Banking is a risky business and there will always be bad loans. Private banks lack a proper governing structure and ethics, and try to avoid RBI scrutiny, say experts

The failure of Yes Bank and the Reserve Bank of India’s consequent intervention has come as no surprise. The writing was on the wall for those who cared to read it, yet many, including the banking regulator and the government, failed to take timely action. “The RBI, as regulator, should have taken action against Yes Bank more than two years ago as it gave all indications of being in a bad financial position. Instead of taking over, the RBI kept telling the bank to correct itself,” says C.H. Venkatachalam, general secretary, All India Bank Employees’ Association, drawing parallels with United Western Bank and Global Trust Bank, both of which collapsed due to lack of timely action.

Emphasising that banking is a risky business and there will always be bad loans, Venkatachalam says that in the case of Yes Bank, the problem was compounded by the fact that it was not being run properly. “They were recklessly advancing loans instead of behaving like a responsible bank. Banks must take risks, but they were over-risking,” he says. “Yes Bank has been suffering various problems, including issues of ­divergence, non-disclosures, mounting bad loans, inadequate capital, inability to augment capital etc.”

Ashish Kajla of the Centre for Financial Accountability faults lack of clarity in the Yes Bank board’s functioning and the resignations of board members over the past two to three years. “Essentially, the question is of corporate governance and how far private sector banks are following the ethics of corporate governance. Often, public sector banks are said to fail on this front due to political and other pressures on them, but I think Yes Bank was definitely not compliant with corporate governance norms, as is evident in the divergence of NPAs ­either through non-reporting or misreporting continuously,” he says.

Contrary to popular belief that ­private banks are more efficient and adhere to compliances, experts say they lack a proper governing structure and ethics, and take care to not come under RBI scrutiny. They are market-driven and often evergreen bad loans. While public sector banks do it by restructuring, private banks use more technical loopholes.

Distress signals started emanating from Yes Bank from 2016-17. Its loan book jumped from Rs 55,000 crore in 2014 to Rs 2.41 lakh crore in 2019 ­despite the slowdown in the economy post-demonetisation. The annual scrutiny of banks by the regulator should have rightfully raised questions and prompted early action. Most of Yes Bank’s exposure was to companies that have gone bankrupt or are in the process of going down.

“My first concern is that private sector banks, non-banking financial companies (NBFCs) and cooperative banks are not regulated adequately,” says E.A.S. Sarma, a former finance secretary who has been trying to draw government attention to irregularities in the financial sector and is part of a whistleblower group.

Experts fear there is going to be a huge crisis in NBFCs, which in turn are linked to private banks. For instance, Yes Bank gave a huge loan to DHFL, which is alleged (in a complaint to the ED and CBI) to have been diverted to political parties without the requisite certificates being issued. Some of the other deals by Yes Bank under probe ­include purchase of debentures worth Rs. 3000 crore from DHFL and a loan of Rs 750 crore to RKW Developers for a Bandra reclamation project, but the amount was not invested in the project.

Sarma says that many NBFCs and private banks reroute money to shell companies and privately held firms, as has been alleged in the case of DHFL and Indiabulls Housing Finance. The modus operandi is to give loans to a company, which in turn invests in the promoters’ shell companies. The ­rerouting helps them in increasing promoters’ personal gains. “RBI and SEBI should have seen this happening much earlier,” says Sarma. He claims that during his tenure in the finance ministry, timely action had helped prevent the collapse of three banks and safeguard interests of depositors.

In a recent report, CRISIL says that ­defying general lending caution, unsecured loans of non-banking institutions are growing at over 25 per cent this fiscal ­because of rising propensity for personal loans and attractive risk-adjusted ­returns. In five fiscals through 2019, ­unsecured loans logged a compound ­annual growth rate of over 30 per cent.

When the crisis in the banking sector due to NPAs deepens, there is a strong incentive for promoters to try to take money out. This is what happened in the case of Yes Bank, say experts. They fault the RBI’s regulatory mechanisms with its focus on micro-regulation, claiming it serves no purpose.

Professor Vikas Srivastava of IIM Lucknow says that from a credit risk perspective, in most countries where central banks are reasonably efficient, approximately 2.3 per cent of loans and 1.6 per cent of deposits on an average are at risk. “So, in the normal course of doing business, banks would provision for ­recovery of such loans either through higher pricing or higher provisioning. In the case of risky businesses, banks will not provide loans unless they are matched with higher provisioning,” says Srivastava. He explains that banks and regulators have to pick up on early warning signals, which in Yes Bank’s case, ­appeared when profits went down from Rs 4,200 crore in 2017-18 to Rs 1,700 crore in 2018-19 and the expenditure of the bank increased from Rs 21,300 crore to Rs 32,500 crore. ‘Other provisions and contingencies’ went up from Rs 1,600 crore to Rs 5,800 crore, while the provision coverage ratio was inadequate, which means that the bank was looking at higher expected losses than usual in the credit space. The liabilities were around Rs 68,400 crore, of which ­approximately Rs 20,900 crore came from deposits, signalling that the bank was borrowing the rest in the short term.

Experts say the Yes Bank case may not be as bad as the PMC Bank crisis, but what is similar in both cases is the risk provision coverage ratio being ­inadequate. There is a liquidity problem, which the RBI is trying to resolve through infusion of risk capital via State Bank of India.

As Yes Bank depositors await more clarity on what is going to happen after the cap on withdrawals ends on April 3, there are also concerns over reports about other private sector banks that have either been ­embroiled in scams—ICICI Bank and Axis Bank—or are running in losses, such as Lakshmi Vilas Bank.

While some financial sector experts negate this concern, Professor Sebastian Morris of IIM Ahmedabad says that at this stage, all ­financial institutions—NBFCs and private banks—ought to be re-examined, particularly those that have grown rapidly in this period of economic slowdown because that growth might be happening by giving credit to friends and relatives. “Many banks in the private sector are unsafe as they are too highly leveraged to be healthy. There are problems everywhere, but in the present economic scenario, some are more ­unsafe than others,” he says.

The article published in The Outlook India can be published here.

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