Hastily engineered mergers to rescue troubled banks have obvious shortcomings

| Updated on November 18, 2020 Published on November 18, 2020

The ideal resolution should entail a comprehensive valuation exercise, transparent invitation of bids from interested parties and a final decision involving key stakeholders that maximises their value

To anyone who tracks Indian banking, it cannot come as a surprise that Lakshmi Vilas Bank (LVB) has been placed under moratorium by the Centre on the advice of the Reserve Bank of India, pending a resolution plan. The bank was placed under the RBI’s Prompt Corrective Action (PCA) framework in September 2019, after a spell of scorching growth left it with gross non-performing assets of 17.3 per cent and a Tier 1 capital ratio of 4.46 per cent — well below regulatory requirements. Abortive attempts to merge with one non-bank and get an equity infusion from another, amid a leadership vacuum, underlined its problems. It is baffling that the RBI let the bank muddle through such prolonged problems without stepping in. In the event, it is good that the central bank has finally acted, imposing a 30-day moratorium and offering depositors some indication of the way forward, by proposing a resolution plan where LVB’s assets and liabilities will be merged into DBS Bank India. While depositor claims will be fully protected, LVB’s equity share capital and reserves will be fully written off.

It is obvious that the RBI and Centre now have a well-rehearsed script to bail out ailing commercial banks after the YES Bank and Global Trust Bank episodes, but such rescue packages suffer from obvious shortcomings. The ideal resolution for any distressed commercial entity should entail a comprehensive valuation exercise, transparent invitation of bids from interested parties and a final decision involving key stakeholders that maximises their value. But hastily engineered shotgun weddings for commercial banks skip these important steps. With the banking industry in consolidation mode, finding willing suitors every time a commercial bank runs into trouble may prove a tall ask in future. With the need to protect depositors taking priority every time, these expedient rescues leave very little time for the regulator to either launch a forensic audit into the bank’s books or investigate the flaws in its lending practices that led it into a quagmire in the first place. In the Global Trust Bank or YES Bank cases, for instance, there’s still no official account of whether it was related party loans, negligence or plain misjudgement that led to the rapid bad loan build-up.

A thorough investigation into the affairs of failing banks, even if post mortem, is critical for both the regulator and stakeholders in banks to learn useful lessons that can help them spot and pre-empt failures in future. It also seems unfair that every time a commercial bank is rescued, equity shareholders are called upon to take a complete haircut on their holdings, with no questions asked. Of course, in the dissolution of any commercial entity, claims of equity shareholders always rank last after all other classes of creditors and stakeholders. But, then, as the true owners, they are certainly entitled to full disclosure on what went wrong at the entity they invested in and the valuation exercise that reduced their residual value to zero.

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Published on November 18, 2020
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