How to fight a banking crisis
The world has undergone enough banking crises that some useful lessons might be gleaned from past experience. A working paper from the IMF attempts to do just that with a database of all systemic banking crises between 1970 and 2007 - a total of 42. Systemic Banking Crises: A New Database offers up a few guidelines on what to do when faced with a crisis:
Our preliminary analysis based on partial correlations indicates that some resolution measures are more effective than others in restoring the banking system to health and containing the fallout on the real economy. Above all, speed appears of the essence. As soon as a large part of the financial system is deemed insolvent and has reached systemic crisis proportions, bank losses should be recognized, the scale of the problem should be established, and steps should be taken to ensure that financial institutions are adequately capitalized.
Perhaps just as important is what has not worked well during a crisis:
Government-owned asset management companies appear largely ineffective in resolving distressed assets, largely due to political and legal constraints.
Instead of governments managing assets, the IMF study suggests a different approach:
To relief [sic] indebted corporates and households from financial stress and restore their balance sheets to health, intervention in the form of targeted debt relief programs to distressed borrowers and corporate restructuring programs appear most successful.
Update: An electronic version of the database is available on Luc Laeven's website.
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On the issue allow me to extract the following from my Voice and Noise!
As I have always seen it, the costs related to a bank crisis are the following three:
1. The actual direct losses of the banks at the outbreak of the crisis. These are represented by all those existing loans that are irrevocably bad loans and therefore losses without a doubt.
2. The losses derived from mismanaging the interventions (workout costs). These include, for example, losses derived from not allowing some of the existing bad loans the time to work themselves out of their problems. They also include all the extraordinary legal expenses generated by any bank intervention in which regulators in charge want to make sure that they themselves are not exposed to any risk at all.
3. The long-term losses to the economy resulting from the “Financial Regulatory Puritanism,” that tends to follow in the wake of a bank crisis as thousands of growth opportunities are not financed because of the attitude “we need to avoid a new bank crisis at any cost.”
For the sake of the argument, I have hypothesized that each of these individual costs represents approximately a third of the total cost. Actually, having experienced a bank crisis at very close range, I am convinced that the first of the three above costs is the smallest ... but I guess that might be just too politically incorrect to pursue further at this moment.
Posted by: Per Kurowski | Sep 29, 2008 4:59:07 PM