Blueprint to deal with Yes Bank crisis and beyond | Opinion
To protect the depositors, the bank must be quickly reconstructed, but without distorting incentives for investors. So, losses and the cost of resolution must be fairly imposed on the investors.
With Yes Bank placed under a moratorium, depositors and businesses relying on the bank face a difficult time. A bank of this size — Rs 3.5 lakh crore worth of total assets as of end-September 2019 — has not failed in India in recent decades. When it failed, Global Trust Bank had about 0.5% of the total deposits held by scheduled commercial banks. Yes Bank holds about 1.8%. The situation presents certain short-term challenges, and highlights the need for certain reforms. In the short term, there are two interrelated challenges - protecting Yes Bank’s depositors, and maintaining trust in the private banking system.
To protect the depositors, the bank must be quickly reconstructed, but without distorting incentives for investors. So, losses and the cost of resolution must be fairly imposed on the investors. The draft reconstruction scheme released by the Reserve Bank of India (RBI) proposes dilution of shares -- the number of shares increased from 255 crore to 2,400 crore - with a face value of Rs 2 per share. State Bank of India (SBI) is expected to take a 49% stake at a price of Rs 10 per share (including a premium of Rs 8) -- Rs 11,760 crore of capital infusion. Since the total market capitalisation of Yes Bank on Friday was about Rs 4,100 crore, this is essentially a bailout by SBI, and eventually by its shareholders. Further, additional tier 1 capital instruments are to be written down. This is puzzling. Since shareholders will benefit from the SBI bailout, why not also convert these instruments into common equity? These issues need to be considered carefully.
If Yes Bank is resolved effectively, it will help restore some faith in the system. However, this episode can still lead to a change in perception about risks in private banks. Bank runs are often self-fulfilling prophecies — people withdraw deposits under the false impression that a bank is unsafe, and by withdrawing in hordes they precipitate the failure of a healthy bank. The key is to not let false impressions form.
The situation is ripe for rumour mongering. At end-September 2019, the capital adequacy ratio of Yes Bank was 16.3% while the average for all private banks was 16.6%. Going by the stock market activity, it seems that the moratorium came as a shock. Since Yes Bank failed so precipitously, and there is an ongoing economic slowdown, it is easy for depositors to believe rumours.
An additional factor in India is that depositors looking for safety can just move to public sector banks. As Professor Viral Acharya has shown in his research, there is much greater market discipline on private sector banks than on public sector banks, because the latter are seen to enjoy government support. So, depositors of private banks need to be doubly convinced about the safety of their deposits. It helps that the government has increased the deposit insurance cap from Rs 1 lakh to Rs 5 lakh. Even the previous cap fully covered 92% of the accounts. That leaves the problem of larger value deposits. If the rumour mills start spinning, the Centre and the RBI must counter them actively.
Looking beyond these short-term challenges, and looking back at the weaknesses of the regulatory framework that contributed to this situation, two reform agendas must be pursued urgently — reforming the RBI, and building a mechanism for resolving failed financial firms.
It is clear that banking supervision in India needs reform. For many banks, supervisors either failed to find the truth or delayed its recognition. At end-September 2018, the gross non-performing assets of Yes Bank were just 1.6%, but a year later, they were reported to be 7.4%. Reform of banking supervision is essentially reform of the RBI.
RBI is one of the few public agencies in India for which the problem is less of capacity, and more of accountability. The RBI Act should be amended to introduce accountability- and transparency-related provisions — open and transparent consultations while making regulations; annual publication of plan and performance as a regulator; rule of law in issuing orders and directions; and so on. Further, the RBI Board must function as a proper governance mechanism. This requires restructuring the board, changing the profile of its members, and reforming the committee system of the Board. While the RBI tends to resist such reforms, perhaps the challenges of recent years reveal the need for such reforms as means to improve its own legitimacy.
RBI is also burdened with too many responsibilities. The government must reduce RBI’s responsibilities — all securities regulation should move to the Securities and Exchange Board of India; debt management should be hived off to an independent debt management agency; and infrastructure systems operated by RBI should be corporatised.
There is a missing link in India’s financial regulatory architecture: a specialised mechanism for resolution of failed financial firms. Because of this, there are no good options for dealing with a situation such as Yes Bank’s. Most G-20 countries have built specialised capabilities to resolve failed financial firms. Such a mechanism can keep a check on the regulator’s tendency to delay recognition of failure, thereby ensuring quick and orderly resolution. In India, this reform was thwarted by the political economy in 2018, when the Financial Resolution and Deposit Insurance (FRDI) Bill was withdrawn. The Centre should bring a revised version of the law, and put some political capital into it.
An economic crisis and a series of institutional failures have led to this situation. Let us see whether the government and the RBI will learn the right lessons.
(Suyash Rai is a fellow at Carnegie India. The views expressed are personal)