CRISIS RESOLUTION OF LARGE BANKS IN SMALL COUNTRIES

1. CRISIS RESOLUTION OF LARGE BANKS IN SMALL COUNTRIES David G Mayes Bank of Finland

2. A HOME AND A HOST PROBLEM • Host country problem – bank is systemic, when it is not so in the home country • Interests not aligned – the Finnish and New Zealand problem (Branches vs Subsidiaries) • Home country problem – bank is large relative to GDP • Too big too save – the Swiss problem • Difficult to organise burden sharing • Many countries • Too difficult to organise – the Swedish problem • Case where branch is systemic to bank but not to host country

3. NORDEA PROBLEMS POSED BY AN EEA BRANCH STRUCTURE Market Share 2004 Banking Insurance Denmark 25 20 Estonia 11 2 Finland 40 35 Norway 15 9 Sweden 20 6

4. 4 REGIMES • Supervisors and market satisfied with performance • Normal times no need for action • Supervisorily compliant, poor market performance • Market should be acting • Supervisors concerned (poor market performance?) • Supervisors and market should be acting • Thought insolvent • Authorities have to act • For satisfactory resolution all regimes must work

5. A SECOND DIMENSION:INSTITUTIONS • Supervisors, central banks, deposit insurers, governments, courts • EU/EEA limitations on solutions • A major contrast with the US, the role of the deposit insurer • National/Supranational/Co-operative bodies

6. SUPERVISORS AND MARKET SATISFIED WITH PERFORMANCE • How do we handle – supervision; Lender of last resort; deposit insurance? – main focus of discussion but not the most intractable problems

7. SUPERVISORS AND MARKET SATISFIED WITH PERFORMANCE • How do we handle – supervision; Lender of last resort; deposit insurance? • Supervision – main debate is over the difference between home country as lead/consolidating supervisor and college of supervisors – Europe not yet ready for a ‘federal level’ player • Basel 2 forces a team approach for supervisors – Pillar 2 committee • Key issue is ‘systemic’ branches – host must be involved • Need equal access to database on the group not exchange of information on home choice under an MoU • Already in operation with Baltic States since May 1 2004 • Strong degree of harmonisation of regulations and supervisory practice helped by CEBS • Large element of mutual trust required

8. SUPERVISORS AND MARKET SATISFIED WITH PERFORMANCE • How do we handle – supervision; Lender of last resort; deposit insurance? • Supervision • Lender of last resort – traditional definition (collateralised market lending preferred to individual institution), central banks already working together even though only one in the Eurosystem. Different currency lending supplied by the relevant NCB, ex ante discretionary limits. MoU in June 2003.

9. SUPERVISORS AND MARKET SATISFIED WITH PERFORMANCE • How do we handle – supervision; Lender of last resort; deposit insurance? • Supervision • Lender of last resort • Deposit insurance – still a problem • Not ‘transferable’ • More expensive in Sweden than Finland – competitive disadvantage to operate as a branch from Sweden – this and the common approach under Basel 2 may destroy European company idea • Needs new EU directive to resolve it (grandfathering not possible). Moral hazard from legacy and perceived willingness to bail out

10. SUPERVISORILY COMPLIANT, POOR MARKET PERFORMANCE • Market discipline • Basel 2 disclosure insufficient – not even up to New Zealand 1996 levels of relevance, timeliness, frequency or auditing • Need plausible route for action – takeover – but by whom when market share already high? • Market signal from sub-debt? Must really be at risk. Action needs to follow – commitment by supervisor? Not really under discussion – pushes burden on supervisor – market should solve most problems

11. SUPERVISORS CONCERNED • Prompt corrective action • Much better to avoid a serious problem by early action when no public money at risk • Mayes, Halme and Liuksila – compulsory resolution at zero net worth (or earlier) • Is there a co-ordination problem? • Is there an incentive problem? • Incidence of losses not same as location of business • Where are the shareholders? Where are the unsecured creditors? Where are the knock on risks (contagion)? Where is the insured deposit liability? Employees?

12. THOUGHT INSOLVENT • Need universal solution, prior legal agreement to support it – home supervisory country? • Territoriality possible outside EU but subsidiaries have to be individually viable • Territoriality essential if home has dometic depositor preference • In many respects distinction between subsidiary and branch very limited – functions, source of strength • Legal basis for intervention varies considerably over the EU – public vs. private law • Can we distinguish systemically important from other operations (Hüpkes, 2004)? • Specialised institutions • Not all claims have to be dealt with immediately (NZ approach) • Reputation – (contagion within the organisation) • Rating driven close-outs

13. THOUGHT INSOLVENT • Need universal solution, prior legal agreement to support it – home supervisory country? • Do we need a resolution agency? Mayes and Liuksila (2003) Mayes (2004) Could exist for a group of countries, could exist for each systemic bank • Avoid some conflicts of interest – needs to act early to minimise losses, no loss of reputation from supervisory ‘failure’ • Could be a shell to be staffed on demand from the participant supervisors • Judicial and execution functions

14. THOUGHT INSOLVENT • Need universal solution, prior legal agreement to support it – home supervisory country? • Do we need a resolution agency? Mayes and Liuksila (2003) Mayes (2004) Could exist for a group of countries, could exist for each systemic bank • There is no European equivalent to the FDIC • Most deposit insurers are asset managers with very small staffs • Not usually depositor preference • No least cost resolution requirements • Least cost for whom in systemic case – wider than depositors – taxpayers? • ‘EDIC’ route for non-systemic cases?

15. WHEN SHOULD RESOLUTION AGENCY STEP IN? • At PCA stage? As soon as a problem is identified preparations should start for the worst • sharpens incentive to make voluntary solution work • Need to value claims in a hurry NZ solution of compulsory bank systems to make this easier • Is it possible to step in before shareholder value thought zero as with 2% rule in US? • ECJ ruling suggests no, shares must be thought worthless • Guarantee is key part of Mayes, Halme and Liuksila (2003) – can this be offered by an agency on behalf of governments?

16. WILLINGNESS TO PRE-COMMIT RESOURCES UNDER INSOLVENCY ENTAILS CONFIDENCE IN PRE-INSOLVENCY PROCEDURES • Whose fault was the insolvency? An event in another country? An action by another country’s authorities? Need joint prior responsibility • Not possible to argue about who should pay at the time? Could CEBS act as an immediate adjudicator? • Need to be convinced that all possible was done in regimes 1,2 and 3 to commit to regime 4. This is not currently the case

17. DESIRABLE PRINCIPLES • Banks have strong self-interest in prudence • Market offers effective correction mechanisms for weak performance • Plausible solution method without bail out • Assign losses up front • Can keep systemic operations going • Ex post guarantee • Can act fast enough in a crisis • PCA early and unavoidable, information available • Previously agreed loss-sharing among countries and procedures for resolution, with clear leader • Clear and full macroeconomic accounting

18. ISSUES FOR EU RETHINK • Pure home country control – collegial • Deposit insurance - transferability • A resolution agency • Insolvency law