Bad Bank

Bad Bank is a set up to buy bad loans or non-performing assets of other banks/financial institutions that it cannot recover. After taking the bad loans, such banks try to recover the amount using various recovery methods. For example, the original bank or the institution may clear the balance sheet after transferring those assets.

Most recently, Deutsche Bank announced its plan to close the stock trading business and shift Eur 75 billion risk-weighted assets to Bad Bank.

• A bad bank is a separate entity established to purchase and manage non-performing assets from other banks or financial institutions to recover value from those troubled assets.
• After purchasing the non-performing assets, the bad bank may attempt to recover the money through various techniques, such as restructuring, loan workouts, or asset sales. 
• By separating the non-performing assets from the other loans or assets, the original bank or institution can separate its good assets from the bad ones. 

The corporate structure of this bank may also assume risky assets of the group of the financial institutions rather than buying only from a single bank.

Generally, when taking over such loans, such banks inspect the quality and recoverability of those loans and keep the high margin for the takeover.

By segregating the bad loans from the other loans, the original bank can keep bad assets separately from the good ones so that the good ones do not get contaminated with the bad ones.

For example, Grant Street bank was created in 1988 to house the bad assets of Mellon Bank. This was the first bad bank creation, and the Mellon bank became the first bank to use this strategy. As a result, it was decided that Grant Street bank would hold $ 1.4 billion of Mellon bank's bad loans.

The shareholders of the Mellon bank have then issued the shares of the bad bank and the dividend on the one for one basis. As a result, the early investors of Grant street bank made good profits, and after some years, i.e., in the year 1995 bank was dissolved after repaying the amount of all bondholders and meeting its all objectives.

1. By segregating the bad loans from the other loans, the bank can keep non-performing assets from contaminating good ones. By segregating the two and keeping them mixed, the investors and the other stakeholders may get to know the financial health and the performance of the banks with certainty, impairing the ability to lend, trade, borrow, and raise the capital.
2. As the new bank will be formed with the main purpose of the recovery of the non-performing loans, the speed of the rally will also be more, and hence the loans will be recovered soon, and the bad bank will get the specialization in that.
3. With the creation of such a bank, the burden of recovery of bad loans will be reduced from the original bank's side, which can then look into the main business.
4. Such banks can make profits as they usually keep a high level of margin before acquiring the non-performing loans.

1. The idea of creating such a bank for managing the bad loan is a simple one, but in practicality, it is quite complicated. Before taking steps to transfer the bad loans to the bank banks, many factors have to be considered, such as organizational, structural, and financial trade-offs. The effect of the factors on the bank's liquidity on the bank's profit, and the bank's balance sheet is difficult to judge, especially in a crisis.
2. It is possible that such a bank may not go for acquiring the critical loans of the other bank, which are somehow difficult to recover for and may concentrate only on acquiring the easily recoverable loans.
3. Sometimes the pressure may arise for the bank, and in that, it might adopt unethical ways to recover the loans.
4. It is possible that the other bank may disclose the wrong information or may not disclose the actual position of the loan account with the help of the window dressing to the bank that is acquiring the loan.
5. The high margin taken by the bad banks for taking the non-performing loans may curtail the profits of the other bank.

1. The main goal of segregation of the non-performing loan for the other loan is to allow the investors to know the bank's financial health with a greater level of certainty.
2. When taking over such loans, generally, the bad banks inspect the quality and recoverability of those loans and keep the high margin for the takeover.
3. They may not go for acquiring the critical loans of the other bank, which are somehow difficult to recover for, and may concentrate only on acquiring the easily recoverable loans.

The idea of creating a bad bank for managing the non-performing loan is a simple one, but in practicality, it is quite complicated. Before taking steps to transfer the non-performing loans to the bank banks, many factors have to be considered, such as organizational, structural, and financial trade-offs.

This article has been a guide to Bad Bank and its definition. Here we provide an overview of what bad banks do and examples, advantages, and disadvantages. You may learn more about our articles below on investment banking –

• Banks Credit Risk
• Banks Leverage Ratios
• Investment Banking Division