DH Deciphers | The LVB crisis and what it portends for India's banking industry

On November 17, 2020, the central government imposed a month-long moratorium on the Chennai-headquartered Lakshmi Vilas Bank (LVB), superseded its board and capped withdrawals at Rs 25,000 following a "serious deterioration" in the lender's financial position. The government took the decision on the recommendation of the Reserve Bank of India (RBI), which also proposed merging the LVB with the Singapore-headquartered DBS Bank.

The LVB is the third private-sector bank to face such a situation since September 2019, after the Punjab and Maharashtra Co-operative (PMC) Bank and YES Bank. What explains this crisis in the banking industry? Is it just bad loans or something else? Let's find out:

Did LVB run out of money?

Unlike YES Bank, LVB never saw a bank run (when a large number of customers of a bank withdraw their deposits fearing that it will run out of money). Its net withdrawals stand at Rs 900 crore and deposit base at Rs 20,050 crore, which was Rs 20,973 crore at September 30, 2020. This dip in the deposit base is quite normal in the festive season when people tend to hoard cash. At the time of the moratorium, the bank had a decent CASA ratio of 30%. CASA refers to the amount of money that is deposited in the current and savings accounts — the cheapest source of funds for a bank.

Read | An end to Lakshmi Vilas Bank: A future for banking amalgamations

What was the problem then? Why did RBI place it under moratorium?

Over the past two years, the LVB's asset quality has deteriorated severely. By September 2020, a quarter of its loan book was stuck in bad loans (loans that will not be repaid), along with stress in the many other accounts. All these accounts needed to be written off, and the bank needed capital for this. As part of its capital hunt, LVB explored many other options — merger with Indiabulls Housing Finance, capital infusion by stressed-asset fund manager Tilden Park Capital Management, and more recently, capital infusion by commercial finance provider Clix Capital. But none of these proposals could receive approval of the RBI.

What was the RBI's solution?

In order to stabilise the bank, the RBI has proposed amalgamating LVB with DBS Bank India — a wholly-owned subsidiary of DBS Bank Singapore, which had been looking for access to India's large retail banking market. To facilitate this transition, the RBI had to supersede the LVB board and appoint an administrator. The RBI took the decision as a precaution to avoid a bank run.

Read: DBS faces potential culture clash as it scoops up distressed Lakshmi Vilas Bank

What happens to LVB depositors?

The depositors of the LVB will ideally become the customers of DBS Bank at the end of the merger. Every savings bank or current account or any other deposit account, including a fixed deposit, will be opened at DBS Bank on the date the merger comes into force. The nature of the accounts and the name of the respective holder will remain the same. According to the proposed scheme, DBS Bank will pay interest on deposits at the existing LVB rate until the merger date.

What about LVB shareholders?

This is the tragic part. The shareholders have suffered due to the actions (such as reckless lending) by the LVB management in corroboration with some of the employees. In a travesty of fate, the RBI has promised LVB employees that their jobs are safe while letting the shareholders suffer.

Retail shareholders own 46.73% of the bank (making them the single largest investor group) while the promoters' stake is just 6.8%. After the merger, all the equity capital will be written off. Not just that, 97,245 retail shareholders who own Rs 243.89 crore (valuation as of market close on November 17) will see their 15.47 crore equity shares being written off as well — making them lose a lot of money. Unsurprisingly, the LVB shares lost 53.35% between November 17 and November 24 on the BSE.

Read: Learning lessons, one bank collapse at a time

Didn't the RBI have any other option to rescue LVB?

Truth be told, the RBI of late has been more of a reactive regulator than a proactive one. That LVB was facing an existential crisis was public knowledge. The RBI gave no reason whatsoever while rejecting the proposal to merge the LVB with Indiabulls last year. While the merger of a healthy private bank with a weak private bank at fair market value is a reasonable solution to the problem, it's come a bit late. In the past year, retail shareholders increased their stake in the LVB by 900 basis points (or 9%), believing the LVB management's promise of capital infusion. In hindsight, the RBI could have acted earlier and saved the interests of retail shareholders.