What is a Bad Bank?

Most recently, Deutsche Bank announced its plan to close the stock trading business and shift Eur 75 billion risk-weighted assetsRisk-weighted AssetsRisk-weighted asset refers to the minimum amount that a bank or any other financial institution must maintain to avoid insolvency or bankruptcy risk. The risk associated with each bank asset is analyzed individually to figure out the total capital requirement.read more to Bad Bank.

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Example of the Bad Bank

For example, Grant Street bank was created in 1988 to house the bad assets of Mellon Bank. This was the first bad bank creation, and the Mellon bank became the first bank to use this strategy. As a result, it was decided that Grant Street bank would hold $ 1.4 billion of Mellon bank’s bad loans.

The shareholders of the Mellon bank have then issued the sharesIssued The SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner’s equity on the Company’s balance sheet.read more of the bad bank and the dividend on the one for one basis. As a result, the early investors of Grant street bank made good profits, and after some years, i.e., in the year 1995 bank was dissolved after repaying the amount of all bondholders and meeting its all objectives.

Advantages

Disadvantages

  • The idea of creating such a bank for managing the bad loan is a simple one, but in practicality, it is quite complicated. Before taking steps to transfer the bad loans to the bank banks, many factors have to be considered, such as organizational, structural, and financial trade-offs. The effect of the factors on the bank’s liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more, on the bank’s profit, and the bank’s balance sheetBank’s Balance SheetThe bank’s balance sheet is different from the company’s balance sheet. It is prepared on the mandate by the Bank’s Regulatory Authorities to reflect the tradeoff between the bank’s profit and its risk and its financial health.read more is difficult to judge, especially in a crisis.It is possible that such a bank may not go for acquiring the critical loans of the other bank, which are somehow difficult to recover for and may concentrate only on acquiring the easily recoverable loans.Sometimes the pressure may arise for the bank, and in that, it might adopt unethical ways to recover the loans.It is possible that the other bank may disclose the wrong information or may not disclose the actual position of the loan account with the help of the window dressingWindow DressingWindow dressing in accounting refers to the intentional manipulation of financial statements by company management in order to present a more favourable picture of the company to users of the financial statement before it is released to the public.read more to the bank that is acquiring the loan.The high margin taken by the bad banks for taking the non-performing loans may curtail the profits of the other bank.

Important points of the Bad Bank

  • The main goal of segregation of the non-performing loan for the other loan is to allow the investors to know the bank’s financial health with a greater level of certainty.When taking over such loans, generally, the bad banks inspect the quality and recoverability of those loans and keep the high margin for the takeover.They may not go for acquiring the critical loans of the other bank, which are somehow difficult to recover for, and may concentrate only on acquiring the easily recoverable loans.

Conclusion

The idea of creating a bad bank for managing the non-performing loan is a simple one, but in practicality, it is quite complicated. Before taking steps to transfer the non-performing loans to the bank banks, many factors have to be considered, such as organizational, structural, and financial trade-offs.

This article has been a guide to Bad Bank and its definition. Here we provide an overview of what bad banks do and examples, advantages, and disadvantages. You may learn more about our articles below on investment banking –

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