency: Failure to pay obligations as they fall due Regulatory insolvency: Non-compliance with minimum solvency ratios

Bank Insolvency Framework b) Applicable concept of Bank Insolvency (cont.) For banks the perception of the supervisor is key. “A bank is insolvent when the bank regulator says so...” - Concept of insolvency as a trigger point: Whenever a competent, independent regulator perceives the bank as potentially (imminent?) or actually insolvent measures under the BI regime should start to be taken.

Bank Insolvency Framework c) Starting point: Bank Intervention Measures from the State Authorities which imply a direct interference with the administration of the Bank. Examples: Cease and desist NO Order to change directors NO or administrators

Bank Insolvency Framework c) Starting point: Bank Intervention (cont.) Recapitalization orders NO “Recovery Program” NO - when specific implementation and design are carried out by the banks’ administration YES - when implementation or specific design are made by (or under the orders from) the banking regulator or its agents

Bank Insolvency Framework c) Starting point: Bank Intervention (cont.) Agent of the Bank Regulator YES in the Board of Administration (veto powers, etc.) “Controlled administration” YES Administration YES (with or w/o ownership participation

Bank Insolvency Framework d) Objectives Primary objectives 1. To protect the payment systems 2. To preserve the efficient provision of credit and banking services to the economy

Bank Insolvency Framework d) Objectives (cont.) Preconditions: 1. Public confidence in the Banking System 2. Technical capability of the Banking System

Bank Insolvency Framework d) Objectives (cont.) Secondary objectives 1. Market discipline 2. Efficiency of the process 3. Equity of treatment

Bank Insolvency Framework Secondary Objectives (cont.) The secondary objectives become the paramount ones when the bank has been closed (Banking Liquidation) and it is only in this context that all principles applicable to Corporate insolvency apply equally to the two processes. ( i.e. The 3 secondary objectives, plus all principles reflected in Principle 6 of the Legal Framework for Corporate Insolvency)

Bank Insolvency Framework Conclusion The scope of the BI regime is: Very wide, and Different from the scope of the CI Regime (similar only in the context of Bank Liquidation)

II. Importance of the Institutional, legal and regulatory framework to deal with bank insolvency, including in the context of systemic crisis Strategy Framework Implementation

Country Examples-Mexico 1994 Was the intervention and resolution regime too weak? Long time required to intervene (resolve) large insolvent banks Inadequate framework for the use of public funds Difficulties to allocate resources to recapitalize banks. Deficient bankruptcy regime Problems to force defaulted debtors to repay their loans.

Country Examples-Thailand 1997 Lack of legal protection for bank authorities Authorities afraid of intervening banks or take prompt corrective measures to prevent problems from growing. Lack of explicit deposit insurance Weak legal regime for the intervention /resolution of financial institutions. Were they a factor to decide the adoption of a blanket guarantee covering all deposits in the system? Was the above decision timely? Relation between the adoption of the blanket guarantee and the costs associated with the crisis resolution. Deficient bankruptcy regime Problems to force debtors to repay or renegotiate their loans.

Country Examples-Korea 1997 Excessive constraints to entry of foreign investors Delays to sell large intervened banks Fragmented financial sector legislation Authorities dealt rapidly with banks’ problems, but failed to recognize and rapidly solve problems of other non- bank financial institutions. Deficient bankruptcy regime Problems to force defaulted debtors to repay their loans.

Country Examples-Ecuador 1998 Lack of legal protection to bank authorities Authorities afraid to intervene banks or take appropriate corrective measures before a bank collapses. Weak institutional arrangements High Turnover of senior government officials. Main decisions revoked by courts or the legislative. Deficient bankruptcy regime Problems to force defaulted debtors to repay their loans or restructure their debts..

Turkey 1999 Adequate legal framework but not sufficient 1999 New Banking Law Allowed rapid intervention of small and medium insolvent banks. But fiscal problems prevented Rapid resolution of insolvent banks. Once the funding was resolved Resolution of insolvent banks proceeded adequately.

Global Bank Insolvency Initiative Objectives: 1. To determine the appropriate institutional, legal and regulatory framework to deal with bank insolvency including in the context of systemic crises. ( “the framework”) 2. To, progresively, create an international consensus regarding the framework including best practices and alternatives to deal with bank insolvency.

Bank Insolvency Initiative Bank Insolvency Initiative Objectives: 3. To design a methodology for the assesment of the countries’ institutional, legal and regulatory framework to deal with bank insolvency, and 4. To facilitate the provision of technical assistance to countries for the improvement of their “framework”.

Participating Institutions Coordination WB (leading institution) IMF (main partner) Participants (International Institutions) BIS, FSI, BCBS Regional Development Banks Participants (Countries) All countries through: Bank Supervisory Agency Central Bank Deposit Insurance Agency

Work Program ( ) 2 Global seminars (Basle, Washington) 5 Regional seminars (Uruguay, Poland, Malaysia, South Africa, Lebanon) Core Consultative Group Final report and supporting documents Regional Support Groups Consultation/ Questionnaire and global database Internet web-site

Key Framework Institutional aspects Who decides Who implements Need to avoid gaps and duplications of responsibilities Eliminate uncertainty as to which authority is in charge Legal protection and accountability Bank regulator/bank restructuring authority Accountability to whom? Principles and mechanisms for the use of public funds Least-cost solutions Transparency Fairness

Key Framework Bank Intervention Clear rules for bank intervention Flexibility to carry out an intervention whenever the bank authority deems it necessary. Entry Rules New foreign and domestic investors “Fit and proper” rules Mechanisms for bank restructuring and resolution Mergers and acquisitions “Purchase and assumption” transactions Bridge banks Good bank-bad bank Other

Liquidation Deposit payoff Asset resolution Debt restructuring and recovery Deposit insurance Limited deposit insurance Schemes to assist troubled institutions Other Systemic Crises A separate regime? Regulatory forbearance Key Framework

Beyond the Legal Framework Crises type 4 Judicial system Enforcement capabilities Other issues

The World Bank Bank Insolvency and the Global Bank Insolvency Initiative Ernesto Aguirre, Manager of Banking Regulation, June 20, 2002