YES Bank fiasco is deeply disconcerting

YES Bank was, by all accounts, an ambitious entity that dreamed big and believed in speed. No wonder, within a little over 15 years of its existence since its birth in 2004, it became the fourth largest private bank in India with total assets of about ₹4 lakh crore. Even in the not-so-encouraging moments towards the end of 2019, its CEO confidently spoke about achieving growth exceeding 25 per cent. And, it spent a good deal of money in publicity and image-building.

The mood-elevating curious words that adorned its annual report for 2017-18 were ‘Future Now’. As an aside, Albert Einstein established, more than a century back, that nothing can move speedier than light, because in that case future will precede not only present but past as well. But for all its promise of speed and being able to raise big-ticket money from investors at will, it came down with a loud thud last week.

There was something surreal about the way YES Bank functioned. It defies logic how a bank which disclosed capital adequacy of 16.5 per cent and gross NPA of only 3.22 per cent as late as March 31, 2019, could fail in less than 12 months. One doubts if all the executive talk and carefully planted media stories throughout 2019 about its plans to garner fresh equity involved any serious efforts or were merely hot-air balloons or acts of trapeze aimed at some gullible audience.

The fall of YES Bank, coming as it does, on the heels of a series of existential crises witnessed earlier in IDBI Bank, IL&FS, DHFL, PMC Bank, Altico Capital, on the one hand, and shocking reports of high-profile wrongdoings in two major private sector banks, on the other, provides yet another reality check confirming how fragile the Indian financial sector is.

What went wrong? Well, just about everything. Weak corporate governance, dysfunctional boards, poor external auditing standard, breakdown of market discipline, low supervisory competence and, above all, lack of political will to clean up the mess that was created by long years of corrupt nexus between politicians, promoters and bankers.

The YES Bank episode couldn’t have come at a worse time, when the growth impulses in the economy are impaired with limited headroom available for further fiscal and monetary stimulus. The economy will have to pay a heavy price and may even have to face a long-term debility, resulting from the diminution of public trust in the stability of the banking system, the incipient signs of which are now only too apparent.

No gains will be made by harping on the misdeeds and wrongdoings of the past. Already, doubts about the resolve and ability of the leaderships in the government as well as in the RBI to promptly and effectively remedy the situation have arisen. A sense of despair, fear and, possibly, anger about the financial system is taking hold. A political price will likely have to be paid.

RBI’s role

Financial sector is special everywhere, since it is inherently risk-prone due to the presence of negative externality: pursuance of bad policies and practices by any one entity can cause damage to others or the system itself. This constitutes the main rationale for regulating banks/NBFCs. While the Indian regulatory regime closely reflects the global standards, the supervisory performance of the RBI hasn’t kept pace with the growing complexities of the financial sector.

In the case of YES Bank, a question is being asked if the actual extent of under-reporting of NPA in 2018-19 far exceeded the figure of ₹3,277 crore, as determined by the supervisors then. This is highly likely, since at least 50 per cent of YES Bank’s equity at ₹26,904 crore as of March 31, 2019, must have been eroded by way of additional loan loss at the time of the moratorium on March 6.

The RBI should reveal the chain of main events leading to YES Bank’s collapse, including any supervisory lapse in estimating the bank’s true economic capital in the light of its risk exposures, especially to bad loans. It was widely known for long that the bank’s non-interest income was bloated, at times by way of receipt of unusually high fee income from new corporate borrowers, involving an informal quid pro quo in this regard.

There were sufficient indications of egregious irregularities to be taken note of. For example, a spurt in the ratio of non-interest income to net interest income took place during 2016-17 and 2017-18, when loan growth rates were also very high at 35 per cent and 54 per cent respectively.

Restructuring scheme

It appears that SBI, which will initially put ₹2,450 crore for getting 49 per cent stake will soon try to rope in other investors for more equity infusion. Thankfully, SBI has sufficient experience and professional bandwidth to make a serious and meaningful effort to revive YES Bank for the sake of its depositors. A lot will, however, depend on the legality of the proposed extinction of liability for AT1 bonds, estimated at nearly ₹11,000 crore.

That the government has eschewed the option of amalgamating it with SBI is indicative of a departure from the policy applied for the merger of the failed Global Trust Bank (GTB) with Oriental Bank of Commerce (OBC) in 2004. That merger proved disastrous for OBC, which was a well-performing public sector bank then. Its competitive position vis-à-vis its peers began falling in a few years’ time thereafter (see Table). At the time of GTB’s merger with OBC, the shareholders of GTB got nothing, meaning thereby that OBC obtained it free. But OBC realised later that the deal was not as sweet as it had seemed, because GTB’s bad loans turned out to be way above what was revealed at the time of merger, thereby inflicting sizeable provisioning loss on it.

OBC’s return on assets, which is a good summary indicator of overall performance was much higher in 2004-05 and earlier, the average being about 1.50 per cent during 2001-02 to 2004-05. It fell to an average of 0.98 per cent over the next seven years. Clearly, there were other factors contributing to OBC’s decline, most notably the politically-dictated widespread evergreening of bad loans in 2009-10 and thereafter.

But the forced amalgamation of GTB proved to be a huge shock for OBC from which it never recovered. Its impending disappearance in a few weeks from now will leave behind a sad tale of short-sighted and opportunistic banking policy, mindless government intervention and massive value destruction, among others.

Restoration of policy credibility

The present government has told us on a few occasions that although it had the option of making public a white paper on the state of the banking system it had inherited, it chose not to do so because, in its judgment, that step could have undermined financial stability. Hence, it opted for reforming the system through policy changes. But unfortunately, the policy approach seems to lack strong focus and direction.

Also, the political slugfest on who did what has become unbearable and even offensive. The government would do well to have a rethink on issuing a white paper which will clear the air of uncertainty and also restore policy credibility.

Through The Billion Press. The writer is a former central banker and consultant to the IMF

COMMENT NOW