Bad bank

For a more literal "bad bank" see bank fraud.

A bad bank is a corporate structure to isolate illiquid and high risk assets held by a bank or a financial organisation, or perhaps a group of banks or financial organisations.[1] A bank may accumulate a large portfolio of debts or other financial instruments which unexpectedly increase in risk, making it difficult for the bank to raise capital, for example through sales of bonds. In these circumstances, the bank may wish to segregate its "good" assets from its "bad" assets through the creation of a bad bank. The goal of the segregation is to allow investors to assess the bank's financial health with greater certainty.[1] A bad bank might be established by one bank or financial institution as part of a strategy to deal with a difficult financial situation, or by government or some other official institution as part of an official response to financial problems across a number of institutions in the financial sector.

In addition to segregating or removing the bad assets from parent banks' balance sheet, a bad bank structure permits specialized management to deal with the problem of bad debts. The approach allows good banks to focus on their core business of lending while the bad bank can specialize in maximizing value from the high risk assets.[2]

Such bad bank institutions have been created to address challenges arising during an economic credit crunch to allow private banks to take problem assets off their books.[3] The financial crisis of 2007–2010 resulted in bad banks being set up in several countries. For example, a bad bank was suggested as part of the Emergency Economic Stabilization Act of 2008 to help address the subprime mortgage crisis in the US. In the Republic of Ireland, a bad bank, the National Asset Management Agency was established in 2009, in response to the financial crisis in that country.

Models

In a 2009 report, McKinsey & Company identified four basic models for bad banks.[1]

Examples

Mellon Bank (1988)

The first bank to use the bad bank strategy was Mellon Bank,[1] which created a bad bank entity in 1988 to hold $1.4 billion of bad loans.[4] Initially, the Federal Reserve was reluctant to issue a charter to the new bank, Grant Street National Bank, but Mellon's CEO, Frank Cahouet, persisted and the regulators eventually agreed.[4]

A dumping ground for non-performing energy and real estate loans,[5] Grant Street was spun off with its own five-member board of directors and about $130 million in Mellon capital; it was named for a main street in Pittsburgh which was home to Mellon Financial headquarters. It took no public deposits. Mellon shareholders were issued shares in both the good and bad banks on a one-for-one basis, as a dividend. After the Grant Street National Bank had fulfilled its purpose, issuing preferred shares and equity purchase contracts to finance the purchase of $1 billion in Mellon's bad loans at 57% of face value, then collecting what it could on the individual loans, it was liquidated and its employees quietly returned to Mellon Bank.[6]

Grant Street's early investors made handsome profits; the bank was dissolved in 1995 after repaying all bondholders and meeting its objectives.[4]

Swedish banking crisis of 1992

The Swedish banking crisis of 1992 was the direct result of a combination of over speculation in property assets and the exchange rate of the Swedish krona. By 1992 three of the four major banks were insolvent.

The Swedish authorities engaged McKinsey & Company to help design a solution, and chose to establish two bad banks, Retriva and Securum. Retriva took over all the nonperforming loans from Gota Bank and Securum took over the non-performing loans from Nordbanken, with the good bank operations continuing as Nordea. The government retained a significant equity stake in Nordea. Lars Thunell was appointed to lead Securum, supported by Anders Nyrén and Jan Kvarnström to manage its toxic book, at the time valued at sek 51 billion.

The performance of Securum has been analysed by many, such as Claes Bergström.[7] While the figures are debated, depending on initial costs and the time frame the cost was no more than 2% of GDP (an extremely good result) and eventually both bad banks made a positive return.[8] Nordea has been considered one of the strongest and best performing banks in Europe.[9]

International commentators such as Brad DeLong and Paul Krugman have suggested the Swedish bad banking model be adopted internationally.[10]

France

Finland

The Finnish banking crisis of the 1990s caused the collapse of two major banks, the Säästöpankki group/SKOP and STS Bank. The government founded the bad banks ("property management companies") OHY Arsenal and Sponda, which took over the bad debt. In 2015 Arsenal started the process of winding down by deliberately filing for bankruptcy. 200 million of remaining capital has been collected during the bankruptcy. However, Arsenal is still involved in court cases and may not be disestablished until they are complete. Sponda was privatized and listed in Helsinki Stock Exchange in 1998, and in 2012, all government-held shares were sold by their holder, the government's asset management company Solidium. As of 2016, Sponda operates and remains on the stock market.

Indonesia (1998)

During the Asian Financial Crisis which emerged in Indonesia and several other countries in Asia in 1997 and 1998, the Indonesian government established the Indonesian Bank Restructuring Agency (IBRA) as an official body to oversee the asset disposals of an extensive number of distressed banks.

Belgium

The 2008–09 Belgian financial crisis is a major financial crisis that hit Belgium from mid-2008 onwards. Two of the country's largest banks – Fortis and Dexia – started to face severe problems, exacerbated by the financial problems hitting other banks around the world. The value of their stocks plunged. The government managed the situation by bailouts, selling off or nationalizing banks, providing bank guarantees and extending the deposit insurance. Eventually Fortis was split into two parts. The Dutch part was nationalized, while the Belgian part was sold to the French bank BNP Paribas. Dexia group was dismantled, Dexia Bank Belgium was nationalized.

US sub-prime mortgage collapse of 2008

In early 2009, Citigroup dumped more than $700 billion worth of impaired assets into bad bank Citi Holdings.[11] By 2012, the Citi Holdings bad bank represented 9% of the total Citigroup balance sheet.[12][13]

In March 2011, Bank of America segregated almost half its 13.9 million mortgages into a bad bank composed of risky and worst-performing “legacy” loans.[14]

Baltic crisis of 2008–2011

Estonia, Latvia, and Lithuania joined the European Union in 2004, attracting an influx of foreign investment and launching a real estate bubble which burst during the financial crisis of 2007–08, leaving the countries saddled with foreign debt. Riga-based Parex Bank, the largest Latvian-owned bank, was vulnerable as it held large sums from foreign depositors (which began withdrawing assets around the time of Lehman Brothers September 2008 collapse) and was heavily exposed to real estate loans. Latvia's government took a controlling interest in Parex in November 2008, spinning off Citadele banka as a good bank in August 2010. The bad assets were left behind, effectively creating a bad bank with the original Parex Banka name and no retail depositors. The Parex "bad bank," its core retail functions stripped out by the 2010 split, gave up its banking licence in 2012 to become professional distressed asset management company Reverta.[15]

While the crisis was focused in the markets of Estonia, Latvia and Lithuania, it involved Swedish banks, so Sweden was also exposed. The Baltic Crisis was partly initiated by the global credit crunch, but it revealed questionable lending practices of all major Swedish banks. Swedbank was particularly exposed, given its 50% share of market and well over sek150 million of impaired loans. With the support of the Swedish authorities the new CEO of Swedbank, Michael Wolf, engaged bad bank specialist Kvanrnstrom, European Resolution Capital and Justin Jenk who lead the formation and management of Swedbank’s bad banking operations (Financial Resolution & Recovery and Ektornet).This work was part of wider revolutionary change at Swedbank.[16] This bad bank’s creation was covered in depth and published in a book by Birgitta Forsberg.[17] The steps by management and this team were instrumental in rescuing Swedbank and stabilizing the region’s economy. Today, Swedbank is considered one of Europe’s stronger and better performing banks.

United Kingdom

In 2010 the UK government established UK Asset Resolution, a state owned limited company to manage the assets of the two bankrupt nationalised mortgage lenders Bradford & Bingley and Northern Rock (Asset Management).[18] This bad bank manages a total mortgage book of £62.3bn (as at 30 September 2013)[19]

In 2013, the Royal Bank of Scotland transferred £38.3bn of its worst loans to an internal bad bank.[20] In 2014, Barclays Bank dumped the bulk of its commodities operation[21] and fixed income business[22] into an internal "bad bank" as part of a restructuring in which it greatly curtailed its investment banking activities.

Germany

Germany has several bad banks dating as far back as the 1980s, Bankaktiengesellschaft (BAG), owned by the Federal Association of German 'Volksbanken und Raiffeisenbanken' Co-operative Banks, Bankgesellschaft Berlin, Erste Abwickelungsanstalt and FMS Wertemanagement. The Erste Abwickelungsanstalt and the FMS Wertmanagement together hold 190 Bn € and 170 Bn € respectively from the failed WestLB and Hypo Real Estate.

Spain (2012)

In 2012 the Spanish government granted powers to the Fund for orderly restructuring of the bank sector (FROB) to force banks to pass toxic assets to a financial institution whose role is to remove risky assets from banks balance sheets and to sell off the assets at a profit over a 15-year period. The SAREB (Restructured Banks Asset Management Company) has assets of close to €62Bn on its balance sheet.

Portugal (2014)

On 3 August 2014, Banco de Portugal, Portugal's central bank, announced a €4.4 billion bailout of Banco Espírito Santo (BES) that heralded the end of BES as a private bank. It will be funded by the European Stability Mechanism. The bank will be split into a healthy bank, Novo Banco, while the toxic assets remain in the existing bank.[23]

Some major conclusions from the experiences in Sweden

All three bad bank structures have been deemed text book examples of success. They resolved the toxic loans and made positive returns to the relevant stakeholders. This body of work has been referenced by governments and authorities around the world as best practice and some of its lessons applied (most recently in Ireland, Spain, Cyprus and Slovenia).[24]

Criticism

Critics of bad banks argue that the prospect that the state will take over non-performing loans encourages banks to take undue risks, which they otherwise would not, i.e. a moral hazard in risk-taking. Another criticism is that the option of handing the loan over to the bad bank becomes essentially a subsidy on corporate bankruptcy. Instead of developing a company that is temporarily unable to pay, the bondholder is given an incentive to sue for bankruptcy immediately, which makes it eligible for sale to a bad bank. Thus, it can become a subsidy for banks on the expense of small businesses.

See also

References

  1. 1 2 3 4 Gabriel Brenna, Thomas Poppensieker, and Sebastian Schneider (December 2009). "Understanding the bad bank". McKinsey & Company. Retrieved 8 May 2014.
  2. ↑ Cade, Eddie (2013). Managing Banking Risks: Reducing Uncertainty to Improve Bank Performance. Routledge. pp. 141–142. ISBN 9781135952143.
  3. ↑ Morning Edition. "Why A 'Bad Bank' Is A Good Idea". NPR. Retrieved 2013-04-10.
  4. 1 2 3 Fitzpatrick, Dan (8 August 2008). "The Return of 'Good Bank-Bad Bank'". Wall Street Journal. Retrieved 8 May 2014.
  5. ↑ "Mellon Will Shift $1 Billion in Bad Loans : Forming Entity to Help Improve Ailing Finances - Los Angeles Times". Articles.latimes.com. 1988-07-26. Retrieved 2014-08-04.
  6. ↑ Moore, Heidi N. (2008-09-08). "The ‘Bad Bank’ Experience: Lessons From Mellon-Grant Street - Deal Journal - WSJ". Blogs.wsj.com. Retrieved 2014-08-04.
  7. ↑ Bergström, Clas; Peter Englund; Per Thorell (May 2003). "Securum and the way out of the Swedish Banking Crisis" (PDF). Summary of a report commissioned by SNS – Center for Business and Policy Studies.
  8. ↑ Hagan, Sean; Christopher Towe (17 April 2009). "An overview of bank Insolvency" (PDF). IMF Staff Papers.
  9. ↑ Ingves, Stefan (September 2006). "Finansiella kriser i ett internationellt perspektiv". Riksbanken.
  10. ↑ Dougherty, Carter (22 January 2009). "Sweden’s fix for bank: nationalize them". New York Times.
  11. ↑ http://www.crainsnewyork.com/article/20130715/BLOGS02/130719938/citis-bad-bank-shrinks
  12. ↑ Steve Schaefer (15 October 2012). "Citigroup: Making The Good Bank-Bad Bank Model Work". Forbes.
  13. ↑ Christina Rexrode and Maureen Farrell. "Citi’s $7 Billion Settlements Ruins First Profitable Quarter at Its Bad Bank". WSJ.
  14. ↑ Dawn Kopecki (8 March 2011). "BofA Segregates Almost Half of its Mortgages Into ‘Bad Bank’". Bloomberg.
  15. ↑ "The once mighty fall further". Baltictimes.com. 2010-08-04. Retrieved 2014-08-04.
  16. ↑ Billing, Anders; Birgitta Forsberg (28 August 2009). "Revolutionen i krisbanken". Affärsvärlden.
  17. ↑ Forsberg, Birgitta (2010). Fritt fall: spelet om Swedbank. Ekerlids. ISBN 91-7092-140-7.
  18. ↑ "BBC News - 'Don't call us the bad bank' - what Northern Rock did next". BBC News.
  19. ↑ http://www.ukar.co.uk/~/media/Files/U/Ukar-V2/Attachments/fact-sheet/factsheet-16052014.pdf
  20. ↑ Max Abelson and Michael J. Moore (30 April 2014). "Barclays Said to Name Bommensath to Oversee ‘Bad Bank’". Bloomberg.
  21. ↑ "Barclays to create 'bad bank' for non–core assets". Telegraph.co.uk. 30 April 2014.
  22. ↑ Frances Coppola (30 April 2014). "Barclays' Bad Bank Plan Shows It Can't Bounce Back". Forbes.
  23. ↑ "Portugal in 4.9 billion euro rescue of Banco Espirito Santo". Reuters. Retrieved 3 August 2014.
  24. ↑ Krugman, Paul (28 September 2008). "The good, the bad, and the ugly". The New York Times.

External links

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