The "Diamond Share" & Corporate Governance

24th September 1599 marked start of a huge corporation called "East India Company" (EIC) to trade in South East Asia and India[1].  This company received Royal Charter on 31st December 1600 for trade.  Main motive of EIC is to maximise value / earnings to its shareholders.  This EIC achieved this mainly through ruthless means and slightest regard for corporate governance.  To achieve its objective of maximise earnings EIC maintained a huge army and seized power in India through bribes, wars, deceits, agreements, divide and rule strategy, puppet governments, ruthless implementation of tax laws and the like.  At one point in time 1/4th of Britain's income was generated by EIC and its shares were used as reserve currency, such was the power of this corporation.  Since 1750 there were quite a lot of pressure in Britain to reign in EIC but every time the company came out unscathed and none of its officers were convicted of any misdoing.  One who came close to be questioned was Warren Hastings but he too was acquitted after a 7 year trial. 

Let's now move to modern India and its corporates which are in line of fire for alleged scandals and corporate governance issue.  Listed below are an illustrative list.

1.    Satyam (2009)

2.    Saradha Group (2013)

3.    Ketan Praekh (2001)

4.    Speak Asia Scam (2011)

5.    Kingfisher (2014)

6.    Sahara (2010)

7.    PNB (2018)

8.    UTI (2008)

9.    Fortis Healthcare (2018)

10. Punjab and Maharashtra Cooperative Bank (2019)

11. IL&FS (2018)

Let me stop here as this list can go on.  What is common with the above list?  "Investigation is going on".  The persons allegedly involved in these scandals had very brief stints with law and now are free.  Reams of papers 'were prepared' 'are being prepared' and 'will be prepared' by investigating agencies (CBI, SFIO, IT etc) but still the result is unchanged "Investigation is going on".  When these investigations will end and when final orders will be passed is anyone's guess.

This brings in a similarity between centuries old EIC and modern business both of which work for maximizing their shareholder wealth with least regard to corporate governance and at the same time go scot free albeit some interventions by law enforcing agencies which never get conclusive.  We hear of multiple raids on corporates, politicians - how many of them finally ends up in conclusive court cases?  Yes there are arrests made then people are out on bail in a short period of time and nothing beyond this.   

This is what ails our system in India.  There is no definitive period in which investigations have to be completed there is no definitive period by which courts have to pronounce their judgements.  The case goes on as Robert Frost says "miles to go..". 

Let us move to the subject matter of this blog.  YES Bank - the "Diamond share". 

[2]Financial audited report of YES Bank for the financial year 2018-19 provided the below picture

  

[3]Q1, Q2 & Q3 results for 2019-20 provided the below picture

                                                                                    Rs. in crores

           

In 9 months’ time since publication of its results of March 2019 YES Bank had around 25% reduction in its Advances and Deposits.  There is significant increase in Gross NPA a whopping 486% and Net NPA which shot up a whopping 221%.   Gross NPA from an amount of Rs.7,882 crores in March 2019 increased to Rs.40,709 crores in December 2019.  This vitiates the estimate of Enforcement Directorate of around Rs.42,000 crores in NPA earlier in March 2020. 

Gross NPA - The jump of 486% in 9 months to Rs.40,709 crore!  What triggered this sudden spurt?  Did this happen all of a sudden now in 2 quarters as it is made up in the results?  Let us discuss below.

1.  When publishing its results for March 2016-17, YES bank revealed understatement of NPA by Rs.4,176 crores in the year 2015-16 (see below extract from 2016-17 financials). 

2.    The below note was added to the financials by YES bank to say action is being initiated to assure investors

3.  Within 6 months of publishing 2016-17 report wherein gross NPA was reported at Rs.2,018 crores as on 31.3.2017, Q2 report for 2017-18 was published and the following was reported which re-stated NPA to Rs.8,373 crores as on 31.3.2017.

4.    In short from the reported Rs.2,018 crores NPA was increased to a whopping Rs.8,373 crores, hence an under-reporting of Rs.6,355 crores of NPA in 2016-17 

5.    Now move to 2019.  NPA reported increased by a whopping Rs.32,827 crores or 486% in 9 months.  Unbelievable but true as per reporting of YES Bank. 

This systematic gross under-reporting of NPA (with multiple revisions on intervention by RBI) meant that all stake holders were shown an un-real picture while bank was going all out to lend to industries leading to deficiency in capital adequacy ratio.   Capital adequacy ratio which was at 16.3% on 30.9.2019 nosedived to 4.1% on 31.12.2019 (in 3 months monstrous fall)  breaching the norm set under Basel III forcing YES bank to seek additional capital infusion which did not materialise and hence re-structuring had to be done by Government using tax payers money and finances of a strong bank.  This nosedive was not sudden but due to systematic failure of the system perpetrated by undue growth of credit without adequate safeguards which ought to have been put in place.  This is not only to blame the system, but also the stakeholders who made it happen viz, management, credit rating agencies, auditors, government agencies who failed to spot the systematic rout at the inception stage and let it grow beyond proportions.  In short poor governance standards and its consequent divergence in NPA reporting brought about a big down fall of the bank.

In its report for Q2 2019-20 auditors had a clean unqualified report.  However in Q3 2019-20 (which was declared after moratorium was declared by RBI) there are a series of qualifications including doubt on “going concern concept” also (getting wiser after the event?).  The following are the main qualifications raised by auditors in Q3 report which relates to Uncertainty related to Going Concern due to

1. Q3 loss of Rs.18,560 crores and a total 9 month loss of Rs.19,046 crores
2. Decline in Banks deposit base
3. Increase in Non-Performing Asset (NPA)
4. Breach of mandatory Statutory Liquidity Ratio (SLR) & breach of mandatory Liquidity coverage Ratio (CLR) requirement – promoting a provision of Rs.86 crores in books of accounts toward penalty for this breach (wasteful expenditure)
5. Breach of mandated CET1 ratio which is at 0.6% in December 2019 as against mandated requirement of 7.375%

All the above 5 items did not surely happen in Q3 2019 but reported in Q3 2019 leading to serious doubts on corporate governance and reporting.

Turning to stock market, data on beta of YES Bank stock is as below, which shows the volatility it underwent and shocks it undertook.  It is expected beta will continue to be high as uncertainty still continues.

Conclusion

Corporate Governance is an important subject in classrooms and all major financial courses run a separate paper on this subject.  But when it comes to application of this a lot is let to be desired mainly due to greed of making a quick fortune.  Over the years scandals have been part and parcel of corporates and India has a very poor track record in bringing to book perpetrators of these scandals and giving them adequate punishments so that there will be a serious deterrent for others.  Our laws and safe-guarders of law which include investigators and courts should put in their 100% to ensure that the perpetrators of scandals do not go scot free after initial arrests and being in limelight for about 6 months and then go into oblivion.  We need to have fast track courts to investigate corporate frauds and conviction should be made within 1 or 2 years at the maximum.  This will bring in corporate governance and belief in system for investors who are the ones at the receiving end finally. 

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[1] Reference – Anarchy by William Dalrymple

[2] Audited Financial Report YES Bank 2018-19

[3] Audited / Unaudited Quarterly Financial results of YES Bank