India, home to one of the world's worst piles of bad debt, once again finds itself defending the stability of its financial system after the biggest bank failure in its history.
The Reserve Bank of India took to Twitter on Sunday to affirm the safety of deposits in the wake of a decision to seize Yes Bank Ltd. and invite the nation's largest lender to make a confidence-building share purchase. It also announced an unprecedented move to permanently write down Yes Bank's 87.8 billion rupees ($1.2 billion) of additional tier 1 bonds -- hybrid securities, which can be written off if certain triggers are breached.
The dramatic actions are intended to avoid a disorderly collapse of India's fourth-largest private bank and reassure investors, who on Friday dumped Indian financial stocks. Still, the plan to write down perpetual securities threatens to hurt fund raising, with one lender already shelving a move to sell similar securities. At a time when India's economy is growing at the slowest pace in 11 years and the coronavirus is hurting global growth, the RBI's proposal may crimp banks' ability to raise the capital needed to fight $190 billion of stressed loans.
"This will pose challenges for smaller or weaker lenders to raise funds as investors turn averse to risk," said Srinivas Rao Ravuri, chief investment officer at PGIM India Asset Management Pvt., which holds Yes Bank's AT1 debt. "It will lead to a huge impact on the category."
And it's not just fund-raising that will be hurt. Central bank data shows loan growth sank to a more than two-year low in February, despite the RBI reducing borrowing costs five times last year. The slowdown may worsen.
"It may constrain banks from stepping up credit growth going ahead," said Karthik Srinivasan, head of financial services at ICRA Ltd., the local arm of credit assessor Moody's Investors Service.
Total outstanding AT1 debt in the Indian banking system is 930 billion rupees, according to ICRA. Of this, 390 billion rupees was issued by private banks. India's rupee corporate bond yields climbed about 3 basis points in Mumbai on Monday, according to traders, even as sovereign yields plunged.
Still, the intervention by RBI may help pacify depositors scarred by failures and scandals in banks as well as shadow lenders since the collapse of Infrastructure Leasing & Financial Services Ltd. in September 2018. The central bank on Sunday in a tweet tried to reassure depositors again. On Friday, four police vans guarded Yes Bank's headquarters in Mumbai.
Yes Bank's shares rose 12% as of 9:54 a.m. in Mumbai on Monday, after dropping 56% Friday, while State Bank of India fell 6%. The RBI is due to receive public feedback Monday on its proposal that State Bank of India will immediately invest 24.5 billion rupees for as much as a 49% stake. Bloomberg News reported on Thursday that the government had approved a plan for State Bank to buy stake in Yes Bank.
Yes Bank's troubles are rooted in the rapid expansion under its former Chief Executive Officer and co-founder Rana Kapoor. In his last full year in charge -- the year to March 2018 -- Yes Bank had the fastest loan growth of any bank in India. But it was also piling on risk. The RBI forced Kapoor out last year after challenging Yes Bank's accounting, saying the lender was downplaying the scale of its spiraling bad loans.
The lender's rapid growth -- its assets tripled in the five years to 2019 -- means its failure will have ramifications across the economy. Yes Bank loaned more than 400 billion rupees to India's troubled shadow banks, property developers and power generators. It also financed enough renewable energy projects that could generate New Delhi's power needs.
"With Yes Bank's seizure, India is losing a major financier to green and infrastructure sector," said Sandeep Upadhyay, managing director of Centrum Infrastructure Advisory Ltd. "Even high quality projects will struggle to get financing or refinancing, and that could have a ripple effect."
The shadow banking crisis that erupted in September 2018 added to Yes Bank's woes. A Credit Suisse report last year said the company had the biggest proportion of outstanding loans to large stressed borrowers, including to Anil Ambani group companies and Dewan Housing Finance Corp., which was seized by the RBI in November.
"There is a trust deficit" around non-performing assets of banks, shadow lenders and housing finance companies, Ananth Narayan, a professor at Mumbai-based SP Jain Institute of Management & Research, said in a series of tweets. "Solutions exist. One path could be acknowledgment, one-time holistic solution" such as creating a bad bank, followed by tough reforms, he wrote.