## _sdn1105

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---

### Executive Summary — Overview and Key Findings
- Compares policy choices in recent and past crises, explains why those choices varied, and assesses the state of financial and operational restructuring and institutional reform.
- Conclusion: the diagnosis and repair of financial institutions and overall asset restructuring are much less advanced than they should be at this stage and moral hazard has increased. Vulnerabilities in the global financial system remain considerable and continue to threaten the sustainability of the recovery.
- Key findings:
  - Asset recognition and operational restructuring remain incomplete; governments and supervisors need to recognize nonperforming assets and undertake deeper operational restructuring of enterprise and household debts.
  - In-depth diagnoses, including strict and transparent stress tests, still need to be conducted for persistent weaknesses in bank balance sheets.
  - When diagnoses call for credible recapitalization plans or liability restructuring, they should be carried out swiftly in ways that do not worsen sovereign debt burdens.
  - Some countries require targeted government interventions to alleviate debt overhangs in the household and commercial real estate sectors.
  - Asset restructuring should be market-driven, supported by tighter regulations in loan-loss classification, provisioning, disclosure, and enhanced supervision.
  - Confidence remains highly dependent on explicit and implicit central bank and government support; moral hazard has increased partly because sectors became more concentrated.
  - Policy steps to restore incentives and market discipline include reducing complexity, improving capital structures, and possibly restricting the scope and activities of large financial institutions.

### Differences: Recent Crisis versus Past Crises
- Crisis samples:
  - Past crises: occurred in 17 countries during 1991–2002.
  - Recent crises: manifestations of the 2007–09 global financial crisis as it appeared in 12 countries.
- Pre-crisis conditions in recent crises:
  - Stronger credit growth and asset appreciation, with sharper increases in household leverage and house prices.
  - Financial systems were generally larger and more concentrated; global assets of the five largest banks were typically more than 300 percent of their home country’s GDP.
  - Cross-border claims exceeded 90 percent of GDP in some recent cases — described as "six time larger than in past crises."
- Innovations and shadow banking:
  - Securitization layers (CDOs), credit default swaps, and rapid growth of nonbank institutions (mortgage lenders, broker dealers, money market funds) amplified interconnectedness and obscured risk.
- Conventional pre-crisis indicators (profitability, liquidity, capital) appeared stronger, obscuring risks outside banks’ balance sheets and the threat of large-scale systemic liquidity withdrawals.

### Phasing and Policy Response Patterns
- Typical three phases in past crises:
  1. Containment — deal with acute liquidity stress and stabilize financial liabilities.
  2. Resolution and balance sheet restructuring — remove insolvent institutions and recapitalize viable ones.
  3. Operational restructuring and asset management — restore soundness and rehabilitate nonperforming loans.
- Recent crisis deviations:
  - Liquidity support and guarantees were deployed early and "more extensively relative to GDP."
  - Rapid, broad recapitalization mitigated real effects but comprehensive operational and asset restructuring progressed more slowly than in past crises.
  - Conditions imposed on institutions receiving public support were less-stringent than in past crises.
- Trade-offs:
  - Early accommodative monetary and fiscal policies helped restore confidence, but less attention to in-depth diagnosis and earlier asset restructuring increased moral hazard and raised overall costs.
- Timing/visualization cues (analysis framing):
  - Time axis relative to crisis peaks: T-12, T-9, T-6, T-3, T=0, T+3, T+6, T+9, T+12 (quarters before and after).
  - Vertical axis labeled in percent: 0 2 4 6 8 10 12 14 16 18 (%).
  - Legend: "PastRecent"; "Solid lines : Introduction of recapitalization programs"; "Dashed lines :" (truncated).

### Liquidity, Central Bank Support, Funding Strains, and Guarantees
- Capital losses and liquidity:
  - By end-2007, over 70 percent of banks’ losses came from structured products and securitized positions.
  - Liquidity needs rose sharply due to reputational risks, increased on-balance-sheet obligations, and heavy reliance on wholesale funding; interbank spreads widened dramatically.
- Central bank actions:
  - Extended the duration of liquidity facilities and eased counterparty and collateral requirements.
  - Established new facilities to alleviate liquidity shortfalls in specific markets.
  - Implemented large-scale asset purchases and unconventional, quantitative interventions (e.g., Federal Reserve and Bank of England purchased large amounts of securities; ECB introduced a covered-bond program).
  - Coordinated through central bank swap facilities.
  - Outcome: central banks’ balance sheets expanded much more than in previous crises and support was more flexible.
- Funding strains, guarantees, and deposit insurance:
  - Guarantees were applied more selectively than in past crises; formal guarantees often targeted specific banks or new debt issuance only.
  - Deposit insurance:
    - Belgium, Luxembourg, and the Netherlands increased limits from €20,000 to €100,000 as part of an EU-wide decision.
    - The United States more than doubled them.
    - Some countries guaranteed all retail deposits.
  - Guarantees extended to nonbank financial institutions (notably the United States in response to a run on money market funds, a $3 trillion industry).
  - Governments issued sector-support statements to bolster confidence.
- Accommodative policies:
  - Monetary policy: short-term interest rates relaxed significantly early on to historical lows; several reserve-currency central banks committed to maintaining low interest rates for prolonged periods.
  - Fiscal policy: accommodative fiscal policies maintained aggregate demand and asset values; many undertook countercyclical fiscal measures and allowed automatic stabilizers to operate. Fiscal responses were more coordinated across countries than in past crises.

### Capital Support, Accounting Changes, and Public Recapitalizations
- Private sector recapitalization:
  - From September 2007 to September 2008, private capital injections covered 71, 78, and 94 percent of announced losses for U.S., European, and Asian institutions, respectively (IMF, 2008).
  - Over 2007–09, private investors contributed about 61 percent of recapitalization capital overall; about 86 percent in the United States versus 47 percent in the euro area.
- Accounting and valuation changes:
  - October 2008: accounting standards boards allowed banks to reclassify certain assets as held-to-maturity, permitting historical or amortized cost reporting and greater reliance on firms’ assumptions/models during illiquid market conditions. This flexibility limited immediate capital-raising needs.
- Public recapitalizations:
  - Totaled $441 billion: $245 billion in the United States under TARP and $196 billion in the European Union.
  - Represented 5 percent of GDP on average—about one-third of the amount provided in past crises.
  - Public recapitalizations were spread broadly to have rapid effect and avoid stigmatization, potentially foregoing benefits of separating viable from nonviable institutions.

### Asset Restructuring: Extent, Instruments, and Selected Measures
- Nonperforming loans (NPLs):
  - Rise in NPLs was much less pronounced in recent crises compared to past crises; write-downs of impaired assets appeared gradually and were lower to date.
- Asset restructuring approaches:
  - Two processes defined:
    1. Diagnosis, market valuation, provisioning, write-offs, sales, deleveraging.
    2. Borrower restructuring: financial (maturity extensions, interest reductions) and operational (asset sales, cost reductions).
  - Recent crises favored case-by-case asset restructuring with public relief mainly via guarantees rather than widespread use of “bad banks”; guarantees require little upfront funding but impose contingent fiscal costs.
- Use of AMCs and asset purchases:
  - Fewer assets removed via public AMCs or bad banks than in past crises, with notable exception Ireland: distressed loans with book value equivalent to 44 percent of GDP transferred to a public AMC (NAMA).
  - U.S. Public Private Investment Program (PPIP) amounted to 0.1 percent of GDP.
  - Central banks purchased private securities to support markets, but these purchases were not directly aimed at asset restructuring.
- Selected asset relief measures (amounts reported as in source):
  - Belgium: structured assets guaranteed for Dexia (10.5), KBC (33.5), Fortis (29.4); “bad bank” for Fortis: 28.7 representing 6.0 percent of GDP.
  - Germany: WestLB structured assets $7.0 (swap facility), “bad bank” WestLB $107.8 representing 3.2 percent of GDP.
  - Netherlands: ING RMBS, mortgage loans $35.1 representing 4.4 percent of GDP (backup facility).
  - United Kingdom: RBS and Lloyds pools of assets $524 and $483 representing 24.0 and 22.2 percent of GDP; “bad banks” Northern Rock and Bradford & Bingley total assets 121 and 79.3 representing 5.6 and 3.6 percent of GDP respectively.
  - United States: Citigroup and Bank of America real estate-related $301 and $118 representing 2.1 and 0.8 percent of GDP; “bad banks” Bear Stearns and AIG RMBS, CDOs $30.0 and $52.3 representing 0.2 and 0.4 percent of GDP.
  - Ireland (NAMA): banks’ distressed real estate-related assets $97.8 representing 44.0 percent of GDP.
  - United States: Government Sponsored Entities and banks new MBS and legacy MBS/loans $197.6 and $14.2 representing 1.4 and 0.1 percent of GDP respectively.
  - Notes: For asset guarantees, amount refers to guaranteed (book) value of portfolio; for asset purchases, amounts generally refer to book value of assets transferred.

### Costs of Crises and Cross-Country Variation
- Cost metrics:
  - Direct fiscal support reached 5 percent of GDP on average as of end-2009 for recent crises versus 15 percent for past crises.
  - Broader fiscal costs: projected increases in debt for the four-year period after crisis onset are about 25 percent of GDP for recent crises—higher than in past crises.
  - Output losses: median cumulative output losses over four years: 25 percent of GDP for recent crises versus 35 percent for past crises.
  - For the whole world, output losses from recent crises were 3.3 percent versus 0.2 percent for past crises.
- Cross-country variation:
  - Major advanced countries: direct costs relatively small, 3 percent to 5 percent of GDP.
  - Smaller countries: direct costs up to 17 percent for Iceland (excluding Icesave) and 25 percent for Ireland (as of end-2010).
  - As a share of banking assets, direct costs are more comparable across countries.

### Policy Choices, Lessons, and Operational Restructuring
- Accommodative policy mix contained systemic spillovers but may have transferred costs forward via higher public debt and possibly slower recovery.
- Diagnosis before recapitalization:
  - Past crises typically featured thorough independent examinations before recapitalization; recent crises often provided quick support to all institutions, limiting separation of viable from nonviable institutions.
  - Stress tests in the United States and the EU were conducted after initial recapitalizations; they restored short-term confidence but had uneven long-term credibility.
  - Lesson: conduct strict and transparent stress tests and credible recapitalization plans immediately, even while accommodative policies are in place.
- Operational restructuring:
  - Less intrusive measures (cost cutting, management changes, forced write-downs) were used less than in past crises, except where governments took majority ownership or nationalized institutions.
  - Bank solvency improvements were driven mainly by recapitalization, low interest rates, and fiscal stimulus—conditions that may not persist.
- Dealing with distressed borrowers:
  - Asset-side restructuring lagged compared with past crises; incomplete disclosures and accounting changes hinder transparency and liquidity.
  - Limited use of AMCs reflects asset complexity; capital injections with nonperforming loans left on banks’ balance sheets risk continued losses, weakened profitability, management capacity absorption, and regulatory forbearance.
  - Historical contrast: Sweden implemented comprehensive and fast asset resolution; Japan’s delayed approach imposed enormous costs.

### Box 1 — Sweden versus Japan: Bank Restructuring and Asset Management
- Sweden:
  - Created a bank resolution agency after initial ad hoc interventions failed (fall of 1990).
  - Agency evaluated banks on a forward-looking basis, categorized banks as solvent or insolvent, forced shareholders to recapitalize solvent banks, and took control of insolvent ones.
  - AMCs set up for two nationalized banks; problem assets conservatively valued and transferred to AMCs.
  - Confidence began to recover as early as 1993.
  - Ultimate fiscal costs totaled only 4 percent of GDP.
  - Contributing factors: global economic recovery and a 30 percent depreciation in the currency.
  - Problem assets were mainly relatively simple commercial and residential real estate loans; banks operated domestically.
- Japan:
  - Crisis triggered in 1995; authorities provided emergency liquidity and government guarantees.
  - Recapitalization schemes in 1998 and 1999 failed to restore confidence.
  - Zero interest rate policy adopted in February 1999; quantitative easing introduced in early 2001 and increased substantially in 2002.
  - Stronger diagnostics and asset disposal targets in fall 2002 and two AMCs ultimately helped restore stability.
- Lessons:
  - Delays in recognizing problem loans exacerbate crises and postpone recovery.
  - Weak accounting practices and regulatory forbearance blunt incentives for remedial action and hinder price formation.
  - Liquidity provision can mitigate immediate effects but may mask solvency problems and delay restructuring.
- Household debt:
  - Debts amounted to more than 130 percent of disposable income in the United States and more than 160 percent in some European countries.
  - Bank efforts to reduce household loan burdens have been insufficient; government mortgage-restructure programs have been small in scope and largely ineffective.
- Systemic risk and moral hazard:
  - For the 12 recent crisis countries, assets of the five largest banks rose from 307 percent of GDP before the crisis to 335 percent in 2009.
  - Large-scale public support equated to a contingent liability equivalent to one-fourth of GDP at the peak of the crisis and exacerbated perceptions of “too important to fail.”
  - Few creditors were forced to write down claims; shielding creditors restored confidence quickly but increased moral hazard.
- Policy recommendations (high-level):
  - Living wills and recovery and resolution plans.
  - Restrictions on types of activity (for example, the Volcker rule limits proprietary trading).
  - A capital charge or levy commensurate with systemic risk an institution creates.
  - Limiting public support to systemically important banks, including contingent capital or bail-in instruments with clear triggers.
  - Limiting proliferation of complex financial instruments.
  - Strengthen resolution regimes to allow losses to be borne by uninsured creditors and enhance supervision of cross-border exposures.

### Appendix IV — Resolution Approaches, Restructuring, and Moral Hazard
- Liquidation of the whole bank and insured depositors paid out:
  - Costs borne by: Shareholders, uninsured creditors and the Deposit Guarantee Fund (DGF).
  - Implications for moral hazard: No moral hazard.
  - Comments: Rarely used in recent (and in past) crises and only for small banks due to contagion concerns.
- Good/bad bank split (sale of protected liabilities and good assets; liquidation of other liabilities and bad assets):
  - Costs borne by: Shareholders, creditors, the DGF, and the authorities if significant wider liabilities are rescued.
  - Implications for moral hazard:
    - If most uninsured creditors are left behind, effect on moral hazard will be zero (or low).
    - If significant noninsured creditors are rescued (e.g., wholesale deposits), moral hazard will rise.
  - Comments: Called a purchase and assumption in the United States; often used for small banks in the recent crisis with some exceptions.
- Recapitalization by the government / nationalization:
  - Costs borne by: Shareholders and the authorities; creditors unlikely to incur losses unless recapitalization fails and firm is insolvent.
  - Implications for moral hazard: Significant moral hazard (creditors are bailed out; shareholder dilution or compensation exacerbates moral hazard).
  - Comments: Used extensively in recent and past crises.
- Open bank assistance (failed firm survives under original ownership via subsidized funding, asset guarantees/purchases, liability guarantees):
  - Costs borne by: The authorities and shareholders depending on terms of assistance.
  - Implications for moral hazard: Significant moral hazard.
  - Comments: Extensively deployed in the recent crisis, typically in conjunction with recapitalization by the authorities.

### Consolidated Policy Implications and Recommendations
- Finish financial sector repair and reform:
  - Conduct in-depth diagnoses, including strict and transparent stress tests.
  - Implement credible recapitalization plans or liability restructuring without shifting undue burden to sovereigns.
  - Pursue targeted programs where necessary to address household and commercial real estate debt overhangs.
  - Strengthen regulations on loan-loss classification, provisioning, and disclosure; enhance supervision to support market-driven asset restructuring.
- Strengthen resolution toolkits:
  - Develop more-effective national and international resolution tools for a complex and interconnected system.
  - Design infrastructures to wind down systemically important nonbank financial institutions and cross-border banking organizations.
  - Design mechanisms to ensure losses are borne by creditors rather than taxpayers, including rules for cross-border burden sharing.
  - Enhance supervision of cross-border exposures and related systemic risks.
- Restore incentives and market discipline:
  - Rethink policies to reduce threats from large institutions through reduced complexity, better capital structures, and possible restrictions on scope and activities.
- Preserve constructive recent responses while addressing weaknesses:
  - Keep early stabilization via accommodative policies but improve conditionality of public support and pursue more decisive asset restructuring.

*Source: EXECUTIVE SUMMARY and selected sections, _sdn1105.*

### Executive Summary ......................................................................................................

### EXECUTIVE SUMMARY

### Overview
- The paper compares policy choices in recent and past crises, explains why those choices varied, and assesses the state of financial and operational restructuring and institutional reform.
- Conclusion: the diagnosis and repair of financial institutions and overall asset restructuring are much less advanced than they should be at this stage and moral hazard has increased. Vulnerabilities in the global financial system remain considerable and continue to threaten the sustainability of the recovery.

### Key findings on financial repair, moral hazard, and systemic vulnerabilities
- Asset recognition and operational restructuring remain incomplete; governments and supervisors need to recognize nonperforming assets and undertake deeper operational restructuring of enterprise and household debts.
- In-depth diagnoses, including strict and transparent stress tests, still need to be conducted for persistent weaknesses in bank balance sheets.
- When diagnoses call for credible recapitalization plans or liability restructuring, they should be carried out swiftly in ways that do not worsen sovereign debt burdens.
- Some countries require targeted government interventions to alleviate debt overhangs in the household and commercial real estate sectors.
- Asset restructuring should be market-driven, supported by tighter regulations in loan-loss classification, provisioning, disclosure, and enhanced supervision.
- Confidence in financial systems remains highly dependent on explicit and implicit central bank and government support; moral hazard has increased partly because sectors became more concentrated.
- Policy steps suggested to restore incentives and market discipline include reducing complexity, improving capital structures, and possibly restricting the scope and activities of large financial institutions.

### Differences in the recent crisis versus past crises
- The recent crisis was unusual in speed, breadth, and the types of countries affected; it was global, with major advanced countries and recently integrated EU countries most affected.
- The study compared two samples of crises:
  - Past crises: occurred in 17 countries during 1991–2002.
  - Recent crises: manifestations of the 2007–09 global financial crisis as it appeared in 12 countries.
- Pre-crisis conditions:
  - Recent crises exhibited stronger credit growth and asset appreciation, with sharper increases in household leverage and house prices.
  - Financial systems in recent crises were generally larger and more concentrated; global assets of the five largest banks were typically more than 300 percent of their home country’s GDP.
  - Cross-border claims exceeded 90 percent of GDP in some recent cases — described as "six time larger than in past crises."
- Innovations and the "shadow banking system" amplified interconnectedness and obscured risk: securitization layers (CDOs), credit default swaps separating on- and off-balance-sheet credit risk, and rapid growth of nonbank institutions (mortgage lenders, broker dealers, money market funds) contributed to systemic importance outside traditional banking.
- Conventional pre-crisis indicators (profitability, liquidity, capital) appeared stronger, especially among advanced economies, which obscured risks outside banks’ balance sheets and the threat of large-scale systemic liquidity withdrawals.

### Phasing and policy response patterns
- Typical three phases in past crises:
  1. Containment — deal with acute liquidity stress and stabilize financial liabilities.
  2. Resolution and balance sheet restructuring — remove insolvent institutions and recapitalize viable ones.
  3. Operational restructuring and asset management — restore soundness and rehabilitate nonperforming loans.
- Recent crises followed the containment phase (liquidity support and guarantees) but diverged thereafter:
  - Liquidity support and guarantees were deployed early and "more extensively relative to GDP."
  - Rapid, broad recapitalization across many countries mitigated real effects of the crises.
  - Subsequent progress with comprehensive operational and asset restructuring has been slower in the recent crises than in past crises.
  - Conditions imposed on institutions receiving public support were less-stringent than in past crises.
- Trade-offs observed: the quicker deployment of accommodative monetary and fiscal policies helped restore confidence, but less attention to in-depth diagnosis and earlier asset restructuring increased moral hazard and raised overall costs.

### Policy implications and recommendations
- Finish financial sector repair and reform by:
  - Conducting in-depth diagnoses, including strict and transparent stress tests.
  - Implementing credible recapitalization plans or liability restructuring without shifting undue burden to sovereigns.
  - Pursuing targeted programs where necessary to address household and commercial real estate debt overhangs.
  - Strengthening regulations on loan-loss classification, provisioning, and disclosure, and enhancing supervision to support market-driven asset restructuring.
- Strengthen resolution toolkits:
  - Develop more-effective national and international resolution tools to preserve financial stability in a complex and interconnected system.
  - Design infrastructures to wind down systemically important nonbank financial institutions and cross-border banking organizations.
  - Design mechanisms to ensure losses are borne by creditors rather than taxpayers, including rules for cross-border burden sharing.
  - Enhance supervision of cross-border exposures and related systemic risks.
- Restore incentives and market discipline:
  - Rethink policies to reduce the threat that large financial institutions pose to systemic stability, including through reduced complexity, better capital structures, and possible restrictions on scope and activities.
- For future crises, preserve constructive aspects of the recent response (early stabilization via accommodative policies) while improving weakest areas (more-stringent conditionality of public support and more decisive asset restructuring).

*Source: EXECUTIVE SUMMARY, _sdn1105 - Executive Summary.*

### 2007. All dates are relative to crisis peaks, with periods referring to quarters before or after.

### _sdn1105 - 2007. All dates are relative to crisis peaks, with periods referring to quarters before or after.

### Crisis policy responses and sequencing
- In some countries affected by the recent crisis—namely Iceland, Ireland, and Ukraine—the sequence and type of responses more closely resembled those of past crises.
- Common elements observed:
  - Due diligence of the viability of financial institutions and quality of assets.
  - Public recapitalization.
  - Removal of nonperforming assets.
  - Operational restructuring.
  - Adoption of IMF programs.
- Policy mixes varied across countries, reflecting differences in:
  - Causes of the crises.
  - Severity of the crises.
  - Whether crises also involved a currency (text truncated regarding full description).

### Timing and visualization cues (as presented)
- Time axis expressed relative to crisis peaks: T-12, T-9, T-6, T-3, T=0, T+3, T+6, T+9, T+12 (quarters before and after crisis peaks).
- Vertical axis labeled in percent: 0 2 4 6 8 10 12 14 16 18 (%).
- Legend notes:
  - "PastRecent" appears to compare past and recent episodes.
  - "Solid lines : Introduction of recapitalization programs"
  - "Dashed lines :" (legend entry text truncated in provided content).

### Key points for interpretation
- The provided excerpt emphasizes that standard resolution steps (due diligence, recapitalization, asset cleanup, restructuring, IMF engagement) were applied in specific recent cases, aligning them with historical crisis-policy patterns.
- Chart framing indicates analysis of policy action timing relative to crisis peak across a 24-quarter window (T-12 to T+12) with percentage-scaled measures, distinguishing past versus recent episodes and timing of recapitalization program introductions.

*Source: _sdn1105 - 2007. All dates are relative to crisis peaks, with periods referring to quarters before or after.*

### Introduction of

### Introduction of liabilities guarantees

### Liquidity and Central Bank Support Measures
- Capital losses emerged early as losses on securitized assets due to expectations of default and deteriorating economic conditions; traded assets were often marked to market or recorded at fair value.
- By end-2007, over 70 percent of banks’ losses came from structured products and securitized positions.
- Liquidity needs rose sharply due to reputational risks, increased on-balance-sheet obligations, and heavy reliance on wholesale funding; interbank spreads widened dramatically.
- Central banks:
  - Extended the duration of liquidity facilities and eased counterparty and collateral requirements.
  - Established new facilities to alleviate liquidity shortfalls in specific markets.
  - Implemented large-scale asset purchases and unconventional, quantitative interventions (e.g., Federal Reserve and Bank of England purchased large amounts of securities; ECB introduced a covered-bond program).
  - Coordinated through central bank swap facilities.
- Outcome: central banks’ balance sheets expanded much more than in previous crises and support was more flexible.

### Funding Strains, Guarantees, and Deposit Insurance
- Funding strains prompted provision of guarantees, including to shadow banks, but more selectively than in past crises when blanket guarantees were common.
- Formal guarantees in recent episodes were largely applied to specific banks or new debt issuance only.
- Countries increased deposit insurance coverage limits quickly; examples noted in the source:
  - Belgium, Luxembourg, and the Netherlands increased limits from €20,000 to €100,000 as part of an EU-wide decision.
  - The United States more than doubled them.
  - Some countries guaranteed all retail deposits.
- Guarantees were extended to nonbank financial institutions (notably the United States in response to a run on money market funds, a $3 trillion industry).
- Governments also issued sector-support statements to bolster confidence.

### Accommodative Monetary and Fiscal Policies
- Monetary policy:
  - Short-term interest rates were relaxed significantly early on to historical lows (major central banks took coordinated actions).
  - Several reserve-currency central banks committed, at least conditionally, to maintaining low interest rates for prolonged periods.
  - Low policy rates and ample liquidity helped banks preserve intermediation margins despite higher funding costs, supported asset values, reduced risk of debt-deflation spiral, and limited nonperforming loans initially.
- Fiscal policy:
  - Accommodative fiscal policies maintained aggregate demand and asset values, indirectly supporting financial institutions.
  - Policymakers generally allowed automatic stabilizers to operate; many undertook countercyclical fiscal measures.
  - Fiscal stimulus helped reduce expected defaults on bank loans (citing Aghion et al., 2009, and Laeven and Valencia, 2011).
  - Fiscal responses were more coordinated across countries than in past crises.
- Figure 3 (descriptive): median short-term interest rates and median fiscal balances compared between Past and Recent crises across quarters (T-8T-4T = 0T+4T+8).

### Capital Support
- Private sector recapitalization:
  - From September 2007 to September 2008, private capital injections covered 71, 78, and 94 percent of announced losses for U.S., European, and Asian institutions, respectively (IMF, 2008).
  - Over 2007–09, private investors contributed about 61 percent of recapitalization capital overall; about 86 percent in the United States versus 47 percent in the euro area.
- Accounting and valuation changes:
  - October 2008: accounting standards boards allowed banks to reclassify certain assets (including complex structured securities) as held-to-maturity, permitting historical or amortized cost reporting and greater reliance on firms’ assumptions/models during illiquid market conditions.
  - This flexibility limited immediate capital-raising needs.
- Public recapitalizations:
  - Totaled $441 billion: $245 billion in the United States under TARP and $196 billion in the European Union.
  - Represented 5 percent of GDP on average—about one-third of the amount provided in past crises.
  - Public recapitalizations were spread broadly to have rapid effect and avoid stigmatization, potentially foregoing benefits of separating viable from nonviable institutions.

### Asset Restructuring: Extent and Instruments
- Nonperforming loans (NPLs):
  - Rise in NPLs was much less pronounced in recent crises compared to past crises; write-downs of impaired assets appeared gradually and were lower to date.
  - Reasons: types of assets involved (securitized loans declined earlier), corporate sectors generally not overleveraged, and defaults following only when real economy conditions worsened.
  - Figure 4 (descriptive): NPLs / Total Assets (%) Past vs Recent across quarters (T-8T-4T = 0T+4T+8).
- Asset restructuring approaches:
  - Two processes defined:
    1. Diagnosis, market valuation, provisioning, write-offs, sales, deleveraging.
    2. Borrower restructuring: financial (maturity extensions, interest reductions) and operational (asset sales, cost reductions).
  - Recent crises favored case-by-case asset restructuring with public relief mainly via guarantees rather than widespread use of “bad banks”; guarantees require little upfront funding but impose contingent fiscal costs.
- Use of AMCs and asset purchases:
  - Fewer assets removed via public AMCs or bad banks than in past crises, with notable exception Ireland: distressed loans with book value equivalent to 44 percent of GDP transferred to a public AMC (NAMA).
  - U.S. Public Private Investment Program (PPIP) amounted to 0.1 percent of GDP.
  - Central banks purchased private securities to support markets, but these purchases were not directly aimed at asset restructuring.

### Selected Asset Relief Measures (Table 2 highlights)
- Asset guarantees and “bad banks” in recent crises included:
  - Belgium: structured assets guaranteed for Dexia (10.5), KBC (33.5), Fortis (29.4); “bad bank” for Fortis: 28.7 ($ bn) representing 6.0 percent of GDP.
  - Germany: WestLB structured assets $7.0 (swap facility), “bad bank” WestLB $107.8 representing 3.2 percent of GDP.
  - Netherlands: ING RMBS, mortgage loans $35.1 representing 4.4 percent of GDP (backup facility).
  - United Kingdom: RBS and Lloyds pools of assets $524 and $483 representing 24.0 and 22.2 percent of GDP; “bad banks” Northern Rock and Bradford & Bingley total assets 121 and 79.3 representing 5.6 and 3.6 percent of GDP respectively.
  - United States: Citigroup and Bank of America real estate-related $301 and $118 representing 2.1 and 0.8 percent of GDP; “bad banks” Bear Stearns and AIG RMBS, CDOs $30.0 and $52.3 representing 0.2 and 0.4 percent of GDP.
- AMCs / asset purchases:
  - Ireland (NAMA): banks’ distressed real estate-related assets $97.8 representing 44.0 percent of GDP.
  - United States: Government Sponsored Entities and banks new MBS and legacy MBS/loans $197.6 and $14.2 representing 1.4 and 0.1 percent of GDP respectively.
- Notes: For asset guarantees, amount refers to guaranteed (book) value of portfolio; for asset purchases, amounts generally refer to book value of assets transferred.

### III. Policy Choices and Preliminary Lessons
- This section assesses costs (output losses, fiscal costs, increases in public debt) and reviews policy responses relative to good practice and past crises; provides preliminary lessons on effectiveness.

A. The Costs of Crises
- Metrics for costs: direct fiscal costs (direct outlays), broader fiscal costs (increase in public debt over a horizon), and real output losses.
- Direct fiscal support:
  - Reached 5 percent of GDP on average as of end-2009 for recent crises versus 15 percent for past crises (Figure 5; costs measured as of 2009).
  - Lower direct costs reflect accommodative monetary and fiscal policies, reduced public recapitalization, decentralized management of distressed assets, and greater use of guarantees.
  - Guarantees reduce upfront fiscal outlays but raise contingent fiscal liabilities.
- Broader fiscal costs:
  - Projected increases in debt for the four-year period after crisis onset are about 25 percent of GDP for recent crises—higher than in past crises.
- Output losses:
  - Median cumulative output losses over four years: 25 percent of GDP for recent crises versus 35 percent for past crises.
  - For the whole world, output losses from recent crises were 3.3 percent versus 0.2 percent for past crises.
- Cross-country variation:
  - Major advanced countries: direct costs relatively small, 3 percent to 5 percent of GDP.
  - Smaller countries: direct costs up to 17 percent for Iceland (excluding Icesave) and 25 percent for Ireland (as of end-2010).
  - As a share of banking assets, direct costs are more comparable across countries.

B. Policy Choices and Preliminary Lessons
- Overall accommodative policy mix:
  - Accommodative monetary and fiscal policies contained systemic spillovers by preventing sharp interest rate increases and currency depreciations and by propping up asset values.
  - However, this mix may have transferred costs forward via higher public debt and possibly slower recovery.
  - The stance often precluded thorough due diligence and early deep restructuring; the presumption should favor deep restructuring early on even when accommodative policies are pursued.
- Diagnosis before recapitalization:
  - Past crises typically featured thorough independent examinations to assess asset values and viability before recapitalization; nonviable institutions were closed or sold off.
  - In recent crises, policymakers often provided quick support to all institutions to reduce systemic consequences, limiting separation of viable from nonviable institutions.
  - Stress tests in the United States and the EU were conducted after initial recapitalizations; these tests restored short-term confidence but had uneven long-term credibility.
  - Lesson: conduct strict and transparent stress tests and credible recapitalization plans immediately, even while accommodative policies are in place, to avoid delayed restructuring and dependence on implicit/explicit government support.
- Operational restructuring of distressed institutions:
  - Less intrusive measures (cost cutting, management changes, forced write-downs) were used less than in past crises, except where governments took majority ownership or nationalized institutions.
  - EU state support carried restrictions on balance sheet growth, dividends, and compensation; U.S. TARP imposed more limited ongoing conditions (compensation limits and Treasury permission for dividend increases).
  - Bank solvency improved mainly via recapitalization, low interest rates, and fiscal stimulus—conditions that may not persist.
  - With new regulatory requirements (e.g., Basel III) and overextended systems, profitability will be under pressure and market pressures plus regulatory reforms will be crucial to drive operational restructuring.
- Dealing with distressed borrowers:
  - Asset-side restructuring lagged compared with past crises; incomplete disclosures and accounting changes hinder transparency and liquidity.
  - The limited use of AMCs reflects asset complexity; capital injections with nonperforming loans left on banks’ balance sheets risk continued losses, weakened profitability, management capacity absorption, and regulatory forbearance.
  - Historical contrast: Sweden implemented comprehensive and fast asset resolution; Japan’s delayed approach imposed enormous costs.

*Source: _sdn1105 - Introduction of*

### Box 1. Bank Restructuring and Asset Management: Sweden versus Japan

### Box 1. Bank Restructuring and Asset Management: Sweden versus Japan

### Comparative responses and timelines
- Sweden:
  - Initial ad hoc interventions in the fall of 1990.
  - When those failed, a new bank resolution agency was established to comprehensively deal with the crisis.
  - The agency evaluated troubled banks on a forward-looking basis, categorized banks as solvent or insolvent, forced shareholders to recapitalize the former, and took control of the latter.
  - Asset management companies (AMCs) were set up for two nationalized banks; problem assets, conservatively valued—particularly real estate loans—were transferred to the AMCs.
  - The process helped put a floor under real estate prices and facilitated the return of investors; confidence began to recover as early as 1993.
- Japan:
  - A financial crisis was triggered in 1995 when several regional deposit-takers failed.
  - Authorities responded with emergency liquidity and a government guarantee of bank liabilities.
  - Recapitalization schemes in 1998 and 1999 failed to restore confidence.
  - A zero interest rate policy was adopted in February 1999; quantitative easing was introduced in early 2001 and increased substantially in 2002.
  - These measures eased liquidity problems but did not address uncertainty over bank solvency.
  - In the fall of 2002, authorities set quantitative targets for disposal of nonperforming loans and conducted rigorous examinations with more stringent provisioning standards; along with two AMCs established to underpin asset prices, these measures ultimately helped restore stability.

### Outcomes, fiscal costs, and contextual factors
- Sweden:
  - Ultimate fiscal costs totaled only 4 percent of GDP.
  - A global economic recovery and a 30 percent depreciation in the currency contributed to favorable outcomes.
  - Problem assets were mainly relatively simple commercial and residential real estate loans; banks operated domestically rather than cross-border.
- Japan:
  - Liquidity and monetary measures (zero interest rate policy, quantitative easing) mitigated liquidity shortages but delayed resolution of solvency uncertainty until stronger diagnostics and asset disposal targets in fall of 2002.
- Comparative context:
  - Sweden’s features—simple asset composition, domestic banking system, and centralized state-funded restructuring—facilitated quick valuation and restructuring and were not characteristics of more recent crises.

### Key warnings and lessons
- Delays in recognizing problem loans may exacerbate a financial crisis and postpone recovery.
- Weak accounting practices and regulatory forbearance:
  - May blunt incentives for remedial action.
  - May sustain uncertainty about asset values and solvency.
  - May hinder price formation.
- Liquidity provision:
  - May mitigate immediate effects of a systemic crisis while masking fundamental banking problems.
  - Without comprehensive measures to recognize losses and address resulting capital shortfalls, extended exceptional liquidity provision may delay necessary restructuring.

### Household debt, restructuring, and recovery implications
- Households in many countries accumulated large debts prior to the crisis:
  - Debts amounting to more than 130 percent of disposable income in the United States.
  - Debts amounting to more than 160 percent in some European countries.
- Consequences:
  - For many households these debts became too onerous to service given unfavorable economic conditions.
  - Low interest rates ease debt servicing currently but risks will increase as interest rates return to normal levels.
- Policy and restructuring status:
  - Bank efforts to reduce household loan burdens have been insufficient.
  - Government programs to restructure home mortgage loans have been small in scope and largely ineffective, as indicated by recurrent defaults on restructured loans.
  - Restructuring needs to be accelerated through a more effective mix of private and public actions.

### Systemic risk, moral hazard, and structural changes
- Post-crisis concentration:
  - For the 12 recent crisis countries, the assets of the five largest banks rose from 307 percent of GDP before the crisis to 335 percent in 2009.
- Public support and moral hazard:
  - Large-scale public support equated to a contingent liability equivalent to one-fourth of GDP at the peak of the crisis and exacerbated perceptions of “too important to fail.”
  - In recent crises, few creditors were forced to write down claims due to contagion risk; shielding creditors restored confidence quickly but increased moral hazard and perpetuated too-important-to-fail problems.
- Required measures:
  - Governments must wean banks off implicit public support, scale down deposit insurance schemes, and restore creditor discipline.
  - Reduce incentives for complexity to facilitate restructuring and diminish expectations of bailouts.
  - Measures should be well targeted, globally coordinated, and flexible to local factors.

### Policy recommendations and resolution tools
- Examples of measures to reduce moral hazard and systemic risk:
  - Living wills and recovery and resolution plans.
  - Restrictions on types of activity (for example, the Volcker rule limits proprietary trading).
  - A capital charge or levy commensurate with the systemic risk an institution creates.
  - Limiting public support to systemically important banks, including carefully designed and monitored contingent capital or bail-in instruments with clear triggers so losses are shared fairly.
  - Limiting proliferation of complex financial instruments.
- Caveats:
  - Policymakers must be cognizant of possible unintended consequences, as many measures remain untested.
  - Enhanced frameworks and tools adopted to resolve complex (including cross-border) institutions are only a start; more progress is needed, particularly on cross-border resolution.
- Institutional and supervisory priorities:
  - Strengthen resolution regimes to allow losses to be borne by uninsured creditors.
  - Enhance supervision of cross-border exposures and related risks.
  - Ensure frameworks address burden sharing, cross-border deposit insurance claims, secrecy laws, and other legal impediments.

*Sources: Drees and Pazarbasioglu (1998), Ishi (2009), Ingves and Lind (2008), Syed, Kang and Tukuoka (2009).*

### APPENDIX IV. Resolution Approaches, Restructuring and Moral Hazard

### APPENDIX IV. Resolution Approaches, Restructuring and Moral Hazard

### Liquidation of the whole bank and insured depositors paid out
- Costs Borne by:
  - Shareholders, uninsured creditors and the Deposit Guarantee Fund (DGF)
- Implications for Moral Hazard:
  - No moral hazard
- Comments:
  - This tool has been rarely used in recent (and in past) crises) and only for small banks due to concerns about contagion.

### Good/bad bank split (sale of protected liabilities and good assets; liquidation of other liabilities and bad assets)
- Costs Borne by:
  - Shareholders, creditors, the DGF, and the authorities if significant wider liabilities are rescued
- Implications for Moral Hazard:
  - To the extent that all (or most) uninsured creditors are left behind in the liquidation, the effect on moral hazard will be zero (or low).
  - Shareholders and creditors left behind will receive what they would have earned in whole company liquidation (typically zero for shareholders).
  - But if significant noninsured creditors are rescued, e.g. wholesale deposits, then moral hazard will rise.
- Comments:
  - This transaction is called a purchase and assumption in the United States.
  - The rescued liabilities and the good assets are sold to a third party perhaps via the intermediate step of a bridge bank.
  - This tool has mainly been used for small banks in the recent crisis with some exceptions.

### Recapitalization by the government / nationalization of a failing bank
- Costs Borne by:
  - Shareholders and the authorities. It is very unlikely that the creditors incur losses, unless the recapitalization fails and the firm is subsequently put into insolvency.
- Implications for Moral Hazard:
  - Creditors are bailed out, creating significant moral hazard.
  - If shareholders are only diluted or receive compensation this will further exacerbate moral hazard.
- Comments:
  - This tool has been used extensively in the recent crisis (as in past crises).

### Open bank assistance which allows a failed firm to survive under original ownership
- Forms of Assistance:
  - Subsidized funding
  - Subsidized asset guarantees or asset purchases
  - Liability guarantees
- Costs Borne by:
  - The authorities and shareholders depending upon the terms of the assistance. E.g. if assets are purchased at less than book value, or asset guarantees include a first loss piece for the firm, shareholders incur losses.
- Implications for Moral Hazard:
  - Significant moral hazard.
  - Creditors will only incur losses if not guaranteed and the firm is subsequently placed into liquidation.
  - Worse still, shareholders remain owners of the firm and may not face significant losses depending upon the degree of subsidy in the government assistance.
- Comments:
  - These measures have been extensively deployed in the recent crisis.
  - Typically these measures have been deployed in conjunction with recapitalization by the authorities.

*APPENDIX IV. Resolution Approaches, Restructuring and Moral Hazard*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2011/_sdn1105.pdf_