At the core of the Eurozone crisis is the deadly embrace between banks and governments. Sovereign fragility has led to pressure on banks’ balance sheets. The weak fiscal position of governments in many periphery countries, on the other hand, has led to delays in recognising bank problems and addressing them (Acharya et al., 2012). The situation, however, also has a political dimension, as regulators in many European countries have become too close to the regulated entities. The combination of regulatory capture and incentives to forebear, exacerbated by easy access to ECB liquidity, has led to further delays in addressing bank fragility.

What to do? The problem of legacy assets cannot – and should not – be addressed as part of the intended framework of a Eurozone banking union. A full mutualisation of banking risks is also not possible and not desirable for political reasons. Currently, there appears to be deadlock between policymakers favoring a centralised solution to the Eurozone banking crisis, and those favoring a country by country approach. Last week’s ECOFIN statement still puts a heavy emphasis on national solutions (ECOFIN 2013a).

As an alternative, we propose a unified Eurozone approach to speed up the long-delayed crisis resolution, by combining elements of centralised control with elements of decentralised implementation. Specifically, following Beck, Gros and Schoenmaker (2012) we suggest the establishment of a central and independent Eurozone Restructuring Agency (ERA) that is in charge of coordinating the restructuring and recapitalisation of viable and liquidating non-viable banks throughout the Eurozone. The agency should be a temporary vehicle, with a clear sun-set clause, so that it ends its duty after the banking union will be completed.

Due to its temporary nature, our proposal differs importantly from previously discussed schemes. The institution should be solely concerned to deal with legacy problems of the past crisis and is not intended to address any future bank failures within the banking union. This is crucially different from the current discussion on a Eurozone public backstop for troubled banks, which continues to mix the resolution of legacy problems with guarantees for future losses.

For example, the banking union’s Single Resolution Mechanism (SRM), as currently discussed, will be responsible of dealing with past and future banking losses. Legacy problems would be solved over time, with the risk of further costly delay. In addition, it is uncertain when the SRM will be up and running and whether the current funding proposals will suffice to deal with unviable banks and toxic assets from the past. In light of this situation, we believe that a bridge solution that exclusively aims at cleaning up legacy losses is a quicker and more transparent way to resolve the ongoing bank distress in the Eurozone. It would also facilitate the banking union to go ahead in a forward looking way.

Building on a successful model

Bad banks, or asset management companies (AMCs) have become a popular tool to resolve national banking crises and clean up bank balance sheets. As discussed by Klingebiel (2000), Calomiris (2003), and Schäfer and Zimmermann (2009), several countries have resolved a large stock of non-performing assets successfully with centralised asset-management companies. These experiences were especially favorable in countries with a strong legal framework and for agencies with a narrowly defined mandate, namely that of cleaning up unviable banks and selling off their assets. This is what we have in mind here.1

A Eurozone restructuring agency (ERA)

We propose that by mid-2014, at the end of the process of the asset quality review (AQR) and stress tests, weak banks be referred to a temporary Eurozone Restructuring Agency for restructuring and resolution purposes.

  • In the first phase of its existence, the resolution agency would have to separate weak banks into viable and unviable financial institutions, based on the results of AQR and stress tests.

Unviable banks would be liquidated while viable weak banks would be restructured, preferably in the form of a separation of good and bad banks. This phase should also involve a partial or full bail-in of junior (and maybe senior) creditors of unviable banks. Liquidating unviable banks should thus involve minimal public funding, with losses borne mostly by non-insured creditors and equity holders.

  • In the second phase, the ERA would gain responsibility with regard to both the good and the bad banks that emerged from phase one.

Once the bail-in of bank creditors is completed, the ERA would inject capital in the good banks, but in return receive equity claims in them (as currently envisioned in the case of direct ESM bank recapitalisation, see ECOFIN, 2013b). One arm of the ERA would thus partially or fully own and manage the good banks, and sell them at the best achievable price after the restructuring is finalised. The second arm of the ERA would be responsible for liquidating the assets of the bad banks, and these assets would also be partially or fully owned by the agency.

The ERA would be jointly owned by the 17 Eurozone members, in the same proportion as their shares in the European Stability Mechanism (ESM). All liabilities, but also assets and equity stakes in the good banks, would thus indirectly be owned by European taxpayers. As a result, any returns from the asset liquidations or bank sales would be disbursed to the ERA shareholders and, thus back to the Eurozone governments.

Financing and control

In essence, the ERA scheme amounts to an exchange of bailout money (from creditor countries) against management control over weak and failing banks and their assets (in debtor countries). It is obvious that a lot of capital will be needed for the scheme to work.

The initial funding for the ERA could come from the ESM, in a way that preserves the ESM’s AAA creditor status. This could require paying in additional ESM capital or additional loan guarantees by Eurozone governments, including from creditor countries like Germany. Early on, the ERA should also seek market funding for additional equity stakes in individual banks. In addition, the ERA itself could be given the ability to issue bonds on the market.

With its capital the ERA would provide loans and/or capital to AMCs and bad banks across Eurozone countries, including to those entities that have already been created (e.g. FROB in Spain or NAMA in Ireland). The ERA would also replace the current ESM scheme of recapitalising banks by lending to the sovereigns or via direct recapitalisation.

At the end of the process, the ERA will thus become a mother entity with decision and delegation power over national resolution schemes. This means that a country like Spain would have to give up sovereignty in deciding how its unviable banks will be restructured and how its assets will be liquidated.

Convincing the north and the south

How can creditor and debtor countries be convinced to agree to such a scheme? We propose the following ideas:

  • Asymmetric return pay-offs
    While ESM loans to the sovereigns only involve down-side risk, our scheme has the advantage that positive returns (upside risks) will be redistributed back to the ERA shareholders in proportion to their paid in capital, i.e. in line with ERA ownership shares. This would mean that creditor countries will receive larger pay-offs if things turn out favorably, even if these revenues come from debtor countries such as Spain. This asymmetric pay-off scheme and the guarantee to participate in potentially profitable asset and bank sales in the future is advantageous for creditor countries such as Germany and will give them an incentive to participate.
  • Collateralised losses
    Downside risks should, however, be borne in proportion to country risks, at least in the long-run. We see at least two options to assure that debtor countries (with many weak banks) bare the fair share of potential future losses.
    One option is that ECB’s future seignorage gains are redistributed from debtor to creditor countries in line with losses incurred on banks headquartered in the respective countries.
    Another option is that debtor countries post collateral with the ERA, such as gold reserves or shares in state-owned companies, which could be sold in case the losses are ultimately larger than expected. To avoid a seizure of their collateral, debtor countries will have incentives to support the ERA and to assure that good banks and bad assets are sold at the highest price possible.
    We do not envision bank levies to finance legacy losses, but rather to support the forward-looking Single Resolution Fund within the banking union, as currently discussed.
  • A menu of restructuring options
    Decision powers should be transferred gradually, depending on the amount of capital needed. Such a menu could make the scheme more acceptable for debtor countries, which do not face the binary choice of giving or not giving up sovereignty over their banking systems. Similarly, one could make capital for direct recapitalisations more expensive than lending, in terms of ownership rights.
  • An agency with teeth
    The institutional setup should give ERA sufficient power and independence to exercise its control rights and assure that assets are liquidated effectively, in the interest of taxpayers. Some ideas for assuring this are listed in the next section.
Institutional setup and mandate

The ERA should have a clear-cut mandate – to administer the restructuring and resolution of insolvent banks in the short term, and to supervise the liquidation of non-performing assets quickly and at minimal cost to European taxpayers. The agency should be transparent and never be allowed to become a permanent bureaucracy.

To implement its mandate, the institution should be legally independent – akin to the ECB or the Bundesbank – so as to insulate it against political pressures from European or national actors (including from the ESM). This is important for several reasons. The newly created institution would be responsible for a huge portfolio of corporate, financial, and real estate assets. Moreover, the agency’s mandate will unavoidably require making politically sensitive decisions on asset liquidations, seizures, and evictions. To cushion against potentially adverse impact of these asset liquidations, national governments could consider enacting financial support programs for affected firms and households.

The agency will have centralised decision power over the bad banks and their assets portfolio, as well as over the good banks. However, bank management and the liquidation of the non-performing assets are, in our opinion, best done at the local level. This means that national AMCs should be set up where needed. Existing schemes would give up some of their powers, but benefit from the additional capital cushion from the ERA.

To avoid fraud and misuse of money on the local level, the ERA should closely supervise the activities of national asset management companies. The activities of bad banks should be centrally audited, while good banks should be managed independently and be strictly supervised by the ECB. But ERA’s competences should go beyond mere oversight. The central agency should also hire expert teams with full management powers that intervene locally when things turn sour. Similarly, ERA should be able to dispatch teams of expert asset liquidators to restructure and sell off particularly large and attractive or particularly troublesome asset portfolios of problem banks.

The ERA will also require 'legal teeth', meaning legal superpowers which enable it to liquidate assets and recover the proceeds from these sales. Indeed, it is widely recognised that legal hurdles have been a main reason for bad performance of AMCs in the past. Eurozone member governments should therefore be required to grant the ERA special legal powers. They should also agree to implement adequate bankruptcy and foreclosure laws that are standardised across the Eurozone. Finally, the ERA should have good access to EU courts to overrule debtor-friendly court decisions on the national level.

We propose that the ESM should host (but not control) the Eurozone Restructuring Agency, in alignment with funding. This could foster economies of scale and facilitate preconditions for ERA’s success, in particular a skilled management, and good information and management systems. However, the ERA should also be allowed to open branch offices in financial centers such as London, Frankfurt or Paris, in order for it to hire the best and brightest restructuring experts – in the interest of taxpayers.

The advantages of our proposal

While our proposal is not a panacea for the resolution of the Eurozone crisis (and will face high legal and political barriers), it has some critical advantages over the current approach, which has overly relied on regulatory forbearance as well as implicit bailouts and liquidity support by the ECB:

  • It would create a “clean plate” for a forward-looking Eurozone banking union and allow a quicker resolution of current bank distress across the Eurozone. A centralised bank resolution agency on legacy losses would be a necessary complement to the three pillars of Eurozone bank regulation, supervision, and deposit insurance.
  • It would add transparency on the losses incurred so far, and create more certainty about the resources needed to resolve the crisis. This is crucial to re-establish confidence in the soundness of European banks. Importantly, it would also force creditor and debtor countries within the Eurozone to compromise on a scheme to clean up bank balance sheets and on the distribution of losses, instead of further delaying this process.
  • Any cash injection (bailouts) would imply a partial or full transfer of bank ownership and a more direct control over the bank wind-down and assets. Taxpayers would thus jointly participate not only in the down-side risk but also in the up-side risk. This contrasts with previous practice, which merely gives out loans to governments to recapitalise their banks, but does not involve a transfer of equity on the Eurozone level.
  • A centralised institution would create clear rules of the game and replace the current patchwork of national solutions. The freedom from political intervention and strong legal powers could speed up the liquidation of bad assets and maximise returns in the interest of European taxpayers
Conclusions and challenges

Our proposal is one of several steps to resolve the ongoing Eurozone banking crisis. It is not a panacea and other reforms are needed, for example, reducing banks’ incentives to invest in national government bonds. We are also well aware that the devil will lay in the details and that many open questions remain. Which assets should be transferred into the bad banks, and at what price? How should legacy assets be defined? How long should the ERA operate? What is the best degree of private ownership in individual banks and national AMCs? Is collateral and future seignorage sufficient to assure fair burden sharing? And how can the real sector costs of bank wind-downs and asset liquidations be reduced?

Despite these and many other open questions, we believe that a centralised and concerted effort is needed to clean up bank balance sheets in the Eurozone. The banking union cannot go ahead without solving the problem of legacy assets first.


Acharya, Viral, Philipp Schnabl, Itamar Drechsler (2012), “A tale of two overhangs: The nexus of financial sector and soverign credit risks”,, 15 April.

Beck, Thorsten, Daniel Gros and Dirk Schoenmaker (2012), “Banking union instead of Eurobonds – disentangling sovereign and banking crises”,, 24 June.

Calomiris, Charles, Daniela Klingebiel and Luc Laeven (2003), “Financial Crisis Policies and Resolution Mechanisms: A Taxonomy from Cross-Country Experience,” in Patrick Honohan and Luc Laeven (eds.), Systemic Financial Distress: Containment and Resolution, Chapter 2, Cambridge: Cambridge University Press.

ECOFIN (2013a), “Council statement on EU banks' asset quality reviews and stress tests, including on backstop arrangements”.

ECOFIN (2013b), “ESM direct bank recapitalisation instrument“Main features of the operational framework and way forward”.

Jassaud, Nadege and Heiko Hesse (2013), “Balance-sheet repairs in European banks”, 13 April 2013.

Klingebiel, Daniela (2000), “The Use of Asset Management Companies in the Resolution of Banking Crises.” Working Paper 2294. Washington, D.C.: World Bank.

Schäfer, Dorothea and Klaus F Zimmermann (2009), “Bad bank(s) and recapitalisation of the banking sector”,, 13 June.

1 In the still on-going European crisis, different models have been applied, ranging from internal bad banks and bank restructuring units (e.g. Royal Bank of Scotland), a split up of good and bad bank (e.g. UBS in Switzerland) national bad bank schemes (e.g. Ireland’s National Asset Management Agency (NAMA). Closer to our idea is the Spanish Fund for Orderly Bank Restructuring (FROB), created for the Spanish caja sector and with the task to liquidate non-viable savings banks and recapitalize viable ones. See also Jassaud and Hesse (2013).

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