An arranged union has set a banking precedent2 min read . Updated: 18 Nov 2020, 08:22 PM IST
The RBI’s move to rescue LVB through its merger with the local unit of a Singapore bank may help address a moral hazard problem and make foreign banks rethink their presence here
Private-sector lender Lakshmi Vilas Bank (LVB) was in need of a rescue after its latest efforts to raise money faltered, even as its financial situation grew dire. With bad assets piled up and its capital cushion left all but hollow, it seemed on the verge of collapse—which would have left depositors in the lurch and shaken confidence beyond its walls—when the Reserve Bank of India (RBI) intervened on Tuesday. Moments after the finance ministry suspended LVB’s credit operations for a month on its advice, the central bank superseded its board, appointed an interim administrator, capped withdrawals of cash at ₹25,000, and put out a draft proposal to merge LVB with the well-funded DBS Bank India Ltd (DBIL), the local unit of Singapore’s DBS Bank that is expected to pump in ₹2,500 crore for its operational revival. Under RBI’s plan, LVB’s shareholders are to get nothing, as its entire paid-up share capital will be written off. Arguably, this is how it should be.
In such cases, what the regulator must defend are the interests of depositors, above all, lest public perceptions of bank safety suffer a blow; the sorry episodes of Yes Bank and Punjab and Maharashtra Cooperative Bank remain fresh in many minds. On Wednesday, LVB’s administrator duly assured its account holders of sufficient cash availability. Equity holders, in contrast, are the designated risk bearers—and profit makers—of any such enterprise. That their liability for a business’s failure is legally limited to the money they had invested in it is protection enough. If they too were bailed out, it would perpetuate a problem of moral hazard that seems to afflict lenders more than others. Loans are likelier to go bad and eviscerate banks if managers and their minders expect taxpayers to pick up the tab. In LVB’s case, though, sundry owners did try to exert control over its management. This September, they voted much of its board out, including its then chief. In the eye of that storm was its attempt to merge with Clix Capital, whose loan book reportedly looked dicey to many, after its 2019 proposal to merge with Indiabulls Housing Finance was turned down by RBI, partly on account of the latter’s high exposure to the stressed realty sector.
Also of significance is the fact that a foreign-owned entity looks set to take charge of LVB’s operations. This has evoked a protest from a union of public-sector bank officers that appears keen to portray it as a sellout of national interests. Such distinctions of ownership, however, should not be made, so long as LVB’s troubles are resolved. It would help, though, if we had clarity on how exactly RBI arranged the deal. For a while now, our central bank has been trying to nudge foreign banks that operate as branch outposts here to incorporate themselves in India as wholly-owned subsidiaries. DBIL is among the few that have registered. If its capital base appears particularly strong as a proportion of its risk-weighted assets, it is also because its asset book is still rather small, even smaller than LVB’s. It needs to expand, clearly, for which LVB’s 563-branch network could prove handy. While RBI has long restrained most foreign bank outposts from expanding their physical reach, DBIL, as a domestic entity, may perhaps expect to open new outlets or acquire other lenders with greater ease. If so, then a DBIL-LVB union could send other banks based abroad an incentive signal to register locally should they want wider expansion avenues. It’s another matter that they may prefer to reach out online.