This post draws attention to two recent examples of best current practice for dealing with a problem bank that is not indispensable to the economy.
Key lessons: no need for capital injections if the bank is not going to survive; no protection for unguaranteed subordinated debt holders. In a nutshell, the problem bank is wound up; the guaranteed depositors transferred to a strong bank.
While it is now clear that Lehman Brothers was too large and complex a bank to be wound up, this is not true of many other banks. Indeed, even since Lehmans a number of quite large banks have been intervened. The cases of Washington Mutual and Bradford and Bingley are instructive for any authorities faced with a problem bank whose continued operation is not vital to the economy.
These banks were seen by the authorities as having no viable future, and as not being indispensible to the economy. Their continuing business was transferred to other banks. Government only injected sufficient funds to cover insured depositors: no new capital was needed as the rump banks were gradually being wound up. Holders of uninsured and unguaranteed subordinated debt and preference shares faced heavy losses (they had been earning higher interest in recognition of default risk).
On September 25th, 2008, Washington Mutual, one of the largest banks in the US, was intervened by Federal Authorities. Its insured deposits and mortgage book was sold to the bigger bank JP Morgan Chase. Retail customers were able to continue access their accounts the following morning and in the same old branches, but now owned by JPM. Little or nothing was left to pay WaMu’s $22.6bn in unsecured debt, let alone the shareholders. See: www.fdic.gov/bank/individual/failed/wamu.html
On September 29th, 2008, Bradford and Bingley, a large UK mortgage lender, was intervened by the British Authorities. All of the deposits were transferred to Abbey National and depositors had continued access to their funds through the B&B branches, now operated by Abbey. Mortgage holders continued to make debt service payments to B&B, now owned by the Government. Subordinated debt holders will lose much of their investment. See: www.hm-treasury.gov.uk/press_97_08.htm