The YES Bank Conundrum

Events around Yes Bank seemed shocking yet expected. The paradox perhaps is an offshoot of the interesting history of Yes Bank. It was founded in 2003-04 by Rana Kapoor and Ashok Kapur. From a symbolic poster boy of modern age Indian private sector banking to being the fall guy of the long term consequences of the crony socialism at play especially in the early half of the current decade, it has been an eventful journey for good or bad. Indian banking sector had been dominated by the public sector following the nationalisation of banks in 1969. As private banks were allowed post 1991, the new ones generally emerged as off shoots of either non-banking financial institutions or development financial institutions. These included ICICI Bank and HDFC Bank among others. The story of Yes Bank however was one of the first to begin as green-field private bank.

The death of Ashok Kapur in a terror attack in 2008 saw a monopolization of control by Rana. He was the archetype new age banker going aggressive on asset creation. RBI is normally conservative, did not like Rana but remained passive with occasional spurts of activity as Rana went about his shenanigans. The culmination of the Yes Bank saga was all too evident and in the last few months or so was a question of when and not if. Therefore it seems surprising that people are shocked. It conceivably is a manifestation of eternal Indian belief that the government would rescue the failed organizations

As RBI puts across a reconstruction plan with SBI in the lead, quite a number of questions and possibilities arise. It must be to credit to RBI that it has put out the recapitalisation plan in public for review. One must await for the next few days for the contours of final restructuring plan to emerge yet some questions can be discussed and analysed.

In normal run-in (run-ins are rarely normal), the equity shareholders take the hit followed by preferential shareholders and the different categories of bond holders. There is no doubt a dilution of share equity with the new face value of share being Rs.2 per share. Yet, rather than equity being written down, it is Tier One debt that is being written down. Tier One debt comprises about perpetual bonds and in the case of Yes Bank amounts to around Rs. 8,400 crores. Tier I debt is senior to equity and hence cannot be written down before equity. Perpetual bonds are essentially a quasi-debt instrument. The difference between a regular debt and perpetual bond is there is no fixed maturity. To allow an exit route for an investor, these instruments usually come with ‘call option” that can be exercised after a stipulated period.  In a scenario of collapse, these bond holders are next in line after equity share holders to receive a hit. In fact for Yes Bank, secondary trading has stopped in the last few days. The RBI plan if approved can imply few pointers.

There would be obvious legal challenges to the plan and that might put paid to the efforts of RBI to set right the structural inefficiencies in the bank. Secondly, the future of these instruments might become a major question mark in the days ahead. The example of not honouring the commitments of AT-1 bond holders would increase the premium which some accounts suggest could be nearly 280 basis points. This would increase the cost of capital for Indian financial institutions and other firms and thus the spill over would lead to rise in interest rates downstream.

While RBI might be morally compelled to protect the rights of deposit holders, they are not compelled to protect rights of equity share holders. The logic behind the protection scheme seems to be the pattern of the shareholding. Shareholding is combination of promoter’s holdings, institutional holdings and retail and non-institutional holdings. Over a period of time, the promoters have diluted their stake and is well known signal that something is amiss. Promoters know something more about their firm than others and thus when they seek to exit despite an apparent emotional attachment, it is signal to the rest of the shortcomings in the firm performance. In a universe of information asymmetry, signals are followed and tracked to plan one’s decision. Promoter’s dilution was followed by offloading of shares by institutional shareholders. Thus currently it is the non-institutional shareholders or retail holders who have maximum equity. India is still perhaps obsessed with the romantic notion of protecting retail equity shareholders. This measure if followed up despite the dilution of share ownership will lead to a moral hazard. As the economy expands, the run-ins or business failures irrespective of consequences are bound to increase. It will set an erroneous precedent to protect shareholders with minimum damage while allowing the debt holders to bear the penalty.

Secondly, there is also another moral hazard in the making. It would be curious to see RBI’s benchmarks for rescue operations. PMC Bank depositors are already crying foul. As a matter of fact, it is comparing chalk and cheese. Yes Bank is one of the top five private sector banks with presence across the country thus necessitating different yardstick for rescue operation. PMC Bank, a cooperative bank was localised and functioned on a very different paradigm. Yet there is a need for the government to bring an IBC equivalent for the financial sector. The deposit insurance bill was an intended step towards this but bad publicity aggravated by weak communication put paid to the efforts. There is a need to bring back a measure with better consultation and communication.

There is no doubt, bank run-ins are in part caused by deficiencies in over sight by the regulators and appropriate enquiries will have to happen. Business failure, willing or otherwise will increase, only the certainty of swift trial and conviction for willing default and failure would cause the former to decline. As the dust settles down on Yes Bank, the government must create new oversight agency for banking and financial institutions. It is yet another case of RBI failure to handle the situation. RBI perhaps is overburdened with multiple activities and thus trade off means certain shortcomings creep in. Yes Bank is a lesson to be learnt on many fronts.