Banks should be left to sort out their own toxic assets and troubled loans and create so-called "bad banks" with enough financial clout to be able to unwind over time, a veteran of such restructurings told Reuters.
"Individual bad banks are a better solution than a single bad bank because they are more manageable and faster to get moving," Jan Eric Kvarnstroem told Reuters in an interview.
Kvarnstroem, a Swedish banker whose European Resolution Capital was set up to advise on bad bank projects, headed the Dresdner Bank unit that restructured bad loans earlier this decade and was a pivotal player in Sweden's much-vaunted banking rescue in the 1990s.
He said a key consideration in setting up a bad bank was for leaders to have a clear view on the strategy of the healthy bank and allow its employees to focus on doing business.
"You have to design the surviving bank so that it is fit for the future," said Kvarnstroem, adding those who set up toxic assets are in the best position to help get rid of them.
His view echoes that of Martin Blessing, chief executive of Commerzbank which now owns Dresdner.
German Chancellor Angela Merkel has also said she opposes setting up a central bad bank to warehouse toxic assets that would leave taxpayers to foot the bill.
But the state will be forced to take a lead role in sorting out the crisis and restoring confidence in the banking system. The EU is working on a common approach.
Banks struggling to slog their way clear of the toxic on their balance sheets need a clear sense of what to take with them and what to leave behind, and face years of work before the complex derivative and structured finance products at the heart of the current crisis can be laid to rest, Kvarnstroem said.
Bankers and governments must not lose sight of a few basic management principles in deciding how to deal with bad assets, which have already prompted more than $700 billion in writedowns in the United States and Europe alone.
TAXPAYER BENEFIT
Kvarnstroem said any state efforts to smooth restructuring must allow taxpayers to benefit from any upside.
"You have to find some kind of formula to attract private capital into the bank but also treat new money from shareholders and money from the government in a similar way," he said.
JP Morgan analysts calculate that four German banks — Commerzbank, Deutsche Postbank, Hypo Real Estate and Aareal Bank — alone hold around 93 billion euros ($121 billion) in "at risk" loans and securities on which they face 34 billion euros in potential writedowns.
Kvarnstroem said banks need to "ring-fence into discontinued business, not just assets that are toxic but also those that don't support the core business, because if you have a shortage of capital, you have to free up risk capital from activities that don't bring very much".
The bad bank, once created, must have the financial wherewithal to work down its portfolio of bad credits without depressing market prices, even if it takes years, he said.
Dresdner Bank's Institutional Restructuring Unit completed its task — working down a 35 billion euro portfolio — in less than three years, half the time originally planned, while Sweden's bank restructuring had been planned to last 15 years.
A source close to European banking regulators has told Reuters the current batch of complex structured assets could take a bad bank decades to unwind.
MAKING TOXICS SWEAT
There was also no getting around the difficult task of drilling into the sub-components of the asset-backed securities now smouldering on banks' balance sheets, Kvarnstroem said.
"You've got to get to grips with the underlying assets as soon as possible to influence them to try to perform better."
That meant the bad bank must employ experts in business sectors such as real estate, while still minimising costs.
"You have to judge how to protect your assets, whether it's worth it, and how you do it. That takes a hell of a lot more work than just monitoring if the loan pays interest," he said.
Sweden's banking recovery gave hope that banks could be cleaned up, well capitalised and properly managed, letting taxpayers recover a big part of their equity injection, Kvarnstroem said.
"You had a small loss from the bad bank, good performance from the focused, good bank and a stabilisation of the system."
