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The plight of India’s banking sector seems to only be getting worse, with Lakshmi Vilas Bank (LVB) being the latest major lender to find itself in a state of crisis. The 94-year-old South Indian financial institution was placed under moratorium by the RBI, while the Central Bank was looking into merging the troubled lender with another institution in order to rescue it.

The Cabinet then approved a proposed merger with Singapore-based DBS Bank who will infuse fresh capital of Rs. 2,500 crores. The entire share capital along with the reserves & surplus will be written off as well.

What went wrong at LVB?

The problems at LVB have been apparent for a few years now, with their losses getting worse year by year. Withdrawals from the bank have been increasing while liquidity has been decreasing. The bank’s non-performing assets (NPAs) stand at a perturbing 25.4% of its total advances as of June 2020, up 8 percentage points from the same time last year. 

The downfall appears to have begun when the bank shifted its focus from lending to small and medium enterprises (SMEs) to larger businesses around 2016-17. In 2017, LVB loaned out Rs. 720 crores to Malvinder and Shivinder Singh (the two brothers who were involved in the Ranbaxy fiasco). The money, however, was taken from two fixed deposits that were in the name of Religare Finvest Ltd. and contained Rs. 400 crores and Rs. 350 crores respectively. All of this was done in collusion with two senior employees at LVB. Religare has filed a lawsuit against LVB and has also filed a complaint against the Singh brothers, which is what led to the RBI placing LVB under moratorium.

Why does the banking sector repeatedly find itself in this position?

Public sector banks in India have a disappointing history of being taken advantage of by sophisticated businessmen. Vijay Mallya and Nirav Modi are notable recent examples. The trend is worrying and reveals certain characteristics of PSBs that need to be addressed if such debacles are to be prevented in the future.

At the heart of it all is an all but too evident existence of incompetency. No one seems to be aware of the suspicious activity going on at these institutions and it is difficult to say where the buck really stops. There is a lack of proper oversight and seemingly passive conduction of one’s daily affairs. It is also the case that many of these employees working at PSB’s do not earn the kinds of salaries that their counterparts at private banks do. Add to this a deceptive individual who can charm mid-level employees and what you have is a simple recipe for an invariable banking calamity.

Bank employees seem to be of the opinion that the big shot clients who come their way run businesses that are ‘too big to fail’. This is the same mentality that led to the financial collapse in 2008. The mentality highlights a certain lack of financial or business acumen. An individual from a well reputed organisation is asking for an enormous loan does not necessitate that the loan will be paid back, or that the venture will be successful. Every business must be treated with the same amount of scrutiny. What this means is that the banking industry in our country needs to do its due diligence and enforce standards and practices acroass the board that raise the level of professionalism.

Another reason is more systemic in nature. Small businesses in India have very poor access to credit. Banks total lending to such enterprises makes up a dismal 5% of their total credit extensions. Indian banks seem to prefer lending large amounts to singular entities instead of lending small amounts to many entities. There is an obvious lack of diversification of risk. This is largely due to a lack of competition within the industry as the RBI is very hesitant to hand out new banking licenses.

 If we zoom out a bit and take a look at the trends in the banking sector over time, certain points emerge to the surface. At present, the number of NPAs in the banking sector as a whole stands at 8.5% of their total assets. This number is expected to climb to 12.5% in 2020-21, with a possibility that it could even rise to 14.7% thanks to the coronavirus. They had been as high as 25% during the mid-90s when India was in particularly bad shape economically, but we managed to bring that figure down to just 2.2% by 2007. The financial crisis that year saw NPAs steadily rise over the next decade.

 Simultaneously, real bank credit growth has stagnated at under 10% between 2014 and 2019. It was 25% during the economic boom of the early 2000s. The issue with the low growth here has to do with the fact that the government primarily relies on monetary policy to spur economic growth, and yet the public clearly remain un-enticed by such an offering. Rising NPAs and falling credit growth are symptomatic of an economy that is struggling. Naturally, the banking sector is at the heart of every economy, and ours is in dire need of reformation.

What could be done to address these issues?

The RBI currently acts as the sector’s watchdog. It regulates the activity and handles any crisis that comes its way. Many of the issues are solved by forcing another, more stable PSB to bail out the one that’s in trouble. The State Bank of India and Life Insurance Corporation have been called into action numerous times. The problem with this is that the cost of the failures of the PSB in question is to be borne by the taxpayer, who is in no way responsible for the crises. It also places undue stress on an institution that is amongst the few in the sector that is actually doing well.

Observers have called for the establishment of a new regulatory authority whose sole focus would be on the banking sector. The new entity will also be responsible for handling cases of fraud and failure. The government passed the ‘Insolvency and Bankruptcy Code’ in 2016 which deals with issues of failures of such institutions.The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002 also addresses some key issues that have to do with allowing a bank to take control of a defaulters collateral assets in order to secure its repayments. The idea, however, is to simplify the framework within which such business occurs.

Currently, the law only allows for firms to be liquidated or merged. This is not a sustainable practice as there are only a few domestic institutions that can afford to take on such burdens. With respect to the LVB case, the RBI has a foreign entity for the bank to merge with, and already there are complaints about culture clashes and a general distaste for foreign presence in long-standing domestic institutions.

The Financial Resolution and Deposit Insurance Bill’s (FRDI) aim was to set up a single regulatory entity, but it got caught up in controversy and was subsequently dropped from discussions. As a compromise, the maximum amount insured for deposits was raised to Rs. 5 lakh. The US, in comparison, insures its depositors up to $250,000, or Rs. 1.75 crores. While we can not necessarily make a direct comparison due to differing standards, the difference between the two is nevertheless striking.

With the number of banking failures over the last few years, the government ought to look into bringing back the FRDI Bill into parliament for discussion, or at least propose an alternative to it.

For comments, feedback and views please write to pavan@bclindia.in 

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