It seems there’s no stopping persistent bank failures in India. Over recent years, there this has happened across categories of banks: public sector banks (IDBI Bank), new private sector banks (Yes Bank) and cooperative banks (PMC Bank and several others). The failures have even reached the shores of NBFCs (IL&FS) and housing finance companies (DHFL).
Post Diwali, we saw yet another bank failure as the Reserve Bank of India (RBI) announced the amalgamation of Lakshmi Vilas Bank (LVB) with DBS India, a subsidiary of DBS Singapore. On the same day, RBI issued directions to Mantha Urban Cooperative Bank Ltd to not accept deposits and give loans.
RBI classifies LVB as an Old Private Sector Bank (OPSB). Thanks to RBI’s move with LVB, suddenly this category of private banks — distinct from new private sector banks that came into being post 1994 — has come into the spotlight. At the time of bank nationalisation in 1969, there were 50 OPSBs; today there are only 12 such banks. Over the same period, the share of OPSBs in total banking assets has also declined from 6.6% to 4.4%.
There’s a strong regional focus to this listing (see chart). Nine of the dozen are from the three southern states; Karur and Thrissur have served as headquarters of five banks. Most of these banks continue to have a large percentage of branches still in the home states. Most of these banks started as community banks, as suggested by their names like Catholic Syrian Bank, Karur Vysya Bank, Tamilnad Mercantile Bank and so on.
The average age of these banks is 95 years; in fact 10 of these banks are older than the RBI. These banks have survived many twists and turns, from independence, bank nationalisation and the 1991 reforms.
While capital adequacy ratio remains comfortable in most of the OPSBs barring LVB, other indicators are weak. The net NPA ratio is high in Karur Vysya Bank, Nainital Bank and J&K Bank. Return on equity is negative for Catholic Syrian Bank, and low for Dhanalakshmi Bank and Karur Vysya Bank.
Comparing OPSBs with other peer groups, we can see its staff expenses equal those of public sector banks. The return on equity in OPSBs has declined and lagged that of New PSBs. In fact, the OPSBs are closer in performance to public sector banks who suffer from several government mandates and constraints.
This is not a new problem. The RBI in its fourth history volume (1981-97) had identified several problems with functioning of the OPSBs: “Apart from general problems like low capital base, large load of sticky advances/loan losses, low profitability and inadequate provisioning for bad loans, private sector banks were also beset with special problems that affected their performance and their ability to continue as viable units in the long run.”
Given that old PSB’s overall small share in Indian banking is small, why should RBI focus on these banks?
Clearly, problems persist in the OPSBs beyond LVB. Some of the other banks such as Catholic Syrian Bank, Dhanalakshmi Bank etc, are suffering as well. The localness of these banks and concentration of their branches in home states also poses unique problems as bank runs can spread much quickly.
We have learnt from the global financial crisis and India’s own banking and NBFC troubles that failure of a small financial entity could pose problems for the entire banking system. A problem in one entity spreads to the entire system relatively quickly. Of course, there’s high uncertainty due to the ongoing crisis post covid-19 which makes the system highly vulnerable.
Lakshmi Vilas case
Interestingly, there are precedents of an old PSB being taken over by a foreign bank. In 2002, Vysya Bank was officially taken over by ING and became known as ING Vysya Bank. Of course, barring foreign bank participation, the contours of this transaction were very different. Moreover, ING exited in 2014 by selling the bank to Kotak Mahindra Bank. Then, in 2019, Canada based Fairfax India Holdings Corporation (FIHC) bought 50% of Catholic Syrian Bank after getting an approval from RBI after a long wait.
LVB was close to failure in 2019 itself. The bank was also placed under RBI’s Prompt Corrective Action (PCA) framework in September 2019. In the quarter ending September 2020, LVB incurred losses worth ₹397 crore, more than its capital of ₹336 crore. On top of losses, the bank had gross NPAs of 24.5% of advances.
As a result, RBI in its recent press release noted that: “The financial position of The Lakshmi Vilas Bank Ltd has undergone a steady decline with the bank incurring continuous losses over the last three years, eroding its net-worth. In absence of any viable strategic plan, declining advances and mounting NPAs, the losses are expected to continue.” Apart from financials, the bank has suffered from serious mis-governance with shareholders rejecting reappointment of several top management officials.
In February 2019, DBS decided to convert its India operations into a wholly-owned subsidiary giving the former an independent status. DBS Bank India Ltd (DBIL) has a total capital of ₹7,109 crore, amounting to capital adequacy ratio of 16% and Gross NPA ratio of 2.7%. DBIL will bring additional capital of ₹2,500 crore to support the amalgamation.
Given the poor financials, DBIL agreeing to amalgamate LVB is a brave and risky strategy. DBIL has opted for a digital strategy in India which they call as “Phygital” and have tagged themselves as digibank. LVB could provide a southern footprint to DBIL but is unlikely to match the technological prowess of the latter. There could be cultural challenges as well.
One could see this amalgamation in two other ways. First, RBI seems to be confident of giving subsidiary foreign banks equal rights to amalgamate banks as other Indian banks. RBI recently released a report of its working group on ‘Ownership Guidelines and Corporate Structure for Indian Private Sector Banks’. The report has argued that large corporates (and large NBFCs) may be allowed as promoters of banks (allowed to convert into banks).
This decision is going to be controversial as we have had industries owning banks in the past but these banks were seen as serving their owners. This was one of the major reasons for bank nationalization as well. However, by allowing foreign banks to take over Indian banks one can avoid this criticism, and yet allow the banking sector to benefit from increased competition.
Second, this deal could be seen as a way to further cement India-Singapore ties. The recent conflict with China and pandemic has led to scramble for new alliances. Singapore has been a stable partner for India. DBIL may be a very small entity in India (just 0.35% of Indian banking sector) but is a major Singapore bank and also indirectly controlled by the government.
Singapore is a world-class financial centre and one can leverage these decisions to shape India’s own international financial services centre in Gandhinagar.
The governance factor
In its fourth volume of history, RBI noted that OPSBs suffered from “business rivalry of the dominant controlling groups”and “interference in day-to-day affairs by directors”. In 2014, the Nayak Committee on governance in banks echoed similar thoughts. The committee noted that some OPSBs have made progress, in others “the community hold remains intact, either tacit or explicit”.
The report laid out the concerns: these banks have the designation of a ‘promoter director’ who controls everything around the bank: shareholder voting, the board and the employees. The CEO’s role is of a figurehead. The committee had noted that RBI should attempt to diversify bank boards and mandate prior RBI approval for directors in such banks.
RBI has tried to implement the suggested changes in governance of the OPSBs. Of the 10 listed old PSBs (Tamilnad Mercantile Bank and Nainital Bank are not listed), six have 100% public ownership: City Union Bank, Karnataka Bank, Dhanalakshmi Bank (DLB), South Indian Bank, Federal Bank and RBL Bank. In this way, RBI has ruled out the role of ‘promoter director’.
In the other four, there are diverse promoter ownership. J&K Bank’s promoter is the government (68.2%); CSB’s promoter is FIH Mauritius Investments (49.7%); both Karur Vysya and LVB have local promoters (2.1% and 6.8% each). In case of LVB, we saw how the promoter director was voted out by its shareholders.
Apart from the promoters, we have two broad categories: institutions and individuals. In the institutions category, we mainly have mutual funds, insurance companies and Foreign Institutional Investors (FIIs). Three banks have either zero or very little ownership by mutual funds: DLB, South Indian Bank and J&K Bank. Five banks have zero or little ownership by insurance companies: DLB, South Indian Bank, J&K Bank, Catholic Syrian Bank and City Union Bank.
FIIs have been kinder. The average shareholding of FIIs in the dozen is 14.5% with a low of 3.2% in Catholic Syrian Bank and high of 34.4% in RBL Bank.
In the individual category, shareholding in the 10 banks averaged 44%, with a low of 18.7% in Catholic Syrian Bank and high of 79% in Karnataka Bank. In DLB and South Indian Bank, an NRI owns 19.1% and 9.1% of the bank respectively. In DLB, South Indian Bank and Catholic Syrian Bank, an NRI owns 19.1%, 9.1% and 2.1% of the banks respectively.
This share-ownership analysis shows that despite reforms, there is a long way to go in cleaning up the OPSBs. Clearly, mutual funds and insurance companies have already voted on the performance of some of these banks.