LVB deal presents new M&A battleground
After Diwali, we witnessed another bank failure as the Reserve Bank of India (RBI) announced the merger of Lakshmi Vilas Bank (LVB) with DBS India, a subsidiary of DBS Singapore. On the same day, RBI instructed Mantha Urban Cooperative Bank Ltd not to take deposits and make loans.
RBI classifies LVB as a former private sector bank (OPSB). Thanks to RBI’s transfer with LVB, this category of private banks – distinct from the new private sector banks created after 1994 – suddenly came to the fore. When the banks were nationalized in 1969, there were 50 OPSBs; today there are only 12 such banks. During the same period, the share of OPSBs in total bank assets also decreased from 6.6% to 4.4%.
This list has a strong regional focus (see graph). Nine of the dozen are from the three southern states; Karur and Thrissur served as the 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 out as community banks as suggested by their names like Syrian Catholic 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, independence, bank nationalization and 1991 reforms.
While the capital adequacy ratio remains comfortable in most OPSBs except 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.
By comparing OPSB with other peer groups, we can see that its personnel costs are equal to those of public sector banks. The return on equity of the OPSBs has decreased and is lower than that of the new PSBs. In fact, OPSBs are closer in performance to public sector banks which suffer from several government mandates and constraints.
This is not a new problem. The RBI in its historic fourth volume (1981-97) identified several problems in the operation of OPSBs: Private sector banks also faced particular problems which affected their performance and their ability to remain viable units in the long term. . “
Given that the small overall share of the former PSB in indian bank is small, why should the RBI focus on these banks?
Obviously, problems persist in OPSBs beyond LVB. Some of the other banks such as Syrian Catholic Bank, Dhanalakshmi Bank, etc. also suffer. The location of these banks and the concentration of their branches in the home states also pose particular problems, as bank runs can spread very quickly.
We have learned from the global financial crisis and the banking problems of India and the NBFC that the failure of a small financial entity could cause problems for the entire banking system. A problem in one entity spreads relatively quickly throughout the system. Of course, there is great uncertainty due to the ongoing post-covid-19 crisis that makes the system very vulnerable.
Lakshmi Vilas case
Interestingly, there are precedents for a buyout of an old PSB by a foreign bank. In 2002, Vysya Bank was officially acquired by ING and became ING Vysya Bank. Of course, except for the participation of foreign banks, the contours of this operation were very different. In addition, ING withdrew 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 obtaining RBI approval after a long wait.
LVB was close to failure in 2019 itself. The bank was also placed under the RBI’s Rapid Corrective Action (PCA) framework in September 2019. During the quarter ending September 2020, LVB suffered losses of an amount ??397 crore, more than his capital of ??336 crores. In addition to the losses, the bank had gross NPAs of 24.5% of the advances.
As a result, RBI in its recent press release noted that: “The financial condition of Lakshmi Vilas Bank Ltd has suffered a steady decline, with the bank recording continuous losses over the past three years, eroding its net worth. In the absence of any viable strategic plan, declining advances and growing NPAs, the losses are expected to continue.
In February 2019, DBS decided to convert its activities in India into a wholly-owned subsidiary, giving the former an independent status. DBS Bank India Ltd (DBIL) has a total capital of ??7,109 crores, representing a capital adequacy ratio of 16% and a gross NPA ratio of 2.7%. DBIL will provide additional capital of ??2500 crore to support the merger.
Given the bad financial situation, DBIL agrees to merge LVB is a courageous and risky strategy. DBIL has opted for a digital strategy in India which they call “Phygital” and have identified themselves as digibank. LVB could provide a southern footprint for DBIL, but it is unlikely to match the latter’s technological prowess. There could also be cultural challenges. .
We could see this merger in two other ways. First, the RBI seems convinced to give foreign subsidiary banks the same rights to merge banks as other Indian banks. RBI recently released a report from its working group on “Ownership Guidelines and Corporate Structure for Indian Private Sector Banks”. The report argued that large corporations (and large NBFCs) can be licensed as bank promoters (allowed to convert to banks).
This decision is going to be controversial because we have had industries that owned banks in the past, but those banks were seen as serving their owners. It was also one of the main reasons for the nationalization of banks. However, allowing foreign banks to buy out Indian banks can avoid this criticism, while allowing the banking sector to benefit from increased competition.
Second, this agreement could be seen as a way to strengthen ties between India and Singapore. The recent conflict with China and the pandemic have led to the search for new alliances. Singapore has been a stable partner for India. DBIL may be a very small entity in India (only 0.35% of India’s banking sector), but it is a large bank in Singapore and also indirectly controlled by the government.
Singapore is a world-class financial center and one can leverage these decisions to shape India’s own center for international financial services at Gandhinagar.
The governance factor
In its fourth story volume, RBI noted that the OPSBs suffered from “commercial rivalry from dominant control groups” and “interference in the day-to-day affairs of directors.” In 2014, the Nayak Committee on Governance in Banks echoed similar reflections. The committee noted that some OPSBs have made progress, in others “the grip of the community remains intact, tacit or explicit”.
The report exposes the concerns: these banks have the designation of a “promoter director” who controls everything around the bank: the vote of the shareholders, the board of directors and the employees. The role of the CEO is that of a figurehead. The committee noted that the RBI should attempt to diversify bank boards and require RBI pre-approval for directors of those banks.
RBI tried to implement the suggested changes in the governance of the OPSBs. Of the 10 former PSBs listed (Tamilnad Mercantile Bank and Nainital Bank are not listed), six are 100% publicly owned: City Union Bank, Karnataka Bank, Dhanalakshmi Bank (DLB), South Indian Bank, Federal Bank and RBL Bank. In this way, RBI excluded the role of “promoter director”.
In the other four, the property of the promoters is diverse. The promoter of J&K Bank is the government (68.2%); The promoter of CSB is FIH Mauritius Investments (49.7%); Karur Vysya and LVB both have local promoters (2.1% and 6.8% each). In the case of LVB, we saw how the promoter’s director was rejected by his shareholders.
Besides promoters, we have two main categories: institutions and individuals. In the category of institutions, we mainly have mutual funds, insurance companies and foreign institutional investors (FII). Three banks have no ownership or very few mutual funds: DLB, South Indian Bank, and J&K Bank. Five banks have little or no ownership by insurance companies: DLB, South Indian Bank, J&K Bank, Catholic Syrian Bank and City Union Bank.
The FII have been nicer. The average participation of the IFIs in the dozen is 14.5% with a minimum of 3.2% in Catholic Syrian Bank and a maximum of 34.4% in RBL Bank.
In the individual category, the participation in the 10 banks was on average 44%, with a minimum of 18.7% in Catholic Syrian Bank and a maximum 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% respectively of the banks.
This shareholder analysis shows that despite the reforms, there is still a long way to go to clean up the OPSBs. Obviously, mutual funds and insurance companies have already voted on the performance of some of these banks.
Amol Agrawal is Assistant Professor of Economics at the University of Ahmedabad.
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