Financial Protection Private Banks Launch Own 'Bad Bank'

Germany's top private banking association has created its own national bank to help rescue or wind down ailing financial firms, Handelsblatt has learned.
Jürgen Fitschen from Deutsche Bank talks shop with Michael Kemmer, managing director of the Association of German Banks.

"Bad banks" have been all the rage in the past few years. Deutsche Bank, Commerzbank and many other major banks around the world sought to separate billions in bad loans, built up during the financial crisis, from the rest of their banking operations. The job of these internal "bad banks" was to sell off and wind down the bad loans before they infected the rest of the financial firm.

Governments have also gotten in on the act. Italy this year agreed to set up a bad bank to take bad loans out of the hands of the country's struggling private banks.

Now Germany's top private banking association is getting in on the act, and is looking to create a more permanent solution that could help in a future financial crisis, Handelsblatt has learned.

The country's new bad bank, the first of its kind, will have a starting capital of €25 million. The new bank, called EIS-Einlagensicherungsbank, or EIS deposit insurance bank, could also draw from an existing rescue fund run by the association, which its members pay into voluntarily.

The EIS deposit insurance bank "can become active ahead of possible difficulties with banks on behalf of the deposit insurance fund," Dirk Cupei, head of the financial market stability division at the association, told Handelsblatt. The deposit insurance fund was created more than a decade ago to secure customer deposits in case of bank defaults.

The Association of German Banks counts more than 200 private commercial banks among its members, including Deutsche Bank and Commerzbank. Other banking networks in Germany, such as savings banks and cooperatives, have their own form of common deposit insurance and help to bail out their members, though neither of them has set up a "bad bank."

There are no direct models for the deposit insurance bank in Germany. When savings banks run into trouble, the industry has tended to rely on mergers and acquisitions to avert bankruptcies.

The deposit insurance bank will be a small operation. It will have two managing directors and a small number of employees, with only a handful working exclusively for the bank.

There are no direct models for the new bad bank in Germany. When savings banks and state-backed regional banks run into trouble, as some did during the financial crisis, the industry tended to rely on mergers and acquisitions to avert bankruptcies.

Mr. Cupei stressed that it will not be the new bank's responsibility to help every ailing bank. "In some cases, intervention ahead of time can make more economic sense than insolvency," he said, adding that "in other cases, financial market stability dictates that banks be wound down orderly."

The new bad bank could also technically wind down lenders that cannot be rescued, with help from the deposit insurance fund, according to Mr. Cupei. In the future, the bank could also perform the task of compensating depositors on behalf of the fund, he added.

The Association of German Banks decided to set up the EIS deposit insurance bank after it was forced to act to save several of its members since the financial crisis. When the Düsseldorfer Hypothekenbank was once again in serious financial difficulties about a year ago, for example, the association provided warrants and liquidity assistance to avert a bankruptcy.

That particular bank got into trouble after losing money on  bonds that had been issued by the ailing Austrian bank Hypo Alpe Adria, which has since been nationalized. The owner of Düsseldorfer Hypothekenbank, U.S. financial investor Lone Star, refused to step into the breach. The banking association intervened, partly out of concern for the reputation of the German bond market.

"The deposit insurance bank enables the deposit insurance fund to optimize measures it has already taken successfully in the past," Mr. Cupei said. In the future, the fund could eschew warrants and instead "extract troubled portfolios from the bank and transfer them to the deposit insurance bank, thereby stabilizing the bank," he added, explaining the new scope of action.

Ultimately, the involvment of the deposit insurance bank will depend on the circumstances of individual cases. "The bank's mission is not to stabilize every lender that runs into trouble," said a bank representative, who asked not to be identified.

Even before the new bank is created, the deposit insurance fund had already played a role in getting some investors their money back. Since the Compensation Scheme of German Banks was established in 1998, the investors of nine financial institutions have been compensated.

The biggest case to date was the bankruptcy of Lehman Brothers in Germany. The latest example is Canada's Maple Bank, which was shut down by Germany's banking regulator BaFin because the bank was unable to pay several hundred million euros in back taxes it owed the German treasury for illegal dividend-stripping deals.

 

Frank Drost is a Handelsblatt editor in Berlin, covering financial supervision and banks. To contact the author: [email protected]