YES Bank rescue plan may cause wider economic pain in the country, says S&P

The risk premiums for AT1 instruments of private sector banks in India will spike in the aftermath of the Yes Bank bailout according to the rating agency

Global Rating agency Standard and Poor's today said a bail-out packege for troubled private lender Yes Bank will keep India banking sector contagion at bay.

However, its rescue plan poses pain for investors in bank hybrid securities, tightening of credit markets. There is possibility of wider economic pain in the country, S&P said in a statement.

The risk premiums for additional Tier 1 (AT1) instruments of private sector banks in India will spike in the aftermath of the Yes Bank bailout. As per the proposed draft reconstruction scheme, Yes Bank's AT1s will be entirely and permanently written down.

Reserve Bank of India and Indian government are working with the State Bank of India (SBI) to inject capital into Yes Bank which has 1.8% of the country's bank deposits (as of March 31, 2019).

The government had earlier put Yes Bank under moratorium restricting the bank's operations, and capping deposit withdrawals at Rs 50,000. This gives the government time to rescue the weak lender. As per the draft reconstruction scheme, SBI will infuse capital into the bank and acquire up to a 49 per cent stake.

"We view the Indian government as highly supportive of the banking sector. The Indian government has consistently supported weak commercial banks by promoting the merger of distressed institutions with stronger lenders," agency said.

The government has historically not allowed commercial banks to fail and has in the past swiftly stepped in to address trouble. The current weak economic and high-fear global investment environment has prompted the government to support the recovery of Yes Bank. "However, in better times, we believe the government would think twice about pushing such a package for relatively small banks," S&P said.

Referring to AT-1 bonds, S&P said the write-off of AT1s is in line with view that these instruments will absorb losses at private sector banks, unlike public sector banks.

The AT1s, a hybrid instrument designed to protect banks during distress, will absorb the maximum loss. This may increase the risk premium on all Indian bank sector Tier 2 subordinated bonds, it added.