12 April 2011

Øystein Olsen: Ensuring financial stability in turbulent times

•  Even with a sound, long-term framework, situations will arise where a crisis management system is needed. Such a system is also important for preventing crises. With a credible crisis management system, a bank can continue providing key banking services when it encounters problems, while the owners and unsecured creditors bear the losses. This is the most important instrument we have to counter moral hazard in the financial system.
• The system for crisis management in Norway was never put to the test during the financial crisis. International experience nevertheless suggests that changes to the Norwegian system should be made in order to improve it and enhance its credibility. Banks should be required to draw up plans for winding up operations without putting financial stability in jeopardy. For it to be credible, banks must have transparent group structures. In addition, clear rules should be introduced to define when the authorities are to intervene and apply the crisis resolution tools in a problem bank. This must occur before the problems in a bank become so serious that it can no longer operate without external recapitalisation.
• The authorities must have instruments that can be applied rapidly in such an early intervention. In some countries the authorities already have the option of splitting up a bank and subsequently selling it in parts, or the option of transferring vital parts to a bridge bank for continued operation. A newer instrument in the international debate is what is called internal recapitalisation – or bail-in. Internal recapitalisation means in principle that debt is converted into equity capital. This can provide a basis for the bank to continue operating.

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