Crisis Management and bank resolution

The views and opinions expressed in this presentation are those of the author and do not necessarily reflect the official policy or position of the Central Bank of Malta

workshop organised by

The Islands and Small States Institute, Malta

16-20 April 2012

Rationale for crisis management

“A set of actions taken by authorities in order to contain a financial crisis and avoid potentially disruptive effects on the financial system or the real economy.”

The Brouwer Report

• Costs of crises: • Global financial crisis – trillions of $

• Past crises – 15-20% of GDP

• Various studies and organisations

(IMF/World Bank) recommend a

credible crisis management

framework

• Countries must ensure sound frameworks for the management of financial crises and the orderly resolution of banks.

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Global initiatives

• G20 – core elements of a new global financial regulatory framework

• FSB – “Key attributes of Effective Resolution Regimes for Financial Institutions”, requires jurisdictions to:

• Designate resolution authorities with powers to intervene and resolve non-viable institutions using a number of tools

• Provide incentives for cross-border cooperation to get the best outcome for financial stability for jurisdictions affected by a financial institution’s failure

• Make sure all institutions have recovery and resolution plans that are regularly reviewed, updated and tested each year

• Put in place crisis management groups appropriate for each cross-border bank, involving the relevant authorities and underpinned by cooperation agreements

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An EU framework for troubled and failing banks The Commission’s Communication (Oct 2010) sets out a general framework for a comprehensive EU framework for troubled and failing banks:

• STEP 1: A legislative proposal for a harmonised EU regime for crisis prevention and bank recovery and resolution

• STEP 2: Further harmonisation of bank insolvency regimes – legislative proposals by December 2012

• STEP 3: The creation of an integrated resolution regime, possibly based on a single European Resolution Authority, by 2014

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An EU regime for crisis prevention, bank recovery and resolution “Technical details of a possible EU framework for bank recovery and resolution” DG Internal Market and Services Working Document

• Measures: all stages from prevention to early intervention to resolution to winding up

• Scope: banks and investment firms (initially, subject to review)

• Overriding objective: reduce ‘social cost’ of bank failure and moral hazard, by orderly restructuring and dissolution of banks in severe financial difficulty, whilst avoiding costs to taxpayers and preserving critical services essential for financial stability, as an alternative to insolvency and consequent market disruption (Lehman 09/2008).

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7 core principles of the EU framework The EU framework for prevention, crisis management

and resolution is based on the following objectives :

• Put prevention and preparation first – planning = preparation

• Provide credible resolution tools – minimise risks and ensure continuity of services

• Enable fast and decisive action – clarity and legal certainty

• Reduce moral hazard – appropriate allocation of losses

• Contribute to a smooth resolution of cross border groups

• Ensure legal certainty – appropriate safeguards for stakeholders

• Limiting distortions of competition

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Role and responsibilities

In peace time During a crisis

Institution itself Ensure its safety and soundness Conduct proper risk management

Minimise costs and negative externalities

Authorities Strong regulatory framework Adequate supervision

Early intervention Resolution

Central bank Financial stability Payments system overseer Monetary operations

Emergency liquidity assistance (LOLR)

Regulator Regulation Supervision Compliance

Micro-data Solvency state of the institution

Finance Ministry Recapitalisation - public funds Guarantees

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Implementation of a domestic crisis management framework • Definition of a financial crisis

• Systemic impact assessment

• Legislative issues for consideration

• Structure for cooperation and deliverables

• Exchange of information

• Resolution of potential conflicts

• Cross-border implications

• Communication

• Logistics

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Main elements of a crisis management framework Defining a crisis situation

• Not all crises are systemic

• Not all banks must be saved – nature of the crisis (fraud?)

• Need to assess cost of acting or not acting

• Case for a systemic impact assessment

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Main elements of a crisis management framework Systemic Impact Assessment

• Aim – to determine the costs and benefits of saving or letting the bank go

• Potential impact on

• Other financial institutions

• Financial markets

• Financial infrastructure

• Real economy

• A common language for the authorities identifying the extent of interconnectedness, the size and substitutability.

• Heat map

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Main elements of a crisis management framework The systemic impact assessment heat map

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Main elements of a crisis management framework Legislation underpinning the response to a financial crisis

• Legal mandate and responsibilities

• The provision of Emergency Liquidity Assistance

• Resolution powers and resolution measures

• Exchange of information domestic and across countries

• Insolvency and winding up measures

• Procedures for liquidation

• Deposit Guarantee Scheme

• The provision of public funds

• Competition issues

• What are the implication of state aid?

• What are the issues arising in cross-border cooperation?

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Emergency liquidity assistance

• Central banks act as lenders of last resort

• Emergency liquidity assistance (ELA) is provided to illiquid but solvent institutions

• The responsible authority must prepare guidelines for the provision of ELA and agree on specific principles e.g. eligible institutions, the acceptable collateral, the interest rate, applicable haircuts, the term of the loan

• ELA should be short term and temporary and not qualify as monetary financing

• Formal decision making structure

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Main elements of a crisis management framework • Structure for cooperation and deliverables

• Needs further input when central bank and supervisory authorities are separate and therefore cooperation issues are important

• MoUs

• Bilateral or tripartite Committees

• Need for clarity regarding

• Responsibilities of authorities – solvency, liquidity, public funds

• The evaluation stage

• Recommendations by individual authorities in line with responsibilities

• Be in a position to advise Governors / Minister

• Policy decisions

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Main elements of a crisis management framework • Resolution of potential conflicts

• Is the institution illiquid and/or insolvent?

• Is it systemically important?

In a crisis, it is difficult to determine decisively the state of the institution

• What is the information that is required?

• How would the central bank be able to cooperate in the resolution of a systemically important but insolvent institution?

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Main elements of a crisis management framework • Information to be exchanged

• What is information is essential and what is relevant?

• Who is in the best position to provide it?

• Micro data

• Macro analysis

• Economic information

• Public sector assessment

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Main elements of a crisis management framework • Cross-border implications – home / host issues arising from:

• Presence of cross-border international banks

• Presence of systemically important branches or subsidiaries

• What are the principles for cooperation?

• Cross-border impact can be large

• transfer of liquidity and assets

• use of collateral

• presence or value of parental guarantee

• other home / host country issues (consolidated supervision; impact of resolution by home country; provision of information regarding a systemically important bank in a small country)

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Crisis simulation exercises

• It is important not only to understand the underlying principles which regulate the management and resolution of crises but also to have a tested operational framework that would a priori facilitate the process of crisis management.

• Simulation exercises may be aimed at (inter alia): Testing the functioning and operational effectiveness of existing arrangements

• Testing the assessment of systemic risk at domestic and cross-border level

• Testing coordination of decision-making, and

• Enhancing preparedness of competent authorities with a focus on information-sharing.

• Logistics involved

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Resolution

• Resolution measures can be taken when a credit institution is failing or likely to fail, and the conditions for resolution are met

• Three possible trigger conditions considered for resolution:

• Institution has incurred or is likely to incur losses that will deplete its equity or is likely to become balance sheet insolvent

• Institution no longer meets, or is likely to fail to meet its licensing requirements

• Institution no longer possesses, or is likely to fail to possess, sufficient regulatory Tier 1

• No other measures are likely to avert failure and restore the condition of the institution in a reasonable timeframe

• Necessary in the public interest

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Resolution tools

• To enable authorities to ensure the continuity of essential services and to manage failure in an orderly way

• Powers to effect the takeover of a failing bank or firm by a sound institution

• Sale of business tool

• Asset separation tool

• Debt write-down

• Or, to transfer all or part of its business to a temporary bridge bank

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Resolution financing arrangements • MS must have financial arrangements in place to ensure that

resolution is backed by adequate financial measures

• Issues for consideration:

• Fund target size (% of eligible liabilities?)

• Contributions determined for each institution (pro-rata on the basis of its eligible liabilities?)

• Relationship with Deposit Guarantee Schemes – DGS funds may be used under certain conditions to finance the transfer of deposits to another bank, provided guaranteed depositors do not loose claim to non-transferred deposits up to guaranteed amount (confidence)

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Way forward

• The Central Bank of Malta:

• Domestic Standing Group

• Contingency plan for resolution

• Crisis management framework

• Simulation exercises

• Operational guidelines

• Cross border cooperation

• Preparedness of institutions

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Thank you

Graziella Gatt Manager

Policy, Crisis Management & Stress Testing Financial Stability Department

Email: gattg@centralbankmalta.org

April 17, 2012