Financial System Crisis Preparedness and Management Prepared by D.S. Hoelscher and presented by David Walker, IADI
Overview of session I. Presentation #1 Financial System Crisis Preparedness and Management II. Presentation #2 A Deposit Insurer s Role in Contingency Planning and Crisis Management III.Workshop Exercise 2
Presentation #1 overview I. Background II. Impact of systemic crises III. Policies for managing past systemic crises IV. What was different in the recent global crisis? V. Policy responses VI. FSB crisis preparedness VII. Role of deposit insurer in system-wide crisis management VIII. Lesson learned
1992-2002, the golden age of systemic crises I. Background Finland, Norway, Sweden (1992), Indonesia, Korea, Malaysia, Thailand (1998), Russia (1998), Turkey (2001), Argentina (2002). Crises due to both macroeconomic and microeconomic factors Golden age because policy options were greater. Recent global crises: new challenges, more limited policy options
II. Impact of Systemic Crises
Real Growth Indonesia 2,500,000 2,000,000 Trend GDP GDP 1,500,000 1,000,000 500,000 0 Source: WEO. 1986 1989 1992 1995 1998 2001 2004
Fiscal Costs (In percent of GDP) Crisis Period Gross Outlay Recovery Net Cost Assets 1/ Chile 1981-83 52.7 19.2 33.5 47.0 Ecuador 1998-2001 21.7 0.0 21.7 41.3 Indonesia 1997-present 56.8 4.6 52.3 68.1 Korea 1997-2000 31.2 8.0 23.1 72.4 Malaysia 1997-2000 7.2 3.2 4.0 130.6 Sweden 1991-93 4.4 4.4 0.0 102.4 Thailand 1997-2000 43.8 9.0 34.8 117.1 Turkey 2000-present 29.7 1.3 30.5 71.0 Source: IMF. Notes: 1/ Assets of deposit money banks in the eyar before the first crisis year.
III. Policies for Managing a Systemic Crisis
Stylized Phases of Crisis Management Phase 1 Stabilize the Financial Situation > Creditor Expectations Phase 2 Restructure and Reorganize Banks Phase 3 Manage Impaired Assets Phase 4 Exit from Crisis Policies
Phase 1: Stabilize Creditor Panic Priority objective: Provide liquidity All countries extended emergency liquidity Required minimum or no conditions Measures: Protect depositors, possibly with a full or blanket guarantee o Government support critical for credibility Guarantees cannot solve the crisis o Combine with revised macroeconomic program o Combine with medium-term restructuring program Be transparent in policies --to regain confidence
Depositor Protection Blanket guarantee Finland Sweden Thailand Indonesia Korea Malaysia Turkey 30 1 2 70 No blanket guarantee Argentina Norway Russia
Phase 2 Restructure and Reorganize Banks Once financial system is stabilized Diagnosing viability More than meeting current regulatory capital Focus on medium term viability (ability to generate profits) Three stages: 1. Examined current information on capital, liquidity 2. Conduct forward-looking assessment How business model will meet changing conditions Determine how long to meet fully prudential requirements 3. Agree on operational plan, additional
Initiate a bank-by-bank strategy: Viable, undercapitalized banks: present time-bound restructuring plans, private recapitalization Be subject to intensive reporting and monitoring Insolvent, unviable banks: Should be intervened and resolved as soon as possible Should be passed to agency responsible for resolution Deposits should be transferred to sound banks
Restructuring and resolution tools Monitored forbearance to allow time to restructure Resolution tools used o Private sector options > Mergers and acquitions > Recapitalization or sales o Public sector options > Purchase and assumption > Bridge banks > Public sector capital support > Liquidation
Diagnosis Bank Resolution ublic assisted P&A Yes Private offers? Restructure Sale No Nationalization Viable? Yes No Least cost resolution Restructuring Plan (MOU) Resolution Yes Systemic? No Fulfill? Sale? Yes No Yes No Release from special regime Purchase and assumption (P&A) Liquidation
Use of Public Money Recapitalization: May be justified under special circumstances Designed to encourage private sector contributions Safeguards: All losses imposed on existing shareholders. Operational restructuring. Positive net worth to be eligible for public support. Payment for the shares in tradable government bonds. Conversion of Tier 2 capital if the CAR falls below given ratio.
Phase 3: Manage Impaired Assets Benefits of asset management entity Improves bank balance sheets Allows banks to focus on core business Economies of scale in resolving similar assets Limitations of asset management entity Tendency to hold assets too long Fiscal cost
Phase 4: Exit from Crisis Exit from blanket guarantee if applied Exit from government ownership of banks Sale of assets taken over Overhaul of regulations to not repeat mistakes
IV. Recent Global Crisis
Recent Global Crisis The crisis was different: Not traditional crisis securities not loan portfolio Collapse of collateral value created losses in securities Creditor fear spread to ALL securities markets Core funding from securitization failed But policy response broadly consistent with standard model Significant provision of liquidity Extension of guarantees to all creditors Public funds to stabilize asset markets Public funds to stabilize firms
Recent Policy Responses However, some important differences Could not avoid dealing with global banks Recapitalization: preferred shares not public funds Limited diagnosis or evaluation Few conditions on use of public funds New policy tools Emphasis on prevention Private funding not public funding Bail-in of creditors rather than taxpayer money
V. G-SIFI Crisis Prevention Framework Crisis Management Groups Responsibility of authorities. Pre-crisis group resolution plans In crisis cross-border cooperation Cooperative agreements Recovery and resolution plans Resolvability assessments Inter-institutional agreements Define roles of authorities before and during crises Responsibility of the financial institution Broad resolution strategies Operational plans with stress scenarios Responsibility of authorities Resolution strategies Operational plan to implement them Ensure they are feasible and credible
VI. Role of Deposit Insurance
Expanding Role of Deposit Insurance Clearer focus on financial stability Less concern about moral hazard from high coverage Expanding the mandate of deposit insurers Higher depositor protection likely to remain More intrusive supervision Focus on integrating three safety net functions Supervision, depositor protection, problem bank resolution Less distinction between stable and crisis policies
VII. Lessons for Crisis Planning
Lessons for Crisis Planning Planning under uncertainty Have the legal authority to act General plans, not specific scenarios Make crisis preparations part of routine Plan for failure What counts is the planning, not the plans Surprises will happen. Identify what must be protected; build redundancies. Agility needed in problem identification, decision making
IADI Latin America/North America and Caribbean Reginal Committee TAW Sao Paolo: 24-26 April 2017 (V4) David Walker Secretary General, IADI David.Walker@iadi.org
Overview of presentation #2 I. What is system-wide crisis preparedness and management? II. Role of deposit insurers and lessons learned from past crises. III.International standards focus on IADI Core Principles. IV.Challenges and initiatives.
I. What is system-wide crisis preparedness and management? Crisis: Any situation that is threatening or could threaten to harm people or property, seriously interrupt business, significantly damage reputation and/or negatively impact the bottom line. Every system and organization (e.g. the financial system, deposit insurer and other safety-net participants) is vulnerable to crises.
Contingency planning is a key foundation for crisis preparedness and management. Planning involves assessing vulnerabilities and the steps needed to address crisis impacts and mitigate them. Need to include formal information sharing and coordination protocols (ex-ante) with key stakeholders. Communication planning and preparedness helps minimize panic, confusion. All plans need to be tested and enhanced on a regular basis. Crisis management is the process and procedures by which an organization(s) deal with a crisis.
II. Role of deposit insurers 1) Financial crises occur frequently around the world. Many examples: international financial crisis 2008-09, Russia 1998, Asia 1997, Mexico 1990s, US savings and loan crisis 1980s... 2) Deposit insurers have important roles within the financial safety net in dealing with banking crises although this role varies with the specific mandate of the insurer. First, all deposit insurers help avoid bank runs and keep the small-scale depositors off the street. Second, deposit insurers with more extensive resolution powers play a greater role in crisis management. In the case of those insurers given major responsibilities for systemic bank resolution (e.g. USA, Japan, Poland, Canada, Korea, Kenya, Mexico and Malaysia) a very critical role.
3) Lessons learned in past crises:* Contingency planning important for both small and large-scale failures. Integration of deposit insurers into safety net crisis management frameworks promote more effective resolution which helps reduce resolution costs and minimize the exposure of taxpayers to loss. Development of cross-border crisis preparedness and management framework needed to alleviate international contagion affects. Crises are not always bad they can provide opportunities to introduce beneficial reforms! *Sources: BIS, FSB, IADI and IMF.
III. International standards on crisis preparedness and management IADI Core Principles Contingency planning and crisis management for deposit insurers and for system-wide framework specifically addressed in CP6. Financial Stability Board Key Attributes emphasize high level information sharing within jurisdictions (and in crossborder situations) with a focus on GSIB resolution authorities. But, standards and guidance lacks specifics on the degree of integration for deposit insurers. European Union: Deposit Guarantee Scheme Directive mandates contingency planning for deposit insurers in the form of stress testing -- but not clear on need for comprehensive involvement of deposit insurer in system-wide contingency planning/crisis management... even in situations where the deposit insurer must make its financial resources available to fund non-payout resolution!
IADI Core Principle 6: Contingency planning and crisis management» The deposit insurer (DI) should have in place effective contingency planning and crisis management policies and procedures, to ensure that it is able to effectively respond to the risk of, and actual, bank failures and other events.» The development of system-wide crisis preparedness strategies and management policies should be the joint responsibility of all safety-net participants.» The deposit insurer should be a member of any institutional framework for ongoing communication and coordination involving financial safety-net participants related to system-wide crisis preparedness and management.
EC1: The deposit insurer has its own effective contingency planning and crisis management policies and procedures in place, to ensure that it is able to effectively respond to the risk of, and actual, bank failures and other events. Effective contingency planning and crisis management avoids uncertainty, confusion and panic. Key components: 1) Assessment of vulnerabilities. 2) Range of tools, policies and procedures to address contingencies. 3) Financing. 4) Human resources (e.g. planning and crisis management team) 5) Develop internal/external information sharing and coordination arrangements. 6) Practice makes perfect both internally and externally (e.g. tabletops and simulations). 7) Incorporate lessons learned in future planning.
EC2: The deposit insurer develops and regularly tests its own contingency planning and crisis management plans. Testing is particularly important in systems where there have been few failures or if new systems and practices have been developed but never used. Examples of testing: 1) Scenario planning and tabletop exercises (tend to be at a high-to-medium level and focuses on key activities and who does what when etc.). 2) Simulations which test preparations for failure (e.g. payout sims) and other events. 3) Testing can be for specific systems and practices or comprehensive. 4) Testing can be specific to the DI or can involve other safety net participants and even other jurisdictions (e.g. US and UK have done international tabletops and simulations to test cross-border information flows and coordination). 5) Testing components typically include: i. Establishing clear goals. ii. Preparation of background materials. iii. Discussion of roles and responsibilities (who does what when). iv. A coordinator to provide direction and guidance. v. Wrap-up discussion on outcomes and lessons learned. vi. Documentation of results. vii. Revisions to practices and procedures and manuals.
EC3: The deposit insurer is a member of any institutional framework for ongoing communication and coordination involving safety-net participants related to system-wide crisis preparedness and management. Jurisdictions have been encouraged to create formalized inter-agency information sharing and policy coordinating agreements and bodies e.g. Financial Stability Committees (FSC): IMF and World Bank. a) Best practices for FSCs point to regular communication even when there may not appear to be any major risks in the system. b) Roles, responsibilities and decision-making processes need to be clear and coordination protocols specific. c) In periods of crisis, the FSC can become the body to implement the crisis management strategy. The DI, irrespective of its mandate, should be a full member of such inter-agency bodies. Examples: a) Financial Stability Oversight Council (US) b) CDIC Board/Senior Advisory Committee/Financial Institutions Supervisory Committee (Canada) c) Ministry of Finance Stability Committee (Mexico) d) Financial Stability Council (Turkey)
EC4 & 5: The deposit insurer participates in regular contingency planning and simulation exercises related to system-wide crisis preparedness and management involving all safety-net participants and communication plans. The DI needs to be: a) Routinely included in all relevant meetings and exercises; b) Have full access to preparations and review of results; c) Participate in the development of communication plans that are part of the contingency/crises management process; and d) Participate in the development of action plans.
IV. Challenges and initiatives Progress on fully incorporating deposit insures in contingency planning and crisis management frameworks has been slow and uneven. Reasons include: General resistance in safety nets to devoting sufficient resources to proactive planning; Reluctance to share information and coordinate roles and responsibilities across agencies; Lack of understanding on best practices arrangements; and Limited research undertaken in this area and lack of uniform guidance. New initiatives include: Incorporation of crisis preparedness and planning requirements in IMF/WB assessments and technical assistance guidance (e.g. explicitly stated in IADI CPs). World Bank simulation exercises (e.g. Albania, Philippines and Kenya). Toronto Centre workshops on crisis preparedness and management. IADI commitment to greater research, guidance and implementation of effective contingency planning and crisis management.
1. Public Policy Objectives (PPOs) 2. Mitigating Moral Hazard 7. Cross-border Issues Compliant Largely Compliant Materially Non-compliant 3. Mandate 4. Powers 5. Governance 6. Relationship with Other Safety Net 8. Compulsory Membership 9. Coverage 10. Transitioning from Blanket Guarantee 11. Funding 12. Public Awareness 13. Legal Protection 14. Dealing with Parties at Fault 15. Early Detection, Timely Intervention & 16. Effective Resolution Processes 17. Reimbursing Depositors 18. Recoveries (Number of jurisdictions with the assessment result) *2009 set of IADI Core Principles 0 2 4 6 8 10 0 2 4 6 8 10
Developing IADI Research and guidance on contingency planning and crisis management: New Technical Committee (2017) 1) What are the essential elements of the contingency planning and crisis management processes for a deposit insurer? 2) How do the crisis management and contingency planning practices differ across deposit insurers? What are there key characteristics? 3) How effective are these arrangements (i.e. case studies) and where are the gaps? 4) What are communication strategies in a crisis situation? How can we ensure that communication plans are consistent and the DI is included in these plans? 5) How can one ensure that system-wide coordination arrangements are adequate and the deposit insurer plays an effective role in these arrangements?
Conclusions All deposit insurers have a key role in minimizing the risk of runs and in contributing to financial stability in a crisis. Insurers with more extensive resolution powers play a greater role in system-wide crisis preparedness, management and resolution. Lessons learned from crises show that deposit insurers need to be better integrated into the safety net in terms of contingency planning, crisis management coordination. For IADI a focus on: Working with partners to promote greater involvement for deposit insurers in crisis planning & management. Developing more IADI research and guidance on crisis planning & management.
Workshop Exercise I. Discussion points: 1) What are the current arrangements for contingency planning and crisis management in your deposit insurance system? 2) How do the deposit insurer and the financial safety-net participants share information and coordinate activities in normal times and during a crisis? 3) What are the challenges you face as a deposit insurer to effective contingency planning and crisis management?