Managing Financial Crises - IADI · GFC: 12 countries, of which 10 are advanced Earlier crises: 18 countries, of which four are advanced How do policy choices and outcomes differ?

Managing Financial Crises

Stijn Claessens, Head of Financial Stability Policy & Deputy Head, Monetary and Economic Department

2019 IADI Biennial Research Conference: “Towards Building a More Resilient Financial System –Challenges in Deposit Insurance and Bank Resolution”, 23 May 2019–24 May 2019

Disclaimer: The opinions expressed are those of the author and do not necessarily reflect views of the Bank for International Settlements.

There have been many crises, everywhere and of various types

There have been many crises over centuries More common in emerging markets earlier, but great financial

crisis (GFC) affected predominantly advanced countries Crises come in (regional) waves: Latin America, Asia, US/Europe...

While causes vary by type, they are interrelated Boom (and bust) patterns are common to most Banking, currency and sovereign crises can overlap since one can

lead to the other

But identifying and classifying crises is still an art Samples vary, and so do related studied consequences…

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Crises are recurrent events. So one can learn from history…

0

20

40

60

80

100

120

140

160

180

1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Banking, currency, default,

and inflation crises(BCDI index)

BCDI index + stock market

crashPanic of 1907

World War I - hyperinflation

Great Depression

World War II - more defaults

Oil shock-inflation

Emerging market crises and Nordic and Japanese banking crises

Great financial crisis

Com

posi

te

Cris

is

Inde

x

World aggregate (1900–2010): A composite index of banking, currency, sovereign default and, inflation crises, and stock market crashes (weighted by their share of world income)

Source: Reinhart and Rogoff, 20103

Financial crises can have large and long-lasting effects on the real economy

Output Evolution after Banking and Currency Crises (Percent of pre-crisis trend)-1

5-1

0-5

0

-1 0 1 2 3 4 5 6 7

Banking Crises

-15-10

-50

-1 0 1 2 3 4 5 6 7

Currency Crises

Note: Figure reports mean difference from year t = –1; 90-percent confidence interval for estimated mean; first year of crisis at t = 0; years on x-axis.

4

Costliest banking crises since 1970s includes some recent crises

57 55

44 44 44 43 41

32 32 31

Indon

esia

1997

Arge

ntina

19

80Ice

land

2008

Jama

ica

1996

Thail

and

1997 Ch

ile

1981

Irelan

d 20

08Ma

cedo

nia

1993 Tu

rkey

2000

Korea

19

97

Fiscal cost(In percent of GDP)

108 103

88 83 8273 72 68 65 63

Guine

a-Biss

au

1995

Cong

o, R

ep

1992 Ch

ile

1981

Urug

uay

1981

Arge

ntina

20

01 Irelan

d 20

08Ice

land

2008

Indon

esia

1997

Tanz

ania

1987

Nige

ria

1991

Increase in debt(In percent of GDP)

143130

121109 106 106 106 106 102 98

Kuwa

it 19

82Co

ngo,

DR

1991

Burun

di 19

94Th

ailan

d 19

97Jo

rdan

19

89Ire

land

2008

Latvi

a 20

08Ca

mero

on

1987

Leba

non

1990

Ecua

dor

1982

Output loss(In percent of GDP)

Source: Laeven and Valencia (2012)5

Comparing causes provides lessons…As does comparing crises management Approaches vary

What differs every time? Does it matter? What to do for the next crisis?

Compare banking crises for samples of countries GFC: 12 countries, of which 10 are advanced Earlier crises: 18 countries, of which four are advanced

How do policy choices and outcomes differ? All unique, but some commonality in causes GFC was more global

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Liquidity support much larger in GFC

Note: All dates are relative to the peak of the crisis, with periods referring to quarters before or after onset of crisis. Medians.

0

2

4

6

8

10

12

14

16

18

T-12 T-9 T-6 T-3 T=0 T+3 T+6 T+9 T+12

(%)

Earlier GFC

Liquidity support (In percent of GDP)

77

Monetary and fiscal policy provided more support in GFC than in the earlier crises...

8

00.20.40.60.8

11.21.41.6

T-4 T = 0 T+4 T+8(Quarters)

Median Short Term Interest Rates(Index)

-8

-6

-4

-2

0

2

T-8 T-4 T = 0 T+4 T+8

(%)

(Quarters)

Median Fiscal Balances(% of GDP)

Note: All dates are relative to the peak of the crisis, with periods referring to quartersbefore or after onset of crisis. Medians.

Earlier GFC

The real effects of crises were thus mitigated

Probability of remaining in a recession in a sample of recessions with and without financial crises.

9

Public recapitalisation was seven quarters after guarantees extended in earlier crises

02468

1012141618

T-12 T-9 T-6 T-3 T=0 T+3 T+6 T+9 T+12

(%)

Solid lines: Introduction of recapitalisationprograms

Dashed lines: Introduction of liabilities guarantees

Liquidity support (In percent of GDP)

10

Note: All dates are relative to the peak of the crisis, with periods referring to quarters before or after onset of crisis. Medians.

Earlier GFC

But in GFC, public recapitalisation much sooner (two quarters)

02468

1012141618

T-12 T-9 T-6 T-3 T=0 T+3 T+6 T+9 T+12

(%)

Solid lines: Introduction of recapitalisationprograms

Dashed lines: Introduction of liabilities guarantees

Earlier GFC

Liquidity support (In percent of GDP)

11

Note: All dates are relative to the peak of the crisis, with periods referring to quarters before or after onset of crisis. Medians.

And while private markets contributed more, thus lower initial fiscal costs, in GFCs public debt (countercyclical fiscal) and global costs (more severe crisis) were higher

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Cost of Past and Recent Crises(Medians, in percent of GDP)

0

10

20

30

40

50

Direct Fiscal Costs Increase in PublicDebt

Output Losses World Output Loss

(%)

Earlier GFC

Restructuring in GFC vs past were qualitatively similar, except for guarantees, DI and AMCs

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0%

20%

40%

60%

80%

100%Bank Holidays

Deposit Freezes

Increase in depositinsurance

Significantadditional

guarantees

All liabilitiesguaranteed

Asset guarantees

Asset Purchases

Nationalizations

BankRecapitalization with

Public Funds

Asset ManagementCompanies

Earlier GFC

Resolution is key. Less differentiation, less ‘conditionality’ ⇒ less deep restructuring Viability assessments limited ex-ante (too little time)

Stress tests ex-post, and of varying quality

Conditions for assistance limited

More/easier support to potentially non-viable institutions

(“open bank assistance”), little resolution feasible

‘Traditional’ restructuring tools much less used

Limited asset restructuring, eg mortgages

More reliant on flow measures and monetary policy 14

Lessons for deposit insurance in crises

Deposit insurance serves multiple goals for a single bank Prevent runs Protect depositors Ease resolution

Deposit insurance important too in systemic crises Prevent system-wide runs Help protect depositors as well as other creditors

- Eg leverage guarantees provision Ease resolution overall

- Build on experience

Lessons on deposit insurance in systemic crises More still to be learned, especially on resolution

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Edited by: Stijn Claessens, M Ayhan Kose, Luc Laeven and Fabián Valencia

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