Crisis Management: The Experience of the Federal Deposit Insurance Corporation and the Resolution Trust Corporation, 1980-1994

Author: None
Publisher:
Publishing Date: 2004-07-01
Features: The financial industry is the core of the modern market economy, and the healthy development of the financial industry is closely related to the healthy development of the entire society's economy. This point can be seen in both industrialized countries and emerging market countries through numerous theoretical discussions and practical cases. Since the 1980s, frequent banking crises have occurred internationally, leading to increasing attention being paid to the importance of banking crisis management both domestically and internationally. Comrades like Liu Shiyu and Wang Kejin have conducted in-depth theoretical research and long-term work experience on banking crisis management and have engaged in close communication and cooperation with experts from the U.S. Federal Deposit Insurance Corporation (FDIC). They have compiled and published the book "Crisis Management" by the FDIC in their spare time, which helps us fully understand the strategies and measures adopted by the FDIC and the Resolution Trust Corporation (RTC) in banking crisis management, the disposal methods for failed banks, their historical evolution, and the effectiveness and lessons learned from these strategies, measures, and methods. This translated work will play a crucially important role in helping China establish a banking crisis management mechanism suitable for its national conditions.
China's financial system is dominated by indirect financing. By the end of 2003, the total assets of China's banking financial institutions amounted to 2.76 trillion yuan, accounting for 95% of the total assets of all financial institutions in China. Since 2000, the ratio of M2 to GDP has shown a year-on-year increase, rising from 1.51 in 2000 to 1.89 in 2003. These two high ratios, while bringing great potential for the development of China's banking industry, also pose certain risks to the financing structure of the entire society. In fact, for a considerable period, due to the focus of reforms being on agriculture, state-owned enterprises, and the development of export-oriented economies, the banking industry was positioned to support these reforms, and the reform of establishing modern financial enterprises in the banking industry lagged behind. After the Asian financial crisis, the Chinese government took a series of measures to rectify the financial order, dispose of financial risks, and deepen financial reforms, including: appointing supervisory boards to state-owned key financial enterprises to strengthen financial supervision and performance evaluations; issuing 270 billion yuan in special treasury bonds to replenish the capital of state-owned commercial banks; establishing financial asset management companies to strip and dispose of non-performing loans from four state-owned commercial banks; closing a number of severely illegally operating and insolvent financial institutions to prevent the spread of payment risks; strengthening and improving financial supervision, implementing prudent accounting principles, a five-tier classification system for loan quality, and bank disclosure rules; and on the basis of deepening the comprehensive reform of state-owned commercial banks, exploring rural financial system reforms, and vigorously developing capital markets, expanding the pilot reform of rural credit cooperatives in 2003. By the end of 2003, two pilot banks were selected, with capital injections from foreign exchange and gold reserves to promote the shareholding reform and listing of state-owned commercial banks, and the pilot reform of state-owned commercial banks' shareholding transformation was officially launched according to the "one bank, one policy" approach.
The shareholding transformation of state-owned commercial banks aims to reform them into modern commercial banks with sustainable development capabilities and international competitiveness in accordance with the requirements of the modern enterprise system, through financial restructuring, internal reforms, particularly improving corporate governance structures and public listings. The pilot reform of rural credit cooperatives launched in 2003 emphasized combining the resolution of historical burdens, policy support, and mechanism transformation, with a focus on clarifying property rights, increasing capital and expanding shares, transforming operational mechanisms, and improving corporate governance structures. This is an excellent starting point. Only by establishing and improving financial institutions and laying a healthy microfoundation for the financial industry can macroeconomic policies be effectively implemented, and the stable development of the financial industry can be ensured.
It is worth noting that China's economy simultaneously has the dual characteristics of a "transitional economy" and an "emerging market," making banking crisis management in China more challenging. Therefore, China must urgently establish a market-based banking crisis management mechanism suitable for its national conditions. In this regard, we have already accumulated some successful experiences and lessons worth reflecting on. In the past, the disposal of problem financial institutions was mostly handled through rescue measures, with administrative dissolution (closure) or bankruptcy being adopted only for severely insolvent institutions in payment crises with no hope of rescue. While rescue measures can maximize the protection of depositors' interests and minimize negative impacts, they also give rise to serious moral hazard. Relying primarily on central bank resources to dispose of failed financial institutions not only weakens the central bank's financial control capabilities but also directly or indirectly leads to inflation. Additionally, the lack of sound laws and regulations related to the market exit and liquidation of financial institutions, coupled with the absence of specialized liquidation agencies, has led to the protracted and difficult liquidation of administratively dissolved (closed) financial institutions. In the future, it is essential to establish a deposit insurance system suitable for China's national conditions, with deposit insurance companies performing the functions of deposit insurance and bank liquidation. Learning from successful international experiences, we should also explore and leverage the role of asset management companies in banking crisis management.
In 1999, China established four asset management companies, specializing in acquiring, managing, and disposing of non-performing assets of state-owned commercial banks. Practice has proven that this is a beneficial attempt by China to establish a market-based mechanism for disposing of failed financial institutions. In the future, how to further enhance the role of asset management companies in China's banking crisis management is a major theoretical and practical issue that requires further research and exploration by all parties. From the successful experiences of other countries, it is necessary to establish and develop China's asset market, further enhance the functions of asset management companies, enrich their asset disposal methods, improve the external environment for disposing of non-performing bank assets and the market exit of financial institutions, perfect the organizational structure and operational mechanisms of asset management companies, and explore ways to utilize foreign capital to dispose of China's non-performing assets.
In the aforementioned aspects, the book "Crisis Management" compiled by the U.S. Federal Deposit Insurance Corporation can provide certain insights for China's banking crisis management. This book is a crystallization of the experiences of the U.S. Federal Deposit Insurance Corporation and the Resolution Trust Corporation in banking crisis management since the 1980s. The banking and thrift industry in the U.S. faced a severe financial crisis in the 1980s, the most serious since the Great Depression of 1929-1933. During this period, a total of 9,755 banks were closed, resulting in $1.4 billion in depositor losses. From 1980 to 1994, 1,617 banks participating in the federal deposit insurance program (with a total assets of $302.6 billion) were either closed or assisted by the Federal Deposit Insurance Corporation; at the same time, 1,295 thrift institutions (with a total assets of $621 billion) were either closed by FSLIC or RTC or assisted by FSLIC. The disposal methods for failed banks and thrift institutions mainly included three types:
1. Purchase and Assumption Transactions (PA): Healthy institutions purchased part or all of the assets of failed banks or thrift institutions, at least assuming all deposits covered by the deposit insurance or all deposit-type liabilities. From 1980 to 1994, among the 1,617 problem and failed institutions handled by the Federal Deposit Insurance Corporation, 1,188 (73.5%) were resolved through this method; among the 747 institutions handled by RTC, 497 (66.5%) were also resolved through this method.
2. Deposit Payoffs: This involved direct cash compensation to preserved deposits when no buyer could be found or when the bidding cost for PA transactions was too high. Generally, small banks were more likely to adopt the cash compensation method when they failed. When handling cash compensation, other financial institutions did not bear liabilities or purchase assets. The Federal Deposit Insurance Corporation or RTC directly compensated preserved depositors of failed banks, or compensated preserved deposits through healthy institutions acting as agents for the Federal Deposit Insurance Corporation or RTC (i.e., "transfer of preserved deposits"). The Federal Deposit Insurance Corporation handled 18.3% of institutions through this method; RTC handled 12.3%.
3. Open Bank Assistance (OBA): This involved providing financial assistance to institutions still operating but not yet closed, including loans, donations, deposits, asset purchases, or liability assumption, and creating conditions and opportunities for the institution to quickly regain viability or for its assets to be effectively taken over by the private sector. In practice, the Federal Deposit Insurance Corporation did not frequently use the OBA method to handle problem institutions, as it could only provide OBA transactions when it deemed the institution should continue to operate and its continued existence was "necessary" for the banking services provided to the local community. The Federal Deposit Insurance Corporation used OBA transactions in only 8.2% of cases.
In terms of the assets disposed of, among the approximately $705 billion in total assets handled by the Federal Deposit Insurance Corporation and RTC, about $305 billion were disposed of completely during the processing procedures, while the remaining $4 billion were resolved through other methods, including auctions and sealed-bid sales, securitization, equity partnerships, the use of asset management contracts, forbearance programs, income maintenance agreements, net worth certificates, the implementation of bridge banks/conservatorships, branch breakups, and manager liability claims. The successful experience of RTC and the Federal Deposit Insurance Corporation in disposing of assets demonstrates that, without affecting the local market environment, assets should be disposed of quickly to maximize "clean-up recovery" and maintain "consistency in disposal policies," thereby preserving public confidence in the banking system during crises, reducing the economic and social costs of crisis disposal, and maintaining the stability of the banking system.