Lakshmi Vilas Bank: Proposed Resolution Shows a Shift in Stance by RBI and Indian Govt, Says S&P
The Reserve Bank of India (RBI)'s swift resolution of troubled Lakshmi Vilas Bank (LVB) will keep contagion at bay and help maintain stability in the banking system. RBI's decision to consider a foreign bank, beyond just homegrown institutions, to bail out LVB demonstrates its willingness to put control of banking assets in foreign entities, says a note from S&P Global Ratings.
 
The central bank has proposed merging LVB with DBS Bank India Ltd. As part of the proposal, DBIL, the wholly-owned subsidiary of Singapore-based DBS Bank Ltd will inject Rs25 billion into the merged entity to support its financial position. 
 
S&P Global Ratings says it believes this deal is positive for India's banking sector and will bring the much-needed relief to LVB which has been struggling for many years. 
 
RBI had put the private-sector lender under prompt corrective action (PCA, or under watch by the central bank) in September 2019, and the search for a white knight had been on since then. "We believe the RBI took into account DBIL's healthy balance sheet and capitalization when considering potential suitors for LVB," the ratings agency added.  
 
Lakshmi Vilas Bank, which has only a 0.2% market share, is the only non-government-owned bank under PCA. Recently, the shareholders of LVB at their annual meeting ousted seven directors of the Bank, including its managing director and chief executive (CEO). RBI had to step in and appoint a panel comprising three independent directors.
 
S&P says, "We have always viewed the Indian government as highly supportive of the banking sector. The government has consistently supported weak commercial banks by promoting the merger of distressed institutions with stronger lenders. It has historically not allowed commercial banks to fail and has swiftly stepped in to address trouble. In this case also, the RBI and the government stepped quickly to prevent any loss to the creditors, including depositors, and maintain system stability." 
 
In the bailout of private sector Yes Bank Ltd earlier this year, the RBI called upon government-controlled State Bank of India (SBI) and other large Indian banks for capital support.
 
According to the ratings agency, the acquisition of LVB will not materially affect the financial position of DBS. LVB is small when compared to DBS, accounting for less than 1% of the group's total assets.
 
"That said, LVB will significantly expand DBIL's footprint in India. As of 30 September 2020, LVB had 563 branches, compared with DBIL's 27. The merger could provide a DBIL with meaningful physical presence, which we believe is needed to complement the digital strategy the bank is already pursuing in India. LVB will also help DBS penetrate deeper into southern parts of India," S&P added.
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    COMMENTS

    Udayan Dasgupta

    1 week ago

    How are such deals arrived at? Is there competitive bidding?

    DBS's Ratings Not Immediately Affected by Takeover of Lakshmi Vilas Bank: Fitch
    The proposed takeover by Singapore-based DBS Group Holdings Ltd of India's The Lakshmi Vilas Bank Limited (LVB) is not sufficiently large to immediately affect DBS's credit ratings, says Fitch Ratings. However, the ratings agency says, it signifies about the bank's growth strategy that could shape its earnings and capitalisation risks over the medium term and potentially alter its credit profile.
     
    DBS established 21 new branches in India in 2019 for a total of 33, but the proposed transaction will add as many as 563 branches, a greater number than that of all other foreign banks in India put together. LVB's network is focused in south India, with three-quarters of its branches located in three states - Tamil Nadu, Andhra Pradesh and Karnataka. 
     
    Fitch says, "We regard LVB's branches as one of its most coveted residual assets for a foreign buyer and believe the ready-made platform that will enable deeper market penetration is the key draw for DBS."
     
    According to the ratings agency, DBS pivoted to a hybrid physical-digital approach after incorporating a local subsidiary in 2019 and aims to build out more than 100 physical touchpoints across India by the end of the year, having previously emphasised a digital banking model. 
     
    "The proposed acquisition dovetails with the bank's stated strategy and could significantly accelerate its ambitions in India upon successful integration to help it reap growth opportunities in the medium term. LVB's balance sheets amount to less than 1% of DBS's risk-weighted assets (RWA), assets and equity, meaning it will not immediately affect the group's asset quality, profitability or capitalisation and, consequently, its credit ratings," Fitch added.
     
    India's banking system is under significant stress and Fitch says it has a negative outlook on the operating environment, whose factor midpoint of 'bb' is eight notches lower than Singapore's 'aa-'. The net loans of DBS Bank India Ltd, DBS's onshore subsidiary, made up less than 1% of the group's loan portfolio at end-June, but should this proportion increase materially in the next few years, it could weigh on the bank's blended operating environment factor score, on which Fitch already have a negative outlook.
     
    According to the ratings agency, a weaker assessment of DBS's operating environment into the 'a' category would have significant ramifications for its financial profile and would almost certainly lead to a downgrade of its standalone credit ratings. 
     
    "We do not envision its Indian business expanding at such a pace, but we are watchful if the proposed LVB acquisition is a harbinger of aggressive balance sheet expansion - whether organically or inorganically," Fitch added.
     
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    The Time Value of Money
    Human misery cannot be quantified by an inanimate number, such as, “Gross domestic product (GDP) is expected to contract by x% over the next one year.” Human misery is real – it affects every aspect of human existence; social, emotional, economic and mental. 
     
    The ramifications of the COVID pandemic and the all-round deep misery it has caused, and is causing, is being felt by one and all. But is the way relief provided by the government of India by waiving part of the interest payable on loans to a section of borrowers, in any way justifiable – both in terms of what has been done and the way it has been done?
     
    A rupee today is more valuable than a rupee say one year from now, or for that matter a rupee tomorrow – this is what is known as the time value of money.
     
    A rupee in hand today may either be used for consumption or be saved. If used for consumption, it would yield one rupee of satisfaction. If it is saved and invested in an earning asset, the rupee, after one year, would be more valuable than its value today. 
     
    Moreover, the future is always uncertain. If the rupee is not consumed immediately, there is the risk that it might be stolen, borrowed and not returned, lost, or simply lose value due to inflation. Therefore, there are multiple logical reasons why a rupee today is more valuable than the same rupee after the passage of any period of time.
     
    The mechanism used to keep track of the time value of money is by way of interest and discount rates. A practical matter, which has to be kept in mind while calculating interest, is the period for which the interest is to be calculated. Once interest is applied, it becomes part of the dues of the borrower and indistinguishable from the principal dues. 
     
    By convention and tradition, interest calculated at yearly intervals is known as simple interest but when it is calculated at shorter intervals, say monthly or quarterly, it is known as compound interest. It is interesting and pertinent to observe that even simple interest gets compounded at yearly intervals. 
     
    Periodic calculation and payment of interest by borrowers reassures banks and gives an objective basis for evaluating the quality of the loan as well as the quality of the bank’s health. If interest is not being serviced in a timely manner, it is a clear indication that the borrower is either into financial troubles or his inclination to repay his dues has reduced.
     
    Loan contracts are commercial agreements between the borrower and the lender and it is assumed that both are not only competent to enter into the contract but are also doing it without any kind of extraneous pressures. Legal recourse in interpretation or enforcement of commercial agreements is taken only if there is disagreement between the borrower and the lender on the terms of the contract or some of the clauses are considered legally untenable. 
     
    Either party to an agreement may take recourse to legal measures for getting an impartial appraisal and decision on the terms of the agreement or the legality of the contract. Other than that, courts, as a policy, should not, and do not, interfere in the working of legally binding valid agreements. 
     
    For giving relief to a class of people having difficulty in servicing their borrowings, it is understandable, but not necessarily justified, for the government to step in as a result of political pressures. No one would disagree that the cohort availing loans are not only economically and politically powerful but also very vocal. 
     
    However, for the honourable courts to push for waiver leaves one with a sense of disquiet. First, there seems to be no conflict between the borrowers and lenders. If borrowers have difficulty in repayment, they need to approach the lenders for relief who, in turn, have to evaluate the validity of such demands on merits. 
     
    Second, the small sub-set of people, who are able to avail loans in the first place, are in general better placed in life than the rest of the population. They become even better off by having larger capital at their disposal through the borrowing arrangement. If part of the legitimate dues are then waived off, they become still better off. The bigger the loan, the bigger the waiver which, in turn, leads to higher increase in income and wealth inequalities in society – at the cost of all those who have not availed borrowed capital!
     
    Third, it sets a (very dangerous) legal precedent of seeking legal recourse to avoid paying legitimate dues. 
     
    Fourth, the benefit to individual borrowers from waiver of the quarterly compounding effect over two quarters would be marginal compared to the size of the borrowing, but its effect in derailing the maintenance of discipline for efficient and effective operation of financial markets is massive and, ultimately, adversely affects each and every aspect of the real economy.
     
    The time value of money is one of the fundamental truths of life and keeping this in mind is essential for the smooth functioning of our economy and society. It is as fundamental as, say, the law of gravity. Without gravity, none of the planets would be able to maintain their orbits, there would be no regular seasons, evolution as we know it, would not happen. Life without gravity is inconceivable. Similarly, not accounting for the time value of money can lead the entire social and economic superstructure to collapse.
     
    The decision of waiving compounding of interest was something that our esteemed democratically elected government and honourable courts should have given more thought to, before pushing the banks to implement it.
     
    (The author worked with various banks - public, private, and foreign both in India and abroad - for nearly 30 years and is currently on a self-imposed sabbatical to try and understand as to what ails Indian banking and what, if anything, can be done to improve its functioning.)
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    COMMENTS

    Ramesh Popat

    6 days ago

    all categories of borrowers got a big chunk.
    but the middle class who suffered a lot in the year
    are untouched so far. too low deposits rates added
    fuel in the fire. real inflation is much more now.
    will anyone wake up for them?!

    Kamal Garg

    6 days ago

    In the first place, courts should not have intervened in the matter at all. All borrowings are a commercial contract between borrower and lender. If a Government of the day wants to give some relief to its populace based upon some consideration, let the government give such relief and courts have no role to play here. And rightly also, GoI has already announced some relief in the matter based upon their understanding of the issue and the broader social and economic objective in mind, why the courts are still intervening in the matter is not understandable.

    ramaninv1953

    1 week ago

    A Very lucidly written Article.

    sachin_pu

    1 week ago

    This is one of the best articulated piece I have read in recent times. Thank you!

    s5rwav

    1 week ago

    Due to Consistently High Level of Retail Inflation, Purchasing Power of Rupee has Eroded over a Period of Time. Further, Return on Saved Money and Invested is Not Lucrative. As a Result, Commoners Suffer Irrevocably. I am Babubhai Vaghela from Ahmedabad. Thanks.

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