Consolidation in Banking Sector in India
“The Indian banking system could be better off if some public sector banks are consolidated to have fewer but healthier entities, as it would help in dealing with the problem of stressed assets”.
– Urjit Patel, Former RBI Governor
Recently, the 93-year-old lender, Lakshmi Vilas Bank (LVB) made it to the list of recent financial sector failures. After several quarters of waning financials, the lender was placed under a moratorium and is set to be merged with DBS Bank India. While bank failures are not a novel occurrence, the material size and quick succession of financial institutions going under the bus are worrisome.
In the past few years, investors have witnessed the failure of IL&FS, DHFL, Yes Bank, PMC Bank, and now Lakshmi Vilas Bank. IDBI Bank, was on the brink of a collapse by Life Insurance Corporation’s (LIC) capital infusion, thereby taking over a majority stake in the bank. While IDBI Bank’s case maybe is inconsequential in size as compared to India’s financial sector but bank failures, put together, throw up some important lessons for the Reserve Bank of India and the country’s financial sector at large.
While there exist two types of bank consolidations – voluntary and forced, the latter is widely prevalent across continents. Globally, the prime driving force for voluntary bank consolidation activity is a stiff competition that puts focus on synergy, growth and operational efficiency, and profitability. The merger of ING Vysya Bank, having a strong presence in South India, with Kotak Mahindra Bank having a stronghold across West and North India driven by synergy and demonstrated clear economic logic.
However, the latter type of bank consolidation is viewed from the perspective of the resolution of a weak bank and the “too big to fail” principle followed by the authorities. As a result, such mergers and acquisitions have facilitated corporate restructuring leading to the emergence of large banking and non-banking financial institutions both in – size and might.
Section 45 of the Banking Regulation Act, 1949 empowers the Reserve Bank of India (RBI) to make a scheme of reconstruction or amalgamation of a bank with another bank if it is in the depositors’ interest or in the public interest, or in the interest of the banking system as a whole. The operation of the weak bank may be kept under a moratorium for a certain period of time to ensure smooth implementation of the scheme.
Many private sector banks have been merged with other private sector banks or the PSBs under this mechanism. The recently forced matrimony between the Indian arm of the Singapore lender, DBS, and Lakshmi Vilas Bank is a salient example of the applicability of this provision since the onset of the COVID-19 pandemic. Resultantly, LVB will cease to exist and its deposits will appear on the books of the India unit of DBS Group Holdings Ltd., Singapore’s biggest bank.
In hindsight, this approach is a cleaner solution as opposed to the handling of the Punjab & Maharashtra Co-operative Bank Ltd. (PMC) implosion, whose loan book was associated with a bankrupt developer, and more than a year later, the larger PMC depositors remain trapped under RBI’s orders. In another instance of a messy bailout, authorities permanently wrote down $1.2 billion of Yes Bank’s liabilities, wherein the complete loss was borne by Tier 1 bondholders and relied upon State Bank of India for capital infusion.
Such past instances are indicative of the authorities’ past refusal to give a decent burial to a failed institution. However, regulations and notifications passed on account of COVID-19 provide for a convenient regulatory cover to delay recognition of stressed assets, and therefore, the success of such bank consolidations may not be known until March 2022.
Banks as a whole have exhibited sluggish performance followed by an increase in Non-Performing Assets (NPAs) in recent years. As a result, such consolidation or merger of financial institutions can help them ride off troughs with relative ease and bring Indian banks into competition with global banking giants. In the case of DBS-LVB, DBS being Singapore’s largest lender is well-capitalized and has deeper expertise to handle large credits and large NPA, provided the consolidation is well-calibrated and based on sound economic logic.
On the flip side, the merger of a weak bank (here, LVB) with a strong bank (here, DBS) may lead to a weaker merged entity in the event the merger process is handled inadequately. Issues inflicting the weaker bank such as higher NPAs and capital shortages may get transmitted to the stronger banks due to unduly haste or a mechanical merger process. Moreover, the existence of large-sized stressed banks may lead to systemic implications as the governments almost always bail out banks that are “too big to fail” using taxpayers’ monies.
Finally, in view of the above, the RBI must act preemptively when a financial institution has weakened beyond repair. For instance, in the case of Lakshmi Vilas Bank, its books revealed the need for a rescue for over a year, however; the institution was left high and dry to the point of complete capital erosion.
Therefore, the RBI’s decision to broaden the search beyond a “national team” is a good sign and indicates that the regulator wants control of banking assets to be in strong hands. While such forced mergers may be detrimental to the wealth of bidder banks, time shall reveal whether the DBS-LVB merger is fair and equitable to both banks involved in the merger.
Tags: consolidation in the banking industry, consolidation in the banking sector, consolidation in banking sector, banking sector consolidation, financial sector failures