Financial Crisis: T he R ole of D eposit I nsurance Session 3 Bank Resolution

1. Financial Crisis: The Role of Deposit Insurance Session 3 Bank Resolution Jerzy Pruski – President of the Bank Guarantee Fund Basel, 9th June 2011

2. Resolution Crisis Containment Costs and Instruments Used 8-9th June 2011 2

3. Crisis Containment Costs The capacity to minimize crisis containment costs is shaping up to be a major challenge for developed nations The financial crisis of 2008-2009 has shown that crisis containment costs are on the rise, particularly for taxpayers Source: IMF – Crisis management and resolution 8-9th June 2011 3

4. Resolution as a Way of Limiting Crisis Response Costs Fiscal burden and systemic repercussions of actions taken against insolvent banks based on Čihák & Nier (2009) Benefits of resolution process Reduction of the systemic risk of potential bankruptcy Regulators assume control Reduction of burden on taxpayers Costs borne by existing shareholders Reduces moral hazard and increases market discipline Bailout Fiscal Costs Traditional Solutions Disorderly Bankruptcy Resolution Systemic Risk (instability) 8-9th June 2011 4

5. Possibilities and restrictions in instrument use Size of bank Risk associated with resolution Possibility of using private sector solution Deposit Insurance Fund Empirical evidence of resolution Small local High Many potential buyers on the market Available Possible to accumulate the required funds within the DGS Considerable Broad experience of the FDIC in the US market, though other countries have also employed similar solutions Low Ability to carry out the process quickly and efficiently. It does not generate any systemic risk for the country in question National, systemically significant Depends on the conditions prevalent in the given country and its financial markets Limited capacity High cost of accumulating the required funds Limited Depends on the way it is carried out. May result in systemic risk for the country in question Limited Some FDIC experience in the US and limited experience in selected countries High Generates systemic risk in the home country, but also causes turbulence in international markets Multinational Very limited Can only be taken over by a larger financial institution (if such exists), leading to a rise in systemic risk No scope for accumulating them Required amounts exceed the capacity of a single country Almost non-existent The most common solution was nationalization According to FDIC resolution can be an effective process to reduce negative results of multinational banks insolvency 8-9th June 2011 5

6. Instruments used in instances of insolvency Country Extensive liquidity support Significant restructuring Asset purchase Guarantees Nationalizations Selected Asset Relief Measures during Recent and Past Crises – European market Austria Belgium Denmark Germany Iceland Ireland Latvia Luxemboug Netherlands Ukraine UK USA X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X Source : IMF 8-9th June 2011 6

7. Containment and Resolution Policies Bank holidays past crises* recent crisis** Asset Management Companies Deposit Freezes Increase in deposit guarantees Bank Recapitalization with Public Funds Significant addtional guarantees Nationalizations *Past crises (1991-2002) – 17 countries: Finland, Norway, Sweden, Brazil, Mexico, and Jamaica, Indonesia, Japan, Korea, Malaysia, Thailand, Colombia, Ecuador, Russia, Turkey, Argentina and Uruguay. **Recent crisis (2007-2009) – 12 countries:Austria, Belgium, Denmark, Germany, Iceland, Ireland, Latvia, Luxembourg, the Netherlands, Ukraine, the United Kingdom, and the United States. All liabilities guaranteed Asset Purchases Asset guarantees Source : IMF 8-9th June 2011 7

8. Resolution of small banks Multifaceted importance 8-9th June 2011 8

9. Concentration of the US banking sector Number of banks Share in GDP Total assets in billion $ Average total assets in billion $ • The number of banks with assets amounting to less than 0.01% of GDP exceeds 7 500. These banks are distributed throughout the region. • These banks’ assets comprise nearly 25% of the total assets of the entire US banking sector, therefore: • the likelihood is high of a case of insolvency emerging among this group, • the financial ramifications of the degree of effectiveness of managing bank liquidations among this group are significant 8-9th June 2011 9

10. The problem of insolvency among US banks • In the US, resolution of small state banks is carried out effectively thanks to the extensive experience and institutional competence of the FDIC • In terms of big banks, there was a lack of adequate tools and experience – hence public funds were employed Remaining banks Banks supervised by the FDIC The FDIC has at its disposal both tools and competencies with respect to liquidating small banks Lack of ready solutions to carry out a resolution process. One of two solutions is possible: Resolution Lehman Brothers Bankruptcy Average assets: $0.9 bn* assets: $639 billion American International Group Citigroup Bank of America Using public funds Average assets: $1200 billion *Excluding Washington Mutual Bank 8-9th June 2011 10

11. Opportunities for resolution with respect to small banks in Europe Large number of banks Sector is fractionalized Concentration of big banks • The financial sector in many European countries is significantly fractionalized • A large number of small banks operate in these markets • As in the US, there is economic justification for employing resolution tools to liquidate these types of banks in the event of insolvency 8-9th June 2011 11

12. Big Bank Risks 8-9th June 2011 12

13. Location of the biggest banks • The problem of big banks is a primarily European problem The majority of the 40 biggest banks in the world are situated in Europe The assets of Europe’s biggest banks markedly exceed the GDP of their home countries In non-European countries, the assets of the biggest banks do not exceed the GDP of those countries 8-9th June 2011 13

14. Changes in the banking system The period preceding the financial crisis of 2008-2009 was characterized by a systematic rise in the risk of insolvency of big banks, mainly European ones Rise in leverage Rapid rise in both regular assets and non credit-obligation assets Liquid Assets / short termnon-Deposit Liabilities 8-9th June 2011 14

15. Funding Risk Consolidated International claims of reporting BIS banks vis-à-vis banks,immediate borrower basis(trillions of US$) Funding structure $10T $8T $6T $4T Commercial paper, medium-term notes, asset-backed commercial paper, a-b securities, repurchase agreements, total return swaps, hybrid and repos, ABS CDOs etc all countries developed countries Europe Shadow bank Liabilities 5 years x3 Traditional bank Liabilities 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source : IMF The development of the international market for funding instruments should remain under tight supervision The size of the market is conducive to transferring country risk and financial market risk between different geographical regions The market for wholesale funding instruments has surpassed the traditional market of financing banking activities By contrast with traditional liabilities, these new instruments introduce significant risk to the banking sector 8-9th June 2011 15

16. Funding Risk (2) Net Stable Funding Ratio • The high risk associated with operational funding is generated by large European banks • These banks have a limited pool of stable sources of funding • For a large proportion of this group, the credit volume exceeds the volume of deposits by a factor of 2.5 • Operational funding is carried out by means of wholesale financing NSFR Net Stable Funding Ratio (NSFR) is a ratio of available to required stable funding 8-9th June 2011 16

17. Poor capital base Equity/Assets 2009 ROA 2009 Low risk High risk Assets/GDP Assets/GDP • A significant source of risk is the confluence of two threats: • the size of the banking sector relative to GDP • poor capital security of banks Materialization of risk Large banking sectors with a concomitant low capital security demonstrated the lowest capacity to withstand the financial crisis 8-9th June 2011 17

18. Limited capacity to employ public funds Relying on public funds in the event of insolvency of Europe's biggest banks is practically impossible due to the fiscal condition of the countries involved Used data - 2009 8-9th June 2011 25th May 2011 18

19. Conclusions 8-9th June 2011 19

20. Mitigating the risk: „too big to fail” Need for healthy public finances Regulatory framework Macroprudential Minimizing the cost of insolvency Increased capital requirements Special Resolution Regime Increased liquidity requirements Prevention Early intervention Resolution The problem of „too big to fail” remains Mitigating the risk of negative impact of business on the country and on markets Balance sheet restructurization and re-engineering individual banks to ensure a secure business model Creating a secure structure for the banking sector 8-9th June 2011 20

21. DGS: a leading institution in banking resolution Resolution Economies of scale (one fund smaller than the sum of two separate funds) Strengthening of the financial stability Common public interest Positive international empirical evidence Homogenous responsibility Strengthening of the economic growth Cost reduction of bank failure Employment of crises management tools Higher protection of consumers Deposit Insurance 8-9th June 2011 21

22. Robust domestic stability network as prerequisite for effective cross-border safety net Ministry of Finance Central Bank/ ? Macroprudential Central Bank strong & complete domestic financial stability system Deposit Guarantee Scheme Financial Services Authority Resolution & pay-box 8-9th June 2011 22

23. Discussion 8-9th June 2011 23