INTRODUCTION

Recapitalizing banking systems is a messy and risky business. Governments come under tremendous pressure to buy all the nonperforming or problematic loans in a distressed banking system, to subsidize the borrowers and to put the banks back on to a profitable basis with a comfortable capital margin. The goal of lobbyists is that there should be “no losers,” yet someone has to bear the losses that have been incurred and are reflected in the need for recapitalization. As a result of these pressures, governments often assume obligations greater than they should, given other priorities for the use of public funds. Sometimes they assume more than they can afford leading to subsequent disorderly reliance on the inflation tax.

In the resolution phase, there is time to get things right. For a while, this may be done while keeping the bank under official nationalized control, and while that is the case it is probably too soon to be thinking in terms of recapitalization. Eventually, though, the authorities will generally want to return the bank to normal autonomous functioning under private ownership. This may be done by a financial restructuring of each failed bank, or by merging the continuing business into a healthy bank. In either case, there will have to be an additional transfer of value from official sources. In this way, bank recapitalizations often involve an official injection of resources into failed institutions.