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Are Bad Banks a Good Idea?

STOCKHOLM – The idea of a “bad bank” appears to grow more popular by the day in countries where toxic assets have paralyzed lending. The Swedish bank cleanup in the early 1990’s is often cited as an example of how successful this idea can be. But the lessons that are sometimes derived from Sweden’s experience are based on misunderstandings of what we actually did, and of how our system worked.

The initiative to set up a “bad bank” in Sweden was taken not by politicians, but by the management of Nordbanken. Following years of mismanagement and reckless lending, the bank was the first big victim of the commercial property market’s decline in 1990.

Nordbanken had become fully state-owned and a new management was put in place to restore the bank to viability. But it soon turned out that the managers had little time to spend on Nordbanken’s core banking business, because they had to focus disproportionately on handling an enormous variety of assets. And every quarter brought new write-offs that ruined efforts to rebuild the bank’s reputation and its employees’ morale.

The radical solution was to separate all the assets that were alien to the bank’s core business, mainly real estate companies, but also firms in the manufacturing, construction, and service industries.