BANK CRISIS RESOLUTION AND FOREIGN-OWNED BANKS Robert E. Eisenbeis* and George G. Kaufman** * Director of Research, Federal Reserve Bank of Atlanta **Loyola University Chicago and Consultant, Federal Reserve Bank of Chicago

Motivation CROSS-BORDER EXPANSION IN BANKING IN THE FORM OF FOREIGN-OWNED BANKS IS GROWING RAPIDLY CROSS-BORDER EXPANSION IN BANKING IN THE FORM OF FOREIGN-OWNED BANKS IS GROWING RAPIDLY BUT BANK INSOLVENCIES ARE NOT NECESSARILY RESOLVED EFFICIENTLY AT LEAST COST TO THE ECONOMY BUT BANK INSOLVENCIES ARE NOT NECESSARILY RESOLVED EFFICIENTLY AT LEAST COST TO THE ECONOMY THEREFORE, HOW DO FOREIGN-OWNED BANKS AFFECT THE ABILITY OF HOST COUNTRIES TO RESOLVE INSOLVENCIES IN THESE BANKS EFFICIENTLY? THEREFORE, HOW DO FOREIGN-OWNED BANKS AFFECT THE ABILITY OF HOST COUNTRIES TO RESOLVE INSOLVENCIES IN THESE BANKS EFFICIENTLY? AND DOES THE MODE OF ENTRY – BRANCHES V SUBSIDIARIES AFFECT EFFICIENT PROBLEM RESOLUTION? AND DOES THE MODE OF ENTRY – BRANCHES V SUBSIDIARIES AFFECT EFFICIENT PROBLEM RESOLUTION?

Conclusions THE BRIGHT SIDE OF CROSS BORDER BANKING THE BRIGHT SIDE OF CROSS BORDER BANKING –EXPANSION IN CROSS-BORDER BANKING GENERALLY PRODUCES MAJOR ADVANTAGES »IMPROVED EFFICIENCY AND »STABILITY WHEN THINGS ARE GOING WELL THE DARK SIDE OF CROSS-BORDER BANKING THE DARK SIDE OF CROSS-BORDER BANKING –EXPANSION, PARTICULARLY THROUGH ESTABLISHMENT OF FOREIGN BRANCHES, MAY INCREASE GREATLY THE COSTS OF RESOLVING INSOLVENCIES

EFFICIENT BANK INSOLVENCY RESOLUTION EFFICIENT RESOLUTION = MINIMIZE LOSSES = CREDIT LOSSES & LIQUIDITY LOSSES EFFICIENT RESOLUTION = MINIMIZE LOSSES = CREDIT LOSSES & LIQUIDITY LOSSES PRINCIPLES PRINCIPLES –PROMPT LEGAL CLOSURE AT POSITIVE CAPITAL (MINIMIZE CREDIT LOSSES) –PROMPT ESTIMATES OF CREDIT LOSSES (RECOVERY VALUES) AND ASSIGN HAIRCUTS –PROMPT REOPENING OF LARGE BANKS (MINIMIZE LIQUIDITY LOSSES) –PROMPT REPRIVATIZATION AND RECAPITALIZATION

PROMPT LEGAL CLOSURE (MINIMIZE CREDIT LOSSES) OUST SHAREHOLDERS AND SENIOR MANAGEMENT OUST SHAREHOLDERS AND SENIOR MANAGEMENT SEPARATE BANK BANKRUPTCY CODE (FDIA) SEPARATE BANK BANKRUPTCY CODE (FDIA) –NOT BHCs PCA UNDER FDICIA (5 CAPITAL ZONES) USING MARKET- MIMICKING SANCTIONS/SPEED BUMPS PCA UNDER FDICIA (5 CAPITAL ZONES) USING MARKET- MIMICKING SANCTIONS/SPEED BUMPS –DISCRETIONARY –MANDATORY BRIGHT LINE CLOSURE RULE (MINIMUM 2% EQUITY ÷ TOTAL ASSETS) BRIGHT LINE CLOSURE RULE (MINIMUM 2% EQUITY ÷ TOTAL ASSETS) –PRESPECIFIED –WELL PUBLICIZED –LOSSES PRIMARILY TO SHAREHOLDERS MINIMIZE PROBABILITY OF RUNS MINIMIZE PROBABILITY OF RUNS

PROMPT ESTIMATE AND ALLOCATION OF CREDIT LOSSES REGULATORS PREPARED UNDER PCA REGULATORS PREPARED UNDER PCA AVOID TBTF/SRE AVOID TBTF/SRE REQUIRED LOSS SHARING STRENGTHENS MARKET DISCIPLINE REQUIRED LOSS SHARING STRENGTHENS MARKET DISCIPLINE

PROMPT REOPENING (MINIMIZE LIQUIDITY LOSSES) NO PHYSICAL CLOSURE NO PHYSICAL CLOSURE INSURED DEPOSITORS ACCESS TO PAR VALUE INSURED DEPOSITORS ACCESS TO PAR VALUE UNINSURED DEPOSITORS ACCESS TO ESTIMATED RECOVERY VALUE UNINSURED DEPOSITORS ACCESS TO ESTIMATED RECOVERY VALUE –ADVANCE DIVIDENDS BORROWERS ACCESS TO CREDIT LINES BORROWERS ACCESS TO CREDIT LINES BRIDGE BANKS BRIDGE BANKS CAN AVOID TBTF/SRE CAN AVOID TBTF/SRE

PROMPT REPRIVITIZATION AND RECAPITALIZATION REGULATORS PREPARED UNDER PCA REGULATORS PREPARED UNDER PCA LEAST – COST RESOLUTION LEAST – COST RESOLUTION GOVERNMENT – OWNED/OPERATED BANKS NOT EFFICIENT GOVERNMENT – OWNED/OPERATED BANKS NOT EFFICIENT REQUIRE MINIMUM ADEQUATELY – CAPITALIZED STATUS REQUIRE MINIMUM ADEQUATELY – CAPITALIZED STATUS

PROBLEMS IN EFFICIENT RESOLUTION INTRODUCED BY FOREIGN-OWNED BANKS (DARK SIDE OF DIRECT CROSS-BORDER BANKING) PROMPT LEGAL CLOSURE PROMPT LEGAL CLOSURE –DATA LESS MEANINGFUL –CLOSURE DECISION FOR BRANCHES BY HOME COUNTRY »DIFFERENT CLOSURE AND ENFORCEMENT RULES IN DIFFERENT COUNTRIES »HOME COUNTRY REGULATORS CONFLICTED –HOST COUNTRIES PROBLEMS WITH SUBSIDIARIES

Table 3 POSSIBLE DEPOSIT INSURANCE SYSTEMS DIFFERENCES IN DIFFERENT COUNTRIES Account coverage Account coverage –Maximum amount –Type of account, e.g., interbank –Foreign currency deposits –Coinsurance Ownership Ownership – Private vs. public (government) Funding (premiums) Funding (premiums) –Ex-ante vs. ex-post –Magnitude –Risk-based vs. flat –Regular vs. topping up Reserve fund Reserve fund – Minimum magnitude – Voluntary or required Government support Government support –Explicit (official) vs. implicit –Credibility of private funding (premiums) Speed of payment if insolvency Speed of payment if insolvency –Insured depositors - to par value –Uninsured depositors - to market (recovery) value – Advance dividends vs. as assets sold Claim filed –Automatically – By claimant Pre-insolvency intervention – Prompt correction action (PCA) Declaration of insolvency – Private creditors or government agency – Insurance agency vs. other – Closure rule vs. discretion (forbearance) Insolvency resolution –Administered by insurance agency, other agencies, or bankruptcy court –Least cost resolution (LCR) – Insurer serves as receiver/conservator – Too big to fail Membership – Mandatory or voluntary Other –Coinsurance –Offsetting

PROBLEMS IN EFFICIENT RESOLUTION (cont) PROMPT ESTIMATES OF LOSSES PROMPT ESTIMATES OF LOSSES –DIFFICULT FOR BRANCHES –DIFFICULTIES FOR SUBSIDIARIES PROMPT REOPENING PROMPT REOPENING –BRANCHES BY HOME COUNTRY –DIFFERENT DEPOSIT INSURANCE PAYMENT AND RESOLUTION TIMING SCHEMES –HOME COUNTRY CONFLICTS –CROSS-BORDER INSURANCE PAYMENTS –SUBSIDIARIES EASIER –FUNCTIONALITY

PROBLEMS IN EFFICIENT RESOLUTION (cont) PROMPT REPRIVITIZATION AND RECAPITALIZATION PROMPT REPRIVITIZATION AND RECAPITALIZATION –GREATER NEGATIVE NET WORTH –BRANCHES PROBLEM –INSUFFICIENT DOMESTIC CAPITAL –CULTURAL/LANGUAGE PROBLEMS

Conclusions INCREASED COSTS TO HOST COUNTRIES MAY ARISE FROM INCREASED COSTS TO HOST COUNTRIES MAY ARISE FROM –LACK OF ACCESS TO TIMELY AND ACCURATE INFORMATION –DIFFICULTIES IN COORDINATION WITH HOME COUNTRY REGULATORS –UNCERTAINTY AS TO WHEN HOME COUNTRY REGULATORS MAY INTERVENE –DIFFERENCES IN INSOLVENCY AND PCA CRITERIA –DIFFERENCES IN LEGAL REQUIREMENTS FOR TREATMENT OF CREDITORS –DIFFERENCES IN DEPOSIT INSURANCE REGIMES –PROBLEMS IN PROVIDING TIMELY ACCESS TO CLAIMS –INCENTIVES FOR HOME COUNTRY REGULATORS TO FAVOR THEIR CITIZENS RELATIVE TO HOST COUNTRY CITIZENS –DIFFERENCES IN THE RELATIVE SIZE AND IMPORTANCE OF AN INSTITUTION IN ITS HOME COUNTRY RELATIVE TO HOST COUNTRY

Conclusions (cont.) PROBLEMS ARE LESS, BUT NOT INSIGNIFICANT, WHEN EXPANSION TAKES PLACE VIA SUBSIDIARIES AS OPPOSED TO BRANCHES. PROBLEMS ARE LESS, BUT NOT INSIGNIFICANT, WHEN EXPANSION TAKES PLACE VIA SUBSIDIARIES AS OPPOSED TO BRANCHES. IN LIEU OF PROBLEMS, AND IN ABSENCE OF UMBRELLA DEPOSIT INSURANCE SYSTEM AND CLOSURE AND REGULATORY POLICIES, HOST COUNTRIES WOULD BE BETTER OFF TO PROMOTE ENTRY THROUGH SUBSIDIARIES RATHER THAN BRANCHES. IN LIEU OF PROBLEMS, AND IN ABSENCE OF UMBRELLA DEPOSIT INSURANCE SYSTEM AND CLOSURE AND REGULATORY POLICIES, HOST COUNTRIES WOULD BE BETTER OFF TO PROMOTE ENTRY THROUGH SUBSIDIARIES RATHER THAN BRANCHES.

POSSIBLE REMEDIES PROBLEMS ARISE FROM DIFFERENCES IN CLOSURE RULE AND DEPOSIT INSURANCE SCHEMES AND ENFORCEMENT – GREAT HETROGENIETY PROBLEMS ARISE FROM DIFFERENCES IN CLOSURE RULE AND DEPOSIT INSURANCE SCHEMES AND ENFORCEMENT – GREAT HETROGENIETY COOPERATION PROBLEMS COOPERATION PROBLEMS SOLUTION – LESS HETROGENIETY SOLUTION – LESS HETROGENIETY SINGLE, MULTINATIONAL REGIMES SINGLE, MULTINATIONAL REGIMES PROBLEMS PROBLEMS TRANSITION SOLUTION – SUBSIDIARIES TRANSITION SOLUTION – SUBSIDIARIES STRONG SEIR – PCA & LCR STRONG SEIR – PCA & LCR