The last-minute scramble to cobble together a rescue plan for private lender Yes Bank underscores the need for a transparent, quick and effective resolution framework to deal with bank failures as the economy slows and financial markets become more complex.
In the absence of such a framework, several questions about the Yes Bank rescue remain. First, neither the government nor the Reserve Bank of India has explained the true extent of the financial troubles at Yes Bank and why its rescue was important for financial market stability other than to say it was done to protect depositors at the bank. If you are arm-twisting India's largest state-controlled but publicly listed lender, the State Bank of India, to invest up to 24.5 billion rupees ($331 million) to buy a 49 per cent stake in Yes Bank, surely tax payers and SBI's minority shareholders have a right to know? What we have been told is that under the stewardship of the bank's larger-than-life founder Rana Kapoor, the bank aggressively sold loans to dodgy corporate clients, earning him the nickname of the lender-of-the-last-resort. As the economy slowed, this resulted in a sharp deterioration in asset quality, but we remain in the dark about the magnitude of the hole in Yes Bank's books. Suresh Ganapathy, an analyst at Macquarie Capital Securities, has estimated the bank's net worth could be zero if we assume that a large portion of its below-investment-grade assets have been written off. But if that were the case, why had the central bank not placed Yes Bank in its prompt corrective action framework that outlines policy actions when a bank's financial condition worsens below a mark? A glance at the company's balance sheet at the end of the second quarter doesn't show negative cashflows, a warning that an entity is facing liquidity issues, and its Basel III capital adequacy ratio - a measure of financial soundness of the bank - was a respectable 16.3%. That suggests that since September 30, 2019, more loans to stressed sectors have become irrecoverable and have had to be written off but we don't have the numbers.
Yes Bank founder Rana Kapoor was arrested by the ED on Sunday after almost 16 hours of questioning in Mumbai
There could be several reasons for the lack of clarity. The auditor's notes in the company's second-quarter report point to complaints of irregularities at the bank that were being investigated. Soon after the rescue plan was announced, Mr. Kapoor was arrested on March 8 on charges of money laundering. Specifically, he has been accused of receiving kickbacks from various corporate entities on disbursal of loans. Mr. Kapoor has denied all charges against him. In the past, the government was criticised for allowing businessmen wanted in connection with financial fraud to escape to the UK. This time, it is possible the government chose to keep its findings under wraps until the arrest was made. It is also more than likely that in the financial third-quarter, both the bank's asset quality and deposits deteriorated sharply, but the RBI kept silent to prevent a run on the bank and because Yes Bank was still wooing international investors to raise capital. Market participants will have to wait till later this month to get an idea of the true extent of the problem at Yes Bank when it declares its third-quarter results.
Secondly, as a part of the resolution, the RBI has proposed to write down the entire value of Yes Bank's perpetual bonds, also called Additional Tier1 bonds. Perpetual bonds holders have claims after senior debt holders in the event of default. Converting debt into equity is a possible option in bank resolution, so it is entirely possible that some of the big institutional holders of perpetual bonds will be offered equity - the potential investors that SBI, acting as a bridge bank, hopes to bring in. This would not be fair, especially to the less financial-savvy retail investors of the AT1 bonds who perhaps sought them as an alternative to fixed deposits without comprehending the full extent of the risk. Would RBI review whether retail investors were mis-sold AT1 bonds and whether in future they should be allowed to invest in such instruments?
Worried customers of Yes Bank stand in a queue to withdraw money after the RBI capped withdrawals at Rs 50,000
Thirdly, while getting SBI to rescue Yes Bank is good first step for the troubled bank's shareholders, the benefits for SBI aren't clear. RBI Governor Shaktikanta Das told reporters that getting SBI as an investor in the initial phase of the rescue deal was a "market-based alternative" to a tax-payer-funded government bailout, the assumption being that SBI will only be acting as a bridge bank and it would be a matter of time before potential private investors are roped in. The fact that SBI wouldn't be allowed to reduce its stake to below 26 per cent for at least three years would also help to restore confidence in Yes Bank. What seems unfair though is that minority shareholders at SBI weren't consulted about the investment. And it does appear that SBI's management had no choice but to accede to playing saviour in the interest of financial-market stability. Whether the rescue pays off will depend on the bank's ability to find those private investors and ensure that depositors don't abandon the bank. SBI has said it would try to implement a reconstruction of Yes Bank much before the end of a 30-day moratorium (restrictions on loans and withdrawals) imposed by the central bank to prevent a run on the bank. Macquarie's analyst estimated that Yes Bank could need as much as $3 billion of new funding in the next 12 to 18 months. That is a tall order.
Finally, the market's perception that banks, public or private, will be rescued by the government if they are seen as 'too big to fail' creates an implicit guarantee that acts as a hidden subsidy to these lenders. In the case of the rescue of a private bank with tax-payer money, it amounts to socialization of losses. Credible resolution plans should remove this perception. Finance Minister Nirmala Sitharaman's assurance that the government wouldn't allow any bank to fail doesn't do that. Governments cannot prevent failures but they can draft rules to ensure an orderly resolution process to ensure the stability of the financial system. Those responsible for poor risk management and alleged irregularities at the bank should be held accountable, and private shareholders, bondholders and large depositors should understand that it is entirely possible that a bank can fail and they may suffer losses if they are not vigilant of management. Doing so would improve market discipline in the pricing of risks. This should, in turn, strengthen incentives for them to demonstrate to their customers, clients and investors that they aren't taking excessive risks.
(Indrani Dattagupta is a financial writer and has previously worked for The Economic Times, Dow Jones Newswires and The Wall Street Journal.)
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