XIV Banking System Restructuring
- T. Asser
- Published Date:
- April 2001
Once a systemic banking crisis412 occurs, the monetary authorities must act quickly and decisively to contain the crisis and its effects on the national economy. A systemic banking crisis generally requires measures that address not only the banking system itself but also the root causes and the effects of the crisis outside the banking sector. Thus, for instance, the authorities will not only try to contain the crisis by restoring public confidence in the banking system and to preserve a minimum of essential banking services, including measures to compensate for the sharp contraction in bank credit that typically follows a banking crisis, but will also take steps to protect other parts of the financial sector, such as the capital markets, and payment and securities transfer systems.
Restoring public confidence in the banking system, at home and abroad, is one of the most urgent and daunting tasks facing the monetary authorities. The recent history of banking crises in the United States, Latin America, Scandinavia, and East Asia teach that usually, to be successful, a response to a systemic banking crisis must include the following key elements.413
An interagency bank crisis team should be appointed to prepare a comprehensive bank restructuring program for adoption by the political establishment and to coordinate execution of the program among the various agencies concerned, such as the bank regulator, the deposit insurance agency, the central bank, and the ministries of finance, treasury, and economic affairs. It is preferable to entrust bank restructuring to an interagency team. Usually the effects of a systemic banking crisis extend well beyond the banking system. In a national economic crisis, the restructuring of the banking sector will largely depend on the ability of the domestic corporate sector to meet its liabilities toward the banks, and may well require corporate sector reform. Finally, the operational and financial assistance needed for the rehabilitation of the banking sector exceeds the capacities of the bank regulator, usually demands significant fiscal outlays and far-reaching structural reforms of the regulatory and legal frameworks in which banks operate, and therefore requires the firm support of the political establishment.
Recent analyses of banking crises in the 1990s show that the probability of success of a bank restructuring program is improved and the negative macroeconomic impact of a banking crisis is reduced if, from the beginning, the program is conceived and presented to the public as a consistent and comprehensive strategy; programs that developed in a piecemeal fashion over time were deemed less successful.414
A bank restructuring program should detail macroeconomic and financial policies and measures designed to contain the crisis and to restore viability to the banking system. It should accompany and be consistent with a credible macroeconomic stabilization program with comprehensive financial sector restructuring and reform strategies. A bank restructuring program should provide appropriate incentives to all economic agents concerned (depositors and other bank creditors, bank owners, borrowers, and bank administrators) in order to promote the restructuring process, to reduce moral hazard, and to minimize the cost of bank restructuring to the government. Adoption and execution of a bank restructuring program should be marked by prompt publication of the program and its revisions, and by frequent disclosure of all significant information concerning the restructuring process to interested parties, both at home and abroad.
Bank restructuring is nearly always required in order to avoid that insolvent institutions would continue to operate and thereby worsen the crisis by contributing to distortions in economic incentives and moral hazard. Taking control of insolvent banks is typically needed to facilitate debt workouts and the resumption of capital flows, and to minimize fiscal costs and monetary policy constraints. Structural reforms may be required to address public concerns that fundamental flaws in the banking system contributed to the crisis. Often reforms cannot be limited to the institutional, administrative, and legal framework in which banks conduct their activities, but must extend beyond the banking system to correct structural deficiencies in the corporate sector (Korea) or even the sociopolitical regime (Indonesia).
In the five countries most affected by the Asian crisis of 1997,415 extensive liquidity support was provided by the central bank. Such support must usually be sterilized by monetary policy operations, even though a central bank’s ability to engage in open-market operations may be constrained by the crisis. An added bonus of open-market operations is that they can help in redistributing liquidity from banks with increasing deposits to banks losing deposits and credit lines.416 In countries whose law excludes central bank liquidity support to banks that are deemed insolvent, financial assistance must be provided by the government.417
Among the most serious conditions accompanying a systemic banking crisis is the loss of confidence in the local economy on the part of foreign exchange traders and foreign financial institutions. Foreign exchange reserves and foreign trade credit lines must be protected. Foreign investors must be dissuaded from liquidating their local investments. Especially foreign banks must be persuaded to keep their local branch offices open, as the implicit home office guarantee of their liabilities may attract domestic deposits and thus exert a stabilizing influence on the deposit base.418 Foreign exchange speculators must be denied access to local currency loans and derivative instruments used for sales of the national currency in the foreign exchange markets. Therefore, capital outflows may have to be curtailed by capital controls419 and debt-rescheduling arrangements may have to be negotiated.
Many countries faced by a systemic banking crisis during the last two decennia have resorted to issuing a blanket guarantee protecting depositors and other creditors of banks.420 To be accepted by the public and to stem runs on the banks, a blanket government guarantee must be credible. The credibility of the guarantee can be enhanced by various measures. For instance, blanket government guarantees issued by Asian countries during the crisis of 1997 were strengthened by making the terms of the guarantee explicit, by issuing the guarantee in the form of a law or decree, and by making the guarantee part of a comprehensive restructuring strategy and the country’s macroeconomic program.421 The moral hazard inherent in such guarantees may be reduced by limiting the time during which the guarantee will be in effect, as well as by denying bank owners free ridership by closing insolvent banks and imposing guarantee fees on solvent banks, even though it is notoriously difficult to find a proper price for such guarantees.
In a systemic banking crisis, insolvent banks should be closed expeditiously. Among the advantages of closing insolvent banks are the elimination of further losses and moral hazard, and the termination of official liquidity support. However, the closure of a significant part of a national banking system carries major costs; these include the resulting systemic reduction in banking services, such as domestic credit lines and the intermediation of payments and securities transfers, as well as the risk that bank closings fuel panic runs on other banks, although this risk can be alleviated by a credible blanket guarantee from the government.422
If the closure of all insolvent banks would lead to the extinction of the banking system, for instance, because the country has only several large banks all of which are insolvent, other solutions must be found. These may consist of open-bank assistance by the monetary authorities, preferably under provisional administration including nationalization of the banks in whole or in part by the government (while any remaining part of the bank would be liquidated).423
The law may offer special instruments designed to combat a banking crisis. For instance, in Germany, the banking law authorizes the federal government by regulation to establish a moratorium for any bank when a banking crisis threatens, namely, if there is reason to fear that banks may encounter financial difficulties that warrant expectations of grave danger to the national economy and particularly to the orderly functioning of general payments; the law extends the protection of the moratorium beyond debt service to other transactions of the bank, and provides that no execution, attachment, or foreclosure can be carried out or completed concerning bank assets protected by the moratorium.424 As was suggested before,425 it is difficult to understand how banks placed under such a moratorium could continue their operations, and it must be considered doubtful whether a general suspension of payments can do much to maintain or to restore confidence in the banking system. For these reasons, during a banking system crisis, a moratorium, though useful for insolvent banks placed in receivership pending their liquidation or merger with another institution, might be counterproductive for banks that are still viable and that need to continue their operations as normally as possible in order to provide indispensable banking services. Compared with a moratorium, a blanket guarantee appears to be preferable because it is designed to promote confidence in the banking system by ensuring payment of bank liabilities and to support the national economy by ensuring the continued more or less normal operation of viable banks.
2. Institutional and Functional Features
Absent a banking crisis, the bank regulator is usually in charge of administering the corrective measures indicated when banks become illiquid or insolvent. Although staff and budgetary resources available to a bank-supervision agency are usually adequate to discharge this function on an incidental basis, they are rapidly overwhelmed by a full-blown systemic banking crisis, threatening its ability to continue prudential supervision of the banks that remained more or less healthy.426
Often, the financial structure of the bank regulator is ill-suited to carry out the task of reorganizing a significant part of a banking system. Usually, the regulator cannot bear the costs of such reorganization from its own resources, not even if it is the central bank. And, if the central bank is the bank regulator, it is often not authorized to extend financial assistance to banks that are insolvent, or to receive budgetary funds for its own account other than in the form of equity capital; moreover, it may well be regarded as improper for a central bank to do all the commercial activities required in a banking system reorganization for its own account and on its own books. If the regulator is constituted as a commission without legal personality, it may lack the legal and financial robustness required for the task and its funding.
In some countries, the deposit insurance agency is designated by law to take the lead role in the bank restructuring process.427 As was explained before,428 this role of the deposit insurance agency is bound to create conflicts between its interests as a major bank creditor and its fiduciary duties as an impartial administrator of bank resolution procedures. Another problem is that, usually, the funding of the deposit insurance agency is insufficient for the task; as is common for other types of insurance funds, deposit insurance is normally not funded to cover the risk of a universal disaster in the form of massive defaults on deposit liabilities of banks. Therefore, in most systemic banking crises where there is deposit insurance, the deposit insurance fund will have to be recapitalized, sometimes more than once, requiring significant fiscal outlays. It is the hope that such outlays can be curtailed and that the banking system can be stabilized with a minimum of demand on the deposit insurance fund that drives governments into issuing blanket guarantees to depositors and other bank creditors.
Typically, the reconstruction of a banking sector demands more than the closing and liquidation of insolvent banks. It requires the consolidation of insolvent banks or parts of such banks into viable institutions that can serve the banking system. This endeavor extends beyond the treatment of individual banks to the restructuring of the entire banking sector.
Therefore, often, systemic banking crises do not lend themselves to treatment in the general insolvency courts. If large numbers of bank failures are involved, the courts would be overwhelmed, especially when, as is often the case, the systemic banking crisis is accompanied by a general economic crisis causing massive failures in the corporate sector to be administered in the same insolvency courts. Also, a systemic and consolidated approach to bank restructuring cannot be reconciled with traditional judicial insolvency procedures designed to treat insolvent enterprises on an individual basis. This is an important reason for placing systemic bank restructuring outside the framework of general insolvency law. And, in a systemic banking crisis, the consideration that individual bank owners and creditors are thereby deprived of the protection afforded by a proper judicial insolvency proceeding is outweighed by the overriding national interest in restoring the banking system in the shortest possible time.
Bank Restructuring in Sweden
The successful strategy followed by Sweden during the banking crisis of the early 1990s may serve to illustrate the content and execution of a comprehensive bank restructuring program.429
One of the main components of the strategy was the blanket guarantee announced by the Swedish government in September 1992 to the effect that all bank commitments would be met on a timely basis and that no depositors, creditors, or other counterparties of banks would suffer any losses. The blanket guarantee received parliamentary ratification by the Bank Support Act of December 1992. Only share capital and perpetual debentures were excluded from the guarantee. The government was authorized to provide financial assistance in the form of loan guarantees, capital contributions, and other appropriate measures, without the constraint of an upper limit. The Bank Support Act of 1992 provided, inter alia, that support provided to banks in the form of payments should be recovered to the fullest extent possible, but that the government should not endeavor to assume ownership of banks. The blanket guarantee was considered to be exceptional and temporary; it was repealed by parliament and replaced by a limited deposit insurance scheme in July 1996. In May 1993, a Bank Support Authority was formally established as an independent agency to manage the government support system.430
Other principles underlying the success of Sweden’s bank restructuring strategy have been summarized as follows:431
The key element of the restructuring program was the formation of a broad political consensus. This consensus was supported by timely information to all domestic parties. Transparency and disclosure of information were crucial for regaining confidence domestically and abroad; the implications of support measures for depositors and investors were extensively reported.
It was decided that to place the lead restructuring agency within existing institutions, such as the Ministry of Finance or the Riksbank, might have interfered adversely with the roles of these institutions. Therefore, a separate institution—the Bank Support Authority—was created to implement the bank restructuring strategy. The formation of an institutional framework clarified the respective roles for the Ministry of Finance, the Riksbank, the Financial Supervisory Authority, and the Bank Support Authority. At the same time, there was a continuous exchange of information among the institutions.
Diagnosis was the first step in the restructuring exercise. A common yardstick—based on the capital adequacy ratio and other financial ratios—was designed to measure the degree of problems in banks. Initially the banks were divided into two main categories: those that were considered viable and those that were not. While banks in the first category received support, the ones in the second category were closed or merged, and the banks’ creditors were paid off.
Distorted incentives were minimized through the conditionality measures embedded in support agreements. The foremost conditions included changing management and upgrades of internal control and risk-management systems (which in most cases were found to be inadequate). The parliamentary guarantee did not cover owners’ capital; in case of financial support by the government, owners typically lost their equity stakes.
Structural reforms of the accounting, legal, and regulatory framework and of prudential supervision were enacted. Clear guidelines on asset classification and valuation of banks’ holdings of collateral (real estate and other assets) were set, with the Bank Support Authority monitoring compliance with these procedures.
The establishment of institutions for loan workout was given high priority. Problem assets were transferred, at an assumed market price,432 to a separate asset-management company. As with other types of support provided to the banks, strict conditionality was attached to these operations. This approach facilitated the orderly sale of assets and allowed problem banks to continue their usual business without having to handle a large volume of workout cases. The asset-management company could recruit the specific expertise needed for transforming the bad assets into salable assets. The Bank Support Authority funded the asset-management companies and was their sole owner.
Bank Restructuring Corporations
Several of the countries faced with a systemic banking crisis in recent years have established one or more separate state agencies to rehabilitate or to liquidate problem banks. The most common such agencies are bank restructuring corporations (BRCs).
The activities of a BRC should be defined and delineated in time and scope by the law establishing the BRC. For instance, a BRC may be created to handle a systemic crisis for a temporary period, typically five or more years. The law may prescribe a division of labor between the BRC and the deposit insurance agency based on the type of banking institution, or the nature of the task, i.e., bank restructuring versus asset management. In other cases, a BRC may be created to handle a more discrete problem, such as the restructuring and bank restructuring of insolvent state-owned banks.
The law establishing the BRC should specify the criteria to be used for identifying banks whose financial condition permits them to continue banking operations under the supervision of the bank regulator, banks that should be closed and liquidated outright, and banks whose financial condition or position in the banking system makes them eligible for bank restructuring. For the banks that fall in the last two categories, regulatory responsibility may be transferred from the bank regulator to the BRC. The law should provide that such a transfer must be publicly notified and has the effect of transferring complete control over the bank and its assets to the BRC.
The BRC will take immediate control of the banks transferred to it, and will secure their assets by removing them from the control of bank managers and owners. The banks to be liquidated will be wound up; those of their assets that cannot immediately be sold will be kept or transferred to another entity (hospital bank or asset management entity) for management and future disposal.
Preferably, the law should require the BRC to carry out its bank restructuring activities in accordance with detailed bank restructuring plans, one for each bank brought under the jurisdiction of the BRC. The plans are formulated on the basis of an assessment by the BRC of the financial condition of the bank and the chances that the bank can be successfully restructured. These plans may be agreed upon between the BRC, the bank regulator, and the monetary authorities, so as to ensure their consistency with the country’s overall bank restructuring program and budget constraints. They may periodically be revised and updated to reflect, inter alia, changes in the needs of the banking system and the condition of banks submitted to the bank restructuring process.
The goals of a BRC are to consolidate the banking system, to recapitalize viable banks, and to improve bank balance sheets by removing nonperforming assets. Consolidation may take a number of forms. Thus, BRCs typically restructure, liquidate, or sell problem banks, and manage, restructure, or sell assets of problem banks. They may use techniques for maximizing the going-concern value of banks—notably purchase and assumption transactions—that are similar to the resolution procedures used in a bank receivership. In one approach, two or more insolvent institutions under the BRCs jurisdiction are merged by the BRC into a new institution, which is then recapitalized with government funds. By so doing, larger and (at least in theory) more viable institutions are created that may later be reprivatized by selling stock back to the public. In a second approach, an insolvent bank is merged with a solvent bank that may be undercapitalized, which may then receive a capital infusion of government funds from the BRC. In either case, the BRC is sometimes able to recoup some of its costs from the sale of shares at a later date.
Recapitalization of an insolvent bank typically involves the infusion of new capital into the institution, with or without a merger or consolidation, with new management installed by the BRC running the bank until it may be reprivatized. Cleaning bank balance sheets may be accomplished by having the BRC or another entity purchase assets, hopefully at market values to avoid any subsidy that would result in a valuation based on book values; the assets may later be sold in a variety of transactions, including, but not limited to, bulk sales and asset securitization.
An often controversial policy issue is whether and how the BRC will provide financial assistance to acquirers of insolvent banks. In some cases, the BRC has the power to grant financial assistance to acquirers of banks, such as equity, loans, deposits, guarantees, or indemnities. It is often difficult to find acquirers of banks unless all nonperforming assets have been removed, and the balance sheet completely cleaned out. However, even in such cases, the threat of litigation from former owners, managers, and creditors can give rise to a contingent liability that acquirers will want to be protected against. In such cases, the ability of the BRC to provide a guarantee or indemnity may be a necessary aspect of the financial assistance that it can offer. The use of guarantees and indemnities may create contingent liabilities on the BRC’s balance sheet that may linger far beyond the agency’s role in the acquisition itself. The difficult question of who should bear the risk of loss may be resolved in different ways at different stages of a systemic crisis, depending on the demands of and the degree of competition between buyers of insolvent banks.
One of the thorniest problems encountered in a banking system crisis is that the establishment of reasonable values for many bank assets has become difficult. Nonperforming loan asset values are nearly impossible to assess as the impaired creditworthiness of many corporate borrowers rapidly deteriorates further. Collateral values are hard to determine as markets for those assets dry up. Valuations based on discounted present values become unreliable as the uncertainties concerning cash flows, interest rates, and other financial variables increase. Nevertheless, such valuations are usually necessary for banking institutions to asses their book value in order to determine whether they are insolvent and, if so, whether they meet the criteria for restructuring or outright liquidation. In addition, asset values drive choices between different restructuring strategies and ultimately help determine sales prices. A contributing problem is that this uncertain environment may produce dramatic differences in accounting results for similar asset classes, not only over time, but also simultaneously for different banks, as asset valuations increasingly come to depend on judgments that can honestly differ. Although this problem cannot be solved definitively, it can be reduced by establishing, by bank regulation, firm accounting rules, standards, and procedures that must be applied uniformly to all banks entering the restructuring process.433
Autonomy of BRCs
There is widespread agreement that, to be successful at these tasks, BRCs must have sufficient autonomy. The need for autonomy means mainly that the agencies should be created either as private corporations or as independent legal entities of the state, and that they should be operationally and financially separate and distinct from the political establishment and national monetary authorities, such as the central bank. Financial autonomy requires adequate funding of the agencies from reliable sources, such as the state budget, through loans from the deposit insurance agency, or from proceeds of sales of bank assets. Experience indicates that countries that have established an autonomous BRC generally have been more successful than those that have chosen not to endow it with sufficient independence.434
Among the reasons given why autonomy is a fundamental legal objective are the following. First, the cost of restructuring the banking sector during a time of financial crisis will be significant, necessitating direct appropriations as part of the budgetary process or funding from other sources, which requires the recipient BRC to have the corporate structure of an independent legal entity allowing it to receive, and to be independently accountable for the use of, such funds. Accordingly, systemic bank restructuring legislation typically establishes BRCs as independent legal bodies and makes explicit provision for funding that includes capitalization by the government and sometimes the authority to borrow from the central bank or the government, or to issue debt instruments that may or may not carry the full faith and credit of the state.
In addition, making a BRC part of, or effectively controlled by, the bank regulator, would give rise to real or perceived conflicts of interest based on differences in the roles played by the BRC and the regulator. The bank regulator should maintain an arm’s-length relationship with the BRC, which typically operates and owns stock in insolvent banks while those banks may continue to be supervised by the bank regulator. Moreover, the bank regulator is not well situated to make the operational decisions required in managing a bank, liquidating assets, or to decide on when and how to resolve a bank by sale, merger, or liquidation, or to issue stock to recapitalize or reprivatize a bank.
Finally, organizing a BRC as an autonomous entity helps to insulate and protect the rest of the government, including the central bank and the ministry of finance, from political shock waves that often follow the myriad difficult decisions that must be taken by the BRC. These include removing bank management, curtailing or overriding ownership interests, restructuring the bank’s assets and liabilities, and managing, collecting, and liquidating problem assets. At the same time, the independence of the agency helps to insulate and protect it from political interference, as bank owners, depositors, and other creditors and borrowers seek to influence or overturn BRC decisions. The use of an independent board of directors, a majority of whom are not government ministers, typically has the effect of promoting and reinforcing the autonomy of bank restructuring corporations, as do stringent restrictions on the removal of board members that protect them from the political fallout of unpopular decisions.
The foregoing consideration should not be taken to exclude the bank regulator entirely from the bank restructuring process. The bank regulator and the BRC should consult each other regularly with respect to banks undergoing restructuring in order to facilitate their eventual reentry into the economy. The bank regulator retains primary responsibility for determining for each bank whether that bank should be transferred to the BRC for restructuring or liquidation and, once the bank has been restructured by the BRC, whether control of the bank should be returned to its owners.
There are countries, however, that would not admit the degree of autonomy needed by a BRC and where, therefore, a BRC would not be the most suitable instrument to restructure a banking sector. For example, a country may determine that a centralized BRC could not be endowed with the requisite autonomy from the political establishment or could not be properly staffed with qualified personnel. Such countries may elect instead to pursue a banking system restructuring plan that relies on the banks themselves to reorganize their financial condition. This may be done in accordance with debt workout procedures established for the purpose that cover not only bank debt but also non-performing loan assets of banks; participation by the banks in the plan and their compliance with its requirements may be ensured by offering appropriate incentives to the banks, including financial support from the government.435 Alternatively, the threat that the bank regulator will use its statutory authority to deprive owners of undercapitalized banks of their equity interest may be sufficient incentive for such owners actively to pursue the recapitalization or merger of their banks.436
3. Legal Aspects
To be effective, BRCs must be grounded in strong and well-conceived legislation whose underpinnings rest on principles of administrative law, including in particular transparency and proportionality. Often, this will include special banking system restructuring legislation establishing BRCs, setting rules for the transfer of banks to their jurisdiction and for the exit of banks, and governing the administration and operation of the BRCs.
During a banking crisis, full public disclosure of the objectives pursued in rehabilitating the banking system and of the applicable institutional arrangements and rules of law is a prerequisite for restoring public confidence in the banking system. Therefore, the law governing the BRC and its activities must use clear, comprehensive, and unambiguous language and must be comprehensible to bank owners and management, potential investors in, and buyers of, restructured banks and their assets, and the public at large. The need for transparency is especially important in defining the grounds and procedures for referral and transfer of a failing bank to the BRC; the legal effects of the transfer of a bank to the BRC on the powers and rights of bank owners and managers with respect to the bank; the content and scope of the powers of the BRC; and the circumstances under which banks referred to the BRC must be liquidated and their licenses must be revoked. Also, if the statute of a BRC grants rights, powers, and procedures that conflict with or override other laws, such as company law, bankruptcy law, securities law, real property law, and employment law, the hierarchy between the statute of the BRC and these other laws should be clearly stated in the organic law of the BRC.
Grounds for Referral of Banks
What grounds will be used by the bank regulator to refer a bank to the BRC? Typically, banks must be insolvent before they are referred to the BRC. The definition of insolvency should be clearly stated in the law, such as the failure of the bank to pay its obligations as they fall due. Balance sheet insolvency, based on liabilities being greater than assets, and regulatory insolvency, based on capital inadequacies, are also used. Additional criteria may be imposed, such as the size of a bank’s deposit liabilities or loan assets, in order to limit the number of banks that are referred to the BRC.
Legal Effects of Referral of Banks
Based on the fact that it concerns a quasi-insolvency process, the referral of a bank to the BRC should be ipso facto, and for the duration of the restructuring process, vest the powers of all corporate organs of the bank in the BRC, and place the bank in a debt-service moratorium where enforcement actions by creditors against the bank are suspended, except perhaps for foreclosure on collateral. The law must be clear that, when a bank comes under the jurisdiction of the BRC, the BRC becomes solely responsible for the management and operation of the bank.
Another policy issue involves the legal status of the bank: will a bank remain open (i.e., will its banking license still be in place) while it is under BRC administration, or will the bank be closed as part of the restructuring process? The answer will in part depend on the question whether the bank should be rescued for systemic reasons or not.
Powers of the BRC
In serving the goal of transparency of public administration and legal certainty, the powers of the BRC should be explicitly stated in the law, with more rather than fewer listed. These powers should be established by statute, and not by decree as the latter are easily changed, contributing to uncertainty about the law. For the BRC, these powers typically include three levels of authority, starting with the BRC’s authority as a juridical person, with all the powers flowing therefrom, such as the power to own and dispose of property, to sue and be sued, and to enter into and enforce contracts. The second level of BRC authority derives from the powers of the bank under administration, its owners and managers, such as the power to take deposits, to lend money, and to sell and restructure the bank and its assets and liabilities; it is based on a statutory provision that vests these powers in the BRC. The last level of authority is the so-called “superpowers” commonly granted to trustees or receivers under a bankruptcy regime, such as the power to stay litigation, to repudiate burdensome contracts, to transfer liabilities without creditor consent, and to reinstate contracts that have terminated based on a bankruptcy or insolvency clause.
An unusual power, which may be practically significant, that should be granted to the BRC is the power to charter new banks that could function as bridge banks in a purchase and assumption transaction or as permanent new banking institutions combining assets and liabilities of two or more closed banks.437
As the powers necessary for a successful banking system restructuring must typically be unusually extensive, care should be taken that the powers granted by law to the BRC are proportional to the agency’s tasks. Although the serious consequences of a systemic banking crisis justify unusual restrictions on property rights, this justification does not support measures that are clearly excessive. This means that the scope of the powers of the agency should not extend beyond what is strictly necessary to discharge its tasks. In particular, the law should not contain an open-ended grant of authority to the BRC permitting it to create additional powers for itself or to expand its statutory powers through the issuance of regulations, decrees, or orders.
There are unfortunate instances where the principle of proportionality is flouted and a BRC is given excessive powers. One of these concerns the Indonesian Bank Restructuring Agency (IBRA). During the Asian crisis of 1997, IBRA was established with extensive powers listed in the banking law of Indonesia.438 These powers were subsequently expanded by government regulation,439 well beyond the scope of what was provided in the banking law. In particular, the government regulation authorized IBRA to determine “the procedure needed to control, manage and undertake ownership measures concerning … assets under restructuring,” which were defined to include not only the assets owned by the insolvent banks administered by IBRA but also assets owned by the debtors of these banks.440 The stated intent of this authority was to permit IBRA to force debtors of the banks under its administration to negotiate with IBRA in good faith. The draconian result was that IBRA, established under the banking law for the resolution of banks entrusted to its administration, could effectively control not only the restructuring of those banks but also indirectly the restructuring of all corporations that had debts to such banks, by threatening seizure of the assets of “uncooperative” corporations. Thus, IBRA could exercise control over much of the corporate sector of Indonesia. These excessive powers did little to give IBRA domestic and international credibility.
Rights of Bank Owners
Banking system restructuring generally requires the transfer to a BRC of all rights of owners in banks submitted to BRC jurisdiction. To be effective and efficient, banking system restructuring must override the safeguards afforded by the company law to shareholders; this is fully justified by the severity of a systemic banking crisis. Also, as in any bank restructuring, free ridership of existing bank owners must be avoided.
In some countries, the transfer of bank ownership to a government agency, such as a BRC, may raise questions as to its constitutionality. Where possible, these should be addressed by the law so as to avoid taxing an already overburdened judiciary and regulatory system by unnecessary litigation. However, the risk of successful litigation on the part of owners or managers of a bank transferred to a BRC should not be exaggerated. Given that the insolvent bank’s share price at this point is usually at or around zero, and that the level of its capital is at zero or below, ownership interests, while legally valid, will have only a theoretical value in the marketplace. In other words, even if an owner could prove to a court that there has been a taking of property by the government in a manner contrary to law, the damages that could be proven and claimed would be de minimis.
Review of Administrative Acts
Normally, the agencies involved in banking system restructuring are government agencies and as such they and their acts are governed by administrative law, including procedures for administrative review. Because of the urgency and exceptional nature of a banking system restructuring, there is justification for curtailing the rights of interested parties to administrative review of such acts, at least to the extent necessary so as not to suspend the process of bank restructuring or liquidation of banks submitted to the bank restructuring regime. These restrictions on judicial authority should also apply to the civil courts, denying them the right to interfere in the bank restructuring process. In many countries, such restrictions are supported by the ability of interested parties to sue the bank restructuring agencies or the government for damages in civil court.
Exit and Sunset Provisions
Banking system restructuring legislation should prescribe precise criteria and procedures for the exit of rehabilitated banks from the jurisdiction of a BRC. Without these, the BRC might be subjected to unnecessary litigation by bank owners eager to regain control over their property. Even apart from the threat of litigation, exit criteria and procedures appear to be mandated by the goals of transparency and legal certainty.
The banking system restructuring law should have explicit sunset provisions that limit its life and that of the BRC to an expiration date, in order to avoid a situation in which this extraordinary regime would be used to restructure banks in circumstances unrelated to the banking crisis for which it was created. If necessary, the deadline can be extended by formal amendment of the legislation. These provisions should cover the transfer of any remaining assets and liabilities from the BRC and any associated asset management entity to the government.
However, there is an important disadvantage attached to such sunset provisions. Once the law has expired, its revival would require a full-fledged legislative procedure. In some countries, it takes a considerable period of time after a systemic banking crisis develops to draft and adopt suitable restructuring legislation, delaying restructuring of the banking system. Keeping restructuring legislation on the books would avoid such delays. This can be achieved, without risking that the restructuring law would be applied outside crisis situations, by limiting the effect of sunset provisions to a suspension of the law’s operation, and by providing in the restructuring law that the law may be reactivated only under certain conditions pursuant to a simplified legislative process, such as a parliamentary resolution or a governmental decree issued with the advice and consent of the legislature.
In banking crises where existing regulatory and judicial resources are not equipped to administer a large number of failing banks, banking system restructuring should be carried out by a legally independent bank restructuring corporation (BRC) endowed with sufficient operational autonomy and financial resources. BRCs should be granted powers commensurate with their tasks. These powers should be clearly specified in the law.
The law should prescribe precise grounds and procedures for transferring failing banks to the banking system restructuring process and should provide that, upon transfer, the rights of existing bank owners and managers are vested in the BRC for the duration of that process. The law should require a restructuring plan for the banking sector as a whole and individually for each bank subjected to the banking system restructuring regime.
The law should contain precise exit criteria for reconstructed banks and a suitable sunset provision for the law itself.