Insights into Editorial: Banking on bailouts: On Yes Bank crisis

Context:

One of the major private player Yes Bank (India’s fifth largest private sector bank) has also come under the RBI action for mounting bad loans.

In order to save Yes Bank from collapsing and to preserve people’s trust in the Indian banking system, RBI has taken several measures.

It placed the financially troubled Yes Bank under a moratorium, the Reserve Bank of India announced a draft ‘Scheme of Reconstruction’ that entails the State Bank of India (SBI) investing capital to acquire a 49% stake in the restructured private lender.

Reasons for Yes Bank Crisis:

1. The alacrity with which the bailout has been proposed is commendable, given that Yes Bank’s stock tumbled 56% on the BSE, eroding shareholders’ holdings and dragging the 10-bank S&P BSE Bankex down with it, an indicator of the contagion risk that a sudden bank resolution can pose to the financial system.
2. However, the decision to suspend normal business operations raises several worrying questions, both about the health of the banking sector, and the adequacy of the oversight role that regulators essay.
3. Domino effect of IL&FS crisis: Yes Bank illustrates the widening damage from India’s shadow banking crisis, which has left the Bank with a growing pile of bad loans.
4. Yes Bank’s total exposure to Infrastructure Leasing & Financial Services(IL&FS) and Dewan Housing Finance Corp (DHFL) was 11.5% as of September 2019.

Deteriorating Financial Position:

1. The financial condition Deteriorated due to its inability to raise capital to address potential loan losses. The bank was experiencing losses and inadequate profits in the last four quarters.
2. It will also have adverse impacts on the Banking sector. People will gravitate towards public sector banks which are already reluctant to provide credit.
3. Private banks will be forced to offer higher deposit rates, keeping the cost of credit higher.
4. Thereby banks will not be able to cater the credit requirement which is a prerequisite to realise the dream of becoming a $5 trillion economy by 2024-2025.

Governance Issues:

1. The bank had serious governance issues. That is the reason former Deputy Governor of RBI Mr.R Gandhi was included in the BOD of the yes bank. Ultimately the bank reported NPA of Rs 3,277 crore in 2018-19.
2. Yes Bank’s troubles are not exactly new or unique and its problems with mounting bad and dodgy loans reflect the underlying woes in the borrower industries, ranging from real estate to power and non-banking financial companies.
3. The continued inability of several corporates to repay their loans resulting in many landing up in insolvency proceedings has meant that lenders have been the hardest hit.
4. Yes Bank, which is yet to report third-quarter financials, suffered a dramatic doubling in gross non-performing assets over the April-September six-month period to 17,134 crore, even as it scrambled to raise capital to shore up its balance sheet.

Huge Liabilities:

1. The Yes Bank has a total liability of 24 thousand crore dollars. The bank has a balance sheet of about $40 billion (2.85 lakh crore rupees). The Yes Bank has to pay $ 2 billion to increase the capital base.
2. With the economy in the throes of a persistent slowdown, the prospects of banks’ burden of bad loans easing soon are limited.
3. The fact that the lender ended up at the resolution stage, without ever being placed under the central bank’s Prompt Corrective Action (PCA) framework, also raises a question mark over how and why Yes Bank eluded the specifically tailor-made solution to address weakness at banks.

What is Prompt Corrective Action (PCA)?

1. PCA is a framework under which banks with weak financial metrics are put under watch by the RBI.
2. The RBI introduced the PCA framework in 2002 as a structured early-intervention mechanism for banks that become undercapitalised due to poor asset quality, or vulnerable due to loss of profitability.
3. It aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector.
4. The framework was reviewed in 2017 based on the recommendations of the working group of the Financial Stability and Development Council on Resolution Regimes for Financial Institutions in India and the Financial Sector Legislative Reforms Commission.
5. PCA is intended to help alert the regulator as well as investors and depositors if a bank is heading for trouble. The idea is to head off problems before they attain crisis proportions.
6. Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to restore the financial health of a bank.

Prompt Corrective Action (PCA) Measures:

1. RBI can place restrictions on dividend distribution, branch expansion, and management compensation.
2. Only in an extreme situation, would a bank be a likely candidate for resolution through amalgamation, reconstruction or winding up.
3. RBI may place restrictions on credit by PCA banks to unrated borrowers or those with high risks, but it doesn’t invoke a complete ban on their lending.
4. RBI may also impose restrictions on the bank on borrowings from interbank market.
5. Banks may also not be allowed to enter into new lines of business.

The Insolvency and Bankruptcy Code (IBC) mechanism needs to be strengthened to meet global standards with active involvement of the government, regulators, lenders, borrowers and the judiciary.

Conclusion:

With several other public sector banks currently engaged in merging with weaker peers as part of the Centre’s plan, it has fallen on the country’s largest bank to play the role of a white knight to a private rival.

While Yes Bank’s depositors are sure to heave a huge sigh of relief, India’s banking sector is still far from out of the woods. Clearly, the RBI and Centre have their task cut out in ensuring that the need for such bailouts is obviated.

The central bank had in recent years flagged several concerns, including a distinct divergence between the reported and RBI’s own findings on the bank’s financials.

This could then be a good opportunity for the RBI to review its PCA guideposts and revise them to ensure that such a slipping under the radar does not recur. The choice of SBI as the investor to effect the bailout reflects the paucity of options the government has.