LVB deal showcases new M&A battlefield

Post Diwali, we saw yet another bank failure as the Reserve Bank of India (RBI) announced the amalgamation of Lakshmi Vilas Bank (LVB) with DBS India, a subsidiary of DBS Singapore. On the same day, RBI issued directions to Mantha Urban Cooperative Bank Ltd to not accept deposits and give loans.

RBI classifies LVB as an Old Private Sector Bank (OPSB). Thanks to RBI’s move with LVB, suddenly this category of private banks — distinct from new private sector banks that came into being post 1994 — has come into the spotlight. At the time of bank nationalisation in 1969, there were 50 OPSBs; today there are only 12 such banks. Over the same period, the share of OPSBs in total banking assets has also declined from 6.6% to 4.4%.

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There’s a strong regional focus to this listing (see chart). Nine of the dozen are from the three southern states; Karur and Thrissur have served as headquarters of five banks. Most of these banks continue to have a large percentage of branches still in the home states. Most of these banks started as community banks, as suggested by their names like Catholic Syrian Bank, Karur Vysya Bank, Tamilnad Mercantile Bank and so on.

The average age of these banks is 95 years; in fact 10 of these banks are older than the RBI. These banks have survived many twists and turns, from independence, bank nationalisation and the 1991 reforms.

While capital adequacy ratio remains comfortable in most of the OPSBs barring LVB, other indicators are weak. The net NPA ratio is high in Karur Vysya Bank, Nainital Bank and J&K Bank. Return on equity is negative for Catholic Syrian Bank, and low for Dhanalakshmi Bank and Karur Vysya Bank.

Comparing OPSBs with other peer groups, we can see its staff expenses equal those of public sector banks. The return on equity in OPSBs has declined and lagged that of New PSBs. In fact, the OPSBs are closer in performance to public sector banks who suffer from several government mandates and constraints.

This is not a new problem. The RBI in its fourth history volume (1981-97) had identified several problems with functioning of the OPSBs: “Apart from general problems like low capital base, large load of sticky advances/loan losses, low profitability and inadequate provisioning for bad loans, private sector banks were also beset with special problems that affected their performance and their ability to continue as viable units in the long run.”

Given that old PSB’s overall small share in Indian banking is small, why should RBI focus on these banks?

Clearly, problems persist in the OPSBs beyond LVB. Some of the other banks such as Catholic Syrian Bank, Dhanalakshmi Bank etc, are suffering as well. The localness of these banks and concentration of their branches in home states also poses unique problems as bank runs can spread much quickly.

We have learnt from the global financial crisis and India’s own banking and NBFC troubles that failure of a small financial entity could pose problems for the entire banking system. A problem in one entity spreads to the entire system relatively quickly. Of course, there’s high uncertainty due to the ongoing crisis post covid-19 which makes the system highly vulnerable.

Lakshmi Vilas case

Interestingly, there are precedents of an old PSB being taken over by a foreign bank. In 2002, Vysya Bank was officially taken over by ING and became known as ING Vysya Bank. Of course, barring foreign bank participation, the contours of this transaction were very different. Moreover, ING exited in 2014 by selling the bank to Kotak Mahindra Bank. Then, in 2019, Canada based Fairfax India Holdings Corporation (FIHC) bought 50% of Catholic Syrian Bank after getting an approval from RBI after a long wait.

LVB was close to failure in 2019 itself. The bank was also placed under RBI’s Prompt Corrective Action (PCA) framework in September 2019….