Bad bank resolutions and bank lending

Focus

The paper asks whether bad banks, more formally known as impaired asset segregation tools, and recapitalisation lead to a recovery in the lending of the originating banks and a reduction in their non-performing loans.

Contribution

Bad banks have become a widely used way for supervisors and private investors to clean up the balance sheets of troubled banks. Yet the literature still lacks a comprehensive study on which specific design for a bad bank is best at promoting bank lending and reducing non-performing loans. This paper fills the gap by assembling and analysing a new data set on 38 impaired asset management schemes ("bad banks") that covers a total of 135 banks from 15 European banking systems over the 2000-16 period.

Findings

The main finding is that bad banks are effective in cleaning up balance sheets and promoting bank lending only if asset segregation is combined with recapitalisation of the bank's balance sheet. Used in isolation, neither tool will suffice to spur lending and reduce future NPLs. Looking at a wide range of episodes, we find that assets segregation is more effective when (i) asset purchases are funded privately; (ii) smaller shares of the originating bank's assets are segregated; and (iii) asset segregation occurs in countries with more efficient legal systems.

Abstract

The paper investigates whether impaired asset segregation tools, otherwise known as bad banks, and recapitalisation lead to a recovery in the originating banks' lending and a reduction in non-performing loans (NPLs). Results are based on a novel data set covering 135 banks from 15 European banking systems over the period 2000-16. The main finding is that bad bank segregations are effective in cleaning up balance sheets and promoting bank lending only if they combine recapitalisation with asset segregation. Used in isolation, neither tool will suffice to spur lending and reduce future NPLs. Exploiting the heterogeneity in asset segregation events, we find that asset segregation is more effective when: (i) asset purchases are funded privately; (ii) smaller shares of the originating bank's assets are segregated; and (iii) asset segregation occurs in countries with more efficient legal systems. Our results continue to hold when we address the potential endogeneity problem associated with the creation of a bad bank.

JEL codes: E44, G01, G21

Keywords: bad banks, resolutions, lending, non-performing loans, rescue packages, recapitalisations