They may have got a raw deal, but it is a good lesson for speculators
As the Lakshmi Vilas Bank moratorium ended in just 10 days as against the 30 day freeze, depositors of LVB were in a cheerful mood. Their money in the bank had been protected. However, investors in LVB did not share similar sentiments as they saw their investment virtually wiped out in a matter of hours. What exactly happened to LBV investors?
Investors in LVB get a raw deal
When we talk of investors in LVB, we only focus on the equity shareholders and the bond holders in the bank. Both have got a raw deal. Let us look at the shareholders first. The RBI, as part of the rescue plan, sought to write off the entire equity and any free reserves to set off against the negative net worth of the bank. That literally means; equity shareholders were left holding worthless paper. DCB India is an unlisted bank and the government plans to cancel the original shares of LVB post-merger.
In a swift move, the RBI instructed LVB to write off Rs.320 crore of Tier-2 bonds out of the total Rs.360 crore of bonds issued. Here again, this is a case like Yes Bank where the AT1 bonds worth Rs.8,000 crore were fully written off. Tier-2 bonds are part of Tier-2 capital and were specially allowed by the Basel Committee. These bonds contain a specific clause that in the event of a bank becoming unviable the amounts can be written off under Section 45 of the Act. That is exactly what happened!
Highlights Caveat Emptor
In Latin there is a popular term called, “Caveat Emptor”; which means let the buyer beware. This forms the basis of all financial contracts and investing in equity and debt is no different. In most investment contracts, there is a default risk and the closer you hold investments to the actual default, the higher the risk that you run. The RBI and government have highlighted that its primary task is to protect the interests of the small bank depositor and the integrity of the financial markets. It is difficult to expect the central bank or the government to start worrying about the interests of the equity and bond investors who enter into such contracts fully cognizant of the risks involved. That Caveat Emptor logic was evident in Yes Bank and it is again evident in the case of LVB.
Lesson for speculators too
It is common for individual and other institutional investors to speculate in troubled banks in the fervent hope that the government and RBI would bail them out. That hope was misplaced in the first place and the RBI has just said that in unambiguous terms. Traders buying into speculative stocks or bonds in the midst of distress do so in the hope of making big profits. They must be prepared for big losses too. It may look painful for the investors but the LVB crisis is not new. If they still held on, that is a risk they have chosen!