Yes Bank Crisis: RBI’s Trysts With Large Private Bank Failures
Each occasion that large private banks have gotten into trouble has opened a can of worms for the regulator, writes Amol Agrawal.
In the late hours of March 5, 2020, the Reserve Bank of India placed Yes Bank under a moratorium till April 3. This comes as the latest instance of a long and troubled history of large private banks failing in India, and the RBI having to step in to deal with them.
Travancore National And Quilon Bank – 1938
The failure of Travancore National and Quilon Bank in 1938 was the first such instance. The TNQ Bank was the result of a 1937 merger between Travancore National Bank (1912) and Quilon Bank (1919). The RBI itself had started functioning in 1935, and the failure was a unique problem for not just the newly-merged bank, but also the nascent central bank. The merger had been hailed as the largest in south-Indian banking history and made it the fourth largest bank in India.
The pride of south India became its worst nightmare in merely a year.
The TNQ Bank suspended payments on June 21, 1938, and was liquidated in August. The promoters of the bank – KC Mammen Mapillai and CP Mathen – were sent to jail and liquidation proceedings ran for 17 years with the bank being finally dissolved in 1955.
The reasons for this failure were a deadly cocktail of politics, economics, and communal problems. The powerful dewan of Travancore state – CP Ramaswami Iyer – had once supported the merged bank but soon became its foremost detractor. The logo of TNQ Bank resembled the emblem of the state and despite repeated attempts, the promoters refused to change the logo. TNQ Bank was also accused of rallying behind political and religious movements in Kerala, earning the ire of the dewan. Iyer forced a run on the bank by distributing pamphlets in the Madras and Mylapore regions, which claimed that TNQ Bank was run by thieves and plunders.
Apart from politics, the bank also had unstable finances. In just six months following the merger, TNQ Bank expanded in an unprecedented manner. This unsustainable growth made it easier for the dewan to push a bank run. TNQ Bank reached out to the RBI for support and the central bank conditioned its help on the state of the balance sheet. TNQ Bank wanted immediate help which RBI could not provide. Later investigations showed that the balance sheet of the bank was off, the bank was buying its own shares to increase market value, all the realisable securities had been realised by April-May 1938, the directors had taken heavy loans, etc. This story is common to most failed banks.
The RBI’s actions were heavily criticised as it was not able to provide timely assistance. The RBI defended its stance arguing that the central bank could only provide help if the bank furnished information about its financials and in the case of TNQ Bank, the promoters were reluctant to share that.
The central bank learned a major lesson. It needed more powers to obtain information and exercise control and supervision over the affairs of banks.
Then RBI Governor James Taylor prepared the proposed Banking Regulation Act by 1939 itself but its passage was delayed for a decade due to World War II and India’s independence. The act finally came into being in 1949.
Crises In Bengal-Based Banks (1947-50)
The years just before India’s independence were a tricky period for banks in the Bengal region. Volume-II of the RBI History documents show that there were around 850-900 small banks in the region. Most of them were classified as ‘loan offices’ which hardly followed any banking principles. However, they had mobilised deposits making them prone to a run once depositors discovered poor management, which is exactly what happened. The Bengal government dithered and even suspended RBI inspections of banks based in the region. This compounded the problem which spiraled after Partition.
Of these, Nath Bank was a major Calcutta-based bank and failed in May 1950. Given the large-scale failures and complicated liquidation proceedings, the government agreed to an experiment of giving the RBI the role of a liquidator for large banks having deposits of Rs 5 crore. But even as RBI became a liquidator for Nath Bank, the latter already owed emergency funds to the former, creating a conflict for the RBI being the liquidator as well as a creditor. This brought the experiment to an end, as the RBI would, in most cases, have extended such emergency funding, leading to conflicts in all cases.
United Bank of India was an outcome of the merger of four small banks in Bengal: Comilla Banking Corporation, Bengal Central Bank, Comilla Union Bank, and Hooghly Bank. All four banks suffered a run following the failure of Nath Bank.
Palai Central Bank – 1960
In the period from 1951 to 1960, around 315 more banks failed. Of these, Palai Central Bank’s failure in 1960 was the most significant. PCB, like TNQ Bank, was established in the state of Travancore, in 1927, and was managed by K Joseph Augusti from 1931. Palai Central Bank grew into a fairly large bank from small origins and was included in RBI’s Second Schedule in 1937.
RBI had learned of Palai Central Bank’s troubles as early as 1948 but could not act as the banking law did not apply to princely states.
The first RBI inspection in 1951—as the Banking Regulation Act was enforced and applied across the country—showed familiar loopholes: loans to directors and their families, a generous dividend, loss-making branches and so on. The RBI cautioned the bank but the advisory was ignored. In a seeming error of judgment, the RBI chose not to take stiff action against the bank thinking it will improve its practices, but this decision eventually created a bigger crisis.
Instead, the RBI decided to appoint an administrator (just like Yes Bank) to oversee developments. The PCB management opposed this tooth-and-nail as PCB was based in a small town and the word would spread quickly leading to an eventual run on the bank. To address this concern, the RBI agreed to deploy the observer at Kottayam, which was 27 kilometres from Palai’s headquarters. PCB’s management dissented again, and instead appointed a former officer of Imperial Bank.
The RBI inspection in 1955 showed no improvement as PCB was losing both capital and deposits. The inspection also made a case for the exclusion of PCB from RBI’s Second Schedule but doing so would lead to problems for other banks in the region.
In subsequent communication, the RBI asked for the removal of Augusti which was opposed, for the fear that it would ‘spread mistrust’. By 1958, it became clear to the RBI that PCB’s performance should result in a denial of its banking licence, but this drastic step too was not taken. The PCB management kept ignoring the RBI’s directions and instead argued that they had made progress since the first inspection report despite all evidence arguing just the opposite. So much so, they objected to the RBI’s direction for not declaring dividends.
In a turn of events in 1959, the RBI allowed PCB to open a new deposit scheme. The central bank didn’t ask PCB to stop raising fresh deposits but made it difficult to do so, by asking PCB to stop advertising, not allowing it to open new branches and so on. The 1960 inspection showed that of total loans worth Rs 5.28 crore, only Rs 2.21 crore was recoverable and the remaining doubtful and sticky. The bank was in deep losses leading to a run on the bank in June 1960, which reached other south Indian banks as was feared.
This was followed by a much-criticised liquidation that was announced on Aug. 8, 1960. The liquidation process was messy and took 27 years and the liquidator was unable to recover any part of the Rs 2.88 crore liability towards directors and auditors of the bank.
Some said the RBI acted too late, others questioned liquidation, and some others said the RBI should have warned before pushing the liquidation button.
The then Finance Minister Morarji Desai defended the RBI in Parliament but questioned then RBI Governor HVR Iyengar over the decision. Prime Minister Jawaharlal Nehru also conveyed that perhaps saving the bank would have been a better decision. The RBI governor defended the central bank’s actions, saying that liquidation was the only option as several chances had been given to the bank.
After the Palai Central Bank episode, the RBI began to prefer the merger route to failed banks, which has been detailed in an earlier column. The RBI was also aided by the enactment of deposit insurance in 1961 which provided more comfort to depositors.
After the criticism it received for Palai Central Bank, the RBI worked out an intermediate route for the resolution of failed banks. It would first place the failed bank under a moratorium for a period to prevent the bank run and conserve its assets. Second, it would merge or amalgamate the failed bank with a suitable large and stable bank. This proposal was enacted as Section 45 of the Banking Regulation Act in just a month after the failure of PCB. The RBI even tried to use this new power to amalgamate PCB with Punjab National Bank but the court ruled it out as it would hurt depositors. The enactment of deposit insurance in 1961 also provided comfort to depositors.
Global Trust Bank – 2004
Global Trust Bank was a new private bank, licenced in 1994 and got into trouble in a mere 10 years. The situation was resolved via moratorium and subsequent merger and is relevant to the Yes Bank case.
On July 24, 2004, the RBI placed GTB under a moratorium period till Oct. 23, 2004. The RBI permitted depositors to withdraw up to Rs 10,000. By July 26, 2004, RBI had worked out the amalgamation of GTB with the Oriental Bank of Commerce. Under the scheme, the entire amount of the paid-up capital and reserves of the transferee bank—that is GTB—would be treated as provisions for bad and doubtful debts and depreciation in other assets of the transferor bank, OBC. All the depositor accounts of GTB were moved to OBC. The employees of GTB would continue to work as employees of OBC. The scheme was approved by the government in quick time and GTB was merged with OBC on Aug. 14, 2004.
RBI’s Conundrum
On each occasion that large private banks have gotten into trouble, it has opened a can of worms for the regulator. It is never clear whether, and when, the regulator should act and try to prevent the crisis. If the regulator chooses not to save the bank, it faces sanction from the public. If it chooses to save the bank, there are questions of moral hazard and timing. The Yes Bank case once again raises the demand for instituting a resolution and liquidation authority for financial entities.
In a speech after the Palai Central Bank crisis, then RBI Governor Iyengar said in a speech: “The Reserve Bank’s powers are not ... a substitute for the efficiency and integrity of the managements themselves ... In the final resort, if a management does not listen to advice and chooses to be recalcitrant and it is felt that continued pressure would be useless, the Reserve Bank would have no option but to close down [the bank] in the interests of the depositors. But this decision involves a delicate balancing of several factors, some of them operational, some psychological.”
Sixty years later, RBI Governor Shaktikanta Das echoed the same sentiment in an interview with BloombergQuint. India’s banking history has rhymed, over decades.
Amol Agrawal is a faculty member at Ahmedabad University. He has a PhD in Indian Banking History and writes the Mostly Economics blog.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.