Now that Moody’s has upgraded its rating of YES Bank with a positive outlook and the moratorium on withdrawal has lifted, the beleaguered private sector bank can get back to doing business again. While its future is wide open, and it will have to struggle to regain customer and investor confidence, it is vital to learn some lessons from the debacle by what was not so long ago an aggressive private sector high-flier.

The major burden of learning from the fiasco falls on the shoulders of the banking regulator Reserve Bank of India. The Department of Financial Services, which is supposed to keep a watchful eye over the entire financial sector — in particular both public and private large commercial banks — also needs to do some learning, but that is dependent on the prevailing political culture.

The economic administrators of the Department will conduct themselves largely on the basis of their understanding of which way the heads of their political masters are turned. Additionally, and perhaps most importantly, the new management — which will have the backing of key investors of the recapitalised banks, like the State Bank of India, and leading private sector entities like HDFC and ICICI Bank — will have to be careful not to run too fast.

Delayed action

First, the issue of whether the RBI acted promptly enough. P Chidambaram has highlighted the fact that YES Bank’s advances grew at a compound annual rate of over 34 per cent during 2014-19 (with a spike during the two post-demonetisation years of 2016-18), while the loan book of the entire banking system grew at 9.5-10 per cent. This in itself should have sent alarm bells ringing. But the RBI action came almost two years later, when the bank’s board was superseded earlier this month. In between, Rana Kapoor, founder and CEO, exited in January 2019 and former RBI deputy governor R Gandhi was put on the board in May 2019.

Action by the RBI should have come 6-8 months before it actually did, according to Shriram Subramanian, chief executive of proxy advisory firm InGovern. Former RBI governor Raghuram Rajan says that “YES Bank has given us enough notice that it has been in difficulty.” The notice came from the fact that YES Bank had been struggling to raise funds, had virtually stopped lending and was simply taking “unbridled risk…merely by window dressing its accounts,” adds Subramanian.

The plight of YES Bank has highlighted a peculiarity of the Indian banking system, which can be an intrinsic source of problems stretching right into the future. The majority of assets in the Indian banking system are commandeered by public sector banks. Thus, there is no comparison between the sense of security that they provide and that which private sector banks can offer. Long-established private sector banks, particularly those in the South, where there has been a robust indigenous tradition of banking (remember Syndicate Bank, a pioneer in banking innovation in its privately owned days?), can depend on their old customer base and reputation.

Aggressive lending

But what does a new private sector bank, which seeks to leverage private initiative and modern technology, as did YES Bank, do to attract and retain deposits? It has perforce to pay more than the competition, for which it has to earn a better margin. Thus, a degree of aggression has to be built into the business model, which is the opposite of the conservatism that is a part of the essence of sound banking, be it publicly or privately owned.

In such a situation, a new generation bank will occasionally fall, with the quality of lending not keeping pace with the rate of growth of lending. The dilemma of Indian banking is that public sector banks have to be more professionally-run with a governance system in which politicians and bureaucrats do not interfere. But private ownership, free of such provisions, has its own set of problems. The big challenge that the Indian banking system will face right now is of smaller banks struggling to retain their existing deposits. Several smaller South India-based banks have issued statements to quell uncertainty among their depositors in the wake of an analysis in a news channel that went viral. The RBI also chipped in with an assurance of safety. However, the uncertainty of depositors in the wake of temporary moratorium on withdrawal of deposits from two banks successively, PMC Bank and YES Bank, indicates the issue will not disappear simply through statements.

In fact, the recent crises have highlighted a more fundamental issue: does India have too many banks which can access deposits from the public, and can the regulator monitor all of them regularly and rigorously? The uncertainty among depositors in smaller banks has been unnecessarily prolonged by the government being unable to sharply hike the ceiling for deposit insurance. A hike from the current ₹1lakh to ₹5 lakh was promised in the Budget. But that was over a month ago. We haven’t heard much since..

The writer is a senior journalist

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