Bad Bank(s) and Recapitalization of the Banking Sector
AbstractWith banking sectors worldwide still suffering from the effects of the financial crisis, public discussion of plans to place toxic assets in one or more bad banks has gained steam in recent weeks. The following paper presents a plan how governments can efficiently relieve ailing banks from toxic assets by transferring these assets into a publicly sponsored work-out unit, a so-called bad bank. The key element of the plan is the valuation of troubled assets at their current market value - assets with no market would thus be valued at zero. The current shareholders will cover the losses arising from the depreciation reserve in the amount of the difference of the toxic assets' current book value and their market value. Under the plan, the government would bear responsibility for the management and future resale of toxic assets at its own cost and recapitalize the good bank by taking an equity stake in it. In extreme cases, this would mean a takeover of the bank by the government. The risk to taxpayers from this investment would be acceptable, however, once the banks are freed from toxic assets. A clear emphasis that the government stake is temporary would also be necessary. The government would cover the bad bank's losses, while profits would be distributed to the distressed bank's current shareholders. The plan is viable independent of whether the government decides to have one centralized bad bank or to establish a separate bad bank for each systemically relevant banking institute. Under the terms of the plan, bad banks and nationalization are not alternatives but rather two sides of the same coin. This plan effectively addresses three key challenges. It provides for the transparent removal of toxic assets and gives the banks a fresh start. At the same time, it offers the chance to keep the cost to taxpayers low. In addition, the risk of moral hazard is curtailed. The comparison of the proposed design with the bad bank plan of the German government reveals some shortcomings of the latter plan that may threaten the achievement of these key issues.
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Bibliographic InfoPaper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 897.
Length: 29 p.
Date of creation: 2009
Date of revision:
Financial crisis; financial regulation; toxic assets; Bad Bank;
Other versions of this item:
- Dorothea SchÃ¤fer & Klaus F. Zimmermann, 2009. "Bad Bank(s) and Recapitalization of the Banking Sector," Working Paper / FINESS, DIW Berlin, German Institute for Economic Research 3.1B, DIW Berlin, German Institute for Economic Research.
- Schäfer, Dorothea & Zimmermann, Klaus F., 2009. "Bad Bank(s) and Recapitalization of the Banking Sector," CEPR Discussion Papers 7349, C.E.P.R. Discussion Papers.
- Schäfer, Dorothea & Zimmermann, Klaus F., 2009. "Bad Bank(s) and Recapitalization of the Banking Sector," IZA Policy Papers 10, Institute for the Study of Labor (IZA).
- G20 - Financial Economics - - Financial Institutions and Services - - - General
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-07-03 (All new papers)
- NEP-BAN-2009-07-03 (Banking)
- NEP-CFN-2009-07-03 (Corporate Finance)
- NEP-FMK-2009-07-03 (Financial Markets)
- NEP-REG-2009-07-03 (Regulation)
You can help add them by filling out this form.
Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:CitEc Project, subscribe to its RSS feed for this item.
- Ito, Takatoshi, 2009. "Fire, flood, and lifeboats: policy responses to the global crisis of 2007-09," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Oct, pages 207-249.
- Boysen-Hogrefe, Jens & Dovern, Jonas & Groll, Dominik & van Roye, Björn & Scheide, Joachim, 2010. "Droht in Deutschland eine Kreditklemme?," Kiel Discussion Papers 472/473, Kiel Institute for the World Economy (IfW).
- Dorothea Schäfer, 2012. "Financial Transaction Tax Contributes to More Sustainability in Financial Markets," Discussion Papers of DIW Berlin 1198, DIW Berlin, German Institute for Economic Research.
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