IASbhai Daily Editorial Hunt | 24th Nov 2020
“If there is no struggle, there is no progress.” – Frederick Douglass
EDITORIAL HUNT #257 :“Explained : RBI’s Moratorium on Banks | UPSC”
Explained : RBI’s Moratorium on Banks | UPSC
Srinivasan Varadarajan is a veteran banker and market expert
Banking health and the ‘K Curve’ dynamics
Focusing on trends in valuation metrics can provide clues; more stronger banks are needed
SYLLABUS COVERED: GS 3 : Banking
Consolidation of PSU banks into few large banks requires a new vision. That needs to be drawn out for these banks to ensure that they have differing value propositions to offer to the economy and market.Comment -(GS 3)
- Private Banks dispersion
- Road map for Public Banks
- Safety of Funds and Assurance
- MORATORIUM ON BANKS : On November 17, the Centre, acting on the recommendation of the Reserve Bank of India (RBI), imposed a moratorium on Lakshmi Vilas Bank (LVB) for a period of 30 days.
- DETERIORATED FINANCIAL POSITION : the regulator placed it under the Prompt Corrective Action (PCA) framework, which restricts certain operations depending on the severity of financial stress.
- FINDING INVESTORS : After allowing time for the bank to find investors to shore up its capital, the RBI has appointed an administrator for a merger with the Indian subsidiary of the Singapore-based DBS Bank.
- OTHER BAILED OUT BANKS : Similar moratoria were placed in the recent past on other lenders too, including Yes Bank and Punjab and Maharashtra Co-operative Bank.
WHAT IS A MORATORIUM?
- MORATORIUM PLACED : The RBI, the regulatory body overseeing the country’s financial system, has the power to ask the government to have a moratorium placed on a bank’s operations for a specified period of time.
- CEILING THE LIMITS : Usually, there is a ceiling that limits the amount of money that can be withdrawn by the bank’s customers.
- EXCEPTIONS : The regulator allows for funds of a larger quantum to be withdrawn in case of an urgent requirement, such as medical emergencies, but only after the depositor provides the required proof.
- LIFTING A MORATORIUM : Often, the moratorium is lifted even before the originally stipulated deadline is reached.
- INJECTING FUNDS : With investors led by State Bank of India (SBI) infusing ₹10,000 crore into Yes Bank, the moratorium was lifted on March 18.
SOURCES : LIVEMINT
WHEN DOES IT COME INTO PLAY?
- NET WORTH OF THE BANK : Usually, the RBI steps in if it judges that a bank’s net worth is fast eroding and it may reach a state where it may not be able to repay its depositors.
- ASSETS AND OBLIGATIONS : When a bank’s assets decline below the level of liabilities (deposits), it is in danger of failing to meet its obligations to depositors.
- CITADEL BANK : After banks were nationalised in 1969, the RBI sought to always intervene to protect depositors’ interests and prevent commercial banks from failing.
HOW DOES A MORATORIUM PREVENT A ‘RUN’ ON THE BANK?
- TRUST DEFICIT OF DEPOSITORS : A moratorium primarily helps prevent what is known as a ‘run’ on a bank, by clamping down on rapid outflow of funds by wary depositors.
- FINANCIAL ASSESSMENT : A moratorium gives both the regulator and the acquirer time to first take stock of the actual financial situation at the troubled bank.
- REALISTIC APPROXIMATIONS : It allows for a realistic estimation of assets and liabilities, and for the regulator to facilitate capital infusion, should it find that necessary.
- MERGER : Singapore’s DBS bank has promised to infuse ₹2,500 crore into the merged entity, once it takes over LVB.
- NORMALCY IN THE BANKS : Even if they are temporarily handicapped , the bank would soon return to normal functioning once a bailout is arranged.
A KEY METRIC
- A MEASUREMENT TOOL : The key metric for financial companies would be the ‘Price to Book Value’ ratio (P/BV).
- P/BV VALUE : The P/BV holds the mirror on the two critical attributes the market values most: adequacy of current capital and runway available to the entity for profitable growth.
- TRUST IN THE BANKS : A P/BVB ratio above 1 indicates that the market believes that the company can grow and generate Return on Equity (RoE) above the hurdle rate that investors expect.
- MISTRUST IN BANK : A P/BV below 1, on the other hand, indicates that the market either does not believe the bank has recognised all its bad loans or has the business model to deliver returns above the hurdle rate.
SOURCES : SBI
PRIVATE BANKS’ DISPERSION
- GROWTH CHART : The growth trajectories of these entities with dispersed P/BV will be varied, resulting in a classic K Curve playing out.
- THE CONCEPT : The K Curve depicts the inequality existing between different financial entities in terms of their attributes that determine their future growth and profitability.
- PRIVATE BANKS HEALTH : One can clearly see a couple of banks which have always had their P/BV above 3 on a consistent basis.
- THE MARKET INSIGHT : They are long-term bets, have access to sufficient capital but have to demonstrate a business model that works across cycles.
IS THE SAFETY OF FUNDS ASSURED?
- FINDING ACQUIRERS : It depends on whether the struggling bank or the regulator is able to find acquirers or investors to save the day.
- A SOUND CAPITAL INFLUX : With Lakshmi Vilas Bank, the regulator had a ready acquirer with a sound capital base in DBS Bank India.
In the case of Punjab and Maharashtra Co-operative Bank , there is still no sign of a buyer.
SOURCES: THE HINDU EDITORIAL HUNT | Explained : RBI’s Moratorium on Banks | UPSC