## _cr10150

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---

### Background and objectives
- Crisis management framework purpose:
  - Halt an unfolding crisis and minimize its impact; speed is essential.
  - Provide a clear decision-making process and definition of responsibilities for involved institutions (central bank, supervisory entities, bank resolution authority, deposit insurance agency, Ministry of Finance (MOF), and where relevant home supervisors).
  - Enshrine processes in laws and memoranda of understanding (MOUs).
- Core policy areas a comprehensive framework must cover:
  - Enhance market confidence (primarily via guarantees).
  - Liquidity provision (LOLR facilities, FX swaps, reserve relaxation).
  - Strengthen balance sheets (diagnostics, resolution arrangements, funding).
  - Facilitate loan restructuring (incentives and breathing space for borrowers).
- Design requirements for measures:
  - Provide latitude of implementation, credibility, sustainability, and a clear exit strategy.

### Role, strengths, and risks of blanket guarantees (Box 1)
- Historical containment: Finland, Indonesia, Japan, Korea, Sweden, and Turkey used blanket guarantees to contain crises.
- Credibility depends on authorities’ commitment; often formalized immediately in law.
- Implementation and costs:
  - Guarantees are easy to implement and have no up-front fiscal costs.
  - Over time guarantees produce moral hazard and large fiscal contingent liabilities.
- Sunset clauses introduced in the current crisis (durations preserved exactly):
  - Australia (3 years); Denmark (2 years); Greece (initially blanket, then up to EUR 100,000 for three years); Hong Kong (untill 2010); Ireland (September 2010); Malaysia (December 2010); New Zealand (2 years); Singapore (December 2010), UAE (3 years), Mongolia (5 years).

### Serbian crisis response measures (overview)
- Immediate steps after October 2008 deposit outflow:
  - Increased deposit insurance coverage from EUR 3,000 to 50,000 per depositor per bank.
  - Expanded coverage to include small and medium legal entities and sole entrepreneurs.
  - Shortened DIA payout period from 30 days to three days.
- Launch of a voluntary Financial Sector Support Program (FSSP) in conjunction with the IMF-supported program:
  - Enshrined in commitment letters and an MOU between MOF, NBS, and DIA, with a confidential Annex (roadmap for bank resolution and LOLR elements).
  - NBS issued regulations introducing an LOLR facility, additional liquidity facilities, and incentives for loan restructuring.

### Liquidity measures under FSSP
- LOLR facility:
  - Can be extended for up to one year at 150 percent of the policy rate to solvent banks against selected liquid collateral.
  - Eligibility: All banks operating in Serbia (not limited to FSSP participants).
- Additional liquidity facilities for FSSP participants:
  - Extended dinar liquidity facility to help banks with loan restructuring.
  - FX swap facility with a two week maturity and an implicit roll over guarantee.
- FX swap facility aggregate pool:
  - The FX swap facility offers each bank a swap line out of a designated pool of funds of up to EUR 1 billion (Box 2).

### Balance sheet strengthening and resolution under FSSP
- NBS diagnostic and stress testing:
  - Two-phased methodology: (i) on-site inspections focusing on loan portfolio performance; (ii) stress testing on adjusted bank statements under a downward scenario.
- Resolution roadmap categories:
  - Type 1: Banks that can raise private funding to increase capital adequacy ratio (CAR) to 12 percent.
  - Type 2: Banks that can apply for capital injection from the state.
  - Type 3: Banks that will be liquidated.
- Definition of systemic banks eligible for state capital injection:
  - CAR of less than 2 percent of the total assets and 1 percent of retail deposits.
  - Based on this definition there are 19 systemic banks in Serbia out of 34.
- Non-systemic banks deemed viable by NBS may receive public recapitalization up to 50 percent of the capital required.

### Loan restructuring under FSSP
- Permitted restructurings:
  - Extend remaining loan maturity by at least 12 months or reduce monthly payments by 20 percent.
  - For such restructured loans, lower loan loss provisioning is required.
- Participating banks’ commitments (Box 2 summary):
  - 27 banks operating in Serbia (out of 34) have signed up to the program.
  - Program expires in 2010.
  - Banks required to: (i) obtain parent commitments to keep exposure at end-2008 levels throughout 2009–10 (review at end-2009) for foreign subsidiaries; (ii) keep sufficient capitalization and liquidity; (iii) participate in IMF-methodology stress tests under a downside scenario.
  - NBS expects to complete diagnostics for all banks by end-2009.
- NBS regulatory adjustments to facilitate commitments:
  - Raised subordinated debt-to-Tier I capital ratio limit from 50 to 75 percent.
  - Raised net open position from 10 to 20 percent of capital.

### Law on Banking Sector Stability (draft and provisions)
- Purpose and activation:
  - Provide an ex-ante framework for coping with future financial catastrophes; allow GOS to respond quickly with pre-determined tools once certain triggers are activated.
  - Law is permanent, but measures are implemented only when a crisis is declared.
- Crisis declaration and powers:
  - GOS (upon NBS proposal) can declare a systemic crisis, subject to prior opinion of MOF and DIA.
  - During a systemic crisis, blanket guarantee on all deposits and, if needed, all bank liabilities, can be extended.
  - The cost test for bank resolution can be waived.
  - Funding for financial assistance is to be authorized by an extraordinary session of the Parliament.
  - GOS equity acquired through financial assistance must be divested within a year.
  - NBS can request GOS issue guarantees for solvent banks without sufficient collateral or for significantly undercapitalized systemic banks.
  - GOS guarantee would be given against bank collateral that includes mortgages (up to 70 percent of book or market value—whichever is lower), receivables (up to 60 percent of book value) and acceptable securities.
  - GOS must report on measures undertaken to the Parliament once per month during a systemic crisis.
  - Systemic crisis can be revoked by the GOS upon NBS or DIA suggestion.

### Assessment of legal provisions and trade-offs
- Alignment with best practice:
  - Law covers enhancement of market confidence, liquidity provision, and balance sheet strengthening.
  - Provides latitude of implementation and includes an exit strategy.
- Benefits:
  - Capacity to use crisis tools without further Parliamentary approval.
  - Credibility of adopted measures.
  - Enhanced coordination between GOS and NBS.
- Downside risk:
  - If not well explained, provisions could trigger market and public anxiety.
- International practice:
  - Some countries use standalone laws (e.g., Lithuania); others amend multiple laws (e.g., the US).
  - Determination of crisis typically involves MOF in consultation with central bank and deposit insurance agency.

### Key recommendations and technical amendments
- Manage high deposit insurance coverage introduced in October 2008:
  - Coverage increase was an extrema ratio; DIA resources are limited (DIA has enough resources to cover the deposits of any of the 20 smallest banks individually, or the sum of the smallest 9) and has no emergency funding arrangements.
  - Under the new limit, 99 percent of the deposit in number and 90 percent in volume are covered.
  - Recommended policy mix:
    - Approval of legal provisions that allow for various degrees of blanket guarantees.
    - Reduction of coverage level with a carefully managed public information campaign.
    - Establishment of an emergency funding arrangement for the DIA should a medium/large bank be liquidated.
  - Other post-October measures to speed deposit repayment are judged not credible; more detailed recommendations are in the Deposit Insurance Technical Note.
- Minor amendments to the draft law advised:
  - Rapid approval mechanism for GOS guarantees for LOLR and flexibility in determining collateral and haircuts for LOLR.
  - Removal of a resolution roadmap that makes almost all undercapitalized banks eligible for recapitalization with GOS funding.
  - Legal amendments allowing institutions other than banks to carry loans on their balance sheets.
  - Development of MOUs on crisis management with home jurisdictions of the largest investors in the country.
  - NBS should develop a systemic risk assessment to implement legal provisions and identify systemic crises.
- Specific guidance on enhanced LOLR measures:
  - Include provision to rapidly obtain GOS guarantees through urgent Parliamentary procedure.
  - Do not prescribe a static list of collateral or allowed haircuts in the law; restrict collateral lists in normal times via NBS regulation and expand lists for crisis times.

### Resolution mapping and Annex amendment (from section 18)
- Purpose and issue:
  - Resolution mapping in the Annex to the crisis MOU is intended to promote stability by protecting all liabilities in the largest banks.
  - Proposed bank resolution tools include a comprehensive definition of financial assistance but exclude guarantees on debt issue for banks not in receivership because financial assistance can be provided only to intervened banks.
  - With the new resolution tools and the Law on Banking Sector Stability, the objective of protecting liabilities of largest banks can be achieved in a less costly fashion.
- Recommendation:
  - Amend the Annex to bring it in line with the new resolution and crisis framework.

### Loan restructuring, blocked account system, and secondary loan market
- Constraints:
  - NBS regulations for individual-bank loan restructuring have limited impact due to the blocked account system, which de facto requires a multi-party workout process.
  - Only banks are allowed to carry loans on their balance sheet and as a result no secondary market for loans exists in the country.
  - Consequence: Measures to incentivize banks to clean up their loan books cannot have much impact under the current legal and market structure.
- Recommendation:
  - Restructure the blocked account system and remove legal impediments to a secondary loan market. Specific recommendations are presented in the Corporate Credit technical note.

### Crisis management memoranda of understanding (MOUs)
- Recommendation:
  - Crisis management MOUs should be urgently developed with the most important home supervisors.
- Rationale:
  - Foreign banks are important in the Serbian market; authorities need MOUs with the home jurisdictions of the largest investors in the country.
  - Absence of MOUs for non-crisis situations leaves no basis of cooperation to start from in a crisis.
  - A crisis management framework works best if built on cooperation in normal times.
- Best practice example (Box 3 — Nordic MOU key elements):
  - Regular and formalized exchange of information and cooperation between home and host supervisors; cooperation in normal times builds trust and communication channels to ensure speed of action in times of crisis.
  - Clear division of responsibilities between host and home supervisors and amongst home and host country entities involved in crisis management (e.g., Ministry of finance, Central Bank, deposit insurance funds and resolution agencies), including who will take the lead on liquidity provision, on solvency determination, and on bank intervention.
  - Basic element of burden sharing for liquidity and solvency.

### Systemic risk assessment to implement Law on Banking Sector Stability
- To implement the Law and identify systemic crisis, NBS should develop a systemic risk assessment.
- Recommended steps for NBS to single out a systemic crisis:
  - (i) identify the critical elements of the financial system, i.e. systemically important banks, critically important financial infrastructure and key financial markets (liquidity sources and markets for risk management);
  - (ii) define a contagion channel matrix, which identifies contagion channels between various elements of the financial system and the real sector; and
  - (iii) appoint a unit that is in charge of monitoring systemic risk based on framework provided by (i) and (ii).

*Source: _cr10150 - 1. Credibility and Exit from Blanket Guarantees*

### 1. Credibility and Exit from Blanket Guarantees .......................................................................4

### 1. Credibility and Exit from Blanket Guarantees

### Background and objectives
- Crisis management framework purpose:
  - Halt an unfolding crisis and minimize its impact; speed is essential.
  - Provide a clear decision-making process and definition of responsibilities for involved institutions (central bank, supervisory entities, bank resolution authority, deposit insurance agency, Ministry of Finance (MOF), and where relevant home supervisors).
  - Enshrine processes in laws and memoranda of understanding (MOUs).
- Core policy areas a comprehensive framework must cover:
  - Enhance market confidence (primarily via guarantees).
  - Liquidity provision (LOLR facilities, FX swaps, reserve relaxation).
  - Strengthen balance sheets (diagnostics, resolution arrangements, funding).
  - Facilitate loan restructuring (incentives and breathing space for borrowers).
- Design requirements for measures:
  - Provide latitude of implementation, credibility, sustainability, and a clear exit strategy.

### Role, strengths, and risks of blanket guarantees (Box 1)
- Blanket guarantees have historically contained crises in Finland, Indonesia, Japan, Korea, Sweden, and Turkey.
- Credibility of guarantees depends on authorities’ commitment; often formalized immediately in law.
- Guarantees are easy to implement and have no up-front fiscal costs, but over time produce moral hazard and large fiscal contingent liabilities.
- Countries that introduced guarantees in the current crisis included sunset clauses with the following durations preserved exactly:
  - Australia (3 years); Denmark (2 years); Greece (initially blanket, then up to EUR 100,000 for three years); Hong Kong (untill 2010); Ireland (September 2010); Malaysia (December 2010); New Zealand (2 years); Singapore (December 2010), UAE (3 years), Mongolia (5 years).

### Serbian crisis response measures (overview)
- Immediate steps after October 2008 deposit outflow:
  - Increased deposit insurance coverage from EUR 3,000 to 50,000 per depositor per bank.
  - Expanded coverage to include small and medium legal entities and sole entrepreneurs.
  - Shortened DIA payout period from 30 days to three days.
- Launch of a voluntary Financial Sector Support Program (FSSP) in conjunction with the IMF-supported program:
  - Enshrined in commitment letters and an MOU between MOF, NBS, and DIA, with a confidential Annex (roadmap for bank resolution and LOLR elements).
  - NBS issued regulations introducing an LOLR facility, additional liquidity facilities, and incentives for loan restructuring.

### Liquidity measures under FSSP
- LOLR facility features:
  - Can be extended for up to one year at 150 percent of the policy rate to solvent banks against selected liquid collateral.
  - Eligibility: All banks operating in Serbia (not limited to FSSP participants).
- Additional liquidity facilities for FSSP participants:
  - Extended dinar liquidity facility to help banks with loan restructuring.
  - FX swap facility with a two week maturity and an implicit roll over guarantee.
- FX swap facility aggregate pool:
  - The FX swap facility offers each bank a swap line out of a designated pool of funds of up to EUR 1 billion (Box 2).

### Balance sheet strengthening and resolution under FSSP
- NBS diagnostic and stress testing:
  - Two-phased methodology: (i) on-site inspections focusing on loan portfolio performance; (ii) stress testing on adjusted bank statements under a downward scenario.
- Resolution roadmap categories:
  - Type 1: Banks that can raise private funding to increase capital adequacy ratio (CAR) to 12 percent.
  - Type 2: Banks that can apply for capital injection from the state.
  - Type 3: Banks that will be liquidated.
- Definition of systemic banks eligible for state capital injection:
  - CAR of less than 2 percent of the total assets and 1 percent of retail deposits.
  - Based on this definition there are 19 systemic banks in Serbia out of 34.
- Non-systemic banks deemed viable by NBS may receive public recapitalization up to 50 percent of the capital required.

### Loan restructuring under FSSP
- Participating banks may restructure loans by:
  - Extending remaining loan maturity by at least 12 months or reducing monthly payments by 20 percent.
  - For such restructured loans, lower loan loss provisioning is required.
- Participating banks’ commitments (Box 2 summary):
  - 27 banks operating in Serbia (out of 34) have signed up to the program.
  - Program expires in 2010.
  - Banks required to: (i) obtain parent commitments to keep exposure at end-2008 levels throughout 2009–10 (review at end-2009) for foreign subsidiaries; (ii) keep sufficient capitalization and liquidity; (iii) participate in IMF-methodology stress tests under a downside scenario.
  - NBS expects to complete diagnostics for all banks by end-2009.
- NBS regulatory adjustments to facilitate commitments:
  - Raised subordinated debt-to-Tier I capital ratio limit from 50 to 75 percent.
  - Raised net open position from 10 to 20 percent of capital.

### Law on Banking Sector Stability (draft and provisions)
- Purpose:
  - Provide an ex-ante framework for coping with future financial catastrophes; allow GOS to respond quickly with pre-determined tools once certain triggers are activated.
  - Law is permanent, but measures are implemented only when a crisis is declared.
- Crisis declaration and powers:
  - GOS (upon NBS proposal) can declare a systemic crisis, subject to prior opinion of MOF and DIA.
  - During a systemic crisis, blanket guarantee on all deposits and, if needed, all bank liabilities, can be extended.
  - The cost test for bank resolution can be waived.
  - Funding for financial assistance is to be authorized by an extraordinary session of the Parliament.
  - GOS equity acquired through financial assistance must be divested within a year.
  - NBS can request GOS issue guarantees for solvent banks without sufficient collateral or for significantly undercapitalized systemic banks.
  - GOS guarantee would be given against bank collateral that includes mortgages (up to 70 percent of book or market value—whichever is lower), receivables (up to 60 percent of book value) and acceptable securities.
  - GOS must report on measures undertaken to the Parliament once per month during a systemic crisis.
  - Systemic crisis can be revoked by the GOS upon NBS or DIA suggestion.

### Assessment of legal provisions and trade-offs
- The Law on Banking Sector Stability meets best practice criteria:
  - Covers enhancement of market confidence, liquidity provision, and balance sheet strengthening.
  - Provides latitude of implementation and includes an exit strategy.
  - Benefits: (i) capacity to use crisis tools without further Parliamentary approval; (ii) credibility of adopted measures; (iii) enhanced coordination between GOS and NBS.
  - Downside: If not well explained, provisions could trigger market and public anxiety.
- International practice:
  - Some countries include systemic crisis provisions in a standalone law (e.g., Lithuania), others via amendments to multiple laws (e.g., the US).
  - Determination of crisis typically involves MOF in consultation with central bank and deposit insurance agency.

### Key recommendations and technical amendments
- Manage high deposit insurance coverage introduced in October 2008:
  - Coverage increase was an extrema ratio; DIA resources are limited (DIA has enough resources to cover the deposits of any of the 20 smallest banks individually, or the sum of the smallest 9) and has no emergency funding arrangements.
  - Under the new limit, 99 percent of the deposit in number and 90 percent in volume are covered.
  - Recommended policy mix:
    - Approval of legal provisions that allow for various degrees of blanket guarantees.
    - Reduction of coverage level with a carefully managed public information campaign.
    - Establishment of an emergency funding arrangement for the DIA should a medium/large bank be liquidated.
  - Other post-October measures to speed deposit repayment are judged not credible; more detailed recommendations are in the Deposit Insurance Technical Note.
- Minor amendments to the draft law advised:
  - Rapid approval mechanism for GOS guarantees for LOLR and flexibility in determining collateral and haircuts for LOLR.
  - Removal of a resolution roadmap that makes almost all undercapitalized banks eligible for recapitalization with GOS funding.
  - Legal amendments allowing institutions other than banks to carry loans on their balance sheets.
  - Development of MOUs on crisis management with home jurisdictions of the largest investors in the country.
  - NBS should develop a systemic risk assessment to implement legal provisions and identify systemic crises.
- Specific guidance on enhanced LOLR measures:
  - Include provision to rapidly obtain GOS guarantees through urgent Parliamentary procedure.
  - Do not prescribe a static list of collateral or allowed haircuts in the law; restrict collateral lists in normal times via NBS regulation and expand lists for crisis times.

*Source: _cr10150 - 1. Credibility and Exit from Blanket Guarantees*

### 18.      The resolution mapping included needs to be updated in light of the new resolution

### _cr10150 - 18.      The resolution mapping included needs to be updated in light of the new resolution

### Resolution mapping and Annex amendment
- The resolution mapping included in the Annex to the crisis MOU is intended to promote stability by protecting all liabilities in the largest banks.
- The proposed bank resolution tools (applicable both in normal and crisis times) include a comprehensive definition of financial assistance.
- The comprehensive definition of financial assistance includes all required tools, except for guarantees on debt issue for banks that are not in receivership, because financial assistance can be provided only to intervened banks.
- Due to the introduction of proposed resolution tools (see Bank Resolution Section) and the Law on Banking Sector Stability, the same objective of protecting liabilities of largest banks can be achieved in a less costly fashion.
- Recommendation: Amend the Annex to bring it in line with the new resolution and crisis framework.

### Loan restructuring, blocked account system, and secondary loan market
- NBS regulations aimed at promoting loan restructuring on an individual bank basis can have limited impact due to the blocked account system, which de facto requires a multi-party workout process.
- Only banks are allowed to carry loans on their balance sheet and as a result no secondary market for loans exists in the country (see Bank Resolution Technical note).
- Consequence: Measures to incentivize banks to clean up their loan books cannot have much impact under the current legal and market structure.
- Recommendation: Restructure the blocked account system and remove legal impediments to a secondary loan market. Specific recommendations on how to improve the systems are presented in the Corporate Credit technical note.

### Crisis management memoranda of understanding (MOUs)
- It is recommended that crisis management MOUs be urgently developed with the most important home supervisors.
- Rationale: Foreign banks are important in the Serbian market; authorities need MOUs with the home jurisdictions of the largest investors in the country.
- Urgency is heightened by the absence of MOUs for non-crisis situations with these authorities; without MOUs, the Serbian and relevant home authority do not have a basis of cooperation to start from.
- Observation: A crisis management framework works best if built on cooperation in normal times.
- Box 3: MOU on Crisis Management Between the Nordic Countries (considered a best practice example) — key elements include:
  - Regular and formalized exchange of information and cooperation between home and host supervisors; cooperation in normal times builds trust and communication channels to ensure speed of action in times of crisis.
  - Clear division of responsibilities between host and home supervisors and amongst home and host country entities involved in crisis management (e.g., Ministry of finance, Central Bank, deposit insurance funds and resolution agencies), including who will take the lead on liquidity provision, on solvency determination, and on bank intervention.
  - Basic element of burden sharing for liquidity and solvency.
- Source cited in Box 3: Management of a financial crisis in banks with cross border establishments—Memorandum of Understanding between the central banks of Denmark, Finland, Iceland, Norway and Sweden.

### Systemic risk assessment to implement Law on Banking Sector Stability
- To implement the provisions included in the Law on Banking Sector Stability, and identify systemic crisis, NBS should develop a systemic risk assessment.
- To single out a systemic crisis, the NBS should:
  - (i) identify the critical elements of the financial system, i.e. systemically important banks, critically important financial infrastructure and key financial markets (liquidity sources and markets for risk management);
  - (ii) define a contagion channel matrix, which identifies contagion channels between various elements of the financial system and the real sector; and
  - (iii) appoint a unit that is in charge of monitoring systemic risk based on framework provided by (i) and (ii).

*Source: _cr10150 - 18.      The resolution mapping included needs to be updated in light of the new resolution*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10150.pdf_