As from what is understood from the words of Matt Salmon, former US Representative, “Companies have the right to succeed, but they also should have the right to fail”
But what if they can affect the Whole economy?
Bailout is a term we use to describe the financial support that is extended to a company. It can be in different ways. Direct loans or guarantee of a third party or subsidies. Sometimes complete restructuring maybe required but that can effect the shareholders, creditors , management etc. There may not be dividend payments, management may have to undergo changes, cap on salaries for a stipulated time period, relaxation of rules that can impact accounts of the entity.Everything depends on the situation.
There are many instances when government has spend tax payer money to save out banks. But can India afford a bailout and that too in a situation like this where extraordinary decisions are the go to.
Bailouts around the world
The Great Depression in 2008 had created a lot of fuss in the worldwide economy. The concept of “Too Big To Fail” and Moral Hazard came to the foreplay as theorists and analysts started discussing the matter.
First major intervention of a government to bailout was for Bear Stearns case where the Fed created an SPV and lent it 28 billion $, and now JP Morgan owns Bear Stearns.
American International Group also called AIG now removed from list of systemic risk was given bailout worth $150 billion. But in Fannie mea and Freddy maer direct infusion of funds from the treasury was given and there was replacement of management, and a scale down on future operations
If we come to the continent of Europe, we can find that the rescue of NordLB, a German savings Bank was given a green light. Italy gave 1 billion$ to recapitalize MCC ,a state-owned bank. We can say that between October 2008 and December 2012 EU government has spent nearly 600 billion euros on recapitalizing banks.
Even before corona outbreak, domestic demand had fallen and bad debt posed risk to India’s economy. But Indian government is not far, for the past 3 decades, RBI has not allowed any commercial bank to fail, the previous track record of this second populous country is quite satisfactory when it comes to bailout. In 2002, the UTI Bailout was not only successful, it also gave the government a holding in other giants like LIT and ITC.
Yes Bank Case Study
The most recently talked about bailout was of Yes Bank which is one of the 3rd biggest private lender in the country. If you study the case of Yes Bank it is obvious that the fall was not sudden. During its peak of success, it started lending billions to companies, some clients were already under financial stress which was a huge problem. The ratings given by agencies like UBS, the under reporting of NPAs everything was a sign. As a result moratorium was imposed which led to bank run among depositors who were shocked. ED Rana Kapoor was also arrested for money laundering. That’s when government entered and decided to restructure the entity.
Under Banking Regulation Act,1949 sec 45 (4) the scheme of Yes Bank Ltd – Reconstruction Scheme 2020 was launched under which some important measures were:
SBI took 49percent stake
Investing banks were not allowed to reduce holding below 26 percent before the completion of 3 years
All employees were made to work at the same pay scale at least for 1 year.
AT1 bonds worth 10,800 crore was to be wiped out. This is the first ever case where AT1 bonds worth this much issued to investors were cancelled.
Emergency credit line of Rs 60,000 crore opened by RBI
The plan is perfectly stitched but we cant be sure how much perfect it would work and how difficult it could be for the bank to recover in the coming months as the pandemic is still looming around.
Pros and Cons of Bank Bailout
As we had talked about the “Too Big To Fail ”concept. We can say that it is better for the government to intervene in time so as to avoid the industry from crumbling or else it may lead to a complete collapse of financial system.
But bailing out banks are also something not to be taken as the best option as it encourages a moral hazard which allows not only promoters but also the stakeholders like customers to take higher than recommended risks in financial transaction. Entities start to count on bailouts when things go wrong which can be disastrous.
The question is whether bailout can be the top option in the current situation. We may need to think twice.
As the economy is reeling under the COVID 19 pandemic and with demand and growth going far down as it can be. India is struggling to stand on its feet while trying to rescue the drowning banks. Measures worth 8.1 lakh crore has been spent on the stimulus package Atmanirbhar Bharat. Do we have that much financial capability or funding to get banks out of trouble. Before taking a hasty decision we need to analyze whether it is worth the effort.
We cannot completely disapprove the concept of Government bailing out banking sector. In situations when confidence need to be instilled and excitement needs to be brought back in the minds of investors, Government needs to step in. After all, stabilizing the economy must be every government’s priority. When the Entity becomes someone Too Big To Fail, it becomes worth taking the risk.
Written By Mr. Gaurav Tripathi, Law Student at UPES, Dehradun.