The term bad bank denotes a financial institution which is set up by one or more core banks (parent banks) in order to dispose of and manage asset which are not beneficial to them. By transferring these negative assets to a bad bank, parent banks can improve their profit-to-loss ratios, evade responsibility for losses, maintain good credit ratings or avoid regulatory problems. In many cases, bad banks are opened as part of government-sponsored bank bailout plans.
Assets which may be transferred from a bank or other financial services provider to a bad bank include: non-strategic assets; bad debt; illiquid assets; assets deemed as high-risk. In some cases, bad banks may also manage assets which do not fall in line with current regulatory requirements.
Once a bad bank has been established, unwanted assets are transferred from the establishing bank(s) or financial services provider(s) to the bad bank. These assets are transferred from the books of the parent bank(s) to those of the newly-established bad bank. These assets are then managed by the bad bank, which may find buyers for them or write them off. In the case of too big to fail institutions, bad banks may be used as part of taxpayer-sponsored government bailout plans for banks. In addition to private banks and financial institutions, governments also make use of bad banks to dispose of unwanted assets and improve their credit ratings.
An example of a bad bank is the special purpose entity (SPE) set up for Swiss bank UBS in cooperation with the Swiss National Bank (SNB). UBS was authorized to transfer up to 60 billion US into this SNB-funded SPE. Assets transferred to this bad bank were not included in UBS balance sheets.
More on this topic:
Swiss bank failure and depositor protection guide
Deal of the Day 
