Bad Banks: A Comprehensive Guide to Banking Crises

Bad banks are essentially separate entities created by banks to isolate and manage their bad loans and other toxic assets.

This concept was first introduced in the 1990s in Germany, where it was used to deal with the aftermath of the country's reunification.

Bad banks help banks to clean up their balance sheets by transferring these assets to a separate entity, allowing them to focus on lending and other core banking activities.

In a typical bad bank setup, the assets are transferred at a discounted value, which helps to reduce the bank's losses.

By doing so, bad banks enable banks to recover from financial crises and get back to lending to the economy.

A bank is a financial institution that provides a range of financial services to its customers.

Banks accept deposits from individuals and businesses, which they use to make loans to others.

They also provide other services like checking and savings accounts, credit cards, and loans.

Banks act as intermediaries between savers and borrowers, matching those with excess funds to those who need them.

They generate revenue by charging interest on loans and fees for services.

Banks are usually insured by a government agency, such as the FDIC in the US, which protects depositors' funds up to a certain amount.

This insurance gives depositors confidence in the safety of their deposits.

The history of banking crises is a long and complex one, but there are some notable examples that can help us understand the concept of bad banks. One such example is the Swedish banking crisis of 1992, which was caused by a combination of over-speculation in property assets and the exchange rate of the Swedish krona.

By 1992, three of the four major banks in Sweden were insolvent. To address this crisis, the Swedish authorities engaged McKinsey & Company to help design a solution.

The solution involved the establishment of two bad banks, Retriva and Securum. These bad banks took over the non-performing loans from two of the major banks, with the good bank operations continuing as Nordea.

The government retained a significant equity stake in Nordea, which was eventually considered one of the strongest and best performing banks in Europe. Lars Thunell was appointed to lead Securum, supported by Anders Nyrén and Jan Kvarnström to manage its toxic book, valued at sek 51 billion at the time.

The performance of Securum has been analyzed by many, including Claes Bergström. While the figures are debated, the cost of the bad bank solution was no more than 2% of GDP, an extremely good result.

Other notable examples of bad bank solutions include Crédit Lyonnais in 1994 and Dexia.

In Sweden, the banking crisis of 1992 was a major turning point in the country's financial history. The crisis led to the establishment of two bad banks, Retriva and Securum, which took over nonperforming loans from insolvent banks.

Securum, in particular, was a success story, with analysts estimating that its cost was no more than 2% of GDP. This was a remarkable result, considering the initial costs and time frame involved. The government retained a significant equity stake in Nordea, which has since become one of the strongest and best-performing banks in Europe.

The Swedish model has been praised by international commentators, including Brad DeLong and Paul Krugman, who have suggested that it be adopted internationally. Other countries, such as Germany and Finland, have also established bad banks to deal with their own financial crises.

Bad Banks is a prime example of how German TV is changing, premiering at the Berlinale International Film Festival and later becoming available online.

The show's online viewing figures were impressive, with more than a million views within a week, prompting the networks to order a second season.

Bad Banks has since been snapped up by Hulu in the US and has aired in over 40 countries, showing how German series are now reaching global audiences.

Filming of the second season began in January 2019, with new episodes continuing the story of the financial world's crisis.

The show's success is a testament to the enduring presence of bankers, with the writers able to find new storylines in the real-world headlines about ongoing bank troubles.

The show's director, Christian Schwochow, has even gone on to helm episodes of The Crown, a sign of the growing influence of German creatives in the industry.

In 1998, Indonesia faced the Asian Financial Crisis, which led to the establishment of the Indonesian Bank Restructuring Agency (IBRA) to oversee the asset disposals of distressed banks.

The Asian Financial Crisis emerged in Indonesia and several other countries in Asia in 1997 and 1998. The Indonesian government took swift action to address the crisis.

IBRA was created as an official body to manage the asset disposals of the distressed banks. This move helped to contain the crisis and prevent further economic damage.

The Indonesian government's decision to establish IBRA was a crucial step in resolving the country's banking crisis. It allowed for a systematic approach to addressing the problem.

IBRA played a key role in restructuring the banking sector in Indonesia. Its efforts helped to restore stability to the country's financial system.

The Indonesian government's experience with IBRA serves as a model for other countries facing similar banking crises. It highlights the importance of swift and decisive action in addressing such challenges.

The Asian Financial Crisis had a significant impact on Indonesia's economy. It led to widespread job losses and economic hardship for many people.

However, the establishment of IBRA helped to mitigate the effects of the crisis. It allowed the government to take control of the situation and implement measures to address the banking crisis.

Sweden's banking crisis of 1992 was a perfect storm of over-speculation and exchange rate issues that left three major banks insolvent.

The Swedish authorities wisely brought in McKinsey & Company to help design a solution, which included establishing two bad banks, Retriva and Securum. The government retained a significant equity stake in Nordea, which continued as a good bank.

Retriva took over non-performing loans from Gota Bank, while Securum took over those from Nordbanken, with a toxic book valued at sek 51 billion. Lars Thunell led Securum, supported by Anders Nyrén and Jan Kvarnström.

The performance of Securum has been analyzed by experts like Claes Bergström, who found that the cost was no more than 2% of GDP, an extremely good result. Both bad banks eventually made a positive return.

In fact, Nordea is now considered one of the strongest and best performing banks in Europe. International commentators like Brad DeLong and Paul Krugman have suggested adopting the Swedish bad banking model internationally.

Here are some key takeaways from the Swedish experience:

The Baltic Crisis of 2008-2011 was a significant economic event that affected Estonia, Latvia, and Lithuania. These countries joined the European Union in 2004, attracting foreign investment and launching a real estate bubble that eventually burst during the financial crisis.

The crisis was particularly severe in Latvia, where Riga-based Parex Bank held large sums from foreign depositors that began withdrawing assets around the time of Lehman Brothers' collapse in September 2008.

Latvia's government took a controlling interest in Parex in November 2008 and spun 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.

Swedbank, a major Swedish bank, was also exposed to the crisis, with over sek150 million of impaired loans. The Swedish authorities supported the new CEO of Swedbank, Michael Wolf, who engaged bad bank specialists to form and manage Swedbank's bad banking operations.

The creation of Swedbank's bad bank was instrumental in rescuing the bank and stabilizing the region's economy. Today, Swedbank is considered one of Europe's stronger and better performing banks.

The United Kingdom has a unique approach to managing bad assets. In 2010, the UK government established UK Asset Resolution, a state-owned limited company to manage the assets of Bradford & Bingley and Northern Rock.

This bad bank manages a total mortgage book of £62.3bn as of 30 September 2013. That's a significant amount of money.

The Royal Bank of Scotland also got in on the action, transferring £38.3bn of its worst loans to an internal bad bank in 2013. This move was likely a smart decision given the bank's troubled history.

Barclays Bank took a similar approach, dumping the bulk of its commodities operation and fixed income business into an internal "bad bank" in 2014.

Germany has several bad banks dating back to the 1980s, including Bankaktiengesellschaft (BAG) and Bankgesellschaft Berlin.

One of these bad banks is the Erste Abwickelungsanstalt, which holds 190 billion euros in assets from the failed WestLB.

The FMS Wertmanagement, another German bad bank, holds 170 billion euros in assets from the same failed institutions.

Germany's bad banks were inherited from the 1980s, with some still struggling to recover today.

In 2009, the Austrian government nationalized Hypo Alpe Adria to prevent a bank collapse.

The bank was dismantled in 2014, but not before it had served as a bad bank to hold toxic assets.

Interestingly, the Swedish banking crisis of 1992, which also involved the creation of bad banks, was resolved with a cost of no more than 2% of GDP.

This is a remarkable outcome, especially considering the scale of the crisis.

The Swedish bad banking model, which involved the creation of two bad banks, Retriva and Securum, has been cited as a successful example by international commentators like Brad DeLong and Paul Krugman.

The model was used to resolve the crisis by separating the good and bad assets of the banks, allowing the good assets to continue operating as a strong bank.

In contrast, the Austrian government's decision to nationalize Hypo Alpe Adria and dismantle it later on was a more drastic measure.

However, it's worth noting that the Swedish model was specifically designed to address the crisis in a more targeted and efficient way.

Here's a brief comparison of the two approaches:

The Swedish model's success highlights the importance of having a clear plan in place to address financial crises, rather than relying on more drastic measures like nationalization.

Finland has a unique approach to handling banking crises, as seen in the case of the Säästöpankki group/SKOP and STS Bank collapse in the 1990s.

The government created two bad banks, OHY Arsenal and Sponda, to take over the bad debt.

In 2015, OHY Arsenal started the process of winding down by filing for bankruptcy, which resulted in the collection of 200 million euros of remaining capital.

Sponda, on the other hand, was privatized and listed on the Helsinki Stock Exchange in 1998.

By 2012, the government had sold all its shares in Sponda, and it continues to operate on the stock market as of 2016.

India has a clear plan for establishing a Bad Bank, with Parliament needing to enact a legislation to make it a reality.

The Government will retain a minority stake in the Bad Bank, while private investors will hold the majority. However, the Government will have the right to veto any decision made by the Bad Bank.

Professionals from various fields will be part of the management team, and political interference will be kept to a minimum.

The Bad Bank will not acquire an NPA if its long term economic value is less than its market value.

The valuation of NPAs will be done by professional agencies, and the transfer price will not be more than the long term economic value of the bad asset.

The Bad Bank will have a safety net provision, including a lack of Government guarantees on its subordinated debt, a 'Claw back provision' in form of a surcharge on banks, and a purchase price involving an average haircut of 30% on large accounts.

In 1988, Grant Street National Bank was created to house the bad assets of Mellon Bank. This is an example of a bad bank structure.

A bad bank is essentially a separate entity that holds a bank's nonperforming assets, allowing it to start fresh and begin lending again. The financial crisis of 2008 saw a renewed interest in this solution.

Federal Reserve Chair Ben Bernanke proposed using a government-run bad bank to clean up private banks with high levels of problematic assets. This would have allowed banks to start lending once more.

In 2009, the Republic of Ireland formed a bad bank called the National Asset Management Agency to deal with its own financial crisis.