Issue of Lakshmi Vilas Bank – Prompt Corrective Action

GS 3 Indian Economy Inclusive growth and issues arising from it,planning, mobilization of resources.

Introduction 

         Prompt Corrective Action (PCA)  is a framework under which banks with weak financial metrics are put under watch by the RBI.
        The RBI introduced the framework in 2002 as a structured early-intervention mechanism for banks that become undercapitalised due to poor asset quality or vulnerable due to loss of profitability.

  • aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector

Contemporary Issue:

  • Reserve Bank of India imposed a 30-day moratorium on Chennai based Lakshmi Vilas Bank Ltd (LVB) 
    • and put in place a draft scheme for its amalgamation 
    • since its financial position underwent steady decline and posted loss for the last 3 consecutive years.
  • Under these developments, RBI has imposed the following conditions:
    • RBI has put a cap of Rs 25,000 on withdrawals from the bank.
    • Draft Scheme for amalgamation includes the amalgamation of LVB with DBS Bank India, a subsidiary of DBS of Singapore. 
    • Amalgamation will include all business, assets, estates, rights, titles, etc. of LVB.

Background:

  • LVB shifted its focus from SMEs(Small and Medium Enterprises) to large businesses
    • in 2016-17 and loaned Rs 720 crore against fixed deposits of Rs 794 crore 
    • which later turned into bad loans.
  • In 2018, Religare Finvest sued the Delhi branch of LVB to recover fixed deposits worth about Rs 800 crore that the bank invoked to recover those loans.
  • RBI put LVB under Prompt Corrective Action (PCA) framework in 2019 
    • due to which the bank was not able to issue fresh loans or open a new branch anywhere.
    • Now RBI has formalised a scheme for its amalgamation as mentioned above.

Reason:

  • Erosion of the bank’s net-worth: Deposits has undergone a steady decline, with continuous losses over the last three years.
  • Experiencing low levels of liquidity: Inability to raise adequate capital from market and due to continuous withdrawal of deposits.
  • Increase in Non-performing assets: Almost one fourth of the bank’s advances have turned bad assets
    • Its gross non-performing assets (NPAs) stood 25.4% of its advances as of June 2020.

Types of PRIVATE BANKS in INDIA

  • Old generation Private Banks: 
    • Private banks existed in India at the time of nationalization of major banks but were not nationalized due to their small size or some other reason. 
    • After the banking reforms, these banks got a license to continue 
    • have existed in India along with new private banks and government banks. 
    • Ex: LVB, CUB, KVB etc.
  • New generation Private Banks: 
    • Those who were formed after the bank nationalization. 
    • Ex: Axis, Yes Bank, HDFC.

Amalgamation:

  • Under Section 45 of the Banking Regulation Act
    • a scheme of reconstruction or amalgamation can be prepared by RBI, during the period of amalgamation only.
    • Once the moratorium comes into effect, the bank cannot lend
    • existing depositors cannot withdraw beyond a specified amount.
  • But the practice of imposing a moratorium was seen as disruptive as it carried the risk of undermining depositor confidence in the banks and financial stability.
  • Thus, the government empowered RBI under Banking Regulation (Amendment) Ordinance 2020 
    • to prepare a reconstruction scheme 
    • without having to first make an order of moratorium on barring deposit withdrawals.

Data/Issues facing Private Banking Sector:

  • Collapse of IL&FS(Infrastructure Leasing & Financial Services) in 2018 
    • had set off a chain reaction in the financial sector, leading to liquidity issues and defaults.
  • RBI had earlier this year bailed out Yes Bank through a scheme backed by State Bank of India and other banks
  • Punjab & Maharashtra Co-op Bank was hit by a loan scam involving HDIL(Housing Development and Infrastructure Limited) promoters and the bank is yet to be bailed out.
  • Most of the old generation Private banks do not have strong promoters, making them targets for mergers or forced amalgamation. 
    • For ex: 
      • In Karur Vysya Bank, the promoter stake is 2.11%
      • in Karnataka Bank, there’s no promoter
  • Asset Quality: biggest risk to India’s banks including Private banks is the 
    • rise in bad loans or Non Performing Assets(NPAs) 
    • along with the slowdown in the economy. 
    • Ex: 
      • banks lend to pharmaceuticals and IT seem to have benefited from reduced NPA 
      • those who lend to hospitality, tourism, aviation expect to increase NPA’s further.
  • Regulatory challenges : RBI’s CAR (Capital Adequacy Ratio) and other stringent regulations reduce Private sector banks Alternative investment opportunities
  • HR challenges: 
    • Shortage of experienced and trained private bankers 
    • high attrition levels means that talent is always in short supply
  • Infrastructure challenges: 
    • Lack of appropriate and adequate physical and IT infrastructure is one of the major challenges facing the PB sector in India. 
    • Bank branches are not well equipped 
      • to cater HNIs(High Net Worth Individuals) and UHNWIs(Ultra High Net Worth Individuals).

Way Forward 

  • RBI constituted KV Kamath Committee:
    • recommend on the financial parameters required for a one-time loan restructuring window 
    • for corporate borrowers under stress 
    • due to the pandemic can reduce stressed assets and NPAs not only in private banks but in the entire banking system as a whole.
  • Narashimham committee 
    • recommendation of Introduction of Narrow Banking Concept 
    • where weak banks will be allowed to place their funds only in the short term and risk-free assets 
    • can be followed in Private banks when they face loss for 4 consecutive quarters 
    • instead of RBI step into amalgamation or bailout
  • PJ Nayak Committee: 
    • Splitting the Chairman and Managing Director and 
    • allocating them fixed tenure of 3 to 5 years.
  • Insolvency and Bankruptcy Code should be better utilized and have to complete within the provided timeline.
  • Private banks have to improve their Promoters stake or look out for promoters.

Conclusion 

      With BASEL III norms on the cards Indian Banking sector has to be strengthened especially PSBs but that doesn’t mean the Private can be left out.       
A mutually strong, competitive private banking is the key to push the entire banking system.

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