Research Primer: Options for Bank Restructuring
A new position paper* put together by the International Monetary Fund’s research department looks at the options for restructuring systemically important banks while minimizing the burden on taxpayers. The paper finds no magic bullet and concludes given the difficulties in arranging debt-for-equity swaps ,taxpayer involvement is inevitable.
“When designing a restructuring plan for a systemically important bank, a key issue is to limit transfers from taxpayers. Essentially, this involves avoiding unnecessary subsidies to debt holders and maximizing the economic value created by the restructuring.”
We find that there is no magic bullet.
Some of our key findings are the following.
- • In a framework in which cash flows are independent of capital structure, restructuring is theoretically possible by converting some debt into equity. This is, however, difficult in practice.
- • Without changing debt contracts, all restructuring involves transfers from the government. A plan subsidizing common equity issues and buying back debt is close to optimal. Subsidized asset sales are more costly to taxpayers, since debt holders benefit more.
- • The precise design of a restructuring should take into account the value created or destroyed because of changes in the participants’ behavior. Expertise and incentive of managers are concerns that should be addressed in restructuring.
- • If assets are undervalued as a result of liquidity or “lemons” problems, the government can make profits by buying assets above market value but below fundamental value. A caveat is that such undervaluation is difficult to assess.
- • Asymmetric information on the value of future payoffs makes equity holders reluctant to support restructurings involving new-claim issues. A restructuring impasse can be avoided through (1) conducting stress tests with credibly publicized results, (2) using compulsory rather than voluntary schemes, (3) providing contingent guarantees for banks to avoid new-claim issues, or (4) making banks issue low-information-sensitive claimssuch as convertible debt or preferred stocks.
“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.”
*The Economics of Bank Restructuring: Understanding the Options
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