The IndusInd Bank share crash holds many lessons: Most of all for RBI

The fact that the banking sector’s regulator, the Reserve Bank of India (RBI), chose to approve only a one-year extension for the bank’s CEO, rather than the three years sought by its board, and that too without explaining why, did not help matters. 

Also Read: Mint Explainer: How IndusInd Bank slipped up on foreign currency hedging

Fortunately for IndusInd Bank and for our banking system at large, the panic was contained to the stock market and the bank’s investors. Its depositors did not react in the same knee-jerk fashion. So, even as IndusInd’s stock fell 27% to close at ₹656 on 11 March, erasing about ₹19,000 crore of its market capitalization, there was no run on the bank. 

Clearly, investor trust, which rides on the credibility that a lender commands in capital markets, has proven more fickle than depositor trust. Part of the reason for this is that investors have no backstop. They have no choice but to take a hit when share prices fall, while depositors count on RBI to ensure their deposits are safe.

Given how closely banks are interlinked, we should be thankful that there seems no sign of any systemic risk to the banking system and financial stability is not at threat. Yet, the IndusInd stunner is a wake-up call on several fronts. 

Also Read: IndusInd Bank promoter Ashok Hinduja backs MD, says balance sheet remains strong

First, banks need to improve internal controls. Second, RBI must improve the quality of its inspections. And third, the regulator must assure us both greater transparency and prompt action. At the very least, RBI should have issued a statement on why it had approved only a truncated term for the bank’s CEO and reassured depositors that their money is safe. Fourth, we need to reinforce the accountability of bank auditors. And, last but not least, we must insist that promoters walk their talk. 

Ashok Hinduja, chairman of IndusInd International Holdings, told Mint that the bank’s investors have his “full support.” To back this up, he’d be well advised to bring in fresh equity to make good the loss and restore the bank’s net worth. 

The suspect transactions, as reported, go back many years and came to light as a result of an internal probe. Rather than directly hedging its foreign currency borrowings and deposits with external counterparties, the bank apparently used its internal desk to create a hedge—in blatant violation of RBI guidelines.

It is not clear how or why these escaped the gimlet eye of RBI inspectors. The regulator has long cautioned both merchants and banks against the risks of unhedged foreign-exchange exposures. 

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In the past, the relative stability of the rupee against the dollar lulled many market participants into leaving their forex exposure unhedged. But all that changed with the ascent of Donald Trump to power in the US. 

RBI is now trying to assess whether such irregularities afflict only IndusInd Bank or are symptomatic of a broader malaise in Indian banking. It has asked many large banks to provide details of their foreign currency liabilities (including foreign-currency non-resident deposits and forex-denominated bonds), clarify whether their risk is hedged and verify the effectiveness of hedges as well as their positions in the market for forex derivatives. 

Hopefully, we have no further unpleasant surprises in store. And the lessons of this episode will not be forgotten.