## Exceptional Public Solvency Support to the Banking Sector: Pitfalls and Good Practices — Preface & Introduction

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### Preface: contributors and acknowledgements
- Contributions from current and former staff of the Financial Crisis Preparedness and Management Division, IMF Monetary and Capital Markets Department.
- Special acknowledgments for inputs and comments: Thierry Bayle, David Blache, Tomoaki Hayashi, Jan Nolte, Jaime Ponce, and Alvaro Piris.
- Additional inputs from Hee Kyong Chon, Luc Riedweg, and Ebru Sonbul Iskender (Monetary and Capital Markets Department’s Financial Supervision and Regulation Division).
- Direction and guidance provided by Marina Moretti and Marc Dobler.
- Administrative support provided by Charmane Ahmed, Kene Ndir, Geovana Pessoa, and Margo Vandenbroucke.

### I. Introduction — context, historical experience, and recent policy framework
- Historical role of public resources
  - Public solvency support to distressed banks has been a common feature of crisis responses aimed at protecting financial stability and restoring confidence.
  - Example cost figures from past crises:
    - "Direct government support (excluding guarantees, before recoveries) amounting to 3.5 percent of GDP for advanced G20 economies (IMF 2010)."
    - "Gross recapitalization costs for some emerging markets of 10–40 percent of GDP (Laeven and Valencia 2018)."
  - Laeven and Valencia (2018) dataset findings:
    - Identified 151 systemic banking crises over 1970–2017.
    - Median costs: 6.7 percent of GDP for high-income countries and 10 percent of GDP for low- and middle-income countries.
    - Associated increases in public debt of 21.1 percent and 16.4 percent of GDP, respectively.
- Moral hazard and accountability concerns
  - Substantial taxpayer costs and perceived lack of accountability for banks’ shareholders and senior management have intensified debates about moral hazard from government interventions.
- International policy steps to reduce reliance on public bailouts
  - G20 Summit, November 2010 (Seoul): endorsed FSB policy framework to reduce moral hazard and address the "too-big-to-fail" problem.
    - Objectives include enhancing institutions’ resilience via enhanced capital requirements and enabling orderly resolution.
    - Expectations for supervisory effectiveness and intensity to:
      - enhance operational independence and resourcing of supervisors;
      - strengthen supervisory techniques (including horizontal reviews, stress testing, and business model analysis);
      - enhance macroprudential surveillance;
      - foster greater collaboration between home and host authorities.
  - FSB Key Attributes of Effective Resolution Regimes for Financial Institutions (KA), endorsed by G20 leaders in November 2011:
    - Aim to enable resolution without systemic disruption and without exposing taxpayers to loss.
    - Call for operationally independent administrative authorities; sound governance; adequate resources; robust accountability mechanisms; protection against liability for actions taken in good faith; a broad range of resolution powers; and development of frameworks for recovery and resolution planning.
    - Note: "An updated versions of the KAs, incorporating additional guidance, was released in 2024 (FSB 2024)."
  - Total loss-absorbing capacity (TLAC) standard, 2015:
    - Seeks to ensure global systemically important banks (G-SIBs) can absorb losses and be rehabilitated without public support.
    - G-SIBs are expected to ensure adequate loss-absorbing capacity (LAC) through issuance of instruments meeting specific requirements; some authorities have applied similar requirements to other banks.
- Remaining challenges
  - Implementation of the "ending too-big-to-fail" framework is progressing, but significant work remains to enhance resolvability of all financial institutions that could be systemically significant or critical if they fail (FSB 2023).
  - Establishing sufficient LAC can be challenging, especially for institutions that have not traditionally relied on capital market funding.
  - Consequently, under exceptional circumstances, country authorities may still need to rely on public sector support and temporary public ownership to safeguard financial stability — an approach acknowledged in the KA (Box 1).
- Purpose of the note
  - Provides guidance on use of fiscal resources for public solvency support as an exceptional crisis management measure.
  - Draws on IMF involvement in bank restructuring programs and technical discussions with national authorities.

### BOX 1. Exceptional Solvency Support and Bank Resolution Regimes — Funding arrangements and objectives
- Funding arrangements are essential in modern bank resolution regimes to provide liquidity in resolution, capitalize bridge banks, and facilitate deposit transfers.
- Two stylized options in the KA:
  - Privately financed deposit insurance or resolution funds with ex ante industry contributions.
  - Temporary public funding with ex post recovery from the banking sector under strict conditions to minimize taxpayer costs and moral hazard.
- KA acknowledges temporary public ownership as a “last-resort” (KA 6.5); state losses should be recovered from unsecured creditors or, if necessary, the financial system more widely (for example, through ex post levies).

### BOX 1 — Rationale, risks, and minimum conditions for exceptional public solvency support
- Why governments recapitalize banks
  - Banking sector distress disrupts payment, clearing, and settlement functions; erodes asset values; reduces credit flows; and can slow economic growth.
  - Typical crisis drivers: unsustainable macroeconomic policies; rapid financial liberalization and excessive credit growth; weak governance and risk management; large bank-sovereign linkages, dollarization, or weak regulation and supervision.
  - Private recapitalization may be unavailable in systemic distress due to limited capacity of existing shareholders, low risk appetite of new investors, fire-sale risks, and simultaneous distress across many banks.
  - Public solvency support is a last-resort when private solutions and credible resolution regimes cannot ensure financial stability (Addo Awadzi and others 2018; Moretti, Piris, and Dobler 2020).
- Minimum conditions for exceptional public solvency support
  - Recapitalization strategies should be based on accurate, up-to-date asset quality assessments and quantification of capital shortfalls, including forward-looking stress tests.
  - Diagnostic programs should use prudent assumptions on projected loan losses, collateral valuations, profitability, and liquidity needs; external participation can help confidence and reduce legal challenges.
  - Identify origins of idiosyncratic weaknesses (governance, risk management, internal controls, fraud, delayed loss recognition) to prevent recurrence.
  - Public solvency support should:
    - Be reserved for institutions whose failure, individually or as a group, pose systemic risks.
    - Be predicated on loss allocation to former owners and, if possible, junior creditors; existing shareholders should be diluted commensurate with losses; hybrids converted or written down per contractual provisions.
    - Allow for concurrent private sector investments where possible; government underwriting and mechanisms (for example, call options or rights of first refusal) can facilitate private participation and eventual acquisition of government stakes.
      - Example facts: in the Spanish recapitalization program, burden-sharing reduced public support needed by about 25 percent; around 70 percent of affected hybrid instruments had been marketed to retail investors; subordinated debt holders were allowed to reinvest remaining amounts in a senior debt product with an annual 2 percent coupon payable on maturity.
    - Not introduce unfair competition (for example, overcapitalization, large government deposits, off-market NPL transfers, regulatory forbearance).
  - Legal mandates should be clear and integrated into public financial management frameworks covering (1) budget formulation, (2) execution, (3) accounting and reporting, (4) fiscal risk management, and (5) audit.
  - Credible restructuring plans must be timebound and supported by financial projections for income, expenditure, balance sheet items, cashflows, and key regulatory ratios.
  - Management changes and independent professional management (including independent board members) are typically necessary.
  - Governance: a high-level interagency committee should coordinate decisions (including the Ministry of Finance, supervisory agency, and central bank) and, for large programs, establish technical working groups for asset valuation, contract negotiation, and stakeholder communications. External expert support is advisable.
  - Bank ownership arising from recapitalization should be the exclusive responsibility of the government—not other safety net participants.
  - Statistical treatment:
    - If a realistic return is expected, the government records an increase in financial assets and the transaction has no effect on the deficit but may increase gross government debt.
    - If no realistic return is expected, the transaction is treated as a capital transfer and reflected in the government deficit; substantial doubt about long-term viability warrants classification as a capital transfer.
  - Accountability: investigate potential wrongdoing, conduct forensic audits, pursue restitution where culpability is found, submit illicit activity suspects to competent authorities, and publish transparency on estimated costs and recoveries through periodic fiscal risk statements.
  - Independent post-mortem reviews by external experts are advised.

### BOX 1 — Support modalities, instruments, and trade-offs
- Support modalities
  - Assisted mergers: maintain critical functions with limited upfront taxpayer cost but may create too-big-to-fail and competition concerns.
  - Direct asset acquisition: exposes the government to future losses and can create moral hazard if transfer prices are too high.
  - Direct recapitalization: offers greater control over rehabilitation if carefully designed to protect taxpayers and minimize moral hazard.
- Instrument-specific guidance
  - Equity investments (Common Equity Tier 1) strengthen capital with high-quality, fully loss-absorbing instruments; provide government shareholder powers; offer a clear exit via divestiture but can be difficult to unwind if market conditions do not improve.
  - Trade-offs between economic ownership and voting rights: governments may acquire common shares or nonvoting capital instruments; regulatory considerations affect eligibility for regulatory capital.
  - Historical example: Troubled Asset Relief Program (United States) Capital Purchase Program: more than one-third of $700 billion (that is, $250 billion) allocated to the Capital Purchase Program, with $204.9 billion invested.
  - Contingent convertible capital instruments (including AT1): unsuitable when significant losses have crystallized or recipient banks lack revenues to pay remuneration; jurisdictional differences complicate cross-border consistency.
- Divestiture imperative
  - Governments should initiate divestitures as soon as market conditions allow, aiming to return the bank to private ownership even if some market value is sacrificed.

### Governance of temporary government investments (from BOX 1)
- Independent and professional representation of government-held bank shares is important to achieve timely transfer back to private ownership and to avoid political interference.
- Maintain clear delineation between government socioeconomic objectives and its role as commercial shareholder.
- Good practices for exercising shareholder rights on a commercial, arm’s-length basis:
  - Establish a holding company–type structure or a dedicated unit within the Ministry of Finance to advise on bank ownership matters.
  - Ensure transparent arrangements and professional management to improve prospects of successful rehabilitation and divestiture.
- Empirical finding: staff analysis suggests public banks tend to have lower financial soundness indicators and weaker performance than private banks.

### BOX 2. A Closer Look at Shareholder Management Arrangements — cross-country examples
- United Kingdom
  - UK Financial Investments (UKFI) established in November 2008 to manage government investments on a commercial basis; operations transferred to UK Government Investments (UKGI) in 2018, with UKGI operating on similar principles.
- Greece
  - Hellenic Financial Stability Fund (HFSF) established in July 2010; wholly owned by the state but with administrative and financial autonomy and a two-tier management structure of independent professionals; monitors supported banks and seeks return to private ownership.
- Ireland
  - Shareholding and Financial Advisory Division of the Department of Finance manages government shareholdings (Bank of Ireland, Allied Irish Banks, Permanent TSB); Relationship Framework Agreements limit ministerial intervention in day-to-day operations.
- Israel
  - 1983 bank stock crisis response used multiple committees and independent shareholder committees to exercise shareholder responsibilities and limit day-to-day government involvement.
- Ukraine
  - Shareholder Management Unit within the Ministry of Finance oversees state-owned banks; Banking Law prescribes supervisory board composition (two-thirds independent), competitive selection, dismissal criteria, and relationship agreements to underscore operational autonomy.

### BOX 2 — Design and governance principles for shareholder management entities
- Preserve supported banks’ operational independence irrespective of legal ownership structure.
- Key measures:
  - Framework agreements defining and limiting modalities for interaction and reporting.
  - Procedures for selection of executive board members of supported banks.
- Governance of the shareholder management entity:
  - Board composition ideally with a majority of independent members and no government officials in executive roles.
  - Procedures for selecting and appointing board members.
  - Agreements to regulate which strategic decisions require government approval, including divestiture strategy.
- Transparency on performance and achievement of objectives is crucial for accountability to taxpayers.

### BOX 2 — Professional management, independent boards, and remuneration
- Professional management and independent boards enhance value generation and shield senior management from political pressure.
- Supported banks should compete on market terms, act in good faith, and avoid protracted government reliance.
- Authorities may maintain lists of potential candidates for crisis management binders to expedite appointments.
- Remuneration modalities should curb excessive risk taking while allowing attraction and retention of talent; avoid imposing public sector salary caps on supported banks and focus on alignment with prudent risk management and timely disclosure of remuneration policies.

### BOX 3. Remuneration Reforms in Practice — governance and measurement
- Governance mechanisms
  - Robust oversight and involvement of independent control functions (human resources, risk management, compliance, internal audit) are important.
  - Independent Compensation Committees of nonexecutive directors can establish and monitor compensation systems.
- Measurement of performance
  - Financial metrics should be risk-adjusted (for example, risk-adjusted return on capital and return on capital).
  - Compensation frameworks should include risk indicators for asset quality (nonperforming loans), capital adequacy, liquidity, and revenue volatility.
  - Nonfinancial metrics (operational incidents, regulatory findings, audit reports, customer complaints) should be considered.
  - Legal challenges to clawbacks remain significant, especially for older contracts without explicit clawback mechanisms.
- Aligning compensation with reprivatization objectives
  - Link compensation to realization of market value; award a substantial proportion of variable compensation in shares or share-linked instruments vesting upon successful transfer to the private sector.
  - Consider clawbacks if bank performance lags or actions undermine long-term value creation.
  - Public solvency support should trigger review of compensation structures of highly paid employees.
- Supervisory independence and oversight
  - Maintain supervisory independence; institutions benefiting from public support should face the same supervisory scrutiny as comparable private institutions.
  - Supervisors should ensure vulnerabilities are addressed decisively and scrutinize realism of restructuring plans.
  - Escalate implementation delays or robustness concerns promptly, requiring corrective actions from bank management.
- Transparency and disclosure
  - Public banks should be subject to the same disclosure requirements as private banks; governments may demand even more stringent disclosures about state-bank relationships.
  - Good practice: governments publish details of public support arrangements and implement safeguards to monitor government fund usage.
- Aligning compensation and risk taking
  - Use a mix of instruments (cash and shares); variable components should be subject to in-year ex ante adjustment and deferral (for example, three to five years), with ex post changes for misconduct or material breaches.
  - CEO and CRO compensation warrant close attention.

### BOX 4. How to Design Effective Recapitalization Bonds — purpose and trade-offs
- Purpose
  - Bond recapitalization seeks to alleviate sovereign financing constraints that may otherwise preclude public solvency support to distressed banks.
  - Key advantage: does not deplete cash reserves and avoids issuance of debt securities to third-party investors.
  - Main precaution: bond characteristics should not undermine medium-term bank viability or immobilize bank balance sheets.
- Marketability and liquidity
  - Marketable bonds facilitate liquidity management via sale or repo operations.
  - Risk: recipient banks might sell bonds opportunistically and reinvest proceeds in riskier assets.
  - Recommendation: curtail tradability during an initial period when operational restructuring plans are prepared; permit bonds to be used as collateral (subject to haircuts) for central bank refinancing.
- Interest rates
  - Minimizing government coupon costs can conflict with banks’ need to restore profitability.
  - Fixed-rate instruments help recipients when interest rates are elevated; for governments, locking in high coupons increases fiscal outlays.
  - Policy imperative: provide duly remunerated instruments to avoid eroding banks’ interest margins and jeopardizing viability.
- Maturity
  - Avoid substantial maturity mismatches and large duration gaps.
  - Recommendation: provide a mix of securities with different maturities (possibly reopening previous issuances) to support asset-liability management and smooth government debt servicing.
- Currency
  - Governments generally prefer domestic currency bonds to avoid exchange rate risks.
  - Exception: heavily dollarized banking systems may require foreign currency–denominated securities to minimize currency mismatches.

*Source: IMF Technical Note — Exceptional Public Solvency Support to the Banking Sector: Pitfalls and Good Practices (Preface and Introduction; BOX 1–4).*

### Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 

### Exceptional Public Solvency Support to the Banking Sector: Pitfalls and Good Practices — Preface & Introduction

### Preface: contributors and acknowledgements
- Contributions from current and former staff of the Financial Crisis Preparedness and Management Division, IMF Monetary and Capital Markets Department.
- Special acknowledgments for inputs and comments: Thierry Bayle, David Blache, Tomoaki Hayashi, Jan Nolte, Jaime Ponce, and Alvaro Piris.
- Additional inputs from Hee Kyong Chon, Luc Riedweg, and Ebru Sonbul Iskender (Monetary and Capital Markets Department’s Financial Supervision and Regulation Division).
- Direction and guidance provided by Marina Moretti and Marc Dobler.
- Administrative support provided by Charmane Ahmed, Kene Ndir, Geovana Pessoa, and Margo Vandenbroucke.

### I. Introduction — context, historical experience, and recent policy framework
- Historical role of public resources:
  - Public solvency support to distressed banks has been a common feature of crisis responses aimed at protecting financial stability and restoring confidence.
  - Example figures from past crises:
    - "Direct government support (excluding guarantees, before recoveries) amounting to 3.5 percent of GDP for advanced G20 economies (IMF 2010)."
    - "Gross recapitalization costs for some emerging markets of 10–40 percent of GDP (Laeven and Valencia 2018)."
  - Laeven and Valencia (2018) dataset findings:
    - Identified 151 systemic banking crises over 1970–2017.
    - Median costs: 6.7 percent of GDP for high-income countries and 10 percent of GDP for low- and middle-income countries.
    - Associated increases in public debt of 21.1 percent and 16.4 percent of GDP, respectively.
- Moral hazard and accountability concerns:
  - Substantial taxpayer costs and perceived lack of accountability for banks’ shareholders and senior management have intensified debates about moral hazard from government interventions.
- International policy steps to reduce reliance on public bailouts:
  - G20 Summit, November 2010 (Seoul): endorsed FSB policy framework to reduce moral hazard and address the "too-big-to-fail" problem.
    - Objectives include enhancing institutions’ resilience via enhanced capital requirements and enabling orderly resolution.
    - Expectations for supervisory effectiveness and intensity to:
      - enhance operational independence and resourcing of supervisors;
      - strengthen supervisory techniques (including horizontal reviews, stress testing, and business model analysis);
      - enhance macroprudential surveillance;
      - foster greater collaboration between home and host authorities.
  - FSB Key Attributes of Effective Resolution Regimes for Financial Institutions (KA), endorsed by G20 leaders in November 2011:
    - Aim to enable resolution without systemic disruption and without exposing taxpayers to loss.
    - Call for:
      - operationally independent administrative authorities with responsibility for exercising resolution powers;
      - sound governance, adequate resources, robust accountability mechanisms, and protection against liability for actions taken in good faith for such authorities;
      - a broad range of resolution powers that can be applied—subject to safeguards—to financial institutions, holding companies, nonregulated operational entities, and branches of foreign firms;
      - development of frameworks for recovery and resolution planning.
    - Note: "An updated versions of the KAs, incorporating additional guidance, was released in 2024 (FSB 2024)."
  - Total loss-absorbing capacity (TLAC) standard, 2015:
    - Seeks to ensure global systemically important banks (G-SIBs) can absorb losses and be rehabilitated without public support.
    - G-SIBs are expected to ensure adequate loss-absorbing capacity (LAC) through issuance of instruments meeting specific requirements; some authorities have applied similar requirements to other banks.
- Remaining challenges:
  - Implementation of the "ending too-big-to-fail" framework is progressing, but significant work remains to enhance resolvability of all financial institutions that could be systemically significant or critical if they fail (FSB 2023).
  - Establishing sufficient LAC can be challenging, especially for institutions that have not traditionally relied on capital market funding.
  - Consequently, under exceptional circumstances, country authorities may still need to rely on public sector support and temporary public ownership to safeguard financial stability — an approach acknowledged in the KA (Box 1).
- Purpose of the note:
  - Provides guidance on use of fiscal resources for public solvency support as an exceptional crisis management measure.
  - Draws on IMF involvement in bank restructuring programs and technical discussions with national authorities.

*Source: IMF Technical Note — Exceptional Public Solvency Support to the Banking Sector: Pitfalls and Good Practices (Preface and Introduction).*

### BOX 1. Exceptional Solvency Support and Bank Resolution Regimes

### BOX 1. Exceptional Solvency Support and Bank Resolution Regimes

### Funding arrangements and resolution objectives
- Funding arrangements are essential in modern bank resolution regimes to provide liquidity in resolution, capitalize bridge banks, and facilitate deposit transfers.
- Two stylized options in the Key Attributes of Effective Resolution Regimes (KA):
  - Privately financed deposit insurance or resolution funds with ex ante industry contributions.
  - Temporary public funding with ex post recovery from the banking sector under strict conditions to minimize taxpayer costs and moral hazard.
- KA acknowledges temporary public ownership as a “last-resort” (KA 6.5), with government subscription to newly issued shares and write-downs of existing shareholders; state losses should be recovered from unsecured creditors or, if necessary, the financial system more widely (for example, through ex post levies).

### Why governments recapitalize banks: rationale and risks
- Banking sector distress disrupts payment, clearing, and settlement functions; erodes asset values; reduces credit flows; and can slow economic growth.
- Typical drivers of banking crises include:
  - Unsustainable macroeconomic policies (for example, large current account imbalances, persistent budget deficits, unsustainable public debt).
  - Rapid financial liberalization, excessive credit growth, asset price bubbles.
  - Weak governance and risk management in banks.
  - Large bank-sovereign linkages, dollarization, or weak regulation and supervision.
- “Gambling for redemption” by weak banks increases systemic risk via riskier operations, weak underwriting, delayed loss recognition, complex group structures, or fraudulent accounting.
- Emergency central bank liquidity and government guarantees may be necessary for liquidity runs but are typically insufficient alone; restoring solvency is critical.
- Private recapitalization may be unavailable in systemic distress due to:
  - Existing shareholders’ limited capacity.
  - Low risk appetite of new investors.
  - Fire-sale risks in asset divestitures.
  - Simultaneous distress across many banks competing for a finite pool of resources.
- Public solvency support is a last-resort when private solutions and credible resolution regimes cannot ensure financial stability (Addo Awadzi and others 2018; Moretti, Piris, and Dobler 2020).
- Recapitalization programs typically appear in the restructuring and resolution phase after near-term liquidity stabilization and before distressed asset management.
- Public solvency support carries substantial taxpayer cost risks and political pressures; bailouts can be hard to unwind and may require long-term privatization efforts.

### Minimum conditions for exceptional public solvency support
- Recapitalization strategies should be based on accurate, up-to-date asset quality assessments and quantification of capital shortfalls, including forward-looking stress tests.
- Diagnostic programs should use prudent assumptions on projected loan losses, collateral valuations, profitability, and liquidity needs; external participation can help confidence and reduce legal challenges.
- Identifying origins of idiosyncratic weaknesses (governance, risk management, internal controls, fraud, delayed loss recognition) is essential to prevent recurrence.
- Cost-effectiveness and minimizing moral hazard require showing stakeholders that strategies minimize public costs. Public solvency support should:
  - Be reserved for institutions whose failure, individually or as a group, pose systemic risks.
  - Be predicated on loss allocation to former owners and, if possible, junior creditors; existing shareholders should be diluted commensurate with losses; hybrids converted or written down per contractual provisions.
  - Allow for concurrent private sector investments where possible; government underwriting and mechanisms (for example, call options or rights of first refusal) can facilitate private participation and eventual acquisition of government stakes.
    - Example facts: in the Spanish recapitalization program, burden-sharing reduced public support needed by about 25 percent; around 70 percent of affected hybrid instruments had been marketed to retail investors; subordinated debt holders were allowed to reinvest remaining amounts in a senior debt product with an annual 2 percent coupon payable on maturity.
  - Not introduce unfair competition (for example, overcapitalization, large government deposits, off-market NPL transfers, regulatory forbearance).
- Legal mandates should be clear and integrated into public financial management frameworks covering (1) budget formulation, (2) execution, (3) accounting and reporting, (4) fiscal risk management, and (5) audit.
  - In the absence of standing authorizations, supplementary budgets may be required on an expedited basis.
- Credible restructuring plans must be timebound and supported by financial projections for income, expenditure, balance sheet items, cashflows, and key regulatory ratios; measures to entrench viability may incur near-term losses (for example, divestitures, redundancy plans, IT investments).
- Management changes and independent professional management (including independent board members) are typically necessary to insulate operations from political interference and improve rehabilitation prospects.
- Governance: a high-level interagency committee should coordinate decisions (including the Ministry of Finance, supervisory agency, and central bank) and, for large programs, establish technical working groups for asset valuation, contract negotiation, and stakeholder communications. External expert support is advisable.
- Bank ownership arising from recapitalization should be the exclusive responsibility of the government—not other safety net participants—to avoid conflicts of interest; shares should be transferred to the government as soon as possible if temporarily held by other authorities.
- Statistical treatment:
  - If a realistic return is expected, the government records an increase in financial assets and the transaction has no effect on the deficit but may increase gross government debt.
  - If no realistic return is expected, the transaction is treated as a capital transfer and reflected in the government deficit; substantial doubt about long-term viability warrants classification as a capital transfer.
- Accountability: investigate potential wrongdoing, conduct forensic audits, pursue restitution where culpability is found, submit illicit activity suspects to competent authorities, and publish transparency on estimated costs and recoveries through periodic fiscal risk statements.
- Independent post-mortem reviews by external experts are advised to draw lessons and strengthen supervision; supervisors should evaluate their own activities and prepare action plans where needed.

### Support modalities: instruments and trade-offs
- Government support options include assisted mergers, direct acquisition of problem assets, and direct recapitalization; each has distinct trade-offs.
  - Assisted mergers can maintain critical functions with limited upfront taxpayer cost but may create too-big-to-fail and competition concerns.
  - Direct asset acquisition exposes the government to future losses and can create moral hazard if transfer prices are too high.
  - Direct recapitalization offers greater control over rehabilitation if carefully designed to protect taxpayers and minimize moral hazard.
- Equity investments (Common Equity Tier 1) are a straightforward, transparent recapitalization approach:
  - Strengthen capital base with high-quality, fully loss-absorbing instruments.
  - Give the government shareholder powers (board appointments, approval of mergers, dividend policies).
  - Provide a clear exit via divestiture, but can be difficult to unwind if market conditions do not improve.
- Trade-offs between economic ownership and voting rights:
  - Governments may acquire common shares or nonvoting capital instruments; the latter preserves private control and may reduce concerns about political interference.
  - Regulatory considerations affect eligibility for regulatory capital.
- Historical example and figures:
  - Troubled Asset Relief Program (United States) Capital Purchase Program: more than one-third of $700 billion (that is, $250 billion) allocated to the Capital Purchase Program, with $204.9 billion invested.
- Contingent convertible capital instruments (including AT1) were used precautionarily during the global financial crisis, but AT1 going-concern loss absorbency remains largely untested. Key cautions:
  - Such instruments are unsuitable when significant losses have already crystallized or when recipient banks lack revenues to pay remuneration.
  - If perceived negatively, conversion could trigger liquidity squeezes.
  - Jurisdictional differences in AT1 implementation (sequencing of CET1/AT1 write-downs, conversion vs permanent write-downs) complicate cross-border consistency.
- Table 1 summary (selected pros and cons preserved in substance):
  - Common equity: underpins confidence; immediate burden sharing via dilution; government voting rights increase influence; disadvantages include potential public sector interference, no meaningful recoveries until divestiture, and difficulty to unwind.
  - Convertible debt instruments: flexible terms and potential financial upside; nondilutive nature preserves control for original shareholders and may undermine accountability; not practicable after loss crystallization; additional costs may complicate rehabilitation.
- Governments should initiate divestitures as soon as market conditions allow, aiming to return the bank to private ownership even if some market value is sacrificed; privatization options include domestic/international equity sales or private sales.

### Governance of temporary government investments
- Independent and professional representation of government-held bank shares is important to achieve timely transfer back to private ownership and to avoid political interference that can erode viability.
- Maintain a clear delineation between government socioeconomic objectives and its role as commercial shareholder to preserve legitimacy and facilitate divestiture.
- Good practices for exercising shareholder rights on a commercial, arm’s-length basis include:
  - Establishing a holding company–type structure or a dedicated unit within the Ministry of Finance to advise on bank ownership matters.
  - Ensuring transparent arrangements and professional management to improve prospects of successful rehabilitation and divestiture.
- Empirical finding noted: staff analysis suggests public banks tend to have lower financial soundness indicators and weaker performance than private banks.

*Source: tnmea2025010 - BOX 1. Exceptional Solvency Support and Bank Resolution Regimes.*

### BOX 2. A Closer Look at Shareholder Management Arrangements

### BOX 2. A Closer Look at Shareholder Management Arrangements

### Cross-country examples of shareholder management arrangements
- United Kingdom
  - Responsibility for managing government shareholdings from crisis interventions was initially entrusted to UK Financial Investments (UKFI), a government-owned company established in November 2008.
  - UKFI was tasked with managing the government’s investments on a commercial basis, aiming to protect and create long-term value for the taxpayer while giving due regard to other policy considerations, including financial stability and competition.
  - UKFI’s board comprised a chairman, a chief executive, and six nonexecutive directors.
  - In 2018, the operations of UKFI were transferred to UK Government Investments (UKGI), a government-owned company created in 2015 to take on functions and operations of the Shareholder Executive; UKGI continues to operate on similar principles with a mandate to manage investments on a commercial basis while pursuing orderly disposals.
- Greece
  - The Hellenic Financial Stability Fund (HFSF) was established in July 2010 to contribute to the stability of the Greek banking system in the public interest.
  - HFSF is wholly owned by the state but enjoys administrative and financial autonomy, with a two-tier management structure largely comprising independent professionals.
  - HFSF monitors performance of supported banks (Alpha Bank, Eurobank, National Bank of Greece, and Piraeus Bank) and seeks to ensure they operate on market terms and are returned to private ownership in an open and transparent manner.
  - Relationship Framework Agreements document principles governing the relationship, underscore HFSF’s commitment to respect banks’ business autonomy and avoid actions that could prevent, restrict, or distort competition; supported banks agree to adopt best practice corporate governance frameworks and seek HFSF’s consent on certain issues (for example, amendments of restructuring plans and remuneration policies).
- Ireland
  - Management of the government’s shareholdings and investments in the financial sector (Bank of Ireland, Allied Irish Banks, and Permanent TSB) is allocated to the Shareholding and Financial Advisory Division of the Department of Finance.
  - The Division is responsible for monitoring banks’ performance, protecting the government’s shareholder rights, and advising the minister on privatization strategies.
  - Relationship Framework Agreements signed with each bank specify that the minister does not intervene in day-to-day operations but is entitled to receive periodic briefings on achievement of business plans.
- Israel
  - During the bank stock crisis of 1983, safeguards were designed to counteract government involvement in day-to-day management without institutional overhead.
  - The approach established multiple committees, including a public committee of experts appointed by the Minister of Finance, which appointed independent shareholder committees to execute shareholder responsibilities, including board nominations.
  - Shareholder committees were instructed to exercise voting rights at their own discretion, except to oppose proposals that would weaken rights attached to the government’s shares and their transferability.
  - Committee members were subject to competence and independence standards, could not serve on more than one committee, and divestiture decisions remained under the purview of the Minister of Finance with share transactions requiring explicit written instructions.
- Ukraine
  - Oversight of state-owned banks is entrusted to a dedicated Shareholder Management Unit within the Ministry of Finance to ensure investments are managed on a commercial basis.
  - The ministry has sought supervisory boards with a two-thirds majority of independent members to strengthen corporate governance in state-owned banks.
  - The Banking Law:
    - Outlines the state’s responsibilities as shareholder;
    - Specifies eligibility criteria for supervisory board members (two-thirds of whom need to be independent);
    - Prescribes the competitive selection process for supervisory board members;
    - Specifies dismissal criteria.
  - The government (represented by the cabinet of ministers) has entered into relationship agreements with the banks that underscore operational autonomy; address provision of information by supervisory boards; establish communication protocols; provide principles for remuneration of managers; and elaborate on the annual assessment of supervisory boards.

### Design and governance principles for shareholder management entities
- Preserve supported banks’ operational independence irrespective of legal ownership structure.
- Concrete measures to ensure independence include:
  - The establishment of framework agreements between the entity and the banks that define, and clearly limit, modalities for periodic interaction and reporting (particularly delicate if there are minority shareholders).
  - Arrangements for the selection of executive board members of supported banks.
- Functioning of the shareholder management entity should be supported by clear understandings with the government on:
  - Composition of its board (ideally with a board majority comprising independent members, and no government officials in executive roles).
  - Procedures for selecting and appointing board members.
- Agreements guiding the relation between shareholder management entities and the government should regulate which strategic decisions would require government approval, including those related to the divestiture strategy.23
- Transparency on the performance of the shareholder management entity and achievement of its objectives (in qualitative and quantitative terms, for example, performance of shareholder responsibilities and realization of recoveries) is crucial for accountability to taxpayers.

### Professional management, independent boards, and governance safeguards
- Professional management and independent board members can enhance value generation at state-supported banks.
- Shielding senior management from political pressure helps prevent unprofitable or excessively risky activities that would discourage private sector investors from eventual takeover.
- Supported banks should aim to improve medium-term marketability to domestic and foreign investors by:
  - Competing on market terms;
  - Acting in good faith;
  - Avoiding protracted reliance on the government.
- A management team with clear reprivatization goals will aim to maintain financial ratios in line with those of other banks, protecting reputation and reducing need for potentially onerous restructuring by future owners.
- Independent board members provide safeguards against political interference and conflicts of interest.
- Authorities may maintain lists of potential candidates as part of crisis management binders to address challenges in identifying suitable managers and board members under time pressure.
- Transparent nomination and dismissal processes, together with clearly outlined roles and responsibilities of board members (including ex officio members) in board charters, reinforce corporate governance and accountability.24

### Remuneration practices for supported banks
- Remuneration modalities should be designed to curb excessive risk taking and prevent misspending of scarce public resources.
- Compensation practices can amplify risk taking by rewarding short-term profits over prudent risk management; introducing sound compensation practices encourages a healthy risk culture and supports legitimacy of support operations by demonstrating prudent use of public funds.
- Supported banks should not be placed under limitations that preclude attracting and maintaining talent, as this could undermine financial performance and reduce government ability to maximize value of its investment.
- Governments should avoid imposing caps on remuneration or transposing salary limits for public officials to supported banks; instead they should:
  - Seek effective alignment of compensation practices with prudent risk management;
  - Pursue timely and comprehensive disclosure of remuneration policies.25

*Sources: Country authorities; and UKGI, HFSF, Ireland’s Department of Finance, and Ukraine Ministry of Finance websites.*

### BOX 3. Remuneration Reforms in Practice

### BOX 3. Remuneration Reforms in Practice

### Governance mechanisms
- Robust oversight and involvement of independent control functions (for example, human resources, risk management, compliance, and internal audit) are critically important to ensure the effectiveness of remuneration policies.
- Independent Compensation Committees, comprising nonexecutive directors, can help reinforce governance mechanisms by establishing and monitoring banks’ overall compensation systems.
- Control functions can provide input to relevant board committees on quantitative and qualitative criteria used for aligning variable remuneration with banks’ risk appetite frameworks, and otherwise advise on how to respond to risk events that could trigger clawbacks or negative adjustments (“malus”) to variable compensation.

### Measurement of performance
- Financial metrics used to determine variable compensation should be duly risk-adjusted, for example, risk-adjusted return on capital and return on capital.
- Compensation frameworks should incorporate risk indicators for asset quality (nonperforming loans), capital adequacy, liquidity, and revenue volatility.
- Nonfinancial metrics should also be considered (for example, data on operational incidents, findings of regulatory examinations and audit reports, and customer complaints).
- Although the FSB’s progress report highlights some successful applications of clawback, legal challenges—ranging from challenges in proving culpability to costs of legal action potentially exceeding the amount due for recovery—may still be considerable, especially for older contracts that lack explicit clawback mechanisms.

### Aligning compensation with reprivatization and public support objectives
- Linking compensation with the realization of market value will help align incentives of senior management and staff with the government’s reprivatization objectives.
- A substantial proportion of variable compensation could be awarded in shares or share-linked instruments (for example, warrants) that vest upon successful transfer of the bank to the private sector.
- Clawbacks should be considered if bank performance lags or actions are not aligned with long-term value creation and prudent risk taking.
- The provision of public solvency support should trigger a review of the compensation structures of highly paid employees to ensure that they are compatible with desired risk outcomes.

### Supervisory independence and oversight of restructuring
- Maintaining supervisory independence is critical for effective oversight of state-owned institutions.
- Institutions that have benefited from public solvency support should be subjected to the same supervisory scrutiny as privately owned institutions of comparable size and complexity.
- There should be no erosion of supervisory standards and powers, and prudential requirements based on public ownership, and board members of banks placed under government control should meet the same fit and proper requirements that apply to other institutions (Adams, Aydin, Chon, Morozova, and Iskender 2020).
- Oversight of restructuring measures should feature prominently in prudential supervision of banks benefiting from public solvency support:
  - Supervisors should ensure vulnerabilities that may have contributed to capital shortfalls are addressed decisively, including through comprehensive restructuring of the bank’s operations.
  - Supervisors should closely scrutinize the realism of restructuring plans (including under stressed conditions) and maintain a close dialogue with the bank’s management, its board of directors, and internal and external auditors about the effectiveness of its risk control environment and the sustainability of its business model, after recapitalization.
  - Implementation delays or broader concerns about the robustness of the measures taken by the bank should be promptly escalated, with bank management required to take corrective actions as needed.

### Transparency and disclosure
- Public banks should be subject to the same disclosure requirements as those applicable to private banks (Adams, Aydin, Chon, Morozova, and Iskender 2020).
- Governments may have valid reasons to be even more demanding of the banks they own, especially regarding the relationships between the bank and the state (for example, in connection with lending to state-owned enterprises).
- It is good practice for governments to publish the details of any public support arrangements, with additional safeguards put in place to approve, monitor, and track how the government funds are used.

### Aligning compensation and risk taking (design features)
- A mix of instruments (for example, cash and shares) is generally preferable to ensure risk taking is duly aligned with long-term objectives for value creation.
- Variable components should be subject to in-year ex ante adjustment and deferral (for example, three to five years), with the possibility to make ex post changes in case of misconduct and material breaches of risk management policies or other internal requirements.
- CEO and CRO compensation, in particular, warrants close attention.

*Source: BOX 3. Remuneration Reforms in Practice (tnmea2025010).*

### BOX 4. How to Design Effective Recapitalization Bonds

### BOX 4. How to Design Effective Recapitalization Bonds

### Purpose and trade-offs
- Bond recapitalization seeks to alleviate sovereign financing constraints that may otherwise preclude the provision of public solvency support to distressed banks.
- Key advantage for the government: it does not deplete cash reserves and avoids the issuance of debt securities to third-party investors, which can prove impossible or prohibitively expensive at times of crisis.
- Main precaution: bond characteristics should not undermine the medium-term viability of the recipient bank, for example, by immobilizing banks’ balance sheets (if secondary bond markets lack depth or the instrument are not marketable), or provide the recipient with insufficient earnings to ensure sustainable returns going forward.

### Marketability and liquidity
- Providing recipient banks with bonds that are marketable (and for which secondary trading occurs) will facilitate liquidity management because the bonds can either be sold or used in repo operations with private counterparts.
- Risk: supplying bonds that the recipient bank may sell opportunistically could be detrimental to bond market development if proceeds are reinvested in more risky assets to boost near-term profitability.
- Recommendation: curtail tradability of the bonds during an initial period when operational restructuring plans are still being prepared and opportunistic behavior is most likely.
- Even during restricted tradability, recipient banks should be able to use the instruments as collateral (subject to adequate haircuts) for refinancing operations with the central bank to address near-term liquidity pressures.

### Interest rates
- The government’s interest in minimizing costs by reducing coupons may conflict with banks’ efforts to restore profitability.
- If the recapitalization takes place while interest rates are elevated, fixed-rate instruments would be advantageous for recipients; considerations would be exactly opposite for the government because locking in high coupons would generate higher fiscal outlays over the lifetime of the bonds.
- Policy imperative: although potential debt-servicing constraints of the government need to be carefully considered, failure to provide duly remunerated instruments is counterproductive because it erodes banks’ interest margins, potentially jeopardizing their viability.

### Maturity
- When using bonds for recapitalization purposes, avoiding substantial maturity mismatches and potentially large duration gaps becomes critically important.
- Recommendation: provide a mix of securities with different maturities (possibly through reopening previous issuances) to enable more effective asset and liability management by the supported bank(s) while allowing the government to smooth its debt-servicing obligations.

### Currency
- Under most circumstances, governments will want to provide domestic currency bonds because they will be reluctant to take on (or increase) exchange rate risks.
- Exception: if supported banks are heavily dollarized, the provision of foreign currency–denominated securities may be necessary to minimize currency mismatches.

*Source: Andrews and Josefsson 2003.*

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_Source: https://www.imf.org/-/media/files/publications/tnm/2025/english/tnmea2025010.pdf_