What are Bad Banks?

The term “bad bank” can refer to a number of different financial institutions, including both failing banks and a special kind of state-guaranteed institution for non-performing assets. The first type may be responsible for financial crises, while the second is often suggested as a solution to one. Specially-created bad banks can help restore confidence in the financial industry and get economies out of a recession.

Bad Bank Performance

When banks manage their money poorly, they can end up creating a bad financial situation, not just for themselves, but for their customers and everyone connected to those customers. In cases where multiple banks start behaving badly, they can cause problems with whole economies.

Poor lending and investing practices resulted in the economic crash of 2008, for instance. This crash affected not just the US economy, but countries all over the world, in many different markets. It also reduced consumer trust in lenders and banking.

Bad Banks for Bad Assets

The phrase “bad bank” can also refer to a bank guaranteed by the state and created to hold non-performing, or toxic, assets. In some cases, a major bank may voluntarily split into a bad bank and a good bank, placing the toxic assets in the bad portion of the business.

These assets may include delinquent loans, mortgage-backed securities and other investments that aren’t currently worth their full amount. Placing these types of assets in bad banks allows other banks to remove the bad assets from their balance sheets. This lets the original bank focus more on lending and less on non-performing assets.

A bad bank is often created in times of economic crisis, and these institutions have been used in Ireland, Sweden and other countries, but are not common in the US. When a bad bank is created as a subsection of an existing bank, it is usually allowed to fail in order to bolster business for the good bank.

Government bad banks are operated somewhat differently. The country’s treasury department provides capital for the bad assets, purchasing them from failing financial institutions. The bad bank lasts for 5 to 6 years and attempts to resolve as many of the toxic assets as possible.