In the inflationary environment of the 1970s and early 1980s, many retail savings and loans institutions (also known as thrifts) in the United States were paying high market rates for their deposit borrowings, but earning below-market rates on their assets (mostly in the form of residential and commercial mortgages). In short, many thrift 'borrowed short to lend long'.

Most banks and thrifts were restricted to operating in certain geographical areas. When regional economies (e.g. Texas, New England) sank into recession and commercial and residential real estate markets collapsed, many thrifts were faced with significant non-performing loans. At the same time, thrift industry deregulation in 1982 gave troubled thrifts the ability to take bets on risky investments with much of the risk covered by deposit insurance. In addition, at certain institutions, there was also mismanagement and fraud.

From 1980 through 1991, around 1,400 banks failed or received government assistance and during the same period, approximately 1,100 thrifts failed.

The crisis led to the insolvency of the Federal Savings and Loans Insurance Corporation (FSLIC), which provided a government insurance guarantee over thrift retail deposits, and shook the solvency of the Federal Deposit Insurance Corporation (FDIC), which provided similar insurance over retail bank deposits. At the end of 1991, the Bank Insurance Fund (BIF) administered by the FDIC carried a deficit balance of US$7 billion.

The US Government seized and liquidated many institutions, and assisted others through capital contributions, asset loss coverage guarantees, yield maintenance agreements and/or regulatory forbearances. Many institutions were merged with healthy institutions, while others were sold.

Integral to the Government's response was the passing of far-reaching legislation to overhaul the banking/thrift sector and provide an effective mechanism for government intervention.

In particular, the legislation created the Resolution Trust Corporation (RTC) to resolve the problem of troubled thrifts. The RTC's brief was to take over the non-performing loans of failed thrifts, and actively manage these assets to maximise value pending eventual disposal.

Formed in 1989, the RTC had at its peak assets totalling approximately US$1 trillion. All these assets have been successfully disposed and the RTC ceased operations in 1996.

Mexico

During the 1980s and early 1990s, many Mexican financial institutions were privatised. In subsequent years, high economic growth rates led new, inexperienced bank owners to aggressively expand credit portfolios to compensate for high prices paid during the privatisations. Capital levels were relatively low by international standards, as were credit standards.

Prior to Mexico's 1995 economic crisis, bank asset quality had already begun to deteriorate. Mexico's balance of payments deteriorated sharply throughout 1993 and 1994, resulting in a crisis in international investor confidence, large outflows of capital and, finally, a significant devaluation of the peso in December 1994. Soaring interest rates brought on an economic recession and shook the Mexican banking and financial system. Banks' asset quality declined further as consumers and corporates struggled to survive. Liquidity problems also arose as banks found it difficult to roll over maturing certificates of deposit.

The Government received financial assistance from the United States, the World Bank and the Inter-American Development Bank. This allowed the Government to provide support to banks through the Bank Fund for Savings Support, Fondo Bancario para Proteccion del Ahorro (FOBAPROA).

FOBAPROA is a trust established by Banco de México to provide "preventive support" to problem banks. Its existence predates the 1994-1995 banking crisis. FOBAPROA's stated mission is to cover all bank liabilities, except subordinated debt. FOBAPROA has generally acted as the lead agency in resolving bank problems since the peso crisis.

One of the major FOBAPROA assistance programmes implemented was the purchase of impaired loan assets from banks at net book value (on the basis of the Mexican rating system) in exchange for a requirement for the bank in question to raise new equity. FOBAPROA instituted this programme on a case by case basis. In some instances, FOBAPROA purchased $2 of loans for every $1 of equity injected, while in other cases, the ratio was as high as 5 to 1.

As the Mexican economy has pulled out of recession, the sense of crisis in the banking sector has eased, although there are lingering asset quality problems, especially in mortgage loans. The role of FOBAPROA continues.

Sweden

The Swedish economy, which had expanded rapidly in the deregulated environment of the mid to late 1980s, contracted sharply between 1991 and 1993.

Real estate markets declined sharply due to high interest rates and the recessionary environment. Banks, which had a significant portion of their loan exposure in the construction and real estate sectors, felt the impact. Several banks faced insolvency concerns. Nordbanken, Sweden's third largest bank, required a capital infusion and was ultimately taken over by the government in 1992.

The Swedish government's initial step was to guarantee the safety and soundness of the banking system, stating it would stand behind the banks. The government adopted legislation creating a comprehensive programme to restructure the banking system. The Government's expressed support facilitated the private sector recapitalisation of the banks.

Two banks were taken over by the Government, which formed asset management companies to acquire the non-performing assets of these banks. The other four major banks in Sweden were encouraged to form their own similar asset workout vehicles to take over problem real estate loans. These real estate companies effectively became asset management operations for the banks' underperforming real estate assets. The Government allowed the banks to deconsolidate these vehicles.

The banking sector has since recovered together with the economy, which in turn has improved overall asset quality. Several bank-owned real estate companies have been or will be spun off to shareholders.

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