9.2.1 The rationale of asset relief measures

As footnote 5 of the IAC explains, banks typically hold a variety of assets, such as financial assets (treasury bills, debt securities, equity securities, traded loans and commodities), derivatives (swaps, options) and loans. During the financial crisis, the market value of many assets fell dramatically. As a result, many banks had “impaired assets” on their balance sheets. Impaired assets are assets whose market value has fallen below the book value. Impaired assets are sometimes described by the term “toxic assets”. However, the notion of “impaired assets” is broader than “toxic assets”.1 Impaired assets also include assets on which high losses are expected.2

If losses materialise and a bank has to write down on these assets, then this results in a decline of equity, which might endanger the viability of the bank. Markets know that banks have impaired assets, but they do not know how large the losses on these assets will be. The very existence of impaired assets therefore creates uncertainty. Uncertainty can be around the exposure of banks to impaired assets or around the size of expected losses.

As highlighted before, confidence is crucial to the banking sector. Uncertainty regarding asset valuation can be damaging in several ways. First of all, markets may overestimate the expected losses on impaired assets. Such a negative market perception may result in higher financing costs for banks.3 Secondly, uncertainty may have repercussions to the real economy. Writing down on impaired assets reduces the bank’s equity. In order to restore the capital ratio, the bank either has to attract new equity or to reduce the RWA. Since investors may not always be interested in providing capital to troubled banks, those banks may opt for the second option (i.e. reducing assets). Reducing the amount of assets can be achieved in two ways. The first way is by not renewing maturing loans. This might lead to a contraction of credit; in other words: a credit crunch. The second way to reduce the amount of assets is by selling some of the assets. However, this may further depress asset prices. This phenomenon is known as “fire sales”.

In order to remove market uncertainty and to revive market confidence, Member States have undertaken measures to relieve banks from their impaired assets. The aim of asset relief measures is to reduce the provisioning or write- down needs of the beneficiary bank and to protect its capital base. Asset relief measures remove a source of volatility on the bank’s balance sheet. In that regard, asset relief measures free up capital, because they reduce the RWA of the beneficiary bank. The ultimate goal of asset relief measures is improving the financial position of banks and their access to finance and increasing bank lending to the real economy.