Prospects for the utilization Part 1
Wednesday, April 14, 2010 18:19Prospects for the utilization of the emergency lending to insolvent banks in international financial relations
C. Giannini, employee research department of the Bank of Italy, examines the theoretical and practical aspects of the rescue of insolvent banks and examines the possibility of its use for resolving debt crises and maintain stability of global finance.
The rapid development since the beginning of XX century a system of bank reserves has forced the national financial authorities of many countries to think about the introduction of special measures, if not to prevent, then to overcome the financial turmoil. The crisis of 30-ies stimulated the creation of a complex regulatory system, including: special legislation to regulate banking activities and, above all matters of bankruptcy and liquidation of banks and watchdog bodies to reduce the risk of banking operations in part by restricting competition, the institution of “lender of last resort situation “(lender-of-last-resort), ie special financial institutions with sufficient resources and relevant public authority, which allows him to interfere in the activities of individual banks to avert a crisis. The task of such creditor – to give credit to solvent banks experiencing temporary difficulties with liquidity. Theoretically rescue operation must fulfill an educational function, so it creators assumed that the credits will be issued under the penalty rate and additional collateral. The most common “last lender” does not favor one bank, a consortium of banks, for rescue operations require a creditor has no significant assets or the ability to quickly mobilize in the event of a crisis. The practice of sharing credit, which arose in the United States under the clearing-houses (clearinghouse), showed the advantage of this system, because it can resolve the emergency situation through redeployment of existing reserves without attracting new ones. The modern organization of the rescue of troubled banks, in addition to technical subjects (in this role is usually the central bank), performing the operation includes country’s political leadership (government and / or legislative body), because very often it is not about saving a single bank, and the prevention of the collapse of the banking system in a series of bankruptcies. Such operations require huge financial investments, which are impossible to implement without the support of the government or legislators. By some estimates, the cost of operations to rescue the banking system, for example, in Finland, up to 8% of GNP of the country, in Sweden and Norway – 4% of GNP in the United States – 3%. Until recently, the most common form of organization of rescue operations was a joint loan problem banks by bank consortium. In some countries, for these purposes, special financial institutions. In Germany, for example, short-term liquidity problems are resolved from the Liquidite Consortium Bank, which co-sponsors were Bundesbank (30%) and a number of commercial banks. According to British researchers reviewed the operations to resolve the banking crises that occurred in the 80’s – early 90’s, from 104 cases in only two central banks (CB) have expressed their desire and are able to carry out rescue operation at its own expense . In some countries, like France, the Banking Act gives the Bank the right to enlist for rescue operations means other members of the banking system.
More recently, financial liberalization and increased competition among banks significantly limited the ability of the Central Bank to raise funds for lending to troubled banks. The state’s role in saving the banks for a long time remained limited due to strict financial management and low capital mobility. However, in the face of increased banking instability, owing to increased competition in financial markets and increased cross-border movement of capital, the importance of state intervention in the financial sector increases. If in the early 80’s, the number of credit transactions, financed jointly by a State and private banks, either from the state deposit insurance was roughly equal, whereas in the early 90-ies of state funds as a source of lending to insolvent banks were used in two times more often than any other financial sources. Explanation of this trend by not least associated with an increased scope of operations, as well as changes in policy priorities in favor of the Central Bank’s monetary management. Experience has shown that 30-ies, it is very difficult to distinguish between illiquidity and insolvency of the bank, and in times of crisis such differences may be made only after the fact. Moreover, the threat of escalating the crisis in forcing the collapse of the creditor-rescue make quick decisions based on incomplete and sometimes inaccurate information. Another lesson learned from the 30-ies – even bankruptcy clearly insolvent bank can often have the most negative social consequences. And even if ultimately one or the other bank was liquidated, the government first took action that, according to experts, were to mitigate the effects of this transaction to the financial system. In principle, the world practice knows no single recipe for saving the bankrupt bank. Much depends on the time and place of operation. However, there is a certain set of intervention strategies. The first provides a package of measures, including emergency assistance, or an infusion of new capital, ie, using the method of “lender of last resort situation” in its pure form. The second strategy is to establish control over the troubled bank by one or more banks. Often, such control is introduced after the financial injections from the state.
The third strategy involves the introduction of a special management of failed banks by deposit insurance agency or a special government body. In extreme circumstances the government may hold the nationalization of the bank or, if the crisis is systemic in nature, to nationalize the entire banking system. The fourth possibility of resolving the crisis – the elimination of the bank. Usually, this operation are either very small banks or banks that are in a hopeless situation. To carry out such operations in the banking law provides special rules. All of these strategies differ from each other primarily the degree of liability of shareholders and managers of banks for the mistakes. The presence of fault management by banks in the exacerbation of the crisis, as well as its degree, is determined either by the Central Bank (where they have a monitoring function), or special regulatory authorities. Supervision of banks can, if necessary to demand from them a more cautious policy, and also provides an opportunity for the financial difficulties more accurately assess the situation and take appropriate decisions. At the same time, the world practice knows the number of cases where the inadequacy of the findings of monitoring bodies leads to bad strategic decisions in respect of certain banks. In particular, this applies to the BCCI in the UK, Drexel Burnham Lambert in the United States, Banco Ambrosiano in Italy and Credit Lyonnais in France. The modern system of emergency lending is not an educational nature and does not provide for penalties. In most cases, loans to insolvent banks are provided on concessional terms. In some countries, such as Japan, the Law (1997), governing the TSB, the last allowed the banks to provide collateral-free basis of the additional liquidity if they are “due to accidental circumstances suddenly begin to experience a shortage of means of payment (Article 33 ), and the Ministry of Finance may ask the Bank to maintain liquidity assistance on special terms – in special cases where it is necessary for polderzhaniya about the entire financial system “(Article 38). Similar approaches are formulated and in the banking law adopted in Italy. In accordance with this law, which allows the Central Bank to provide troubled banks at subsidized interest loans, conducted rescue operations in the early 80-ies Banco Ambrosiano, and in the 90 – Banco di Napoli. Thus, the idea of punishment the guilty banks now a thing of the past. The reason is that penalties can only worsen the plight of the bank, as well as the possibility of negative influence of excessive rates on emergency loans for the capital market. In addition, many experts believe that the penalty interest on loans and the tightening of conditions for granting them does not necessarily contribute to a more cautious policy of troubled banks. Recently, however, increasingly the question is how to prevent the damage caused by abusive behavior bank, or at least reduce it. In particular, the report “Financial stability in emerging market economies” (1997), “a group of ten, said that in supporting financial institutions, governments need to avoid pre-negotiate the terms and timing of assistance. In addition, the report recommended that the authorities carefully analyze the performance of troubled banks in terms of its negative impact on the financial system and market discipline in order to apply to the offender as appropriate. Also during the crises of insolvency of sovereign states under conditions of free capital movements and deregulation of national financial markets indicated increased instability of world financial system. The creators of the Bretton Woods system deals with the financial instability as a national problem. Monitoring the movement of capital was a fundamental rule in the regulation of international financial relations. The Bretton Woods Agreement did not provide for the coordination of national surveillance for the Bank of cross-border movement of capital, and banned the IMF’s own resources to support the financial situation in individual countries in the event of a mass outflow of capital. He was not provided and the mechanism of emergency lending by international banks or individual countries. However, starting in the mid 60-ies as to reduce the effectiveness of capital controls in the restoration of convertibility of the U.S. government and Britain are trying to set up special mechanisms to maintain exchange rates of reserve currencies in case of sudden capital outflows.
