Expensive conundrum

In the season for global virus infection, India's financial sector is facing the prospect of another kind of a virus. The financial intermediaries have been facing serious difficulties for the last several years, including the rising levels of non-performing assets of public sector banks and earlier last year, the existential threat to the non-banking financial companies following the bankruptcy of the biggest of them.

A sudden slow-down of the economy, triggered by lower consumption expenditure, could just as well spring some more nasty surprises. A slowing economy naturally puts pressures on borrowers as their activity levels dip and revenues take a similar hit. More stressed loans are just another spillover effect of such proceedings.

Yes Bank, one of the newest private sector banks in the country, which had a rather vibrant image until a couple of years back, has now faced a similar kind of future like the NBFCs last year. Yes Bank has been in the twilight zone between viability and potential failure for some time now. Like the public sector banks, its loans were going bad and its investments were proving dud. Income stream was getting attenuated and the demands of bond investors were straining.

These are nothing new. Only recently, the Punjab and Maharashtra Bank had a similar knotty situation. The bank's management was found to have diverted substantial funds to preferred corporates, including those floated by members of the bank management. Reserve Bank of India had to intervene and set matters right for securing the interests of the small-time depositors of the bank.

Here as well, the Reserve bank intervened Thursday evening to supersede the bank's management and takeover administration. The management of the bank has been given adequate leeway by Reserve Bank to mend matters. The RBI had preferred a "market-led" reconstruction of the bank's affairs. This meant raising funds from the private sector sources or some equity investment by private equity firms.

The current management under its CEO has been trying exactly this. They have been running from pillar to post for funds, such as from private equity sources. The bank had even informed the stock exchange of the possibility of funds inflow. Some of the investors had several rounds of discussions with the Reserve Bank representatives as well. However, finally, nothing came in.

Meanwhile, the depositors were getting increasingly worried and withdrawing their money. The bond investors were asking for their funds as well. Obviously, even the most sound bank cannot meet obligations if they all come at once. The imposition of a partial moratorium on payments by the bank was unavoidable and could be the only way to stem a full-scale run. The RBI intervention and assurance to the depositors about the safety of their funds is timely.

However, Yes Bank is not just any small bank. Therefore, whatever happens to the bank and the necessary reconstruction effort, both have some wider implications. It will have implications which need to be contained.

Its balance sheet size is fairly large and runs into over Rs 4 lakh crore. A sudden collapse would have involved large sums of money being lost to the depositors. This could even dent public confidence in banks, particularly the new private sector banks.

A crop of these banks have been given licence to start in the last couple of years. The issues of the viability of new private banks cannot be avoided. Such possibilities could not have been altogether outside the radar of policy-makers.

The bank reportedly requires Rs 27,000 crore fresh capital infusion immediately. In the current context, the amount is not humongous. For saving the trust of the public in these banks, the price might not be too much. The talk is that State Bank of India has been requisitioned already and a deputy managing director of the bank is in charge of the reconstruction effort.

However, this also raises the issue of "moral hazard". Should public money be used for private failures? Worse, the case would be indefensible if the mismanagement has been deliberate and wanton. Experts point out that even if half of the required new capital has to come from SBI, its net worth will get dented by some 6 per cent. In effect, the sins of the erstwhile management will be washed in the end by the depositors of the State Bank of India.

Alternatively, the entire assets and liabilities of the bank should be taken over and all assets of the promoters and former management, including all personal assets, be frozen at once. The bank's entire stake should be taken over so that they lose total control. The RBI has done well by freezing all investments of the bank and assets which should be helpful.

Yes Bank's denouement has not come out of the blue. Its affairs have been going bad to worse every passing day. The rating of the bank has been downgraded and its stock price was reflecting the deterioration. Maybe, giving such a long rope, the RBI could have willy nilly diluted some of the assets which could have been useful during the process of reconstruction.

Yes Bank gives some lessons for the regulators and the government when they have allowed so many of the private banks. There is a need for high vigil from the regulator and any early signs of stress should be immediately addressed. When the much larger public sector banks are facing such a huge task for reconstruction, fresh burdens for rehabilitating private ones could become untenable.

Maybe, light-touch regulation does not work. More strident reviews and intelligence system for the financial sector might do some good. The financial intermediaries are critically important for the economy because if a single, say, manufacturing industry, goes under it does not leave a footprint beyond itself. Liquidation of a single financial intermediary can send reverberations throughout the economy. Most critically, it can hurt the sentiment of the saver. They are the cornerstone of an economy.

Views expressed are strictly personal