The RBI announced a moratorium on Yes Bank after efforts to find a buyer for the bank by its promoters failed. As a consequence, depositors will not be able to withdraw more than Rs 50,000 of their own money, except under special circumstances.
The moratorium on Yes Bank underlines key problems in the Indian banking system. In today’s legal framework, by the time the RBI takes action, it is quite late in the day and depositors suffer. Timely action requires that a new owner for a bank is found before such actions become necessary. At present, no one has the legal powers to step in and sell the bank before it reaches this point.
The damage caused by the lack of a legal framework for resolution is not limited to the depositors of Yes Bank. The present framework has wider implications for the economy as a whole. In particular, the lack of a resolution law and framework means that if a bank fails, the tax payer pays for it, directly or indirectly. If SBI or LIC step in to buy shares in Yes Bank, their losses are covered by the tax payer.
Instead of the moratorium, the legal framework should have provided oversight of the bank by the RBI and a Resolution Authority, and long before it came to this pass, the Resolution Authority should have found a buyer for it. Depositors should not have had to face a moratorium on their deposits. SBI or LIC should not be forced to buy it out. The tax payer should not have to suffer this burden.
The need for a resolution mechanism
A resolution mechanism will also help create a banking system that can cater to the needs of credit growth of the economy.
While it is said that the problem today is that there is inadequate demand for credit, this is true only if we ignore the millions of small firms and borrowers who are considered credit unworthy by our banks, who borrow from informal credit markets at exorbitant rates of interest.
There are close to 51 million small business units in the country, out of which only five million units have access to formal credit. The banking system in India lends less than five per cent of its total loans to small businesses. That too, primarily, because public sector banks are mandated to fulfil targets such as those given to them under schemes like Priority Sector Lending or the Mudra scheme.
All over the world, small firms get working capital loans from banks. In India, even though small businesses are willing to pay high interest rates, they are not considered attractive customers by banks. In the present system, with the public sector dominating banking sector, there is very little incentive for banks to lend. The banking sector needs competition within. It needs banks that want borrowers. It needs banks that give working capital loans to small businesses.
By now, it is clear that public sector banks cannot fulfil this role. Either the existing PSBs need to be privatised, or more private bank licences need to be given. But while private banks should be allowed to enter, their failure should not become a burden on the tax payer. An effective regulatory mechanism needs to be put in place. It has to reduce the risk of failure, yet allow it, and have the promoters of private banks be stripped of their assets if they run the bank to the ground.
Without a resolution mechanism for banks, the regulator, RBI, or the government should be concerned about giving new bank licences. In the last decade, very few private bank licences have been given by the RBI. Allowing entry of banks which would not be allowed to fail and would become a burden on the exchequer would create a new problem. Thus, more entry into banking or privatisation has to be coupled with a mechanism for exit, with minimum cost to consumers, borrowers and the tax payer.
FRDI Bill on a fast track
The current legal framework only allows struggling banks to be merged or liquidated. In 2004 Global Trust Bank, a failed private sector bank, was merged with the Oriental Bank of Commerce, a public sector bank. There are very few state banks strong enough now to take on such a burden. Forcing SBI, one of the few PSBs with a healthy balance sheet, to buy a failed bank, would be so unfair. The only other option is to sell off each loan or asset one by one, which can take as long as 10 years. There are limited options.
We need to create a mechanism to sell a bank as a living entity to another bank. A Resolution Authority, similar to the Federal Deposit Insurance Corporation in the US, is needed to take over failing banks and either run them temporarily, sell them, infuse equity or, as a last resort, liquidate them.
When the FRDI Bill was introduced in Parliament to create a Resolution Authority, this was the attempt. Unfortunately, it got mired in controversy. To address concerns with the Bill, the Union Budget 2020-21 raised the deposit insurance cap to Rs 5 lakh.
The Finance Minister has subsequently announced that the FRDI Bill will be brought back to Parliament. The Yes Bank moratorium should help put the bill on fast track.
The author is an economist and a professor at the National Institute of Public Finance and Policy. Views are personal.