IndusInd Bank’s black box moment: What investors must decode before buying the stock

Investing, like flying, is all about managing risk. And when things go wrong, the way an industry responds determines its long-term safety.

The recent IndusInd Bank saga brings to mind an important lesson from aviation—one that could help investors avoid financial turbulence.

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Modern air travel is safer than ever, with just one fatal accident per 16 million flights. That’s not by chance. It’s because the aviation industry learns from its mistakes. Every aircraft is equipped with two black boxes—one that records mechanical data and another that captures cockpit conversations. When an accident happens, investigators analyze these black boxes to pinpoint the cause and implement corrective measures. More importantly, pilots are encouraged to report errors without fear of punishment, fostering a culture of transparency and improvement.

This approach, known as Black Box Thinking, helps aviation evolve. But in investing, such transparency is often lacking.

Take IndusInd Bank. Recently, its chief executive attempted to address concerns about the bank’s governance lapses related to derivative transactions.

“The treasury thing has been a big blow personally to me also, but I think it's a matter of time that the bank will come up, and I don't think there are any hidden skeletons in the cupboard, and we are not hiding any losses, or we are not hiding anything from the investors,” CEO Sumant Kathpalia recently said in a media interaction.

He insisted that the bank was committed to transparency. Yet, regulatory actions suggest otherwise.

In December 2024, the Reserve Bank of India (RBI) imposed a ₹2.7 million penalty on IndusInd Bank for violating deposit interest rate guidelines. The regulator found that the bank had opened savings accounts for ineligible parties, breaching established norms.

Adding to its troubles, the RBI curtailed Kathpalia’s reappointment to just one year, rejecting the bank board’s proposal for a three-year term. The decision stemmed from the regulator’s dissatisfaction with IndusInd’s risk appraisal process.

Further compounding concerns, top management engaged in significant insider selling of shares of the bank in 2023 and 2024—a disclosure made through stock exchange filings.

So, what should investors take away from this?

Much like in aviation, where black box data helps prevent future accidents, investors should look for insider indicators that signal corporate governance risks. Here are seven key red flags that shouldn’t be ignored:

Use of derivatives and risky financial instruments – Since the 2008 financial crisis, derivatives have been labeled “financial weapons of mass destruction.” Companies that aggressively use them to boost profits should have their risk management policies scrutinized.

Role of auditors – Auditors are supposed to flag financial irregularities, yet history shows they sometimes fail to do so—or even enable misconduct. In 2008, PwC was implicated in the Satyam Computers fraud, a massive corporate governance failure.

A decade later, the same pattern emerged, with auditors resigning en masse rather than exposing frauds.

Between January and May 2018, 32 auditors resigned, a seemingly small number but significant given the reasons cited—which were not part of the usual audit contract cycle. Such resignations are often an early warning sign, particularly in small-cap companies.

Lack of transparency – A relentless pursuit of growth can push management to diversify into unrelated businesses, overleverage balance sheets, or make overpriced acquisitions—all at the cost of shareholder returns.

Instead of acknowledging these risks, companies often downplay or outright deny poor capital allocation decisions. Investors should be wary of opaque disclosures, aggressive expansions, and questionable M&A activity.

Quality of assets – At IndusInd Bank, marked-to-market (MTM) derivative losses lacked independent audits, highlighting a critical oversight gap. While internal scrutiny existed, external audits could have flagged potential issues in hedging positions and asset quality.

Regular audits help detect early signs of financial stress. Without them, banks risk accumulating non-performing assets (NPAs)—which erode return on equity and diminish net worth. Poor asset quality is a red flag for long-term shareholder value destruction.

Solvency – A deteriorating loan book affects a bank’s profitability, liquidity, and overall solvency. A sharp decline in capital adequacy ratio (CAR) can lead to regulatory restrictions on deposits, lending, and even cash withdrawals in extreme cases. Investors should monitor CAR trends to assess a bank’s financial resilience.

Promoter pledging – While not illegal, excessive share pledging by promoters can be a red flag, especially in overleveraged firms. If the company defaults, pledged shares may be dumped into the market, causing a sharp price decline. This not only erodes investor value but also risks promoters losing control of the company.

Contingent liabilities – These off-balance-sheet obligations materialize only when a specific event occurs. While they may seem harmless, they can pose a serious financial threat if they represent a large portion of a company’s net worth. When triggered, they can wipe out substantial equity, leaving investors blindsided.

Individually, these indicators might not raise alarm bells. But when combined, they paint a clearer picture of a company’s financial health. Investors should carefully evaluate these insider signals before betting on a stock—especially one that appears to be a “value buy.”

In conclusion, insider activities alone do not always signal weakness in a stock—insider selling, for instance, may simply reflect a promoter’s liquidity needs. However, the warning signs outlined here serve as a critical checklist for investors evaluating potential value buys.

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If you're considering IndusInd Bank as a value investment, the key question is whether its net worth remains stable. Labelling it a deep value stock without thoroughly assessing its financials and regulatory scrutiny would be premature.

More importantly, companies with weak corporate governance often lose their premium valuation multiples for extended periods. Before jumping in, take a step back and check if the company’s governance history justifies its price.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com