2-amc

The Role of the Asset Management EntityAn East Asian Perspective

David Cooke and Jason Foley

David Cooke is Director, Barents Group, USAJason Foley is Senior Associate, Barents Group, USA

2 A STUDY OF FINANCIAL MARKETS

SummaryEast Asias

1 financial systems are burdened with a

large volume of nonperforming assets (NPAs),2 in-

cluding nonperforming or past due loans and realestate and other assets pledged as collateral for loans.These assets impede the ability of financial institu-tions to serve the prudent intermediation needs oftheir communities. The faster such problems and theircauses are dealt with, the better. Experience has re-peatedly shown that delay usually makes resolutionprograms more complex and costly and slows eco-nomic recovery.

To resolve NPA problems and help restore thehealth and confidence of the financial sector, thecountries in East Asia have used one or more assetmanagement company (AMC) models. The mostcommon AMC model used centralizes this activityin a government agency. However, some countrieshave opted for a more decentralized approach in-volving the creation of several bank-based AMCs.Each model has its advantages and disadvantages,and there are no ironclad rules regarding which ap-proach to use in a given instance. In general, though,the more pervasive or systemic the problem or theless developed the business culture or legal infra-structure, the greater the need for coordination andfor emergency legal reforms or special powers toresolve NPAs or both. In such an environment, acentralized, government-based strategy may be themost effective. On the other hand, if a countrys NPAproblems are limited or concentrated and the gov-ernment can afford to take a gradual approach, abank-based AMC may be more appropriate. Butregardless of the approach taken, the following guid-ing principles are suggested for the creation and op-eration of AMCs:

Assess the scope, magnitude, and implica-tions of the NPA problem objectively and tho-roughly;

Develop and implement business plans for promptaction;

Recognize the need for and obtain objective ex-pert advice;

Select and coordinate the appropriate NPA reso-lution strategy and AMC model;

Establish clear goals and objectives for theAMC;

Promote the transparency and consistency ofthe AMCs operations;

Minimize potential conflicts of interest in theAMCs operations;

Provide the AMC with adequate operationalauthority;

Provide for objective oversight and governanceof the AMC;

Provide the AMC with adequate purchase andoperational funding;

Assess the need for and provide the AMC withspecial legal powers;

Organize the AMC to maximize its efficiencyand expertise;

Develop performance-based asset managementand recovery plans and principles;

Plan for the best use of private-sector assetmanagement;

Promptly evaluate and implement managementinformation systems;

Value assets carefully, consistently, and objec-tively;

Provide essential asset management in the in-terim; and

Support asset value enhancement decisions withcost-benefit analysis.

The severity of the NPA problem in East Asiaranges from significant to severe, perhaps even over-whelming. Some countries appear to be farther alongthan others in addressing their NPA problems, but,as noted below, all are still trying to cope with a dif-ficult and challenging task.

In Thailand, the government dealt promptly anddecisively with NPA problems in the finance com-panies, but has not done the same for the bankingsector, where NPA problems are still pervasive. The

3THE ROLE OF THE ASSET MANAGEMENT ENTITY: AN EAST ASIAN PERSPECTIVE

current government policy of encouraging state-owned and private banks to establish their ownAMCs appears overly optimistic and is likely to re-quire substantial government coordination and finan-cial support.

In Indonesia, the NPA problems appear to be themost severe by far, of all the countries surveyed.The sheer magnitude of the fiscal and political costof resolving the NPA problems requires drastic ac-tion and broad public support. Policies and proce-dures must be perceived as transparent, fair, and ef-fective. But in the current political environment, re-solving NPAs will be extremely difficult.

In Malaysia, the government promptly reducedNPA problems by transferring them to a centralized,government-run AMC. While it is still too early totell, the approach appears well coordinated and com-prehensive. The government plan allows banks toretain NPA levels of up to 10 percent. How this willaffect bank operations is not clear. Also, the sound-ness and enforceability of the governments policyof requiring banks to increase their loan growth to8 percent appear questionable. The potential impacton domestic lending and foreign investment of theAMCs extensive powers to unilaterally controldebtor obligations is not known. Another unknown isthe extent to which the AMCs plans to enhanceasset values will affect the development of amarket-based private sector.

The Korean government has achieved majorstrides in addressing the loan problems in the finan-cial sector. The government AMC faces an impor-tant challenge but is actively working to improve itsmanagement of distressed assets. At issue is thelegislative authority of the government AMC tomake working-capital advances to debtor compa-nies.

In the Philippines, problem assets are significantin extent but substantially less than in other EastAsian countries. The experience of the AMC in thePhilippines provides valuable insights into the impor-tance of operational independence.

IntroductionPurpose of the StudyThe past two decades have seen more than a hun-dred banking crises worldwide. Most problems in thefinancial sector culminate in high levels ofnonperforming assets (NPAs). To resolve their NPAproblems, countries have tried various bank restruc-turing and asset management strategies. Many coun-tries have set up, or are setting up, some type ofasset management company (AMC) to acquire,manage, and recover the NPAs of troubled or failedfinancial institutions (see Figure 1).

This study has four objectives: To review the impact of NPAs on East Asias

financial institutions and economies, To review potential strategies for resolving NPA

problems, To analyze AMCs in general and from an East

Asian perspective, and To propose guiding principles for the design and

operation of AMCs.The study gives a general overview of the reso-

lution strategies and operations of AMCs in seve-ral countries. (Further details are provided in Ap-pendixes 1 and 2.) It excludes specific policy rec-ommendations for East Asian governments. Infor-mation was gathered from professional experience,available published sources, and a limited number

Figure 1: Countries Where Asset ManagementCompanies Have Been Established orAre Being Contemplateda

a Shown as shaded areas on the map.Source: Barents Group, International Monetary Fund, and World Bank.


of meetings with government and private-sector of-ficials in Indonesia, Korea, Malaysia, Philippines,and Thailand.

3

Causes and Effects ofNonperforming Asset BuildupAs the Asian miracle brought high levels of capi-tal inflows to East Asia, the lack of developed capi-tal markets, coupled with an inexperienced finan-cial sector, resulted in many imprudent credit deci-sions. Often, loans were made at the direction orencouragement of governments, to promote indus-trial growth and macroeconomic goals. Prudentiallending standards and supervisory safeguards werelargely absent. Businesses became highly leveragedand vulnerable to market and economic setbacks.When local currencies were devalued, major com-panies could no longer service their foreigncurrencydenominated debt. The funding problemsof major companies led to a chain reaction through-out the economic food chain. Smaller companieslost their access to working capital. The credit fau-cet that had been so free-flowing was abruptlyturned off. Table 1 indicates the magnitude of thefinancial crisis in East Asia.

High levels of NPAs can severely affect an eco-nomy in several ways. Earning assets in the finan-cial sector decline even as operating expenses in-crease. Management and financial resources are di-verted to NPA problems and away from more pro-ductive uses. The illiquid nature of NPAs and loss ofdepositor and interbank confidence often give rise tofunding problems.

NPA problems can make banks very averse torisk capital in making new loans. Conversely, banks,hoping to increase their capital, may choose to takeon even riskier loans. Neither course of action isgood for business. The first results in a credit crunchthat slows the pace of economic recovery. Thesecond only worsens NPA problems. NPA prob-lems can also dramatically impede the efficiencyof property markets. Real estate properties tied up

Table 1: Magnitude of Financial Sector Crisis inEast Asia

Source: Appendix Table A2.1.

Country

Indonesia(1997 topresent)

Korea(1997 topresent)

Malaysia(1998 topresent)

Thailand(1997 topresent)

Type and Approach

Banking System (estimate at peak levels) 70% of loans (about 50% of gross domestic

product [GDP] in 1997) were nonperforming.Insolvent Banks 16 small banks were closed by the govern-

ment in 1997. 54 banks (constituting about one-fourth of

total banking assets) were government-controlled/-supervised as of year-end 1998.

38 banks were closed, 9 were recapitalized,and 7 were nationalized in March 1999.These institutions represented about one-fifthof bank deposits.

Banking System (estimate at peak levels) 35% of loans (about 35% of GDP in 1997)

were nonperforming.Insolvent Banks 5 small banks were closed, 2 large banks

were nationalized, and 7 banks wererecapitalized. These institutions representedmore than one-fourth of total banking assets.

18 out of 30 merchant banks were insolvent(merchant banking assets represented about5% of total banking assets).


were nonperforming.Insolvent Banks 10 financial institutions (representing about

one-eighth of total banking assets) receiveda RM6.2 billion injection.

Mergers among commercial banks, financecompanies, and merchant banks areencouraged by the government.


were nonperforming. Nonperforming loans(NPLs) for the largest domestic bank werereported to be as high as 84%.

Insolvent Banks 58 finance companies (representing about

one-eighth of total banking assets) weresuspended by the government.

Government intervened in 6 local commercialbanks and signed memorandums of under-standing with 4 others. These institutionsrepresented about one-third of total bankingassets.

as collateral to defaulted loans can create stagnantproperty markets with excess capacity. Finally, theunavoidable government costs of resolving systemicNPA problems can overwhelm fiscal budgets anddivert resources away from important governmentprograms.


THE ROLE OF BANK CREDITBefore the Asian financial crisis, the export boom inthe region created tremendous capital inflows thatwent largely to financial institutions, predominantlybanks. Capital markets were too new or too unde-veloped to absorb the funds directly. Thus, financialleverage provided by banks was used to promotefast-paced private-sector growth. Table 2 shows theratio of domestic credit growth to gross domesticproduct (GDP) growth. Much of this growth went tothe real estate sector, especially in Indonesia, Ma-laysia, and Thailand where 30 percent or more ofthe loan portfolios were in real estate credits.

THE ROLE OF BANKING REGULATION ANDSUPERVISIONIn a number of Asian countries, financial liberaliza-tion and inadequate licensing controls resulted in in-tense competition within the financial sector. Domes-tic banks had to compete against foreign banks, non-bank financial institutions, and newly chartered banks.Competition for business often leads to a relaxationof lending standards. The risk of asset deteriorationis even greater when, as was the case in most ofEast Asia, the financial sector does not have muchexperience in managing problem assets. In such anenvironment, it is vitally important to have in placean effective regulatory and supervisory frameworkthat promotes safe and sound banking practices. InEast Asia, such a framework did not exist beforeand during the economic boom. Regulators wereunprepared, and licensing controls, enforcement tools,

and accounting and lending procedures proved to beinadequate. Capital adequacy and loan classificationcriteria were not well established or enforced. Regu-latory standards for currency risk management, creditevaluation, and public financial disclosure were lack-ing. Easy access to credit, plus intense competitionfor loans and inadequate supervision, leads to assetquality deterioration.

MAGNITUDE OF NONPERFORMING LOANSAs Table 3 shows, financial institutions in East Asiawere, or continue to be, burdened with very high lev-els of nonperforming loans (NPLs).

4 As previously

noted, neither NPAs nor NPLs are uniformly de-fined. The US classifies as nonaccrual or nonper-forming all loans for which interest payments arepast due for at least 90 days. Possibly by using amore lenient definition of NPLs, several East Asiancountries appear to have underestimated the true lev-els of their NPLs. According to the central bank ofIndonesia, for example, NPLs for all commercialbanks stood at 20 percent as of March 1998. Thetable shows the estimated NPL levels and their per-centage as well as that of domestic credit to GDP,during the peak years of the crisis. As illustrated inthe table, the amount of leverage or bank credit in aneconomy will determine the real size of the NPLproblem and the ultimate cost of resolution.

NONPERFORMING ASSETS AND FISCAL COSTMany countries tend to put off acting on their NPAproblems partly because the cost of not addressingthem is less direct. However, when they do eventu-ally deal with such problems, the impact on statebudgets is extensive, as Table 4 shows. Moreover,given the estimated levels of nonperforming loans,some of these cost estimates are likely to rise.

5

FINANCIAL IMPACT OF NONPERFORMINGASSETSNPAs affect the financial condition of a bank in seve-ral ways. Banks must set aside loss provisions for

Table 2: Ratio of Growth in Domestic Credit to thePrivate Sector to GDP Growth, 19901997(percent)

GDP = gross domestic product.na = not available.Source: Calculations based on IMF figures.

Country 19901995 1996 1997

Indonesia 1.3 1.2 naKorea 1.1 1.3 1.4Malaysia 1.4 1.8 2.5Philippines 3.2 3.2 2.5Thailand 2.1 1.5 4.0


adversely classified loans.6 Even with more liberal

classification standards, most East Asian banks do notearn enough to charge for these provisions and wouldneed to substantially reduce their capital account. Re-ductions in capital can raise severe problems in com-plying with regulatory capital and lending limit regu-lations as well as in maintaining market confidence.

The more funds a bank needs to reserve for losses,the less its capital leverage to make new loans. Also,the quality and quantity of bank earnings suffer asassets become nonperforming. Net interest margins

7

shrink as a result of the loan interest income lost.Likewise, options to increase loan yields are limited

when NPA levels are high and the economy is understress. Good loans are hard to find and banks areunable or unwilling to make them. Some banks, des-perate to increase asset yield, resort to making higher-yielding but riskier loans. In general, however, banksmake fewer loans, resulting in a credit crunch. Netinterest margins typically are further squeezed byrising funding costs caused by a decline in public andinvestor confidence. Governments can help offsetrising funding costs by taking such actions as lower-ing reserve requirements or providing low-cost liquid-ity loans or deposit guarantees. The fiscal and mon-etary impact of such actions should, however, becarefully evaluated.

NONPERFORMING ASSETS AND THE CREDITMARKETTable 5 shows the impact of the financial crisis overthe past three years on the growth of loans in se-lected East Asian countries.

8 As might be expected,

the pace of loan growth slowed dramatically, reflectingthe economic turndown.

NONPERFORMING ASSETS AND THEPROPERTY SECTORFinancial institutions directed much of their lendingto real estate, helping inflate market prices. Now thatthe bubble has burst and asset values have declined,the existence of NPAs is causing continued difficul-

Table 3: Magnitude of NPLs

GDP = gross domestic product, NPL = nonperforming loan.a The government of Mexico has estimated the countrys peak NPL levels to be 13 percent, considering only past-due interest and not the balance of the loans. Aggregate peak NPL

levels are estimated to have been at least 50 percent.Source: Asiaweek, 8 January 1999; Emerging Markets Investor, November 1998; International Monetary Fund, International Financial Statistics, 1998; and Barents Groupexperience and interviews.

Peak Year % of Domestic % of NPLs to % of NPLsCountry of Crisis Credit to GDP Total Loans to GDP

Indonesia 1998 75 70 53Korea 1998 100 35 35Malaysia 1998 140 30 42Philippines 1998 30 15 5Thailand 1998 140 50 70Mexicoa 1995 30 >50 >15Sweden 1992 60 11 7United States 1992 60 3 2

Table 4: Estimated Amount and Annual Interest Costof Government Debt Issued to Pay forBank Restructuring, as of December 1998

Source: International Monetary Fund, World Economic Outlook and InternationalCapital Markets, December 1998.

In Local Approximate % ofCountry Currency US$ Equivalent GDP

AmountIndonesia Rp300 trillion 70 billion 29Korea W74.7 trillion 60 billion 18Malaysia RM48.4 billion 13 billion 18Philippines P100 billion 3 billion 4Thailand B1.6 trillion 43 billion 32

Annual Interest CostIndonesia Rp40 trillion 5.4 billion 3.5Korea W8 trillion 6.4 billion 2.0Malaysia RM3.5 billion 0.9 billion 1.3Philippines P11.9 billion 0.3 billion 0.5Thailand B143 billion 4.0 billion 3.0


and the capacity of the banking sector before relyingon it to work its way out of the situation. Otherwise,if the banking sector lacks the required capacity andparticularly if the NPA problem is severe, the prob-lem could only get worse, and could even put thecountrys political, social, and economic infrastruc-ture at risk. Programs that effectively resolve sys-temic NPA problems must be implemented promptlyand comprehensively.

Programs to ResolveNonperforming AssetProblemsResolving problems in the financial sector involvessetting priorities and making difficult decisions. Theprocess is usually painful and there are no easychoices. Also, goals and objectives tend to change inpriority at various stages in a financial crisis. Thissection will discuss how these goals and prioritieschange and describe the NPA resolution programsmost often used worldwide. Finally, the resolutionstrategies used by selected countries will be re-viewed.

Resolution Goals and PrioritiesResolution goals and priorities tend to depend on thenature and magnitude of the crisis as well as a widerange of political, social, and economic factors. Priori-ties usually change over time and objectives may con-flict, resulting in trade-offs and compromises. In theearly stages of a systemic crisis, primary emphasis is

Table 5: Growth of Loans, 19961998 (percentagechange over previous year)

( ) = negative values are enclosed in parentheses, na = not available.a Annualized estimates.Source: Central banks.

Item 1996 1997 1998

IndonesiaCommercial banksa 24 26 12)

KoreaDeposit money banks 16 13 (1.5)Other financial institutions 22 15 (20)

MalaysiaCommercial banks 25 27 5)Finance companies na 24 (15)

ThailandCommercial banks 14 25 (10)Finance companies 14 (64) na)

Table 6: Vacancy Rates, Capital Values, and Rents in East Asia

( ) = negative values are enclosed in parentheses, na = not available.Source: Estimates based on charts from Jones Lang LaSalle.

Office Vacancy Rates (%) Percentage Change, 19951998

Item 1995 1998 Capital Value Rent

Bangkok, Thailand 21 30 (45) (32)Jakarta, Indonesia 9 23 (67) (42)Kuala Lumpur, Malaysia 4 15 (22) (30)Manila (Makati), Philippines 1 8 (13) 3)Seoul, Korea na na (8) (4)

ties in the property sector. As Table 6 shows, va-cancy rates are increasing while capital values andrents are falling in East Asian economies.

NPA problems affect the property sector by leav-ing banks and other financial institutions with a largeinventory of existing or potential foreclosed real es-tate. Banks are likely to be reluctant to sell theseproperties aggressively to avoid additional losses.Investors, on the other hand, become unwilling tobuy as long as a large property inventory remainsbecause of the potential impact on pricing. The re-sult is an inefficient market, a sluggish real estatesector, and a delayed recovery.

When faced with growing levels of NPAs, gov-ernments tend to look to the financial sector for rem-edies rather than commit government resources.However, this strategy often backfires. Governmentsmust fully understand both the scope of the problem


given to preventing the collapse of the financial sys-tem from causing an economic meltdown. Becausea financial system simply cannot function without con-fidence, depositors and investors must be reassuredthat there is no need for panic. Without such confi-dence, there can be no payment system, no safe ha-ven for depositors, and no reliable source of credit toenterprises and individuals.

Governments typically resort to measures suchas providing depositors (and often creditors) with fullguarantees and assuring sufficient liquidity for banksto meet depositor demands for funds. Priority is of-ten given to providing financial assistance to preventbank failuresand the bigger a bank is, the morelikely that the government will not let it fail. Minimiz-ing adverse effects on employment and making creditmore accessible to enterprises are also importantconsiderations.

Fiscal considerations are typically assigned a highpriority in resolution strategies. Policies are there-fore likely to favor bank assistance programs. Butgovernment officials, with their limited time and re-sources, often tend to rely on overly optimistic as-sumptions. Bankers, as might be expected, almostalways estimate the cost of rehabilitating their bankto be less costly than a liquidation or government-assisted sale to third-party investors.

Other considerations may influence policy. Forexample, there may be a strong reluctance to nation-alize the banking system because of concerns thatgovernment-run banks would disrupt market-basedbanking. This concern is understandable since gov-ernment-run banks in a number of countries havebeen used to fund political initiatives rather thanprivate-sector needs, and banking services, skills, andregulation have deteriorated. However, not all coun-tries are so averse to the temporary nationaliza-tion of troubled banks as part of bank bailout pro-grams. The success of such actions will likely de-pend on the extent of the governments operatingcontrol and the length of time controlling ownershipis maintained. In general, less is better.

Still another factor that affects a resolution strat-egy is an inherent preference or requirement to re-tain domestic ownership and control of the bankingsystem. Governments often rely on their bankingsystems to finance projects that would otherwiserequire fiscal budget allocation. Domestic ownershipcan also be a politically sensitive issue fueled by con-cerns that a country is selling out to foreigners. Lastbut not least, domestically owned banks are likely toresist increased competition from foreign banks. Suchconcerns are also likely to favor bank assistance strat-egies over assisted but involuntary sales to new in-vestors. However, such preferences usually conflictwith, and eventually give way to, the greater need tofind strategic capital investors.

In a crisis, avoiding the risk of moral hazard, im-posing market discipline, and even ensuring opera-tional fairness and transparency are usually lower-priority objectives. This is not to say that countriesare indifferent, as many countries have attempted todesign programs that address such issues. Nonethe-less, saving the system is the highest and most ur-gent priority, and compromises may have to be madewhere other objectives are concerned.

As a financial crisis and the risk of an economicfree fall subside and the banking system stabilizes,priorities typically change. Governments now havemore time and experience to evaluate their actions,and the risks are also lower. The public also has moretime to assess the actions taken. The fiscal, social,and political implications of the governments deci-sions are likely to be scrutinized very closely, andcan often become very contentious. Governmentpolicies often shift from saving banks to resolvingnonviable banks through greater use of interventions,involuntary mergers, or liquidations.

No matter which goals a government choosesto prioritize, the NPA resolution program must im-prove the overall health of the banking system andthus promote economic development. Experiencehas shown that there is no panacea or single solu-tion for all problems. Each crisis is different, and


resolution strategies should reflect each countrysunique environment. Several programs have beenused in the past by governments facing systemicbanking crises.

Nonperforming Asset ResolutionProgramsA government typically takes one of three ap-proaches to solving a banks NPA problems, depend-ing on their severity: (i) assist the bank, (ii) assist thedebtor, or (iii) intervene and take over the manage-ment of the banks assets. Each program affects theway in which NPAs are valued and serviced. Thefirst two approaches tend to interfere much less thanthe third in the way that banks and debtors operate.Generally, the government intervenes when it per-ceives a banks NPA problem to have become toounmanageable for the institution. In this case, agovernment-sponsored AMC is often established.The more directly the government involves itself inmanaging NPAs, the greater the likelihood that po-litical concerns may diminish the efficiency of op-erations. However, governments are often better ableto focus effectively on issues of fairness, transpar-ency, and competitiveness.

In the next section, three basic approaches to re-solving NPA problems will be presented as a gen-eral overview, with several examples from Asia,Mexico, Sweden, and US. Further information canbe found in the appendices.

Bank Assistance ProgramsIn a bank assistance program the government facili-tates the rehabilitation of a troubled bank. The assis-tance takes the form of regulatory forbearance orfinancial assistance, which may include the acquisi-tion of nonperforming loans and assets.

REGULATORY FORBEARANCERegulatory forbearance occurs when the governmenteases regulatory rules to allow troubled banks to con-tinue operating. Forbearance is a hold strategy used

when the government believes that problems can beresolved without making a financial commitment. Ittypically includes relaxing or waiving either or bothregulations and accounting rules. The most commonexamples of regulatory forbearance concern centralbank reserve requirements or prudential standardssuch as loan concentration limitations, minimum capi-tal requirements, loan classification, and loan-lossprovisioning. Accounting rules are relaxed whenbanks are allowed to defer loss recognition, for ex-ample, or to accrue unearned loan income or recordintangible assets.

Many governments have resorted to some typeof forbearance but with mixed success. In manycases, the problems have worsened, raising criticismsthat the government did not act forcefully enough.Success is largely influenced by macroeconomic fac-tors such as the strength of the economy. However,it also depends heavily on bank management. Expe-rience has repeatedly shown that bank managersoften find it hard to objectively assess the scope oftheir problems and react suitably. Also, managersdesperate to salvage a sinking ship may worsen mat-ters by taking on greater risks in an effort to improveearnings. Successful forbearance programs must in-clude realistic operational targets for banks, a pro-cess for actively monitoring progress, and, if neces-sary, a credible contingency plan.

In Korea, the government relaxed the provision-ing requirements for NPAs and for losses on bankssecurities portfolios between 1995 and 1996. In Ma-laysia, the government carried out capital controls inSeptember 1998, while progressively lowering statu-tory reserve requirements. It also relaxed restric-tions on lending to the property and equity sectors.The Philippine government, in 1983, granted banksregulatory forbearance with respect to the require-ment to maintain reserves against their bad loans.As was the case in the US, these East Asian at-tempts generally led to a further deterioration of bank-ing assets. Very rarely does regulatory forbearanceachieve the desired effect.


FINANCIAL ASSISTANCEIn addition to, or in lieu of, a forbearance strategy, anumber of governments have provided financial as-sistance to troubled banks. Most governments,through their central banks, provide short-termliquidity assistance. In Malaysia, for example, the gov-ernment recently injected about US$1 billion into ninebanking institutions in return for equity shares. Usu-ally but not always, liquidity loans are provided on ashort-term, fully secured basis, with little, if any, im-pact on the fiscal budget. A number of countries havealso provided longer-term capital assistance, often inthe form of debentures that may be convertible to asubstantial equity interest in the bank. In many cases,assistance is provided to facilitate the merger of thetroubled bank with a healthier bank. Such assistancetypically involves earnings guarantees, asset loss pro-tection, or the removal of distressed assets.

While providing financial assistance is a commonpractice in systemic crises, it is not without its crit-ics. A common complaint is that financial assistancegives rise to moral hazard by protecting bad bankmanagers and owners against the consequences oftheir actions. Financial assistance transactions typi-cally raise fairness questions about how banks wereselected for assistance. In Indonesia, for example,the governments apparent decision to assist a majorbank immediately stirred public concerns about po-litical influence. Competing banks also complain thatassisted banks enjoy favorable regulatory treatment,particularly in the case of banks where the govern-ment retains a significant ownership interest. In Swe-den, for example, bankers complained bitterly thatalmost all assistance benefited a state-owned bankthat used its government ownership and support tocapture market share from private bankers.

Complaints against assistance largely depend onwho gets it and how and when any ownership inter-ests are sold. If the assistance is made to facilitateacquisition by a qualified and healthy bank in a com-petitive sale transaction, criticism is likely to be littleand short-lived. The faster the privatization, the bet-

ter for market-based competition. The stronger andmore independent the acquiring bank, the lower therisk of moral hazard. On the other hand, if assis-tance is given to merge one weak bank into another,the result can be a bigger problem, not a better bank,as a number of countries have found. In a systemiccrisis, however, willing strategic investors can beimpossible to find, for financial as well as politicalreasons. Domestic banks, fearful of competition, tendto oppose the assisted sale of troubled banks to for-eign competitors. Still, several East Asian govern-ments have moved to help contain losses and attractnew strategic investors by reducing barriers to for-eign entry. In the end, governments may see no otheroption than to assist in the consolidation of banks inthe hope of improving efficiency and performance.While this course of action may not be the best, itmay well be inevitable.

NONPERFORMING ASSET ACQUISITIONFinancial assistance, as noted previously, often in-volves the removal of NPAs. Healthy banks usuallydo not want to take over another banks NPAs be-cause of the substantial risk and managerial effortinvolved. They want reassurance that the risks aremeasurable and small. Also, healthy banks are oftenreluctant to manage bad assets because of the drainon human resources as well as the potential distrac-tions from new business development. Trying to sellassets to unwilling bankers can therefore prove tobe an extremely long and often unsuccessful effort.The healthier the acquiring banks, the greater theloss guarantees are likely to be. Rather than sell as-sets at what are considered to be fire-sale prices,governments often replace these assets with cash orbonds. The bad assets are then either left with themanagement of the acquiring bank or moved to anAMC, an entity established to acquire, manage, andrecover the nonperforming assets of troubled or failedfinancial institutions. In Korea, for example, the gov-ernment encouraged some banks to take oversmaller insolvent institutions, including some of their


problem assets, at fair transfer prices. In other cases,the government persuaded strategic foreign inves-tors to acquire larger banks in return for its promiseto purchase NPAs of merged banks and supply fundsfor recapitalization.

Debtor Assistance ProgramsAnother bank resolution program involves govern-ment assistance to borrowers in meeting their debtobligations. A number of governments facilitate ormediate debt restructuring negotiations. Others pro-vide direct financial assistance. Some countries haveestablished corporate debt restructuring agencies(CDRAs) to encourage voluntary meetings betweencreditors and debtors, and to oversee an indepen-dent assessment of a companys viability and worth.Other countries have established debtor assistanceprograms to ease the burden of decreased employ-ment, rising interest rates, or devalued currencies.In a systemic crisis, such programs tend to be verypopular politically and can be as necessary as bankassistance programs. On the other hand, they arenot without risk. Assistance may be given inconsis-tently or unfairly. The programs can raise moralhazard and undermine a payment culture if not prop-erly managed.

A number of East Asian countries have estab-lished CDRAs to encourage voluntary meetings be-tween creditors and debtors. Table 7 lists severalEast Asian governments that have adopted a CDRAstrategy. More details on debt restructuring can befound in Appendix Table A2.3.

Bank Intervention ProgramsIn resolving banking problems, governments oftendecide that the best course of action is to interveneand take control of a troubled bank, at least tempo-rarily. This approach may be used when a bank isconsidered so insolvent or so complex that assistanceis not a viable option. In general, intervention takesone of three forms, depending on the intended objec-tive: formal intervention, informal intervention, orclosed bank liquidation.

FORMAL INTERVENTIONFormal intervention typically refers to official govern-ment control of a bank and its operations until a per-manent solution can be found. The bank may be placedunder conservatorship, wherein new management isbrought in to run the bank, or a limited-life, special-purpose bridge bank may be created to take overthe operations, deposits, and assets of the failing

Table 7: East Asian Government Participation in Corporate Debt Restructuring, as of August 1999

na = not available.Source: Corporate debt restructuring agencies.

Total Book No. of CompaniesNo. of Value of Restructured

Business Applicants (book value ofCountry Corporate Debt Restructuring Agency Applications Debt restructured debt)

Indonesia (1998) Indonesian Debt Restructuring Agency 4 na na(INDRA) Jakarta Initiative 251 US$23 billion 24

(US$3 billion)

Korea (1998) Corporate Restructuring Committee 102 na 80(US$28 billion)

Malaysia (1998) Corporate Debt Restructuring Committee 62 US$9 billion 13(US$2 billion)

Philippines (1982) Securities and Exchange Commission 35 na 3na

Thailand (1998) Corporate Debt Restructuring Advisory Committee 689 US$37 billion 340 agreed(US$20 billion)

52 actual(US$3 billion)


private bank. The government-controlled bank con-tinues to provide essential banking services but usu-ally under strict operational guidelines. The basic ob-jective is to rehabilitate and then privatize the bank.Shareholders and other subordinated claims are usu-ally paid only in the unlikely event that funds are leftover after the final resolution and repayment of gov-ernment funds. As may occur in an open bank merger,NPAs are normally carved out to facilitate privatiz-ation and placed under separate asset management.

In Japan, the government has partially relied onthis strategy to resolve its banking crisis. If a take-over candidate for an insolvent bank cannot be foundwithin a reasonable period of time, the governmentassumes control of the banks operations by estab-lishing a bridge bank. If no recipient bank is foundwithin a given period to purchase the failed bank, itwill be placed under liquidation.

One danger of this strategy is that the govern-ment may not be able to reprivatize the bank within areasonable time frame, essentially nationalizing thebank and directing more credits. In Indonesia, forexample, the government recently took over theoperations of seven banks without clearly articulat-ing its plans for their privatization.

INFORMAL OR DE FACTO INTERVENTIONAn informal intervention is one where, rather thantake official control of a troubled bank, the govern-ment works with the owners to find a solution totheir problems. Typically, as has occurred in Mexico,this involves appointing a de facto intervenor to over-see bank operations. Selected members of seniormanagement may be replaced and the authority ofthe banks board of directors is effectively eliminated.The purpose of de facto intervention is the same asthat of formal intervention. However, the processtends to be less disruptive to ongoing operations andpublic perceptions than formal intervention, althoughit also appears less transparent and may raise fair-ness concerns. The informal approach works bestfor banks with a significant underlying business value

which would be lost in a formal takeover. Thus, theprocess requires the ability to objectively identify suchinstitutions as well as gain public acceptance.

BANK CLOSURE AND LIQUIDATIONA third intervention option is to close and liquidate abank. This option is most appropriate for insolventbanks that have little intangible value or that presentconsiderable risk if they are not closed, as would bethe case if a bank had potential litigations or obliga-tions that could mean large losses. Bank liquidationsmay be handled through purchase and assumption(P&A) transactions that look very similar to merg-ers between good banks except that the purchasersdo not take on potential liability for any contestedactions against the closed bank. In P&As, healthybanks agree to assume the deposits and other liabili-ties of a failed bank in return for its good assets andcash or notes from the government. As in an openbank merger, healthy banks are normally not inter-ested in taking over distressed assets, even at heavilydiscounted prices. The bad assets are left behind tobe resolved in liquidation or bankruptcy. Alternatively,if a P&A cannot be arranged, both good and badassets would be assigned to an AMC.

This option is typically not viable if a country lacksthe fiscal resources and the adequate legal and op-erational infrastructure to carry out the costly andcomplicated intervention. The laws of many coun-tries restrict bank regulators from closing banks.Countries have used this approach with small banks,but very rarely with large banks as such an actioncould precipitate a bank run. In general, banks shouldbe liquidated only as part of a comprehensive resolu-tion strategy. The World Bank comments:

A strictly market-based approach to failedbanks would call for their liquidation. Indeed,this is the best solution for isolated, small bankfailures: clean surgery is often less messy thanslow medicine. But where large banks suffer froma lack of public confidence and large segmentsof the banking system are insolvent, liquidation


only masks the problem. If banking fragility is asymptom of economy-wide problems, liquidationalone is neither practical nor useful. The reso-lution of systemic bank problems therefore mustbe part of an overall strategy to restructure andreform fundamental inefficiencies in theeconomy.

9

COUNTRY-SPECIFIC RESOLUTION PROGRAMSTable 8 highlights the bank resolution programsknown to be employed in some selected countries.

The Asset ManagementCompanyOver the past decade, unprecedented levels of NPAshave plagued the financial systems of many coun-tries. In virtually all cases, governments have inter-vened to create, or assist in the creation of, AMCsto manage the resolution of problem assets. One ofthe first government AMCs was the Federal De-posit Insurance Corporation (FDIC) in the UnitedStates, created nearly 70 years ago to insure depos-its. Faced with failures to a degree never before ex-

perienced, the US Congress decided to centralizethe liquidation of bank assets in FDIC rather thanleave the process to separate court-administeredbankruptcy procedures. Also, during the 1990s, othercountries such as Mexico and Sweden establishedmajor government-owned AMCs. Several countriesin East Asia have similarly set up AMCs to managedistressed or nonperforming assets.

The rest of the chapter will focus on government-assisted and government-supervised AMCs. First,the objectives of an AMC and the timing of its es-tablishment will be discussed. Next, three basicAMC models and their specific characteristics, plusspecific examples, will be analyzed. Finally, best-practice guidelines for designing and operating anAMC will be proposed.

Objectives and ConflictsAMCs are established to acquire, manage, and re-cover illiquid or nonperforming assets from financialinstitutions. Relieving banks of the burden of NPAsshould allow them to focus better on financing thedevelopment of new business opportunities thatstrengthen the economy. The transfer should help

Table 8: Country Resolution Programs

NPA = nonperforming asset.Source: Barents Group, International Monetary Fund, and World Bank.

Regulatory Financial NPA Debtor Bridge/BankCountry Forbearance Assistance Acquisition Assistance Conserv. Liquidation

Chile x x x x x xChina, Peoples Republic of x x xHungary x xIndonesia x x x x x xJapan x x x x x xKorea x x x x x xMalaysia x x x x xMexico x x x x x xPhilippines x x x x x xPoland x xSpain x x x x xSweden x x xThailand x x x x xUnited States x x x x


restore depositor and investor confidence and reducethe threat of market disruptions. AMCs should maxi-mize recovery value while minimizing costs. Theycan also help build industry expertise in loan resolu-tion, besides serving as a catalyst for important legalreforms in bankruptcy procedures and loan collec-tion, as was the case in Thailand. AMCs can play animportant role in developing capital markets throughsecondary asset instruments, as they are doing inKorea.

AMCs may obtain NPAs in negotiated transac-tions with banks, usually as part of a bank assistanceprogram or as a result of bank interventions. Theprimary objective of creating them depends on onesviewpoint. The government is usually concerned withmaintaining financial stability and stimulating eco-nomic recovery, while troubled banks are most con-cerned with survival. Typically, governments wantto rehabilitate the financial sector while keeping fis-cal costs and the risk of moral hazard to a minimum.Reconciling these twin objectives can be very chal-lenging.

Almost without exception, troubled banks wantgovernment assistance but with few or no stringsattached. They see AMCs as an important alterna-tive for removing or reducing their NPA burden, butthey want to obtain as high a price as possible for theNPAs to avoid further charges to their capital ac-count. Eventually, banks may voluntarily sell theirassets at a price they consider less than fair becausethe government or the marketplace requires them tobring their distressed assets down to a manageablelevel. However, the sale process often involveslengthy negotiations between the banks and the AMCwhich unfortunately delay the proper servicing of theNPAs during the interim.

Timing of IntroductionIt is generally agreed that at some point NPAs canbecome such a serious drag on the ability of a bank-ing system to serve its economy that the most prac-tical solution would be to remove them and place

them in an AMC. However, there is disagreementon what that point is, or when it is reached. Severalsigns, however, indicate the need for action. One in-dicator is the level of NPAs held by financial institu-tions. (However, the level of manageability dependson the complexity and composition of the NPAs aswell as the economic, financial, and political environ-ment.) Another indicator of severity is eroding con-fidence, as evidenced by deposit outflows or declin-ing stock values. Clearly, a country needs to moveswiftly and aggressively to restore confidence whenthis occurs.

Still another indicator of severity is the inability orunwillingness of banks to make new loans, creatinga credit crunch that worsens an economys decline.A further indicator is a sharp decline in formerly ro-bust real estate markets, evidenced by increasingforeclosures, falling rents and values, and a growinginventory of unsold properties.

Few countries have demonstrated the political,economic, and social will to establish an AMC be-fore the problem reaches crisis proportions. None-theless, the earlier the NPA problems can be resolved,the sooner the banking sector can contribute to thesustained economic recovery of the country.

Asset Management CompanyModelsThe term asset management company (AMC) isused here to refer to any organizational unit cre-ated to manage and recover financial assets ac-quired from troubled or failed financial institutions.Such entities include asset workout departments orunits of banks, bank-owned subsidiaries or affiliatedcompanies, private companies, and government-owned asset management agencies. The severityor systemic nature of a countrys NPA problemusually dictates the NPA resolution strategy andthe parameters for judging its success. A countrysinstitutional, legal, and market conditions also influ-ence the decision. Typically, the primary goal is tomaximize net present value recovery in order to


minimize losses to either the selling bank or thegovernment, depending on the AMC model used.Government-based AMCs may have additionalchallenges such as minimizing adverse market im-pact from the asset recovery process or helping torehabilitate troubled banks and distressed borrow-ers. Objectives intended to promote economic andpolitical stability can create conflicts within AMCoperations and need to be prioritized.

For example, banks are likely to oppose AMCprograms to sell assets rapidly at substantial dis-counts, out of concern over the implications on thevalue or management of their own assets. Theyusually argue that values will be driven down un-necessarily and at substantial cost to the govern-ment and the banking industry. In Mexico, despiteencouraging results from the pilot program, innova-tive campaigns to sell assets in equity participationtransactions with private-sector asset managerswere put on hold because of criticism from thebanking sector. In the US, industry concern playedan important role in legislation designed to preventsavings and loan assets from being sold below fairvalue. Within a few months, the US decided to relyprimarily on competitive marketing to maximize re-coveries, rather than trying to maximize asset val-ues by actively managing assets.

10 Success for the

US was measured not only by how far costs werekept to a minimum but also by how fast distressedassets were returned to private ownership. The pre-vailing view was that the sooner assets were sold,the faster the necessary market repricing and effi-ciencies would occur.

However, the relative size of the problem and themarkets undoubtedly influence such strategies. InSweden, for example, where NPA problems repre-sented a much more significant part of the economy,greater emphasis was placed on maximizing valuethan on carrying out reprivatization. In Indonesia,Korea, Malaysia, and Thailand, the governmentAMCs are attempting to maximize value by activelymanaging assets.

In general, most bank resolution programs involveremoving NPAs from normal bank operations. Usu-ally, one of two basic AMC modelsa bank-basedmodel or a government-based modelis used. Inthe bank-based model, NPAs are transferred to aspecialized bank department or workout unit or toa separate special-purpose organization affiliated withthe bad bank. In the government-based model, onthe other hand, a government-sponsored agency iscreated to acquire and resolve the bad assets. Manycountries have established one or more of these struc-tures to deal with their problem loans. The variousapproaches used in selected countries are listed inTable 9.

The AMC models used in these countries varyin their degree of centralization. Sweden and the

Table 9: Asset Management Company ModelsUsed in Selected Countries

Source: Barents Group, International Monetary Fund, and World Bank.

Date Workout Bad GovernmentCountry Established Unit Bank Entity

Australia 1990 xChina, Peoples

Republic of 1999 xChile 1983 xCzech Republic 1991 x xFinland 1991 xGhana 1989 xHungary 1993 xIndia 1999 xIndonesia 1998 xJapan 1999 xKazakhstan 1995 xKorea 1998 xLithuania 1996 xMalaysia 1998 xMexico 1994 x xMoldova 1995 xNorway 1991 xPhilippines 1984 xPoland 1993 xSlovak Republic 1991 x xSlovenia 1993 x xSpain 1980 xSweden 1991 xThailand 1998 x xUnited States 1989 xVenezuela 1994 x


United States are two developed nations that aredeemed to have succeeded in working out their NPAproblems. The US set up a government agency tomanage the asset resolution process. Sweden useda somewhat more decentralized bank-based modelcoupled with close government oversight. Othercountries such as Mexico and Poland have reliedmore extensively on decentralized bank-based AMCmodels. Table 10 indicates the AMC type and ap-proach used in selected East Asian countries.

Broadly speaking, a number of factors should beconsidered when deciding what benefits each AMCmodel brings and what issues it raises, and whichmodel is therefore most appropriate (Table 11).

BANK-BASED ASSET MANAGEMENTCOMPANYThere are two bank-based AMC approaches: work-out units and bad banks. In the case of workout units,the NPAs are moved to a separate bank departmentbut remain in the banks books. In the case of a badbank, the NPAs are transferred to a separate affili-ated organization that specializes in managing badassets. The assets are no longer reflected in thebanks books, at least not on a nonconsolidated ba-sis. Consolidation would likely occur for the bank orits parent company where a controlling interest inthe bad bank is retained. The creation of bank-basedAMCs may or may not involve some governmentfinancial assistance.

The bank-based approach offers several poten-tial benefits: (i) use of in-house experience and knowl-edge about the NPA, (ii) maintenance of importantbanking relationships, (iii) strengthening of expertisein the resolution of bank NPAs, and (iv) establish-ment of new business relationships with new inves-tors involved in asset workouts. Another very im-portant consideration is that a bank-based AMC islikely to have more operational flexibility than a gov-ernment entity. This flexibility can be particularlyvaluable in retaining qualified personnel and in struc-turing transactions.

Table 10: Asset Management Company Type andApproach Used by Selected East AsianCountries

a RAB was initially created to manage the quality assets of the failed financecompanies, leaving the bad assets to the AMC. In January 1998, however, thegovernment announced that the RAB would no longer serve in this capacity, butwould instead act as a commercial bank.

b In September 1999, the government announced that Krung Thai Bank would transfersome of its NPAs to the central bank for management and disposition.

Source: Appendix Table A2.1.

Country

Indonesia(1997 topresent)

Korea(1997 topresent)

Malaysia(1998 topresent)

Thailand(1997 topresent)

Type and Approach

Type Indonesian Bank Restructuring Agency

(IBRA) restructuring agencyApproach Centralized approach IBRA has two main functions: to supervise

banks in need of restructuring and to managethe assets it acquires in the bank restructur-ing process through its asset managementunit

Type Korea Asset Management Corporation

(KAMCO) restructuring agencyApproach Centralized approach; special-purpose

vehicle for the management and dispositionof banking system nonperforming assets(NPAs)

Type Danaharta restructuring agencyApproach Centralized approach; special-purpose

vehicle for the management and dispositionof banking system NPAs

Type Financial Sector Restructuring Authority

(FRA) rapid disposition agency Asset Management Corporation (AMC)

restructuring agency Radhanasin Bank (RAB)a restructuring

agency Bank-Based Asset Management Company

(BBAMC) Central Bank Asset Managementb

Approach FRA centralized approach; two main

functions: evaluate finance companiesrehabilitation plans and sell their assets

AMC centralized approach; bidder of lastresort for FRAs bad assets

RAB centralized approach; bidder for FRAsgood assets

BBAMCs decentralized approach forcommercial banks (private and state),including the transfer of Krung Thai BanksNPAs to the central bank


However, while bank-based AMCs may havesome benefits, they are not without operational prob-lems. Because of their decentralized nature, bank-based asset recovery strategies may conflict witheach other. While competition may benefit investors,there is a greater risk that the lack of coordinationwill result in lower recovery values. Where govern-ment funds are involved, some level of coordinationis desirable to protect the public interest. Therefore,the greater the level of government support and thenumber of bank-based AMCs, the more persuasivethe argument for government coordination. At somepoint, a centralized AMC would appear to be themost practical approach.

The bad-bank AMC approach may also lead toconflicts and a lack of objectivity within the bank. Bankmanagement or loan officers may unduly influencethe asset management and disposition process. Con-versely, the AMC may attempt to influence its recov-ery rate by persuading the originating bank to buy backrestructured but substandard loans. Also, the decen-tralized AMC provides greater opportunity for fraudand outside influence, particularly for larger credits.

Another consideration concerns the legal envi-ronment, particularly asset sales, collateral, andbankruptcy laws. If the legal environment is mark-edly unfriendly to lenders, governments may opt topush for necessary legal reforms. However, theprocess can be lengthy and controversial. More-over, the AMC may have to be given special pow-

Table 11: Asset Management Company Models

Source: Barents Group.

Bank-Based Government-BasedItem Workout Unit Bad Bank Centralized

ConsiderationExtent of industry problems Limited Concentrated SystemicNeed for government funding None Limited SignificantNeed for legal reform Low Medium HighNeed for special legal powers Low Low/Medium Medium/High

Potential Benefits and IssuesSynergies with originating bank High Moderate to High LowConflicts with originating bank High Moderate to High LowIndustry-wide coordination Low Low High

ers that exceed what is normally advisable. In theUS for example, the Resolution Trust Corporation(RTC) was authorized to override state laws andset aside burdensome contracts. In Malaysia, thegovernment provided its AMC with extensive au-thority to circumvent existing bankruptcy laws.While such powers may be beneficial, granting themto bank-based AMCs may be very difficult politi-cally. Also, monitoring and controlling such powersto prevent misuse will be a major challenge. Wherespecial powers are needed to override the judicialbranch, a centralized approach may be the onlypractical alternative.

Workout UnitIn general, keeping distressed assets within the

bank but in a separate workout unit has some advan-tages. Organizationally, loan officers are better ableto focus on business development while dedicatedspecialists can focus on loan recovery strategies.Keeping the bad assets within the bank also pro-vides an opportunity to develop in-house expertiseas well as capture any spin-off business that resultsfrom loan workouts or asset marketing. Further, keep-ing the activity within the bank should help ensureorderly communication and data transfer betweenthe loan department and the workout unit. But forthese advantages to be realized, the workout unitshould have both operational independence and per-formance-based employment incentives.


While there are some potential advantages, how-ever, the major drawback of workout units concernsthe remaining exposure to losses. Unless the NPAproblem is measurable and relatively small, the work-out unit will do little to rehabilitate the bank or re-store confidence. If NPA levels are high, a workoutmodel will not be effective without new capital orfinancial assistance. Once government assistance isprovided, safeguards should be instituted to ensurefairness, consistency, and objectivity.

The workout-unit approach was adopted in Po-land in 1993. The government instructed largely state-owned banks to transfer to separate workout unitstheir assets that were classified as losses or doubtfulassets, representing an estimated 30 percent of totalloans. In return, the government provided financialassistance to cover loss provisions. It granted thebanks special powers to negotiate workout agree-ments with debtor enterprises on behalf of all credi-tors. If a voluntary debt workout schedule could notbe reached within one year, the banks were requiredto file for bankruptcy for the firm, liquidate the firm,or sell the NPAs. Within a year, nearly 98 percent ofthe larger loans had been restructured. However, theWorld Bank estimated that 1520 percent of theworkout cases did little more than delay loss recog-nition.

11 It is questionable whether the Polish model

would work for countries like Indonesia and Thai-land, where NPA levels are much higher and assetsare widely dispersed and involve mostly the privatesector.

Bad BankInstead of creating a workout unit, banks may be

encouraged by the government to set up bad-bankAMCs. As incentives, the government might allow amore optimistic valuation of transferred assets; notrequire consolidation for regulatory reporting andcapital purposes; or provide financial assistance tofacilitate the transfer. Frequently, the governmenttakes a substantial ownership interest in the rehabili-tated good bank.

Placing the NPAs in a separate but affiliatedentity does not cancel the previously mentioned is-sues regarding resources and expertise but it allowsthe bank and the AMC to focus more on their pri-mary mission. Also, it creates two potential sourcesof funds to repay any financial assistance from thegovernment. One is from the sale of the bad-bankAMC or its assets, and the other is from the even-tual sale of shares in the good bank.

The bad-bank AMC also raises the same con-cerns about expertise, objectivity, incentives, and thegranting of special powers, noted with the workout-unit model. Moreover, relying on several bad banksmakes it more difficult to coordinate asset marketingor packaging options and precludes the operationaleconomies of scale that a centralized AMC wouldoffer. Besides, uncoordinated bad banks competingto sell in a buyers market are likely to intensify adownward spiral in asset prices.

As noted earlier, governments may need to pro-vide financial assistance to persuade banks to setup AMC affiliates. In Thailand, the governmenthas indicated that budgetary constraints prevent itfrom setting up a centralized AMC for banks as itdid for the finance companies. Banks have there-fore been encouraged to set up their own AMCs,but so far the response has not been encouraging.Only a handful of banks have begun to plan forsuch a strategy.

In Sweden, two AMCs established by the gov-ernment to separately take over the assets of twobanks were eventually merged to take advantage ofefficiencies and economies of scale. The resultingentity, known as Securum, closed in 1997 after fiveyears of operations. The government provided finan-cial incentives and operational independence to at-tract private-sector experts to manage Securumsassets. Securum created several subsidiary organi-zations to suit different asset types and locations, andits strategy included the privatization (full or partial)of these operations. Privatization has been takingplace, but its extent is not known.


In the Peoples Republic of China (PRC), the gov-ernment recently announced the creation of a bad-bank AMC to take up to US$36 billion in assets fromthe China Construction Bank. The government hopesthat the AMC will serve as a model for the otherthree large state banks. The bad-bank approach isbelieved to have been chosen because the govern-ment feared that the amount of NPAs in the systemwas too large for a centralized AMC to handle. Asin Sweden, the four AMCs are likely to be ultimatelycentralized to take advantage of closer industry co-operation, efficiencies gained in systems implemen-tation, and economies of scale in asset valuation,management, and disposition.

If the NPA problems in a country are indeed largeand widespread, a centralized approach may be abetter option. Establishing several bad banks mayease some of the pressure on both government andbanks to resolve the NPA problem. However, theexperience of other countries shows that governmentsmust offer some sort of incentive to create separatebad banks. Providing financial assistance can raisedifficult political and operational issues. Whicheverapproach is used, the strategy needs to be carefullythought out. Having to redo the design, implementa-tion, and operation of AMC strategies will increasethe ultimate cost of resolution.

GOVERNMENT-BASED ASSET MANAGEMENTCOMPANYThe more systemic the NPA problem, the greaterthe need for a government-led, centralized approach.A centralized strategy may also be used when bankmanagement is not capable of operating a bank-basedAMC. A government generally employs this strat-egy as part of a bank recapitalization/restructuringprogram. The government carves out the NPAs fromthe banks being restructured and replaces the badassets with government bonds on the banks balancesheets. The NPAs are owned by the governmentand may be managed directly by the AMC, partiallycontracted out to private managers, or even left with

the banks themselves to service. The AMC may bea special-purpose entity designed solely to acquire,manage, and recover NPAs, or it may also have otherfunctions like deposit insurance or bank recapitaliza-tion. Because many centralized AMCs are formedin a crisis, the government is often pressured to en-act legal and regulatory reforms and may grant theAMC significant loan recovery powers.

Centralizing NPA problems in a governmentagency offers certain advantages. From an opera-tional standpoint, the government AMC should beable to achieve certain economies of scale in hiringand training appropriate staff and building manage-ment information systems (MISs). Centralizing as-set management and disposition functions should fa-cilitate asset packaging and marketing, and ensureconsistency and transparency within the AMC. Also,the risk of different bank-based AMCs competing todrive down sale values should be reduced. Thegreater the number of institutions, the more exten-sive the debtor interrelationships, and the more simi-lar the assets, the greater the need for governmentcoordination and oversight. On the other hand, a gov-ernment AMC usually has too little flexibility in itscompensation structure to attract qualified person-nel or provide performance-based financial incen-tives. Also, concerns about public perceptions mayunduly slow decision making.

A government AMC should be in a better positionto develop strategies that maximize recovery value.These strategies might include holding onto certainassets in order to achieve better pricing, providingfunding to rehabilitate a business or an asset, or evenrestructuring entire business sectors. The danger hereis that losses will increase if decisions are based moreon power and politics than on sound business judg-ment. In Malaysia, the government-based AMC plansto enhance asset values by giving the state a greaterrole in owning and managing certain businesses, asituation that may impede the development of theprivate sector. From a legal standpoint, a govern-ment-sponsored AMC should be in a better position


to receive extraordinary asset recovery powers thatpolitically could not be given to the private sector.

In April 1999, Japan announced that it was estab-lishing a government-based AMC, the Resolution andCollection Corporation (RCC), modeled after the USRTC. RCC was created through the merger of theResolution and Collection Bank and the Housing LoanAdministration Corporation, which had both tried butfailed in the past to recover the NPAs of the finan-cial system. Unlike its predecessors, RCC is em-powered by new legislation to acquire NPAs fromhealthy institutions, not just failed ones.

HYBRID MODELSSeveral countries have used a hybrid model in de-signing, implementing, and operating AMCs. InMexico, the government created a centralized AMCto acquire NPAs, but asset operations were verydecentralized. The selling banks were retained toservice these assets with relatively little oversightand coordination. Despite incentives to encouragebanks to maximize recoveries, progress in the speedand amount of recovery has been very slow and sub-ject to much criticism.

In the Philippines, the government recently out-lined a proposal for a national AMC that would be amajority-owned, private-sector asset managementfirm. The Department of Finance has reportedlyasked three government banks to contribute up to49 percent of the equity, with the rest to come fromthe private sector. In theory, an approach that com-bines limited government funding and passive own-ership with private-sector ownership and expertisecould offer substantial benefits.

India is trying out a coordinated private-sectoroption. Five commercial banks recently announcedplans to create a privately owned AMC. The AMCwould buy NPAs from the banks at prices to benegotiated. If successful, this approach could helpmarshal limited asset management expertise, cre-ate economies of scale, and expand marketing op-tions. However, much will depend on the satisfac-

tory resolution of pricing standards and funding re-quirements.

Recommended AssetManagement CompanyGuidelinesCountries have used different strategies to resolveNPA problems in their financial sector. Their experi-ence suggests that there is no single best practiceapproach for all situations. However, when imple-menting an AMC strategy, governments should con-sider the following guiding principles.

Asset Management CompanyTimelineA common mistake in establishing any organizationis to underestimate its complexity and the time andeffort required. Before implementing an AMC strat-egy, a country should first diagnose the nature andextent of its banking problems. The findings shouldbe considered when deciding what type of AMC touse. While not all-inclusive, Table 12 outlines somekey tasks and general time frames for the design,implementation, and operation of an AMC. Of course,much depends on the size of the problem, the levelof government and private-sector expertise in man-aging distressed assets, and the level of developmentand sophistication of the market.

The design phase is the most critical as early de-sign decisions can greatly influence the course theAMC takes and its ultimate resolution costs, in bothfinancial and political terms. This phase must be ex-ecuted carefully to ensure that the strategy and de-sign of the AMC are built on as clear an understand-ing of the problem as possible. For example, over-emphasizing early NPA disposition before the po-tential NPA inventory is understood can lead to un-realistic expectations and dissatisfaction on the partof government, investors, and the public in general.This is not to argue that the asset disposition processshould be delayed unnecessarily. An orderly and com-


petitive disposition process will strengthen investorconfidence in the commitment to resolve NPA prob-lems and can provide momentum to the recovery pro-cess. However, it is very important that operationalstrategies be carefully designed and that the govern-ment use credible and experienced people who un-derstand the issues and can objectively balance gov-ernment goals with those of bankers and investors.

LEGAL CONSIDERATIONSFor the AMC to operate efficiently, the resolutionstrategy should also include assessing the legal in-frastructurethe efficiency of the courts case man-agement system and the adequacy of bankruptcy,tax, property ownership, collateral, and foreclosurelaws. The government should ensure that appropri-ate laws are in place to permit the foreign ownershipof assets. Finally, it should create a framework fordebt workouts.

Many East Asian countries lack the type of legalinfrastructure that is necessary for quick recovery.While Korea has a court system that is consideredto be relatively efficient in enforcing collateralizedclaims, many other East Asian countries have lawsthat are seen as time-consuming, inefficient, and un-predictable. The mechanism for collateral registra-tion is often poorly developed, particularly for chattelmortgages. On the other hand, there are legal re-

quirements that do not seem to serve a substantivepurpose and that can impede the development ofmarket-based reforms. If the political system doesnot facilitate these legal reforms in the given time,the government should grant the AMC temporaryspecial legal powers. (Some of East Asias key bank-ruptcy and foreclosure issues are summarized inAppendix Table A2.5.)

UNDERSTAND THE PROBLEM AND THEENVIRONMENTBefore establishing an AMC, a country should firstdiagnose the nature and extent of its banking prob-lems. It is extremely important to understand the prob-lem before designing a solution. The liquidity andsolvency of the financial sector, including the scopeand complexity of NPA problems, should be care-fully evaluated. The nature of corporate debt shouldbe assessed. For example, in many East Asian coun-tries, foreign creditors hold significant portions ofdomestic corporate debt. In Indonesia, for instance,foreign creditors hold 60 percent of domestic corpo-rate debt, according to World Bank estimates.

12 The

holding of corporate debt by foreign creditors canimpede an AMCs efforts to restructure NPLs todomestic enterprises. In some cases, the acquisitionof foreign-held debt by an AMC could expedite reso-lution. However, AMCs are not always authorized

Table 12: Asset Management Company Timeline

MIS = management information system, NPA = nonperforming asset.Source: Barents Group.

Phase 1Planning (06 months)Strategic Plan Measure size and impact of NPA problem Assess funding needs and sources Develop resolution strategy and goals Design governance structure Assess legal environment and needs Draft and propose necessary legislation Develop asset recovery principlesOperations Plan Design organizational structure for

operations Establish valuation/pricing principles Develop communications strategy Assess MIS needs and alternatives Develop staffing strategy and standards Establish outsourcing standards

Phase 2Start-Up (48 months) Develop staffing plans and

position descriptions Recruit, select, and train staff Design NPA valuation process

and procedures Design asset transfer process

f low Establish data collection process

and procedures Implement MIS and accounting

interfaces Develop operating manuals

Phase 3Operations (35 years) Collect and disseminate data Prepare asset management and

recovery plans Carry out market outreach programs Value and acquire assets Service assets Sell assets Carry out loan workouts Undertake asset funding and

enhancement Carry out outsourcing and monitoring Implement financial monitoring and

reporting


to acquire foreign-held debt. While the authority toacquire NPLs held by foreign-held institutions shouldbe tightly controlled and limited, in certain cases theacquisition may be economically justifiable. For ex-ample, when foreign creditors own a relatively smallshare of a domestic corporations debt but effec-tively have the authority to block a restructuring pro-gram, it may make sense for the AMC simply tobuy out their debt.

A program of bank reviews conducted by quali-fied experts should be implemented very early inthe process. Factors to be reviewed should includenot only the banks financial condition and man-agement but also their experience and capability tomanage loan problems. The findings of these re-views should be considered when deciding whetherto use bank- or government-based AMCs. Actionplans should be based on the results. In Thailand,although the government acted promptly to resolvethe NPA problems of finance companies, compre-hensive strategies still have to be developed fordealing with the pervasive problem of NPAs in thebanking sector.

In addition to the financial problem, a governmentshould also consider the countrys cultural, political,and legal environment when designing an AMC strat-egy. This includes public and investor understandingand support for the strategy, creditor attitudes andexperience in working with distressed debtors, debt-ors attitudes toward paying debts, and the courtsattitude toward creditors. The political environmentrelative to the level of consensus needed to resolvethe crisis and the nature of directed lending has to betaken into account. Also, it is important to assess therelationship of the loan problems to the economy, in-cluding the role of excessive leverage in the crisisand the degree to which the crisis is depriving viablebusinesses of access to credit. Finding the right bal-ance between providing too much credit and provid-ing too little can be very challenging, particularly whenan AMC is assigned the task of minimizing assetlosses and supporting business recovery.

DEVELOP AND IMPLEMENT BUSINESS PLANSFOR PROMPT ACTIONStructuring solutions usually involves a number ofsteps that take more time than what was antici-pated or is desirable. Action plans must be devel-oped and implemented to educate the public, gar-ner political support, and enact necessary legisla-tion. At the same time, the country should begin todevelop a business plan to guide the activities ofthe AMC. The business plan should address boththe structural design and the operations of the AMC.The sooner this plan is developed, the better. AnAMC is likely to need an eight-month planningand start-up period to design policies and proce-dures, inventory assets, build systems, and hire andtrain appropriate personnel.

On the other hand, governments must act promptlyto resolve the NPA crisis. A recent IMF study con-cluded that countries that acted within one year ofthe emergence of significant credit problems havehad the most success in resolving their bankingcrises.

13In Indonesia, for example, the government

has come under increasing criticism for not address-ing the banking problems early enough. In 1993, thepercentage of NPAs to total banking assets in Indo-nesia was estimated to be 14 percent. By March1999, this figure had grown to about 70 percent.

RETAIN INDEPENDENT AND OBJECTIVEEXPERTISEMany governments have retained foreign expertiseto assist them in diagnosing the problems in their fi-nancial sector, developing an AMC strategy, startingup operations, training local resources, and transfer-ring expertise. It is important not only for govern-ments to assess their need for expertise, foreign orotherwise, but also for them to understand the moti-vations of their advisers because the advice givenmay not always be objective and neutral. Potentialconflicts of interest can thus be avoided. In East Asia,for example, several investment banking firms thatoffered strategic advice on how to package certain


asset portfolios were also on the buy side. Althoughmany investment banks offer sound design and op-erational advice, governments should not rely uponthese advisers to ensure that internal firewalls are inplace. From experience, it has been observed thatthe integrity of these firewalls is, at times, suspect.To avoid a conflict of interest, or at least the percep-tion thereof, the selection of foreign consultants shouldbe made on a competitive basis.

SELECT AND COORDINATE THENONPERFORMING ASSET RESOLUTIONSTRATEGY AND THE ASSET MANAGEMENTCOMPANY MODELThe selection of the most appropriate AMC model,or a variant thereof, should take into account theseverity or systemic nature of the NPA problemand the countrys institutional, legal, and market con-ditions. In general, the more pervasive the problem,the greater the need for governments to play anactive role in the resolution of distressed assets.This might involve the creation of one or moregovernment-based AMCs. However, the numberof AMCs should be limited to avoid public confu-sion and contradictory practices. In addition, al-though competition between AMCs may be healthy,it may also be counterproductive.

In Malaysia, for instance, a single AMC leads andcoordinates the asset management and recovery pro-cess with other government agencies. In Thailand,on the other hand, the government created severalAMCs without providing adequate guidance and co-ordination. As a result, the Thai AMCs do not ap-pear to be working in harmony to resolve thecountrys NPA problem.

The existence of widespread NPA problems doesnot preclude the establishment of bank-based AMCsin lieu of, or in addition to, government agencies.However, decisions to create bank-based AMCswith government assistance should be made onlyafter careful evaluation of the potential for abuseand public criticism. Thailand is currently experi-

menting with this dual strategy. However, experi-ence has shown that when an NPA problem is largeand systemic, a single centralized, government-based AMC is most effective in achieving efficien-cies and economies of scale.

Asset Management CompanyStructural DesignWithin the business plan, the government should fi-nalize the AMCs structural design and operations inconsultation with its advisers. The best-practiceguidelines discussed below are meant for those AMCcircumstances where public funding is necessary andgovernment participation is required.

ESTABLISH CLEAR OBJECTIVESClear objectives should be established for AMC gov-ernance and operations. The objectives should stresstransparency, fairness in transactions, and efficiencyin operations, and should be based on realistic timeand recovery expectations. The objectives shouldsupport maximum coordination and clarity of gover-nance. Potential conflicts between objectives, suchas having to assist borrowers, expedite sales, andmaximize values, should be minimized as much aspossible. The AMC should be a special-purposevehicle. Having multiple responsibilities is challeng-ing for any organization, particularly a newly estab-lished AMC faced with carrying out a difficult andoften unpopular task. Without clear goals, the AMCwill have difficulties prioritizing tasks and operatingindependently.

Where conflicts do exist within the same organi-zation, priorities should be established. The relativeimportance of value maximization compared withloss minimization should be decided early. The time-ly return of assets to the private sector at fairvalues should be assigned a high priority along withminimizing market disruption or interference.Government-subsidized AMCs should be prohibitedfrom speculative or unsubstantiated risk taking. TheAMC should be focused on the recovery of the


assets of financial institutions and not on its ownsurvival or expansion.

Finally, objectives should encourage an orderlytermination of the AMCs activities at a legally es-tablished sunset date for privatization. Parliamen-tary approval should be required for an extension.In most of the East Asian countries surveyed,government-based AMCs do not have a legally fixeddate for ceasing to operate. Although many of thegovernments argued that they could not predict howlong the recovery would take, this open-ended policymay discourage the timely termination of operations.Once the nonperforming assets have been broughtdown to reasonable levels, the banking sector shouldbe sufficiently healthy to manage them.

14

PROMOTE TRANSPARENCY AND CONSISTENCYThe public as well as investors must understandand support the AMCs initiatives. This is especiallyimportant in countries experiencing political un-certainties. Priority should be given to explainingwhat is being done, why, and how. The AMC shouldlook for ways of developing market outreach pro-grams. Operational policies and plans should bemade public to help promote transparency andconsistency. An AMC should regularly provideinformation on its progress. Financial results shouldbe published, using internationally accepted ac-counting practices, and should be audited by anindependent entity. Sales transactions should bebroadly marketed and negotiated sales should beavoided. Many AMC transactions will likely in-volve negotiations with debtors which, for practi-cal reasons, cannot be opened to the public. None-theless, policies should be developed to promoteconfidence in the integrity of the process. Thesewould include guiding principles and approval pro-cedures to be applied in such negotiations. Similarsteps should be taken for other aspects of AMCoperations. For example, the selection criteria andprocess for hiring administrators to manage as-sets should be made known.

Lack of transparency can often result in a con-flict of interest, or at least the appearance thereof.In Indonesia, for example, the government, whilestating that the AMC had developed guidelines forits decision making, has not made these guidelinesknown to the public because of the many nontech-nical dimensions of the NPA problem. In Malaysia,the AMC plans to issue semiannual operating re-ports that provide information on asset acquisitionsand recoveries, but does not plan to make its board-approved operating policies public. In addition, itdoes not publish the criteria for the selection of spe-cial administrators, appointed officials who take overand manage a debtor company. Operating policiesare also not published in Korea and Thailand. Inthe US, on the other hand, the Resolution TrustCorporation maintained a public reading room wheremost operational and financial documents could beviewed.

MINIMIZE POTENTIAL CONFLICTS OFINTERESTEthical standards should be developed for employ-ees and consultants to promote confidence in the in-tegrity and fairness of AMC operations. At a mini-mum, employees and their interests should be pro-hibited from buying AMC assets, except under verystrict public guidelines. Employees should be barredfrom establishing any employment or business rela-tionships with potential investors or contractors. Asmentioned above, financial consultants should be pro-hibited from bidding for specific asset transactionsthat they helped to structure.

PROVIDE ADEQUATE OPERATIONALAUTHORITYAn AMCs activities are likely to be controversialand subject to criticism which can impede progress.Therefore, an AMC must have the independenceand authority to operate efficiently. At the minimum,this includes the ability to hire and fire employeesand to provide competitive compensation to attract


quality personnel. Other important powers includethe power to employ private-sector contractors; tospend funds to maintain or enhance asset valueswhere appropriate; and to provide financing, equityparticipation, and limited warranties to facilitate salestransactions. The AMC might also be authorized toborrow money and issue government-backed debt.Such authority should, however, be limited and closelymonitored. Even with bank-based AMCs, the gov-ernment should have some oversight role, dependingon the extent of its involvement.

The Philippines experience in NPA recoveriesshows the importance of operational independencefor an AMC. The countrys AMCs operations areoverseen by a board of trustees, which in turn is su-pervised by the Committee on Privatization (COP),a cabinet-level body headed by the Secretary of Fi-nance. The Asset Privatization Trust (APT) has lim-ited operational authority as the COP must approveall sales transactions.

PROVIDE FOR OBJECTIVE OVERSIGHT ANDGOVERNANCEWhile an AMC should have a great deal of opera-tional independence, provisions should be made forbalanced, nonpartisan government oversight. Re-gardless of whether several bank-based AMCs ora single AMC is established, the government shouldconsider appointing an independent oversight boardto ensure transparent, consistent, and efficient op-erations. To give the board credibility, it should in-clude a mix of senior government officials and well-regarded representatives from the private sector.Its members might include officials from the Minis-try of Finance and the central bank; one or morerepresentatives from the World Bank or the AsianDevelopment Bank; and private-sector represen-tatives from the financial and industrial sectors. Theboard should not be directly involved in the dailyoperations of the AMC and none of its membersshould participate in transaction decisions or be af-filiated with specific AMC cases. The boards re-

sponsibilities should be limited to hiring (and firing)AMC management and approving proposed oper-ating and capital budgets, as well as operationalpolicies and strategies. Other responsibilities couldinclude approving rules of ethics to prevent opera-tional conflicts of interest and implementing pro-grams to monitor compliance with approved poli-cies, budgets, and strategies. Finally, in order toeducate the

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