## msfcea ## Source details **Canonical URL:** [msfcea](https://www.imf.org/-/media/files/publications/dp/2020/english/msfcea.pdf) ## Other formats - [Markdown version](/-/media/files/publications/dp/2020/english/msfcea.pdf.md) - [Structured JSON version](/-/media/files/publications/dp/2020/english/msfcea.pdf.json) --- ### Preface — purpose, scope, and contributions - Purpose and scope - Updates IMF operational guidance on preparing for and managing systemic banking crises drawing on IMF MCM staff advice, Executive Board Papers, IMF staff publications, and country documents. - States: “Unless stated otherwise, the guidance is generally applicable across the IMF membership.” - Clarifies exclusions: “The paper does not summarize the causes of the GFC, its evolution, or the policy responses adopted; these concepts have been well documented elsewhere.” It also focuses on legal and operational crisis-preparedness and management elements rather than the full reform agenda since the crisis. - Contributions and acknowledgements - Reflects contributions from the Financial Crisis Preparedness and Management Division, Central Bank Operations Divisions of MCM, and significant input from IMF Legal Department staff. - Acknowledges a long list of contributing staff and notes Tobias Adrian and Miguel Savastano for “providing intellectual direction and clarity.” - Views and responsibility - Declares: “The views expressed in this paper, as well as any errors, are the sole responsibility of the authors and do not necessarily represent the views of the IMF Executive Board or other members of the IMF staff.” ### Context, motivation, and key changes since the GFC - Systemic crisis characteristics - Recurring across IMF membership; panics with creditor runs are “rare events in any one country” but relatively frequent globally. - Common causes: “high leverage, booming credit, an erosion of underwriting standards, exposure to rapidly rising property prices and other asset bubbles, excessive exposure to the government, inadequate supervision, and often a high external current account deficit.” - Financial distress typically lasts several years and is associated with large economic contractions and high fiscal costs (Laeven and Valencia 2018). - GFC-specific differences in policy responses - Liquidity support: “The size and scope of liquidity support provided by major central banks was unprecedented.” More counterparties, longer maturities, wider collateral. - Guarantees: explicit liability guarantees deployed more selectively; implicit guarantees and public solvency support were widespread; “Systemic financial institutions were rarely liquidated or resolved.” - Cross-border resolution: lack of enforceable cross-border mechanisms led to breakup of some cross-border groups. - Nonperforming assets: more emphasis on banks managing NPLs internally or via market disposals; centralized AMCs used selectively. ### Regulatory reform agenda objectives (post-GFC) - The new architecture aimed to: 1. “enhance capital buffers and reduce leverage and financial procyclicality”; 2. “contain funding mismatches and currency risk”; 3. “enhance the regulation and supervision of large and interconnected institutions, including by expanding the supervisory perimeter”; 4. “improve the supervision of a complex financial system”; 5. “align governance and compensation practices of banks with prudent risk taking”; 6. “overhaul resolution regimes of large financial institutions”; 7. “introduce macroprudential policies.” - IMF contributions through multilateral and bilateral surveillance including FSAP, Article IV missions, and Global Financial Stability Reports. ### Structure and high-level message - Part I: crisis preparedness—design and operational features of a well-designed financial safety net and evolution of IMF staff advice. - Part II: operational strategies and techniques to manage systemic crises. - Emphasis: “better-prepared authorities are less likely to resort to bailing out bank shareholders and creditors when facing such circumstances.” --- ### Part II — Crisis management: phases and policy focus - Crisis phases (not necessarily sequential) - Containment — stem creditor runs and stabilize liquidity in the acute panic phase; typically short-lived. - Restructuring and resolution — diagnose bank soundness and recapitalize or resolve failing institutions; typically implemented over the following year or more. - Dealing with distressed assets — identify and remove impediments to effective resolution of distressed assets; implementation likely to stretch over several years. - IMF engagement - IMF staff provide support and advice on supervisory practice, resolution, deposit insurance, and emergency liquidity in IMF member countries. ### The Financial Safety Net — pillars and reforms - Four pillars (Figure 2): (1) supervisory early intervention, (2) resolution of financial institutions, (3) deposit insurance, and (4) central bank liquidity assistance. - Post-GFC international standards and reforms referenced: - FSB Key Attributes of Effective Resolution Regimes; - IADI Core Principles for Effective Deposit Insurance Systems (revised); - Basel Committee Core Principles for Effective Banking Supervision (2012 revisions); - Evolution of central bank liquidity practice (Committee on the Global Financial System 2017; Dobler and others 2016). - FSAP: financial safety net assessed under IMF–World Bank FSAP; formal assessments against Key Attributes and IADI Core Principles can be published as part of FSAP. --- ### Supervisory early intervention — lessons and recommendations - Core problem: failure to decisively address weak banks increases losses, contagion, moral hazard, and competitive distortions. - Basel Core Principles (2012) strengthened supervisory practices by: - Increasing supervisory intensity/resources for systemically important banks; - Applying a systemwide macroprudential perspective; - Emphasizing recovery measures and corporate governance; - Requiring “a clear framework or process for handling banks in times of stress.” - Supervisory best practices - Early detection via enhanced monitoring, reporting, onsite inspections, and stress tests. - Use of a “ladder of intervention” with clear but flexible triggers. - Proportional enforcement escalating when management/shareholders fail to restore the bank. - Supervisory attributes: intrusive, adaptive, skeptical, proactive, comprehensive, conclusive. - Necessity of adequate resources, legal authority/protection, clear mandate, operational independence, strong governance, and accountability. - Persistent shortcoming: weak governance and inadequate staffing/budget remain major compliance gaps. --- ### Resolution regimes — powers, design, governance, and benefits - Purpose: resolve failing banks without undermining financial stability, preserve depositor access and critical functions, enable performing assets to continue as going concerns. - Legal/operational requirements - Strong administrative resolution authority with solid legal foundation; powers exercisable quickly without shareholder/creditor consent and ideally before balance sheet insolvency. - Creditor safeguards including “no worse off than in liquidation” mechanisms. - Key Attributes emphasize statutory bail-in powers, recovery and resolution planning, international cooperation, and creditor safeguards. - Benefits of broadened toolkit - Move beyond liquidation/nationalization to improve trade-offs between fiscal cost/moral hazard and stability. - Encourage manager discipline, reduce systemic spillovers, weaken sovereign-bank nexus, reduce “too-important-to-fail” funding advantages. - Institutional design and governance - Resolution authority independence, transparent processes, adequate funding, independent decision makers, legal protection. - Core in-house cadre supplemented by prearranged external expertise. - Options when failures infrequent: central bank or supervisor may assume resolution responsibilities with firewalls. - Ex post evaluation and accountability recommended. - Alignment with liquidation - Options: fully administrative regime or dual regime with court-appointed liquidator; courts should not hinder prompt implementation of lawful resolution measures. --- ### Deposit insurance and depositor preference - Deposit Insurance (DIS) post-GFC reforms and design principles - Reforms: higher coverage levels, elimination of coinsurance, faster payouts, ex ante funding, restrictions on DIS funds for open bank assistance, strengthened information sharing. - IADI guidance: capacity to reimburse most depositors within seven days (IADI 2014); rule out coinsurance. - Design: protect most retail depositors by number but not most deposits by value; build fund over time (for example, about five years) via regular ex ante contributions. - No international consensus on fund sufficiency; staff use cross-country comparisons and prudent margins. - Back-up liquidity arrangements, including government support, are necessary. - Operational independence and governance - IADI Core Principle 3: “no government, central bank, supervisory or industry interference that compromises the operational independence of the deposit insurer.” - Exclude active bankers from DIS governance; key elements (coverage, contributions, ex ante funding) should be enshrined in law; DIS typically public-sector entity with legal protection for staff. - Mandate options - Stand-alone agency with resolution powers for large sectors; “paybox plus” mandate in jurisdictions with infrequent failures, with safeguards to avoid overexposure or open bank assistance. - Depositor preference - Gives depositors higher priority than other creditors in liquidation, reducing DIS costs and facilitating resolution. - Tiered or general depositor preference most advantageous with a DIS. - Avoid “national depositor preference” as it impedes cross-border cooperation (Key Attribute 7.4). - Introducing depositor preference may raise wholesale funding costs or incentivize secured funding; complements may be needed (minimum LAC, limits on encumbrance). --- ### Emergency Liquidity Assistance (ELA) — framework and operational lessons - Purpose: central bank liquidity to prevent temporary illiquidity from causing insolvency and contagion. - Framework principles - Eligibility: all banks should be eligible; central bank discretion to include certain nonbank entities (for example, central clearing counterparties). - Solvency test: ELA normally provided when supervisor deems entity solvent and viable; assessments must be forward-looking with credible funding plans. - Collateral: ELA should be adequately collateralized; accept wide range of unencumbered assets with valuation systems, predetermined haircuts, settlement, and realization arrangements. - Duration: may need maturities longer than overnight; counterparties should prepare funding plans and incentives to repay; contingency if ELA discontinued. - Cost: ELA rates (typically spread over policy rate) should discourage unnecessary use without exacerbating strains; no clear “above market” benchmark in dysfunctional markets. - Governance/indemnities: central banks should seek government indemnities where solvency/viability is in doubt; clarity on indemnity circumstances. - Disclosure: confidentiality until stability no longer endangered; possible ex post disclosure and lagged full balance sheet publication. - Challenges and operational issues - Stigma: standing facilities underused; systemwide facilities, widened OMOs, and moral suasion used during GFC to mitigate stigma. - Foreign-currency ELA: legal capacity and funding critical where deposits/funding are foreign currency–denominated; central bank swap lines were used by major advanced economies. - Liquidity in resolution: banks in resolution may require central bank liquidity (for example, bridge banks); central banks should provide liquidity subject to safeguards and government indemnity; many central banks lack capacity due to solvency/licensing constraints. - Example: Hong Kong SAR announced a Resolution Facility in August 2019, available to a bank placed into resolution, with any losses recoverable from the industry via a levy. --- ### Key elements checklist for resolution frameworks and crisis readiness - Scope: resolution regime should cover any institution that could be systemically significant. - Resolution authority: designate operationally independent administrative resolution authorities with clear mandates, responsibilities, and adequate resources. - Resolution powers: broad powers to assume control, replace management, appoint an administrator, transfer ownership, transfer assets/liabilities to private purchaser or bridge bank, bail-in creditors (write down/convert), and establish AMV to purchase NPLs; powers should be exercisable quickly without shareholder/creditor consent. - Set-off, netting, collateral, client asset segregation: protect these arrangements, with authority able to suspend temporarily. - Safeguards: creditors should receive compensation if made worse off than in liquidation; judicial actions should not delay or reverse resolution measures if lawful and in good faith. - Resolution funding: minimize public fund exposure; establish privately financed DIS or resolution funds or ex post recovery mechanisms for temporary public funding. - Cross-border cooperation: empower and encourage resolution authorities to cooperate with foreign counterparts; Crisis Management Groups and institution-specific cooperation agreements for G-SIFIs recommended. - Resolvability assessments: regularly undertake for all G-SIFIs and require changes where needed. - Recovery and resolution planning and information sharing: require planning and eliminate impediments to domestic and cross-border exchange of information among authorities. --- ### Contingency planning, operational preparedness, and communications - Institutional preparedness - Core entities: central bank, supervisory/regulatory agencies, resolution authority, deposit insurer, Ministry of Finance. - Functions (supervision, resolution, ELA) should be operationally separate with safeguards; functional separation can mitigate risks where capacity limited. - Crisis manuals, table-top exercises, simulations, and legal protection for officials recommended. - Recovery and resolution planning - Recovery plans developed by firm management with Board approval; include triggers and measures, strategic options; supervisors may require implementation. - Resolution plans developed by authorities to guide resolution, remove impediments, and define strategies (SPE or MPE). - LAC must be issued from appropriate group entities to effect preferred strategies (for example, non-operating holding company for SPE). - Operational preparedness (ELA and collateral) - Many central banks have not implemented arrangements to accept wide collateral range for ELA. - Manage collateral risk via minimum credit quality, haircuts, concentration limits, margin calls. - Preposition eligible loan pools and pre-specify eligible debtors and haircuts to accelerate ELA. - Legal enforceability of security claims on nonstandard collateral may require ex ante legislative changes. - Domestic and cross-border cooperation - Formal coordination arrangements and crisis preparedness inter-agency committees recommended. - Key Attributes call for empowerment of resolution authorities to cooperate and share confidential information with foreign counterparts and provide transparent processes to give domestic effect to foreign resolution measures. - Regular intra- and inter-agency simulation exercises advised (example: Nordic-Baltic Financial Crisis Simulation exercise in 2019 involved participation of 31 authorities across 8 countries). - Crisis communications principles - Communications must be part of a comprehensive policy package that credibly addresses root causes. - Do not communicate problems without solutions; explain who bears losses in plain language; do not overpromise; speak with one voice; prepare templates and education in advance. --- ### Containment, stabilization, and systemic liquidity provision - Containment focus: ensure banks can meet maturing liabilities and withdrawals; ELA is main instrument. - Non-reserve currency issuers: systemwide liquidity assistance can cause inflationary and exchange rate pressures and compromise monetary transmission; widescale provision seen in the GFC unlikely to be replicable in non-reserve currency countries. - Liquidity provision operational notes - Effectiveness depends on institutions’ willingness/ability to on-lend liquidity; fragmentation may require new facilities targeting affected institutions. - Market support programs should incentivize re-entry while considering central bank costs, risks, and moral hazard. - Example: Term Auction Facility during GFC expanded counterparties beyond primary dealers. --- ### Guarantees, asset guarantees, and AMCs - Liability guarantees - Can stem runs and restore confidence; often temporary and fee-based; depend on sovereign credibility. - Blanket guarantees constrain resolution options, raise moral hazard, tighten bank-sovereign nexus; removing them is complex. - Dell’Ariccia and others (2018b) estimate conditional probability of a sovereign debt crisis when a banking crisis emerges at 51 percent. - Asset guarantees vs AMCs - Asset guarantees provide a partial floor on losses, contingent liabilities with no immediate government debt impact. - AMCs permanently remove risk from bank balance sheets, require upfront cost/time, immediately affect government debt (unless structured otherwise), and may take many years to wind up. - AMCs used selectively where multi-creditor, large-value, non-core illiquid assets and fiscal capacity justify them. --- ### Administrative measures: capital controls and deposit restrictions - Use as last-resort to stop runs and protect liquidity, balance of payments, and payments systems. - Design principles - Calibration to allow day-to-day transactional needs; allow household/firm withdrawals up to certain amounts over a period. - Restrictions distortive, resource-intensive to enforce; should be removed as soon as conditions allow and eased gradually with recovery. - Must comply with Article VIII of IMF Articles of Agreement and Institutional View on capital flows; capital flow management on outflows can be consistent in crisis as part of broad policy package. - Case examples: Cyprus, Greece, Iceland - Greece: €420 limit on cash withdrawals per week (any currency); domestic credit card payments unlimited; €2,000 foreign cash limit per individual per foreign trip. - Cyprus: €300 limit on cash withdrawals per day in each credit institution; domestic transfers limited to €5,000 per day per bank account (higher with committee approval); payments abroad by card limited to €5,000 per month per person; foreign transfers limited to €5,000 per day (higher with committee approval); €1,000 foreign cash limit per individual per foreign trip. - Iceland: no limits on domestic currency withdrawals; ISK 500,000 foreign cash limit per individual per foreign trip; private sector credit card issuers/banks introduced their own limits. - Operationally, processing approvals initially took one to three days; Greece lifted final cross-border restrictions in September 2019; Iceland lifted some controls after eight years in some cases. --- ### Restructuring, diagnostics, and valuation (AQR and stress testing) - Bank diagnostics objectives and triage - Diagnostic examinations (often with independent third parties) to establish credible balance sheet valuations; stress tests and AQRs central. - Viability triage: (1) viable and compliant; (2) viable but undercapitalized and/or illiquid; (3) nonviable. - Valuation for resolution - Quick, reliable valuation of assets/liabilities prerequisite; “size of the hole” estimated to determine funding shortfall. - Counterfactual valuation estimates liquidation outcomes to ensure “no creditor worse off” safeguard. - Operational needs: granular, up-to-date MIS; capacity to outsource valuation at short notice with established principles and scenarios. - Good AQR practices - Comprehensive terms of reference, set accounting/collateral valuation/regulatory standards; provide macro forecasts for key variables (for example, GDP growth, unemployment, exchange rates, interest rates) and property values (residential real estate index, commercial real estate index). - Disciplined project management with governance and oversight; include local participation; decide ex ante on financing sources to avoid undermining confidence. - Stress testing uses - Ongoing supervision (examples: Comprehensive Capital Analysis and Review by US Fed; EU-wide stress tests by EBA). - Macroprudential diagnostics and forward-looking crisis diagnostics that include all systemic and distressed institutions; use realized shock as baseline when applicable. --- ### Resolution tools: P&A, bridge banks, bail-in, LAC/TLAC, and recapitalization - Partial asset and liability transfer (P&A) - Transfers deposits to healthy bank; DIS may cover gaps on least-cost basis; advantages: deposit access preserved, often higher going-concern asset values. - Limitations: infeasible for very large/complex banks or absent purchasers. - Bridge bank - Temporary government-owned institution to assume good assets and insured deposits; requires management, business plan, licensing capability, and clear governance. - Pre-drafting and pre-identifying managers recommended; valuation must be prudent; reverse transfer powers limited in scope/time. - Bail-in - Statutory bail-in writes down/convert loss-absorbing liabilities into equity to impose losses on creditors without liquidating legal entity. - Complexities: interaction with securities laws and ownership suitability rules. - Simpler systems may not need bail-in if other tools suffice. - LAC and TLAC - TLAC: unsecured liabilities including equity, subordinated debt and some senior debt (excluding deposits/structured debt) with maturity at least one year for G-SIBs. - D-SIBs may require LAC buffers to facilitate resolution. - Retail investor exposure to bail-in instruments should be limited by investor protection measures. - Recapitalization using public funds - Last resort, used only when stability severely threatened and under strict conditions. - Preconditions: losses recognized and equity written down before public funds; attribution of losses among creditors is key. - Ownership/management post-recapitalization should be managed by finance ministry or specialized agency. - Instruments: equity participations, non-core capital (contingent convertibles, redeemable preference shares) under specific conditions; contingent capital for temporary buffer enhancement. - Sovereign financing constraints: government bond recapitalization raises feasibility and market-reaction concerns; bond characteristics (interest rate, maturity, marketability, collateral use) matter. - Example: Iceland’s 2008 recapitalization triggered a sovereign downgrade and foreign outflows. --- ### Dealing with distressed assets, NPLs, and AMCs - Key findings on NPLs - High NPLs impede viability, credit growth, and recovery by increasing provisions, tying up capital, and increasing funding costs. - Managing very large NPL portfolios requires specialist skills beyond typical bank management. - Heavily indebted firms reduce investment incentives, damping recovery and asset values. - Effective strategies typically combine tightened supervision, insolvency/enforcement reforms, and measures to facilitate asset disposal and distressed debt markets. - Banks’ options for NPLs - Restructure loans; settle at discount; sell risk to third parties; enforce collateral; or use insolvency proceedings. - Supervisory policy recommendations - Ensure sufficient loss-absorbing capacity; swift loan loss recognition, robust provisioning, prudent collateral valuation guidance, timely write-offs, enhanced disclosure. - Operational measures: enhanced monitoring, internal NPL workout units, operational targets to reduce NPLs. - Insolvency and enforcement reforms - Need efficient enforcement/insolvency laws and institutions; examples: faster foreclosure, judge specialization, e-auction platforms, streamlined SME processes. - Remove informational and tax obstacles (credit bureaus, searchable registers, tax rule reforms). - Distressed asset markets and AMCs - Distressed asset markets require reliable enforcement frameworks and risk capital; legal/regulatory reforms often necessary. - Centralized AMCs advantages: economies of scale, bargaining power, specialized skills, uniform valuation. - Risks: political interference, weak governance, inflated acquisition prices, inadequate documentation, large upfront funding needs. - Good-practice AMC features: - Clear, commercial mandate to maximize recovery and reduce public liabilities over fixed lifespan. - Independent Board and management; operational flexibility (market pay, hire advisers). - Limited lifespan (“sunset” clauses). - Transparent valuation benchmarks, audited financials, oversight (parliamentary committee). - Separate operating budgets and sufficient funding; use market-rate remunerated government bonds acceptable as central bank collateral; long tenors to realize asset value. - Seek market funding where feasible to minimize distortions and impose market discipline. - Central bank ownership/funding of AMCs not advisable. --- ### Excessive related‑party exposures — three‑pillar resolution approach - Risks - Conceal credit/concentration risk, poor governance, AML/CFT violations, fraud; tie up capital and reduce solvency. - Three-pillar approach 1. Legal reforms: disclosure, prudent limits, conflict-of-interest rules, grounds for license revocation for non-transparent ownership, presumptions shifting “burden of proof” to banks. 2. Bank diagnostics: identify ultimate beneficial owners, related-party exposures, assess compliance with limits using control, economic dependency, acting-in-concert criteria. 3. Enforcement actions: remove unsuitable shareholders, unwind excessive related-party exposures via repayment, disposal, or ownership change. - Implementation - Best within comprehensive financial-sector strategy; where legal reform delayed, ringfence suspected exposures and implement full measures after stabilization. --- *Source: msfcea - Extracted from the IMF staff paper (Part I and Part II content, Boxes 1, 3, 4, 5, 8, and 9 as presented in the source PDF).* ### Preface ���������������������������������������������������������������������������������������������������������������� ### Preface ### Purpose and scope - Updates the IMF’s work on general principles, strategies, and techniques from an operational perspective in preparing for and managing systemic banking crises in light of the experiences and challenges faced during and since the global financial crisis. - Summarizes IMF advice from staff of the IMF Monetary and Capital Markets Department (MCM), drawing on Executive Board Papers, IMF staff publications, and country documents (including program documents and technical assistance reports). - States: “Unless stated otherwise, the guidance is generally applicable across the IMF membership.” - Clarifies what the paper does not cover: “The paper does not summarize the causes of the GFC, its evolution, or the policy responses adopted; these concepts have been well documented elsewhere.” It also notes it does not cover the full reform agenda since the crisis, but focuses on key elements of a legal and operational framework for crisis preparedness and operational strategies and techniques to manage systemic crises if they occur. ### Contributions and acknowledgements - Reflects contributions of the Financial Crisis Preparedness and Management Division and the Central Bank Operations Divisions of MCM, and significant input from staff of the IMF Legal Department. - Special acknowledgements list: Mark Adams; Atilla Arda; Thierry Bayle; David Blache; Mark Buessing-Loercks; Laszlo Butt; Luis Cortavarría Checkley; Oana Maria Croitoru; Franck Dupont; Ender Emre; Olivier Frécaut; José Garrido; Ivan Guerra; Alessandro Gullo; Joaquín Gutierrez Garcia; David S. Hoelscher; Gayon Hosin; Silvia Iorgova; Jaime Jaramillo Vallejo; Deeksha Kale; Edda Rós Karlsdóttir; Darryl King; Mesmin Koulet-Vickot; Suchitra Kumarapathy; Paul Leonovich; Peter Lõhmus; Mario Mansilla; Greta Mitchell Casselle; Johan Molin; Michael K. Moore; Dermot Monaghan; Rafel Moyà Porcel; Diarmuid Murphy; Jan Nolte; David C. Parker; Jean Portier; Oleksandr Pysaruk; Constant Verkoren; and Oliver Wünsch. - Acknowledges Tobias Adrian and Miguel Savastano for “providing intellectual direction and clarity,” and Charmane Ahmed and the administrative team for “excellent support throughout the project.” ### Views and responsibility - Declares: “The views expressed in this paper, as well as any errors, are the sole responsibility of the authors and do not necessarily represent the views of the IMF Executive Board or other members of the IMF staff.” ### Context and motivation: systemic crises and the GFC - Notes that systemic financial crises are recurring and that panics with creditor runs are “rare events in any one country” but have occurred relatively frequently across the IMF membership. - Identifies common causes: “high leverage, booming credit, an erosion of underwriting standards, exposure to rapidly rising property prices and other asset bubbles, excessive exposure to the government, inadequate supervision, and often a high external current account deficit.” - States: “Financial distress typically lasts several years and is associated with large economic contractions and high fiscal costs (Laeven and Valencia 2018).” - Emphasizes that the global financial crisis (GFC) “transcended national and regional boundaries” and shares several features with past crises but had greater global reach because it originated in advanced economies with large financial sectors. ### Key differences in crisis responses during the GFC - Size and scope of liquidity support: - “The size and scope of liquidity support provided by major central banks was unprecedented.” - “More liquidity was provided to more counterparties for longer periods against a wider range of collateral.” - Much support was “through liquidity facilities open to all market participants,” while some was provided as emergency liquidity assistance (ELA) to individual institutions. - Use of explicit and implicit guarantees: - “Explicit liability guarantees were more selectively deployed than in past crises.” - During the GFC explicit guarantees typically applied only to specific institutions, new debt issuance, specific asset classes, or were capped. - “Implicit guarantees were widespread, as demonstrated by the extensive public solvency support provided to financial institutions and markets.” - “Systemic financial institutions were rarely liquidated or resolved,” and where resolution occurred, some cases proved “destabilizing for the broader financial system.” - Cross-border resolution challenges: - “Difficulties in achieving effective cross-border cooperation in resolution between authorities in different countries came to the fore.” - The lack of mechanisms to enforce resolution measures on a cross-border basis “led, in some cases, to the breakup of cross-border groups into national components.” - Approach to nonperforming assets: - “More emphasis was placed on banks’ ability to manage nonperforming assets internally or through market disposals, with less reliance on centralized asset management companies (AMCs).” - Progress in addressing distressed assets and deleveraging was sometimes slower due to protracted weak growth, the large scale of the problem, and gaps in legal frameworks. ### Regulatory reform agenda (post-GFC objectives) - The new architecture aimed to: 1. “enhance capital buffers and reduce leverage and financial procyclicality”; 2. “contain funding mismatches and currency risk”; 3. “enhance the regulation and supervision of large and interconnected institutions, including by expanding the supervisory perimeter”; 4. “improve the supervision of a complex financial system”; 5. “align governance and compensation practices of banks with prudent risk taking”; 6. “overhaul resolution regimes of large financial institutions”; 7. “introduce macroprudential policies.” - Notes the IMF’s contribution through multilateral and bilateral surveillance, including the Financial Sector Assessment Program (FSAP), Article IV missions, and Global Financial Stability Reports. ### Relation to prior work and intended content of the paper - Builds on the IMF’s 2003 paper (Hoelscher and Quintyn 2003) and subsequent staff experience. - States: “The paper summarizes the general principles, strategies, and techniques for preparing for and managing systemic banking crises, based on the views and experience of IMF staff, considering developments since the GFC.” - Organization: - Part I: crisis preparedness—design and operational features of a well-designed financial safety net and how staff advice evolved, drawing from international standards and good practice. - Part II: operational strategies and techniques to manage systemic crises if they occur. - Emphasizes that “better-prepared authorities are less likely to resort to bailing out bank shareholders and creditors when facing such circumstances.” ### Extract from Table 1: Lessons on the Design of the Financial Safety Net - What is Similar? - “Escalating early intervention and enforcement measures” - “Special resolution regimes for banks” - “Establishing deposit insurance (if prior conditions enable)” - “Desirability of depositor preference” - “Capacity to provide emergency liquidity to banks, at the discretion of the central bank” - What is New? - “More intrusive supervision and early intervention powers” - “A new international standard on resolution regimes for systemic financial institutions requiring a range of resolution powers and tools” - “An international standard on deposit insurance, requiring ex ante funding and no coinsurance” - “Liquidity assistance frameworks with broader eligibility conditions, collateral, and safeguards” - Note appended to the table: “IMF staff does not recommend establishing a deposit insurance system in countries with weak banking supervision, ineffective resolution regimes, and identifiably weak banks. Doing so would expose a nascent scheme to significant risk, (when it has yet to build adequate funding and operational capacity) and could undermine depositor confidence.” *Preface — Managing Systemic Banking Crises—New Lessons and Lessons Relearned* ### Part II, on crisis management, discusses aspects of a policy response to a ### Part II — Crisis management ### Scope and focus - Addresses a policy response to a full-blown banking crisis. - Details the evolution of IMF advice in light of what worked well—or less well—during the GFC, reflecting the experience of IMF staff in actual crisis situations. ### Evolution of IMF advice - Emphasizes lessons drawn from GFC experience and actual crisis engagements by IMF staff. - Notes that the narrative reflects what “worked well—or less well” during the GFC. ### Organization around three distinct aspects - The narrative is organized around policies for dealing with three distinct aspects of systemic banking crisis. - The text includes a footnote marker: "3". - A related footnote marker "2" appears referencing prior literature (for example, Claessens and others (2010), among many other studies). ### Key conceptual points and caveats - While tempting to describe these as phases, they need not be sequential. - If the authorities are well-prepared, as described in Part I, shocks that would have triggered a systemic crisis in the past may not do so in the future. *Source: msfcea - Part II, on crisis management, discusses aspects of a policy response to a (PDF).* ### Introduction ### Introduction ### Crisis phases and policy focus - Containment—strategies and techniques to stem creditor runs and stabilize financial sector liquidity in the acute phase of panic and high uncertainty. This phase is typically short-lived, with an escalating policy response as needed to avoid the collapse of the financial system. - Restructuring and resolution—strategies and techniques to diagnose bank soundness and viability, and to recapitalize or resolve failing financial institutions, which are typically implemented over the following year or more, depending on the severity of the situation. - Dealing with distressed assets—strategies and techniques to clean up private sector balance sheets that first identify and then remove impediments to effective resolution of distressed assets, with implementation likely to stretch over several years. - IMF engagement: IMF member countries continue to cope with financial panics and widespread financial sector weakness. IMF staff provide support and advice on supervisory practice, resolution, deposit insurance, and emergency liquidity in IMF member countries. ### The Financial Safety Net: structure and reforms - Four pillars of the financial safety net (Figure 2): (1) supervisory early intervention, (2) resolution of financial institutions, (3) deposit insurance, and (4) central bank liquidity assistance. - Pre-GFC shortcomings: powers and tools incomplete in many advanced economies; policy responses uncoordinated across jurisdictions, hampering responses to failing cross-border institutions. - Post-GFC international standards and reforms: - Financial Stability Board (FSB): Key Attributes of Effective Resolution Regimes for Financial Institutions. - International Association of Deposit Insurers (IADI): Core Principles for Effective Deposit Insurance Systems (revised). - Basel Committee: revised Core Principles for Effective Banking Supervision (2012 revisions strengthened supervisory powers for recovery and early intervention). - Evolution of central bank liquidity practice, including ELA (Committee on the Global Financial System 2017; Dobler and others 2016). - FSAP link: the financial safety net is a key element of the financial stability framework assessed under the IMF and World Bank Financial Sector Assessment Program (FSAP); formal assessments against the Key Attributes and IADI Core Principles can be published as part of the FSAP. ### Supervisory early intervention: lessons and recommendations - Core problem: failure to decisively address problems at weak banks leads to greater losses and contagion risk; unchecked bad practices generate moral hazard and competitive distortions. - Basel Core Principles (2012 revisions) strengthened supervisory practices by: - Increasing supervisory intensity and resources for systemically important banks. - Applying a systemwide, macroprudential perspective. - Emphasizing effective recovery measures and corporate governance. - Adding an essential criterion: supervisors must have “a clear framework or process for handling banks in times of stress, such that any decisions to require or undertake recovery or resolution actions are made in a timely manner.” - Supervisory best practices: - Early detection via enhanced monitoring, reporting, onsite inspections, and stress tests. - Use of a “ladder of intervention” with clear but flexible triggers. - Proportional enforcement that escalates when management/shareholders fail to restore the bank. - Supervision should be intrusive, adaptive, skeptical, proactive, comprehensive, and conclusive. - Supervisors require adequate resources, strong legal authority and protection, clear mandate, operational independence, strong governance, and accountability to avoid capture. - Persistent shortcoming: weak governance and inadequate staffing/budget remain greatest compliance gaps with the Core Principles. ### Resolution regimes: powers, design, and governance - Purpose: address weak or failing banks without undermining financial stability; preserve depositor access and critical functions, and enable performing assets to be managed as going concerns. - Legal and operational requirements: - Strong powers for an administrative resolution authority with solid legal foundations to prevent reversal by legal challenges. - Powers should be exercisable quickly, without shareholder and creditor consent, ideally before balance sheet insolvency. - Creditor safeguards (including mechanisms to ensure that creditors are made no worse off than in liquidation) are critical to balance stability and property rights. - Key Attributes: codify international best practices in resolution, extend IMF advice, add statutory bail-in powers, establish recovery and resolution planning, international cooperation, and creditor safeguards. - Benefits of broadened resolution toolkit: - Enables authorities to move beyond liquidation or nationalization—improving trade-offs between fiscal cost/moral hazard and financial stability risks (Figure 3 conceptual: moving from straight to concave policy trade-off). - Encourages stakeholder discipline on managers, reduces systemic spillovers, weakens sovereign-bank nexus feedback, and reduces “too-important-to-fail” funding advantages. - Institutional design and governance: - Resolution authority should be independent from government and the financial sector, have transparent processes, sound governance, adequate funding, independent decision makers, and legal protection. - Staffing model: core in-house cadre supplemented by prearranged external expertise (public and private sector). - Where failures are infrequent, central bank or supervisor may assume resolution responsibilities with adequate firewalls. - Ex post evaluation and accountability for resolution authority performance. - Alignment with liquidation: - Two approaches: fully administrative regime (resolution and liquidation under resolution authority) or “dual regime” with court-appointed liquidator for full bank failure or rump post-resolution. - Court roles should not hinder prompt, effective implementation or reverse resolution measures taken within legal powers. - Administrative authorities should play significant roles in judicial liquidation frameworks (initiate liquidation, appoint liquidator, monitor conduct). ### Depositor protection: deposit insurance and depositor preference Deposit Insurance (DIS) - Post-GFC reforms and lessons: - Higher coverage levels and, in the EU, more harmonized coverage; elimination of coinsurance; faster payouts; enhanced depositor awareness; ex ante funding; restrictions on using DIS funds for open bank assistance; strengthened information sharing across safety net participants. - Coinsurance exacerbated bank runs (example: UK); IADI Core Principles rule out coinsurance. - Design principles: - Protect most retail depositors by number, but not most deposits by value (exclude high-value deposits). - Capacity to reimburse most depositors within seven days (IADI 2014). - Build sufficient fund over time (for example, about five years) via regular ex ante contributions by all banks. - No international consensus on fund sufficiency; staff rely on cross-country comparisons, historical and expert experience, and a prudent margin in advice. - Back-up liquidity arrangements, including government support, are necessary. - Operational independence: - IADI Core Principle 3: “no government, central bank, supervisory or industry interference that compromises the operational independence of the deposit insurer.” - DIS governance should exclude active bankers to avoid conflicts of interest and capture; key elements (coverage level, contributions, ex ante funding) should be enshrined in law. - DIS typically should be a public-sector entity with legal protection for staff. - Mandate options: - In large banking sectors, a stand-alone agency with resolution powers may be appropriate. - In jurisdictions with infrequent failures, a “paybox plus” mandate (reimburse insured deposits and fund resolution on least-cost basis) can be better suited; safeguards required to avoid overexposure of DIS funds and prohibit open bank assistance. Depositor Preference - Role: gives depositors higher priority of claim than other bank creditors in liquidation, facilitating depositor protection and reducing costs to DIS. - Benefits: - Reduces cost of protecting depositors in liquidation or resolution (subrogation of DIS). - Facilitates resolution by reducing legal challenges to deposit transfers or bail-ins. - Protects payments and economic activity by preserving access to deposit-based payment flows. - Design notes: - Tiered or general depositor preference offer most advantages in jurisdictions with a DIS. - Avoid “national depositor preference” (different priority by nationality or location) because it impedes cross-border cooperation in resolution (Key Attribute 7.4). - Introducing depositor preference may raise wholesale funding costs or incentivize secured funding; may need complements such as minimum loss-absorbing capacity (LAC) or limits on encumbrance. ### Emergency Liquidity Assistance (ELA): framework and lessons - Purpose: central bank liquidity to mitigate risk that temporary illiquidity leads to insolvency and to avoid contagion; critical due to banks’ maturity transformation. - Framework principles and lessons post-GFC: - Eligibility: all banks should be eligible, not only predesignated systemically important ones; central banks may need discretion to include certain nonbank entities (for example, central clearing counterparties) where necessary. - Solvency test: ELA normally provided at central bank discretion to entities deemed by the supervisor solvent and viable; assessments must be forward-looking and consider credible funding plans. - Collateral: ELA should always be adequately collateralized; central banks may accept a wide range of unencumbered assets with systems for valuation, predetermined margins (“haircuts”), settlement, and realization. - Duration: central banks may need to extend ELA at longer maturities than overnight; counterparties should prepare detailed funding plans and incentives to repay; contingency plans needed if ELA is discontinued. - Cost: ELA rates (typically spread over policy rate) should discourage unnecessary use but not exacerbate strains; no clear “above market” benchmark when markets are dysfunctional. - Governance and indemnities: central banks should seek government indemnities when providing ELA where solvency/viability is in doubt; clarity between central bank and government on indemnity circumstances. - Disclosure: confidentiality for ELA applicants should be maintained until financial stability is no longer endangered; central banks may disclose ex post and publish full balance sheet with a lag. - Challenges and operational issues: - Stigma: significant obstacle to use of standing facilities; systemwide facilities, widened open market operations, and moral suasion were used during the GFC to mitigate stigma. - Foreign-currency ELA: legal capacity and funding to provide ELA in foreign currency are critical where deposits or funding are foreign currency–denominated; central bank swap lines were used during the GFC by major advanced economies; advance agreements or regional arrangements and IMF support are relevant considerations. - Liquidity in resolution: a bank in resolution may need central bank liquidity to maintain critical functions (for example, a bridge bank); central banks should be able to provide liquidity subject to safeguards and typically backed by a government indemnity; many central banks currently lack capacity due to solvency/licensing conditions. - Example: The Hong Kong SAR announced a new Resolution Facility in August 2019, available to a bank placed into resolution, with any losses being recoverable from the industry via a levy. ### Key elements and recommended features (summary checklist) - Scope: resolution regime should cover any financial institution that could be systemically significant. - Resolution authority: designate operationally independent, administrative resolution authorities with clear mandates, roles, responsibilities, and adequate resources. - Resolution powers: provide broad powers to assume control, replace management, appoint an administrator, transfer ownership, transfer assets and liabilities (to private purchaser or bridge bank), bail-in creditors (write down/convert), and establish an asset management vehicle (AMV) to purchase NPLs; powers should be exercisable quickly without shareholder or creditor consent. - Set-off, netting, collateralization, segregation of client assets: protect these arrangements, with authority able to suspend temporarily. - Safeguards: creditors should receive compensation if made worse off than in liquidation; judicial actions should not delay or reverse resolution measures if authority acted within powers and in good faith. - Resolution funding: minimize public fund exposure; establish privately financed deposit insurance or resolution funds or ex post recovery mechanisms for temporary public funding. - Cross-border cooperation framework: empower and encourage resolution authorities to achieve cooperative solutions with foreign counterparts. - Crisis Management Groups: home and key host authorities should maintain crisis management groups that actively review and report on resolvability and recovery/resolution planning for G-SIFIs. - Institution-specific cross-border cooperation agreements: put in place between relevant authorities to manage information sharing and responsibilities for all G-SIFIs. - Resolvability assessments: resolution authorities should regularly undertake resolvability assessments for all G-SIFIs and require changes to business practices, structure, or organization where needed. - Recovery and resolution planning: require planning for recovery and resolution of institutions that could be systemically significant. - Information sharing: eliminate impediments to domestic and cross-border exchange of information among authorities in normal times and during crisis. *Source: msfcea - Introduction* ### Box 1. Summary of Financial Stability Board Key Attributes of Effective ### Box 1. Summary of Financial Stability Board Key Attributes of Effective Resolution Regimes ### The need for resolution funding - Resolution powers require effective funding arrangements. - Orderly resolution tools require sufficient and readily available funding. - At the point at which a bank must be resolved, its buffers of liquidity and capital will typically have been eroded. - Resolution funding may be needed to effect an orderly resolution, for example by backing a transfer of deposits to another bank; purchasing impaired assets; or injecting liquidity after a bail-in of creditors. - Pre-established arrangements should allow the resolution authority to promptly mobilize the financial resources necessary, so that authorities are not constrained to rely on public funds as a means of resolving firms. ### Types of funding arrangements accepted by the Key Attributes - (1) privately (industry)-financed deposit insurance funds, - (2) privately funded resolution funds, or - (3) temporary access to government funds with a mechanism for ex post recovery from the industry for costs incurred by the government. ### Design flexibility and IMF staff considerations - The Key Attributes afford significant flexibility in the design of resolution funding arrangements, including whether they should be funded ex ante or ex post and their optimal size. - When advising countries on their resolution funding arrangements, IMF staff weigh the following: - Characteristics of the financial system: The capacity of the financial industry to contribute to resolution funding and the relative significance of the bank versus nonbank sector. - Legal and institutional architecture: Institutional efficiencies within the resolution regime, including synergies in the policy objectives of protecting depositors and effective resolution. - Capacity: The institutional capacity of the authorities including with regard to availability of expertise, governance, and independence. ### Guidance on establishing or using resolution funds - In many countries, the case for establishing a separate resolution fund is not strong. - In countries with no deposit insurance fund, or with a fund that has insufficient resources, priority should be given to increasing DIS resources and making the fund available to support bank resolutions, subject to safeguards. - In countries wherein there may be good reasons for establishing a separate resolution fund (for example, to support the resolution of systemic nonbanks) it may be advisable to set up an ex post resolution fund, if scarce national savings would be better deployed elsewhere. - Separate resolution funds should have clear legal and operational frameworks and be subject to safeguards to minimize moral hazard. *Source: Croitoru, Dobler, and Molin (2018).* ### Box 3. Different Forms of Depositor Preference ### Box 3. Different Forms of Depositor Preference ### Institutional Framework - Strong institutional frameworks and operational preparedness are essential to minimize moral hazard and enable effective crisis response. - Core entities of the financial safety net: central bank, financial supervisory and regulatory agencies, resolution authority, deposit insurer, and Ministry of Finance. - Supervision, resolution, and ELA functions should be operationally separate and have adequate safeguards to minimize conflicts of interest. - Where capacity is limited and failures infrequent, functional separation can mitigate risks when a single pre-existing authority performs multiple roles. - Crisis management expertise should be developed and maintained through crisis and resolution manuals, table-top exercises, and simulations. - Financial safety net authorities and their current and former officials, staff, and agents should be covered by effective legal protection, including protection for actions in support of decisions by foreign authorities; operational arrangements should cover legal costs. ### Recovery and Resolution Planning - Recovery plans: - Developed and maintained by firm management, reviewed and approved by the firm’s Board of Directors, and assessed by supervisors. - Should include pre-identified triggers and measures to reduce risk profile and conserve capital, and strategic options (divestiture of business lines, restructuring liabilities). - Supervisors should have the power to require implementation of recovery measures. - Resolution plans: - Developed and updated by resolution authorities to guide the resolution of failing firms and remove impediments to effective resolution (simplifying group structures, ensuring adequate LAC, strengthening servicing agreements). - Resolution strategies for cross-border firms may follow single point of entry (SPE) or multiple point of entry (MPE) approaches. - Adequate LAC must be issued from appropriate group entities to effect the preferred strategy (for example, a non-operating holding company for SPE). - The FSB monitors progress for G-SIBs through the resolvability assessment process (RAP); home authorities report annually and high-level findings are summarized in the FSB’s annual resolution report. - IMF staff do not participate in firm-specific recovery and resolution planning (including crisis management groups). ### Operational Preparedness (ELA and Collateral) - Many central banks have not implemented arrangements to accept a wide range of collateral for ELA. - Central banks manage collateral risk via minimum credit quality requirements, haircuts, concentration limits, and margin calls. - Nonstandard, nontraded, illiquid bank assets entail considerably higher risks due to lack of observable credit quality or market prices; due diligence on individual loans is challenging. - Prepositioning of eligible loan pools and pre-specifying eligible debtors and minimum prudent haircuts can reduce risks and accelerate ELA provision. - In markets with well-developed securitization conventions, existing market expertise and standardized contracts facilitate central bank risk management. - In jurisdictions without such markets, larger haircuts are needed to manage uncertainty. - Ensuring legally enforceable security claims on nonstandard collateral may present legal challenges; debtor notification/consent requirements can limit use of credit claims as ELA collateral and may require ex ante legislative changes. - Prepositioning of collateral should be undertaken for systemic entities under recovery and resolution planning. ### Domestic and Cross-Border Cooperation - Information exchange and cooperation are key to managing failing D-SIBs or systemwide crises, requiring legal and operational capacity for information sharing subject to confidentiality safeguards. - Formal coordination arrangements are replacing informal mechanisms; a crisis preparedness function should be assigned to an inter-agency committee (crisis management or financial stability committee) including all financial safety net authorities. - Committees should have clearly specified roles, responsibilities, operating procedures, and meet periodically in normal times to oversee crisis plans. - IADI Core Principle 6 prescribes deposit insurance agency participation in national crisis-management cooperative frameworks; where committees have dual mandates, two standing working groups can be established. - The Key Attributes call for national resolution regimes to: 1. Empower and strongly encourage resolution authorities to act to achieve cooperative solutions with foreign counterparts. 2. Empower resolution authorities to share information with foreign counterparts, with protections for confidential information. 3. Provide transparent and expedited processes to give domestic effect to foreign resolution measures. - Regular intra- and inter-agency financial crisis simulation exercises, including foreign agencies where relevant, are advisable to test operational preparedness. Key examples and figures: - Nordic-Baltic Financial Crisis Simulation exercise in 2019 involved the participation of 31 authorities across 8 countries. ### Contingency Planning, Simulations, and Table-top Exercises - Contingency planning should identify human resources, legal bases, lines of communication, and action plans for SIFI or systemwide failures across all systemic financial subsectors (banking, insurance, securities). - Crisis simulations test capacity to respond to severe shocks, can be modeled on real or hypothetical shocks, and may overlay contemporaneous developments (for example, a deposit run). - Table-top exercises typically focus on failure(s) of systemic banks and test policymakers’ ability to agree on diagnosis and policy responses; they are useful for testing recovery and resolution plans and cross-border cooperation arrangements. - Resolution authorities in the United States have conducted such exercises with UK and EU officials. ### Crisis Communications - Crisis communication planning and templates should be prepared in advance during normal times. - Key principles for communication during systemic banking crises: - Do not communicate problems without solutions; communications must be part of a comprehensive policy package that credibly addresses root causes. - Deliver bad news in clear, definitive, but not alarmist terms; explain which creditors will bear losses (and which will not) in plain language. - Do not overpromise; avoid asserting there will be no more bad news when conditions remain turbulent. - Speak with one voice; coordinate consistent messaging through one or a select few spokesperson(s). - Preparations in advance include identifying target groups, communication channels, draft templates for press releases and responses, and ongoing education during normal times. ### Containment and Stabilization - Containment during a financial panic must focus on ensuring banks can meet maturing liabilities and deposit withdrawals. - Central bank liquidity can help unfreeze markets, reduce incentives to run, and allow time to diagnose problems and implement comprehensive strategies; ELA is the main instrument and first line of defense. - For non-reserve currency issuers, systemwide liquidity assistance can have destabilizing macroeconomic effects (inflationary and exchange rate pressures) and compromise monetary transmission; such widescale provision as seen in the GFC is unlikely to be replicable in non-reserve currency countries. - Compared to past crises, the GFC featured more selective guarantees, more frequent permanent increases in deposit insurance limits, and limited use of blanket public sector guarantees. - Containment measures alone cannot stabilize situations where underlying solvency problems lack a credible path to viability; ELA and other measures may buy time while comprehensive strategies are deployed. ### Systemic Liquidity Provision - Systemwide central bank liquidity provision was a defining GFC response, often implemented by widening counterparties and expanding collateral eligibility and tenors. - Support to financial institutions may require changes in open market operation terms and facilitation of onward lending; due diligence and appropriate haircuts are critical to minimize risks and moral hazard. - Effectiveness depends on institutions’ willingness and ability to on-lend liquidity; fragmentation may require new facilities to directly address affected institutions. - Support to financial markets may be needed where market-based financing is important and segments freeze (for example, US asset-backed commercial paper market in 2008); programs should incentivize re-entry while considering central bank costs, risks, and moral hazard. - Liquidity provision in systemic crises entails heightened risks and depends on market structure and central banks’ ability to contain macro implications, including exchange rate effects. - Example: Term Auction Facility during the GFC expanded counterparties beyond the normal small group of primary dealers. ### Government Guarantees (Liability Guarantees) - Government liability guarantees can stem creditor runs and restore confidence; countries often increase deposit insurance coverage limits, which may be credible only if the DIS has a government backstop. - If coverage levels are already high, marginal benefit may be small; authorities must evaluate unwinding temporary arrangements to avoid permanent larger DIS needs. - Blanket guarantees (covering bank liabilities except capital, subordinated debt, and other loss-absorbing liabilities) were used frequently in past crises and less so in the GFC. - Blanket guarantees depend on sovereign credibility; if sovereign debt sustainability is in question, guarantees may fail to restore confidence. - Guarantees constrain resolution options, raise moral hazard, and tighten the bank-sovereign nexus; removing blanket guarantees can be sensitive and time-consuming. - Partial guarantees limit contingent liabilities but may not preserve confidence if lack of confidence is pervasive; market pressures may shift withdrawals to non-guaranteed liabilities. - IMF staff advise liability guarantees be part of contingency planning, temporary, and subject to a fee to reduce moral hazard and incentivize private restructuring. - Guarantees transfer risk to the government and can undermine sovereign debt sustainability if called; authorities should have resources to cover liabilities of weakest institutions. - Dell’Ariccia and others (2018b) estimate the conditional probability of a sovereign debt crisis occurring when a banking crisis emerges at 51 percent. ### Asset Guarantees and Asset Management Companies - Asset guarantees on pools of assets provided a floor on bank losses, reducing solvency uncertainty; banks retained upside if recovery exceeds expected values. - Guarantees are usually partial and provided for a fee; if called, they have economically similar effects to government asset purchases. - Asset guarantees can be deployed quickly, are quick/easy to exit, are contingent liabilities with no immediate impact on government debt, but are temporary and do not permanently clean up balance sheets if not called. - Public asset management companies (AMCs) permanently remove risk from balance sheets, secure upside value for the AMC/government, can yield efficiencies in loan workout, and improve bank liquidity if payment is in cash or government bonds eligible for central bank funding. - AMCs require upfront cost and time to establish, have immediate impact on government debt (unless structured otherwise), and may take many years to wind up. ### Administrative Measures (Capital Controls and Deposit Restrictions) - Capital controls and deposit restrictions may be needed as last-resort measures to stop runs and protect liquidity, balance of payments, and the payments system. - Deposit restrictions should contain destabilizing outflows while minimizing negative economic impacts; depositors should retain ability to use cash and bank deposits for day-to-day transactions. - Restrictions should allow household and firm withdrawals up to a certain amount over a certain period, calibrated by depositor type and currency based on available liquidity. - Widespread electronic payments facilitated domestic transactions under withdrawal restrictions during the GFC and aided tax collection (example: Greece in 2015 saw significant increase in debit and credit card use). - In cases where a subset of banks is perceived as weak, depositors may shift funds to safer banks, aggravating liquidity stress; restrictions on domestic transfers may be needed (for example, Cyprus in 2013). - Restrictions on external transfers can protect banking system liquidity and contain balance-of-payments pressures; they should comply with Article VIII of the IMF’s Articles of Agreement and the Institutional View on liberalization and management of capital flows. - Capital flow management measures on outflows can be consistent with the Institutional View in crisis circumstances as part of a broad policy package and should be rescinded once the crisis is over. - Deposit withdrawal restrictions and capital flow measures are distortive, require significant operational resources to enforce, and may encourage transactions that test limits, causing spikes in cash withdrawals and potential cash shortages. - Administrative restrictions should be removed as soon as conditions allow, with gradual easing sequenced with economic recovery and financial system strengthening. Case examples and operational experience: - Cyprus, Greece, and Iceland adopted administrative measures during and after the GFC with similarities: bank holidays (Cyprus and Greece), limits on domestic cash withdrawals and domestic transfers (Cyprus and Greece), controls on capital outflows (Iceland), and calibration of limits to everyday transactional needs. - Processing of approvals under restrictions initially took one to three days after implementation; transaction limits were gradually increased and liberalization of cross-border transactions occurred last. - In Greece, final cross-border restrictions were lifted in September 2019; in Iceland some controls remained for years and were lifted after eight years in some cases. *Source: Box 3. Different Forms of Depositor Preference (msfcea - Box 3. Different Forms of Depositor Preference).* ### Box 4. Administrative Measures in Cyprus, Greece, and Iceland ### Box 4. Administrative Measures in Cyprus, Greece, and Iceland ### Containment and Stabilization - Containment and Stabilization - 45 *Source: msfcea - Box 4. Administrative Measures in Cyprus, Greece, and Iceland* ### Box 4. Administrative Measures in Cyprus, Greece, and Iceland (continued) ### Box 4. Administrative Measures in Cyprus, Greece, and Iceland (continued) ### Calibration of selected administrative measures - Greece - €420 limit on cash withdrawals per week (any currency); no cash drawn via checks or credit cards - Domestic credit card payments on goods and services unlimited - €2,000 foreign cash limit per individual per foreign trip - Cyprus - €300 limit on cash withdrawals (including withdrawals via bank tellers and debit, credit or prepaid cards) per day in each credit institution; cash could not be drawn on checks - Domestic card payments on goods and services limited initially but lifted two days later - Domestic transfers between accounts in different banks limited to €5,000 per day, per bank account (higher with committee approval) - Payments abroad by card limited to €5,000 per month per person - Foreign transfers limited to €5,000 per day (higher with committee approval) - €1,000 foreign cash limit per individual per foreign trip - Iceland - No limits on domestic currency withdrawals and domestic payments/transfers - ISK 500,000 foreign cash limit per individual per foreign trip - Credit card companies/banks introduced their own limits on payments abroad ### Restoring confidence and ensuring institution viability - After liquidity containment, authorities should ensure each institution is viable on a forward-looking basis—able to meet capital, liquidity, and other regulatory requirements; attract market funding and satisfy redemptions; and generate adequate returns. - Effective restructuring and resolution requires: - a robust diagnosis of causes and impact of financial distress, - resolution of nonviable entities, - restructuring of weak but viable entities. - If the financial safety net lacks pillars described in Chapter 2, emergency legislation may be needed to strengthen it, including authorization for public solvency support on an extraordinary basis. ### Bank diagnostics: objectives and common practices - Purpose: identify the size and distribution of losses and identify viability of individual institutions. - Common elements: - Diagnostic examinations of banks (often conducted or assisted by independent third-party private firms) to establish credible valuations of bank balance sheets. - Use of stress tests and standardized approaches to estimating problem assets (asset quality reviews, AQRs). - Key elements of a successful diagnostic approach: - An AQR applying uniform and rigorous valuation criteria to all banks through a centralized process; participation of external parties or adoption of new valuation standards (for example, IFRS or more robust loan classification and provisioning rules). - An assessment of viability on a forward-looking basis, comprising a business plan assessment and, where appropriate, systemwide stress testing, to form a view of banks’ resilience under baseline and adverse economic scenarios. - Viability assessments enable a triage into three categories: 1. viable and compliant with regulations; 2. viable but undercapitalized and/or illiquid; 3. nonviable. ### Individual bank valuations to support resolution - Quick and reliable valuation of assets and liabilities is prerequisite for effective resolution for banks identified as failing or likely to fail. - Valuation uses: - determine extent of losses and least costly resolution option; - estimate the “size of the hole” (shortfall in net assets to be filled by imposing losses on shareholders and creditors or using resolution funds). - Counterfactual valuation: - estimate what assets would realize in liquidation and what each creditor class would have received on the date of resolution to ensure creditors are not made worse-off. - valuation typically re-run ex post once more information is available. - Operational notes: - resolution authorities need more granular and up-to-date information than routine supervisory reports; firm-specific recovery and resolution planning should ensure management information systems can provide necessary data quickly. - valuation functions can be outsourced to private sector experts; ex post valuations for “no creditor worse off” safeguard benefit from independent valuers. - contractual arrangements should enable outsourcing at short notice, with established valuation principles and macroeconomic scenarios. ### Systemwide restructuring and resolution: strategy and implementation - After diagnostics, a clear and comprehensive restructuring strategy is needed to restore banking system soundness. - Strategy should: - cover triage of viable and nonviable banks and actions to strengthen viable banks through restructuring and recapitalization, and to resolve nonviable banks; - outline actions, timelines, responsibilities, and options for each entity examined; - involve all members of the financial safety net. - Supervisory forbearance and delaying resolution is typically the least advisable route and usually results in higher resolution costs. - Banks deemed viable with recapitalization plans should face intensive supervision before returning to regular oversight; banks whose problems cannot realistically be addressed by shareholders should be resolved. ### Assessing resolution options and tools - Resolution toolkit aims to allocate losses to shareholders and creditors while preserving systemically important services and avoiding unnecessary destruction of value. - Having an array of tools allows tailoring to case specifics; selection depends on availability of adequate loss-absorbing capacity (LAC) or resolution funding. - Partial asset and liability transfer (Purchase & Assumption, P&A) - transfers deposits to a healthy bank instead of paying out depositors in liquidation; deposit insurance fund may cover any gap on a least cost basis. - advantages: depositors retain access, often higher going-concern asset values, potential premium for deposit book. - limitations: may be infeasible for large/complex failing banks, if authorities unprepared, or no purchaser is found. - Bridge bank - moves performing assets and some liabilities (at minimum insured deposits) into a temporary government-owned bridge bank and liquidates remainder; bridge bank marketed for sale. - bridge bank can be designed to avoid carrying contingent liabilities; ownership and governance structure should be clear. - valuation must be accurate; if assets/liabilities are transferred back into liquidation at scale, credibility and effectiveness of bridge banks can be undermined. - Bail-in - statutory bail-in involves writing down and converting loss-absorbing liabilities into equity. - conceived to impose losses on creditors without liquidating the original legal entity, potentially lowering execution risks for large cross-border banks. - implementation complexities include interaction with securities regulations and fit-and-proper criteria for new owners. - countries with simpler banking systems may not need bail-in if other tools achieve loss absorption. - Loss-absorbing capacity and TLAC - reforms post-GFC sought to enhance TLAC—unsecured liabilities including common equity, subordinated debt and some senior debt (excluding deposits and structured debt) with a maturity of at least one year—of G-SIBs. - some jurisdictions require D-SIBs to maintain an LAC buffer to facilitate resolution. - retail investor exposure to bail-in-able instruments should be limited by investor protection measures such as sufficiently high minimum lot sizes and stringent suitability requirements. - Case note: Cyprus in 2013 highlighted disruptive effects on public confidence of trying to impose losses on depositors in absence of adequate LAC. ### Recapitalizing banks using public funds - Public recapitalization should be last resort, used only when financial stability is severely threatened and subject to strict conditions. - Preconditions and design: - losses should first be recognized and equity capital written down before public funds injected to avoid bailing out shareholders. - attribution of losses to other creditors is a key decision balancing stability, cost minimization, and moral hazard. - Ownership and management of recapitalized banks: - ownership interests following recapitalization should be managed by the finance ministry or a specialized agency to avoid conflicts of interest for central banks or deposit insurers. - Recapitalization instruments: - equity participations appropriate when losses accrued and urgent capital is needed and can separate ownership and management credibly. - non-core capital (contingent convertible instruments, redeemable preference shares, subordinated instruments) suitable if bank already meets minimum core capital and owners/managers are fit and proper. - contingent capital best used to increase buffers on a precautionary, temporary basis where private solutions are expected forthcoming. - Sovereign financing constraints: - if a sovereign lacks market access, recapitalization using government bonds instead of cash may be the only option but raises feasibility concerns and may trigger adverse market reactions. - characteristics of bonds used matter: (1) interest rates high enough to allow recipient bank profitability; (2) maturities consistent with expected recovery in franchise value; (3) bonds marketable and acceptable as collateral for central bank operations. - Example: Iceland’s 2008 recapitalization announcement triggered a sovereign downgrade and subsequent foreign funding and deposit outflows for banks. ### Good practices for designing an AQR by independent firms - Develop comprehensive terms of reference covering scope and assessment methodologies with detail on loan classification and provisioning to ensure objectivity, transparency, and rigor. - Set accounting, collateral valuation, and regulatory standards to be applied; may require prior regulatory reforms and enforcement mechanisms. - Provide macroeconomic forecasts for key variables (for example, GDP growth, unemployment, exchange rates, interest rates) and property values (residential real estate index, commercial real estate index) to ensure consistent collateral values and capture conjunctural risks. - Use disciplined project management with explicit governance and strong oversight; allocate sufficient resources and include local participation to enhance ownership and local knowledge. - Decide ex ante on strategy and financing sources to cover identified shortfalls; absence of sufficient resources can undermine confidence and lead to speculation that results were tailored. - Focus on prudent internal credit rating systems and loan-loss buffers; loss estimates should be based on conservative assumptions with recovery values reflecting expected liquidation values and discounts for forced-sale and time-value of money. - Require independent valuation of collateral by accredited agents using internationally recognized valuation approaches (such as International Valuation Standards); limit valuations to income for assets with cashflows and apply conservative discounts in distressed environments. *Source: IMF staff analysis.* ### Box 5. Good Practices in Asset Quality Review Design and Implementation ### Box 5. Good Practices in Asset Quality Review Design and Implementation ### Asset quality assessment: scope and methodology - The diagnostic must consider "the effectiveness of the creditor rights and institutional (especially judicial) frameworks and their impact on collateral values." - Assessments should include: - Sampling actual loans and collateral. - Testing "the reliability and credibility of the methodologies used to estimate loss provisions." - Coverage of "individual and general provisions." - Evaluation of "the credit information available, the rigor of the loan underwriting process, the effectiveness of internal loan review and risk controls, and the policies and capacity for loan recovery and debt restructuring." ### Stress testing in systemwide diagnostics (Box 6: Crisis Stress Testing) - Stress testing has been used in different ways: - Ongoing supervision: - Example programs: "the annual Comprehensive Capital Analysis and Review by the US Federal Reserve, and the annual EU-wide stress tests by European Bank Authority." - Uses: "assess capital adequacy under potential stress scenarios of banks using common assumptions." - Results used to "enhance financial resilience, for example, by requiring higher capital (under Pillar 2 of the Basel capital framework), identify risks and vulnerabilities and assess banks’ risk management." - Since the GFC "such stress testing has become a central component of ongoing banking supervision." - Macroprudential diagnostics: - Authorities assess "systemwide vulnerabilities (typically including feedback/second-round effects)" to: 1. "calibrate macroprudential policies," and 2. serve "as a forward-looking diagnostic exercise as part of a crisis response." - In crisis-response diagnostics: - Stress tests should include "all systemic as well as distressed and near-distressed institutions." - The baseline should be "determined by the realized shock (which may so severe as to require little or no further stress overlay is needed)." - Results can be used for "a triage which differentiates the soundness of banks in the system and identifies capital needs on a forward-looking basis." - When combined with "prudent and transparent assumptions and communication, combined with credible arrangements to inject the necessary capital (from private or if necessary, public sources) such stress tests can play a crucial role in regaining public trust in the banking system," with the Supervisory Capital Assessment Program in the United States during the GFC given as an example. ### Bridge bank design and operational readiness (Box 7: Making a Bridge Bank Operational) - Advanced preparation: - Authorities must "be able to incorporate and license a new bank on short notice and transfer assets and liabilities to it quickly." - A bridge bank requires "a management team, a business plan, and the ability to manage day-to-day operations." - Pre-preparation examples: "drafting a bridge bank charter in advance and pre-identifying a list of potential managers which meet fit and proper criteria." - Prudential requirements: - "The supervisors should be able to expedite a banking license to the new institution." - "The resolution framework should stipulate if some prudential requirements can be met with a delay on an exceptional basis." - Ownership and governance: - "The government should be the owner and adequate governance arrangements adopted (Box 8)." - Valuation and transfer of assets and liabilities: - "The resolution authority should undertake a prudent valuation" before transfer. - Transfer decisions should be guided by "marketability." - Prefer transferring "a narrow subset of good assets and deposit liabilities" to facilitate sale. - Warns that a bridge bank "might not be stable if the liabilities transferred to it are callable and are not (explicitly or implicitly) protected." - Only "good assets and liabilities that need to be protected to preserve financial stability should be transferred into the bridge bank." - Reverse transfer powers (put-back option): - Such powers "should be subject to a time limitation and only be used under a narrow set of circumstances (such as to address valuation errors)." - Otherwise, they "will undermine confidence in the bridge bank tool, as creditors will fear being transferred back and have incentives to run." - Time limits: - "The resolution framework should include incentives for the state to divest as soon as feasible." - "Strict time limits on a bridge bank are not advisable as they could undermine the authorities’ negotiating power with potential buyers." ### Principles for public solvency support (Box 8: Good Practice in Public Solvency Support) - Overarching guidance: - Public solvency support "involves significant cost, risk, and moral hazard." - Prefer private solutions and, if unattainable, "orderly resolution without recourse to public funds." - Public support may be unavoidable "in exceptional circumstances; for example, when spillovers are high, or an effective resolution regime is not in place." - When used, government support should be provided "only under strict conditions that maximize burden-sharing, minimize moral hazard, and protect taxpayers." - Systemic stability: - "Public support should be used only for cases with a material risk of destabilizing the financial system or jeopardizing the continuity of essential payment, clearing, and settlement functions." - Burden sharing: - "All unrecognized losses must be identified, ideally via a comprehensive asset quality review, if time allows, and the bank’s equity and other capital instruments written down for the losses, prior to providing public funds." - To the extent compatible with stability and law, loss allocation should follow "the creditor hierarchy, ultimately affecting claims of uninsured, senior unsecured creditors." - Restructuring requirements: - Solvency support must be paired with "a comprehensive restructuring plan that addresses structural weaknesses and helps restore long-term viability, including via cost-cutting and strengthening the risk management framework, capital, and liquidity planning, etc." - "Public solvency support should be remunerated to help mitigate moral hazard." - Plans should provide for "recovery of public support within a reasonable timeframe, if necessary, via divestitures of selected assets and business lines." - Governance measures: - "Managers responsible for the failure of the bank should be replaced, executive compensation capped, and any bonuses paid to senior management prior to the failure clawed back (if possible)." - To allow internal capital generation, "dividend payments (if any original shareholders remain) need to be suspended until solvency support is repaid." - Authorities should "establish a high-level inter-agency committee to coordinate the operation, ensure timely and consistent information is released publicly, and manage the public sector’s interest on an arm’s length basis." - "Central banks and supervisors should not contribute to recapitalizations to avoid potential conflicts of interest." - The central bank "may need to provide collateralized liquidity to viable banks that have been recapitalized in, or outside of, the resolution regime." - Strict oversight: - Recipients of public support must face "strict supervision and enhanced reporting to prevent excessive risk taking, foster robust governance and safe and sound practices, and ensure consistent implementation of the restructuring plan." - Supervisors should "establish measures to prevent asset stripping, monitor and, if needed, block intra-group and insider transactions." - Exit planning, review, and transparency: - Exit planning: "Divestment strategies should be carefully analyzed and initiated as soon as market conditions allow," with the objective "to return the bank to private ownership within a reasonable period—even if that entails losses on the original investment." - Review: "A review, conducted with independent expertise, should focus on the events that led up to the failure, and identify the structural weaknesses in the bank’s business model, governance, and risk controls" and should "determine the culpability of senior management." - Supervisory self-evaluation: "The supervisor should also closely evaluate its own role" to identify improvements. - Transparency: "Ongoing disclosure on the actual and estimated cost of the public solvency support and any recoveries realized (updated periodically) is crucial for accountability to taxpayers." *Source: https://www.imf.org/-/media/files/publications/dp/2020/english/msfcea.pdf* ### Box 8. Good Practice in Public Solvency Support (continued) ### Box 8. Good Practice in Public Solvency Support (continued) ### Restructuring and Resolution — key findings - High NPLs can weigh on bank viability, credit growth, and economic recovery by affecting banks’ net income and profitability through loan loss provisions and interest suspension, tying up capital (given high risk weights on NPLs net of provisions), and affecting bank funding costs due to lower expected profitability and higher risks for investors. - Managing very large NPL portfolios is not a core competency of banks or their managers and requires specialist skills. - Heavily indebted firms have less incentive to invest because profits will go to repay debt, damping cyclical recovery and lowering the value of distressed debt and corporate assets. - International experience before and during the GFC suggests that a comprehensive strategy is most effective in resolving high NPLs (Aiyar and others 2015). - Banks have five basic options to deal with NPLs (Figure 6): restructure the loan terms; settle with borrower at a discount to the amount due; dispose of the risk to third parties; enforce their rights against loan collateral; or seek insolvency proceedings. - A comprehensive NPL strategy typically includes three core elements: tightening regulation and intensifying supervisory oversight; eliminating gaps in the insolvency and enforcement framework; and introducing measures to facilitate disposal of risky assets including development of a distressed debt market. - Measures often need supporting changes in the tax regime and reforms to improve access to information. - Efforts to address NPLs should start as soon as possible during a crisis; reducing large NPL stocks is a protracted process that often takes years and significant progress may occur only as the economy recovers. - Compared to previous crises, the GFC made more use of decentralized debt workout strategies and less of centralized ones; centralized AMCs were used selectively where multi-creditor, large-value, non-core illiquid assets and fiscal capacity justified them (examples cited: Ireland, Slovenia, Spain). ### Supervisory policy — recommendations and operational elements - Sufficient loss-absorbing capacity in banks is a precondition to effective loan workout; undercapitalized or unprofitable banks have incentives to underreport NPLs, capitalize unpaid interest, and delay loss recognition. - Swift loan loss recognition and robust provisioning, income recognition, and write-offs underpin banks’ incentives to tackle high levels of NPLs. - Supervisory regulation and guidance on collateral valuation and provisioning can ensure consistent and prudent application of accounting rules, including impairment triggers, provisioning methodologies for collectively assessed loans, and management judgment and assumptions. - Supervisory policy and guidance are particularly critical on: - Classification and forbearance, to ensure past due, unlikely to pay, or temporarily relieved loans are classified appropriately. - Loan restructuring, and conditions that would allow a restructured loan to no longer be considered impaired. - Interest accrual on NPLs, to avoid accrual of uncollectible income on loans past due. - Collateral valuation, to ensure credit-enhancing collateral used to reduce provisioning is conservatively valued (for example, through guidance on appraisal practices). - Write-offs, to support timely write-off for uncollectible loans (where feasible through time-bound requirements) without first exhausting legal remedies. - Disclosure, to increase market transparency and discipline. - Prudential oversight actions to foster active NPL resolution include placing banks with high NPLs under enhanced monitoring; requiring development of internal NPL management capabilities, plans, and tools; and setting operational targets to reduce NPLs or write-off problem loans. - Separating management of impaired loans from regular loan servicing (in-house or subsidiary workout units) can facilitate NPL management by concentrating specialist skills and improving accountability while noting consolidated supervision and adequate provisioning remain critical. ### Insolvency and debt enforcement — findings and reforms - Effective NPL resolution requires a well-functioning set of legal tools for debt collection, restructuring, and disposal, based on the two pillars of enforcement and insolvency. - A clear and efficient legal framework enables timely, transparent, and predictable recovery of claims and strengthens incentives for meaningful out-of-court debt restructuring. - Distressed asset prices are heavily influenced by the duration, cost, and effectiveness of legal tools for debt restructuring, insolvency, or enforcement. - An effective legal framework requires both appropriate legislation and robust institutions (IMF 1999; UNCITRAL 2004; World Bank 2016); reforms often needed in both areas. - Examples of reforms addressed at crisis-country problems: - Enhancing debt enforcement and foreclosure processes to achieve faster asset recoveries (e.g., ensuring clear legal title to collateral, limiting appeals, setting short preclusive deadlines; introducing e-auction platforms). - Strengthening the judicial system by increasing judge specialization, rationalizing fees, and introducing performance measures for insolvency professionals. - Augmenting out-of-court frameworks with hybrid features to generate more rapid and cost-effective results and relieve courts in a crisis. - Facilitating rapid exit of nonviable firms and rehabilitation of viable firms, including via expedient in-court approval of settlements negotiated out of court, and simplified, cost-effective insolvency processes for SMEs (Bergthaler and others 2015). - Facilitating participation of public creditors in restructuring by eliminating super-priorities of public claims (where they exist), introducing flexibility on debt relief for tax liabilities, and providing general guidance for insolvency and debt restructuring decisions. - Informational and tax obstacles to effective restructuring should be removed: credit bureaus, publicly searchable debt and property registers, access to information and legal advice for debtors; removing tax disincentives such as limits on tax deductions for write-offs or loan loss provisions. - If the crisis is systemic, additional public policy interventions may be needed to ensure creditor coordination and standardized restructuring approaches (examples: “London” or “Istanbul” approaches), noting these require extensive stakeholder negotiation and may be effective mainly as the economy recovers; public creditor concessions or coordination roles may be necessary. ### Distressed asset markets — enablers and legal/regulatory reforms - Disposal of distressed assets via outright sales and securitizations alleviates burden on bank balance sheets; distressed asset management is a specialized task where value can be created through expertise and economies of scale. - A distressed asset market typically comprises specialized nonbank participants and joint ventures of specialists, banks, and investors; such markets can raise recovery values, free up bank lending capacity, and facilitate resource redeployment. - Prior conditions for successful distressed asset markets: reliable and efficient legal framework to enforce creditors’ rights and adequate availability of risk capital; in many countries these conditions are not met and private markets are rare because normal volumes of bad assets are too low to justify a stand-alone industry. - Legal and regulatory reforms often necessary to support development of a distressed asset market: - Remove legal obstacles to asset transfer (for example, debtor permission requirements). - Shorten foreclosure and liquidation court proceedings to increase recovery values. - Clarify priority of claims in liquidation. - Facilitate timely and accurate information on distressed borrowers and asset sales. - Ensure collateral valuations are realistic. - Remove fiscal obstacles to public sector participation. - License (or simplify licensing for) nonbanks to buy distressed assets and undertake debt restructuring. ### Centralized Asset Management Companies (AMCs) — advantages, risks, and governance - Centralized AMCs can be useful elements of the policy mix to address systemic crises but are no panacea. - Advantages of centralized AMCs: - Economies of scale and scope—consolidating assets from many banks can address multi-creditor issues. - Bargaining power—especially with large borrowers and syndicated loans. - Specialized skills—concentrating scarce expertise in financial and operational restructuring. - Uniform valuation criteria—can help price discovery and credit discipline. - Operational risks of AMCs: - Political and stakeholder interference/pressures. - Unclear objectives, weak organization and skills, or a weak legal framework. - Accountability, transparency, and media pressures. - Inappropriate financial structure given cash flow. - Inflated acquisition prices. - Inadequate documentation. - AMCs typically require substantial upfront government funding or guarantees; they need liquidity to cover negative cash flows in initial years and adequate capital to absorb initial losses; good-practice governance frameworks are essential. - Central bank ownership or funding of AMCs is not advisable because it exacerbates conflicts of interest. - Price at which assets are transferred to AMCs is critical: the financial objective should be to recover the amount paid over the AMC’s fixed-term life (i.e., to break even); acquiring assets at above-market prices transfers losses to taxpayers and effectively bails out shareholders and creditors. - Public resources, if necessary, should be transparent in amount and beneficiaries and provided only after asset losses are recognized and accrued on banks’ balance sheets. - Supervisors should engage with participating banks to ensure valuation practices are appropriate, including collateral valuations; time-bound collateral haircuts that consider collateral type and NPL duration are an effective technique (example: Spain in 2016 compelled banks to lower collateral valuations depending on collateral type and loan delinquency duration). - Profit-and-loss sharing agreements (claw-backs) can reduce ultimate impact on bank capital but will not avoid upfront losses and may prevent asset derecognition or risk transfer for capital purposes. - Granting AMCs special powers to accelerate recoveries should be avoided as it can introduce unfair competition and unequal treatment; focus instead on reforms to improve insolvency and foreclosure regimes for all market participants. ### Excessive related-party exposures — risks and three-pillar resolution approach - Excessive related-party exposures present a major risk to financial stability by concealing credit and concentration risk, often on preferred terms, reducing bank profitability and solvency, and tying up capital that could finance legitimate businesses. - Opaque bank ownership facilitates hiding related-party exposures and is associated with poor governance, AML/CFT violations, and fraud; unknown ultimate beneficial owners impede shareholder accountability and verification of capital quality. - Resolving related-party problems requires a three-pillar strategy: - Legal reforms: introduce international standards for transparent disclosure and monitoring of bank owners and related parties; include prudent limits, strict conflict-of-interest rules, and escalating enforcement measures; make non-transparent ownership a legal ground for license revocation or resolution; authorize the supervisor to presume a related party in certain circumstances, shifting the “burden of proof” to banks. - Bank diagnostics: identify ultimate beneficial owners and related-party exposures and transactions; assess compliance with prudential lending limits for related-party and large exposures; use criteria including control, economic dependency, and acting in concert; consider risk-related features such as preferential terms, documentation quality, and internal controls. - Enforcement actions: remove unsuitable bank shareholders (for example, where ultimate beneficial owners are not identified or are unsuitable) and unwind excessive related-party exposures through repayment, disposal, or resolution of the relationship (change in ownership of the bank or the borrower). - The three-pillar approach is best implemented within a comprehensive financial sector strategy; where legal reforms cannot be implemented during early intervention, suspected related-party exposures and liabilities should be swiftly identified and ringfenced, with full implementation once the system stabilizes. *Source: IMF staff analysis as presented in msfcea - Box 8. Good Practice in Public Solvency Support (continued).* ### Box 9. Dealing with Excessive Related-Party Exposures ### Box 9. Dealing with Excessive Related-Party Exposures ### Dealing with Distressed Assets — Mandate and Objectives - Mandate: The stated objective of the asset management company (AMC) should be to maximize the recovery value of transferred assets and reduce public contingent liabilities over a fixed lifespan, with a clear commercial focus. ### Governance - The Board and senior management of an AMC should be composed of individuals independent of government or active market players, with relevant expertise and market credibility. - Rationale: AMCs may be subject to strong political or market pressures from borrowers or investors seeking preferential treatment. ### Independence and Operational Flexibility - AMCs should be established as autonomous entities, with: - flexibility over pay and staffing (that is, to set incentives for staff on market terms, not constrained by public sector employment norms); - the ability to hire advisory firms; - the ability to set and execute operational and valuation policies; - adequate protection from litigation for staff to facilitate resolution, foreclosure and liquidation of assets. ### Limited Lifespan (“Sunset” clauses) - Centralized AMCs should have limited lifespans to avoid the risk of creating a permanent bureaucracy and to establish the right incentives to realize asset values expeditiously. ### Valuation of Assets and Performance Measurement - To avoid distorting incentives and for fair accountability: - The AMC’s performance in maximizing value should be measured against a realistic benchmark. - A review of asset values should be undertaken once the AMC has established its valuation models. - Current values should be compared to the starting balance sheet to measure performance. - The starting balance sheet should show values below the transfer price if assets were transferred at above market prices. ### Transparency and Accountability - AMCs should publish operational and financial plans and prepare audited financial statements based on current market valuations of assets. - Oversight should be provided by appropriate governance bodies (for example, a parliamentary committee). ### Funding and Financial Structure - The AMC’s operating budget should be separated from the funding allocated for asset purchases and be sufficient to cover start-up costs. - Government bonds used to fund asset purchases should be remunerated at market rates and accepted as collateral for central bank liquidity. - Tenors should be long enough to allow for realization of the value of the assets through sale, restructuring, or foreclosure and sale of collateral. - Seeking some market funding (with no guarantees) can help minimize competitive distortions and maintain clear incentives for the AMC by giving a market-based cost of funding to facilitate operational financial decisions. *Source: Box 9. Dealing with Excessive Related-Party Exposures, msfcea - Box 9. Dealing with Excessive Related-Party Exposures* --- _Source: https://www.imf.org/-/media/files/publications/dp/2020/english/msfcea.pdf_