The Banker Who Crushed His Diamonds

by Furquan Moharkan

  How successful this measure has been in curbing inflation in the country is questionable. In case of retail inflation, which the RBI uses to determine interest rates in the country, food amounts for 45.86 per cent of the weightage—the highest. And there are hardly any people who stand in queues at any bank’s loan counters to buy food from the market.

  However, this rise in the policy rates does lead to a hike in the lending rates—and mostly hits the corporate borrowers. In Rana’s case, it was more painful after he gained control of the bank. His business model was an utter failure with high interest rates at the macroeconomic level. Let me tell you why.

  One evening at his Samudra Mahal residence, which was formerly owned by Gwalior’s royal family, Rana met the owner of a famous shipping company that was going through a lot of stress. A large private lender was after the owner for repayment and time was running out for the company. The money involved was around Rs 3500 crore. As no one was willing to bail him out, the liquidation of the company was being talked about.

  But that was not to be the case, as Rana Kapoor was there to save the day. A well-wisher of the shipping company promoter told him that Kapoor, who was then at the helm of YES Bank, would be the only person willing to bail him out. The businessman could not reach the banker despite making many calls but then, a couple of days later, Kapoor’s office reached out to him. A dinner meeting was arranged at Samudra Mahal. For two hours the two men talked about everything but business. As the dinner progressed, Rana got down to it. ‘So, you need Rs 3.5 billion?’ he asked the shipping company promoter.

  What the promoter heard next was unbelievable. Rana was willing to extend a credit line worth Rs 5000 crore to him over the span of the next twelve years. Reluctantly, as he lacked options, he gave in to Rana’s offer. But like every other good thing you buy in life, this also came at a cost: He was supposed to pay 10 per cent of the amount upfront, which came to be approximately Rs 500 crore.

  Rana was known to be an extravagant person, someone who threw lavish parties for the borrowers. As his Samudra Mahal apartment seemed to be small to accommodate such a lifestyle, Rana coughed up Rs 1280 crore for an apartment block that sat on about 14,000 square feet, right next to Mukesh Ambani’s home Antilia. The plan was to demolish the structure and build a bungalow.

  Known among the industry captains as the lender of last resort—a moniker meant for the RBI—Rana had lent to every other defaulter on the street, many of whom became insolvent after the debt bomb exploded in 2019. According to ED officials, who are now investigating the bank and Rana, YES Bank had lent to entities like Reliance Anil Dhirubhai Ambani Group, Essel Group, DHFL, Jet Airways, Cox & Kings, CG Power, among others.

  Most of these companies had been under durable stress from quite some time, and Rana was willing to lend to them at 10 per cent upfront payment, which he was using to bulge his profits for the year the lending happened in.

  Despite the bank being a publicly listed entity, where regulators—the RBI and SEBI—have strict governance metrics, all of which went for a toss. ‘The bank was run as a one-man show,’ said an executive who worked closely with Rana over the years.

  While on one hand Rana was indulging in deep financial impropriety, many other executives, overtly and covertly, contributed to what came to be known as the India’s biggest banking mess. It is alleged that the accounting team never red-flagged the window dressing of the bank’s financials. But the bigger partner in crime was the team from the bank that was tasked with risk assessment. There is a famous joke about Rana Kapoor’s tenure at YES Bank, as explained by one of the bank’s executives: ‘There are two types of business models for banks in India—one is the HDFC Bank model, the other is the YES Bank model. In case of HDFC Bank, a risk team sets the metrics and the sales team gets the borrowers accordingly. In case of YES Bank, the sales team gets the exposure and then the risk team adjusts the metrics accordingly.’

  The role of the risk team doesn’t end here. Despite exposure to a gamut of bankrupt and near-bankrupt entities, YES Bank, under Rana Kapoor, was showing profit in every quarter. How were they managing it? The answer lies in evergreening, a ploy to mask loan defaults by giving new loans to help delinquent borrowers repay or pay interest on old loans. Apart from Rana, suspicion also fell on a very senior executive from the risk team, who still holds the same position. ‘Initially, he (the risk team executive) was reluctant. Then he used to sit in Rana’s cabin every other day and evergreen the loan,’ an executive who is still serving in the bank once told me.

  How was this syndicate working? There were, allegedly, at least three senior executives, including Rana Kapoor, who were trying to adjust the risk metrics of the bank, according to former employees of YES Bank. One executive was from the banking side and another from the risk team. One of the two executives left YES Bank just a month after Rana Kapoor’s exit. The other executive is still working at YES Bank and had access to the board even after Rana Kapoor’s exit. He was recently shifted from the coveted post he held after State Bank of India (SBI) took charge of the bank.

  While their transactions might be shady, like Rana Kapoor these people too enjoyed their work and were workaholics. ‘He used to be more of a doer. He didn’t have that chalta hai attitude,’ a friend of mine who worked with one of these two executives later revealed. They were decision makers and were supported by a man whose focus was data analysis. The position that was given to this executive was way above his experience level. He used to help them with manipulating the underwriting process at the ledger level, one source told me.

  Underwriting is the process that banks and other financial institutions use to assess the creditworthiness or risk of a potential borrower. During this stage of the loan process, the underwriter checks the borrower’s ability to repay the loan based on an analysis of their credit history, collateral and capacity.

  What he essentially used to do is manipulate the expected cash flows on the basis of projecting high prospective growth from the ledger details. ‘They knew it was difficult to scrutinize the ledger details of the borrowers. Everyone would check it only on the surface level,’ a person who knew about this cabal closely told me. These allegations of evergreening became more obvious with the Mackstar fiasco in 2019.

  According to the offshore investor Ocean Deity Investment Holdings—an erstwhile arm of DE Shaw and the 78 per cent-owner in Mackstar, the Indian joint venture (JV) where HDIL entities hold minority stake—the loans from YES Bank to the JV were not authorized by the majority shareholder. It is alleged that the money was transferred to bank accounts of other HDIL group companies, almost simultaneously, to repay loans taken by them from YES Bank. HDIL, owned by the Wadhawan brothers, was also allegedly involved in the PMC Bank scam.7

  Another case in point here is an exposure to an infrastructure company, with interests in the cement business as well, based in north India. The company, which was already in stress by 2015, was a borrower with YES bank and had an overdraft facility in the bank. An overdraft helps to restore the cycle of rotation of the influx and out-flux of money runway. In late 2015, the company asked for more funds to the tune of Rs 1900 crore. But the money flow in the overdraft account had stopped by then. There was also a friendly non-banking financial company, which was allegedly getting huge sums of funds from YES Bank at cheap rates. Rana Kapoor also wielded a huge influence on the promoters of one of the small finance banks. Both these entities were asked to give short-term loans to the infrastructure company, so that it could put that money in the overdraft facility. The loan process started and was cleared in the hope that there would be a binding agreement to buy out a certain portion of the cement assets by a leading corporate house based in Mumbai. The upfront fee taken for this loan was 15 per cent, or Rs 280 crore, which was shown as the profit for the period. Later on, this infrastructure company went bankrupt. In fact, in 2019, YES Bank, under its new management, also filed a petition against one of the subsidiaries for bankruptcy.

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p; This lending was happening at a time when a global brokerage house, UBS, had come out with a report critical of YES Bank. The report, which was published on 7 July 2015 and sent to UBS’s clients, said that YES Bank lent almost 125 per cent of its own net worth to stressed companies. While downgrading YES Bank shares to a sell rating with a lower price target of Rs 740.00 (Rs 1000 previously), UBS had said:

  Private sector banks are trading at an 18 per cent premium to five-year P/one-year forward BV given higher growth premiums and better asset quality. While earnings visibility is higher for private sector banks, we believe some of these banks are more vulnerable to a de-rating if asset quality surprises negatively.

  YES has reported strong asset quality so far, with its impaired loans ratio the lowest among its peers at 1.2 per cent. However, according to our study, it is most vulnerable to a large corporate default. Estimated loans to potentially stressed companies (our sample) recorded a 60 per cent CAGR over FY12-15E and would be 125 per cent of the net worth for YES Bank. We believe consensus is not factoring in a sharp increase in credit costs for YES. We downgrade YES from Buy to Sell, with a lower price target of Rs 740.00 as we raise our credit cost assumptions by 34–41bp and cut our FY16/FY17 earnings estimates by 15 per cent/16 per cent.

  For the banks under our coverage, we cut our FY16-17 earnings estimates by 0–16 per cent as we raise our credit cost estimates by 0–40bp and cut our loan growth forecasts by 0–2 per cent. Consequently, we lower our average valuation per share for the banks under our coverage by 0–15 per cent.

  Interestingly, I was working with UBS back then as an investment banker. At Verity Knowledge Solutions, a UBS-affiliate in India, I was part of the financial institutions group team—a group of investment bankers working at the backend of the compiling and analysing information about the banks, asset managers, fintech companies and insurance companies. Though I usually used to work on US asset managers and British insurance companies, I had worked extensively on Indian banks as well. Though I can’t recollect working on this report, since those were my last days at Verity-UBS (I left investment banking on 24 August 2015), I do remember that I used to work extensively on comparable Indian banks. Probably some part of that work led to this report, though this is conjecture. Rana Kapoor, who was obsessed with his image, went and complained to SEBI, accusing UBS of alleged bias. His reaction shocked Indian markets.

  The report further said that 23 per cent of the bank’s loans were backed by unlisted shares of the borrowers. There is an extract about it in the report: ‘In our sample set, SOE banks and Axis have a high share of loans backed by immovable property (around 35 per cent), while YES Bank had the highest share of loans backed by unlisted shares and current assets (23 per cent). [As much as] 10–20 per cent of loan approvals were granted on subservient charges by YES, ICICI and Axis.’ The bank’s tussle with UBS didn’t end here. In June 2018, YES Bank, in an email, asked UBS to drop coverage of the bank following a 21 May UBS research report on eight Indian banks for its clients, which claimed that YES Bank had the highest credit exposure to the troubled power sector.

  Back at the bank, the relentless lending continued. One such case were loans to DHFL. YES Bank’s dealing with DHFL during Kapoor’s tenure has now come under severe scrutiny of the ED. The ED had found out that DHFL had sanctioned a loan of Rs 600 crore to a firm controlled by Rana Kapoor’s family, at a time when DHFL had failed to repay its dues to YES Bank. The debt exposure of DHFL in terms of short-term debentures between April and July 2018 was Rs 3700 crore. YES Bank also gave a loan of Rs 750 crore to RKW Developers, which is under the scanner for financing underworld kingpin Dawood Ibrahim’s aide Iqbal Mirchi who purchased properties in south Mumbai.

  One of the biggest borrowers for YES Bank, and the biggest defaulter, has been Anil Ambani and his company. Most of this lending happened after 2013. To understand the significance of this, it is important that we delve a little into Anil Ambani’s past.

  In the past decade, two political controversies rocked the country—the 2G scam and the Rafale scam. The common link in both these scams was Anil Ambani’s alleged involvement. One market adviser handling Anil Ambani’s assets, who has been working closely with Anil for years, told me on the condition of anonymity that after his involvement in the 2G affair, Anil saw his credit lines crunched. ‘Because of the 2G scam, banks stopped funding him in 2011–12. That was the first thing that went wrong for him,’ he said. Yet another senior executive who has worked very closely with Anil alleged that he lacks the patience and endurance required in running a business.

  Take the example of the Delhi Metro: On 23 January 2008, the Delhi Metro Rail Corporation Limited (DMRC) awarded a thirty-year build-operate-transfer PPP contract to the Reliance Energy–CAF consortium. It was built at a cost of Rs 5700 crore, of which Reliance Infrastructure paid Rs 2885 crore ($580m). Five years later, on 27 June 2013, Reliance Infrastructure communicated to DMRC that they were unable to operate the line beyond 30 June 2013. Following this, the DMRC took over operations of the Airport Express line from 1 July 2013 with an operations and maintenance team of 100 officials. The tale of the Yamuna Expressway, which Reliance Infrastructure exited prematurely in 2019, is no different.

  Despite Anil’s craving for quick money and his resultant impatience, there was one bank that was always ready to lend money to him—Rana’s YES Bank. But, in a very peculiar way, Reliance Nippon Asset Management (RNAM)—a mutual fund joint venture between ADAG and Nippon—had given credit in hundreds of crores to Morgan Credits Private Limited, a company controlled by Rana’s family members and a part of the promoter group at YES Bank. Another time this deal raised eyebrows was when, immediately after Anil Ambani’s Reliance exited from RNAM, by selling the stake, RNAM started shares of YES Bank pledged by Morgan Credits. The official stance of RNAM was that it was a margin call—a decision to sell the pledged asset after its value has dropped below a particular market price. However, analysts on Dalal Street say that there is more to the deal than what meets the eye.

  Finance Minister Nirmala Sitharaman made a lot of noise after the bank collapsed on 5 March 2020. Many of her arguments at the presser the following day were partial truths or blatant lies, which we will decipher in a later chapter, but here let’s focus on her claims on advances. Quite contrary to her claim, the problem at YES Bank was never a legacy. During the tenure of the Prime Minister Narendra Modi-led National Democratic Alliance government, YES Bank’s advance book showed an average incremental surge of 38.3 per cent till Rana left, one and a half times more than the average incremental growth under the Manmohan Singh-led United Progressive Alliance-II government.

  But let’s be fair. It was a private bank and there is little you can blame the government for in case of mis-governance. The gross lack of regulation is a factor which will be dwelled upon later in this book.

  A look at the numbers reveals a rot which would need a larger investigation. The RBI data reveals that the gross domestic savings and gross capital formation (GCF), or investment, reached a new low of 30.3 per cent and 29.1 per cent of the GDP in FY17, from a high of 34.6 per cent and 36.7 per cent, respectively, in FY12. Such was the reckless lending by YES Bank that its credit growth in calendar year 2017 outpaced that of the banking industry by an unbelievable 36 percentage points, which should have led to alarm bells ringing in the RBI.

  In fact, former Finance Minister of India, P. Chidambaram was the first one to point out this discrepancy, which led to a political furore by the ruling Bharatiya Janata Party (BJP) after the fall of YES Bank. ‘I was among the first to point this out when people were rushing to defend YES Bank. I am amazed that neither the Department of Banking in the Ministry of Finance nor the RBI noticed the obvious anomaly. The difference between the industry-wide growth rate and YES Bank’s growth rate was too large to be considered “good performance” by YES Bank. It was an obvious case of reckless lending. The authorities failed in their duty,’ Chidambaram said.

  If the RB
I was unable to sniff out this level of discrepancy in the numbers of the entity regulated by them, we can draw two conclusions: either it was complacent or it had no clue about what was happening right under its nose. With all these discrepancies building up against Rana Kapoor, what finally triggered the RBI into action?

  All this lending was done at a time when investment as part of the country’s gross domestic product was diminishing over the years. Driven primarily by wholesale lending, there was a valid question that needed to be asked: Who is the bank lending to if investments were falling? Well, the answer was simple. It was lending to stressed entities to help them pay off debts to other banks, and then evergreening their exposure by further lending. This led to a vicious chain which ultimately led to an unrealistic loan growth in the books of the bank. Such was the magnitude that, on an average, from 2014 to 2018, the bank’s credit grew at an average 28.1 percentage points more than that of the sector every year.

  In hindsight, the government could have swooped on in YES Bank back then, but it didn’t. This, in turn, indicates towards policy paralysis and the callous attitude of the government.

  On his part, Rana Kapoor was betting disproportionately on real estate. By the time he left the bank, the total exposure to real estate and its closely related sectors was over 10 per cent, which included the exposure to housing finance companies. Rana Kapoor was banking on the fact that the slowdown won’t prolong much, and that things would be normal for him as the housing market would clear its unsold inventory. On these grounds, he was hoping the discrepancies would never surface. This meant that he was committing a fraud over uncertain speculations.

  The other factor that would have led Rana to do this, according to insiders, is the confluence of certain factors—precedence, over-confidence and subject matter knowledge. Rana was a man who had manipulated most people in his life—this is a grudge many people who have known him hold. Rana knew this, according to these people as well as his co-workers. He was good at collections (collecting repayments), as we saw from his stint at Rabo India Finance.