People Walk Past an IDBI Bank Automated Teller Machine in Mumbai (Photographer: Robert Stewart/Bloomberg News) 

The Fractured Legacy Of IDBI Bank

On Friday, the insurance regulator approved a proposal to allow the Life Insurance Corporation of India to buy up to 51 percent in IDBI Bank Ltd, BloombergQuint reported. The approval came with caveats. LIC will pump in about Rs 13,000 crore but will not get management rights. It will also reduce its stake in the bank back to about 15 percent over a 5-7 year period.

Simply put, this is a bailout of IDBI Bank by LIC.

Justifiably, there is concern about why LIC is being called upon to bail out the bank. Does this investment make sense for LIC? Why should policyholder money be used to bail out a stressed bank? All valid questions.

But if you turn the lens around and see it from IDBI Bank’s perspective, the questions are different. How did IDBI get here? And what were the options in front of it and its promoter – the government? And what will be the future of IDBI.

The bank needed a rescue. This has been clear for a few quarters now.

  • Gross non performing assets have risen to Rs 55,588 crore.
  • There are still Rs 18,781 crore in stressed assets classified as standard.
  • Overall, 36 percent of the total loan book is seen as stressed by rating agency India Ratings.
  • The core equity tier-1 ratio was at 7.42 percent as of March 2018 – just marginally above the minimum requirement of 7.375 percent.

So What Were The Options?

The IDBI Bank management had come up with a few ways to deal with the stress.

Option 1: Stop corporate lending and focus on retail loans. Which they did.
Option 2: Raise capital by selling non-core assets. They succeeded in raising Rs 5,000 crore.
Option 3: House the corporate loans in a separate entity and bring in investors into the ‘good’ retail bank. Which they did not get permission for.

But given the size of the problem, none of this was good enough. A broader solution was needed.

The most straight forward solution was to have the government put in more (substantially more) capital. But that wasn’t forthcoming. The second option was a merger with a stronger bank. But with asset quality weakness spread across the banking sector, it would have been near impossible for any bank to digest IDBI Bank without getting sick itself.

There was a third option.

Wind down the bank, says R Balakrishnan who has four decades of experience in finance and was a member of the founding team at rating agency CRISIL. The retail bank, with loans and deposits, could have been spun off. The good corporate loans could have been sold to other banks. The bad loans could have been housed in an entity focused on recoveries, Balakrishnan says.

The authorities felt there wasn’t enough time to execute a complex turnaround plan, said a person familiar with the matter.

And so they picked what they perhaps thought was the best of bad options. By allowing LIC to pick up 51 percent in IDBI Bank, the lender will likely get some immediately needed capital to tide through this period of bad loan resolution, which will likely stretch out over the next two years.

The Many Shapes Of IDBI

With a capital infusion, the immediate issue may get partly addressed. But with LIC being asked to bring down its stake in the bank to about 15 percent over a 5-7 year period, the future of IDBI remains unclear. Will a private investor come in after the clean-up and pick up at least parts of it? Will it get merged with another lender? It’s tough to tell at this stage.

Should IDBI Bank emerge in a new avatar, it wouldn’t be the first time the organisation has changed its stripes.

IDBI was one of the original trio of development finance institutions. IFCI was set up in 1948. ICICI in 1955. And then IDBI in 1964. The Indian economy was weak back then and needed support to build up domestic industry and reduce dependence on imports.

At the time of incorporation, IDBI was set up as a subsidiary of the Reserve Bank of India. It’s mandate was wide. To lend to industrial corporations, state finance corporations, scheduled banks, state co-operative banks. It could borrow funds via the issue of bonds and debentures. Bonds issued by IDBI, along with ICICI and IFCI, were given SLR (statutory liquidity ratio) status. This meant that, as an investment, they were essentially on par with central government bonds.

In 1976, the RBI transferred its ownership in IDBI to the government.

Over the next decade, IDBI saw its influence grow. It was much ahead of ICICI and IFCI in terms of project finance, says R.K. Bansal, who was with IDBI Bank for over 30 years and retired as an executive director. IDBI would borrow from the markets and banks and then lend to industry. Lending decisions were made at the top and interest rates were fixed, explains Balakrishnan.

Till the 80s, banks were not allowed to give term loans, which meant that IDBI had a clear advantage, recalls Bansal. But once banks started to do term lending, IDBI was on the back foot since it couldn’t match the rates at which banks were lending, Bansal told BloombergQuint.

In 1992, the government withdrew SLR status to bonds issued by development finance institutions, delivering another blow to IDBI.

In a speech in 2013, former RBI deputy governor KC Chakrabarty explained why this was important.

As the DFIs were set up as public sector enterprises, the market perceived the borrowings made by them as having implicit government guarantee. This induced a sense of profligacy in the behaviour of the DFIs while borrowing. Further, in the absence of a competitive environment for project lending, the entities became quite complacent and disregarded the viability of the projects financed, while pricing. The crossholding of shares amongst the DFIs also led to a contagion effect in creating NPAs.
KC Chakrabarty, Former RBI Deputy Governor (2013 Speech)

By the turn of the century, IDBI had run into trouble.

Gross NPAs between 1999 and 2003 ranged from 14 percent to 17 percent, forcing a rethink on the future of IDBI. In 2003, the government repealed the IDBI Act converting IDBI Ltd. into a banking company.

The Move Into Retail

Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services, says that it had become clear, even in the early 90s, that development finance institutions would need to move into retail banking.

Parekh recalls that he was first called on to draft IDBI’s application for a commercial bank in 1992. The commercial bank began operations as a subsidiary of IDBI in 1994. ICICI Bank, due to its more private sector bent, managed to grow its retail banking operations far more quickly than IDBI Bank, Parekh told BloombergQuint. Still, IDBI Bank managed to build up a decent retail branch network and liabilities franchise between 1994 and 2004.

In 2004, the retail bank was merged with IDBI. According to Parekh, the merger actually ended up destroying the value in the retail bank. The large size of the corporate book meant that the retail operations were dwarfed.

Data from the bank’s annual reports show that till 2010, only 13 percent of IDBI Bank’s advances were retail. Today, close to 45 percent of the loans are in the retail category but that is also because the bank has been de-growing its corporate loan book.

Bansal acknowledges that, in hindsight, the bank could have focused more on retail operations sooner. There was always a focus on retail liabilities but not enough on retail assets.

NPAs: Back To The Past

IDBI’s previous brush with poor asset quality in early 2000s was not very different from what it faces now. Back then, too, infrastructure companies, particularly steel, were in trouble. Ironically, many of the companies that were in IDBI’s bad loan book then are present now.

But at that time the economy recovered quite quickly and restructuring under the corporate debt restructuring mechanism worked, says Bansal.

The relatively easy recovery from the bad loan cycle of 2000 meant that IDBI did not shy away from taking large bets in the 2008-10 period. When large corporate investments restarted, IDBI jumped back in head first.

Almost every bank is feeling the heat from that lending cycle now. But for IDBI, the impact has been severe.

  • The bank has an exposure to 11 of the 12 accounts in the RBI’s first list of stressed assets.
  • It has exposure to 19 of the 29 accounts in the RBI’s second list of stressed assets.
  • It has a 64 percent provision coverage against the first 12 accounts and a 55 percent coverage against the second set of accounts.

And that is the core reason why LIC has been roped in to bail out of IDBI. The lender needs large amounts of capital. Not just this year but perhaps for the next few years. Recoveries remain dependent on the progress of resolution under the Insolvency and Bankruptcy Code. The experience so far has not been great.

Can IDBI recover from this cycle and maintain an independent identity?

Yes, says Bansal. When the recoveries begin, IDBI’s balance sheet will recover faster than others since the lender has a larger exposure to the stressed accounts, he says.

Maybe, says Parekh. Provided a progressive management is put in place. The retail bank should be demerged and allowed to grow, he says.

No, says Balakrishnan. Its retail operations should be sold through a transparent auction process and the institution wound down.

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