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Sanitation or liquidation?

In the course of their activities, financial institutions often face serious problems that can lead to very negative consequences, up to the bankruptcy procedure. This is especially important for banks and microfinance organizations, as their liquidation can have very negative consequences for clients – individuals and legal entities holding their deposits in these structures.

The main causes of bankruptcy

In the Russian Federation, the bankruptcy of financial institutions is most often provoked by both internal and external determinants. Internal factors of bankruptcy of a financial organization can be assigned (individually or collectively):

– a small amount of the bank’s own financial resources or MFIs;

– low liquidity of assets;

– poor quality of the resource potential of the financial institution (this is, above all, dependence on interbank loans);

– unsatisfactory level of management of the daily activities of the bank or microfinance organization (there can be both intentional fraud and poor quality of management due to managerial illiteracy). Finally, in many cases of bankruptcy, the initial reputational risks of a bank or a financial institution can play a role.

As for external factors that could lead to the bankruptcy of a microfinance organization, they may include economic crises, instability of the socio-political situation, change of political regime or government, military-political conflicts, peculiarities of regulatory and legal regulation of banking activities.

In case bankruptcy of a financial institution is inevitable, the question arises of the need to resolve the current situation by either liquidating the organization (revoking the license) or sanitizing it (by means of a set of specially developed measures).

Sanation as a way to prevent bankruptcy

Let’s consider the peculiarities of the financial organizations sanation separately. The sanation of a bank or other financial organization is understood as the development and implementation of a set of state and banking measures to prevent bankruptcy, improve the financial situation of the bank and protect the interests of creditors and investors. These measures are taken to rebuild the credit institution’s financial debts and allow it to get rid of non-profitable assets.

Sanation is useful if the bank plays a key role in the financial and economic life of the region or country. Then its liquidation would have caused serious damage to the economy of the country, therefore, debt restructuring becomes a strategically important task. The second situation, justifying the need for sanation, is the serviceability of the financial institution itself, in the presence of liquidity problems caused by the behavior of depositors who have taken their deposits.

The implementation of the sanation procedure requires the financial institution to enter temporary management. In Russia, it is implemented by the Deposit Insurance Agency (DIA), which performs temporary management functions until the election of a new bank manager. During the sanation procedure, the bank receives financial assistance in the form of a loan with a minimum interest rate. This measure allows the bank to promptly solve all the problems that have arisen in the relationship with depositors and creditors. As a rule, credit is provided directly by the Deposit Insurance Agency, however, in some cases, financial resources of third-party investors may be attracted, for whatever reason, interested in providing them to the financial institution.

The main advantages of sanation

The sanation procedure has a number of visible advantages. First, the financial organization does not cease to exist, it has the opportunity to restore its activities and return to the fulfillment of the usual functional duties. Secondly, which is especially valuable for the bank’s clients, sanation allows depositors to use their deposits. Thirdly, the financial institution retains the opportunity to develop and implement new loan products, which also contributes to the rapid restoration of previous activities. Finally, a financial institution can afford to abandon such a measure as a reduction in the number of staff, i. Its employees retain jobs, which is important in the context of the social importance of the work of banks. It should be noted that in comparison with the deprivation of a license bank, sanation is a very soft measure. After all, in the case of depriving a license, depositors of a financial institution are reimbursed much less money. For the payment of money on significant deposits from a bank that has fallen into a difficult financial situation, in most cases, simply no money.

Of course, the sanation of a financial institution will require its leadership to take urgent measures. First and foremost, it is necessary to present a qualitative analysis of the expenditure-income side of the organization’s operation with a view to optimizing it. It is necessary to reduce expenses of the financial organization, or to increase its incomes. The most common measures to reduce costs include organizational and staff activities in the area of personnel polic

y, a reduction in current costs for the material and technical support of the financial organization, the liquidation of branches and offices that do not generate profits.

In the process of sanation, the financial organization also has the opportunity to optimize its organizational structure. As noted above, inefficient management is one of the most common causes of financial problems for organizations. In order to improve the quality of management, a financial institution can change its personnel policy, improve the quality of internal control over personnel activities, invite outside consultants.

Extraction of additional funds for settlement with depositors and other customers of the bank can be ensured by the sale of part of the property of the financial organization. So, the financial organization can realize its assets that do not generate income, lease out premises or other property, assign assets.

Revocation of license and liquidation as an extreme measure

A financial institution can choose to reorganize as a measure to prevent bankruptcy. Its essence lies in the «absorption» of an inefficient financial organization by another organization of a similar profile that does not have such problems. Sanation is carried out either in the form of a merger, or in the form of accession. However, in not all cases, financial institutions are seamlessly and in due time fulfill the Bank of Russia’s financial recovery requirements.

In this situation, according to the federal legislation regulating the activities of the Central Bank of the Russian Federation and the insolvency (bankruptcy) of financial organizations, an interim administration is appointed to the bank, which within six months must develop measures for financial recovery of the bank and apply measures to collect debts. If in the process of this activity the interim administration manages to restore the normal functioning of the banking organization, the latter returns to the usual rhythm of activity, and the temporary administration is removed. In the event that the financial recovery of the bank is impossible, a decision is made to eliminate it. The Bank of Russia withdraws the license to conduct banking activities, which entails taking a decision on the liquidation of a financial institution.

Liquidation of a financial institution is a big blow to the positions of its depositors and, in general, to the financial market. First, in the financial market, a player disappears with whom certain plans and hopes were associated, which had certain obligations. Secondly, depositors and clients of a liquidated financial institution face significant difficulties in obtaining their deposits and investments. After all, as it is known, the Deposit Insurance Agency provides reimbursement of only the minimum amount of deposits to 1.4 million rubles. Large deposits are returned in the course of the order as a result of the sale of the property of the banking organization.

Pros and cons of sanation

Unlike liquidation of a financial institution, its sanation is a more encouraging measure, which is generally filled with positive content for depositors and clients. First of all, it is necessary to understand that the sanation of a financial institution practically does not entail any changes for the depositor or the client. First, depositors of a financial organization do not lose deposits or interest. Unlike liquidation, it is possible to receive all funds both within the insured amount and larger deposits. At the same time, the process of sanation can lead to a temporary «freezing» of deposits for a certain period. Most often it’s two to three weeks, or a month. It is possible that the Deposit Insurance Agency will return the insurance amount in the event of a revocation of the license faster than the depositor will be able to withdraw its funds during the sanation.

However, such a scheme can be beneficial only to those investors who have very small deposits and expect to immediately withdraw them from the financial institution. If during the sanation the depositor retains his deposits in the financial institution, then he has quite real prospects not only not to worsen his financial situation, but also to improve it significantly. This is because after the sanation, the bank’s credit policy and its position on deposits undergo certain changes and, what is equally important, often in the best for the client side. Even more beneficial is the sanation for legal entities that have deposits in a financial institution. They get the opportunity to return the invested funds, which is very problematic in the event of liquidation of a financial institution.

As for debtors of banks, sanation does not mean any large-scale changes in the payment of loan payments. They need to continue to be paid, as the financial organization of its existence has not ceased. However, there are certain nuances. First, it is necessary to make sure that the previous requisites of the financial organization are preserved. Secondly, a financial institution that has gained control over a «problem» organization may have better lending offers, and this aspect of sanation also needs to be addressed.

The main trends of sanation in modern Russia

For financial markets, sanation is a more acceptable and beneficial procedure. First, this financial agent maintains a presence on the market, continues to fulfill its obligations. Secondly, as a result of sanation, its activities can improve, which will also have a positive effect on the overall state of the financial market. However, we should not forget about a number of problems related to the procedures for rehabilitation. So, according to the Agency for Deposit Insurance on January 1, 2017, the total amount of financing of sanation measures in Russia amounted to 1.2 trillion rubles. But such a large-scale financing of health-improving measures did not lead to the refusal of sanatoriums from additional assistance, for which they turn often enough. Many turnaround companies themselves are not in a better financial situation, which negatively affects the effectiveness of their sanation activities. An analysis of the consequences of the rehabilitation procedures for specific financial institutions revealed that by the end of 2016 only 5 out of 15 organizations had a positive outcome.

The need to improve the efficiency of sanation in modern Russia has prompted the Bank of Russia to carry out the reform of sanation. As the most important goals of the reform, cheaper sanation procedures, their acceleration and increase of transparency are considered. The main instrument for reducing the cost and improving the efficiency of the sanation measures may be the launch of a fund for the consolidation of the banking sector. The process of capitalization of rehabilitated financial institutions will begin immediately after the transition to sanation. In addition, in order to ensure transparency of the sanation procedures, the Bank of Russia plans to introduce control over the funds used. So the Central Bank wants to minimize the likely consequences of financial abuses on the part of organizations – turnaround companies.