What is a bad bank?

A “bad bank” is a specially established bank holding company (often set up by the government) into which the “bad loans” of one or more existing banks are transferred. These problematic loans, also referred to as “toxic financial products”, are taken over from the banks at low prices (with substantial discounts). By removing these bad loans from their balance sheets, the credit quality of the affected banks improves, creating room for them to issue new loans.

An example is the National Asset Management Agency (NAMA) in Ireland, which was created to relieve Irish banks of their non-performing loans. Although a “bad bank” helps stabilise financial institutions, there is a risk that the losses are ultimately borne by taxpayers, since it is effectively a state-backed institution.

In short, a “bad bank” can offer a solution for banks in distress, but it is a complex and sometimes controversial way of restoring banks’ balance sheets.