Bank failures have achieved a hat-trick within a short period: the PMC Bank, YES Bank and now Lakshmi Vilas Bank. The LVB episode is not an isolated one and has macro implications, especially in the context of the ‘overcrowded’ banking landscape of southern India.

At March-end 2019, that is, before the latest round of PSB mergers, six out of 17 PSBs were headquartered in the South, and so were nine out of 12 ‘old’ characteristically small private banks. Too many banks create too many problems and this should evoke some proactive, practical and timely thinking on the part of all stakeholders.

As the recently released RBI Report of the Internal Working Group to Review Extant Ownership Guidelines and Corporate Structure for Indian Private Sector Bank observes, “differing regulatory regimes … have the potential to raise concerns about uneven playing fields as well as scope for regulatory arbitrage.” As in the case of PSBs, consolidation of ‘old’ private banks must be seriously considered, some of which have substantial foreign investment.

Three types of ownerships — the state-owned (PSBs), the privately-managed, newly-licensed (NPvBs) and the old private sector community-dominated banks (OPvBs) — characterise the banking space. The first set of NPvBs became operational in 1994 and the second set in 2015. The OPvBs comprise those private banks that existed before 1969 but were not nationalised. The OPvBs continue to be regional in character and much smaller than both sets of NPvBs. Over time, the PSBs have been yielding market share to the NPvBs. The share of the former’s deposits and advances fell to 66 per cent and 61 per cent in 2019 from 78 per cent and 76 per cent in 2012, respectively. As recommended by the Narasimham Committee (1991), the Central government has started consolidating PSBs, collapsing the SBI and its Associate Banks into a single entity and merging several nationalised banks among themselves.

The new generation private sector banks, over the years, have acquired many NPvBs and OPvBs to fuel their growth inorganically and increase market share.

Concentration risk

As against 36 OPvBs in 1970, there were just 12 by March-end 2020. Out of these 12 OPvBs, nine are headquartered in the South: four each in Kerala and Tamil Nadu, and one in Karnataka.

At March-end 2020, 7,158 or 85.7 per cent of their total 8,350 branches were located in the Southern region. Of the total branches in the Southern region, 52.6 per cent belonged to just two States — Tamil Nadu (29.3 per cent) and Kerala (23.3 per cent). The Karnataka Bank Ltd, which had the largest branch network among the nine, had 87.6 per cent of its branches in Karnataka alone.

Consequently, the businesses of these banks grew around the southern region and within the region, in the above-mentioned three States. Moreover, their businesses, especially loan exposures were similar across the region as well as sectors. Advances to the services sector dominated in seven out of eight banks. Almost a third of the outstanding advances was concentrated in this sector with a range of 19-46 per cent over the banks.

Thus, they constituted a source of concentrated risk, not only for the region but also for the sectors financed, which can be easily contagious in the event of a crisis. The contagion can exacerbate if such small banks are fairly interconnected, which is likely due to their geographical contiguity. However, their small size may not produce any systemic impact.

Size question

In banking literature, the connection between size of a bank and its vulnerability is an unsettled issue. However, compared to their bigger counterparts the smaller banks lack capital strength to withstand onslaughts from risks not paying off. While big bank failures can generate a systemic impact, the smaller ones damage the regional economies faster and more. In the case of failures, smaller banks are easily allowed to perish, whereas the bigger ones are considered ‘too-big-to-fail’.

At March-end 2019, the combined balance sheet size of the nine OPvBs in the Southern region stood at ₹5,476 billion constituting just 3.5 per cent of the combined balance sheet size of the domestic SCBs. Their net worth totalled ₹434 billion accounting for 3.8 per cent of that of the domestic SCBs.

Deposits at ₹4,723 billion constituted 86 per cent of their total liabilities (domestic SCBs: 79 per cent) and 10.9 per cent of net worth (domestic SCBs: 10.7 per cent). Thus, these banks were highly leveraged through deposits.

Advances at ₹3,725 billion constituted 68 per cent of the total assets (domestic SCBs: 60 per cent). The C:D ratio stood at 7.9 per cent (domestic SCBs: 7.6 per cent).

Thus, their assets composition was more tilted towards advances compared to domestic banks.

On an average 6.7 per cent of the total deposits in the eight banks was concentrated with the 20 largest depositors. Two banks had it at 10 per cent each and one at almost 20 per cent. In the case of advances, nearly a tenth of the total advances was with the 20 largest borrowers. For four banks, it ranged between 12.7 per cent and 15.9 per cent. Higher levels of concentration, especially in advances, proves deleterious if such loans fail.

Considering the nine OPvBs, the average GNPA ratio steadily increased during 2015 to 2019, from 2.38 per cent to 5.20 per cent. In three banks, the ratio was very high, ranging between 7.47 per cent and 15.3 per cent. Only two banks had the ratio below three per cent each.

Now is the time

There is a dire need for consolidation in the banking space. . PSBs’ mergers, with the best intentions, can be procedural/technical in nature, mostly based on synergy, capital adequacy and tax planning/credits.

In OPvBs, however, the arduous task of match-making is to be done by the regulator, largely based on commercial considerations.

Consolidation of OPvBs is necessary at this juncture. Well-run NPvBs and some foreign entities may be open to acquisitions, and the central bank could consider this step as one of the best ways of restructuring. But the sooner it is attempted, the better it is for the banking industry.

Baby bank failures are already a reality with the regulator having placed/extended 80 UCBs under ‘directions’ during 2019-20 and counting further, it runs to over 50 during 2020-21 hitherto. Trust has to be restored. Instead of waiting for the inevitable, the central bank should pursue amalgamating the vintage banks with stable ones when the going is good.

Rath is a former Chief General Manager of the RBI and Das is a former economist with SBI. (Through The Billion Press)