India’s central bank steps in to rescue a small 93-year-old bank

The empty filling.
The empty filling.
Image: LVB Facebook Page
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The Reserve Bank of India (RBI) has decided to step in to stop the unraveling of a 93-year-old small private bank that could have destabilised India’s Rs97 lakh crore ($1.3 trillion) banking system.

The central bank has proposed (pdf) to merge Chennai-based Lakshmi Vilas Bank (LVB), which has been struggling with allegations of poor governance and a mounting bad loan problem, with DBS Bank India, a part of the Development Bank of Singapore. The RBI has also put a cap of Rs25,000 on withdrawal from LVB’s customers’ accounts till Dec. 16.

“The rapidly deteriorating financial position of the LVB relating to liquidity, capital and other critical parameters, and the absence of any credible plan for infusion of capital has necessitated RBI to take immediate action in public interest and particularly in the interest of the depositors and accordingly,” the RBI said in a statement.

On Sept. 25, shareholders of LVB ousted managing director and chief executive officer S Sundar along with seven directors on allegations of mismanagement and poor governance. Sundar had been appointed to the bank in January this year.

Even though LVB is a fairly small player in India’s financial sector, analysts have been worried for several weeks because an implosion at the bank could have had an outsized impact at a time when the industry is reeling with Covid-19 linked challenges. India’s banking system is facing a fresh wave of bad loans triggered by the Covid-19 slump. Besides, the collapse of Punjab Maharashtra Co-operative (PMC) bank, Yes Bank, and IL&FS have riled the financial system over the last two years.

“The Reserve Bank of India has let the situation at Lakshmi Vilas Bank linger for too long. It cannot afford another accident in the financial sector after IL&FS, PMC, and Yes Bank,” Institutional Investor Advisory Services (IiAS) had said last month.

The big banking mistake

The implosion at LVB did not happen overnight. In fact, the decay had been setting in for a long time.

The bank was founded in 1926 by a group of businessmen in the southern Indian state of Tamil Nadu with an aim to finance small businesses in the region. With this principle at its core, the bank continued to grow its loan book gradually, posting decent profits and paying a good dividend to its shareholders.

But between 2008 and 2017, it decided to change its unique strategy and copy what large banks were doing.

At the time, India’s leading private lenders such as ICICI Bank and Axis Bank were focusing on corporate players to expand their loan books. LVB joined the bandwagon and initially tasted success.

It clocked speedy growth by giving loans to large corporates. Between 2008 and 2017, LVB’s loan book rose 515% whereas deposits jumped four times.

However, the strategy backfired badly when a bunch of the bank’s borrowers became defaulters. This led to a sharp increase in bad loans or non-performing assets (NPAs) on LVB’s books.

Now, LVB has an exposure of around Rs2,000 crore to some of India’s largest corporate defaulters such as Nirav Modi, Cafe Coffee Day, Reliance Housing Finance, Religare, Jet Airways Group, and Cox and Kings.

The bank’s gross NPAs stand at a whopping 24.45% of the total book and its tier-1 capital buffer (protection against risky assets) is in the negative territory—way below the Indian central bank’s requirement of 8.75%.

The bank claims that a large chunk of these NPAs is from companies in the infrastructure sector.

Mounting NPAs have taken a massive toll on LVB’s financials as it has to set aside money as provisioning for these bad loans. The high provisioning led to the bank posting losses in three of the last five years.

In September 2019, LVB was put under the Reserve Bank of India’s (RBI) prompt corrective action (PCA) in an attempt to revive it. PCA is a set of operating guidelines created by the central bank for banks with high NPAs, losses, and inadequate capital.

But the programme did not do much for LVC as it continues to grapple with its issues. And the recent vote out by shareholders only made things worse.

Failed bids

Before the RBI intervened, some players in the financial sector had shown interest in LVB.

Since October, the bank was in talks with non-banking financial company (NBFC) Clix Capital for a merger. Last year, the RBI had rejected a proposal to merge LVB with Indiabulls Housing Finance, another NBFC.

DBS could be the right match as it can absorb LVB’s losses.

According to the RBI’s statement, DBS India has a healthy balance sheet, with strong capital support. The bank’s gross bad loans and net bad loans stood at 2.7% and 0.5%, respectively in June. “It will bring in additional capital of Rs2,500 crore upfront to support credit growth of the merged entity,” the RBI said.