The recent consolidation in the banking sector in India has been prompted more by distress than by strategic moves. To avert the immediate systemic collapse, ailing banks are lifted out of their death pits, promoters are shunted out and new rescuers found. This year itself we saw the bailout of Yes Bank, and now it is Lakshmi Vilas Bank (LVB).
The Reserve Bank of India's decision to hand over a sick LVB to the Indian unit of Singapore-based DBS Group Holdings left many in the industry scratching their heads. That the cash-starved Chennai-based bank would fall off the cliff had become a foregone conclusion ever since it failed repeatedly to raise capital and had bad loans of a malignant size that kept hurting. But DBS Bank as the buyer came as news out of the blue, prompting India's banking unions to protest against the RBI's proposed merger of the 94-year-old local lender with a foreign bank.
Having a foreign bank as the rescuer and gobbler, invited by the RBI, India's banking regulator, is an uncommon development. Never before in the banking history of our country, say critics, has a foreign bank acquired an entire Indian bank in such fashion. There have, in fact, been patches when there were policies against the expansion of foreign banks in India.
"The RBI has acted in stealth. Why did it choose a foreign bank? It is the beginning of many such takeovers by foreign banks," fumed All India Bank Employees' Association (AIBEA) general secretary CH Venkatachalam.
The turn of events raises some important questions: Why DBS Bank India, the wholly owned subsidiary of Singapore's DBS Bank? Why not merge LVB with an Indian public sector bank, or with an Indian private bank for that matter?
Let's begin with the animadversion against DBS or the foreign bank angle. It's not just the unions but also the shareholders who have criticised the RBI's draft scheme of amalgamation. "The RBI has hurt Indian investors to favour a foreign one. It has given LVB to a foreign entity on a platter. At this rate why will Indian investors invest? There is no fair-value analysis, no protocols followed, and the regulator has just gone ahead and used its powers," Srei Infrastructure Finance vice chairman Sunil Kanoria told ETNow. Srei holds 3.34% stake in LVB.
There is the counter side to this argument. LVB should go to a good buyer, there's no disputing that. DBS is the largest bank in Southeast Asia, is well run and well capitalised, there's no disputing that. The senior management of LVB couldn't find an investor or raise sufficient capital for long, there's no disputing that. The lone argument left is that DBS is having foreign parentage. That reasoning in today's context seems weak in the eyes of the government, the banking regulator, and many others.
Unlike other foreign banks except the State Bank of Mauritius, DBS has set up a wholly owned subsidiary in India to pursue ambitions here. The other foreign banks have followed the branch-led model to grow in India. If DBS spreads by weeding out the weak and crippled LVB, it will bring in a conservative discipline in the banking business culture and introduce modern processes. A strong bank in India with modern practices is good for the country, which is aiming to become a $5-trillion economy by 2024.
So, how will the merged entity of LVB with DBS Bank India (DBIL) look like? It will immediately bloat the balance sheet size by 2.5 times, NPAs will halve and capital adequacy will move into positive territory. As on 30 September 2020, LVB stared at a 24.5% NPA (Rs 4,063.27 crore) of its total loans, while net NPA was at 7.01% (Rs 946.72 crore). Capital adequacy was at -2.85%.
DBIL's gross NPA and net NPA, on the other hand, were low at 2.7% and 0.5%, respectively, as on 30 June 2020. The bank's regulatory capital was Rs 7,109 crore and capital-to-risk-weighted assets ratio (CRAR) was at 15.99% (against requirement of 9%). Common equity tier-1 (CET-1) capital, at 12.84%, was well above the requirement of 5.5%.
DBIL will also bring in new capital of Rs 2,500 crore. Even without the infusion of additional capital, the RBI said the combined balance sheet of DBIL "would remain healthy after the proposed amalgamation", with CRAR at 12.5% and CET-1 capital at 9.61%.
"A bailout of LVB was needed as the NPAs were high and the quality of management was circumspect. DBS, which has just 34 branches in India, gets a foothold to expand using LVB's 563 branches and a loyal customer base. The loan book almost doubles. Besides, the DBS investment reflects foreign confidence in the Indian market," said Saumya Agarwal, an independent insights provider who has worked with CRISIL and HSBC Securities.
Could LVB have been a catch for an Indian private-sector bank? The top three-HDFC Bank, ICICI Bank and Axis Bank-are not looking at inorganic growth now. For Kotak Mahindra Bank, the fourth in the league, there is no need to swallow another bank strong in South India, as in 2014 the Uday Kotak-controlled bank had acquired ING Vysya Bank in an all-stock deal valued at around Rs 15,000 crore. The fact is that no Indian private bank showed any interest in LVB.
So, would a public sector bank have adopted LVB? The bank officers' unions-AIBOC, AIBOA, INBOC, and NOBO-have urged the RBI to hand over LVB to a nationalised bank. In the past three decades, failed private banks have always been amalgamated with public sector banks. Global Trust Bank was given to Oriental Bank of Commerce, IDBI Bank went to Life Insurance Corporation of India, Nedungadi Bank was taken over by Punjab National Bank, and Yes Bank was bailed out by the State Bank India. So why not LVB?
"This is for the first time that an old-generation private sector bank is being amalgamated with a foreign bank subsidiary. The country at this juncture needs more public sector banks to cater to the financial needs of the citizens and revive the economy. We demand that LVB be nationalised in national interest. We also demand that the top executives of LVB be held properly accountable for running the bank to ground," the four officers' unions wrote in a note.
Which public sector banks should bell the cat? Ten public sector banks have been merged into four this April, thus leaving them with the top task of synergising processes for at least the next couple of years. Last year saw the amalgamation of Bank of Baroda, Vijaya Bank and Dena Bank.
India now has 12 public sector banks, down from 27 in 2017. There are five anchor banks leading the merged entities, six banks that are independent, and, of course, the State Bank of India (SBI). Out of this 12 public banks, seven are large and five much smaller.
The five anchor banks are Punjab National Bank (merged banks are Oriental Bank of Commerce and United Bank of India), Bank of Baroda (Dena Bank and Vijaya Bank), Union Bank of India (Andhra Bank and Corporation Bank), Canara Bank (Syndicate Bank) and Indian Bank (Allahabad Bank). The six banks that remain independent are Bank of India, Central Bank of India, UCO Bank, Indian Overseas Bank, Punjab and Sind Bank and Bank of Maharashtra.
So which of them is in a position to pick up LVB and not depend on capital infusion from the government? SBI, which is India's largest bank by assets, has its hands full after being saddled with Yes Bank. The other public banks also have very little room to grab more as they need to focus on lightening their NPAs, weighing the impact of an economy weakened further by the coronavirus pandemic, and raising capital.
"Banks have very little desire to do inorganic growth in the current situation. They are struggling with organic growth itself and are cautious when growing their balance sheet at a time when there is concern of new NPA creation. There is also need to raise capital. Consolidation in the sector is being led by stress. Even among public banks consolidation has led to size and scale but no visible improvement in the NPA situation. Covid has added to the deterioration," said Agarwal.
The banks being of different sizes and problems, RBI governor Shaktikanta Das worked on different rescuers for Yes Bank and LVB. In case of Yes Bank, SBI was made to acquire a 48.2% stake for Rs 6,050 crore while a clutch of private banks like ICICI, Axis, Kotak Mahindra and Federal Bank were made to participate in the reconstruction scheme.
"Yes Bank's fund requirement was large even for a strong bank like SBI to support alone. So the RBI's reconstruction scheme outlined a combination of banks to participate," said ICRA vice president and financial sector ratings head Anil Gupta.
SBI, which is required to hold at least 26% in Yes Bank for at least three years, reduced its stake to 30% after the troubled private bank had raised Rs 15,000 crore through a follow-on public offering (FPO).
The RBI's plan in the case of Yes Bank was to provide immediate oxygen, then allow it to grow, and in the end let it stand on its own. Probably the RBI reasoned that the bank was pulled down by its bad corporate loan book and the promoter's linkages, but the other elements of the organisation were in place.
In the LVB case, the RBI had limited options as the bank's financial conditions deteriorated continuously and the shareholders rose in revolt against the senior management. A flurry of events preceding the end was uncomfortable to anyone following the history of LVB, which had initially financed the business community of the people in and around the textile city of Karur in Tamil Nadu and then grown out of its humble origins to be a strong regional player. In India's general climate of shareholder passivism, the unseating of a majority of the bank's board members, including promoter KR Pradeep and interim managing director and CEO S Sundar, was unprecedented. During the coronavirus pandemic, the voting out was conducted at the bank's annual general meeting, held on 25 September via video conferencing.
There is a lesson to learn from the LVB story. The guard of business entities should not end just at the promoter level. Carl Icahn has shown through his shareholder activism how he can bring value to companies that he deems are undervalued and poorly run. But shareholder activism in this case may not be rewarded as it came too late in the day to save the bank.
Fearing the bank's inability "to raise adequate capital to address issues around its negative net worth and continuing losses", the RBI decided to have DBS as the saviour. The draft amalgamation scheme would mean that LVB would come under the fold of DBS and cease to exist.
While Das initially received criticism for being a student of history and not economics, under his tenure two banks of different statures have been saved from burial due to interventions of the regulator. This is not to do away with the argument that the RBI could have possibly stepped in earlier to stem the rot.
Another twist in the tale is that this is a rare occasion in India when a merger has had no compensation given to the shareholders. A close parallel is the acquisition of Global Trust Bank (GTB), which was associated with various financial discrepancies, by Oriental Bank of Commerce (OBC) in 2004. The shareholders of GTB, which included Goldman Sachs and International Finance Corporation, received nothing against their shares as the net worth had turned negative. GTB depositors, however, suffered no loss. But unlike the DBS-LVB deal where two private banks are involved, including the Indian unit of a foreign parent, in the GTB case the acquirer, OBC, was a public-sector bank.
Sixteen years later, the shareholders of LVB will get nothing as DBS subsumes all the assets and liabilities of the Chennai-headquartered bank. This has prompted LVB promoter KR Pradeep to accuse the RBI's draft scheme of amalgamation of LVB with DBS as "smelling of injustice" and to plead that "there can't be zero price for LVB shareholders". In an interview with Indianbankingnews.com, he says that all he is asking for is a valuation to be done and "the RBI should strike a balance between the existing shareholders of LVB and the acquirer".
As matters stand, the RBI has yet to issue the final merger scheme for LVB with DBS. It is likely to do this during the week so as to help complete the resolution for LVB by 16 December. Earlier, the central bank had said that it would receive suggestions and objections on the draft scheme from members, depositors and other creditors of both the banks up to 5 pm on 20 November.
The Fall of Two Banks
Chronicling these strands of historic development without drawing a parallel between Yes Bank and LVB, the two banks to fall this year, will be incomplete as there is much to learn from the way they collapsed. Both were run with different ambitions, stamps of authority and individuality. Yes Bank was also much bigger, younger, modern and pan-Indian while LVB grew from bottom up and stayed regional.
Yes Bank had the stamp of Rana Kapoor, all through. He was the founder-promoter, the main architect, and the chief executive by all connotations. A banker by profession, he turned entrepreneur, led Yes Bank to become the fourth-largest private-sector bank, and wanted to grow it more. He made Yes Bank the banker to the rich people and some of the top corporates; he also brought into his banking net the growing middle-class in India. His shadows ran everywhere in the bank, until he fell. Yes Bank rose and fell, along with him.
Lakshmi Vilas Bank had no such vision, ambitions, skills, or prowess. Though it grew beyond Karur and the state of Tamil Nadu, it never became a banker to the rich class. It mainly catered to the mid-section of the society and the small and medium enterprises (SME).
Started in 1926 by seven progressive businessmen under the leadership of VSN Ramalinga Chettiar, the bank had the mission to cater to the financial needs of the local people who were engaged in various trading businesses, industries and agriculture. The big breakthrough came during 1961-65 when LVB acquired nine small-sized banks to considerably expand its branch network. There were also efforts to grow nationally, and it branched out to the other states of South India. The bank now is spread across the country with a total of 563 branches and 974 ATMs, but is mainly a regional player in the South.
LVB never had the stamp of a single individual power centre. While Kapoor could decide on the fortunes of Yes Bank, Lakshmi Vilas Bank now has 25 promoters owning just 6.8% of the bank. In essence, there are four promoter groups. Pradeep, a chartered accountant and an advocate, came in as a shareholder as late as 2007 and became a director in 2009.
LVB never could transition to a new-age, 21st-century bank. Born in the early part of the 20th century, it did introduce technological innovations and moved from a product-centric to a customer-centric approach. But it is far from being a modern bank with strong digital skills and underwriting processes that DBS, its acquirer, has institutionalised.
Matching the business cultures of the two banks could be challenging. LVB has a more traditional approach to serving depositors and borrowers. Corporate governance issues have also been dogging the bank. DBS, on the other hand, has a very prudent and conservative culture to credit appraisals and underwriting. LVB's 4,100 staff will eventually get pruned and those who remain will have to be oriented to working in a new-age bank, an employee in LVB said.
Yes Bank has never had such issues. The bank was founded in 2004, headquartered in India's commercial capital Mumbai, and Kapoor was a charismatic and flamboyant leader. He had deep connections in the corporate world and the loan book grew from a concentration of borrowers. But these chunky loans, which led to the rapid rise in the asset portfolio, became problematic. It was when these corporate biggies fell from their perch that Yes Bank tumbled. There were allegations of the promoter diverting funds, and he is currently in the jail.
"All the fundamentals of a good organisation are in place. If you just take out the NPA problem on the corporate book, then you have a well-run bank," Yes Bank managing director and CEO Prashant Kumar said in an interview with Indianbankingnews.com.
This is not the case with LVB. Though NPAs ultimately pulled down the bank, there is no evidence yet of fraudulent practices. The largest loan extended to a single company was Rs 200 crore, the credit portfolio was well diversified, and there was no concentration of borrowers. "NPAs came due to faulty business decisions rather than fraudulent practices. But there were corporate governance issues. And a modern organisational structure could not be created," said a senior executive who is no longer with the bank.
The origins of the trouble can be traced to the period when the bank changed its strategy, chased faster growth, and started lending to large companies by participating in syndicated loans. The ambitions to grow large were nursed in 2010 and the bank enjoyed a good run for the next few years. But the NPAs started looking bigger after the RBI introduced in 2016 the asset quality review (AQR) to weed out toxic assets in the banking system. The slide started thereon.
The NPAs started bulging and peaked at Rs 4,233 crore in the year ended 31 March 2020, spread over sectors like steel and infrastructure. "We participated in consortium loans to groups like Reliance Home Finance, Altico, Cafe Coffee Day (CCD) and IL&FS. These loans became problematic. The bank was not mis-run nor was it a victim of fraud. The upper limit of our loan to a single entity was Rs 200 crore," said Pradeep.
It was not just the NPAs that led to the sinking of the bank. Raising capital became more and more difficult amid valuation expectations of the promoters. Provisioning against the NPAs rose to almost 80%, further eroding capital. The bank needed to be on the rescue boat of investors.
"If raising capital was possible during 2017-18, we could have tackled the other issues and also pushed for growth," said a former senior executive of the bank.
The deathblow came when the RBI imposed prompt corrective action (PCA) against LVB in September 2019 due to the high levels of bad loans, insufficient capital to manage risks, and negative return on assets for two consecutive years. This meant the bank had to cut lending to corporates, focus on reducing the concentration of loans to certain sectors, and shrink the balance sheet.
The noose tightened around LVB's neck when the RBI rejected in October the merger proposal of Indiabulls Housing Finance and the bank after examining it for more than six months. Then came the Clix Capital proposal, but it could not conclude and the RBI imposed a one-month moratorium on LVB. It also proposed merging LVB with DBIL as the troubled bank was found to have no credible revival plan.
