Bad bank
Bad bank is a term for a financial institution created to hold nonperforming assets owned by a state guaranteed bank.[1] Such institutions have been created to address challenges arising during an economic credit crunch wherein private banks are allowed to take problem assets off their books.[2] Securum, a Swedish bank founded to take on bad assets during the Swedish banking rescue of 1991 and 1992, is an example of such a bank.
The financial crisis of 2007–2010 resulted in bad banks being set up to handle the crisis in a variety of 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 Ireland, a bad bank, the National Asset Management Agency was established in 2009, in response to the financial crisis in that country.
Experiences from Swedish bad banking
Sweden went through a major banking crisis in the 1990s. Three out of the four major banks were insolvent. The Swedish government chose to establish two bad banks, Retriva and Securum. Retriva took over all the nonperforming loans from Gotabank and Securum took over the non-performing loans from Nordbanken. Some major conclusions from the experiences in Sweden:
- By separating the non-performing loans from the banks, it was possible to start the process of focusing the banks back to lending. Trying to work out all the non-performing loans inside the bank only prolonged the healing process in the organisation and reduced the ability of the bank to lend more to the public and businesses.
- Repairing the balance sheet of the banks is only one important element to get the banks back to normal lending activities. The other major element is organisational processes.
- The organisational requirements are very different in a bad bank than in a normal bank. A good bank is a 'process' organisation while a bad bank is a 'project' organisation. The skill set and the emphasis on type of skills are different in a restructuring and winding up situation than in a lending situation.
- The first year of the bad bank determines its success. The challenge is the large number of non-performing loans in a wide variety of situations with regards to geographical location, type of industry, size and type of problem. If the bad bank does not quickly get control of the loans, a lot of value is lost and the capital requirements of the bad bank can change dramatically. To be successful, a well-defined process on how to handle the different loans has to be established. This process has to be followed and managed with force and speed in the organisation. If not, the bad bank will easily end up in chaos.
- When a bad bank has gone through its credit work-out process, the remains of the bad bank is often asset ownership. Therefore the bad bank in its life span changes dramatically from being at the outset basically a bank with a large number of loans to later in life a large asset-owning company. A common mistake is to think of this last phase of the bad bank as a kind of investment company. An investment company has very well defined objectives regarding what type of assets they want to acquire. They choose the assets they want to acquire. A bad bank gets all the assets that are left after the credit work-out process.
- A lifetime of 10–15 years is too long for planning purposes. The world changes substantially in such a long life span. Most banking crises are over in a 5–6 year period. A 5–6 year time span is the logical time to use for planning purposes and the time line to use for winding down a bad bank.
Bad banking in Finland
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. 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.
References