Yes Bank rescue: India's TARP moment?

Why did the Reserve Bank have to take the moratorium route to sew the deal? Why now?

Early Friday morning, a senior banker woke me up with his outbursts on the phone: “Is this the way to save a bank? We are killing it and creating a big trust deficit in the financial system.”

He was referring to the moratorium imposed on Yes Bank Ltd by India’s banking regulator the previous day, capping withdrawal of money by its depositors at Rs 50,000 each. The Reserve Bank of India (RBI) also superseded its board and appointed an administrator, a year after it ousted the bank’s promoter — CEO Rana Kapoor and appointed Ravneet Gill as the new boss.

Freezing of all activities of a bank of Yes Bank’s size in March, the last month of a financial year, creates enormous inconvenience for all. It has been big time into cash management of companies. How will they manage? Many medium and small enterprises will not be able to pay their suppliers and those microfinance borrowers that have banking relationship with Yes Bank will be stuck. Indeed, for medical and other emergencies, a depositor can withdraw more but there is no window for those who plan their investments in March to save on income tax and/or need to pay advance tax in the middle of the month.

Another senior banking consultant said Yes Bank should have been auctioned to the highest bidder. That’s the best way to revive it and discover its worth.

There was merit in these arguments. But by Friday evening, when the RBI put up the draft reconstruction scheme for the bank, I am sure both agreed that this is the best possible way to revive Yes Bank, given the circumstances.

The last time a new private bank was put under moratorium was in July 2004 —Global Trust Bank Ltd. Within 72 hours, it was merged with public sector Oriental Bank of Commerce. This time, India’s largest lender, the State Bank of India (SBI), is the white knight. But it is not merging Yes Bank with itself; it will put in up to 49 per cent equity, revive it, and could continue to hold at least 26 per cent stake for the next three years.

The RBI has not allowed any commercial bank to fail in the past three decades. It has always played the role of a matchmaker but this is the best deal it has stitched. Why am I saying so? Before that, why did the RBI have to step in? And why now?

The deal has been in the works for months. All of us know that Yes Bank needs capital, desperately. But what is not in the public domain is the flight of deposits. Even the best of banks fail when depositors rush to withdraw money en masse. Yes Bank’s deposit portfolio has been eroding fast over the past few months.

The RBI gave it a new CEO and left it to the market to find a solution to the problem. That was the first choice. Indeed, many prospective investors walked in, did a recce  but walked out as either they were not convinced about the quality of assets or were gripped by the fear of the unknown — how many accounts would turn bad in the future. Over the past one year, whenever a new large bad asset surfaced in the banking system, Yes Bank has been exposed to it.

There have been investors willing to take a bet on the bank but the Securities and Exchange Board of India’s (Sebi's) takeover norm and pricing formula came in the way. These investors were bargaining for a lower price and higher stake, not in conformity with the norms of the market regulator. In April 2009, the Mahindra group could rescue the scam-hit Satyam Computer Services Ltd after Sebi waived the norms. Under the current takeover code, the market regulator does not have any discretion to do that.

The only way it could be waived is through the moratorium route, exercising RBI’s powers under Section 45 of the Banking Regulation Act. That’s how SBI can acquire a 49 per cent and at Rs 10 per share.

At this price SBI would bring in Rs 2,450 crore. That will not be enough to bring Yes Bank back on track. What next? SBI’s presence will create confidence and excite the investor community to take a fresh look at Yes Bank. I assume a rights issue will follow — the pricing of which is not governed by the Sebi norms. Besides, when an investor buys a share at a rate cheaper than the market price, under the income tax law, the difference is treated as profit and one needs to pay tax on that but this is not applicable to shares bought from a rights issue.

A rights issue becomes successful when at least 90 per cent of it is subscribed. SBI will probably underwrite the issue and other investors (including those that wanted to buy Yes Bank shares at a cheaper price but could not because of the Sebi norms) may pick up shares. Depending on the response, SBI can bring down its stake immediately after the rights issue.

The RBI has not allowed any commercial bank to fail in the past three decades

All this is expected to happen fast. Even though the moratorium is for one month, one can expect that it will be business as usual for Yes Bank by the second half of March.

Since it is not a merger, there will not be any value erosion for SBI stakeholders. No depositor will lose money, no branch of Yes Bank will be closed and none of its employees will lose their jobs. The current investors in Yes Bank will also see value, if they are willing to stay put. The only loser in the deal are those that invested in the bank’s additional tier-I or AT-1 bonds, of Rs 10,800 crore — mostly mutual funds. Such bonds are quasi-debt instruments and carry higher risks. Media reports say that the bond holders will move court against the RBI plan of writing them down permanently.

While the write-down will unnerve bond holders and Indian banks will find it difficult to raise money through this route in the future, RBI’s plan is in sync with the Basel III guidelines on such instruments. The agreements between the investors and the bank for such bonds, I understand, do not have any formula and provision for converting the AT-1 bonds into equity or a temporary write-down to be followed up by write-up later. Even if such a provision had been there, still the bond holders might not have got anything as Section 45 of the Banking Regulation Act, under which Yes Bank is being reconstructed, gives RBI freedom to overrule all such provisions.

To start with, SBI should keep a good amount of deposit with Yes Bank to instil confidence in others and the RBI can open a liquidity window, if needed. This could be an Indian version of the Troubled Asset Relief Program (TARP) of the US, financed not by the government but by a government-owned entity. If all goes well, the SBI will make money from its investment.

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd.
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