Lakshmi Vilas Bank (LVB) Crisis

ECONOMY/ GOVERNANCE

Topic: General Studies 3:

• Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Lakshmi Vilas Bank (LVB) Crisis

Context: After the failures of IL&FS, Punjab & Maharashtra Cooperative Bank and DHFL, and the bailout of Yes Bank, the RBI has now decided to impose a 30-day moratorium on Lakshmi Vilas Bank Ltd (LVB).

RBI has also put in place a draft scheme for amalgamation of LVB with DBS Bank India, a subsidiary of DBS of Singapore and has raised concerns about the safety of the financial system.

Why was LVB put under moratorium and amalgamated with DBS Bank?

• Continuous Losses: The RBI said the financial position of the Chennai-based LVB, which has a network of 563 branches and deposits of Rs 20,973 crore, has undergone a steady decline, with continuous losses over the last three years eroding the bank’s net-worth. LVB posted a net loss of Rs 397 crore in the September quarter of FY21, as against a loss of Rs 112 crore in the June quarter
• Rising NPAs: Serious governance issues in recent years have led to deterioration in its performance. 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, as against 17.3% a year ago.
• Low Liquidity: It was also experiencing continuous withdrawal of deposits and low levels of liquidity. 
• Unable to raise Capital: The bank has not been able to raise adequate capital to address these issues. The bank management had indicated to the RBI that it was in talks with certain investors, but failed to submit any concrete proposal

Are depositors and the financial system safe?

• Assurance & Insurance by RBI: The RBI, which put a cap of Rs 25,000 on withdrawals, has assured depositors of the bank that their interest will be protected. One safety net for small depositors is the Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary, which gives insurance cover on up to Rs 5 lakh deposits in banks.
• Amalgamation will prevent further slide: The combined balance sheet of DBS India and LVB would remain healthy after the proposed amalgamation, with Capital to Risk Weighted Assets Ratio (CRAR) at 12.51% and Common Equity Tier-1 (CET-1) capital at 9.61%, without taking into account the infusion of additional capital.

Rising Crisis in Banking Sector

• The collapse of IL&FS in 2018 had set off a chain reaction in the financial sector, leading to liquidity issues and defaults
• Punjab & Maharashtra Co-op Bank was hit by a loan scam involving HDIL promoters and the bank is yet to be bailed out.
• The near-death experience of Yes Bank in March 2020 sent jitters among depositors. The RBI bailed out Yes Bank through a scheme backed by State Bank of India and other banks.
• Shareholders of LVB and Dhanlaxmi Bank recently firing their chief executive officers in the span of a week.

What happens to investors in these banks?

• Bad Experience for Yes Bank Investors: Shareholders in Yes Bank faced a significant erosion in wealth as the stock price crashed below Rs 10 per share from a peak of Rs 400 per share
• Near total loss for existing shareholders of LVB: In the case of LVB, equity capital is being fully written off. This means existing shareholders face a total loss on their investments unless there are buyers in the secondary market who may ascribe some value to these. 
• In its draft scheme for the amalgamation, the RBI said that “On and from the appointed date, the entire amount of the paid-up share capital and reserves and surplus, including the balances in the share/securities premium account of the transferor bank, shall stand written off.”

Issues facing old-generation private banks- Lack of strong promoters

• The functioning of many such banks has been under scrutiny in the last couple of years, as most of them do not have strong promoters, making them targets for mergers or forced amalgamation. 
• Two other South-based banks – South Indian Bank and Federal Bank – have been operating as board-driven banks without a promoter. 
• In Karur Vysya Bank, the promoter stake is 2.11% and in Karnataka Bank, there’s no promoter. 
• The problems in 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 Y V Reddy, announced a moratorium on private sector lender Global Trust Bank, which was then reeling under huge losses and bad loans. The bank was merged with public sector Oriental Bank of Commerce within 48 hours under an RBI-led rescue plan.
• Nearly 16 years later, the RBI has followed a somewhat similar approach on resuscitation of the troubled lenders of Yes Bank and now LVB. 
• The moratorium announcement was followed by a reconstruction plan for Yes Bank and capital infusion by banks and financial institutions, with SBI, ICICI Bank, Kotak Mahindra Bank, HDFC, Axis Bank and others putting in equity capital in the reconstructed entity. 

Will loan stress caused by the pandemic impact the banking system?

• Business Cycle disrupted: NPAs in the banking sector are expected to increase as the pandemic affects cash flows of people and companies.
• Differential Impact of Pandemic on Sectors: However, the impact will differ depending upon the sector, as segments like pharmaceuticals and IT seem to have benefited in terms of revenues. NPA accretion in cash-rich sectors like IT, pharmaceuticals, FMCG, chemicals, automobiles is expected to be smaller when compared to areas like hospitality, tourism, aviation and other services.
• K V Kamath Committee recently came out with recommendations on the financial parameters required for a one-time loan restructuring window for corporate borrowers under stress due to the pandemic.

Conclusion

• While banking observers agree that the RBI has acted whenever a bank or an NBFC faced trouble, the question remains whether it made the interventions swiftly.

Connecting the dots:

• Yes Bank Crisis