Bad banks

The aim of the "bad bank" plan is to clean up lenders' balance sheets and restore confidence in the financial sector. The bill, drafted by Finance Minister Peer Steinbrueck, would enable banks to receive state guaranteed loans on commercial terms, in exchange for offloading their troubled assets.

Through the government's financial market stabilization fund, SoFFin, lenders would be able to swap toxic assets for guaranteed state loans worth 90 percent of the original value of the assets. Lenders would pay an annual fee and be able to "freeze" the assets until better times come along. After a maximum of 20 years, they would have to pay back any losses to the government. Some believe the German banks hold more than 200 billion euros of troubled assets.

"In the interests of the real economy, we are buying time so that the so-called toxic assets can be cleared up," explained Chancellor Angela Merkel's chief of staff, Thomas de Maiziere.

What's worthless today, may not be tomorrow

"It's not clear how toxic these assets really are," said finance expert, Otto Salms of the liberal Free Democrats (FDP). "Some of these assets may well be worth more again once the crisis ends and the economy recovers. If that's the case, the banks may end up having to write off much less at a later date than they would if they were forced to liquidate these assets today."

Economic recovery and financial liquidity go hand in hand. One of the factors that's been driving the crisis around the world is that banks have stopped lending to each other because they haven't been able to assess the size of the financial black holes on each other's balance sheets.

Berlin hopes that by removing bad holdings from balance sheets banks will start lending to each other again, as well as to businesses and consumers. This in turn would help kick-start the German economy, the biggest in Europe, which is expected to shrink by six percent this year.

Shareholders, not taxpayers, to bear the burden

Under the plan, which comes five months before a general election, any liabilities at the end of maturity would accrue to shareholders, and not to the taxpayer.

"It's only right that whoever made profits through taking high risks over the years, must also be prepared to take the losses," explained financial expert Johannes Kahrs, of the Social Democrats (SPD), the coalition partners of Chancellor Angela Merkel's Christian Democrats (CDU). "I think that's reasonable, it's a basic economic principle."

Some critics say the scheme is flawed because it is voluntary. Banks are not to be forced to dispose of toxic assets through the SoFFIN national rescue program.

The government insists that "good banks" are interesting for investors and a cleaned up, reliable balance sheet will attract capital. The draft legislation still has to go before both the lower and upper houses of parliament, the Bundestag und Bundesrat.