1. Cross-border stability framework:
Lessons from the global financial crisis
Jerzy Pruski
BFG 15th Anniversary Conference
Warszawa, 21 May 2010 1 1

2. Domestic financial stability framework
Completeness & efficiency of the system 2 2

3. Low effectiveness of existing crisis management tools
Global financial crisis 2007 – 2010 / response options
Private sector solutions
Bailout/nationalization
Standard bankruptcy proceedings
Scope
Very limited
Broadly used
Very limited
Examples
Important M&A
Bear Stearns (JP Morgan)
Merrill Lynch (BoA)
Negative examples:
ABN Amro (RBS, Santander
and Fortis)
TARP, AIG, CitiGroup, RBS,
Lloyds TSB, Northern Rock, Fortis,
Dexia, KBC, AIB, Commerzbank,
Hypo Real Estate
Available only for small banks.
Not resorted to after the collapse
of Lehman Brothers for fear of
systemic risk
Standard legislation
Ineffective:
need for quick decisions
inadequate for specific
circumstances
Significant changes required
Fiscal burden of financial turmoil must to be drastically limited 3 3

4. ? Robust domestic stability network
as prerequisite for effective cross-border safety net
Regulations
Rescue function
(temporary)
Ministry of
Finance
MoF
DGS
Rescue function:
to be extended
& implemented
Central
Bank
Liquidity
Financial Services Authority
strong & complete
domestic
financial stability system
Regulations
Supervision
Deposit Guarantee Scheme ?
Special resolution regimes:
to be implemented
Pay-box
Rescue function
Periodic financial crises remain inevitable in a market economy
even despite strong domestic stability network 4

5. Need for effective rescue and resolution functions
Complete toolkit of instruments a pre-condition for effective crisis management
Rescue
Resolution
Change of ownership required
No change
of ownership
Private sector solution not available
Bailout/Temporary
nationalisation
Private sector
solutions
Bank restructuring
or capital injection
Rescue activities not justified
Moral hazard
Tools
to support M&As
Assistance for
existing shareholders
Special receivership powers
Authority for Purchase and Assumption
Rescue function (capital injection and/or liquidity support)
Orderly liquidation
Insurance
Pay-box function 5 5

6. Resolution function FDIC Reduction of: Receivership Failed Bank
Sell the whole bank
Receivership
Cost and systemic risk assessment
Failed Bank
Quick decision
Sell asset pools
Liquidate assets
FDIC
Sell deposits & branches
Coverage for insured deposits
(DGS)
Alternative
model
Insured deposit pay-out
Reduction of:
systemic risk
amount of required funds
moral hazard 6

7. Significance of special resolution regimes
Fiscal and stability costs*
Advantages
*based on Čihák & Nier (2009)
Reduction of systemic risk of default
Transfer of control to regulators
Reduction of fiscal cost
Costs transferred to existing shareholders
Reduction of moral hazard
Better market discipline
(Indirect costs)
„Bailout”
Fiscal costs
Ordinary resolutions
Disorderly bankruptcy
(Direct costs)
Special resolution
Stability costs
Systemic financial stability impact 7 7

8. Cross-border interconnectedness
Additional risks and challenges 8 8

9. Cross-border interconnectedness
Global economy
cross- border dimensions
Broad range of benefits of globalisation
Insufficient information
Crisis contagion
Increased risk of crisis
&
Extraordinary challenge for crisis management 9

10. Cross-border risk management
Cross-border banking groups imply:
enormous complications for financial safety net
modifications in the toolkit of stability instruments and new regulatory authorities
Domestic market risk
External risk
Default
risk
Microprudential
Country 1
Macroprudential
Country 2
Bank 11
Cross-border dimensions
Bank 21
Bank 12
Prevention instruments
Bank 1
Bank 2
Bank 22
Bank 13
Crisis management
Bank 14
interbank links 10 10

11. Cross-border connections Risk monitoring limitations
Systemic risk
Limitations
Identification of systemically important
institutions requires access to data on entire
cross-border network
Total picture of the risk is not visible
from the perspective of a single country
Source - IMF
In addition to a local component, the risk imposed on domestic banks depends
on external foreign risk, which is only partially visible 11 11

12. Limiting the risk of crisis
Available solutions for mitigation of cross-border crisis risk
Robust domestic safety net
Harmonization + cooperation
Integrated solutions
Effective domestic financial
stability system
Mostly non-binding
Some decisions are transferred
to international level
Pending construction
Difficult to implement
Involves the issue of individual state independence
legal aspect – different legal rules
burden sharing aspect 12

13. European Union
Financial stability system enhancement 13 13

14. Existing cross-border stability framework in the EU
monetary policy
stabilization policy
European
ECB
Euro Area
Regulations
ESRB, EBA
not authorized to impose
fiscal cost
New solutions
Union
Crucial importance however still:
non-binding
limited efficiency
Harmonisation
Crucially important but remain:
Coordination
Urgent need for new and rigorously enforced fiscal rules 14

15. Proposed cross-border stability framework
European stability framework legs behind domestic standards
Fragmented
Non-binding
Lack of funds
Currently discussed solutions
Basel III
Limitations and barriers
lack of ex-ante burden sharing
non – existant legal framework for transfer of assets
legal differences
lack of common bankruptcy law
ESF European Stability Fund
ERA European Resolution Agency
EDGS European DGS
IES Integrated European Supervisor
EMF European Monetary Fund 15

16. Risk of overregulation
Sources of global financial crisis
Macroprudential
Microprudential
Macroeconomics
European Systemic Risk Board
New regulations
Theory and practice
of macroeconomic policy
essentially unchanged
selective scope
(only banking sector)
- effectiveness not fully proved
incomplete cost-benefit analysis
limited territorial scale
limiting the scale of operations
- focus on stability of consumer prices
- not oriented to asset prices and
monetary aggregates
- fiscal policy
- FX regime
Remains to be tested
Risk of overregulation
Outstanding:
fiscal problems
global imbalances
asset bubbles 16

17. Risk of suboptimal policy mix
Monetary policy
Fiscal policy
Supervisory and regulatory
policy
Low interest rates and monetary
easing despite improvement
of economic situation
Recently reached deficit and debt
levels force budgetary restraint
Focus on new regulation rather than
more effective supervision
Banking regulations
Restrict the range and scope
of banking activity
Counter-cyclical measures
Pro-cyclical measures
Pro-cyclical measures
The risk of inconsistent monetary – regulatory policy mix
The entire burden of emerging from the crisis rests on monetary policy with successively
lower interest rates and a familiar potential for future assets bubbles 17 17