1. MANAGING SYSTEMIC BANKING CRISES
Luis Cortavarria
International Monetary Fund
Monetary and Financial Systems Department

2. Banking Problems Worldwide 1980–2003
Banking Crisis
Significant Banking Problems
No Significant Banking Problems/Insufficient Information

4. Crisis Management: Complexity vs. Simplifications
Banking crises are chaotic events:
They emerge suddenly.
They are intertwined with political and social problems.
Crisis management in this environment is complex:
There is no time.
Conditions of banks are unknown.
There are legal and institutional limitations.
Challenge:
Design a comprehensive program consistent with local conditions without time and information.

5. Crisis Management Framework
Treatment of systemic crises differ from treatment of individual bank failures.
Tools appropriate for one may aggravate the other.
Systemic crisis management—three stages:
Crisis containment
Bank restructuring
Asset management

6. Stage One: Crisis Containment
Containment must be an immediate priority.
Reforms not effective in face of generalized panic
Measures cannot last forever
Available tools:
Emergency liquidity assistance
Blanket guarantees
Immediate bank intervention
Administrative measures

7. Stage One: Crisis Containment
These tools are controversial.
Legitimate concerns about costs and misuse.
How to avoid pitfalls?

8. Emergency Liquidity Aim Restore depositor and creditor confidence.
Pitfalls
Macroeconomic pressure
Increase monetary aggregates
Can support insolvent banks
Losses to the central bank
Prone to abuse

9. Emergency Liquidity Options Sterilize liquidity injections
Introduce liquidity triggers
Enhanced supervision of recipient banks

10. Blanket Guarantee Aim Pitfalls
Stabilize creditor fear, give time to design policies
Pitfalls
Not credible if government fiscal position is weak.
High cost in case of large solvency.
Moral hazard if prolonged, if no restructuring.

11. Administrative Measures
Aim
Stop liquidity outflows when confidence is not restored.
Types:
Deposit freezes
Deposit restructuring
Capital and exchange controls

12. Administrative Measures
Pitfalls
Extremely disruptive to:
Payment system
Economic activity
Private sector confidence
Exemptions
Unwinding process
Must be viewed as a final, desperate measure to stop runs if all other tools have failed

13. Stage Two: Bank Restructuring
Aim
Restore banking system profitability and solvency
Steps
Diagnosis and triage
Restructuring the banking system:
Resolution of unviable banks
Restructuring of viable but undercapitalized banks.

14. Diagnosis and Triage Aim Pitfalls
Identify banks in need of restructuring/resolution
Pitfalls
Data limitations

15. Diagnosis and Triage How can pitfalls be addressed?
Use concept of “medium-term viability” in addition to solvency.
Require banks to produce forward-looking business plans:
common assumptions and worst-case scenario analysis; and
stress tests and simulations to confirm viability.
Audits
Classify banks

16. Bank classification: Sound and solvent Undercapitalized Insolvent
but viable
Insolvent and
nonviable

17. Bank diagnosis: Continue Viable? Yes No Fail? under MOU No Yes Bank
Resolution
Shareholders
Recapitalize

18. Bank Restructuring Aims: Options:
Remove unviable banks from the system.
Return viable banks to profitability.
Options:
Private sector
Public sector
Combination

19. Bank Restructuring Pitfalls Delays Excessive forbearance
No losses imposed on shareholders
Partial resolution (while “praying for redemption”)
Limitations in the legal framework:
Inability to wipe out shareholders
Restrictions for sale of assets
P & A transactions
Lack of protection for supervisors

20. Bank Restructuring How can pitfalls be addressed?
Planning—think through how crises will be managed.
Aim for least cost-restructuring outcome:
Private sector solutions
Restricted public sector-assisted solutions
Single authority to oversee crisis management
Strengthen legal and regulatory system (difficult during a crisis).

21. Bank Restructuring Ensure political consensus (possible but difficult)
Avoid inadequate tools
Proper communication
Accountability

22. Bank Restructuring Limitations to this approach
If misused, costly, can cause moral hazard.
Alternatives have been proposed:
Allow illiquid banks to fail one by one.
Apply depositor haircuts on restructured banks.
Rarely used in practice.
Does irreversible damage to potentially healthy sections.
May not be least cost: economic costs > fiscal costs
Very high social and political costs.

23. Stage Three Asset Management
Aim
Allow banks to focus on banking.
Options:
Private asset management companies (AMCs)
Centralized (public) AMCs
Difficulties:
Weak market demand for distressed assets
Weak property rights
Unrealistic expectations about recovery rates
Weak legal frameworks
Poor loan documentation

24. Conclusions Crisis management is a balancing act.
Need to act quickly under extreme uncertainty.
Lessons from past crises must be combined with deep country-specific knowledge.
Planning is key to successful crisis management.
Bank restructuring is a long and painful process.
Strategy should be comprehensive.
Clear independence of the banking authorities.

25. Thank you