Bank Rescues: How Often Have Shareholders Seen An Equity Write-Off?

The RBI’s decision to write down equity as part of the Lakshmi Vilas Bank-DBS India merger has precedence.

A cyclist rides along an empty street past the Reserve Bank of India (RBI) headquarters during a lockdown imposed due to the coronavirus in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)
A cyclist rides along an empty street past the Reserve Bank of India (RBI) headquarters during a lockdown imposed due to the coronavirus in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

The Reserve Bank of India’s draft plan for the amalgamation of The Lakshmi Vilas Bank Ltd. with DBS Bank India Ltd. includes a complete write-off of equity.

According to the scheme of amalgamation, the paid-up share capital and reserves and surplus, including the balances in the share/securities premium account of Lakshmi Vilas Bank, shall be written off. Shares of the bank will be delisted from exchanges once the merger is complete.

On Thursday, the Business Standard newspaper reported that equity shareholders may approach the RBI to review this decision. At least two large shareholders in the bank confirmed to BloombergQuint that they do intend to write to the regulator seeking a review. They spoke on the condition of anonymity.

Lakshmi Vilas Bank has a 93.2% public shareholding, which includes foreign portfolio investors (8.65%), insurance companies (6.4%) and institutional investors (30.82%), with non-institutional investors holding the rest.

Depositors Over Shareholders

In such situations the Banking Regulations Act would supersede the Companies Act, as it is a question of protecting depositors, said TN Manoharan, the RBI-appointed administrator for the bank. So unlike other companies, Lakshmi Vilas Bank would not need shareholder approval to delist its shares, he said addressing a press conference.

According to a person with direct knowledge of RBI’s thought process, the resolution of an insolvent bank would need to prioritise depositors over all other stakeholders. This is a stance the RBI has even taken in the past, when a private bank had become insolvent.

In the early 2000s, at least three private banks saw their net worth turn negative. To protect the depositors of these banks, the RBI announced amalgamation schemes with other lenders. In each of these cases, equity shareholders were eventually wiped out.

Lakshmi Vilas Bank Paves The Way For DBS Bank’s India Ambitions

Nedungadi Bank

In 2002, Kozhikode-based Nedungadi Bank was put under an RBI moratorium, where depositors were permitted to withdraw only Rs 5,000.

In November 2002, an amalgamation plan was announced with Punjab National Bank, which was completed in 2003. In its statement, the RBI said shareholders of the bank will be entitled for payment of pro rata value of shares only if any surplus remains after paying off the depositors and creditors. “Importantly, draft scheme of amalgamation does not envisage allotment of shares of Punjab National Bank to the shareholders of Nedungadi Bank Ltd.,” it said.

As of March 2002, Nedungadi Bank had a deposit base of around Rs 1,400 crore and advances worth Rs 750-800 crore. It had a network of 174 branches largely spread in Kerala.

Global Trust Bank

In July 2004, the RBI announced a three-month long moratorium on Global Trust Bank, during which depositors were allowed to withdraw only Rs 10,000.

The private bank and its promoters were named in investigations into the 2001 stock market scandal. In an interview with Business Standard, after the failure of the bank, its chairman Ramesh Gelli admitted that between 1999 and 2001, the bank’s exposure to capital market entities went up to 30% of its total assets.

Global Trust Bank eventually ended up with a negative net worth.

Two days after announcing the moratorium, the RBI released a draft amalgamation scheme for the bank with government owned Oriental Bank of Commerce.

As part of the plan, the RBI said the paid-up capital and reserves of the private bank shall be treated as provision for bad and doubtful debts and depreciation in other assets.

According to a December 2005 news report in The Financial Express, Oriental Bank of Commerce informed stock exchanges that the aggregate amount representing the value of the assets determined as readily realisable assets of Global Trust Bank shall be credited to an asset account. The surplus amount, if any, after appropriating towards the liabilities of the Global Trust Bank, shall be distributed pro-rata among the shareholders after 12 years from Aug. 14, 2004.

Further communication on the issue is not available.

Ganesh Bank Of Kurundwad

In January 2006, the RBI announced that Ganesh Bank of Kurundwad would be put under moratorium for three months. According to an RBI statement, this was because the bank’s capital adequacy ratio had fallen to -5.83%.

Within 48 hours of announcing the moratorium, the RBI came up with its draft plan, where the operations of Ganesh Bank were to be merged with Kerala-based Federal Bank. Similar to the events at Global Trust Bank, the regulator in this case had said that the entire paid-up share capital and reserves of Ganesh Bank shall be used to provide against bad and doubtful debts and depreciation in other assets.

The smaller lender had attempted to oppose this decision in court, but the petition was rejected by the Supreme Court, which paved the way for the merger in September 2006.

From Yes Bank To Lakshmi Vilas Bank, Lessons From Bank Failures

No Single Template

Not all stressed banks have seen the same format for resolution.

In March, the RBI put private sector lender Yes Bank Ltd. under moratorium, following which, a rescue plan led by State Bank of India and other local lenders was announced. The plan involved only the additional tier-1 bonds being fully written down, owing to their loss-absorbing nature. Equity shareholders saw their shares locked in and diluted but not written off.

Yes Bank’s reported net worth was at Rs 25,000 crore as of March 2020. However, analysts believed that this would stand substantially reduced if stress was fully accounted for.

“Equity capital by definition is risk capital, so investors must take the risk. In the event of a bank going down, equity investors will be first hit. That is just the nature of it all. Normally in amalgamation or merger, there is protection afforded to the equity holders, but in this case, the net worth was eroded so much that no such protection can be given,” said HR Khan, former deputy governor of the RBI.

The Lakshmi Vilas Bank Rescue Does Not Mark A Trend

Ajay Shaw, partner at DSK Legal, said the RBI has requisite powers as a banking regulator in such cases.

“Indian banks do not have a formal insolvency process to resolve stress. In the absence of such a legal framework, the RBI has powers supervening all regulations. The regulator’s first preference will always be the depositors and all other stakeholders will have to follow the waterfall scheme, like it happens under bankruptcy,” Shaw said.