Yes Bank: Too Big to Fail
Updated: Mar 8, 2020
The Reserve Bank of India (RBI) released a draft reconstruction plan for Yes Bank on Friday, in an attempt to rescue the bank that has been facing liquidity and solvency issues for quite some time now.
As per the plan, SBI has expressed an interest to invest in the bank. The plan said it would hold a 49 per cent stake in Yes Bank initially. This is not to be reduced to below 26 per cent before the completion of at least three years.
SBI said it would invest a total of Rs 2450 crores initially in exchange for a 49 per cent stake in Yes Bank.
Let’s discuss how we arrive at Rs 2450 crore in the first place.
The NSE website shows Yes Bank, as of 31st December 2019, had about 255 crore shares outstanding with a face value of Rs 2. This represents 100% of the share capital.

Now if SBI is to invest, it would be issued fresh equity, not allotted a part of the existing equity. That means to get 49% stake, SBI would have to be issued 245 crore new shares, taking the total equity share capital to 500 crore shares following the reconstruction.
How? Note that 49% of 500 crore shares comes to 245 crore shares. So, 255 crore shares initially plus 245 crore shares issued to SBI is equal to 500 crore shares.
The RBI plan also says that SBI must invest at a premium of Rs 8 per share on a face value of Rs 2.

Now, remember how a note by Macquarie stated that SBI should not pay more than a rupee per share of Yes Bank?
Here is part of the note:
Well, this makes sense.
As of this date, Yes Bank has not disclosed the third quarter (Oct-Dec 2019) results. But a look at the balance sheet corresponding to the September 2019 quarter shows that Yes Bank had net worth (or Reserves and Surplus) of about Rs 27000 crores.

In other words, this is what would remain after deducting all the liabilities from the bank’s assets.
But remember, this is assuming that the assets figure mentioned in the balance sheet remains as it is. For a bank, loans disbursed form a part of assets (on which the bank receives interest income) whereas deposits garnered or funds raised from other sources form a part of liabilities (on which the bank pays interest).
What if some debtors fail to pay the loan back? The asset side of the bank must reduce in that case, thus reducing the net worth (which is assets minus liabilities), isn’t it?
What the Macquarie report essentially says is the bank may not receive back a large part of the corporate loans it disbursed earlier (which are reported on the asset side of the bank). The amount of these loans could be greater than Rs 27000 crore, or the net worth figure.
What does this mean? It means the bank, after accounting for a large part of the corporate loans that may sour, would be worth zero. Unless it raises more funds from the market, it may not be able to pay back its liabilities (even after liquidating its assets). Since the bank is worthless, Macquarie said it doesn’t make sense for SBI to pay more than Rs 1 per share of Yes Bank.
But as mentioned earlier, the RBI’s plan requires SBI to invest funds at a price of Rs 10 per share. We do not know how the RBI arrived at this valuation. But assuming Rs 10 per share, SBI will have to invest 245 crore shares multiplied by Rs 10 per share, which is equal to Rs 2450 crore.
So far so good.
But is Rs 2450 crores enough for the bank?
Obviously not.
Remember, Yes Bank had tried to raise about $2 billion or Rs 15000 crore from the market earlier. Assuming it needs at least this much capital for both capital adequacy and growth, SBI may have to invest a larger amount within the following three years to maintain at least a 26% stake in Yes Bank – and 26% of Rs 15000 crore is Rs 3900 crore.
So SBI may have to invest at least Rs 1400 crore more.
Note that this is assuming that Yes Bank would require Rs 15000 crore of additional capital. If it requires more capital, then SBI would need to invest even more. The rest of the capital would have to be raised either from Qualified Institutional Placements or a rights issue or similar mechanism.
Will Yes Bank’s shares continue to be traded on exchanges or will they be delisted?
It is tough to say with certainty as of today. But if these do continue to be traded as usual, they would witness a massive dilution.
What do we mean by dilution? It simply means that every rupee of profits earned by Yes Bank in future would be divided amongst a larger share of investors compared to earlier.
As of December 2019, remember Yes Bank had 255 crore shares. So every rupee of profits was divided by 255 crore shares. Now, profits would have to be divided by 500 shares. This is a massive 49 per cent dilution. The arithmetic is as follows: (255 crore shares/500 crore shares) -1 = 49% dilution
This is not all. The RBI’s draft reconstruction plan also says that the authorized share capital is to be raised to 2400 crore shares. If the paid-up capital is eventually raised to this level, then it'd imply a massive 90 per cent dilution. In other words, every rupee of earnings would have to be divided amongst 2400 crore shares as against 255 crore shares at present. The arithmetic is as follows: (255 crore shares/2400 crore shares) -1 = approx. 90% dilution.
This should obviously come to weigh on the bank’s stock price, assuming they continue to be traded as earlier.
And finally, should SBI bail out Yes Bank in the first place?
From the perspective of minority shareholders of SBI, this is certainly negative. While the bank has assured investors that its capital adequacy, future plans or growth would not be impacted by this investment in Yes Bank, the relevant question is this: Where would SBI get funds to invest in the bank?
One answer is from the proceeds it received from IPO of SBI Cards, which are to the tune of approximately Rs 2800 crore. But it would also have to pay long-term capital gains tax on these proceeds, which is 10% of the total capital gains (not the total proceeds) above Rs 1 lakh.
So the final amount it received from SBI Cards would be lower than Rs 2800 crore. Still, these proceeds should suffice initially.
This is certainly negative for SBI’s minority shareholders since they would lose out on any profits that SBI “could” have earned had it used the proceeds to fund its own loan growth.
Secondly, this also sets a poor precedent. Would SBI similarly be forced to bail out other banks in the future? If yes, this would only encourage the problem of moral hazard –- in the sense that financial institutions would have lesser incentives to manage risks prudently or stay away from taking undue risks, in the expectation that SBI or LIC would eventually come to the rescue.