The Yes Bank crisis exposed weaknesses in banking supervision and the need for a dedicated resolution framework. Trouble had been building for years as Yes Bank's CEO and CFO oversaw underreporting of bad loans. Its loans were exposed to troubled firms and exceeded deposits. Non-performing assets ballooned while ratings downgraded and deposits fled. The RBI needs improved supervision and accountability for lapses. A specialized resolution mechanism is also needed to diagnose and resolve troubled banks swiftly to avoid systemic risks. While the RBI supervises banks, they must also strengthen governance to establish accountability.

1. Yes Bank: The anatomy
of crisis

2. Introduction
The various fraud which have taken place in the banking sector in India indicate that
there is a weakness in banking supervision. The RBI needs to put in place robust
systems that address poor risk culture and failures in controls and governance. The time
is perhaps ripe for introduction of a dedicated resolution framework for swift resolution
of troubled financial firms to avoid disruption to the financial system.
The Yes Bank crisis is one of the latest incidents exposing fault lines in the financial
sector.

3. On 5th March, 2020, the Government placed a moratorium on Yes Bank which though
initially planned for 30 days was lifted on 18th March 2020. Withdrawals by depositors
and creditors had been restricted to Rs. 50,000 (except in special circumstances where
the limit is raised to Rs. 500,000). The RBI had superseded the bank’s board and
appointed an administrator in charge of the bank.

4. What exactly took place?
Trouble had been building up at Yes Bank for several years. CEO, Mr. Rana Kapoor and the CFO
oversaw the massive underreporting of bad loans for FY (fiscal year) 2016: the bank initially
reported bad loans of Rs.7.49 billion which was revealed to be Rs. 49.26 billion the next year. Mr
Kapoor was denied an extension to continue post by RBI in 2018. Its loan book showed
exposure to troubled firms like Dewan Housing Finance Corporation. The bank was lending
beyond its means with credit deposit ratio at 106% as of September 2019. The NPAs had
ballooned from 1.60% of its gross advances in September 2018 to 7.39% in September 2019.
Over the past year, it has been steadily downgraded by several credit ratings agencies and
unable to raise capital. The bank’s ability to meet regulatory norms on capital adequacy had
been crucially impacted with rising bad assets. Market value had eroded substantially. The last
few months alone saw a flight of deposits and several FIIs (foreign institutional investors) and
mutual funds offload half their stakes in the bank. The RBI has also had its nominee on the
board since early 2019.

5. Improving central bank supervision
As a regulator, the RBI is in charge of supervising banks. The Banking Regulation Act
bestows significant powers and discretion on the RBI in this regard. It can intervene in
the operations of a bank to secure the interests of public and depositors. It decides
what constitutes such interest. For instance, it can depute observers to watch board
proceedings, remove managerial persons including CEOs and appoint their
replacement. The string of frauds and failures unearthed in recent years in the banking
sector, starting with the PNB (Punjab National Bank) scam and now the Yes Bank crisis,
however indicate weaknesses in supervision. A key issue is that banks were allowed to
hide their bad assets for several years. The non-recognition has implications in the form
of inadequate provisioning by banks which is then reflected inaccurately in the pricing
of borrowings. Matters concerning shareholding, voting rights, board appointments,
management, and winding up are all subject to RBI’s policies.

6. to be continued….
This leads to information asymmetries which provide an incorrect picture of the sector
and impede decision-making. These problems arising in banks point to the need for
improving banks’ disclosure norms as well as RBI’s supervisory capacity. RBI needs to
put in place robust systems that address poor risk culture and failures in controls and
governance. It also needs to be accountable for any lapses in it’s supervision.

7. The case for a specialised resolution
mechanism
A key lacuna in the current financial regulatory landscape is that it lacks a specialised
mechanism for prompt resolution of banks. RBI acts as a banking regulator and also has
limited powers towards resolution of banks. However, there are inherent conflicts of
interest in the role of a micro-prudential regulator and of a resolution authority. As a
micro-prudential regulator of banks, RBI is concerned with reducing the chances of
bank failures. This however conflicts with the objective of a resolution authority who
must diagnose failure early and move quickly to resolve the firm. Delays can impose
considerable costs in the form of destruction of wealth, hardship to depositors and
other stakeholders, business discontinuity, and even systemic instability.

8. The buck stops with the banks
While central bank is responsible for supervision, banks must be held accountable for
their own governance. Strong governance is important to establish credibility,
accountability, and to attract capital. In its report of May 2014, the RBI appointed
Committee chaired by Dr. P.J. Nayak made several recommendations for strengthening
governance at both public and private sector banks. The Committee’s observations
concerning private banks on two counts – ownership constraints and management
compensation – are relevant in the current context. Small shareholders tend to be less
engaged in the firm’s affairs and accordingly, offer one less avenue to scrutinise and
hold management accountable. Incentive structures for senior management link
profitability with compensation, incentivising evergreening of loans, and in turn,
affecting the quality of assets and reporting at the banks. The Committee
recommended asset quality reviews to locate evergreening, stringent penalties, and
diversification of boards to enhance independence and performance.

9. Thank you
Nikhil Priya (MCOM, University of Madras)