Not so much bail-out as rip-off

Whenever there is a systemic banking crisis there is a need to recapitalise the banking/financial system to avoid a destructive credit contraction. But purchasing toxic/illiquid assets of the financial system is not the most effective and efficient way to do this.

Such government-led recapitalisation – via the use of public resources – can occur in a number of ways: by purchasing bad assets or loans; an injection of preferred shares; an injection of common shares; a purchase of subordinated debt; an issuance of bonds to be placed on the banks’ balance sheet; an injection of cash; credit lines extended to the banks and government assumption of government liabilities.

A recent IMF study (pdf) of 42 systemic banking crises across the world shows how different crises were resolved.

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In only 32 of the 42 cases was there any government financial intervention of any sort; in 10 cases systemic banking crises were resolved without any such action. Of the 32 cases where the government did recapitalise the banking system, only seven included a programme of purchase of bad assets/loans (like the one proposed by the US Treasury).

In 25 other cases there was no state purchase of such toxic assets. Even in cases where bad assets were purchased – as in Chile – dividends were suspended and all profits and recoveries had to be used to repurchase the bad assets. Of course, in most cases multiple forms of government recapitalisation of banks were used.

But government purchase of bad assets was the exception rather than the rule. It was used only in Mexico, Japan, Bolivia, Czech Republic, Jamaica, Malaysia, and Paraguay. Even in six of these seven cases, purchase of bad assets such recapitalisation was combined with such moves as government purchase of preferred shares or subordinated debt.

• A d v e r t i s e m e n t

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