Mint Explainer: The Madras high court order that's put RBI in a spot

Based on this valuation, the regulator is expected to reassess its decision to write down the shares and tier 2 bonds of LVB. This decision follows a lawsuit by LVB bondholders and minority shareholders challenging the writedown of their investments.

Mint explains the significance of the court's order and what it means for RBI.

What is the order about?

In December 2020, bondholders and minority shareholders of the erstwhile Lakshmi Vilas Bank filed a suit against the write-down of their investments in tier 2 bonds worth ₹320 crore after the bank's merger with DBS Bank. They argued that the Centre-approved merger scheme was silent on this write-down and accused RBI of acting arbitrarily.

Read More: ‘LVB integration complete; DBS now looks for growth’

On 26 April, the Madras High Court passed a final order refusing to interfere with RBI's decision. It, however, directed RBI to reassess the shares and assets of both DBS Bank and LVB before the amalgamation and reconsider the reduction in the value of the shares and the writeoff of tier 2 bonds. The court has given RBI four months to complete this assessment.

What were the observations made by the court?

The Madras High Court criticized RBI's lack of transparency in selecting DBS for amalgamation. It noted that 12 proposals were considered, but their terms and conditions were not disclosed, ostensibly to maintain confidentiality.

"Even if the decision has to be taken secretly in the interest of the Banking sector, the RBI has to maintain files. The decisions are to be recorded. Such decisions are liable to be placed before this court while it calls for Judicial Review," it noted in the order.

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The court also criticized RBI for not protecting shareholders' interests, failing to determine a swap ratio, and not conducting a comparative valuation of LVB and DBS shares. RBI only considered LVB's negative net worth before writing down its shares to zero, without accounting for the market value of its assets.

What is RBI likely to do?

India's central bank plans to appeal against the order in the Supreme Court, reiterating that its actions were necessary to protect depositors.

Complying with the order would require appointing an official valuer to reassess the shares and assets of DBS and LVB.

How does RBI approve amalgamations?

There are two types of amalgamations in the banking sector: compulsory and voluntary. Compulsory amalgamations are induced or forced by the RBI under Section 45 of the RBI Act to protect depositors and the public interest.

When a bank faces financial distress, RBI places it under moratorium and frames a merger scheme to transfer its assets and liabilities to a stronger bank. This scheme is sent to the concerned banks, depositors, shareholders, and others for feedback. After considering the inputs, RBI finalizes the scheme and sends it to the central government for approval and notification in the official gazette.

RBI usually keeps the process of selecting a suitor confidential to protect public depositors.

How is this different from the Yes Bank order?

In the case of Yes Bank, the Bombay High Court had questioned the writing off of additional tier 1 bonds worth ₹8,415 crore after the bank's reconstruction. The Supreme Court put this order on hold after RBI argued that it would render Yes Bank non-viable.

In the case of LVB, the Madras High Court questioned the procedure followed by RBI in amalgamating LVB and DBS and subsequently writing off shares and bonds. The court has directed RBI to revalue the shares of LVB and DBS, noting that unlike with Yes Bank, both shares and tier 2 bonds were written off for LVB due to its negative net worth.