Big lessons from the Lakshmi Vilas bank crisis for customers: change accounts at the first sign of trouble!

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Whether it was PMC Bank or LVB or any other financial institution in difficulty, the financial situation of these banks was deteriorating steadily.

By Raj Khosla

The Lakshmi Vilas Bank (LVB) crisis shocked hundreds of thousands of troubled bank customers and investors. Looking back, it’s easy to point out what went wrong with the bank that ultimately led to its merger with DBS. However, it cannot be denied that the writing had been on the wall for quite some time. Whether it was PMC Bank or LVB or any other financial institution in difficulty, the financial situation of these banks was deteriorating steadily.

As a customer or depositor, there’s not much you can do after a bank places restrictions on withdrawals. Likewise, there is little that shareholders can do when the stock price is falling every day. But if you take preventative measures, you can avoid getting caught in such tricky situations. Here are some steps that may help you:

Don’t be lured by high rates

In fact, LVB offered high interest rates on deposits. The high rates are a sign that the bank is in desperate need of deposits and is trying to attract customers. The 1 to 2 percentage point higher return should not be the reason to opt for a less secure deposit. Put your money in a well-capitalized bank to keep it safe, even if it means earning a slightly lower interest rate. Safety, not returns, should be the primary concern.

A comforting aspect for depositors is the deposit insurance of Rs 5 lakh offered by the Deposit Insurance and Credit Guarantee Corporation (DICGC). However, the insurance is limited to only Rs 5 lakh per customer. If his deposits are greater than Rs 5 lakh, the customer could face a possible loss.

Not all eggs in one basket

It is also unwise to rely on a single institution for an essential service such as banking. Small banks like LVB should never be the main account. Always keep 2-3 bank accounts. Maintain an account with a next-generation full-service private bank to take advantage of the efficiency they offer. Make sure it is a well capitalized bank (HDFC Bank, Axis Bank or ICICI Bank). Another could be in a well-capitalized PSU bank like the State Bank of India or the Punjab National Bank.

Likewise, when investing in bank deposits, divide your money among several banks. Diversification between 2-3 banks will also improve deposit insurance coverage. Coverage is Rs 5 lakh per person per bank.

Avoid weak fundamentals

LVB’s weakening finances were no secret. The major problem was the bad debts on his books, which completely wiped out his net worth. The bank’s gross NPA has steadily increased over the past three years. Gross NPA was 10% in 2018, which rose to 15.3% in 2019 and is now 25.4% in 2020. This means that Rs 1 in Rs 4 loaned by LVB will not return. In contrast, strong banks such as HDFC Bank and Kotak Bank have gross NPAs of 1.08% and 2.55% respectively.

Investing in a bank with a gross NPA of 25% and a net NPA of almost 10% is too big a bet, for very little additional returns. Unfortunately for shareholders, the RBI’s proposed merger plan indicates that shares or bonds of LVB will be delisted upon the merger. The price will therefore eventually drop to zero. Investors who always buy stocks in the vain hope that stocks might recover are throwing away their hard-earned money.

Essentially, keep a hawk eye on the fundamentals of the bank you’re dealing with and change your account at the first sign of trouble. Additionally, maintaining accounts with multiple and diverse banks will always be helpful.

(The writer is Managing Director, MyMoneyMantra.com)

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