LVB Merger and Banking for Corporates: Decoding the Churn

The Indian banking space is in a state of intense churn.

Not surprisingly, the Reserve Bank of India (RBI) has come under intense public scrutiny for the latest developments on the banking front. Do they portend well for a healthy way forward? Or, do they point to a kind of an avoidable irrationality on the part of the banking regulator?

The merger of Lakshmi Vilas Bank (LVB) with DBS Bank, an Indian subsidiary of a Singapore bank, and the proposal of the internal working group of the RBI to open up the banking space for corporates have come as sweeping statements of intent by a determined authority.

As they play out, these events are already turning out to be change-making events, much to the chagrin of many industry watchers.

The fragility of LVB was never in doubt. Its governance standards over the last few years were poor. These were indeed no secret. Given this backdrop, the RBI did well to step in.

Nevertheless, questions are bound to be raised over the delay in its action. Even leaving aside this though, the RBI will have a lot more to clarify in the LVB issue. The way in which it has set out to solve the problem is curious, to say the least.

An unprecedented merger of LVB with a private bank on terms that are unexplained and claimed to be unjust by many is what sets apart this case.

In this instance, the share value in an amalgamation is set at nil. Also, certain debts issued by the bank are written off fully. However, the depositors are assured full protection. The discrimination defies logic. In the absence of any explanation for this discriminatory strategy, one is likely to let the mind run amok. Already, the shareholders and bondholders have braced themselves for a long drawn out legal battle by moving the Madras high court against the grossly discriminatory act of the RBI.

On the liability side, the depositors are protected but the bondholders aren’t. Nobody is going to grudge the protection of depositors’ money. But the amalgamation scheme as envisaged by the RBI clearly lacks proportionality and logic. In the case of Yes Bank, the shareholders stood protected. Certain Tier-I bondholders were denied any payment, however.

Also read: Why This Is Not the Right Time to Allow Corporate Ownership in Indian Banks

In another example, IDBI bank was rescued and did no damage to any stakeholder. The YES Bank case was different, one may argue. There were whispers around the promoter and the top management of Yes Bank. Questions were also raised about their integrity.

In the LVB case, however, there had been no sound byte on any such major integrity questions. Yet, LVB gets the rawest deal!

When mounting losses erode share capital completely, theoretically it is correct to say that the share has no value. It doesn’t play out that simply in practice, however. Is it right to dictate in this instance that the shares have no value? Can the embedded intangible value of branch network and trained staff be just overlooked? It is clear that this needs adequate explanation by designated experts such as valuers to establish its acceptability.

Unfortunately, the RBI seems to have either given the exercise a miss or has not bothered to share the results of its exercise publicly. One does need to give the RBI a little bit of freedom as these decisions are difficult to judge – whether taken timely or belated.

But the RBI can be faulted for not keeping the room open to professionally assess the residual shareholder value of LVB. Instead, it has gone in for an amalgamation scheme that necessarily requires the share value to be predetermined. If only people inside the RBI had cared to dust the files of the 1970s when banks were nationalised, they could have, perhaps, come out with a structure that would have helped them to manage the LVB rescue better. Clearly, that would have made them leave the issue of computing compensation to the shareholders a post-takeover exercise with sufficient expert inputs.

When banks were nationalised several summers ago, the companies that operated the banks and their shares were not disturbed. The government then rather preferred to set up new companies to take over the banking business carried out by the erstwhile banks with all its assets, liabilities, employees etc. The erstwhile companies remained in existence with their shares, and the compensation for the acquisition was paid to the said companies. This enabled the former owners to dispute and get additional compensation wherever possible and the shareholders of the erstwhile banks chose their own ways of using the compensation amount to their benefit.

Likewise, the banking business of LVB should have been taken over with effect from whatever chosen date leaving the shareholders and the bondholders intact in the existing company i.e. LVB. Subsequent to the takeover, the value of the business can be assessed – whether it carries any residual value or not. In the event the residual value is admitted, the amount could be paid by the transferee entity to the transferor entity i.e. LVB. This could have also kept alive the brand name LVB and helped shareholders of LVB to decide if they wish to carry out some other legitimate business post the transfer.

The RBI action in this instance may have been unavoidable. It may entirely be within the domain of a regulator to pick up a candidate – which is a right entity, in its wisdom, for merging LVB. Nevertheless, the LVB imbroglio reveals that transparency is conspicuous by its complete absence. This failure to lay bare the reasons for doing something or the other is unlikely to help the banking regulator to gain public trust.

As LVB is pushed into the pages of history by an action of the regulator, questions are asked as to why the banking regulator is giving a longer rope for rescuing some bigger NBFCs (non-banking finance companies) who have run up much larger liability vis-a-vis LVB. Dewan Housing, Reliance Capital, ILFS and others are still being rescued! Is there a method in the discriminatory strategy of RBI?

This discrimination will only distort the borrowing cost for NBFCs and nudge them to quit or merge with bank.

Opening wide the bank doors

It is in this light that a proposal put forth by an internal RBI working group proposed for opening the bank doors to large corporate and industrial houses must also be seen. The working group has suggested amendments to the Banking Regulation Act, 1949 to plug leaks before opening up the bank doors.

The proposal has elicited huge thumbs down with many big names such as Raghuram Rajan and Viral Acharya, who piloted the RBI not long ago during the UPA regime, stoutly opposing the move. Will the present dispensation push this proposal through? The sanitisation of the environment in terms of laying out stricter standard operating procedure is a sine qua non before embarking on such an adventure in the banking field.

The more it is opened up, the more regulated banking will become. And, does the present set up in the RBI have enough elbow room to extend its supervisory control over the banking field, which is turning out to be far more complex in terms of playing dynamics.

Watch: Safest Way Is to Not Allow Corporates to Float Banks, but India Is Credit-Starved: SBI Ex-Chairman

Should they be opened to corporate/industrial houses, there should be:

· Minimum nominees of the RBI on the boards of such banks.
· Transparent criteria for appointment of IDs (independent directors).
· Enough IDs on their boards so that the promoters don’t bulldoze their way.
· No voting for the promoter on ID appointment.
· Cap on promoter-director on the board.
· Chairman has to be an independent director.
· The appointment of CEO and executive director should be cleared by IDs and RBI nominees.
· RBI should put in public domain clear guidelines for assessment of fitment.
· There should be a ceiling period for any director on the board including promoter director.
· All transactions between promoters and the bank must have unanimous approval of all IDs and RBI nominees.
· All board and committee meetings must be video-graphed and preserved.

At a time when corporate debts are under stress and cases under IBC (Insolvency and Bankruptcy Code) on the rise, the regulator may have to be a bit circumspect before letting the banking field wide open. Well, the banking space is set to see a major metamorphosis. How will that turn out for the industry as whole? Either way, it could only be action-packed.