rbis-reconstruction-plan-for-yes-bank-and-at-1-bonds

The Reserve Bank of India (RBI)  announced a draft reconstruction scheme to bail out the troubled Yes Bank, aimed at protecting depositor’s funds while bringing in the State Bank of India as an investor. 

Background:  

  • Before the release of the draft, the government had put a moratorium on Yes Bank till April 3 following its deteriorating financial condition and the banking regulator superseding the board for 300 days and appointed an administrator.
  • The new Board will have at least six members, an MD & CEO, a non-executive chairman, and two non-executive directors, while the remaining two nominee directors would be appointed by the SBI. 
  • The members of the Board so appointed shall continue for a period of one year, or until an alternate board is constituted by Yes Bank Ltd., whichever is later.

Reasons for YES Bank Crisis

  1. Governance Issues And Practices: As confirmed by the RBI, the governance of Yes Bank is very much at fault. It was under scrutiny for a long time as the bank did not report the true values of NPAs.
  2. Balance Sheet Scam: RBI discovered on many occasions that Yes Bank was under-reporting gross NPAs.

For the year ended March 2019, the RBI discovered underreported NPAs worth ₹2,299 crores. 

  1. Shareholders too had a role to play as they ratified remuneration hikes and renewal of tenure for Mr. Kapoor despite public information of the serial underreporting of NPAs.
  2. Inability to raise capital: The bank was unable to raise sufficient money to meet the capital required, which is mostly due to the bad investment and loans given out by the bank. 
  3. High-Risk Money Lending: As per reports, the bank has been lending money to entities who were unable to raise any from anywhere else. 
  4. No Investors: Given the deteriorating state of the bank, there were no investors ready to put in money, which led to further failure of the bank. 
  5. The outflow of Liquidity:  The worsening state of the bank was very much in sight, causing huge amounts of withdrawals from the bank. 
  6. The fallout of NBFCs - Yes Bank’s total exposure to Infrastructure Leasing & Financial Services(IL&FS) and Dewan Housing Finance Corp (DHFL) was 11.5% as of September 2019.

All in all, the domino effect of the deterioration of the bank is quite evident. This is evident from the high tier I capital adequacy ratio which stood at 11.5% against the regulatory requirement of 8.875%.

Features of Draft Resolution Plan

  • For employees of the bank, service conditions, including remuneration, will remain the same, at least for one year. This does not, however, include key managerial personnel, on whom the Board can take a call.
  • According to the draft resolution plan, the authorized capital for the reconstructed bank will be ₹5,000 crores, with 2,400 crore equity shares of ₹2 each aggregating to ₹4,800 crores.
  • The SBI will pick up a 49% stake, according to the scheme. The deal would be at a price not less than ₹10 per share with a face value of ₹2. To pick up a 49% stake, SBI will have to invest ₹2,450 crores.
  • The SBI cannot reduce its holding below 26? fore completion of three years from the date of infusion of the capital. 
  • The central bank said all the deposits and liabilities of the bank will continue in the same manner in the reconstructed bank, unaffected by the scheme.
  • The Additional Tier 1 (AT-1) bondholders of Yes Bank, have objected to the RBI’s reconstruction plan for Yes Bank which seeks to write down (AT-1)bonds or perpetual bonds fully.
    • YES, Bank issued these bonds to mutual funds (MFs), banks treasuries and retail investors.

Concerns:

The decision to suspend normal business operations raises several worrying questions, like the health of the banking sector, and the adequacy of the oversight role that regulators play. 

  1. Not a new problem: Yes Bank crisis is not new or unique and its problems with mounting bad loans reflect the underlying woes in the borrower industries, ranging from real estate to power and non-banking financial companies. For example, the inability of several corporates to repay their loans resulting in many landing up in insolvency proceedings has affected the lender's hardest. 
  2. Questioning PCA: The fact that the lender ended up at the resolution stage, without ever being placed under the central bank’s Prompt Corrective Action (PCA) framework, put a question mark over how and why Yes Bank evade the specifically tailor-made solution to address weakness at banks. 
  3. SBI as an angel: The choice of SBI as the investor, will increase the financial burden of the country’s largest bank.

Prompt Corrective Action(PCA)

  • It is a framework under which banks with weak financial metrics are put under watch by the RBI.
  • The RBI introduced the PCA framework in 2002 as a structured early-intervention mechanism for banks that become undercapitalized due to poor asset quality, or vulnerable due to loss of profitability. The framework was reviewed in 2017.
  • Applicable: The PCA framework is applicable only to commercial banks and not too co-operative banks and non-banking financial companies (NBFCs).
    • It may be noted that of the 21 state-run banks, 11 are under the PCA framework.
  • It aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector.
  • Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to restore the financial health of a bank.
  • The PCA framework deems banks as risky if they slip some trigger points - capital to risk-weighted assets ratio (CRAR), net NPA, Return on Assets (RoA) and Tier 1 Leverage ratio.
  • If the banks hit such trigger points certain structured and discretionary actions are initiated.

Capital Adequacy Ratio (CAR)

  • The Capital Adequacy Ratio, also known as capital-to-risk weighted assets ratio (CRAR) is a measure of a bank's available capital expressed as a percentage of a bank's risk-weighted credit exposures
  • It is used to protect depositors and promote the stability and efficiency of financial systems around the world.

Non-Performing Asset(NPA)

A nonperforming asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days. Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.

Bail-in and Bailout

The bailout is a general term for extending financial support to a company or a country facing a potential bankruptcy threat. 

  • It can take the form of loans, cash, bonds, or stock purchases. 
  • A bailout may or may not require reimbursement and is often accompanied by greater government supervision and regulations.

A bail-in provides relief to a financial institution on the brink of failure by requiring the cancellation of debts owed to creditors and depositors. 

Difference between bailout and bail-in

  • A bail-in is the opposite of a bailout, which involves the rescue of a financial institution by external parties, typically governments, using taxpayer’s money for funding. 
  • Bailouts help to keep creditors from losses while bail-ins mandate creditors to take losses.
  • In case of a bail-in, the bank’s own deposits are used to rescue the bank or address its liabilities.

What lies ahead

  • According to RBI, the resolution (of Yes Bank) will be done very swiftly. The 30 days which have been given for resolution, is the outer limit.
  • The scheme has taken care of the employees as it mandates that they will continue to have the same remuneration and service conditions for at least one year.
  • However, the board will have the freedom to discontinue the services of the Key Managerial Personnel (KMPs - are vested with the most important roles and functionalities) at any point in time after following the due procedure. 
  • There will be no change in the offices or branch networks of the reconstructed bank.
  • The current moratorium has been brought into effect keeping the depositors’ interest in mind and towards restoring their confidence. 
  • A solution is being worked upon to revive the Bank well before the moratorium period of thirty days ends. The Bank is also taking the necessary steps to ensure seamless transactions for the customers. 

Way forward

  • India needs financial sector reforms: The most important one is to free the banking sector of state control. 
    • If state-owned banks cannot be privatized, then, as suggested by the  P.J. Nayak Committee, they could at least be placed under the ownership of a holding company. This would at least put a layer between the government and the banks it owns. 
  • RBI needs to review its PCA: To ensure that such a crisis does not recur. This will avoid the need for such bailouts.
  • Corporate governance norms must be followed strictly.
  • Lending to entities after due verification of their creditworthiness and assessment of their risk-weightage.
  • Strengthening NBFCs, as weak NBFCs will further put the burden on Banks by reducing credit options.
  • Strengthening of the Credit Rating Framework in the country: To ensure a better rating of debtors on the basis of their ability to pay back their interests and loan amount on time and the probability of them defaulting.

AT-1 bonds

What are AT-1 bonds?

  1. These are annual coupon-bearing bonds and they have no fixed maturity date. 
    1. They entail a higher interest rate as compared to that of fixed deposit rates which makes them an attractive investment option.
    2. These are effectively hybrid instruments that carry higher risk when compared with secured bonds.
    3. The holders of these bonds can sell them in the secondary debt market unless the issuer redeems them.
  2. There is no legal obligation on the part of the issuer to redeem these bonds.
    1. It is up to the discretion of the issuing body to pay Interest on these bonds.

When were they introduced?

  • They were introduced post the 2008 financial crisis, in order to protect depositors of a bank that is operating and making a profit, under The Basel-III accord. 

What was the purpose of the Introduction?

  • The instrument provides for the imposition of losses on its holders without the bank being liquidated after the common equity tier-1 (CET 1) ratio of the lender falls below a certain threshold level and triggers the point of nonviability.
  • As per RBI rules based on the Basel-III framework, AT-1 bonds have principal loss absorption features, which can cause a full write-down or conversion to equity on breach of a pre-specified trigger of common Tier 1 capital ratio falling below 6.125 percent.

Can banks write down AT-1 bonds?

  • Banks cannot use the conversion or write-down of AT1 instruments to support the expansion of the balance sheet. 
  • It is only intended to replenish the equity of a bank in the event it is depleted by losses.

What is Core common equity Tier 1(CET 1)?

  1. It is a component of Tier 1 capital that comprises common stock held by a bank or any other financial institution. 
  2. It was introduced in 2014 as a capital measure to exercise precaution in case of the economy being hit by a financial crisis.

Capital Adequacy Ratio (CAR)

  • The Capital Adequacy Ratio, also known as capital-to-risk weighted assets ratio (CRAR) is a measure of a bank's available capital expressed as a percentage of a bank's risk-weighted credit exposures
  • It is used to protect depositors and promote the stability and efficiency of financial systems around the world.

Basel Norms

About

  1. Originally set in 1974, the most recent set of norms, called Basel III.
  2. These are a common set of global standards to be implemented by banks across countries.
  3. After the 2008 financial crisis, need arose to strengthen the banking system further so that they could meet further risks. 
  4. To meet these dangers, banks were asked to maintain a certain minimum level of capital and not lend all the money they receive from deposits.
  5. This acts as a buffer during hard times. The Basel III norms also consider liquidity risks.

Pillars of the Basel Norms for Banking

  • Pillar 1
    • Minimum Regulatory Capital Requirements based on Risk-Weighted Assets (RWAs): Maintaining capital calculated through credit, market and operational risk areas.
  • Pillar 2
    • Supervisory Review Process: Regulating tools and frameworks for dealing with peripheral risks that banks face.
  • Pillar 3
    • Market Discipline: Increasing the disclosures that banks must provide to increase the transparency of banks.

Capital requirements under Basel 3 norms

  1. The capital norms recommend Capital Adequacy ratio (CAR) be increased to 8 percent internationally, while in India it is 9 percent.
  2. Out of the 9 percent of CAR, 7 percent of Risk-Weighted Assets (RWA) has to be met by Tier 1 capital while the remaining 2 percent by Tier 2 capital.
  3. So, if the bank has risky assets worth Rs 100, it needs to have Tier 1 capital worth Rs 7. This capital can be easily used to raise funds in times of trouble.
  4. In addition, banks also have to hold an additional buffer of 2.5 percent of risky assets, called Capital Conservation Buffer (CCB).
  5. Banks maintain 5.5 percent Common Equity Tier 1 (CET 1) as against 4.5 percent required under the Basel III framework.
  6. The banking regulator introduced Basel III norms in India in 2003 and aims to bring in all commercial banks by March 2019.

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