Banking Crisis and Instruments to Deal with Them: Bank Intervention and Resolution of Weak Banks

Topics: Fractional-reserve banking, Risk, Bank Pages: 6 (1916 words) Published: May 6, 2013
Banking Crisis and Instruments to Deal
With Them: Bank Intervention and
Resolution of Weak Banks

I. Introduction
Accounting for trillions in assets worldwide, the banking system is a crucial component of the global economy. The health of an economy and the health of the banks have been strongly correlated because of critical role of the banking system as a financial intermediation, payment system etc. So there could also be a situation that the problems not related to banking system can cause a problem for bank/banks and thatmay lead to the banking crisis in the country. In many respects, most banking crises are quite similar. Banks make increasingly risky lending decisions during economic expansions and fail to rein in their activities before a turn in the economy. Eventually businesses struggle during the downturn, fail to repay their loans, a few banks collapse and then depositors run to get their money out before their bank collapses. With the sudden outflow of money, banks curtain their lending activity, the business cycle continues to worsen, more loans go bad and more banks go bust. Banks are susceptible to many forms of risk which have triggered occasional systemic crises. These include liquidity risk (where many depositors may request withdrawals in excess of available funds), credit risk (the chance that those who owe money to the bank will not repay it), and interest rate risk (the possibility that the bank will become unprofitable, if rising interest rates force it to pay relatively more on its deposits than it receives on its loans). Generally there are many different solutions and actions that should have been taken during the crisis, such as liquidity support or policy changes, that will mostly prevent the crisis. But in this paper we will discuss how to deal with major issues in restructuring financial institutions and resolving bankrupt banks after a major crisis and the situation is more or less stable in banking system. But of course there is no unique solution of the banking problems such as recapitalization, as in the case of just recapitalization of the banks, which suffered of the bad risk management or bad governance which leads huge money to be wasted, will not resolve the situation with the profitability of bank or banks.

II. Regulatory Forbearance
Regulatory forbearance within this paper means a situation when banks during their operation violate the regulatory requirements, such as capital adequacy ratio, but are allowed to continue operating in a non-proper way for a while, with hope that after some period they will meet the requirements. Although regulatory forbearance can have some advantages, it can cause moral hazard. The people who are responsible for the bank to work in the improper, poor way are not being punished, for them to be more attentive and try to comply with the requirements or to pay more attention to the regulations, which can mean more respect to the state regulatory body. Also there may be some lack of competition, when some meet the requirement which causing expanses and some do not. The opponents of this policy argue that regulatory forbearance contradicts the implementation of the regulation at the time it is most needed (Honohan and Klingebiel 2002).The lack of enforcement of certain requirements can cause for weak banks to be involved into risky operations which itself can lead to more difficult situation. Also the resources used in weak bank can add more value in better managed banks, which can be another incentive not to violate the rules. Paper suggests for the regulators, in the case that some banks could increase the capital and can face the problems, there should be clear plan of meeting the requirements and should be strongly monitored by the regulators to avoid problems to have multiplicative effect, if the bank is failing while resolving the problem. III. The banks’ rising new capital

This is good but at the same time seems unrealistic during...

References: 1. Hoelscher, David S. And Quintyn Marc. Managing Systemic Banking Crises. Occasional Paper #224 IMF, 2003.
2. Hanson, James A. and Neyens Ruth L. “Achieving Results in Bank Lending for Bank Restructuring and Privatization,”.
3. Honohan, P., and Klingebiel, D. “Managing the Real and Fiscal Effects of Banking Crises, World Bank Discussion Paper # 428.
4. Caprio Gerard and Klingebiel Daniela. 2002. “Episodes of Systemic and Borderline Banking Crises.”
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