Why there is no need for a direct government intervention in case of a potential private bank failure?
Pursuant to the full public exposition of the shadow banking crisis last year that later spilled over to banking sector (thanks to its over-bought infrastructure, unchecked Real Estate lending and a potential telecom mishap), there has been a shout for the rescue of one particularly large private sector bank called Yes Bank from both arm-chair / social media intellectuals followed by business journalists. The fear-mongering about a system wide contagion and stories plus hypothesis about the absolute need for a forced merger with another Public Sector bank and a potential bail-out by the government, is only adding to the already raging bushfires within the financial system. The collapse of ILFS, DHFL, PMC bank etc. sent alarm bells ringing across the system and pessimists took the first opportunity to predict the end of the world. What needs to be understood is that Indian economy primarily relied on Financial Services, Real Estate and offshore IT services for its 25 year persistent rally. This is now seeing a massive correction (a much needed one?). The other fundamental sectors like Infrastructure, manufacturing, technology and businesses driven by innovation have been left to nothing but ancillaries due to successive governments faulty policies, populism, brain drain due to lack of effective and merit-based educational and employment opportunities onshore.
The whole idea of privatization itself is to free a private individual from the state’s clutches to decide what she/he wants to do with the profits generated out of the system and also digest losses even if it means declaring bankruptcy and owing up a failure. This thought was put under a stress test back in 2008 when Treasury Secretary of USA, Hank Paulson decided to send a message to private corporations that government isn’t a bailout machine (the Lehman crisis). What happened later is unfortunate, but today India needs exactly the same type of leadership where if a systemically important financial institution is about to bite dust, government has to let that happen and empower the regulator to launch a full-fledged investigation on the circumstances that led to the failure and hold promoters accountable in case of a fraud. If the government has shown will power by cutting corporate taxes in a country with a socialist mindset, the onus is on the private owners to count the number of chickens coming home to roost and find a solution or declare their ecosystem bankrupt. On one hand, the system needs free flow of capital and on the other, the shadow banking and cooperative bank crises left retail investors and depositors grappling for their money leading to a catch-22 situation. The Retail segment losing its deposits when an institution like Yes Bank fails wouldn’t necessarily be the end of the world, as it is a part and parcel of the economic system. At this juncture, it is paradoxical to pump in the tax money to save other tax payers as it’s the regulator which has to step forward to safeguard small depositors and up the defences. Market economies are expected to have crests and troughs and it is the periodic correction of the market that makes economies mature like America and parts of Europe. Governments of the emerging markets on one end let their cronies grow into behemoths whose failure can devour the economy, and on the other end wasted public money by running loss making PSUs and also bailed out private companies and individuals (rich farmers in our case) to protect their vote bank. This lack of knowledge and understanding on the part of the electoral college cost us many generations of potential enterprising population that considered government money / services freebies.
Having said that, a major failure is always a perfect opportunity for sweeping reforms by the regulator with its sharpened teeth as against the government itself stepping in with its public armour. This is a perfect opportunity for the RBI to tighten the norms for setting up a commercial bank itself rather than squeezing institutions on the Net demand and Time liabilities which pay no interest. For instance, it makes absolutely no sense to hold on to the minimum exposure limits of 15% of the total bank’s Capital per corporate and 30% per group at a time few corporates are turning into behemoths too big to handle for the system and too sweet to resist for politicians. These exposure limits have to be brought down by atleast 5%-10% each in the next 5 years. The categories of provisioning need an overhaul too. In the first instance, the RBI has to increase the number of days from 90–120 to classify as an NPA while maintaining the Special mention accounts status as is. This can be possible if RBI allows banks to accept Credit and Political Risk Insurance to enhance the credit profile of its sub investment grade assets while disbursing loans. These insurance policies being quite famous in the West and Far east, also allow banks to get capital relief thus expanding their books and creating more employment. RBI has been cautious in implementing the same in India over banks going berzerk with these tools in hand, but situation is no different without them. These policies which are assigned to domestic banks at a heavy premium give an opportunity also to broad base the Insurance sector and also give an entry to Specialty Insurance market in India which is currently insignificant. They also protect the banks interests as the foreign reinsurance companies would want their fronting counterparts to do heavy due-diligence before issuing a policy, which in a way is going to counter-act or atleast balance the potential harm from corrupt domestic credit rating agencies. Gone were the days of cautious approach as banks today need a much flexible market access while regulators keep them on a tight leash over potential loan frauds and corruption at the board level. Apart from this, the loss provisioning under NPA’s must be extended to 15 months from the current 12 months, helping banking fraternity save their balance sheets as the IBC is already in full swing and has provided a massive opportunity for banks to keep fraudsters on tenterhooks.
Apart from these, 75% FDI must be allowed within 5 years of successful banking operations under automatic route. The minimum promoter holding via the non-operative financial holding company has to increased to 25% from the existing 15% to make promoters more accountable, while keeping a close tab on the number of board seats held by the promoter family when it falls below 51%. Most importantly, the pressure of priority sector lending has to be brought down for the private players and let privately owned banks choose their profitable avenues within the guidelines of RBI.
For now, Yes Bank is still a small pebble in the financial system. Before the so-called contagion spreads, RBI needs to take up this golden opportunity to play a significant role as a progressive and effective regulator.