Bad bank

A bad bank is a corporate structure to isolate illiquid and high risk assets held by a bank or a financial organisation, or perhaps a group of banks or financial organisations. A bank may accumulate a large portfolio of debts or other financial instruments which unexpectedly increase in risk, making it difficult for the bank to raise capital, for example through sales of bonds. In these circumstances, the bank may wish to segregate its "good" assets from its "bad" assets through the creation of a bad bank. The goal of the segregation is to allow investors to assess the bank's financial health with greater certainty. A bad bank might be established by one bank or financial institution as part of a strategy to deal with a difficult financial situation, or by government or some other official institution as part of an official response to financial problems across a number of institutions in the financial sector.

In addition to segregating or removing the bad assets from parent banks' balance sheet, a bad bank structure permits specialized management to deal with the problem of bad debts. The approach allows good banks to focus on their core business of lending while the bad bank can specialize in maximizing value from the high risk assets.

Such bad bank institutions have been created to address challenges arising during an economic credit crunch to allow private banks to take problem assets off their books. The financial crisis of 2007–2010 resulted in bad banks being set up in several countries. For example, a bad bank was suggested as part of the Emergency Economic Stabilization Act of 2008 to help address the subprime mortgage crisis in the US. In the Republic of Ireland, a bad bank, the National Asset Management Agency was established in 2009, in response to the financial crisis in that country.

In a 2009 report, McKinsey & Company identified four basic models for bad banks.

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