The rescue act

Yet another financial institution has failed and is being rescued. The Reserve Bank of India (RBI) on Tuesday proposed to merge Lakshmi Vilas Bank (LVB) with the Indian subsidiary of Singapore-based DBS Bank. LVB was also placed under a moratorium by the government for a month and depositors would be allowed to withdraw only Rs 25,000 during this period. According to the plan, the entire paid-up share capital, and reserves and surplus of LVB will be written off. However, the interests of depositors and employees will be protected. In the end, this might look like a smooth process, where the interests of depositors and employees are protected, and a troubled entity is merged with a strong financial institution looking for growth opportunities. DBS Bank has a healthy balance sheet with sufficient regulatory capital. It is also willing to put additional capital in the merged entity to support credit growth. Both the government and the regulator have done well to initiate the process in a synchronised manner — the RBI announced the amalgamation scheme within minutes of the government putting the bank under moratorium. This contained the damage to a large extent. Further, writing off the existing equity sends a strong signal to shareholders in banks that they could be the biggest loser in the case of mismanagement. The RBI has also done well by sending a strong signal that it wants control of banks in strong hands. That explains its decision to allow the Indian subsidiary of a foreign bank to take control of LVB.

However, it would have been better if the central bank acted much earlier as LVB’s financials had been deteriorating over a long period of time. The capital in the bank had practically eroded and gross non-performing assets  climbed to over 25 per cent at the end of the last fiscal year. It was also fairly clear that the bank was finding it difficult to raise capital. In fact, the shareholders of the bank in September voted against the reappointment of several board members and the chief executive. The LVB failure is not an isolated incident. There has been a series of failures of banks and financial institutions in recent times, including Infrastructure Leasing & Financial Services (IL&FS), Punjab & Maharashtra Co-operative (PMC) Bank, Dewan Housing Finance Corporation Ltd, YES Bank, and now LVB.

This raises concern over the delay in the central bank’s intervention. In the case of PMC Bank, the fraud was detected late, and in the case of IL&FS, YES Bank and LVB, the problem was allowed to fester for far too long. In YES Bank, questions over the management’s repeated claims of raising capital have been doing the rounds for some time. The annual inspections by the central bank, which are supposed to detect warning signals on what’s beneath the numbers, perhaps need to be much more robust. 

The need for effective supervision in the financial sector cannot be overemphasised. There would always be institutions that will fail over time, but the need is to take corrective measures in time to minimise their impact on the system and stakeholders, such as depositors. The regulator is trying its best to improve the entire supervision framework, something that’s urgently needed for taking quick corrective action in such cases.


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