The Reserve Bank of India (RBI) recently made news headlines with its decision to impose a 30-day moratorium on the Chennai-based Lakshmi Vilas Bank Ltd (LVB). This move comes in response to the breach of the Prompt Corrective Action (PCA) thresholds, as observed on March 31st, 2019. The RBI has set specific regulatory trigger points as part of the PCA framework. These points pertain to three central parameters – capital to risk-weighted assets ratio (CRAR), net non-performing assets (NPA), and Return on Assets (RoA).
Lakshmi Vilas Bank’s Struggles and Challenges
The LVB episode started unraveling following the Yes Bank crisis in March 2020. Yes Bank’s crisis was a consequence of India’s wider shadow banking issue, leading to the eventual collapse of IL&FS in 2018. Similarly, Punjab and Maharashtra Cooperative Bank also fell victim to a loan scam. Failing to develop a credible revival plan, the RBI decided to impose a moratorium on LVB under the Banking Regulation Act, 1949, to protect the interest of the depositors and to maintain banking stability.
Over the last three years, LVB has faced continuous losses, resulting in a decline in its net worth. Almost one-fourth of the bank’s advances have turned into bad assets. LVB has also struggled to raise sufficient capital to remedy these issues. Concurrently, serious governance concerns have led to further deterioration in the bank’s performance. LVB, like many such banks, lacks strong promoters, making them potential targets for mergers.
Rising NPAs and Investor Impact
The bank’s gross non-performing assets (NPAs) were at 25.4% of its advances as of June 2020, compared to 17.3% in 2019. This inability to raise capital to solidify its balance sheet is majorly due to these rising NPAs. The pandemic is expected to cause an increase in NPAs in the banking sector as cash flows of individuals and companies are affected.
Existing shareholders will face a complete loss on their investments unless there are buyers in the secondary market who may ascribe some value to these. Individual investors will also face a loss on their investments in AT-1 bonds, as per RBI rules based on the Basel-III framework.
Shares of LVB closed at a 20% lower circuit, indicating that there would only be sellers and no buyers. A lower circuit is enforced to temporarily halt trading on an exchange and curb panic-selling.
The RBI’s Measures in Reaction
The RBI closely monitors the performance of private banks and large Non-Banking Financial Companies (NBFCs). In response to LVB’s situation, they imposed a moratorium and capped the cash withdrawal limit at Rs. 25,000. The RBI has also proposed a draft scheme for the merger of LVB with DBS Bank India.
The combined balance sheet of DBS India and LVB will remain healthy after the proposed amalgamation, with Capital to Risk-Weighted Assets Ratio (CRAR) at 12.51% and Common Equity Tier-1 (CET-1) capital at 9.61%. The RBI may require other banks and financial institutions to inject equity capital into the reconstructed entity. In 2019, a bank recapitalisation programme worth Rs. 70,000 crore was announced to help Public Sector Banks boost their capital reserves and enhance credit flow into the economy.
Way Forward: Learning from Past Crises
Bank crises like the one faced by LVB are not new or unique. These problems reflect the inherent issues in the financial sector, including those in real estate, power, and non-banking financial companies. In September 2020, an expert committee headed by K V Kamath recommended financial parameters for a one-time loan restructuring window for corporate borrowers affected by the pandemic. This crisis offers an opportunity for stakeholders to review their existing frameworks and revise them accordingly to meet timely needs.
