Reconstruction Scheme for YES Bank — Key to Survival of the Indian financial systems

The government finally rescued Yes Bank, the country’s biggest-ever banking failure, by asking state-run State Bank of India to infuse Rs 7,250 crore and take 45% stake in the bank. Reserve Bank of India cleared the ground for the takeover. Proactively, the central bank had unveiled a draft reconstruction scheme on March 6 for the capital-starved Yes Bank and even superseded the bank’s board for 30 days on the ground of a “serious deterioration” in its financial position and the absence of a viable revival plan. The government had even put a sudden moratorium on cash withdrawals. While the country’s largest lender may have rescued Yes Bank, the crisis clearly indicates the level of financial stress in the banking and financial sector.

If one looks at Q3 FY20 results of YES Bank LTD published soon after the announcement of the reconstruction scheme, it is crystal clear that the bank net worth is wiped out fully with negative capital hence in common parlance it has collapsed and cannot continue to do its business without augmenting its capital and have the confidence of its creditors including all current, fixed deposit and saving account holders.

Crumbling of a bank this size can have loss of confidence in the whole financial systems which could lead to a collapse of multiple institutions and companies. After the bank on its own failure to get the investors in the last six months to avoid its collapse, the government has no choice but to come out with the bailout plan in the form of the scheme.

The Central Government has notified the “YES Bank Limited Reconstructed Scheme, 2020” (Reconstruction Scheme) in the exercise of powers conferred by sub-section (4) and sub-section (7) of section 45 of the Banking Regulation Act, 1949 which came into force on 13th March 2020.

Reserve Bank of India (RBI) has the power to make an application to the Central Government for an order of moratorium in respect of Banking Company when RBI is of the opinion that there is “Good Reason” to do so. Banking Regulation Act, 1949 does not list down the specific events on the occurrence of which RBI may make an application to Central Government for an order of moratorium. RBI has discretionary power to make such application to Central Government. During the period of moratorium if the RBI is of the opinion that it is necessary in the interest of stakeholders, it may prepare a scheme for –

1. the reconstruction of banking company
2. the amalgamation of banking company with other banking institutions.

RBI on March 6 placed in public domain a draft reconstruction scheme inviting suggestions and comments from the public including the banks’ shareholders, depositors and creditors before 9th March 2020. Timeline provided for submitting the suggestions o the draft reconstruction scheme RBI was a too little.

According to the Banking Regulation Act,1949 Reconstruction scheme prepared by the RBI will override provisions of the all other laws or agreements, awards, or any other instrument.

Features of the Reconstruction scheme

• Authorised share capital of the reconstructed bank i.e. YES Bank will increase to Rs.62,00,00,00,000 (Rs. 60,00,00,00,000 Equity shares and 2,00,00,000 Preference shares.
• Shares will be allotted to the investors at Rs. 10 (Face value- Rs. 2 + Premium — Rs. 8). There will be lock-in period of three years from the commencement of this Scheme to the extent of 75% in respect of —

(i) shares held by existing shareholders on the date of such commencement;

(ii) shares allotted to the investors under this Scheme:

Provided that the said lock-in period shall not apply to any shareholder holding less than one hundred shares.

• There will be a restriction on voting rights on the shares held by the investors.

An investor, other than the investor bank, may exercise voting rights to the extent of

(i) it’s shareholding; or

(ii) nine per cent. of the total voting rights of all the shareholders of reconstructed bank; or

(iii) as may be decided by the Reserve Bank,

whichever is lower. However, RBI has the rights to allow voting rights even beyond 9% but not exceeding 15% to a particular investor.

All investors including SBI has been given capital gain tax exemption which may arise due to subscription under the scheme.

• Shri Prashant Kumar, former Chief Financial Officer and Deputy Managing Director of State Bank of India, will act as Chief Executive Officer and Managing Director and Shri Sunil Mehta, former Non-Executive Chairman of Punjab National Bank, will be Non-Executive Chairman.
• All employees of the YES Bank shall continue as the employee of the reconstructed bank after the scheme of reconstruction with the same remuneration. There will not be any change in the terms of services w.r.t retirement, determination of office. However, Board of Directors of the reconstructed bank after following the due procedure can discontinue the service of Key Managerial Personnel (KMP).
• There will not be any change in the offices or branch network of reconstructed bank.
• YBL’s Basel III Additional Tier 1 (AT-I) Bonds of Rs. 8,415 crores have been written down.

Legal Analysis

Insolvency and Bankruptcy Code (IBC) V/s Reconstruction Scheme

The Bank and financial institutions are not covered by Insolvency Bankruptcy Code. So waterfall provisions as given under SEC 53 of IBC is to be applied and in most cases when financial creditors are not paid in full, shareholders equity, at least of the promoters is wiped out and reduced to nil and in all other equity shareholders are also compelled to lose major part of their equity, if not 100% as in the case Essar Steel Ltd.

Banks and financial institutions are in unique positions. Creditors and debtors both its customers. Their creditors are all unsecured and general public and corporate holding current accounts and savings accounts. Any bail out /resolution plan in a way it is done for all other industries, might not only not work but also lead the bank to collapse resulting in huge destruction of value for all the stakeholders and loss of confidence in the whole banking system. So going by the process of forming of i) Committee of Creditors, ii) announcing a moratorium on withdrawals, iii) getting Resolution/bailout plan approved by them and iv) finding the resolution applicant and minimum time of 270 days to reach there will be disastrous for the health of the bank and its customers. Leverage is almost ten times of its net worth as compared to around two to three times in any other industry. So even 5% of its assets going bad will cripple the bank severely and 10% of its assets going bad can bankrupt any bank. It has also large exposure inter se with other banking and financial institutions. So, its assets and liabilities components required it to be rescued either by large dose of capital infusion as in the case of public sector banks or merging the bank with some stronger bank.

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