SUPERVISORS VS ECONOMIC POLICY-MAKERS T HE B EHAVIOUR OF B ANKS T OWARDS F INANCIALLY D ISTRESSED D EBTORS AND THE R EGULATORY F RAMEWORK European Central Bank 27 January 2016 Prof. Dr. Ignacio Tirado, LLM Universidad Autónoma de Madrid European Banking Institute
OUTLINE • Introduction • Ex Ante Effect of Insolvency Systems • The Internal Management of Loans • The Taxonomy of Lending • Regulatory Rules
INTRODUCTION • Focus: banks as creditors. Other side of coin of NPLs 1) Adequate Institutional Framework • 3 Assumptions: 2) Adequate Level of Information 3) No Extraordinary Time (Crisis) AIM: To Preserve Value by Rescuing Viable Business Without Undermining the Banking Sector Viability: Objective Viability of Business (without debt) [ Value higher than piecemeal liquidation ] External Factors Considered
THE EX ANTE EFFECT OF THE INSOLVENCY SYSTEM THE PROTECTION OF BANKS IN A WAY CONSISTENT WITH RESCUE PROCEEDINGS
EX ANTE –DESTRUCTIVE- PROTECTION MECHANISMS • The Set-Up: – Several Loans with Cross-Default Clause – Covenants: Information/Solvency Ratio/Negative Pledge, etc. – Acceleration by Default of Any – Automatic Acceleration by Pre-Inso/Inso petition • Acceleration Death of Business n If Viable • Ordinary Measures: Ban on Ipso Facto Clauses – Not enough – Analysis of Acceleration based on some Covenants (info, etc.) – The Solvency Ratio Covenant • Mechanisms create bad incentives
POSSIBLE SOLUTIONS • Controlled Implementation of Directive on Financial Collateral • Codes of Conduct • Effective Supervision and Implementation of CoC • Adequate Insolvency Position for Banks, to Discourage Value-destructive Moves – Absolute Priority Over Collateral – Highest Ranking for Post-Commencement Finance (including finance provided in Workouts) – Limitation of Unjustified Priorities over Unsecured Lending (esp. Public Claims)
INTERNAL MANAGEMENT OF DISTRESSED LOANS
Internal Loan Management • Different Internal Structures. Most common: – (Simplified): Concession/Management + Recovery – (Expanded): C/M + Turnaround Division + Recovery • Problems: – Ex.: RBS The Tomlinson Report – Different Objectives: Short Term vs Future Business – Insufficient Communication – Sometimes absence of Objective Decision-Maker. The importance of the “intermediate section”. “Separation” of origination from turnaround/recovery – The problem of adequate staffing (with adequate skills)
More on Distressed Debt Management • Recovery: Externalization of Loan Management – Tendency to favour short-term/narrow approach – Dependent on level of autonomy: • Reporting Duties Risk of Mismanagement • Reporting to Correct Internal Department (not only Recovery) • Sale of the Portfolio: – Price ≥ Value x Probability of Recovery – Cost of Mangm. – Sales tend to reduce drastically chances of debtor rescue – Acquirer has no incentive to restructure/No capacity – Sale should be limited to piece meal cases, unless, on case by case basis, to Distressed Debt Fund/Private Equity
SOME SOLUTIONS • Supervisor´s control over adequate structure + adequate resources • Client segmentation and appropriate NPL management. Special structure for (M)SME • Bank´s internal complaints department strengthened and independent • Financial Sector Ombudsman
TYPES OF DEBT, TYPES OF BEHAVIOUR SECURED VS UNSECURED/FIXED VS FLOATING
How Do Banks Lend? • (a) Lending based in viability of project vs (b) collateral- based lending • (a) “on the books”; (b) much more common • (b) Behaviour depends on type of security: – (b.1) Fixed Recovery: Passivity. No incentive to rescue • C ≥ Loan: Reconcile different incentives Comm. /Loan M. Incentive to rescue.Future business • C ≤ Loan Incentive to Rescue - (b.2) Floating/Equivalent Incentive to Rescue The Supervisor´s Approach is Key in this Matter • System of appraisers also key. Need to avoid conflict
Specific Problems of (M)SME lending • Smaller loans Banking Passivity – Soft Law: Codes of Conduct – Hybrid Instruments: Sanctions for Passivity • Personal Guarantees – Can be good to reduce debtor moral hazard, but … – Abuse undermines entrepreneurial activity – Balance needs to be achieved Good Discharge System + Adequate Supervision
THE REGULATORY FRAMEWORK THE EFFECT OF PROVISIONING AND OTHER REGULATORY NORMS ON BANK BEHAVIOUR TOWARDS DISTRESSED DEBTORS
BANKS AS CREDITORS VS BANKS AS DEBTORS * Not provisioned, more open to negotiate • High Influence * Provisioned: Incentive to Sell P.; lack of interest to pursue credit, unless … • Adequate system of reclassification -Objective Justification. Granular Analysis -External Appraisers? -Problem of Cost for (M)SMEs • The Supervisor´s Dilemma: Regulatory Forbearance vs Evergreening • Other elements to consider: -Rules that ban financing to distressed debtors; - Rules that limit asset holdings; -Tax rules
Thank You Contact: ignacio.tirado@uam.es
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