What is Bad Bank? Meaning & How They Work

The banking world is always changing and the term ‘bad bank’ has gained serious importance, especially during financial crises. But what exactly is a bad bank and how does it work? A bad bank is a financial institution set up to take over and manage non-performing assets (NPAs) or bad loans from struggling banks. Simply put, it helps manage bad loans and stabilise the economy. 

Read on to understand its meaning and how it functions with a special focus on bad banks in India.

Bad Bank Meaning

A Bad Bank is an institution formed to buy and take care of assets from another bank storing non-performing assets like bad loans. Here, a bad loan means the money borrowed but not repaid on time, making it hard for banks to recover. Bad banks separate bad loans from good ones, helping regular banks focus on their main work. This cleans up their balance sheets and improves financial health. It also plays a very crucial role in stabilising the economy, preventing banking collapses and restoring confidence in the financial system.

How Bad Bank Works

The mechanism of how a Bad Bank works involves several key steps:

• Identification of Bad Assets: 

Assets identified as non-performing include watching and classifying them by banks. These loans and advances do not generate any income; they will not be realised.

• Transfer of Assets: 

The holding bank moves bad loans to the bad bank, usually at a lower value, considering risks and recovery chances.

• Management of Bad Assets: 

Bad banks manage these assets by restructuring the loan, asset sale or legal actions for recovery.

• Recapitalisation: 

The original bank may be financially supported through recapitalisation to strengthen its balance sheet and resume normal lending activities as it is freed of bad assets.

Bad Bank Examples

Many countries have implemented the bad bank concept with varying degrees of success. A few bad bank examples include:

1. USA: 

The Troubled Asset Relief Program (TARP) was initiated during the financial crisis of 2008 to buy up toxic assets from banks and stabilise the financial system.

2. Ireland: 

The National Asset Management Agency (NAMA) was formed in 2009 to manage the toxic assets of Irish banks as a political measure out of the country’s banking crisis.

3. Germany: 

Initiatives such as FMS Wertmanagement to have a bad bank appropriate to the timeframe and then later manage the non-performing assets of German banks within the financial storm.

Bad Bank in India

Recently, ‘bad banking’ has become a major concern in India, with rising bad loans affecting the banking sector. The government and RBI are now exploring structured solutions to manage this growing issue.

1. Creation of the National Asset Reconstruction Company Limited (NARCL): 

Announced in 2021, NARCL, also called the ‘bad bank’, was established to take over and manage the NPAs of Indian banks. This initiative aims to clean up the balance sheets of public sector banks and improve their financial health.

2. Functions of NARCL:

NARCL will buy bad loans from banks on a discount grab and manage recovery. Restructuring, resolving and selling assets would also maximise recovery while minimising losses.

3. Impact on the Indian Banking Sector: 

A bad bank in India could help revive the banking sector, clear bad loans and boost fresh lending to restart economic growth.

Bad banks help clean up bad loans and revive the banking sector, making lending smoother. At Fibe, we ensure easy access to credit with instant cash up to ₹5 lakhs and hassle-free EMIs, keeping repayments stress-free.

FAQs on Bad Banking

How do banks sell bad loans?

Banks sell their non-performing assets to asset reconstruction companies (ARCs) or bad banks at discounted prices. The ownership of the loan is transferred to the purchasing entity, which is responsible for recovering dues.

Why are Bad Banks created?

Such banks are created to contain and manage non-performing assets, improving the health of original banks. They will help banks focus on their core functions instead of on bad loans, making the banking system more stable.

Which is the first bad bank in India?

The first bad bank established in India is the National Asset Reconstruction Company Limited (NARCL), founded in 2021 to solve the problem of non-performing assets in the Indian banking industry.