Moratorium on Lakshmi Vilas Bank

Lakshmi Vilas Bank was incorporated in 1926 and started its operations in the banking and financial services. It is headquartered in Chennai, Tamil Nadu. The Government has put Lakshmi Vilas Bank under moratorium for 30 days, till 16th December 2020 as it failed to submit any concrete revival plan to RBI. This is third bank after PMC and Yes bank within 1 year to go under moratorium and first one after Pandemic lockdown. Reserve Bank of India this time, was quick to propose revival plan by merging it with DBS bank.

What has led to this liquidity crunch problem?

This banking shock has not occurred overnight. There have been some red flags which investors perhaps missed and kept investing. This bank has been struggling since last 4 years to survive and failed to submit concrete plan for its revival to RBI. There were also governance issues which led to the deterioration of its management.

Since December 2017, Lakshmi Vilas Bank has continuously been booking losses except the March 2020 quarter where it showed a profit of 90 crores, but huge amount of this profits accounted for other incomes. The core business activity was not the contributor to this chunk of profits.

Second major indicator was its ever-risingNon-Performing Assets (NPA) which were approximately 25%. This indicates that almost one fourth of its total assets were NPAs. It is enough for investors to understand the ailing fundamentals of the bank.

As per BASEL norms, Capital Adequacy ratio should be above 12.5%. Lakshmi Vilas Bank’s capital adequacy ratio was -2.4% which was another indicator for investors to exit.

What went wrong in Lakshmi Vilas Bank lending?

Lakshmi Vilas Bank has extended great amount of loan to the corporates. It increased its loan value by recklessly lending to companies. In short run it looks good that this bank has enough money to lend but in longer run when companies were not able to repay on time then all money lent become NPAs causing losses to the Lakshmi Vilas Bank. From 2010 to 2017, the loan book of Lakshmi Vilas Bank has increased 4 times by lending to corporates. Among these lenders were infamous businessman Nirav Modi, Jet airways, Religare, Coffee day Enterprises to whom Lakshmi Vilas Bank lent extensively without proper due diligence. At the beginning of 2018, RBI started putting pressure on Lakshmi Vilas Bank to improve their assets and reduce NPAs, but Lakshmi Vilas Bank could not redeem itself.

Why Government puts banks under moratorium?

Whenever RBI observed cash strapped situation and deteriorating fundamentals persisting in a Bank, then RBI does a quality check of assets and when it finds that a Bank is beyond redemption then it recommends putting the bank under moratorium. As per the recommendation, Finance Ministry then approves the putting of moratorium on the Bank.

Moratorium period is imposed on banks so that they can resolve their structural issues and chalk out a plan for revivalby suspending the services for some period. An Administrator is chosen who uses his expertise of corporate restructuring to revive the bank. Former non-executive chairman of Canara bank, Mr. T. N Manoharan is proposed to be the administrator of Lakshmi Vilas Bank. T.N Manoharan has assured that depositors’ money is safe and merger will be completed before the deadline. He also asked employees not to get panicked as their jobs are secure and their salaries will be paid on time. His top priority is to get the bank on business again.

The route taken by RBI to save the Lakshmi Vilas Bank

RBI, was very quick to bring foreign bank DBS to save the cash strapped Lakshmi Vilas Bank. DBS bank currently operates in India through its wholly owned subsidiary DBS Bank India Limited (DBIL). The Merger of DBS with Lakshmi Vilas Bank will benefit both the banks. ₹ 2,500 crore capital infusion by DBS bank will help Lakshmi Vilas Bank to sustain and in return former bank will get the huge market penetration that Lakshmi Vilas Bank has in India. This ₹2,500 crore capital infusion will help the merged entities to improve their credit growth and sustain in the industry.

Relief to Depositors-Depositors can withdraw maximum amount of ₹25,000 during the moratorium period ending 16th December 2020 until next order comes from RBI. RBI is very careful in safeguarding depositors’ money and it has also assured that depositors’hard-earned money is safe; they do not have to panic. We have observed in case of Yes bank that depositor’s money was safe and moratorium was lifted once the situation became better.

What about the shareholders?

RBI proposed draft has mentioned that it may write off the entire paid up capital. Writing off equity means that shares can turn to value zero, but this is only proposed draft and final draft will come on 20th November 2020. There are lots of debates going on in the market about writing offs. RBI’s main objective is to save the depositors money and in order to do that shareholders and bondholders may have to bear losses. There is a tussle going on between shareholders and RBI as shareholders are demanding a full probe into the matter as their money is going to get wiped out fully. The legal options are there for shareholders to file a suit, but outcome is evident that older shareholders are not likely to get anything.

Lesson for investors

Whenever there is any red flag in banking sector whether it is rising NPAs or declining growth, shrinking solvency ratios etc., investors should not shy away from exiting. Sometimes investors do not invest wisely, and their hard-earned money gets wasted because they did not think about the risk before investing. There should be some framework of ‘know your bank’ to protect the interest of both depositors and investors.

Wise sector-Not even a single Mutual fund invested in Lakshmi Vilas bank as Mutual funds are known for their rigorous risk analyzing capabilities. Mutual Funds prove that they know where to invest and how to invest. They know the importance of investors’ money and that they cannot invest it in loss making entities. They already knew the danger and were successful in reading under the lines when Lakshmi Vilas Bank was making losses continuously. When it comes to knowing the financial markets, no one is better placed than Mutual funds.

So, Kudos to Mutual Funds!