Yes Bank Crisis

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Topic: General Studies 3:

• Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

In News: Reserve Bank of India governor Shaktikanta Das said that the Yes Bank resolution will be done very swiftly and that 30 days is an outer limit. 

Last week, the central bank put Yes Bank under moratorium and capped withdrawals at Rs 50,000 per account till further orders. The central bank had taken over the Mumbai-based bank’s board for 30 days amid a serious deterioration in India’s fifth-largest private sector lender’s financial position. 

The governor said that the decision was at a “larger level” and not at individual entity level. The move is aimed at ensuring safety of the financial system. Das has assured a swift action from the central bank’s end so as to put in place a scheme to revive the Bank. 

Yes Bank has been facing difficulties ever since new chief executive Ravneet Gill took charge last March and revealed massive stress in the loan book. Significantly, public sector lender SBI along with some other financial institutions has come forward to bail out the bank, according to media reports. PTI also reported that LIC has been asked to team up with the public sector bank for a stake buy.

The First Red Flag

Between 2004, when it was launched, and 2015, Yes Bank was one of the buzziest banks. In 2015, UBS, a global financial services company, raised the first red flag about its asset quality. The UBS report stated that Yes Bank had loaned more than its net worth to companies that were unlikely to pay back. However, Yes Bank continued to extend loans to several big firms and became the fifth-largest private sector lender.

According to one estimate, as much as 25% of all Yes Bank loans were extended to Non-Banking Financial Companies, real estate firms, and the construction sector. These were the three sectors of the Indian economy that have struggled the most over the past few years.

Yes Bank’s NPAs were not as alarmingly high as some of the other banks in the country. But what made it more susceptible to bankruptcy was its inability to honestly recognise its NPAs — on three different occasions, the last being in November 2019, the RBI pulled it up for under-reporting NPAs — and adequately provide for such bad loans. Yes Bank also fared poorly on provision coverage ratio, which essentially maps the ability of a bank to deal with NPAs.

Nobody on Yes Bank’s side: While debtors failing to pay back was the central problem, what further compounded Yes Bank’s financial problems was the reaction of its depositors. As Yes Bank faltered on NPAs, its share price went down and public confidence in it fell. This reflected not only in depositors shying away from opening fresh accounts but also in massive withdrawals by existing depositors, who pulled out over Rs 18,000 crore between April and September last year. It is estimated that up to 20% more withdrawals could have happened between October and February. So essentially, Yes Bank lost out on capital (money) from both depositors and debtors.

The contagion impact on other private banks: The banking system runs on trust. The Yes Bank episode could likely push depositors away from private sector banks.

But private banks have become too big to fail. 

And with the growth of non-bank lenders, the explosion in financial market activity and the interconnectedness of everybody, the stage is set for mass convulsions, if things are not quickly brought under control.

The government now has a fantastic opportunity ahead of it in the next few years. 

• Crashing oil prices could boost fiscal gains
• Wariness over supply chain concentration in China can drive FDI inflows to India
• Structural reforms, low corporate tax and low interest rates can spur growth and drive the economy towards the $5-trillion target by 2024. 

The opportunity should not be frittered away by lax regulation and delayed action in the banking and financial sector.

Note: 

If the account is frozen:A moratorium places a complete freeze on most activities of the bank. Section 45 of the Banking Regulation Act, 1949, empowers the RBI to place such a moratorium for up to six months at a time—and can be extended until a more permanent fix for the problem is found. This is intended to prevent a further deterioration in the bank’s finances.

AT1 Bonds

AT-1, short for Additional Tier-1 bonds, are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet the Basel-III norms. After a string of banks turned turtle in the global financial crisis, central banks got together and decided to formulate new rules (called the Basel-III norms) that would make them maintain stronger balance sheets.

In India, one of the key new rules brought in was that banks must maintain capital at a minimum ratio of 11.5 per cent of their risk-weighted loans. Of this, 9.5 per cent needs to be in Tier-1 capital and 2 per cent in Tier-2. Tier-1 capital refers to equity and other forms of permanent capital that stays with the bank, as deposits and loans flow in and out.

Why is it important?

• One, these bonds are perpetual and carry no maturity date. Instead, they carry call options that allow banks to redeem them after five or 10 years. But banks are not obliged to use this call option and can opt to pay only interest on these bonds for eternity. 
• Two, banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value without getting into hot water with their investors, provided their capital ratios fall below certain threshold levels. These thresholds are specified in their offer terms.
• Three, if the RBI feels that a bank needs a rescue, it can simply ask the bank to cancel its outstanding AT-1 bonds without consulting its investors. This is what has happened to YES Bank’s AT-1 bond-holders who are said to have invested ₹10,800 crore. 

Connecting the Dots:

1. Was Yes Bank is another example of delayed action? Comment.