Yes Bank
Depositors stand in queue for withdrawals outside Yes bank in Mumbai, India, Friday, March 6, 2020. Panicked depositors rushed to branches of a cash strapped private Yes Bank to withdraw money as the central bank placed it under a moratorium and superseded its board and it capped deposit withdrawals at rupees 50,000 (USD$ 705) per account for a month Image Credit: AP

Dubai: India’s latest bank rescue plan comes with a moral hazard of using taxpayers’ money to bailout loan delinquents and banks that failed basic regulatory norms.

Under a Government of India approved bailout plan for the crisis-ridden Yes Bank, State Bank of India (SBI), India’s largest lender will pick up 49 per cent stake at an estimated Rs24 billion.

Any bail out of a private sector entity by public sector undertakings (PSUs) or government creates a moral hazard. Barely 18 months after the shadow banking crisis, the government and the Reserve Bank of India (RBI) is once again entangled in a $2 billion bank rescue.

Links to shadow banks

The crisis at Yes Bank has its roots in its linkages to failed shadow banks and lending standards that flouted all prudential norms of bank financing. The government took over IL&FS, a leading shadow bank, in 2018 in an effort to reassure creditors after the defaults. And last year, the Reserve Bank of India seized control of another struggling shadow lender, Dewan Housing Finance Corp

Yes Bank’s total exposure to shadow lenders and developers that were caught up in a funding crunch since late 2018 was 11.5 per cent as of September 2019. In addition the lender has the largest share of outstanding loans to large stressed borrowers, such as Anil Ambani group companies, Essel Group, Dewan Housing and IL&FS.

Yes Bank founder Rana Kapoor being taken to a court after being arrested by Enforcement Directorate under money laundering charges, in Mumbai, Sunday, March 8, 2020. The arrest comes after charges of alleged financial irregularities and mismanagement .

From a rising star to a zombie

Yes Bank’s transformation from a rising star among India’s new generation, tech savvy private sector banks to a capital starved lender has its roots in its lending standards, poor corporate governance and the integrity of its founder, Rana Kapoor, a seasoned banker.

Bankers say in his autocratic decision making, prudential norms for corporate loans were openly flouted by Kapoor to gain quick fee income and show a bigger loan book. Kapoor hardly paid attention to the management and board and made most of the decisions himself. When the non-performing loans began to mount, the bank slowly slipped into the zombie zone.

A ‘Zombie’ bank is a bank that is practically insolvent but continues to exist through hiding bad loans on their balance sheet. The bank can continue its operations by rolling over bad loans instead of writing them off. This process is called as forbearance lending or zombie lending.

When too many of a bank’s customers are falling into severe indebtedness, the bank will also fall into insolvency. An insolvent bank has a tendency to continue to give loans to debt trapped borrowers to show that everything is fine. Doing so, the bank is hoping for an improvement of the situation of its borrowers. Here, the bank is hiding the truth to escape from the punitive actions of the regulator.

Looming credit risk

Poor governance standards leading to mounting NPLs across the banking system in the country is likely to have its backlash on lenders in the form of both cost and availability of funding.

State Bank of India (SBI) Chairman Rajnish Kumar. Under a Government of India approved bailout plan for the crisis-ridden Yes Bank, SBI will pick up 49 per cent stake in Yes Bank at an estimated Rs24 billion. Image Credit: ANI

“In our view, India’s financial sector broadly needs to raise governance standards and restore trust. In the past few years, regulators have identified many governance shortcomings among Indian lenders, most recently at Punjab and Maharashtra Cooperative (PMC) Bank Ltd,” rating agency Standard & Poor’s said in a recent note.

According to the rating agency if Yes Bank’s resolution process is prolonged, there is a risk the broader banking environment may take a hit. This may raise investors’ perception of credit risk in the system, tightening funding.

“Many mutual funds hold Yes Bank securities. A depreciation in the value of these instruments would hurt credit funds, potentially triggering capital outflows. This could widen spreads and drain the credit available to lower-rated entities,” S&P said.

Swift action needed, but at whose cost?

A swift resolution in terms of recapitalization of Yes Bank through State Bank of India and other investors is an imperative to send out the right message to investors and bond holders to rescue the bank and ring fence the banking system from a potential contagion. But that comes with a cost to the taxpayers.

Clearly taxpayers are the biggest casualty in the government-approved bailout plan of YES Bank by a State Bank of India (SBI)-led consortium, says the latest report by global research and brokerage firm Macquarie.

Indian public sector banks’ NPAs that stood at 14.6 per cent in public sector banks (PSBs) as of March, 2018. Considering their capitalization levels, most of these entities were near bankruptcy, if not from the government recapitalisation to the extent of Rs 2.5 lakh crore over the last five years.

“The fact that government is considering such a bail out proposal clearly shows the risk inherent in investing in PSU banks/companies who continue to be subjected to the vagaries and compulsions of the government. The bigger casualty is taxpayers as their money is being used to infuse capital in PSU banks time and again. In other words, it is the taxpayers who are bailing out Yes Bank indirectly in our view,” Macquarie wrote in a recent note.

SBI’s dilemma
Analysts believe that SBI’s potential acquisition of 49 per cent stake in Yes Bank will ultimately culminate in a shotgun marriage that will force it to merge.
“The key risk factor (for SBI) is depositors’ behaviour once the moratorium is lifted. "...possibility of an outright merger of Yes Bank into SBI cannot be ruled out if liquidity stays tight due to deposit withdrawals," HSBC said in a note on Tuesday.
In bank acquisitions, the acquirer is keen more on the target’s liabilities and not its assets. In the context of SBI’s potential acquisition of Yes Bank, analysts say SBI is subject to undefined risks on both liabilities and assets.
“We are unsure of YES Bank’s quality of liabilities franchise, which perhaps could have further got affected due to the current solvency issues,” Macquarie said in a note.

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