A leading mortgager of the country is in the news for finding itself a new home– HDFC Bank (“Bank”) announced its merger with its holding company, HDFC Ltd.
In 2021, the FM, Nirmala Sitharaman, expressed her opinion on the need for larger-sized banks like that of SBI to meet the needs of the growing economy effectively. India is expected to be the fourth-largest market for private wealth internationally by FY 2028, according to IBEF. In the backdrop of this chorus, banks are picking sides to remain relevant.
BANKING– THEN AND NOW
The Indian banking system has noticed a paradigm shift from physical banking to a digital model. The pandemic inspired, financial support to SMEs and MSMEs have banks becoming digital and offering last-mile connectivity. NBFCs have contributed as the missing link in offering financial support to SMEs; despite the setback NBFCs have been facing with increased regulatory vigil from the RBI.
The resilience expected from the financial systems is demanding. The financial crisis of 2008, changes in Tax structure through the introduction of GST, demonetization, the Pandemic, loan repayment moratoriums, the Ukraine-Russia conflict, and artificial liquidity induced to combat the pandemic are key factors causing a decline in revenue performance of Banks. The RBI has been taking several corrective and resurrective measures, but the magnitude of the problem is deep and wide.
RBI, through a working group, recommended that certain large NBFCs, post fulfilling specific criteria, should be converted into banks.
REGULATORY QUALIFICATION TRIGGERING THE MERGER
- Recently, the RBI came up with scale-based regulations for NBFCs, which would divide these into layers based on their size and activity. HDFC Ltd. was classified under the topmost layers, being a large NBFC, which meant enhanced regulatory requirements for the entity.
- Another regulation that triggered the merger is the uniformity in the classification of NPAs between housing finance companies, banks, and NBFCs alike.
- The decrease in the gap between the arbitrage of banks versus NBFCs was a factor, too.
With several other factors playing a role, the merged entity hopes to improve profitability. A long lingering plan materialized.
THE WAY AHEAD FOR HDFC TWINS
HDFC Ltd. subsidiaries are planned to be transferred to the Bank, which will make the entity 100% public-owned. The shareholders of HDFC Ltd. are to receive 41% ownership of the Bank, and hopes are that the arrangement will be closed within the next 12-18 months post regulatory and customary approvals.
The biggest gain for the Bank post-merger would be a competitive advantage, possibly making it the second-largest, following the State Bank of India.
Statistics show that 70% of HDFC Ltd. customers do not bank with the Bank. A merger will enable a larger balance sheet, allowing the Bank greater penetration for providing loans even in the infrastructure space. The synergy between the two entities is expected to generate cross-selling opportunities for bank products.
CHANGES EXPECTED
The first of many such mergers will bring inefficiencies within some troubled banks and NBFCs to the forefront, causing a possible domino effect to attempt to close the market-share gap between other entities and HDFC.
Fitch Ratings claims that such a merger and the tighter regulatory requirements in the sector would trigger an evolution among NBFCs, particularly for those having banking aspirations.
The banking sector faces heavy competition from FinTech and NBFCs. This merger will open the doors for foreign investments to come into India. Without losing much time, HDFC Ltd. is looking to sell 10% of its stake in HDFC Capital to Abu Dhabi Investment Authority.
REVISITING HISTORY
Earlier in 2020, while RBI suggested converting certain large NBFCs into banks, this was not made effective as a policy.
In 2019, Lakshmi Vilas Bank (LVB), a private sector lender, proposed a merger with home financier Indiabulls Housing Finance Ltd. However, RBI rejected the merger within six months from the proposal date. The rejection came just following RBI’s decision to place LVB under the Prompt Corrective Action framework due to its bad loans and lack of capital for two continuous years. However, later, LVB merged with DBS, a Singapore-based bank.
Internationally, the Pandemic has made banks fragile because of the constant low-interest rates, loan moratoriums, and poor quality of security. The banks have to get innovative in their survival approach to tide over the slurge of instability.
Anyhow, for now, the merger between the HDFC twins awaits the approval of the sectoral regulators– RBI, SEBI, and CCI.
Sources:
- https://www.zeebiz.com/market-news/news-hdfc-hdfc-bank-merger-9-reasons-rationales-that-prompted-this-amalgamation-expert-decodes-182195
- https://www.financialexpress.com/industry/banking-finance/hdfc-mergers-domino-effect-fitch-says-hdfc-twins-deal-could-pave-way-for-more-banking-ma-deals/2489355/
- https://www.wsj.com/articles/european-banks-consider-mergers-for-survival-11600596001
- https://timesofindia.indiatimes.com/business/india-business/private-banks-set-to-become-larger-consolidation-likely-over-fy22-24-report/articleshow/87315007.cms
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