State Bank of India (SBI), the nation’s largest state-owned financial institution, along with a six private sector banks that includes Housing Development Finance Corporation (HDFC), Kotak Mahindra Bank, and Axis Bank will together account for a 75% ownership of Yes Bank, the fourth largest private sector bank in India following a near $1.4 billion agreement reached this month.
The bailout reflects the tasks facing the Reserve Bank of India (RBI) to write-off distressed assets without inducing a system wide panic. But by allocating both public and private money into the rescue, investors and depositors are now questioning what other dangers lurk within the country’s financial system.
The lifeline not only produces an investment moral hazard but reflects the few good options available to address the economic crisis now plagued by the covid-19 disruption, with further impairments now increasingly likely.
Pulling Others Down
Confidence in India’s private and public finances were already low before the Yes Bank bailout, representing India’s second banking scare over the past six months. The RBI placed a moratorium on Punjab and Maharashtra Co-operative Bank (PMC) in September 2019, which was heavily exposed to Housing Development and Infrastructure that went bankrupt in August.
SBI taking a 49% stake in Yes Bank overlaps other government efforts to avert a balance of payment crisis amid an almost 10% India rupee depreciation in the past year. To narrow the budget deficit the government intends to privatize key state assets, including a proposal to list Life Insurance Corporation of India (LIC), the biggest insurance company in the country with 70% market share and a stable dividend income.
Optimism to find private capital may be misplaced if assets owned by SBI and LIC fall under additional stress. LIC holds 51% of IDBI Bank, a state-owned lender with the most toxic balance sheet.
The deteriorating economic backdrop and tightening capital market conditions exacerbated by the covid-19 pandemic becomes more challenging, as “India lacks significant fire power to throw at the economy” commented Neil S. Mascarenhas, a Fund Manager at Hamon Investment Group.
Forced by the RBI, private sector banks allocating capital in Yes Bank creates an investment inefficiency. As the bailout is not one single institution, but rather “pulling in everyone to help,” said a former buyside investment analysts in Hong Kong who asked to remain anonymous. “It’s not just the money, but the name (like HDFC) that government wants to inject that is relevant,” he explained.
The confidence test will likely take two forms. First, whether deposits will leave their money at Yes Bank. While the RBI has stated that Yes Bank’s liquidity remain adequate, queues of people waiting outside branches to withdraw deposits suggests otherwise.
The second test will be to see if Indian bank shareholders continue to hold financial stocks as earnings. Falling deposits push down the current and savings account (CASA) ratio which increases operational expenses, while capital misallocation lowers return on assets (ROA).
Falling bank share prices reinforce bank runs and deposit withdrawals, extending the downward pressure in sector confidence. So far, the signals are not good. Since March 5, when the RBI put Yes Bank under moratorium, shares of other private sector banks plunged, with RBL Bank dropping 45% and IndusInd Bank shedding 57%, for example.
Foreign Interest
The Yes Bank bailout comes as foreign investors were already concerned about an investment climate that has seen a nationalistic agenda take precedence over economic reforms.
The good news is that investors remain keen for India’s macro story. This was evident following the IPO for SBI’s credit card business this month which raised $1.4 billion after a 26.5-times oversubscription.
The challenge for Yes Bank’s SBI appointed board of directors is whether they can clean up the balance sheet sufficiently to attract foreign interests. Non-performing assets accounted for almost 20% of the loan book, versus a less than 5% at Axis, Mahindra, and HDFC.
According to analysts at Jefferies India, Yes Bank requires around $4 billion to be recapitalized, prompting questions over the country’s economic health and other distressed assets in the pipeline.
The sad irony is that India Inc. needs a financial institution like Yes Bank to provide credit at a more dire point in the economy cycle. Yes Bank was branded as a ‘yes’ bank when other banks replied ‘no.’ With the RBI asking whether confidence lingers in the banking system, the answer remains unclear.
