Why did Yes Bank suffer in India?

Yes Bank is all over the news now.

What’s happening and how did we get here?

For that, let’s understand how banks actually work.

You keep your money in banks. But the bank doesn’t really charge you anything for it. Given the services they offer - ATM, net banking, so many branches, and so on - it is surprising they don’t charge you.

In fact, in a savings bank account, you actually get around 3.5% interest.

How is this happening?

Banks make money by giving out loans. And the money for these loans is basically depositor’s money - your money.

This is why loan rates are always higher than FD rates. They earn money by using your money.

So what happens if you go to the bank and ask for all your money? They will give it to you without an issue.

But if everybody asks for all their money back, the banks will not be able to - because that money has been loaned out!

Banks work on this assumption that not everybody will want to withdraw all their money at the same time.

The trick with loans is if you are willing to take the risk (give loans to those who are less likely to pay back) you can earn higher interests.

This is a very tough balance.

If you give loans to riskier people, you can make higher profits. If those risky people are unable to pay back, the bank loses the money.

If a large number of loan takers refuse to pay back, the bank is in trouble. It is the depositor's money after all that the bank is giving out as loans.

Like other banks, Yes Bank too had given out loans.

And it seems like they gave too many loans to those who wouldn’t pay back.

Trouble started brewing when RBI started to smell bad loans in Yes Bank. RBI grew cautious. They wanted a change in management.

They basically wanted the bank’s founder Rana Kapoor to resign and replace himself with someone else.

It is believed that RBI felt Rana Kapoor was giving out too many risky loans.

After a lot of prodding, they managed to do just that.

The new management with Ravneet Gill as CEO, inherited along with the bank, its bad loans.

One way out of dealing with the bad loans was to raise enough money to fund its daily running. And over time, the management would clean out the bad loans.

Now, why would any investor give Yes Bank loads of money to run operations?

Because they would believe that the bank would manage to wriggle out of this mess and become profitable. And because they would have invested in the company, they would make money out of it.

Yes Bank’s attempts at raising money were unsuccessful.

This is probably an indication of how poor the loans of the bank were. Investors looked at the bank and stayed away from it.

Finally, once the operational cash was running out, RBI decided that it had had enough.

It decided to merge the bank with SBI.

Now, when this news hits, depositors (people who have bank accounts in Yes Bank) would feel scared. So they would rush to take out all their money.

When this happens, the bank ends up exactly where it never hopes to be - everyone wants their money back.

So to deal with this, RBI imposed a moratorium. Nobody can take out more than Rs 50,000 for around a month.

A lot of fintech companies depended on Yes Bank's infrastructure. The moment this news broke out, the bank’s share cracked big time. In moments, the price went from around Rs 37 down all the way to Rs 9.

Countless investors who were hoping the bank would turn around lost money.

Still, the share price is around Rs 16 at the end of the trading day.

What is making it stick there? Clearly some investors are still hoping to see a turn around of some kind.

By the time the moratorium is lifted, RBI hopes to merge the bank with SBI, which will allow Yes Bank to dilute its bad loans.

Till early Friday, depositors were worried they would lose some of their savings.

Fortunately, it seems everybody will get all their money back.

RBI has put out a scheme for the reconstruction of the bank. And it seems likely depositors will not lose any money.

Has this happened before?

Yes. Once, in 2004.

The bank’s name was Global Trust Bank. It was also amalgamated with another bank and the amalgamation happened in around 14 days.

In the case of Yes Bank, it is believed the moratorium will be lifted much before the ~30 day period.

Let’s hope the depositors get access to all of their money as soon as possible. :)

[Source: Groww Digest.]