“Bad banks” and their role in the deleveraging process

The crisis management of banks in Spain 
“Bad banks” and their role in the deleveraging process
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1 de noviembre de 2017

A good bank/bad bank scheme is a well-established banking crisis management tool, repeatedly used in the past throughout financial systems. Moreover, it has received legal recognition and is expressly contemplated in the ‘resolution toolbox’ of the EU resolution directive (the "BRRD"). The spin-off of an ailing institution into two vehicles –whether those vehicles are actual companies or not– may not be, in itself, enough as a resolution tool, but it is a relatively frequent step and resolution strategies often involve its use. The fundamentals of the idea are rather simple: damaged or legacy assets demand effort and management to maximise recovery and, when commingled with the healthy part of a banking business, they are not only unproductive but also drag in financial, technical and managerial resources that would more profitably be devoted to assets that can deliver better returns and, above all, to the origination of new business. Therefore, it is often –though, needless to say, not always– useful to establish a separation between legacy assets and healthy ones, and to put each under the appropriate managerial structure, so that the bad assets may be divested in an orderly fashion, turned around, or liquidated in the least harmful way possible, whereas the good ones, unencumbered, may form a new, viable institution.

While ‘good banks’ are invariably banks, ‘bad banks’ often are not. This is because in order to maximise recovery, managers of bad banks need to be freed from the constraints of banking regulation that apply to banks which are a going concern. This is easier, of course, when the bad bank and the good bank operate as separate legal entities, but that need not be the case.

In this article we shall briefly examine the notion and its use in the crisis management of banks, in particular since 2007, and with special focus on the Spanish case which, in addition to being the closest to the author’s experience, is, to his knowledge, the most relevant in recent history in terms of the volume of assets involved.

Investing in distressed debt in Europe: the TMA handbook for practitioners, November 2016. 

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1 de noviembre de 2017