Saving India’s vintage private sector banks

By Ganga Narayan Rath and Manas R. Das

Bank failures have achieved a hattrick within a short period: the PMC Bank, the Yes Bank and now the Lakshmi Vilas Bank (LVB). To think that the LVB episode is an isolated event will be too short-sighted. The event has macro implications, especially in the context of the ‘overcrowded’ banking landscape of Southern India. For example, at March-end 2019, i.e., before the latest round of mergers in the PSB space, six out of 17 PSBs were headquartered in the South, and so were nine out of 12 ‘old’ characteristically small private banks. Too many banks create too many problems and this should evoke some proactive, practical and timely thinking on the part of all stakeholders. As the recently released RBI Report of the Internal Working Group to Review Extant Ownership Guidelines and Corporate Structure for Indian Private Sector Bank observes, “differing regulatory regimes … have the potential to raise concerns about uneven playing fields as well as scope for regulatory arbitrage.” So, as has been done in the case of PSBs, albeit belatedly, serious thought must be accorded to consolidate the ‘old’ private banks, some of which have substantial foreign investment.

Three types of ownerships – the State-owned (PSBs), the privately-managed, newly-licensed (NPvBs) and the old private sector community-dominated banks (OPvBs) – characterise the Indian commercial banking space. The first set of NPvBs became operational in 1994 and the second set in 2015. The OPvBs comprise of those private banks which existed before 1969 but were not nationalised because their operations were too narrow, catering to small regions and/or communities. The OPvBs continue to be regional in character and much smaller than both sets of NPvBs.

To think that the LVB episode is an isolated event will be too short-sighted. The event has macro implications, especially in the context of the ‘overcrowded’ banking landscape of Southern India.

Over time, the PSBs have been yielding market share to the NPvBs. The share of the former’s deposits and advances fell to 66% and 61% in 2019 from 78% and 76% in 2012, respectively. As recommended by the Narasimham Committee (1991), the Central government, being the majority owner of the PSBs, has started consolidating them, collapsing the SBI and its Associate Banks into a single entity and merging several nationalised banks among themselves. More consolidation may be on the cards.

The new generation private sector banks, over the years, have acquired many NPvBs and OPvBs to fuel their growth inorganically and increase market share. This column tries to take an aggregate view of the OPvBs, given the demands of the marketplace and evolving techno-financial solutions.

Concentration Risk

As against 36 OPvBs that existed in 1970, there were just 12 by March-end 2020, as several of them had failed and were to be merged with other banks. Out of the 12 OPvBs in operation today, nine are headquartered in the South: four each in Kerala and Tamil Nadu, and one in Karnataka. At Mar-end 2020, 7,158 or 85.7% of their total 8,350 branches were located in the Southern region. Of the total branches in the Southern region, 52.6% belonged to just two States - Tamil Nadu (29.3%) and Kerala (23.3%). The Karnataka Bank Ltd., which had the largest branch network among the nine, had 87.6% of its branches in Karnataka alone, with the other eight banks having relatively fewer branches there.

Consequently, the businesses of these banks grew around the Southern region and within the region, in the above-mentioned three States. Moreover, their businesses, especially loan exposures were similar across the region as well as sectors. Advances to the services sector dominated in seven out of eight banks for which the relative figures were available. In aggregate, almost a third of the outstanding advances was concentrated in this sector with a range of 19% - 46% over the banks. While in respect of four banks, ‘industry’ loans followed ‘services’ loans, and in another four, ‘personal’ loans followed ‘services’ loans.

While big bank failures can generate a systemic impact, the smaller ones damage the regional economies faster and more. In the case of failures, smaller banks are easily allowed to perish, whereas the bigger ones, more often than not, are considered ‘too-big-to-fail’.

Thus, they constituted a source of concentrated risk, not only for the region but also for the sectors financed, which can be easily contagious in the event of a crisis. The contagion can exacerbate if such small banks are fairly interconnected, which is likely due to their geographical contiguity. However, their small size may not produce any systemic impact.

Size Question

In banking literature, the connection between size of a bank and its vulnerability is an unsettled issue. However, compared to their bigger counterparts the smaller banks lack capital strength to withstand onslaughts from risks not paying off. While big bank failures can generate a systemic impact, the smaller ones damage the regional economies faster and more. In the case of failures, smaller banks are easily allowed to perish, whereas the bigger ones, more often than not, are considered ‘too-big-to-fail’.

At Mar-end 2019, the combined balance sheet size of the nine OPvBs in the Southern region stood at `5,476 billion constituting just 3.5% of the combined balance sheet size of the domestic SCBs (i.e., ASCBs excluding foreign banks, RRBs and SFBs). Their net worth totalled `434 billion accounting for 3.8% of that of the domestic SCBs.

Deposits at `4,723 billion constituted 86% of their total liabilities (domestic SCBs: 79%) and 10.9% of net worth (domestic SCBs: 10.7%). Thus, these banks were highly leveraged through deposits.

Well-run NPvBs and some foreign entities may not be averse to the idea of acquisitions to effectively face competitive pressures, and the Central bank could consider this step as one of the best ways of restructuring. But the sooner it is attempted, the better it is for the banking industry and it can rejuvenate depositors’ trust in the banking system.

Advances at `3,725 billion constituted 68% of the total assets (domestic SCBs: 60%). The C-D ratio stood at 7.9% (domestic SCBs: 7.6%). Thus, their assets composition was more tilted towards advances compared to domestic banks.

Data on ‘concentration’ of deposits and advances with the 20 largest clients was available for eight out of the nine OPvBs. Coming to deposits, on an average 6.7% of the total deposits in the eight banks was concentrated with the 20 largest depositors. Two banks had it at 10% each and one at almost 20%. In the case of advances, nearly a tenth of the total advances was with the 20 largest borrowers. In the case of four banks, it ranged between 12.7% and 15.9%. Higher levels of concentration, especially in advances, proves deleterious if such loans fail.

Non-Performing Loans

Considering the nine OPvBs, the average GNPA ratio steadily increased during 2015 to 2019, from 2.38% to 5.20%. In three banks, the ratio was very high, ranging between 7.47% and 15.3%. Only two banks had the ratio below three percent each.

Now is the Time

The present banking scene in India necessitates consolidation efforts. Bigger and more stable banking institutions can bolster their competitive edge. PSBs’ mergers, with the best intentions, can be procedural/technical in nature, mostly based on synergy, capital adequacy and tax planning/credits. In OPvBs, however, the arduous task of match-making is to be done by the regulator, largely based on commercial considerations.

The Central bank should pursue amalgamating the vintage banks with stable ones when the going is good in order to eschew fire-sales and destruction of shareholder and investor wealth.

If consolidation of the PSBs is desirable, the same in the case of OPvBs is necessary at this juncture. Well-run NPvBs and some foreign entities may not be averse to the idea of acquisitions to effectively face competitive pressures, and the Central bank could consider this step as one of the best ways of restructuring. But the sooner it is attempted, the better it is for the banking industry and it can rejuvenate depositors’ trust in the banking system.

One expects bank failures to be the rarest of rare events. Baby bank failures are already a reality with the regulator having placed/extended 80 UCBs under ‘directions’ during 2019-20 and counting further, it runs to over 50 during 2020-21 hitherto. Trust has to be restored. Instead of waiting for the inevitable, the Central bank should pursue amalgamating the vintage banks with stable ones when the going is good in order to eschew fire-sales and destruction of shareholder and investor wealth.

(Ganga Rath is a former Chief General Manager of the Reserve Bank of India and Manas Das is a former economist with SBI)