The twin themes of this book—surveillance and resolution--involve
issues that are at the core of the IMF's recent work on the financial
sector. Although the intensity of this work is relatively new, the IMF
has long recognized that an appropriate macroeconomic policy stance alone
is not sufficient to maintain balance in an economy; sound underlying
microeconomic conditions are also vital. In no area is this more important
than in monetary policy. Maintaining a monetary policy stance geared to
price level stability requires a sound and competitive banking system
to transmit policy signals and to ensure the efficient allocation of financial
resources. Moreover, maintaining openness to international capital markets
requires a sound and well-regulated banking system through which these
flows can be intermediated. The IMF helps to promote bank soundness through
its surveillance, lending, and technical assistance activities.
In its surveillance activities, the IMF aims to improve
the macroeconomic environment and structural framework in which banks
operate.
In its discussions with member countries, the IMF calls attention to emerging
macroeconomic problems and structural deficiencies and recommends appropriate
policy actions. The IMF's efforts to strengthen member countries' banking
systems are also reflected in the design of IMF-supported lending programs
and technical assistance, which in recent years has focused increasingly
on banking legislation, regulation, and supervision and on the design
of bank safety nets, including lender-of-last-resort facilities and deposit
insurance schemes.
Since the mid-1990s, partly in response to the Mexican and Asian crises,
the IMF has kept a watchful eye on financial sector issues, paying greater
attention to the banking sector, the sustainability of capital flows,
and situations where crises could spill over into other markets. At its
April 1998 meeting, the IMF's governing body, the Interim Committee (now
the International Monetary and Financial Committee), set a demanding agenda
for the IMF's work, including the central role to be played by the IMF
in crisis prevention through its surveillance and its role in encouraging
members to strengthen their macroeconomic policies and financial sectors.
The Interim Committee also called upon the IMF to help members strengthen
their domestic financial systems by encouraging them to develop supervisory
and regulatory frameworks that are consistent with internationally accepted
best practices, as well as strengthened standards for bank and nonbank
institutions. Subsequently, the IMF has enhanced its surveillance of the
financial sector through the Financial Sector Assessment Program (FSAP)
conducted jointly with the World Bank.
In addition to its surveillance and institutional development work, the
IMF has also provided extensive technical assistance to member countries
in banking system restructuring—the management and resolution of banking
sector problems. IMF staff has been actively engaged in assisting member
countries in reestablishing their banking and financial sectors on a sound
basis both during and immediately after financial crisis, frequently in
the context of IMF-supported programs. Given the relatively high number
of the IMF's 184 member countries that have experienced significant banking
sector problems during the last decade, this has provided IMF staff with
a unique vantage point from which to consider the issues involved in bank
system restructuring and to gain a comparative perspective on the effectiveness
of crisis management and resolution arrangements.
In recent years the IMF has spent a good deal of time
developing "best practice" standards that allow it to judge the strength
of banking systems and of the related bank safety net. Moreover, the IMF
staff has also sought to reflect upon the expertise it has developed in
assisting member countries to resolve their banking sector problems in
the aftermath of financial crises. The present volume can be viewed as
one outcome of this ongoing effort, in that it is concerned primarily
with the practical lessons that can be drawn in building a sound financial
sector and in both the prevention and management of banking system instability.
It represents a distillation of the collective experience of the staff
of the Monetary and Exchange Affairs Department (MAE), which has primary
responsibility within the IMF for these areas. Given the breadth of the
subjects considered, the present volume can inevitably only deal with
selected issues.
The first part of this volume examines IMF surveillance and the best practice
standards that serve as a benchmark for judging financial systems. Key
prerequisites for banking system soundness are high standards of prudential
supervision and regulation. The IMF's work, through the FSAP process and
through its technical assistance program, which is increasingly shaped
by the outcome of the resulting Financial Sector Stability Assessments,
aims to help member countries raise their standards of supervision. In
this way, member countries enjoy both improved access to international
capital markets and an improved ability to manage the resulting capital
flows. The IMF's work in this area is supported by the now well-established
body of international best practice standards for banking supervision,
with the work of the Basel Committee at its center. The key document of
these standards is the Committee's Core Principles for Effective Banking
Supervision, although the work of other financial organizations also
has a direct bearing on the development of these best practice standards.
One important issue highlighted by the IMF's experience is that the existing
body of international capital standards for banks presuppose adequate
and comprehensive rules on the recognition and valuation of assets and
liabilities, as well as the adequacy of rules for making provisions for
impaired assets. Although a number of crisis-hit countries appeared to
include banks that were well-capitalized according to international standards,
their capital adequacy was overstated by the failure to recognize adequately
(and hence provision for) nonperforming loans. Hence a robust system of
loan classification and provisioning must be at the center of any system
of banking supervision. The second chapter by Luis Cortavarria, Claudia
Dziobek, Akihiro Kanaya, and Inwon Song reviews this important issue.
Foreign currencydenominated lending lies as the heart of the linkage
between currency vulnerabilities and financial sector weakness. As a number
of recent financial crises have demonstrated, foreign currency lending
to domestic residents by domestic financial institutions can destabilize
the banking system if such lending is not properly monitored and controlled.
In the third chapter, Fernando Delgado, Daniel Kanda, Greta Mitchell Casselle,
and R. Armando Morales argue against placing too much emphasis on outright
restrictions on this type of lending. Instead, bank regulators and firm
management need to pay close attention to developing internal control
systems to ensure that banks are able to identify and control their risks.
Another form of risk at the micro-institutional level that can rapidly
be translated into banking system instability at a macro level is the
risk of illiquidity. Indeed, one of the primary reasons why special regulation
of banks is necessary is because they engage in a process of maturity
transformation, turning short-term liabilities into long-term assets.
The robustness of banking systems, and of the financial sector more generally,
can be enhanced if banks have access to deep and liquid money markets.
Although the conditions for the existence of these markets are often taken
for granted, they form an essential component of financial sector soundness.
The fourth chapter by Claudia Dziobek, J. Kim Hobbs, and David Marston
reviews some of the issues in establishing a sound infrastructure for
liquidity management.
The framework for a systemic liquidity policy should be supplemented by
emergency liquidity support, both for individually distressed institutions
and for systemic disruptions. Emergency lending to one or a few nonsystemic
institutions will necessarily differ from the support given to systemically
important institutions, whose troubles could threaten serious banking
sector instability. But in Chapter 5, Dong He argues that properly designed
lending procedures, together with clearly laid out authority and accountability
and disclosure rules, are all central to a well-functioning lender-of-last-resort
function.
The final two chapters of Part I focus on the institutional structure
of regulation. The lack of comprehensive consolidated supervision has
been at the root of a number of banking sector problems. Some have argued
that some of these problems might have been avoided if a single integrated
regulatory agency had existed that could have surveyed the entire financial
sector. Many IMF member countries have recently taken steps to create
this very kind of integrated agency, thus attracting widespread international
interest. In the sixth chapter, Richard Abrams and Michael Taylor review
this trend and consider the circumstances in which the integrated approach
might be adopted. They argue that the decision will rest on a complex
matrix of factors that will vary according to the circumstances of particular
countries.
In addition to the regulatory function itself, many countries distribute
the responsibility for ensuring the soundness of the financial system
among a variety of bodies. These include the government (usually the ministry
of finance), the central bank, the supervisory agency (or agencies), and
sometimes a deposit insurance agency as well. In times of crisis, a dedicated
crisis resolution body is also often established. The extent to which
these institutions are allocated clearly defined responsibilities and
how they coordinate their activities can have important implications for
the soundness of the financial system as a whole. In Chapter 7, Peter
Hayward seeks to set out some guiding principles concerning the respective
roles of these different bodies, so as to achieve the efficient allocation
of their responsibilities and to ensure effective coordination.
Part II is concerned with banking system "restructuring." This term does
not necessarily refer to the bank consolidation that is being observed
in many countries around the world, but with the management and
resolution of banking sector instability. Since in most countries
serious banking sector problems are a rare event, the expertise and specialist
knowledge concerning the most efficient mechanisms for resolving banking
crises can rarely be found within a single country. A sense of what constitutes
"best practices" in bank crisis resolution requires the degree of specialization
and cross-country experience that the IMF is perhaps uniquely placed to
provide.
Even the best-regulated and managed banking system
can be overwhelmed by a sufficiently severe macroeconomic shock such as
a sudden drop in currency values. In managing and resolving banking sector
instability, one needs to bear in mind that the best practice in normal
times may not represent the best practice in a crisis. This distinction
runs through many of the chapters contained in Part II. Nonetheless, all
the papers have as an overarching concern the need to minimize moral hazard,
the notion that "bailouts" (or a promise of support) prompt recklessness
among investors.
Countries whose banking systems have suffered only modest damage can cope
by encouraging bank mergers and the acquisition of weaker banks by stronger
ones. This technique raises important antitrust issues that exist in a
particularly acute form in banking, especially because there is a prudential
dimension to mergers and acquisitions in the financial sector that does
not exist in mergers in other sectors of the economy. Thus, in considering
mergers in the banking sector, there is a need to consider the interaction
between competition law and prudential supervision. Michael Andrews examines
in Chapter 8 some of the issues that arise in this comparatively neglected
area and attempts to provide an overview of the principles and best practices
that should be applied to financial sector mergers and acquisitions.
Where attempts to rehabilitate insolvent banks fail or are not feasible,
then the banks should be liquidated. As insolvency laws differ among countries,
universally applicable procedures for bank liquidation cannot be developed.
However, there are a number of issues that must be addressed, irrespective
of the legal environment, including the treatment of shareholders, the
respective responsibilities of the central bank and the supervisory agency
(where these are different), and the role and responsibilities of the
bank liquidator. These issues are considered by David Hoelscher in Chapter
9, which also seeks to lay out specific procedures to be followed at each
stage of the liquidation process.
Where the financial crisis has led to a collapse of asset values, a dislocation
of secondary markets, and widespread real sector insolvency, a range of
different techniques for banking sector restructuring and resolution is
required. Chapter 10 by David Woo reviews two further possible approaches
to resolving a systemic crisis--the creation of asset management companies
and the creation of out-of-court centralized corporate debt workout frameworks--that
have come to define the core asset management infrastructure of countries
most seriously affected by recent financial crises. In addition to investigating
their respective roles and evaluating their strengths and weaknesses,
his chapter also seeks to develop benchmarks for assessing best practice
in their design.
In several recent cases, the resolution of banking sector problems has
involved the use of substantial amounts of public funds to permit banks
to write off bad debts and to be returned to capital adequacy. Recapitalizing
banks is a complex process that requires significant government intervention
and careful management at both the strategic and individual bank levels.
Chapter 11 by Charles Enoch, Gillian Garcia, and V. Sundararajan highlights
the range of operational and strategic issues to be addressed and the
institutional arrangements needed to foster an effective banking system
restructuring and to maximize the return on the government's investment.
The approaches to recapitalization have varied, with different countries
choosing different mixes of capital injections and asset purchase and
rehabilitation. The choice of an appropriate mix is critical to minimizing
the expected present value of government outlays net of recoveries.
Where banking system restructuring has involved public funds, it will
have often required the issuance of vast quantities of public debt. While
government support to bank restructuring through the issuance of public
debt can help address the immediate crisis, it can result in escalating
costs to the government, raising significant--and often unanticipated--medium-term
risks related to fiscal and debt sustainability and financial stability.
Priya Basu in Chapter 12 concludes this volume by presenting a simple
operational framework for quantifying, analyzing, and reducing such costs
on an ex post basis.
As already noted, this volume has a strong practical flavor with most
chapters growing out of the authors' close involvement in dealing with
these issues in the context of IMF programs or technical assistance. Many
of the chapters have appeared as Operational Papers of MAE or Working
Papers of the IMF. As their name suggests, Operational Papers are intended
to provide practical advice to experts working in the field, and are authored
by MAE staff based on their own extensive practical experience of the
subject under review. By including these papers as chapters of the present
volume we hope to make this important body of work available to a wider
audience. |
