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

I. Background

1992-2002, the “golden age” of systemic crises

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

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

1986 1989 1992 1995 1998 2001 2004

Source: WEO.

Trend GDP

GDP

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

No blanket guarantee

Argentina

Norway

Russia

70

30

1

2

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

Bank Resolution

Diagnosis

Viable?

Restructuring Plan

(MOU)

Resolution

Fulfill? Yes

No

Yes

No

Systemic?

No Least cost resolution Private

offers?

Yes

Release from special regime

Sale?

No

Yes

Purchase and assumption

(P&A)

Liquidation

Public assisted P&A Yes

Restructure Sale

Nationalization No

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

Cooperative agreements

Recovery and resolution plans

Resolvability assessments

• Responsibility of authorities. • Pre-crisis group resolution plans • In crisis cross-border cooperation

• 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

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

Expanding Role of Deposit Insurance

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

David Walker

Secretary General, IADI David.Walker@iadi.org

IADI Latin America/North America and Caribbean Reginal Committee TAW

Sao Paolo: 24-26 April 2017 (V4)

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 cross-

border 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.

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.

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.

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.

EC2: The deposit insurer develops and regularly tests its own contingency planning and crisis management plans.

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)

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.

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.

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.

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.

0 2 4 6 8 10

9. Coverage

8. CompulsoryMembership

7. Cross-border Issues

6. Relationship withOther Safety Net…

5. Governance

4. Powers

3. Mandate

2. Mitigating MoralHazard

1. Public PolicyObjectives (PPOs)

CompliantLargely CompliantMaterially Non-compliant

0 2 4 6 8 10

18. Recoveries

17. ReimbursingDepositors

16. Effective ResolutionProcesses

15. Early Detection,Timely Intervention &…

14. Dealing with Partiesat Fault

13. Legal Protection

12. Public Awareness

11. Funding

10. Transitioning fromBlanket Guarantee

(Number of jurisdictions with the assessment result)

*2009 set of IADI Core Principles

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?