Yes Bank’s crisis puts India on warning

India’s fragile financial system is swinging between despair and hope. Two separate incidents — both featuring the lender YES Bank recently underscored the drag of past underwriting follies as well as the lift from a digital reset. It will take time, but good things will come to Indian banking as a result of the present crisis.

Start with the sudden default by financier Altico Capital India on a Rs 19.97 crore ($2.8-million) interest payment to Dubai-based Mashreqbank PSC. Clearwater Capital Partners-backed Altico, which borrows money from banks and mutual funds to make loans to property developers, called the situation a “liquidity crisis.” And that made YES Bank investors gloomy.

Based on January data, the midsize Indian bank had a Rs 450 crore exposure to Altico, the third-highest after Mashreq and HDFC Bank Ltd. While HDFC Bank, the country’s most valuable lender, has the capital — and current profit — to take the occasional credit hit, YES’s capital cushion is already frayed by dodgy loans to beleaguered shadow banks and troubled tycoons. Both these borrower groups have found it hard to refinance debt since the collapse last year of IL&FS Group, a large Indian infrastructure financier and operator. Altico’s unravelling shows that an end to credit woes is not yet in sight.

At more than $200 billion, the pile of bad loans is bigger than Italy’s. State-run banks are carrying the bulk of the burden, but at least they’re getting dollops of taxpayers’ money and being merged into fewer banking groups. A private-sector lender like YES doesn’t have a formal public backstop. If it can’t fend for itself, the central bank could step in and force an arranged match with a better-run bank. The terms won’t be favourable to shareholders.

To avoid such a fate, YES needs to raise growth capital by convincing new investors that the worst is over. And that brings us to the week’s other big incident. YES shares jumped 13.5% after reports that One97 Communications, which owns the Indian digital payments network Paytm, may buy out a 9.6% stake in YES from Rana Kapoor, the lender’s co-founder. Kapoor was forced to step down as CEO early this year by the Reserve Bank of India amid controversy over bad-debt accounting.

New CEO Ravneet Gill, brought in to clean up the mess, told Reuters last week that YES was looking to sell a minority stake to “one of the world’s top three technology companies that had not previously invested in a bank.”

Investors pushed the stock higher despite their many misgivings. Only two years ago, YES had a high price-to-book multiple and an even bigger price-to-truth ratio, a term I’d coined to describe shareholders’ refusal to question the subterfuge at India’s private-sector banks. Although the banking regulator had found bad loans to be four times what YES had disclosed in audited results, very few analysts believed something could go seriously wrong given Kapoor’s substantial stake — his skin in the game.

That was then. Now, YES is a battered lender gasping for capital. Despite the many regulatory hurdles on the way to a possible alignment with Paytm, which the latter hasn’t confirmed, a deal could help the bank break free of its checkered past — and reemerge as a digital lender.

If Paytm can monetize the data of its 350 million mobile wallet users by giving them point-of-sale loans using the balance sheet of a bank — whether YES or someone else — the payment firm will get a second wind. Paytm founder Vijay Shekhar Sharma had an early advantage as mobile payments pioneer, but PhonePe and Google Pay are giving him stiff competition. Paytm’s losses are ballooning and it’s becoming evident that without old-fashioned lending, there may be no other path to profitability for a pure payments business. Mukesh Ambani, plans to use his rapidly growing Jio to offer customers discounts and vouchers that would be honoured even by neighbourhood stores. But for extending point-of-sale credit, Ambani would also need to borrow the balance sheet of a bank.

For YES, point-of-sale financing could be a growth avenue at a time when the turmoil in India’s formal and shadow banking sectors refuses to end. It’s put the brakes on what authorities were until recently claiming to be the world’s fastest-growing major economy.

But alongside the despair, hope is building for a new model led by supply-chain credit, asset securitization, digital lending, and joint underwriting by finance companies (which know their borrowers) and banks (which have stable deposits).

The tug of war between the past and the future of banking in India is getting interesting. What happens to YES could be a gauge of which way the balance of power is shifting.