India’s second largest financial institution, IDBI, has finally received the government’s attention on its plans of transforming into a universal bank. Over the past few months, the institution has been working hard towards converting into a bank.
Its initial plan of converting into a bank was not accepted by the RBI. This was due to the fact that the institution had been set up as a statutory corporation and banking activity was not permissible under the IDBI Act. The RBI also turned down the institution’s request of relaxing some of the banking norms (CRR, SLR) as the central bank has not given any relaxation to ICICI also.
In order to revive IDBI’s business and restore confidence, the Finance Minister is expected to announce a road map for IDBI’s transformation into a bank, in his budget speech. Accordingly, the government will set up a new entity under the Companies Act, 1956. IDBI’s assets and liabilities would be transferred to this new company and the existing IDBI Act would be repealed. Subsequently, a large public sector bank would be merged with this new entity.
This move of the government would be positive for IDBI, which is lacking funds and is facing challenging business conditions. In the first nine months of the current fiscal, IDBI’s total income declined by 4% and earnings witnessed a steep drop of 55%. This was mainly due to a 58% jump in bad and doubtful debts provisions. During the period, the total loans disbursed by the institutions were also lower by 23%. This clearly reflects the dismal state of IDBI’s business. Considering this, a leading rating agency has downgraded its bonds rating to ‘AA’ from the earlier ‘AAA’ making it difficult for IDBI to raise capital from the market at lower costs.
The institution’s merger with the bank would allow it to raise funds at a relatively lower cost and increase it spread. Public sector banks generally have wide spread network. IDBI can leverage these to distribute its personal finance products, which will help it to widen revenue base. However, before the institution starts its new life it needs to clear its large pool of NPAs (net NPAs of Rs 84 bn in FY01, accounting for about 91% of net worth).
The FM’s move has also cleared the issue of IDBI’s reverse merger with its banking arm, IDBI Bank that would now operate as a separate entity. Over the last few months, IDBI Bank, a new generations private sector bank was lacking capital for rapid expansion in its business. The bank would now be able to attract a strategic partner and raise funds. Its valuations would also get an upward re-rating once the detailed plan for its parent is cleared in the budget. IDBI Bank currently trades at a price to book value ratio of 1.2x.
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