As IDFC rejoices for bagging a banking licence, the expected decline in profitability over next few years of building the bank will be a major challenge for the infrastructure finance company, according to experts.
Mumbai-based IDFC Ltd received an in-principle nod to set up a bank and is given 18 months to comply with the RBI guidelines and meet regulatory requirements for commencement of the banking business.
In a report by India Ratings & Research, it said “IDFC Ltd will be beneficial to its credit profile in the long term, provided the transition is managed appropriately. However, the successful conversion from an infrastructure non-banking finance company into a commercial bank with a strong retail deposit franchise and a diversified loan book will be a major challenge.”
Rajiv Lall, Executive Chairman of IDFC on Friday said, “In the next 24 - 36 months, there will be pressure on our profitability as we put our systems and processes in place…We won’t be focused on our Balance Sheet growth for the next three years.”
India Ratings expects IDFC’s profitability metrics drop sharply in the near-to-medium term due to the regulatory requirements of maintaining a statutory liquidity ratio of 23 per cent, cash reserve ratio of 4 per cent and priority sector lending of 40 per cent. “Also, operating costs will increase significantly from a build-up of branch network and employee talent pool. Maintaining credit costs at low levels will be important as the company starts lending to non-infrastructure sectors, while the infrastructure sector is likely to continue to face a harsh operating environment,” the report said.
With a headcount of 600 employees at present, IDFC expects to grow it to at least 1,500 to 2,000 over the next 18 months.
”However, the company will be able to maintain a robust capital buffer, as its loan portfolio will be diversified to include new borrowers / loan products in which it has little experience. While the loan book will become more granular than before, the efficiency of risk management systems for the new business lines will be tested,” India Ratings said.
It further added that IDFC’s access to retail funding through low-cost current and savings accounts and retail term deposits could help in diversifying its funding profile and reduce funding costs in the long-term. Nonetheless, building a retail deposit franchise will be a key management challenge, due to a competitive market environment and high requirements to open branches in non-urban areas.
India Ratings said it would continue to evaluate the company’s detailed strategies for its transition into a commercial bank and factor the impact into its ratings.