Mains Paper 3: Economy
Prelims level: Lakshmi Vilas Bank
Mains level: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment
• RBI decided to recommend the imposition of a one-month moratorium on Lakshmi Vilas Bank (LVB).
• RBI also simultaneously announced a draft scheme of amalgamation that entails the Indian unit of the Singapore government-controlled DBS Bank taking over the capital-starved private lender.
• This marks a welcome intervention by the banking regulator.
Warding off risks:
• The well-choreographed move will protect the interests of depositors and employees, while shareholders will see the value of their holdings written off once the merger is operationalised.
• Eight months before, another flailing private lender, Yes Bank, was rescued by an RBI-orchestrated capital infusion.
• The Karur-based bank’s proposed bailout signals that the regulator is keen to proactively step in to ward off risks to wider financial sector stability.
• That the LVB had become a candidate for regulatory intervention was evident after its continuous losses, steady erosion of its net worth and inability to raise fresh capital to bolster its balance sheet.
• Despite being placed under the RBI’s Prompt Corrective Action framework in September 2019, the lender’s finances deteriorated to the point where its gross ratio of non-performing assets to advances shot up to 25.4% in March 2020 and the Tier 1 Capital ratio turned a negative 0.88% at the end of that quarter.
• The capital ratio subsequently worsened to -4.85% by the end of September, tipping the central bank’s hand.
Banking sector concern:
• Overall banking sector health, however, remains a significant concern notwithstanding this latest rescue effort.
• On Wednesday, Gita Gopinath, the IMF’s chief economist, flagged the wide-ranging damage the COVID-19 pandemic had inflicted on the global economy and warned of deeper legacy scars — more stress on corporate balance sheets and governments burdened with large debt.
• For all its liquidity bolstering measures since March, the RBI now faces the prospect of having to maintain a heightened vigil over scheduled commercial banks, as well as non-banking financial companies and mortgage lenders, given the threat of contagion from a failure here.
• The RBI had in its Financial Stability Report in July pointed out that its stress tests indicated that the gross NPA ratio of commercial banks could worsen to 14.7% by March 2021, from 8.5% a year earlier, if the pandemic’s adverse economic impact caused the GDP to contract by 8.9% in the current fiscal.
• In October, the bank forecast India’s GDP would shrink by 9.5% and earlier this month cautioned that “lurking around the corner” was the major risk of stress intensifying among households and firms that could spill over into the financial sector.
• The RBI has its task cut out in ensuring it keeps the crucial engine of credit ticking over as the economy strives to revive.
• Overall banking sector health is a concern despite the RBI’s pre-emptive rescue efforts.
Q.1) Why was LVB put under moratorium and amalgamated with DBS Bank? What are the issues faced by old-generation private banks? Why Promoters are important?