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What Can We Learn From The Failure Of Yes Bank?

Every crisis is an opportunity for all stakeholders to reflect upon, and learn from the mistakes. This one is no different. So, let us look at the learnings from the Yes Bank failure and restructuring.

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Yes Bank is a large size Indian private bank. Its capital structure has recently been restructured with the directive from the Reserve Bank of India (RBI) under Sec 45-I of the RBI Act, 1934. The bank had been going through a stressful period for a few years. The RBI has intervened to ensure that the interest of the depositors is protected and there is least damage to the banking system as a whole.

Every crisis is an opportunity for all stakeholders to reflect upon, and learn from the mistakes. This one is no different. So, let us look at the learnings from the Yes Bank failure and restructuring. For each of these points, keep an eye on the fact that failure has happened.

Learnings for the Board of Directors

The Board of any company is an agent of the shareholders. It must, at all times, keep focussed on the long term interest of the shareholders. Some of the specific tasks of the Board are:

  1. Lay down the risk appetite framework – The Board must approve in clear and measurable terms as to how much risk a firm is allowed to take. 

  2. Ask the Senior Management to demonstrate, on a continuous basis, that the latter are not violating the limits placed by the Board.

  3. Align the incentives of the Management with the shareholders. This can be done through affirmative actions like stock options or restrictive actions like limiting the powers of the Management, if required. 

  4. Take suitable actions whenever it is not satisfied. The actions can be to ask the Management for corrective action, inform the shareholders of any deviations, etc. In the worst case, the director should resign from the position if she is not able to function properly.   

Learnings for the Senior Management

By definition, the Senior Management is often at a conflicting position vis-à-vis the shareholders or the Board. In spite of a lot of brainstorming globally, this issue of conflict has not yet been fully resolved. But, even after assuming that the incentives are aligned, the Management needs to remember the following:

  1. Strengthen the ability to evaluate the risk-return trade-off in case of every proposal. This should be done through suitable staffing capabilities, positive atmosphere for constructive dissent, and transparent decision making processes. The need for the right mix of knowledge, skills, and attitude begins right at the top. 

  2. Implement effective processes and controls. A process based operation and decision making conserves the time and effort of the Managers leading to higher effectiveness. The need for exceptions at certain times is quite valid and does not invalidate the integrity of processes.

  3. Ensure effective communication within and outside the firm. The values and priorities of the Senior Management must be known and clearly understood by the staff. Ambiguity in communication or whimsical decisions by the Management leads to the staff being confused anand  guessing about how to approach their regular work. 

Learnings for the regulator

The independence of a regulator is a myth and it has a difficult task balancing between the various stakeholders. Within such constraints, the regulator should keep the following in mind:

  1. Prioritise your objectives. Obviously, there will be multiple, and even conflicting, objectives to serve. But, remember that each of the options of priorities has its own risk and reward for the regulator itself as well as the stakeholders. For instance, the asset quality review (AQR) and the recently circulars, issued by the RBI, on recognition of default were seen as harsh by the affected banks. But these were introduced for better management of the systemic risks, and RBI should have stayed the course on these. Diluting these initiatives has signalled to the banks and markets that they would be exempted from paying for their poor decisions, at least in the short term.

  2. Strengthen your capabilities. Even within the constraints of pressures from the government and regulated entities, the regulator must work efficiently. The intellectual and operational capability of the regulator comes into doubt when significant lapses of omission are realised at a later date. Training of the staff, appropriate incentives, and making use of industry experts are important.

Learnings for the government

  1. Do not make misleading assurances to the customers. In most cases of failure of banks and non-banks, the government and the regulator have assured the depositors that their money would be safe. They know very well that this is neither desirable nor possible for them to deliver on such assurances, but they continue to do so. In fact, they have not just failed to, but also added to this belief through their actions.

  2. Educate the customers. The education cannot be limited to just generic messages from the government to the customers. For instance, bank depositors should receive specific information about the risks to their deposits in their specific banks. Of course, this can happen only if the government is willing to devise a policy of compensation to the depositors from its own kitty.   

Learnings for the customers

  1. The customers need to be aware of the risks in the products bought by them. Bank depositors have traditionally believed that their deposits are risk free. They need to realise that they, and only they, would bear the pains of any failure of a bank. So they must, on their own, be vigilant about the risks of their deposits in the banks. For a large majority of depositors, who cannot assess the risks on their own, the government will have to appoint public trustees who can represent the depositors.

Learnings for investors

The investors are usually the last set of stakeholders that any government or regulator is concerned about. That is rightly so, because they are supposed to be the risk takers in the capital structure of a firm. The investors too have the opportunity to learn a few things.

  1. There is no free lunch in the stock market. If there is one, it is random, and not necessarily repeatable. So, both the bond and equity investors should do their own due diligence before investing. 

  2. Evaluate your assumptions. Many events seem to be thought of as never likely to happen, just because they have not happened in the past. Investors need to have a fair estimate of the chances of rare events. For instance, a bond investor may sign on an agreement to forego the principal in case of a rare event like bank closure, in exchange for receiving a higher coupon. This must be done with open eyes, without ruling out the possibility of a big loss.

In summary, the recent events at Yes Bank provide the opportunity for all stakeholders to learn and be prepared for any such future events. The principles apply generically, across a wide range of firm failures.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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Dr. Hemant Manuj

The author is Associate Professor & Area Head – Finance at Bhavan's SPJIMR.

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