Don’t blame LIC; disinvestment stumbling is the problem

The consensus about Life Insurance Corporation of India’s proposed investment in beleaguered IDBI Bank is that it is a bad, very bad idea.

Stock market pundits, banking and insurance experts, economists and the media have uniformly dubbed it a retrograde move, one that is bound to fail given the insurmountable problems at IDBI and LIC’s lack of expertise in turning around failing banks.

IDBI shares have bounced back somewhat immediately after the deal’s announcement at the end of June, though they are still far away from the March levels.

The fall could be a reflection of the tough road ahead for B Sriram, the newly-appointed managing director of IDBI Bank, and his team who have to grapple with shrinking market share, rising bad loans and the absence of a credible retail strategy to take on the might of the NBFCs and smarter private sector bank rivals.

IDBI Bank is now under the prompt and corrective action (PCA) mode of Reserve Bank of India which bars it from lending though it can still collect deposits so the first step will be to convince RBI that IDBI is ready to do normal business again.

The primary argument against the LIC-IDBI deal is that it is a gross misallocation of resources. Policyholders’ money should not be used to bail out ailing banks especially when there is no clear turnaround strategy.

Returns to policyholders will suffer as these investments lag the broader market or worse, collapse sparking a government bail-out.

While the argument about government’s over reliance on the LIC may be on the mark, the fears about LIC’s financial performance suffering due to the IDBI deal are grossly exaggerated. Let’s examine the argument one by one.

The IDBI investment of just over Rs 10,000 crore (including investments before 2018) is less than 2 per cent of LIC’s equity assets under management (AUM) of over Rs 5 lakh crore. Equity is only 20 per cent of the total assets. The percentage of its holdings in PSU banks may be higher but one should note not all these investments are struggling. State Bank of India, Bank of Baroda, for instance, are neither under PCA, nor is their financial position as bad as IDBI or some of the PCA banks.

Secondly, there is the question of LIC’s products and its status as a government-backed insurance company. A small, negligible portion of its policies are unit-linked insurance plans or ULIPs. The majority of its products are traditional protection plans.

A sovereign guarantee on all LIC products ensures that the policyholders get sum assured and vested bonus as most of the plans are participating plans, where 95 per cent of the surplus is allocated to policyholders. This guarantee ensures that policyholders don’t lose out in the unlikely event LIC fails to discharge its obligations.

Ajit Ranade, chief economist of the Aditya Birla group made an interesting observation on Twitter on Wednesday. He wondered whether LIC should be analysed like a mutual fund on a rate of return basis given that it is a pure insurance company. Also, should not its metrics be things like claim settlement ratio, time taken to process claim etc, he askedRs It is an important distinction to keep in mind while analysing LIC’s financials.

LIC attempts to generate surpluses which can be used to make payouts for claims or endowment policies have to be closed. A small portion of its massive equity portfolio underperforming for some periods is unlikely to have a significant impact on such payouts especially when there also exists the Corporation’s debt portfolio which is several times larger than the equity portfolio.

Of course, an insurance company’s investment portfolio can go wrong and clobber its financials but LIC seems an unlikely candidate at this point given the size of its overall investment in PSU banks as a percentage of its equity AUM.

This, however, does not mean that the government has done something fantastic by persuading LIC to buy into IDBI. The problem with the transaction is less about LIC’s ability and financial clout and more about the government’s own readiness in dealing with bank recapitalisation and disinvestment.

IDBI Bank was among the earliest candidates for disinvestment. It was supposed to be privatised a few years back as selling down the govt stake did not involve amending the Bank Nationalisation Act. Despite the best efforts of the PMO and the finance minister, Arun Jaitley, it did not happen.

You can blame the usual ills for this — red tape bureaucratic inertia and an unwillingness to take risks but the problem is that the first failure has now come back to haunt the government.

A private investor would have been far more nimble-footed in recognising the problem of NPAs and taken steps to tackle it if it had been sold two years ago. The management would have got sufficient breathing room, if early and timely recognition had happened, to tackle issues relating to the bankruptcy court and the RBI’s February 12 circular.

Today, IDBI Bank is in a far worse shape and private investors are unwilling to even come close. With elections looming and the bad loan problem only becoming bigger, the government, in desperation, has palmed it off to LIC.

Now, LIC could still make some money from it if IDBI Bank turns around in the next two or three years. It is difficult but not an impossible task, but the whole saga shifts the limelight onto the government’s approach to disinvestment which has been tentative, wary and devoid of strategic intent. It is almost as if the government is unsure of what to do.

In FY18, the disinvestment target was met thanks to ONGC’s purchase of HPCL shares. In the previous year, the government came close again to meeting the target but this was thanks to buybacks by some big PSUs.

The Air India privatisation flopped, not due to market conditions but due to the government’s own conditions like insistence on a 24 per cent equity stake, a desire to keep Air India separate etc. One wonders how the disinvestment target of Rs 80,000 crore is going to be met this year given that market conditions are far more volatile.

Disinvestment should not be done in a piecemeal manner and only when the government needs money. It should be an ongoing process aimed at giving PSUs more autonomy, which will in turn help broaden the market and extract some returns for the government from its long-held investments. This will help avoid mishaps like Air India and IDBI Bank.