A New Auction Design For A Bad Bank To Achieve Its Goals

Livemint     23rd March 2021     Save    
QEP Pocket Notes

Context: Highlighting the key reforms needed to effectively operationalize the proposed public bad bank idea.

Issues with the proposal of Bad Bank by the government: It fell short of principles of: 

  • Enabling fair value discovery: Written down book values are accounting conveniences and do not represent market value. Merely inviting counter-bids from private ARCs is not sufficient.
  • Crowding out private investment: It will end up with 15% cash and 85% securities, the value of which will be protected by a government guarantee - skews the market in favour of the public ARC.

Way forward: Retain the advantages of the present scheme while fixing its drawbacks

  • Drop government guarantee: Subsidize 15-20% of the cash component of every deal to counter-balance the ability of private ARCs to raise foreign capital at low rates of interest.
  • Expand the addressable market for ARCs: As suggested in RBI’s draft circular of August 2020, private ARCs should also be allowed to bid for distressed assets that have not yet been deemed NPAs.
  • Raise the minimum cash proportion to 35%: To discourage deals at inflated values, address the inadequate transfer of risk out of the government-public-sector bank combine.
  • Equalize and rationalize accounting gains: Gains in the form of avoidance of provisioning should be available in an identical fashion for transactions of the public ARC as well as private ARCs.
  • Introduce a two-dimensional bidding process: Consisting of a proposed deal value and a proposed cash proportion that is greater than or equal to the stipulated minimum. 
  • Replace the Swiss Challenge with a combinatorial auction: Bring in the threshold for prescribing an absolute majority like the 66% required for a decision on a resolution plan in the Insolvency and Bankruptcy Code.
    • In combinatorial auctions, bidders are allowed to bid for combinations of objects. 
    • For instance, in a spectrum auction, a bidder, instead of bidding separately for each circle, can also be given an additional option of bidding for certain combinations of circles with significant complementarities (like Delhi and Haryana).
QEP Pocket Notes