## _041709 ## Source details **Canonical URL:** [_041709](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_041709.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_041709.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_041709.pdf.json) --- ### Preface — Purpose, scope, and context - Purpose and scope: - Provides an overview of the legal, institutional, and regulatory framework to address cases of bank insolvency (deposit-taking institutions only). - Intended primarily to inform IMF and World Bank staff work and to provide guidance to member countries. - Excludes other types of financial institutions and cross-border bank insolvency issues. - Part I: bank insolvency in periods of financial stability. Part II: bank insolvency in periods of systemic crisis (expanded/updated). - Context and related work: - Part I based on the “Global Bank Insolvency Initiative” (joint IMF/World Bank initiative launched in 2002). - Part II prepared by IMF staff to stimulate discussion given evolving practices. - IMF and World Bank preparing additional related papers and coordinating with other international bodies. ### Part I — Key institutional and legal findings (executive summary) - Primary objective: - Safeguard the stability of the financial system. - Definition of “insolvency proceedings”: - All official action involving removal of management and/or limits/suspension of shareholders’ rights and assumption of direct control when a bank crosses a “threshold.” - Two commonly distinguished proceedings: - Official administration: official authority assumes managerial control to protect assets, assess condition, restructure or place in liquidation. - Liquidation proceedings: aim at value-maximizing realization of assets and equitable distribution of proceeds; results in dissolution. ### Institutional design — choice of regime, authority, thresholds, and accountability - Choice of regime: - Options: corporate insolvency framework with bank-specific modifications, or a special bank insolvency regime. - Trend toward special regimes; corporate insolvency is court-based; special regimes may be court-based or administrative. - Authority to commence proceedings: - Banking authorities almost universally empowered to initiate proceedings; often exclusive competence. - If others may commence, banking authorities should participate at all stages. - Thresholds for commencement: - Regulatory threshold: permit commencement when net financial position falls below a specified level even if net worth positive (quantitative or qualitative). - Balance-sheet threshold: negative net worth (liabilities exceed assets). - Illiquidity threshold: inability to pay as obligations fall due. - Judicial review and liability: - Administrative insolvency proceedings should permit judicial review limited to legality and manifest error; remedies must be clear. - Many jurisdictions limit liability of authorities to cases involving gross negligence or bad faith; statutory indemnification recommended. ### Official administration — structure, powers, safeguards, and termination - Two phases: - (i) diagnosis (due diligence and assessment); (ii) restructuring/liquidation (salvage attempts or transfer to liquidation). - Appointment and qualities of official administrator: - Law should specify appointing authority, “fit and proper criteria,” limited grounds for dismissal, and that only appointing authority can dismiss. - Fit and proper criteria include banking and resolution experience, training in banking/accountancy/law, integrity, and absence of conflicts of interest. - Powers and operational elements: - Transfer of control moment and scope must be specified; prevent interregnum and asset dissipation. - Administrator authorized to continue operations as necessary, protect assets, apply for avoidance of preferential contracts, hire/fire staff, maintain premises and systems. - Moratorium should not be automatic; discretionary use preferred. - Licensing implications: law should specify whether license revocation, suspension, or deferred revocation is permitted during administration. - Confidentiality: allow flexibility for limited non-disclosure; full disclosure of administrator’s reports after conclusion. - Timetable, cost, accountability: - Speed: duration should be as short as possible; law should set timetables but avoid excessive rigidity. - Cost: legal rules should allocate who bears expenses; at minimum the bank bears relevant expenses; administrative expenses often given preferred ranking. - Termination: powers cease only after restructuring, restoration, or transfer to liquidator; final report required. ### Bank restructuring — techniques, investor negotiations, transfers, and supervisory role - Authorized restructuring techniques: - Broad authority to implement mergers, purchase-and-assumption transactions, “good-bank/bad-bank” separation, bridge banks, and publicly-assisted restructuring. - Administrator may implement corporate actions that normally require shareholder approval (sometimes subject to court or supervisory approval). - Negotiations with investors and use of proprietary information: - Administrator can solicit/assess bids, negotiate sale conditions, recognize market valuations even if below book value, and disclose proprietary information under confidentiality agreements. - Transfer of assets and liabilities: - Administrator must be authorized to sell assets or arrange assumption of liabilities piecemeal or as a pool. - Explicit statutory provision recommended to allow transfers of liabilities (e.g., deposits) without prior creditor consent. - Supervisory approval: - Banking authorities must vet new major shareholders and senior managers on fit-and-proper grounds and examine restructuring terms; consult home-country supervisor for foreign acquirers. ### Bank liquidation — objectives, powers, moratorium, and distribution - Liquidator appointment and powers: - Law should specify appointing authority; liquidator immediately receives full control, becomes sole legal representative, and succeeds to governance rights. - Liquidator authorized to preserve assets, engage in commercial transactions for the estate, hire professionals, advance funds to protect collateral, maintain deposit accounts, and invest prudently. - Supervision, transparency, and accountability: - Liquidator need not seek permission for every action; appointing authority may give directions and prior approval for major decisions. - Liquidation must be highly transparent with periodic reporting and accounting reviews. - Moratorium: - Liquidation should trigger an automatic moratorium/suspension of collection activity; stay on current legal actions and bar on filing new actions except with appointing authority permission. - Where no deposit insurance exists, law may allow immediate distributions to depositors up to a specified amount. - Payment orders, financial contracts, and netting: - Legal framework must address moratorium timing and treatment of netting, set off, novation, and close-out arrangements; avoid disruptive “zero-hour rule” effects. - Avoidance powers and asset realization: - Liquidator can terminate executory contracts, apply to court to avoid unfair/prejudicial pre-insolvency transactions, and manage/realize assets to maximize returns. - Claims, depositor payout, and priority: - Liquidator invites creditors to file claims within specified periods (examples: as short as 90 days; six months; possibly one year). - Deposit insurance payouts occur outside liquidation; deposit insurer subrogated to depositors’ rights to extent of payments. - Law must specify order of priority for distributions; shareholders are residual claimants. ### Judicial review, liability limits, and protections for officials - Scope of judicial review: - Should be circumscribed to avoid undermining banking authorities’ effectiveness; courts assess legality and not substitute policy discretion unless manifest error, abuse, or misuse of power. - Review proceedings should be conducted expeditiously and normally should not stay insolvency proceedings. - Monetary compensation (damages) may be the only effective remedy where restoration is infeasible; legal framework may limit circumstances for damages. - Limits on liability and personal protections: - Law should establish clear limits on damages; many jurisdictions limit liability to gross negligence or bad faith. - Express statutory protection from civil liability for actions/omissions taken in good faith is recommended. - Individuals should be indemnified for expenses in successfully defending civil claims; no protection for fraud or willful misconduct. - Officials should not be subject to criminal prosecution for negligent performance of duties. ### Part II — Systemic crises: definition, phases, and strategic objectives - Definition and characteristics of systemic banking crisis: - Typically includes one or more of: (i) severe problems in a large part of the banking system; (ii) system-wide loss in bank asset quality; (iii) widespread loss of credit discipline; (iv) danger of collapse of payment and settlement systems. - Authorities often must identify systemic risks quickly with limited information. - Three interlinked crisis phases: - Crisis containment: stabilize creditor expectations and halt runs via liquidity provision and other measures. - Restructuring: resolve banks in distress, restoring soundness or liquidating. - Asset management: medium-term restructuring of nonperforming assets. ### Institutional arrangements for systemic crisis management - Policy development and coordination: - Clear mechanism for policy development and coordination is critical; some countries form a high-level policy group headed by a senior official (e.g., minister of finance or prime minister). - Authorities must “speak with one voice,” maintain coordinated communications, and clearly allocate roles among agencies. - Choice of restructuring authority: - Options: rely on existing banking authorities or establish a new restructuring agency (benefits of separate agency include avoiding perceived conflicts of interest and concentrating specialized skills). - Asset management institutions: - Asset management companies (AMCs) — public or private — often manage impaired assets; AMCs should be subject to oversight and good governance. ### Regulatory and legal measures for crisis containment and restructuring - Four main crisis-containment measures: - (i) emergency liquidity assistance (ELA); - (ii) blanket guarantees; - (iii) certain administrative measures (including deposit freezes and bank holidays); - (iv) exchange controls. - Emergency liquidity assistance: - In systemic crises ELA scope may expand; ELA often requires collateral and penalty rates, but crisis conditions may warrant eased terms. - Safeguards typically: sterilization tools, collateral, above-average interest, liquidity triggers tied to supervisory actions, enhanced supervision of recipients. - Blanket guarantees: - Can calm market fears if credible; typically cover all unrelated creditors (depositors, interbank, foreign creditors) and often exclude shareholders and insiders. - Credibility depends on political commitment, resolution framework strength, government capacity to cover costs, and communication strategy. - Risks: moral hazard, delayed restructuring, contingent fiscal liabilities. - Administrative measures and exchange controls: - Administrative measures (deposit withdrawal restrictions, maturities extensions, securitization of deposits) are disruptive and legally challengeable; should permit periodic withdrawals up to specified amounts and be time-limited with exit policies. - Exchange controls may be used if crisis includes balance-of-payments pressures; must be comprehensive, enforced, and consistent with IMF obligations. ### Restructuring strategies, public assistance, and nationalization - Bank categorization for resolution strategies: - (i) viable and meeting prudential ratios; - (ii) viable but insolvent or undercapitalized; - (iii) insolvent and nonviable. - Options: - Private-sector solutions: shareholders recapitalize/restructure; if they fail, seek alternative private owners. - Public-sector recapitalization: considered to preserve viable institutions or where failure threatens systemic stability; recapitalization should follow loss absorption by existing owners. - Temporary nationalization: used in exceptional cases; should be temporary and followed by privatization at earliest opportunity. - Principles for public assistance (recapitalization): - Shareholders must absorb accumulated past losses before public funds used. - For banks crossing regulatory threshold with positive net worth, shareholders’ positions diluted accordingly. - For balance-sheet insolvency, public funds provided only after shareholders surrender or write down shares. - State should retain right to reclaim expenditure and participate in gains when restructuring succeeds. - Box 1 (recapitalization scheme characteristics) — selected points: - Public solvency support as last resort. - Positive net worth required for eligibility unless owners/new investors restore CAR to above zero. - Convertibility: Tier 2 capital provided by government should automatically convert to Tier 1 if CAR falls below a specified ratio (possibly 8 percent). - Payment: government should pay for shares in tradable government bonds issued on market terms. - Pledge of shares by majority shareholders to protect public investment. ### Asset management and AMCs — pricing, powers, and governance - Pricing and incentives: - AMCs should normally purchase assets at market value (or appropriate estimated long-term recovery value). - Purchasing at inflated prices creates hidden subsidies to shareholders or creditors and must be avoided. - Legal and enforcement considerations: - Effective asset management depends on adequacy of secured rights and corporate insolvency law. - Where frameworks are weak, AMCs may need special powers — but such powers should be temporary, fully transparent, subject to oversight, and judicial review. - Governance: - AMCs require unambiguous mandates, independence, good governance, oversight, separate budgetary process, reporting to parliament, and strict audits. - Public AMCs should be temporary and self-liquidating with incentive structures limiting undue prolongation. ### Exiting from crisis measures — sequencing and limits - Forbearance and temporary easing: - Any temporary easing should be explicit, transparent, closely monitored, and phased out as quickly as stability permits. - Phasing out blanket guarantees: - Remove protection first from more sophisticated creditors, then large creditors, and finally remaining depositors when system stability demonstrated. - Market notice of removal can be given in advance (possibly 6–12 months). - Administrative measures: - Pose severe risks to private confidence and must be eliminated as soon as practicable. ### Liquidation initiation, conduct, and practical issues - Grounds and initiation: - Law must specify grounds for liquidation; regulatory threshold often suffices for administration but liquidation may require balance-sheet threshold or illiquidity threshold. - License withdrawal and liquidator appointment: - Commencement of liquidation typically leads to license revocation; law should specify who places bank in liquidation and appoints the liquidator. - Upon appointment liquidator receives full control, books, records, and governance rights. - Estate establishment and asset protection: - Possession of all assets passes to liquidator; liquidator must inventory assets, verify nominal and real values, and have powers to preserve and realize assets. - Liquidator must have authority to advance funds, redeem secured assets, enter into contracts for professionals, and make prudent investments. - Moratorium, payment systems, and netting: - Liquidation triggers automatic moratorium on collection activity; treatment of payment orders depends on timing rules (avoid disruptive “zero-hour rule”). - Settlement finality provisions recommended to prevent reversal of payment orders prior to commencement. - Netting/close-out arrangements generally should be enforceable to prevent chain defaults; where exclusion applies, careful analysis of systemic risk needed. - Claims, verification, priority, and distribution: - Creditors invited to file claims within statutory deadlines (examples include 90 days; six months; possibly one year). - Priority classes commonly include: liquidation costs; employees; government taxes; secured creditors; unsecured general creditors; depositors; deposit insurance agency (subrogated); subordinated bondholders; shareholders as residual claimants. - Jurisdictional variants exist; some give depositors preferential treatment or first priority for part of claim. - Termination and unclaimed assets: - After final distribution and final accounts, liquidation ends and bank’s legal personality dissolved; unclaimed assets handled per law (e.g., held by trustee then may become state property). ### Operational and timing considerations (diagnosis, audits, and practical constraints) - Bank diagnosis: - Supervisory staff can perform initial assessments; external audit teams provide independent judgment but typically take over three months to contract and complete. - One alternative: supervisors perform initial assessment; external auditors complete later. - Timing of restructuring and sale: - Diagnostic phase can be very brief (e.g., a few days or a weekend) in some cases to enable rapid takeover, sale, or liquidation. - Maximum durations vary by jurisdiction; timetables should be realistic to avoid value erosion by protracted processes. - Information, confidentiality, and transparency trade-offs: - Authorities require flexibility for confidential negotiations with potential investors; full disclosure of reports should occur after administration concludes. ### Empirical and consultative inputs (preparation of the Initiative) - Preparation and consultative process: - Report prepared during 2003–2004 and updated periodically thereafter; coordinated by IMF and World Bank staff with consultative input from BIS, Basel Committee, Financial Stability Institute, European Commission, and participants from 17 developed and developing countries. - Two global seminars held with participation from representatives of 78 countries. - FSAP assessment note: - More than 80 percent of the 135 countries assessed through FSAP were found compliant or largely compliant with Basel Core Principles elements on legal framework for supervision, authorization, compliance and soundness; compliance was 66 percent for taking necessary remedial action under the legal framework, including bank resolution. *Source: Preface; Part I summary; Part II — Key Features of the Framework for Systemic Crises (IMF and World Bank staff).* ### Preface................................................................................................................. ### Preface ### Purpose and scope - Provides an overview of the legal, institutional, and regulatory framework that countries should put in place to address cases of bank insolvency. - Primarily intended to inform the work of the staffs of the International Monetary Fund (IMF) and World Bank, and to provide guidance to their member countries. - Deals exclusively with the legal, institutional, and regulatory frameworks for insolvent banks (deposit-taking institutions); other types of financial institutions are not covered. - Addresses the regime at the domestic level; issues of cross-border bank insolvency fall outside the scope of the study. - Part I focuses on bank insolvency in periods of financial stability; Part II focuses on bank insolvency in periods of systemic crisis and is an expanded and updated version of the relevant chapter of the Global Bank Insolvency Initiative report. ### Context and related work - Part I is based on the report of the “Global Bank Insolvency Initiative,” a joint initiative of IMF and World Bank staffs launched in 2002 and conducted with a broad consultative process involving supervisory authorities, international financial institutions, and leading experts. - Part II was prepared by IMF staff and represents the views of IMF staff; it is meant to stimulate discussion given evolving practices. - IMF staff are preparing additional papers on the causes of the current financial crisis and lessons for macroeconomic policy and regulation. - The World Bank works with international standard-setting bodies and client countries to strengthen legal, regulatory, and supervisory frameworks, and supports financial sector development and stability through grant and lending instruments, bilateral technical assistance, and instruments such as the joint IMF/World Bank Financial Sector Assessment Program and Standards and Codes Initiatives. - IMF and World Bank staff acknowledge ongoing work by other international bodies (for example, the Basel Committee on Banking Supervision’s study on cross-border bank resolution) and will seek complementarity and coordination. ### Key institutional and legal findings (Part I summary) - Primary objective of a bank insolvency framework: to safeguard the stability of the financial system. - Definition of “insolvency proceedings”: all types of official action involving removal of management and/or imposition of limits on, or suspension of, shareholders’ rights and assumption of direct control by a banking authority or officially-appointed person when a bank crosses a “threshold” for commencement of proceedings. - Two commonly distinguished proceedings (may be combined): - Official administration: an official authority assumes direct managerial control to protect assets, assess condition, and either restructure the bank or place it in liquidation. - Liquidation proceedings: aim at value-maximizing realization of assets and orderly, equitable distribution of proceeds to creditors; results in dissolution of the bank. ### Institutional design issues - Choice of regime: - Some countries use corporate insolvency frameworks with modifications for banks; others use a special legal regime for bank insolvency. - Trend toward establishment of special regimes. - Corporate insolvency is invariably court-based; special bank regimes may be court-based or administrative. - Authority to commence proceedings: - Banking authorities are almost universally empowered to initiate bank insolvency proceedings; in many jurisdictions they have exclusive competence. - Where others may commence, banking authorities should be entitled to participate at all stages. - Threshold for commencement: - Legislation should specify the “threshold” for commencing proceedings. - Frameworks should establish a “regulatory threshold” allowing commencement (e.g., when a bank’s net financial position has fallen below a specified level, even if net worth remains positive). - Crossing the regulatory threshold should permit initiation of official administration; in some countries it may justify liquidation commencement. - Accountability and judicial review: - For administrative insolvency proceedings, judicial review should be provided, conducted expeditiously, and limited to legality rather than reassessing discretionary judgments except for manifest error, abuse, or misuse of power. - Legal framework should be clear on available remedies. - Liability protection for authorities and staff: - Many jurisdictions limit liability to cases involving gross negligence or bad faith. - Legal frameworks should grant express statutory protection from civil liability and indemnification for legal expenses for board members, staff, and agents acting in good faith. ### Official administration: structure and legal elements - Two phases: (i) diagnosis (due diligence and prospects assessment); (ii) restructuring/liquidation (salvage attempts or transfer to liquidation for non-viable parts). - Key legal elements to include: - Appointment, replacement, discharge of official administrator: law should specify appointing authority, “fit and proper criteria,” and limited dismissal grounds (e.g., gross negligence); only the appointing authority should dismiss. - Mandatory vs. discretionary commencement: law must specify whether crossing a threshold requires or permits official administration. - Transfer of control: law should specify moment and scope of transfer from owners/managers to administrator and prevent any “interregnum” enabling asset dissipation. - Protection of assets and operation: official administrator authorized to continue operations as necessary to maintain value; power to apply for avoidance of certain contracts that gave preferential treatment. - Moratorium: should not be automatic on commencement of official administration; should be discretionary because automatic moratoria may be ineffective or counterproductive. - Licensing implications: law should specify whether license revocation is permitted at commencement, or whether suspension or deferred revocation is possible. - Confidentiality, transparency, accountability: authorities need flexibility for non-disclosure in some cases; full disclosure of official administrator’s reports after conclusion of administration. - Termination of official administration: powers cease only after necessary restructuring, restoration to a going concern, or transfer to liquidator; official administrator prepares final report and is then discharged. ### Bank restructuring: powers and safeguards - Official administrator should be authorized to use a wide variety of restructuring techniques, separately or in combination, and to implement corporate actions that would normally require shareholder approval (subject sometimes to court or banking authority approval). - Negotiations with prospective investors: - Official administrator generally able to solicit and assess bids, negotiate sale conditions, and recognize market valuations even if below book value, subject to supervisory approval. - Transfer of assets and liabilities: - Official administrator must be authorized to sell assets or arrange assumption of liabilities piecemeal or as a pool. - Explicit statutory provision should allow transfers of liabilities (e.g., deposits) without prior consent of creditors or counterparties. - Supervisory approval: - Banking authorities must be able to approve new major shareholders and senior managers on fit and proper grounds and examine restructuring terms to ensure prudential standards. - For foreign acquirers, supervisor should consult counterpart in acquirer’s country. - Use of proprietary information: - Official administrator should be permitted to disclose bank information to potential investors for due diligence; confidentiality agreements may be used. - Specific transaction types discussed: mergers, purchase-and-assumption transactions, “good-bank/bad-bank” separation and bridge banks, and publicly-assisted bank restructuring. ### Bank liquidation: objectives and legal design - Appointment and powers of liquidator: - Law should specify who appoints the liquidator. - Upon appointment, liquidator should immediately have full control of assets, be sole legal representative, and succeed to governance rights and powers of shareholders and management. - Liquidator should have legal powers to preserve assets, engage in commercial transactions in the estate’s name, enter contracts for professionals, advance funds to protect collateral, maintain deposit accounts, and make prudent investments. - Supervision and oversight: - Liquidator should not need permission for every action; appointing authority may give directions on general conduct and plan. - Law may require prior approval for some financially important decisions. - Transparency and accountability: - Liquidation must be highly transparent, subject to reviews for proper accounting and periodic reporting. - Moratorium: - Liquidation should lead to an automatic moratorium or suspension of all collection activity against the bank, including a stay on current legal actions and a bar on filing new actions except with appointing authority permission. - Where no deposit insurance exists, law may enable the liquidator to make immediate distributions to depositors up to a specified amount against deposit liabilities. - Treatment of payment orders and financial contracts: - Legal framework must address moratorium implications for uncompleted payment and securities settlement transactions and treatment of netting, set off, novation, and/or close-out arrangements in financial contracts. - Avoidance of transactions: - Liquidator should be authorized to terminate executory contracts if termination increases estate value and to apply to court for avoidance or rescission of unfair/prejudicial transactions, subject to payment system finality. - Management and realization of assets: - Liquidator authorized to manage assets, restructure loans, negotiate settlements or compromises, and realize assets in the most advantageous manner. - Law should permit transfer of contractual relationships without counterparty consent where appropriate. - Liability of bank officers: - Liquidator should investigate potential liability of owners, former directors, and managers for wrongful conduct and be authorized to bring civil actions where liability is established. - Distribution to creditors and depositor pay-off: - Liquidator should invite creditors to file claims within a specified period. - Where a deposit insurance scheme exists, a parallel process of notices, filings and payments to insured depositors is normally necessary. - Legal framework should provide for deposit insurance agency’s subrogation to depositors’ rights to the extent payments were made under the scheme. - Distribution of proceeds and termination: - Law must specify the order of priority for distribution of liquidation proceeds; classes of creditors to be ranked are discussed in the study. - Upon completion of final distribution and final accounts/report, the liquidation ends and the bank’s legal personality is dissolved subject to formalities. *Source: Preface and Executive Summary (IMF and World Bank staff).* ### Part II. Key Features of the Framework for Systemic Crises ### _041709 - Part II. Key Features of the Framework for Systemic Crises ### Overview - The legal, institutional and policy framework needed to address cases of bank insolvency during periods of systemic instability or systemic crisis is qualitatively different from the framework for periods of financial stability. - The framework for systemic crises will generally draw on the framework in place during stable periods and must include a flexible policy response that aims at: - protecting the payment system, - limiting the loss of depositor and creditor confidence, and - restoring solvency, liquidity and stability to the banking system. - The study draws lessons from previous systemic crises and recognizes that practices in this area are evolving. ### Definition and Characteristics of a Systemic Banking Crisis - A systemic banking crisis is typically characterized by financial sector distress of such a magnitude that it has an adverse effect on the real economy as a whole, and will usually include at least some of the following elements: - (i) severe financial problems in a large part of the banking system; - (ii) a system-wide loss in bank asset quality; - (iii) widespread loss of credit discipline; and - (iv) a danger of collapse of the payment and settlement systems. - Banking authorities will often have to identify systemic risks quickly and, in most instances, with limited information. ### A. General Considerations - Strategies to manage systemic crises typically include three phases that are interconnected and may run concurrently: - Crisis containment. The first and most urgent phase entails stabilizing creditor expectations, through a combination of liquidity provision and other measures, and halting creditor runs, including depositor runs. - Restructuring. The second phase seeks the resolution of banks in financial distress and their restoration to financial soundness and profitability or their liquidation. - Asset management. The third phase of the strategy, which has a medium-term time horizon, focuses on the restructuring of nonperforming assets. - A strong legal, institutional, and regulatory framework governing the resolution of individual cases of bank insolvency in normal times can help resolve bank insolvencies in a systemic crisis. ### B. Institutional Arrangements for Systemic Crisis Management - A critical feature of a successful crisis management framework is a clear mechanism to ensure effective policy development and coordination. - Some countries have formed a high-level policy group, headed by a high-ranking government official. - Institutional questions and responsibilities to consider: - Crisis containment. The authorities will need to make the most urgent policy and budgetary decisions in relation to the containment of the crisis. - Restructuring. Some authority must be responsible for diagnosing individual banks, reviewing their restructuring plans and ensuring their implementation, and requiring their modification where necessary. A choice must be made between relying on the existing banking authorities or establishing a new agency to oversee bank restructuring. A separate agency has benefits including avoidance of the appearance of conflict of interest, and the concentration of needed skills in a single agency. - Asset management. The principal role in the management of impaired (bad or doubtful) assets of the banking system is often played by financial institutions other than banks (e.g., asset management companies or “AMCs”) that may be either private or public sector institutions. AMCs can have mandates, in particular, to liquidate banking assets from closed institutions, or to conduct asset management in the context of broad restructuring activities. Where an AMC is established, it should be subject to adequate oversight that ensures adherence to principles of good governance. ### C. Regulatory and Legal Arrangements for Systemic Crisis Management - The legal and policy measures to be employed will vary with each phase of the crisis. - Crisis containment. Four sets of measures have particularly been employed by countries to contain creditor runs: - (i) emergency liquidity assistance; - (ii) blanket guarantees; - (iii) certain types of administrative measures; and - (iv) exchange controls. - Emergency liquidity assistance. - The conditions for providing emergency lending by central banks differ in periods of financial stability and in a systemic crisis. - Country practice in this area is evolving. Central banks are expanding the scope of emergency assistance while specifying appropriate safeguards. - Blanket guarantees. - Some authorities have resorted to a blanket guarantee of all bank liabilities (except to related parties) to calm market fears. - The precise form has ranged from implicit guarantees or declarations of policy intentions to a formal guarantee set out in legislation. - The essential feature of a successful blanket guarantee is its credibility. - Determining when a guarantee is warranted is a difficult policy judgment, and presents several risks to financial stability over the medium term. - Administrative measures. - Administrative measures or “deposit freezes” may take a variety of forms and, in particular, may restrict deposit withdrawals, extend deposit maturities, or securitize deposits. - They are disruptive and will often be subject to legal challenge. - Provision should be made for periodic withdrawals up to specified amounts. - Exchange controls. - Exchange controls are, in some cases, employed when a banking crisis is accompanied by pressure on the balance of payments. - To be effective, such controls must be comprehensive, fully enforced, and part of a broader policy package. - Moreover, they should be consistent with members’ obligations under the IMF’s Articles of Agreement. - Bank restructuring in a crisis. - Bank restructuring is a multi-year process. - The legal framework. The legal and regulatory framework governing bank insolvency should be reviewed and, where necessary, strengthened. To be effective, it will need to embody the features of the framework for normal times described in Part I of this study, although some aspects may need to be modified to deal with the systemic crisis. - Tasks in bank resolution. In approving a resolution strategy for each bank, the banking authorities would typically differentiate between banks that are: - (i) viable and meeting their prudential capital adequacy ratios and other regulatory requirements; - (ii) viable but insolvent or undercapitalized; and - (iii) insolvent and non viable. - Options for restructuring. Bank restructuring strategies may involve private sector solutions or public sector assisted solutions. - Under private sector solutions, shareholders retain the responsibility to recapitalize and restructure their bank. - A public sector recapitalization program may be considered when it is necessary to preserve viable institutions that otherwise would have failed, or nonviable institutions whose creditors cannot be adequately protected or whose failure threatens the stability of the financial system. - In certain cases, the authorities may consider temporary nationalization as a solution. Once financial conditions stabilize, the nationalized bank, or its surviving part, should be privatized at the earliest possible opportunity. - Asset management. - AMCs should normally purchase assets at market value. - The effective management of impaired assets depends to a large extent on the adequacy of the legal framework for secured rights and general corporate insolvency. - Where the legal framework is not sufficiently well-developed, asset recovery vehicles may need to be given special powers, subject to proper oversight and mechanisms for judicial review. ### D. Exiting From Crisis Measures - In systemic crises, any policy of temporary easing of regulatory compliance should be transparent (and thus explicit) and subject to close monitoring. - If blanket guarantees or administrative measures have been introduced, they must be phased out at an appropriate pace. - Firm deadlines may not be possible to establish at the outset of the crisis. *Source: Part II. Key Features of the Framework for Systemic Crises* ### 13. In designing a framework for bank insolvency, consideration needs to be given to a ### 13. In designing a framework for bank insolvency, consideration needs to be given to a number of fundamental legal and institutional questions. ### A. Institutional Framework for Bank Insolvency - Division of responsibilities among banking authorities (bank supervisor, deposit insurance agency, central bank) has no single preferred method; effectiveness depends on clearly and comprehensively specified legal powers and responsibilities, with no gaps and no duplication of functions. - Bank insolvency regime must be built on a solid framework for banking supervision that ensures: - Legal mandate: the legal mandate and functions of each agency involved with bank supervision should be clearly delineated and a mechanism for the resolution of potential conflicts should be provided for in the law. - Autonomy: the banking authorities should be endowed with operational autonomy,11 adequate legal powers and the human and budgetary resources necessary to effectively perform their functions free from external pressure. - Coordination: provision for the exchange of information and timely coordination between the banking authorities and other relevant agencies (in particular, the supervisors of the securities and insurance sectors). - Confidentiality and accountability: banking authorities should operate with the maximum degree of transparency compatible with the need to preserve confidentiality; many decisions involve confidential matters and, in most cases, confidentiality needs to be maintained. - Ensure banking authorities are accountable for their actions and that adequate reporting arrangements are in place.12 ### B. Choice of Bank Insolvency Regime - Authorities must decide whether to: - rely upon the general corporate insolvency framework, with appropriate modifications, or - put in place a special regime designed exclusively for banks. - Corporate insolvency law: - Some countries apply corporate insolvency frameworks to banks but typically introduce bank-specific modifications to: - establish a procedure for the imposition of official administration; - provide special treatment of financial contracts, unsettled payment and securities transactions, and financial collateral; - appoint the banking authority, or a person proposed by it, as administrator and/or liquidator; - address the operation of the deposit insurance scheme, including establishment of a right of subrogation for the deposit insurance agency to the claims of depositors for amounts it has paid them. - Special bank insolvency regime: - A special legal regime may facilitate timely action and consistency between supervisory and insolvency functions; particularly useful where corporate insolvency framework is weak and ineffective. - Trend toward special regimes in recent years. - Judicial vs. administrative proceedings: - Corporate insolvency proceedings invariably take place in the courts; special bank regimes may be court-based or administrative (initiated and conducted by banking authorities without judicial involvement). - Trade-offs: - Court-based system: may promote greater accountability and protection of rights but can be slow and the judiciary may lack banking expertise. - Administrative system: vests decision-making with banking experts and allows rapid action; requires provision for ex post judicial review of banking authorities’ actions to ensure accountability. - Hybrid approaches exist: official administration by banking authorities without judicial involvement, with liquidation proceedings under courts.13 ### C. Commencement of Bank Insolvency Proceedings - Key questions the framework must address: - Who may commence insolvency proceedings against a bank? - What is the triggering event or “threshold” that must be crossed before insolvency proceedings may be commenced? - Who should be in control of a bank upon commencement of insolvency proceedings? - Authority to commence proceedings: - Corporate insolvency law and bank insolvency law differ: corporate insolvency often initiated by the enterprise or creditors; bank insolvency places primary role with banking authorities due to mandate to protect system stability and informational advantage. - Banking authorities are almost universally empowered to initiate insolvency proceedings14; many jurisdictions grant banking authorities exclusive competence to commence proceedings (justifications: systemic implications of publicity; prevention of frivolous creditor actions). - Some court-based systems permit commencement by banking authorities, owners, management, and/or creditors to preserve stakeholders’ rights and to address possible inaction by authorities.15 - Where parties other than banking authorities may commence proceedings, law should require prior consultation with banking authorities and entitle them to participate at all stages, access court files, receive documents and notifications, participate in hearings and meetings, submit restructuring plans, and raise objections. - Thresholds for commencement (legislation should specify): - Illiquidity threshold: insolvency proceedings may be commenced when entity is unable to pay obligations when they fall due. - Bank illiquidity is complex: temporary liquidity problems may not indicate insolvency; liquidity problems in a solvent bank can often be addressed through inter-bank borrowing or emergency liquidity assistance by the central bank. - Balance-sheet threshold: insolvency proceedings may be commenced when balance sheet shows negative net worth (liabilities exceed assets).16 - By the time a bank reaches negative net worth, it may be too late for a structured and orderly resolution. - Regulatory threshold (additional, earlier threshold): insolvency proceedings may be commenced when net financial position has fallen below a specified level, even if positive net worth remains. - The regulatory threshold may be quantitative (based on capital position, specified leverage ratio, or a fraction of prudential ratios)17 or qualitative (severe financial/operational stress or serious risk of contagion). - Crossing the regulatory threshold should permit authorities to initiate official administration to take direct control for restructuring or liquidation. - Assumption of control: - Upon initiation of insolvency proceedings, full control should be transferred immediately to an official administrator or liquidator. - In court-based systems, provisional administration must be in place during any interval between petition filing and court decision to conserve assets. - Banking authorities should suspend or dismiss management and Board members responsible for failure; where risk of asset dissipation exists, management may need immediate expulsion without advance notice. - In court-based systems, law should empower banking authority to unilaterally suspend management with petition filing or present an ex parte application. ### D. Challenges against the Banking Authorities’ Actions - Affected parties (owners, creditors) frequently bring legal challenges in courts against: - decision to commence insolvency proceedings, and - actions taken after commencement (e.g., restructuring assets and liabilities). - Challenges ensure accountability and protection of rights but must not undermine effectiveness of insolvency framework or stability-preserving efforts. - Legal framework should clearly specify circumstances for challenges and available remedies. - Two principal forms of challenge: - Judicial review of banking authorities’ actions: courts review legality and may overturn actions exceeding authority.18 - Actions seeking damages from banking authorities or officials for actions taken in insolvency context; sometimes both forms are combined. - Judicial review is generally available where insolvency proceedings are administrative in nature and authorities acted without prior court approval; where proceedings are court-based, actions of banking authorities are normally subject to prior judicial authorization. *Source: IMF PDF chapter on designing a framework for bank insolvency.* ### 38. In the context of bank insolvency, the scope for judicial review should be clearly ### In the context of bank insolvency, the scope for judicial review should be clearly circumscribed ### Judicial review: scope and conduct - Judicial review should be circumscribed so as not to undermine the effectiveness and credibility of the banking authorities’ actions in protecting financial stability. - Review process characteristics: - Should not be so intrusive and unpredictable as to discourage prompt and decisive action by banking authorities. - Should respect the banking authorities’ technical expertise and should not permit a court to second-guess or substitute its own policy views for those of the relevant banking authority. - Should determine whether the banking authorities have acted legally and should not allow the court to reassess the exercise of discretion by the banking authorities unless there is clear evidence of a manifest error of fact or an abuse or misuse of power (e.g., an “arbitrary or capricious” decision). - Reconsideration of decisions on the merits should be confined within the banking authority to the extent possible and incorporated into its internal operating procedures. - Any proceedings reviewing banking authorities’ decisions should be conducted as expeditiously as possible. - In most cases, it will be inappropriate for insolvency proceedings to be stayed pending the outcome of review proceedings. - Where restoration of the prior situation is no longer feasible due to intervening events, the only effective remedy may be monetary compensation (i.e., damages); the legal framework may limit circumstances in which damages may be awarded. - The legal framework should be clear as to the available remedies. ### Actions for damages and limits on liability - Affected parties will often sue banking authorities and their officials personally seeking damages for alleged improper conduct. - Legal framework design: - Should establish clear limits on circumstances in which damages may be awarded. - Many jurisdictions expressly limit liability of banking authorities to cases involving gross negligence or bad faith. - Remedies when bank actions inflict unjustified damage and restoration is infeasible: monetary compensation (damages), subject to legal limitations on awards. ### Personal liability, protections, and standards for officials - Issue: potential personal liability of Board members, staff and other officers or agents of banking authorities (including official administrators or liquidators). - Legal framework should grant express statutory protection from civil liability for actions and omissions taken in good faith in discharge of legal responsibilities. - Jurisdictional approaches: - Some jurisdictions apply a single standard protecting both agencies and individuals equally. - Other jurisdictions protect individuals more than public agencies (agency may be held liable while individuals do not incur personal liability). - Relevant provisions on legal protection must be comprehensive and unambiguous to provide correct incentives. - Scope of protection should not require the individual to demonstrate that his or her conduct was “reasonable”, “not negligent” or consistent with some other state of mind of this type. - Board members, staff and other officers or agents should not be subject to criminal investigation or prosecution for actions related to mismanagement or negligent performance of duties. - Individuals should be indemnified for expenses incurred in successfully defending against a civil claim arising from actions and omissions taken in good faith in the normal course of official duties. - No protection should be provided for fraudulent actions or willful misconduct. ### Official administration: purpose and choices - Purpose: - Official administration is a form of insolvency proceeding where a bank is placed under “official administration”. - The official authority (banking authority, court-appointed administrator or administrator appointed by the banking authority) takes control and decides on restructuring or liquidation. - Official administration provides an opportunity to assess the bank’s condition promptly and to protect assets. - Key trade-offs: - Legal framework must balance protection of shareholders with protection of the public and depositors’ interests. - Jurisdictions often combine elements of different approaches to achieve an appropriate balance. ### Imposition of official administration - Thresholds: - Legal framework must specify thresholds for commencement of official administration, including the regulatory threshold. - Systems: - Mandatory system: banking authorities required by law to impose official administration once specified conditions are met. - Discretionary system: law grants flexibility to decide whether to impose official administration. - Advantages and disadvantages: - Mandatory systems can limit regulatory forbearance, provide defense against political interference and unwarranted legal action, and signal that action will be taken. - Discretionary systems allow more calibrated responses to individual circumstances. - Most systems incorporate a mix of mandatory and discretionary elements; this mixed approach is advisable to balance rigidity and uncertainty. - A predominantly mandatory system may be advisable where banking authorities may be under pressure to exercise forbearance, which can lead to accumulation of losses, distortion of competitive conditions, non-compliance, moral hazard, and undermining of authorities’ role. ### Phases of official administration - Official administration normally comprises two phases: - (i) diagnosis; and - (ii) restructuring and/or the placement of the bank in liquidation. - Duration: - Can be very brief (e.g., no more than a few days or over a weekend) in some countries until a takeover, sale of core business, or placement in liquidation occurs. - Diagnosis phase: - Official administrator conducts due diligence, assesses asset and liability values, capital adequacy and liquidity, and prospects for restoring the bank as a going concern. - Decision whether to attempt restructuring or initiate liquidation depends on prospects and relative cost assessments. - Diagnostic phase can be very short when restoration is clearly impossible. - Restructuring phase: - Attempts to salvage banking business through financial and operational measures. - No clear division between restructuring and liquidation; both may use similar techniques, e.g., sale of business units. ### Elements required in legal framework for official administration - Speed: rapid and decisive response minimizes costs to depositors, creditors and taxpayers; duration under official administration should be as short as possible; monitoring to cease restructuring when unsuccessful. - Appointment, replacement and discharge of official administrator: - Law must specify who appoints, replaces and discharges the official administrator and set terms of reference if not an official agency. - Decision to impose official administration should: (i) name the official administrator; (ii) specify the official administrator’s powers; and (iii) suspend or annul powers of management and governance bodies. - Law must be clear on moment and scope of transfer of control; allow no interregnum. - Fit and proper criteria should include experience in banking and managing banking resolution cases, training in banking, accountancy, or law, integrity and good reputation, and absence of conflicts of interest. - Official administrator must have feasible terms of reference setting principal objectives, tasks, and accountability methods. - Only the appointing authority should have the right to dismiss; dismissal should be simultaneous with appointment of successor and transfer of powers. - Grounds for replacement/dismissal should be specified and limited (e.g., inability over an extended period to perform duties, gross negligence, unlawful conduct, non-compliance with fit and proper criteria). - Determination of bank’s financial condition: - Within a legally specified time frame, official administrator should inventory assets and liabilities and have authority to obtain all relevant information, access all locations, conduct ad-hoc investigations, and recruit assistance. - Protection of assets and operation of bank’s business: - Official administrator authorized to protect assets, pursue claims, defend the bank in court, and have sufficient autonomy to act in depositors’ and creditors’ interest while avoiding unnecessary interference with property rights. - Authorized to continue operations to maintain bank value; full powers to manage loan portfolio including collection of nonperforming loans. - Powers include hiring and firing officers and staff, maintaining premises and systems, undertaking basic transactions, and limiting certain types of business where beneficial for maintaining bank value and in depositors’/creditors’ interest. - Avoidance of contracts and liability claims: - Official administrator should be able to apply to courts to avoid certain contracts entered into within a defined period preceding insolvency proceedings (e.g., preferential transfers, attempts to preempt collective creditor rights). - Categories of transactions subject to avoidance and clear criteria should be established in law. - Official administrator responsible for bringing actions on behalf of the bank against former directors and managers for damages from mismanagement, negligence or fraud. - Decision on restructuring or liquidation: - Official administrator assesses whether bank may be restructured or liquidated; authority to decide may be independent or require court/banking authority approval depending on jurisdiction. - Bank restructuring techniques: - Legal framework should unambiguously authorize official administrator to use a wide variety of techniques, including far-reaching corporate actions that would normally require shareholders’ approval (e.g., sale of bank business or parts thereof), subject in some cases to court or banking authority approval. - Set off and netting arrangements: - Appointment of official administrator may trigger close-out under netting arrangements; legal framework could specify whether a very brief suspension is permissible. - Timetable: - Legal framework needs to set a timetable for critical elements; maximum duration differs across jurisdictions and depends on mandate/objectives. - While process should be completed as quickly as possible, excessive rigidity should be avoided; knowing time is running out can reduce bank value as purchasers hold out for better price. - Confidentiality, transparency and accountability: - Law should balance confidentiality, transparency and accountability. - Certain measures may require public disclosure; authorities should retain flexibility to act rapidly without advance disclosure in some instances (e.g., negotiations with potential investor/purchaser). - Full disclosure of official administrator’s reports should occur after official administration concludes. - Cost of official administration: - Legal framework should provide rules on who bears expenses; at minimum the bank should bear all relevant expenses. - In many jurisdictions, administrative expenses are given preferred ranking in insolvency proceedings. - Flexibility and systemic implications: - Law should provide flexibility for exceptional bank failures with clear systemic implications. - If failure has serious systemic implications, restructuring techniques that minimize contagion and adverse effects on the real economy should be employed; curtailing systemic risk takes precedence in official administration. - Termination of official administration: - Powers of official administrator cease only after necessary restructuring operations performed, bank restored as a going concern, or bank (or remainder) transferred to the liquidator. - Provision required for orderly transfer of power and information to the liquidator. - Official administrator should prepare a final report including balance sheet and profit-and-loss statement and be officially discharged after report issuance. - Any remaining responsibility of official administrator should be based on assessment of the official administrator’s report. *Source: _041709 - 38. In the context of bank insolvency, the scope for judicial review should be clearly circumscribed* ### 53. A number of important legal issues arise in the context of official administration. ### _041709 - 53. A number of important legal issues arise in the context of official administration. ### Key legal issues (paragraph 53) - Three particularly important questions are: (i) the precise scope of the official administrator’s powers and their impact on the rights of the bank’s shareholders; (ii) the implications of official administration for a bank’s license; and (iii) the imposition of a moratorium. - Consideration could be given to periodic reporting on expenses incurred. - The standards under which the official administrator can be held liable should be clearly established in the law. ### Scope of the official administrator’s powers (paragraphs 54–57) - Recommendation: legal framework should provide the official administrator with extensive powers to deal effectively with an insolvent bank, including the power to significantly restructure the bank’s business without the consent of the bank’s owners. - Not all countries confer such a broad grant of authority; some preserve all or some governance rights of shareholders. - Three categories of decision-making powers can be distinguished: - normal managerial powers regarding the conduct of the bank’s day-to-day affairs of the type exercised by the management prior to the commencement of insolvency proceedings; - extraordinary powers of insolvency law (relating to the avoidance of certain contractual obligations, the binding transfer of assets and liabilities, etc.); - powers to engage, in the context of bank restructuring, in corporate actions of the sort that, in normal times, would require the approval of shareholders in a general meeting. - Legal framework must draw a balance between prompt, effective action and preservation of shareholders’ property and governance rights (e.g., voting rights). Approaches include: - giving the official administrator complete control (favors speed and effectiveness); - allowing day-to-day management by the official administrator while requiring shareholder approval for far-reaching restructuring; or - empowering the official administrator to seek court approval of restructuring plans or to invite shareholders to participate in recapitalization when shareholders refuse to consent. - On dilution and recapitalization: - In typical failing-bank cases, shares will be of little or no value. - Existing shareholders should not unduly benefit from financial contributions provided by third parties (e.g., new shareholders or public funds) such as by means of recapitalization. - Where a bank’s share capital is written down recognizing the accrued losses in anticipation of a restructuring, existing shareholders that are not participating in the subsequent capital increase should not benefit from the effects of the recapitalization. - Where the bank still has positive net worth, and its shares are transferred, existing shareholders should receive compensation, whether at the time of the relevant action or at a later point; shareholders should be granted the right to seek a review of the valuation process. ### Licensing implications of official administration (paragraph 58) - Law should clearly specify the implications that the commencement of official administration may have on a bank’s license. - Approaches observed in practice: - in many countries, banking authorities are permitted by law to revoke the bank’s license upon the commencement of or during official administration; - in other countries, revocation is required by law upon commencement of official administration, thereby terminating any banking business in the bank (may be too rigid if the bank can be restructured as a going concern). - Intermediate approaches: - law may provide for the license to be suspended or for the decision on its revocation to be deferred as necessary to accommodate restructuring measures during official administration. - Upon completion of restructuring, banking authorities must ensure all licensing and operational requirements are met. ### Imposition of a moratorium (paragraphs 59–60 and footnotes) - Under corporate insolvency law, commencement of insolvency proceedings usually involves a moratorium (mandatory suspension of collection activity by individual creditors) to prevent an enforcement race and provide time for reorganization or orderly liquidation. - In official administration of an insolvent bank, a moratorium raises complex issues: - A moratorium will provide, at most, a very narrow window for the exploration of restructuring possibilities. - In some cases it may help protect an open bank from its creditors while restructuring is conducted; in many other cases it may simply constitute a step toward liquidation. - A complete and protracted moratorium will be tantamount to termination of the bank as a going concern; a partial or temporary moratorium may not prevent further deterioration. - A moratorium in official administration will, at best, be effective for a very short period and, in some cases, may prove counterproductive. - Policy guidance: - the legal framework should not provide for the automatic imposition of a moratorium upon commencement of official administration; rather, the law should permit declaration of a moratorium on a discretionary basis. - Footnotes: - A moratorium could be used as legal justification for a “bank holiday” of a few days’ length. - A moratorium may be combined with a prohibition to make payment (partial or full) and take new deposits; retail payments up to a certain amount may be allowed, and new deposits should be accepted only to the extent covered by deposit insurance or otherwise secured—scope of restrictions should be determined in close collaboration with the deposit insurance agency. ### Bank restructuring — Purpose and scope (paragraphs 61–65) - Once the bank’s financial situation is diagnosed in official administration, the official administrator may seek to restructure the bank’s business to secure its continuation; restructuring should be completed as rapidly as possible, minimize disruptions to the financial system, and limit costs to depositors, other creditors, and taxpayers (where applicable). - Bank restructuring must address causes, not just symptoms, of insolvency. Measures may include: - transfer of the bank’s shareholding or asset base to new investors able to meet prudential requirements; - merger with or acquisition by a well-capitalized, well-managed bank; - purchase-and-assumption transactions involving some assets and liabilities; - complex structures such as “bridge banks” or “good-bank/bad-bank” separation; - combinations of restructuring techniques. - Legal framework design: - full or partial restructuring by means of any available private-sector solution should be attempted as a first priority. - bank restructuring should not distort competition by subsidizing failure and implicitly penalizing efficient banks; competition law may contain this principle and competition authorities should cooperate with banking authorities. - Legal status outcome: - some techniques allow the bank to survive as a legal entity (e.g., acquisition and recapitalization by a new owner); - other restructurings may spin off viable units and liquidate the residual entity, dissolving the bank’s legal personality. - Restructuring must proceed with speed and flexibility; exceptional tools (public resources, forbearance, postponing strict resolution) must be justified by reasonable certainty that the bank failure would cause a combination of: (i) interruption or collapse of payment and settlement systems; (ii) runs on other banks; and (iii) severe downturn in economic activity. ### General legal considerations relating to bank restructuring (paragraphs 66–68) - Common restructuring techniques: - mergers or acquisitions; - purchase-and-assumption transactions; - creation of bridge banks or “good-bank/bad-bank” separation; - temporary nationalization of the bank as a last resort in large systemic failures. - Legal framework must not hinder operations necessary to implement chosen technique; restructuring techniques are typically carried out in the context of official administration but may also occur under liquidation. - For jurisdictions where official administration is conducted under judicial supervision, references to official administrator powers include powers exercised by the insolvency court or with its approval. - Legal framework should include clear dispositions on: - Bank restructuring techniques: law should unambiguously authorize the official administrator to use a wide variety of restructuring techniques, to adopt new practices, and to decide and implement far-reaching corporate actions that would normally require shareholder approval (for some decisions court or banking authority approval may be required). - Negotiations with prospective investors: official administrator should have legal capacity, subject to supervisory approval, to call for, receive and assess bids and to negotiate acquisition conditions; official administrator should be empowered to recognize valuations at market value, even if lower than book value, and to negotiate compensation, indemnification or recourse arrangements as appropriate. - Transfer of assets and liabilities: official administrator must have authority to sell assets or arrange assumption of liabilities, piecemeal or as a pool; lack of a legally certain technique for wholesale assumption of liabilities can impede restructuring and could be addressed by an explicit statutory provision that no prior consent from creditors or counterparties is required for such operations. - Supervisory approval of restructuring arrangements: banking authorities must vet on fit-and-proper grounds new major shareholders and senior managers and examine financial terms to ensure prudential standards are met after the transaction; where ownership is transferred to a foreign acquirer, the supervisor should consult with its counterpart to establish effective supervisory arrangements. - Use of the bank’s proprietary information: official administrator should protect proprietary information but may disclose detailed information to potential investors for due diligence under confidentiality agreements and only to parties seriously interested in participating in restructuring. *Source: _041709 - 53. A number of important legal issues arise in the context of official administration.* ### 69. Where a third party—and especially another healthy bank—is capable and willing to ### 69. Where a third party—and especially another healthy bank—is capable and willing to ### Restructuring by third-party acquisition (open-bank basis) - Paragraph 69: A failed bank can be restructured as an open bank (no suspension or interruption of operations) by transfer of all shares from existing shareholders to a third party that will assume recapitalization and future management. - New owners acquire the legal entity itself, not merely assets and liabilities. - Transfer structures: - simple acquisition of the failed bank’s shares by the solvent bank; - bank-to-bank merger; - use of a bank holding company to bring previously unaffiliated banks under common ownership, provided “parallel” ownership does not create supervisory problems. - The applicable company and/or banking laws determine the range of permissible techniques. ### Powers of official administrators and shareholder treatment - Paragraph 70: Outside insolvency, corporate restructuring measures (share write-downs, issuance of new capital) typically require a majority shareholder vote; for failed-bank restructuring, the official administrator should have powers to: - force a write-down of the value of existing shares in formal recognition of accrued losses; - enable subsequent recapitalization by issuance of new shares to new investors. - Paragraph 71: Where law grants an abstract/general power to sell a bank under official administration, technical provisions must address: - mechanism for recognition of shareholders’ losses and the writing down or mandatory transfer of their shares; - treatment of minority shareholders; - distribution of sale proceeds; - de-listing and treatment of listed shares if traded on an exchange; - procedural and accounting consolidation issues in mergers. - Some jurisdictions provide special procedures (including shortened notification periods) to expedite banking mergers. ### Purchase-and-assumption transactions (D) - Paragraph 72: Under purchase-and-assumption, a viable part of the bank’s business is transferred to another bank which acquires some assets and assumes some liabilities as a pool or ongoing business unit. - At the limit, all assets and liabilities may be transferred (close substitute to full merger/acquisition). - Acquirer purchases operations, not the corporate entity or its license; the bank under official administration remains a legally distinct entity and the official administrator remains responsible for remaining operations or liquidation steps. - Paragraph 73: Advantages: - effective where full merger/acquisition is unfeasible or undesirable; - lower transaction costs; - greater flexibility to separate viable from non-viable operations and spin off the former. - Paragraph 74: Modalities depend on economic objective: - effective take-over: include transfer of intellectual property intangibles (trademarks); - partial transfers: assign specified asset pools with proportional deposits/liabilities; - distinction between full transfer of distinct sub-units (whole lines of business, divisions, branches including both good and poor quality assets) versus “clean” transfer (carve-out of good-quality assets for transfer; bad assets left for liquidation). - Paragraph 75: Deposits: - Law should establish clear rules for deposit treatment; - Where possible, deposits should transfer to acquiring bank and depositors’ positions remain unaffected; - Any deposits that cannot be covered by corresponding asset transfer or equivalent cash infusion should remain with bank under official administration for liquidation; - Formal approval of such transfers by banking authorities or courts may be useful. ### “Good-bank/Bad-bank” separation and bridge banks (E) - Paragraph 76: Jurisdictions may allow purchase-and-assumption variants that separate good-quality assets from substandard assets to continue operations as an open bank free of past losses or impaired assets. - Paragraph 77: Transfer with or without recourse: - With recourse: impaired assets assigned to subsidiary/asset-management company/collection fund/special-purpose vehicle; recourse/indemnification arrangements and contractual incentives for maximized collection may be used when assigned outside corporate group. - Without recourse: isolates surviving part from liability of existing impaired assets to achieve a clean break. - Paragraph 78: “Good-bank/bad-bank”: - Official administrator sells nonperforming loans/substandard assets to separate entity (“bad bank”) for collection; - Sale normally at market values or, if assisted with public funds, at higher (possibly nominal) values or with subsidy; - “Bad bank” typically an asset management company, temporary and wound up after asset liquidation; - If set up by official administrator/banking authorities/state, it should adhere to good governance, sound and transparent management, and effective collection. - Paragraph 79: Bridge-bank technique: - Create a new licensed bank under control of banking authorities or official administrator to carry on operations; - Bridge bank assigned performing assets and some or all deposits/liabilities; - Impaired assets and remaining liabilities remain with bank under official administration, which is closed and liquidated; - Allows operations to continue without interruption pending permanent solution. - Paragraph 80: Bridge banks are interim solutions: - Should be operated conservatively, accept deposits and make low-risk loans to regular customers; - Management goal: preserve franchise value and minimize financial system disruption; - Balanced and transparent legal/regulatory framework and requirement for rapid transfer to private sector when conditions permit are essential. ### Publicly-assisted bank restructuring (F) - Paragraph 81: International convergence: absent systemic crisis, discretionary open-ended use of public funds to keep failed banks afloat and cover losses is unjustifiable because it: - transfers commercial losses to taxpayers; - validates poor bank management; - prevents market discipline and undistorted competition. - Paragraph 82: Where individual bank failure is non-systemic, public funds generally should not be used in restructuring or liquidation, except where use of deposit insurance funds to restructure is permitted and deemed more advantageous and cost-effective than payout against insured deposits. - Some countries authorize or require deposit insurance agencies or other restructuring agencies to provide limited financial assistance when this is likeliest to result in a less costly resolution from the agency’s perspective. - Paragraph 83: Forms of public assistance may include: - direct capital injection, guarantees, loans, inducements or incentives to potential acquirers; - under exceptional circumstances, “loss-sharing” arrangements; - assistance aimed at enabling merger or purchase-and-assumption where not commercially feasible otherwise; - operations can be within or outside formal official administration. - Paragraph 84: Fundamental principle: - Recapitalization should occur only after existing owners absorb all accumulated past losses; - Shareholders’ net position must be verified and recognized via appropriate write-downs of own-fund items; - For banks under official administration that crossed the “regulatory threshold” but have positive net worth, shareholders’ participation should be diluted accordingly; - For banks whose liabilities exceed assets and have crossed the “balance-sheet threshold”, public funds should be provided only after shareholders surrender shares or their position is written down/eliminated; - Shareholders should not gain benefit from restructuring except to extent they directly participated in bearing costs. - Paragraph 85: Public assistance alone cannot address underlying weaknesses: - Assistance should accompany a plan to restore sound management and profitability; - State should retain right to reclaim expenditure and participate in gains when restructuring succeeds. ### Bank liquidation: nature, objectives, and framework (V.A) - Paragraph 86: Liquidation dissolves a bank after a liquidator assumes legal control, collects and realizes assets, and distributes proceeds to creditors in accordance with pari passu treatment and applicable priority rules. - Paragraph 87: Liquidation appropriate where restructuring is infeasible or where viable operations are spun off leaving residual non-viable part for liquidation. - During liquidation, bank continues as legal entity but is no longer a going concern; - Bundles of assets may be sold as a business to maximize economic value. - Paragraph 88: Primary objective: preserve and optimize collection of the bank’s assets so creditors (including depositors) receive as much as possible. - Effective bank liquidation requires legal system answers to special banking problems to avoid disorderly closure and systemic spill-over effects. - Paragraph 89: Liquidation framework should comprise clear rules for: - formally placing the bank in liquidation; - terminating banking activities; - assigning to a qualified official tasks related to liquidation of the failed bank’s estate; - preserving the bank’s assets, including suspension of all collection activity against the bank (“moratorium”); - realizing assets in an orderly and cost-effective manner; - distributing proceeds equitably to various classes of creditors (including depositors) in a fair and transparent manner without violating relative priority; - protecting validity of orders entered into payment and securities settlement systems; - ensuring immediate enforceability of close-out netting and collateral arrangements relating to financial transactions; - immediately separating securities held in custody by the bank on account of third parties; - providing for speedy compensation of depositors through the deposit insurance scheme. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_041709.pdf* ### 90. There are different ways in which bank liquidation will be initiated, depending on the ### _041709 - 90. There are different ways in which bank liquidation will be initiated, depending on the ### Liquidation initiation and grounds - Law must specify the grounds upon which liquidation proceedings may be commenced. - Regulatory practice: - Crossing the “regulatory threshold” often suffices for placement in official administration, but a more stringent test may be applied for liquidation and dissolution. - Some systems require insolvency in the full balance-sheet sense, i.e., net worth negative (“balance-sheet threshold”). - Some jurisdictions accept inability (or expected inability in the near future) to honor payment obligations as they fall due (“illiquidity threshold” / general cessation of payment). - Overall objective: initiate insolvency proceedings sufficiently early to avoid dissipation of assets and pursuit of assets by individual creditors to the detriment of other creditors. ### License withdrawal and appointment of liquidator - Commencement of liquidation proceedings normally leads to withdrawal of the bank’s license, terminating any banking business. - In most countries, banking authorities are required to revoke the bank’s license upon commencement of liquidation proceedings. - In a few countries, authorities are permitted but not required to revoke the license. - Law should specify who has authority to place a bank in liquidation and appoint the liquidator (e.g., a court or the banking authorities). - Decision to place bank in liquidation should include appointment of a liquidator. - Immediately upon appointment by the court or banking authorities (appointing authority): - Liquidator should be given full control of the bank’s assets. - Liquidator becomes the sole legal representative and succeeds to all governance rights and powers of shareholders and management, whose involvement is terminated. ### Role, powers, and supervision of the liquidator - Primary role: conserve, realize and distribute the estate’s assets. - Liquidator requires extensive powers set out clearly in legislation to perform tasks effectively and economically. - Liquidator’s role does not include managing the bank as a going concern to restore viability, though continuation of certain operations may be necessary to maximize returns from asset sales. - Liquidator should have power to engage in commercial transactions in the name and for the account of the bank’s estate. - Partial continuation of banking activities (e.g., acceptance of new deposits) is unlikely and inconsistent with the essence of liquidation. - Supervision: - Law should specify form and degree of supervision of the liquidator. - Liquidator should not be required to obtain permission for every action to avoid delays and paralysis. - Appointing authority should be able to give directions on general conduct and plan of liquidation. - Law may require prior approval by appointing authority for some financially important decisions. - Transparency and procedural protections: - Liquidation framework must be characterized by a high degree of transparency. - Owners, management, creditors, and the public should have opportunity to obtain information on the decision to close a bank and subsequent decisions affecting them. - Liquidation process should be subject to reviews for proper accounting and require periodic reporting. - Persons should have a right to be heard when their rights, interests in assets or duties under the insolvency law are affected, provided proceedings are expedited. - Creditors should have right to challenge decisions concerning validity and value of their claims. - Law may permit a creditors’ committee to advise the liquidator and review actions that affect creditors’ interests (e.g., sale or auctioning of assets). ### Establishment of estate and protection of assets - Possession of all insolvent bank’s assets should pass automatically to the liquidator upon appointment. - Liquidator should be given physical possession of the bank’s books and records (including all computer files) and supporting documentation (including all documents creating security interests) governing lending transactions. - At start of liquidation, liquidator must be able to perform stock-taking and prepare an inventory of the estate comprising all assets owned by the bank at the time it entered into liquidation. - Liquidator must verify each asset and determine its nominal value (as reflected in bank’s books) and real value (as revealed by appraisals and other valuation methods appropriate for each asset type). - Liquidator must enjoy all legal powers necessary to preserve individual assets and protect estate value; must be able to exercise all rights of the bank in the assets, and claims on borrowers must not be affected by liquidation proceedings. - Liquidity for liquidation process: - Legislation must ensure liquidator is not incapacitated from making immediate payments against various costs. - Mechanism must allow liquidator to make payments directly out of the estate or otherwise recover running costs of the liquidation without waiting for final distribution. - Recovery of liquidator’s remuneration should be provided for, with additional safeguards such as requirement of prior approval by appointing authority or courts. - Contracts and external services: - Liquidator must be able to enter into contracts to employ professionals and outside contractors (e.g., loan servicing, legal advice, appraisals, auctioning, accounting). - Advance funds and redemption of secured assets: - Ability to advance funds to protect collateral should be explicitly delineated. - Where the bank has granted a security interest over assets to a creditor, the liquidator should have right to redeem relevant assets if this could increase estate value. - Conservation of proceeds: - Liquidator needs authority to maintain deposit accounts and make prudent investments. - Investments often limited to eligible instruments, in particular government securities. - Making investments may require approval of appointing authority; alternatively proceeds may need transfer to appointing authority or a specified trustee pending final accounting and distribution. ### Moratorium - Placement in liquidation will invariably lead to an automatic moratorium or suspension of all collection activity against the bank. - Moratorium should include stay on all current legal actions against the bank and bar on filing new actions except with permission of appointing authority. - Bar on exercise of contractual rights which become exercisable on debtor’s default, with exceptions: - Enforcement of close-out netting provisions (as discussed elsewhere). - Ability of secured creditors to foreclose on their collateral, in accordance with domestic provisions on secured rights. - Moratorium will cover deposits, preventing depositors from gaining access to savings. - Effect on depositors mitigated where a deposit insurance scheme exists. - Where no deposit insurance, law may permit liquidator to make immediate distributions of up to a specified amount or proportion against deposit liabilities to alleviate hardship for small depositors, insofar as bank’s liquidity allows. ### Treatment of payment orders and financial contracts - Two critical legal issues: - Exact time at which moratorium takes effect. - Treatment of contractual arrangements in financial contracts that provide for set off of mutual claims on commencement of insolvency proceedings. - “Zero-hour rule”: - Some systems date effects of initiation of insolvency proceedings back to beginning of the day on which commencement was declared, potentially rendering outgoing (but not incoming) payment orders and securities transfers within the critical day void and subject to unwind. - This can be exceptionally disruptive and generate gridlock across payment and securities settlement systems. - Settlement finality provisions: - Many countries introduced settlement finality so that commencement of insolvency proceedings against a system participant produces only prospective effects and cannot reverse payment orders that precede commencement. - A few countries make moratorium effective at beginning of day following declaration, or at a moment determined in the decision itself. - Payments and securities settlement systems should be notified of decisions on commencement of insolvency proceedings against a system participant. - Net-settlement systems and close-out: - Netting, set off, novation and/or close-out arrangements are common in financial contracts (foreign-exchange contracts, repurchase agreements, securities trades, derivatives) and master agreements; these economize on liquidity by settling net amounts. - Upon commencement of insolvency proceedings, contractual provisions may close out contracts and subject mutual obligations (including obligations not yet accrued) to set off. - Valid exercise of extended set off rights benefits counterparties by applying all their claims against obligations to the estate. - If set off not permitted, counterparties must pay full mutual obligations into estate and file as unsecured creditors for amounts owed to them, facing delays and probable partial recovery. - Systemic risk from absence of netting: - Failure to permit netting or close-out can cause chain defaults in back-to-back transactions, potentially causing financial distress or collapse of other market participants. - Where law limits automatic termination clauses or set off rights, specific exceptions to permit full enforcement of termination clauses with respect to financial contracts in bank insolvency may be advisable, provided careful analysis shows market-risk reduction outweighs inequality of treatment between financial-sector counterparties and non-financial creditors (including depositors). - A country recognizing insolvency set off might exclude obligations of members of the bank’s own group and other connected persons to prevent unjustified advantage over outside creditors. - Set off and deposits: - Law should indicate whether liquidator or depositors have right to set off a deposit against outstanding loans in insolvency and under what conditions. - Establishing net claims for each individual depositor is cumbersome and may delay payments. - Law should address effects of any set off regarding payouts by the deposit insurance agency. - There are reasons not to permit set off of any insured part of deposits against outstanding loans: - Calculating net claims takes time. - Setting-off insured deposits may frustrate the purpose of deposit insurance, which is to provide small depositors with liquidity. *Source: IMF PDF chapter/section content unit _041709 - 90. There are different ways in which bank liquidation will be initiated, depending on the* ### 111. In line with corporate insolvency law, the legal framework for bank insolvency will ### _041709 - 111. In line with corporate insolvency law, the legal framework for bank insolvency will ### Liquidator powers over executory contracts and transactions - Liquidator authorized to terminate executory contracts where full performance has not occurred if termination will increase the value of the estate. - Specific actions the liquidator may take: - walk away from leases of property; - dismiss employees (subject to applicable labor law provisions); - address supply and service-provision contracts. - Purpose: keep alive only ongoing contractual relationships beneficial for the estate while rejecting the rest. - Subject to payment system finality, liquidator may apply to courts to avoid or rescind certain transactions/transfers made within a specified period prior to insolvency where transactions are unfair/prejudicial to creditors, and seek to reclaim relevant property: - reversal of fraudulent or illegal transactions; - reversal of transactions seeking to create a preference where insolvency was imminent; - reversal of gifts or transfers for less than fair market value; - reversal of transactions with certain related parties, including members of the bank’s group or individuals related to management. - Caveat: avoidance/rescission of preferential transactions in relation to financial contracts may discourage counterparties from extending liquidity support to a bank in difficulty. ### Treatment of borrowers on commencement of liquidation - Liquidator should notify borrowers that: - their debts remain extant and must be paid into the estate; - implications of the moratorium for borrowers’ contractual rights, including any cancellation of credit lines, should be promptly and accurately notified. ### Realization and management of assets - Liquidator should have comprehensive powers to realize assets in the manner most advantageous given circumstances. - Given a bank’s estate largely comprises financial claims rather than real property: - sale of assets should not be limited to traditional prescribed methods (e.g., public auction) if those methods do not produce best returns; - law should provide flexibility to use a variety of techniques, including complex methods, to collect or sell assets individually or in bulk, with minimal loss of value, considering prevailing market conditions. - Liquidator allowed to give representations and warranties in the name of the bank in connection with asset sales. - Law should permit transfer of contractual relationships without counterparty consent and clarify that the successor acquires all rights and remedies. - Timing considerations: - liquidation actions should avoid prolonged processes where timing is critical; - where realization methods are controversial, law might allow prior approval by appointing authority or creditors’ committee to avoid uncertainty and challenges. ### Asset servicing, restructuring, and settlements - Liquidator authority should include: - manage the bank’s assets; - service loans, apply interest and fees, collect payments, and release collateral upon full repayment; - restructure loans by extending maturity, revising amortization schedules, or changing applicable interest rates; - negotiate settlements or compromise claims; - engage in transactions involving reduction in the nominal value of the bank’s claims if commercially justified. - Transparency and accountability: - transactions reducing claim nominal value should be subject to full transparency and accountability; - law should require regular reporting by the liquidator to the appointing authority; - prior approval of the appointing authority may be appropriate for large settlements and settlements of claims against insiders. - In many countries, liquidator may disclaim onerous assets (e.g., unprofitable contracts or property uneconomical to sell); power to disclaim should not be unlimited and appointing authority may retain control. ### Investigation and recovery from management, owners, and insiders - Liquidator must investigate potential liability of owners, former directors and managers for wrongful conduct, especially for transactions at a preference, for less than fair market value, involving fraud, or conversion of assets. - Where criminal or civil wrongdoing is established, liquidator authorized to bring civil actions against directors, managers and/or owners to recover damages or recognize personal responsibility for liabilities. - In some legal systems, liquidator has duty to inform law enforcement authorities if criminal acts are suspected. ### Claims filing, verification, and timing - Liquidator should invite creditors to file claims and publish notice likely to reach most people who had dealings with the bank. - Notice should set out procedure and deadline for filing claims; purpose of deadline: - determine total outstanding liabilities; - finalize estate accounts; - calculate proportion of each claim payable. - Many liabilities may be evident from bank records; liquidator must check amount and validity of each claim. - Late-filed claims: - paid only from any surplus after timely-filed claims have been paid. - Jurisdictional variation in filing periods: - as short as 90 days; - in others, six months; - possibly even one year. - Essential requirement: provide a realistic opportunity for creditors to make claims. ### Interaction with deposit insurance schemes - Where a deposit insurance scheme exists, a parallel process of notices, filings and payments to insured depositors is necessary (except if deposit insurer is also the liquidator). - Payments under deposit insurance take place outside liquidation and are made regardless of sufficiency of the bank’s estate assets. - Deposit insurance can remove majority of depositors from liquidation process; partial coverage implies depositors satisfied only in part must also file a claim in liquidation for the remainder. - Payout of insured deposits should occur as quickly as possible and within a maximum period specified in relevant domestic law. - Legal framework should provide for deposit insurance agency’s subrogation to depositors’ rights to the extent payments were made under the scheme. - In many cases the liquidator can establish depositors’ claims without action by depositors; filing should not be a condition for participation in distribution when bank records suffice. ### Distribution and priority of claims - Once claims verified, liquidator distributes proceeds from asset realization among creditors in proportion to claims and relative order of priority. - Priority classes that should be set out in law (as described): - the liquidator for the costs and expenses relating to the liquidation (often ranks first); - employees (rank depends on country-specific labor laws and social policies); - central and local government for taxes and other claims (rank varies widely); - secured creditors (including interbank lenders holding interests in securities as collateral and, if applicable, the lender of last resort); - unsecured general creditors, including bondholders and holders of certificates of deposit; - depositors; - the deposit insurance agency, to the extent subrogated to depositors’ rights for payments made to them; - subordinated bondholders who rank last of all holders of claims of nominal value; - the bank’s shareholders as residual claimants entitled to distribution only if any surplus remains after full repayment of all bank liabilities at nominal value. - Jurisdictional variants: - depositors generally rank as unsecured creditors; - some jurisdictions give depositors preferential treatment over other unsecured creditors, or first priority for part of their claim (may be appropriate where no deposit insurance scheme exists). - Secured claims and moratorium: - where secured claims are subject to moratorium, they are handled through the general claims process, but in distribution secured creditors receive payment out of realization value of their security up to full amount of their claim; - if security insufficient, secured creditor becomes unsecured creditor for the balance. ### Methods of reimbursement and notification - Law should specify methods to reimburse creditors, including depositors, and how they should be notified of their rights. ### Termination of liquidation and treatment of unclaimed assets - Once realization of all assets is complete, final distribution is made to claimants. - Provision needed for unclaimed assets (including where customers cannot be contacted): - for example, unclaimed assets may be held by a designated trustee for a specified period, after which they become property of the state. - Upon final distribution and preparation of final accounts and report by the liquidator, liquidation ends and, subject to applicable formalities, the legal personality of the bank is dissolved. ### Systemic banking crises — overview and strategic objectives - Part II: expanded and updated discussion of systemic crises; framework for systemic crises differs qualitatively from stable-period frameworks and draws on those frameworks. - Systemic crisis dynamics driven by uncertainty and lack of confidence; inability to distinguish solvent from insolvent institutions leads creditors to run, causing a downward spiral of lost confidence, preemptive creditor runs, illiquidity, and potential collapse of the financial system. - Policy objectives during systemic crisis: - protect the payment system; - limit loss of depositor and creditor confidence; - restore solvency, liquidity and stability to the banking system. - Typical elements characterizing a systemic banking crisis (no single accepted definition): - severe financial problems in a large part of the banking system; - a system-wide loss in bank asset quality; - a widespread loss of credit discipline; - danger of collapse of payment and settlement systems. - Authorities must quickly determine, often with limited information, whether risks justify use of exceptional systemic tools. ### Phases of systemic crisis management - Three interconnected phases (may run concurrently) with different institutional and policy implications: - Crisis containment: stabilize creditor expectations and halt creditor flight (including depositor runs); seek to avoid imposing losses on creditors where possible; may require strategies different from stable-period insolvency practices. - Restructuring: resolution of banks in financial distress through restoration to soundness or liquidation; usually starts once runs have been halted. - Asset management: medium-term restructuring of nonperforming assets. ### Institutional arrangements and preparedness - Authorities face extraordinary pressure: must respond quickly with minimal information; delays aggravate crises and increase eventual costs. - Close coordination among official actors and clarity of roles is essential; institutional framework can facilitate coordination. - Design choice for special institutional structures for systemic crisis management: - provide features in standing legislation ready for activation whenever a crisis occurs; or - put structures in place only after the crisis strikes. - Prospective standing frameworks have advantages but may present difficulties because each crisis differs and ex ante specification of appropriate measures is hard; responding in “real time” allows tailored measures appropriate to the specific crisis. *Italic: IMF staff views as presented in the source document.* ### 132. Regardless of which approach is taken, a critical feature of a successful crisis ### _041709 - 132. Regardless of which approach is taken, a critical feature of a successful crisis ### Governance and coordination - High-level policy group recommended to provide leadership and accountability in development and implementation of stabilization strategy; often headed by a high-ranking government official (e.g., the minister of finance, or even the prime minister) and typically includes senior representatives of the banking authorities. - Responsibilities of high-level group: - Provide political support to deal with vested interests and determine burden sharing practices. - Develop the initial strategy, coordinate and monitor its implementation, and modify the approach in response to unexpected developments. - Alternative: decentralized, technically-oriented advisory committees advising policy makers within existing governmental structure. - Choice of approach depends on factors including strength of existing institutions and past experiences in coordinating policy development. - Under either approach, authorities must: - Speak with one voice and explain clearly to the private sector who is responsible for implementing and coordinating policy development. - Maintain a coordinated and comprehensive communication strategy so the private sector understands diagnosis and strategy. - Clearly establish roles and responsibilities of other government agencies involved in each phase to preserve accountability. ### Institutional issues by crisis phase - For each phase of the crisis, authorities should consider specific institutional issues. Crisis containment - Urgent policy and budgetary decisions required to contain the crisis. - Decisions on feasibility of containment strategies require broad understanding of fiscal and monetary conditions. Restructuring - Restructuring entails detailed diagnosis of individual banks and development and monitoring of restructuring plans. - Some authority must be responsible for: - (i) conducting the diagnosis; - (ii) reviewing the restructuring plans submitted by the banks; - (iii) ensuring the plans are adequately implemented; and - (iv) requiring modification of the plans where necessary. - Implementation is time consuming and requires specialized knowledge. ### Choice of restructuring authority - Two main approaches: - Rely on existing banking authorities: - Retain central role in restructuring individual institutions. - Agree on and monitor restructuring plans presented by shareholders of undercapitalized or insolvent institutions. - Establish a new bank restructuring agency (common if government has nationalized significant number of banks): - (i) In coordination with the banking authorities, approve and monitor restructuring plans; - (ii) Coordinate the work of other agencies (particularly the banking authorities) involved in resolving the crisis; - (iii) Own and manage any banks that have been nationalized. - Benefits of separate agency in systemic crisis: - (i) Can dispel appearance of conflict of interest; - (ii) Concentrates specialized skills for restructuring in a new, separate agency; - (iii) Allows traditional supervisory resources to be dedicated to strengthened supervision. ### Legal, institutional, and regulatory framework - Strong legal, institutional, and regulatory framework governing resolution of individual bank insolvency in normal times facilitates resolution in systemic crisis. - Quality of commercial and property law and prudential regulation influences speed and efficiency of restructuring and asset management. - In some cases existing framework sufficient; in others, changes necessary to expand available tools. - Footnote 74: essential elements include effective rules on asset valuation, accounting and auditing, transfers of property, loan recovery powers of banks, and the fitness and propriety of bank owners and management. ### Asset management - Third phase: resolution of impaired assets often handled by institutions other than banks (e.g., “bad banks”, collection agencies, asset management companies — AMCs). - Two broad approaches to impaired assets: - Individual-bank based: banks set up work-out units or private AMCs; private institutions can respond quickly and efficiently in selling assets to other private entities. - Centralized public AMCs: public sector establishes public AMC(s) to deal with impaired assets of entire system. - Public AMCs may be relatively more efficient when problem is large, special powers needed, or required skills are scarce. - Such institutions acquire banks’ assets and restructure individual loans, relieving banks from time-consuming process. (Footnote 75: public and private AMCs can exist side-by-side, or create a public-private AMC.) - AMC mandates: - Narrow-mandate AMCs: take over and liquidate banking assets from closed institutions; often focus on rapid asset disposition, sometimes at expense of value maximization. - Broad-mandate AMCs: conduct asset management within broad restructuring activities; resolve assets from failed institutions and may act as bank restructuring agency overseeing restructuring of viable but distressed institutions. - Some AMCs have multiple objectives. ### Governance and performance of public AMCs - AMCs must have unambiguous mandates. - Proper oversight required to ensure adherence to principles of good governance (e.g., respecting transfer of assets to AMC). - For public AMCs, good governance is essential to: - Maximize value of impaired assets; - Minimize fiscal costs; - Prevent deterioration in credit discipline. - Institutional structure of public AMC must ensure independence in operations, freedom from political interference, and accountability for performance. - Public AMCs are normally established as independent entities with a separate budgetary process, typically reporting regularly to parliament and public, and subject to strict audit procedures. (Footnote 76: a public AMC will often be funded with proceeds of bonds issued by the government or by the agency itself with a government guarantee, with repayment period designed to be consistent with expected life of the agency.) - Public AMCs are meant to be temporary and self-liquidating; incentive structures should avoid undue prolongation of activities. - Experience with public AMCs is mixed; they perform more effectively in countries with sounder and more transparent institutional environments. - FSAP assessment: More than 80% of the 135 countries assessed through the Financial Sector Assessment Program (FSAP) were found to be compliant or largely compliant with the principles contained in the Basel Core Principles of Banking Supervision that deal with the legal framework for supervision, authorization of banking, compliance and soundness. However, compliance was much lower (66%) in terms of taking necessary remedial action under the legal framework, including for bank resolution. ### Regulatory and legal arrangements for systemic crisis management - Legal and policy measures vary by crisis phase; measures necessary at crisis containment stage may differ from those in restructuring and asset management phases. - Key measures relevant in the three phases are described (section begins). Crisis containment measures - Immediate priority: develop comprehensive restructuring strategy that contains crisis and stabilizes creditor confidence. - Four sets of measures particularly employed to contain creditor runs: - (i) emergency liquidity assistance; - (ii) blanket guarantees; - (iii) certain types of administrative measures; and - (iv) exchange controls. - Each measure has different institutional and regulatory conditions for successful implementation. Emergency liquidity assistance (ELA) - In stable periods, illiquid banks obtain short-term liquidity from standing central bank credit facilities with strict access requirements, limited size, available only to solvent banks, and penalty interest rates. - In systemic crisis, such limitations can aggravate situation; ELA should be available to all banks because market participants will run if they believe their bank unprotected from liquidity pressures. - Some central banks have expanded coverage to include all types of institutions whose failure could have systemic impact (e.g., interbank markets, insurance firms, other non-bank financial institutions). - Central bank may need authority to provide liquidity support to wide range of institutions whose failure would undermine financial stability. - Countries differ on whether to set out ELA conditions in legislation or regulations; some prefer explicit provision, others rely on “constructive ambiguity” to limit moral hazard and preserve flexibility. (Footnote 77: contingency planning remains essential.) - Having explicit authority and facility available can help stabilize private sector expectations. - Safeguards increasingly included to mitigate risks from excessive liquidity support; typical safeguards for banks receiving ELA: - The monetary authorities have adequate tools to sterilize monetary expansion, and can introduce or intensify open market operations to control monetary aggregates. - Recipients must provide collateral and pay at least an above-average rate of interest. Over the course of the crisis, conditions may need to be eased compared with normal times. - Liquidity triggers set out in legal framework (e.g., central bank legislation or regulations) reduce likelihood of excessive assistance; triggers typically require banking authorities to take specified supervisory actions as ELA provided to a bank increases. A typical trigger is the measure of liquidity as a percent of bank capital; as that ratio increases, increasingly strong supervisory measures are initiated. (Footnote 78: banks typically first subject to special on-site inspections, followed by placement of supervisors on Boards of Directors; at a point determined by law, liquidity triggers can permit supervisory intervention in the bank.) - Authorities will engage in enhanced supervision of banks receiving emergency support to ensure central bank liquidity is used as intended and not to fund deposit runs rather than increase asset volumes; attention to corporate governance is needed where problems stem from poor management rather than contagion. - In highly dollarized economies, central banks have established higher liquidity requirements than customary in non-dollarized economies and built up international reserve buffers. Blanket guarantees - Employed when macroeconomic adjustment and supervisory intervention are ineffective in halting runs. - Blanket guarantee of all bank liabilities except to related parties can calm market fears. - Immediate fiscal costs of successful blanket guarantee are limited as runs are halted immediately; medium-term costs difficult to quantify. - During restructuring, authorities can finance costs without public resources by relying on private resources from original shareholders or new private investors; public resources needed only to cover residual costs. (Footnote 79: under some circumstances central bank may provide immediate financing but government expected to fund program or commit to recapitalization of central bank in case of losses; fiscal costs higher the weaker the financial system and the smaller available private resources.) - Credibility of guarantee essential; determinants of credibility include: - (i) political commitment (and sometimes statutory backing); - (ii) strength of banking system and bank resolution framework; - (iii) perceived ability of government to cover resulting costs; - (iv) strength and comprehensiveness of authorities’ communication strategy describing guarantee and financing. - Blanket guarantees typically cover all unrelated creditors: depositors, interbank creditors, and foreign creditors. Protecting only some creditors (e.g., only depositors) may undermine stability by creating incentives for uncovered creditors to run preemptively. (Footnote 80: runs by creditors with very small exposure may not jeopardize stability and costs of including them in guarantee correspondingly small.) - Foreign currency deposits generally covered but payout can be made in local currency. Off-balance sheet liabilities such as swaps and derivatives are also covered because they convert to on-balance items in event of default. - Exceptions to blanket guarantee generally few: often include (i) shareholders and holders of subordinated debt; (ii) deposits held by insiders, related parties, and unnamed accounts; (iii) deposits held in foreign subsidiaries of domestic banks. - Forms of guarantee vary: implicit guarantees (no public announcements but in practice protect creditors), declarations of policy intention (not formalized in law but potentially sufficient), and formal guarantees set out in legislation specifying operation and financing. Choice depends on country-specific conditions. *Source: _041709 - 132. Regardless of which approach is taken, a critical feature of a successful crisis* ### 154. Determining when a blanket guarantee is warranted is a policy judgment that is ### 154. Determining when a blanket guarantee is warranted is a policy judgment that is ### Blanket guarantees: when warranted and associated risks - Determining when a blanket guarantee is warranted is a difficult ex ante policy judgment because crises evolve unpredictably and decisions must be made without full information. - A blanket guarantee will rarely be advisable if the stability of the banking system is not threatened because it can contribute to moral hazard and undermine risk-taking incentives. - A blanket guarantee may be warranted when authorities fear losing control of events and determine that contagion—or the threat of contagion—from failing banks to the broader banking system is significant; once such a determination is made, the blanket guarantee should be quickly put in place. - Reliance on a blanket guarantee raises at least three medium-term risks to financial stability: - Abuse, particularly where banking authorities are subject to political interference and the system is dominated by vested interests. - Removal of pressure for rapid resolution of banking problems, potentially increasing overall crisis costs by delaying restructuring. - Creation of a contingent liability for the government that is difficult to quantify ex ante. - Policy implication: use the relative stability provided by a blanket guarantee to move aggressively to identify and resolve insolvent and nonviable institutions. ### Administrative measures (including “deposit freezes” and bank holidays) - Administrative measures may be adopted if other measures fail; they include restrictions on deposit withdrawals, extending deposit maturities, or securitizing deposits. 81 - Such measures have been used sparingly. They are disruptive to the payment system, depositor confidence, and economic activity, and often face legal challenges alleging confiscation or illegal interference in property rights. - Administrative measures should be viewed as a final—possibly desperate—effort to stop a generalized run on banks. - If administrative measures are used: - Periodic withdrawals up to specified amounts should be permitted. - They should only be in place for limited periods of time and exit policies should be prepared in advance. - Bank holidays: - Provide only a very limited period to develop a comprehensive strategy. - If extended beyond a few days, they aggravate the crisis, causing: (i) substantial economic costs; (ii) pressure for selective “defrosting”; and (iii) significant opportunities for abuse and rent-seeking. - Lifting a bank holiday must coincide with implementation of a highly credible and comprehensive crisis strategy to be effective. - Exchange controls: - May be employed when the banking crisis is accompanied by unsustainable pressure on the balance of payments; can slow a run on the currency and the liability base of the banking system. 82 - Should be imposed only as part of a comprehensive balance-of-payments strategy, be comprehensive, fully enforced, and consistent with members’ obligations under the IMF’s Articles of Agreement. - Beneficial effects are temporary as controls encourage circumvention, discourage legitimate transactions, and may negatively affect market confidence. ### Bank restructuring: objectives and multi-year nature - Once the crisis is contained, the primary task is restructuring individual banks to identify viable banks and restore profitability and solvency; bank restructuring is a multi-year process. - Key features and preparatory steps include reviewing and, where necessary, strengthening the legal and regulatory framework governing bank insolvency. ### Legal framework: common shortcomings and needed features - Weak mandate of resolution authorities to restructure banks: entities may lack clear mandates, organizational framework, financial resources, and professional leadership. - Inability to restructure banks: authorities may lack legal power (with or without judicial oversight) to write down shareholders’ equity, sell bank shares, engage in purchase-and-assumption transactions, or transfer certain liabilities (e.g., deposits) with bundles of assets. - Lack of legal protection for Board members, staff, and officials: insufficient protection from personal liability for good-faith actions can impede resolution efforts. - In some cases, temporary modifications of the normal-time legal framework may be appropriate: - Permit temporary, explicit forbearance for some prudential requirements (providing shareholders an explicit, monitored period to restructure and meet prudential requirements). - Adapt accounting and auditing rules, loan and collateral valuation rules. - Strengthen rules on fitness and propriety of owners and managers. - Improve entry criteria for new banks. - Limit related-party lending and risk concentration. ### Tasks in bank resolution: diagnosis, assessment, and viability determination - Diagnosis of individual banks’ financial condition is critical; decision between relying on supervisory staff or hiring external audit teams: - Supervisory staff need to update information and examine ownership structures to determine scope for upfront private support. - External audit teams provide independent judgment but take considerable time (contracting auditors and conducting the exams typically takes over three months). 83 - One alternative: supervisors conduct initial assessments and external auditors perform more complete evaluations later. - Authorities must approve appropriate resolution strategies and be empowered to do so. - Typical categorization of banks: - (i) viable and meeting prudential capital adequacy ratios and other regulatory requirements; - (ii) viable but insolvent or undercapitalized; - (iii) insolvent and nonviable. - Determination of viability is critical; in a systemic crisis financial statements and asset values can be distorted. - Authorities may require owners and management to develop medium-term business plans and cash flow projections, based on realistic macroeconomic assumptions, showing future profitability and medium-term strength. - Authorities must assess future volume of economic activity to ensure banks can become profitable in the new environment. - For undercapitalized but viable banks with fit and proper shareholders unable to recapitalize immediately, time-bound restructuring plans may be allowed: - Plans must set quantitative targets monitored closely until prudential requirements are fully met. - Recapitalization plans typically include limitations on bank activities, including suspension of dividend distributions. - Loss recognition and loss apportionment: - Losses must be recognized promptly. - Restructuring strategies should generally apportion losses in the following order: (i) shareholders; (ii) subordinated creditors; (iii) general unsecured creditors84; and (iv) secured creditors up to the value of their collateral. ### Options for restructuring: private and public sector solutions - Private sector solutions: - Shareholders (original or new) bring capital to positive levels, develop restructuring plans, and implement operational restructuring. - If original shareholders cannot recapitalize within a specified period, other private owners should be sought. - Public sector recapitalization programs: - Considered when necessary to preserve viable institutions that would otherwise fail, or nonviable institutions whose creditors cannot be adequately protected or whose failure may threaten financial stability.85 - Legal framework should permit flexible recapitalization mechanisms: injection of cash, bonds, subordinated debt, and other financial instruments. - For cases without concerns about shareholders and managers, approaches that avoid direct public control should be allowed, including injection of hybrid Tier II instruments (preference shares, convertible notes, participation certificates) that do not have voting rights or interfere with management. - If authorities take an approach involving voting rights and control, they should receive ordinary equity shares. - The design of public recapitalization programs must be clearly laid out in regulation; a summary of good practices is provided in Box 1. ### Box 1 — Criteria and incentives in the recapitalization scheme (typical characteristics) - Last resort: public solvency support should be a last option. - Private participation: eligible banks must have existing shareholders or new private investors willing to inject a significant portion of Tier 1 capital needed. - Operational restructuring: banks must present acceptable operational restructuring plans (strengthen internal controls and risk management, increase revenues, cut costs, deal with nonperforming assets). - Original shareholders should not be bailed out: capital needs must be thoroughly assessed and all losses imposed on existing shareholders before public funds are injected; assessment should be verified by a third party. - Positive net worth: to be eligible a bank must have positive net worth; if not, owners or new investors must bring the CAR to above zero before eligibility. - Pledge: majority shareholders should pledge as collateral shares held in the bank equal to the government’s capital contribution to protect public investment. - Payment: the government should pay for shares in tradable government bonds issued on market terms. - Convertibility: Tier 2 capital provided by the government should automatically convert into Tier 1 capital if the CAR falls below a specified ratio (possibly 8 percent). ### Use of public funds, nationalization, and privatization - Public funds may be required to finance repayment or transfer of deposits of failed banks, purchase impaired assets, and fulfill commitments under guarantees granted while supporting banks, including through temporary nationalization. - Temporary nationalization: - Considered when no suitable acquirer can be rapidly found and a bank’s potential collapse threatens the payment system, credit relations, or confidence. - State assumes temporary ownership with public financial assistance while restructuring is pursued. - Once financial conditions stabilize, the nationalized bank or its surviving part should be privatized at the earliest opportunity. - Efficient administration of a nationalized bank is indispensable to prevent losses from growing and to prepare for rapid privatization. - Law should permit scaling down operations, asset transfers, debt collection and renegotiation, and employee layoffs. - Public authority owning/controlling the bank should have power to design and implement a privatization plan, hire external advisors, prepare financial and operating information, market the bank, and negotiate sales. - Law should not predetermine privatization price (e.g., by reference to indices or ratios); price should depend on bank situation and prevailing market conditions.86 ### Asset management and AMCs - Asset management phase typically involves restructuring nonperforming assets by Asset Management Companies (AMCs). - AMC possible transactions include: - (i) purchase and subsequent resale of bad assets from all banks and possibly non-financial entities; or - (ii) purchase and subsequent resale of both good and bad assets held by banks subject to insolvency proceedings. - If AMC resolves both good and bad assets from institutions under insolvency proceedings: - Important to transfer good assets to another operating institution as soon as possible. - Proceeds from AMC disposition of assets of such institutions accrue to the liquidation account for creditor reimbursement. - If AMC can purchase or resolve bad assets from both closed and open institutions: - It must apply strict criteria in asset selection; in principle AMG should only take on assets it is likely to manage more effectively than the institution holding them. *Source: Excerpt from the supplied IMF content unit 154.* ### 177. Irrespective of its objectives, the AMC should normally purchase assets at market ### 041709 - 177. Irrespective of its objectives, the AMC should normally purchase assets at market ### Asset purchase pricing and incentives - Findings: - The AMC should normally purchase assets at market value (or another appropriate price such as the estimated long-term recovery value). - Using public resources to purchase assets at relatively high prices from an open bank provides a hidden subsidy and bails out private shareholders, concealing the cost of recapitalization. - Purchasing at relatively high prices from a closed institution effectively subsidizes the bank’s creditors. - Policy implications: - Avoid purchasing impaired assets at inflated prices to prevent creating incentives for financial institutions to sell an unjustified portion of assets to AMCs. - Price discipline is essential to limit moral hazard and hidden fiscal costs. ### Legal framework, creditor enforcement, and special powers for AMCs - Findings: - Effective management of impaired assets depends largely on the adequacy of the legal framework for secured rights and general corporate insolvency. - Systemic crises may impair creditor enforcement and corporate insolvency frameworks, compromising asset recovery vehicles. - Granting AMCs special powers can facilitate enforcement of creditor claims and enhance recovery and speed of resolution. - Policy recommendations and safeguards: - Extraordinary powers for AMCs should be: - Temporary in nature. - Fully transparent. - Subject to proper oversight and mechanisms for judicial review. - Careful consideration is required because such powers have serious political implications for the existing system of property rights. ### Exiting from crisis measures (Forbearance, guarantees, administrative measures) - Findings: - Forbearance may be temporarily justified but carries significant risks that must be mitigated. - Any temporary easing of regulatory compliance should be transparent, explicit, and subject to close monitoring. - Forbearance must be phased out as quickly as possible, but paced so as not to undermine financial stability. - Blanket guarantees increase moral hazard the longer they are in place and create opportunities to distort financial intermediation. - Administrative measures pose a more serious threat to the resurgence of private confidence than forbearance or guarantees and must be eliminated as quickly as possible. - Policy guidance and sequencing: - Phase out blanket guarantees once the banking system is sound. - Market notice of removal can be given in advance (possibly 6–12 months). - Lifting of protection should be phased: remove protection first from more sophisticated creditors (e.g., interbank creditors), followed by large creditors, and finally from all remaining depositors once system stability is demonstrated. - While a clear plan for eliminating a blanket guarantee is needed, establishing firm deadlines at the onset of a crisis may be difficult; authorities should appreciate the importance of removing blanket guarantees as soon as possible, recognizing that some countries have extended guarantees beyond initial deadlines. - When combined with an aggressive and successful stabilization program, administrative measures may be rapidly removed. ### Appendix I — Global Bank Insolvency Initiative: preparation and consultative process - Preparation: - The report was prepared during 2003–2004 by staffs of the World Bank and the IMF, and updated periodically thereafter. - IMF coordination: Ross Leckow (Legal Department (LEG)) and David Hoelscher (Monetary and Capital Markets Department (MCM)) with contributions from Jan Willem van der Vossen (MCM), Marc Quintyn (MCM), Maike B. Luedersen (LEG), IMF consultants Christos Hadjiemmanuil, Andrew Campbell, Jose Benjamin Escobar, and Eva Huepkes, and Yvonne Wong (Monetary Authority of Singapore), LEG visiting lawyer. - World Bank coordination: Ernesto Aguirre (Banking and Financial Restructuring Unit (BFR)/Financial Sector Operations and Policy Department (OPD)) with contributions from José de Luna Martinez (BFR/OPD) and Ruth Neyens (BFR/OPD). - Consultative process: - A Core Consultative Group with representatives from the BIS, the Basel Committee on Banking Supervision, the Financial Stability Institute, and the European Commission, as well as participants from 17 developed and developing countries and independent experts, met in 2002 and 2003 to provide advice and discuss successive drafts. - Discussions included deputy governors of central banks, heads of independent banking supervisory agencies and general counsels of central banks from 78 countries at two global seminars held in Basel (January 2002) and Washington, D.C. (June 2003). - Regional outreach seminars were held in Warsaw (March, 2002), Montevideo (April 2002), Cape Town (October, 2003), Kuala Lumpur (December, 2003), and Tunis (March 2004). ### Appendix II — Core Consultative Group and participants (2002–2003) - Organizational chairs and secretariat: - Chairman: Mr. Ernesto Aguirre, Manager, Banking Regulation, BFR/OPD, World Bank. - Secretary: Mr. Jose De Luna-Martinez, Senior Financial Economist, BFR/OPD, World Bank. - Institutional contributors included named representatives from: - World Bank, IMF, Bank for International Settlements, Basel Committee on Banking Supervision, Financial Stability Institute, and the European Commission. - Country participants (selected list preserved exactly as presented): Australia; Brazil; Chile; Czech Republic; Germany; India; Italy; Japan; Mexico; Russia; South Africa; Spain; Sweden; Switzerland; United Kingdom; Uruguay; USA. - Independent experts included named individuals from Barclays Bank, University of Amsterdam, Wharton School, McKinley & Capeloto, Gibson, Dunn & Crutcher LLP, and London University. *Source: IMF/World Bank Global Bank Insolvency Initiative report content as provided.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_041709.pdf_