ECB Says Mix of Bad Bank, Asset Guarantees Curbs Budget Costs
The European Central Bank said governments should consider combining a so-called bad bank with guarantees of securities to achieve the most cost-effective way of ridding lenders of toxic assets.
In draft guidelines being discussed at a meeting of European finance ministers in Brussels yesterday and today, the ECB said the credit crisis shows no sign of ending and that the number of illiquid assets on banks’ books will probably rise.
Lawmakers from Washington to Berlin are studying how to clear the toxic assets clogging bank balance sheets and preventing them from lending. Economist Nouriel Roubini says global bank write-offs could triple to $3.6 trillion, and the ECB is seeking to provide a framework to deal with further woes.
“The credit crisis has not yet reached the bottom of the cycle,” the ECB said in a report obtained by Bloomberg News and dated Feb. 9. “The amount of impaired assets is likely to continue growing in the future.”
Luxembourg’s Jean-Claude Juncker, who led yesterday’s discussion among euro-area finance chiefs, said there is a “vital” need to tackle toxic assets in Europe. He said ministers discussed the issue “at length” and hope to reach agreement among all 27 European Union finance chiefs today.
“The various instruments that might be deployed could be used in some countries for some banks in certain situations,” Juncker said at a press conference in Brussels last night. “We continue to coordinate the European approach to toxic assets, and in the next few weeks, we will be upping the tempo there.”
‘Level Playing Field’
The guidelines aren’t “a one-size-fits-all proposal,” EU Monetary Affairs Commissioner Joaquin Almunia said after yesterday’s meeting, which he attended along with European Commission President Jose Barroso. “We need to guarantee a level playing field,” Almunia said. “This does not mean that all the formulas should be the same.”
While acknowledging that the best strategy varied depending on the bank and country, the ECB noted that Switzerland recently extended aid to UBS AG through a “hybrid scheme” involving elements of a bad bank and insurance. The Swiss National Bank and UBS set up a special fund to buy as much as $60 billion in toxic investments from UBS.
Zurich-based UBS provided $6 billion in capital, which will be used as first protection against losses. The SNB finances the purchase of the assets with secured loans to the fund of up to $54 billion. Such an approach “limits the upfront cost to the government,” the ECB said in the report.
Bad-Bank Approach
The strategy also found support in a separate draft report by the European Commission, which was prepared with ECB input banks issue payday loans. To control costs “one could consider combining a bad-bank approach and asset insurance whereby bad assets are transferred to a single entity which benefits in some way from a government guarantee,” the commission, the EU regulator in Brussels, said in the report.
“This approach combines many of the benefits of the bad- bank approach from the perspective of restoring confidence in the banking system while limiting the budgetary impact,” according to the commission report, which is dated Feb. 6.
The ECB said a bad bank would work best in an environment in which there was uncertainty regarding the future quality of bank assets or the impaired securities are concentrated in a few institutions. Insuring the assets may be the best approach if they are hard to value or governments have bloated public finances, it said.
Cross-Border Activities
The commission also said governments should agree on the criteria for pooling impaired investments to ensure “the consistent treatment of assets” for banks with cross-border activities. An agreement is needed on the range and criteria for eligible assets and how they should be valued “to prevent that differences in approach result in opportunities for cross-border arbitrate and competition distortions,” it said in the draft report.
The commission, which ensures that state aid doesn’t distort competition in the 27-member EU, said governments must avoid a subsidy war, which could hurt public finances. Jonathan Todd, spokesman for EU Competition Commissioner Neelie Kroes, had no comment on the guidelines.
In setting out broad parameters for how governments should craft bank asset-support programs, the ECB said participation should be voluntary and priority given to those with large amounts of impaired assets. The definition of assets eligible for support should be kept broad and valuation of the assets is key to any plan’s success, it said.
Risk should be shared between the state and the banking system, while the program should be allowed to run possibly as long as it takes the assets to mature, according to the ECB report. The banks should be allowed to be run according to business principles and there should be yardsticks established to judge the success of the plan, it said.
There is “a middle course between a bad bank and a guarantee scheme,” Dutch Finance Minister Wouter Bos told reporters after yesterday’s meeting. “But there are a lot of unanswered questions; that discussion is to be continued.”