Bharat Jhunjhunwala
Banks will come under pressure due to the Corona lockdown. Public Sector banks will most likely be bailed out by the government but private banks may face serious odds. This situation gives us an opportunity to review the causes of the recent failure of Yes Bank and the steps taken by RBI to save it.
The rate of interest paid by Yes Bank in September 2017 on savings accounts with deposits of less than `1 lakh was five per cent. At the same time, State Bank of India was paying only 3.5 per cent. A number of depositors put their monies in Yes Bank to benefit from these high rates of interest. How was Yes Bank able to provide a higher interest than other banks? It appears that promoter of the bank Rana Kapoor played the game of “high-risk, high gain.” He provided loans to such borrowers who could not raise loans from other banks. These included companies of the Anil Ambani Group, the Essel Group, the DHFL, the IL&FS and Vodafone that were hugely stressed at that time. Some of these have gone bankrupt since then.
Knowledgeable sources say Kapoor never said “no” to a borrower. Perhaps he asked these “weak” borrowers to pay higher rate of interest on the monies they borrowed. Needless to say, these stressed borrowers may have offered to pay higher rates of interest. For example, a dealer who does not intend to pay the money at all will be happy to offer a price of `25 per kilo for potatoes that may be selling in the market at only `20 per kilo. Similarly, the borrowing companies may have committed to pay higher rates of interest. Alas! Not only was interest not paid on time because the stressed companies went under, but this also led to a liquidity crisis and the Yes Bank went under too. However, the higher rate of interest paid by his borrower-clients—as long as they were able to pay it—enabled Yes Bank to pay a higher rate of interest to its depositor-clients as long as the rot remained hidden. Thus, Yes Bank attracted the depositors by paying a higher 5 per cent rate of interest on monies borrowed by it; lent that money on higher rate of interest to stressed companies; received higher rate of interest on these lending as long as they were able to pay; and used that earning to pay higher rate of interest of 5 per cent on savings accounts against 3.5 percent paid by other banks. It was a high-risk high-gain game that failed.
RBI was already seized of the problems at Yes Bank some time ago. It did not approve the reappointment of Rana Kapoor about a year ago; and instead appointed an officer of its own as director to keep a watch on the situation. It was clear to RBI that recovery of the monies lent by Yes Bank was in doubt. The RBI wanted Yes Bank to bring in new capital so that the Bank had the cushion to absorb a possible default by the borrowers. Banks are required by RBI to maintain adequate amount of capital in proportion to the money lent by them. The underlying idea is that the equity capital of the bank will take a hit if a borrower defaults.
For example, you are allowed to lend up to `1,000 if your capital is `200. You can borrow-and-lend the remaining `80. The underlying assumption is that the bank would be able to withstand a default of loan up to `200. This is called “Capital Adequacy Ratio.” RBI had noted that the borrowers of Yes Bank were stressed and might not be able to repay the borrowed monies. Therefore, RBI had been asking Yes Bank to bring in more capital to create a cushion to absorb such a risk. For example, let us say Yes Bank lent `1,000 on a capital of `200. Now, `150 of the amount borrowed was not repaid. In such a situation, the capital of `150 out of the total capital of `200 will be wiped out, still leaving a balance capital of `50. Thus, RBI wanted Yes Bank to persuade some investor to put in, say, another `100 as capital. The capital base of Yes Bank would then increase to `300 and it would be able to bear the shock of non-repayment of borrowings of `250. Yes Bank, however, was not able to raise such additional capital. Finally, RBI decided that it could not give more time and ordered a freeze of the business
of Yes Bank.
RBI had also placed in public knowledge the precarious condition of the finances of Yes Bank. It had removed Rana Kapoor from Yes Banks’ management and this was given due publicity in the media. This was a warning to the depositors. Those who did not heed have only themselves to blame. It could be argued that RBI should have been more proactive and given such public warning much earlier. It appears that RBI was faced with a dilemma. It could have pulled the rug earlier; or it waited for more time. RBI would have been charged with not providing time to Yes Bank to raise capital if it had pulled the rug earlier. On the other hand, the RBI would be charged with not acting soon enough if it had allowed the Yes Bank to drift further. These are matters of assessment. One can attack RBI, no matter what decision it took. Such arguments are counterfactual and cannot be settled. All that can be said is that at a certain point, RBI felt that the situation was getting out of control and then acted. RBI, therefore, deserves credit for being alert in the matter.
RBI will face multiple such situations in the coming time in view of the corona crisis. Demand will be raised that private banks should be nationalised so that people’s money is not put to peril as has happened with Yes Bank. The ground reality, however, is that if one out of ten private banks has failed; then actually nine out of ten public sector banks have already failed — only the latter’s failure is not visible. They are being kept alive by constant infusion of new capital by the government just as a sick person is kept alive in ICU with constant blood transfusion. Thus, while RBI must be congratulated for steps taken by it to safeguard the small depositors, we must ask whether it has gone too far in trying to save Yes Bank and whether it must save the banks that may fail in the coming times?
The writer is a former Professor of Economics at IIM Bangalore.