Handling systemic financial crisis and interrelationship among financial safety net players Presented by Carlos IsoardOctober 26, 2004
Definition Shock to the viability of financial intermediation and the payments system. Systemic Financial Crisis (SFC) Early detection and diagnosis is crucial.
Three Phases to handle SFC • Containment phase, to stop panic and stabilize the financial system. • Restructuring phase, to restructure the financial system. • Recovery phase, to normalize the system after the restructuring.
I. Containment Phase When creditors and depositors perceive they might lose their money, they start to withdraw their funds. • Provide liquidity to preserve payments system integrity. • Provide blanket guarantee in order to prevent bank runs and contagion. Confidence matters
II. Restructuring Phase • Provide financial support to viable banks. • Remove unviable ones from the system. • Efficient disposition of non-performing assets.
III. Recovery Phase • Remove Blanket Guarantee. • Immediate or smooth transition to limited coverage, i.e. fast-track or gradual. • Ensure prevalence of sound operating environment.
Blanket removal Advantages of gradual removal: • Can begin while working for stability. • Can be concurrent with banking sector recovery. • Public confidence can be sequentially tested along phases. Allows for the strengthening of supervisory and regulatory settings
Who must solve SFC’s? • No safety net player by itself can support the magnitude of an SFC. • Government support is essential. • Fiscal costs must be strictly observed. • Size or severity of problem may justify creation of a specialized unit.
Safety net participants • Regardless of institutional arrangement the safety net must include the following functions: • Regulation • Supervision • Lending of last resort • Deposit insurance • Exit policy
Effective Safety Net • Independence from political and industry influence. • Mandates-powers alignment. • Responsibilities and accountabilities clearly set. • Adequate coordination and information sharing.
Prevention of SFC In addition to: • Sound macroeconomic policies. • Adequate legal / institutional framework. • Strong supervision and market discipline. • Contagion avoidance through prompt resolution of isolated failures. it is critical to: • Enhance interrelationships between members of the safety net. • International cooperation
Cross-border Issues • Globalization and technological progress. • Every safety net participant must adapt. Contagion
Conclusions • SFC hits real sector of the economy. • SFC management is a task of the entire safety net, thus cooperation among participants is critical. • Recommend a contingent plan and tool. • Effective international cooperation.