Whenever the financial crisis happen the concept of bad banks becomes common. In 2009 during the sub-prime crisis so called blogLehman crisis the concept of bad banks was very famous.

As per the information from Bloomberg:

The Bank of Portugal unveiled a 4.9 billion-euro ($6.6 billion) bailout over the weekend that will leave shareholders and junior bondholders with losses, while sparing senior creditors and unsecured depositors. Banco Espirito Santo, once the country’s largest lender by market value, will be split in two, with depositors and healthy assets joining the newly formed Novo Bank while bad loans and junior creditors stay with the old bank until it can be shut down.

“To regulators in Frankfurt and Brussels, this must have seemed the safest way to isolate any residual and tail risks” related to the bank’s Angolan unit and loans to other parts of the Espirito Santo group, Citigroup Inc.

Going back to bad bank, The concept is simple. The bank divides its assets into two categories. Into the bad pile go the illiquid and risky securities that are the bane of the banking system, along with other troubled assets such as nonperforming loans. For good measure, the bank can toss in non-strategic assets from businesses it wants to exit, or assets it simply no longer wants to own as it seeks to lessen risk and deleverage the balance sheet. What are left are the good assets that represent the ongoing business of the core bank.

By segregating the two, the bank keeps the bad assets from contaminating the good. So long as the two are mixed, investors and counterparties are uncertain about the bank’s financial health and performance, impairing its ability to borrow, lend, trade, and raise capital. The bad-bank concept has been used with great success in the past and has today become a valuable solution for banks seeking shelter from the financial crisis.

While the idea is simple, the practice is quite complicated. There are many organizational, structural, and financial trade-offs to consider. The effect of these choices on the bank’s liquidity, balance sheet, and profits can be difficult to predict, especially in the current crisis. Capital and funding markets are still fragile in many regions, and many asset classes have been severely affected.

Will try to publish the concept in detail soon J ..

 

 

 

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