BIS published a working paper that examines whether bad banks, or impaired asset segregation tools, and recapitalization lead to a recovery in the lending of originating banks and a reduction in the non-performing loans (NPLs). A key finding of the study is that only when the two tools are used together do they have the desired effect and a sizable impact on the two response variables: neither tool is effective separately. In countries where the legal system is more efficient, credit recovery and NPLs reductions are stronger in response to impaired asset segregations.
The paper first discusses the mechanisms and different dimensions of asset segregation. Then, it lays out the testable hypotheses, before describing the data and conducting the empirical analysis and moving on to presenting the conclusions of the study. The study is based on a novel data set covering 135 banks from 15 European banking systems during 2000–2016. The main finding is that bad bank segregations are effective in cleaning up balance sheets and promoting bank lending only if they combine recapitalization with asset segregation. The results continued to hold when study addressed the potential endogeneity problem associated with the creation of a bad bank. Used in isolation, neither tool will suffice to spur lending and reduce future NPLs. Exploiting the heterogeneity in the asset segregation events, the study was able to show which features of resolution schemes have a stronger impact on the response variables and found that asset segregation is more effective when:
- Asset purchases are funded privately
- Smaller shares of the originating bank's assets are segregated
- Asset segregation occurs in countries with more efficient legal systems
Keywords: International, Banking, NPLs, Credit Risk, Resolution, Impaired Asset Segregation Tools, Research, BIS
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