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Financial Crisis Management

Systemic Risk Crises, a Paralysed Lender of Last Resort and Special Resolution Regimes

Essay 2011 17 Seiten

VWL - Finanzwissenschaft

Leseprobe

Contents

I. Introduction

II. The evolution and stages of the responses
Regime already in place - the ex ante measures:
1. Deposit Guarantee Schemes
2. Lender of last Resort (emergency loans)
Special Resolution Regime
Measures for the containment
The Liability Side Measures - ex post measure part one
3. Capital Injections
4. Debt Guarantees
The Asset Side Measures - ex post measure part two
5. Asset Purchasing
6. Asset Guaranteeing
Resolving of trouble institutions - ex post measure part three
7. Temporary Nationalisation & Restructuring
8. Bad banks and Good Banks
9. Insolvency

III. outlook

IV. Conclusion

V. References

VI. Annex

Figure 1: Recapitalisation Plans: Comparison of Key Terms

Figure 2: Guarantee Plans: Comparison of Key Plans

Figure 3 Timeline of government actions

I. INTRODUCTION

The recent financial crisis of 2007-2009 (the crisis) has been dramatised as the worst crisis since the great depression in the 1930s.1 Prompt regulatory response was required in order to contain the spread of fear and stop the mistrust with the ultimate goal to restore the confidence into the financial institutions2 and markets as well as prevent the collapse of the real economy.

Financial crises containment can be defined as the enhancement of “… soundness and stability of the banking …”3 which is essential to “…ensure legal certainty and to restore confidence in financial markets”4. Regulators have a whole set of tools to respond to crises, using an existing regime and or implementing a special resolution regime. Latter has a broad span reaching from capital injections to expropriation. Undoubtedly, the measures raise legal questions regarding their raison d’être and liability of those exercising the measures. Moreover, the measures have individual merits and demerits varying in respect of their costs and perspective of the market participants.

The purpose of this essay is to analyse these responses. Therefore, different measures will be identified and evaluated in light of the Economic and Financial Affairs Council’s common principles for action5 and the Commission Communication of State Aid6 which have been determined as representative guidelines for policy makers in drafting a response regime.

It will be concluded that there is no clear cut answer to which are the most successful measures; nevertheless, there is empirical evidence of which are the most favoured responses by regulators.

The measures will be in response to an acute crisis, ie the prevention and resolution of a crisis will not be treated in this essay. In addition, the responses will be limited to the European Union.

The next chapter is dived in 5 parts exploring mechanisms to contain financial crises. It represents a sequence that has been observed in the recent crisis in Europe. Chapter 3 gives an outlook. The last chapter concludes.

II. THE EVOLUTION AND STAGES OF THE RESPONSES

The containment measures listed in 1. to 9. follow in general this sequence. Authorities may also opt against certain measures. What can be concluded, however, is that authorities may first want to exhaust existing remedial mechanisms. If these are determined insufficient, authorities may create special resolution mechanisms, which in the first phase concentrate on the liability side of the balance sheet in order to stabilise the institution. During the second phase, they will concentrate on the asset side in order to restore the economic viability of the institution and hence the confidence in the overall financial market.

Regime already in place - the ex ante measures:

Regulators have already systems in place to deal with institutions that experience liquidity problems. Since those problems can cause contagious bank runs, also schemes are in place that can prevent such a fear from spreading. On an European level, the European Commission allowed also State Aid under Art 87(3)(c) EC Treaty standalone actions to rescue single institutions as done for Northern Rock7. The measures are explained under the Special Resolution Scheme. The measures in this chapter, Deposit Guarantee Schemes and Lender of Last Resort, can prevent crises and also contain calamities.

1. Deposit Guarantee Schemes

Various legal systems have adopted deposit guarantee schemes (DGS).8 The objective of DGSs is to prevent bank runs, ie is the withdrawal of deposits in fear of default of the bank9. Bank runs can be understood as self- fulfilling prophecy, since runs on previously unaffected banks can cause the bank to have liquidity and even solvency problems. The motivation for deposit insurance can be also seen as protection to protect depositors’ wealth.10

There are two types of deposit insurance, implicit and explicit deposit insurance. In the latter case, laws are passed that contain “…specific rules concerning the extent of the ‘insurance’ or protection, the operation of the scheme, and the type of deposits/depositors protected”.11 In case of default, depositors are paid once an institution is closed down.12 By evaluating the protection Lastra claims that it will be political accepted to liquidate banks that have solvency problems. In other words, DGSs are akin to an exit strategy for banks while eliminating negative externalities that may follow such a closure.

It should be noticed that many countries do not have such an explicit scheme, ie if at all an implicit scheme, since many scholars fear that this deposit insurance may encourage moral hazard - which is not a constrain un- der an implicit regime. Arguments against DGS, eg that unprotected depositors in a bank will monitor more actively as suggested by Cargill, Hutchison, and Ito13 as well as Imai, do not reflect the reality of uninformed depositors. Especially, since in bank runs we prevent panics which lack any rational support. Also, it is argued, inter alia, by Lastra that in “… the absence of open bank assistance, management will also be more inclined to run the institution in a prudent manner”.14 Nevertheless, if the payout entails that the institution has to be liquidated, this argument loses its grounds.

2. Lender of last Resort (emergency loans)

The classic role of the lender of last resort (LOLR) entails to unlimited lending for short period, given the bank is able to secure the borrowing with good collaterals. The purpose is to prevent liquidity distress to amount to a solvency problem. In other words, it has an explicit function; it provides ex ante confidence for investors in the protection of their investments. This should prevent bank runs without making an actual lending necessary. However, it is subject to the discretion of authorities, also known as constructive ambiguity, since assistance may also encourage moral hazard. In contrast the LOLR concept with deposit guarantee schemes, Lastra asserts that “…explicit deposit insurance protects mainly the depositors, [while] LOLR protects mainly the financial system (systemic considerations)”.15 The objective of the deposit guarantee scheme can be seen as means to achieve the same objective, stabilisation of the financial market. In favour of the LOLR speaks that this concept would inject money into the market which also favours the interbank lending system. From the regulators per- spective, the usage of the LOLR should be done in case the institution only experiences short term liquidity dif- ficulties, otherwise this mechanism is most likely to delay the process of liquidation by wasting governmental budget.

Special Resolution Regime

As the economic outlook worsened and was perpetuated after the Lehman Brother’s collapse on 15 September 2008, numerous attempts were done to respond to the crisis. Given the impact, wholesale solutions were re- quired, ie a special resolution regime. Concerns that such a regime may distort competition and may great un- reasonable expectations with future implications seemed in the current light inferior.16 The European Commis- sion responded with a Guidance on State Aid schemes17 which allowed countries the implement measures under Art 87(3)(b) EC Treaty, ie to “…remedy a serious disturbance in the economy…”. From a regulatory perspec- tive it means that “[extraordinary] times require extraordinary laws: on the one hand to cope with unforeseen problems, on the other, to demonstrate the state’s persistent capacity to act”.18 Anna Gelpern agrees, she claims financial crisis requires “extraordinary policy measures to stop the spread of untold economic damage, akin to containing a fire or infectious disease”.19 In these situations we often witness the suspension of existing rules to implement those measures, which are different from regular provisions and should thus be seen as “… distinct category of legal and policy choice”.20 She argues that is span is the short term immediate after the occurrence of a crisis which allows for the violation of rules “…dearth of positive law”21 leaving the long term implications unattended.22

[...]


1 J Hilsenrath, S Ng and D Paletta, ‘Worst Crisis Since `30s, With No End Yet in Sight’(18 September 2008) Wall Street Journal in E Gibson-Bolton and M Reiss, ‘Bank bailouts, state aid and the financial crisis’ (2009) 4 Corporate Rescue and Insolvency Journal 162

2 the terms bank, financial institution and institution will be used interchangeably

3 Communication from the Commission, ‘The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis’ (25.10.2008) C 270/2 Information from European Union Institutions and Bodies, Para (3) (EU Communication)

4 ibid Para (5)

5 Economic and Financial Affairs Council, (Luxembourg, 7 October 2008) 2894th Council meeting Press Release (Press Release)

6 EU Communication (n 4) Para 15

7 R A Tomasic, ‘The Rescue of Northern Rock: Nationalization in the Shadow of Insolvency’ (June, 19 2009)1(4) Corporate Rescue and Insolvency 109 <http://ssrn.com/abstract=1422571> accessed 20 April 2011

8 A Demirg, A Kunt and E Kane, ‘Deposit Insurance Around The Globe—Where Does it Work?’ (2001) NBER Working Paper < http://www.nber.org/papers/w8493> accessed 20 April 2011

9 reason is that pay-outs are made on a “first-come, first-served” bases which means that if the bank is close to default depositors who make their claim late may not get their savings

10 Press Release (n 5)

11 R M Lastra, Legal Foundations of International Monetary Stability (Oxford University Press 2006) 125

12 Ibid 125-6

13 TF Cargil, MM Huthcison, T Ito, ‘Deposit Guarantees and the Burst of the Japanese Bubble Economy’(1996) Contempory Economic Policy 14, at 41 et seqq., ibid note (39)

14 Lastra (n 11) 125

15 Lastra (n 11) 127

16 eg Gibson-Bolton (n 1)

17 European Comission, Summary of the Impact Assessment on Deposit Guarantee Schemes [recast] (Brussels, SEC 2010) Commission Staff Working Document (Impact Assessment)

18 KJ Hopt, C Kumpan and F Steffek, ‘PreventingBank Insolvencies in the Financial Crisis: The German Financial Market Stabilisation Acts’(December 2009)10(4) European Business Organization Law Review 515, 517

19 A Gelpern, Financial Crisis Containment (May 7, 2009) 41(4) Connecticut Law Review, 495 <http://ssrn.com/abstract=1401062> accessed 20 April 2011

20 Ibid 497

21 Ibid 497

22 Often disregarded are the sanctity of contracts and the liquidity- solvency distinction which are vital concepts the most jurisdictions.

Details

Seiten
17
Jahr
2011
ISBN (eBook)
9783640988396
ISBN (Buch)
9783640988389
Dateigröße
873 KB
Sprache
Englisch
Katalognummer
v177257
Institution / Hochschule
University of Warwick – School of Law
Note
Distinction
Schlagworte
financial crisis management systemic risk crises paralysed lender last resort special resolution regimes distinction

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Titel: Financial Crisis Management