Legal Foundations

The transfer of responsibility for managing the transferred positions to the resolution agency is accompanied by the transfer of the portfolio and then entitles it to loss compensation. The Financial Market Stabilization Fund Act and the Financial Market Stabilization Acceleration Act provide credit institutions with the opportunity to transfer risk positions and non-strategically necessary business areas to an organizationally and economically independent resolution agency.

Loss Compensation Obligation

According to §7 paragraph 1 of the statutes of the AöR, Soffin is obliged to compensate for all losses until the resolution agency is dissolved according to § 16. The guarantee according to the Financial Market Stabilization Fund Act (FMStFG) § 8a (4) 1b sentence 1 (introduced with effect from January 1, 2014) states that the fund is liable for all loans, bonds, forward transactions structured as fixed deals, rights from options, and other securities to the resolution agency as well as for loans to third parties, provided they are expressly guaranteed by the resolution agency and were taken up, issued, concluded, established, or transferred to the resolution agency during the period in which the fund is solely responsible for loss compensation. Since October 1, 2010, the Customer Focus Group has been handling the liquidation of acquired assets, securities, and derivatives. All employees of the entire Customer Focus Group are obliged to actively and efficiently manage and maximize the value of the portfolio and investments in the interest of all European taxpayers.

Bad Bank

A bad bank is a separate institution for handling risky securities or loans threatened by defaults. By outsourcing such problem portfolios into a bad bank, a bank aims to free its balance sheet from these so-called risk assets in order to achieve better balance ratios and thus better lending opportunities. Furthermore, outsourcing should allow for optimal utilization of securities or loan portfolios without time pressure. In Germany, ultimately the rescue fund SoFFin, i.e., the taxpayer, is liable for the liabilities of bad banks and must cover losses.

How Does The “Bad Bank” Model Work?

For example: Federal Republic of Germany

The federal government has contributed significantly to stabilizing the financial system through several measures. Nevertheless, the necessary trust between market participants has not fully returned to this day. The reason for this is large holdings of risky securities that burden the balance sheets of credit institutions, financial holding companies, and their subsidiaries. These securities tie up equity capital, which reduces banks’ ability to lend more loans to ordinary customers. Therefore, on May 13, 2009, the cabinet passed a law on further developing financial market stabilization that addresses this issue. The core: Banks can establish “bad banks” and transfer structured securities to them. The state guarantees this – banks have to pay for it. The Bundestag passed the law on July 3, 2009.

What are “Toxic Assets” and Why Are They a Problem for Us All?

In uncertain times, banks find it difficult to evaluate and sell structured securities. These papers therefore lead to write-downs every quarter. More capital must constantly be deposited for these papers, which then lacks in lending to customers. This situation hampers further recovery of financial markets and the economy. The federal government sees a need for action – in the interest of all citizens. To exit the crisis, it is important that the financial sector adequately supplies its customers – ordinary businesses around the corner with millions of jobs – with loans again.

How Does The Federal Government’s Bad Bank Regulation Work?

Under the term “bad bank,” various models were discussed on how such papers can be outsourced from banks’ balance sheets. The federal government relies on decentralized “bad banks” to enable “toxic waste disposal” from banks. Since bad banks take the form of special purpose vehicles (SPVs), this model is also referred to as the “special purpose vehicle model.” However, this “toxic waste disposal” does not come free! A bank can establish an SPV – its own “bad bank” – which does not require a banking license. It transfers its risky securities to it with a typical ten percent discount from book value. The cut-off date for book value is June 30, 2008. This means: The book value at that time is reduced by 10 percent to calculate the transfer value. This may not exceed the book value as of March 31, 2009, which was initially intended as a cut-off date.

In return, the bank receives a bond from the SPV in an equal amount.

The state guarantees this bond via SoFFin (the banking rescue fund). The advantage of this exchange lies in that banks can submit these bonds at Bundesbank in exchange for new money – something that was not possible with original securities. This releases equity capital that can now be used for granting new loans.