Bank Amalgamations Warrant Urgent Introspection
Public interest and banks’ amalgamations
Compulsory amalgamations of failing banks are in the public interest. They are primarily intended to provide stability to the financial system, safeguard the depositors’ interests and, in the process, reinforce the credibility of the regulator’s oversight of banks. Following a series of bank failures experienced in India during the first half of the previous century, the establishment of the Reserve Bank of India (RBI) as the banking regulator in 1935 and the enactment of the comprehensive Banking Regulation Act (BRA) of 1949, led to a fair amount of stability in the Indian banking system. 
After successive doses of bank nationalisation in 1955, 1969 and 1980, bank failures have almost always been staved off by merging tottering private banks mainly with State-owned banks. The exceptions were voluntary mergers among the private banks which also helped avoid losses to the depositors. 
For instance, Bank of Madura was taken over by ICICI Bank in 2001; Punjab National Bank (PNB) took over the distressed and controversial Nedungadi Bank in 2003; in 2004, scam-hit Global Trust Bank was merged with the then Oriental Bank of Commerce (since merged with PNB during 2020). 
Several new private banks set up after 1991 merged among themselves. Where the banks were distressed, RBI and the department of financial services (DFS) under the ministry of finance (MoF) intervened by invoking the provisions of the BRA. It ensured that depositors did not lose money but continued to deal with transferee banks. 
Against this backdrop, two recent bank amalgamations need to be examined at greater length. 
Case 1: LVB amalgamation with DBS Bank (2020)
The first case is of Lakshmi Vilas Bank Ltd (LVB), which started in Karur (Tamil Nadu) in the 1920s. LVB, a conservative lender for ages, suddenly took a big leap towards aggressive growth in the middle of the past decade with huge advances to risky borrowers like Jet Airways, Religare, Nirav Modi, and others that turned sour. 
There were reports of fraudulent loans against bulk deposits bringing LVB under the radar of the economic offences wing (EOW) of Delhi police. Its capital shrank and it struggled to maintain its statutory capital adequacy ratio (CAR) as bad loans mounted and losses increased. By 2020, it had a net loss of Rs1,162 crore, gross non-performing assets (GNPA) of 25.39%, and CAR of 1.12%. 
On 17 November 2020, RBI imposed a moratorium on the Bank. Ten days later, DFS approved its amalgamation with DBS Bank India Ltd (DBS) in terms of section 45(2) of BRA. (Read: Lakshmi Vilas Bank and Dhanlaxmi Bank: Self-Inflicted Existential Crisis? -Part 2
Case 2: Amalgamation of PMC Bank with Unity Small Finance Bank (2022)
The second case is of Mumbai-based Punjab and Maharashtra Cooperative (PMC) Bank set up in 1985. As of March 2019, PMC Bank had 137 branches across six states; deposits and advances of Rs11,617 crore and Rs8,383 crore, respectively. It declared a net profit of Rs99.69 crore in March 2019 as against Rs100.90 crore in March 2018. GNPA were 3.76% and net NPAs were 2.19% of its advances while CAR was 12.62% against the 9% level prescribed by RBI.
RBI intervention was triggered by a whistleblower in the Bank revealing fraud, mismanagement, and heavy exposure to Housing Development & Infrastructure Ltd (HDIL) which was systematically covered up. 
Out of PMC Bank’s loan portfolio of Rs8,300 crore, as much as Rs2,500 crore were to HDIL and may have been significantly higher. Bank was clearly on the brink.
On 23 September 2019, RBI imposed a moratorium on the bank superseded its board of directors and appointed an Administrator (Read: PMC Imbroglio: Is RBI Regulating Urban Cooperative Banks as Best as It Can?).
The moratorium was extended several times as RBI struggled to find a solution. Finally, in 2021, a suitor was found in the newly licensed Unity Small Finance Bank (Unity) jointly promoted by Centrum Financial Services Ltd and Resilient Innovations Pvt Ltd (BharatPe). RBI and DFS approved the amalgamation of PMC Bank with Unity on 25 January 2022 under Section 45 of the BRA. 
These are bare facts but they beg many troubling questions.
Common Factors: 
The respective gazette notifications announcing the two mergers spell out many common factors between the two cases. 
The DFS notification on LVB on 25 November 2020 says (italics supplied):
"….whereas, the rapidly deteriorating financial position of the Lakshmi Vilas Bank Limited relating to liquidity, capital, and other critical parameters and the absence of any credible plan for infusion of capital has necessitated Reserve Bank to take immediate action in the public interest and particularly in the interest of the depositors and accordingly, the Lakshmi Vilas Bank Limited was placed under moratorium by an order of the Government …"
" And whereas, during the period of moratorium, the Reserve Bank, is satisfied that in the public interest and the interest of the depositors so to do, in the exercise of the powers conferred by sub-section (4) of section 45 of the said Act, has prepared a scheme for amalgamation of the Lakshmi Vilas Bank Limited with the DBS Bank India Limited." 
The DFS Notification on PMC Bank, dated 25 January 2022, says something similar (italics supplied) on the imposition of the moratorium and the scheme of amalgamation:
"… (moratorium) with effect from the close of business on 23 September 2019 to protect the interest of the depositors and to ensure that the bank‘s available resources are not misused or diverted; 
"…empowers the Reserve Bank to prepare a scheme of reconstruction or amalgamation of banking companies (which include co-operative banks), if so considered necessary in the public interest or the interest of the depositors or to secure the management of the banking company; 
"… Reserve Bank has come to a conclusion that the present position of Punjab and Maharashtra Co-operative Bank Limited calls for the preparation of a scheme of amalgamation;"
RBI and DFS have both affirmed that the banks were in deep trouble and a moratorium and bailout were imperative in the public interest and to safeguard the interest of depositors. The difference, however, is in the kind of treatment meted out to depositors of PMC Bank. 
Troubling Questions
Scrutiny of the respective notifications raises some fundamental questions. In the amalgamation of LVB with DBS, all deposits of LVB were transferred to DBS and honoured, without any loss to the depositors.
In contrast, the terms for PMC Bank are vastly different from those provided to LVB depositors. PMC Bank depositors have been offered a staggered repayment of deposits. Deposits up to Rs5 lakh are insured with the Deposit Insurance and Credit Guarantee Corporation of India (DICGCI). These claims will be settled when submitted by Unity. 
Unity will repay those above this amount in instalments spreading beyond 10 years. The amalgamation scheme provides that no interest will be paid on the deposits for five years from March 2021 and thereafter simple interest at the rate of 2.75% will be paid. 
Alternatively, under Unity’s latest offer, depositors other than those covered by the DICGCI can get their money earlier, provided they are ready to accept a haircut of up to 40%!
PMC Bank depositors have been classified into ‘eligible depositors’, ‘institutional depositors’, and ‘retail depositors’; the first category are those covered by deposit insurance.  
In the case of institutional depositors, Clause 6 of SoA says: (i) on the appointed day, 80% of the balance payable to institutional depositors will be converted into perpetual non-cumulative preference shares of transferee bank with a dividend of one percent per annum payable annually; the balance 20% will be converted into equity warrants of Unity at Rs1 per warrant and these will further be converted into equity shares of Unity when it makes an initial public offering (IPO). 
DICGCI’s Liability 
If DICGCI’s insurance was invoked in one case, why not in the other? An examination of Sections 16, 17, and 18 of the DICGCI Act throws up other issues. Section 16(1) says DICGCI’s liability crystallises only when an order is issued for the winding up or liquidation. 
It reads (italics supplied):
"16. (1) Where an order for the winding up or liquidation of an insured bank is made, the Corporation shall, subject to the other provisions of this Act, be liable to pay to every depositor of that bank in accordance with the provisions of section 17 an amount equal to the amount due to him in respect of his deposit in that bank at the time when such order is made."
Since PMC was not under liquidation, this sub-clause (1) is not applicable. How did RBI and DFS bring DICGCI into the picture? The answer is in sub-clause (2) of Sect.16. It reads:
"(2) Where in respect of an insured bank a scheme of …amalgamation has been sanctioned by any competent authority and the said scheme provides for each depositor being paid or credited with, on the date on which the scheme comes into force, an amount which is less than the original amount and also the specified amount, the Corporation shall be liable to pay to every such depositor in accordance with the provisions of section 18 an amount equivalent to the difference between the amount so paid or credited and the original amount, or the difference between the amount so paid or credited and the specified amount, whichever is less….(italics supplied)"
What does the term ‘original amount’ of deposit mean in this sub-clause? 
Sub-clause 4 provides a clarification:
(4) In this section, (a) “original amount” in relation to a depositor means the total amount due by the insured bank immediately before the date of coming into force of the scheme of compromise or arrangement or, as the case may be, of reconstruction or amalgamation to the depositor in respect of his deposit in the bank in the same capacity and the same right… (italics supplied)
It is simple enough to understand: it is the total amount payable to the depositor by the insured bank before the scheme of amalgamation is announced by the authorities. The total amount of deposit payable to the depositor under the provisions of the Act is limited to Rs5 lakh. 
The Transferee Bank’s Liability:
The transferor bank’s (PMC Bank) liability gets crystallised on the date of amalgamation and this liability is to be honoured by the transferee bank (Unity) since the entire assets and liabilities of PMC Bank stand transferred to Unity from the date of amalgamation. 
This is clear from clause 3 of the SoA. It says: 
"3. Transfer of assets and liabilities and the general effect thereof: (1) On and from the appointed date, the undertaking of the transferor bank will stand transferred to, and vest in the transferee bank, which shall be deemed to include all business…."
The clause contains a long list of items which includes deposits of the transferor bank. It is also relevant to look at clause 4 of the SoA which calls upon the transferor bank to prepare its balance sheet as of 22 November 2021. 
Here are the extracts: 
"4. Closure of books of the transferor bank and preparation of balance sheet:— (1) The books of the transferor bank shall be closed and balanced and the balance sheet prepared in the first instance as at the close of business on 22 November  2021 and thereafter as at the close of business on the date immediately preceding the appointed date,…"
Clause 6 of SoA spells out the method of discharge of liabilities of the transferor bank. The transferee bank is mandated to open deposit accounts in the names of the depositors of the transferor bank as on the date of amalgamation.
This is what the sub-clause (1)(b) says:
"6. Discharge of liability of transferor bank: (1) In respect of:"
"(b) every savings bank account or current account or any other deposit account including a fixed deposit, cash certificate, monthly deposit, deposit payable at call or short notice, or any other deposits by whatever name called with the transferor bank, the transferee bank shall open with itself on the appointed date a corresponding and similar account in the name of the respective holder thereof crediting thereto full amount including interest accrued till 31 March 2021 (italics added)."
It is clear that of the appointed date, Unity Bank should not only open the deposit account for PMC depositors but credit it the full amount including interest accrued till 31 March 2021. As a result, on the appointed day, the transferee bank owes the full amount of deposit standing to the credit of the account of every depositor. However, there is a catch in the sub-clause (c) of Clause 6 of the SoA which now introduces the provisions for a staggered payment of the deposits over and above what is settled under the deposit insurance scheme. Thus, the depositors are left at the mercy of three benefactors - RBI, DFS, and Unity Bank. 
In contrast, nobody lost money in the LVB amalgamation with DBS. Is this discrimination fair?
Failure of RBI and DFS  
RBI has to answer many questions about PMC Bank. Why did it take two and a half years after the moratorium to finalise a scheme of amalgamation? Why is PMC Bank being handed over to a bank that is not yet an established small finance bank? 
Why was DICGCI asked to step in and settle claims of eligible depositors when PMC Bank had not been liquidated? And why was DICGCI not invoked in the case of LVB, which was in a worse financial situation? 
As explained earlier, DICGCI comes on the scene when the insured bank fails or goes into liquidation. But RBI had earlier bent the rules once, to permit this in the case of the politically sensitive Madhavpura Mercantile Cooperative Bank of Ahmedabad, which collapsed due to its loans to scam-accused broker Ketan Parekh.
Why are depositors of PMC Bank being asked to accept a 40% haircut when no such condition was imposed on the depositors of LVB? Is it intended to provide assets of PMC Bank on a silver platter to Unity SFB?
In order to examine the RBI’s failure in diagnosing PMC Bank in time, we should delve into a historic bank failure of the early 20th century. In 1937, Travancore National Bank and Quilon Bank based in the former Madras Presidency were amalgamated to form Travancore National & Quilon Bank Ltd (TNQ). It became one of the largest banks in south India. Less than a year after the amalgamation, there was a run on TNQ followed by protracted liquidation proceedings lasting 17 years. The fledgling RBI came in for severe criticism for its failure to intervene at the right time. When the liquidation was finally completed in 1955, depositors of TNQ received 12 annas and 3 and 1/2 pies out of every rupee (comprising 16 annas, under the pre-decimal Indian currency system). 
In the PMC Bank case, despite the means and power it had, RBI could not detect the fraud. Unfortunately, RBI has no accountability in recommending an amalgamation scheme that is detrimental to the interest of PMC depositors who are entitled to protection under BRA. The all-powerful DFS has also endorsed the scheme without batting an eyelid—only the depositors are paying a price. 
This sorry state of affairs raises many questions. What happens if another bank is similarly mismanaged under RBI’s watch? Which of the two formulae will be applied—a haircut or no haircut? Who should the depositor trust to protect her interest in a crisis when neither RBI nor DFS has helped? There is still time to junk the ad hoc amalgamation plan and offer a better deal to PMC Bank depositors that creates a credible precedent for the future.
(The author was formerly joint general secretary of All India Bank Officers’ Confederation -AIBOC from 1995-2009; he was a director on the board of a public sector bank and authored Reforming the Indian Public Sector Banks-the Lessons and the Challenges (2018)
Kamal Garg
2 years ago
Apart from the details given in the article on LVB and DBS, it is rumoured in the market that DBS was also a serious contestant for DHFL assets which was finally taken up by Piramals and therefore DBS was given LVB as a special case though terms of LVB were more depositor friendly and further that RBI wanted a foreign banking entity to enter into India with a huge pre-established branch network, etc.
2 years ago
No reference made to the price at which the "transferee" bank gets the failing bank. Does it put the transferee's depositors and shareholders' interests at risk?
Replied to nandan.maluste comment 2 years ago
Not sure if any price has been paid in these two or similar cases since the net-worth is usually eroded in the failing banks. Yes, such transactions expose the transferee's 'ds' and 's'' to risk. The primary new exposure areas would be the accuracy of the estimate of fraud/issues in the failing company, expected gains from taking over another bank, and their translation to shareholder value(stock price/valuation etc.). The safety of depositors will be linked to the credit-worthiness of the combined entity which will be linked to it's overall financial strength.
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