Financial Sector Strategies For Public Financial Managers

Miami, Florida May 2009

Paul A. Leonovich Associate Director Banking & Financial Services

United States Department of the Treasury Office of Technical Assistance

OTA MISSION

Strengthen public financial management and financial institutions in developing and transition countries

The International Financial Crisis Country Impacts and Appropriate Policy Responses to Systemic Banking Crises

The Perfect Storm World Financial Crisis & Global Economic Recession

The International Financial Crisis First Order Effects  Freezing up of credit on the international capital markets and within domestic banking systems;  Burgeoning default rates on loans;  Difficulty in rolling over domestic and external debt;  Widening fiscal deficits;  Emerging widespread bank failures; and  Devaluating currencies.

The International Financial Crisis Regions Impacted  Western Europe  Asia  United States  Emerging Europe  Latin America and the Caribbean  Southeast Asia  Greater Middle East

The Global Economic Recession Second Order Effects  Enterprise failures;  Rising unemployment;  Falling levels of GDP/Economic contraction; and  Pervasive economic hardship.

The Global Economic Recession Regions Impacted  All

The International Financial Crisis

What has brought us to this point?

The International Financial Crisis

Failures in risk management

The International Financial Crisis Three Catalysts Excessive levels of investment capital Elevated investor expectations Sustained global economic growth

The International Financial Crisis The Liquidity Driver Altered traditional bank funding streams Unmanageable currency mismatches Deterioration of lending practices

The International Financial Crisis The Asset Price Driver Healthy (i.e. excessive) performance Elevated housing prices in multiple markets Lack of appreciation for cyclicality of the sector Overexposure by lenders Fundamentally different from previous downturns

The International Financial Crisis Balance Sheet Driver Excessive leveraging Increasingly crowded environment Assets moved off balance sheet (complex new instruments: CDOs, CDSs) Inadequate regulatory capital provision Segregation of incentives Reputational risk aspect underestimated

The International Financial Crisis Growth Driver Rapid asset expansion Higher risk profile of lending in numerous markets Insufficient institutional capacity

The International Financial Crisis

The Result

The International Financial Crisis Vicious Downward Spiral Asset price deflation Locking up of credit markets (both consumer and commercial) Crisis of confidence, especially between banks

The International Financial Crisis

Where do we go from here?

Road Forward Improved Application of Regulatory Standards Renewed focus on the Basel Core Principles Efforts to Strengthen risk-based supervision Adherence to Safety & Soundness principles Proper assignation of risk Cyclical alignment of capital adequacy standards Use of prompt corrective actions Holistic supervisory approach Use of statistical early warning systems

Road Forward Problem Bank Resolution Approaches Established best practices  Early intervention  Market-based approaches optimal  Replace bank management  Recapitalization by government only after full diagnostic of bank viability established  Carve out bad (“toxic”) assets if market is viewed to be unrecoverable in near-medium term

Road Forward Problem Bank Resolution Approaches Mergers & Acquisitions (M&A) Good Bank/Bad Bank solutions Bridge Banks Purchase & Assumption Transactions (P&As) Problem Bank Units (PBUs)

Road Forward Role of Central Banks Easing of monetary policy Exchange rate challenges Avoiding deflation Need for sound end game strategy Even once the recovery takes hold, it will be hard to detect the improvement

Road Forward Role of Governments Fiscal stimuli Social safety net provision Need for exit strategy

Thank You

Paul A. Leonovich Associate Director for Banking & Financial Services United States Department of the Treasury International Affairs - Office of Technical Assistance 740 15th Street, N.W., 4th Floor Washington, D.C. 20005 Email: [email protected]