Bad Banks as a Response to Crises: Global Outlook

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During the 2008/09 financial crisis, American and European banks faced massive non-performing loans (NPL). The only player with the resources to assist banks in such situations is the government. This means that the problem as well as its “solution” become a public matter. In the United States, the government chose the Troubled Assets Relief Program (TARP). While its name implies that the US government would buy up troubled assets, in practice it never did so; the money instead went mostly to purchase preferred bank stock, which injected capital into banks (Blinder, 2013). A second choice would be for governments to
nationalize fully a given bank. A third choice is to follow the name of TARP, namely for the government to take over the troubled assets of a given bank or even of most of the financial sector. They usually acquire and then (at some point) try to sell off non-performing assets (Klingebiel, 2000).2 These choices are not mutually exclusive of course; a government can both take over a bank and split off its “toxic” assets, as happened in Germany with Hypo Real Estate.3 Ultimately, our goal is to explain why governments chose to go down a given path to address a financial crisis. Before one can move down the game tree, however, one first has to understand the content of those choices.

This paper, which is an early part of a broader project, examines one branch of the game tree decisionmakers follow when dealing with massive NPLs, namely the creation of public asset management corporations (AMCs), which are colloquially known as “bad banks.” There are several design choices governments face. Should there be one centralized AMC for the financial sector, or should they be created separately for each bank in trouble? Centralised AMCs are given almost the sole responsibility for acquiring and disposing of distressed assets from a country’s banking system. Decentralised agencies either share that responsibility with multiple entities and/or are assigned the job of acquiring and disposing assets from particular banks. Once they are established, who governs them, to whom are they accountable, and what do they do? What determines the choices governments make when designing one or more AMCs? Following the broader institutional design literature, we can anticipate that choices about control and accountability affect the relative success of AMCs in winding down “bad” debts. Much of the existing literature is concerned with the costs of crises to the government. How well AMCs can wind down bad debts greatly influences how costly a banking crisis is for the public.

In this paper we first define what AMCs are and some of their key types. This is a particularly important task as definitions vary considerably between authors. Then we discuss how governments may choose and design AMCs. In the third section we describe our AMC data set. In this paper, we review every AMC that has been created in the past 30 years. They appeared in Africa, the Americas, Asia, and Europe. Currently many European countries are experimenting with recently created AMCs to deal with the fallout of the 2008/09 financial crisis. These include the Irish National Asset Management Agency (NAMA), Spain’s La Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria (Sareb) and numerous German entities set up to help wind down the NPLs of individual banks, such as Hypo Real Estate and WestLB.

Public AMCs were used in previous European banking crises, notably in Finland and Sweden during the early 1990s crisis. AMCs were used extensively in East Asia to help resolve the 1997 Asian Financial Crisis. And AMCs were part of the solution to the savings and loan crisis.

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