Comparative Legal Study On The Resolution Of Problem Financial Institutions

Financial services are the core of the modern economy, and the soundness offinancial institutions is crucial to the economic stability. While the Asian financialcrisis 1997 was caused in part by weak financial sectors, the affected governmentshave expended enormous resources to promote financial stability.The total loss during the Great Depression and Savings & Loan crisis in USA,amounted to several hundred billion dollars. And the so called 'lost decade' in 1990sin Japan, can be directly attributed to one thousand billion non-performing bankingloans. Over the past three decades, financial crises have occurred with increasingfrequency in developing countries, warned the domestic governments must pay moreattention to the legal resolution of problem financial institutions, which relates withthe national economic safety and political stability.The accumulated financial risks in the Chinese financial institutions has beenheavyhearted problem, include several thousand billion yuan non-performing bankingloans, the broker-dealers are deep waist in the 'Comprehensive Treatment' since 2004,five round reconstruction of trust companies, and many bank-run scandals from cityand rural grass-roots credit unions. Obviously, the construction of a good legalresolution mechanism of problem financial institutions, relates not only to the survival of financial institutions, but also to the political and economic stability in China.The thesis starts from the relation between problem financial institutions underfinancial globalization and national financial stability, analyzes the causes of problemfinancial institutions, the responsible authorities, and the legal methods in theresolution, especially highlights the practical challenge confronted with exitmechanism of failed financial institutions, and the recent reform trends. Finally,chapter seven and eight devote on the analysis of Chinese current practice andintroduce reform proposals. The thesis includes eight chapters.Chapter one highlights the problem financial institutions under the financialglobalization. Financial deregulation encourages financial institutions to expand theirinvolvement in the securities and real estate market, and it also intensifies competitionbetween banks and nonbank financial intermediaries. As a result, financialliberalization typically increases the vulnerability of the financial system to suddencollapse in asset values. For these reasons, deregulation has been associated withboom-and-bust cycles and banking crises in many countries since the 1970s. Thechapter defines the concept of 'problem financial institutions', which includes notonly 'failed financial institutions', 'institutions in trouble, 'insolvent financialinstitutions', but the 'illegitimate financial institutions', which violate prudentialregulatory rules. Why the wider research object, because of the need to minimize oravoid losses to creditors, the legal resolution procedures must commence earlier andtherefore precede general bankruptcy proceedings. In some of these countries therewill exist special proceedings under the financial law, but in some countries, theUnited Kingdom for example, bank insolvencies are dealt with under the generalinsolvency law in a judicial process.Chapter two analyses the causes of problem financial institution and itsprevention. From the internal aspect, the causes of the institutional failures can bedivided into three categories: (1) those that result from financial fraud and insider abuse; (2) those that result from insufficient asset diversification; and (3) badmanagement and illegitimate operation. From the outside perspective, the causes ofthe institutional failures include (1) regulatory forbearance; (2) wrongfulgovernmental intervention. And the recent developments of prevention mechanismsinclude, effective prudential regulation, flexible enforcement mechanism includes notonly a consideration of formal remedial measures but also informal remedialmeasures, and the early warning system. To restrict the regulatory forbearance, thereis a interesting discussion of structured early intervention and resolution procedureswhich provide a system of mandatory graduated corrective measures. Structured earlyintervention and resolution make it mandatory for the regulatory authority to takeearly action which is mandatory and not subject to any discretion on the part of theregulator. Such a course of action is aimed at preventing regulators from acting toolate. For choosing the most efficient preventive actions, the cost-benefit analysismethod is helpful.Chapter three provides a detailed examination of the institutional framework forauthorities involved in resolution of problem financial institutions. The authorities canbe classified into two categories: administrative (regulatory) and judicial authority, theformer includes a long list, such as financial supervisory authority, central bank anddeposit protection agency. After a thorough comparison of advantages anddisadvantages of regulatory and judicial insolvency procedures, the conclusion istransferring certain judicial functions to an administrative authority may result inincreased efficiency. The chapter is concerned with the control of regulatory decisionsand considers such matters as administrative review and judicial control of actions ofthe financial regulator, examines the liability of the financial supervisory authority,and it has both the nature and legal basis of potential liability, including such mattersas possible exemption for policy decisions and who will have a cause of action.Chapter four is concerned with legal methods used in the course of resolution ofproblem financial institutions. Upon the initiation of a closure and insolvency procedure, the insolvent institution ceases to exist. If possible, the ongoing businessmay be maintained by regulatory taking control of the problem institution'smanagement and/or assets. Also the financial assistance, includes merge andacquisition, P& A, should be encouraged as preferable to a piecemeal liquidation,which can improve the financial condition directly. Restructuring through state aidmust be limited to exceptional situations where the failure of a institution present to arisk to the financial system as a whole.Chapter five deals with exit mechanism of problem financial institutions. Inpractice, the successful exit will be confronted with many difficulties, which arerooted in the political, economic, and legal traditions. And the core difficulty of exit isthe debt payment, which is closely relates to the governmental safety net. In essence,the safety net is the governmental bailouts of debt payment with the public resources.The different paths dealing with the debt payment, can be classified into explicit andimplicit government-run safety net, which represented by USA and Japanrespectively.Chapter six introduces the recent legal reform trends in exit mechanism. Firstly,as to the relation between the protection mechanism of financial services customersand governmental safety net, the author draws the following principal conclusionsfrom the USA and Japanese experience, include (1) deposit insurance, for all its flaws,is superior to the real-world alternative—implicit government protection of depositorsand discretionary regulatory intervention in bank distress, (2) a well-designed explicitdeposit insurance system that includes a credible bank closure policy is the startingpoint for the design of effective private alternatives to a government-run safety net,and (3) the trend toward greater institutionalization of the Japanese safetynet—culminating in recent legislation to address the financial crisis—reflects increasedpolitical competition and greater emphasis on legal as opposed to reputational systemsof economic ordering in that country. And the other legal reforms in exit policyinclude: emphasis of the expanding obligations of the principals of financial institutions, construction of insolvency risks distribution mechanism based on themarket orientation, and the formation of the substantial and procedural rulesconcerning the governmental bailouts.Chapter seven analyzes the exit of problem financial institutions in China fromthe policy and legal perspective. Based on the analysis of chapter five, Japanese'Financial Regulatory Cartel' framework introduced by the American scholars, alsocan be applied in China. The chapter concentrates on the recent case of governmentalbailout of 'Xinjiang Delong', a private financial holding company, and combines withthe past lessons from the governmental bailouts of problem banks, broker-dealers andtrust companies since 1995, and comes to the conclusion that the Chinese governmenthas provided unlimited guarantee on the debt payment implicitly.In the last chapter, the author proposes some legal and institutional reformsuggestions concerning the financial stability in China. Firstly, government mustmonitor the aggregated financial risks under financial globalization closely, andhighlight the early prevention. Secondly, government must abandon the traditionalbailout approach, the transparent ex ante ground rules for governmental intervention,are preferable to protections based on the noninstitutionalized reputation anddiscretionary intervention of financial regulators. Finally, the reform trend ofgovernmental bailout shall toward greater institutionalization of the Chinese safety netas a promising development reflecting significant changes in our country's politicaland legal structures. To minimize the negative impacts of TBTF policy, governmentmay take three steps to deal with large international financial groups in distress.