What is bank resolution?
• The actions taken by the competent public institutions to solve the
situation of an unfeasible bank.
• Sometimes leads to deposits being paid-back and the withdrawal of
the bank´s license, BUT not always the optimal solution…
Possible situations of a bank
Point of no Return
Risk of Unviable
insolvency Bank
Some
weaknesses
Normal
operations
Measures Corrective actions Regularization Resolution
Plan
Why proper Bank Resolution is
critical?
• Standard business resolution procedures (any equivalent to US
chapter 11 or chapter 7) are too slow and unpredictable.
•Failure of a single financial institution can spillover through the
interbank marketing triggering a liquidity crunch and the fire sale of
assets (selling at distressed prices or paying for liabilities high interest).
Why proper Bank Resolution is
critical?
•Banking system is critical for the economic system:
1) Processing of payments
2) Provision of credit
3) Transmission mechanism of monetary policy
•Has consequences on the depositors, bondholders and shareholders
resources (cost of resolution & assets value).
•Signals a correct system of incentives to the rest of players (moral
hazard issue).
Understanding the common
condition of the troubled banks:
•Two situations are possible:
1. the supervisor finds a single institutions in trouble.
2. the whole financial system is weakened.
•But a common cause:
An “unexpected” decrease of asset values (loans) which causes a
sudden decline in the capital of the financial institution.
Normal situation Distressed Bank
Equity Equity Write-off
Deposits Write-off Deposits against
Bondholders Bondholders which
Loans (assets) Other Debt Loans (assets) Other Debt liability?
What is critical are not the causes
but the situation of the financial
system:
•Supervising institutions tend to choose the appropriated solution based
in the scale and scope of the problem in the financial system.
•What caused the problem is left for posterior analysis, is irrelevant for
choosing the resolution alternative.
•The focus of the supervisor is to return the financial system to the
previous status quo: loans flowing and depositors trusting banks.
Bank 2
Bank 2 Bank 1 Bank 4
Bank 1 Bank 4
Bank 5
Bank 5
Bank 3
Bank 3
Scenario 1: We have a relative small Scenario 2: We have a BIG problem
problem (close the bank) (we cannot close the banks, systemic
resolution solution needed)
Basel Supervision Committee
Recommendation (September 2009)
Living Wills: Planning in advance for orderly resolution
•A living will is a contingency plan for any systemically important cross-
border financial institutions.
•A living will should provide a plan to address the actions needed during a
severe financial distress or financial instability.
Basel Supervision Committee
Recommendation (September 2009)
•The “living will” plan should be proportionate to the size and complexity of
the institution.
•The plan goal should aim to preserve the firm as a going concern, promote
the resiliency of key functions or facilitate the rapid resolution should that
prove necessary.
•Take into account cross-border dependencies, implications of legal
separateness of entities for resolution and the possible exercise of intervention
and resolution powers.
3 basic alternatives for Bank
Resolution Bank
carries
high
Unfeasible
systemic
Solvency
risk
1 Continued operations with some restrictions YES NO
2 Forcing a merger with other institution YES YES
3 Closure of operations NO YES
1 Forbearance and hope
Dependent on:
• Supervisor giving high probabilities to the troubled bank to solve its problems if given enough time.
Goals:
• To dispose orderly troubled assets (to obtain its fair market value and not a distressed value)
• To generate profits from general operations to charge off losses
Tools:
• Passive monitoring (management has autonomy to implement turn around plan) Moral Hazard.
• Active monitoring, central bank submits a strict plan for recovery, monitoring it actively.
1 Forbearance and hope
Remedial Supervisor Time allows
plan is monitors bank to solve
presented developments problems
Advantages Disadvantages
•No cost for taxpayers. •Situation can turn out
worse (and more costly)
•Preserves bank than initially assesed.
operations.
•Moral Hazard
(management is not
punished)
2 Open bank assistance
Dependent on:
• Supervisor thinks bank´s insolvency is not management´s fault
• Problem can easily be solved by an accounting recognition and a capital injection.
Goals:
• To maintain management as it has better information about how to solve the problem.
• To provide discretionary help to the troubled bank through indirect guarantees.
Tools:
• Capital infusion through discount window or direct loans.
• Equity or debt raising with lower interest rates using government guarantees.
2 Open bank assistance
Advantages Disadvantages
•Avoids the costs of a •Costly for the supervisor
bank closure. (fiscal and monetary
impact).
•Preserves bank
operations. •Moral Hazard
(management is not
punished)
3 Government intervention
Dependent on:
• Supervisor thinks bank´s insolvency is management´s fault or is incapable of a turn around.
Goals:
• To return the bank to a healthy position attractive enough to find a merger candidate.
Tools:
• Government technical experts take control of day to day operations.
• Banking industry experts are hired to turn around the troubled bank (preferred solution)
3 Government intervention
Advantages Disadvantages
•Avoids the costs of a •Costly for the supervisor
bank closure. (fiscal and monetary
impact).
•Preserves bank
operations. •Moral Hazard
(management is not
punished)
4 Nationalization of the institution
Dependent on:
• Balance sheet problems so severe that a partial intervention is not helpful.
• Potential buyers are not willing to take the risk.
• Systemic importance for the financial network.
Goals:
•To maintain the bank as a going concern given its critical importance.
Tools:
•A major capital infusion from the Government.
4 Nationalization of the institution
Advantages Disadvantages
•Avoids the costs of a •Costly for the supervisor
bank closure. (fiscal and monetary impact).
•Preserves bank •Bank could be affected by a
operations. hidden agenda (ineficiency).
5 Merger with other banks (induced by
authorities)
Dependent on:
• Potential to improve the balance sheet before auction process.
• Systemic importance for the financial network.
Goals:
•Retain some of the franchise value.
•Integrate depositors and other liabilities (different from shareholders) inside a healthier and
better managed bank.
Tools:
•Auction process.
•Good bank-bad bank solution to isolate worse assets of the bank.
5 Merger with other banks (induced by
authorities)
Advantages Disadvantages
•Preserves bank •May cause problems to
operations. acquiring bank.
•Moral Hazard
6 Purchase and assumptions
Dependent on:
• Balance sheet with many troubled assets but some assets still can have a profitable fair value.
• Other private banks willing to buy the bank´s assets.
Goals:
•Retain some of the franchise value.
•Integrate depositors and other liabilities (different from shareholders) inside a healthier and
better managed bank.
Tools:
•Auction process together with some type of guarantee from the Government to cover troubled
assets losses.
•Good bank-bad bank solution to isolate worse assets of the bank.
6 Purchase and assumptions
Advantages Disadvantages
•Minimizes cost of •Requires voluntary
resolution (preserving participation of other banks.
asset´s fair value). •Requires skills, political
•Small impact on banks will and guidelines.
operations.
•Minimizes moral
hazard.
6 Purchase and assumptions
(good&bad bank formula)
•Legal unity is split in two entities: a Good-bank and a Bad-bank .
•GOOD BANK:
•Retains well performing assets
•Assets avoid loosing value through judicial liquidation process.
•Assumes deposits and labor claims.
•Good-bank operates more efficiently
•Raises capital more easily and at lower rates.
BAD BANK:
•Retains non-performing assets.
•Assumes rest of liabilities.
•Focuses all efforts at loan recovery and self-liquidation.
•Funds recovered are paid back through dividends and interest payments.
•The key issue is funding the entity (debt can be difficult to place).
7 Closure of the bank and payment of deposits
Dependent on:
• Taxpayer cost of maintaining the surviving firm Vs the going concern value.
• Which are the liability holders share in the associated loss.
• Systemic importance for the financial network.
Goals:
•To use efficiently taxpayers money.
Tools:
•Asset disposal plan.
7 Closure of the bank and payment of deposits
Bank is Deposits Bank is
closed are paid liquidated
Advantages Disadvantages
•The problem is •Asset fire sales (distressed
solved sales due to liquidation
process)
•No moral hazard-
market discipline •Bank´s services and jobs
are lost.
•Potential systemic threat
Conclusions on Bank Resolution:
• Central Bank supervision and leadership are necessary in order to
implement needed actions in a short period of time. (over the weekend).
•Political support is needed in order to provide the necessary quantity
of resources that the right solution demands. (unlimited guarantees)
•It is necessary to provide a clear framework for cross-border bank
crisis (relationship among national supervisors, funding and lenders of last resort).
Conclusions on Bank Resolution:
In each case, regulators attempt to limit
the impact of the crisis by some form of forbearance.
Capital inflow usually follows, and
merger talks are not far behind.
Often, forced P & A has the effect of liquidation with government assistance.
Lessons from the experience:
[Link] of intervention are generally larger than anticipated;
2. Interventions aimed at preserving the current institutional structure generally do not achieve
the expected outcome
3. The only sure resolution appears to come from confronting the insolvency directly and
addressing its financial implications, no matter how large.
Regulators, however, often delay action in the hope of a turnaround..
If the regulator is lucky, a change in the aggregate economy will remedy the financial imbalance. However,
regulators are rarely lucky, at least in recent history. Resolution options available to regulators
only permit them to delay the effects of a massive asset valuation change on bank structure in
the hope of a return to financial viability.
If they do not set off a series of counterproductive
incentive effects, they may offer both the regulator and the bank manager time to shore up
balance sheets and improve profitability. But, they offer only a little time and often require
considerable luck. If the banking system can not correct its problems in short order, as was the
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case in the US Thrift Crisis, or if the economy continues to deteriorate, as in the Scandinavian
case, or if the losses are too large, as in France, the policy will not achieve its end. On the
edges these policy options may offer some hope to sustain the institutions’ lending capacity
and consumer confidence for a short period of time. However, in the end, all of these options
are no replacement for sound bank management and a sound balance sheet.