LIC AND ITS EXPOSURE TO PSU BANKS - SCARY PICTURE

By Ruma Dubey

Yesterday, in an interview with Business Standard, the Deputy Governor of RBI literally pressed the alarm bell. He warned that there is a contagion risk because of Life Insurance Corporation’s (LIC) high exposure to public sector banks (PSUs).

And we are not talking about small stake here. After the Government of India, LIC is the second largest shareholder in these PSU banks. The Deputy Governor said that LIC, on an average holds 9.21% stake in Indian banks, including private sector banks. The risk which he is warning us about could be taken as a rejoinder to the statement with the Governor had made a few days ago. He had also warned that bad loans in the Indian banking system might not have peaked yet. And based on the Q4 numbers which have come so far, he is not far from the truth. The numbers have indeed indicated a lot of stress. A few banks, like PNB and Canara Bank showing an improvement in asset quality is too small when looked at, vis-à-vis the bigger picture. Most of the banks have shown an increase in restructuring and usually, restructuring, almost 15-20% of it collapses as NPAs.

The same warning in different tones comes from CRISIL and Moody’s too. Rating agency CRISIL put out a report stating that gross bad debt of the banking system is likely to rise to 4.5% of total assets from 4.3% at the end of FY15. Moody’s India was very categorical in stating that India’ sovereign rating could be affected if banks did not get this bad asset quality fixed.

This is what the Deputy Governor was trying to do – connect the dots and the picture which emerged, was not just a bad state of the already beleaguered banking sector but LIC, the Govt’s mulch cow also facing consequences. And what was its fault? It poured money into banks, surely at the behest of the Govt even when it knew that things were not good. The Govt as such always treats LIC as its personal ATM – any crisis, bank on good ole’ LIC to bail them out. That is what LIC has always done – be the knight in the shining armour. But the Govt has probably over extended this armour and now LIC could get hurt.

And if LIC gets hurt, the ramifications go right down to the lakhs of policy holders of LIC. How? When the investment it has made in these PSU banks runs into a loss, there will be erosion in the NAV of LIC. The money it uses to buy all this equity is obviously what it gets from the policy holders and this means, the capability of LIC to serve the policy holders will be compromised.

The contagion does not end there. It could have ramifications on the markets too. Suppose LIC see’s that its investment is making losses, to cut the losses, it could go on a selling spree of these shares. And that, will not be good for the markets.

Over and above all this, what one needs to question is the capability of the banks. Why the need to always tap into LIC for funds? Because of poor valuations or the knowledge that no one will bite the bait even if they go for a QIP? So if they know this, banks should ideally work on improving the balance sheet but what they do – they create more NPAs knowing fully well that LIC will bail them out. This is a bad habit created by the Govt and it would be very difficult to break it, unless of course, LIC for once, puts its foot down and says, “NO!” And if at all LIC says no, won’t that affect the financial stability of the banks?

For FY16, the Govt in the Union Budget had allocated Rs.7,940 crore for recapitalization of banks. This, many bankers say is too little – how were they going to fund growth while keeping the asset quality good if money was not coming? As mentioned earlier, poor asset quality is not allowing them to get good valuations, hence they fail on raising enough money by themselves. Thus the fall back on LIC, or should we say, the fall guy will continue to remain LIC?