RBI Says YES to Redeem Another Bank from Impending Disaster

The latest shock to hit India’s banking system – YES Bank’s fall from grace – is not the first in the country, neither will it be the last. While every banking crisis rattles the confidence of financial markets, investors and citizens, YES Bank’s fall is particularly concerning given that it has been in operation for only a little over 16 years. Its meteoric rise in such a short timeframe, along with its equally swift downfall, has already led to a chorus of voices asking – why did it take market regulators so long to act?

Banking scams and failures are not new. Some of the recent banking crises mirror those which occurred in the 19th century, in pre-Independence India. A notable example is the case of the Presidency Bank of Bombay (PBB), established by the East India Company in 1840. After operating successfully for over two decades, the bank collapsed in 1867 following the end of a speculative cotton boom which in turn was brought about by an unforeseen end to the US Civil War in 1865.

A new Bank of Bombay was reconstituted immediately in 1868, but not before the losses of PBB were written off as irretrievable debts. Historians have drawn a parallel between PBB and the more recent scam involving Punjab National Bank (PNB), with the difference being that PNB was not allowed to collapse. Instability in the banking system, of which PBB (and before it, several other banks in Bengal) was a casualty, was blamed on banks’ unlimited liability. In 1861, banks were allowed to have limited liability; however, this did not prevent PBB’s collapse six years later.

However, regulations can help only so much. In the absence of fool proof checks and balances, tight governance structures and adherence to codes of conduct, banks will continue to run amok. YES Bank’s private sector peer, ICICI Bank, was recently embroiled in a controversy with allegations of nepotism and favouritism against the bank’s (now former) CEO. These are not the only banks which have been found wanting: modern banking history in India is replete with incidents of several banks failing and leaving people in the lurch.

How YES turned to NO: ‘Banking’ on personal relationships and lack of governance

The present state of affairs at YES Bank was not an overnight development. For years, the bank had been in the news for various reasons such as doling out loans to risky enterprises, reporting lower non-performing assets (NPAs), questionable governance structure and a dubious management structure. These events repeatedly signalled that all was not well with YES Bank.

Yes Bank Timeline Since September 2018
Yes Bank Timeline Since September 2018

Infographic by Alum Knight Partners

A simple 5-year financial statement analysis of YES Bank vis-à-vis its peers would have been sufficient to raise doubts even among more liberal analysts. The bank’s meteoric rise compared to other private banks was astounding.

Yes Bank vs Peers Absolute Growth
Yes Bank vs Peers Absolute Growth

Yes Bank vs Peers CAGR March 2015 to March 2019
Yes Bank vs Peers CAGR March 2015 to March 2019

What was the reason for YES Bank’s spectacular growth in such a short span of time? Most experts have attributed it to MD and CEO Rana Kapoor’s aggressive business style and the desire to strike it big in the shortest possible time. It was an open secret that Kapoor never refused any borrower and extended loans to all enterprises, even those which were in risky sectors or had not been in operation for very long. This prompted some banking analysts to label YES Bank with the moniker ‘bad boy.’

The bank’s capacity to weather many potential storms, at least initially, was due to Kapoor’s ability to manipulate relationships both within the bank and with clients. This power of manipulation was used to take reckless decisions and enlist the services of the bank’s officers to cover them up in case they backfired. He used similar tactics to personally pressurise founders and key personnel of companies who were finding it difficult to meet their loan repayment obligations.

Kapoor’s free run was primarily attributed to the lack of corporate governance and absence of board- driven decision-making. These critical gaps ensured that there was no one to question Kapoor and he had a free reign over the bank’s activities. The lack of accountability had serious implications such as the under-reporting of NPAs by a whopping Rs.4,000+ crores for the year ended March 2016. Concerns over a total failure of corporate governance led to the resignation of Uttam Prakash Agarwal, an independent director, in January 2020 (although his tenure as director was predominantly during the time when the new MD and CEO, Ravneet Gill, had taken over from Kapoor).

Another bank (nearly) bites the dust: What’s next?

Bad debts and NPAs are only a part of the problem – the malaise affecting Indian banks and in fact the entire financial services sector runs much deeper. The issue of radical reforms, which are urgently needed to overcome fundamental (or structural) weaknesses in India’s banking system, continues being sidestepped by successive governments. Although YES Bank is the current focus of attention, the lion’s share of NPAs are held by state-owned banks. The high concentration of public sector banks leads to several issues, not least of which are frequent political interference in policy decisions and top-level appointments.

There is also the question of baling out banks, especially private sector banks, by the government acting on its own or through other entities, possibly a public sector bank (SBI-YES Bank) or financial institution (LIC-IDBI Bank). There are two schools of thought here. One believes that it is incorrect to use taxpayer money (through a state-owned financial institution) to rescue a failing private sector entity. The other believes that such a bailout is necessary since the effect of a bank’s failure will not be limited to the banking sector; it will be felt by the entire economy.

What merits attention in the present case is the huge investment required to rescue YES Bank and the consequences if the restructuring scheme fails. While investors and the financial community wait for a clear picture to emerge, it is being wondered if even Rs.20,000 crores (nearly $3 billion) will be sufficient to prop up the beleaguered bank in the current scenario. RBI’s decision to permanently write down the entire additional tier 1 bonds (AT-1 bonds) issued by YES Bank is likely to prompt investors to explore legal actions, which fill add a further element of uncertainty to the restructuring process.

In the absence of higher accountability and strong governance mechanisms, banks will, in all

likelihood, continue failing and being rescued. High and mighty defaulters will abscond or get away with a few years’ sentencing. Common citizens comprising small depositors and investors will bear the maximum brunt and watch helplessly as they lose their lifetime savings to another banking failure which could have been avoided to begin with.

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning. (Henry Ford)

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Gautam Mehra

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