The Lakshmi Vilas Bank Rescue Does Not Mark A Trend

It’s not obvious that failed banks point to failed supervision, argues TT Ram Mohan.

A man standing in floodwater shares a tray of tea with another man sitting in a canoe in Alappuzha, Kerala. (Photographer: Prashanth Vishwanathan/Bloomberg)
A man standing in floodwater shares a tray of tea with another man sitting in a canoe in Alappuzha, Kerala. (Photographer: Prashanth Vishwanathan/Bloomberg)

The news that Lakshmi Vilas Bank will be merged with DBS Bank India comes as a huge relief. Depositors at LVB will be relieved that, unlike at Punjab and Maharashtra Cooperative Bank, they can expect to access their deposits in full not later than the moratorium period of one month. LVB was among the ‘old private banks’ that existed before liberalisation ushered in a new generation of private banks in the 1990s. It is a small bank with deposits of around Rs 21,000 crore. That even such a small bank is not allowed to fail is telling. The issue is not just systemic risk but the fate of thousands of depositors.

This is a point worth remembering when people talk glibly about ‘bailing in’ depositors, that is, getting depositors to take losses on their deposits when a bank fails. It is very difficult for the government or the regulator to contemplate such an action where small depositors are involved.

The relief in this instance is not just for depositors but for the larger public sector banks.

Time and again, failing private banks have been thrust on PSBs. It happened in 1991 when the State Bank of India was asked to take over the Indian operations of BCCI, the failed international bank. It happened again in 2004 when Global Trust Bank was merged with Oriental Bank of Commerce – itself merged since with Punjab National Bank. Most recently, Yes Bank was acquired by a consortium led by SBI, and a merger is still not ruled out.

True, sometimes a large private bank is called upon to effect a rescue, as with ICICI Bank saving Bank of Rajasthan. But there are differences. Private banks have the capital to be able to absorb a failing bank. They also have far greater freedom to rationalise branches and lay off staff after a merger. They can thus turn a merger into a good commercial proposition. PSBs lack such flexibility in absorbing a merger. They are constrained when it comes to both branch and staff rationalisation. After having a failed bank thrust on them, they are blamed for under-performance.

A branch of The Lakshmi Vilas Bank in Mumbai, India. (Photographer: Mahima Kapoor/BloombergQuint)
A branch of The Lakshmi Vilas Bank in Mumbai, India. (Photographer: Mahima Kapoor/BloombergQuint)
Lakshmi Vilas Bank: The Unravelling Of A 93-Year-Old Lender

RBI’s Supervision And Intervention Questioned

Lakshmi Vilas Bank has been sinking for quite some time. It has been incurring losses for the past three years and its capital adequacy was virtually nil. Questions will again be asked about the effectiveness of the supervisor. Why did the Reserve Bank of India not intervene earlier?

This is a tricky issue, and it’s not obvious that failed banks point to failed supervision. The supervisor would always like to give the board and the management every opportunity to salvage the situation. In the case of LVB, a huge infusion of capital was required. Management repeatedly gave the impression that it was about to close deals with investors from abroad. Very often, management genuinely believes such deals are possible until investors cry off at the last minute.

At LVB, once attempts to secure capital failed, the RBI decided to step in.

It’s a situation in which the RBI is damned if it does and damned if it doesn’t. Act early, and you are accused of micro-managing affairs at a private bank. Act late, and you are guilty of letting things get out of hand.
DBS to Rescue India Lender, First Such Move by Foreign Bank

Don’t Expect Other Foreign Banks To Follow

DBS is, perhaps, the first foreign bank to have taken advantage of the possibilities opened up RBI’s scheme for setting up of wholly-owned subsidiaries by foreign banks. The scheme was unveiled in 2013. Under the scheme, the RBI made it possible for foreign banks to be treated on the same footing as domestic banks (‘national treatment’) provided they were willing to come in through the subsidiary route and not as branches. As subsidiaries, they would not face the constraints on branch expansion that have limited foreign banks operating as branches of their parents.

However, in order to operate as subsidiaries, foreign banks have to comply with various onerous conditions.

  1. They must have minimum capital of Rs 500 crore.
  2. At least 50% of the board members must be Indian.
  3. One-third of the board must comprise independent directors.
  4. At least 25% of branches opened in any financial year must be in unbanked areas.
  5. They have to abide by priority sector requirements.

DBS may see merit in acquiring a South Indian bank, given the presence of a large Tamil population in Singapore. However, the acquisition should not be seen as pointing to more such possibilities.

The promise of ‘national treatment’ under the subsidiary route has not exactly resulted in a rush of foreign banks into India or even a conversion of existing banks into subsidiaries.

For several reasons.

Consequent to the global financial crisis, foreign banks, in general, lack the appetite for large investments in emerging markets. Indeed, many have been retreating from such markets, including India. Many would also be uncomfortable with the corporate governance requirements for foreign bank subsidiaries. Matching the large branch network of PSBs and new private banks through the organic route would be a long-drawn-out and expensive affair.

Mergers hold out the promise of access to a large distribution network. However, the branches of old private banks are concentrated in a few geographies.

Old private banks would not offer foreign banks the pan-Indian, diversified presence that they would be looking for.

That would be possible only through the acquisition of, or mergers with, PSBs. That is the serious opportunity that would interest some of the biggest international banks.

Alas, the opportunity is unlikely to materialise soon. Acquisitions of PSBs would require amendments to the Bank Nationalisation Act and would be hugely contentious in political terms. The RBI itself has long been wary of any large foreign bank presence in India until such time as public sector banks acquire a measure of stability, something that has proved elusive over the past decade.

It will be a while before large foreign banks think of using the subsidiary route to establish a significant presence in India.

TT Ram Mohan is a professor at IIM Ahmedabad.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.

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