Creation of ‘bad bank’ may help lenders issue loans, boost portfolios

Capital injections from the state and private shareholders totalling some 900 billion dollars in Europe and the US have failed to help banks write off all toxic assets and jump-start lending, forcing some policymakers to rethink the «bad/good bank» model solution. Greece may have to start thinking along these lines as well. The idea of creating a Greek «bad bank» has not yet been officially tossed about but it is being discussed in some banking circles to help local banks carry on lending without thinking about legacy positions. Proponents of the solution argue this approach has already been used in Switzerland, where the Swiss National Bank bought 54 billion dollars worth of assets from UBS, as well as in other European countries. In Greece, where banks appear to hold very few or no toxic assets, a «bad bank» would end up holding more non-performing loans than any other type of assets. This would help banks drastically improve the quality of their loan and bond portfolios and feel more comfortable about giving new loans to households and companies. According to a recent report by Standard & Poor’s, Greek banks may need an additional capital injection of 9 billion euros in addition to the 5 billion envisaged by the national rescue plan in the worst case economic scenario. There is no question that creating a «bad bank» is easier said than done, for it entails a lot of preparation and sometimes the devil may be in the details. Still, Greece could adopt foreign «bad bank» models to its own needs. This «bad bank» could issue state-guaranteed bonds to finance the purchase of non-performing loans from banks at an agreed discount from their face value. It could then use the proceeds from the liquidation of the acquired assets over time to pay off its bondholders with the rest of the bill being paid by the Greek taxpayer. This idea of a «bad bank» implies that there are more non-performing loans, i.e. loans on which no interest has been paid by the borrower for more than 90 days, on the books of local banks than the latter would like to admit. Of course, up until last October, top bankers insisted their banks were capitalized to weather the storm of the global economic crisis. Some even boasted of their strong capital adequacy ratios, such as core Tier I, which indicate their capacity to absorb losses and meet time liabilities. However, much has changed since then. The Greek economy appears to have slowed much faster than anticipated at that time, while neighboring countries in which Greek banks have a presence are facing a deepening financial and economic crisis. Under political pressure and the need to boost their liquidity and capital, most local banks have agreed to participate in the national rescue plan providing for up to 28 billion euros in state aid. The plan aims at keeping loans flowing at a 10 percent clip to help the economy growing in 2009. Some banks have already made use of the plan to boost their liquidity via borrowing from the European Central Bank (ECB). The Greek rescue plan consists of three parts. One part aims at boosting the capital base of banks through the purchase by the Greek state of preferred shares without voting rights worth up to 5 billion euros in exchange for state bonds to be used for borrowing at the ECB. The other two parts of the plan are designed to beef up the liquidity of local banks. One of them provides banks with state guarantees worth up to 15 billion euros in order to issue bonds with maturities ranging from three months to three years. The other part of the rescue program provides banks with special state bonds which they can use as collateral to borrow short-term funds from the ECB.    After adoption of the rescue plan, government and central bank officials, along with others, believe Greek banks are better equipped to cope with a more challenging economic environment in the months ahead. This may be true but it does not mean the plan is enough. There are already doubts about whether banks will make full use of the 28-billion-euro package. There are two reasons for this. First, state guarantees for issuing bank bonds are considered expensive since Greek bond spreads over German bonds of the same maturity and money market rates have widened significantly since the country’s entry into the eurozone, despite narrowing somewhat last week. Second, banks will try to avoid competing with the state in global markets by issuing 2-to 3-year bonds. The national rescue plan may eventually turn out to be sufficient to meet the needs of the Greek banks in the new economic landscape. Nevertheless, the idea of a Greek «bad bank» may still be worth looking into.