Bad bank

The European Commission has temporarily approved plans by the German government create a so-called "bad bank" that would absorb toxic assets from the state-owned bank WestLB.

European Union regulators gave the approval "because it is necessary for reasons of financial stability," they said in a statement. They also promised to open an in-depth investigation into the bad bank plans amid doubts that the lender would pass state aid tests.

The German government would create the bad bank, officially called a "winding down institute," with a transfer of 85.1 billion euros ($121.4 billion) of WestLB's toxic and non-strategic assets.

Germany has provided three billion euros ($4.3 billion) in aid to set up the bank – an amount that European Competition Commissioner Neelie Kroes said surprised her.

"The setting up of the bad bank shows that WestLB's restructuring process is underway," Kroes said. "However I am surprised about the level of the additional aid required and will make sure that the new aid is fully compatible with EU state aid rules."

When bad banks are good

Creation of the bad bank is part of WestLB's restructuring plans, drawn up after the struggling bank got EU approval for five billion euros in guarantees from its owners last year.

The approval came on the condition that WestLB would abandon high-risk areas of business, halve its assets within two years and sell itself to private owners by the end of 2011. The bank's shareholders are also giving an additional one billion euros in guarantees to comply with German bad bank regulations.

Bad banks are created when state-guaranteed banks need to unload loans which have lost most or all of their value. These "toxic assets" are concentrated in the bad bank until they eventually recover, ideally reducing the cost of saving the state bank to taxpayers.

acb/dpa/AFP/AP
Editor: Chuck Penfold