Context: RBI has imposed a moratorium on Lakshmi Vilas Bank and drafted a scheme for a merger.
Why it is a concern?
- Already, India’s banking system is distressed due to the failures of IL&FS, Punjab & Maharashtra Cooperative Bank and DHFL, followed by the bailout of Yes Bank.
- Now, the Reserve Bank of India decision to put in place a draft scheme for the amalgamation of Lakshmi Vilas Bank with DBS Bank India, a subsidiary of DBS of Singapore, has raised concerns about the safety of the financial system.
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
What has been the regulatory response to these failures?
- The announcement of moratorium by banking regulator.
- Followed by a reconstruction plan.
- Followed by the Capital infusion by banks and financial institutions by investing in the equity capital of the reconstructed entity
Issues faced by old-generation private banks?
- Lack of promoters: For example, the 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 making them targets for mergers or forced amalgamation.
Are the depositors and the financial system safe?
- For small depositors, the Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary gives insurance cover on up to Rs 5 lakh deposits in banks.
- Apart from this, additional infusion of capital and the proposed amalgamation will make the combined balance sheet of DBS India and LVB healthy.
What happens to the investors in these banks?
- Equity capital is being fully written off. This means that existing shareholders face a total loss on their investments unless there are buyers in the secondary market.
- The Equity Capital refers to that portion of the organization’s capital, which is raised in exchange for the share of ownership in the company.
- In the case of Yes Bank, too, some individual investors faced a total loss on their investments in AT-1 bonds.
- As per RBI rules based on the Basel-III framework, AT-1 bonds have principal loss absorption features, which can cause a full write-down or conversion to equity.
How far the loan stress caused by the pandemic impact the banking system?
- The impact will differ depending upon the sector, as segments like pharmaceuticals and IT seem to have benefited in terms of revenues whereas sectors like hospitality, tourism, aviation have been hit the most.
- However, due to the Pandemic, the Corporate sector debt that remains under stress has increased (worth Rs 37.72 lakh crore that is 72% of the banking sector debt to industry).
- An expert committee headed by K V Kamath recommended for a one-time loan restructuring window for corporate borrowers under stress due to the pandemic.