Bad bank

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

Bad bank is a term for a financial institution created to hold non-performing assets owned by a state guaranteed bank. Such institutions have been created to address challenges arising during an economic credit crunch whereby private banks are allowed to take problem assets off their books. 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 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.

Experiences from Swedish bad banking

Sweden has developed a world leading reputation for establishing and successfully managing bad banks and the related asset management company structures. Several internationally renowned commentators, such as Bard DeLong and Paul Krugman, have suggested the Swedish bad banking model be adopted internationally.

This reputation is derived from the work of Swedish government officials as well as specialist firms conducted during the Swedish crisis of 1992-94 and Baltic crisis of 2009-2010 (where Swedish banks were heavily involved). On the government side these key individuals include: Anne Wibble, Per Westerberg, Carl Bildt, Stefan Ingves, Bo Lundgren and Urban Bäckström. From the private sector (from 1992) includes the original work teams from McKinsey, which have continued to be involved in may bad banking schemes. In addition Lars Thunell, Anders Nyrén, Jan Kvarnström and others involved in the Nordbanken/Securum structure, with Lars Nyberg at Retriva. In addition from 2009, with Kvantström’s involvement with Justin Jenk and European Resolution Capital they assisted Swedbank to successfully resolve its crisis.

Swedish banking crisis (1992–95) and its two bad banks

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 sv 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 and others. 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. Nordea has been considered one of the strongest and best performing banks in Europe.

The Baltic crisis of 2008-2011 and Swedbank’s own bad bank

This crisis was focused in the markets of Estonia, Latvia and Lithuania but because it involved Swedish banks Sweden was also exposed. The Baltic Crisis was partly initiated by the global credit crunch, but it revealed the questionable lending practices of all the 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. This bad bank’s creation was covered in depth and published in a book by Birgitta Forsberg. 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.

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.

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).

Bad Bank in UK

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). This Bad Bank is responsible for managing £77bn of assets.

Bad Bank in Germany

Germany has several Bad Banks dating as far back as the 80s, 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.

Bad Bank in Spain

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.

Bad banking in Finland

• OHY Arsenal was founded to handle bankruptcy assets.

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

• Troubled Asset Relief Program
• Resolution Trust Corporation

External links

• Comparison of Different Bad Bank Models by U Neyer and Thomas Vieten
• The German government's "bad bank" model, a Bundesbank article