Download Workshop on Financial Stability, Systemic Risk Assessment and

COMESA MONETARY INSTITUTE
Workshop on Financial Stability, Systemic Risk
Assessment and Macroprudential Policy
Kenya School of Monetary Studies
23 August - 1 September 2015
Workshop V: Crisis Resolution Simulation Exercise
Crisis Resolution Simulation Exercise
I.
Introduction
A crisis resolution simulation exercise is akin to a “war game” that simulates a series of
stressful, but realistic, scenarios and shocks, which require quick actions and decisions by
senior policy makers. The purpose of this exercise is to provide participants with essential
practical training (“learning by doing”) on the use of conceptually adequate, but rarely tested,
crisis-management arrangements. Participants will be expected to effectively and efficiently
resolve the failure of a domestic financial group in Country A.
II.
The Scenario
The exercise focuses on handling problems that emerged with a domestic financial and
commercial group that included the following entities:




The 7th largest bank, Eagleton Bank, which has also been identified as a systemically
important bank
Eagleton Bank’s funds management and broker/dealer subsidiary, Eagleton Financial
Services (EFS)
An insurance company owned by the individuals who own the bank, Moon Insurance
Company (MIC)
A property company owned by the same shareholders
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Eagleton Group
of Companies
100% locally owned
Alpha
Investments
Eagleton Bank
7th largest bank with about
10 % share of total bank
assets
Eagleton
Financial Services
An Eagleton Group property
company
Moon Insurance
Company
Has large deposits (own cash and
customers’ cash) in Eagleton Bank
Has large deposits in Eagleton
Bank
Member of the stock exchange
The Eagleton group of companies are 100 percent domestically owned and controlled.
Eagleton Financial Services is 98 percent owned by Eagleton Bank. Moon Insurance
Company is 100 percent owned by a Netherlands-based holding company which in turn is
owned by Eagleton Bank. At the onset of the simulation, Eagleton Bank is beginning to
experience funding problems.
In this financial system, the banking sector accounts for 80 percent of financial system assets,
the insurance sector 15 percent and the capital markets 5 percent. Specifically, there are 35
commercial banks, 12 insurance companies and 15 companies listed on the stock exchange
with 6 stock broker/dealer companies.
Country A is in the process of drafting a financial crisis resolution plan and has convened an
interim Crisis Management Team with the following regulatory authorities: the Ministry of
Finance (MOF), the Central Bank (CBA), the National Insurance Sector Regulator (NIR) and
the Capital Markets Regulator (CMR).
A. Issues with Eagleton Bank
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
Central Bank supervisors reported that, based on a new analysis of intra-group exposures
and the resulting need for higher loss provisions, the bank’s core capital ratio was around
6 percent.

The discovery of a capital deficiency at the Eagleton Bank was quickly followed by
indications of liquidity problems. CBA supervisors reported that the bank was
experiencing a decline in deposits and paying sharply higher interest rates, and that the
bank was exhausting its interbank credit lines. Also, the bank was increasingly tapping
the emergency liquidity facility at CBA, and that its remaining government securities
were all in illiquid longer maturities that were barely adequate to support its borrowings.

MOF was soon informed about a call received from the chairman and main shareholder of
Eagleton Bank requesting support for a possible request by the bank to CBA to be given a
reasonable period of time to raise additional capital. MOF also received a request from
local media to comment on whether the financial system was sound, or whether there
were problems that required the attention of the financial sector authorities.

Eagleton Bank’s situation continued to deteriorate. CBA supervisors reported that
interbank funding was drying up, and that rumours of the bank’s difficulties were driving
more customers away. CBA market operations staff reported that the bank had reached
the limits of its ability to borrow against government securities and its cash position with
the CBA was at the minimum required level. CBA supervisors then reported that they
could estimate that the bank’s capital had fallen below 4 percent.

Highlighting the institutions’ interconnectedness, MOF received an inquiry from a
journalist about a forthcoming article about the bank’s problems and their potential to
spread to affiliated financial institutions and requesting confirmation, for the record, of
what action MOF was taking.

Finally, on a Friday, after having exhausted its holdings of government securities to use
as collateral for further borrowings, Eagleton’s CFO informed CBA that it would require
extraordinary liquidity assistance (ELA) from CBA in order to be able to settle in the
RTGS the following Monday. The CFO asked what they needed to do to obtain liquidity
assistance, including what collateral CBA would accept, and requested the liquidity
assistance to be a long-term loan at market interest rates or lower.

With a decision on whether or not to grant ELA pending, CBA supervisors reported that
Eagleton’s capital had fallen to 1.2 percent of its risk-weighted assets. Given the rapidly
deteriorating condition of the bank, supervisory staff pressed for a resolution decision.

At this point the CBA Governor’s Office received a detailed inquiry from a journalist
stating that they heard CBA is considering intervening in Eagleton Bank, and asking what
steps CBA was going to take. Would CBA provide support even though the law was
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framed in order to facilitate pre-emptive measures and prevent a “bail-out” of troubled
institutions at taxpayers’ expense? On the other hand, if CBA closed Eagleton, would it
guarantee all deposits? How would depositors get paid? How would the Deposit
Protection Fund be replenished?

With need for a resolution of the situation all the group’s financial institutions pending,
Country A’s President’s office informed MOF that public funds should not be put at risk
in resolving Eagleton or any of its group companies. The office asked MOF to inform
CBA.
B. Issues with Eagleton Financial Services

CMR supervisors discovered that Eagle Financial Services (EFS) had improperly lent idle
cash in several large customer brokerage accounts to Alpha Investments, the property
company, and reported that booking the exposure on its own balance sheet would cause
EFS to be in violation of its exposure limit to affiliates.

CMR staff reported that EFS had substantial deposits in Eagleton bank (both its own and
customers’ funds).

CMR thought Eagleton may be on verge of failure, and EFS still had most of its deposits
and customer’s idle cash balances with the bank.

Since Eagleton Bank was the custodian for many of EFS’ client accounts, there was a
need to ensure that the securities in custody were safeguarded. Staff suggested the
possible need to revoke EFS’s license. Staff asked what to do about the customers. At
that time CMR received an inquiry from a journalist stating that they had heard that all of
EFS’s customer’s cash was in Eagleton Bank, asking if that cash being protected by the
CBA, and if not, was it covered by the Investor Protection Fund.
C. Issues with Moon Insurance Company

NIR supervisors discovered that Moon Insurance Company (MIC) had purchased real
estate from a group shareholder at an inflated price, and subsequently reported that
properly provisioning for the overvalued real estate would cause the insurer’s solvency
margin to fall below the 15 percent regulatory minimum.

NIR staff reported that MIC maintained large deposits at Eagleton bank.
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
NIR heard from its staff that Eagleton might fail, and that this might cause a significant
loss to MIC given its large deposits in the bank which might in turn cause the insurer to
breach its solvency requirement. As such, it would not be viable if Eagleton was closed.

NIR was informed by staff that Eagleton’s failure would undermine the viability of MIC
due to the loss of its deposits. While many MIC customers could be expected to switch to
other insurance carriers, some lines such as life insurance might be difficult to transfer
since the funds were depleted to some extent, and therefore there was a need to determine
what options NIR had in assuring the equitable treatment of policyholders and other
creditors. If Eagleton Bank were to fail, winding-up MIC would seem the only option.

NIR also received an inquiry from a journalist about the possible failure of MIC as a
result of a failure of Eagleton, and asking about the implications for policyholders. Who
would pay claims on their policies? Would they lose their insurance cover? Was there an
insolvency fund and if so what were the payments procedures?
III.
Questions
1. How should the regulators respond to the individual institutions’ problems, with respect
to capital and liquidity requirements, and improper transactions?
2. How are they coordinating responses across agencies?
3. How are they responding to stakeholders and the media?
4. Who makes the decisions?
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IV.
Financial Sector Regulations
A. Central Bank of Country A
1. Corrective Action
1.1.
If the Central Bank has reason to believe or finds that the affairs of the financial
institution are conducted in a manner detrimental to the interests of the depositors
or prejudicial to the interests of the financial institution the Central Bank will:
a) Order the financial institution to submit to the Central Bank a capital restoration
plan to restore the financial institution to capital adequacy
b) Enter into an agreement with the board of directors of the financial institution
requiring the financial institution to rectify its significant undercapitalisation
within 90 days, and to restore capital adequacy within 180 days, or within such
shorter periods as the Central Bank shall order
c) Initiate a legally binding cease and desist order, of either temporary or indefinite
duration requiring the financial institution and its management to:
i. stop the improper or unacceptable practice
ii. put a limit to lending
iii. stop any declaration of dividends
iv. suspension of the acceptance of new deposits
v. prohibition or suspension from any other activity that the Central Bank
perceives to be contributing to the liquidity strain in the financial institution
d) Appoint a person, suitably qualified and competent in the opinion of the Central
Bank, to manage the affairs of the financial institution for such period as shall be
necessary to rectify the problem
e) Require the financial institution to reconstitute its board of directors within such a
period as shall be specified
f) Withhold approvals on establishment of new branches
g) Withdraw the foreign exchange dealers’ licence
h) Require the financial institution to add such capital as may be specified
i) Require the directors or management of the financial institution to provide a
written explanation detailing the causes of those losses and the measures to be
taken by the financial institution to rectify the position and avert future losses
j) Restrict the rate of interest on savings and time deposits payable by the financial
institution to such rates as the Central Bank shall determine
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k) Impose any other sanctions as the Central Bank may deem appropriate in the
circumstances
1.2.
If the financial institution has failed to raise its capital to the levels necessary to
rectify its significant undercapitalisation, the Central Bank shall close the financial
institution and place it under receivership, or where the closure of the financial
institution would pose a systemic risk to the stability of the financial system, the
Central Bank shall take the financial institution into statutory management.
1.3.
The Central Bank shall upon taking over management of a financial institution
immediately inform the public.
1.4.
Where the Central Bank is of the opinion that the financial institution is not likely
to comply with prudential standards within a minimum period, the financial
institution is not likely to be able to meet the demands of its depositors or pay its
current obligations as and when they fall due, or the continued operation of the
financial institution would not be in the best interests of the depositors, the public,
or the financial sector, the Central Bank may at any time after taking over statutory
management, close the financial institution and place it under receivership.
1.5.
The Central Bank shall, within twelve months from the date of taking over as a
receiver, consider and implement any or all of the following options either singly
or in combination:
a) Arrange a merger with another financial institution
b) Arrange for the purchase of assets and assumption of all or some of the liabilities
by other financial institutions
c) Arrange to sell the financial institution
d) Liquidate the assets of the financial institution
1.6.
The Central Bank shall take the action which is most likely to result in marshalling
the greatest amount of the financial institution’s assets, protects the interests of
depositors including their interest in the unprotected deposit amounts, minimises
costs to the Deposit Protection Fund and losses to other creditors and ensures
stability of the financial sector.
1.7.
The following are the requirements for accessing the emergency liquidity
assistance:
a) The applicant will have automatic access to a loan where the amount applied for is
not more than 25 percent of the cash reserve requirement (CRR) of the
commercial bank for that maintenance period.
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b) Where the amount applied for is more than 25 percent of the commercial banks’
CRR, the Governor of the Central Bank uses his discretion to accept or reject the
loan application.
c) Eligible collateral for all borrowings is Government Treasury securities. The Bank
extends full face value of the funds applied for to the applicant customer against
Treasury Securities with less than 91 days to maturity or up to 75 percent of the
face value of the collateral instruments with days to maturity of 91 days or more.
d) The term of the loan shall not exceed three months.
e) The ELA loan will be charged interest at the prevailing Central Bank Rate.
2. Deposit Protection
2.1.
The money constituting the Deposit Protection Fund is contributed by all
supervised commercial banks and is placed in an account with the Central Bank.
2.2.
The Central Bank shall make payment of the protected deposit to customers after
ninety days of closure of the financial institution.
2.3.
Upon payment of a protected deposit the Fund shall be entitled to receive from the
financial institution or liquidator, an amount equal to the payment made by the
Fund on account of its subrogation to the claims of any customer or depositor.
B. Capital Markets Regulator
1. There is an Investor Protection Fund for the purposes of granting compensation to
investors who suffer pecuniary losses resulting from the failure of a licensed broker or
dealer to meet his contractual obligations. Monies which have accumulated in the
Protection Fund may be invested by the authority in such manner as may be
determined by the Regulator.
2. The Regulator may revoke the licence of a broker if:
i.
if it is being or will be wound up or dissolved
ii.
if it ceases to carry on the business for which it was licensed
iii.
if the authority has reason to believe that the licensed person or any of its directors
or employees, has not performed his duties efficiently, honestly or fairly
iv.
if the licensed person contravenes any conditions or restrictions applicable in
respect of the licence
C. National Insurance Sector Regulator
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1. Corrective Actions
1.1.
No insurance business may be merged with or transferred to the insurance business
of another insurer except with the permission of the Regulator.
1.2.
An insurer carrying on insurance business shall not be wound up voluntarily except
for the purposes of effecting a merger or transfer. The Regulator may wind up the
business of an insurer where the insurer has not complied with the prescribed paidup capital or security deposit requirements, or where the margin of solvency of the
insurer is less than the minimum requirement.
2. Deposit Protection
2.1.
There is a Policyholders’ Compensation Fund which is managed by a board of
trustees appointed by the MOF. The money of the Fund shall be used to
compensate the policyholders of an insolvent insurer up to 30 percent of their
policy.
2.2.
Every insurer shall hold an account maintained by the insurer for the purpose, a
security deposit of at least 10 per cent of the capital of the insurer. The deposits
shall be invested by the insurer in Government securities or any other investment
as may be approved by the Regulator. All income accruing from a deposit shall be
payable to the insurer making the deposit.
2.3.
In the event of closure or winding up of the insurance business, the security deposit
shall first be utilised for the discharge of any liabilities arising out of policies
transacted by the insurer which are undischarged at the time of closure or winding
up of the insurance business.
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