It is really not much of a surprise that RBI has turned down the proposal to amalgamate Lakshmi Vilas Bank and Indiabulls Housing Finance. To be sure, the rationale for the merger sounded good: each had its frailties, but the strategy was that the cheap deposits from one would help fund the loans of the other, to create a business with scale. However, allowing promoters connected with the real estate business-especially the commercial piece-to enter the banking sector is not a good idea. This was the central bank's philosophy even when the guidelines for new banking licences were announced in 2013 and the reason why many business groups didn't bag one. Since then, promoters with large financial exposures to the real estate sector have entered the financial services space and tried to make a back-door entry into banking, but these attempts were nipped in the bud.
There are those who argue, however, that the financial markets may just have turned a little more vulnerable to defaults; the BankNifty tumbled 770 points on Thursday as investors worried about how Indiabulls would make ends meet. The big concern is that it owes banks a lot of money, which constitute a big chunk of its long-term borrowings of around Rs 1 lakh crore at the end of March 2019. Refinancing loans in this tight-liquidity and risk-averse environment is going to be a big challenge. The banks may claim their loans to Indiabulls are backed by assets, but we know how fast the value of some of these assets can depreciate in a jittery market such as today's. Analysts have pointed out that Indiabulls's exposures to developer funding as also loans against property are somewhat troubling. Therefore, the regulator must ask Indiabulls to deleverage quickly by selling assets.
Indeed, given how growth seems to be stalling and credit offtake is turning negative, it won't hurt to initiate some restructuring of the financial system. There is now definitely a case for greater consolidation with the larger and stronger private sector banks taking over smaller and somewhat fragile lenders-whether banks or even NBFCs-provided the latter have no exposure to commercial real estate and provided the promoters are asked to go. It might seem the central bank is being harsh in not giving smaller banks more time to stabilise their operations but we simply cannot afford another default post IL&FS and DHFL because the risk averseness of lenders is choking the flow of credit. Some merger moves need to be initiated now before any more lenders fail. And the regulator must keep a watch on how NBFCs are raising resources to make sure they are not endangering the system.