By Ira Dugal
The government is looking to sell stake in IDBI Bank Ltd. to Life Insurance Corporation of India. It has already approached the insurance regulator to clear the decks of this stake transfer, BloombergQuint reported on Friday. While BloombergQuint could not ascertain exactly how much stake the government wants to sell, other media reports suggest that it will be a controlling stake.
If so, this would mark the entry of LIC into banking — a long-held ambition which has been snuffed out by the banking regulator in the past.
Will this time be different? And should the entry of the country’s largest insurer into banking be welcomed or feared?
There are a few issues to consider. Key among them is whether IDBI makes for a good investment for LIC and its policyholders. But there are other issues to ponder as well, such as LIC’s existing portfolio, it’s inter-connectedness with the banking sector and the need to ensure that financial stability in not compromised.
Is IDBI A Good Investment For LIC?
Since nationalisation in 1956, LIC has been fully owned by the government. In 2000, the sector was opened up to private and foreign investment. Despite this, LIC continues to command a significant share in the market. LIC’s annual report for 2016-17, the latest available, shows that it had a 71 percent share in total first year premium. As such, the insurer has maintained a steady inflow of funds into its coffers.
The money that it collects from policyholders gets invested across a variety of instruments governed by rules laid down by the Insurance Regulatory and Development Authority of India. Broadly, LIC invests policyholder funds in government bonds, equity of various companies, corporate bonds and debentures. It is supposed to do so in a way to first ensure the security of policyholders funds and then to generate returns on its investments.
Except in an extreme scenario, it is unlikely that policyholders capital would not be protected. Even so, it is worth questioning whether IDBI Bank, a lender with bad loans close to a third of its book, makes for a good investment for LIC.
It is also worth noting that the size of the investment would not be insignificant.
LIC currently holds 11 percent in IDBI Bank. Hypothetically, if it were to buy another 40 percent stake to get to 51 percent shareholding, it would cost the insurer Rs 9,600 crore at current market value.
But that’s not the end of it.
LIC, as a majority shareholder, would need to pump in capital to help clean up IDBI Bank.
India Ratings estimates that IDBI Bank’s total stressed portfolio (including non-fund based faclities) is 35.9 percent of total loans. This means that the bank will need significant amounts of capital to clean-up its books and maintain minimum levels of regulatory capital. According to the rating agency, in 2018-19, IDBI Bank will need more than the Rs 10,000 crore that it received from the government last fiscal.
Even if you take a conservative estimate of Rs 10,000 crore in capital needed, that takes LIC’s immediate capital commitment to IDBI Bank to over Rs 20,000 crore.
Is that money well spent by LIC? It’s tough to argue in favor of that given that the bank has reported losses for six consecutive quarters now. Even though it trades below book value at 0.8 times, few in the market could argue that IDBI Bank makes for a great investment. Note that no private investor has shown an interest in IDBI Bank even though the government has been wanting to sell equity for over two years now. That is a hint of its attractiveness (or the lack of it).
Already Half A Bank And Banking Holding Company
There are other issues to consider. Such as, the existing role of LIC in the credit markets and its inter-connectedness with the banking sector.
LIC’s annual report for 2016-17 shows that 4.4 percent of LIC’s investments went directly into lending. That’s Rs 1.09 lakh crore in loans given out by LIC.
In addition to this direct loan portfolio, LIC is also a significant investor in non-government debt securities. As per existing rules, LIC can invest upto 35 percent in equities and bonds of companies.
The point here is that LIC is already a material player in the credit markets. Should it now have majority ownership of a bank, its exposure to companies and sectors would need to be tracked at an aggregate level so as to avoid a build up of risk.
Also as part of its investment activities, LIC has been an active investor in public sector banks. This was particularly true in 2015 and 2016, when LIC bought into preferential share issues of a number of government run banks to cover for the shortage of capital.
As a result, LIC’s shareholding in these banks has risen.
Shareholding data from stock exchanges shows that LIC holds more than 10 percent in at least six government banks.
Apart from holding equity in banks, LIC invested in debt securities issued by banks, including additional tier-1 bonds. As such, its connectedness to the banking system is already significant.
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