Volume II - PDF - International Association of Deposit Insurers

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•BACKGROUND DOCUMENTS• Part I: Research Discussion Papers Resolution of Failed Institutions Abstract: The timely and effective resolution of failed insured institutions is an important element in financial safety-net arrangements. Different exit strategies for such institutions may have considerably different cost implications for the deposit insurer and implications for other safety-net participants, the government, public, banking industry, and economy. Cooperation among the various safety-net participants, both before and after failure, is essential if timely and effective resolutions of failed institutions, particularly large insured institutions, are to be accomplished. This paper was prepared in response to requests from representatives of numerous countries that participated in the Working Group’s outreach programs. The purpose of the paper is to describe the main issues relating to the resolution of troubled institutions. The paper is not concerned with any questions relating to where in the financial safety net the authority for resolutions should reside. The responsibilities of deposit insurers for various aspects of resolution activity are likely to be country-specific, reflecting their particular mandates. However, regardless of the specific responsibilities of the deposit insurer in any particular country, the manner in which troubled institutions are resolved can have a major effect on the funding requirements and other aspects of the deposit insurer’s operations. 107 Guidance for Developing Effective Deposit Insurance Systems: Volume II
•BACKGROUND DOCUMENTS• Part I: Research The timely and effective resolution of failed insured institutions is an important element in financial safety-net arrangements. Different exit strategies for such institutions may have considerably different cost implications for the deposit insurer and implications for other safety-net participants, the government, public, banking industry, and economy. Cooperation among the various safetynet participants, both before and after failure, is essential if timely and effective resolutions of failed institutions, particularly large institutions, are to be accomplished. This paper was prepared in response to requests from representatives of numerous countries that participated in the Working Group’s outreach programs. 1 The purpose of the paper is to describe the main issues relating to the resolution of troubled institutions. The paper is not concerned with any questions relating to where in the financial safety net the authority for resolutions should reside. The responsibilities of deposit insurers for various aspects of resolution activity are likely to be countryspecific, reflecting their particular mandates. 2 However, regardless of the specific responsibilities of the deposit insurer in any particular country, the manner in which troubled institutions are resolved can have a major effect on the funding requirements and other aspects of the deposit insurer’s operations. Pre-Resolution Activity Before a troubled financial institution reaches the point where resolution is necessary, it generally has been the object of various efforts to strengthen its operations. Such actions may have included restructuring efforts that, in broad outline, are similar to resolution transactions, in that they involve a merger with, or acquisition by, a healthy institution. These efforts frequently are described as “private-sector” solutions and do not impose a cost on the deposit insurer or the government. Private-sector solutions Healthy institutions may be willing to combine with weaker ones in a number of situations. However, if financial inducements are required to attract an acquirer, such inducements in a private-sector transaction generally result from concessions made by creditors or owners of the troubled institution, rather than from outlays by the deposit insurer. As a result, successful private-sector solutions may be viewed essentially as “no-cost resolutions” from the standpoint of the deposit insurer. Owners and creditors of a troubled institution often have strong incentives to accomplish a merger or acquisition, because their losses generally will be greater if the institution continues to deteriorate and fails. On the other hand, they may be slow to acknowledge the seriousness of the institution’s condition and reluctant to yield control of the institution, or make the concessions necessary for it to be an attractive acquisition or merger partner for a healthy institution. Owners of troubled institutions may have little incentive to explore private-sector solutions unless they perceive that the authorities may close the institution if such solutions cannot be arranged. As a result, privatesector solutions cannot always be accomplished without the active participation of the relevant safety-net participants even though the deposit insurer bears no cost. The legal authority of the responsible safety-net participants differs among countries and, in some countries, limits their ability to play a role in private-sector solutions for troubled institutions. In other cases, the safety-net participants may bear significant legal exposure to creditors dissatisfied by the terms of the merger or acquisition. In some countries, owners of troubled institutions may have taken legal action against the resolution authority for closing an institution and officials of the authority faced personal liability. 3 Such a legal environment may have the effect of permitting troubled institutions to continue to operate for 108 Guidance for Developing Effective Deposit Insurance Systems: Volume II
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FINANCIAL STABILITY FORUM Guidance
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