Rescue act, again

By forcing SBI to take over Yes Bank, the government and the Reserve Bank of India appear to have abdicated their responsibility to ensure the systemic safety of the Indian banking system.

Rana Kapoor, Yes Bank founder, in ED custody on March 8.

India’s biggest bank rescue act could not have happened at a more inopportune time. The collapse of Yes Bank—an oddly sounding name for a bank that is now on life support—and the rescue package initiated by the government diverts resources and distracts attention from an unprecedented pandemic that the government has its hands full with. What happened on March 5, when the Reserve Bank of India (RBI) announced a moratorium on withdrawals from Yes Bank and a temporary takeover as its custodian, would have surprised only those who were habitually used to looking the other way when there was ample evidence that the private bank was a serial offender not just in terms of banking regulations but also in terms of dressing up balance sheets.

The RBI’s “draft” reconstruction scheme did not leave much room for doubt that the central bank was acting at the behest of the Finance Ministry. The diminishing autonomy of the RBI in recent years, not only as a regulator but also as a systemic watchman, had set the ground for this directed script. In keeping with the penchant for using other state-owned financial institutions—as was the case with Life Insurance Corporation’s takeover of IDBI Bank in 2018—the Yes Bank rescue is being compered by State Bank of India, India’s biggest bank.

Yes Bank had assets to the tune of Rs.3 lakh crore, but assets as defined in the banking industry are a peculiar artefact of accounting practices. Assets in banking are actually loans that have been extended, and they are assets only because they generate returns for a bank, which is what assets are supposed to deliver. But when assets turn bad, non-performing assets (NPAs) in banking parlance, they are very different from the way assets function in other realms of the economy. An asset in the hands of other entities can be liquidated to generate capital, but in the case of a bank when an asset turns bad the bank starts bleeding its capital base. Now for some specific context to the story of Yes Bank, which was the darling of the media for its buccaneering spirit.

When the entire Indian banking industry was locked into a credit freeze, partly because of its unwillingness to lend because of impaired balance sheets and also the poor demand for credit following the economic slowdown, Yes Bank seemed to be on a different planet altogether. Its advances increased by a whopping 338 per cent between 2013-14 and 2018-19 (see chart). The other side of this apparently rosy picture of a heavier loan book lay in its accounting practices, of which the RBI was fully aware as early as 2017. The RBI discovered huge holes in the bank’s books, especially in the manner in which it concealed NPAs in order to inflate profits.

Hemindra Hazari, the intrepid financial analyst well known for speaking his mind, had pointed out in October 2017 that Yes Bank was a serial offender in this regard. He pointed out that for fiscal year 2015-16 Yes Bank disclosed its gross NPAs as Rs.7,490 crore but the RBI estimated these to be Rs.49,257 crore, a shocking divergence of 558 per cent. Incidentally, the RBI also found divergences to the extent of 155 per cent by Axis Bank and of about 20 per cent in the case of ICICI Bank.

In the following year, 2016-17, the sordid story was repeated. Whereas the Yes Bank management reported gross NPAs of Rs.20,186 crore, the RBI found these to actually amount to Rs.83,378 crore, a divergence of Rs.63,552 crore. Consequently, the net profit for 2016-17 was scaled down from Rs.33,301 crore as claimed by the bank, to Rs.23,161 crore, a scaling down by Rs.10,140 crore.

Obviously, this dressing of accounts was intended to conceal the true extent of provisions that needed to be made, with obvious consequences for profitability. In other words, the only reason for concealing the NPAs was to boost profits as shown in its books. The RBI’s revision resulted in the scaling down of net profit by a whopping 22 per cent for 2016-17. Not just that, the revision also resulted in the scaling down of the bank’s capital base (Tier-1) by about 4 per cent. Hemindra Hazari pointed out in a 2017 report that Yes Bank did not report this significant divergence discovered by the RBI as it went shopping for a fresh bout of equity injection (at Rs.1,500 a share) from institutional investors, amounting to $750 million, in March 2017. He pointed out that the lead merchant bankers to the issue failed to conduct due diligence. Hazari also pointed out that Yes Bank was excessively top heavy even when compared with its peers among private banks. In 2015-16, for instance, Yes Bank, with assets of about Rs.1.65 lakh crore, had a “top management” strength of 146, whereas ICICI Bank, commanding assets to the tune of Rs.7.09 lakh crore, had a “top management” of just 32. Hazari also found a significant churn in the extent of the “top management,” which he characterised as being odd.

Yet, the RBI, despite mounting evidence that it was well aware of the reckless ways of the top management at Yes Bank, allowed the promoter and CEO, Rana Kapoor, to complete his term in January 2019. Neither the RBI nor the Finance Ministry thought it fit to send a clear message that it intended to curb the buccaneer banker. The flurry of cases filed against him by the Central Bureau of Investigation (CBI) and the Enforcement Directorate serve no purpose as the damage has already been done. In any case, these cases now under scrutiny have no relevance either to the health of the bank or to bringing him to book for having driven it to the ground.

The normal process of bankruptcies cannot be allowed to proceed in the case of banks, especially large ones like Yes Bank, simply because an uncontrolled collapse poses significant systemic risk to the entire banking system. A significant aspect of this relates to the need to protect the interests of depositors, although the Narendra Modi regime has time and again tried to change the rules of protection but has only stalled in the face of protests.

Saving a bank

So the question was never about whether to save Yes Bank but about how to get it done. The choice of SBI as the adopting parent of a wayward child is indicative of its sheer hypocrisy. While the Modi government has gone out on a limb arguing that governments ought not to be in business, or that business institutions ought to focus sharply on their business interests, it nevertheless sees nothing wrong in thrusting a dud asset in the hands of its tallest child in the banking sector , SBI.

The restructuring plan that is now operational makes Yes Bank all but a subsidiary of SBI. It can own up to 49 per cent of the bank (currently just below it), of which 26 per cent is subject to a lock-in of three years. It is clear to anyone in the banking world that the capital infusion of Rs.10,000 crore needs to be followed by much, much more fund injection. Given the state of the economy and the rising risk aversion, as evidenced by the collapse of markets worldwide, this is going to be a costly affair if it materialises at all. What this means is that SBI will need to throw more good money after the bad it has already sunk in this venture.

Matters have been worsened by the uncertainty surrounding Yes Bank’s Additional Tier-1 (AT-1) bonds valued at almost Rs.11,000 crore. The initial draft restructuring plan advocated a complete write-off of these bonds, which are of a very special class. Such bonds exist in “perpetuity” until they are extinguished at certain pre-specified trigger points. Since these bonds are akin to equity, which carry a high level of risk, all over the world they are sold only to institutions, never to individuals. But Yes Bank, in keeping with its status as an innovator par excellence, mis-sold them to retail customers too; moreover Provident Fund and pension fund investments have also been made in these instruments, which are now in jeopardy. Faced with mounting protests, the decision to cancel these bonds has been kept out of the finalised scheme for restructuring the bank. However, since these instruments generally carry a higher rate of interest, supposedly reflecting the higher risk associated with them, it is now likely that the interest rate on fresh issues of such bonds in order to bolster the capital base of the bank would result in higher costs for the bank because of the higher risk premium that goes with investments in a sagging bank.

The reliance on public sector banks as saviours at a time when they are already reeling under the burden of NPAs is fraught with serious risk. The case of IDBI’s takeover by LIC is the most recent example of how a well-performing institution is saddled with a dud asset. Even if one accepts the logic that only public sector banks are available for such a takeover, there is nothing in either the rule books or economic logic that prevents the government from funding the salvage operations. Both the RBI and the government, being responsible for protecting the systemic safety of the financial sector, have the power as well as the wherewithal to undertake the task directly instead of offloading it to a bank, knowing fully well that this poses systemic risk as well. For now, the RBI has extended a line of credit of Rs.60,000 crore. The fact that depositors have not made a rush to the exit could well be because of these measures. But as more NPAs come to light the line of credit may well be inadequate to staunch their hurried exit.

It is possible that at some point down the road SBI may be forced to take over the rump of a bank that it now holds albeit only partially in theory. If and when that happens, the full weight of responsibility for having contrived a crisis at India’s biggest bank would well fall on both the RBI and the Finance Ministry. For now, a cover-up of sorts has been managed as other weighty and urgent issues grab the attention of the country.