In the ever-evolving banking and finance landscape, the term “bad bank” has emerged as a significant concept, especially in economic crises and financial stability. But what is a bad bank, and how does it function? This article explores the bad bank meaning, how bad bank works, and provides bad bank examples, with a particular focus on bad banks in India.
A Bad Bank is an institution formed to buy and take care of assets from another bank storing non-performing assets such as bad loans. The economics of bad banks is in segregating non-performing assets from the healthy assets of the source bank so that the latter can focus on its core business rather than carry a weight of non-performing loans. Bad banks isolate bad debts and cleanse the balance sheet of troubled banks to renew their financial health.
The mechanism of how a Bad Bank works involves several key steps:
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 specified bad assets from the holding bank to the bad bank. Such transfer is generally below the values to account for the actual risks and recovery values associated with the assets.
Bad banks now manage and recover these assets. This management may include restructuring the loan, asset sale, or legal actions for recovery.
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.
Several countries have implemented the bad bank concept with varying degrees of success. Notable bad bank examples include:
The Troubled Asset Relief Program (TARP) was initiated during the financial crisis 2008 to buy up toxic assets from banks and stabilize the financial system.
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.
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.
In relatively recent historical times, “bad banking” has crept into discussions in India, with its associated effect on banking sector performance showing an alarming level of non-performance and a growing concern with rising volumes. The Indian government and Reserve Bank of India (RBI) have begun looking at structured solutions as untenable.
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.
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.
The expected outcomes for the Indian banking sector from establishing the bad bank in India would be significant as it seeks to reprieve the banking sector, open up momentum for fresh lending into the economy, and kick-start it again.
Bad banks are an increasingly critical concept for dealing with the challenges emanating from the proliferation of non-performing assets in banks. What is a bad bank? How does it work? These questions can provide us with an explicit knowledge of the significance of bad banks in keeping financial households stable. Bad bank mechanisms emerged in various countries, such as bad banks in India, illustrating their weighting in managing financial crises and spurring growth. Meet all your credit needs with Fibe and improve your credit score.
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.
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.
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.
