This IMF report should be required reading for every policy maker, indeed every citizen with an interest in policy questions. The IMF manages to survey all the main policy options and describes all the main tricks of the trade. If you want to make sure you understand the key options in bank restructuring, this is a great place to start. Good too as a refresher.
The report is written in plain English, and very pedagogical. The text is only just 32 pages long. It can be read I think with no prior knowledge of finance.
The report indeed is too short, and falls short of any direct criticism of past policies. The reader has to draw his or her own conclusions. The IMF remains as diplomatic as ever.
The report is in particular geared towards understanding how best to limit transfers from taxpayers to private interests. That ought to have been, and has to be, the Numbr One policy issue for many western governments today, and Ireland chief among them. That is also what the IMF is being asked to advised governments on nowadays.
The answer? “Essentially, this involves avoiding unnecessary subsidies to debt holders and maximising the economic value created by the restructuring”.
However… “We find that there is no magic bullet.”
Yet, “A plan subsidising common equity issues and buying back debt is close to optimal”.
In the case of banks such Anglo etc…I’d qualify that by adding “buying back debt at close to zero prices”.
The beauty of the report is that it gives a framework to compare different options.
There is however no easy way out of jail…. “we find that the best course for a government is to combine several restructuring options to solve the multifaceted problems.” “The best overall strategy involves both asset- and liability side interventions.”
Beware a guarantee. For one “it over insures the high-quality banks as in recapitalisation cases
Beware NAMA… “Subsidised asset sales are more costly to taxpayers, since debt holders benefit more”.
The IMF also argues “Restructuring a systemically important bank is likely to bring aggregate economic gains”. I am rather sceptical. The issue in part revolves around what a systemically important bank is. Small niche boutiques would not enter into the category. Not unless you thought there could be implications for euros flowing out.
I know nothing about such risks. The IMF however pleads for more openness and transparency from policymakers.
Management is another big issue for the IMF. “Bank restructuring, particularly asset sales, should involve some form of public-private partnership”. “One way to select managers in a transparent and efficient way is to auction off the management contracts to a predetermined group of professional investors who meet certain standards of quality.” I might have missed something. But I have not heard of any such policies in Ireland.
Some of the other advice could also be taken on board immediately by the present Irish government …
“the costs to taxpayers and the final beneficiaries of the subsidies should be more transparent in all plans. Treatment of managers and shareholders could be less favourable.”
Yes indeed. It is absolutely imperative that the costs to the taxpayer are reduced. I am not sure, in 2010 or beyond, that the IMF, the EU or any other body or state will have any money left in the kitty to rescue taxpayers drawn into the maelstrom.
This report thus will help make governments think a little bit harder about the long term consequences of their support for bank creditors.
The report might even help limit future calls on IMF funds. Particularly so if informed citizens and the opposition can rally together and not the country’s future be dictated by bad policy making and / or interest groups.
———————————————————————
And if you really can’t be bothered to open the pdf, here is the SUMMARY:
Based on a simple framework, this note clarifies the economics behind bank restructuring and evaluates various restructuring options for systemically important banks.
The note assumes that the government aims to reduce the probability of a bank’s default and keep the burden on taxpayers at a minimum. The note also acknowledges that the design of any restructuring needs to take into consideration the payoffs and incentives for the various key stakeholders (i.e., shareholders, debt holders, and government).
If debt contracts can be renegotiated easily, the probability of default can be reduced without any government involvement by a debt-for-equity swap.
Such a swap, if appropriately designed, would not make equity holders or debt holders worse off. However, such restructurings are hard to pull off in practice because of the difficulty of coordinating among many stakeholders, the need for speed, and the concerns of the potential systemic impact of rewriting debt contracts.
When debt contracts cannot be changed, transfers from the taxpayer are necessary.
Debt holders benefit from a lower default probability. Absent government transfers, their gains imply a decrease in equity value. Shareholders will therefore oppose the restructuring unless they receive transfers from taxpayers.
The required transfer amounts vary across restructuring plans.
Asset sales are more costly for taxpayers than asset guarantees or recapitalisations. This is because sales are not specifically targeted to reduce the probability of default. Guarantees or recapitalisations affect default risk more directly. Transfers can also be reduced if the proceeds of new issues are used to buy back debt.
Depending on the options chosen, restructuring may generate economic gains. These gains should be maximised.
Separating out bad assets can help managers focus on typical bank management issues and thereby increases productivity. Because government often lacks the necessary expertise to run a bank or manage assets, it should utilise private sector expertise. Low up-front transfers can help prevent misuse of taxpayer money. Moreover, the design of bank managers’ compensation should provide incentives to maximise future profits.
If participation is voluntary, a restructuring plan needs to appeal to banks.
Bank managers often know the quality of their assets better than the market does. This means banks looking for new financing will be perceived by the market to have more toxic assets and, as a result, face higher financing costs. Banks will therefore be reluctant to participate in a restructuring plan and demand more taxpayer transfers. A restructuring that uses hybrid instruments—such as convertible bonds or preferred shares— mitigates this problem because it does not signal that the bank is in a dire situation. In addition, asset guarantees that are well designed can be more advantageous to taxpayers than equity recapitalisations. A compulsory program, if feasible, would obviously eliminate any signalling concerns. Information problems can also be mitigated if the government gathers and publicises accurate information on banks’ assets.
In summary, systemic bank restructuring should combine several elements to address multiple concerns and trade-offs on a case-by-case basis.
In any plan, the costs to taxpayers and the final beneficiaries of the subsidies should be transparent. To forestall future financial crises, managers and shareholders should be held accountable and face punitive consequences. In the long run, various frictions should be reduced to make systemic bank restructuring quicker, less complex, and less costly.
@ Ciarán O’Hagan
What a great summary! And I like the criticisms of the government too. You have saved me the effort of reading yet more bs from the IMF.
Thanks!
Very good post Ciaran. Do you think former Ballymore Properties Ltd director and economist Dr Bacon has adequate experience solving banking crises? I’ve tried google but the closest I got was a sandwich called “Crouching Tiger, Hidden Bacon”. It costs ¥6, considerably less than €90bn.
3 replies on “IMF on bank restructuring”
This IMF report should be required reading for every policy maker, indeed every citizen with an interest in policy questions. The IMF manages to survey all the main policy options and describes all the main tricks of the trade. If you want to make sure you understand the key options in bank restructuring, this is a great place to start. Good too as a refresher.
The report is written in plain English, and very pedagogical. The text is only just 32 pages long. It can be read I think with no prior knowledge of finance.
The report indeed is too short, and falls short of any direct criticism of past policies. The reader has to draw his or her own conclusions. The IMF remains as diplomatic as ever.
The report is in particular geared towards understanding how best to limit transfers from taxpayers to private interests. That ought to have been, and has to be, the Numbr One policy issue for many western governments today, and Ireland chief among them. That is also what the IMF is being asked to advised governments on nowadays.
The answer? “Essentially, this involves avoiding unnecessary subsidies to debt holders and maximising the economic value created by the restructuring”.
However… “We find that there is no magic bullet.”
Yet, “A plan subsidising common equity issues and buying back debt is close to optimal”.
In the case of banks such Anglo etc…I’d qualify that by adding “buying back debt at close to zero prices”.
The beauty of the report is that it gives a framework to compare different options.
There is however no easy way out of jail…. “we find that the best course for a government is to combine several restructuring options to solve the multifaceted problems.” “The best overall strategy involves both asset- and liability side interventions.”
Beware a guarantee. For one “it over insures the high-quality banks as in recapitalisation cases
Beware NAMA… “Subsidised asset sales are more costly to taxpayers, since debt holders benefit more”.
The IMF also argues “Restructuring a systemically important bank is likely to bring aggregate economic gains”. I am rather sceptical. The issue in part revolves around what a systemically important bank is. Small niche boutiques would not enter into the category. Not unless you thought there could be implications for euros flowing out.
I know nothing about such risks. The IMF however pleads for more openness and transparency from policymakers.
Management is another big issue for the IMF. “Bank restructuring, particularly asset sales, should involve some form of public-private partnership”. “One way to select managers in a transparent and efficient way is to auction off the management contracts to a predetermined group of professional investors who meet certain standards of quality.” I might have missed something. But I have not heard of any such policies in Ireland.
Some of the other advice could also be taken on board immediately by the present Irish government …
“the costs to taxpayers and the final beneficiaries of the subsidies should be more transparent in all plans. Treatment of managers and shareholders could be less favourable.”
Yes indeed. It is absolutely imperative that the costs to the taxpayer are reduced. I am not sure, in 2010 or beyond, that the IMF, the EU or any other body or state will have any money left in the kitty to rescue taxpayers drawn into the maelstrom.
This report thus will help make governments think a little bit harder about the long term consequences of their support for bank creditors.
The report might even help limit future calls on IMF funds. Particularly so if informed citizens and the opposition can rally together and not the country’s future be dictated by bad policy making and / or interest groups.
———————————————————————
And if you really can’t be bothered to open the pdf, here is the SUMMARY:
Based on a simple framework, this note clarifies the economics behind bank restructuring and evaluates various restructuring options for systemically important banks.
The note assumes that the government aims to reduce the probability of a bank’s default and keep the burden on taxpayers at a minimum. The note also acknowledges that the design of any restructuring needs to take into consideration the payoffs and incentives for the various key stakeholders (i.e., shareholders, debt holders, and government).
If debt contracts can be renegotiated easily, the probability of default can be reduced without any government involvement by a debt-for-equity swap.
Such a swap, if appropriately designed, would not make equity holders or debt holders worse off. However, such restructurings are hard to pull off in practice because of the difficulty of coordinating among many stakeholders, the need for speed, and the concerns of the potential systemic impact of rewriting debt contracts.
When debt contracts cannot be changed, transfers from the taxpayer are necessary.
Debt holders benefit from a lower default probability. Absent government transfers, their gains imply a decrease in equity value. Shareholders will therefore oppose the restructuring unless they receive transfers from taxpayers.
The required transfer amounts vary across restructuring plans.
Asset sales are more costly for taxpayers than asset guarantees or recapitalisations. This is because sales are not specifically targeted to reduce the probability of default. Guarantees or recapitalisations affect default risk more directly. Transfers can also be reduced if the proceeds of new issues are used to buy back debt.
Depending on the options chosen, restructuring may generate economic gains. These gains should be maximised.
Separating out bad assets can help managers focus on typical bank management issues and thereby increases productivity. Because government often lacks the necessary expertise to run a bank or manage assets, it should utilise private sector expertise. Low up-front transfers can help prevent misuse of taxpayer money. Moreover, the design of bank managers’ compensation should provide incentives to maximise future profits.
If participation is voluntary, a restructuring plan needs to appeal to banks.
Bank managers often know the quality of their assets better than the market does. This means banks looking for new financing will be perceived by the market to have more toxic assets and, as a result, face higher financing costs. Banks will therefore be reluctant to participate in a restructuring plan and demand more taxpayer transfers. A restructuring that uses hybrid instruments—such as convertible bonds or preferred shares— mitigates this problem because it does not signal that the bank is in a dire situation. In addition, asset guarantees that are well designed can be more advantageous to taxpayers than equity recapitalisations. A compulsory program, if feasible, would obviously eliminate any signalling concerns. Information problems can also be mitigated if the government gathers and publicises accurate information on banks’ assets.
In summary, systemic bank restructuring should combine several elements to address multiple concerns and trade-offs on a case-by-case basis.
In any plan, the costs to taxpayers and the final beneficiaries of the subsidies should be transparent. To forestall future financial crises, managers and shareholders should be held accountable and face punitive consequences. In the long run, various frictions should be reduced to make systemic bank restructuring quicker, less complex, and less costly.
@ Ciarán O’Hagan
What a great summary! And I like the criticisms of the government too. You have saved me the effort of reading yet more bs from the IMF.
Thanks!
Very good post Ciaran. Do you think former Ballymore Properties Ltd director and economist Dr Bacon has adequate experience solving banking crises? I’ve tried google but the closest I got was a sandwich called “Crouching Tiger, Hidden Bacon”. It costs ¥6, considerably less than €90bn.