Banking Crisis in the Past—Lessons for the Future

I. Policy Response to Systemic Crises 1992-2002

A. Triggering the Crises

B. Liquidity Policies

C. Stabilizing Creditor Expectations

D. Bank Restructuring and Resolution

Diagnosing viability

Determining levels of forbearance

Developing restructuring strategies

E. Recapitalization with Public Resources

II. Policy Response to the Current Global Crisis

A. Liquidity Policies

B. Stabilizing Creditor Expectations

C. Bank Restructuring and Recapitalization

Bank failures

Recapitalization

Diagnosis and stress testing

Systemically Important Financial Institutions

III. Policy Choices and Lessons

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Banking Crisis in the Past—Lessons for the Future

Systemic banking crises appear suddenly and evolve chaotically. Major financial crises often start with small, apparently minor shocks that trigger a vicious cycle of loss of creditor confidence, creditor and depositor runs, loss of liquidity and further loss of confidence. If not addressed quickly, financial insolvencies will spread throughout the banking system.

Preparation and planning are often more effective in crisis management than trying to predict the onset of a crisis. Early warning systems and stress testing are useful supervisory tools but, when a crisis breaks out, authorities must operate in an environment of limited data, rapidly changing conditions, and significant uncertainties. Moreover, needed policy responses are often outside the normal range of policies actions. Developing a political consensus can be difficult and time consuming. Having an agreed policy framework in place can be critical in dealing quickly with shocks and limiting contagion.

The experiences of countries addressing systemic crises over the last twenty years provide important guidance for developing such a policy consensus. Systemic crises occurred in the Nordic crises of 1992 (Finland, Norway and Sweden), the Asian crisis of 1998 (Indonesia, Korea, and Thailand), and in Russia (1998), Turkey (2001) and Argentina (2002). While there were differences in specific policy positions, these countries all followed a broadly policy consistent approach. That approach can help guide preparations for future crises.

A question that is still under analysis is whether the policy response to the current crisis diverged significantly from early approaches.1 Initial conditions differed in important ways from earlier crises. Global markets are now more integrated and the fiscal constraints (particularly the size of public debt) more binding. As a result, countries affected by the current crisis (largely the US and European countries) adopted policies that differed in important aspects from what had been implemented in previous crises. A question that remains under discussion is how much of the more traditional framework remains valid and what are the policy issues that remain to be analyzed and evaluated.

This paper is divided into three sections. The first will describe the evolution of crisis management strategies adopted by the emerging economies between 1992 (the Nordic crisis) and 2002 (the Argentina crisis). The second section will describe the policies adopted by the advanced economies in response to the current financial crisis. The last section will discuss pending policy choices that have emerged from the recent experiences.

1 A clear classification of the current crisis remains elusive. The crisis was triggered by a loss of confidence in structure products and capital markets in the US in 2007/8 and spread to European countries in 2008/9. Some initial success at limited the impact of the crisis was reversed by a second stage of the crisis focusing on sovereign debt levels and the capacity of countries to implement policy adjustments. A clearer differentiation and analysis awaits future researchers. For the moment, this paper will merely refer to the “current crisis”, ignoring its evolving nature.

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I. POLICY RESPONSE TO SYSTEMIC CRISES 1992-2002

A key lesson learned from past cases is that successful crisis management requires more than just bank restructuring and resolution policies. The restructuring and resolution of banks must take place within an effective and comprehensive policy environment aimed, first, at stabilizing public confidence and, second, addressing bank weaknesses and distress. The policy framework that emerged from the crises in the 1990s had four broad stages:

accommodating liquidity policies to manage liquidity pressures,

policies to stabilize creditor confidence and preventing or halting depositor runs,

restructuring and resolution policies to resolve weak or failed banks, and

policies to manage and resolve nonperforming assets.

The period between 1992 and 2002 was, in some sense, the golden age for systemic crises management. While the countries undergoing the crises faced deep insolvencies and sharply deteriorated macroeconomic conditions, they also had some advantages in resolving those crises (Table 1). First, the level of globalization was smaller than today, reducing interlinkages and sources of capital flight. Second, capital markets were less developed, so the spread of risk to nonbank financial institutions was lower and the contagion of the crisis more limited. Finally, governments of the affected countries, while dealing with serious macroeconomic imbalances, had low levels of public debt and, in most cases, low levels of dollarization. The policy options, therefore, were wider than for more recent crises.

A. TRIGGERING THE CRISES

The financial crises were triggered by a variety of different events but generally came after years of growing imbalances. Financial crises were triggered by often seemingly minor shocks that brought out long standing financial weaknesses. These shocks came in a variety of forms, both macroeconomic and microeconomic in origin. The Asian crisis was triggered by maturing short term external debt in Thailand, the Turkish crisis by the failure of a small, domestic bank, and the Argentine crisis by political shocks and unanticipated changes in policy direction.

Table 1: Initial Conditions‐‐Selected Cases of Systemic Crises

Finland Norway Sweden Thailand Indonesia Korea Malaysia Russia Argentina Turkey

OverviewCrisis date (year and month) Sep‐91 Oct‐91 Sep‐91 Jul‐97 Nov‐97 Aug‐97 Jul‐97 Aug‐98 Dec‐01 Nov‐00Currency crisis (Y/N) (t-1, t+1) Y N Y Y Y Y Y Y Y Y  Year of currency crisis 1992 1992 1992 1997 1997 1997 1997 1998 2002 2001Sovereign debt crisis (Y/N) N N N N N N N Y Y N  Year of sovereign debt crisis 1998 2002

Macroeconomic conditionsFiscal balance/GDP 5.6% 2.5% 3.4% 2.4% ‐1.1% 0.2% 2.0% -17.0% ‐3.6% -15.0%

Public sector Debt/GDP 14.0% 28.9% 14.2% 26.4% 8.8% 35.2% 52.5% 50.8% 51.3%

Inflation 4.9% 4.4% 10.9% 4.8% 6.0% 4.9% 3.3% 11.1% ‐0.7% 68.8%

Net Foreign Assets/M2 12.7% 10.3% 4.8% 25.1% 21.6% 15.6% 23.2% 9.5% 24.2% 17.8%

Deposits/GDP 52.3% 54.4% 40.6% 76.9% 44.7% 36.6% 119.5% 14.6% 28.2% 37.3%

GDP growth 0.1% 1.9% 1.0% 5.9% 7.8% 7.0% 10.0% 1.4% ‐0.8% -3.4%

Current Account/GDP ‐2.4% 5.4% -0.7% -6.0% ‐3.0% -3.8% 0.2% 0.4% ‐0.5% -0.5%

Banking sector conditoinsPublic banks and NPL's

Peak NPLs (as % of total loans) 13.0% 16.4% 13.0% 33.0% 32.5% 35.0% 30.0% 40.0% 20.1% 27.6% Percent govt ownership 13.4% 43.7% 23.2% 17.1% 42.3% 23.4% 9.9% 33.0% 30.0% 35.0%Significant bank runs (Y/N) N N Y N Y Y Y Y Y N Largest one-month deposit drop (%) 5.6% 22.6% 12.0% 6.0% 21.0% 6.8%Credit boom (Y/N) N N Y N N N N N N Annual credit to GDP (in %) 8.0% 2.9% 10.6% 4.5% 1.1% 7.1% 9.5% 6.1% 6.1%

4

5

Hunaddressed for several years. Often such weau

Wfundamentals of the banking system—resulteperceptions about the soundness of the bankintheir portfthe banking systemw

B.

SFalling liquidity resulting fromdifficulties with wholescited, large creditors, both foliquidp

Tconditions. 2). Measured as a percent of deposits, peak liquiover 50 percent in Indonesia. On average, centrpercent of initial banking sectorcrisis but rather gave the auproblemt

Cworried abocollateral and penalty interest railliquid mM

owever, these shocks occurred in an environment of financial distress that had gone knesses were not even recognized or poorly

nderstood (Box 1). On the eve of the systemic crisis, countries faced such weaknesses as:

a prolonged period of rapid credit growth following financial liberalization and growing nonperforming assets (Finland, Indonesia, Norway)

asset concentration (Russia in government bonds, Sweden in real estate)

increased exposure to foreign exchange rate and interest rate risks (Russia, Turkey)

short term funding risks (Turkey)

hile all of these stresses could be managed, the triggering event—often unrelated to the d in a sudden shift in private sector g system. Given the inherent weaknesses in

olios, banks were unable to confront these pressures, leading to a loss of credibility in , concerns about the ability of the authorities to reverse the deterioration, and

ide spread runs.

LIQUIDITY POLICIES

ystemic crisis almost always began as a liquidity problem in some or all of the banks. nonperforming loans, aggressive credit expansion, and

ale funding mechanisms reduced bank liquidity. In the systemic crises reign and domestic, were the first to recognize the emerging

ity problems and were the first to leave. Smaller retail deposits began to run as the liquidity ressures became more evident.

he crisis countries reviewed here all extended emergency liquidity, often with only limited Total support more than doubled in the first year of the crisis in all countries (Table

dity support ranged from 6 percent in Finland to al banks provided liquidity amounting to over 20

deposits. Provision of such liquidity did not resolve a banking thorities time to diagnosis and address the more fundamental

s. The top priority at this stage is merely to stop depositor and creditor runs and protect he payment system.2

onditions for access to such central bank support were typically eased. Central banks ut ensuring market liquidity and temporarily eased access requirements such as

tes. Such conditions are appropriate in stable periods but, when arkets are threatening financial stability, the provision of liquidity becomes a priority.

oreover, in a systemic crisis, the value and quality of collateral may not be known, while

2 The authorities must also limit the impact of this support on prices and the exchange rate. Many central banks were able to use available monetary instruments to sterilize the growth in base money.

Table 2: Containment Phase‐‐Selected Systemic Crises

Finland Norway Sweden Thailand Indonesia Korea Malaysia Russia Argentina Turkey

Emergency liquidity support Y Y Y Y Y Y Y Y Y YSupport different across banks? Y Y Y Y

Collateral required N N Y Y

Remunerated (Y/N) N YPeak support ( % of deposits) 5.5% 6.2% 9.4% 25.9% 53.8% 28.9% 12.2% 31.5% 24.3% 22.2%Lower reserve requirements N N N N N N Y N N

Deposit freeze N N N N N N N N Y NIntroduction  2001Duration (in months) 12

Bank holiday N N N N N N N N Y NIntroduction  2001Duration  (in days) 5

Blanket guarantee Y N Y Y Y Y Y N N YDate of introduction Feb‐93 Sep‐92 Aug‐97 Jan‐98 Nov‐97 Jan‐98 Dec‐00Date of removal Dec‐98 Jul‐96 Jan‐05 Jul‐05 Dec‐00 Aug‐05 Jul‐04Duration (in months) 70 46 89 78 37 91 43Previous explicit deposit insur Y Y N N N Y N N Y YCoverage of guarantee 1 2 2 2 2 3 2

1/ All creditors except shareholders

2/ All liabilities except shareholders

3/ All deposits

6

7

emf

Wdifferbecause data are poor or outdatedmliquidity support to the entire syw

C.

Otargetconfidencesolvent and liquid ones. This generalized loss ofof needed liquidity bui

Aguarantees to stem the crisis(see Table 2). The success of that policy stance lethe samand failure to roll over debt put equal pressuextremability to hoIndonesia, wc

Uthat approachfoverall sovereign debt levels were not excessidollarization of the banking systemc

xcessive penalty rates may add to banks’ distress. At the same time, the central bank must aintain its intervention rates at levels sufficiently high to make it a source of last (rather than

irst) resort for liquidity.

hile, in principle, liquidity support should only be provided to solvent banks, the entiation between solvent and insolvent banks is often difficult in systemic crises

. Moreover, ceasing liquidity support to some selected banks ay not be feasible if it interrupts the payment system and risks widening the crisis. Stopping

stem would be even more infeasible. As a result, such support as provided to all banks facing liquidity pressures.

STABILIZING CREDITOR EXPECTATIONS

nce creditors, including depositors, lose faith in the banking system and start to run, ed measures aimed at insolvent banks will not be sufficient to reverse the loss of

. In a systemic crisis, depositors and creditors in general run from all banks, including confidence not only drains the banking system

t makes recapitalization and other restructuring polices impossible to mplement.

common tool used in the 1990s and early 2000s was the introduction of a blanket . In 1992, the Nordic countries were the first to adopt a guarantee

d Asian crisis countries and Turkey to follow e approach. The guarantee extended to all creditors, not just depositors, as creditor runs

res on the banks. The blanket guarantees were ely successful, reflecting as much on the political support for the policy as the perceived

nor the guarantee. Even in countries facing difficult fiscal conditions, such as ere able to convincingly implement the guarantee, halting depositor and other

reditor runs.

se of deposit freezes and bank holidays were uncommon, with only one country adopting . Concerned about the level of dollarization and weak public finances, Argentina

roze all deposits, halting the run but causing considerable strain in the payments system. 3 While ve, the authorities were concerned about the

.4 The deposit freeze initially extended to all deposits. As onditions stabilized, the authorities gradually lifted the freeze.

3 The freeze (the “corrilito”) was gradually removed as the macroeconomic environment and financial conditions in the banking system improved. 4 In [1995], the Argentine government passes the Convertibility Law, declaring that the peso and dollar were at par. Subsequently. dollars and pesos circulated freely, with no distinction made between the two currencies.

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As with liquidity support, a blanket guarantee alone does will not resolve the crisis. Calming creditor panic was a necessary first step before beginning to implement comprehensive stabilization policies. With deposit runs under control, the authorities could then remove insolvent banks from the system without spreading contagion to otherwise sound banks. The subsequent restructuring polices could take place in a calmer period where bank-by-bank strategies could be implemented.

D. BANK RESTRUCTURING AND RESOLUTION

Once depositor confidence had stabilized, the authorities turned to the difficult task of restoring individual banks and the system to profitability and solvency. Authorities in the crisis countries highlighted here all adopted policies to strengthen viable banks and resolving insolvent or nonviable banks. Their experience showed that bank restructuring is a multi-year process. Banks were first diagnosed and, then, bank-by-bank strategies were developed. Strategies were dynamic, with economic conditions evolving and bank policies refined and continually updated.

While the details of restructuring strategies differed and tools were not universally applied (see below) a number of common principles were followed in all countries. First, supervisors were responsible for ensuring that all banks had fit and proper owners and managers. If the existing shareholders were deemed unfit, they were replaced or the bank was intervened. Second, all existing losses on the books of the banks were recognized up front, allowing the authorities to have a clear understanding of the condition of the banks. As described below, some restructuring strategies incorporated a formal, phased loss recognition or phased buildup of capital levels but the initial diagnosis was normally based on recognizing fully all losses. Finally, banks would be subject to intensive supervision with frequent (often quarterly) monitoring of the progress in implementing their business plans and meeting their projected.

Diagnosing viability

The immediate task that all authorities struggled with was obtaining an accurate diagnosis of both the current financial condition of banks and their medium-term prospects. Supervisors in the Nordic countries, the Asian counties, Turkey and Argentina all relied initially on traditional supervisory tools including risk-weighted capital adequacy ratios (CAR) and appropriate provisioning rules. However, viability assessment required a more comprehensive approach. Specifically, a bank was considered viable if it could remain profitable over the medium term. Coming to such a judgment required a three phased approach:

First, supervisors examined current information on banks’ portfolio, capital, and liquidity. In Turkey, outside auditors were hired to assess each of the banks in the system. In Argentina, the banks were charged with assessing the financial conditions based on uniform criteria for asset valuation prepared by the supervisory authorities.

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Second, a forward-looking assessment were required of the banks, indicating how their business model will confront changing economic conditions and how long it will take to meet fully prudential requirements. Such restructuring plans had to include time bound monitorable targets and were approved by the supervisors (see below). Supervisors in both Turkey and Argentina, for example, incorporated such assessments in standard supervisory oversight, giving them a clearer view about bank strategies and future risks. The authorities recognized that such projections would change over time. As targets were missed, therefore, the supervisors worked with banks to agree on a forward-looking and enhanced restructuring plan.

Third, based on the forward looking plans, supervisors identified possible gaps, where additional capital will be needed, and whether such capital is likely to be forthcoming. Banks unable to prepare acceptable plans or banks unable to implement their plans were considered nonviable and were resolved. The viability of other banks may take some time to determine as the restructuring plans are implemented.

Determining levels of forbearance

Recapitalizing banks in the midst of a systemic crisis was challenging. Asset prices were unknown, equity markets are closed, and options for private investors were limited. Asian banks faced sharply deteriorated loan portfolios. Indonesia in particular, faced a banking system that was severely undercapitalized with a significant number of major banks formally insolvent. Turkish banks carried significant amounts of “duty losses” arising from NPLs on directed lending operations, many Russian banks were highly exposed to the defaulted GKOs and Argentina bank carried losses arising from the asymmetric pesification of the

Table 3: Resolution Phase‐‐Selected Systemic Crises

Finland Norway Sweden Thailand Indonesia Korea Malaysia Russia Argentina Turkey

Forbearance Y Y N Y Y Y Y Y Y YInvolvent banks operational N N N N Y Y N Y Y NEasing prudential regulations Y Y N Y Y N Y Y Y Y

Bank restructuring Bank closures

Bank closures (Y/N) N Y N Y Y Y N Y N YBanks closed or liquidated 0 2 0 1 66 22 0 399 0 12

Other FI closures (Y/N) N N Y N Y N N NWhere shareholders protecdted? Y N Y N N N N  N

Nationalizations Y Y Y Y Y Y Y Y Y YMergers Y Y Y Y Y Y Y Y N Y

Did private investers inject capital? N Y Y Y Y YSales to foreigners Y Y Y N N N Y

Banks sold to foreigners (5 years) 3 8 0 0 0 2Bank restructuring agency Y Y Y Y Y Y Y Y Y NAsset management company Y N Y Y Y Y Y Y N Y

10

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dbank shareholders and fp

Ubut the type of forbearacountries would not havSupervisors in all countries excepmmto continue to operate. Such fperiod of timm

Fprudential normshowing how quickly thmtemdifficult negotiation between banks and the superviscapital for equity investmintensive reporting and monitoring. Ifwith themand resolved. Banks operating under p

Developing restructurin

Orestructuring agency, began developing bank-by-banksave all banks but to leave a privatized, effeca

ollarized portfolios. 5 Addressing such losses immediately posed insurmountable challenges for or the authorities. The supervisory authorities were forced to consider the

rovision of limited regulatory forbearance to prevent the collapse of the entire system.

nder such conditions, most countries offered some form of formal, monitored forbearance nce differed among countries. Most banks in the systems of the crisis

e been able to raise adequate capital to recapitalize fully their banks. t Sweden , therefore, eased prudential regulations, effectively

asking capital losses (Table 3). The authorities in Indonesia, Korea, Russia, and Argentina ade such forbearance explicit by permitting severely undercapitalized or even insolvent banks

ormal forbearance was typically permitted for only a specified e and was designed to give banks time to rebuild their business and adapt to the new

acroeconomic reality.

orbearance came with specific requirements for banks. All banks not meeting the original s were required to agree with the supervisors on time-bound restructuring plans,

ey will become profitable and how they will maintain solvency over the edium term. Such plans called for gradual implementation of loan loss provisions or a

porary acceptance of reduced capital ratios.6 The resulting recapitalization timetable was a ors as there was often a very limited pool of

ent and nonexistent capital markets. Such plans were subject to banks are not able to present such plans, fail to comply

, or if the bank became insolvent after agreeing on a program, the bank was intervened such plans were generally required to suspend dividend and

rofit distributions until the required level of capital has been restored.

g strategies

nce the diagnosis was completed, the supervisors, or often a newly created bank strategies. The objective was not to

tive, and profitable banking system. Countries used range of restructuring options including:

P&A transactions where deposits and assets were purchased by a solvent, private bank.

5 Turkish banks had carried losses accumulated over a long period of time from directed lending that the government had promised to cover (duty losses). On the eve of the 2002 crisis, those losses represented a significant portion of banks’ portfolios. In Argentina, the authorities had converted dollar assets at a lower exchange rate than dollar liabilities, technically resulting in wide spread insolvencies. 6 The former method was used in Thailand, the latter in Indonesia and Korea.

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Merger with an existing bank that was strong enough to absorb the failed bank.

Sales of the bank, sometimes often to foreign interests

Nationalization, through either direct takeover of the failed institution or use of a bridge bank (or de novo bank).7

Most countries reviewed used a combination of tools. Often significant government intervention in the banking system was required at an early stage (Table 4). The countries used a variety of tools to restructure their financial systems.

All countries nationalized some banks, at least temporarily. Turkey nationalized the largest number (18) with on average countries nationalizing approximately 5. Those nationalized banks were ones considered too big to close or that played a significant role in the payments system but where shareholders were unable to recapitalize their bank. But not all nationalized banks remained in state hands. Many passed to the private sector through subsequent mergers or sales. Only about half of the countries samples retained nationalized banks in their systems.

An important resolution tool was either purchase and assumption transaction or mergers.8

All countries except Indonesia, and Russia relied on this technique. Failing banks were intervened and closed, with performing assets and liabilities sold to operating banks, or such banks were merged in full. Sales to other solvent banks were a source of capital and expertise.

While domestic capital was in sort supply, sales of banks to foreign investors was a difficult political choice. Only three countries (Thailand, Korea, and Turkey) sold banks to foreign investors.9

7 For a bridge bank, the original bank is closed and liquidated and all assets and liabilities are transferred to a newly established bank temporarily under the control of the government but with a plan for rapid sales. 8 In a purchase and assumption transaction, the failed bank is closed and performing assets plus relevant liabilities are purchased by an on-going institution. 9 Some countries found it difficult to sell banks to foreign investors but, in the long run, opening the financial system to such investors increased available capital and introduced specialized expertise.

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Table 4 : Use of Restructuring Tools

Country Total Mergers/sales Nationalized P&A Closed

Argentina 11 4 5 2

Finland 172 44 128

Indonesia 73 4 69

Korea 33 12 2 5 14

Malaysia 50 50

Philippines 26 26

Russia 158 6 152

Sweden 1 1

Thailand 74 16 2 56

Turkey 34 12 18 4

The restructuring of the banking system and the development of bank-by-banks strategies was technically challenging and most countries opted to create a special bank restructuring agency. Most counties established a new bank restructuring agency in the midst of the crisis to handle to large tasks of bank restructuring. The one exception was Turkey, which had recently established a broad based deposit insurance fund responsible for bank restructuring and resolution. These agencies drew on staff from the supervisors and the central bank. They were responsible for developing the bank strategies, monitoring their implementation, and modifying plans as needed.

As containment policies were successful and depositor confidence stabilized, the authorities began to close and liquidate nonviable institutions. With deposits were guaranteed, the closure of any single institution would not undermine confidence in the system. The intervention and liquidation of insolvent banks reduced the size of the banking system by a significant amount. There are two measures: the number of institutions (representing the effort of the authorities) and the reduction in total assets of the system.

Finland, Indonesia, Korea and Turkey underwent the sharpest consolidation in the number of institutions closed and liquidated, with the number of banks falling by 30-35 percent over a three year period (see table 3). The other systems underwent reductions of around 6-10 percent of the number of institutions.

As a percent of banking assets, banking systems fell by between 1-2 percent (Norway and Thailand), with the banking systems in Turkey and Korea falling by around 10 percent

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and a 13 percent reduction in the Indonesian banking system). This pattern suggests that the bulk of the consolidation focused on small and medium sized banks.

E. RECAPITALIZATION WITH PUBLIC RESOURCES

Every country in the sample except for Russia provided government supported recapitalization programs. Such programs were needed even when shareholders were both fit and proper and willing to support their institution. In the midst of a crisis, equity investments are in short supply and the government felt it appropriate to provide financial support under very strict conditions and limitations (Table 5).

The public recapitalization programs in the countries were broadly similar. The authorities required shareholders to support their institution or be disenfranchised. Even if unable to recapitalize fully their banks, some contributed was required. Public support was given through the injection of government bonds. About half the programs received Tier I capital (at times without voting rights) while the other half of the countries received tier II capital or preferred, nonvoting shares. Those receiving Tier II capital preferred to limit the extent of direct government involvement in the ownership of the institution.

Conditions were normally put on the use of public funds. The authorities were willing to use public resources to support financial stability but needed commitments ensuring that the investments would not be misused and that the funds would be recovered. Programs injection Tier II capital, for example, typically included conversion clauses that transformed the Tier II capital to Tier I capital with full voting rights if the bank’s financial conditions failed to improve or of targets were missed. Public recapitalization programs in Asia and Turkey imposed such conditions on bank activities. Examples of safeguards used in Turkey are provided in Box 2.

Total costs of these programs were substantial. One of the defining characteristics of the countries under consideration was the low levels of public debt. This allowed countries to support the recapitalization of their banking system, in expectation that they would generate adequate returns over the medium run. Total fiscal expenditures, as a percent of GDP, were significant, reflecting the poor initial conditions in the banking system and the costs of rebuilding solvent institutions. Indonesia had the highest costs—almost 40 percent of GDP—followed by Turkey (24 percent), Korea (19 percent), Thailand (18 percent) and Malaysia (16 percent.) After taking into consideration recoveries and sales proceeds, the Nordic countries broke ever or even made a small profit on their banking crises.

Recapitalization (Y/N) Y Y Y Y Y Y Y N N Y YRecap measures

Cash Y Y Government bonds Y Y Y Y YSubordinated debt Y Y Y YPreferred shares Y Y Y Ordinary shares Y Y Y

Recap level (%) 8.0% 8.5% 4.0% 9.0% 8.0%Recap cost to government ( % GDP) 8.6% 2.6% 1.9% 18.8% 37.3% 19.3% 16.4% 0.2% 9.6% 24.5%Recap cost to government (net) (% GDP) 6.9% 0.6% 1.5% 18.8% 37.3% 15.8% 5.1% 0.2% 9.6% 24.5%

Were losses imposed on depositors? N N N N N N N N Y N N

Fiscal cost net (%GDP) 11.1% 0.6% 0.2% 34.8% 52.3% 23.2% 5.1% 13.2% 6.0% 9.6% 30.7%Gross 12.8% 2.7% 3.6% 43.8% 56.8% 31.2% 16.4% 13.2% 6.0% 9.6% 32.0%Recovery during period t to t+5, where t irst y he criis the f1.7% ear of t2.1% sis3.4% 9.0% 4.6% 8.0% 11.3% 0.0% 0.0% 0.0% 1.3%

Output loss Output loss (3 years) 50.9% 1.2% 14.9% 19.9% 10.0% 0.0% 0.0% 0.0% 0.0% 43.3% 16.3%

TurkeyArgentinaRussiaPhilippinesMalaysiaKoreaIndonesia

Table 5: Public Recapitalization 

Thailand

15

SwedenNorwayFinland

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Treach and the complex nature previous section were largely ccrisis, on the other hand, had a global scope. Macountries were deeply affectedinstitutions affected by the crisa

Tcrises but dobjective was to contain the emprices and prestructuring and operational bank restructuring—weforcing loss recognition and divestemincluding modifications in accouninjection of public fundsr

Timposition of losses on creditoinstitution, its failure andconfidence.significant losses. This concern unsettled mruns. The authorities immd

A.

Acountries but the aimauthorfacilities expanded the role ofprovided support to directly banks. The U.K. aup

Tcrisliquidf

II. POLICY RESPONSE TO THE CURRENT GLOBAL CRISIS

he recent round of systemic crises, which began in mid-2008, was unusual in its global of affected institutions. The systemic crises discussed in the

onstrained to single countries, with little contagion. The current ture economies including the US and European

and the impact spread across the globe. In addition, financial is were large, complex and often global in nature. The regulatory

nd resolution regimes for such type of firms were largely undeveloped.

he public policy responses to the crisis had similar elements used in previous systemic iffered in both scope and implementation. As in past crises, the immediate policy

erging crisis. Efforts focused on limiting the collapse of asset rotecting institutions. The subsequent phases of crisis management—balance sheet

re less forcefully implemented. Rather than ment of original shareholders, current policies put more

phasis on supporting existing institutions. A range of policy interventions were used, ting and valuation rules to maintain reported capital and

. Comprehensive diagnosis of bank viability and operational estructuring, however, were limited.

he crisis was triggered by the failure of Lehman Brothers in September 2008 and the rs. Although Lehman Brothers was a nonbank financial

subsequent imposition of losses on creditors undermined market Market participants came to worry that creditors of large global banks also faced

arkets and raised the threat of wide-spread creditor ediately sought to dispel such concerns, providing liquidity, protecting

epositors, and stabilizing institutions through capital injections.

LIQUIDITY POLICIES

s in the past, the immediate response was to provide liquidity. The methods differed across was to ensure that banks could meet their liquidity needs. The U.S.

ities introduced a large number of facilities targeting different markets (Box 3). Some the Federal Reserve in supporting asset markets and others

thorities induced wide range support facilities roviding both liquidity and capital support (Box 4).

he extent of this liquidity support was unprecedented. Reflecting the complex nature of the is, the globalization of finance and the complex nature of firms, the U.S. authorities provided

ity support to both bank and nonbank institutions and allowed access to its liquidity acilities to both US and non-US institutions. Facilities were put in place to support money

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markets, funding sources to banks dependent on a collapsing securities market, and support nonbank financial institution and even, in some cases, private enterprises.

This broad provision of liquidity did stabilize markets. By the end of 2008 and the beginning of 2009, the focus had shifted from liquidity position of banks to the solvency of banks. Concerns crystallized about the long term value of structured products either held on banks’ portfolios or held in off balance sheet accounts. With the concerns about liquidity ebbing, concerns about solvency and medium-term viability led to measures to protect bank creditors.

B. STABILIZING CREDITOR EXPECTATIONS

Containment efforts were more diffuse than in past systemic crises. Rather than offer blanket guarantees protecting all creditors, countries adopted selective guarantees that targeted those markets under stress. As the loss of confidence centered on structured products rather than the loan portfolio, central banks adopted measures to ease counterparty risk and make direct asset purchases and other unconventional quantitative interventions. Authorities also moved to support asset prices through public sector guarantees. Specific banks were guaranteed and new debt issuances were guaranteed (Appendix Table 1).

Preemptive measures were also taken to stabilize depositor expectations. Instead of a 100 percent blanket guarantee, authorities enhanced deposit insurance coverage. Before the crisis, coverage levels in Europe averaged 1.4 times per capita GDP and, in Asia, averaged 2.2 times per capita GDP. However, there was a significant variation among countries. As the crisis spread, many countries believed that these levels were inadequate to stabilize depositor expectations. Almost 50 countries adopted some form of enhanced depositor protection.

The majority of countries opted to increase significantly coverage. Over 60 percent of countries opted to increase significantly protection levels while a smaller portion (40 percent) introduced or re-introduced full depositor guarantees (Table 6). The size of the increases varied significantly across countries, ranging from 75 percent to 400 percent, reflecting a variety of domestic considerations. As a result of these actions, coverage levels in Europe increased two times to 4.8 times per capita GDP while increases in Asia were considerably higher, rising to 26 times per capita GDP. This sharply higher level of coverage in Asia may reflect, in part, the regions experiences in the late 1990s, when blanket guarantees were adopted in many crisis countries.

Table 6: Coverage Levels

Coverage Ratio 1/ Old 2/ New Old New Europe 1.4 4.8 Albania 700 2,500 2.0 6.9 Austria 20 50 0.6 1.5

Belgium 20 100 0.6 3.2 Bulgaria 40 100 4.6 11.4 Croatia 100 400 1.3 5.3 Cyprus 20 100 0.9 4.7 Czech Republic 25 50 1.8 3.8

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Estonia 20 50 1.7 4.9 Finland 25 50 0.7 1.6 Germany 20 50 0.7 1.7 Greece 20 100 0.9 4.7 Hungary 6,000 13,668 2.3 5.3 Ireland 20 100 0.5 2.7 Latvia 20 50 2.0 6.0 Lithuania 22 100 2.3 12.5 Luxembourg … 100 … 1.3 Malta 20 100 1.4 7.3 Netherlands … 100 … 2.9 Poland 23 50 2.4 6.2 Portugal 25 100 1.6 6.5 Romania … 50 … 9.2 Russia 400 700 1.4 2.5 Spain 20 100 0.8 4.4 Sweden 25 50 0.7 1.6 Switzerland 30 100 0.4 1.4 Ukraine 50 150 2.4 7.6 United Kingdom 35 50 1.5 2.2 Asia/Pacific region 2.2 26.8 Australia … 1,000 … 17.4 Indonesia 100,000 2,000,000 4.6 82.5 Kazakhstan 700 5,000 0.7 4.8 New Zealand … 1,000 … 23.3 Philippines 250 500 3.0 6.0 Western Hemisphere United States 100 250 2.1 5.4 1/ Ratio of coverage level to per capita GDP. 2/ In thousands of national currencies.

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C. BANK RESTRUCTURING AND RECAPITALIZATION

In the current crisis, bank restructuring was largely achieved through capital injections without requiring either operational restructuring or bank diagnosis. Bank nationalization was infrequent and, rather, authorities opted to provide unconditional capital support and left shareholders and managers in full control of their institutions. It was argued that the complex financial structures of global institutions required expertise obtained over years of operational experienced. Where the institution was unviable, the authorities opted to merge the banks with other sound institutions. Bank failures Banking difficulties began in 2007, although there were few indications of an impending systemic crisis. In January 2007, the U.K. authorities nationalized Northern Rock, after almost six months of providing liquidity and seeking merger partners. Creditor confidence in Northern Rock has been undermined by its deteriorating mortgage portfolios and liquidity difficulties. In the United States, capital market disruptions and resulting funding pressures and the intervention and resolution of three major U.S. institutions: mergers were arranged for Countrywide an Bear Stearns and IndyMac, unable to find a merger partner, was closed with assets and liabilities transferred to a bridge bank

In the final months of 2008, the pace of bank intervention and resolution sharply accelerated. Triggered by the September failure of Lehman Brothers, market conditions sharply tightened for bank funding. In September, 10 large financial institutions required public intervention, followed by another 15 in October. Holding to the idea that the weaknesses of each institution were not part of a systemic collapse, authorities sought solutions on a bank-by-bank basis. In the last quarter of 2008:

The U.K. authorities provided liquidity and waived competition rules to arrange for the merger of HBOS with Lloyds and then nationalized Bradford and Bingley.

The U.S. authorities closed Lehman Brothers and Washington Mutual, arranged the sale of both Merrill Lynch and Wachovia, and took a significant ownership share of the insurance company AIG.

Luxembourg, Belgium, and the Netherlands split up and recapitalized the regional bank, Fortis.

Pressures continued in October with the collapse of the three Icelandic banks and capital support to three large U.K. banks (RBS, Lloyds, TSB) and six French banks.

Citi required a combination of guarantees and additional capital support from the United States.

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Recapitalization By early 2009, nine countries directly injected public funds into banks. Capital injections amounted to approximately US$500 billion with the United States injecting by far the largest amount—almost two-thirds of the total—followed by the United Kingdom (Table 7). These injections were not based on a comprehensive assessment of capital needs or on an assessment of the viability of the recipient financial institutions. Rather, they were triggered by a combination of funding needs, deteriorating market perceptions, and a desire to ensure that bank capital levels were considered adequate by markets to absorb future losses.

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Table 7: Capital Support for G20 1/

Total Total Percent (Sept. 08 - Feb '09) (Sept '08 - June '09) GDP 4/

Country US$ billion US$ billionArgentina 0.0 0.0Australia 0.0 0.0Brazil 0.0 0.0Canada 0.0 0.0China 19.2 19.2 0.18 France 17.0 39.9 1.48 Germany 26.6 55.7 1.64 India 0.0 0.0Indonesia 0.0 0.0Italy 0.0 0.0Japan 0.0 1.3 0.03 Mexico 0.0 0.0Netherlands 22.3 28.4 3.48 Russia 20.3 37.7 2.85 Saudi Arabia 2/ 2.7 0.0South Africa 0.0 0.0South Korea 2.3 3.1 0.39 Spain 0.0 0.0Turkey 0.0 0.0United Kingdom 52.6 60.5 2.59 United States 3/ 236.0 246.6 1.76 Total 399.0 492.4

Note: Average exchange rate from 10/08 - 06/09 is used.

1/ Amounts represent actual capital injected into banks from government and does not include capital committed and not yet reflected in banks' balance sheets. 2/ This amount represents direct lending and not a capital injection; therefore omitted in total amount for June. 3/ Includes asset guarantees issued by governments in form of capital.

4/ GDP derived from quarterly nominal WEO figures (China from CEIC).

These recapitalization requirements differed from those in past crises. Rather than providing shareholders time to meet capital requirements, banks were called on to capitalize fully and, in some cases, to exceed prudential capital requirements. Concerns about the market perception of bank strengths resulted in efforts to have the bank hold significant amounts of capital. In keeping with the emerging revision of Basel capital rules, banks’ capital was planned to increase at least to 10 percent of risk-weighted assets and, in the case of systemically important financial institutions, to 12.5 percent.

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As private investors were unable to raise needed funds, governments purchased preferred shares to boost capital. Governments became investors in banks rather than having a role in the direction of the restructuring process. This option reflected both the view that the original owners and management were better able to manage the banks as well as a concern the about market reaction should the government take ownership of complex, global institutions. (Table 8). 10 Direct ownership—the purchase of ordinary shares—was used in fewer than 10 percent of the cases (selected cases in Germany, the United Kingdom, and the United States). Less common were the provision of silent participations (Germany) and hybrid subordinated debt (France.)

Table 8. Forms of Capitalization 1/ Source: Government announcements and information on official websites.

Injection Amount Percent

Common 30.7 7.7

Preferred Shares 307.0 77.0

Subordinated Debt 13.2 3.3

Other/Unspecified 48.0 12.0

Total 399 100

1/ Exchange rates as of 2/23/09

The use of conditionality for capital support evolved over the crisis. Initially, few conditions were placed on banks receiving public resources. The authorities were reluctant to impose government-directed conditions in the belief that the situation in the banks would stabilize quickly and the market would respond negatively to government intervention in the operations of private banks. As the crisis evolved, public reaction to the extensive use of public resources became stronger. Concern about reduced lending activities of banks and the high levels of compensation paid to bank owners and managers raised domestic pressures. Gradually, capital

10 Preferred shares do not give the investor voting rights. If investors want to have a say in the operations of the institution, they need ordinary shares. Some public sector recapitalization programs initially inject convertible preferred shares that convert to ordinary shares under predetermined conditions.

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support plans came with a range of limitations. Unlike the more intrusive conditionality of past crises, conditions focused on limiting foreign lending and, to a lesser extent, on limiting dividend bonus payments (Table 9). Only one country, Italy, required the presentation of a restructuring plan.

Table 9. Conditions to Use Public Funds

Dividends Salary

Restrictions Lending Rules 1/

Code of Ethics

Board Membership

France √ √ √

Germany √ √ √

Italy √ √ √

Japan √

Netherlands √ √

Russia √

Saudi Arabia √

South Korea √

United Kingdom √ √ √ √

United States √ √ √

Source: Various government announcements and information on official websites.

1/ Governments have announced that funds be directed toward domestic economies to

Diagnosis and stress testing Programs to diagnose bank conditions and viability were limited and began only following capital injections. Rather than conducting a supervisory evaluation and diagnosis of bank viability, supervisors conducted more limited stress tests. In some cases, only a subset of bank portfolios was stressed. Both the United Kingdom and the United States conducted stress tests as conditions for participation in either the asset protection program (U.K.) or the capital assistance program (U.S.). But these tests were neither systemic nor comprehensive review of the viability of institutions receiving public support. The European Union has also announced its support of stress testing. Stress tests are a limited tool for crisis management. Supervisors frequently use stress tests to judge the robustness of the current portfolio. Such tests can identify vulnerabilities of the current

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portfolio to a shock. But stress tests do not provide much information about the medium term viability of a bank or about the robustness of a bank’s business model. Reliance on stress tests, therefore, may lead to misunderstand about the viability and robustness of the banking sector. Stress test results can also be market news. For that reason, differences existed in the rules concerning publication of results. Some countries conducted such stress tests as part of the regulatory and supervisory oversight and did not publish results. Others have opted to use the publication of stress test results to reinforce the view that the financial system is capable of absorbing predicted losses.

Systemically Important Financial Institutions

The current crisis crystallized concerns about the treatment of systemically important financial institutions (SIFIs.) Traditional option for bank resolution and resolution were known to be inadequate for globally important or systemically important institutions. The scope and global nature of this crisis has forced national authorities and international organizations to find means of dealing with them.

The Financial Stability Board has recently proposed a series of measures for the next global crisis. The “too-big-to-fail” problem could be addressed by an integrated set of policies that included:

A new international standard for reform of our national resolution regimes. These “Key Attributes of an Effective Resolution Regime” are in draft and will shortly be issued. They setg out the responsibilities, instruments and powers that all national resolution regimes should have to deal with such institutions.

SIFIs will be required to have their own resolvability assessments and for recovery and resolution planning. These plans will allow home and host authorities to prepare for crises.

SIFIs will have additional capital tro increase their loss absorption capacity.

SIFIs will be subject to more intensive supervision, including through stronger supervisory mandates, resources and powers, data aggregation capabilities, risk governance and internal controls.

National authorizes are also drafting their own rules. The United States, for example, passed the Dodd-Frank Act giving authority to U.S. supervisory institutions to intervene and resolve large financial conglomerates. Its objectives were to increase transparency, limit risk-taking by banks, and formalize supervisory agencies’ authority over all financial institutions, irrespective of size. The United Kingdom has also expanded and strengthened its resolution regimes.

While the problem posed by SIFIs is significant, the effectiveness of these policies remains unclear. The framework is still under development and the implementing rules and regulations are still to be written. The laws are complex and the financial institutions they are meant to

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address are global and equally complex. There will be a long period of time for regulations to be written and only then can the testing and evaluation be possible.

III. POLICY CHOICES AND LESSONS

The experiences of countries managing systemic crises point to an effective framework that can guide policy responses to a shock.. That framework involves ensuring that liquidity shortages do not worsen the crisis, removing incentives for creditor runs, and having an adequate tool kit for bank restructuring and resolution exists.

At the same time, crises can evolve in unpredictable ways, making early planning and rapid response essential. Many countries struggled at policy coordination in the early stages of a crisis. Getting a consensus about the use of liquidity support facilities and on the diagnosis and policy options was time consuming. Liquidity concerns were addressed by the central bank, creditor protection often as the responsibility of a broader policy group, and frequently, the responsibility for bank restructuring was diffuse. Strengthening the policy coordination framework before the crisis and preparing for the crisis made policy responses more effective. Specifically:

Having an agreed institutional setting for policy coordination in place before the crisis proved useful for policy coordination. In stable times such inter-agency groups generate consensus on emerging risks. In crisis times, the coordination group centralizes the diagnosis and helps generate a consensus on appropriate policy responses.

Crisis countries needed a variety of different resolution options. When a large number of banks are failing, a single resolution options is unlikely to be sufficient. Crisis management has been more effective and more efficient when countries had prepared in advance a range of resolution options. Such options are best supported by detailed manuals and procedures.

Testing alternative scenarios proved helpful. No crisis can be predicted but many of the fundamental issues can be identified and prepared in advance, include such issues as leadership responsibility, information sharing, criteria for selecting among different resolution options, policy views about the role of public resources, conditionality for public support can all be agreed on in advance of a crisis.

The importance of providing liquidity in a system crisis reaffirmed in the cases reviewed. While controversial in some quarters, provision of liquidity was seen by authorities as essential for managing the crisis. Such provision was provided extensively, far beyond the off-sited dictates of Bagehot. Similarly, reliance on “constructive ambiguity” may undermine stability.

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When institutions are uncertain of their ability to obtain liquidity in an increasingly illiquid market, preemptive runs will occur.

The usefulness of wide-spread creditor protection was confirmed. While blanket guarantees were far less common in the recent crisis, full depositor protection and creditor protection played a central role in stabilizing expectations, limiting contagion, and providing time for the authorities to develop and implement restructuring strategies.

Experiences from past crises suggest the usefulness of an early and comprehensive diagnosis of the financial conditions of banks. In the period 1992-2002, supervisory diagnosis had multiple benefits. It provided a guide for the use of public resources and provided a platform for intensive monitoring of the institution as it undertook operational reforms. In the current crisis, authorities opted for rapid disbursement of capital with little diagnosis. Stress tests were the principle diagnostic tool in the current crisis. However, stress tests have only limited applicability. They help evaluate the current portfolio but only provide limited insight into a bank’s viability. To be effective, stress tests should be complimented with simulations of banks’ core profitability and business model. Appropriate levels of capital remain a debated topic. In past crises, banks were allowed to operate while undercapitalized if was an agreed, monitorable operational restructuring plan. This approach gave shareholders time to raise capital in weak markets. In the current crisis, shareholders were required to meet high levels of capital—often beyond historic prudential norms—to support market perceptions of stability. This requirement posed particularly difficult problems as the amount of public resources was limited. A policy issue going forward is whether the economic impact of the higher capital requirements on growth is offset by stronger market perceptions of financial sector stability. Operational restructuring is a critical part of crisis management. Systemic crises change relative prices, change the competitive nature of the economy, and can result in significant changes in cost structures. Banks must be able to thrive in the changed conditions. One option was the agreement among supervisors and shareholders on operational reforms, buttressed by a formal, time bound restructuring plan. Implementation of the plan is then monitored by the supervisors so that emerging performance gaps can be quickly addressed.

Recapitalization is typically required to ensure financial sector stability. Reliance on private capital—through shareholder recapitalization, mergers, or sales—is the preferred option. In some cases, however, there was a need for public resources. In past crises, public recapitalization came with strict restrictions. In the current crisis, however, such restrictions were late in coming and less binding. A concern, however, is that banks receiving unconditional support without effective oversight or limits may misuse public money, delay repaying the government, or follow inappropriately risky policies. Some conditionality, therefore, is appropriate. For example, authorities could require both a comprehensive diagnosis of the financial position of financial

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institutions, full loss recognition, and a forward-looking assessment of bank viability, including an assessment of the quality of bank assets.

The experience of the current crisis raises some questions about the best instruments to recapitalize a bank when using public funds. The recent reliance on preferred shares and Tier II capital improves capital ratios and does not require the government to take an ownership stake in the banks. By leaving the performance of the bank, however, authorities faced difficult decisions concerning the unconditional provision of public monies. Experience suggests that (i) some conditions should be imposed from the beginning and (ii) public shares can convert to Tier I capital if the bank fails to implement its restructuring plan or if the bank’s financial position sharply deteriorates.

These issues are complex and can take time to resolve putting a premium of policy preparation and coordination. Given the chaotic nature of crisis, the better prepared are the authorities, the more effective will be the policy response. The ability to intervene quickly can be key to limiting the cost of a crisis and returning the financial system to stability as quickly as possible.

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References

Basel Committee on Banking Supervision (2009): Report and recommendations of the Cross-border Bank Resolution Group – consultative document, September.

Beck, T, D Coyle, M Dewatripont, X Freixas and P Seabright (2010): Bailing out the banks: reconciling stability and competition, Centre for Economic Policy Research.

Borio, C (2008): “The financial turmoil of 2007–?: BIS Working Papers, no 251, March.

——— (2009): “Ten propositions about liquidity crises”, BIS Working Papers, no 293, November. Also available in CESifo Economic Studies.

Calomiris, C, D Klingebiel, and L Laeven (2005): “Financial crisis policies and resolution mechanisms: a taxonomy from cross-country experience”, Chapter 2 in P Honohan and L Laeven (eds), Systemic financial crises – containment and resolution.

Claessens, S, D Klingebiel and L Laeven (2005): “Crisis resolution, policies and institutions: empirical evidence”, Chapter 6 in P Honohan and L Laeven (eds), Systemic financial crises – containment and resolution.

Committee on the Global Financial System (2008): “Central bank operations in response to the financial turmoil”, CGFS Reports, no 31, July.

Honohan, P and L Laeven (eds) (2005): Systemic financial crises: containment and resolution, Cambridge University Press.

Hoelscher, D (ed) (2006): Bank Restructuring and Resolution, Great Britain: Palgrave Macmillan Press.

Hoelscher, D and S Ingves (2006): “The resolution of systemic banking system crises”, Chapter 1 in D Hoelscher (ed), Bank restructuring and resolution.

Hoelscher, D and Marc Quintyn (2003), Managing Systemic Banking Crises, Washington, International Monetary Fund

Hoggarth, G (2003): “Resolution of banking crises: a review”, Bank of England Financial Stability Review, December.

Huizinga, H and L Laeven (2009): “Accounting discretion of banks during a financial crisis”, CEPR Discussion Papers, no 7381.

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Appendix Table 1. Creditor Guarantees

Any change in deposit insurance

Wholesale borrowing guaranteed Both

Date of first guarantee

United States √ √ √ 3-Oct-08

Germany √ √ √ 6-Oct-08

Spain √ √ √ 7-Oct-08

United Kingdom √ √ √ 7-Oct-08

Netherlands √ √ √ 7-Oct-08

Australia √ √ √ 12-Oct-08

Italy √ /1 √ √ 13-Oct-08

Saudi Arabia √ √ √ 17-Oct-08

France √ 19-Oct-08

South Korea √ 19-Oct-08

Mexico √ 20-Oct-08

Russia √ √ √ 21-Oct-08

Canada √ 23-Oct-08

Indonesia √ 23-Oct-08

1/ Italy did not increase its deposit insurance limit or expand the coverage; however, the government will provide a "supplementary" guarantee meaning that if the private scheme is unable to cover all losses, the government will reimburse.

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Box 1. The Gradual Building of Banking Problems in Selected Crises Episodes

Finland 1992: Through the 80's Finland implemented a process of financial liberalization. The deregulation led to a rapid credit growth which at its peak in 1988 reached 30 percent y-y. Problems began as early as 1989 when intense surveillance started on Skopbank, a commercial bank that acted as a central bank for the savings banks. The bank had pursued an aggressive lending policy in the boom years. Problems continued surfacing until the crisis became full-blown in the summer of 1992.

Indonesia 1997: Following financial liberalization, the banking system grew rapidly with large conglomerates establishing their own bank. Fears about the quality of loans portfolios existed since the late 80's and early 90's and became evident with liquidity pressures at some banks in 1988, the incident with Bank Suma in the early 1990's (connected lending), and problems at state-owned banks (as early as 1994 large losses were found at BAPINDO) were left unaddressed. However, the crisis became full blown only after the Thai Baht devaluation. A first effort to address problems entailed closing 16 banks in November 97 (most with connected lending issues).

Norway 1991: The years before the mid-eighties were characterized by rapid acceleration in domestic credit. The sharp decline in oil prices in 1986 and the stock market crash in 1987 turned the page inducing significant losses in the banking sector and the economy. Several banks experienced severe problems in 1988 onwards and had to ask for public support. In the summer of 1988, Sunnmorsbanken (a medium-sized regional bank) was found to be heading towards insolvency. Problems at other banks, including the largest commercial banks continued surfacing until the crisis became full-blown in the fall of 1991.

Russia 1998: Throughout the 90's, lending to the private sector was sluggish and buying and selling Russian treasury bonds became the core business of some large banks. Following the Asian crisis, foreign investors who were highly attracted by the yields of GKO's began buying large amounts of FX future contracts from banks fearing a currency crisis in Russia. As a result, banks accumulated large FX risk. These vulnerabilities were exacerbated by weaknesses in accounting standards, supervision, transparency, and corruption. Banks experienced massive losses with the devaluation of the currency in August 1998.

Sweden 1992: Signs that the real estate market had reached its peak in the fall of 1989 triggered a substantial decline in the stock market. Around this period, one of the finance companies Nyckeln, with heavy exposure to real estate, found itself unable to roll over maturing its debt and the crisis spread to the whole market for commercial papers. The pressures also spread to other segments of money markets. In the next few months a number of other finance companies also went into bankruptcy. Credit losses were later identified at banks as well. The crisis reached systemic proportions in the Summer 1992.

Thailand 1997: Significant exposures to the real estate sector had developed throughout the nineties due to the lack of prudential limits on loan concentration. Concerns about asset quality surfaced as early as 1995, but provisioning remained low. Symptoms of distress became evident in March 1997 when a number of finance companies were suspended and others began requesting liquidity support. The crisis became fully blown in July 1997 when a currency meltdown took place.

Turkey 2000: 8 banks taken over in 1997-1999, but no significant restructuring was implemented. Furthermore, unregularized losses at state-owned banks were large already in 1999, estimated at 12 percent of GNP. Some more private banks were taken over by the SDIF in Oct-00, increasing tension about stability of the banking system. Through out this period, banks built up large exposures to interest rate risk (state banks) and exchange rate risk (private banks). The crisis became fully systemic when a large bank cut its credit lines to a few smaller banks in November 2000. They were heavily dependent on overnight funds and reacted by liquidating public securities which triggered a downward spiral in prices of government securities causing large losses at state-owned banks. Pressures continue until the currency depreciated substantially hitting private banks.

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Box 2. Elements of the Public Recapitalization Program in Turkey

Public sector recapitalization programs must be designed in light of specific circumstances and government policies. Not all programs will be alike. The availability of shareholder resources, the extent of recapitalization needed, and the legal structure will all affect program design.

In 2001, Turkey initiated a public sector recapilization program with the following criteria and conditions:

Last resort. A public solvency support scheme should be viewed as a last option when there are no other alternatives available.

Private participation. For a bank to be eligible for public support, existing shareholders or new private investors must be willing to inject at least half of the Tier 1 capital needed.

Operational restructuring. To qualify for support, banks must present an acceptable operational restructuring plan, including measures to strengthen internal control, risk management, increase revenues, and cut costs and to deal with NPLs.

No bailout of existing shareholders. Capital needs in banks must be thoroughly assessed and all losses imposed on existing shareholders before public funds are injected. The assessment of capital needs should be verified by a third party. Preferably, the shares held by the government should have preferred status to shares held by the old shareholders. Thus, if there are additional losses over a given period of time, say six months, those losses should be absorbed by the old shareholders.

Positive net worth. To be eligible for support a bank must have a positive net worth. If not, existing owners or new private investors must bring the capital adequacy ratio (CAR) to above zero before a bank would be eligible for public support.

Shareholders’ rights. The government should have the right to appoint at least one board member irrespective of its capital contribution. Such board member(s), who should have documented experience in banking, should have veto powers on matters material to the soundness of the bank.

Price. The government should pay net book value for the shares.

Buy backs. When the government wants to sell its shares, existing shareholders should have the right of first refusal for a given period, say two years. The price should be whichever is highest of (a) the government’s investment cost (principal and interest); (b) net book value; and (c) market price (including third party offers).

Pledge. To protect the public investment, majority shareholders in the bank should be required to pledge as collateral to the government shares held in the bank equal to the government’s capital contribution. The shares will be used as collateral in the event the government faces losses when it sells its shares in the bank.

Payment. The government should pay for the shares in tradable government bonds issued on market terms.

Convertibility. If the government provides Tier 2 capital, it should automatically be converted into Tier 1 capital if the CAR falls below a certain ratio, say 8 percent, and the private shareholders do not immediately bring it up to above 8 percent.

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Box 3 : US 2008 Containment Measures Deposit Insurance/Creditor Protection Asset purchase/Liquidity Provision

March 2008 A securities lending program TSLF (Term Securities Lending Facility). It will lend

up to 200bln to primary dealers secured for 28 days. A lending program to provide credit to brokers the PDCF (Primary Dealers Credit

Facility). Extended to January 2009. September 2008

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) broadened and the collateral for the Term Securities Lending Facility (TSLF) expanded.

Federal Reserve Board, with support of the Treasury Department, authorizes the $85 billion loan to the American International Group (AIG)

Full guarantee for all eligible, publicly traded money market mutual funds. Guarantee fee paid by funds; losses up to $50 billion guaranteed by assets of Exchange Stabilization Fund. Effective for one year.

The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) established, to provide funding to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds under certain conditions.

The Open Market Trading Desk (Desk) began purchasing short-term debt obligations issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks in the secondary market.

October 2008 Deposit insurance coverage increased from US$ 100,000 to 250,000 for all deposits; effective till December 31, 2009.

Emergency Economic Stabilization Act of 2008 (TARP) signed, enabling Treasury to purchase troubled assets from financial institutions. $700 billion allocated.

A liquidity backstop facility for U.S. issuers of commercial paper (Commercial Paper Funding Facility (CPFF) established, which will purchase three-month unsecured and asset-backed dollar denominated commercial paper directly from high quality eligible issuers.

FDIC guarantees (unlimited) non-interest bearing accounts (typically used by small businesses such as payroll processing accounts) and all senior unsecured debt issued by banks before June 30, 2009.

Will use 250 bn of TARP funds to take capital stakes through Capital Purchase Program via senior preferred, non-voting shares (Tier I) in qualifying financial institution (QFI). Nine major US banks (Citigroup, Bank of America, Goldman Sachs, Wells Fargo, J P Morgan, Morgan Stanley, Merrill Lynch, State Street, and Bank of New York Mellon) have signed up to date. Program will be associated with stringent executive compensation rules. Dividends will be restricted.

A program -- Money Market Investor Funding Facility (MMIFF)—to support a private-sector initiative initiated to provide liquidity to U.S. money market investors.

November 2008 Treasury Secretary announced that the plan to purchase ‘toxic assets’ had been

dropped and instead TARP funds would be used for direct equity purchases in banks. The $200 billion Term Asset-Backed Securities Loan Facility (TALF) created to

help market participants meet the credit needs of households and small. December 2008

The government will invest $6 billion to support GMAC, the auto financing giant.

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Box 4 : UK 2008 Containment Measures

Deposit Insurance/Creditor Protection Asset purchase/Liquidity Provision April 2008

Bank of England announces plan to swap banks' risky mortgage assets for at least 50 billion pounds of government debt -- the so-called Special Liquidity Scheme

October 2008 DI increased for all deposits from £2,000 (@ 100%) and £35,000 (@ 90%) to £50,000 @ 100%.

Debt guarantee – Government guarantees short to medium term debt issuance (up to 36 months) to meet maturing funding needs (estimated to be around 250 bn. pounds) for eligible institutions that are able to raise appropriate amounts of Tier I capital.

The government is to make £500bn available to UK banks and building societies for recapitalization. Bank debt that is guaranteed under the Government's guarantee scheme will be eligible in all of the Bank's extended-collateral operations. Recapitalization assistance – 8 banks commit to raise 25 bn (aggregate) of Tier 1 capital by year end, and govt stands ready to underwrite this amount if needed through subscription to preferred stock.

UK government will guarantee about 250 billion pounds ($439 billion) in short- and medium-term borrowing by banks. £200 bn will be made available from the Bank of England. It will also guarantee borrowing in Sterling, Euros, and US dollars.

Bank of England ready to lend banks at least 200 billion pounds ($351 billion) via auctions to make sure banks have enough cash to operate.

November 2008 The Government’s investments will be managed on a

commercial basis by a new arm’s-length company, ‘UK Financial Investments Limited’ (UKFI), which is wholly owned by the Government. UKFI will work to ensure management incentives for banks in which it has shareholdings are based on maximizing long-term value and restricting the potential for rewarding failure. It will also oversee the conditions of the recapitalization fund.