The actual cost of Yes Bank collapse

Legitimising the fear of political blowback against letting the market take its course may be the real price to be paid

Yes Bank has become the fourth financial sector institution to collapse since 2018. Others on the list include IL&FS, Dewan Housing and PMC Bank. There have been collapses in the non-financial sector meanwhile like Jet Airways.

Indians, it may be argued, have become blasé about corporate collapses, so frequently have they occurred. In a way, it is so. The collapse of a non-financial institution surprises the public but does not make the event a traumatic one, except for those who lose jobs.

The difference between the two sectors has got created with the establishment of the Insolvency and Bankruptcy Board of India. It has shepherded through several large companies to the gallows; sometimes with less harsh outcomes. Witness the giant Essar Steel changing hands to become AM/NS Steel or the liquidation of the relatively smaller Orchid Pharma. In these cases and more, the erstwhile wink and nod system of corporate governance, that made it impossible to figure out the sudden unexplained collapse of a firm, has been replaced with a predictable set of outcomes. The Indian state, which till 2016 had no mechanism for an orderly exit of firms, has got its first one.

It is important to realise why this mechanism is so important for an economy like India. The combination of low per capita income and the lack of an adequate safety net makes the exit of a company from the Indian corporate space quite traumatic for significant segments of the population. Yet, it is important if capital has to be deployed effectively that there should be an efficient system for its recovery.

This has been absent in the financial sector. The Financial Sector Legislative Reforms Commission had recommended the formation of a winding-up mechanism for this sector too, viz., the Financial Resolution and Dispute Insurance Bill. While the Bill aims to play this role, the waterfall mechanism it has suggested where depositors above a certain financial threshold too take a hair cut is unlikely to pass muster in Parliament. But this is not the major problem.

The key problem for the financial sector is the presence of both public sector and private sector entities in all segments. By definition, a public sector company cannot go under because of the sovereign guarantee, no matter how poorly it is managed. This is problematic. For the public, however, unless they are shareholders, this seems good enough. It gives a false sense of security. This is the operating environment that makes the government reach for solutions like in the case of Yes Bank, which may be financially harsh for those who did business with Yes Bank, the larger market and of course the economy (the RBI and the government had to choose between very limited options).

It is quite possible that many deposit holders, not just of Yes Bank, will retreat to the safety of public sector banks. A state like Maharashtra has already ticked off its employees who operate salary accounts in non-public sector banks.

To avoid such an outcome the central government should, therefore, post Yes Bank, push to create a banking environment that is led by the shareholders. In other words, push for the privatisation of the banks. Any institution should be able to run the risk of failure if the economy has to prosper. A safety net mechanism can only then be properly devised to save those in the lower-income bracket. A weak bank with state support will continue to suck up tax money-led support over a long spell. This is tantamount to asking the poor to finance richer segments.

For instance, the insurance sector is beset by the same weaknesses. The lack of adequate insurance cover for people is because of the inefficiency of this environment. But one can be fairly sure that there will be a renewed blowback against not only the small public issue of Life Insurance Corporation but also against the mergers of the three general insurance companies. That their private-sector cousins are doing no better is no excuse to saddle the government with the bill to keep these ones in pink. These are not productive capital investments.

Legitimising the fear of political blowback against letting the market take its course could become the actual cost of the makeover of Yes Bank. Two decades ago, the government paid a heavy price (about Rs 15,000 crore) to compensate the holders of US-64, the first mutual fund offering of the erstwhile UTI even though it was not a government-run scheme but was perceived to be so. Such action now, the context of the present crisis at Yes Bank, could prove to be far more costly. A far better course is making the operating environment for the financial sector competitive and putting in place a credible safety net.

(The writer is a business journalist and can be reached at [e-mail])

Disclaimer: The views expressed above are the author’s own. They do not necessarily reflect the views of DH.