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

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).