What are Bank failures ? | UPSC
What are Bank failures ?
WHY IN NEWS:
The Reserve Bank of India decision to impose a 30-day moratorium on Lakshmi Vilas Bank Ltd (LVB) and put in place a draft scheme for its amalgamation with DBS Bank India.
SYLLABUS COVERED: GS 3: Economy : RBI : Mergers
- This could occur because the bank in question has become insolvent, or because it no longer has enough liquid assets to fulfill its payment obligations.
- When a bank fails, assuming the RBI insures its deposits and finds a bank to take it over.
- Its customers will likely be able to continue using their accounts, debit cards, and online banking tools.
- Bank failures are often difficult to predict .
- The central Bank does not announce when a bank is set to be sold or is going under.
- It may take months or years to reclaim uninsured deposits from a failed bank.
- This might happen because the bank loses too much on its investments.
- It’s not always possible to predict when a bank will fail.
WHAT HAPPENS WHEN A BANK FAILS?
- When a bank fails, it may try to borrow money from other solvent banks in order to pay its depositors.
- If the failing bank cannot pay its depositors, a bank panic might ensue in which depositors run on the bank in an attempt to get their money back.
- When a bank fails, the central bank takes the reins, and will either sell the failed bank to a more solvent bank, or take over the operation of the bank itself.
- Ideally, depositors who have money in the failed bank will experience no change in their experience of using the bank.
- In the event that a failed bank is sold to another bank, account holders automatically become customers of that bank, and may receive new checks and debit cards.
WHY WAS LVB PUT UNDER MORATORIUM ?
- The RBI said the financial position of the Chennai-based LVB, which has a network of 563 branches and deposits of Rs 20,973 crore, has undergone a steady decline.
- It has met continuous losses over the last three years eroding the bank’s net-worth.
- The bank has not been able to raise adequate capital to address these issues.
- Serious governance issues in recent years have led to deterioration in its performance.
- LVB posted a net loss of Rs 397 crore in the September quarter of FY21, as against a loss of Rs 112 crore in the June quarter.
- Its gross non-performing assets (NPAs) stood 25.4% of its advances as of June 2020, as against 17.3% a year ago.
- State Bank of India (SBI) had the highest amount of NPAs at over Rs 1.86 lakh crore .
- It is followed by Punjab National Bank (Rs 57,630 crore), Bank of India (Rs 49,307 crore).
- A recent merger proposal had come from AION-backed Clix Capital but the discussions didn’t work out.
- The bank was earlier wooed by SREI Capital.
- It almost tied up with Indiabulls Housing Finance, but the RBI objected to the merger proposal.
- The bank management had indicated to the RBI that it was in talks with certain investors, but failed to submit any concrete proposal.
ARE DEPOSITORS AND THE FINANCIAL SYSTEM SAFE?
- The RBI, which put a cap of Rs 25,000 on withdrawals, has assured depositors of the bank that their interest will be protected.
- The RBI had earlier this year bailed out Yes Bank through a scheme backed by State Bank of India and other banks.
- The RBI and the government have often assured that the financial system is safe and sound, but a spate of failures have the potential to affect the confidence of depositors.
WHAT HAS GONE WRONG WITH THE SECTOR?
- The collapse of IL&FS in 2018 had set off a chain reaction in the financial sector, leading to liquidity issues and defaults.
- The near-death experience of Yes Bank in March 2020 sent jitters among depositors.
- Old-generation private banks had come under the spotlight, with shareholders of LVB and Dhanlaxmi Bank recently firing their chief executive officers in the span of a week.
- The LVB episode started unfolding after the RBI and banks led by SBI bailed out fraud-hit Yes Bank.
- The RBI has been monitoring the performance of private banks and large NBFCs.
WHAT HAPPENS TO INVESTORS IN THESE BANKS?
- Shareholders in Yes Bank faced a significant erosion in wealth as the stock price crashed below Rs 10 per share from a peak of Rs 400 per share.
- In the case of LVB, equity capital is being fully written off.
- Entire amount of the paid-up share capital and reserves and surplus, including share/securities of the transferor bank, shall stand written off.
- In the case of Yes Bank, too, some individual investors faced a total loss on their investments in AT-1 bonds.
- As per RBI rules based on the Basel-III framework, AT-1 bonds have principal loss absorption features, which can cause a full write-down or conversion to equity.
ISSUES FACED BY OLD-GENERATION PRIVATE BANKS?
- The functioning of many such banks has been under scrutiny in the last couple of years.
- Two other South-based banks – South Indian Bank and Federal Bank – have been operating as board-driven banks without a promoter.
- In Karur Vysya Bank, the promoter stake is 2.11%, and in Karnataka Bank, there’s no promoter.
- The problems in LVB follow the similar challenges faced by Yes Bank as well as Punjab & Maharashtra Co-operative Bank in recent times.
REGULATORY RESPONSE TO THESE FAILURES?
- On July 24, 2004, the RBI, announced a moratorium on private sector lender Global Trust Bank, which was then reeling under huge losses and bad loans.
- Nearly 16 years later, the RBI has followed a somewhat similar approach on resuscitation of the troubled lenders of Yes Bank and now LVB.
- The moratorium announcement was followed by a reconstruction plan for Yes Bank and capital infusion by banks and financial institutions.
- The RBI has acted whenever a bank or an NBFC faced trouble, the question remains whether it made the interventions swiftly.
IMPACT ON BANKING SYSTEM
- NPAs in the banking sector are expected to increase as the pandemic affects cash flows of people and companies.
- However, the impact will differ depending upon the sector, as segments like pharmaceuticals and IT seem to have benefited in terms of revenues.
- Corporate sector debt worth Rs 15.52 lakh crore has come under stress after Covid-19 hit India, while another Rs 22.20 lakh crore was already under stress.
- This effectively means Rs 37.72 crore (72% of the banking sector debt to industry) remains under stress.
- Companies in sectors such as retail trade, wholesale trade, roads and textiles are facing stress, whie NBFCs, power, steel, real estate and construction were already under stress when the pandemic began.
SOURCES: IE | What are Bank failures ? | UPSC