Nationalized German property lender Hypo Real Estate plans to funnel about 210 billion euros ($298 million) in "toxic" assets into a so-called "bad bank" in the latter half of 2010, with the hope of rebuilding after a devastating year.

Hypo Real Estate is a "natural candidate" for a bad bank, according to Dr. Michael Schroeder at the Center for European Economic Research.

"HRE is really one of the worst banks in Germany. Most of the other banks are in a much better situation," he told Deutsche Welle.

Hypo Real Estate nearly went under in 2009 after being heavily hit by the financial crisis. It is now wholly owned by the German government's Soffin bank-rescue fund, which had deemed the bank too big to fail.

Berlin, with help from financial institutions, kept HRE afloat with some 100 billion euros in guarantees. Seven billion were paid back last year.

While the German government has thrown its support behind the bad bank program, the scheme has attracted its fair share of skeptics too.

HRE aims to re-privatize

The bank said the creation of a bad bank would allow it to focus on supplying credit for the real estate and public sector and "accelerate the process of preparing the group for an eventual re-privatization."

The Munich-based lender, one of Germany's biggest financial institutions, submitted its application to create a bad bank to the German government's Financial Markets Stabilization Agency on Thursday, one day before the end of a six-month period during which it could apply.

The government has said it wants to see the bank return to private ownership, but has not yet specified a time frame. HRE has said it doesn't expect to garner profits before 2012.

Are "bad banks" the right solution?

Advocates of bad banks argue that they allow banks to stay in business without having to worry about old assets eroding capital.

However, many German banks are against the program on the grounds that the rules add costs for banks taking part while doing little to cut risks to shareholders.

In addition, a nationalized bank faces incentive problems, according to Dr. Schroeder.

"For example, the management of the bank that is under the supervision of Soffin has to limit their management compensation to half a million per year," much less than what they usually receive, which creates a disincentive, said Schroeder.

Meanwhile, the European Commission has expressed doubts about the ability of HRE to survive in its current form. It has also criticized what it called "market disturbances" caused by the massive government bailout.

Now the EU will have to sign off on whether to allow the property lender to create Germany's largest bad bank.

Author: Vanessa Johnston (rc)

Editor: Susan Houlton