The Use of Guaranteesin Resolving Systemic Banking Crises Stefan Ingves Director, Monetary and Financial Systems Department

International Monetary Fund

Norges Bank Conference on Banking Crisis Resolution–Theory and Policy

June 16–17, 2005

Oslo, Norway

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Outline of Presentation

1. Types of Depositor Protection

2. Features of General Guarantees

3. Conditions for Effective Implementation

4. Measures to Limit Distortions

5. Unwinding Guarantees

6. Conclusions

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Types of Depositor Protection Comes in many forms

1. Explicit denial of protection 2. Implicit coverage (ambiguous coverage) 3. Explicit limited coverage4. General guarantee of all creditors or depositors

A continuum from first to last

References to 16 countries in the paper

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Types of Depositor Protection

In stable times, the first three alternatives1. An explicit denial of protection

2. Implicit coverage (ambiguous coverage)

3. Explicit limited coverage

However, in systemic crises, general guarantees Nordic countries (early 1990s) Asian crisis countries (late 1990s) Turkey (2000–02)

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Types of Depositor Protection

Four types of General Guarantee

1. De facto guarantees

2. Statement of policy

3. Legally binding guarantee of financial institutions solvency

4. Legally binding commitment to pay depositors

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Types of Depositor Protection

Four types of General Guarantee

1. De facto guarantees No public policy announcements Failed banks resolved so no depositor loses Argentina (2002–03), the Dominican Republic

(2003–04), and Russia (1998–99)

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Types of Depositor Protection

Four types of General Guarantee

2. Statement of policy A clear statement of public policy Not legally binding Norway (1991–93) no blanket guarantee issued,

but public promise to secure depositors

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Types of Depositor Protection

Four types of General Guarantee

3. Guarantee of financial institutions solvency Institutions, not depositors protected

Legally binding commitment Details never spelled out Bank resolution agencies transfer deposits to viable

institutions with assets, or take over and recapitalize banks

Sweden (1991–93), Turkey (2000–02)

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Types of Depositor Protection

Four types of General Guarantee

4. Legally binding commitment to pay depositors Depositors directly protected Depositors paid directly by authorities Indonesia and Thailand

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Types of Depositor ProtectionWhat determines choice?

Institutional capacity Degree of public sector credibility Strength of legal traditions

Policy objectives Desire to maintain policy flexibility Importance of ambiguity in policy formulation

Magnitude of crisis Degree of Uncertainty

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Features of General Guarantees Deposit Coverage

Depositors (possibly creditors) but not shareholders Foreign currency deposits covered in local currency

Institutions Depends on structure of financial system Commercial banks Near-bank deposit-taking institutions (finance companies

in Thailand and merchant banks in Korea) Overseas branches (Korea, Malaysia, and Sweden)

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Conditions for Effective Implementation Political Commitment

Information Strategy

Credibility Manageable fiscal and monetary policies Sustainable debt levels Non-dollarized economy

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Conditions for Effective Implementation General guarantees have been controversial

High costs Market distortions Moral hazard

Governments must ensure benefits outweigh costs Need for estimate of solvency The worse financial conditions, the higher the cost Higher the cost, the stronger must be the fiscal

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A Last Resort Two types

Ex ante, well-defined last resort (Japan today) Truly last resort, lack of other functioning legal

framework

Coordinated effort Ministry of Finance, Central Bank, Supervisor,

Debt Officer, Bank Restructuring Agency

“Owner of Last Resort”

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1999

Private14%

Regional5%

Foreign & Joint venture

12%

State69%

1996

Foreign & Joint venture

9%

Regional2%

Private52%

State 37%

Indonesia: Banking System Ownership

2005

Private41%

Regional6%

State 40%

Foreign & Joint

venture13%

1996 1999 2005

Source: Bank Indonesia and Fund staff estimates (1996 totals based on credit, not assets. All State totals include IBRA.)

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Measures to Limit Distortions

Coverage and Transparency Minimum necessary protection

Explicit binding guarantees more credible than

implicit arrangements

Coverage clearly explained

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Measures to Limit Distortions Minimize moral hazard

Exclude shareholders, related parties and subordinated debt holders

Intensify bank supervision Institute controls to avoid abuse

Legal issues Remove legal impediments to enforcement Institute controls to prevent fraud

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Measures to Limit Distortions Need adequate package of measures

General guarantee alone will not contain crisis Comprehensive approach helps contain costs

Adequate package includes Adopt a comprehensive strategy Evaluate financial condition of banking system Rapid bank interventions if needed

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Measures to Limit Distortions

General guarantee becomes one pillar of bank resolution framework Central bank as lender of last resort

Government as owner of last resort

General guarantee as additional tool to ensure

financial stability following systemic crisis

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Unwinding Guarantees The longer in place, greater are distortions

A plan for eliminating guarantee is needed Concrete timetable is difficult given uncertainty Some set expiration date at establishment

Ecuador, Korea

Some linked expiration date to stabilization Mexico

Information strategy

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Conclusions

Decisions when crisis breaks out

Are preconditions present? Can guarantee be credible? Sufficient fiscal capacity? Acceptable costs of the guarantee?

Does value of maintaining stability exceed costs?

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Conclusions Design features of the guarantee

Time period Which creditors Exclude shareholders and related parties Strengthen supervision

Design of supportive reform program Macroeconomic stabilization Bank restructuring

Thank you