Explained: Why Is Dhanlaxmi Bank Currently Under RBI's Radar?

The Reserve Bank of India (RBI) has been closely monitoring the financial health of Dhanlaxmi Bank just after the bank postponed its capital management raising intentions. Besides, a section of the bank's shareholders also started calling for an emergency shareholder meeting to revoke the influence and authority of the bank's managing director and CEO.

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The bank approved a rights issue of up to 130 crores on March 17, after which it declared an expansion project that included establishing an administrative office and opening 20 different branches in the southern part of India. The administration has also been accused of failing to provide adequate justification for the cost increase. As a result, a group of minority shareholders called for an Extraordinary General Meeting (EGM) in April. Two of the nine shareholders, B. Ravindran Pillai and B. Govindan, claimed that the bank was in financial distress. The EGM was attended by 46 shareholders in total. According to RBI regulations, shareholders with a 10% stake in the firm can invite an EGM.

Dhanlaxmi Bank was even incorporated into the RBI's Prompt Action Framework (PCA) to address significant financial degradation, as its liquidity management had previously fallen below necessary levels.

How do banks like Dhanlaxmi end up being on RBI's radar?

The RBI has set supervisory monitoring criteria based on the following three parameters: NPA-Net Non-Performing Assets, ROA-Return On Assets, and CRAR-Capital to Risky Assets Ratio. An NPA is a loan on which the principal or interest payment has been past due for 90 days. A unique initiative to reduce outstanding debts and prevent the formation of new NPAs is launched if total combined NPAs surpass 10% but fall far short of 15%.

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RoA is a type of profit margin that measures the yields on assets owned by a company or banking institution. If the institution's ROA is less than 0.25%, the RBI prevents it from establishing new lines of business. Just like the Dhanlaxmi Bank, which was planning to open several branches in southern India, irrespective of its financial constraints.

The CRAR ratio evaluates a bank's monetary sustainability by determining its investment resources in terms of a percentage of its risk-weighted credit exposure to assist banks in safeguarding their depositors and encouraging financial health.

What is the significance of CRAR?

In the case of Dhanlaxmi Bank, the CRAR fell from 14.5% to approximately 13% at the end of March this year, prompting the RBI to assess the bank's financial situation. Ideally, banks must maintain a CRAR of 9% or higher under Basel-III standards.

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The weight assigned to the asset's value when calculating the institution's capital adequacy ratio is greater for riskier asset types retained on a bank's balance sheet. Consequently, the bank's capital adequacy ratio falls, indicating a greater risk of failure during a crisis.

CRAR measures a bank's ability to continue functioning even if it suffers substantial losses in its lending portfolio. If the overall value of a bank's assets falls below the total value of its liabilities, the bank will cease to exist because its capital will be destroyed, rendering it insolvent. In conclusion, it guarantees that banks have a sufficient buffer concerning tier 1 capital to accumulate a rational amount of loss and tier 2 capital in case of liquidation.