This piece is part of Scroll.in’s Hard Times series, which seeks to simplify the Great Indian Slowdown for readers. You can find the rest of the pieces from the series here.

India’s fifth largest private bank has effectively been taken over by the state. On Thursday, the Reserve Bank of India, which regulates banking, put Yes Bank under a moratorium. It suspended its board, installed a new Chief Executive Officer and indicated that there was a path forward.

On Friday, the RBI announced a reconstruction plan for the bank, which would protect those who have deposits, but move a significant chunk of ownership over to another “investing bank”, expected to be the public-sector State Bank of India.

In the meantime, however, those who have deposits in the bank can only withdraw Rs 50,000 per month. And soon after this limit was announced, net banking as well as debit and credit cards stopped working, with knock-on effects for various digital banking services that depended on Yes Bank.

What’s going on?

What went wrong at Yes Bank?

There have been troubles at Yes Bank for years now. It is a relatively younger private bank, having received its licence and begun operations in 2004. It grew quickly, seeing its loan book in particular balloon over the last decade, growing to Rs 3 lakh crore. This growth meant that its stock was also a high flyer, trading at more than Rs 1,400 at one point. (Shares were split after that, and are likely to be diluted further after the reconstruction).

Yet after the death of one of its co-founders in 2008, there had been questions of the management under promoter Rana Kapoor. The bank often handed out loans to firms that were not able to get credit easily elsewhere, a strategy that allowed it to expand operations – but add on plenty of risk as well.

As the economy began faltering, these chickens came home to roost. Over the years Yes Bank had lent out to Cafe Coffee Day, CG Power, Jet Airways, DHFL and IL&FS, all companies or consortiums that have fallen apart and caused tremendous stress in India’s financial sector over the last few years. The Reserve Bank of India had repeatedly pulled up the bank for under-reporting its Non Performing Assets, which stood at 7.4% as of September 2019.

There were also many questions about the management, including conflicts of interest, which led to the RBI eventually refusing to permit an extension to Rana Kapoor as chief executive and managing director due to “highly irregular credit management practices, serious deficiencies in governance and a poor compliance culture”.

Over the last six months, a new CEO and a board that included an RBI appointee attempted to raise fresh capital from new investors, promising that the bank would be rescued first by a major technology firm (Microsoft) and then by an eccentric man who claimed to be Canada’s richest person, yet lived in a 3-star motel out in the countryside.

When it became clear that no genuine investors were likely to save the day, the RBI decided it had to step in before a major bank went bust, threatening the entire financial sector.

What happens next to the bank?

The Reserve Bank of India on Friday put out a draft reconstruction plan for Yes Bank. This would see an investor bank, with the RBI making it clear that this was likely to be the State Bank of India, buying up 49% of Yes Bank’s shares after reconstruction, at a price not less than Rs 10. That would mean SBI paying about Rs 11,760 crore for the purchase.

Existing shareholders will see their stocks severely diluted, such that they end up with just 11% of the shares, while the remaining 40% would presumably come from other institutions. Those who invested in additional tier 1 bonds issued by the banks – perpetual bonds that operate somewhat like shares with both a higher risk and a higher return – will see their money written down entirely.

On Thursday, several media organisations had reported that the Life Insurance Corporation may also be expected to put money into Yes Bank. The RBI said that all current employees would keep their jobs for at least a year, except for key managerial personnel who could be dismissed by the new board.

In effect, the new set up would see SBI – if it is confirmed as the “investor bank” – managing Yes Banks’s assets and liabilities, even though with just 49% shares, the bank will not be considered public sector.

What does that mean for those who have accounts?

Right away, deposit holders have to abide by the terms of the moratorium, which is in place for a month. That means that they cannot withdraw more than Rs 50,000 from the bank, unless they can prove a medical emergency or a planned educational expense, or a few other exceptions.

The Reserve Bank of India and SBI are expected to move quickly to put the reconstruction plan into place. In the past, this has meant that withdrawal limits have ended sooner than expected, and account holders have been able to withdraw or continue banking as before.

If this goes according to plan, account holders should not be too worried, beyond the limits imposed for this month.

What does it mean for the rest of the financial sector?

This is more complex.

First is the effect on digital banking. PhonePe, owned by Walmart, is one of the country’s biggest digital payments platforms. But it worked in partnership with Yes Bank. When the moratorium was put in place, PhonePe’s entire operations also came to a halt.

This had effects for many people, merchants and individuals, far beyond just Yes Bank’s customer base. Although PhonePe is working to restore services, the knock-on effect of the moratorium on its platform has raised questions about whether the RBI took into account the full impact of its moves.

Beyond the digital question, there is also the concern about India’s banking sector woes. Part of Yes Bank’s problems may be put down to mismanagement, but the Great Indian Slowdown also means that Non Performing Assets will remain a concern even for better-run banks.

Unlike a scandal that emerged in 2019 at the Punjab National Bank and the difficulties at the Punjab and Maharashtra Cooperative Bank – which also saw withdrawal limits imposed – the RBI cannot claim to have been taken by surprise by Yes Bank. It, in fact, was cognisant enough about problems that it insisted on an appointment on the bank’s board last year. Yet this was not enough to prevent the bank from needing a state rescue.

As Bloomberg’s Andy Mukherjee points out, “it was blindingly obvious even two months ago that the authorities needed to end this theater of the absurd and force SBI to get into the driver’s seat at Yes. It was the only way to stop a run on deposits that could easily become a contagion and knock the wind out of Indian finance. Yet the authorities dragged their feet.”

That SBI is able to take over the bank without depositors facing any problems should come as a relief. But it also raises questions about whether the public sector bank will be called in to rescue others, even as India’s economic slowdown might lead to more dire times for the financial sector. This is the real concern: RBI knew what was going on, yet took its time to fix the problem. What happens when the next crisis comes from out of the blue?

Also read:

Bad Apples: An illustrated guide to the Indian banking sector crisis