Was the selection of DBS India a rational consideration? Did LVB’s pre-amalgamation valuation justify the denial of compensation to shareholders? These are big questions
On November 17, the Central Government imposed restrictions on the withdrawal of funds from the Lakshmi Vilas Bank (LVB) till December 16, (except for a maximum Rs 25,000 per account as relief to small depositors) on the advice of the Reserve Bank of India (RBI). Plus, the LVB’s Committee of Directors was superseded. The RBI invited suggestions and objections “within three days” on a draft scheme of amalgamation of LVB with DBS Bank India. On November 25, the Central Government approved the scheme proposed by the RBI. The LVB-DBS merger came into force on November 27 and the moratorium imposed on withdrawals was lifted. Foreign banks may operate in India either by having their branches in the country directly owned/operated by them or by creating a wholly-owned subsidiary (WOS) registered here. The Singapore-based DBS Group Holdings Limited has been operating in branch mode since 1994 but switched to WOS model in March 2019.
All the assets and liabilities of LVB now stand transferred to DBS India. By June, DBS India had a sizeable customer deposit base of Rs 24,700 crore, including Rs 5,700 crore as low-cost deposits. It is now busy rebranding LVB branches and ATMs with its logo. The parent foreign bank is expected to bring an additional investment of Rs 2,500 crore. DBS India, with just over 30 branches in the country (most of its business is in the branchless mode) now gets ownership of the LVB’s fixed assets (historical, depreciated cost of Rs 463 crore on March 31, mainly comprising 560 branches and 970 ATMs); cash and investments with the RBI (Rs 1,048 crore on March 31) and other investments (Rs 5,384 crore on March 31). The LVB gets access to deposits of Rs 21,443 crore, including about Rs 6,000 crore low-cost CASA (current and savings accounts) deposits. On the flip side, DBS has to service LVB’s borrowings (Rs 756 crore on March 31). Out of the total advances (Rs 13,828 crore outstanding on March 31), about one-fourth were Non Performing Assets (NPAs). The gross NPA ratio had deteriorated from 15.3 per cent on March 31, 2019 to 25.39 per cent on March 31 this year and remained high at 24.45 per cent on September 30.
While the LVB’s 20 lakh depositors and 4,000 employees can heave a sigh of relief, its over 97,000 investors have been hit hard. Forced mergers of banks are nothing new but in an unprecedented action in the LVB’s case, the shareholders have been divested of their equity shareholding, reserves and surpluses. Since the value of equity shares is officially decreed to be zero, the erstwhile owners of the LVB will not get any share in the LVB+DBS banking entity. Also hurt are bondholders as all of LVB’s Basel-III compliant Tier-2 bonds worth Rs 318 crore were written down. Bond-holders will not get back their invested money, nor interest on them. Significantly, srapping Tier-2 bonds is an unprecedented action. The move was thus both, swift and uncommon, but the problem had been brewing for some time. The LVB had been incurring losses for the past 10 quarters and the RBI initiated Prompt Corrective Action (PCA) in September 2019, which asked the bank to bring in additional capital, restrict further lending to corporates, reduce NPAs and improve the Provision Coverage Ratio to 70 per cent.
These actions/decisions of the Central Government and the RBI have been challenged by the LVB’s shareholders in Mumbai and Madras High Courts (HCs). The Mumbai HC declined to stay the amalgamation but kept the plea filed before it for monetary compensation pending. The Madras HC, too, declined to stay the amalgamation but passed some interim orders giving some relief to the LVB’s shareholders on a petition filed by AUM Capital Market Private Limited, a retail investor holding shares in LVB.
Shareholders contend that they have been deprived of the LVB’s ownership without any monetary compensation. This amounts to unjust enrichment of a foreign bank. The manner of selection of DBS India as the transferee company has also been questioned. What has frustrated the LVB shareholders is the fact that the same DBS that has now acquired the bank with zero compensation to shareholders had offered to buy 50 per cent of the LVB’s shares for at least Rs 100 per share in 2018. Since then, the LVB’s value deterioration has been fast. The share price of the LVB lost 58 per cent this year and went to less than Rs 10 a share. The LVB’s total business shrank from Rs 47,115 crore at the end of September 2019 to Rs 37,595 crore at the end of September this year.
By then, the LVB’s Tier-1 Capital Ratio and overall Capital Adequacy Ratio (CAR) as per Basel-III norms had turned negative. With a large gross NPA ratio of 24.45 per cent, the LVB had a negative net worth of Rs 699 crore. Therefore, scrapping the shares and Tier-2 bonds of the LVB means that the bank has been practically wound up, with core investors asked to bear the accumulated losses. And the junked entity has been handed over to a white knight investor to take over in the interest of the LVB’s 20 lakh depositors. Aggrieved shareholders contend that even if the authorities have the power to reduce the share value during an amalgamation, reducing share value to zero cannot be done without very compelling reasons. And these reasons (if any) have not been disclosed.
Instances of commercial banks failing are rare. As the Government and the RBI are empowered to order consolidation, compulsory amalgamation and liquidation of small banks, no commercial bank has failed. Forced mergers of weak banks with stronger ones are a normal practice to safeguard depositors’ interest.
The LVB is one of the oldest private banks. It was founded in 1926 with a fairly distributed ownership. At the end of March 2012, the LVB had 12.92 per cent non-resident shareholding, which increased to 43.1 per cent by March 2019. During the period, resident individual shareholding came down from 56.73 per cent to 27.7 per cent. Resident financial institutions increased their stake from 8.47 per cent to 20.9 per cent.
The 20.9 per cent Indian Financial Institutions and 38.4 per cent foreign companies, together commanding majority control of the LVB, failed to exercise due diligence and control the management even as the bank’s lending portfolio became problematic. The LVB is a banking company registered under the Companies Act, 1956. Banking companies are governed differently from other companies in India. They are regulated by both the Companies Act and the Banking Regulation Act, 1949. And the Banking Regulation Act, being a specialised law, takes precedence over the conflicting provisions of the Companies Act. Section 45 of the Banking Regulation Act, 1949 empowers the RBI to apply to the Central Government “for suspension of business by a banking company and to prepare a scheme of reconstitution of amalgamation.” So the triggers, processes, control mechanism and so on for mergers and acquisitions are different than those for non-banking companies.
Just like the Companies Act, the Insolvency and Bankruptcy Code applies to banking companies, too, but the Banking Regulation Act prevails over the other two Acts. The one month “moratorium” imposed on the LVB on November 17 was akin to anaesthesia that is given before a surgery. Keeping the LVB under a moratorium for too long would have affected 20 lakh depositors. The RBI had to find an able and willing investor ready to take over. For the last two years, the LVB and its promoters have been trying to lure investors to infuse additional capital to meet regulatory norms.
For the takeover of financially-distressed non-banking companies, resolution professionals are appointed by the National Company Law Tribunal (NCLT). This invites tenders from potential investors and the company is handed over to the highest bidder. In the case of weak banks that are in need of rescue, there is no such practice of inviting tenders. The transferee banking company is selected based on the professional judgment of the RBI. Whether the selection of DBS India was based on rational considerations and whether the LVB’s pre-amalgamation valuation justified shareholders/bondholders being denied any monetary compensation are now sub-judice. Judicial review of regulatory wisdom is not unprecedented.
(The writer is former Special Secretary, Ministry of Commerce and Industry)
