Yes Bank crisis may be over for its depositors but India’s banking sector won’t recover soon

Out of the woods?
Out of the woods?
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The worst is behind for India’s embattled Yes Bank, or so the country’s central bank has assured nervous depositors and investors. Yet, the recent feverish behaviour of the private lender translates into an epidemic-like scenario for India’s troubled banking sector.

In a hurriedly-called press conference yesterday (March 16), Reserve Bank of India (RBI) governor Shaktikanta Das assured all stakeholders that its reconstruction plan for Yes Bank is credible and sustainable.

The RBI had placed the bank under a moratorium on March 5. Withdrawals were capped at Rs50,000 ($676) per depositor regardless of the number of accounts. Till then, the lender had been regularly making headlines for all the wrong reasons—corporate governance mess, raids by the enforcement directorate on the promoter’s premises, and erosion of capital.

The moratorium will be lifted on March 18, Das said at the press briefing.

A consortium of banks led by the State Bank of India (SBI) has come to the rescue of the cash-strapped Yes Bank. The plan involves investments of over Rs10,000 crore ($1.35 billion) for a 49% stake in the bank by the consortium.

News of the bank’s restructuring led to an upswing in Yes Bank’s share price, which suggests it is out of the woods. This may hold true for its investors and depositors, but not for the banking sector or the Indian economy as a whole.

Spill-over effects

The impact that Yes Bank’s troubles will have on the banking sector are varied.

Contagion effect: Panic spreads faster than confidence as investors are, generally, risk-averse. The implosion of Yes Bank may affect the businesses of other private lenders and shadow banks. They will have to face scepticism over their financials and public mistrust. A prime example of this is an order reportedly issued by the government of Maharashtra recently, to all its departments and civic bodies, to refrain from parking money in private banks.

Impact on SBI: The initial rescue of Yes Bank was to be orchestrated by SBI and the Life Insurance Corporation of India (LIC)—the government’s go-to financier. However, LIC has stayed away from the bailout as it already holds an 8.06 % stake in the bank. This has effectively put the primary onus of the rescue on SBI—further impacting its stressed bottom-line.

Enhanced scrutiny of promoter-run banks: At the heart of the Yes Bank crisis were lax corporate governance standards and under-reporting of bad loans going back multiple years, so much so that RBI had denied an extension to the term of ex-CEO (and founder) Rana Kapoor in 2018. Bandhan Bank, another promoter-run bank, was, since 2018, barred from opening new branches without prior approval for violating shareholder norms.

This situation raises an afterthought, as to how promoter-run banks can be made to toe the regulatory line.

Impact on the economy

Yes Bank’s problems can have a crippling effect on the Indian economy, too. Some scenarios that are likely to play out are:

Digital payment mistrust: Yes Bank had one of the most widespread digital payment networks in India, powering transactions on sites like PhonePe, 5Paisa, and Flipkart. The sudden curbs on its operations, and limited functionality of its cards, will result in merchants’ money getting frozen.

Impact on mutual fund industry: The debt funds of many asset management companies (AMCs) took a severe beating as many of them had an exposure to the bonds and non-convertible debentures (NCDs) of the bank. Yes Bank is also a constituent of the Nifty 50 index, and hence it is present in many index funds, whose values deteriorated.

Increased supervisory role for RBI: The central bank has been at the helm of the Yes Bank rescue act by superseding its board and convincing SBI to fund the bailout. However, a critical question remains: if the RBI was aware of the precarious financial situation, why did it wait till it reached a point of no return? Whatever the outcome of this debate is, the consensus around enhanced regulatory powers for RBI is making firm ground.

Loss of reputation for India: The Yes Bank crisis comes in the backdrop of a prevailing environment of financial stress within the telecom and the airline sectors, prompting reconsideration by global investors as to the efficacy of sector-related policies. With the added strain of economic turmoil caused by Yes Bank, global fund houses are bound to seek safer havens or approach any further investments into the Indian economy with caution.

Re-look at generous savings interest rates: Yes Bank was one of the many private banks offering generous interest rates (as much as 7%) on its savings accounts. This practice is simply not sustainable. Now, the Yes Bank crisis is sure to prompt a reconsideration of the business model.

The dramatic case that unfolded around Yes Bank involving its collapse and, subsequently, the rescue act in collaboration with SBI was far from unforeseen. In fact, the swift reaction by RBI only highlights the extent to which it was familiar with the situation. Thus, in the aftermath, there are just two candidates for fixing accountability: the promoter and RBI.

The central bank needs to assert its regulatory oversight, or else the banking sector will rapidly transform into banks functioning like pseudo-legalised chit funds.

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