Issue of Lakshmi Vilas Bank | 19th November

News: Reserve Bank of India imposed a 30-day moratorium on Chennai based Lakshmi Vilas Bank Ltd (LVB) and put in place a draft scheme for its amalgamation since its financial position underwent steady decline and posted loss for the last 3 consecutive years.

Under these developments, RBI has imposed the following conditions:

• RBI has put a cap of Rs 25,000 on withdrawals from the bank.
• Draft Scheme for amalgamation includes the amalgamation of LVB with DBS Bank India, a subsidiary of DBS of Singapore. Amalgamation will include all business, assets (including tangible and intangible), estates, rights, titles, etc. of LVB.

Background of the LVB issue:

• LVB shifted its focus from SMEs(Small and Medium Enterprises) to large businesses, in 2016-17 and loaned Rs 720 crore against fixed deposits of Rs 794 crore, which later turned into bad loans.
• In 2018, Religare Finvest sued the Delhi branch of LVB to recover fixed deposits worth about Rs 800 crore that the bank invoked to recover those loans.
• RBI put LVB under Prompt Corrective Action (PCA) framework in September 2019 due to which the bank was not able to issue fresh loans or open a new branch anywhere.
• Now RBI has formalised a scheme for its amalgamation as mentioned above.

Why this decision was taken?

• Erosion of the bank’s net-worth: Deposits has undergone a steady decline, with continuous losses over the last three years.
• Experiencing low levels of liquidity: Inability to raise adequate capital from market and due to continuous withdrawal of deposits.
• Increase in Non-performing assets: Almost one fourth of the bank’s advances have turned bad assets. Its gross non-performing assets (NPAs) stood 25.4% of its advances as of June 2020.

RBI’s power of amalgamation

• Under Section 45 of the Banking Regulation Act, a scheme of reconstruction or amalgamation can be prepared by RBI, during the period of amalgamation only.
  • Once the moratorium comes into effect, the bank cannot lend, and existing depositors cannot withdraw beyond a specified amount.
• But the practice of imposing a moratorium was seen as disruptive as it carried the risk of undermining depositor confidence in the banks and financial stability.
• Thus, the government empowered RBI under Banking Regulation (Amendment) Ordinance 2020, to prepare a reconstruction scheme without having to first make an order of moratorium on barring deposit withdrawals.

Issues facing Private Banking Sector:

• Collapse of IL&FS(Infrastructure Leasing & Financial Services) in 2018 had set off a chain reaction in the financial sector, leading to liquidity issues and defaults.
  • RBI had earlier this year bailed out Yes Bank through a scheme backed by State Bank of India and other banks
  • Punjab & Maharashtra Co-op Bank was hit by a loan scam involving HDIL(Housing Development and Infrastructure Limited) promoters and the bank is yet to be bailed out.
• Most of the old generation Private banks do not have strong promoters, making them targets for mergers or forced amalgamation. For ex: In Karur Vysya Bank, the promoter stake is 2.11%, and in Karnataka Bank, there’s no promoter
• Asset Quality: biggest risk to India’s banks including Private banks is the rise in bad loans or Non Performing Assets(NPAs) along with the slowdown in the economy. This unforeseen COVID-19 Pandemic just increased that further. However, the impact will differ depending upon the sector.

Ex: banks lend to pharmaceuticals and IT seem to have benefited from reduced NPA and those who lend to hospitality, tourism, aviation expect to increase NPA’s further.

• Regulatory challenges : RBI’s CAR (Capital Adequacy Ratio) and other stringent regulations reduce Private sector banks Alternative investment opportunities
• HR challenges: Shortage of experienced and trained private bankers and high attrition levels means that talent is always in short supply
• Infrastructure challenges: Lack of appropriate and adequate physical and IT infrastructure is one of the major challenges facing the PB sector in India. Bank branches are not well equipped to cater to HNIs(High Net Worth Individuals) and UHNWIs(Ultra High Net Worth Individuals)

Solutions and way forward

• RBI constituted KV Kamath Committee tasked to recommend on the financial parameters required for a one-time loan restructuring window for corporate borrowers under stress due to the pandemic can reduce stressed assets and NPAs not only in private banks but in the entire banking system as a whole.
• Narashimham committee recommendation of Introduction of Narrow Banking Concept where weak banks will be allowed to place their funds only in the short term and risk-free assets can be followed in Private banks when they face loss for 4 consecutive quarters instead of RBI step into amalgamation or bailout
• Splitting the Chairman and Managing Director and allocating them fixed tenure of 3 to 5 years as advised by the PJ Nayak Committee can be followed for Private banks.
• Insolvency and Bankruptcy Code should be better utilized and have to complete within the provided timeline.
• Private banks have to improve their Promoters stake or look out for promoters.

Conclusion

With BASEL III norms on the cards Indian Banking sector has to be strengthened especially PSBs but that doesn’t mean the Private can be left out. A mutually strong, competitive private banking is the key to push the entire banking system.

Important Definitions:

HNIs: In India, those peoples who have more than 2 crores investible surplus are considered high net worth individual (HNI)

NPA’s: A loan whose interest and/or installment of principal have remained ‘overdue ‘ (not paid) for a period of 90 days is considered as NPA.

Stressed assets = NPAs + Restructured loans + Written off assets

Restructured asset or loan: assets which got an extended repayment period, reduced interest rate, converting a part of the loan into equity, providing additional financing, or some combination of these measures

Written off assets: assets which the bank or lender doesn’t count the money the borrower owes to it. The existing shareholders face a total loss on their investments unless there are buyers in the secondary market who may ascribe some value to these.