"Bad bank" is a specially created bank holding company (often by the government) in which the "bad loans" of one or more existing banks are collected. These problematic loans, also called "toxic financial products," are taken over from the banks at low rates (at steep discounts). Taking over these bad loans improves the credit quality of the banks involved, which in turn creates room to provide new loans.

An example is the National Asset Management Agency (Nama) in Ireland, which was created to relieve Irish banks of their non-performing loans. Although a "bad bank" helps stabilize financial institutions, there is a risk that the problems will eventually be passed on to the taxpayer, since it is effectively a state-owned bank.

In short, a "bad bank" can provide a solution for banks in distress, but it is a complex and sometimes controversial way to restore banks' balance sheets.