Explained: Why It's a Bad Idea for LIC to Buy IDBI Bank

Should LIC’s customers, who signed up to insure their own lives, be forced to bail out a dying state-run lender?

New Delhi: The Narendra Modi government is looking to unload a large chunk of its stake in IDBI Bank Ltd to the Life Insurance Corporation of India (LIC), the country’s largest public insurer.

While there is some confusion over how much LIC will invest, the development has raised eyebrows, with questions being raised over whether pouring policyholder funds (roughly Rs 20,000 crore) into what is arguably India’s worst-performing public sector bank.

Should LIC’s customers, who signed up to insure their own lives, be forced to bail out a dying state-run lender? The Wire breaks it down.

Why is LIC doing this?

The first thing you need to understand about LIC is that it is a giant.  Nearly 20 years after the life insurance market was thrown up to private and foreign players, it still commands a 71% market share in what analysts call ‘total first-year premium’, a term used for the amount of money that policyholders cough up during the first year they sign up for one.

LIC issues roughly 20 million policies every year. Overall, it manages insurance contracts for at least 250 million people through 300 million life insurance policies and rakes in annual premium income of a little over Rs 3 lakh crore.

This has translated over the years into a formidable balance sheet – nearly Rs 30 lakh crore – which in turn allows it to invest anywhere between Rs 2 lakh crore and Rs 2.5 lakh crore every year in the capital markets. It will remain a large lender regardless of whether or not it ends up buying IDBI: its FY’17 annual report shows that it gave out over Rs 1 lakh crore in loans that year.

All this means one simple thing: the public life insurer is used as a convenient ATM by whichever government happens to be in power at the Centre.

Over the last four years, it has given questionable soft loans to the Railways, subscribed to the power sector’s Ujwal Discom Assurance Yojana (UDAY) bonds and invested in the National Investment and Infrastructure Fund. All this apart from being an active partner of the Centre’s disinvestment agenda.

Credit: Reuters

Credit: Reuters

How much is LIC planning to invest in IDBI Bank?

In 2015 and 2016, LIC already came to the rescue of a number of public sector banks to cover for their shortage of capital and bought into preferential share issues.

As a result of this and past investments, the life insurer already owns about 11% of IDBI.

There’s still some confusion over what stake LIC will take in IDBI – latest news reports say that it pick up another 30% or so, bringing its holding to 40%, while others say that will take the full 51%.

The investment will cost anywhere between Rs 8,000 crore to Rs 12,000 crore at current market prices. Now, this money won’t go towards IDBI, it will go in buying the Centre’s stake.

On top of this investment, IDBI requires another Rs 10,000-13,000 crore to clean up its books and maintain minimum levels of regulatory capital. So LIC will have to cough up somewhere around Rs 20,000 crore or a little over $3 billion in the first round.

But will this be enough? This brings us to our next question.


Is IDBI a good bet for LIC?

As at least one financial analyst puts it, the Rs 20,000 crore that LIC will have to shell out is, more or less, money down the drain.

Why? Primarily because even among the generally sorry state of public sector banks, IDBI ranks particularly low.

The bank’s gross non-performing assets (NPAs) rose to Rs 55,588 crore in March 2018, up from Rs 44,753 crore a year earlier. Its gross NPAs are nearly 28% of its total loan book (the highest among all banks). India Ratings, a credit ratings agency, reckons that if all of its distressed loans, which are currently classified as standard assets, are to be marked down, the bank’s NPAs would rise to almost 36% of its total advances.

With its losses widening to Rs 5,663 crore for the quarter ending March 2018, up 77% from the Rs 3,200 crore loss reported in March 207, IDBI will be a money-grabbing blackhole for the next three years.

More alarmingly, its capital position remains dangerously close to the minimum requirement of 7.375% even though the Modi government plowed in a little over Rs 10,000 crore of taxpayers’ money into the bank last fiscal year.

Add to this the fact that IDBI currently doesn’t have a full-time CEO and MD that the RBI doesnt expect it to come out of ‘prompt corrective action’ (PCA) until 2020-21, and its unclear whether the bank is worth saving at this point.

What does this investment mean for LIC policy-holders?

LIC  takes policyholder funds and invests that money in order to do two things: One, ensure the security of those funds. And two, to generate returns on its investments. The bulk of its investment goes into more traditionally safe outlets like government bonds, but as shown above, the rest of its money sometimes goes into riskier stuff.

One argument that is being made out in defence of the IDBI deal is that this money is a drop in the ocean when compared to LIC’s size and its other investments. For instance, in 2016-2017, the life insurer earned Rs 1.8 lakh crore in investment income. The IDBI transaction would require roughly Rs 20,000 crore upfront and more installments of Rs 10,000 crore in the next two to three years.

Rajesh Chakrabarti, a professor at Jindal Global Business School, believes that LIC is “too massive and its stability is unlikely to be impacted by an acquisition of this size”.

Media reports, quoting unnamed government officials, have made similar arguments.

This type of defence, however, ignores two main counter-arguments. Firstly, it is possible to acknowledge that the IDBI deal is essentially a case of throwing good money after bad – even if the acquisition doesn’t threaten LIC’s very existence or that it won’t wipe out policyholder funds.

Secondly, it completely ignores the systemic issues that this transaction raises. Is it okay if a a ‘too-big-to-fail’ entity like LIC  is allowed to enter the banking sector? In the past, in 2015 and 2016, when the life insurer stepped in and invested in government-run banks by participating in preferential share issues, the RBI publicly raised financial stability risks.

“There is a contagion risk or interconnected risk. Suppose the banking sector is not doing well and is in trouble, the equity holding of LIC will see a value erosion. This [affects] the capability of the insurer to serve their policyholders,” then central bank deputy governor S.S. Mundra said in an interview in 2015.

At the time, Mundra and the RBI also underscored another problem: Allowing India’s public sector bank to rely on LIC for easy capital is an issue of moral hazard. After all, the main reason that they depend on LIC is because they clearly are not in a position to raise that same capital from the markets.

Why is the government pushing for this deal to go through then?

There are multiple reasons, but in short, the Modi government is killing two birds with one stone.

By allowing LIC to take IDBI, the worst-performing public sector bank, off of its hands, it is no longer directly responsible for the institution’s NPA headaches and its accompanying capital requirements.

The Centre has also been looking, for two years, to be able to reduce its stake in IDBI in particular. During the budget speech for 2016-17, finance minister Arun Jaitley had announced the government’s intentions to pare down its stake in IDBI to less than 50%. However, nothing much has happened on that front, with the prime minister’s office even writing a letter to the finance ministry, reminding it of the budget promise and seeking details of the proposed stake sale.

As market analyst and economist Vivek Kaul notes, the LIC-IDBI deal will also help the Modi government meet its disinvestment target of Rs 80,000 crore for this year, a goal that became more difficult with the Air India flop-show.

Will regulators allow this to happen?

Out of all public sector banks banks, it’s easiest for this to happen with IDBI Bank as it doesnt come under the Bank Nationalisation Act. This means that the bank can be sold without any legislative changes.

On the other hand, LIC is governed, in part at least, by the Insurance Regulatory and Development Authority (IRDA). The IRDA has capped LIC’s equity investment in other firms at 15%, which means that theoretically, the life insurer can’t buy a 51% stake without permission (although legal experts believe there could be some leeway as the LIC Act, 1956 precedes the IRDA Act, 1999).

Nevertheless, IRDA”s board meets in two days, during which they will presumably take a call on whether an exemption can be granted in this case.