Months of speculation over the fate of YES Bank came to an unsettling end last week, with the RBI superseding the bank’s board and placing a month-long restriction of ₹50,000 on withdrawal of deposits. The RBI has also proposed a reconstruction scheme, wherein the SBI is all set to bail out the capital-starved private lender. Given that YES Bank has currently about 255 crore shares outstanding, the SBI picking up 49 per cent stake in the bank (as per the draft reconstruction plan) would imply an initial capital infusion of ₹2,450 crore. There are also talks of roping in other investors — insurance behemoth LIC, for instance — to pump in additional capital.

In putting up such a rescue plan, the RBI possibly hoped to restore people’s faith in India’s financial system, which has taken a massive blow after the series of crises — IL&FS, DHFL and PMC Bank — that have unfolded in just over two years. With the largest lender (having the government backing) and possibly the largest life insurer (having deep pockets) stepping in to rescue an ailing YES Bank, the RBI and the government may have hoped for depositors to find some comfort.

But will they? Even after the restrictions on withdrawal are lifted after a month, will depositors continue to park their money in YES Bank? A lot of this would depend on how the revival plan takes shape, and whether other investors can be roped in to infuse more capital into the bank.

But as it stands — based on the publicly-available information — the revival of the once-fancied private sector bank appears a herculean task, if the merger with the SBI or any other public sector institution is to be ruled out for now. The significant amount of stress in YES Bank’s book that would require huge provisioning is likely to erode the bank’s capital substantially. Unless the SBI and the regulator ensures an immediate resolution and sizeable capital infusion into the bank, reviving YES Bank would be a tall task.

The stress math

YES Bank has been one of the fastest growing private sector banks. Its loans grew at a scorching pace of 38 per cent CAGR between FY14 and FY18, backed by a robust growth of 28 per cent in deposits during this period. The trouble with the private bank began as early as the March 2017 quarter, when it first declared significant divergence in bad loans (pertaining to the previous FY16 fiscal). Subsequently, it reported steeper divergences in NPAs pertaining to FY17, in the September quarter. With the bank reporting divergences of ₹4,176 crore for 2015-16 and ₹6,355 crore for 2016-17, concerns over governance and asset quality started to mar the otherwise steady and robust growth in loans. By the time the bank declared its FY19 fourth-quarter results — reporting a sharp rise in slippages and stressed book (BB and below-rated corporate loan book) — the fast-deteriorating asset quality was unmistakable. Why the powers that be waited so long to intervene would be a pointless to debate at this point in time.

So let’s cut to the chase and look at the bank’s current book.

Based on the numbers available for the September quarter, YES Bank’s gross non-performing assets stood at ₹17,134 crore or 7.4 per cent of loans. The bank’s provision cover (outstanding provisions for GNPAs) is a low 43 per cent. If one assumes an average recovery rate of 45 per cent on bad loans, then the bank will have to provide an additional 12 per cent or about ₹2,000 crore of provisioning in the near future.

Then there is the looming risk from the bank’s sizeable stressed book. As of September 2019, the bank’s BB and below book stood at ₹31,400 crore. Given the slow resolution in these accounts and risk emanating from exposure to the telecom sector, a recovery rate of, say, 70 per cent on these accounts would imply that the bank needs to make about ₹9,500 crore of additional provisions for these accounts.

Finally, the bank has a huge ₹65,000-odd crore of BBB corporate book, which may entail an additional ₹13,000 crore of provisions even if we assume a 80 per cent recovery rate. In all, YES Bank may need to provide an additional ₹18,000-20,000 crore in the near term. This, considering the bank’s core capital, is a humongous amount.

According to Basel III disclosures for the bank as of September 2019, YES Bank’s Common Equity Tier-I capital (CET-I) stood at ₹27,299 crore. Including the additional Tier-I capital of ₹8,787 crore, the bank’s total Tier-I capital stood at ₹36,086 crore as of September 2019. In relation to this core capital, the bank’s stressed assets and the additional provisions required are a sizeable figure, only highlighting the urgency with which massive capital needs to be infused into the bank.

It is important to note here that the bank, in a bid to conserve capital, has been consolidating its loan book. In the first half of the current fiscal, the bank’s advances have shrunk by about 7 per cent (over the March 2019 quarter). Hence, additional capital over and above the ₹20,000-crore estimate will be required to fund the bank’s lending operations.

The SBI’s initial commitment to pump in ₹2,450 crore of capital is just a drop in the ocean. Will the SBI and the regulator be able to muster support from other investors to fill the void?

Beyond the book

The bigger worry, however, is whether there are other skeletons waiting to tumble out of YES Bank’s book. Why did the RBI choose to impose a moratorium straight away, rather than place the bank under Prompt Corrective Action (PCA)?

PCA is a framework under which banks are put under watch by the RBI, if they slip below certain norms on three parameters — capital ratios, asset quality and profitability. Depending on the threshold levels, the RBI can place restrictions on dividend distribution, branch expansion, and management compensation. Only an extreme situation — breach of the third level of threshold (CET-I ratio slipping below 4.25 per cent) — would identify a bank as a likely candidate for resolution through tools such as amalgamation, reconstruction, and winding up.

YES Bank’s CET-I ratio stood at 8.7 per cent as of September 2019. Could the RBI have found wide disparity in the bank’s numbers? Could the actual assessment of the bank’s asset quality imply the bank was breaching the regulatory thresholds on capital?

Hard to say. But it does cast a shadow over the possibility of finding investors to infuse a huge amount of capital into the bank. Hopes are pinned on LIC to play the knight in shining armour once again. But given that the insurance behemoth is already having to infuse sizeable capital into the ailing IDBI Bank (in which it holds 51 per cent stake), to what extent it can step up to bail out YES Bank needs to be seen. Above all, the systemic risk within the banking system percolating into other segments of the financial system maybe a recipe for disaster.

Merger option

Bailing out YES Bank through a forced merger with another bank may then appear as the only likely solution. And why not? The Indian banking system is replete with instances of RBI forcing a merger of a weak bank with a stronger one to safeguard depositors’ interests. In 2003, Punjab National Bank took over Nedungadi Bank, the oldest private sector bank, after the latter’s net worth was completely wiped out due to accumulated losses. In 2004, after various financial discrepancies came to light, the RBI forced a merger of Global Trust Bank with Oriental Bank of Commerce.

But the question is, do we have strong enough banks that can absorb YES Bank’s losses?

Over the past two years, there have been a slew of merger announcements in the PSU bank space. The SBI, that merged its five associate banks in 2017, continues to be weighed down by sharp slippages and divergences in bad loans. Bank of Baroda, that was merged with Dena Bank and Vijaya Bank, continues to post losses and relies on the Centre to meet its capital requirements. The future of the mergers announced by the Centre — folding 10 PSBs into four — is already dodgy given the sordid states of finances of many of these banks.

With PSU banks out of the equation (taking away the blissful idea of limitless capital support from the Centre), will private sector banks offer themselves up for matchmaking? Until there is more clarity on the final reconstruction plan of YES Bank and on the other investors willing to pump in capital, the future of YES Bank looks murky.

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