I believe banking institutions are more dangerous to our liberties than standing armies,’ wrote US president Thomas Jefferson in 1816. Going by the panic after Yes Bank was put under moratorium on March 5, Jefferson had his finger on the pulse of what can happen when public confidence in banks is shaken.

According to Reserve Bank of India (RBI), it tried its best. But since Yes Bank was facing ‘regular outflow of liquidity’, it had no alternative but to apply to GoI for imposing a moratorium under Section 45 of the Banking Regulation Act, 1949. Really? Was there no alternative? More importantly, are there any lessons for us in the Yes Bank fiasco?

Brothers in Alms But, first, a caveat. Yes Bank is not the first — nor is it going to be the last — bank to fail. However, as the collapse of Lehman Brothers in 2008 has shown, bank failure can have a catastrophic effect on the financial system and the wider economy, and can’t be treated lightly. Now, to the lessons.

1. There must be a clear separation of ownership and control. Both Global Trust Bank (GTB) — which went belly up in 2004, and had to be rescued through a merger with public sector Oriental Bank of Commerce — and Yes Bank were headed by powerful founder-promoters, who brooked no challenge to their authority. Caps on promoter holding are no guarantee against misuse of authority.

2. It is not enough for RBI to ensure promoters pass the ‘fit and proper’ test while granting the bank licence. As with rating agencies, whose responsibility does not end with the initial rating, the ‘fit and proper’ test must be a continuing exercise. Good supervisors must have their ears to the ground.

3. Given the enormous scope for misuse of authority, it is never a good idea to allow bank CEOs long tenures. Sadly, this commonsense rule has been observed more in breach than in practice in India.

4. Banking is about trust. It is about taking (informed) risks with public money. Eternal vigil is the price for safety and stability. More so in the context of modern banking, where the fractional reserve system allows banks to keep a fraction of depositors’ money and lend the rest, even as they promise to pay depositors on demand. And in full. The onus on bank boards, auditors and banking supervisor is enormous.

5. Selection of board directors must be more selective. Yes Bank’s board included stellar names like former finance secretary Ashok Chawla and former agriculture secretary Radha Singh. Yet, the board seems to have been content to let Rana Kapoor call the shots and lend aggressively even as loan growth slowed to single digit across the industry.

6. Likewise, selection of bank’s auditors must be done with more care. Yes Bank’s efforts to window-dress its balance sheets would not have been possible unless its auditors, initially SR Batliboi and Co and BSR and Co (from 2019), were willing to play along.

7. Most importantly, there is no substitute for efficient supervision, and prompt and effective follow-up. The buck stops with RBI. Supervision must be beefed up through lateral entry of bankers with domain knowledge. And it must be followed by prompt corrective. The deterioration in Yes Bank’s financial health was known for more than two years. There was a letter from a whistleblower as well. But RBI gave the bank an unduly long rope.

Don’t Waver on Waiver 8. The mandatory cooling period for deputy governors and senior RBI officials, particularly those responsible for bank supervision, must be strictly enforced. Waivers, if granted, must be the exception before they are allowed to join regulated entities, in any capacity.

9. There is need for more transparency. A moratorium is imposed as a last step when it is feared a bank will not be able to pay its depositors. Yes Bank’s net worth, a measure of its ability to repay its depositors, is positive on December 2019, even according to latest numbers released on March 14, 2019.

Finally, some questions. Could RBI have managed the fallout better? Could the draft restructuring scheme have been announced sooner to reassure depositors? As with GTB, could it have been timed to coincide with the weekend, rather than Thursday evening? Could greater care have been taken to ensure Yes Bank’s ATMs and branches were stocked with enough cash to meet depositors’ needs?

Remember, the restructuring scheme is, at best, only a partial solution, especially since the hole in Yes Bank’s balance sheet is larger than anticipated (net loss Rs 19,047 crore as in December 2019) and is likely to grow as the economy slows further. If Yes Bank had to be bailed out — since the alternative of letting a large bank go under is not an option — would direct infusion of taxpayer money have been better than asking listed banks, public and private, to step in?

Today, ‘nationalisation’ is a bad word. But it is more likely to succeed (as seen in advanced economies after the 2008 crisis) than the (clumsy?) public-private partnership now being attempted.

Henry Ford, who, like Jefferson, had a lifelong distrust of finance companies, had said, ‘It is well enough that people do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.’ Ford was right. Most people do not understand or care about banking and monetary policy. They just want to be sure their money is safe. RBI and GoI must ensure that. Otherwise, they risk a ‘revolution’.

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