Bad bank likely to follow Swiss challenge method

Plan aimed at price discovery of assets; IBA working closely with Finmin, RBI

The proposed ‘bad bank’, to be floated by the banking industry, will likely follow the Swiss challenge method for price discovery of assets, sources close to the development said. This means that even as an asset is transferred to the new asset reconstruction company (ARC) at a pre-agreed price, bids will be called from others later and the highest bidder will get the asset.

The model also prevents the amendment of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act (Sarfaesi Act), which mandates a bidding process before the transfer of any asset from banks books, while keeping the whole process less cumbersome and time consuming.

Bad assets worth ~500 crore and above, against which 100 per cent provisioning has been done, may be transferred to the bad bank. The transfer can happen only when 75 per cent of the banks holding the account agree on it.

Sources said the final outline of the ARC could come anytime now, most probably in March. The Indian Banks’ Association (IBA) is closely working with the finance ministry and the Reserve Bank of India (RBI) on this. Bad loans eligible for transfer are being identified and banks are busy making 100 per cent provisions against them. The bad bank will likely start its operations with assets worth ~1.5 trillion, sources said.

Union Finance Minister Nirmala Sitharaman announced the creation of the bad bank during the Budget presentation on February 1. Emails sent to the finance ministry and the RBI remained unanswered till the time of going to press.

It is understood that public sector banks will hold more than 70 per cent in the bad bank, while private banks will own the rest.

The source banks would have to incur a haircut of 70 per cent. The 30 per cent, to be transferred by the new ARC to banks, will be by means of upfront cash and security receipts (SRS) fully guaranteed by the government, sources said. Of the 30 per cent value to be paid to banks, 85 per cent will be through SRS fully backed by the government and the rest 15 per cent will be in upfront cash. This is not clear yet if SRS will continue to enjoy the government guarantee if private parties outbid the bad bank in the Swiss challenge method.

Since the portfolio is expected to be ~1.5 trillion, the ARC will have to transfer ~6,750 crore to banks in upfront cash.

This cash transfer will be done from the equity put by banks owning the ARC. So, on a net basis, the equity infusion will be a neutral transaction of sorts for the banks, according to sources.

The bad bank will be managed by a private-run ARC for a fee. Any recovery above the 30 per cent value at which it is transferred to the ARC will be transferred to the source banks after deducting the fee.