Updated: November 19, 2020 8:01:05 am
A Lakshmi Vilas Bank ATM in Mumbai on Wednesday. (Express photo: Narendra Vaskar)
After the bankruptcies of IL&FS, Punjab & Maharashtra Cooperative Bank and DHFL, and the rescue of Yes Bank, the decision of the Reserve Bank of India to impose a 30-day moratorium on Lakshmi Vilas bank Ltd (LVB) and launched a draft scheme for its merger with DBS Bank India, a subsidiary of DBS Singapore, has raised concerns about the security of the financial system.
Why was LVB discontinued and merged with DBS Bank?
The RBI said the financial position of Chennai-based LVB, which has a network of 563 branches and deposits of Rs 20,973 crore, has seen a steady decline, with continuing losses over the past three years eroding the bank’s net worth. . The bank has not been able to raise adequate capital to address these issues. It was also experiencing continuous deposit withdrawals and low levels of liquidity. The serious governance problems of recent years have led to a deterioration in their performance. LVB posted a net loss of Rs 397 crore in the September quarter of fiscal 21, versus a loss of Rs 112 crore in the June quarter. Almost a quarter of the bank’s advances have been converted to bad debt. Its gross non-performing assets (ANP) stood at 25.4% of its advances as of June 2020, compared to 17.3% a year ago.
A recent merger proposal came from Clix Capital, backed by AION, but the discussions did not work out. The bank was previously courted by SREI Capital. He almost linked up with Indiabulls Housing Finance, but the RBI opposed the proposed merger. The bank’s management had indicated to the RBI that it was in discussions with certain investors, but did not present any concrete proposals.
Are depositors and the financial system safe?
The RBI, which has put a limit of 25,000 rupees on withdrawals, has assured the bank’s depositors that their interests will be protected. The combined balance sheet of DBS India and LVB would remain healthy after the proposed merger, with a capital to risk-weighted asset (CRAR) ratio of 12.51% and Common Equity Tier 1 (CET-1) of 9 , 61%, without taking into account the infusion of additional capital.
The RBI had bailed out Yes Bank earlier this year through a scheme backed by State Bank of India and other banks. A safety net for small depositors is the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of RBI, which provides insurance coverage for bank deposits up to Rs 5 lakh. The RBI and the government have often ensured that the financial system is safe and sound, but a number of flaws have the potential to affect the confidence of depositors.
Read also | Lakshmi Vilas Bank moratorium: depositors’ money is safe, assures RBI-appointed administrator
What has gone wrong in the sector?
The collapse of IL&FS in 2018 had set off a chain reaction in the financial sector, leading to liquidity problems and defaults. Punjab & Maharashtra Co-op Bank was hit by a loan scam involving HDIL promoters and the bank has yet to be rescued. Yes Bank’s near-death experience in March 2020 sparked nervousness among depositors. The RBI action against LVB was expected after shareholders recently voted against the appointment of seven directors to its board.
Old-generation private banks had become the center of attention, and the shareholders of LVB and Dhanlaxmi Bank had recently fired their CEOs within a week. The LVB episode began to unfold after the RBI and SBI-run banks bailed out Yes Bank, affected by the fraud. The RBI has been monitoring the performance of private banks and large NBFCs.
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What about investors in these banks?
Yes Bank shareholders faced significant wealth erosion as the share price fell below Rs 10 per share from a high of Rs 400 per share. In the case of LVB, the share capital is amortized in full. This means that existing shareholders face a total loss on their investments unless there are buyers in the secondary market who can attribute some value to them. LVB shares closed 20% lower on Wednesday. In its draft scheme for the merger, the RBI said that “On and as of the date indicated, the total amount of paid-in capital and reserves and surplus, including balances in the bank’s equity / securities premium account transferor, will be canceled “.
Also in the case of Yes Bank, some individual investors faced a total loss on their investments in AT-1 bonds. Almost 9 billion rupees in AT-1 bonds sold to various institutional investors and high net worth individual investors in the secondary market were written off entirely. According to RBI rules based on the Basel III framework, AT-1 bonds have capital loss absorbing characteristics, which can cause full amortization or conversion to equity. 📣 Express Explained is now on Telegram
What are the problems faced by the older generation private banks?
The operation of many of these banks has come under scrutiny in recent years, as most of them do not have strong promoters, making them targets for mergers or forced mergers. Two other southern-based banks, South Indian Bank and Federal Bank, have been operating as board-run banks without a promoter. At Karur Vysya Bank, the promoter stake is 2.11%, and at Karnataka Bank, there is no promoter. The problems at LVB follow the similar challenges faced by Yes Bank, as well as Punjab & Maharashtra Co-operative Bank in recent times.
What has been the regulatory response to these failures?
On July 24, 2004, the RBI, then headed by YV Reddy, announced a moratorium on private sector lender Global Trust Bank, which was then reeling from huge losses and bad loans. The bank merged with the public sector Oriental Bank of Commerce in 48 hours under an RBI-led bailout plan.
Almost 16 years later, the RBI has taken a somewhat similar approach to reviving troubled lenders from Yes Bank and now LVB. The moratorium announcement was followed by a rebuilding plan for Yes Bank and infusion of capital by banks and financial institutions, with State Bank of India, ICICI Bank, Kotak Mahindra Bank, HDFC, Axis Bank and others contributing equity capital in the reconstructed entity. While banking observers agree that the RBI has acted whenever a bank or NBFC was in trouble, the question remains whether it intervened quickly.
Will the credit stress caused by the pandemic affect the banking system?
NPAs in the banking sector are expected to rise as the pandemic affects the cash flows of individuals and businesses. However, the impact will vary by sector, as segments such as pharmaceuticals and information technology appear to have benefited in terms of revenue. The accumulation of NPAs in cash-rich sectors such as IT, pharmaceuticals, consumer goods, chemicals, and automobiles is expected to be lower compared to areas such as hospitality, tourism, aviation, and other services.
A committee of experts headed by KV Kamath recently made recommendations on the financial parameters required for a one-time loan restructuring window for corporate borrowers under stress due to the pandemic. Corporate sector debt worth Rs 15.52 lakh crore has come under stress after Covid-19 hit India, while another Rs 22.20 lakh crore was already under stress. This effectively means that Rs 37.72 crore (72% of the banking sector’s debt to industry) remains under stress. Businesses in sectors such as retail, wholesale, roads and textiles are facing stressful situations, while NBFCs, energy, steel, real estate and construction were already under pressure when the pandemic began. .
This article first appeared in print on November 19, 2020 under the title ‘What does a bankrupt bank mean’.
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