Context: The Reserve Bank of India (RBI) announced a draft reconstruction scheme to bailout the troubled Yes Bank, aimed at protecting depositor’s funds while bringing in the State Bank of India as an investor.
- 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 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 crisis
- 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.
- 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.
- High Risk Money Lending: As per reports, the bank has been lending money to entities who were unable to raise any from anywhere else.
- 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.
- Outflow of Liquidity: The worsening state of the bank was very much in sight, causing huge amounts of withdrawals from the bank.
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%.
Non Performing Asset(NPA)
A non performing 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.
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 authorised capital for the reconstructed bank will be ₹5,000 crore, with 2,400 crore equity shares of ₹2 each aggregating to ₹4,800 crore.
- 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 face value of ₹2. To pick up 49% stake, SBI will have to invest ₹2,450 crore.
- 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 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.
- 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 lenders hardest.
- 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.
- 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 undercapitalised 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 to 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.
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 of time after following the due procedure.
- There will be no change in the offices or branch network 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 necessary steps to ensure seamless transactions for the customers.
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 burden on Banks by reducing credit options.
- Strengthening of the Credit Rating Framework in the country: To ensure 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.
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.