RBI's out-of-the-box solutions may strengthen India's banking sector

Whether YES Bank, PMC Bank or LVB, year 2020 has seen the regulator taking market-oriented solutions to rescue failed banks

Beleaguered lenders YES Bank, Punjab and Maharashtra Co-operative Bank (PMC Bank), and Lakshmi Vilas Bank (LVB) have a common link, besides being troubled names. 

When in deep distress, the Reserve Bank of India (RBI) did not go for the tried-and-tested measure of merging them with a public or private sector bank. Rather, it took a different approach towards their rescue. In the case of YES Bank, State Bank of India took only 49 per cent stake (with private lenders acquiring a smaller stake) to ensure stability. PMC Bank, placed under moratorium in September 2019, stunned many by welcoming applications from investors to convert to a small finance bank (SFB), this month. 

This follows the RBI’s directive to allow such co-operative banks to convert to an SFB, this year. PMC Bank could be an interesting test case if quality investors show interest. Depositors of PMC Bank have the option to convert their deposits to equity.

Likewise, the solution for LVB has been no less out of the box. While the regulator has allowed India-incorporated foreign banks to take 10 per cent stake (or higher in case of extreme distress), LVB’s proposed merger with DBS Bank India will be the first of its kind.  “Considering the RBI’s conservative stance in the past, we are pleasantly surprised by this move,” says Suresh Ganapathy of Macquarie Capital.

For Nilesh Shah, MD and CEO of Envision Capital, market-oriented solutions framed with the objective of retaining institutional flavour will go a long way in protecting and attracting investors’ interest in banks. While the RBI has identified stakeholders whose interests are most important, it has placed equal weight on the entity, though this stand is presently being debated. However, some introspection is important.

YES Bank was a widely held entity, with foreign and domestic institutional investors holding 28.5 per cent stake and non-institutional investors holding over 43 per cent, as of December 31, 2019. 

Experts say once a moratorium is imposed on a bank, the interest of equity investors need not be the RBI’s top concern.  “However, had equity investors been wiped off a stock once the darling of foreign investors, it would have — considering its position in the pecking order — led to other banks losing their appeal too,” says a person privy to the developments in YES Bank. Since covenants of additional tier-1 bonds permitted a markdown, the RBI chose to exercise the option. In LVB’s case, Shah says the ownership pattern doesn’t merit a YES Bank-style solution. “If equity investors have put in risk capital, they will have to pay a price for it,” he argues. LVB’s negative net worth position also justifies the delisting decision.  Many say it was this differentiated approach that set these resolution mechanisms apart. “DBS Bank India is a well-regulated institutional investor that will protect LVB’s depositors,” says Shah. However, will these out-of-the-box efforts yield results. Ananth Narayan, an international banking expert now on the YES Bank board, says we need to give these solutions some time. 

“Rome wasn’t built in a day,” he said. While global precedents like Lehman Brothers, Bern Sterns, and Merrill Lynch were examples of disbanding key assets to investors and a bunch of banks bailing them out subsequently, Narayan points out that not all have been successful.

Back home, he lauds the RBI’s efforts to stitch new solutions but feels the marriage wouldn’t have happened without the moratorium being imposed. “Whether YES Bank or LVB, there was market interest. Yet, nothing went through without the RBI’s intervention.”  How can deals happen in the natural course if investors are hazy about the quality of banks, he questions.

Nevertheless, he is hopeful that these small steps should lead to the most talked about Financial Resolution and Deposit Insurance (FRDI) Bill becoming a reality soon. Without a strong resolution mechanism, investors may remain sceptical about signing big cheques.  “The practice of depositors leaning on the RBI’s assurance, while being lured by banks offering 8-10 per cent interest, is questionable,” says Narayan.

THE BAILOUT PLAN

March: YES Bank

>SBI and 7 other pvt banks took 75 per cent stake in YES Bank

>Existing shareholders holding 100 or more shares imposed with 3-year lock-in

>In July, the bank raised Rs 15,000 crore of fresh equity through FPO; Tilden Park was allotted 9.9 per cent stake 

 PMC Bank

>In November 2020, the bank called for application from investors to convert to a SFB

>Potential investors to submit EOI by Dec 15

>PMC Bank was placed under moratorium in September 2019

 Lakshmi Vilas Bank

>On Tuesday, RBI proposed a merger with DBS Bank India, a locally incorporated subsidiary of DBS Bank, Singapore

>This is the first case of exploring a locally set-up foreign bank to acquire an Indian bank

>Draft guidelines indicate that existing equity share capital may be written down