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Handling Problem Financial Institutions. J.P Sabourin President and Chief Executive Officer Canada Deposit Insurance Corporation. December 9, 2003. CDIC Objects. CDIC Mandate. Provide insurance against loss of deposits (maximum $60,000)

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Handling Problem Financial Institutions

J.P SabourinPresident and Chief Executive Officer

Canada Deposit Insurance Corporation

December 9, 2003


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CDIC Objects

CDIC Mandate

  • Provide insurance against loss of deposits (maximum $60,000)

  • Promote standards of sound business and financial practices

  • Minimize exposure to loss for the Corporation


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CDIC Objects

The Corporation pursues objects throughout the life cycle of members

  • Oversees member application process

  • Undertakes ongoing risk assessment, monitoring, intervention

  • Deals with financial institution failures


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Deposit Insurance Application Process

Institutions must obtain approval from:

  • Minister of Finance

  • Office of the Superintendent of Financial Institutions (OSFI)


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Deposit Insurance Application Process

Board of Directors

  • Licensed under Bank Act or federal or provincial legislation

  • CDIC ensures sound financial and governance footing of institutions

CDIC Act


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Deposit Insurance Risk Assessment, Monitoring and Intervention Process

Insurer (CDIC)

Supervisor (OSFI)

  • Provision of insurance

  • Assessment and management of risk

  • Traditional supervisory role

Assessment of safety and soundness of institutions


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Deposit Insurance Risk Assessment, Monitoring and Intervention Process

Risks to CDIC are both internal and external to member institutions. They include:

  • Soundness and prudence of risk management activities

  • Financial performance

  • Economic and competitive environment

  • Compliance with statutory requirements


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Deposit Insurance Risk Assessment, Monitoring and Intervention Process

CDIC’s Standards of Sound Business and Financial Practices

  • Applied to “directing minds” of an institution

  • Sanctions can, and are, imposed when there is a breach of the Standards

    • Termination of insurance policy

    • Legal action against management and directors


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Deposit Insurance Risk Assessment, Monitoring and Intervention Process

Differential Premium System

  • Able to charge institutions a higher premium

    • Disincentive to higher risk-taking

  • Provides and early warning to developing problems

    • Information gathering allows for timely and appropriate action against institutions


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Intervention Process

CDIC may apply measures / sanctions to minimize exposure to loss

Premium Surcharge

  • Short-term behaviour modification

  • Can be applied to healthy institutions that are following a riskier path

1


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Intervention Process

CDIC may apply measures / sanctions to minimize exposure to loss

Special examination

  • Detailed review of assets and liabilities

  • Assessment will dictate options for intervention and resolution

2


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Intervention Process

CDIC may apply measures / sanctions to minimize exposure to loss

Termination of policy

  • Can be imposed immediately if and institution is in breach of Standards, by-laws or conditions of the policy

3


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Intervention Process

CDIC may apply measures / sanctions to minimize exposure to loss

Termination of policy

  • Deposits in these institutions are insured for two years for demand deposits or to maturity for longer-term deposits

  • Steps are generally taken to liquidate the bank or find a going concern solution

3


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Dealing with Failures

Options for intervention

  • Formal liquidation and payout

  • Sale of the institution

  • Options are assessed accounting for:

    • Stability of the overall financial system

    • Minimizing exposure to loss for CDIC


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Dealing with Failures

1. Deposit payout

  • CDIC releases payments to a maximum of $60,000

  • Depositor preference does not apply

    • Insured, uninsured and general creditors receive a proportionate return

    • “Modified payout” – funds are transferred to another member institution in a lump-sum payment


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Dealing with Failures

2. Purchase and assumption

  • Actual purchase of the shares or purchase of some or all of the assets and the assumption of all liabilities

1

  • “Clean institution” purchase and assumption

    • Purchase only the highest quality assets and assumes all liabilities

    • May purchase only specific pools of assets


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Dealing with Failures

2. Purchase and assumption

  • Actual purchase of the shares or purchase of some or all of the assets and the assumption of all liabilities

2

  • “Whole institution” transaction

    • All assets are purchased

    • Occurs before insolvency

    • Seen as re-capitalization of institution


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Dealing with Failures

2. Purchase and assumption

  • Bids reflect the expected value of assets, liabilities and perceived franchise value

  • CDIC provides financial assistance for the difference between the market value estimate and the liabilities assumed

  • Assistance varies:

    • Fixed dollar amount;

    • Secured loan; or

    • A combined solution.


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Dealing with Failures

Distinctions for purchase and assumption transactions

  • All depositors (uninsured or insured) receive full payment

  • Non-deposit creditors may receive partial or full payment

  • Full or substantial losses are imposed on subordinate debt holders and shareholders


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Failure Resolution of Central Guaranty Trust Company

Central Capital Corporation

Central Guaranty Trustco

Central GuarantyTrust (CGT)

(Late 1980s) 4th largest trust company in Canada


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Failure Resolution of Central Guarantee Trust Company

Early 1990s

Trustco showing deficits

CGT paying high

dividends to Trustco


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Failure Resolution of Central Guaranty Trust Company

December 1991

  • CGT Q3 = $116 million loss

  • CDIC constructed financial models to compare formal liquidation versus a going concern transaction


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Failure Resolution of Central Guaranty Trust Company

  • Expression of interest solicited from 45 organizations

  • Toronto-Dominion Bank (TD) agreed to acquire $9 billion of assets and all liabilities

    • Also acquired personal and pension trust business


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Failure Resolution of Central Guaranty Trust Company

  • CDIC provided a $1.35 billion loan for the transaction

  • The loan was converted to an asset management company (Adelaide Capital Corporation)

  • Adelaide managed, collected and optimized recoveries with assets to retire the CDIC loan

  • Transaction closed January 1, 1993


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Criteria for Assisting a Transaction

  • Cost of purchase and assumption must resemble cost of liquidation

  • CDIC must have assurance of future viability of the institution

  • Must provide sufficient capitalization and meet capital requirements

  • CDIC must receive sufficient specified repayment of assistance


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Criteria for Assisting a Transaction

  • Assistance must benefit troubled member, depositors and CDIC

  • Transaction must involve substantial investment or a guarantee (or combination) from acquirer

  • Acquirer must share risk with CDIC

  • Proposal must provide for adequate management resources


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Criteria for Assisting a Transaction

  • Acquirer must service all assets

  • Professionally managed bidding process must be in place

  • Acquirer must establish quantitative limits on all financial items in a proposal

  • Shareholders, subdebtholders and other creditors must be prepared to make some concessions


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Conclusion

  • Need for open communications and a transparent process

  • Open communication must extend to the public

  • Need to revisit trigger mechanisms to initiate an intervention situation

  • Determination of ongoing viability results in prompt action before insolvency


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Handling Problem Financial Institutions

J.P SabourinPresident and Chief Executive Officer

Canada Deposit Insurance Corporation

December 9, 2003


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