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When & How Does A Bank Go Bankrupt

| Published on March 9, 2020

The Yes Bank’s recent moratorium by the Reserve Bank of India has left a lot of corporates in worry. This is not the first time such a scenario has been presented to a bank. It might seem that the rate at which these banks make money would help them in solving their issues especially at times of crisis by minting more money. However, that is not the case. A bank is proposed to become ‘insolvent’ or ‘bankrupt’ if it has a large number of debts that it cannot pay off. This can happen if the bank shells out too many loans to customers without assuring the tendency of the returns. This creates a situation for the bank where its assets cost way less than its liabilities.

In a regular scenario, a bank can fail in the following ways,

● Initially, the said bank is in a healthy position with more assets than liabilities. The shareholder equity is positive which leaves the bank solvent as it is.

● Banks grant loans to their customers. Some of these customers default on the loans which is not a problem to begin with as the banks can restore them by using the shareholder equity for a while. As more and more customers declare that they cannot pay back the loans or require more time to do so, the loans are written down and a new value is asserted for them which can also be declared as a ‘zero’ value.

● If it is confirmed that these loans would not be repaid at all, they get termed as ‘bad loans’ and are wiped out from the balance sheet altogether. This increases the liabilities in comparison to the assets leaving the bank in a crisis where even the sale of those assets does not recover the pending dues of the depositors.

Source

Yes Bank is the fifth largest private sector bank in India. In an unfortunate turn of events, the RBI took over the bank in the late hours of March 5th, 2020 and is going to withhold the same till 3rd April 2020. Customers with an account in Yes Bank can only withdraw up to Rs. 50,000 in a single month. In a similar fashion, the infamous Punjab National Bank scam of Rs. 11,400 crore involving Nirav Modi and Mehul Choksi was a major bust leaving this public sector bank in shambles. While the government supports large banks in times of distress, more often than not smaller banks are slowly cut off from the list.

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