It is time for regulators to rely more on research based advance warning indicators.

 

Indian banking seems to be moving from one crisis to another, from IL&FS to PMC Bank to now the collapse of Yes Bank. This time, the regulatory apparatus is responding real time to the crisis in India’s fourth largest private bank. It is also clear that a rescue plan for Yes Bank should be in place sooner than later. This author expects that a revival plan and a long term roadmap will be in place in the next few days and the takeover would be complete far ahead of the 30-day RBI deadline. There are several roadblocks though—firstly the set of investors who provided tier 1 capital (AT1), who have now lost their money, will move court and put a spanner, whether SBI will be able to attract investors as part of a consortium or will have to buy 49% of the stake and whether the new management of the bank will be able to run it efficiently. But the key takeaway from Finance Minister Nirmala Sitharaman and SBI Chairman Rajnish Kumar’s press conference was two-fold—allowing Yes Bank to sink will cause a contagion in the economy, which needs to be avoided at any cost, and that the depositor’s money will be protected. A contagion due to a meltdown in the financial sector will most certainly impact the broader economy very significantly. Coupled with serious growth concerns, a contagion could possibly throw the entire economy out of gear. The SBI Chairman was right in pointing out that when the US decided not to save Lehman Brothers and let it file into bankruptcy, it was forced to issue a much larger bailout package for the world’s largest economy by pumping in trillions of dollars.

But what many depositors, foreign institutional investors, domestic investors, shareholders must be asking is the lessons from the Yes Bank episode. After all, if it can happen to India’s fourth largest bank then it can happen to small companies (remember the NBFC or the shadow-banking space continues to be a matter of concern for both regulators and government).

Yes Bank’s troubles are most certainly not unique and its persistent problems with mounting bad and dodgy loans reflect the underlying troubles in the borrower industries, right from the power sector to real estate to the non-banking financial companies. Quite naturally, the continued inability of several corporates to repay their loans resulting in many landing up in insolvency proceedings has meant that lenders have been the hardest hit. Yes Bank, which has a large retail network, started out with a focus on corporate lending and has a large exposure to several companies that have now gone into liquidation or are being probed for irregularities.

But what is most important is the fact that Yes Bank seems to have gone straight into the resolution stage, without ever being placed under the Central bank’s Prompt Corrective Action (PCA) framework. What does that tell us about the framework and the ease with which banks’ managements are able to circumvent it? PCA is meant to address the fundamental issue of the weakness of banks. Though the lender’s stated operational metrics had not breached the pre-set thresholds for triggering the PCA action, the Central bank, had, in recent years, been extremely unhappy with Yes Bank’s functioning—slapped multiple fines, asked founder-CEO Rana Kapoor to exit and appointed its own independent director. RBI’s concerns included a distinct divergence between the reported and its own findings on the lender’s finances.

Ideally, RBI should possibly take a fresh look and review its PCA guideposts and revise them to ensure bank’s fraudulent practices are not so easily slipped under the radar.

It is time for regulators to rely more on research based advance warning indicators. The Economic Survey rightly mentioned the need for a health index for non-bank finance companies (given the present financial state of shadow banking post the IL&FS mess). It is important to identify practices such as ever-greening of loans early. Remember, Yes Bank started reporting huge jumps in NPAs and losses from 2018 onwards. Ideally, with the help of sophisticated techniques any significant deviation of actuals from the expected would have set alarm bells ringing even in 2016 or earlier and would have led to early detection and timely action.

Governance reforms in both public and private banks is another key area that will most certainly get focus now. Some recommendations from the P.J. Nayak committee like Bank Board Bureau have been put in place; it’s time for others to also be accepted.

We need to move from post-mortem to pre-empting such crises. After all, India’s toxic assets are causing a huge drain on capital markets, dampening sentiment and are making fresh capital more scarce. In the interim, depositors of Yes Bank can heave a sigh of relief as an SBI-led bailout is almost certain. Meanwhile, investigating agencies are now trying to probe how much of Yes Bank’s NPAs due to reckless lending were a result of corporate greed, corruption or the neta-businessman-banker nexus.

Gaurie Dwivedi is a senior journalist covering economy, policy and politics.

 

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