Good bank, bad bank: solution at last

A year of dithering and Gordon Brown's government has finally realised what many have argued all along: first that the only sensible way to unwind the investments it was forced to make in the banking sector is to adopt the good bank/bad bank model; and second that the only solution to having banks that are too big to fail is to make them smaller, as Richard Nixon's Treasury Secretary George Schultz famously quipped.

The Independent this morning reveals that Lloyds, Royal Bank of Scotland and Northern Rock will be split up when the Government sells off the UK taxpayers' involuntary investment. Each will be split into a 'good bank' and a 'bad bank' at the start of next year, whereupon ministers will begin exploring sale options with a deal possibly finalised before the general election.

The Independent goes on to report: "The remaining 'bad' bank will remain in state hands for the time being although sales of 'tranches' of the more risky mortgages it holds will be explored in the longer term."

Sir Richard Branson's Virgin Money is said to be in talks with former Northern Rock chairman Bryan Sanderson with a view to adding him to its board ahead of a possible bid for the Rock. Tesco is also rumoured to be interested in a bid for banking assets.

The most successful implementation of the good bank/bad bank model took place in Sweden when the country went through a property market collapse which threatened the financial system in 1991.

The government's financial intervention at that time ended up costing the taxpayer nothing, and, depending on how one calculates these things, may even have yielded a profit.

The biggest difference between the Swedish experience then and the UK’s problem now is that the Swedish banks, whether they received state aid or not (and only one refused it), voluntarily and independently each split away their more problematic assets into a bad bank.

The reason they did so was recently simply summarised by one of the bank treasurers involved at the time: “We realised that nursing difficult assets takes a radically different type of management than doing normal standard banking business. We saw it as a sensible business decision."

And they were right: within a short time ("about half the time we thought that it would take" the treasurer said), the 'bad' banks’ assets turned out to be really quite good, and the Swedish banking system, almost 20 years later, bears not a single scar from that trauma.