The good bank bad bank conundrum

Matt Buttell

The concept of "Good Bank Bad Bank" goes back all the way to the days of the Great Depression. As bank after bank began to fail in the wake of the stock market crash of 1929, the US government acquired failing banks' devalued assets, allowing the still viable part of the bank to go forward with those of its assets which still retained their value, and with fresh funds.

The concept is still going strong in today's vulnerable financial services market. Just last week, amidst the resurgence of the bankers' bonus debate, it was announced that the good bank bad bank model was to be introduced in the UK via failed high street mortgage lender Northern Rock.

According to reports, Northern Rock will be split into two business so that one, the "good bank," can retain savers' money, carry out new lending and hold some existing mortgages, while a second business, the "bad bank," is set to hold the rest of the mortgages and repay outstanding government loans.

Financial guarantees

Now though, the Treasury has warned that the firm may lose retail deposits worth billions once the government removes financial guarantees from the state-owned lender next spring.

That's because, according to Treasury insiders, the government intends to remove the 100 percent guarantees so the "good bank" can be valued and sold back to the private sector.

Its a pressing concern, with analysts predicting that if the Treasury assumptions are realised, a loss of deposits would undoubtedly lower the price that the UK government could attract in any sale of the good bank.

What's more, when Northern Rock received the go-ahead to divide itself into a good bank, bad bank set-up - the first step towards the firm's re-privatisation - the move also came with the news that Chancellor Alistair Darling would be injecting another GBP£3 billion of working capital into the bank, and lending it another GBP£8 billion.

As if compounding the fact that banks' futures are now more uncertain than ever, while Lloyds Banking Group has also announced a rights issue to raise around GBP£13 billion, as its biggest shareholder, the Treasury will subscribe almost GBP£6 billion of that. And, RBS, currently 70 percent taxpayer-owned will see that figure rise to 84 percent.

Outside of the UK, the good bank bad bank argument also continues to swell. Just last week, Neelie Kroes - the European Competition Commissioner - remained in fierce negotiations amidst fears she would impose strict conditions on banks that had been rescued by government bodies.

Kroes already shook-up the market by ordering Dutch financial group ING to sells its insurance business - worth more than GBP£10 billion - and halving the size of the Dutch group. "My job is about acting as referee," Kroes has explained in the past. "If we think of the European economy as a football match, I set and enforce the rules of the game. We make sure it is a fair match and that there is punishment for people and companies that break the rules and spoil the game for others."

The regulator has also already forced Commerzbank, now 25 percent owned by the German government, to halve its balance sheet, and has demanded disposals by Fortis, the state-rescued Belgian bank.

Back in the UK, with the good bank band bank model now on the horizon, there is concern that splitting up firms could in fact be detrimental to competition rules. While RBS, Lloyds and Northern Rock face a split, the likes of Barclays and HSBC grow with abundance; sparking concern that competition is actually being reduced rather than increased for these standalone banks, as state-owned competitors have their offerings weakened.

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Northern Rock sale moves closer | Northern Rock to get the green light