In our previous section (‘The Bad Bank Proposal and Value Innovation Process’, Mint, March 10), we examined and found the government’s proposal for a bad bank in view of the rhetoric of “minimum government, maximum governance” which is inferior to these principles: 1) All markets Initiating affordable value innovation by creating a level playing field for players;
Recall, the proposed Public Property Restructuring Corporation (ARC) will implement a 15-85 division between cash and securities in its acquisition of non-performing assets (NPAs). Therefore, it ends up with 15% cash and 85% securities, the value of which is protected by a government guarantee.
Having a sound value-innovation process for NPAs is a necessary condition for success. The Parliamentary Panel on Finance recently wrote book values that do not indicate accounting facilities and market value. This is especially true for large accounts and the latest NPLs. As explained in the previous section, inviting counter-bids from private ARCs is not enough to give a sound market process. It is important to create a level playing field for all market players, which does not currently exist due to the unequal treatment of public and private ARCs.
One silver lining of Public ARC’s proposed structure is that for consortium-led debt financing, if multiple banks are in competition, it would be well worth providing a loan to each major borrower. This allows control over the affected organization while avoiding multiple rounds of negotiations with different organizations. Our solution retains its advantages while addressing the shortcomings of the current scheme. It has the following features:
Leave the government guarantee: it will inevitably bypass the market in favor of public ARC. In its place, the government should support the public ARC by subsidizing 15-20% of the cash portion of each contract. This concession reflects the ability of private ARCs to raise foreign capital at a lower interest rate.
Expand the Addressable Market for ARCs: As indicated in RBI’s August 2020 Draft Circular, private ARCs should be allowed to auction off affected assets that are not yet considered NPAs, referred to as SMAs.
Raise the minimum cash ratio to 35%: The problem with the 15% cash ratio is that it encourages contracts with increased values, which artificially promotes bank books, following write-offs in the future. Also, when the government writes less of the securities, having 85% of the NPA as securities indicates an inadequate transfer of risk from the public-public-sector bank merger. The market can provide market values in alignment with the fair value of NPLs at high levels of cash that reflect high risk transfer.
Equalize and rationalize accounting profits: Profits in the form of provisioning avoidance should be available in the same manner for public ARC and private ARC transactions. In addition, the accounting profits should be below the binary method and the profits should not exceed the prescribed minimum of 100%. Instead, there should be a sliding scale of profit — that is, a cash ratio of 35% representing earnings of 35% of accounting profits and so on. This promotes a higher level of risk transfer.
Introduce two dimensional bidding process: There should be two dimensional bids with the proposed contract value and the proposed cash ratio should be greater than or equal to the prescribed minimum. These two dimensional bids should be converted into cash equivalents by using the appropriate adjustment factor for the security receipt component.
Replace Swiss Challenge with Combinatorial Auction: A new rule must be adopted that, for every account with more than five lenders, the availability of more than 50% of the borrower’s outstanding amount will automatically trigger the auction of the NPL of the account. Maintained by all banks. This is equivalent to the IBC rules, which indicate an absolute majority of 66% to make a decision on a resolution plan. The decision to sell NPAs requires a lower level than the decision to transfer ownership. All these NPLs should be sold simultaneously through a combinatorial auction. In a combinatorial auction, bidders are allowed for combinations of items. For example, in a spectrum auction, instead of bidding separately for each circle, a bidder may also offer an additional option of bidding for a combination of certain circles with substantial fillers (e.g. Delhi, Delhi and Haryana). This auction format is useful when there is a high level of synergy between the items being auctioned. Bidding selection for individual items continues.
It is true that the total number of packages that the bidder can choose from is large. For example, with 10 banks, it works for a total of 1,023. In the case of NPA auctions, offer packages may be limited to a combination of NPA holdings that enable a 66% stake in the corporate borrower. The carefully crafted combinatorial auction has been used successfully for US spectrum sales.
Reducing the expansion of public capital and initiating affordable value innovation should be the ladstar for a government that leads a debate on minimalism. The above principles provide a way to implement government intentions.
Rohit Prasad and Yogesh B. Mathur are Professor, MDI Gurgaon, and Senior Advisor, Reconstruction, Grant Thornton respectively. These are the personal opinions of the authors.