Yes Bank, a private bank with assets of around Rs 3 lakh crore, has come crashing down. The collapse of the bank has rattled the markets and caused the shares of other banks to tumble. The government and the Reserve Bank of India will do what it takes to protect the depositors of the bank. Reviving the bank, however, is a formidable challenge.
A bank as large as Yes Bank cannot be allowed to fail – its failure threatens the entire banking system. The best course would have been for a private investor or investors to have acquired the bank, infused capital and revived it. The RBI gave the management several months to arrange just that but with no success.
No credible investor was willing to come forward although several names were talked about. It may well be that adverse conditions in the Indian economy as well as in the world economy created too many uncertainties for potential investors. The turbulence caused by the spread of the coronavirus may well have doomed the efforts to rope in a private investor.
The straightforward option then was for the government to take over the bank. That is what happened with large banks worldwide during the global financial crisis of 2007.
But the Indian government is in no mood to infuse capital into a private bank at a time when it is severely strapped for finances.
In the budget for FY 2020-21, the government could not spare any money for public sector banks.
The talk was that SBI, LIC and, perhaps, some other banks would form a consortium to rescue Yes Bank. The RBI has promised a resolution in a month’s time. It makes little sense to say that the RBI has been late in attempting a rescue. Allowing the markets to effect a rescue must always be the first option and it’s not as if the RBI has waited for too long in exhausting this option. The question now is what form the rescue will take.
The Script Of Past Rescues
The time-tested course has been for RBI to merge a failed bank with another bank. No private bank would be interested, so it’s the public sector that must bear the burden of rescue. One course would have been for SBI to merge Yes Bank with itself. Another would be for LIC to merge it with IDBI Bank in which LIC has a 51 percent stake.
Neither course had much to commend it. By many estimates, Yes Bank requires at least Rs 25,000 crore of capital. SBI would be severely stretched in providing such an amount. LIC has deeper pockets. But it has its hands full in turning around IDBI Bank. Moreover, the integration of a failed bank with a very weak bank is hardly the best recipe for effecting a turnaround of the two banks.
How The Proposed Plan May Unfold
Under the draft plan proposed by RBI, it appears that a merger is not being favoured at this point. The plan proposes that any investor including SBI can pick up a 49 percent stake in the equity of Rs 5,000 crore at Rs 10 per share, which would amount to around Rs 2,450 crore.
This can only be stage one of the rescue plan.
It is intended to bring in a solid promoter whose involvement would stem the outflow of deposits that is certain to take place once the present 30 -day cap on withdrawal of deposits over Rs 50,000 is lifted.
In stage two, SBI would have to look for a private investor to whom shares would be issued at a suitable premium so that the necessary infusion of capital can take place. Perhaps LIC and a few private banks can be induced to provide just enough capital to help improve performance and make the bank attractive to a large private investor. In principle, the plan has much to commend it. It would imply a temporary bailout at low cost to public institutions followed by infusion of private capital.
But Will It Work?
The catch in the plan is that depositors may have little incentive to stay with Yes Bank, however solid the credentials of SBI or any other promoter. What if a private investor can’t be found? Why take chances, depositors would ask themselves. A government guarantee of public deposits would be needed to stanch the exodus of deposits. But the government would balk at such a radical move.
As has happened in the past, the mantle of bailing out failed private banks will fall on the much-reviled public sector. If the bank is merged with SBI, one hopes that capital support from the government will be forthcoming.
There would be delicious irony in such an outcome. We have seen a terrific clamour for privatisation of public sector banks in recent years. Some have urged that the government drop its stake in PSBs below 50 percent so that they can have private bank-like compensation structures. A merger of a failed private bank – and a large player at that- with a public institution should get people to examine their prescriptions.
Private banks run by professionals have turned out to be poor performers – Centurion Bank, Global Trust Bank, Yes Bank, to cite a few examples.
The ones that have done well are those that have had the support of a group.
The most prominent ones—ICICI Bank, HDFC Bank, Axis Bank—all have some form of public sector parentage which helped create the element of trust that is so vital in banking. Not all that is private is gold.
The Optical Reordering In The Market
The Yes Bank experience should also make people sceptical about comparisons of public and private sector bank performance that are used to tout the supposed superior efficiency of private banks. These comparisons are often based on relatively short periods of time. As we know from Yes Bank and other private banks, private sector firms can dazzle briefly and then bite the dust. Failed private banks disappear from the data set whereas the public sector failures remain.
This creates what is called ‘survivor bias’ in the data on PSBs, one that distorts the comparison of performance. Worse, public sector performance is dragged down where PSBs are forced to absorb failed private banks.
The evil that private banks do lives after them – in PSBs. The good that PSBs do is oft interred in their financials.
PSBs are compelled to bear the costs of non-commercial objectives—Jan Dhan Yojana, demonetisation of currency, etc.—for which they are not compensated.
In the 2004-09 economic boom, private investment in infrastructure was financed overwhelmingly by the public sector while private banks stuck mostly to retail finance. When things turned sour in the infrastructure and related sectors, the pain was felt by PSBs. The gap between public and private performance, it’s worth reminding ourselves, often has to do with the privatisation of profit and the socialisation of loss.
TT Ram Mohan is a professor at IIM Ahmedabad.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.
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