Press reports indicate that the Insurance Regulatory and Development Authority of India has cleared the proposal of Life Insurance Corporation of India to raise its stake in the ailing state owned IDBI bank to 51%. The approval is of course accorded with caveats: One, it will inject about Rs 13 000 cr in to IDBI as equity; two, it will not get management rights; and three, it has to reduce its stake in the bank to about 15% over a period of 5-7 years. Before getting into the sanctity of LIC’s proposal to hike its stake in an ailing bank, let us first take a look at the financials of IDBI bank, for it alone can equip us to judge the investment decision of LIC fairly.
As the non-performing assets of IDBI bank raised beyond a threshold, RBI has placed it under the prompt corrective action frame work in May 2017. The bank has posted a net loss of Rs 8238 cr for the financial year ending March 31, 2018. Its current gross nonperforming assets are hovering around 28%, which is the second highest ratio ever witnessed in the banking system. As a result of this growing menace, even the capital infusion of R10 600 by the government last fiscal, that too, over and above the R 2 200 cr added between fiscal 2015 and fiscal 2017 could not enable it to meet its capital requirements. As the bank’s current Tier I capital stood at 7.4 percent, which hardly meets the mandated requirement of 7.37 percent, it has to freeze its lending and branch expansion plans. Intriguingly, the bank has also reported a negative RoA for the last three consecutive years. The rating agencies (India ratings) have marked 36 % of total loan book as stressed assets. Thus, its prospects for turning into profit in the near future appears to be bleak. Obviously, the bank needs a rescue.
It is against this background that the government appears to have asked the state owned LIC to bail out the bank by rising its stake in it from the current level of 10.37% to 51%. With this capital infusion, its immediate problem of capital inadequacy gets partly answered. But the big question is: will IDBI bank be able to turn around within 5 to7 years for LIC to withdraw its capital as directed by IRDA and bring its stake in it back to 15%? The answer to this question is anybody’s guess! The way the NPAs are raising in PSBs and the resulting continued erosion in the capital coupled with falling net interest margin no one is sure when this bleeding will stop.
Now turning to LIC, the first thing that strikes our mind is: LIC is an independent body that is answerable to its policyholders. The capital that it is asked to infuse into IDBI is premium collections that are supposed to be invested by LIC mostly in risk-free securities to earn income so as to honour its commitments to the policyholders at a future date.
Indeed, IRDA, the regulatory authority that overseas the functioning of insurance business in the country has set certain investment guidelines for insurance companies to follow while investing their premium income with the sole objective of diversifying the risk and thereby ensure safety of the investment and the return thereof. Under the said regulations, LIC is permitted to have an equity exposure up to 15% in a single company.
That being the rule, any deviation from the norm would only mean undermining the safety of insures’ funds. And that’s what the present proposition of LIC to invest funds in IDBI exceeding the 15% cut off limit, that too, in an already ailing bank would precisely mean.
It is this underlying philosophy that is raising many irritating questions. True, investment of 12 000 cr might be a small fraction of LIC’s balance sheet of Rs 1.24 lakh cr. But how about the prudence of the investment? For the government it might be an easy way out to rescue the bank but as a principle it is bad, for the investment is in no way beneficial. Should the experiment go wrong, will LIC be able to answer its policyholders’ claims? Also, would it not question the wisdom of IRDA in granting such exemptions to rules framed by it? Ironically, we are building institutions, framing prudent regulations but take pleasure in frequently tinkering with them. This playing with the independence of regulatory bodies and financial institutions may not augur well for the system.
Over the years, LIC has become the unfortunate milch cow of the government at the centre for bailing it out from many of its share disposal programmes, etc and this is going on unabated irrespective of the political party in power. This is the biggest worry, indeed!
So long as the going is good, and institutions continue to be ‘going-concerns’, there may not be any apparent threat to the financial system. But prudence commands us to remember the fate of UTI, the erstwhile behemoth of capital markets that helped government in disinvestment of its stake in Public Sector Undertakings, etc. Institutions of LIC’s magnitude are capable of creating contagion risk in the system and hence command that we handle them with care.