In The End, It Took A Whole Village To Rescue Yes Bank

Yes Bank should serve as a reminder that India still does not have a full-fledged framework for resolution of financial firms.

People rescued from floodwater in Alappuzha, Kerala, on Aug. 22, 2018. (Photographer: Prashanth Vishwanathan/Bloomberg)
People rescued from floodwater in Alappuzha, Kerala, on Aug. 22, 2018. (Photographer: Prashanth Vishwanathan/Bloomberg)

The contours of the rescue plan for Yes Bank—put under a moratorium by the Reserve Bank of India on March 5—are starting to get clearer now.

Eight financial institutions have so far approved investments in the lender, committing Rs 12,550 crore in capital to help meet the bank’s immediate needs, according to a release by the bank. The largest contribution comes from State Bank of India, which will put in Rs 6,050 crore. ICICI Bank will invest Rs 1,000 crore, as will HDFC. Axis Bank will invest Rs 600 crore, while Kotak Mahindra Bank will contribute Rs 500 crore. Bandhan Bank will invest Rs 300 crore and IDFC First Bank will put in Rs 250 crore.

This makes the Yes Bank rescue a first of its kind, where, the government and the RBI, have brought together some of the country’s largest financial institutions to bail out a stressed lender.

Until now, the standard operating procedure was to stitch together a merger of a weak lender with a stronger one. Global Trust Bank was merged into Oriental Bank of Commerce, United Western Bank was merged into IDBI Bank. In other cases, even before a moratorium was imposed, the RBI moved in and found solutions. The merger of Bank of Rajasthan with ICICI Bank fell into this category.

If a similar option had to be exercised in the case of Yes Bank, SBI would have been the only contender. It is the only bank with a balancesheet large enough to absorb Yes Bank. It is not clear why the authorities stayed away from using that option. Perhaps it was the fear of creating a moral hazard by suggesting that government owned banks will absorb the mistakes of private enterprise. Or perhaps it was the belief that Yes Bank could be revived as a standalone entity.

Whatever the reason, policymakers have opted for a community bailout of sorts for Yes Bank.

It’s not just India’s financial institutions that stepped in, the RBI used its powers as the lender of last resort in more than one ways over the last week or so.

It provided liquidity support to ensure that the inter-bank market was not disrupted and products like tri-party repo agreements involving Yes Bank were unwound in an orderly fashion. Temporary relief on maintaining cash reserve ratio was provided to the lender, according to a person familiar with the matter. In addition, the RBI will continue to provide liquidity support once the moratorium is lifted to meet any deposit outflows if needed, the bank’s administrator Prashant Kumar told BloombergQuint in a recent conversation.

The RBI has also side-stepped its own rules to allow for the rescue. The rules say that a bank cannot hold more than 10 percent in another bank. Here, SBI is not only being permitted to exceed that shareholding limit, it is also being asked to hold at least 26 percent in Yes Bank for a period of three years. SBI has also been exempted from a provision of the Banking Regulation Act, which says that a bank cannot hold more than 30 percent equity of a company.

It truly did take the whole village to rescue Yes Bank.

The reason for the rescue is now clearer.

As of the end of the September 2019 quarter, Yes Bank had advances of Rs 2.24 lakh crore and deposits of Rs 2.09 lakh crore. Its bad loans stood at Rs 17,134 crore or 7.39 percent of its loan book. Its provision coverage ratio, which shows how well protected the bank is, was low at 43 percent. Its common equity tier-1 ratio stood at 8.7 percent, just above the minimum requirement of 8 percent.

At that stage, it seemed reasonable to assume that the bank will be able to raise some capital over the October-December quarter, although it looked challenging.

We now know what happened to the bank’s financials since September, that eventually led to the RBI’s decision to impose deposit restrictions on the bank and dismiss its board.

The bank lost Rs 72,000 crore in deposits, which stood at Rs 1.37 lakh crore as on March 5. That’s a 34 percent drop in the bank’s deposit base in about six months. Bad loans jumped to Rs 40,709 crore or nearly 19 percent of its loan book. CET-1 fell to a mere 0.6 percent.

Essentially, by the time March rolled around, the bank’s core equity tier-1 capital was wiped out and there was a run on the bank’s deposits. The RBI had no choice but to place the lender under moratorium.

That done, the RBI and the government are now attempting to reconstruct the bank with the help of large financial institutions. The capital committed so far will not be adequate at all but may suffice for a start, particularly if other investment commitments follow in the coming days.

The key question is what shape the bank will take once deposit restrictions are lifted.

Since Yes Bank has not been merged into a stronger lender, the first important monitorable is whether depositors keep the trust. At its very core, banking is based on trust. Would a depositor who has seen her or his money locked in even for a short period of time choose to stay with the bank? This concern is relevant not just for retail depositors but even for corporations who maintain large current account balances that they may need at short notice.

To be sure, given its new marquee shareholders, Yes Bank will have no trouble raising bulk deposits. But can it once again start building its CASA or low cost deposit pool?

The next question will be the kind of lending the bank will do. Growing the loan book won’t immediately be a priority for the bank. But when it does start focusing back on growth, the aggressive lending to large and mid-sized corporates that Yes Bank was built on, will probably be shunned. If Yes Bank, like many other banks, moves towards retail lending, will it become a me-too lender with a chequered past?

And finally, governance, the conduct of the board and the strength of the management will be watched with a hawk eye. Why, you ask? After all, SBI is the bank’s largest shareholder. Well, recent history tells us that shareholding of large reputable institutions is not always enough. As a reminder, the likes of Life Insurance Corporation, Orix Corporation, HDFC and SBI were all large shareholders in Infrastructure Leasing and Financial Services. They failed to prevent the fall of that institution.

The Yes Bank rescue should also serve as an urgent reminder for Indian policymakers. A reminder that India still does not have a full-fledged framework for resolution of financial corporations.

The window opened under the IBC was applicable only for non-bank lenders. Not everyone was convinced it was the most appropriate option. For banks, there is still no resolution framework.

So it is still up to the RBI and the government to cobble together rescue plans. They may have succeeded in doing so in many cases. But surely a growing financial sector in a large emerging economy needs a clear rule-based resolution framework for financial firms.

With at least the first step in the Yes Bank rescue done, the RBI and the government would do well to work urgently towards putting that in place.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.