Carving out legacy assets: a successful tool for bank restructuring?
Separating ‘legacy assets’ from banks’ core business is central to the rehabilitation of Europe’s banking system. How can Europe progress in its ongoing effort to rid the financial system of legacy assets, and equip it with renewed growth?
This material was originally published in a paper provided at the request of the Committee on Economic and Monetary Affairs of the European Parliament and commissioned by the Directorate-General for Internal Policies of the Union and supervised by its Economic Governance Support Unit (EGOV). The opinions expressed in this document are the sole responsibility of the authors and do not necessarily represent the official position of the European Parliament. The original paper is available on the European Parliament’s webpage (here). © European Union, 2017
The separation of so-called legacy assets from the remaining healthy business of a bank has become a central concern in risk management and supervision. In the European Union, non-performing loans amount to over €1 trillion and an additional stock of non-core assets that is at least as large is also being offered in the secondary market.
Banks have employed various organisational models to separate these assets from their core business. At one extreme, banks have tasked specialist staff to focus on workout or selective sales, while the bulk of these assets remain on the same balance sheets. To do this, appropriate incentives have to be set for bank staff, and a number of failures that are inherent to the market for loan sales have to be addressed.
At the other extreme, in situations of serious distress, countries set up external asset management companies (AMCs), either specific to an individual bank, or working across the industry for specific types of loans. As the transfer to another entity crystallises the value loss of legacy assets, this option requires a capital injection and restructuring of the bank’s balance sheet.
Past EU experience has demonstrated the effectiveness of AMCs, in particular when they work with a large part of the banking sector and are focused on specific loan types. Asset separation in conjunction with an asset management company can also be an effective tool for bank resolution, but the difficulties inherent in setting up an AMC and achieving a track record in restructuring should not be underestimated. Countries are well advised to prepare the legal basis for such entities.