On November 17, when the Reserve Bank of India imposed a month-long moratorium on the Chennai-based Lakshmi Vilas Bank (LVB), the central bank also doled out a proposal that sought to merge the beleaguered LVB with that of DBS Bank India (DBIL)—the Indian subsidiary of Singapore-headquartered DBS, a leading financial services group in Asia.

On the very same day, DBIL in an official release, expressing enthusiasm for the proposed merger, remarked how the RBI's scheme would provide stability and better prospects to LVB’s depositors, customers, and employees following this time of uncertainty. “At the same time, the proposed amalgamation will allow DBIL to scale its customer base and network, particularly in South India, which has longstanding and close business ties with Singapore,” the release added.

In little over a week, on November 25, the RBI formalised the scheme of amalgamation of LVB into DBIL, a scheme that would come into effect from November 27. The RBI announcement followed a cabinet approval of the scheme. In a press note, the government highlighted that the combined balance-sheet of DBIL would remain healthy even after amalgamation and its branches would increase to 600.

“The speedy amalgamation and resolution of the stress in LVB is in line with government's commitment to a clean banking system while protecting the interests of depositors and the public as well as the financial system,” the press note added. On its part, RBI added that customers, including depositors of LVB, will be able to operate their accounts as customers of DBIL, from November 27 onwards. “Consequently the moratorium on Lakshmi Vilas Bank will cease to be operative from that date,” RBI added.

While it is now certain that shareholders of LVB stand wiped-out, and would have to pursue legal route to stake their claims, LVB’s depositors have reasons to relax. And DBIL, which was running 33 branches until November 17, will now have 596 branches under its fold.

On November 18, in a note articulating the nuances of the proposed merger, Fitch Ratings Singapore highlighted that LVB is not sufficiently large to immediately affect the credit rating of Singapore-based DBS Group Holdings—the parent entity of DBIL.

“However, what it signifies about the bank's growth strategy could shape its earnings and capitalisation risks over the medium term and potentially alter its credit profile,” said Fitch Ratings’ Willie Tanoto, Priscilla Tjitra and Saswata Guha. The trio observed that while DBIL established 21 new branches in India in 2019, and which went up to a total of 33, but the proposed transaction will add as many as 563 branches, a greater number than that of all other foreign banks in India put together.

LVB's network is focused in South India, with three-quarters of its branches located in three states—Tamil Nadu, Andhra Pradesh, and Karnataka. Fitch Ratings’ analyst regard LVB's branches as one of its most coveted residual assets for a foreign bank and believe the ready-made platform will enable deeper market penetration for DBS.

While DBS Bank has been present in India for 26 years, since 1994, DBIL is the first among the large foreign banks in India to start operating as a wholly-owned, locally incorporated subsidiary of a leading global bank. Back in 2016, it launched India’s first, mobile-only bank—digibank, which now has over 2.6 million customers.

As per Fitch Ratings, DBS pivoted to a hybrid physical-digital approach after incorporating a local subsidiary in 2019 and aims to build out more than 100 physical touch-points across India by the end of the year, having previously emphasised a digital banking model. “The proposed acquisition dovetails with the bank's stated strategy and could significantly accelerate its ambitions in India upon successful integration to help it reap growth opportunities in the medium term,” the trio added. “LVB's balance sheets amount to less than 1% of DBS's risk-weighted assets (RWA), assets, and equity, meaning it will not immediately affect the group's asset quality, profitability or capitalisation and, consequently, its credit ratings.”

However, India's banking system is under significant stress and Fitch Ratings has a negative outlook on the operating environment, whose factor midpoint of 'bb' is eight notches lower than Singapore's 'aa-'. The net loans of DBIL, DBS's onshore subsidiary, made up less than 1% of the group's loan portfolio at end-June 2020, but should this proportion increase materially in the next few years, it could weigh on the bank's blended operating environment factor score, on which the rating agency already has a negative outlook.

At the parent level, Fitch Ratings warn that a weaker assessment of DBS's operating environment into the 'a' category would have significant ramifications for its financial profile and would almost certainly lead to a downgrade of its standalone credit ratings. “We do not envision its Indian business expanding at such a pace, but we are watchful if the proposed LVB acquisition is a harbinger of aggressive balance sheet expansion—whether organically or inorganically,” the trio flagged.

According to a retired public-sector banker, LVB could open up a Pandora's box for DBIL. The banking veteran suggests looking at the build-up of losses at the beleaguered bank over the last three years, and the mounting non-performing assets (NPAs) in the same period.

In terms of losses, in 11 out of the 12 quarters, between December 2017 and September 2020, the bank posted losses ranging from ₹39.2 crore to ₹622.3 crore. Except for the quarter ended March 2020, when LVB posted a profit of ₹92.9 crore, the cumulative losses of the other 11 quarters added to a whopping ₹2,993.8 crore.

During the same period, LVB’s gross and net NPAs moved from ₹1,427 crore and ₹1,060.5 crore in quarter ended December 2017, to ₹4,063.3 crore, and ₹946.7 crore each in quarter ended September 2020. The March 2020 quarter saw gross NPAs peak to ₹4,233.3 crore, while net NPAs had peaked to ₹1,772.7 crore in quarter ended September 2019.

As percentage of advances, the gross and net NPAs have shot up from 5.66% and 4.27% in December 2017 to 24.45% and 7.01% in September 2020. Like actuals, the gross and net NPA ratios peaked to 25.39% and 10.47% in March 2020 and September 2019, respectively.

While DBIL has committed a fresh capital of ₹2,500 crore in the combined bank, the expanded bank has come-in free of cost with its inherent liabilities of high-cost deposits, as compared to what DBIL offers, and also the employees who are camping in for a minimum three years at the terms they were employed with LVB.

So while DBIL has ample reasons to be enthused with this merger, yet significant challenges abound, not only concerning LVB's liabilities, but also with the attempt to integrate two culturally different banks and their parallel employee mind-sets.

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