# **Introduction**

Bank failures and banking crises are a common and costly phenomenon. For example, Caprio and Klingebiel (2000) found that from the late 1970s until 1999 there were at least 113 systemic crises in 93 countries (16 from Latin America and the Caribbean -LAC) and 50 non-systemic in 44 countries (4 from LAC). Bank failures often result in large costs and impose diverse risks that affect other banks and the stability and health of the financial system in general through contagion. Costs involved are varied, including fiscal expenditures as large as 40-60 percent of GDP in some cases,<sup>1</sup> deposit losses, and other less evident costs such as hampered access to finance and reduced trust in financial systems. This reduces the capacity of financial systems to enhance growth and reduce poverty. Among risks, contagion is particularly harmful as a bank failure may generate systemic effects (i.e. affecting one or several banks that account for a large share of the financial system). This is heightened in developing countries, where contagion can be more harmful and spread more easily given institutional weaknesses. In this context, theoretical and empirical evidence indicates that the manner in which bank failures are dealt with (or “resolved”), makes a large difference in terms of total costs, capacity to preserve banking business, coverage of deposits, and minimization of contagion.

Notwithstanding the importance of individual bank failures for policy making and implementation, the literature on bank resolution (BR), even when extensive, tends to focus on systemic failures.<sup>2</sup> This study complements existent literature by adopting **a non-systemic approach, while focusing on BR in practice** . Existing literature on BR was reviewed and integrated with the practical knowledge learned from World Bank operational and analytical work and direct experience executing and advising various BR processes in LAC.

The ultimate goal of the study is to develop a practical set of guidelines on how to design an adequate bank resolution framework (BRF) and how to implement an efficient bank resolution method (BRM) among available choices and within a given framework. The study is organized into six sections that deal with different BR issues and together aim to guide policy making and implementation. Section II describes six basic pillars required to build a BRF that will facilitate the implementation of efficient BRMs. Section III analyzes the main BRMs, delineating their advantages and disadvantages, describing the circumstances under which they tend to be most appropriate, and establishing efficiency requirements. Section IV looks into the good bank – bad bank (GB-BB) approach, as it is found to be one of the most efficient BRMs according to the specified criteria. This Section provides a description of the method, analyzes how it meets efficiency requirements defined, and offers practical tips for its implementation. Section V presents the GB-BB method in practice by illustrating with three examples different prevailing environment, banking institutions, ways to implement this BRM and results. Finally, Section VI presents some concluding remarks.

> 1 Examples include the following countries, with estimated costs as a percentage of GDP in parenthesis (Caprio and Klingebiel, 2000): Argentina (about 55 percent 1980-1982), Indonesia (50- 55 percent in 1999), China (net losses of 47 percent in 1999), Thailand (net losses of 42 percent in 1999), and Chile (42 percent).  These examples correspond largely to systemic crises. In general, average costs of BR are much lower than these examples, but still relevant. For instance, based on questionnaires to 19 deposit insurers, the International Association of Deposit Insurers (IADI 2005) found that in the last ten years the average BR cost as a percentage of GDP has been 5.5 percent.

> 2 See, for instance, Dziobek and Pazarbasioglu (1998); Lindgren et. al. (1999); Claessens, Klingebiel and Laeven (2001); and Hoggarth, Reidhill and Sinclair (2004).

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