World Bank Dealing with weak banks in FinSAC countries: progress and challenges ahead 2024 Dealing with weak banks in FinSAC countries: progress and challenges ahead CONTENTS ABBREVIATIONS AND ACRONYMS ................................................................................................ 4 Executive Summary...................................................................................................................... 5 1. Introduction ................................................................................................................... 11 2. Scope of the paper .......................................................................................................... 13 3. Key financial and regulatory features of FinSAC client countries’ financial systems ........... 20 4. Measures undertaken by banks and supervisory authorities to mitigate and overcome distress ...................................................................................................................................... 29 4.1. Recovery planning and execution ............................................................................................. 29 4.2. Early detection and dealing with weak, but viable banks......................................................... 33 4.3. Managing financial stress.......................................................................................................... 35 5. Managing banking crises in systemic scenarios ................................................................ 42 5.1. Context and explanation ........................................................................................................... 42 5.2. What is the true extent of the losses? ...................................................................................... 42 5.3. An independent valuation ........................................................................................................ 47 5.4. Loss coverage: who foots the bill? ............................................................................................ 48 5.5. Availability of resolution tools in crisis scenarios ..................................................................... 51 5.5.1. Transfer Transactions.................................................................................................... 51 5.5.2. Bridge bank transactions .............................................................................................. 59 5.5.3. Open bank resolution using bail-in powers .................................................................. 60 5.6. The need for public backstops .................................................................................................. 64 5.7. Dealing with asset quality ......................................................................................................... 65 5.8. Funding in resolution ................................................................................................................ 70 5.9. The need for domestic and cross-border coordination ............................................................ 73 6. Recommendations .......................................................................................................... 75 7. References...................................................................................................................... 77 Annex 1: key recent AMCs .......................................................................................................... 80 Annex 2: key banking failures 2013-2023 .................................................................................... 83 Annex 3: banks ownership structure per country ........................................................................ 99 The Financial Sector Advisory Center (FinSAC), based in Vienna, was established in June 2011 as a follow-up mechanism of the Vienna Initiative. It is financed by the Austrian Government. FinSAC provides independent, confidential, and tailored financial stability expertise, technical advice, and implementation support covering macro and microprudential themes and issues related to bank failure to client countries in the Emerging Europe and Central Asia (ECA) region including European Union (EU) candidate and potential candidate countries (Albania, Bosnia and Herzegovina, Georgia, Kosovo, Moldova, Montenegro, North Macedonia, Serbia, and Ukraine) and EU neighborhood countries (including Armenia, Azerbaijan, and Uzbekistan). 2 Dealing with weak banks in FinSAC countries: progress and challenges ahead FIGURES Figure 1: Number of banks in FinSAC client countries in 2022 ............................................................. 20 Figure 2: Bank Ownership in FinSAC countries by asset share ............................................................. 21 Figure 3: Evolution of bank solvency ratios in FinSAC client countries (2012-2022)............................ 22 Figure 4: Evolution of bank return on assets ratios in FinSAC client countries (2012-2022) ............... 22 Figure 5: Evolution of bank NPL ratios of FinSAC client countries (2012-2022) ................................... 23 Figure 6: Resolution authorities in FinSAC client countries .................................................................. 25 Figure 7: Recovery options for FinSAC client countries: common measures in banks’ recovery plans (RP) ........................................................................................................................................................ 31 Figure 8: Selected cases of systemwide AQRs & viability assessments ................................................ 43 Figure 9: Stylized burden sharing models for open bank resolution .................................................... 50 Figure 10: Stylized burden sharing models for closed bank resolution ................................................ 51 Figure 11: Selected asset protection schemes/loss sharing agreements in transfer transactions ...... 55 Figure 12: Possible investors in transfers transactions: pros and cons ................................................ 58 Figure 13: Stylized high-level overview of applying bail-in powers to different creditors .................... 61 Figure 14: Options for dealing with bad assets in bank resolution ...................................................... 66 Figure 15: Selected asset protection schemes/loss sharing agreements in open bank transactions .. 67 Figure 16: Selected Asset Management Companies ............................................................................ 80 Figure 17: Selected cases of banking failures in the period 2013-2023 ............................................... 83 Figure 18: Albania ................................................................................................................................. 99 Figure 19: Armenia................................................................................................................................ 99 Figure 20: Azerbaijan .......................................................................................................................... 100 Figure 21: Bosnia and Herzegovina..................................................................................................... 101 Figure 22: Georgia ............................................................................................................................... 102 Figure 23: Kosovo ................................................................................................................................ 102 Figure 24: Moldova ............................................................................................................................. 103 Figure 25: Montenegro ....................................................................................................................... 104 Figure 26: North Macedonia ............................................................................................................... 104 Figure 27: Serbia ................................................................................................................................. 105 Figure 28: Ukraine ............................................................................................................................... 106 Figure 29: Uzbekistan.......................................................................................................................... 108 BOXES Box 1. Selected systemic banking crisis in Eastern European countries during the last decade .......... 16 Box 2. Resolution strategies and resolution entities in cross-border banking groups in FinSAC client countries ............................................................................................................................................... 25 Box 3. The failure of Sberbank Europe AG subsidiaries ........................................................................ 27 Box 4. Foreign ownership in crisis scenarios: pros and cons ................................................................ 31 Box 5. Quasi-resolution regimes: the International Bank of Azerbaijan .............................................. 35 Box 6. 2020-2021 Asset Quality Review in Montenegro ...................................................................... 46 Box 7. The pitfalls of acquisition by a troubled lender: Kazkommertzbank (KKB)................................ 57 Box 8. Bail-in: the case of PrivatBank in Ukraine .................................................................................. 62 Box 9. AMCs in selected countries ........................................................................................................ 68 Box 10. Capital controls used by Ukrainian authorities in 2014 ........................................................... 72 3 Dealing with weak banks in FinSAC countries: progress and challenges ahead ABBREVIATIONS AND ACRONYMS ABB International Bank of Azerbaijan AMC Asset Management Company AQR Asset Quality Review BAMC Bank Assets Management Company of Slovenia BCBS Basel Committee on Banking Supervision BiH Bosnia and Herzegovina BRRD Bank Recovery and Resolution Directive EBRD European Bank for Reconstruction and Development ECA Europe and Central Asia ELA Emergency Liquidity Assistance EU European Union EUR Euro FinSAC The World Bank Financial Sector Advisory Center FSB Financial Stability Board GDP Gross Domestic Product GFC Global Financial Crisis IMF International Monetary Fund KKB Kazkommertzbank NPL Non-Performing Loans PLF Problem Loans Fund of Kazakhstan SREP Supervisory Review and Evaluation Process ToR Terms of Reference UAH Ukrainian hryvnia UK United Kingdom US United States / United States of America USD United States dollar 4 Dealing with weak banks in FinSAC countries: progress and challenges ahead Executive Summary i. Key vulnerabilities in the banking systems of FinSAC client countries were exposed during the global financial crisis (GFC). Unrestrained loan growth in the run up to the GFC, fueled by wholesale and intragroup funding, especially in foreign currency, led to unsustainable business models. Once the crisis struck, banks faced rising levels of nonperforming loans (NPL) that required high loan loss provisions and had problems to fund their assets. Banks were forced to cut lending, resulting in deleverage, further losses, and recessionary pressures. Authorities, international financial institutions, and banks established the Vienna Initiative, with a firm commitment to never let this happen again. Since then, FinSAC client countries have implemented far-reaching reforms, following international and European Union (EU) standards, that are markedly improving the resilience of FinSAC banking sectors. ii. Authorities in FinSAC client countries 1 continue their preparations to manage systemic banking crises. Although there has not been a global systemic banking crisis since the GFC, bank failures have continued to happen during the last decade, as evidenced by cases in Azerbaijan, Bosnia and Herzegovina (BiH), Moldova, Montenegro, North Macedonia, Serbia, and Ukraine. In some of these countries, bank failures resulted in episodes of financial instability and systemic crisis, as illustrated by large banking failures in Ukraine (2013-2017), Azerbaijan (2015-2017), and Moldova (2014). Other countries in the broader ECA region have also gone through large systemic banking crises, including Kazakhstan (several crises’ episodes), Tajikistan (2015) and Russia (2015-2017). iii. The financial systems of most FinSAC client countries share some common features. They are bank-centric financial systems, with limited relevance of capital markets and insurance. Just a handful of banks (from 10 to 20) operate in FinSAC client countries, with elevated levels of foreign ownership. In Ukraine and Uzbekistan, state-owned banks hold high market shares. iv. In the last decade, most FinSAC countries have upgraded their prudential frameworks. They have upgraded prudential frameworks and reinforced standards on capital adequacy, liquidity and funding, credit risk classification and provisioning, corporate governance, and risk management. Reforms were driven by a willingness to tighten their regulatory regimes in line with new international standards and, in many cases, with the EU, as many FinSAC client countries are EU candidates. v. Banking sectors in FinSAC client countries have improved their financial situation in recent years. NPL ratios have been on a consistently downward path. Bank are operating with sound capital and liquidity levels, while they have also managed to improve their profitability. vi. Banks and authorities alike have stepped up contingency planning for crises. Banks in most FinSAC client countries are required to regularly prepare recovery plans, while resolution authorities are defining their resolution strategies to deal with non-viable banks. Most countries have also upgraded their toolkit for early intervention measures for weak, yet viable banks. vii. Banks in FinSAC countries face specific challenges when implementing recovery plans. First, shallow local capital markets and lack of access to international markets may render the issuance of bonds or shares, or the sale of assets, including loan portfolios, non-viable options. 1 Albania, Armenia, Azerbaijan, Bosnia and Herzegovina (BiH), Georgia, Kosovo, Moldova, Montenegro, North Macedonia, Serbia, Ukraine and, Uzbekistan. 5 Dealing with weak banks in FinSAC countries: progress and challenges ahead Second, the assessment of the financial capacity of shareholders is key, as any recovery plan is likely to require a hard financial commitment by the bank’s shareholders. Third, the recovery prospects of banks integrated in foreign banking groups usually depend on the support offered by parent companies, including share injections, intragroup loans, or guarantees. viii. Authorities should calibrate how foreign parent companies may decide to act in case of problems of their subsidiaries. As local subsidiaries in FinSAC client countries have become financially self-sufficient, the need for group support has decreased. Moreover, resolution planning approaches based on the identification of multiple resolution entities (or entry points) may reduce the likeliness of support by parents. Nevertheless, recent history shows very few examples of parent banks refusing to support their local subsidiaries in the region. ix. Critically, most FinSAC client countries have upgraded their frameworks to manage the failure of non-viable banks, following the Financial Stability Board’s (FSB) Key Attributes and the EU’s Bank Recovery and Resolution Directive (BRRD). Countries have introduced a new definition of non-viability as the key condition for applying the resolution framework. They have established independent resolution authorities, usually as separate units of central banks, with broad powers to implement closed or open bank resolutions. Moreover, FinSAC client countries have begun to introduce arrangements for ensuring the availability of resolution funding, including requirements for banks to issue loss-absorbing debt, setting up industry-financed resolution funds, and enabling deposit insurance funds to make contributions to bank resolution. Nonetheless, long implementation periods or lack of access to capital markets can significantly decrease the effectiveness of these arrangements in the short and medium term. x. The new framework was tested in early February 2022 by the failure of Sberbank Europe’s subsidiaries in BiH and Serbia. Following international sanctions against the Sberbank’s Europe, the liquidity of the firm’s subsidiaries quickly dried up, as depositors rushed to get their funds back. BiH and Serbia used their new resolution powers to swiftly transfer the shares of their local subsidiaries to other banks, effectively addressing any risks to financial stability. xi. To successfully prepare for managing bank failures in systemic scenarios, authorities may need to consider a broad range of exceptional actions. Doubts over asset quality and solvency can quickly spread, triggering systemic liquidity pressures. To counter them, authorities will need to take measures to underpin the liquidity of the banking sector. An effective, comprehensive emergency liquidity assistance (ELA) framework is essential to ensure the central provision of liquidity to banks. Once the situation has been stabilized, authorities will need to deal with solvency, restructuring and asset quality. xii. Comprehensive assessments, including asset quality reviews (AQR) and viability exercises, are essential to estimate the losses and the systemwide capital needs. A credible and well- managed assessment is the best tool for authorities to be able to separate viable banks from those that should be resolved or liquidated, and to determine the systemwide capital shortfall. These exercises should be technically sound, have a forward-looking nature, be transparent, and, if possible, be undertaken with the assistance or cooperation from internationally recognized firms. xiii. Resolution authorities in FinSAC client countries may face specific challenges when using their resolution powers in systemic crises. Authorities may, for example, struggle to find a 6 Dealing with weak banks in FinSAC countries: progress and challenges ahead suitable buyer in challenging financial conditions and need to consider buyers that they would be reluctant to admit in normal conditions, as more conventional buyers may be put off by asset quality or contingent liability risks, or by their own risk tolerance. Organizing a sale in stressed conditions may result in damaging leaks that can worsen the liquidity position of the firm and jeopardize the effective resolution of the failed firm. Transfers to third parties often need to be topped up to offset the negative asset value, as transferred liabilities are usually higher than the transferred assets. This top-up may be a contribution from an industry arrangement (deposit guarantee or resolution fund) or through the bail-in of certain liabilities. Several mechanisms can help mitigate these challenges. Systematic resolution planning can enable authorities to better understand the operational requirements of these transactions, especially when these are very infrequent. Granting loss-sharing agreements for asset portfolios or certain liabilities can encourage potential buyers to participate in the process. Writing off loss absorbing debt can contribute to offset any negative net asset value. xiv. Bridge banks are useful when there is not sufficient time to arrange a transfer to a third party. When bank failures are triggered by sudden liquidity crises, authorities may not have had sufficient time to organize a transfer to another entity. In these situations, setting up a bridge bank can buy time to find suitable buyers. But setting up a bridge bank is a complex process and authorities need to consistently and thoroughly prepare for it, striking a balance between its transitory nature and the need to ensure its financial viability. Authorities must determine the regulatory regime applicable to the bridge bank including prudential and corporate governance frameworks. They must also determine the sources of capital for the bridge bank. As transferred liabilities are usually larger than the transferred assets, an equity contribution may be required to absorb losses and to recapitalize the bridge bank. Furthermore, authorities should consider how the bridge bank would access funding if it cannot use private funding markets. There should also be a clear sunset clause set, to avoid the bridge bank becoming “a bridge to nowhere”. xv. There is limited regional experience of open bank transactions based on the use of bail-in powers. FinSAC countries are implementing resolution laws that give authorities the ability to write down or convert into shares certain liabilities. These powers are needed to implement open bank resolutions, which are expected to be key for managing systemic bank failures. Nonetheless, a sound legal framework alone is not enough for the effective use of bail-in powers. Few banks in FinSAC client countries have a liability structure that can support the exercise of bail-in powers, as few banks have issued loss-absorbing bonds. Emerging bank resolution experience provides evidence that recapitalization itself may not result in winning back trust from funding providers, as liquidity backstops are usually required to stabilize non- viable banks. Open bank resolution needs to be accompanied by a restructuring plan that should deal with the weaknesses that provoked the failure of the bank. To increase the resources available for successfully using bail-in powers, authorities can request that banks issue loss-absorbing debt instruments and set up industry-funded resolution funds. For better operational preparedness, authorities can demand that banks prepare bail-in playbooks, outlining the steps they would take to support bail-in implementation. Credible funding backstops in resolution can increase the credibility of open bank resolution. xvi. In a systemic scenario, the use of public money cannot be fully ruled out. The new resolution regimes introduced by FinSAC client countries seek to ensure that taxpayers’ money should always be the last resort when absorbing losses in bank resolution. Nonetheless, there might be situations where taxpayers’ funds may be required, as any other alternative (e.g., bail-in of 7 Dealing with weak banks in FinSAC countries: progress and challenges ahead deposits) may result in an unacceptable threat to the country’s financial stability. Before any public support, the amounts needed for loss absorption and recapitalization should be clearly quantified (ideally, through an AQR) and shareholders and certain debtholders should first absorb losses. The modalities for public support (e.g., capital injection, guarantees on assets or liabilities, extension of loans, etc.) should be clear, together with the reimbursement mechanism. When public support results in a bank’s partial or total nationalization, mechanisms to ensure that the bank is managed at arm’s length should be implemented. A restructuring plan should be approved and implemented as soon as possible, with the main goal of a quick privatization and ensuring its running as a commercial bank. Authorities should resist the temptation of using the nationalized banks as a development institution or as a policy instrument. xvii. A key element of banking failures is asset quality. Bank failures are usually triggered by low asset quality and high levels of NPLs. A large stock of NPLs is usually a significant obstacle for both closed and open bank resolutions. The inclusion of toxic assets in closed bank resolutions can complicate transactions, as buyers may be reluctant to assume them unless some guarantees are provided or may attach little value to them, resulting in very low offers. In open bank resolutions, doubts over asset valuations can make banks unable to raise funding in markets. Authorities can contemplate different options. First, the provision of asset protection schemes can facilitate both closed and open bank resolutions, as was evident during the 2023 US bank failures or the Credit Suisse state-assisted merger with UBS. Publicly owned and funded asset management companies (AMC) can be used to house the toxic assets from several failed banks, but this option is complicated by several factors, including its potential impact on sovereign debt sustainability, the operational complexities surrounding its establishment (including the determination of the scope of the transfer or the transfer prices), and the risk of political interference in its decision making. The use of AMCs has been very limited by FinSAC countries (only Azerbaijan), although some other countries in the ECA region have used this option (e.g., Kazakhstan, Slovenia, and Russia). xviii. The availability of funding is essential to overcome any banking crisis. During crisis situations, liquidity pressures and lack of access to funding markets requires central banks to act as lenders of last resort, usually through ELA. In FinSAC client countries, the performance of lender of last resort by central banks raises specific challenges. High dollarization of banking systems may require the provision of liquidity in foreign currency, quickly depleting a central bank’s currency reserves. Lack of acceptable collateral may require public guarantees on the loans by the central bank. In some countries, it may be complicated by the institutional framework (for example, a ban on central bank lending to banks, as is the case in BiH) or the lack of an own currency (Kosovo, Montenegro). Moreover, few FinSAC countries have adapted their lender of last resort facilities to their new bank resolution framework. In extreme, systemic crises, countries must be prepared to contemplate more drastic measures, such as increasing deposit insurance coverage, blanket guarantees, moratoria on certain liabilities, and, in very extreme cases, imposing long-lasting capital controls that restrict cash withdrawals or bank transfers, particularly in foreign currency. xix. As many FinSAC client countries are small host countries, cross-border coordination and cooperation are important, in both normal and stressed times. Local subsidiaries in FinSAC client countries are often systemic, yet very small in the context of banking groups they belong to. Home countries sometimes lack the incentives to actively coordinate with the small hosts, as the subsidiaries have a limited influence in the banking group’s consolidated risk profile. 8 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC authorities must therefore be proactive in establishing and maintaining constructive relationships with home authorities, actively pursuing participation in supervisory and resolution colleges, signing cooperation agreements, and engaging in regular, bilateral cooperation, including the discussion of recovery and resolution plans. Moreover, authorities in FinSAC client countries can benefit from “lateral coordination” with other host authorities within the same group and may organize or participate in cross-border resolution simulation exercises. Recommendation Recovery and Banks and resolution authorities should step up their efforts in recovery and resolution resolution planning. Through recovery planning, banks can regularly test the planning effectiveness of their crisis management arrangements with dry runs and simulation exercises. Supervisors can make further efforts to integrate their assessment of recovery plans into their overall supervisory framework through the assessment of banks’ recovery capacity. On resolution plans, after identifying the preferred resolution strategies, authorities should seek to involve banks in facilitating their resolvability, by issuing standards and regularly engaging with banks. During resolution planning, authorities should focus on the operational steps for implementing the key resolution tools, including transfer strategies, bridge banks, and open bank bail-in resolution. Authorities should closely involve banks in these processes, as the execution of the resolution tools would require their participation. Introduction of FinSAC countries without FSB Key Attributes-based new resolution new resolution frameworks should renew their efforts towards their introduction and regimes implementation. Setting up resolution authorities, conferred with broad resolution powers, can be instrumental in facilitating a failed bank’s orderly exit from the market, using either closed or open bank resolutions. Countries need to consider their burden sharing models for dealing with banking crises. In open bank resolutions, authorities should implement policies supporting the funding sources for absorbing losses and recapitalizing failed banks, including by considering the possibility of introducing minimum loss-absorbing requirements and setting up and financing resolution funds. For closed bank resolutions, authorities should consider the possibility of requesting contributions from the deposit insurance fund to top up the shortage of assets that is likely to arise in any resolution scenario. Effective lender of Most central banks in FinSAC client countries need to upgrade their ELA last resort frameworks. First, central banks in the region should coordinate their function, including exceptional liquidity arrangements with the new bank resolution framework. in resolution Second, central banks in highly dollarized economies need to consider how they may provide liquidity in foreign currency by, for example, entering into swap agreements with other central banks. Third, central banks should also operationalize their capabilities to provide liquidity against a broader range of high-quality collateral, including by improving their data processing and valuation capabilities. 9 Dealing with weak banks in FinSAC countries: progress and challenges ahead Recommendation Enhancement Authorities should improve their capabilities to address systemic crises. preparedness for Authorities in FinSAC countries should engage in resolution simulation systemic crises exercises, either domestic or cross-border. The exercises should include the active participation of all relevant authorities (e.g., central bank, banking supervisor, resolution authority, ministry of finance, deposit insurance agency, market supervisor, etc.). Small host FinSAC client countries should step up their efforts in cross- border coordination and cooperation. As small hosts may not receive much attention from home authorities, FinSAC small hosts should continue to actively seek the participation in supervisory and resolution colleges, and engage on bilateral coordination, not only with home authorities, but also with other hosts (lateral coordination). Contingency plans are key. National authorities need to understand the type of actions they may need to take during a systemic banking crisis. These discussions can be held in the countries’ financial stability committees or similar fora. Authorities may explore the nature and requirements of systemwide diagnostics, the specificities of public support frameworks, the mechanisms for avoiding liquidity outflows in extreme scenarios, and the options for dealing with a potential large stock of non-performing assets. 10 Dealing with weak banks in FinSAC countries: progress and challenges ahead 1. Introduction 1. Systemic banking crises have been commonplace in FinSAC client countries and, more broadly, in the ECA region during the last 30 years. A first wave of crises was triggered by the transition to a market economy of former communist and socialist countries at the beginning of the 1990s. More crises arose around the Russian bond moratorium crisis in 1998. Many countries saw further distress and failures during the GFC. Since then, several episodes can be identified, including Moldova (2014), Ukraine (2014-2016), Azerbaijan (2017), Tajikistan (2017), and Russia (2017-2018). Some of these crises are explained in Box 1. 2. This paper outlines the key elements of effective frameworks to handle weak banks and takes stock of FinSAC client countries’ progress towards establishing these. It focuses particularly on preparedness for systemic scenarios. It provides an overview of the key features of FinSAC countries’ financial systems, identifies recent relevant reforms, and outlines important areas for further attention, including recommendations to guide areas for focus. 3. The paper endeavors to conceptualize the key policy debates surrounding weak banks within the realm of regional financial systems characteristics. The focus is directed towards specific areas rooted in the shared features of banking systems in the region, the existent safety nets, the reforms introduced in most FinSAC client countries, and FinSAC’s accumulated experience derived from technical assistance to client countries. Consequently, the paper places a heightened emphasis on certain elements of the banking crisis management framework, which may differ from expectations in a different regional context. 4. Some FinSAC client countries have built up very relevant experience in dealing with weak banks, by introducing recovery plans, using new resolution powers, or liquidating banks. Countries in the region had to handle banking failures, in isolation and during systemic crises. In some cases, they were forced to adopt extreme measures such as introducing blanket guarantees, transferring toxic assets to AMCs, and even enforcing capital controls. Preventative measures such as AQRs and stress testing have become more frequent for health-checking the banking sector. The paper includes recent, relevant examples to draw lessons from them. 5. The paper seeks to strike a balance between theory and practice, incorporating selected regional case studies. Whenever possible, the paper strives to illustrate the diverse situations authorities in the region may encounter by drawing lessons from recent, pertinent case studies. The references in the text are complemented by two Annexes, explaining the most relevant individual problem cases for banks in the region and the use of AMCs. 6. The paper is mainly addressed to policymakers, authorities, and banks in FinSAC client countries and, more broadly, in the ECA region. It seeks to provide information and guidance to further embed and enhance existing reforms. Not all approaches or recommendations will be relevant for all countries, but readers are nonetheless invited to deepen their understanding of the key policy areas and possible challenges/solutions. 7. The following sections are structured as follows. Section 2 clarifies the scope of the paper and defines some key terms used. Section 3 explores the key financial and regulatory features of FinSAC client countries. Section 4 outlines the frameworks that FinSAC client countries have in place to deal with weak banks. Section 5 considers additional elements that authorities in 11 Dealing with weak banks in FinSAC countries: progress and challenges ahead the region may need to consider when managing systemic banking crises. Finally, Section 6 outlines the main recommendations. 12 Dealing with weak banks in FinSAC countries: progress and challenges ahead 2. Scope of the paper Regional focus: FinSAC client countries 7. This paper focuses on the experiences of FinSAC client countries from the Eastern Europe and Central Asia (ECA) region in undertaking reforms to manage bank failures. It considers primarily FinSAC client countries but also reflects relevant practices from other countries in the region (Belarus, Kazakhstan, Kyrgyz Republic, Russia, and Tajikistan). Some examples from EU countries, the United Kingdom (UK), and the United States (US) are employed to illustrate certain sections with relevant examples and case studies. 8. It mainly considers the evolution of financial systems and the reforms introduced after the GFC that sought to better prevent or manage banking crises. It notes the measures and tools that banking supervisors and resolution authorities use to manage banking distress, including failures, especially during bank systemic crises. 10. It should not be understood as a comprehensive or universal guide towards managing systemic banking crises. This paper does not intend to replace or supersede the already available criteria and principles issued by international standards setters, such as the Basel Committee on Banking Supervision or the Financial Stability Board and other comprehensive Policy Papers by other international financial institutions, such as the International Monetary Fund. It draws significantly on the EU regulatory framework, as many FinSAC client countries are candidate countries and are therefore aligning their frameworks to the EU. 11. It aims to identify the good practices that FinSAC client countries may use in dealing with weak banks, especially during systemic scenarios. As bank failures rarely happen in isolation, the paper focuses on handling weak banks during systemic banking crises, as these situations typically involve several weak banks and a general distrust in the financial system. Nonetheless, these practices are also relevant for managing individual weak banks. Definition of terms used: weak banks 12. This paper uses the definition of “weak banks” by the Basel Committee on Banking Supervision (BCBS). Pursuant to the BCBS Guidelines for identifying and dealing with weak banks 2, a weak bank is one whose liquidity or solvency is impaired or will soon be impaired unless there is a major improvement in its financial resources, risk profile, business model, risk management systems and controls, and/or quality of governance and management in a timely manner. A weak bank might be considered viable, in which cases the bank’s senior managers will be expected to be kept at the helm, but the supervisor may require to take measures to address their problems. In this paper, weak but viable banks are also referred to as “troubled banks” or “banks in distress/distressed banks.” A weak bank may also be identified as non- viable, typically when it does not meet or is not expected to meet its applicable minimum requirements and there is no other measure can effectively address its financial troubles. Definition of terms used: viable and non-viable banks 13. No internationally harmonized definition of “non-viability” exists, although international frameworks 3 usually underscore two elements. The first component is that the identification 2 Basel Committee on Banking Supervision, July 2015. 3 Key Attributes for Effective Resolution Regimes (FSB, 2011). Guidelines for identifying and dealing with weak banks (BCBS, July 2015). 13 Dealing with weak banks in FinSAC countries: progress and challenges ahead of non-viable banks should be assessed based on transparent and well-defined indicators. The indicators may relate to a bank’s compliance with its minimum prudential requirements (including but not limited to capital adequacy), its liquidity situation (inability to make payments as they come due), or to its negative asset value (assets lower than its liabilities). A complete assessment will consider not only the current situation but will also take a forward- looking view to assess those triggers (“likely to fail”), effectively enabling authorities to consider a bank as non-viable before the its balance sheet insolvency. Considering a bank “non-viable” should be a last resort so a second condition is usually related to the unlikeliness of any alternative measure, either supervisory or bank-led recovery (including even the bank’s takeover by another solvent institution) to restore the firm’s financial position. 13. The definition of a bank as non-viable usually requires professional judgment. Weak banks may report overstated asset values and capital adequacy ratios, which force authorities to delve into banks’ books and apply their own criteria for challenging those valuations. When assessing banks’ recovery plans, authorities should determine whether those plans are feasible, credible, and likely to result in restoring the financial situation of the bank. Transparent legal conditions, a well-defined decision-making supervisory framework, and legal protection for banking supervisors support authorities in making these decisions. 14. The distinction between viable and non-viable is paramount for the subsequent handling of a weak bank. Viability, or the lack of it, is the key criteria for determining how a weak will be handled, including the applicable crisis management regime, and who will be in charge of it. A weak but viable bank will typically continue to be steered by its board of directors and senior management, under the remit of the supervisory authority, which may force the bank to take measures to bolster its financial position or improve its governance or risk management practices. The management of a non-viable bank, especially if systemically important, will be transferred to the resolution authority, that may use a special resolution manager or temporary administrator, to implement far-reaching powers that can override shareholders’ or creditors’ property rights. Non-viable small banks may instead be liquidated and their insured deposits reimbursed. 15. The paper also distinguishes between open and closed bank resolutions. A closed bank resolution implies that some of the activities (assets and liabilities) of the failed bank would be transferred to a third party, while its license will be revoked and therefore its legal personality extinguished. In open bank resolutions, often called “going concern resolution”, authorities restructure a failed bank’s equity and liabilities, to ensure that losses are absorbed, and the bank is recapitalized so it can continue its operations. As a result, its license will not be revoked. 16. Some countries may have intermediate regimes, applicable to weak banks with serious viability problems yet still viable. Some legal frameworks provide authorities with powers to write down capital instruments outside the resolution frameworks, or to force banks into a merger and acquisition transaction without shareholders’ consent. Definition of terms used: systemic banking crises 17. There is no single harmonized definition of “systemic banking crisis”. It is important that policymakers and practitioners can promptly identify a banking crisis as the set of actions and 14 Dealing with weak banks in FinSAC countries: progress and challenges ahead policies for its management to have specific features. Different authors define “banking crisis” or “systemic banking crisis” in different ways: • Laeven and Valencia (2013) define banking crisis as an event that meets two conditions: (i) significant signs of financial distress in the banking system (as indicated by bank runs, losses in the banking system, and/or bank liquidations), and (ii) significant banking policy intervention measures in response to significant losses in the banking system.4 • Reinhart and Rogoff (2009) define banking crises based on two types of events (i) bank runs that lead to the closure, merging or takeover by the public sector of one or more financial institutions and, (ii) if there are no runs, the closure, merging, takeover, or large-scale government assistance of an important financial institution (or group of institutions) that marks the start of a string of similar outcomes for other financial institutions. • Demirguc-Kunt and Detragiache (1998) define banking crisis in a more flexible manner, as a crisis where any of four conditions are met: (i) the ratio of nonperforming assets to total assets in the banking system exceeded 10 percent, (ii) the cost of the rescue operation is at least 2 percent of the gross domestic product (GDP), (iii) banking sector problems resulted in a large scale nationalization of banks, and (iv) extensive bank runs take place or emergency measures such as deposit freezes, prolonged bank holidays, or generalized deposit guarantees are enacted by the government in response to the crisis. • A simpler definition, used for this paper, is found in World Bank (2019). A (systemic) banking crisis occurs when many banks in a country are in serious solvency or liquidity problems at the same time, either because they are all hit by the same outside shock or because failure in one bank or a group of banks spreads to other banks in the system. 18. After the GFC, systemic crises have continued to arise in FinSAC client countries, while also happening in other countries in the Eastern Europe and Central Asia. Poor governance and management practices, reckless loan growth, inadequate or even corrupt major shareholders, related party and foreign currency lending and inadequate regulation and supervision have been at the heart of these crises. Box 1 explores in more detail the crises in Moldova, Ukraine and Russia, while Annex II contains more information on the individual banking crises across the region. 4 The definition of “significant losses” depends on meeting either of these conditions (i) a country banking system exhibits significant losses resulting in a share of NPLs above 20 percent of total loans or bank closures of at least 20 percent of banking system assets, (ii) fiscal restructuring costs of the banking sector are sufficiently high, exceeding 5 percent of GDP. The authors consider policy interventions to be “significant” when three of the following six measures have been used; (i) deposit freezes and/or bank holidays; (ii) significant bank nationalizations; (iii) bank restructuring fiscal costs (at least 3 percent of GDP); (iv) extensive liquidity support (at least 5 percent of deposits and liabilities to nonresidents); (v) significant guarantees put in place; and (vi) significant asset purchases (at least 5 percent of GDP). 15 Dealing with weak banks in FinSAC countries: progress and challenges ahead Box 1. Selected systemic banking crisis in Eastern European countries during the last decade Moldova: bank heist (2014) 5 In 2008 and 2010, three Moldovan banks were sold to related parties of one individual. First Unibank (a small bank), then Banca Sociala (a medium-sized bank) and then the largest systemic bank in the country: Banca de Economii, which was state-owned at that time. The state ownership was diluted by issuing new shares to the individual, who took loans from the bank to buy the new shares issued by the bank. From 2012 to 2014, many lending operations between these three banks and the shareholder’s related parties were conducted, with a fraudulent nature. Most loans were granted to insolvent companies offshore, including shell companies in the UK and Hong Kong, which were never reimbursed. Loans to fictitious borrowers resulted in USD 1 billion losses (around 80 percent of the assets of the three banks at the time). As losses were unveiled, it was evident that the three banks could not continue their operations. The banks were placed under a special administration regime and international audit firms were appointed to perform an asset quality review. Afterwards, the state provided these three banks with a USD 870 million loan to enable them to pay their liabilities, including their deposits. The loan was provided by the National Bank of Moldova, against the collateral of a 25-year maturity government bond that the state is repaying in annual instalments. 6 The loan amount was at that time 12.5 percent of the country’s GDP. The three banks used the loan to repay the deposits in a process that lasted more than six months. Related party deposits were not repaid and remained in the failed banks. Once the repayment process ended, the banks liquidated. The National Bank of Moldova continued its clean-up of the banking sector and placed the largest locally owned banks under temporary administration, due to lack of transparency in their shareholder structures (see Annex II for more details). They would be sold years later to other private investors. Moreover, overarching reforms were introduced in the country, including a new Bank Recovery and Resolution Law in 2016 and significant improvements in banking supervision, covering a thorough review of banks’ significant shareholders and transactions with related parties. Ukraine: massive banking clean-up and nationalization of the largest bank (2014-2017) In 2014, the economic slowdown triggered by the Revolution of Dignity was the tipping point of a major banking crisis in the country. Years of poor regulatory and supervisory enforcement had resulted in widespread problems in the banking system, particularly in domestic banks. Many firms were used as “pocket banks” or “piggybanks” by their owners, 7 channeling deposits towards their non-financial activities. In more egregious cases shareholders engaged in asset 5 This section is based on the Kroll Report investigating the fraud at the 3 banks: https://www.bnm.md/files/Kroll_%20Summary%20Report.pdf. 6 According to information from the National Bank of Moldova, see: https://www.bnm.md/en/content/press- release-5. 7 See https://badbanks.bank.gov.ua/ 16 Dealing with weak banks in FinSAC countries: progress and challenges ahead stripping, money laundering, and other fraudulent activities. The framework for managing banking failures in Ukraine was streamlined in 2012 8 and involved the National Bank of Ukraine withdrawing licenses and transferring the banks to the Deposit Guarantee Fund, either to be liquidated or their assets and liabilities transferred to another bank or a bridge institution. In case of systemically important banks, the state was able to bail them out. In 2014, the National Bank undertook a comprehensive assessment of the health of the banking sector through an AQR and stress test of the largest 35 banks’ capital adequacy, following the European Banking Authority’s scenarios. 9 The exercise covered banks holding around 80 percent of the assets of the banking sector and revealed capital shortfalls for 18 firms, which were forced to prepare recapitalization plans. In five cases, firms and their shareholders were unable to present a credible recapitalization plan, so the banks were transferred to the Deposit Guarantee Fund and liquidated (including Delta Bank, Ukraine’s fourth largest bank, with 5 percent of banking assets at that time 10). Further economic deterioration and hryvnia (UAH) depreciation soon demanded a new assessment. A new exercise was undertaken by the National Bank in 2015, involving the AQR of the 60 largest banks over a two-year period (20 banks during 2015 and 40 during 2016). As a result of the exercise, 39 banks reported capital shortfalls, 8 of which were resolved, 11 including the nationalization of the largest bank. This exercise was supplemented with a comprehensive review of banks’ lending to related parties in 2015-2016, that covered 99 banks, 44 of which reported breaches of concentration requirements. 12 Crucially, the exercise revealed a large capital shortfall in the largest Ukrainian bank, PrivatBank that would trigger its nationalization in 2016. 13 At that time, the bank’s market share was above 15 percent, and higher than 30 percent in retail banking, 14and intermediated more than half of the country’s retail and small and medium enterprise’s payment transactions. The bank’s business model was largely based on taking retail deposits and providing corporate loans to related parties. The bank was owned by prominent individuals in Ukraine. 15 The second exercise resulted in huge credit losses in the bank, largely explained by related party lending (according to the National Bank, virtually the entire corporate loan book were loans to related parties 16). As a result of the losses and recapitalization needs, the shares of PrivatBank 8 See: https://bank.gov.ua/en/archive-news/all/122099-national-bank-of-ukraine-brings-the-nbu-regulations- into-line-with-the-law-of-ukraine-on-households-deposit-guarantee-system. 9 Data can be consulted in National Bank of Ukraine’s Annual Report 2014, page 78. 10 See https://www.fg.gov.ua/en/banki-v-upravlinni-fondu/jsc-delta-bank and https://bank.gov.ua/en/news/all/at-delta-bank-vidneseno-do-kategoriyi-neplatospromojnih. 11 Data can be consulted in National Bank of Ukraine’s “Results of bank diagnostics as of 07/20/2017” (in Ukrainian) https://bank.gov.ua/admin_uploads/article/Test_Results_20072017.pdf?v=4. 12 Data can be consulted in National Bank of Ukraine’s press release, “The National Bank of Ukraine Completes Its Diagnostics on Related Party Lending by Banks”, 27 February 2017 (https://bank.gov.ua/en/news/all/natsionalniy-bank-zavershiv-protseduru-diagnostichnogo-obstejennya- bankivskih-operatsiy-z-povyazanimi-osobami). 13 More information can be found in https://www.fg.gov.ua/banki-v-upravlinni-fondu/banki-prodani- derzhavi/pat-kb-privatbank. 14 The evolution in the period 2014-2017 can be consulted in National Bank of Ukraine’s Financial Stability Report, June 2018, page 38, https://bank.gov.ua/admin_uploads/article/FSR5_June_2018_eng.pdf?v=6 15 Shareholder structure before the takeout by the National Bank of Ukraine can be consulted (in Ukrainian) in: https://bank.gov.ua/files/Shareholders/305299/305299_20160331.pdf. 16 According to a National Bank of Ukraine assessment, 97 percent as of 1 November 2015. Data can be consulted in: https://bank.gov.ua/en/news/all/vistup-golovi-natsionalnogo-banku-valeriyi-gontarevoyi-pid-chas- 17 Dealing with weak banks in FinSAC countries: progress and challenges ahead were transferred to the state in December 2016, after a public recapitalization of EUR 5.4 billion (around 6.5 percent of Ukraine GDP at that time) and a write-off of PrivatBank’s Eurobonds (for a nominal value of USD 595 million) 17 (see Box 8 and Annex II for more details). The nationalization of the bank was followed by widespread legal challenges, as the former owners tried to recover the property of the bank. In an unprecedented clean-up of the banking sector, 94 banks out of 180 were liquidated by the Deposit Guarantee Fund in the 2014-2017 period. 18 Major reforms were introduced to upgrade the banking regulatory and supervisory framework, including to ensure that National Bank supervision staff could quickly identify banks’ weaknesses and unsound practices and take early action before the deterioration becomes irreversible. Russia: Banking Sector Consolidation Fund and nationalization of the Garden Ring Banks (2017-2018) During 2017-2018, the Central Bank of Russia nationalized some of the largest privately- owned banks in the Russian banking sector, using its own financial resources through the Banking Sector Consolidation Fund. Prior to 2017, when a bank was insolvent or was in difficulties, the Deposit Insurance Authority either requested the Central Bank to withdraw the license and placed the bank into liquidation or appointed a temporary administrator and sought an acquirer to take over and restructure the weak bank. 19 Usually, the Central Bank provided low-cost lending to the acquirer to facilitate the restructuring. Starting from 2013, the Central Bank started a massive clean-up process of the banking sector, where hundreds of banks saw their licenses withdrawn. During this period, the Central Bank’s powers to take over banks were very limited. During the clean-up process, some privately-owned banks took over many of the weak banks from the Deposit Insurance Authority. These acquisitive entities were willing to assume high risks and were able to quickly grow their assets, in some cases even to be identified as systemically important institutions. A new Federal Law passed in May 2017 20 created the Banking Sector Consolidation Fund. 21 This gave the Central Bank the ability to take over failing banks, write-off their shares and some of their liabilities, recapitalize them, transfer their bad assets to an AMC, and restructure them with the goal of ensuring they become viable again. Critically, the funds required for recapitalization, for providing liquidity, and other purposes (e.g., asset separation) were provided directly by the Central Bank through the Banking Sector Consolidation Fund. spilnogo-brifingu-z-ministrom-finansiv-oleksandrom-danilyukom-schodo-perehodu-privatbanku-u-derjavnu- vlasnist. 17 See https://bank.gov.ua/en/news/all/povidomlennya-derjatelyam-yevroobligatsiy-privatbanku. 18 33 in 2014, 33 in 2015, 19 in 2016 and 9 in 2017. Moreover, 2 banks were liquidated in 2020, 1 in 2021, 4 in 2022 and 5 in 2023. Data can be consulted in https://www.fg.gov.ua/en/statistics/number-of-failed-member- bank. 19 In accordance with the Federal Law No 175-FZ dated October 27, 2008 "On Additional Measures to Support the Financial System of the Russian Federation in the period up to December 31, 2011". 20 Federal Law of 01.05.2017 No. 84-FZ “On Amendments to Certain Legislative Acts of the Russian Federation”, May 2, 2017. 21 See https://www.cbr.ru/collection/collection/file/27724/cbr_ir_2020-03.pdf (slide 25) for more details. 18 Dealing with weak banks in FinSAC countries: progress and challenges ahead In August 2017, after massive liquidity outflows, the Central Bank took over Bank Otkritie, 22 at the time a systemically important institution and the largest privately-owned bank in Russia. A temporary administrator was appointed, bad assets were transferred to a bad bank, and the Central Bank injected capital and liquidity. As a result, Bank Otkritie was nationalized. In September 2017, the Central Bank took a similar measure with B&N Bank, 23 another large, privately-owned systemically important institution. In December 2017 it was the turn of Promsvyazbank, 24 another privately-owned systemically important institution (the 9th largest bank at that time). During 2018 the CBR again used its powers to intervene in other, smaller banks (mainly Rost Bank in March 2018 and Asian-Pacific Bank in April 2018 25). The Central Bank used one subsidiary of Bank Otkritie (National Bank Trust 26) as a bad bank or AMC, as non-performing assets of failed banks were transferred to this entity. See Annex I and II for more details on National Bank Trust and bank failures in Russia. Once stabilized, the Central Bank took further measures to restructure the nationalized banks. Bank Otkritie and B&N Bank were merged, with a view to returning the combined entity to private hands. The Central Bank’s initial plans were curtailed after the February 2022 Russian invasion of Ukraine, although Bank Otkritie was sold to VTB, another state-owned bank. 27 PromvyazBank was retained as a state-owned institution, but other smaller entities were sold to private investors. 22 See https://www.cbr.ru/eng/press/pr/?file=29082017_190359eng2017-08- 29t19_03_27.htm#highlight=otkritie and https://www.cbr.ru/eng/press/pr/?file=07122017_160722eng2017- 12-07t16_06_50.htm#highlight=otkritie. 23 See https://www.cbr.ru/eng/press/pr/?file=21092017_114120eng2017-09- 21t11_40_27.htm#highlight=bank%7Cbanks. 24 See https://www.cbr.ru/eng/press/pr/?file=15122017_110615eng2017-12- 15t11_15_59.htm#highlight=promsvyazbank. 2525 https://www.cbr.ru/eng/press/pr/?file=26042018_105931eng2018-04-26t10_56_13.htm. 26 https://www.cbr.ru/eng/press/pr/?file=26042018_105931eng2018-04-26t10_56_13.htm. Report for 2018 (in Russian) https://www.trust.ru/upload/iblock/23a/%D0%9E%D1%82%D1%87%D0%B5%D1%82%20%D0%B1%D0%B0%D 0%BD%D0%BA%D0%B0%20%D0%B7%D0%B0%202018%20%D0%B3%D0%BE%D0%B4.pdf. 27 See https://www.cbr.ru/eng/press/pr/?file=638077401227576761eng_bank_sector.htm#highlight=otkritie. 19 Dealing with weak banks in FinSAC countries: progress and challenges ahead 3. Key financial and regulatory features of FinSAC client countries’ financial systems 19. Many financial sectors in FinSAC client countries share some common features. They are bank-dominated, where usually few banks operate, typically ranging from 10 to 20 (Figure 1 ). A very modest role is played by capital markets and the insurance sector in financial intermediation.28 Foreign ownership 29 is high, for example the market share of foreign- controlled banks is as high as 75 percent in Serbia, around 84 percent in Kosovo, and above 75 percent in the Federation of BiH (Figure 2). Figure 1: Number of banks in FinSAC client countries in 2022 30 Source: FinSAC with information from central banks and supervisory authorities 31 28 Although in certain countries, non-bank financial organizations have a limited, but still relevant, role. 29 With some exceptions (Azerbaijan, Georgia, Uzbekistan), where foreign ownership shares are rather low. The elevated levels of foreign ownership across the region are explained by the process of privatization undertaken in the transition towards a market economy. Former non-market economies’ financial sectors comprised state- owned banks that were in urgent need of restructuring and fresh capital. In this context, Western European banking groups (mainly Austrian, French, German, and Italian) bought the shares of state-owned banks during privatization processes. 30 The buckets show the number of FinSAC client countries based on their number of active banks. 31 Information obtained from the Bank of Albania; Central Bank or Armenia; Central Bank of Azerbaijan; Banking Agency of the Federation of BiH and Banking Agency of the Republika Srpska; National Bank of Georgia; Central Bank of the Republic of Kosovo; National Bank of Moldova; Central Bank of Montenegro; National Bank of North Macedonia; National Bank of Serbia; National Bank of Ukraine; and Central Bank of Uzbekistan. 20 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 2: Bank ownership in FinSAC countries by share in total assets 32 Source: FinSAC with information from central banks, national bank associations and banks 33 20. Banks in the region have enjoyed several years of improving asset quality and profitability and stronger capital and liquidity positions. Banks across FinSAC client countries have been operating with higher levels of solvency (Figure 3), liquidity, and profitability (Figure 4) and improving asset quality (Figure 5). 34 Consolidation in FinSAC client countries’ banking sectors has continued during the last years, with some banking groups playing an active role. 35 32 We have defined three categories by the nature of the bank ownership: (i) state-owned: for cases where the local sovereign domestic state owns a controlling stake in a bank, defined as one above 50 percent of the bank’s share capital; (ii) subsidiary of a foreign bank: banks that are subsidiaries of a foreign bank or included in a foreign banking group, including those controlled by the state of a third country; (iii) other banks: includes all other ownership models. 33 Information as of December 31, 2023, for Armenia, Azerbaijan, Georgia, Moldova, Ukraine and Uzbekistan. Information as of November 30, 2023, for Kosovo. Information as of September 30, 2023, for Albania, Montenegro, North Macedonia, and Serbia. Data as of June 30, 2023, for the Federation of BiH and the Republika Srpska. 34 NPL ratios decreased quickly during the last decade. In Serbia, NPL ratios went from 9.8 percent in 2017 to 3.6 percent at the end of 2021, and in Albania from 13.2 percent in 2017 to 5.7 percent in 2021. Even in Ukraine, NPL ratios that were at previously remarkably high levels were drastically reduced in the last 5 years (from 54 percent to 30.5 percent), before picking up in 2022 due to the Russian invasion of Ukraine. 35 For example, Hungary’s OTP Bank has acquired several banks in the last 5 years in the Western Balkans (Albania, Croatia, Montenegro, Serbia, Slovenia), Eastern Europe (Moldova) and even Central Asia (Uzbekistan), mainly from France’s Société Générale. Slovenia’s Nova Ljubljanska Banka has been active in the Western Balkans, buying banks in Slovenia (Sberbank) and Serbia (Komercijalna Bank). 21 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 3: Evolution of bank solvency ratios in FinSAC client countries (2012-2022) Source: FinSAC with International Monetary Fund (IMF) and National Bank of Serbia data (Financial Stability Indicators) Figure 4: Evolution of bank return on assets ratios in FinSAC client countries (2012-2022) Source: FinSAC with IMF and National Bank of Serbia data (Financial Stability Indicators) 22 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 5: Evolution of bank NPL ratios of FinSAC client countries (2012-2022) Source: FinSAC with IMF and National Bank of Serbia data (Financial Stability Indicators) 21. FinSAC client countries have strengthened their frameworks for preventing and managing banking crises during the last decade. Regulatory frameworks have been upgraded, supervisory processes streamlined, and new regimes for managing weak banks implemented. As a result, many of these countries have improved their preparedness for dealing with troubled banks. 22. Basel III Standards are being implemented across the region. Many FinSAC client countries have adapted, or are in the process of adapting, their prudential frameworks to Basel III, especially EU-candidate countries seeking to converge with the EU acquis. Capital requirements have been lifted, including capital buffers, and liquidity requirements implemented. 23. Credit risk classification and provisioning standards have become more forward-looking. Many FinSAC client countries have upgraded their classification and coverage standards in line with the expected-loss approach of International Financial Reporting Standard 9. Certain countries have added an extra safety cushion, through incorporating regulatory backstops to constrain the variability of expected credit losses derived from the banks’ internal models 36. Credit risk management frameworks have also been enhanced with requirements for banks reporting high levels of NPLs to prepare strategic and operational plans, where annual internal targets for reducing NPLs and management actions towards achieving them are outlined. Countries have strengthened their frameworks for avoiding past credit risk mistakes, including new standards restricting new lending to unhedged borrowers in foreign currency and introducing new transparency requirements for related party lending. 24. Banking supervisors in FinSAC client countries have upgraded their supervisory policies, procedures, and tools. Many of the supervisory authorities in the region have adopted risk- based supervision approaches, usually inspired by the EU’s supervisory review and evaluation 36 See credit risk regulations of the Banking Agencies of Bosnia and Herzegovina or the National Bank of the Republic of North Macedonia. 23 Dealing with weak banks in FinSAC countries: progress and challenges ahead process (SREP) framework. 37 The implementation of the SREP model is having profound implications on banking supervision, triggering important changes in day-to-day supervision, including the reorganization of resources, the definition of new supervisory procedures, changes in the scope and frequency of on-site inspections, and recruitment of staff with the skillsets required to perform the new tasks. Most authorities are setting risk-based Pillar 2 capital requirements or regularly conducting microprudential bottom-up stress tests. 25. Frameworks to deal with weak but viable banks have been enhanced. FinSAC client countries have upgraded their early intervention frameworks conferring far-reaching powers on banking supervisors, including the ability to replace senior managers and board members, request specific measures to address weaknesses and, impose restrictions over banks’ activities. Banks are required to invest time and resources in crisis preparedness through annual updates of recovery plans or by meeting the new requirements on resolution planning. 26. New bank resolution regimes have been implemented, with resolution authorities given comprehensive powers to manage bank failures. Several FinSAC client countries have passed bank resolution laws, often inspired by the FSB Key Attributes and EU’s BRRD.38 These bank resolution laws typically designate the central bank or the agency in charge of banking supervision 39 as the independent resolution authority (Figure 6). These authorities are given broad powers to implement closed and open bank resolutions, including through transfer and bail-in powers. When using them, authorities have the mandate to protect financial stability, guaranteed deposits, and taxpayer money but they are not restricted by having to minimize the costs to the failed bank’s creditors. 40 37 In many cases, the SREP approach has replaced the US-based CAMELS framework (capital adequacy, asset quality, earnings, liquidity, and sensitivity), which was previously in widespread use in the region. 38 Some FinSAC client countries have already introduced FSB Key Attributes-based bank resolution laws (Albania, Georgia, Moldova, Montenegro, North Macedonia, Serbia, etc.), whereas others are still in the process of introducing them (Armenia, Kosovo) and a few have not yet made a substantial headway in their resolution frameworks. 39 Designating the central bank or the independent banking supervisory agency as the resolution authority has predictably been the most common approach, due to cost efficiency, synergies within banking supervision and other functions, and the independence and prestige of the central bank. The central bank has been designated as the resolution authority in Albania, BiH, Georgia, Moldova, Montenegro, North Macedonia and Serbia. In BiH the two independent banking agencies have been conferred with the new powers. The only exemption is currently Ukraine, where the Deposit Guarantee Fund has been designated as resolution authority, mirroring the situation of other large countries (e.g., Denmark, Poland, Sweden, Turkey, etc.). 40 This mandate is a key difference with the US system. In the US, the Federal Deposit Insurance Corporation, as resolution authority, has the mandate to choose the “least cost option” (i.e., the least cost to the deposit insurance fund), BRRD-inspired resolution regimes are only bound by the “no creditor worse off than in liquidation” principle, that implies that no creditor should receive less in resolution than the amount it would have received in a counterfactual liquidation of the bank. 24 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 6: Resolution authorities in FinSAC client countries Source: World Bank 27. Resolution authorities of some FinSAC client countries are required to prepare resolution plans, at least for large, systemic banks. This is the case for Albania, BiH, Georgia, Moldova, Montenegro, North Macedonia, and Serbia. In resolution plans, authorities outline the powers and tools (resolution strategies) they intend to use when a bank becomes non-viable, identify any obstacles to the application of the selected strategies, and ultimately request banks to undertake measures to address these. Effective resolution plans are key, particularly for foreign-owned banks, as resolution authorities need to consider how the resolution plan of the subsidiary will be coordinated with the foreign resolution authorities of the wider banking group (Box 2). Box 2. Resolution strategies and resolution entities in cross-border banking groups in FinSAC client countries Some Western and Central European banking groups have multiple subsidiaries across Eastern and Southeastern Europe. Austrian Erste Group and Raiffeisen Bank International, Italian Intesa Sanpaolo and UniCredit, German Procredit, Slovenian Nova Ljubljanska Banka, and Hungarian OTP Group are among the most active banks in the region. In the context of resolution planning of cross-border banking groups, resolution authorities need to choose one of two resolution strategies, involving the identification of the so-called “resolution entities” and “resolution groups”: single point of entry or multiple point of entry resolution strategies. A single point of entry resolution strategy assumes that only the resolution authority of the parent company applies its resolution powers, and therefore only the parent qualifies as a “resolution entity”. In case of failure, subsidiaries’ losses would be up streamed to the parent 25 Dealing with weak banks in FinSAC countries: progress and challenges ahead and capital down streamed to them. As a result, only the creditors of the parent company would effectively be absorbing losses. To operationalize this approach, host resolution authorities may require the parent company to preposition loss-absorbing debt to their subsidiaries. The single point of entry resolution strategy assumes that the group will continue operating after its orderly resolution. 41 In a multiple point of entry resolution strategy, resolution authorities identify more than one “resolution entity” in the group, as they expect to use their resolution powers to each resolution entity. In these groups, losses in resolution entities would be expected to be absorbed by their creditors and not necessarily up streamed to the parent company (except for the equity and capital instruments injected by the parent). In case of resolution, banking groups may break up. Therefore, during the planning phase resolution authorities are likely to focus on ensuring that their resolution entities could be independently resolved from the rest of the banking group. 42 The selection of resolution strategy is commonly conducted in crisis management groups or resolution colleges (see Section 6.9). The resolution strategies of some active banks in FinSAC client countries imply the identification of several resolution entities (especially Austrian banking groups), whereas in other cases the parent company is the only resolution entity. 28. Most resolution authorities in FinSAC client countries are defining their models to cover the costs of bank failures. In the wake of the GFC, many countries have moved away from taxpayer-based funding models. The FSB Key Attributes and BRRD seek to ensure that resolution losses will first be assumed by shareholders and creditors and, if needed, by the industry (through resolution or deposit insurance). The possibility of using taxpayers’ funds for bank recapitalization remains possible but is subject to further constraints. While FinSAC client countries have firmly advanced towards “bail-in, not bail-out” regimes, their effectiveness can be hampered by the underdeveloped and shallow private debt markets (precluding the issuance of loss-absorbing debt -a key enabler for bail-in implementation), and non-existent or insufficiently funded resolution funds. Countries may also face more benevolent socioeconomic attitudes towards bailouts; unlike many Western countries, most FinSAC client countries did not need to bail-out their banks during the GFC43 and the state has 41 Some examples of banks with multiple point of entry resolution strategies include Raiffeisen Bank International (see prospectus dated 27 July 2020, EUR 500.000.000 Fixed to Reset Rate Additional Tier 1 Notes of 2020 with a First Reset Date on 15 December 2026, page 17). https://dl.bourse.lu/dl?v=975xooDaiVqlEQOISy9LO3ejUOuwq8xJwirr4SzrGpt2ltDhGng6GywRWZrlSVP6G8Gntx JOyorcT/aSN7gYecoDcjfu+ym5BZ9dQqluKm9LyN9wgNgywMwmFTEsDl3yF1BwpI6H9koQgOMd7MuCIyhmePFe Pho89+coIPpvS54=); Erste Group (see “November 2023 – Erste Group debt investor presentation”, page 29: https://www.erstegroup.com/en/investors/debt/presentations); and OTP Group (see prospectus, page 2, https://www.otpbank.hu/static/portal/sw/file/MTN_Prospectus_Supplement_4rd_20231215.pdf). 42 An example of single point of entry resolution strategy is UniCredit Group (see UniCredit Group Pillar III disclosure as at 30 September 2023, page 21, https://www.unicreditgroup.eu/content/dam/unicreditgroup- eu/documents/en/investors/third-pillar-basel/2023/UniCredit-Group-Disclosure-Pillar-III-as-at-30-September- 2023.pdf). 43 With some notable exceptions, such as Ukraine. 26 Dealing with weak banks in FinSAC countries: progress and challenges ahead a long-term relevant presence in the banking sectors of some countries. 44 Finally, some countries do not have sufficient experience in managing banking crises. 29. The centralized provision of liquidity by the central bank during stress, through ELA is one of the least developed crisis management mechanisms in FinSAC client countries. The lack of an independent monetary policy framework (BiH, Kosovo, Montenegro) or the large stock in foreign currency liabilities in some financial systems (Albania, Armenia, BiH, Georgia, Serbia, etc.) are barriers to the effective provision of last resort liquidity to weak but viable banks. 45 Central banks across the region also face challenges over ensuring how emergency liquidity can be provided to banks undergoing resolution, as just a handful of countries have adapted their ELA regimes to the new bank resolution regimes. 46 This is particularly relevant for open bank resolution. In response, some central banks in FinSAC client countries are starting to move towards assessing a firm’s viability rather than its static solvency. 30. The new prudential framework in FinSAC client countries was largely upheld during the last years. Supervisors across the region reacted promptly to the COVID-19 emergency, quickly implementing moratorium regimes that precluded banks from frontloading massive losses at the height of the pandemic, restricting dividend payments, and compelling banks to adopt measures to ensure their operational continuity. The measures appear to have been successful, averting a wave of major defaults while preserving the financial flows to the real economy. The special moratorium regimes that were introduced were quickly abolished, triggering rather modest increases in NPL ratios. Crucially, the failure of the Sberbank network of Eastern and Central European subsidiaries following international sanctions brought against the Russian parent company was well managed using the new toolbox of the resolution framework (see Box 3 and Annex II for more details). Box 3. The failure of Sberbank Europe AG subsidiaries 47 44 This factor may be particularly relevant in countries with a high level of state ownership in the banking sector (e.g., Azerbaijan, Belarus, Kazakhstan, Russia, Ukraine, Uzbekistan, etc.), as the resolution of state-owned banks creates further challenges. An analysis of the challenges of applying resolution to state-owned banks can be found in Meyerhof, Palermo, and Gutierrez (2022) and in IMF (2022). 45 Or the ability to raise foreign currency funding such as using swap lines with foreign central banks, particularly with the European Central Bank. This was the case for the National Bank of Serbia, the Bank of Albania, and the National Bank of the Republic of North Macedonia during the pandemic, see https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200717_2~7d1fb908e4.en.html. Other examples of credit lines with the European Central Bank can be consulted in the following link: https://www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210204~f8f544a715.sv.html. 46 Particularly, the traditional condition that only “solvent” banks can receive ELA is challenged by open bank resolution. A bank in resolution is very unlikely to be solvent, although the resolution authority may have designed a resolution scheme that ensures its viability as a going concern, usually through open bank resolution. It is precisely for these cases when ELA is most needed, as bailed-in banks may have been recapitalized but the conversion or write-down of capital instruments and liabilities does not generate liquidity for the failed bank. Similarly, a bank that has been resolved is unlikely to retain high quality collateral, as it may have suffered large cash outflows in its run-up to resolution, as the recent cases (e.g., Banco Popular (2017), Credit Suisse (2023), or Silicon Valley Bank (2023)) evidence, and therefore may need a guarantee from the Minister of Finance or other entity (e.g., the resolution fund) to access the central bank’s liquidity. 47 See for more details https://www.srb.europa.eu/en/content/sberbank-europe-ag. 27 Dealing with weak banks in FinSAC countries: progress and challenges ahead Sberbank Europe AG, a bank headquartered in Austria and a subsidiary of Russian’s state- controlled Sberbank, was the intermediate parent company of a network of bank subsidiaries in BiH (with one subsidiary in the Federation and another in Republika Srpska), Croatia, Czech Republic, Hungary, Serbia, and Slovenia. The Austrian bank also had a relevant branch in Germany. Sberbank had acquired these banks from Volksbank International in 2011. 48 As a result of the Russian invasion of Ukraine, the EU, US, and UK imposed sanctions on Sberbank and its subsidiaries in February 2022. Customers quickly lost confidence in Sberbank’s subsidiaries and sought to withdraw their deposits. The parent company was unable to downstream liquidity to its subsidiaries, as international sanctions precluded it from doing so. As a result, the subsidiaries liquidity quickly dried up, and supervisors considered the subsidiaries as non-viable. The Austrian (including the German branch), 49 Hungarian, 50 and Czech 51 subsidiaries had their licenses revoked and were put into liquidation, triggering a deposit pay-out. Other resolution authorities used their resolution powers to manage the failures of these banks: • The Bosnian resolution authorities (in the Federation and in Republika Srpska) transferred the shares of the banks to ASA Banka 52 and Nova Banka 53 respectively. • The National Bank of Serbia sold Sberbank’s Srbija shares to AIK Banka, 54 which had agreed previously to take over some of Sberbank’s Europe subsidiaries in the region. • The Single Resolution Board transferred the shares of Sberbank Banka (Slovenia) to Nova Ljubljanska Bank and Sberbank BH (Croatia) to Hrvatska Postanska Banka. 55 The resolution scheme applied by the authorities corresponded to the so-called multiple point of entry resolution strategy, as all Sberbank’s Europe subsidiaries failed simultaneously. 48 See https://www.nsbanking.com/news/russias-sberbank-acquires-germanys-volksbank-160212/. 49 See the “Decision of the Single Resolution Board” on the liquidation of the Austrian parent company, Sberbank Europe AG, URL: https://www.srb.europa.eu/system/files/media/document/2022-06-10_SRB-Non- confidential-version-of-the-decision-in-respect-of-Sberbank-Europe-AG.pdf. 50 See https://www.mnb.hu/en/pressroom/press-releases/press-releases-2022/winding-up-proceedings-to- start-at-sberbank-hungary-and-its-austrian-parent. 51 See https://www.cnb.cz/en/cnb-news/press-releases/CNB-revokes-licence-of-Sberbank-CZ/. 52 See https://www.fba.ba/upload/docs/a_decision_on_initiating_resolution_proceedings_against_sberbank_bh_JPg .pdf and https://www.asabanka.ba/asa-banka-kupila-je-sberbank-bh-u-federaciji-bih/. 53 https://abrs.ba/en/press-release-banking-agency/n67 and https://abrs.ba/en/press-release-banking- agency/n68. 54 https://www.nbs.rs/en/scripts/showcontent/index.html?id=17829. 55 See https://www.srb.europa.eu/en/content/sberbank-dd-and-sberbank-banka-dd. 28 Dealing with weak banks in FinSAC countries: progress and challenges ahead 4. Measures undertaken by banks and supervisory authorities to mitigate and overcome distress 4.1. Recovery planning and execution 31. Many FinSAC client countries require banks to prepare ex-ante recovery plans, where they outline the measures, they plan to take to overcome possible distress in a range of scenarios, together with their framework for early detection and management of financial crises. A recovery plan should include three elements: (i) slow and fast moving stressed scenarios including capital and liquidity pressures, (ii) credible options to cope with a range of scenarios, and (iii) policies and processes to ensure the timely implementation of recovery options in a range of stress situations. 56 Recovery planning intends to enhance a firm’s crisis preparedness, and therefore should help banks to rapidly detect, manage, and overcome a crisis. Recovery plans are also a useful instrument for supervisors, as they can compel banks to activate them, and take the required measures to deal with a bank’s financial distress. 32. The range of credible recovery measures, including shareholders’ support, for banks in FinSAC client countries depends on the banks’ business model, ownership structure and the institutional features of the systems they operate in. Any feasible recovery plan is expected to involve raising fresh capital, either by current or new shareholders, as this is usually the clearest evidence of the credibility of the bank’s recovery prospects. 57 Banks owned by local investors may struggle to raise capital from current or prospective shareholders, as their current shareholders may have limited financial capacity and raising equity in the market is seldom an option. 58 Against this backdrop, a thorough analysis of shareholders’ financial capacity is crucial to understand whether they are a source of strength. Key shareholders may support banks through different actions, such as subscribing new shares, injecting capital through subordinate loans or other capital instruments, purchasing toxic assets from the bank, repaying loans, making new deposits or loans to banks, or contributing to the bank with other assets they may own. Banks in the region can improve their capital and liquidity by curtailing, or at least reducing, new lending. Although useful during systemic crises, it is potentially damaging to banks’ franchises during idiosyncratic episodes if clients turn to competitors. In addition, as most weak banks tend to suffer from poor profitability, cost-cutting measures are essential to adjust a firm’s overheads to its shrunk revenue base. 59 Finally, weak banks can raise liquidity by launching deposit gathering campaigns (although some may face supervisory restrictions) 60 and through collateralized funding transactions with the central bank, although 56 BCBS, 2015 57 The refusal to even consider injecting fresh capital can be interpreted as lack of trust in the bank’s prospects, as shareholders may be effectively “voting with their feet.” In such cases, banks should consider more drastic measures such as a combination with another solvent bank, to avert its insolvency. 58 A handful of banks have their shares listed in liquid equity markets (e.g., London Stock Exchange), and they might be able to issue new shares if needed. 59 Banks usually take an incremental approach to cost cutting. First, banks will try to reduce certain nonessential expenses, such as those related to marketing and other promotional activities, business travel, or employee training. As distress worsens, banks can be forced to make more drastic adjustments, including the renegotiation of contracts with third-party suppliers, holding back new IT investments, branch closures, and employee lay- offs. 60 Supervisors are aware that weak banks may try to “pay their way out of the crisis” by offering higher remuneration to attract more depositors. These actions may have a detrimental effect on the bank’s funding and earnings position. Authorities may cap the remuneration that weak banks can offer for deposits. In contrast, 29 Dealing with weak banks in FinSAC countries: progress and challenges ahead with significant restrictions if foreign currency is required. Foreign-owned banks may request funding support from their parent companies. 33. Recovery plans for banks in FinSAC client countries tend to reflect the idiosyncrasy of the financial systems they operate in. First, shallow financial markets curtail raising wholesale equity or debt funding. Second, nonexistent secondary markets for loans hinder the sale of performing and, critically, non-performing loans to third-party investors or other banks. Third, as banks in FinSAC client countries seldom own subsidiaries or other equity stakes, the sale of assets to raise capital and liquidity through these actions is rarely possible. Fourth, access to central bank funding is hampered by the institutional structure in some markets and the high levels of liabilities denominated in foreign currency. Fifth, high levels of foreign ownership can anchor the recovery capacity of some banks to financial support measures by parent companies. 34. The recovery prospects might differ markedly for domestically owned banks than for local subsidiaries of foreign banking groups. Capital support by current shareholders may not be possible for local banks, in which case they may need to seek new shareholders or a merger partner. Local subsidiaries in the region have tended to be supported by their parents, as evidenced during the GFC (Box 4). While in most cases local subsidiaries in FinSAC client countries are of small size in a group context, their failure of any subsidiary can have sizable reputational effects. 61 Nonetheless, local supervisors need to carefully analyze the prospects for financial support by parents, especially when home authorities implement resolution planning policies restricting the financial exposures of parents to their local subsidiaries (multiple points of entry).62 In any case, the reliance on group financial support in FinSAC client countries has been sharply curtailed by the strengthening of balance sheets of local subsidiaries during the last decade. Figure 5 outlines the most common measures usually included in recovery plans by banks in FinSAC client countries, differentiating by foreign- owned and domestic banks. 63 authorities may encourage banks to take deposits and liquidity from their related parties (e.g., shareholders, parent company, etc.). 61 Many FinSAC client countries can be considered “small hosts”. The local subsidiaries of foreign banks are systemic for the host country, but they are largely irrelevant for the banking groups they are part of. (See Ahmad et al, 2018). 62 Home authorities may restrict or limit the financial exposure from their parent companies to their subsidiaries to fully enable a multiple point of entry resolution strategy. 63 The Figure relies on the experience gathered by FinSAC in supporting client countries in the operationalization of the recovery planning frameworks. 30 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 7: Recovery options for FinSAC client countries: common measures in banks’ recovery plans (RP) Source: FinSAC own ellaboration Box 4. Foreign ownership in crisis scenarios: pros and cons Many banks in FinSAC client countries are owned by foreign banking groups, and most of them are based in Western Europe. These banks usually maintain a foothold in several countries in the region. In the build-up to the GFC, these foreign parents operated local subsidiaries in FinSAC client countries with a high reliance on parent and wholesale funding. These funding sources enabled them to grow their loan books significantly above their local deposits, often fueling credit bubbles through unsustainable funding models. During the GFC, parent banks were forced to downstream further liquidity and capital to their distressed subsidiaries, putting additional pressures on already weakened parents. Once the crisis was resolved, both supervisors and banking groups took decisive steps to ensure the sustainability of their local subsidiaries’ 31 Dealing with weak banks in FinSAC countries: progress and challenges ahead funding models. The establishment of the Vienna Initiative 64 was a cornerstone of the novel approach. The joint efforts by the authorities represented in the Vienna Initiative yielded positive results: most local subsidiaries in the region are financially self-sufficient and more capitalized, running sustainable business models with much less reliance on their parent companies. Foreign parents can be a source of strength for their distressed local subsidiaries. First, parent companies might support their subsidiaries with capital and liquidity if needed. Belonging to a sound, solvent foreign banking group can be extremely valuable during a systemic crisis scenario, as customers from other competitors may seek to move their savings away (“flight to quality”). A further advantage is that the group can transfer best management practices to local banks during a stressed situation. Finally, in the context of de-risking and scarcity of correspondent banks in some Eastern Europe countries, foreign ownership can become an anchor for the country’s financial stability. Conversely, foreign owners may also be a source of weakness for their subsidiaries. Troubled parents might be exposed to systemic problems in their home countries and local authorities may need to introduce ring-fencing measures to effectively isolate the local subsidiary from the group problems. The cases of Hypo Alpe Adria (2013) and Sberbank Europe (2022) can be illustrative. Moreover, in the run up of the GFC, foreign-owned banks contributed to the build- up of risks in the system, by raising intragroup and wholesale foreign currency funding and extending loans to unhedged borrowers also in foreign currency. Overall, Western foreign ownership of local banks has largely acted as a stabilizing factor for the region’s banking markets. There have been many examples of parent companies that have supported their subsidiaries when it was required and very few examples of solvent parent companies that have refused to support their troubled subsidiaries, although some of the more notable cases in Europe are summarized below. Bayern LB/Rijecka Banka 65 Bayern LB, a public sector German bank (Landesbank), which took over Rijecka Banka from the Croatian State in 2002 but then refused to recapitalize it following the detection of large trading losses (around USD 100 million) in the Croatian bank. The Croatian Deposit Insurance Agency intervened and Rijecka Banka was sold again in 2004, this time to Erste Bank which merged it with its Croatian subsidiary. Nomura/Investicni a Postovni Banka 66 In 1998, Nomura, a Japanese bank, acquired a 46.6 percent stake in the Czech Republic’s Investicni a Postovni Banka as a strategic investor. In 2000, the Czech National Bank identified a capital shortfall in the bank and Nomura made further investments, buying shares and subordinated debt. Nonetheless, the bank suffered massive deposit outflows and, when Nomura declined to further its financial support to the entity, was intervened by the Czech National Bank. 64 See https://vienna-initiative.com/. 65 See https://www.economist.com/special-report/2002/09/14/rogue-trader-rogue-parent. 66 See Bauer, M., et al. 2002. The Rise and Fall of Investicni a Postovni Banka. https://www.readcube.com/articles/10.2139%2Fssrn.2144277 32 Dealing with weak banks in FinSAC countries: progress and challenges ahead Credit Agricole/Emporiki Bank 67 Another well-known case was Credit Agricole’s Greek subsidiary (Emporiki Bank). After buying the bank in 2006, the Greek subsidiary reported massive losses. The parent bank recapitalized its subsidiary several times but ended up walking away from the subsidiary with more than EUR 9 billion losses, after reaching an agreement with the Greek State. 4.2. Early detection and dealing with weak, but viable banks 35. A stressed firm should be subject to close monitoring by its supervisor. Authorities need to keep a continuous focus on the bank, that may include daily (or even intra-daily) liquidity reports, that are complemented with more frequent (than under ordinary supervisory stance) financial and prudential reporting and regular contacts with the bank’s managers and board members. The contacts may also be extended to shareholders, and even with the home supervisor if the bank is owned by a foreign banking group. Supervisors may step up on-site activities, as extensive verification of the situation might be required. 36. In stressed scenarios, banking supervisors are usually forced to take measures on top of those adopted by the bank. First, supervisors should have a comprehensive framework in place for identifying trouble, including both quantitative and qualitative triggers as early warning indicators. Second, they should clarify and reassess the suitability of the bank’s management and administrators to continue to manage the bank. Third, they should consider measures to preserve the financial situation of the bank or rein in the bank’s risk-taking. The measures may be selected from a broad menu of options. The selection of measures should preserve certain degree of flexibility but should also follow transparent and sound escalation and decision-making procedures. Finally, they need to be prepared to escalate the measures if the bank’s situation worsens. 37. As FinSAC client countries roll out new regulatory and supervisory frameworks, they are implementing or upgrading their early warning indicators for early intervention. Authorities use their supervisory ratings (usually based on SREP) to categorize banks according to their risk profile. Unfavorable ratings usually inform supervisory measures. Authorities also use the compliance with the new regulatory standards as early warning triggers (e.g., leverage ratios, liquidity coverage ratios, etc.). 38. When the integrity and professionalism of the bank’s board members and senior managers raises no concerns, the supervisor may allow the weak bank to define and execute its own set of recovery measures, subjecting to its vetting. In these situations, the authority minimizes its intervention in the sound management of a weak bank, mitigating any litigation risks that can arise if more intrusive actions are taken. 39. If the supervisor considers board members or senior managers as unreliable or unsuitable, it may request the bank to replace them. In more extreme circumstances, when bank owners themselves are untrustworthy, the supervisor may appoint a temporary administrator who 67 See https://www.ft.com/content/e7661f54-183d-11e2-80af-00144feabdc0. 33 Dealing with weak banks in FinSAC countries: progress and challenges ahead assumes most or all the powers of the board of directors and senior management (but not of the shareholders’ meeting). 68 40. The benefits of the appointment of a temporary administrator should be weighed against its risks. 69 The appointment must be made public immediately, as any third party contracting with the bank will need to know that the temporary administrator is the bank’s legal representative. The announcement can effectively flag the bank’s delicate situation and magnify liquidity risks, especially when creditors anticipate a resolution situation where the application of the bail-in tool may lead to losses for them. Moreover, the supervisory may be subject to heightened litigation risks if the intervention ends with the failure of the bank, as affected shareholders and creditors may argue that the supervisor was the “de facto administrator” of the bank. Therefore, the appointment of a temporary administrator needs careful consideration, ideally used exclusively for weak yet viable banks whose shareholders cannot be trusted or have been placed under a sanctions regime which effectively impede them from controlling the bank. Such an approach constitutes a significant departure from pre-GFC crisis management regimes, where appointing a temporary administrator was a modus operandi to manage weak firms.70 41. Improving the corporate governance and risk management framework plays usually a pivotal role in addressing the root causes of weak banks’ problems. While credit losses, capital shortfalls, high NPLs, diminished profitability, or poor liquidity are the most common symptoms, weaknesses in corporate governance and risk management are likely to be the reasons for a bank failure. Consequently, supervisors should require weak banks to improve their governance practices or to strengthen their internal control functions. 42. Supervisor may also adopt measures to restrict weak banks’ risk-taking and to preserve capital or liquidity. In stressed situations, troubled banks may be tempted to pursue a “martingale strategies,” doubling down on risk-taking to offset their losses, which can, unsurprisingly, magnify losses and trigger bank failures. To limit these conducts, supervisors have several tools at their disposal, such as tightening large exposure limits, 71 limiting the 68 There are cases where the supervisor may identify senior managers and directors of a bank as suitable, but the controlling or significant shareholders might be unsuitable. For these situations, authorities may decide to restrict or suspend shareholders’ voting rights, based on the detrimental influence that they have on the safe and sound management of the firm, while keeping the bank’s senior managers and directors. 69 The appointment of a temporary administrator can have different modalities. Supervisors may keep the board in place but require an ex-ante validation of their decisions by the temporary administrator (“intervention regime)”. Or they can replace the board and confer its power to one or more temporary administrators (“substitution regime”). 70 In previous regimes the law typically requested the supervisor to appoint a temporary administrator when a bank breached certain solvency or liquidity triggers. Once appointed, the administrator would have a short period (typically, 2 weeks) to prepare a report for the supervisor, recommending a course of action for the firm which might be (i) restoring the bank to a “business as usual” situation, (ii) taking special resolution actions such as the transfer of certain assets and liabilities to a third party or to a bridge bank, or (iii) liquidating the bank, triggering the pay-out of the firm’s insured deposits. 71 A tighter large exposure limit can be useful in different circumstances. It can be imposed when the supervisor has material concerns over the extent of the relationship between the bank and its related parties. In other cases, banks may be tempted into providing new loans to their large and troubled borrowers, precisely to avoid their default, which amounts to no more than “throwing good money after bad” and would result in increasing the losses of the bank once it has failed. 34 Dealing with weak banks in FinSAC countries: progress and challenges ahead exposures to certain economic sectors, 72 or capping a bank’s risk-weighted assets or assets. Supervisors can also limit, restrict, or outright ban certain products or new businesses for the bank, including new acquisitions or the establishment of cross-border branches or subsidiaries. 73 Or restrict the bank’s discretion to make capital distributions (e.g., dividend, bonus bans or prohibiting other discretionary payments on capital instruments). Supervisors must be wary, however, of imposing too many restrictions as this could have a detrimental impact on the firms’ franchise, potentially exacerbating its troubles. These restrictions would typically be accompanied by a set of measures aimed at rehabilitating the financial situation of the weak banks, including via further cost-cutting measures, spinning-off some assets or restructuring certain liabilities. 4.3. Managing financial stress Final measures to prevent non-viability 43. When recovery measures do not work, a weak bank might be compelled or forced to be acquired by a competitor. If the firm fails in restoring its financial position through recovery measures or through other early intervention measures required by the supervisor, the authority might compel or force the bank to find a credible merger/acquisition transaction (shotgun wedding). A takeover by another bank (or foreign entity) may be the last resort to avert the firm’s non-viability. Supervisors must keep in mind that the objectives of bank owners in these situations (e.g., such as maximizing the share price) may clash with those pursued by the supervisor (financial stability and depositor protection). Forced or otherwise authority-facilitated takeovers have been a recurrent crisis resolution mechanism in past crises. A recent case was the state-sponsored takeover of Credit Suisse by UBS (March 2023), where Swiss authorities forfeited the obligation of both banks’ shareholders meeting to approve the transaction to fast track it in a weekend. Box 5. Quasi-resolution regimes: the International Bank of Azerbaijan The International Bank of Azerbaijan (ABB) is the largest commercial bank in Azerbaijan, which held traditionally a dominant deposit market share (above 40 percent). Since its foundation in 1992, the bank has been controlled by the Azeri state, that increased its participation in the bank to 60 percent of its capital during 2013. ABB’s debt instruments were rated by the main credit rating agencies, as it had issued bonds in the international bond markets in several currencies (mainly in EUR and USD) for around USD 3.3 billion. Nonetheless, the debt was not guaranteed by the state. ABB’s troubles grew in 2014 and 2015 in the context of a large open short foreign exchange position at a time of negative macroeconomic developments, including plummeting oil prices and a large depreciation of the manat against the USD. Poor governance (including corrupt practices of the former chairman who was subject to public prosecution), connected lending, and lax credit risk 72 This measure might be applicable in systemic scenarios, where certain economic sectors have been earmarked as particularly vulnerable (for example, the construction, shipping, or aviation sectors). 73 A ban on opening new branches or undertaking any new acquisition ensures that the bank is focused on managing its crisis rather than on desperately seeking short term revenue sources. The supervisor may also enforce caps on the remuneration of deposits, as they are typically expensive, volatile funding sources that are unlikely to materially improve the liquidity position of the bank while increasing the financial costs of the bank. 35 Dealing with weak banks in FinSAC countries: progress and challenges ahead underwriting were also features that resulted in a sharp increase in non-performing loans, amounting to more than 70 percent of the bank’s loan book. The state injected capital in 2015, 74 bringing its stake in ABB above 82 percent 75. Moreover, between 2015 and 2017, ABB transferred a significant share of its non-performing assets to Aqrarkredit (close to AZN 16 billion, or equivalent USD 10.3 billion), 76 a non-banking state-owned financial organization with a mission to extend loans to the agro sector. Aqrarkredit acted effectively as a bad bank or AMC. Aqrarkredit swapped long-term sovereign bonds for ABB’s non- performing assets, providing liquidity support to the bank. See Annex I for more details. Nonetheless, the far-reaching recovery measures were not enough to overcome the situation. The bank and the Azeri state designed a liability management exercise, where ABB’s bondholders were expected to contribute to its recapitalization. In May 2017, ABB suspended its payments to its Eurobonds (but continued paying corporate and retail deposits) and sought protection from their foreign bondholders in a New York Court to enable the collective restructuring of its liabilities. 77 ABB offered three options to senior bondholders: (i) swap bonds for newly issued sovereign debt at 5.125 percent rate but with a 20 percent haircut, (ii) swap bonds for newly issued sovereign debt at 3.5 percent rate with no haircut, or (iii) extend the maturity of bonds (without recourse to the Azeri sovereign) at par value and a 3.5 percent coupon. Subordinated debtholders faced a 50 percent haircut. 78 Most bondholders accepted the bid, which was filed in New York. The liability management exercise was instrumental to improving the bank’s liquidity position, hedging its foreign exposure, and raising fresh capital. With a further injection of state capital into the bank and new management appointed, a restructuring plan was implemented with the overall goal of the bank’s privatization, 79 agreed by the government in 2015. As of 2024, the bank remains state-owned. This case illustrates a very extreme recovery scenario, where some of the bank’s debtholders were compelled to share the burden of the financial rehabilitation of a large, systemic bank. It also evidences that creditors of state-owned institutions may also be subject to losses, even in the context of a bail-out. 74 See the capital structure and the evolution of public capital injections since 2007 in the Investor Presentation dated 23 May 2017, pages 5 and 6. URL: https://abb- bank.az/storage/uploads/files/1596637038_20170523_-_iba_investor_presentation.pdf. 75 International Bank of Azerbaijan Consolidated Financial Statements, note 1. URL: https://abb- bank.az/storage/uploads/files/1600257718_ifrs-2015-2-eng.pdf. 76 See the capital structure and the evolution of public capital injections since 2007 in the Investor Presentation dated 23 May 2017, page 6. URL: https://abb-bank.az/storage/uploads/files/1596637038_20170523_- _iba_investor_presentation.pdf; and International Bank Of Azerbaijan Restructuring Plan Approved in July 2017, press release (AZN 4.9 billion). URL: https://abb-bank.az/index.php/en/maliyye-ve-investisiya/diger- melumatlar/press-relizler/azerbaycan-beynelxalq-banki-ohdeliklerinin-konullu-restrukturizasiyasi-planinin- kreditorlarin-18-iyul-2017-ci-il-tarixinde-kecirilmis-yigincaginda-qebul-olundugunu-elan-edib. 77 See the full list of liabilities involved in the Restructuring Plan, annex 1, URL: https://abb- bank.az/storage/uploads/files/1596634982_restrukturizasiya_plan_abb.pdf 78 See the proposed terms of debt restructuring in the Investor Presentation dated 23 May 2017, pages 15 to 17. URL: https://abb-bank.az/storage/uploads/files/1596637038_20170523_-_iba_investor_presentation.pdf. 79 See the restructuring plan, URL: https://abb-bank.az/az/maliyye-ve-investisiya/diger- melumatlar/restrukturizasiya-plani. 36 Dealing with weak banks in FinSAC countries: progress and challenges ahead 44. Some FinSAC client countries have introduced a last resort regime that enables resolution authorities to apply bail-in powers on capital instruments outside the resolution regime. In these countries, crisis management provisions give authorities the ability to use of some restrictive bail-in powers for capital and other loss absorbing instruments outside resolution. Such powers might be employed when it is imperative to write down or convert these instruments into shares to prevent a bank’s becoming non-viable. This approach can prove beneficial in situations where the bail-in of capital instruments alone is sufficient to recapitalize a bank, thereby stabilizing it without affecting a bank’s operational liabilities. Dealing with non-viable banks 45. When all measures discussed above prove unsuccessful, and the bank eventually becomes not viable, the only remaining alternatives are the resolution or liquidation of the bank. As explained above, FinSAC client countries have overhauled or are overhauling their frameworks for dealing with non-viable banks. Much like the EU system, most countries have implemented two parallel regimes for non-viable banks: (i) a bank resolution framework, which is expected to apply to large and medium-sized banks and (ii) an orderly liquidation regime, either court or administrative based, expected for small firms. Nonetheless, either regimes may be used for any non-viable bank, regardless of its size and business model, depending on the circumstances surrounding its failure. 46. A bank resolution framework seeks to ensure the prompt intervention of the resolution authority in non-viable banks, with broad powers once a bank has been identified as not viable (failing or likely to fail). As discussed in Section 4, many FinSAC client countries have defined non- viability based on two key conditions. First, a bank’s viability may be assessed against clear and transparent triggers related to a bank not meeting its minimum requirements (including but not limited to capital adequacy), its monetary obligations, or maintaining a positive net asset value. Furthermore, the assessment needs to be conducted both at a point in time (“failing”) and on a forward-looking basis (“likely to fail”). Second, that the resolution regime is truly the last resort, and that no other measures taken by the bank, or the supervisor could reasonably address the firm’s financial situation. This condition immediately links the resolution regime with the previous elements of the crisis management framework. The authority needs to prove, when feasible, that it provided the bank with enough time to address the situation by itself. The approval and subsequent unsuccessful execution of a recovery plan is often crucial to evidence that there were no viable measures to overcome the bank’s distress. The condition may also be met if the bank has unsuccessfully tried to seek an acquisition or a merger with another entity. When there is no possible stand-alone set of measures to ensure the recovery of the bank, the authority can reliably prove that the resolution of the bank is effectively the last resort. Importantly, in fast-moving liquidity scenarios, authorities may not be able to give the bank the possibility to address the problems by itself, as deposit runs are characterized by incremental cash outflows and much less time to act. 47. Following the EU framework, many FinSAC client countries have also introduced the requirement that there should be a public interest in the resolution of the bank. Typically, public interest implies the mandate to the resolution authority to assess whether the disorderly failure of the bank could impact the country’s financial stability. 80 If there no public interest in the 80 In the EU, this mandate has been divided into two channels: (i) possible direct or indirect contagion to the rest of the financial system and (ii) sudden interruption of critical economic functions that the failed bank provided 37 Dealing with weak banks in FinSAC countries: progress and challenges ahead resolution of the bank, then the failed firm will be placed into liquidation. The interpretation of public interest is a key consideration when clarifying the scope of the resolution regime. A broad understanding of public interest can support the application of the resolution framework to most failed banks (e.g., Denmark), whereas a more restrictive one would imply that only the failure of the largest entities would be managed through the bank resolution framework (e.g.; Italy). In the context of most FinSAC client countries, where only a handful of banks operate (see Figure 1), it is expected that the resolution regime will be applicable to most bank failures, as even the liquidation of a medium-sized, or even a small bank, may wreak havoc throughout the banking system. 48. A resolution regime gives broad powers to the responsible administrative authority to implement both open and closed bank resolutions. Resolution authorities are conferred with a broad range of powers and tools. They can transfer part or all the assets and liabilities or the shares of the failed bank to a private acquirer or to a newly established bridge bank. 81 They can deploy bail-in powers by writing down or converting into shares certain liabilities of the failed bank, 82 particularly indicated for open bank resolution schemes. They may also transfer certain toxic assets to an AMC. 49. The introduction of resolution regimes signals countries’ unwillingness to fund costly bank bailouts. With some exceptions (Azerbaijan, Moldova, Ukraine), 83 most FinSAC client countries have not bailed-out banks during the last decade, unlike many Western European countries. This may create a less contentious socioeconomic attitude to bailouts. Nevertheless, the introduction of bail-in and other far-reaching powers is a key step towards a model where the costs of banks failures are expected to be predominantly funded by private agents and not by taxpayers. 50. The establishment of a Key Attributes-based bank resolution regime requires effective mechanisms for covering resolution costs. The availability of resolution powers is a necessary but not sufficient condition to guarantee an effective resolution regime. Equally, if not more, important is the availability of financial resources that can be swiftly deployed in bank resolutions. Bail-in powers are only effective if failed banks have previously issued debt instruments that can be converted into shares or written off at the point of non-viability. Similarly, transfer powers will only be effective if the failed bank has either issued loss-absorbing debt or if there is an industry- funded deposit insurance with an expanded mandate to top up the transferred assets, or a resolution fund. The relatively simple balance sheet structure of the banks in FinSAC client countries, where loans and government debt largely funded by equity and customer deposits, provides resolution authorities with few options to exercise their bail-in and transfer powers when resolving non-viable banks. to the economy or the financial system. The immediate consequence of this regime is that different countries in the EU have interpreted the public interest in rather divergent ways. The assessment of the Single Resolution Board of the lack of public interest in the resolution of the Banca Popolare de Vicenza and Veneto Banca in 2017, two medium-size Italian regional lenders active in the Veneto region, remains emblematic; after the immediate negative assessment by the Single Resolution Board, they were liquidated at a high cost for the public purse. 81 Some bank resolution regimes of the FinSAC client countries enable the resolution authority to transfer the shares of the failed bank to a third party or to a bridge bank. This rule is inspired by the BRRD. It was used in the Resolution of Banco Popular in June 2017, where the shares of the bank were transferred to Banco Santander, and during the resolution of Sberbank’s subsidiaries. 82 Typically, some of the bank liabilities are excluded ex-lege, including the insured deposits, secured, or short- term interbank liabilities. Bank resolution regimes often offer further flexibility to exclude other liabilities from bail-in, based on financial stability or the potential impact on the effectiveness of the resolution scheme. 83 Kazakhstan, Russia, and Tajikistan also funded costly bailouts in the last decade. 38 Dealing with weak banks in FinSAC countries: progress and challenges ahead 51. Loss-absorbing debt instruments are one of the key sources to cover the costs of resolution. Some FinSAC client countries are introducing new loss-absorbing requirements. Authorities in the region are requiring banks to issue loss-absorbing debt instruments that can be converted into shares or written-off in a resolution situation, but little progress has been made on the issuance of loss-absorbing debt instruments so far, as requirements are phase in during prolonged periods. 84 Shallow local capital markets, limited access to international capital markets, and tight financial conditions linked to the current environment of high interest rates are key challenges faced by banks. In some cases, local subsidiaries of banking groups may be able to issue such instruments to their parents. 52. Industry arrangements, such as resolution funds and deposit guarantee funds, are another key source for covering the costs of resolution. Bank-funded resolution funds have been introduced by several FinSAC client countries (Albania, Georgia, Moldova, Montenegro, North Macedonia, Serbia), and they are being considered by others. They are usually paid into ex-ante by banks to be deployed in bank resolution, but they have not yet had time for their funding to grow beyond rather modest levels. 53. Some countries have expanded the mandate of deposit insurers into so-called “paybox plus” models. In these cases, deposit insurance funds can also be used to top up the assets of the failed bank in a partial transfer of assets and liabilities to a third party or to a bridge bank. As the transferred assets (e.g., performing loans) in these transactions are likely to be lower than transferred liabilities (frequently insured and uninsured deposits), it is key that countries have the flexibility to make cash contributions or other actions (e.g., guarantees) to the failed bank to facilitate the transfer to an acquirer. 54. The lack of loss-absorbing debt, and resolution funds, or the existence of narrow-mandated deposit insurance funds may result in resolution frameworks still being dependent on public sector support. 85 Transfer and bail-in powers may be curtailed by the lack of available resolution funding, in which cases authorities may need to make very hard choices. Imposing losses to depositors or other liabilities may only be avoided with a bailout. This topic is covered in greater detail in Section 5.6, where we debate the use of bank bailouts. 55. Although the introduction of new resolution frameworks is expected to make bank liquidation less relevant, it may still be required in certain cases. First, the resolution and insolvency regimes can be simultaneously applicable to the same bank failure, 86 particularly during closed bank resolutions. 87 Second, the liquidation regime was historically the framework for dealing with weak 84 Some banks in Romania, Poland, and Croatia. International Financial Institutions have frequently participated in these issuances, subscribing a relevant share of bond issuances. 85 The question may be complicated by the sovereign’s potential lack of access to the debt markets. In some cases, the public sector may be unable to provide the funds required to resolve (or recapitalize) the banks, prompting a sovereign bail-out, potentially linked to a debt restructuring. 86 For example, when the resolution authority decides to selectively transfer the assets and liabilities to a third party or to a bridge bank. Simultaneously or immediately after the transfer, the supervisor would revoke the license of the failed bank and open insolvency proceedings; the creditors that haven’t been transferred to the acquirer will seek to recover their claims with the assets that have remained in the rump. 87 N.B. the case of the resolution of Banco Espirito Santo in Portugal in 2014, where some of the assets and liabilities of the failed bank were transferred to a newly created bridge bank (Novo Banco), and the remaining assets and creditors were left at the failed bank, whose license was revoked by the Banco de Portugal afterwards and placed into insolvency proceedings. A similar resolution scheme was conducted by the Banco de Portugal in the resolution of Banif in 2015, this time selected assets and liabilities were transferred to Banco Santander and the bank’s unwanted assets were transferred to a bad bank (Oitante). 39 Dealing with weak banks in FinSAC countries: progress and challenges ahead banks, and some countries may use them for dealing with banking failures. Liquidation regimes have been used recently in Ukraine (2022), 88 North Macedonia (2020), 89 and Montenegro (2019) 90 and have been key in dealing with large bank failures in other countries, such as Moldova (2014). 91 Third, some countries, especially the largest, may decide to apply a restrictive interpretation of the public interest test, especially if the liquidation regime offers similar powers to the resolution regime and more flexibility in its use. 92 56. Liquidation regimes across FinSAC client countries are less harmonized than resolution frameworks. The lack of an international or a European common reference standard for bank liquidations justifies the differences across the applicable regimes. Unlike the primary objectives of bank resolution, which aim to safeguard financial stability, insured depositors or taxpayers’ funds, and preserve the continuity of critical functions, the primary goal of bank liquidation is to maximize recoveries on behalf of the bank’s creditors. Once the supervisor revokes a bank’s license, insured deposits will be paid out and the insolvency procedure will start. The existing frameworks generally fall into two categories: court-based or administrative-based liquidations, although the classification is not always straightforward: i. In a court-based framework, the insolvent bank’s license is revoked by the authority and subsequently placed under the remit of a judge, who appoints a liquidator to manage the process. The judge authorizes the key actions proposed by the liquidator. The resolution authority often retains some responsibilities, such as formally proposing a liquidator to the judge or a general duty to oversee the process. ii. In an administrative-based framework, the resolution authority is responsible for the process; it appoints a liquidator and assumes the responsibility to decide on the key actions (e.g., assets sales, foreclosures, etc.). 93 In some countries, the resolution authority may also have similar transfer powers that are used in bank resolution regimes. 57. Retaining flexibility on the choice of the regime and actions applicable to a non-viable bank is key. During resolution planning, authorities identify if, in case of failure, the bank is expected to be placed under resolution or liquidation/insolvency and, in case of resolution, the strategy and tools that the resolution authority expects to use. Typically, the failure of a systemically important 88 Ukraine liquidated dozens of banks as part of a 2014-2018 clean-up of the banking sector. More recently, after the Russian invasion in 2022, the National Bank of Ukraine placed two Russian-controlled banks under liquidation: International Reserve Bank JSC (Sberbank’s Ukrainian subsidiary) and Prominvestbank JSC. Another bank (Bank Sich JSC) was declared insolvent in August 2022. See Annex II for more details. 89 Eurostandard Bank’s license was revoked by the National Bank of the Republic of North Macedonia and placed into ordinary insolvency proceedings in 2020. See Annex II for more details. 90 In 2019 the Central Bank of Montenegro revoked the license of two insolvent banks (Invest Banka and Atlas Banka) after failing to find suitable acquirers once the banks had been placed into temporary administration. See Annex II for more details. 91 See Box 1 and Annex II for a more complete explanation. 92 As has happened in Italy, where the Banca d ’Italia is the authority responsible for bank liquidations. The Italian liquidation regime offers comparable powers for closed bank resolutions (transfers of assets and liabilities), but, unlike the bank resolution framework, the use of public funds has fewer strings attached (particularly, it is not subject to the 8 percent mandatory contribution to loss-absorption of shareholders and creditors before resolution funds and public support can be deployed). 93 Nonetheless, the separation between the two regimes is not clear-cut. In most court-based regimes, the resolution authority retains some relevant roles, such as formally proposing the liquidator to the judge or retaining a high-level supervisory function in the process. 40 Dealing with weak banks in FinSAC countries: progress and challenges ahead bank is expected to be managed through open bank bail-in resolution, medium-sized banks through a transfer strategy, and a small bank through insolvency procedures. But nothing is set in stone. One of the key lessons learnt from the US bank failures of March 2023 is that under certain circumstances, the failure of non-systemic banks may have systemic consequences. Or, in the crisis of Credit Suisse, a state-facilitated merger transaction with UBS was undertaken instead of the planned single point of entry open bank bail-in strategy previously agreed among resolution authorities. 41 Dealing with weak banks in FinSAC countries: progress and challenges ahead 5. Managing banking crises in systemic scenarios 5.1. Context and explanation 58. The regulatory framework for most FinSAC client countries appears to be well prepared for dealing with banking crises, but a systemic scenario may require the deployment of the regulatory toolbox in a different manner. In a systemic crisis, the viability of a significant part of the banking sector might be questioned, creating systemic funding risks that in extreme cases can affect the sustainability of the sovereign debt (bank-sovereign feedback loop). In such circumstances, experience shows that authorities need to use their powers and tools in a way that seeks to remove doubts over the viability and sustainability of the banking sector. The following section discusses the steps that authorities can take to remove any lingering questions on the safety and soundness of the banking sector. 59. Systemic crises usually start with an acute phase, where liquidity pressures can affect bank’s capacity to continue their operations. Systemwide liquidity provision, through a lender of last resort or ELA function may be required. In more extreme cases, other measures, such as increasing deposit insurance coverage or providing blanket guarantees can be useful to stabilize the situation. When none of these measures is effective, authorities may need to resort to capital controls and other administrative measures (See Box 10). 60. Amid profound distrust during a banking crisis, systemic bank diagnosis, including AQRs and forward-looking viability assessments, are key to comprehensively identify banks’ capital shortfalls. In systemic scenarios, uncertainty regarding banks’ balance sheets may preclude economic agents from making new extending new funds to the banking sector. Undercapitalized banks may be considered contingent fiscal liabilities for the sovereigns by investors. Questions may arise over private and public financial sustainability. in these contexts, an accurate and credible systemwide bank diagnosis is key, including a thorough review of banks’ asset classification and provisioning practices and a forward-looking assessment of their capital adequacy. 61. Standard resolution toolkits may not be enough for resolving banks during a systemic crisis. Resolution strategies seeking to transfer a failed bank to a third party might not be feasible, as extreme risk aversion may prevent any credible bid. Open bank resolution may be the only viable resolution strategy for a systemic bank. In this scenario, the key question will be where to find the funds to absorb the losses and recapitalize the bank (e.g., loss-absorbing debt, uninsured deposits, resolution funds, or taxpayers’ money) and to underpin its liquidity and funding position. 62. A detailed understanding of and planning for all the operational aspects of resolution will facilitate its smooth implementation. A thorough understanding of the resolution strategies, advanced contingency planning, effective liquidity mechanisms for providing liquidity to banks in stress or close coordination and cooperation with other authorities are key for a successful management of the crises. 5.2. What is the true extent of the losses? 63. Once authorities have managed to stabilize the crisis, the first step towards solving a banking crisis is an accurate diagnosis of the banking sector. During systemic crises, uncertainty about the valuation of banks’ assets is commonplace. When doubts are affecting many banks, the problems are unlikely to be solved using a piecemeal approach. A comprehensive, credible diagnosis is essential to quantify the true extent of the systemwide losses and the capital needs. Relevant 42 Dealing with weak banks in FinSAC countries: progress and challenges ahead international experiences show that diagnostics are more effective when the review covers two separate elements: (i) the asset classification and provisioning or valuation practices (balance sheet assessments or AQRs), and (ii) the forward-looking projection of banks’ capital ratios (capital plans and stress tests). Depending on the crisis, a diagnosis can have other goals, such as analysis of exposures to related parties, assessment of the banks’ credit risk underwriting, monitoring, and restructuring policies, or their internal governance arrangements. The results of these exercises will be the basis for taking corrective actions. 64. AQRs can be used for many different purposes. AQRs carried out in systemic scenarios seek to systematically unveil the losses and capital needs of the banking sector, usually as “defensive measures” against investor and market distrust. Some authorities may choose to undertake regular AQRs (e.g., every three years) to ensure the adequateness of the banking sector asset valuation and capital adequacy. Others may undertake an AQR before being transferred supervisory responsibilities for banks (e.g., the European Central Bank’s AQR). In other cases, AQRs are conducted once the worst of a crisis is over, to obtain a clean health check of the banking system. 65. An AQR is a key step to quantify the losses that have already been incurred or are expected by banks in a systemic scenario. During these exercises, swathes of credit files are sampled and reviewed by an independent third-party, usually a multinational audit firm. The scope of the exercise is typically tailor-made to the nature of the crisis (see Figure 8). The review is undertaken according to the methodology approved in the exercise’s Terms of Reference (ToR). 94 An AQR is mainly a static assessment; it does not require financial projections of the bank’s income statements, balance sheets, or capital ratios. 95 The ToR typically clarifies the reviewed portfolios, the minimum files to be reviewed, and the rules for extrapolating the losses to the unreviewed parts of the portfolios. As a result of AQR, banks’ capital ratios are recalculated after loan reclassifications, and adjustments in loan-loss provisions, and other asset values. 66. AQRs are often supplemented with forward-looking viability assessments. The revenues, costs, assets, liabilities, and capital of each bank are projected in a baseline and sometimes stress tested in an adverse scenario. Capital ratios are usually benchmarked against a hurdle rate, to identify capital shortfalls and facilitate the viability assessment. The methodology and the process to project the banks’ financials in the scenarios are fleshed out in the ToR. Figure 8: Selected cases of systemwide AQRs & viability assessments 96 94 Most authorities have publicly disclosed the methodologies and results of the exercise (ECB, Montenegro, Ireland, Kazakhstan, Spain, etc.). 95 Although for the calculation of expected losses, the assessment should involve the projection of borrowers’ cash flows in different scenarios. 96 References: Ukraine 2023 – Press release “The National Bank begins an assessment of the stability of the banking system in wartime conditions” (in Ukrainian) https://bank.gov.ua/ua/news/all/natsionalniy-bank- rozpochinaye-otsinku-stiykosti-bankivskoyi-sistemi-v-umovah-voyennogo-chasu; Montenegro 2020 – Central Bank of Montenegro, Supervision Department, AQR (https://www.cbcg.me/slike_i_fajlovi/eng/fajlovi/fajlovi_kontrola_banaka/aqr/asset_quality_review_of_banks _in_montenegro_181021.pdf); Kazakhstan 2019 – “Final system-wide report on results of the Asset Quality Review of banks in the Republic of Kazakhstan”, National Bank of Kazakhstan, December 2019; Ukraine 2015- 2016 – “Results of bank diagnostics as of 07/20/2017” (in Ukrainian) https://bank.gov.ua/admin_uploads/article/Test_Results_20072017.pdf?v=4; Ukraine 2014 – NBU’s Annual Report 2014, page 78; Tajikistan 2014-2015 - IMF, Republic of Tajikistan, Financial System Stability Assessment, February 2016,; Bosnia and Herzegovina 2014-2015 – IMF, Bosnia and Herzegovina, Financial 43 Dealing with weak banks in FinSAC countries: progress and challenges ahead Source: FinSAC own ellaboration 67. The results of the diagnostics are used to break banks down into different groups: a. Viable banks with excess capital. This group includes firms whose projected capital ratios are above the hurdle rate. These banks do not need to prepare remediation plans and can therefore continue to operate on a business-as-usual basis. b. Viable banks with capital shortfalls. This group encompasses firms whose projected capital ratios are below the minimum capital hurdles, and therefore face capital shortfalls. They need to prepare recapitalization plans (recovery plans), outlining their remediation measures to restore their capital ratios. Once authorities have thoroughly assessed the plans’ credibility and feasibility, they usually demand that banks execute them within a realistic timeline. Banks within this group can be further broken down into two subcategories: i. Banks that can cover their capital shortfalls by their own means. Recovery plans often combine different measures to cover shortfalls, such as NPL sales, cost-cutting, or strengthening the balance sheet through loan deleveraging and deposit gathering. As a rule of thumb, a credible plan must contain a Sector Assessment Program, Banking Sector Stress Testing, Technical Note, July 2015; Eurozone / ECB 2014 – ECB, “Aggregate report on the comprehensive assessment”, October 2014; Slovenia 2013 – Bank of Slovenia, “Full report on the comprehensive review of the banking system”, ; Greece 2013 – Bank of Greece, “2013 Stress test of the Greek banking sector”, March 2014; Spain 2012 – Oliver Wyman, “Asset quality review and bottom-up stress test exercise”, September 2012; Cyprus 2012-2013 – PIMCO, “Independent Due Diligence of the Banking System of Cyprus”, March 2013; Portugal 2011 - European Commission, “Ex Post Evaluation of the Economic Adjustment Programme, Portugal 2011-2014”, Institutional Paper 040, November 2016; Ireland 2011 – Central Bank of Ireland, “PCAR 2011 Review - Analysis of PCAR banks up to end-June 2012 compared to PCAR 2011”, March 2013. 44 Dealing with weak banks in FinSAC countries: progress and challenges ahead sizable contribution by the bank’s shareholders (see Section 4.1 for more details). ii. Viable banks that cannot fully cover their capital shortfalls by their own means. Some viable banks97 may be unable to cover the capital shortfalls using their own means. 98 These firms may need to accept either a merger with another solvent entity or, as a very last resort, a temporary state recapitalization, particularly for systemic banks. Mergers and acquisitions are preferable to public recapitalizations, as they may not demand taxpayers’ funds, can reduce overcapacity in the system, and can result in more resilient banks. When finding an acquirer is not feasible, public funding can be the banks’ only realistic possibility to avert non-viability. This should be the last resort and be subject to strict conditionality on burden sharing, competition, and protection of taxpayers’ funds (see Section 5.6 for more details). c. Non-viable banks. Some firms may be identified as non-viable, and therefore either resolved or liquidated. The following sections discuss the specific resolution actions and powers applied to these banks. 68. When undertaking AQRs and viability assessments, authorities in FinSAC countries may consider certain key elements: a. Clear determination of the scope of the exercise. Ideally it should cover all banks in a country. This is not always possible, for example given cost-benefit considerations in financial systems with many small banks, where authorities may target a minimum coverage in terms of system assets or risk-weighted assets (see AQRs Ukraine in 2014 and 2015). However, the limited number of banks operating in FinSAC client countries (usually fewer than 20), may enable countries to implement full-scoped exercises (e.g., Montenegro 2020-2021). A second decision entails the identification of the portfolios under review, which should reflect both supervisory and market concerns. b. Clarify the public backstops in case of need. The announcement of a comprehensive assessment can have a detrimental effect in the banking system if it is not clear how capital shortfalls would be covered if firms’ own capital sources are not enough, including public backstops when needed. Without this clarity, such an announcement can exacerbate the loss of confidence in the system and trigger further liquidity risks. In very extreme cases, especially when sovereign solvency is at risk, capital controls or other administrative measures can help contain liquidity and funding pressures. c. Engage seasoned and prestigious professional services firms. Well-recognized, international audit firms can bring valuable audit expertise and manpower to the AQR. International consulting companies can assist with the overall management of the project and provide best practices (modelling, benchmarks, etc.) during the viability assessment and capital shortfall quantification. Engaging international firms can lend 97 The separation between a viable bank not able to cover their capital shortfalls by their own means and non- viable banks is complex and demands professional judgment. In these cases, there is a high risk that non-viable banks seek to have their losses understated to be classified into this category, as authorities may be tempted to “save” certain banks. 98 For example, banks whose capital ratios are above the capital hurdle in the base scenario, but they simultaneously report large shortfalls in the stressed scenario. 45 Dealing with weak banks in FinSAC countries: progress and challenges ahead consistency and credibility to the exercise but can increase costs substantially, often a key driver for small countries with limited financial resources. The model for funding the costs of the exercise should be clear and transparent from the start. d. Define a sound project management framework. These exercises can involve many firms and individuals. A clear strategic and operational framework is essential to ensure consistency and harmonization of the exercise. Authorities should be always governing the process to ensure a proper oversight and provide quality assurance. Moreover, it is a good practice to supplement audit teams with banking supervisors, as they tend to know the firms better and can enhance the comparability of results by ensuring consistency in application of the methodology. Likewise, the exercise can be enhanced by retaining an international financial institution, as they provide useful global experience and lift the credibility of the exercise. e. Set out a comprehensive and detailed methodological approach in the ToR. Estimating credit losses and projecting financial flows demands significant professional judgment. To this end, and to bolster the exercise’s credibility, the ToR should be detailed and fully understood by all participating agents (including comprehensive and granular technical criteria). The principles-based accounting criteria for credit losses should be complemented by technical guidance on the accounting and regulatory classification of the exposures and the assessment of the adequacy of loan-loss provisions and other asset valuations. The exercise should be supported by credible macroeconomic scenarios, (i.e., GDP growth, unemployment rates, real estate prices, inflation rates, etc.), ideally from reputable international financial institutions, as they are the basis for the financial projections. f. Consider how to disclose the results of the exercise. As the exercise may have been triggered by widespread distrust in the financial system, disclosure of the exercise, including its methodology and results is likely to be key to allay market concerns. Nevertheless, authorities should also consider the potential effects that these disclosures can have on the country’s financial stability. Box 6. 2020-2021 Asset Quality Review in Montenegro99 The Central Bank of Montenegro conducted an AQR for the Montenegrin banking sector in 2020 and 2021. It aimed to provide a comprehensive assessment of the credit quality of the sector. The focus of the exercise was on ensuring the adequate classification and coverage of loan portfolios and other relevant assets in the banks’ balance sheets. Although the exercise was executed during 2020 and 2021, the reference date was 2019. The Central Bank retained an international consulting company to assist in the organization of the exercise. Independent international audit firms and appraisal companies were proposed by banks to conduct the exercise. The exercised used the European Central Bank AQR 99 The structure and the results of the exercise are available in: https://www.cbcg.me/slike_i_fajlovi/eng/fajlovi/fajlovi_kontrola_banaka/aqr/asset_quality_review_of_banks _in_montenegro_181021.pdf. 46 Dealing with weak banks in FinSAC countries: progress and challenges ahead methodology and accordingly it was divided into three phases: (i) portfolio selection, (ii) AQR execution, and (iii) quality assurance and final reports and disclosure. The scope of the exercise covered the 13 banks operating at that time in Montenegro. A minimum of five portfolios per bank were reviewed, and the covered portfolios represented at least 64 percent of the risk-weighted assets per bank (above 95 percent in some cases). The exercise also covered other assets, including real estate and foreclosed assets, unlisted equity stakes, and level 2 and 3 bonds. The AQR resulted in additional losses for an amount of EUR 40 million, implying a decrease in the banking sector aggregated capital ratio of 160 basis points. After the adjustments, the aggregated capital ratio was 16.2 percent, materially above the applicable minimum capital ratio (10 percent). Only one bank was required to take capital conservation measures because of the exercise. 5.3. An independent valuation 69. Following the FSB Key Attributes and BRRD, many FinSAC client countries require an independent valuation before taking any resolution action. As a result of the AQR, some banks may be identified as non-viable and placed into resolution. For these banks, most FinSAC client countries require an independent valuation before taking any resolution action. This valuation seeks to help authorities to: (i) assess the viability of the bank, 100 and (ii) inform the resolution scheme to be implemented. 101 Critically, an independent valuation aims to have all losses thoroughly and timely recognized before any resolution action is executed. A counterfactual valuation is usually also required to test how affected shareholders and creditors would have been treated in case of liquidation, to protect affected shareholders and creditors, but also the resolution authority in case of legal challenges. 102 70. While an independent valuation is indicated before taking any resolution action, it is essential when no market price underpins the resolution scheme. While possibly less relevant for transfers to private acquirers (as there has been an auction with bids), an independent valuation is essential to inform any open bank resolution transaction (e.g., bail-in) or the transfer of assets and liabilities to a bridge bank or to an AMC, as none of these transactions is underpinned by a bid from a private sector entity. 71. Performing an independent valuation in the circumstances that usually surround the resolution of a bank can be very challenging. Most resolution regimes foresee the possibility of taking resolution action informed by a provisional valuation prepared by either an independent valuer 100 Particularly if the conditions for entering resolution also entail the assessment of a bank’s assets and liabilities to determine whether the firm’s net asset value is negative. 101 Non-viable banks should be either resolved or liquidated. As previously explained, many FinSAC client countries have upgraded their resolution frameworks for dealing with failed banks. Following the reforms, two regimes often coexist: bank resolution for dealing with large and medium-sized banks and liquidation for managing small bank failures. 102 Known as the “no creditor worse-off than in liquidation valuation.” It may trigger compensation for loss- making shareholders and creditors if it evidences that they would have received better treatment had the bank been liquidated. 47 Dealing with weak banks in FinSAC countries: progress and challenges ahead or by the authority itself. In either case, an independent valuer should carry out a final valuation afterwards. 72. The results of the AQR can be leveraged and combined with the requirements of an independent valuation. While the requirements of an independent valuation may differ from those related to the AQR, the independent valuer may rely significantly on the analysis conducted during the AQR, which can simplify the process considerably. If the AQR has been exhaustive and resulted in a thorough review of the valuation of the bank’s assets, the operational requirements and complexity of the independent valuation exercise will become much less challenging. 73. There is limited experience in preparing independent valuations in resolution as there have only been a few cases in the EU and in FinSAC client countries. 103 These examples have shown that preparing a valuation during a fast-moving bank failure is a complex undertaking. It needs to be thoroughly planned beforehand by the authorities. Launching a public procurement process to award the valuation contract to a third-party firm when a bank is already in trouble may be read by the public as a clear sign of its demise. Valuation processes require that large swathes of data and documents are made available to the valuer; but the failing bank may be unable to timely collect all the relevant information. Once the documentation is available, the full process may require several weeks, if not months, to be properly executed, as asset-by-asset estimations are usually required. If the independent valuer decides to involve many staff and the valuation is performed at the bank’s premises, it may sound the alarm to bank’s employees, giving rise to negative rumors that could trigger deposit runs. Finally, the valuer fees may be significant; clarifying upfront how valuation costs will be funded is key. 74. Authorities can mitigate many of these risks during the resolution planning phase. Although challenging, these hurdles can be overcome. Resolution authorities can sign stand-by agreements with independent valuers that can be activated when needed, to spare the authority from conducting a public tender in the vortex of the crisis while also ensuring the valuer’s availability (the allotment of specific contracts can then be done quickly through mini auctions). Resolution authorities can require banks to regularly test their ability to swiftly generate, collect, and make available all the required data for a valuation process. To this end, authorities can set standards outlining the data that banks must be able to provide and its frequency. 104 Banks must also show they can provide the documents in an online format (through a virtual data room, for example), which can enable valuers to perform their work remotely, and avoid being on site at the bank’s headquarters. The legal framework should clearly identify how and by whom valuation costs should be covered. 5.4. Loss coverage: who foots the bill? 75. Once the size of the bill (the losses and capital needs) has been clarified, the critical questions become how and by whom the shortfalls will be covered. The term “burden sharing” is used to reflect the mix of funding sources to cover capital shortfalls and depends on several aspects, such 103 The resolution of Banco Popular in 2017 remains the most relevant in the EU. Authorities in FinSAC client countries undertook the valuation of Sberbank’s Europe subsidiaries under their remit. See the cases of Sberbank Slovenia https://www.srb.europa.eu/system/files/media/document/2023-12-21_SRB-Non- confidential-version-of-Valuation-2-Report-Sberbank-banka-d.d..pdf and Sberbank Croatia https://www.srb.europa.eu/system/files/media/document/2023-12-21_SRB-Non-confidential-version-of- Valuation-2-Report-Sberbank-d.d..pdf. 104 The Bank of England and the Single Resolution Board initiatives on ensuring valuation readiness and capabilities for banks are illustrative. 48 Dealing with weak banks in FinSAC countries: progress and challenges ahead as the features and financial situation of the bank, the economic scenario, or, in case of viable banks, the resolution scheme. 76. Viable banks are expected to raise capital by their own means, as use of public funds should be reserved for very extraordinary circumstances and subject to strong safeguards. Typically, each viable firm may define their own burden sharing model where the “pain” is shared between shareholders (through new capital contributions, costly dilutions, or dividend cutting), creditors (debt-for-equity swaps), managers (as they may be replaced and/or their bonuses curtailed), and employees (through lay-offs). When a firm faces large capital needs, share placements and cost cutting measures might be topped-up by liability management exercises, where the bank’s creditors are offered to participate in raising capital by swapping their claims for new shares. 77. Different sources might be used to cover the costs of resolution and/or liquidation, as in these cases the decision on burden sharing is no longer on the bank. A first source should be “insiders,” typically comprising the failed bank’s shareholders, its related parties, and subordinated creditors, who should always be exposed to the financial consequences of a bank’s failure. A second source comprises creditors that are expected to be exposed to losses, including loss-absorbing debtholders. A third source encompasses other creditors that may only be subject to losses in very extreme cases, including uninsured depositors and other unsecured creditors. A fourth source is made up of funds available in industry-funded resolution funds. A fifth entails the deposit guarantee funds. Finally, taxpayers’ money may be used in extraordinary circumstances. 78. Although the choice of the burden sharing model in resolution significantly varies across countries, some minimum principles should underpin all models. Shareholders, subordinated creditors, and, where applicable, related party creditors (the “insiders”) should always be subject to losses, as they are directly or indirectly responsible for the decisions that triggered the failure of the bank, or they invested their funds on the basis that they would be exposed to losses if the bank fails (and were therefore supposed to actively exercise market discipline). Certain creditors cannot and should not be subject to losses for reasons related to financial stability or legal security. These are the fully secured creditors, and the insured deposits, as they enjoy legal protection. Any use of taxpayer funds should be subject to strong constraints. 79. The specific burden sharing model in resolution will depend on several factors and is usually contingent on the prevailing economic circumstances. Every country has its own, specific burden sharing model, which may change over time. It depends on the regulatory framework (resolution and liquidation powers) and other aspects such as (i) the authorities willingness to effectively use their resolution powers, (ii) the socioeconomic attitude towards bank bail-outs, at the same time dependent on past banking crises and the existence of a market economy in the country, (iii) the nature of banking ownership, particularly when foreign and state ownership is high, (iii) the access of the banking sector to private debt markets and the availability of loss-absorbing debt instruments, and (iv) the existence of a privately funded resolution fund or the possibility to use the deposit guarantee fund in bank resolutions. Finally, the choice of burden sharing model is also contingent on the prevailing market and economic circumstances when the decision is made. 80. As large banks are assumed to be resolved following an open bank resolution (open bank bail- in), the burden sharing model should reflect this strategy. Open bank resolution primarily seeks the continuity of the operations of the failed firm, often as a stand-alone entity. Besides from absorbing losses, authorities need to find financial resources for recapitalizing the failed bank, so it can operate as a going concern. The choice of the burden sharing model in these cases usually 49 Dealing with weak banks in FinSAC countries: progress and challenges ahead involves a trade-off between bail-in and bail-out. Since the adoption of the FSB Key Attributes, many countries have implemented requirements that force firms to issue loss-absorbing debt instruments to enable resolution through bail-in. These loss-absorbing requirements are not likely to be fully implemented in the near term in most FinSAC client countries, which may increase the chances of bailouts. Some FinSAC client countries have complemented these loss-absorbing debt requirements with privately funded resolution funds, also reducing the risk of using taxpayers’ money. The use of other funding sources in open bank resolution is less relevant, as deposit guarantee contributions are typically off-limits in these situations and extending the bail-in to other creditors (e.g., uninsured deposits) may create unacceptable risks to financial stability and may undermine the failed bank’s business model. Figure 9 outlines stylized different burden sharing models for open bank resolution, based on different policy choices. Figure 9: Stylized burden sharing models for open bank resolution Source:FinSAC own ellaboration 81. The decision on burden sharing is also paramount for closed-bank resolution. Resolution authorities may selectively transfer assets and liabilities to a third-party acquirer or a bridge bank. Loss-absorption is usually achieved by leaving shareholders, subordinated creditors, and related parties in the rump, usually with the failed bank’s unwanted assets. Even so, a contribution is usually required to balance the assets and liabilities, as transferred liabilities tend to exceed the transferred assets. A decision should therefore be made on the funding source to top the latter up. To this end, authorities may use the deposit guarantee fund (in certain regimes, where they 50 Dealing with weak banks in FinSAC countries: progress and challenges ahead can make contributions to bank resolution), the resolution fund (if one exists and is funded), by leaving further creditors in the rump (risking financial stability), or by partially writing off some of the transferred liabilities. Figure 10 outlines stylized different burden sharing models for closed bank resolutions. Figure 10: Stylized burden sharing models for closed bank resolutions Source: FinSAC own ellaboration 5.5. Availability of resolution tools in crisis scenarios 5.5.1. Transfer Transactions A. Key elements of transfer transactions 82. Transfer transactions are one the most frequent resolution tools for dealing with bank failures, particularly in some jurisdictions. In principle, the most desirable way for managing non-viable banks is transferring their assets and liabilities or their shares to a third party, usually a competitor, which can swiftly integrate and operate the failed bank’s critical operations. Most resolution regimes in FinSAC client countries include transfer tools (known as sale of business in the EU and purchase & assumption in the US), which empower resolution authorities to transfer the shares or selected assets and liabilities to a third-party acquirer. Hundreds of failed banks have exited the market through these transactions, particularly in the US. Transferred customers continue to have access to their accounts, credit balances, and other banking services, as the acquirer takes over the transferred activities of the failed bank. 51 Dealing with weak banks in FinSAC countries: progress and challenges ahead 83. The use of transfer powers in FinSAC client countries raise specific challenges and risks, that might be exacerbated in a systemic crisis. Information leaks, a lack of suitable buyers, or complexities in the sale process are common obstacles to these transactions. However, authorities can implement measures to expedite the process. The following paragraphs consider both these obstacles and potential remediation actions. Although also useful when using transfer powers in non-systemic scenarios, they are critical during systemic banking crises. 84. Several steps are required to execute a transfer in resolution, which makes the process challenging. Authorities will be expected to select legal 105 and financial 106 advisors for complex transactions. The sale process typically involves several steps including: (i) pre-selection of interested bidders, (ii) contacting bidders and obtaining signed non-disclosure agreements, (iii) organization of due diligence process, including the data room, (iv) receipt of binding offers, 107 and (v) final decision on winning bid. 85. Many individuals may be involved in the transfer process, heightening the risk of damaging information leaks. In addition to the authorities’ staff, their legal and financial advisors, and the experts conducting the independent valuation, more parties may be involved. These include the bidders’ internal teams and their own legal and financial advisors. Some managers of the failed bank may also need to actively participate in the process, as their cooperation may be required. Given the small size of financial systems in most FinSAC client countries, it may be hard to avoid information leaks. If leaks happen, depositors and other funding providers may demand their deposits, leading to a run on the bank. 86. Authorities should take measures to mitigate the risk of leaks. The resolution authority may reduce the number of individuals involved in the process, for example, by restricting participating parties to those most likely to become active bidders. In this regard, the authority can undertake a pre-selection process during resolution planning. 108 Every participant in the process must be required to sign a non-disclosure agreement and be included in an updated insider list. Finally, the process should be conducted as quickly as possible. 87. Making high quality data available to potential bidders is key to a successful sale. If material information is missing, or the quality of data is poor, bidders may decide to lower their bids or refuse to bid altogether. During resolution planning, authorities can request banks to be prepared to swiftly produce and gather all the required data for a sale process. Authorities can define the 105 Legal advisors assist the authority in the preparation of all the legal documentation for the process, including the confidentiality agreements that any involved party needs to sign, the invitations to the bidding process, and the drafting of the contractual documentation of the purchase & assumption. Involving external legal advisors is particularly recommended if the authority is willing to provide guarantees during the process or it aims to selectively transfer liabilities to the buyer. 106 Financial advisors may be needed to assist the authority in the organization of the sale process, including identifying potential interested bidders and contacting them, organizing the due diligence process, including the data room, and conducting negotiations with the bidders on behalf of the authority. 107 In some cases, an additional phase may involve requesting the interested bidders sending a non-binding offer to the authority. However, this step might be skipped if the transaction is urgent. 108 Some resolution authorities analyze potential interested buyers of banks whose preferred resolution strategy is based on the transfer of assets and liabilities to a third-party. This analysis usually involves assessing the financial and operational capacity of the potential buyers and the strategic rationale of the transaction for the shortlisted buyers. The Single Resolution Board has issued standards to clarify how banks should prepare for transfer transactions to facilitate their resolvability. See https://www.srb.europa.eu/system/files/media/document/20211025%20SRB%20Operational%20guidance%2 0for%20banks%20on%20separability%20for%20transfer%20tools%20FINAL.pdf. 52 Dealing with weak banks in FinSAC countries: progress and challenges ahead minimum information that firms need to collect and upload to a virtual data room and clarify the expected timeframe for doing so. B. Assisted transfer transactions 88. A loss-sharing agreement can facilitate a transfer if there is uncertainty about the quality of the failed bank’s assets or a risk of inadequate due diligence. Giving the buyer guarantees can be key in facilitating transfer actions in cases when there is not enough time for comprehensive due diligence, or when insufficient information is available. Loss-sharing agreements (also known as asset protection schemes) typically involve transferring to the guarantor a significant portion of the losses in earmarked asset or liability portfolios. Such guarantees can: (i) mitigate the information asymmetries that arise in these transactions, (ii) ensure that the guaranteed assets are transferred to the buyer and therefore will be managed by the acquirer, effectively precluding any politically sensitive public management of these assets (for example, if they are transferred to an AMC), (iii) encourage the active and sound management of the assets with a view to maximize the recoveries by granting financial incentives to the acquirer, and (iv) eliminate immediate financial pressures to industry arrangements, as the guarantees may be drawn over an extended period. 89. The guarantees have significant advantages for the beneficiary. Besides protecting it from losses in the covered assets; beneficiaries may consider them when calculating the capital requirements109 and loan-loss provisions for the guaranteed assets. 110 Moreover, certain borrowers included in the guaranteed portfolio may see their fortunes improve, enabling the beneficiary bank to expand its customer base. Finally, the acquiring firm can extract synergies by leveraging its workout units to manage the distressed assets. 90. The guarantor needs to carefully assess the guarantee’s design and structure. Flawed schemes can result in the poor management of the guaranteed assets by the beneficiary, increasing the losses for the guarantor. This risk can be mitigated through a sound legal design of the instrument: i. The scope of the guarantee should be clearly determined, and losses should be subject to a cap. The guarantees should be as specific as possible, strictly covering the losses from the guaranteed assets, that should be ring-fenced. The scope of the guarantees can be determined by following some limited, well-defined criteria. Assets can be earmarked mainly using credit quality (e.g., underperforming or non- performing loans). This criterion can be complemented by economic sector or product, especially when certain exposures (e.g., construction, infrastructure) or products (e.g., high-risk mortgages, loans to related parties, FX lending, etc.) were behind the bank failure. If the guarantee also covers contingent liabilities (e.g., tax liabilities, pending administrative fines, legal challenges, etc.), it will need to comprehensively identify the liabilities within the scope. Loss-sharing agreements 109 It is crucial that the guarantee is instrumented to ensure that it can be eligible as a credit risk mitigation technique by meeting the minimum requirements of the personal guarantees in the applicable regulatory framework. The Basel framework for credit risk mitigation techniques typically require the guarantees to be direct and at first demand, among other requirements. 110 An important question that is commonly raised in these cases is whether the beneficiary should classify the guaranteed assets in the non-performing category. Banks will seek to exclude them, as no losses will be expected from them. Nevertheless, authorities may decide to request the classification of the guaranteed assets according to their asset quality as the guarantees will only influence the losses and therefore the loan loss provisions, and not the accounting classification. 53 Dealing with weak banks in FinSAC countries: progress and challenges ahead cannot cover the general performance of the acquired business or cover any loans originated after the transfer, as this may effectively insure the beneficiary against its own mismanagement (“heads I win, tails you lose”). ii. Incentives should be developed for the sound management of the guaranteed assets and/or the liabilities by the acquirer. Loss-sharing arrangements may include a proportion of losses that should be assumed by the beneficiary 111 (“a franchise”). The guaranteed amount must be high not to be ignored by the beneficiary but not too high to discourage the transfer. Other mechanisms to ensure the sound management of the assets can involve the periodic assessment of the covered portfolio by an independent third-party (monitoring trustee). 112 iii. Guarantees are expected to be provided by industry arrangements. Use of industry arrangements (e.g., resolution fund or deposit guarantee funds) is more natural to instrument guarantees during asset transfers. Public guarantees are less common, particularly in closed bank resolutions. iv. The features of the guarantee should be thoroughly regulated in a contract. The contract must clearly define the concept of “losses” that trigger the coverage, by using “final losses” rather than accounting losses. Contracts must regulate the actions that require the specific approval of the guarantor. Debt forgiveness, portfolio sales, certain restructuring actions, or debt-to-equity-swaps above a minimum threshold should be previously authorized, as they can trigger large payments for the guarantor. v. The guarantor can set up a structure with sufficient resources to monitor the performance of the guarantee. Guarantees usually contain detailed provisions on the definition of losses, the actions that need the prior authorization of the guarantor, and mechanisms for dispute resolution. As disagreements can emerge, 113 guarantors can set up internal or outsourced structures to oversee the performance of the guarantee. vi. A sunset clause is usually an important feature of these contracts. This clause is set at a date that reflects the expectations for the period in which most guaranteed assets may have been wound down. If the guarantee continues to be in force at that date, the contracts commonly regulate a final payment, based on a third-party valuation selected under the rules of the contract. The final payment terminates the contract. 91. Experience during the GFC supports that sale transactions can be enabled by these guarantees. Figure 11 shows cases, most recently in 2023, where asset protection schemes were used in resolution to facilitate asset transfers. These cases were not in FinSAC countries but have been included to illustrate the potential usefulness of these arrangements. 111 The loss-sharing scheme may involve a structure whereby the guarantor assumes most of the losses (80 percent-90 percent), whereas only residual losses are assumed by the beneficiary. Depending on the scheme, the mechanism may be proportional or structured (e.g., the beneficiary only assumes losses beyond a certain level). 112 This mechanism was implemented, for example, in the case of Nord LB. See State Aid Case by the European Commission, specifically paragraphs 33, 38, 122, 126, 141, 142 and 210. URL: https://ec.europa.eu/competition/state_aid/cases1/20203/283125_2123117_150_5.pdf. 113 The beneficiary may, in some cases, have incentives to quickly wind down the guaranteed assets, even at the expense of lower cash flows, whereas the guarantor is typically interested in maximizing the recoveries from the assets. These tensions are natural and should be managed accordingly. 54 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 11: Selected asset protection schemes/loss sharing agreements in transfer transactions Source: FinSAC with information from Spanish Fund for Orderly Bank Restructuring (Resolution Authority) and Bank of Spain; Federal Deposit Insurance Corporation from the US; UBS and Swiss Government; Federal Reserve (FED) C. Transfer of liabilities 92. The transfer of liabilities to a third-party should be considered carefully, as it too raises significant challenges. First, the subordinated liabilities and liabilities to related parties should always be either written off prior to the transfer or left behind in the rump. The decision about other unsecured liabilities should be adopted on a case-by-case basis considering the available bids, and the impact of the decision on the transferred business and on financial stability. The transfer of contingent liabilities can create further challenges. 93. Failed banks may not have thoroughly identified their related party liabilities. Some bank failures are triggered by fraud and transactions with related parties. In these cases, related party transactions, including liabilities, may have been misreported. As transfer transactions are conducted quickly, authorities may not have enough time to accurately identify the related party liabilities, and therefore they might be transferred to the acquirer without suffering any losses. It 55 Dealing with weak banks in FinSAC countries: progress and challenges ahead is important that the authority uses specific mechanisms to reverse the transfer where related party liabilities are identified ex-post. 94. Some resolution frameworks do not give resolution authorities the flexibility to decide on the transfer of contingent liabilities. Bidders may be put off by the prospects of assuming a failed bank’s contingent liabilities, as they are typically difficult to quantify and are subject to significant uncertainties, especially if the failure has involved fraudulent activities. Resolution authorities can mitigate this risk by ensuring that all relevant information regarding contingent liabilities is included in the data room, to enable bidders to conduct their own due diligence. Guarantees can be offered to the buyer covering further losses stemming from these liabilities. D. Selection of acquirers 95. Finding suitable buyers for failed banks is not straightforward and existing banks are usually the best candidates. Finding an acquirer can be challenging, especially in a systemic crisis. Other licensed banks (either locally or foreign owned) are usually the best candidates, as they can combine their existing business with that of the failed bank, extracting synergies from the integration. They are typically in the best position to conduct a thorough and quick examination of the failed bank’s books, as incumbents may share clients and products with the failed bank. When already licensed banks are not willing or able to take over the failed bank, authorities need to scan the market for alternative investors. Foreign banks, private equity funds, or non-financial investors may be considered (Figure 12). 96. Banks already operating in the country may face different hurdles. Competitors may not have sufficient financial or operational capacity to conduct the takeover of a large, failed bank. Local banks may be more focused on underpinning their own viability in systemic scenarios, resulting in muted interest for the failed bank. Parent companies of foreign-owned subsidiaries might not be interested in increasing their exposure to the country, especially if they are having capital pressures at consolidated level. Large banks may not be able to participate in the process on the grounds of excessive concentration in the banking markets, especially when both the potential investor and the failed bank are large, systemic institutions. 97. Authorities should carefully consider the financial situation of the potential acquirers. Troubled banks usually have the most incentives to acquire the failed bank, as they may seek to “save themselves” through the acquisition in a “bidding for resurrection”, especially if “sweeteners” are part of the deal. Transferring the assets and liabilities to a weak institution may temporarily solve today’s problems at the expense of creating a bigger problem in the future. 114 Box 7 explains a case where the acquisition of one troubled bank created a bigger problem. 114 N.B. the cases of Otkritie and BinBank in Russia (the so-called Garden Ring Banks). These banks grew aggressively through the acquisition of failed banks from the Deposit Guarantee Fund, before being themselves resolved after fraud was unveiled during the massive clean-up of the banking sector in 2015 and 2016. See https://www.reuters.com/article/russia-banks-otkritie-fall-idUSL8N1LG67H/ for additional information on the case of Otkritie, including comments from the First Deputy Chairman at the Central Bank of Russia. 56 Dealing with weak banks in FinSAC countries: progress and challenges ahead Box 7. The pitfalls of acquisition by a troubled lender: Kazkommertzbank (KKB) KKB, a systemically important bank in Kazakhstan, acquired BTA, a firm with long-standing solvency and asset quality problems, through a series of shares purchases in 2014-2015. After taking it over, KKB surrendered BTA’s banking license, assumed most of the assets and liabilities of the firm, and funded the assets retained by BTA’s in its own balance sheet. According to the National Bank of Kazakhstan, KKB did not undertake an adequate due diligence of BTA’s assets and, consequently, the acquisition resulted in further losses revealing a net asset shortfall for KKB. 115 In 2017, after several inspections by the National Bank, KKB’s problems were unveiled. The state, through the Problem Loans Fund (effectively Kazakhstan’s bad bank), purchased the firm’s toxic assets at nominal value. 116 After a comprehensive audit of KKB’s assets, its equity was written off to account for further asset value adjustments. Finally, the bank was sold to Halyk Bank for a symbolic amount (KZT 1). The resolution of KKB did not result in any losses for its creditors, including its bondholders. KKB’s shareholders and the state (through the purchase of problematic loans at face value) assumed the costs of the failure of the bank. 98. Authorities may scan the markets when seeking interested investors. Internationally active private equity funds are the by-default alternative investors after competing banks have been ruled out. Private equity investors usually have the financial capacity and willingness to invest more aggressively when other, more traditional, investors are cautious. Some well-known private equity funds have already made controlling investments in banks in the region in recent years. 117 However, private equity investment cycles are typically shorter, effectively pursuing more aggressive business models, and seeking quick business turnarounds. These risks have prompted some authorities to lay out additional requirements for private equity investors, for example, requesting the deposit of a certain amount of cash in an escrow account to be contingently used to recapitalize the bank in case of losses, in addition to the in-depth assessment of the reputation of the fund and their experience in the region. 115 See National Bank of Kazakhstan’s “Financial Stability Report of Kazakhstan 2015-2017”, section 9.1. URL: https://nationalbank.kz/en/news/otchet-o-finansovoy-stabilnosti/rubrics/235. 116 See Box 9. 117 N.B. the case of Advent, that in 2015 acquired 80 percent of the Western Balkan operations of the nationalized Hypo Alpe Adria Bank (the European Bank Reconstruction and Development acquired the remaining 20 percent), that included banks in BiH, Croatia, Montenegro, Serbia, and Slovenia. The holding company that owns Hypo Alpe Adria Bank was listed in the Austrian Stock Exchange in 2019. After subsequent sales of shares, Advent does not control the operations bough to Hypo Alpe Adria Bank (later rebranded as Addiko Bank) any longer. See https://www.addiko.com/static/uploads/press-release-hypo-group-alpe-adria-ag-see-banking- network-acquired-by-advent-international-and-ebrd.pdf 57 Dealing with weak banks in FinSAC countries: progress and challenges ahead 99. Banking groups not operating in the country may also be interested in the takeover of the failed bank. A foreign bank may use the acquisition of a failed bank as an opportunity to enter a new market. In these cases, authorities need to pay special attention to the suitability of the potential buyer, since having a foreign banking license does not necessarily mean sound management, financial capacity, or transparency. They should consider (i) the financial and operational capacity of the foreign bank and the group it may be included in, (ii) whether the acquisition fits into the overall strategy of the acquirer in the region (e.g., it already has a network of local banks in the region), (iii) the ability of the home country to perform consolidated supervision over the resulting banking group, (iv) if the acquisition would impair the ability of the authorities to conduct supervision of the bank, and (v) particular attention should be paid to the track record of the bank in the prevention of money laundering and terrorism financing. 100. Finally, non-financial investors might be willing to take over the bank (Figure 12). Local or foreign non-financial corporations may appear during the selling process, sometimes within a consortium. These investors are less likely to be suitable owners of any bank; authorities must scrutinize the rationale of the bid, the reputation, and the financial capacity of the bidders, as non-financial owners may try to use the bank to cheaply fund their non-financial undertakings.118 Figure 12: Possible investors in transfers transactions: pros and cons Source: World Bank 118 Financial history is littered with bank owners that used bank deposits to cheaply fund their industrial undertakings. The nationalization of the Rumasa Holding in Spain (1983) remains one of the most spectacular cases, involving more than 30 banks, see https://www.bde.es/wbe/en/publicaciones/publicaciones- coleccion/guia-archivos-historicos-banca-espana.html. More recently, the nationalization of Privatbank in 2016, the largest Ukrainian bank, was at least partly explained by the oversized exposures to the non-financial group of the controlling shareholder. 58 Dealing with weak banks in FinSAC countries: progress and challenges ahead 5.5.2. Bridge bank transactions A. Relevant aspects for setting up a Bridge Bank 101. Faced with difficulties finding a buyer for a failed firm, countries may need to buy time through the transfer of assets and liabilities to a bridge bank. Resolution authorities are usually empowered to transfer certain assets and liabilities from the failing bank to a newly-created intermediate or bridge bank, set up to temporarily hold these assets and liabilities and provide the critical functions of the failed bank while finding a suitable buyer. In case of a scarcity of buyers, setting up a bridge bank can be an attractive option, but it does not come without risks. Notably, these entities may become “bridges to nowhere” if the franchise of the failed bank continues to deteriorate during the bridge period and loses any appeal to a potential buyer. Decision-making may become subject to political influence, particularly when the bridge bank is recapitalized by the state. 102. There is only limited experience in setting up and managing bridge banks and few successful cases in FinSAC client countries and more broadly, in the region. Although most FinSAC client countries can set up a bridge bank to transfer a failed bank’s assets and liabilities to it, the experience in its use is rather limited. In Ukraine, the bridge bank Krystalbank was set up to acquire the business of the failed Terra Bank (December 2014) and sold three months later 119 to a third- party investor 120. The bridge bank RVS was established also in Ukraine in June 2015 to acquire the assets and liabilities of the failed Omega Bank and subsequently sold to another investor. In other jurisdictions, there is a broader experience in using bridge banks. In the US, bridge banks are part of the FDIC toolkit and commonly employed when bank failures are triggered by deposit runs, as authorities have not had the time to prepare for the bank’s sale. Recently, bridge banks were again used in 2023 in US for resolving Silicon Valley Bank and Signature Bank. 121 103. Certain key aspects must be considered if a bridge bank is to be established: a. Advance operational planning. A bridge bank needs a specific management team, a business model, operating plan, etc. These aspects must be carefully considered beforehand since it is very unlikely that the authority would have sufficient time to address all the issues when a bank is in trouble. b. Clarification of the regulatory regime. The temporary nature of bridge banks may support a softer regulatory regime, but it will largely depend on the timeframe and the systemic relevance of the bank itself, as funding providers may finance the bridge bank if they perceive it to be sufficiently solvent. In this context, authorities may decide to subject the bridge bank to the minimum capital adequacy requirements but excluding it from any capital buffers, particularly those related to macroprudential and countercyclical considerations. c. Sources of capital. Authorities may set up a bridge bank by selectively transferring to it assets and liabilities from a failed bank. In the best scenario, transferred assets will exceed the liabilities and therefore the bridge bank will naturally operate with a 119 See https://www.fg.gov.ua/articles/1839-do-uvagi-vkladnikiv-pat-terra-bank-vkladi-yakikh-buli-peredani- pat-perekhidniy-bank-kristalbank.html 120 Deposit Guarantee Fund Report for 2014, page 48, URL: https://www.fg.gov.ua/storage/files/zvit-2014- engl.pdf. 121 Bridge banks were established for the resolution of SVB and Signature Bank in March 2023 as sudden liquidity pressures did not allow the resolution authority (the Federal Deposit Insurance Corporation) to find suitable buyers for the banks in time. 59 Dealing with weak banks in FinSAC countries: progress and challenges ahead positive capital position. However, this is very unlikely as: (i) a failed firm typically owns a large amount of non-performing assets and (ii) for financial stability reasons, authorities may decide to transfer the full deposit book, even if uninsured. When the transferred liabilities exceed the transferred assets, authorities may have different options to capitalize the bridge bank: (i) using the bail-in powers to convert some of the transferred liabilities (e.g., senior unsecured debt, uninsured deposits) into shares, (ii) using industry funds, or (iii) recapitalize the bank with public money. Public recapitalization has implications for the governance of the bridge bank, as the ministry of finance will be likely to intervene in the key decisions, particularly on the appointment of board members and senior managers and on the sale of the bridge bank. d. Liquidity and funding. Even if a bridge bank is recapitalized, this does not ensure a bank’s ability to continue funding its assets. Bridge bank depositors, especially if uninsured, may seek to withdraw their funds from it, jeopardizing the liquidity position of the entity. Against this backdrop, authorities may need to identify the funding sources a bridge entity can access. Although private funding sources should be prioritized, markets may be closed for the entity, especially when investors and funding providers do not see realistic prospects for selling the bridge bank. Authorities may need to consider alternative funding sources, such as public guarantees covering ELA funding or other liabilities or, in more extreme cases, imposing a moratorium on certain liabilities to preserve liquidity. See Section 5.8 for more details. e. Sunset clause. Consistent with its transitory function, the operation of a bridge bank is limited to a certain time horizon, to ensure it does not perpetuate in the system. Authorities may set up a bridge bank for a specific period (e.g., one year) and may subsequently decide to extent its life one or several times if the bank is not sold within that period. Nonetheless, the ability to continuously prolong the bridge bank’s operation should be limited by the law. 5.5.3. Open bank resolution using bail-in powers 104. Open bank strategies based on bail-in powers are gradually becoming one key element of modern resolution regimes for large bank resolution. When a non-viable systemic bank cannot be realistically resolved by its transfer to a third-party, writing down the value of its shares and converting certain liabilities into new shares can be a valid solution to stabilize and recapitalize it. 122 The failed bank can continue to operate as a going concern, and therefore its customers, including depositors and borrowers, will continue to have access to their banking services without any interruption. 105. An effective open bank resolution based on bail-in powers requires some preconditions. First, a bank’s liability structure should support the bail-in execution by ensuring that the bank has previously issued loss-absorbing debt. Second, the law should determine the conditions upon which the write down and conversion powers can be used to mitigate any future legal challenges, by avoiding inconsistencies between the insolvency ranking and the bail-in treatment that may give rise to the no creditor worse-off than in liquidation risk. Third, the deployment of bail-in powers should be based on an independent valuation by a third-party. Fourth, following the 122 In addition, bail-in powers can also be combined with other resolution tools, such as writing down the value of the shares and liabilities in a transfer transaction, or to provide capital to a bridge bank. 60 Dealing with weak banks in FinSAC countries: progress and challenges ahead stabilization of the bank, a restructuring plan addressing the root causes of the failure should be required to turn around the business and avoid the repetition of problems. 106. Following global and European trends, some FinSAC countries have complemented the introduction of bail-in powers with requirements for banks to meet minimum loss-absorbing requirements. Global and European standards (FSB’s total loss-absorbency capacity or EU’s minimum requirements for own funds and eligible liabilities) require firms to progressively build up their loss-absorbing capacity, mainly by issuing subordinated or quasi-subordinated debt to wholesale investors that can be written down or converted into capital in resolution. Country experiences have evidenced that loss-absorbing buffers should be built up progressively during an extended period, since required amounts can be large and the pool of interested investors limited. In FinSAC countries, the difficulties of ensuring sufficient loss-absorbing capacity are exacerbated by plain vanilla liability structures (made up of pure equity and deposits) 123 and limited market access. Bailing-in uninsured deposits may be the only and very risky alternative to a costly bail- out. Figure 13 outlines the high-level implications of applying bail-in powers to different creditors in the context of FinSAC countries. Figure 13: Stylized high-level overview of applying bail-in powers to different creditor classes Source: FinSAC own ellaboration 107. Once internal and industry resources have been exhausted, resolution authorities may need to explore additional sources, including public capital. As contributions by deposit insurance funds 123 Banks, especially foreign-owned, may have a limited amount of other liabilities, such as intragroup subordinated and senior liabilities to certain foreign creditors. 61 Dealing with weak banks in FinSAC countries: progress and challenges ahead are not suitable for open bank resolution, authorities may need to resort to public resources. Ideally, they should only be used for recapitalizing the bank, not for absorbing losses. Different mechanisms and structures can be used to channel public funds, with different implications for recoveries and on the public involvement in the governance of the bank. The ministry of finance may decide to directly subscribe new shares to recapitalize the bank, resulting in its partial or full nationalization. In a different approach, an industry-funded resolution fund can borrow from the state to recapitalize the bank (provided that the resolution fund does not have enough funding). This structure can limit the state influence and mitigate taxpayers’ risks, since the state does not control the bank and the industry effectively guarantees the reimbursement of the state loan. The resolution fund would progressively repay the loan to the state using banking sector contributions and revenues from its investments, including from the bailed-out bank’s shares. Some basic principles for the use of public money are detailed in Section 5.6. 108. During extreme systemic episodes, the extent of the losses can force the authorities to apply bail-in powers to senior creditors, including uninsured depositors. During severe systemic crises, the fiscal position of the sovereign may be compromised and may not be able to raise funding to recapitalize banks. In this context, authorities may need to combine partial nationalization with alternative measures, such as extending bail-in powers to uninsured depositors. Restrictions on the availability of deposits, even if uninsured, during systemic scenarios can be detrimental to a country’s financial stability. Harsh and long-lasting capital controls may be required in these situations. For these reasons, bailing-in deposits appears to be a very extreme and risky measure, whose implementation is reserved for exceptional systemic episodes that combine banking crisis with troubled sovereigns. See section 5.8 for more details. 109. When exercising bail-in powers, authorities should carefully consider legal risks. Aggrieved creditors and shareholders will invariably challenge authorities’ decisions in court, using different arguments. Bailing-in liabilities governed by a foreign law may involve litigation risks (see Box 8). Inconsistencies between the insolvency ranking and bail-in sequencing and deficiencies in the independent valuation can be exploited by those bringing legal actions against the authority or the failed bank. 110. Authorities may need to carefully assess the indirect impact that the use of bail-in powers may have in the real economy through corporate channels. The unavailability of corporate deposits may hamper business’ ability to continue their operations, including paying back their loans, creating systemwide asset quality problems. Some bailed-in creditors may refuse to repay their loans to the bank, believing they are entitled to compensate their claims with their bail-in losses (commingling risk). 111. The country’s fiscal and accounting provisions must support bail-in implementation. In some countries, the write-down of liabilities may be considered taxable income, potentially reducing the amount of capital that can be raised through bail-in. Box 8. Bail-in the case of PrivatBank in Ukraine In December 2016, the Ukrainian authorities decided to nationalize PrivatBank, the largest systemically important institution in Ukraine. At that time, the bank was controlled by two oligarchs and had more than 20 million customers with a market share above 30 percent in 62 Dealing with weak banks in FinSAC countries: progress and challenges ahead retail banking 124 and intermediated more than 50 percent of the country’s payment transactions. The bank was considered by the National Bank of Ukraine as following a “vacuum cleaner” business model, using its large retail deposit base to mainly fund the non-financial activities of its owners. The National Bank second AQR exercise in 2015/2016, together with a comprehensive review of Ukrainian banking sector related party lending, unveiled a large capital shortfall in PrivatBank’s balance sheet, after discovering that 97 percent of the corporate loan book involved lending to the bank’s related parties and a large amount of theoretically collateralized loans was nonexistent (see Box 1 and Figure 8 for more details). The shortfall was quantified at UAH 148 billion (USD 5.5 billion at the time). The extensive negotiations with the owners to recapitalize the bank failed. 125 Given the systemic relevance of the bank, the Ukrainian authorities ruled out the liquidation of the bank. Instead, the authorities wrote-off the existing shares, converted certain liabilities into shares, including loans by related parties and also Eurobonds for a total amount of UAH 29.4 billion (USD 1.2 billion at the time), and then transfer the shares to the Ministry of Finance for a symbolic amount (UAH 1). To complete the recapitalization, the Ministry of Finance injected new equity into PrivatBank in February 2017, for an amount of UAH 116.8 billion (USD 4.32 billion at the time). 126 PrivatBank’s case is notable for many reasons. First, it involved the largest systemic bank in the country. Second, the bail-out amounts were above 6 percent of Ukraine’s GDP, a massive figure for a single bank and that is indicative of the fraud’s massive scale. Third, it was the first case of bail-in of senior unsecured liabilities in Eastern Europe (and one of the first in Europe, after Cyprus in 2013-2014). The decisions by the Ukrainian authorities included the bail-in, through write-off, of PrivatBank’s Eurobonds for an amount of USD 595 million, 127 that had been issued through a special purpose vehicle in the UK. The bonds were subject to UK Law, and therefore the decision by the Ukrainian authorities required recognition by British authorities. The UK Courts upheld the decision of the Ukrainian authorities after the Bank of England recognized the Ukrainian framework for bail-in as broadly comparable in its objectives and anticipated results to those of the UK resolution regime. 112. Contingency bail-in plans can be a useful tool (bail-in playbooks). These plans can outline how and when the bailed-in liabilities will be frozen, how the write-down or the conversion into new shares will be implemented, and how the shares will be delivered to the bank’s new shareholders. Plans may also detail the communication and disclosure actions required when exercising these powers. Authorities can require firms, as part of the resolution planning process, to develop bail- in playbooks, as many of the actions required to operationalize bail-in powers can be instrumented through the failed institution. 124 For more details on the events during 2014-2017 see National Bank of Ukraine’s Financial Stability Report, June 2018, page 38, https://bank.gov.ua/admin_uploads/article/FSR5_June_2018_eng.pdf?v=6. 125 Additional details are available in a speech by the former NBU Governor at a joint press briefing with the Minister of Finance (December 2016), https://bank.gov.ua/en/news/all/vistup-golovi-natsionalnogo-banku- valeriyi-gontarevoyi-pid-chas-spilnogo-brifingu-z-ministrom-finansiv-oleksandrom-danilyukom-schodo- perehodu-privatbanku-u-derjavnu-vlasnist. 126 Information can be consulted in National Bank of Ukraine’s Financial Stability Report, June 2017, page 17, https://bank.gov.ua/admin_uploads/article/FSR3eng_final.pdf?v=6. 127 See https://bank.gov.ua/en/news/all/povidomlennya-derjatelyam-yevroobligatsiy-privatbanku. 63 Dealing with weak banks in FinSAC countries: progress and challenges ahead 113. Authorities can develop contingency arrangements for dealing with third-party independent valuers. The independent valuation will inform the losses and the extent of the recapitalization, which in turn are key inputs to determining the scope and extent of the exercise of the bail-in powers. As explained in Section 5.3, the valuation process is complex, requiring extensive preparations both by the authorities and by the valuers themselves. Contingency arrangements can decisively contribute to the success of the process, with authorities implementing procedures to ensure the prior shortlisting of valuers who are independent, possess the required professional capabilities, and can fully access the documentation required for the valuation. 5.6. The need for public backstops 114. In systemic scenarios, taxpayer money may need to be deployed as a last resort to safeguard a country’s financial stability. In cases of insufficient loss-absorbency capacity or pre-funded industry funds, the existence of public backstops is key. Even before the diagnosis of the banking sector, authorities may decide to earmark backstops to cover potential capital shortfalls and, if applicable, resolution costs. Nonetheless, not all countries may afford earmarking public funds from supporting the banking industry, especially in overindebted sovereigns or those with no market access. For these scenarios, capital controls may be required (see Section 5.8 and Box 10 for more details). 115. Public support can be instrumented through different mechanisms, depending on the nature of the crisis, and they are usually combined. Equity injections are indicated for solvency problems, resulting in the partial or total nationalization of the bank. Subordinated loans or other capital instruments may be adequate when solvency problems are perceived as transitory. Asset purchases, usually through a public-funded AMC may be useful in cases where uncertainties on valuation of certain assets can curtail banks’ access to financing. Guarantees to liabilities may also facilitate banks’ access to finance, either to the central bank facilities or to private funding markets. 116. Taxpayers’ funds can only be used where financial stability is at risk, as a last resort, and subject to appropriate safeguards, that are summarized below: a. Burden sharing. Before injecting public funds, shareholders and certain creditors should have absorbed losses and, where applicable, contributed to the recapitalization of the bank (included but not limited to subordinated debtholders and related party creditors). Other creditors’ contributions should be maximized (e.g., senior unsecured creditors) if it does not endanger financial stability or otherwise hamper the resolution of the bank. See the section 5.4 for more details. b. Recovery mechanisms should be clear from the onset. Depending on the nature of the support, the reimbursement mechanism may differ. An investment in shares or in other capital instruments is expected to be recovered by their remuneration (through dividends or interest) and ultimately by selling the capital investments to a third party. If the state intervention consists of purchasing nonperforming assets from banks, the state may recover them through their work out or sale, usually by setting up a public AMC (see Section 5.7 and Annex I). Guarantees on liabilities may need to be properly remunerated, and, in case of calling them, the insolvency ranking shall be stated in the guarantee. If the state decides to extend loans (including subordinated debt) to the bank, the recovery should be made through interest payments and their reimbursement. 64 Dealing with weak banks in FinSAC countries: progress and challenges ahead c. Governments should put in place structures to ensure that the resulting ownership rights are exercised at arm’s length. A partial or full nationalization of a bank should be temporary. Firms must be returned to private hands as soon as market conditions allow. 128 Authorities should avoid using state-owned banks as development institutions. When a bank is state-owned, authorities may introduce measures to mitigate the risk of public interference into bank’s affairs. The minister of finance may appoint independent directors to the bank’s board and avoid any direct role in the decision-making of the bank, giving only high-level instructions on the management of its shareholding (e.g., approval of the strategy). Holding the shares through a specialized agency separated from the minister of finance, managed by independent professionals can increase the operational autonomy of the nationalized bank. 129 Central banks are ill-placed to become shareholders of a nationalized bank, since this situation can create conflicts of interests with their banking supervision and price stability functions.130 d. To pave the way for privatization, the bank’s new directors and managers should prepare a restructuring plan. The plan should identify the root causes of failure and identify the measures that need to be implemented to ensure the long-term financial sustainability of the bank. The execution of a restructuring plan effectively works as a blueprint for a later privatization and should include financial, commercial, and managerial measures to quickly turnaround the business of the bank. The plan may foresee winding down or sale of loss-making and/or non-core parts of the business, streamlining of governance and risk management structures, or cutting costs or increasing revenues through commercial plans. Financial measures may seek to strengthen the balance sheet position through de-risking, limiting risk-weighted assets growth, or increasing the bank’s deposit base. 5.7. Dealing with asset quality 117. Doubts over the quality of banks’ assets may hamper the resolution of trouble banks. During crises, recapitalization may not be enough for a bank to be able to fund its assets as uncertainty on the performance of solvency-threatening large portfolios may persist; funding providers may refuse to finance the bank until the doubts over the valuation of those assets are lifted. 131 Different mechanisms can remove this uncertainty: by writing down the value of the assets (that 128 Admittedly, this period can be very long. For example, in the UK the divestment of shares of the Royal Bank of Scotland (now NatWest) has not been fully executed at the end of 2023, more than a decade after the investment. In Ukraine, UkrgazBank was nationalized in 2009 and continues to be state-owned, as also happened with PrivatBank. In Russia, all banks nationalized during the last crisis (Bank Otkritie, etc.) continue to be state- owned. 129 See UK Financial Investments Limited, which in 2018 was folded into UK Government Investments. See “UK Government Investments Limited Annual Report and Accounts 2017-18”, page 8 https://www.ukgi.org.uk/2018/07/05/uk-government-investments-annual-report-and-accounts-2017-18/. 130 See Box 2 for an explanation of Central Bank of Russia’s ownership of nationalized banks under the Banking Sector Consolidation Fund. The National Bank of the Kyrgyz Republic ownership of Keremet Bank (formerly, Rosin Bank) is also an example. 131 This lack of trust is not without reason. There are many examples of banks that were recapitalized or restructured several times, each time the authorities claimed it was the final one. See the case of Bankia and several other savings banks in Spain, or Irish, Greek, and Cypriot banks during the GFC and the eurozone debt crisis. 65 Dealing with weak banks in FinSAC countries: progress and challenges ahead will immediately result in a large capital shortfall), by transferring the assets to an AMC (with all the problems linked to the set up and management of these vehicles) or by guaranteeing these assets through loss sharing agreements provided by either an industry fund or the ministry of finance. Figure 14: Options for dealing with bad assets in bank resolution Source: FinSAC 118. Using loss-sharing agreements in open bank resolution has several advantages. The guarantees can drastically bring down banks’ capital requirements and the need for new loan loss provisions. The beneficiary bank’s funding position will expectedly improve as funding providers would be reassured by the effects of the guarantee on bank solvency, as losses would be transferred to the guarantor. 119. Most of the critical aspects already discussed for loss sharing arrangements in transfers are also relevant for these guarantees. In addition to what has already been said in Section 5.5 (definition of the scope, incentives, loss definition, authorizations by the guarantor, etc.), it is key that contracts include specific incentives that encourage the early termination of the arrangement by the beneficiary bank. Unlike those used in transfers, guarantees may be remunerated at a level 66 Dealing with weak banks in FinSAC countries: progress and challenges ahead that incentivizes its early cancellation. Additional restrictions can apply to the beneficiary until the guarantee is terminated (i.e., asset caps, limits of the interest rate paid on deposits, ban on acquisitions, etc.). The guarantee should not include any early termination penalty for the beneficiary bank. Experience shows that if these incentives are well structured, beneficiary banks may be interested in terminating as soon as their situation improves. During the GFC, these schemes were used to provide protection to systemic banks in the US and UK for large asset portfolios, 132 and more recently for and Nord LB. 133 Figure 15 outlines the key features for loss sharing agreements granted in open bank transactions. There are no relevant cases in FinSAC client countries. Figure 15: Selected asset protection schemes/loss sharing agreements in open bank transactions Source: FinSAC with information from NORD/LB; the Federal Deposit Insurance Corporation from the US; Asset Protection Agency (UK); Her Majesty's Treasury (UK); Bank of England and European Commission 120. An AMC may be set up to acquire bad or toxic assets from troubled banks, but this raises significant challenges. An AMC may be used for an individual bank failure but is more common in a systemic context. When certain loan or asset portfolios simultaneously affect several firms in the same country, undermining trust in the banking sector, authorities may decide to set up an AMC to buy these assets from the banks and remove the uncertainties affecting them. 121. There are several key considerations for authorities before setting up an AMC. First, the scope of transferred assets, ideally this should only include those responsible for mistrust in the banking sector. Second, which banks should transfer covered assets to the AMC; from a cost-benefit consideration, it is recommended to force only those banks that are either non-viable or being 132 See the case of Citigroup and Bank of America in the US, and of Royal Bank of Scotland and Lloyds Banking Group in the UK. 133 For Nord LB, the State of Lower Saxony provided asset guarantees for 3 portfolios in 2019: (i) maritime-linked NPL assets, (ii) performing shipping loans, and (iii) aviation finance. Moreover, the State of Lower Saxony, together with other public shareholders, recapitalized the bank. 67 Dealing with weak banks in FinSAC countries: progress and challenges ahead viable were forced to accept public support. Third, transfer prices should be transparent, soundly calculated, and subject to independent review. While assets may be priced above their market values (expected to be deeply distressed), they should not be set at or close to nominal or book values, as that may result in a free lunch for the beneficiary banks. Fourth, the funding structure of the AMC is key. Decisions shall be made on the equity and debt structure, considering the financial sustainability of the AMC by realistically projecting the AMC’s expected cash flows and their debt-shouldering capacity. In most cases, AMC’s capital is provided by the state, at least partially. Fifth, a sunset clause is useful to signal that AMCs should not perpetuate in the system, albeit the deadline for liquidation should be considerably longer than in the case of bridge banks. Sixth, the AMC should be subject to a strong regulatory framework for corporate governance, risk management, disclosure, and accounting. Some countries have gone as far as subjecting AMCs to prudential supervision. 122. Besides removing uncertainty from the banking sector, AMCs can bring further advantages. By transferring the assets to the AMC, bankers may refocus on growing their profitable business. Moreover, if AMCs purchase assets from several firms, they may be able to leverage their capacities to work out loans and borrowers, particularly when in case of large borrowers. AMCs can also be instrumental in kickstarting the secondary market for NPLs in the country, since they will be expected to divest through asset sales. 123. There are no relevant experiences of setting up AMCs in FinSAC client countries. Most FinSAC client countries may have difficulties setting up these structures, as they demand significant financial and managerial resources, which cannot be taken for granted in small countries with sovereigns with limited access to capital markets. 134 Nonetheless, comparable countries (e.g., Kazakhstan and Slovenia), have established systemwide AMCs in the last decade. The Central Bank of Russia established one subsidiary of one resolved bank to acquire the toxic assets of all the resolved banks (National Bank Trust 135). Moreover, a state-owned non-banking institution devoted to agricultural credit (Aqrarkredit) was used in 2015-2016 to transfer the toxic assets in the restructuring of International Bank of Azerbaijan, 136 becoming a de facto bad bank. Box 9 explains the Kazakh and Slovenian AMCs. See Annex I for more details. Box 9. AMCs in selected countries Slovenia: Bank Assets Management Company (BAMC) 137 Due to the deteriorating situation in the banking sector caused by several years of economic recession, and with the aim of ensuring financial stability, the Slovenian Government established the Bank Assets Management Company (BAMC) at the end of 2012 138. The BAMC’s 134 With some exceptions. Ukraine and Uzbekistan are large countries with sizable financial sectors. 135 Two more resolved banks (Rost Bank and AVB Bank) were also merged into National Bank Trust. Additional information on the process can be found in sections 1.1, 1.3 and 1.8 of the National Bank Trust’s Annual Report for 2018 (in Russian) https://www.trust.ru/upload/iblock/23a/%D0%9E%D1%82%D1%87%D0%B5%D1%82%20%D0%B1%D0%B0%D 0%BD%D0%BA%D0%B0%20%D0%B7%D0%B0%202018%20%D0%B3%D0%BE%D0%B4.pdf. 136 See Box 5 for more details on the transfer of assets from the International Bank of Azerbaijan to Aqrarkredit. 137 In Slovenian: Družba za upravljanje terjatev bank, d. d. 138 Official Gazette of the Republic of Slovenia, No 105/12. 68 Dealing with weak banks in FinSAC countries: progress and challenges ahead key function was reinforce certain systemic banks by acquiring toxic assets from them, mainly non-performing loans to corporates and SMEs, with a view of maximizing their recoveries through intensive work out activities. During the second half of 2013, the Bank of Slovenia conducted an AQR and a stress test of a the largest banks. 139 The exercise involved third parties, including international consultants and real estate appraisers. Besides covering capital shortfalls, the exercise aimed to facilitate the transfer of deteriorated assets by weak banks to the BAMC. Four large, systemic banks 140 transferred their toxic assets to BAMC in 2013 and 2014. Transfer prices were based on assets’ economic long-term value, estimated at EUR 1.527 million implying close to 70 percent haircut on the assets’ nominal value. The consideration in exchange of the assets was paid by BAMC in both cash and sovereign-guaranteed bonds. BAMC’s focused in maximizing the recoveries from the transferred assets. In 2016, two more banks 141 transferred their deteriorated assets to the BAMC. By October 2022, Slovenia decided to close BAMC by the end of 2022 and transferring all its residual assets and liabilities to the Slovenian Sovereign Holding, which subsequently. assumed the management of the assets. Kazakhstan: Problem Loans Fund During the GFC, the Kazakh economy suffered a sharp recession. The challenging economic situation was exacerbated by poor governance and risk management practices in the Kazakh banking sector. Many banks suffered from poor profitability, weak capital positions, liquidity shortages, and a large stock of non-performing loans, that peaked above 20 percent in 2010 142 and remained at very high levels in the following years. As part of the Post-Crisis Recovery Program, the Problem Loans Fund (PLF) was set up in 2012 by the National Bank of Kazakhstan 143 to assist banks reducing NPLs on their balance sheets. In a multi-pronged effort to deal with asset quality problems, banks were also permitted to establish subsidiaries into which they could transfer the troubled assets from their balance sheets. The PLF acquired non-performing assets from commercial banks, with a view to managing them and maximizing the recoveries. To this end, the PLF issued bonds to fund the acquisition of the assets. Crucially, the loans were purchased at nominal values. From 2012 to 2017, the PLF was managed by the National Bank of Kazakhstan. In 2017, the Fund management was transferred to the Ministry of Finance. From 2017, the PLF undertook several transactions, including the purchase in July 2017 of 59 percent of the loan portfolio of Kazkommertsbank, (see Box 7) a systemic bank for an amount above KZT 2 trillion (USD 6.1 billion at that time). 144 The PLF also facilitated the liquidation of 139 Ten banks and banking groups representing approximately 70 percent of the Slovenian banking system. 140 NLB, NKBM, Abanka and Banka Celje. 141 Probanka and Faktor Banka. 142 World Bank, Bank nonperforming loans to total gross loans (%) – Kazakhstan, https://data.worldbank.org/indicator/FB.AST.NPER.ZS?end=2020&locations=KZ&start=2008&view=chart. 143 Resolution of the Board of the National Bank of the Republic of Kazakhstan dated May 30, 2011, No. 53 "On the Establishment of the Joint-Stock Company "Problem Credit Fund"”. 144 Strategy 2017-2027 of the PLF, December 2020 and changes in November 2021 and September 2022, pages 13-14 (in Russian), https://www.fpl.kz/media/file/strategy-2017-2027.pdf 69 Dealing with weak banks in FinSAC countries: progress and challenges ahead the Bank of Astana in 2018 145 by receiving assets in the amount of KZT 126.4 billion (USD 366 million), as well as obligations in the amount of KZT 100.1 billion (USD 290 million); and purchased a large portfolio of agricultural loans from Tsesnabank for an amount of KZT 1.054 trillion (USD 2.837 billion) in two stages between September 2018 and February 2019.146 5.8. Funding in resolution 124. A firm’s recapitalization may not be enough to underpin its financial position, as a restored capital ratio may not be enough to recover the trust of the bank’s funding providers. In transfer transactions to a third-party, funding gaps are expected to be financed by the acquirer. However, in open bank resolutions and transfers to bridge banks there is no acquirer to inject extra funding. In these cases, the bank’s funding providers may not be fully reassured by the recapitalization of the bank and doubts over its performance may persist, especially in the period following the bank resolution. A recapitalized bank may still have funding needs, that industry arrangements are unlikely to have the financial capacity to cover. Mindful of the potentially large funding needs, central banks are usually in the best position to provide liquidity during banking crises. ELA or other lender of last resort facilities can be key mechanisms to provide funding to banks heading towards or in resolution. 125. The possibility of providing ELA to a bank under resolution might be hampered by a strict interpretation of the traditional requirements of these liquidity facilities. Under Bagehot principles, ELA may only be provided to solvent yet illiquid institutions against sufficient collateral. But when a bank has entered resolution, it is precisely due its non-viability. And a non-viable bank is unlikely to have liquid collateral. It may therefore be difficult for a central bank to provide liquidity through ELA or another special facility to a bank under resolution. 126. An ELA regime may need to be fine-tuned to ensure that it can be used to provide liquidity to banks in open bank resolution. The traditional solvency requirement, measured as a static compliance with minimum capital requirements, can take a forward-looking perspective, using the concept of viability instead. A bank undergoing open bank resolution procedures may be identified as viable, and therefore creditworthy, if there is a credible recapitalization plan that reasonably ensures the turnaround of the bank in a relatively short timeframe. 147 As central banks are commonly also bank supervisors and resolution authorities, they are likely to have first-hand information on the recapitalization plans of a failed bank. Conversely, a bank meeting its statutory minimum capital requirements may not be viable, as new rules mandate authorities to test viability on a forward-looking manner (failing or likely to fail). Some FinSAC client countries have 145 Strategy 2017-2027 of the PLF, December 2020 and changes in November 2021 and September 2022, pages 14-15 (in Russian), https://www.fpl.kz/media/file/strategy-2017-2027.pdf 146 Strategy 2017-2027 of the PLF, December 2020 and changes in November 2021 and September 2022, page 15 (in Russian), https://www.fpl.kz/media/file/strategy-2017-2027.pdf 147 The European Central Bank Agreement on emergency liquidity assessment establishes that a bank that does not meet its solvency requirements can be considered equally solvent if it has defined a credible recapitalization plan in a maximum of 24 weeks. See section 4.1 of the Agreement published in November 2020, URL: https://www.ecb.europa.eu/mopo/ela/html/index.en.html. 70 Dealing with weak banks in FinSAC countries: progress and challenges ahead started to adapt their ELA frameworks to the concept of viability (e.g., National Bank of Moldova, 148 National Bank of Georgia 149), although practices are at a relatively early stage. 127. Central banks may need to widen the definition of eligible collateral. Central banks may accept non-liquid assets such as performing loan portfolios. In FinSAC countries, limited asset encumbrance and secured finance can facilitate pledging loan portfolios to the central banks. Nonetheless, central banks would need to implement mechanisms for estimating collateral values, and engage in operational preparations with banks, to ensure that firms have the documentation and data ready to access the facility. 128. Where banks do not have sufficient available collateral, guarantees may be required. Countries need to examine the mechanisms to facilitate trouble banks’ access central bank funding in cases where viable firms run out of eligible collateral. Even when industry arrangements, such as resolution funds, can extend guarantees, in extraordinary circumstances public guarantees may be the only mechanism to enable banks’ access to central bank funding. 129. Some FinSAC client countries face idiosyncratic challenges when defining their ELA frameworks. Many financial systems are highly dollarized (or euroized), as a large share of the banks’ liabilities are denominated in foreign currency. Kosovo and Montenegro do not have an independent currency. BiH has its currency pegged to the euro and the Central Bank of BiH is legally banned from lending to commercial banks. 150 In dollarized financial systems, scarcity of foreign currency is likely to be a key driver of the banking system liquidity needs. Central banks in the region may resort to currency swaps or liquidity lines with other central banks to cover for foreign currency shortages. 130. Moratoria regimes can buy authorities time in certain cases. Authorities may decide to impose a moratorium on certain liabilities, particularly on deposits, for a short period of time (e.g., 48 hours) while authorities are arranging the resolution schedule. This type of moratorium should be very limited in time and as limited as possible in scope, as it runs the risks of amplifying liquidity risks for the troubled firm. 131. Nonetheless, systemic crises may demand more drastic measures. During systemic banking crises, distrust may affect most banks and authorities may be forced to resort to more extreme actions. Blanket deposit guarantees can signal that no depositor will be expected to make any loses, primarily to stem any deposit outflows. They need to be weighed against its credibility, as the sovereign may need to step in if the guarantees are finally called. The use of blanket guarantees has been relatively infrequent in FinSAC client countries. 151 132. Capital controls may be the last resort in cases where trust in the system has been lost. Capital controls can be adopted to limit depositors’ capacity to transfer funds out of the banking system: 148 See paragraph 25 of the National Bank of Moldova’s Decision “On the approval of the Regulation on Emergency Liquidity Assistance”. URL: https://www.bnm.md/en/content/regulation-emergency-liquidity- assistance-approved-decision-executive-board-national-bank. 149 See article 33, paragraph 3, point (c) of the Organic Law of Georgia on the National Bank of Georgia. 150 As stated in Chapter X, Article 67 paragraph 1, of the Law on the Central Bank of Bosnia and Herzegovina. URL: https://www.cbbh.ba/Content/Read/14 151 Azerbaijan introduced a three-year blanket guarantee in 2016 that was extended three times until April 2021, when it finally expired (see https://www.cbar.az/press-release-2835/on-improving-deposit-insurance- framework?language=en). Belarus continues to have a blanket guarantee for deposits of individuals (see article 8 of the Law No. 369-Z of July 2008 “On Guaranteed Compensation of Bank Deposits of individuals” (in Russian), URL: http://en.adc.by/zakonodatelstvo/law%20369-3.pdf). 71 Dealing with weak banks in FinSAC countries: progress and challenges ahead cash withdrawals and money transfers (especially abroad) might be subject to limitations or ex- ante controls to avoid the systemic insolvency of the banking system. Experience suggests that, once imposed, capital controls are likely to remain in force for lengthy periods and are lifted only slowly as confidence is regained. Box 10 summarizes capital controls introduced by the Ukrainian authorities in 2014. Box 10. Capital controls used by Ukrainian authorities in 2014 152 Severe distrust in the banking sector triggered large deposit outflows for Ukrainian financial institutions during 2013 and 2014. To mitigate systemwide liquidity risks, Ukrainian authorities gradually introduced restrictions on capital controls from February 2014, which were further tightened during 2014 and 2015. The restrictions were gradually lifted but were in place until August 2017. The key restrictions for Ukrainian residents were: - Limits in their cash withdrawals in foreign currency from current and deposit accounts to the foreign currency equivalent of UAH 15.000 daily (around EUR 1.200 at the time). The limit was progressively relaxed several times (UAH 20.000 in September 2015, UAH 50.000 by end 2015, UAH 100.000 in June 2016, and UAH 250.000 in September 2016), until it was abolished in August 2017. - Restrictions on cash withdrawals of domestic currency of UAH 150.000 per day per client from May 2014 (again, later relaxed and lifted in June 2016). - Limits on transfers in foreign currency abroad to the equivalent of UAH 15.000 per month without supporting documents and UAH 150.000 with supporting documents, but they were only imposed for a limited period. - Limits on early repayment of loans in foreign currency to non-residents. Non-residents also faced restrictions in transfers of foreign currency outside Ukraine (UAH 15.000 per month) with supporting documents, albeit exemptions applied. Restrictions also affected legal entities and banks. This case exemplifies that, once capital controls are introduced, they tend to be long-lasting and can only be gradually lifted as they depend on trust in the credibility of the financial system be won back. Similar examples can be found in Cyprus, linked to deposit bail-in of the banking sector (2013), and in Iceland, following its massive banking crisis (2009). New, far-reaching restrictions were introduced by the Ukrainian authorities following the Russian invasion of Ukraine 153on 24 February 2022. Since their adoption, the National Bank has adjusted many times the measures to ensure they remain suitable for the evolving situation. 152 See the initial restrictions Resolution NBU 27.02.2014 No. 104 amend. NBU 06.02.2014 No. 49: https://bank.gov.ua/ua/news/all/pro-zahodi-schodo-zabezpechennya-rivnovagi-na-valyutnomu-rinku. They were relaxed several times, for example, in 2016 https://bank.gov.ua/ua/news/all/natsionalniy-bank-pomyakshuye- timchasovi-obmejennya-na-valyutnomu-rinku. In 2017 the restrictions were lifted altogether for individuals https://bank.gov.ua/ua/news/all/natsionalniy-bank-skasovuye-ostanni-obmejennya-na-vidachu-koshtiv-z- bankivskih-rahunkiv. 153 See the Resolution number 18 of the National Bank of Ukraine. URL: https://bank.gov.ua/en/legislation/Resolution_24022022_18 72 Dealing with weak banks in FinSAC countries: progress and challenges ahead 5.9. The need for domestic and cross-border coordination 133. The management of a crisis in FinSAC client countries is likely to require significant cross-border coordination, as seen during the Sberbank case. As noted earlier, many local subsidiaries of foreign banking groups are relevant players across the region. Therefore, a solvency or liquidity banking crisis may involve the participation of foreign parent entities as, following measures taken by local subsidiaries, banks may resort to group financial support to overcome their troubles. This situation underlines the coordination needs amongst home supervision and resolution authorities, both during normal and crisis situations. 134. FinSAC client countries have mainly a small host perspective. Some FinSAC countries face the well-known “small host problem”: while their local subsidiaries may be relevant (even systemically important) for the host country, they may be individually meaningless in the context of the banking group to which they belong. Therefore, home authorities do not have strong incentives to closely coordinate with small hosts. Home authorities may not invite host authorities to colleges, and small hosts may receive proportionately less information than other host authorities. Against this backdrop, it is important for FinSAC authorities to actively demand attention from home authorities. 135. Cross-border coordination can be streamlined through several mechanisms. First, authorities may require that banks include the group dimension in both recovery and resolution plans, by describing how coordination between the group and the local subsidiary may be conducted during crisis times, or the conditions under which group financial support may be provided. Second, authorities in FinSAC countries may sign or update memoranda of understanding and other coordination arrangements with the relevant home authorities to ensure their applicability under newly introduced resolution regimes. Third, authorities should make efforts to participate in regular coordination and cooperation exercises, for example by joining supervisory and resolution colleges organized by home authorities or by participating, whenever possible, in cross-border crisis simulation exercises. 136. Moreover, lateral coordination between host authorities should be considered. The presence of banking groups with subsidiaries in several FinSAC countries suggests possible coordination of actions between host authorities. The failures of Hypo Alpe Adria (2013-2014) 154 and Sberbank (2022), evidence that subsidiaries belonging to the same group can fail simultaneously, even if the subsidiaries operate locally and have different products, clients, and funding sources. Authorities in FinSAC countries should seek to prepare for these types of crises by cooperating and coordinating between themselves in normal times. 137. As already mentioned, public funding cannot be fully ruled out in a systemic crisis scenario. A lack of better alternatives may prompt authorities to inject public money in banks. In this scenario, close cooperation with the ministry of finance is essential for the effective resolution of the crisis. Regular cooperation and coordination arrangements should be established in normal times to facilitate common understanding of the implications of a systemic crisis, the role of the ministry of finance in that situation, and the conditions under which its intervention may be conducted. 154 See the “The Facts about Hypo Alpe Adria” prepared in April 2016 by the Financial Market Authority (FMA) and the Oesterreichische Nationalbank (OeNB), URL: https://www.fma.gv.at/en/the-facts-about-hypo-alpe- adria/. 73 Dealing with weak banks in FinSAC countries: progress and challenges ahead Planning for coordination of authorities’ activities during crisis times may also involve the deposit guarantee fund. 138. FinSAC client countries should implement effective domestic cooperation and coordination arrangements for both normal and crisis times. Most FinSAC countries have already set up financial stability committees, where domestic authorities with financial stability responsibilities (typically, central banks, ministries of finance, banking supervisors, resolution authorities, market and insurance supervisors, and deposit insurance agencies) regularly share information and engage in common activities for ensuring crisis management readiness and preparedness. 74 Dealing with weak banks in FinSAC countries: progress and challenges ahead 6. Recommendations 139. As a result of reforms introduced during the last decade, banking sectors in FinSAC countries have increased their resilience against financial stress. Reforms have strengthened the prudential requirements, tightened the governance and risk management standards, and introduced new frameworks for dealing with weak banks. As a result, banks’ profitability, capital adequacy, asset quality, and liquidity have improved during the last years. 140. However, this must not encourage complacency. Banking failures are costly affairs and usually result in economic and fiscal costs for countries. The numerous banking crises in recent years, including the turbulence in March 2023, are a clear reminder to remain vigilant. 141. Our recommendations are addressed to policymakers, central banks, supervisory and resolution authorities, and banks alike. Although FinSAC client countries share some common features, they are also very different. Therefore, not all recommendations are relevant for all countries. Policymakers, central banks, authorities, and banks are advised to assess the suitability of the recommendations to the context of their countries. 142. The recommendations are the following: Recommendation Recovery and Banks and resolution authorities should step up their efforts in recovery and resolution resolution planning. Through recovery planning, banks can regularly test the planning effectiveness of their crisis management arrangements through dry runs and simulation exercises. Supervisors can make further efforts to integrate their assessment of recovery plans into their overall supervisory framework through the assessment of banks’ recovery capacity. On resolution plans, after identifying the preferred resolution strategies, authorities should seek to involve banks in facilitating their resolvability, by issuing standards and regularly engaging with banks. During resolution planning, authorities should focus on the operational steps for implementing the key resolution tools, including transfer strategies, bridge banks and open bank bail-in resolution. Authorities should closely involve banks in these processes, as the execution of the resolution tools would require their participation. Introduction of FinSAC countries without FSB Key Attributes-based new resolution new resolution frameworks should renew their efforts towards their introduction and regimes implementation. Setting up resolution authorities, conferred with broad resolution powers, can be instrumental in facilitating a failed bank’s orderly exit from the market, using either closed or open bank resolutions. Countries need to consider their burden sharing models for dealing with banking crises. In open bank resolutions, authorities should implement policies supporting the funding sources for absorbing losses and recapitalizing failed banks, including by considering the possibility of introducing minimum loss-absorbing requirements and setting up and financing resolution funds. For closed bank resolutions, authorities should consider the possibility of requesting contributions from the deposit insurance fund to top up the shortage of assets that is likely to arise in any resolution scenario. 75 Dealing with weak banks in FinSAC countries: progress and challenges ahead Recommendation Effective lender of Most central banks in FinSAC client countries need to upgrade their ELA last resort frameworks. First, central banks in the region should coordinate their function, including exceptional liquidity arrangements with the new bank resolution framework. in resolution Second, central banks in highly dollarized economies need to consider how they may provide liquidity in foreign currency by, for example, entering into swap agreements with other central banks. Third, central banks should also operationalize their capabilities to provide liquidity against a broader range of high-quality collateral, including by improving their data processing and valuation capabilities. Enhancement Authorities should improve their capabilities to address systemic crises. preparedness for Authorities in FinSAC countries should engage in resolution simulation systemic crises exercises, either domestic or cross-border. The exercises should include the active participation of all relevant authorities (e.g., central bank, banking supervisor, resolution authority, ministry of finance, deposit insurance agency, market supervisor, etc.). Small host FinSAC client countries should step up their efforts in cross- border coordination and cooperation. As small hosts may not receive much attention from home authorities, FinSAC small hosts should continue to actively seek the participation in supervisory and resolution colleges, and engage on bilateral coordination, not only with home authorities, but also with other hosts (lateral coordination). Contingency plans are key. National authorities need to understand the type of actions they may need to take during a systemic banking crisis. These discussions can be held in the countries’ financial stability committees or similar fora. Authorities may explore the nature and requirements of systemwide diagnostics, the specificities of public support frameworks, the mechanisms for avoiding liquidity outflows in extreme scenarios, and the options for dealing with a potential large stock of non-performing assets. 76 Dealing with weak banks in FinSAC countries: progress and challenges ahead 7. References 2023 Bank failures. Preliminary lessons learnt from resolution. 2023. 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URL: https://journals.uran.ua/journal-vjhr/article/view/294739. 79 Dealing with weak banks in FinSAC countries: progress and challenges ahead Annex 1: Summary of asset management companies in ECA Section 5.7 of the document considers the use of AMCs to acquire bad or toxic assets from troubled banks. This annex outlines some recent examples of the use of AMCs in countries in the ECA region. Figure 16: Selected Asset Management Companies Asset Assets FinSAC Ownership Type of Year of Financing Country Management Status bought / Purpose client structure institution establishment structure Company received Azerbaijan Aqrarkredit State- Non-banking 1987, 155 2015 Active AZN 16 Issuance of To be a sustainable and profitable  owned state-owned as AMC billion bonds. 157 financial-credit institution providing financial (equivalent a range of services to the agrarian organization to USD sector. 10.3 billion) 156 Kazakhstan Problem Loans State- Ad hoc 2012 Active KZT 4 Issuance of To assist banks to reduce NPLs on Fund owned company trillion bonds and their balance sheets by issuing (equivalent liabilities bonds to fund the acquisition of the to USD received with assets. 10.4 billion assets. at end of 2019) 158 155 Asset transfers took place in the period 2015 – 2018. 156 See the capital structure and the evolution of public capital injections since 2007 in the Investor Presentation dated 23 May 2017, page 6 (AZN 11 billion). URL: https://abb-bank.az/storage/uploads/files/1596637038_20170523_-_iba_investor_presentation.pdf.; International Bank Of Azerbaijan Restructuring Plan Approved in July 2017, press release (AZN 4.9 billion). URL: https://abb-bank.az/index.php/en/maliyye-ve-investisiya/diger-melumatlar/press-relizler/azerbaycan-beynelxalq-banki- ohdeliklerinin-konullu-restrukturizasiyasi-planinin-kreditorlarin-18-iyul-2017-ci-il-tarixinde-kecirilmis-yigincaginda-qebul-olundugunu-elan-edib; and Aqrarkredit Annual Accounts 2020, note 18 (AZN 0.1 billion). URL: https://aqrarkredit.az/upload/Image/Audit%20Hesabat%C4%B1%202020.pdf 157 Those issued in 2015 were subscribed by the Central Bank of the Republic of Azerbaijan and guaranteed by the state. 158 Problem Loans Fund Annual Report 2018 and Annual Report 2019, (https://www.fpl.kz/en/godovoi-otchet). 80 Dealing with weak banks in FinSAC countries: progress and challenges ahead Asset Assets FinSAC Ownership Type of Year of Financing Country Management Status bought / Purpose client structure institution establishment structure Company received Russia National Bank State- Nationalized 1995 Active > RUB Capital To manage maximum recovery Trust owned 159 bank in 2017 2,074 injections by amounts from troubled assets billion the Central received from banks bailed out by (USD 33.5 Bank of the Bank of Russia 2017-2019 (e.g., billion) Russia. 162 National Bank Trust; Bank Otkritie; gross Deposits by Promsvyazbank; B&N Bank; Rost value 160 or the Central Bank; Bank AVB) RUB 236 Bank. billion Liabilities from (USD 3.9 merged banks. billion) net value 161 Closed-end Mixed State- Ad hoc 2018 Active No data Capital To recover the maximum amount Unit Investment owned company available injections by from assets received from the bail Fund Spetsialny the Central out of Asian-Pacific Bank in 2018 Bank. Slovenia Bank Assets State- Ad hoc 2012 Closed EUR 5.8 Issued bonds To sell or restructure assets Management owned company in billion guaranteed by acquired from banks to maximize Company 2022 163 (equivalent the their value, repay its bonds, and to USD 6.2 government. 165 minimize the taxpayer burden. billion at 159 National Bank Trust became state-owned when its parent company, Bank Otkritie, was bailed out in 2017. 160 Based on assets held by the non-core bank assets as of 1 January 2020 (CBR Annual Report 2019, page 152). 161 Received through asset transfers (e.g., Promsvyazbank; B&N Bank) and from mergers with banks by the Central Bank of Russia (e.g., Rost Bank; Otkritie [spin-off of a separate legal entity from PJSC Bank FC Otkritie]; AVB Bank). 162 Central Bank of Russia. Directly or indirectly through Fund of Banking Sector Consolidation. 163 By the end of 2022 all its assets (claims and tangible assets) and liabilities were transferred to the Slovenian Sovereign Holding. 165 Article 12 of the Slovenian Law “On the measures of the Republic of Slovenia to strengthen the stability of banks” establishing the Bank Assets Management Company. 81 Dealing with weak banks in FinSAC countries: progress and challenges ahead Asset Assets FinSAC Ownership Type of Year of Financing Country Management Status bought / Purpose client structure institution establishment structure Company received end of 2022) 164 164 Contractual (gross) value of transferred / merged assets. Imre Balogh “Lessons learnt from work of DUTB” May 2018, page 4 (https://thedocs.worldbank.org/en/doc/922641527522965142-0130022018/original/NPLConferenceDay110ImreBalogh.pdf). 82 Dealing with weak banks in FinSAC countries: progress and challenges ahead Annex 2: Key banking failures in ECA 2013-2023 Figure 17: Selected cases of banking failures in the period 2013-2023 FinSAC Country Bank Resolution type Year Short description client Azerbaijan International Bail-out 2015- ABB is the largest commercial bank in Azerbaijan, which traditionally held a deposit market share  Bank of Asset transfer to 2017 • above 40 percent. Azerbaijan (ABB) AMC • The state injected capital in 2015 and provided liquidity support to the bank. In the period 2015- Debt restructuring 2017, ABB transferred a significant share of its non-performing assets to Aqrarkredit (close to AZN 16 billion 166), a non-banking state-owned financial organization, acting effectively as a bad bank. Aqrarkredit swapped long-term sovereign bonds for ABB’s non-performing assets. • Those recovery measures were not enough to overcome the bank’s troubles. ABB and the Azeri state implemented a liability management exercise, where ABB’s foreign bondholders accepted bond swaps, including haircuts in their nominal value. The state injected additional capital with the intention to privatize the bank. • As of early 2024, the bank remains state-owned. Atabank OJSC and Liquidation 2020 Atabank’s market share in September 2019 was 1.7 percent of the system assets, 1.4 percent of  3 other small • the deposits, and 2.75 percent of loans. banks • As a result of Atabank’s financial problems during 2018 and 2019, it was unable to reimburse client deposits. Atabank was inspected by the Central Bank of Azerbaijan in the second part of 2019 and the bank’s shareholders were told to inject further money into the bank. They did not comply. • The Central Bank of Azerbaijan decided in April 2020 to appoint a temporary administrator for Atabank. The bank license was subsequently revoked and Atabank was placed under liquidation procedures. No losses were imposed to the bank’s depositors, as a blanket guarantee for individuals was in force at the time in the country. • The Central Bank revoked the licenses of 3 small banks (Amrahbank OJSC, NBCBank OJSC, and AGBank OJSC) between April and in May 2020. 166 Equivalent USD 10.3 billion. 83 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client Bosnia & Bobar Banka Liquidation 2014 At the end of the first quarter of 2014, Bobar Banka accounted for 5.2 percent of total assets of the Herzegovina  • banking sector in Republika Srpska, ranking 6th. • On December 23, 2014, the Banking Agency of Republika Srpska, following the proposal by the temporary administrator appointed in late November, decided to revoked Bobar Banka’s license and place the bank under liquidation, triggering an insured deposit pay out by the Deposit Insurance Agency. • The payment of insured deposits began on January 19, 2015. The total number of insured depositors in Bobar Bank, according to the data as of December 23, 2014, was 21.379, for a total amount of BAM 86.6 million (USD 53.9 million). Hypo Alpe-Adria Sale of shares 2014 By the end of the first quarter of 2014, Hypo Alpe-Adria accounted for 7.2 percent of total assets  • of the banking sector in the Federation of BiH and for 17.3 percent in Republika Srpska, ranking 4th and 3rd respectively. • After suffering financial turmoil, in June 2013, Heta Asset Resolution AG (formerly Hypo Alpe-Adria- Bank International, A.G.) transferred part of its subsidiaries to the newly created company Hypo SEE Holding AG., including Hypo Alpe-Adria-Bank d.d., Mostar and Hypo Alpe-Adria-Bank a.d., Banka Luka were subsidiaries of the Austrian state-owned Hypo SEE Holding AG. 167 • In October 2014, the Western Balkan subsidiaries (Croatia, Serbia, Slovenia, Bosnia & Herzegovina, and Montenegro) were separated from Heta Asset Resolution for its subsequent sale to a third party. • In December 2014, funds managed by Advent International (80 percent) and the European Bank for Reconstruction and Development (20 percent) entered into an agreement for the acquisition of the Western Balkan subsidiaries of Heta Asset Resolution. • During 2016 the new group was rebranded as Addiko Bank. The two Bosnian subsidiaries were also renamed. Banka Srpska Liquidation 2016 Banka Srpska a.d. Banja Luka was one of the two smallest banks in Republika Srpska when it had  • its banking license revoked on April 30, 2016, after which its insured deposits were paid out by the Deposit Insurance Agency on May 2016. 167 The Hypo Alpe-Adra Group was nationalized by the Austrian government in December 2009 after suffering large losses in the previous years. 84 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client Sberbank BH d.d. Sale of business 2022 Sberbank BH d.d. Sarajevo and Sberbank a.d. Banja Luka were two of the European subsidiaries of  Sarajevo (share deal) • Sberbank Europe AG, a bank headquartered in Austria and a subsidiary of the Russian Sberbank. (Federation of By the end of 2021 Sberbank BH d.d. Sarajevo had a market share in the Federation of BiH of 6.6 BiH) and percent both in loans and deposits. Sberbank a.d. Banja Luka had market shares of 12.0 percent in Sberbank a.d. loans and 11.5 percent in deposits in Republika Srpska. Banja Luka • Because of the international sanctions on Sberbank and its subsidiaries following the Russian (Republika invasion of Ukraine in February 2022, customers quickly lost confidence in Sberbank’s subsidiaries Srpska) and sought to withdraw their deposits. The parent company was unable to downstream liquidity to its subsidiaries, as international sanctions precluded it from doing so. As a result, the subsidiaries’ liquidity quickly dried up and supervisors considered the subsidiaries as non-viable. • The Banking Agency of the Federation of Bosnia and Herzegovina sold Sberbank BH d.d. Sarajevo to ASA Banka using its transfer powers. • The Banking Agency of Republika Srpska sold Sberbank a.d. Banja Luka to Nova Banka. Serbia Sberbank Srbija Sale of business 2022 Sberbank Srbija a.d. Beograd (accounting for 3.8 percent of Serbian banking sector’s assets) was  a.d. Beograd (share deal) • one of the European subsidiaries of Sberbank Europe AG, a bank headquartered in Austria and a subsidiary of the Russia’s Sberbank. • Because of the international sanctions on Sberbank and its subsidiaries following the Russian invasion of Ukraine in February 2022, confidence in Sberbank’s Europe subsidiaries quickly dried up, as depositors sought to withdraw their deposits. The parent company was unable to downstream liquidity to its subsidiaries, as international sanctions precluded it from doing so. The bank’s liquidity shortage prompted the National Bank of Serbia to consider Sberbank Srbija as non- viable. • The National Bank of Serbia transferred Sberbank Srbija shares to AIK Banka a.d. Beograd, which had agreed previously to take over some of the subsidiaries of the group. Kazakhstan BTA Bank Bail-out 2009- • BTA Bank JSC dates to the USSR. The entity was renamed as BTA Bank in 2008 and was the largest Debt restructuring 2015 bank of Kazakhstan at that time. Sale of shares • In 2009, bank investigators in Kazakhstan accused its former sole owner of issuing billions of dollars in fraudulent loans to offshore companies he secretly controlled. • In the context of anti-crisis measures in February 2009, the Government of Kazakhstan, through its Samruk Kazyna Sovereign Wealth Fund, agreed to purchase 75.1 percent of BTA’s Bank shares. 85 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • Between mid-2009 and 2010, BTA Bank undertook an international debt restructuring exercise with its borrowers in different jurisdictions. The restructuring ended in September 2010, affecting liabilities amounting to USD 16.7 billion. • In 2012, renewed problems forced the bank to deepen the restructuring of its liabilities. As a result, by end 2012 certain labilities were written down from around USD 11.1 billion to USD 3.3 billion. 168 Creditors received cash in the amount of USD 1.618 million and newly issued bonds in the amount of USD 750 million. Moreover, the bank issued new common shares pursuant to the conversion of USD 1.189 million of deposits from Samruk-Kazyna and the Bank received a USD 1.592 million subordinated loan from Samruk-Kazyna. Following these transactions, BTA Bank was effectively recapitalized by approximately USD 10 billion. Samruk-Kazyna increased its majority shareholding in the Bank to 97.3 percent, while former bondholders held around 2.5 percent of the bank’s shares. • In February 2014, Kazkommertsbank and Kenes Rakishev (former chairman of BTA Bank’s Board of Directors) each bought a 46.5 percent stake in BTA Bank from Samruk-Kazyna. Kazkommertsbank paid USD 465 million for the shares. Alliance Bank Bail-out 2009- • Following severe pressure because of the 2008 financial crisis, in 2009 Alliance Bank (Kazakhstan’s Debt restructuring 2014 fourth-largest bank at the time) defaulted on its debts. In early 2009, Samruk-Kazyna bought from Sale of shares the former main shareholder a 76 percent shareholding in Alliance Bank, effectively resulting in the partial nationalization of the bank. The transaction also involved the commitment by Samruk- Kazyna to make a deposit of KZT 24 billion (USD 200 million) in the bank. • Additionally, the bank initiated a debt restructuring process as a last attempt to avoid its failure. The debt restructuring was undertaken in 2010, which reduced the external debt of Alliance Bank from USD 4.5 billion to USD 1.1 billion and extended the residual maturity of the affected liabilities. • Financial troubles continued at Alliance Bank and in early 2014 the bank announced the need for a new debt restructuring. In May 2014 Samruk-Kazyna sold a 16 percent stake to a new shareholder for KZT 1.5 billion (USD 8.1 million), together with a 79.88 percent stake in Temirbank JSC (a former subsidiary of BTA Bank). In November 2014, Alliance Bank completed a debt restructuring by reducing debt from USD 1.2 billion to USD 600 million (mainly through debt-to-equity swap), while also raising a 10-year long-term deposit from Samruk-Kazyna for an amount of KZT 220 billion (USD 1.2 billion) to support the deal. 168 Including deposits of Samruk-Kazyna JSC with the Bank for USD 600 million. 86 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • Alliance Bank in 2015 was merged with two other Kazakh banks, TemirBank and ForteBank. Kazkommertsban Bail-out 2017 • KKB, a systemically important bank in Kazakhstan, acquired the previously nationalized BTA Bank k (KKB) Asset transfer to through a series of shares purchases in 2014-2015. After taking it over, KKB surrendered BTA’s AMC banking license, assumed most of its assets and liabilities BTA to fund the assets that were not Sale of shares transferred. According to the National Bank of Kazakhstan, KKB did not undertake adequate due diligence of BTA’s assets and, consequently, the acquisition resulted in losses for KKB. • In 2017, after several inspections by the National Bank, KKB’s problems were unveiled. The Kazakh State, through the Problem Loans Fund (effectively Kazakhstan’s bad bank), purchased the firm’s toxic assets at nominal value. After a comprehensive audit of KKB’s assets, accounting adjustments triggered the bank’s equity write off. Finally, the bank’s shares were sold to Halyk Bank, the second largest lender at the time, for a symbolic amount (KZT 1). • The resolution of KKB did not result in any losses for its creditors, including its bondholders. KKB’s shareholders and the Kazakh sovereign (through the purchase of problematic loans at face value) assumed the costs of the failure of the bank. Tsesnabank Bail-out 2019 • In 2018, Tsesnabank had a leader position in lending to Kazakhstan’s agro-industrial industry (65 Asset transfer to percent of the agricultural industry loan portfolio) and was the second largest bank in Kazakhstan. AMC The devaluation of the KZT in the years before 2018resulted in a significant increase in the foreign Sale of shares currency-denominated debt burden, that severely affected the creditworthiness of Tsesnabank’s borrowers in the agro industry. • To improve the financial soundness of the bank, Tsesnabank transferred NPLs for an amount around KAZ 1.054 trillion (USD 2.836 billion) to the state-owned Problem Loans Fund during 2018 and 2019. • In addition to the transfer of NPLs, the National Bank (e.g., liquidity provision) and the Government (e.g., through restructuring state-controlled senior unsecured creditors) provided support to Tsesnabank to strengthen its capital and liquidity position and attract new investors. Following the previous transactions, JSC "First Heartland Securities" (a state-owned company) acquired a controlling stake in Tsesnabank in February 2019. • Tsesnabank and First Heartland Bank (another bank entity in the acquiring group) were merged in 2019 to create First Heartland Jysan Bank. ATF Bank Bail-out 2020 • ATF Bank was acquired by UniCredit for USD 2.1 billion in 2007. The bank was later sold in 2013 to Sale of shares a local investor for USD 500 million. 87 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • Following financial troubles, the bank was bailed out by the National Bank of Kazakhstan in 2017, for an amount of KZT 100 billion (USD 260 million). A new bailout was undertaken in early 2020 when NPL reached 29%. ATF Bank’s financial position was bolstered by large cash deposits from Samruk-Kazyna. • At the end of 2020, Jysan Bank acquired 99.77 percent of ATF Bank’s shares. As part of the deal, Jysan Bank recapitalized ATF Bank for KZT 97 billion (USD 230 million). Kyrgyz Rosin Bank Nationalization 2018 • In 2010, Asia Universal Bank was the largest bank in the Kyrgyz Republic. Following a temporary Republic following ELA downturn, the bank was nationalized, and the National Bank of the Kyrgyz Republic appointed a transaction temporary administrator to manage Asian Universal Bank’s affairs. • As a result, the National Bank initiated bankruptcy proceedings for Asian Universal Bank and launched a restructuring process. It set up a bridge bank (Zalkar Bank) to receive certain assets and liabilities from the failed firm. By the end of 2010, Zalkar Bank was the sixth largest bank in the country. • After several failed attempts to sell the bridge bank, in May 2013 Russia’s Investment and Trade Business Holding Company purchased 90 percent of Zalkar Bank’s shares for close to USD 4 million (the Government of the Kyrgyz Republic kept the remaining 10 percent). The bank was renamed “Rosin Bank”. The new shareholder committed to further recapitalize the bank. • From June 2018 to May 2019, a special regime of direct banking supervision, involving the permanent presence of supervisors in the bank, was implemented at Rosin Bank, that at that time was affected by legal problems and liquidity pressures. • In October 2018, the National Bank became the controlling shareholder of Rosin Bank’s shares (71.65 percent) after the bank failed to repay a loan collateralized by shares granted by the National Bank to cope with liquidity problems triggered by deposit outflows. The bank was further recapitalized in 2019 and 2020. In September 2019, the bank was renamed as Keremet Bank OJSC. In early 2024, the Kyrgyz Government took over the bank from the National Bank. Moldova Banca de Bail-out 2014 By the end of 2014, the National Bank of Moldova detected that three banks did not comply with  Economii SA; Bail-in (related • minimum capital requirements. Massive fraud was unveiled at the three banks, that at the time Banca Sociala SA; parties) held around 30 percent of the total assets in the Moldovan banking system. The National Bank of and Unibank SA Liquidation Moldova identified a shortfall of more than 80 percent of the banks’ asset values as a result of large losses from related party lending and widespread fraud connected from the ultimate beneficial 88 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client owner of the banks. The capital position of banks was then stated at minus MDL 12,345.8 million (minus USD 967 million). • The three banks were placed under special administration and the National Bank of Moldova restricted the repayment of deposits to the banks’ related parties. • In October 2015, the National Bank withdrew the banks’ licenses and initiated began the process of their forced liquidation. • To enable the repayment of the banks’ deposits, the National Bank granted loans to the three banks, that were guaranteed by the Moldovan government. A total MDL 6,934 million (USD 543 million) were repaid to individual investors, MDL 4,588 million (USD 359 million) to companies, and MDL 2,623 million (USD 205 million) to financial entities in Moldova. Victoriabank; Special supervision 2016 Due to the detection of problems related to non-transparent shareholder structure and high-risk  Moldova regime/intensive • lending operations, the National Bank of Moldova placed three banks that collectively held at that Agroindbank; and supervision time more than 60 percent of the sector assets (Victoriabank, Moldova Agroindbank, and Moldindconbank Sale of shares Moldindconbank) under a special supervision regime in June 2015. The special supervision regime was replaced with intensive supervision in October 2016 until the problems in these banks were resolved. The National Bank created monitoring groups for each bank that examined the financial situation, transactions, management bodies’ agenda, and participated in the institutional bodies’ meetings of the banks. • In November 2016, Banca Transilvania 169 announced its intention to acquire 39.2 percent of shares in Victoriabank. Banca Transilvania and EBRD agreed to establish an investment holding company to acquire the shares (VB Investment Holding), with the Romanian bank holding around 62% percent and EBRD 38 percent. The deal was closed in January 2018 resulting in VB Investment Holding controlling a 66.7 percent shareholding in Victoriabank, that was subsequently increased to 72.19 percent in 2018. • In April 2019, the National Bank of Moldova revoked the measures prescribed for the special supervision period of Moldova Agroindbank after it was found that the bank was able to ensure the transparency of its shareholders, following the acquisition of 41.09 percent of the bank’s share capital by a private equity fund (Heim Partners limited 170). 169 The second largest commercial bank by assets in Romania by that time. 170 A company representing an international consortium of investors: EBRD, Invalda INVL, and Horizon Capital. 89 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • Moldindconbank was put in early intervention in October 2016. A temporary administrator was appointed (substituting the special supervision regime) because a group of persons acquired a qualifying holding in the bank's share capital (63.89 percent), without prior permission of the National Bank. Voting rights were suspended for these shareholders, and they were required to dispose of shares (the shares were seized as part of a criminal case and cancelled in January 2018, in accordance with legal provisions). Thereafter, the National Bank suspended the mandates of certain members of the management bodies and appointed temporary administrators. A new package of shares representing 63.89 percent of the bank’s share capital was issued and put on sale at the initial price set by an international audit firm. The shares were finally sold to a Bulgarian investor in March 2019 at a total value of MDL 764.0 million (USD 44.5 million). Subsequently, it acquired another 13.73 percent and 0.013 percent, reaching a 77.63 percent holding by the end of 2019. The National Bank ended the early intervention regime of Moldindconbank on February 11, 2020. Montenegro Invest Banka Liquidation 2019 Central Bank’s on-site inspections in 2018 revealed that Invest Banka (market share below 1  Montenegro AD • percent) and Atlas Banka (around 5 percent market share) were critically undercapitalized and and Atlas Banka insolvent. The Central Bank introduced a temporary administration in both banks in December AD 2018. The authority imposed a moratorium on all the banks’ liabilities, save for the exemptions stipulated by the Law, in order to conserve the assets of both banks. • Following the report of the temporary administrator of Invest Banka of December 31, 2018, the Central Bank withdrew the bank’s license in January 2019 and placed the bank under ordinary insolvency proceedings. • The report of the temporary administrator of Atlas Banka evidenced that as of December 2018, with an adequate set of measures (cost cutting, asset sales, debt collection from related parties, capital increase etc.), the bank’s business model could be considered sustainable. • However, after two unsuccessful share issues and a deterioration of the bank’s assets, the Central Bank revoked Atlas Banka’s banking license at the beginning of April 2019, and placed the bank under ordinary insolvency proceedings. North Eurostandard Liquidation 2020 In the years preceding 2020, the National Bank of North Macedonia undertook several supervisory Macedonia  Bank • actions over Eurostandard Bank, mainly related to the bank’s credit risk management practices. In 90 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client June 2020, Eurostandard Bank held 1.6 and 1.7 percent of the system loans and deposits, respectively. • In 2019, the National Bank detected a capital shortfall in the bank and urged shareholders to recapitalize it. The failure to meet the recapitalization commitments and rapid and higher credit risk materialization took the bank’s capital adequacy ratio to critical levels (below 2 percent). • Eurostandard Bank’s license was revoked by the National Bank and the bank was placed under insolvency proceedings in August 2020. The North Macedonian Deposit Insurance Fund reimbursed insured depositors (up to EUR 30,000 per person). Russia Bank Otkritie Bail-out 2017 • In 2017, Bank Otkritie was a systemically important credit institution ranked 8th by assets, as one Asset transfer to of the largest private banks in the country, after years of rapid asset growth, including through the AMC acquisition of several financial institutions in the country. Sale of shares • In July-September 2017, 171 Bank Otkritie financial position deteriorated sharply, as it was excluded from the list of eligible counterparties in the new credit rating regulations of the Central Bank of Russia. Since its potential failure would have entailed a material threat to the Russian financial system, the Bank of Russia decided on August 29, 2017, to implement measures aimed at improving the financial stability of Bank Otkritie, using its new restructuring powers. The measures included the appointment of a temporary administrator, 172 a capital injection and liquidity provision from the Banking Sector Consolidation Fund (owned by the Bank of Russia), guaranteeing the continuity of the bank’s operations. No moratorium on payments under creditors’ claims was introduced. • Despite these measures, Bank Otkritie breached its minimum capital requirements in September 2017. Thus, the Bank of Russia acquired additional ordinary shares of the Bank in the amount of RUB 456.2 billion (USD 7.7 billion) in December 2017, which gave the Bank of Russia 99.9 percent of ordinary shares in the bank. • Part of the bank’s troubled assets were transferred to its subsidiary National Bank Trust, that was used by the Bank of Russia as a bad bank for the management of troubled assets (also from other banks). And was merged by B&N Bank (see below). 171 For example, Bank Otkritie also suffered troubles with liquidity due to non-conformity to the requirements for the credit rating level for raising temporarily available funds of state corporations, the federal budget, and extra-budgetary funds. In July 2017 the bank faced a drastic outflow of corporate and household funds, which exceeded RUB 630 billion over two months. 172 Composed of Bank of Russia officers and employees of the Banking Sector Consolidation Fund management company. 91 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • In December 2022, Bank Otkritie was sold to state-owned VTB Bank for RUB 340 billion (USD 5.1 billion). B&N Bank Bail-out 2017 • Between 2014 and 2016, B&N Bank experienced a quick growth, becoming the 12th bank by assets, (Binbank) Asset transfer to and one of the largest private banks in the country. The growth was facilitated by the acquisition AMC of several failed credit institutions in Russia. 173 However, the acquisition exposed B&N Bank to Sale of shares material risks. • From August 2016, the Bank of Russia requested B&N Bank a plan to improve its asset quality; but the measures were not successful. The bank’s liquidity problems in August–September 2017 prompted the bank’s shareholders to make request to the Bank of Russia for its financial rehabilitation. • The Bank of Russia decided on September 20, 2017, to implement measures aimed at improving the financial stability of B&N Bank. The measures included the appointment of a temporary administration, 174 a capital injection and the provision of liquidity from the Banking Sector Consolidation Fund. No moratorium on payments under creditors’ claims was introduced. • Further support measures by the Bank of Russia were RUB 56.9 billion (USD 1 billion) for recapitalization purposes in March 2018 and the transfer of part of the bank’s troubled assets to the National Bank Trust. • On October 30, 2018, the Bank of Russia decided to merge Bank Otkritie with B&N Bank. The combined entity was subsequently (December 2022) sold to state-owned VTB. Promsvyazbank Bail-out 2017 • In December 2017, the Bank of Russia found Promsvyazbank, a systemic bank and ranked 9th by Asset transfer to assets in Russia, was undercapitalized and required it to increase its capital reserves by over RUB AMC 100 billion (USD 1.6 billion). The bank was not able to raise its capital in the required amounts. Bail-in • On December 15, 2017, the Bank of Russia decided to implement measures aimed at improving the bank’s financial stability, including the appointment of a temporary administrator, 175 as well as capital injections and liquidity provision by the Banking Sector Consolidation Fund, guaranteeing continuity of operations. No moratorium was introduced. 173 Including MDM Bank, Binbank Digital, and ROST BANK. 174 Composed of Bank of Russia officers and employees of the Banking Sector Consolidation Fund management company. 175 Composed by employees of the Banking Sector Consolidation Fund. 92 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • On December 22, 2017, the Bank of Russia decided to bail-in Promsvyazbank’s subordinated debt and certain liabilities to related parties. • In March 2018 Promsvyazbank’s shares were transferred to the State Corporation Deposit Insurance Agency, that raised its shareholding in Promsvyazbank to 99.99 percent, and was then transferred to the Federal Agency for State Property Management. The measure allowed Promsvyazbank to comply with its capital requirements. Additionally, the bank’s troubled assets were transferred to National Bank Trust, the public AMC. • National Trust Bail-out 2018 • National Bank Trust was a subsidiary of Bank Otkritie. When a temporary administrator was Bank Transformation appointed to the latter on August 30, 2017, National Trust Bank continued to operate as a going into an AMC concern. • In March 2018, the Bank of Russia approved a plan to participate in the implementation of measures to prevent bankruptcy of the National Trust Bank, and a temporary administrator was appointed. In May 2018, the Bank of Russia became the majority shareholder 176 by fully subscribing the bank’s capital increase. • In 2018, the Bank of Russia decided to create a Bank of Problematic and Non-Core Assets based on National Trust Bank. Between July 2018 and mid-2019, several banks were merged with the National Trust Bank, including Rost Bank; Bank Otkritie Special Bank (with troubled assets from Bank Otkritie); and JSC AVB Bank. • In addition to those mergers, National Trust Bank also received assets from other banks bailed out by the Bank of Russia, including Promsvyazbank and B&N Bank. • The total value of assets under the management of the Bank of Problematic and Non-Core Assets at the initial book value exceeded 2 trillion rubles (USD 28.7 billion) in January 2019. 177 • In early 2024, the National Trust Bank continues to be majority controlled by the Bank of Russia. 178 Rost Bank Bail-out 2018 • Rost Bank was a subsidiary of B&N Bank. When a temporary administrator was appointed to the latter in September 2017, Rost Bank continued to operate as a going concern. 176 Controlling 99.9999997 percent of the shares, of which a 2.00000057 percent was indirectly held through Bank Otkritie. 177 RUB 207,254 million at fair value (USD 3.0 billion). 178 Bank of Russia Annual Report for 2022, page 170. URL: https://www.cbr.ru/collection/collection/file/46299/ar_2022_e.pdf 93 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • The Bank of Russia then decided on December 2017, to implement measures aimed at improving the financial stability of Rost Bank, including the appointment of a temporary administrator, 179 and capital and liquidity injections by the Banking Sector Consolidation Fund, guaranteeing the continuity of the bank’s operations. On May 2018, the Bank of Russia became the direct owner of more than 99.9 percent of ordinary shares of Rost Bank for RUB 350 million (USD 5.7 million), and two weeks later Rost Bank was merged into National Bank Trust. Asian-Pacific Bank Bail out 2018 • By 2018, the Asian-Pacific Bank ranked 60th by assets and was one of the largest and socially Asset transfer to important regional banks of Siberia and the Far East. AMC • The Bank of Russia in April 2018, implemented measures aimed at improving the financial stability Sale of shares of Asian-Pacific Bank, including the appointment of a temporary administrator, 180 as well as capital injections and liquidity provision by the Banking Sector Consolidation Fund, to ensure the continuity of the bank’s operations. No moratorium was introduced. • In late September 2018 the Bank of Russia acquired additional shares in the Asian-Pacific Bank to become the owner of more than 99.99 percent of the total ordinary shares. • In December 2018, the Bank of Russia decided to establish a Closed-end Mixed Unit Investment Fund Spetsialny managed by Banking Sector Consolidation Asset Management Company using Banking Sector Consolidation Fund funds. This focused on acquiring toxic assets from the Asian- Pacific Bank, facilitating its later transfer to a third-party. • The Asian-Pacific Bank was finally sold in September 2021 to an investor from Kazakhstan Pioneer Capital Invest LLP for RUB 14 billion (USD 192.88 million). Tajikistan Fononbank and Liquidation 2017 • Fononbank and Tojprombank were two small non-systemic banks. Tojprombank • To improve their financial situation and protect the interests of depositors and borrowers, the National Bank of Tajikistan appointed a temporary administration in Fononbank between 2015 and 2016 and in Tojprombank in 2016. • Despite initial recapitalization plans, the National Bank of Tajikistan revoked their banking licenses in February 2017, and the Deposit Guarantee Fund reimbursed their insured depositors. • 179 Made up of Bank of Russia officers and employees of the Banking Sector Consolidation Fund. 180 Composed by employees of the Banking Sector Consolidation Fund. 94 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client AgroinvestBank Bail-out 2021 • The government had acquired capital instruments in several AIB capital issuances since 1992 (2003, and Liquidation 2010, and 2012). The EBRD also became a shareholder in 2009 when it bought a 25 percent + 1 TojiksodiroktBank share in AgroinvestBank. • At the end of 2016, due to AgroinvestBank’s and TojiksodiroktBank’s systemic importance, the National Bank of Tajikistan prepared two recapitalization plans to restore their financial situation, including a capital injection by the government in each bank. The government then became the main shareholder of the two banks. • Following several years of balance sheet losses and sustained financial difficulties, the National Bank revoked their licenses in May 2021. The individual depositors were covered by the Individual Deposit Insurance Fund up to the amount insured of TJS 30,000 for deposits in local currency (approx. USD 2,631). • Ukraine Rodovid Bank Bail-out 2009- The JSC Rodovid Bank (a top 20 bank in Ukraine at the time 181) was severely affected by the GFC  Liquidation 2017 • and in March 2009 a temporary external administration took over the operational management of the bank. In 2009, the Ukrainian Government provided public capital to the bank in an amount of UAH 8.4 billion (USD 1.05 billion). The bank received a further UAH 3.95 billion (USD 495 million) from the state in 2011. As a result, the state ownership increased to 99.9 percent. • From 2011, Rodovid Bank was subject to financial recovery procedures. 182 The goal was to work out the assets retained and repay the received state funds within 5 years, working effectively as a bad bank. However, the original plan was not achieved, due to difficulties in asset work out and Rodovid’s high costs and low revenues. • On February 25, 2016, the National Bank of Ukraine adopted a decision, agreed with the Ministry of Finance, to declare the Rodovid Bank insolvent and to transfer its assets to the Individual Deposit Guarantee Fund. The decision to liquidate the bank was finally adopted on December 19, 2017. Terra Bank Bridge bank 2014 The deterioration of Terra Bank (a top 50 bank in Ukraine at the time) financial situation in July  • 2014 prompted the National Bank of Ukraine to appoint a temporary administrator to directly control the bank’s affairs. Out of more than 160 banks in Ukraine at the time. 181 in accordance with the order of the Cabinet of Ministers No. 880-r of September 14, 2011, the decree of the National Bank of Ukraine No. 471 of December 23, 2011, 182 and license of the bank operating under financial recovery procedures No. 1 of June 15, 2012. 95 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • In the following months, the measures taken by the bank failed to stabilize its financial situation. As Terra Bank was unable meet its financial obligations to depositors and other creditors and breached the regulatory requirements, the National Bank declared it a problem bank in early August 2014. • In December 2014, to facilitate the resolution of Terra Bank, the Deposit Guarantee Fund asset up the bridge institution “Krystal Bank”. On December 22, 2014, the Deposit Guarantee Fund transferred some of Terra Bank’s assets and liabilities to Krystal Bank. After the transfer, Terra Bank's license was revoked, and it was placed under liquidation procedures. • In February 2015, Krystal Bank was sold to a private individual, and in March 2015, lost its status as "transitional or bridge bank" and received a full banking license. Omega Bank Bridge bank 2015 Omega Bank, a small Ukrainian banking institution was declared a problem bank by the National  • Bank of Ukraine in January 2015 due to its direct involvement in risky activities, as evidenced by its deteriorating financial situation. National Bank administrators were appointed. Omega Bank failed to submit credible measures to address its problems and the bank' financials continued to deteriorate. • Subsequently, Omega Bank was classified as insolvent, based on which the Deposit Guarantee Fund placed the bank under temporary administration and in May 2015 established the bridge bank “RVS”, 183 to take over the certain assets and liabilities. • In August 2015, the bridge bank RVS was sold to Ukrainian Business Group LLC for a consideration of UAH 31.86 million (USD 1.46 million). Delta Bank Liquidation 2015 Delta Bank quickly grew its assets, becoming the fourth largest bank by total assets, worth UAH  • 60.303 billion (USD 3.8 billion), as of January 1, 2015. 184 • In early 2014, the National Bank extended loans for an amount of UAH 4,150 million (USD 497 million) to Delta Bank to strengthen the bank’s liquidity position and protect the interests of depositors. Following approval of the bank's capitalization program in September 2014, Delta Bank received an emergency loan worth UAH 960 million (USD 74.3 million) backed by securities guaranteed by the state. 183 Assets The transferred included: (i) nine real estate properties with a total value of UAH 68.7 million (USD 3.3 million); (ii) 33 land plots, with a total value of UAH 12.3 million (USD 0.6 million); (iii) claim credit rights for 65 personal loans worth UAH 6.7 million (USD 0.3 million); (iii) claim credit rights for 204 loans of legal entities worth UAH 140.6 million (USD 6.7 million). 184 Of more than 150 banks in Ukraine at the time. 96 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client • The measures proved to be only a temporary solution to the bank’s problems. Contingency measures by the bank's shareholders and management proved insufficient, and the planned recapitalization never materialized. • As a systemically important bank, the Ministry of Finance and the National Bank explored potential state participation in the recapitalization process. However, given the poor quality of the bank's assets, Delta Bank was declared insolvent by the National Bank at the beginning of March 2015. • 94 percent of depositors were within the minimum guaranteed amount of UAH 200 thousand (USD 8,775), making them eligible for full reimbursement by the Deposit Guarantee Fund. Privatbank Bail-out 2016 In December 2016, the Ukrainian authorities nationalized PrivatBank, the largest systemically  Bail-in • important institution in Ukraine (more than 20 million customers), and previously controlled by two oligarchs. • In 2016, the National Bank unveiled a large capital shortfall in PrivatBank’s balance sheet of UAH 148 billion (USD 5.5 billion), after discovering that 97 percent of the corporate loan book was lent to related parties and many theoretically collateralized loans were nonexistent. • Ukrainian authorities proceeded to write-off the bank’s shares and convert certain liabilities into newly issued shares, including loans by related parties and Eurobonds for a total amount of UAH 29.4 billion (USD 1.2 billion). Once issued those shares were transferred to the Ministry of Finance for UAH 1 (implying the full write-off of the bank’s liabilities). New equity was then injected by the Ministry of Finance into the bank. The recapitalization was completed in February 2017, with the infusion of new capital for UAH 116.8 billion (USD 4.32 billion). IR Bank JSC Liquidation 2022 IR Bank was ranked 10th by total assets in the Ukrainian banking sector at the beginning of 2022. It  • was Sberbank’s fully owned Ukrainian subsidiary. • Following Russian invasion of Ukraine, and in accordance with the resolution of the Board of the National Bank of Ukraine dated February 24, 2022, No. 19 "On the peculiarities of the termination of the activities of banks in conditions of martial law", the National Bank decided on February 25, 2022, to revoke the banking license and liquidate IR Bank. Prominvestbank Liquidation 2022 In early 2022, Prominvestbank was the Ukrainian subsidiary (99.77 percent of bank’s capital) of the  JSC • Russian State Development Corporation VEB.RF. • Following the Russian invasions of Ukraine, and in accordance with the resolution of the Board of the National Bank of Ukraine dated February 24, 2022, No. 19 "On the peculiarities of the 97 Dealing with weak banks in FinSAC countries: progress and challenges ahead FinSAC Country Bank Resolution type Year Short description client termination of the activities of banks in conditions of martial law", the National Bank decided on February 25, 2022, to revoke the banking license and liquidate Prominvestbank. Bank Sich JSC Liquidation 2022 Bank Sich was a small firm ranked in top 30 by total assets in the Ukrainian banking sector. On-site  • inspections by the National Bank between January and August 2022 unveiled Bank Sich’s deteriorating in both asset quality and financial position, including a materially above sector average deposit costs. Moreover, Bank Sich did not to pay interest to the National Bank for refinancing loans provided under an agreement dated October 2018. • The National Bank declared Bank Sich insolvent on August 9, 2022, considering both the bank’s deteriorated financial position and the lack of alternative measures to redress its financial position. The Deposit Guarantee Fund then introduced a temporary administration on August 10, 2022. • After the Deposit Guarantee Fund failed to find a buyer for the insolvent bank, the National Bank decided on October 6, 2022, to revoke Bank Sich’s license and began liquidation procedures on October 10, 2022. 98 Dealing with weak banks in FinSAC countries: progress and challenges ahead Annex 3: Bank ownership structures per country This annex summarizes the ownership structures of banks in some countries in the ECA region. Banks are assigned to one of three categories: • State-owned bank. Covers the cases where public national authorities own more than 50% of the shares or a controlling stake in the firm; • subsidiary of a foreign bank. Includes those banks in which a foreign banking group owns more than 50% of the shares or a controlling stake; or • other: banks with ownership structures that do not fit either of the previous categories (e.g., owned by a third country state; owned by a local group / individual; etc.). Figure 18: Albania Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) American Bank of Investments Other Subsidiary of a Banka Kombëtare Tregtare Çalık Holding Türkiye foreign bank Credins Bank Other Subsidiary of a First Investment FIBank Albania Bulgaria foreign bank Bank, AD Subsidiary of a Intesa Sanpaolo Intesa Sanpaolo Bank Albania Italy foreign bank S.p.A. Subsidiary of a OTP Albania OTP Bank Hungary foreign bank Subsidiary of a ProCredit Holding ProCredit Bank Germany foreign bank AG Subsidiary of a Raiffeisen Bank Raiffeisen Bank Albania Austria foreign bank International AG Tirana Bank Other Union Bank Other United Bank of Albania Other Source: FinSAC with information from banks Figure 19: Armenia Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Ameriabank CJSC Other ACBA Bank OJSC Other AMIO Bank CJSC Other Araratbank OJSC Other Ardshinbank CJSC Other Armeconombank OJSC Other 99 Dealing with weak banks in FinSAC countries: progress and challenges ahead Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) ArmSwissBank CJSC Other Artsakhbank CJSC Other Subsidiary of a Byblos Bank Armenia CJSC Byblos Bank SAL Lebanon foreign bank Converse Bank CJSC Other Evocabank CJSC Other Fast Bank CJSC Other Subsidiary of a HSBC Bank Armenia CJSC HSBC Holdings plc United Kingdom foreign bank ID Bank CJSC Other InecoBank CJSC Other Subsidiary of a Mellat Bank CJSC Mellat Bank Iran foreign bank UniBank OJSC Other Subsidiary of a VTB Bank (Armenia) CJSC VTB Bank PJSC Russian Federation foreign bank Source: FinSAC with information from banks Figure 20: Azerbaijan Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Accessbank CJSC Other AFB Bank CJSC Other Azerbaijan Industry Bank OJSC Other Azer-Turk Bank OJSC State-owned Bank BTB OJSC Other Bank Eurasia OJSC Other Subsidiary of a Bank Melli Iran (Baku Branch) Bank Melli Iran foreign bank Bank of Baku OJSC Other Bank Respublika OJSC Other Subsidiary of a Bank VTB (Azerbaijan) OJSC VTB Bank PJSC Russian Federation foreign bank Expressbank OJSC Other International Bank of Azerbaijan OJSC State-owned Kapital Bank OJSC Other Nakhchivanbank OJSC Other Pasha Bank OJSC Other Premium Bank OJSC Other Rabitabank OJSC Other TuranBank OJSC Other Unibank OJSC Other 100 Dealing with weak banks in FinSAC countries: progress and challenges ahead Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Xalq Bank OJSC Other Subsidiary of a YapiKredi Bank Azerbaijan CJSC YapıKredi Bank AŞ Türkiye foreign bank Yelo OJSC Other Subsidiary of a Ziraat Bank Azerbaijan OJSC Ziraat Bankasi A.Ş. Türkiye foreign bank Source: FinSAC with information from banks Figure 21: Bosnia and Herzegovina Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Federation of BiH Subsidiary of a Addiko Bank d.d. Sarajevo Addiko Bank AG Austria foreign bank ASA Bank d.d. Sarajevo Other Bosna Bank International d.d. Sarajevo Other Intesa Sanpaolo Banka d.d. Bosna i Subsidiary of a Intesa Sanpaolo Italy Hercegovina foreign bank S.p.A. Komercijalno-investiciona Banka d.d. V. Other Kladusa Subsidiary of a NLB Banka d.d., Sarajevo NLB d.d., Ljubljana Slovenia foreign bank Privredna Banka Sarajevo d.d. Sarajevo Other Subsidiary of a ProCredit Holding ProCredit Bank d.d. Sarajevo Germany foreign bank AG Subsidiary of a Raiffeisen Bank Raiffeisen Bank d.d. BiH Austria foreign bank International AG Subsidiary of a Sparkasse Bank dd Bosna i Hercegovina Erste Bank Austria foreign bank Subsidiary of a UniCredit Bank d.d. UniCredit Bank SpA Italy foreign bank UnionBanka d.d. Sarajevo State-owned Subsidiary of a ZiraatBank BH d.d. Ziraat Bankasi A.Ş. Türkiye foreign bank Republika Srpska Subsidiary of a Addiko Bank a.d. Banja Luka Addiko Bank AG Austria foreign bank Atos Bank a.d. Banja Luka Other Banka Poštanska Subsidiary of a Bank Poštanska štedionica a.d. Banja Luka štedionica ad Serbia foreign bank Beograd MF Bank a.d. Banja Luka Other Naša Banka a.d. Banja Luka Other 101 Dealing with weak banks in FinSAC countries: progress and challenges ahead Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Nova Banka a.d. Banja Luka Other Subsidiary of a NLB Bank a.d. Banja Luka NLB Banka Slovenia foreign bank Subsidiary of a UniCredit Bank a.d. Banja Luka UniCredit Bank SpA Italy foreign bank Source: FinSAC with information from banks Figure 22: Georgia Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Bank of Georgia Other Basis Bank Other Credo Bank Other Subsidiary of a Halyk Bank JSC Halyk Bank Kazakhstan foreign bank Subsidiary of a Isbank Georgia JSC Isbank Turkey Türkiye foreign bank Kartu Bank Other Liberty Bank Other Subsidiary of a Pasha Bank OJSC PASHA Bank Azerbaijan foreign bank Paysera Other Subsidiary of a ProCredit Holding Pro Credit Bank Germany foreign bank AG Silk Bank Other TBC Bank Other Tera Bank Other Subsidiary of a VTB Bank VTB Bank PJSC Russia foreign bank Subsidiary of a Ziraat Bank Ziraat Bankasi A.Ş. Türkiye foreign bank Source: FinSAC with information from banks Figure 23: Kosovo Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Banka Ekonomike Other 102 Dealing with weak banks in FinSAC countries: progress and challenges ahead Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Subsidiary of a Banka Kombëtare Tregtare Kosovo J.S.C Çalık Holding Türkiye foreign bank Banka për Biznes Other Subsidiary of a Credins Bank, Kosovo Credins Bank Albania foreign bank Subsidiary of a Komercijalna Banka ad Beograd NLB Banka Slovenia foreign bank Subsidiary of a NLB Bank NLB Banka Slovenia foreign bank Pribank J.S.C. Other Subsidiary of a ProCredit Holding ProCredit Bank Germany foreign bank AG Subsidiary of a Raiffeisen Bank Raiffeisen Bank Kosovo Austria foreign bank International AG Subsidiary of a TEB J.S.C BNP Paribas France foreign bank Subsidiary of a Türkiye Cumhuriyeti Ziraat Bankasi Ziraat Bankasi A.Ş. Türkiye foreign bank Subsidiary of a Türkiye İş Bankasi Türkiye Is Bankasi Türkiye foreign bank A.Ş. Source: FinSAC with information from banks Figure 24: Moldova Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Banca Comerciala COMERTBANK S.A. Other Banca Comerciala ENERGBANK S.A. Other Banca Comerciala EuroCreditBank S.A. Other Banca Comerciala Moldindconbank S.A. Other Banca Comerciala MOLDOVA - AGROINDBANK Other S.A. Subsidiary of a ProCredit Holding Banca Comerciala ProCredit Bank S.A. Germany foreign bank AG Subsidiary of a Banca Comerciala Romana Chisinau S.A. Erste Bank Austria foreign bank Subsidiary of a Banca Banca Comerciala VICTORIABANK S.A. Romania foreign bank Transilvania Banca de Finante si Comert S.A. Other Subsidiary of a Intesa Sanpaolo Joint Stock Commercial Bank EXIMBANK Italy foreign bank S.p.A. Subsidiary of a OTP Bank S.A. OTP Bank Hungary foreign bank Source: FinSAC with information from banks 103 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 25: Montenegro Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Subsidiary of a Addiko Bank AD Podgorica Addiko Bank AG Austria foreign bank Adriatic Bank AD Podgorica Other Subsidiary of a Crnogorska Komercijalna Banka AD Podgorica OTP Bank Hungary foreign bank Subsidiary of a Erste Bank AD Podgorica Erste Bank Austria foreign bank Hipotekarna Banka AD Podgorica Other Lovćen Banka AD Podgorica Other Subsidiary of a NLB Banka AD Podgorica NLB Banka Slovenia foreign bank Prva Banka Crne Gore AD Podgorica Other Universal Capital Bank AD Podgorica Other Zapad Banka AD Podgorica Other Subsidiary of a Ziraat Bankasi Ziraat Bank Montenegro AD Podgorica Türkiye foreign bank A.Ş. Source: FinSAC with information from banks Figure 26: North Macedonia Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Capital bank AD Skopje Other Central Subsidiary of a Centralna Kooperativna Banka AD Skopje Cooperative Bank Bulgaria foreign bank AD Development Bank of North Macedonia AD State-owned Skopje Subsidiary of a Halk bank AD Skopje Halk Bankasi AS Türkiye foreign bank Komercijalna Banka AD Skopje Other Subsidiary of a NLB Banka AD Skopje NLB Banka Slovenia foreign bank Subsidiary of a ProCredit ProCredit bank AD Skopje Germany foreign bank Holding AG Silk Road Bank AD Skopje Other Subsidiary of a Sparkasse Banka AD Skopje Erste Bank Austria foreign bank Stopanska Banka AD Bitola Other Subsidiary of a National Bank of Stopanska Banka AD Skopje Greece foreign bank Greece S.A. 104 Dealing with weak banks in FinSAC countries: progress and challenges ahead Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) TTK Banka AD Skopje Other Univerzal Investment Bank AD Skopje Other Source: FinSAC with information from banks Figure 27: Serbia Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) 3Bank a.d. Novi Sad Other Subsidiary of a Addiko Bank a.d. Beograd Addiko Bank AG Austria foreign bank Adriatic Bank Akcionarsko Društvo Beograd Other Agroindustrijsko Komercijalna Banka AIK Other Banka a.d. Beograd ALTA Banka a.d. Beograd Other API Bank a.d. Beograd Other Subsidiary of a Intesa Sanpaolo Banca Intesa a.d. Beograd Italy foreign bank S.p.A. Subsidiary of a Bank of China Srbija a.d. Beograd Bank of China China foreign bank Banka Poštanska štedionica a.d. Beograd State-owned Subsidiary of a Erste Bank a.d. Novi Sad Erste Bank Austria foreign bank Eurobank Direktna Akcionarsko Društvo Other Beograd Subsidiary of a Halkbank a.d. Beograd Halk Bank Turkey foreign bank Mirabank a.d. Beograd Other Mobi Banka a.d. Beograd Other Subsidiary of a NLB Komercijalna Banka AD Beograd NLB Banka Slovenia foreign bank Subsidiary of a OTP Banka Srbija a.d. Novi Sad OTP Bank Hungary foreign bank Subsidiary of a ProCredit Holding ProCredit Bank a.d. Beograd Germany foreign bank AG Subsidiary of a Raiffeisen Bank Raiffeisen Banka a.d. Beograd Austria foreign bank International AG Srpska Banka a.d. Beograd State-owned Subsidiary of a Unicredit Bank Srbija a.d. Beograd UniCredit Bank SpA Italy foreign bank Source: FinSAC with information from banks 105 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 28: Ukraine Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) A - Bank JSC Other Alpari Bank JSC Other Altbank JSC Other AP Bank JSC Other Asvio Bank JSC Other Bank Portal JSC Other Bank 3/4 JSC Other Bank Alliance JSC Other Bank Avangard JSC Other Bank Credit Dnipro JSC Other BANK FAMILNY Prjsc Other Bank For Investments and Savings JSC Other Bank Grant JSC Other Bank Trust-Capital JSC Other Bank Ukrainian Capital JSC Other Bank Vostok PJSC Other BTA Bank JSC Other CB Accordbank PJSC Other CB Globus JSC Other CB Privatbank JSC State-owned Subsidiary of a Citibank JSC Citigroup Inc. USA foreign bank Clearing House JSC Other Cominbank JSC Other Cominvestbank JSC Other Subsidiary of a Credit Agricole Bank JSC Credit Agricole S.A. France foreign bank Subsidiary of a Credit Europe Credit Europe Bank JSC The Netherlands foreign bank Group N.V. Subsidiary of a Altınbaş Holding Creditwest Bank JSC Türkiye foreign bank Anonim Şirketi Krystal Bank JSC Other Subsidiary of a Deutsche Bank Dbu JSC Deutsche Bank AG Germany foreign bank EIB JSC Other First Investment Bank JSC Other FUIB JSC Other Idea Bank JSC Other IiB JSC Other Subsidiary of a ING Bank Ukraine JSC ING Bank N.V. The Netherlands foreign bank JSB Radabank JSC Other 106 Dealing with weak banks in FinSAC countries: progress and challenges ahead Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) JSB Ukrgasbank PJSC State-owned JSB Pivdenny Bank Pjsb Other JSCB Industrialbank PJSC Other Powszechna Kasa Oszczędności Bank Subsidiary of a Kredobank JSC Polski Spółka Poland foreign bank Akcyjna (General Savings Bank) Lviv JSCB Other Metabank JSC Other Motor-Bank JSC Other MTB Bank PJSC Other Okci Bank JSC Other Oschadbank JSC State-owned Subsidiary of a OTP Bank JSC OTP Bank Hungary foreign bank Subsidiary of a Piraeus Financial Piraeus Bank ICB JSC Greece foreign bank Holdings S.A. Policombank JSC Other Poltava-Bank JSC Other Subsidiary of a Intesa Sanpaolo Pravex Bank JSC Italy foreign bank S.p.A. Subsidiary of a ProCredit Holding Procredit Bank JSC Germany foreign bank AG Subsidiary of a Raiffeisen Bank Raiffeisen Bank JSC Austria foreign bank International AG RwS Bank JSC Other Skandinaviska Subsidiary of a SEB Corporate Bank JSC Enskilda Banken Sweden foreign bank AB (SEB) Sense Bank JSC State-owned Sky Bank JSC Other Tascombank JSC Other Ukrainian Bank for Reconstruction and Other Development JSC Ukreximbank JSC State-owned Subsidiary of a Ukrsibbank JSC BNP Paribas S.A. France foreign bank Unex Bank JSC Other Universal Bank JSC Other Source: FinSAC with information from banks 107 Dealing with weak banks in FinSAC countries: progress and challenges ahead Figure 29: Uzbekistan Parent of the Type of Parent’s home Bank foreign banking bank/ownership country group (if any) Agrobank State-owned Aloqa Bank State-owned Anor Bank Other Apex Bank Other Asaka Bank State-owned Asia Alliance Bank Other AVO Bank Other Business Development Bank State-owned Davr Bank Other Garant Bank Other Hamkorbank Other Hayot Bank Other Invest Finance Bank Other Ipak Yuli Bank Other Subsidiary of a Ipoteka-Bank OTP Bank Hungary foreign bank Subsidiary of a Saderat Bank Saderat Bank Iran foreign bank Kapital Bank Other Subsidiary of a Korean KDB Bank Uzbekistan South Korea foreign bank Development Bank Madad Invest Bank Other Mikrokreditbank State-owned National Bank of Uzbekistan State-owned Octobank Other Orient Finance bank Other People's Bank State-owned Poytakht Bank State-owned Smart Bank Other Subsidiary of a TBC Bank TBC Bank Georgia foreign bank Subsidiary of a Tenge Bank Halyk Bank Kazakhstan foreign bank Trust Bank Other Turon Bank State-owned Universal Bank Other Uzpromstroybank State-owned Uzum Bank Other Yangi Bank Other Subsidiary of a Ziraat Bank Uzbekistan Ziraat Bankasi A.Ş. Türkiye foreign bank Source: FinSAC with information from banks 108 Dealing with weak banks in FinSAC countries: progress and challenges ahead 109