Yes Bank: Keep Ideology Aside

The RBI yesterday superseded the Board of Directors of Yes Bank and imposed a month-long moratorium because of serious deterioration of the Bank’s finances. The withdrawals have been capped at Rs 50,000 to prevent a run on the bank. RBI intends to draw up a revamp or an amalgamation plan before the end of the moratorium. Likely, SBI and LIC, at government’s behest, will come to the rescue and bailout the bank. There is a serious contagion risk that could badly hurt the entire sector if this isn’t resolved speedily. This is no time to debate if this is socialisation of private losses. Government has to take control.

Yes Bank has reached here through a combination of flawed credit decisions that backed Indian promoters no end, bad timing and very poor governance practices. There will be many post-mortems done on what went wrong with blindingly obvious 20-20 hindsight. But let’s look at what’s at risk here. The bank had a 2.09 lakh crores deposit book at the end of Sep 2019. Between then and now this might have gone down to about 1.8 lakh crores. It had a net worth of Rs 25,000 crores which is worth nothing at this moment. By its own admission it had about Rs 31,000 Crs loan book rated BBB and below. The reality will be much worse. So, don’t expect a miracle on loan recoveries. Simply put, the entire deposit book of about Rs 1.8 lakh crores must be saved by the government.

Despite the warning signals for almost 18 months, the government didn’t act decisively enough. The Bank has been trying to raise $ 1.2 billion for over a year now. There were no real suitors willing to take that risk. The Bank kept planting optimistic stories in the press. The retail investors kept believing in them while institutional investors exited. The whole fund-raising saga went from comedy to farce and, finally to this. This is a chronicle of a death foretold in slow motion.

The bailout by SBI and LIC is the only option. It will come at a cost. They have large balance sheets to absorb these losses, but it will still hurt. LIC has been bailing out government since long and no one really has analysed its asset liability matching and reconciliation models. We should assume for the moment it can manage these without any impact on millions of small policyholders who have put their money into the endowment programs that are LIC’s bread and butter. There’s also the risk of moral hazard. While the government has bailed out Banks in the past, there’s no precedence of rescuing a bank with a Rs. 4 lakh crores balance sheet. It will be difficult for it to not intervene when the next crisis comes up.

The government infused Rs. 3.5 lakh crores of capital into PSU Banks last year as per the Budget 2020 speech. The government expects the PSU Banks to meet their recapitalization needs in FY 2021 through capital markets. The market cap of many of these banks are low and their capital needs are high enough to make it difficult to raise this from market unless the government stake goes below 50%. The total private outstanding debt in India is about Rs 65 lakh crores. It won’t be a stretch to assume about 2% of it going completely bad. Things could be worse if the slowdown continues and Covid-19 has any kind of impact on the economy. So, about Rs 1.3 lakh crores of further losses will need to be absorbed. The government has to take a consolidated view of this and bite the bullet once.

The Yes Bank rescue is an opportunity to modify the insolvency law for Banks and other Financial Institutions. Banks run on confidence and trust of its depositors and counterparties and at this moment only SBI and LIC can restore that trust. There is no market mechanism to rescue Yes Bank that won’t destroy its value completely and lead to further crisis in the system. Yes Bank tried it for over a year but failed because no one trusted it.

A temporary nationalisation of Yes Bank is the right option. In fact, it should use this opportunity to go the whole nine yards and resolve some of the festering issues in the NBFC space. A few critically important NBFCs could be bailed out at this moment. The taxpayers will foot the bill, of course. But the systemic losses will be way higher if we let things drift. As few experiences in the past – the bailout of UTI in India and the TARP plan in the US – have shown the government can turn a tidy profit if it doesn’t confuse between ownership and management in running these entities. Nationalisation is a bitter ideological pill for market evangelists to swallow. But we must at this moment.

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