Learning lessons, one bank collapse at a time

The Reserve Bank of India (RBI) has done well to announce some steps to rescue the troubled Lakshmi Vilas Bank (LVB) and to safeguard the interests of its customers. The central government has imposed a 30-day moratorium on the bank on the recommendation of the RBI, and it has given an assurance to depositors and employees. The regulator has also announced a draft scheme for amalgamation of the bank with the Indian unit of DBS Bank, a bank controlled by the Singapore government, which will take over all the assets and liabilities of the LVB. The situation in the wake of the collapse of the Punjab and Maharashtra Cooperative Bank last year, which created much misery and hardship for most depositors, may be averted.

The choice of DBS as the rescuer is appropriate for many reasons. It would be difficult for a bank in India to effect such a deal. DBS is bringing upfront an additional capital of Rs 2,500 crore to the distressed LVB, whose capital base has badly eroded, NPAs have shot through the roof and all other parameters have deteriorated. DBS is an Indian subsidiary, not a branch of a foreign bank, and so will be subject to Indian laws and the RBI’s regulatory scheme. Its gain is that it will inherit 563 branches, 974 ATMs and Rs 20,973 crore of deposits. One downside of the deal for LVB’s investors, especially minority shareholders, is that they will lose all their money because the entire paid-up capital and services will be written off, reducing the shares to zero value. The investors’ concern is legitimate, but the norm to be followed in such situations is that primacy should be given to depositors’ interests.

While the measures taken by the RBI are welcome, there is a view that the regulator could have acted before the crisis reached this stage and the rescue process could have been scripted differently. The RBI had placed the bank under its Prompt Corrective Action framework in September 2019. The crisis kept worsening while many inadequate solutions were considered, and finally the RBI had to act. There was a case for a detailed valuation exercise and invitation of bids from interested parties to decide who offered the best terms and conditions for the rescue act. It is also a matter of concern that there are increasing cases of collapse of financial firms. In the last two years, LVB is the fifth firm to collapse, after IL&FS, Dewan Housing Finance, Punjab and Maharashtra Cooperative Bank and Yes Bank. Many smaller firms have also gone under. There is a need for greater caution in the months ahead, as Covid-19 may make the situation worse.