Banking Sector Banking Sector Governance: General Governance: General Principles and Best Principles and Best

PracticesPractices

Geoffrey P. Miller Geoffrey P. Miller Stuyvesant P. and William T. III Comfort Stuyvesant P. and William T. III Comfort

Professor of LawProfessor of LawDirector, Center for the Study of Central BanksDirector, Center for the Study of Central Banks

New York University Law SchoolNew York University Law School

Issue: Who should manage the Issue: Who should manage the problem of bank insolvency?problem of bank insolvency?

-- What are government’s What are government’s responsibilitiesresponsibilities??-- What are the What are the best practicesbest practices in fulfilling in fulfilling

these responsibilities?these responsibilities?-- What government What government agenciesagencies could could

potentially fulfill those responsibilities?potentially fulfill those responsibilities?-- As among potential agencies, which are As among potential agencies, which are

most qualifiedmost qualified to implement best to implement best practices?practices?

- - What What alternative approachesalternative approaches might be might be considered?considered?

Governmental Responsibilities Governmental Responsibilities for the Banking System as for the Banking System as Related to Bank InsolvencyRelated to Bank Insolvency

Generally AcceptedGenerally Accepted

Controlling price levelsControlling price levels Managing systemic riskManaging systemic risk Smoothing the business cycleSmoothing the business cycle Enforcing fiduciary duties of managersEnforcing fiduciary duties of managers Provision of liquidity to solvent institutions facing Provision of liquidity to solvent institutions facing

temporary cash shortfalltemporary cash shortfall Monitoring and analyzing economic activityMonitoring and analyzing economic activity Resolving failed institutionsResolving failed institutions

Governmental Responsibilities Governmental Responsibilities for the Banking System as for the Banking System as Related to Bank InsolvencyRelated to Bank Insolvency

Generally accepted with qualificationsGenerally accepted with qualifications

Protecting savings of depositorsProtecting savings of depositors Influencing credit allocation in periods of financial distressInfluencing credit allocation in periods of financial distress

Less widely acceptedLess widely accepted

Owning and/or managing commercial banks after (or Owning and/or managing commercial banks after (or before) insolvencybefore) insolvency

Lending to the government to fund bailoutsLending to the government to fund bailouts Preventing failure of individual institutions where Preventing failure of individual institutions where

systematic risk is absentsystematic risk is absent

Best Practices for Managing Best Practices for Managing Bank Insolvency: General Bank Insolvency: General Regulatory ConsiderationsRegulatory Considerations

Best PracticeBest Practice: : Bank regulators should avoid pro-Bank regulators should avoid pro-cyclical responses to problems in the banking cyclical responses to problems in the banking sector.sector.

Best PracticeBest Practice: : Bank regulators should, to the Bank regulators should, to the extent consistent with the preservation of the extent consistent with the preservation of the safety and soundness of banks, allow banks to safety and soundness of banks, allow banks to undertake reasonable business risksundertake reasonable business risks..

Best PracticeBest Practice: : Bank regulators should insist that Bank regulators should insist that commercial banks maintain appropriate levels of commercial banks maintain appropriate levels of capital, as defined by transparent internationally capital, as defined by transparent internationally recognized standards.recognized standards...

Best Practice: Bank regulators should, to the extent feasible, require banks to implement internal risk-management controls and protocols, subject to review and approval by the regulators. Best Practice: Bank regulators should impose and enforce limits on insider lending and other self-dealing activities where the terms of the transactions are more favorable to the insider than would be obtainable in an arm's-length market transaction.

Best Practice: Bank regulators should seek to avoid excessive concentration of ownership of banking assets.

Best PracticeBest Practice: : Bank regulators should Bank regulators should seek to avoid excessive dispersion of seek to avoid excessive dispersion of ownership through geographical or other ownership through geographical or other regulations.regulations.

Best Practice: Best Practice: Bank regulators should, Bank regulators should, where appropriate, utilize the private where appropriate, utilize the private sector to obtain information about bank sector to obtain information about bank solvency and to discipline bank managerssolvency and to discipline bank managers..

Best PracticeBest Practice: : Deposit insurance Deposit insurance programs should be administered in such programs should be administered in such a way as to minimize moral hazard, a way as to minimize moral hazard, consistent with the objectives of consistent with the objectives of preventing instability in the banking sector preventing instability in the banking sector and safeguarding small deposits.and safeguarding small deposits.

Best PracticeBest Practice: : The relevant banking The relevant banking agencies should engage in advance agencies should engage in advance planning to develop cooperative planning to develop cooperative emergency responses to severe financial emergency responses to severe financial system instability.system instability.

Best PracticeBest Practice: : In order to cope with In order to cope with cross-border contagion risk, the relevant cross-border contagion risk, the relevant banking agencies should develop bilateral banking agencies should develop bilateral or multilateral relationships with banking or multilateral relationships with banking regulators in nations with linked regulators in nations with linked economies as well as with international economies as well as with international banking agencies and institutions.banking agencies and institutions.

Best practiceBest practice: : The central bank should The central bank should seek to maintain reasonably stable prices seek to maintain reasonably stable prices in order (among other things) to reduce in order (among other things) to reduce the threat of bank insolvency. the threat of bank insolvency.

Best practiceBest practice: : In order to achieve stable In order to achieve stable prices, the CB should have a reasonably prices, the CB should have a reasonably high level of independence from political high level of independence from political influence.influence.

Best PracticeBest Practice: : The CB should maintain a The CB should maintain a professional staff of the highest quality, including professional staff of the highest quality, including research and legal departments with direct research and legal departments with direct access to the Board.access to the Board.

Best Practices for Managing Bank Best Practices for Managing Bank Insolvency: Issues Related to Insolvency: Issues Related to

Management of Individual FailuresManagement of Individual Failures Best PracticeBest Practice: : Bank regulators should intervene Bank regulators should intervene

promptly to resolve problems prior to or at the promptly to resolve problems prior to or at the point of economic insolvency.point of economic insolvency.

Best PracticeBest Practice: : Bank regulators should seek to Bank regulators should seek to maintain continuity of banking services when maintain continuity of banking services when resolving a failed institution.resolving a failed institution.

Best PracticeBest Practice:: Bank regulators should, Bank regulators should, consistently with the need for prompt resolution, consistently with the need for prompt resolution, seek to achieve an orderly and efficient auction seek to achieve an orderly and efficient auction for the failed institution's assets.for the failed institution's assets.

Best PracticeBest Practice: : Claims of small depositors should Claims of small depositors should be given priority as a matter of law over other be given priority as a matter of law over other unsecured debt of a failed bankunsecured debt of a failed bank..

Best PracticeBest Practice: : In other respects, bank regulators In other respects, bank regulators should maintain contractual priority of claims should maintain contractual priority of claims during the resolution process.during the resolution process.

Best PracticeBest Practice: : Bank regulators should not Bank regulators should not rescue failed banks when the insolvency does not rescue failed banks when the insolvency does not threaten systematic stability.threaten systematic stability.

Best PracticeBest Practice: : Bank regulators should generally Bank regulators should generally remove incumbent managers after a bank has remove incumbent managers after a bank has failed, unless the failure is due to exogenous failed, unless the failure is due to exogenous factors and the incumbent managers are deemed factors and the incumbent managers are deemed to be competent.to be competent.

Best PracticeBest Practice: : Where failure of an institution Where failure of an institution threatens financial system stability, the decision threatens financial system stability, the decision to rescue the institution should be made after to rescue the institution should be made after high-level consultation among responsible high-level consultation among responsible government agencies.government agencies.

Best PracticeBest Practice: : The government should acquire The government should acquire ownership in failed institutions or their assets ownership in failed institutions or their assets only when the ordinary processes for orderly only when the ordinary processes for orderly private disposition of assets are found to be private disposition of assets are found to be ineffectiveineffective..

Best PracticeBest Practice: : To the extent feasible, state-To the extent feasible, state-owned banks should be subject to the same owned banks should be subject to the same general safety and soundness requirements as general safety and soundness requirements as private institutions.private institutions.

Best PracticeBest Practice: : The finances of state-owned The finances of state-owned banks should be accounted for in a transparent banks should be accounted for in a transparent fashion, and their true condition should be fairly fashion, and their true condition should be fairly and realistically disclosed absent persuasive and realistically disclosed absent persuasive reasons for maintaining confidentiality.reasons for maintaining confidentiality.

Best PracticeBest Practice: : If found to be insolvent, state-If found to be insolvent, state-owned banks should be placed in reorganization owned banks should be placed in reorganization as promptly as possible consistent with the need as promptly as possible consistent with the need to maintain the stability of the financial system.to maintain the stability of the financial system.

Agencies with Potential Agencies with Potential Responsibility for Bank Responsibility for Bank

InsolvencyInsolvency

Type of AgencyType of Agency

Central bankCentral bank Finance ministry/treasury departmentFinance ministry/treasury department Specialized financial regulatorSpecialized financial regulator Specialized deposit insurerSpecialized deposit insurer Public prosecutorPublic prosecutor

Level of GovernmentLevel of Government

NationalNational State/provincialState/provincial LocalLocal Self-regulatory organization (clearing house)Self-regulatory organization (clearing house)

Assigning Responsibilities Assigning Responsibilities

Best PracticeBest Practice: : Responsibilities should be Responsibilities should be assigned to the agency or agencies most assigned to the agency or agencies most qualified to implement best practices.qualified to implement best practices.

Best PracticeBest Practice: : Determining the most Determining the most qualified agency requires judgment, qualified agency requires judgment, discretion and political realism.discretion and political realism.

Best PracticeBest Practice: : In assigning regulatory In assigning regulatory tasks to the agency most qualified to tasks to the agency most qualified to implement best practices, policy makers implement best practices, policy makers should consider all relevant factors. should consider all relevant factors.

Best PracticeBest Practice: : In particular, allocation In particular, allocation of responsibility as between the CB and of responsibility as between the CB and other agencies is a matter to be other agencies is a matter to be determined with reference to the facts, determined with reference to the facts, circumstances, and history of a given circumstances, and history of a given jurisdiction.jurisdiction.

Best PracticeBest Practice: : Factors to be considered Factors to be considered include (among others):include (among others):

• History of regulation.History of regulation.• Fragility of the banking system.Fragility of the banking system.• Nature of deposit insurance program (if any).Nature of deposit insurance program (if any).• Structure of the banking industry.Structure of the banking industry.• Presence and market share of government-Presence and market share of government-

owned banks.owned banks.

f)f) Integration of commercial banking with other Integration of commercial banking with other financial activities (e.g., securities, insurance, financial activities (e.g., securities, insurance, fund management, and investment advice).fund management, and investment advice).

g)g) Strength and independence of the judiciary.Strength and independence of the judiciary.

h)h) Relative reputations, expertise, and Relative reputations, expertise, and capacities of the CB as compared with other capacities of the CB as compared with other existing or potential regulators.existing or potential regulators.

i)i) Degree of legal independence of the CB.Degree of legal independence of the CB.

j)j) Political realities.Political realities.

Managing Bank Insolvency: Managing Bank Insolvency: Some Regulatory AlternativesSome Regulatory Alternatives

Narrow BanksNarrow Banks: : Commercial banks would Commercial banks would be required to hold 100% reserves against be required to hold 100% reserves against deposits.deposits.

Government Demand DebtGovernment Demand Debt: : For For countries with fragile banking systems, the countries with fragile banking systems, the government would issue book-entry, government would issue book-entry, variable rate debt instruments payable on variable rate debt instruments payable on demand either to the investor or a third demand either to the investor or a third party, with accounts maintained by the party, with accounts maintained by the commercial banking sector.commercial banking sector.

Assessable StockAssessable Stock: : After failure, holders of a After failure, holders of a bank's stock would be assessed to pay creditor bank's stock would be assessed to pay creditor claims up to some multiple of their holdings.claims up to some multiple of their holdings.

Clearinghouses as self-regulatory Clearinghouses as self-regulatory organizationsorganizations:: After failure, private sector After failure, private sector institutions would organize a resolution of the institutions would organize a resolution of the insolvency either independently or under insolvency either independently or under government supervision.government supervision.