Bailout of yes bank reflects all that is wrong with the financial sector and its supervision

Bailout of yes bank reflects all that is wrong with the financial sector and its supervision

The bailout last week of Yes Bank by the State Bank of India is the largest of its kind in recent times. For all practical purposes, it is an indirect use of public resources to bail out a failed private bank. It was however unavoidable; the only way to preserve the integrity of the financial system and insulate a fragile economy from more damage. Yes Bank has an asset base of over Rs 3 lakh crore, of which over Rs 2 lakh crore are funded by deposits. It is too big to fail.

Last week’s events are not a big surprise because for about two years it was evident that the bank was in trouble. It was pulled up by RBI for understating bad loans and things came to such a pass that in 2018 the central bank ensured the bank’s founder and former CEO Rana Kapoor had to leave. This was followed by the governing board accommodating a nominee of RBI. The bank’s problems were well-documented. The central bank’s anxiety and the need to keep a closer watch were symptoms that Yes Bank’s accounts did not reflect reality; it reported a net profit in July-September quarter of 2019-20.

Given this context, RBI’s decision to impose a temporary moratorium of Rs 50,000 on withdrawals is hard to defend. The moratorium was, according to RBI, on account of a rapidly deteriorating financial position and the absence of a credible plan for capital infusion. RBI could not have been unaware of this situation for a while. Yet, a blunt instrument which hurts deposit holders has been used. On the positive side, a reconstruction plan was quickly put together to allow SBI to hold up to 49% stake in the bank, with an assurance it will not go below 26% for three years. This should lead to an immediate infusion of Rs 2,450 crore.

The Yes Bank episode drives home the point that India’s financial sector is fragile. A part of the problem has been poor supervisory performance of RBI and an abdication of responsibility by government as the majority shareholder in the public sector banking system. The outcome is that the taxpayer has been repeatedly burdened by bailouts. There is scant evidence that these bailouts are accompanied by gover nance refor ms or an improvement in RBI’s regulatory and supervisory skills. Unless these areas receive urgent attention, it is unlikely India’s financial sector will improve its record on capital allocation.