Next Steps for the Banks?

In my previous post, I dealt with what to do if the banks are solvent. But it seems now that the banks are not solvent; at least they will not be solvent in the forseable and credible event of further major losses on their assets (their loan books). What to do with insolvent banks is difficult. 

We need a plan of action to deal with these banks.

The easiest and most straightforward plan are nationalisation or bankruptcy.  

At one extreme is full bankruptcy. Creditors of the bank would be wiped out as seen by the Lehman brothers; this leads to lots of money for lawyers. This is probably a bad move because of the interconnected nature of the banking system; there is lots of paper and therefore lots of legality.

At the other extreme is nationalisation with full reimbursment of those who hae deposited money. The issue with this is that the banks may have very large credit risks, and the UK sovereign may not be able to bear all of these risks. 

Somewhat in the middle is restructuring of the existing banks; swapping the creditors into equity.

After nationalisation, the bank would be seperated into a bad bank and a good bank. The good bank would continue to sell.  Bad banks are equity investments. They contain assets but no lending capability. 

I think the government needs to assume lending capabilities itself. It needs to create some good banks. There should be at least one good bank.

2 comments:

Anton Howes said...

You touched on the best solution: debt-for-equity swaps. Involves government minimally and will not require taxpayer guarantees.

Have posted quite a bit on this myself.

I don't like the idea of government assuming lending capabilities- great potential for statism, favouritism and corruption - what's to stop them denying loans to businesses that donate to opposition parties?

"Good bank, bad bank" sounds alright - problem is valuing assets. If you get it wrong first time, you've tainted the good bank already, or put some good assets in the bad bank. With Debt-for-equity swaps however, you overvalue it to begin with (just in case) and when this emerges, the share prices that you compensated the creditors with rises.

TheClimatePhilosopher said...

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