Stressed Assets in Banks and Bad Bank

Bad bank is not all about bad.

Wiki gives definition of Bad Bank as:

A bad bank is a corporate structure to isolate illiquid and high risk assets held by a bank or a financial organisation, or perhaps a group of banks or financial organisations.A bank may accumulate a large portfolio of debts or other financial instruments which unexpectedly increase in risk, making 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. 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 government or some other official institution as part of an official response to financial problems across a number of institutions in the financial sector.

In addition to segregating or removing the bad assets from parent banks' balance sheet, 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.

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. 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.

Reuters published a report on June 5th on performance of UK Bad Bank. I would request readers to please see the article. The website is :https://in.reuters.com/article/ukar-results-idINL4N23C1ER. It may be seen also that the same Bad bank repays last of the 48.7 billion pounds used to fund the bailouts given to two Banks.

McKinsey & Company helped design a solution, and chose to establish two bad banks on request of Swedish Authorities which were Retriva and Securu and the result can be seen in Swedish banking crisis period of 1972 and after math.

Of course first bad Bank was created to handle banking crisis of Italy to handle problem in nonperforming energy and real esate loans and it was Milan bank. I feel the need of quoting Wiki again.

A dumping ground for non-performing energy and real estate loans, 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 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

It is 2019. in India the NPA figure of december goes by some what Rs.8.41 lakh crores.It is 5th in the world and fourth position is taken by EU. I am not quoting Portugal or PIIGS (Portugal, Italy, Ireland, Greece and Spain) countries. Indias NPA ratio is 400 times more that of Spain. Ref: https://www.businesstoday.in/current/policy/npa-problem-india-ranking-bad-loans-economies-with-huge-npa-bank-recapitalisation/story/266898.html

Bad bank is not all bad. Its creation will clean all mess in the system on a particular date.After that let the banks perform or perish.It has to be survival of the fittest always and the bad bank may make a start with little expenses and I believe the results will be amazing.

It is only profit and profit all the way.

See the result of efforts of UK bad bank. It is just one example. I have already referred the Reuters website before which has the news of June 5th.

Disclaimer: The author's view are strictly his own and personal. He is not an economist or financial expert.