1 / 8

Legal Framework for Bank Insolvency: Basic Arrangements and their Limits

Legal Framework for Bank Insolvency: Basic Arrangements and their Limits. Augusto de la Torre The World Bank Finance Forum June 20-22, 2002. Contents. The basic framework Prior considerations Elements Limits Basic-plus framework Systemic-run cases.

curt
Download Presentation

Legal Framework for Bank Insolvency: Basic Arrangements and their Limits

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Legal Framework for Bank Insolvency:Basic Arrangements and their Limits Augusto de la Torre The World Bank Finance Forum June 20-22, 2002

  2. Contents • The basic framework • Prior considerations • Elements • Limits • Basic-plus framework • Systemic-run cases

  3. Basic FrameworkConsiderations and Definitions • Bank resolution—a key leg of the tripod of capital, monitoring, and exit • See “Beyond the Washington Consensus: Institutions Matter” (1998), chapter 3 • Exit by closure–the ultimate disciplining device • There are no internationally accepted standards, yet • “Fear of closing”—contagion risk from loss allocation to bank creditors, and asset value destruction • “Sound exit framework” = incentive-compatible interaction of LOLR, corrective regimes, closure, resolution techniques, deposit insurance, liquidation

  4. Elements of the Basic Framework (1)Idiosyncratic and Not-Too-Big Cases • LOLR—avoid zombies while deterring unwarranted runs • Avoid over-generous windows and payments-related overdrafts (under-priced, un-collateralized, unlimited) • Involve bank regulator to ascertain solvency vs. liquidity • Corrective regimes—avoid paralysis vis-à-vis gray zones • Move balance in favor of rules vis-à-vis discretion • Regularization plans (responsibility of banks) and strong monitoring & enforcement powers (presumption of legality) • Restrict regimes to private-sector solutions (moral suasion behind the scenes) • The perils of classical “intervention”—co-administration (legal risk) of an open bank (moral hazard)

  5. Elements of the Basic Framework (2) Idiosyncratic and Not-Too-Big Cases • Closure—desiderata • Minimize moral hazard w/o undue increase in contagion risk • Maximize asset value preservation • Closure—key problems • “Hostages” and “refrigeration” • Inadequacies of traditional liquidation • A framework for closed-bank resolution • P&A-type techniques (deposit transfer funded by asset trust) • Limited deposit insurance able to contribute to purchase and assumption, subject to less-cost rule • Judicial liquidation of residual balance sheet • Legal protection—of process, assets, and officials

  6. Basic FrameworkLimits and Pre-requisites • Purely idiosyncratic failures are not very common • BF requires significant segment of sound banks • Capable of absorbing quickly the assets and deposits of failed bank • BF presumes flight to quality (within system) only • Safe LOLR is limited by “borrower of last resort” • LOLR can fuel systemic run (flight out of the system) • BF requires resources (or access to) in the DIF

  7. Basic-Plus FrameworkToo-Big-to-Close Cases • Open-bank capital assistance… • …restricted to “officialized” banks • The “accordion” procedure (Spain, Colombia) • …and subject to tight rules to avoid abuse • Discretional—decision taken by highest level authorities of relevant agencies (U.S.) – discretional • But funded w/o recourse to DIF (i.e., through the budget) • LOLR liquidity assistance against government bonds • Ex-ante contingency planning and “fire drills” Works as long as massive systemic run can be contained, which is problematic for highly indebted EM governments

  8. Generalized (“Type IV”) Crises • Contract-abiding containment fails to avert a massive run • Bank holidays, deposit freezes, deposit securitization • Default spreads across internal and external contracts • By definition, ex-ante legal frameworks are violated • Issues go well beyond the scope of financial sector legal and regulatory framework • Fiscal, exchange rate, debt issues are salient • Focus must shift to prevention and better understanding of the nature of the new, disturbing varieties of crises

More Related