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Topic in News

RBI puts Lakshmi Vilas Bank under moratorium – RBI may merge LVB with DBS Bank India

Why in the news?

  • The Reserve Bank of India (RBI) has recently drafted a scheme of amalgamation for Lakshmi Vilas Bank with DBS Bank India Ltd. owing to a serious deterioration in the lender’s financial position.

Challenges for Smaller banks in India:

  • Effect of crisis in Non-Banking Financial Sector (NBFCs): Crisis in smaller banks illustrate the widening damage from India’s shadow banking crisis. For eg: , Punjab and Maharashtra Cooperative Bank was hit by a loan scam highlighting the riskiness of banks, especially cooperative banks.
  • Declining Net Worth: The financial position of the smaller banks have undergone a steady decline, with continuous losses over the last five years eroding the banks’ net worth.
  • Inability to Raise Capital: Smaller banks have not been able to raise adequate capital to address the issues and are also experiencing the continuous withdrawal of deposits and low levels of liquidity.
  • Governance Issues: Serious governance issues in recent years have led to a deterioration in the performance of the majority of smaller banks and NBFCs.
  • Lack of Promoters: The functioning of smaller banks have been under greater scrutiny as most of them do not have strong promoters, making them targets for premature mergings.
  • Rising NPAs: The gross non-performing assets (NPAs) of all smaller banks collectively stood 13.4% of advances as of June 2020, as against 17.3% in 2019. NPAs in the banking sector is expected to further increase as the pandemic affects the cash flows of people and companies.

Banks merging:

  • The idea of bank mergers has remained alive since 1998 when the 2nd M. Narasimham Committee recommended the government to merge banks into a three-tiered structure —
  1. Three large banks with an international presence at the top
  2. Eight to ten national banks
  3. A large number of regional and local banks.
  • PJ Nayak Committee in 2014 had also suggested that the government either merge or privatize state-owned banks.
  • In 2017, 5 associate banks were merged with SBI – State Bank of Bikaner and Jaipur, State Bank of Hyderabad, State Bank of Travancore, State Bank of Mysore, and State Bank of Patiala.
  • Bhartiya Mahila Bank (BMB) was also merged along with the State Bank of India (SBI).
  • The Finance minister led committee recommended the amalgamation of Regional Rural Banks under Phase-3 consolidation, bringing them down from 56 to 38.
  • There was also a consolidation of 10 commercial banks into 4 bigger banks by 2019.

Why merge banks?

  • Financial viability: To protect weak financially unviable banks from loss, and thereby securing customers and the financial system.
  • Consolidation of banks: Public Sector Banks (PSBs) in India is fragmented, with some of them reeling under the mounting pressures of Non-Performing Assets (NPAs).
  • Adherence to good practices: Bigger banks would also be able to adhere to BASEL III norms and other national and international regulatory requirements without compromising with business prospects.
  • Better regulation and monitoring: The problem of credit lending, based on the twin balance sheet crisis, can be checked by the formation of bigger banks.
  • Low risk: Bigger banks with diverse portfolios have lesser chances of failure since it is unlikely that different sectors of an economy will face a crisis at the same time.
  • Competitiveness: The consolidation of PSBs helps in strengthening its presence globally, nationally, and regionally.
  • Economies of Scale: Merger of banks will result in better scale efficiency due to a rise in the customer base, increased market reach.
  • Enhanced Efficiency: It has the potential to reduce operational costs due to the presence of shared overlapping networks. And this enhanced operational efficiency will reduce the lending costs of the banks.
  • Technological Synergy: All merged banks in a particular bucket share common Core Banking Solutions (CBS) platform synergizing them technologically.
  • Self-Sufficiency: Larger banks have a better ability to raise resources from the market rather than relying on the State exchequer.

Challenges in merging of banks

  • Slower Decision Making: The transition process might slow down the decision-making at the crucial levels in order to merge banks.
  • Geographical Synergy: During the process of the merger, the geographical synergy between the merged banks has remained grossly ignored.
  • The slowdown in the Economy: The move to merge banks is always a good idea, but the timings and the execution have to be perfect. There is already a slowdown in the economy, and private consumption and investments are on a declining trend.
  • Weak Banks merged with very strong banks: A complex merger with a weaker and undercapitalized bank would stall the bank’s recovery efforts as the weaknesses of one bank may get transferred and the merged entity may become weak.
  • Proper merging: A complex merger with a weaker and undercapitalized PSB would stall the bank’s recovery efforts as the weaknesses of one bank may get transferred and the merged entity may become weak.
  • Human Resources constraints: There would be a number of human resources issues such as difficulty in adapting to the new emerging culture, discontent due to far-flung transfers, etc.
  • Hit to customer services: Customer retention would become problematic as there might be a lack of comfort in banking with larger parent banks.
  • Incentivizing monopolistic behavior: Larger banks may follow monopolistic behavior with increased market power – resulting in neglect of local needs.
  • Merging banks without actually increasing capacity: Amalgamation of balance sheets of PSBs will only impact NPA cosmetically, without actually working on NPA recovery. This will further divert the process of NPA resolution.

Way forward:

  • The existence of a vibrant banking sector is a prerequisite for achieving a sustained high economic growth rate in any economy.
  • Unfortunately, India’s banking sector is not in very good shape. The NPAs are mounting and banks are facing operational difficulties on a regular interval.
  • Thus, the time is ripe to take stock of the situation in a comprehensive manner and address each of the problems systematically.
  • Also, the one-size-fits-for should not be followed in each and every case. Each case of failure of banks is different and thus, should be treated differently.
  • Many committees in the past have recommended significant measures such as Prompt Action Measures, regulatory amendments in the RBI Act, Banking Regulation Act, etc.
  • These measures need to be implemented in their actual letter and spirit manner. There is also a need to bring good governance measures in the governance and regulation of banks.
  • The objective of the regulations must be to facilitate smaller banks to transform into bigger banks. Then only the Indian economy would achieve its true objectives of sustained, inclusive and well-distributed economic growth.