RBI repudiates the first ever merger attempt between a bank and a NBFC

Posted On - 4 November, 2019 • By - Akshay Ramesh

A merger between the banks is not a new trend in
the Indian banking sector. In fact, the very first  merger in the Indian banking sector  took place in the year 1921 between the three
presidency banks namely the Bank of Bengal, the Bank of Bombay and the Bank of
Madras when the three banks merged to form a new bank known as Imperial Bank of
India, which was renamed as State Bank of India soon after the independence.

However, this financial year has made its place in
the history of the Indian banking sector due to the first-ever attempt made for
the merger between a bank and the non-banking financial company. But this
merger attempt has failed due to Reserve Bank of India’s (“RBI”)
stringent regulations. With a blind hope of getting the merger approval, the
Lakshmi Vilas Bank and Indiabulls Housing Finance Limited (a non-banking
financial lender) announced their plan of merger in April, 2019 and applied for
the RBI’s nod in May.

Reasons for Merger

Every merger that happens in the banking sectors
more or less has the desirable interest of accomplishing financial stability.
The merging entities i.e., Lakshmi Vilas Bank and Indiabulls Housing Finance
Ltd too had dreamt of achieving financial stability through this merger.

The merger was crucial for Lakshmi Vilas Bank as it
was in desperate need of funds since its CAR at the end of 31 March, 2019 was
7.72%, way below the regulatory requirement of RBI.

At the same time, the merger was equally important
for the Indiabulls Housing Finance Ltd. as it would have given access to
low-cost funds during the situation when the non-banking financial sector faces
the crisis of confidence with banks.

Finally, through this merger, both Lakshmi Vilas
Bank and Indiabulls Housing Finance Ltd. had plans of raising low-cost funds
through public deposits which were struck by the RBI.

Reason for
Rejection

Unfortunately, both Lakshmi Vilas Bank and Indiabulls Housing Finance Ltd
were caught in the web of RBI’s regulatory mechanism which did not favour the
merger plan. Due to this very reason, Lakshmi Vilas Bank had to face the Prompt
Corrective Action (“PCA”) initiated by RBI due to its high level of bad
loans, insufficient Capital Adequacy Ratio (“CAR”) and a negative Return
on Assets (“RoA”). 

Interestingly, as of March 31, 2019, the Lakshmi Vilas bank’s net
non-performing assets stood at 7.49%, CAR at 7.72% and RoA at -2.32%. However,
as per RBI norms, every Indian scheduled commercial bank is required to
maintain a minimum CAR of 9% which was not achieved in the case of Lakshmi Vilas
Bank.

On the other hand, Indiabulls Housing Finance Ltd, a non-banking
financial lender, which intended to merge with Lakshmi Vilas Bank, did not meet
the ‘fit and proper criteria’ of the banking regulator
for the said merger. 

On a whole, these two main reasons altered the scenario wherein the
regulator bank i.e., RBI vide a letter dated October 9, 2019[1],
expressed its strict non-acceptance for the merger between these two entities,
which no doubt has disappointed both Lakshmi Vilas Bank and Indiabulls Housing
Finance Ltd.

Response of
expected merging entities on such rejection.

Though the disapproval of the merger has disrupted
the future plans of both entities, the Indiabulls Housing Finance Ltd. has
taken a positive lead by stating that they are firmly back on the growth path
to become a robust housing finance company soon. However, on the other hand,
the sentiments of the investors on Indiabulls Housing Finance Ltd. (“IBHF”) have drifted negatively since
its shares dropped by 66 percent at Rs. 220 in the Bombay Stock Exchange (“BSE”).
Also, the public interest litigation filed against Indiabulls Housing Finance
Ltd., on the issues of financial irregularities, siphoning off funds and
regulatory violations has created a hassle in the minds of the investors.

However, the true picture of the IBHF’s
non-performing assets at this movement remains unrevealed. Now, the question
that remains in the mind is how IBHF will succeed in its asset/liability
management to boost fresh home loans in the upcoming days.

At the same time, IBHF has claimed that it is
well-capitalized at this stage with cash equivalent reserves of INR28,511 crores
as on August 2019. Meanwhile, the Lakshmi Vilas Bank will now have to independently
explore options for raising capital to help lift the restrictions placed on it.

Legal
Provisions with respect to mergers in the Indian Banking Sector.

Reserve Bank of India (Amalgamation of Private Sector Banks) Directions,
2016[2],
guides the mergers of private sector banks in the Indian banking sector. The
provisions of these directions shall apply to all private sector banks licensed
to operate in India by the RBI and to the Non-Banking Financial Companies (NBFC) registered with the RBI.

These guidelines shall cover two types of amalgamations, one is the
amalgamation of two banking companies and the other is the amalgamation of an
NBFC with a banking company.

The RBI has discretionary powers to approve the voluntary amalgamation of
two banking companies under the provisions of Section 44A of the Banking
Regulation Act, 1949. The voluntary amalgamation of an NBFC with a banking
company is governed by sections 232 to 234 of the Companies Act, 2013.

  • Approval by Board of Directors for the Merger.

Boards
of the concerned banks play a crucial role while dealing with the amalgamation
proposals between two banking companies or between a banking company and an
NBFC. The decision of amalgamation has to be approved by a two-thirds majority
of the total board members and not just of those present and voting.

  • Merger of two banking companies

In terms of Section 44A of the Banking Regulation Act, 1949, the draft
scheme of amalgamation shall be approved by the shareholders of each banking
company by a resolution passed by a majority in number representing two-thirds
in value of the shareholders, present in person or by proxy at a meeting called
for the purpose.

However, before convening the meeting for the purposes of obtaining the
shareholders’ approval, the draft scheme of amalgamation has to be approved by
the Boards of Directors of the two banking companies separately.

In terms of Section 44A of the Banking Regulation Act, 1949, after the
scheme of amalgamation is approved by the requisite majority of shareholders in
accordance with the provisions of the Section, it shall be submitted to the
Reserve Bank for sanction.

  • Merger
    of a bank with an NBFC

When an NBFC proposes to amalgamate with a banking company, the banking
company has to obtain the approval of the Reserve Bank of India after the
scheme of amalgamation is approved by its Board and the Board of NBFC. Wherein,
the RBI may or may not approve the said merger. For instance, in the
above-discussed case, the RBI refused to give its permission for the
amalgamation between Lakshmi Vilas Bank and Indiabulls Housing Finance Ltd.

  • Answers to the
    following questions must be obtained by the Banks before it accepts the merger
    with NBFC
  • Whether the NBFC has violated/is likely to violate any of the RBI / SEBI
    norms and if so, shall ensure that these norms are complied with before the
    scheme of amalgamation is approved.
  • Whether the NBFC has complied with the “Know Your Customer”
    norms for all the accounts, which will become accounts of the banking company
    after amalgamation.
  • Whether the NBFC has availed of credit facilities from banks / FIs,
    whether the loan agreements mandate the NBFC to seek the consent of the bank /
    FI concerned for the proposed merger/amalgamation.

Conclusion

The Indian banking sector from the past two decades
has witnessed many banking mergers. This is due to the increasing competition
amongst the banking companies. The Government of India is also striving towards
the achievement of financial inclusion in India. This has resulted in immense
competition amongst the banking companies to acquire the market share. As a
result of which, many banking companies and non-banking financial companies are
opting for the mode of the merger to expand their service base in the Indian
banking sector. However, the banking regulator, RBI, is also cautious enough in
implementing its regulations, so that the mega-mergers won’t affect the Indian
banking system.

Henceforth, RBI is strict enough in considering the
financial status of the amalgamating entities including private banking
companies, public-sector banks, and NBFCs. As a matter of fact, the
amalgamating baking companies have to first make sure that they have achieved
the requisite CAR as per the RBI norms. A bank with less CAR and huge NPA
problems shall end up facing the PCA by RBI, as we have witnessed in the merger
case of Lakshmi Vilas Bank and Indiabulls Housing Finance Ltd.

On the backdrop of the various scams and defaults
occurring in the Indian financial sector, recently the RBI has decided to
operationalize ‘unified departments for supervision and regulation’ of
commercial banks, urban co-operative banks (UCBs) and non-banking financial
companies (NBFCs) which will be in effect from November 1, 2019[3].

All these recent developments in the Indian banking
sector have rejuvenated the hope amongst the banking customers that the banking
platform has no impediments that would risk their hard-earned money as
deposited with the banks.

Contributed By – Akshay Ramesh, Associate
Gokul.L, Associate

King Stubb & Kasiva,
Advocates & Attorneys

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