RBI must act soon on Lakshmi Vilas Bank to help banking sector




a machine on the side of a building: RBI-India-Lakshmi Vilas Bank


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RBI-India-Lakshmi Vilas Bank

The unravelling of a 93-year-old small private bank is now threatening to destabilise India’s Rs97 lakh crore ($1,3 trillion) banking system.

On Sept. 25, shareholders of Chennai-based Lakshmi Vilas Bank’s (LVB) ousted managing director and chief executive officer S Sundar along with seven directors on allegations of mismanagement and poor governance. Sundar had been appointed to the bank in January this year.

Even though LVB is a fairly small player in India’s financial sector, analysts believe that the timing of this incident could have an outsized impact on the industry. India’s banking system, which is reeling under a spate of corporate defaults, is facing a fresh wave of bad loans triggered by the Covid-19 slump. Besides, the collapse of Punjab Maharashtra Co-operative (PMC) bank, Yes Bank, and IL&FS had riled the financial system over the last two years.

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“The Reserve Bank of India has let the situation at Lakshmi Vilas Bank linger for too long. It cannot afford another accident in the financial sector after IL&FS, PMC, and Yes Bank,” said Institutional Investor Advisory Services (IiAS).

The big banking mistake

The implosion at LVB did not happen overnight. In fact, the decay had been setting in for a long time.

The bank was founded in 1926 by a group of businessmen in the southern Indian state of Tamil Nadu with an aim to finance small businesses in the region. With this principle at its core, the bank continued to grow its loan book gradually, posting decent profits and paying a good dividend to its shareholders.

But between 2008 and 2017, it decided to change its unique strategy and copy what large banks were doing.

At the time, India’s leading private lenders such as ICICI Bank and Axis Bank were focusing on corporate players to expand their loan books. LVB joined the bandwagon and initially tasted success.

It clocked speedy growth by giving loans to large corporates. Between 2008 and 2017, LVB’s loan book rose 515% whereas deposits jumped four times.

However, the strategy backfired badly when a bunch of the bank’s borrowers became defaulters. This led to a sharp increase in bad loans or non-performing assets (NPAs) on LVB’s books.

Now, LVB has an exposure of around Rs2,000 crore to some of India’s largest corporate defaulters such as Nirav Modi, Cafe Coffee Day, Reliance Housing Finance, Religare, Jet Airways Group, and Cox and Kings.

The bank’s gross NPAs stand at a whopping 25.40% of the total book and its tier-1 capital buffer (protection against risky assets) is in the negative territory—way below the Indian central bank’s requirement of 8.75%.

The bank claims that a large chunk of these NPAs is from companies in the infrastructure sector.

Mounting NPAs have taken a massive toll on LVB’s financials as it has to set aside money as provisioning for these bad loans. The high provisioning led to the bank posting losses in three of the last five years.

In September 2019, LVB was put under the Reserve Bank of India’s (RBI) prompt corrective action (PCA) in an attempt to revive it. PCA is a set of operating guidelines created by the central bank for banks with high NPAs, losses, and inadequate capital.

But the programme did not do much for LVC as it continues to grapple with its issues. And the recent vote out by shareholders has only made things worse.

Now, India’s central bank and LVB’s senior leadership must work fast to resolve the management crisis as depositors and investors’ money (pdf) is at risk of being lost forever.

What’s next for Lakshmi Vilas Bank?

While the mass eviction of directors spells uncertainty, analysts believe it’s not all bad because getting rid of an incompetent management team is perhaps the first step towards saving the bank.

The key now is for LVB’s board of directors and senior management to act fast.

In a bid to instil confidence in its customers and shareholders, the bank either needs to raise capital or find a suitable partner that can save it from heading towards insolvency.

Some believe that given its mountain of losses, LVB’s prospects look bleak as of now unless the RBI takes charge. “RBI needs to step in to help the bank to take steps towards recovery,” IiAS said.

The bank is in talks with non-banking financial company (NBFC) Clix Capital for a merger. If the RBI gives a nod to this deal, LVB has a strong chance of survival. However, last year, the RBI had rejected a proposed merger of the bank with Indiabulls Housing Finance, another NBFC.

There has also been some speculation about the RBI asking a large bank to take over LVB.

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