Bad bank

Last updated

A bad bank is a corporate structure which isolates illiquid and high risk assets (typically non-performing loans) 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 become at risk of partial or full default. A large volume of non-performing assets usually make 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 a government or some other official institution as part of an official response to financial problems across a number of institutions in the financial sector.

Contents

In addition to segregating or removing the bad assets from parent banks' balance sheets, 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 (in liquidation), 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] Securities collateralized by the bank's assets were structured and sold by Drexel Burnham Lambert. The securities were divided into two tranches: Senior, which received investment grade rating, and Junior which were high yield securities. Internally at Drexel they were nicknamed CLOWNS which stood for "Collateralized Loan Obligations Worth Nothing Securities". All bonds were paid off at full.

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.[ citation needed ] By 1992 three of the four major banks were insolvent. [7]

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  [ 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. [8] 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. [9] Nordea has been considered one of the strongest and best performing banks in Europe. [10]

International commentators such as Brad DeLong and Paul Krugman have suggested the Swedish bad banking model be adopted internationally. [11]

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. [12] By 2012, the Citi Holdings bad bank represented 9% of the total Citigroup balance sheet. [13] [14]

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. [15]

India's Position

Parliament has to enact a legislation establishing the Bad Bank – by whatever name called – NAMA, PARA, or NAMC. The Government shall retain minority stake in the Bad Bank and invite the private investors to hold the majority. However, the Government should have a right to veto any decision of the Bad Bank. Professionals from various fields should be made part of the management and political interference should be kept to a minimum. The provisions of the Act with respect to acquisition/disposal of bank assets should override any other legal /contractual restrictions including any consent requirements. Valuation of the NPAs should be done by professional agencies and transfer price should not be more than long term economic value of the bad asset. Moreover, the Bad Bank shall not acquire the NPA, if its long term economic value is less than its market value. Safety net provision such as (i) lack of Government guarantees on its subordinated debt, (ii) ‘Claw back provision’ in form of a surcharge on banks, and (iii) purchase price involving an average haircut of 30% on large accounts. [16]

Baltic crisis of 20082011

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 a professional distressed asset management company Reverta. [17]

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. [18] This bad bank’s creation was covered in depth and published in a book by Birgitta Forsberg. [19] 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 nationalised mortgage lenders Bradford & Bingley and Northern Rock (Asset Management). [20] This bad bank manages a total mortgage book of £62.3bn (as at 30 September 2013) [21]

In 2013, the Royal Bank of Scotland transferred £38.3bn of its worst loans to an internal bad bank. [22] In 2014, Barclays Bank dumped the bulk of its commodities operation [23] and fixed income business [24] 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[ when? ] 190 Bn € and 170 Bn € respectively from the failed WestLB and Hypo Real Estate.

Austria (2009)

Hypo Alpe Adria: Nationalised in 2009 by the Austrian government to avert a bank collapse, dismantled in 2014.

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. [25]

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). [26]

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 at the expense of small businesses.

Further reading

Policy Brief: A Brief Comparison of the Bad Bank Experience across Jurisdictions by Dwijaraj Bhattacharya, Amulya Neelam, Deepti George & Madhu Srinivas Dvara Research

How to get the Bad Bank off to a good start by Deepti George & Madhu Srinivas

See also

Related Research Articles

<span class="mw-page-title-main">Nordea</span> Nordic financial institution

Nordea Bank Abp, commonly referred to as Nordea, is a European financial services group operating in northern Europe and based in Helsinki, Finland. The name is a blend of the words "Nordic" and "idea". The bank is the result of the successive mergers and acquisitions of the Finnish, Swedish, Danish, and Norwegian banks of Merita Bank, Nordbanken, Unidanmark, and Christiania Bank og Kreditkasse that took place between 1997 and 2001. The Nordic countries are considered Nordea's home market, having finalised the sales of their Baltic operations in 2019. Nordea is listed on Nasdaq Nordic exchanges in Helsinki, Copenhagen, and Stockholm and Nordea ADR is listed in the US.

Bank of America Home Loans is the mortgage unit of Bank of America. In 2008, Bank of America purchased the failing Countrywide Financial for $4.1 billion. In 2006, Countrywide financed 20% of all mortgages in the United States, at a value of about 3.5% of United States GDP, a proportion greater than any other single mortgage lender.

<span class="mw-page-title-main">Dexia</span>

Dexia N.V./S.A., or the Dexia Group, is a Franco-Belgian financial institution formed in 1996. At its peak in 2010, it had about 35,200 members of staff and a core shareholders' equity of €19.2 billion.

Reverta is a professional-distressed asset management company headquartered in Latvia. With branches in Berlin, Stockholm, Tallinn and representative offices in Tokyo, Moscow, Kyiv, Baku and other cities, the company employs 2,600 staff in 14 countries.

The establishment of the Indonesian Bank Restructuring Agency (IBRA), lit. "National Banking Revitalization Agency") in early 1998 was one of a series of steps taken by the Indonesian government, in agreement with the International Monetary Fund on 15 January 1998, in response to the banking and economic crisis which emerged following the onset of the Asian monetary crisis in mid-1997. Among other things, the drastic depreciation of the rupiah (Rp) reduced bank liquidity, and loss of public confidence in the rupiah and the banking system in general.

Hudson City Bancorp, Inc., based in Paramus, in the U.S. state of New Jersey, was a bank-holding company for Hudson City Savings Bank, its only subsidiary, then the largest savings bank in New Jersey and one of the oldest banks in the United States, with US$50 billion in assets. It is now a fully publicly held entity and a member S&P 500 stock market Index. In 2005, its US$3.93 billion secondary offering of common stock was the largest in United States banking history. At the time, it was also the seventh largest domestic public offering in United States history The bank avoided the excesses of the housing boom and was labeled "best bank of 2007" by Forbes. M&T Bank agreed to acquire Hudson City on August 27, 2012.

This article provides background information regarding the subprime mortgage crisis. It discusses subprime lending, foreclosures, risk types, and mechanisms through which various entities involved were affected by the crisis.

The U.S. central banking system, the Federal Reserve, in partnership with central banks around the world, took several steps to address the subprime mortgage crisis. Federal Reserve Chairman Ben Bernanke stated in early 2008: "Broadly, the Federal Reserve’s response has followed two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy." A 2011 study by the Government Accountability Office found that "on numerous occasions in 2008 and 2009, the Federal Reserve Board invoked emergency authority under the Federal Reserve Act of 1913 to authorize new broad-based programs and financial assistance to individual institutions to stabilize financial markets. Loans outstanding for the emergency programs peaked at more than $1 trillion in late 2008."

<span class="mw-page-title-main">Bankruptcy of Lehman Brothers</span> 2008 bankruptcy of American investment bank

The bankruptcy of Lehman Brothers on September 15, 2008, was the climax of the subprime mortgage crisis. After the financial services firm was notified of a pending credit downgrade due to its heavy position in subprime mortgages, the Federal Reserve summoned several banks to negotiate financing for its reorganization. These discussions failed, and Lehman filed a Chapter 11 petition that remains the largest bankruptcy filing in U.S. history, involving more than US$600 billion in assets.

The Emergency Economic Stabilization Act of 2008, often called the "bank bailout of 2008", was proposed by Treasury Secretary Henry Paulson, passed by the 110th United States Congress, and signed into law by President George W. Bush. It became law as part of Public Law 110-343 on October 3, 2008, in the midst of the financial crisis of 2007–2008. It created the $700 billion Troubled Asset Relief Program (TARP) to purchase toxic assets from banks. The funds were mostly redirected to inject capital into banks and other financial institutions while the Treasury continued to examine the usefulness of targeted asset purchases.

The Sweden financial crisis 1990–1994 was a housing bubble that took place in Sweden that deflated during 1991 and 1992, and resulted in a severe credit crunch and widespread bank insolvency. Similar crises took place in other countries around the same time, such as in Finland and the Savings and loan crisis in the United States. The causes of the crisis were similar to those of the subprime mortgage crisis of 2007–2008. In response, the government took the following actions:

The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector that was passed by Congress and signed into law by President George W. Bush. It was a component of the government's measures in 2009 to address the subprime mortgage crisis.

In the period September 2007 to December 2009, during the events now widely known as the Global Financial Crisis, the UK government enacted a number of financial interventions in support of the UK banking sector and four UK banks in particular.

The 2008–2009 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.

The Finnish Banking Crisis of 1990s was a deep systemic crisis of the entire Finnish financial sector that took place mainly in the years 1991–1993, after several years of debt-based economic boom in the late 1980s. Its total taxpayer cost was roughly 8% of the Finnish GNP, making it the most severe of the contemporary Nordic banking crises. The crisis has been attributed to a combination of macro-economic turbulence, weak regulation, and bank-specific problems. Governmental intervention included bank takeovers, direct monetary assistance and temporary blanket guarantees to the banks.

The Subprime mortgage crisis solutions debate discusses various actions and proposals by economists, government officials, journalists, and business leaders to address the subprime mortgage crisis and broader financial crisis of 2007–08.

<span class="mw-page-title-main">2007–2008 financial crisis</span> Worldwide economic crisis

The 2007–2008 financial crisis, or Global Financial Crisis (GFC), was a severe worldwide economic crisis that occurred in the early 21st century. It was the most serious financial crisis since the Great Depression (1929). Predatory lending targeting low-income homebuyers, excessive risk-taking by global financial institutions, and the bursting of the United States housing bubble culminated in a "perfect storm".

Sareb is the bad bank of the Spanish government. Its purpose is to manage and disinvest high-risk assets that were transferred to it from the four nationalized Spanish financial institutions. The company was formed in 2012.

<span class="mw-page-title-main">Norwest Corporation</span> Former American banking and financial services company

Norwest Corporation was a banking and financial services company based in Minneapolis, Minnesota, United States. In 1998, it merged with Wells Fargo & Co. and since that time has operated under the Wells Fargo name.

Justin Michael Spencer Jenk is a British-Danish business executive and investor. He is a co-founder of the advisory firm, Raktas, and an investor in multiple companies such as: Venturethree, Danfoss-Turbocor, Arcam, Põhjala Brewery and Gate Capital.

References

  1. 1 2 3 4 Gabriel Brenna; Thomas Poppensieker & Sebastian Schneider (December 2009). "Understanding the bad bank". McKinsey & Company. Archived from the original on 7 January 2016. 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.org. NPR. Retrieved 10 April 2013.
  4. 1 2 3 Fitzpatrick, Dan (8 August 2008). "The Return of 'Good Bank-Bad Bank'". The 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. 26 July 1988. Retrieved 4 August 2014.
  6. Moore, Heidi N. (8 September 2008). "The 'Bad Bank' Experience: Lessons From Mellon-Grant Street - Deal Journal - WSJ". Blogs.wsj.com. Retrieved 4 August 2014.
  7. "Im Gespräch: Bo Lundgren: „Ich hätte nie gedacht, dass wir das nochmal machen müssen"". FAZ.NET (in German). ISSN   0174-4909 . Retrieved 5 November 2022.
  8. 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. Archived from the original (PDF) on 21 February 2014.
  9. Hagan, Sean; Christopher Towe (17 April 2009). "An overview of bank Insolvency" (PDF). IMF Staff Papers.
  10. Ingves, Stefan (September 2006). "Finansiella kriser i ett internationellt perspektiv". Riksbanken.
  11. Dougherty, Carter (22 January 2009). "Sweden's fix for bank: nationalize them". The New York Times.
  12. Elstein, Aaron (15 July 2013). "Citi's 'bad bank' shrinks".
  13. Steve Schaefer (15 October 2012). "Citigroup: Making The Good Bank-Bad Bank Model Work". Forbes.
  14. Christina Rexrode & Maureen Farrell (14 July 2014). "Citi's $7 Billion Settlements Ruins First Profitable Quarter at Its Bad Bank". WSJ.
  15. Dawn Kopecki (8 March 2011). "BofA Segregates Almost Half of its Mortgages Into 'Bad Bank'". Bloomberg.
  16. http://corporatelawreporter.com/2017/07/25/jlf-or-ibc-can-a-single-dissenting-lender-derail-the-process-adopted-by-other-lenders-under-extant-jlf-guidelines/>
  17. "The once mighty fall further". Baltictimes.com. 4 August 2010. Retrieved 4 August 2014.
  18. Billing, Anders; Birgitta Forsberg (28 August 2009). "Revolutionen i krisbanken". Affärsvärlden. Archived from the original on 6 April 2016. Retrieved 8 February 2014.
  19. Forsberg, Birgitta (2010). Fritt fall: spelet om Swedbank. Ekerlids. ISBN   978-91-7092-140-7.
  20. Peachey, Kevin (22 May 2014). "BBC News - 'Don't call us the bad bank' - what Northern Rock did next". BBC News.
  21. "Archived copy" (PDF). Archived from the original (PDF) on 23 July 2014. Retrieved 4 July 2014.{{cite web}}: CS1 maint: archived copy as title (link)
  22. Max Abelson & Michael J. Moore (30 April 2014). "Barclays Said to Name Bommensath to Oversee 'Bad Bank'". Bloomberg.
  23. Wilson, Harry (30 April 2014). "Barclays to create 'bad bank' for non–core assets". Telegraph.co.uk.
  24. Frances Coppola (30 April 2014). "Barclays' Bad Bank Plan Shows It Can't Bounce Back". Forbes.
  25. "Portugal in 4.9 billion euro rescue of Banco Espirito Santo". Reuters. Retrieved 3 August 2014.
  26. Krugman, Paul (28 September 2008). "The good, the bad, and the ugly". The New York Times.