Banking Sector

RBI placed financially troubled Yes Bank under a moratorium. It has also announced a draft
‘Scheme of Reconstruction’ that entails SBI investing capital to acquire a 49% stake in
restructured private lender.

 Yes Bank’s stock tumbled 56% on BSE , eroding shareholders’ holdings and dragging 10-bank
S&P BSE Bankex down with it, an indicator of contagion risk that a sudden bank resolution can pose
to financial system.

Yes Bank’s troubles are not exactly new or unique and its problems with mounting bad and dodgy
loans reflect the underlying woes in borrower industries, ranging from real estate to power and non-
banking financial companies.

The continued inability of several corporates to repay their loans resulting in many landing up in
insolvency proceedings has meant that lenders have been the hardest hit.

Yes Bank suffered a dramatic doubling in gross NPA over April-September six-month period to
₹17,134 crore, even as it scrambled to raise capital to shore up its balance sheet.

With economy in the throes of a persistent slowdown, the prospects of banks’ burden of bad loans
easing soon are limited.

The fact that the lender ended up at the resolution stage, without ever being placed under the central
bank’s Prompt Corrective Action (PCA) framework, also raises a question mark.

RBI in recent years flagged several concerns, including a distinct divergence between the reported and
RBI’s own findings on the bank’s financials.

This is a good opportunity for RBI to review its PCA guideposts and revise them to ensure that such a
slipping under the radar does not recur.

The choice of SBI as investor to effect the bailout reflects paucity of options GoI has. With several
other PSBs currently engaged in merging with weaker peers as part of GoI’s plan, it has fallen on
country’s largest bank to play the role of a white knight to a private rival.

While Yes Bank’s depositors are sure to heave a huge sigh of relief, India’s banking sector is still far
from out of woods. Clearly, RBI and GoI have their task cut out in ensuring that the need for such
bailouts is obviated.

RBI announced Yes Bank reconstruction scheme, which clearly suggests that SBI would take on the
burden of rescuing the country’s fifth largest private sector bank. SBI will invest in Yes Bank, and
hold 49.

GoI had no choice but to use the instrument of moral suasion on SBI to acquire the bank. For RBI,
it was imperative to act to save Yes Bank from collapsing, to preserve people’s trust in Indian
banking system.
It will have two adverse impacts: One, people will gravitate towards PSBs which are credit averse,
and two, private banks will be forced to offer higher deposit rates, keeping the cost of credit higher.
Both these are highly undesirable at a juncture when the economy is floundering at a 5 per cent
growth rate.

After being slothful in identifying governance faultlines among a string of players in the financial
sector — IL&FS, DHFL, and now Yes Bank, it was slow to act.

Besides access to books of banks and NBFCs, RBI also receives intelligence from analysts closely
tracking the sector.

Its unwillingness to act quickly and decisively even after identification of structural weaknesses is
cause for serious concern

The troubles of Yes Bank were known for long

Of course, the players are failing their customers. But RBI is also failing to uphold people’s trust and
faith.

The collapse of Yes Bank is yet another black mark for India Inc.

The failure of private sector lender only strengthens the perception that not too many promoters in
India can be trusted to run their businesses and not ruin them.

For all criticism of PSBs and rants about its inefficiency, much of private sector hasn’t exactly
covered itself with glory; integrity levels in the private sector, it would appear, are far more
questionable.

Yes Bank is a collective failure, and everyone—regulators, auditors, rating agencies—must share the
blame.

But, the fear in minds of depositors apart, risk aversion in financial markets will only rise further. It is
surprising that so many mutual funds had an exposure to Yes Bank—equity and debt—and that they
didn’t read the writing on the wall. Each time a lender fails , we discover that MFs have a large
exposure to it.
Perhaps, it is time to have a watchdog for the financial sector outside of RBI which is made
accountable.

There are depositors big and small involved who were attracted by the higher interest rate offered
by private banks like Yes Bank and who would lose hugely if Yes Bank is allowed to collapse.

That would, besides making the government unpopular, most likely set off a chain of withdrawals
from other private banks as well as some weaker public banks, with contagion posing a systemic
threat.

Moreover, firms and agents dependent on Yes Bank for credit to keep them in business may find
their operations disrupted and new credit lines difficult to find. That could lead to their defaulting
on debt they owe other creditors.

There would also be adverse spin-off effects on investors in bonds and instruments issued by Yes
Bank, triggering turmoil in other parts of the financial system.

There have been reports of governance failures, accounting irregularities and balance sheet
weaknesses at Yes Bank for more than two years now.

The collapse of Yes Bank is the tale of a promoter who ran amok, treating a publicly listed
bank as his private company.

The bank’s story is similar to many recent stories of large listed companies that went bust,
companies that were treated like family firms by their promoters.

But what is astonishing in the case of Yes Bank is that though there were laws and regulations to
abide by, like Companies Act and those stipulated by SEBI, the bank had another layer of
compliance requirements under the oversight of RBI, which has its own set of strict guidelines. It
failed in spite of all these.

Listed companies are run by Boards. There is a CEO and MD who runs the company but is
answerable to the Board. But the Board of Directors is perfunctory. Therein lies the rub.
Board has ‘independent directors’ not just because it is a statutory requirement, but also because
this adds prestige to the company and the promoter.

These independent directors rarely perform their function of questioning the decisions of the
CEO, upholding probity, and protecting the minority shareholders’ rights. Nor are they expected
to do so by the promoter or the controlling shareholders who appoint them. However, the moment
these ‘independent directors’ raise concerns on any seeming impropriety, they are shown the
door.

ED arrested Yes Bank’s co-promoter accusing him and his family of using shell companies to
receive kickbacks from bank’s corporate borrowers.
RBI had used its powers to supersede bank’s board and impose restrictions on its operations.
Predictably, SBI has emerged as Yes Bank’s knight in shining armour.

Troubles spilled into public domain two years ago, when, in September 2018, RBI had declined
to extend Mr. Kapoor’s term as MD and CEO. It directed bank to end his tenure by January 31,
2019.

The scam on bank’s balance sheets must have been visible to RBI as far back as in 2015. The
RBI’s AQR had forced Yes Bank, as it had several other banks, to report transparently their
previously unstated NPAs.

Before AQR in 2015, bankers avoided recognising bad loans on their books. They did this by
evergreening, to keep the stressed borrowers afloat.

The RBI found that for year ended March 2016, Yes Bank had classified loans worth ₹749 crore
as gross NPAs, understating the figure by a whopping ₹4,176.70 crore. It directed Yes Bank to
reclassify more loans as NPAs.

Just five months later, in October 2017, bank disclosed, once again, that RBI had discovered
more underreported gross NPAs. For year ended March 2017, under reporting was of the tune of
₹6,355 crore.

Also, Yes Bank was looking for investors for the last few months.

For year ended March 2019, RBI discovered underreported NPAs worth ₹2,299 crore.

How credible can the rescue be when barely three months ago the SBI had disclosed that the RBI
has discovered under-reported NPAs — of ₹11,932 crore for the year ended March 2019 — on
its books?

The Association of Mutual Funds in India has written to RBI and SEBI to allow fund houses a
temporary write down of additional tier 1 bonds of Yes Bank to avoid a huge hit on the net
asset value of schemes that hold such bonds.

RBI’s restructuring scheme of Yes bank mentioned that such bonds would be permanently written
off.

Many fund houses stand to lose thousands of crores if additional tier 1 bonds are completely
written off. Such bonds, known as AT1 bonds in market parlance, are perpetual bonds issued
by banks to meet their long-term capital requirements.

Interestingly, such bonds typically do have a call option after five years and hence if RBI allows
a temporary write down, the fund houses may still be able to stem the potential losses if
valuation of the bank improves after restructuring.
What is it?

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 Basel-III norms.
In India, one of the key new rules was that banks must maintain capital at a minimum ratio of 11.5%
of their risk-weighted loans. Of this, 9.5% needs to be in Tier-1 capital and 2% 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?

AT-1 bonds have several unusual features which make them very different from plain-vanilla
bonds. 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 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 RBI feels that a bank is tottering on the brink and 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.

Why should I care?

AT-1 bonds are complex hybrid instruments, ideally meant for institutions and smart investors who
can decipher their terms and assess if their higher rates compensate for their higher risks.

AT-1 bonds carry a face value of ₹10 lakh per bond. There are two routes through which retail folk
have acquired these bonds — initial private placement offers of AT-1 bonds by banks seeking to raise
money; or secondary market buys of already-traded AT-1 bonds based on recommendations from
brokers.