BL INTERVIEW. 'IDFC Bank's initial strategy will be to focus on high end customers'

Rajiv Lall, Executive Chairman, IDFC Ltd, has his task cut out. The specialised infrastructure financing company is one of the two companies that has got the RBI’s licence to set up a bank. With three decades experience in leading global investment banks, multilateral agencies and in academia, Lall has led the transformation at IDFC. In this recent interview in Chennai, Lall, a BA in Politics, Philosophy and Economics from Oxford University and a Ph.D in Economics from Columbia University, talks about the road ahead for IDFC as it transforms into a bank. Edited excerpts:

Since April 2, when RBI announced that you were one of the two companies selected for a banking licence, what has happened?

A lot has happened. We are working hard to prepare ourselves. We have until October 2015 to launch the bank formally. We are working on two parallel tracks. One is to make sure that all the regulatory compliance issues are sorted out. Because given the regulations for new banks and our existing structure, there are lots of complex, legal things that need to be taken care of. That requires lead time and preparation. In parallel, we are working on the operational issues of the bank, right from defining the strategies of various parts of the bank in a more granular fashion to hiring new people. Lot of our time is spent evaluating talent and trying to pick the right person for the right job.

You have started recruiting for the bank? How many people?

Yes. We must have recruited at least half a dozen senior people reporting to me. Three of them have joined us. Those three are now beginning to recruit their teams. The other two-three people are from IDFC. They are beginning to recruit their respective teams as well. We are working with a couple of consultants to help refine some aspects of the launch strategy.

What will the bank itself be called?

It will just be called IDFC Bank. No need to be very adventuresome and spend lot of money on other consultants who will do a deep psychological study on what the name should sound like, so that it resonates with every Indian and so on. We are okay with relatively simple IDFC Bank.

Like IDFC, it would be registered in Chennai or would the registered office be elsewhere?

We haven’t decided on that. It will be sensible for it to be registered here as well. There is no reason to have it anywhere else.

Would you please explain the structure of IDFC once the bank comes into operation?

IDFC has four subsidiaries – Corporate Investment Banking, Alternative Asset Management, Public Market Asset Management and the Foundation. IDFC is the NBFC, which is the parent. All of IDFC’s assets, its balance sheet will move to the bank and the bank will become the fifth subsidiary of IDFC and four of these subsidiaries that are all financial services companies will be pushed down to below a non-operating holding company. IDFC, the parent, will be the holding company. It will have one subsidiary directly, which will be the Foundation. It will then have a non-operating finance holding company, under which there will be four subsidiaries, three existing ones and the fourth is the bank. Through the scheme of re-organisation, assets and liabilities will move from the IDFC balance sheet to the bank, such that on the very first day of its operations, the bank will also be listed. Every existing shareholder of IDFC, for one share of IDFC, will receive one share in the bank.

What would be IDFC’s function itself once the bank is created and its assets and liabilities are moved to the bank?

It will just be a holding company. It will either be called an investment company or CIC (Core Investment Company) is the acronym used by the RBI. It is a different kind of holding company. Most banks overseas this is how they are held. If you look at JP Morgan or Goldman Sachs, they have a holding company, which is the parent, and then the bank is ring-fenced and their other operations are captured in other subsidiaries. The logic of it is that the bank’s activity should be ring-fenced and protected from potential knock-on effects or infection from other financial services businesses or indeed other businesses that are completely unrelated. This structure was conceived for promoters who are potentially corporates with other businesses. If you are a manufacturing company that is promoting a bank, then in that case that manufacturing company will have been the parent with its various manufacturing subsidiaries and it would be distanced from the bank through the non-operating finance holding company. That is the theory. When you apply that theory to IDFC, this is the result.

Would you look at a merger of IDFC and IDFC Bank at a later date?

No, that is not regulatorily feasible. It is not allowed because the promoter must be held separate from the bank.

But, then the bank will also be doing a whole lot of activities that are there in the other subsidiaries. For instance mutual fund…

No. Regulations say that any activity that can be done through a bank will be done through the bank. Only activities that banks normally do not do, are allowed to be held in other financial subsidiaries. Asset management is not something that a bank does. Again, we don’t know over what timeframe this will happen, but existing banks will have to move to this structure. Today, you take ICICI, HDFC, any bank- they have subsidiaries that do all these things. They have an insurance company. They have an asset management company under them. The RBI has never been happy about this. Because they feel that the bank being a direct shareholder in another business is potentially risky for the bank itself. So, they want to pressure and force eventually these entities to also create a parent holding company, move the subsidiaries from under the bank into that holding company so that everybody eventually will be on a similar structure.

You have until October of next year to start the bank. When do you think the bank will kick off? Would you wait till October or would you be in a position to start earlier than that?

We might be in a position to start off a couple of months earlier. But we will probably do a soft launch… It is so important to ensure that every system is working right. Actually 12 months is not a very long time at all.

But you have been working on this even earlier…

No, it is not a question of working and putting together business plans on paper. Technology has to be bought and tested, the software has to be written and tested. Then there are add on systems, they have to talk to the core technology. Every asset and liability on our book has to be transferred. The de-merger has to happen. That requires a court assisted process, the timeframe of which is not clear. That itself could take six months.

You also have to bring down your foreign shareholding…

That is the first thing we have to do. That has come down from 54.5 per cent to 51.5 per cent. We have 1.5 per cent to go. We expect that by end of August, early September that will be taken care of.

Are your foreign shareholders happy with this…

There has been a lot of interest from our foreign shareholders in IDFC. They are frustrated that they can’t buy more of it. It depends on when they bought. If they had bought when the price was Rs 90, now it is Rs 150, they have made their money. Nobody is that long-term. If they have made their profit, then they will get out because that is how foreign ownership has by itself come down from 54.5 to 51.5. The people who want to get in now, they are frustrated.

You would be yet another private sector bank. There are already a few that are well established. Where would you get your business from?

This is a country of 1.2 billion people and you have two private sector banks that people know, doesn’t mean that is enough. This country keeps growing, the financial system keeps growing at 15-20 per cent a year and public sector banks have their own share of problems. There is a growing community of people who are already getting, who will continue to get increasingly frustrated that they are not getting the financial services that they deserve. I think over time, the last generation of banks that you saw, they just have one size fits all. They all look the same, they do the same thing.

I think the next generational change will be that banks will find their niches. You find that some banks will cater to SMEs more, other banks will cater to large corporates more, some will cater to the base of the pyramid, some will be more rural. And, there will be of course one or two giants that will try to do everything.

Our strategy, at least in the beginning, will be to build on the strength that we have in the corporate market, which is one extreme of the client universe. Next, seek to get our share of urban India and simultaneously reach out to the base of the pyramid. Both on the consumer bank and the corporate bank, we will start at the upper end of the client spectrum. Simultaneously, we will attack the other extreme of the client spectrum. We have this narrative inside IDFC when we talk about dealing with the two extremes of India and Bharat at the same time, and then over time we will fill the middle. Our starting strength is in the high end. We see a huge opportunity in the low end. So, we want to attack that first. Over time, then we will fill in the blank spaces.

Does it also help that there were only two of you that got the licences at the same time?

Of course, it helps. We are fortunate for that having been the case, because most importantly from the point of view of talent acquisition. We are in a nice position of being able to evaluate emerging talent without there being too much competition for it. It is a good situation to be in.

At the time of rollout, how many branches do you think you will have?

We don’t know exactly at this point, but in the next two months we will have much clearer plans and we will be able to talk about it in greater detail.

One of the conditions was that 25 per cent of your branches need to be in unbanked rural areas with population up to 9,999 people …

Not an issue. We will probably do more than that. Definitely do more than that.

You are talking of technology and all that, do you think network is available for you to roll out those branches?

Since we got the licence there have been two important developments that help both these extreme ends of the business that I am talking about. On the base of the pyramid business, the adoption formally by this government, the backing that Aadhar has received, is very criticial. We can use the infrastructure that has already been built on the Aadhar backbone to sift and acquire customers much more easily than before, with much less paper work. That is an important positive development for our plans for Bharat.

On the corporate side of things, the latest circular from RBI that over time we will make lending for infrastructure free of CRR, SLR and PSL requirements, is also very helpful. We can continue to build on our strengths in the infrastructure space and take advantage of the technology for entering…

How exactly would the latest RBI circular help?

It means that the cost of compliance comes down. Our infrastructure, which would have for several years become unprofitable, because of the PSL, CRR, SLR cumulative requirements that we would have to build, account for, that burden diminishes. In fact, the infrastructure lending business would become important for us to cross subsidise the build out of the consumer bank and the Bharat bank.

You mentioned that you would probably end up with more branches in the rural areas than stipulated. Would you have an idea of how many villages there are with the population limit?

There are a large number of villages.

The perception is that the public sector banks have covered them…

If they have covered them, they have covered them in a very ineffectual kind of way. They have covered because they have been forced to do it.

But that will be the case for you also…

No, we are doing it because we know that this is going to be profitable business for us. We know it is going to be really profitable for us. It will be for all kind of lending products. After all, the poor also need credit, MSMEs need credit, they don’t have access to it.

But that hasn’t happened so far…

They don’t get credit from banks because banks have been reluctant to do this.

Banks have been reluctant to do this because, say, if you already have 60,000 employees that are being paid in a particular way, grown up in a certain type of branch environment, it is very difficult to tell them now you please, 'I want you to relocate to Pudukkottai and go to some village 10 km from Pudukottai and do micro-finance lending, community setting three days a week for me'. These guys will not do it very easily and they will do it at a much higher cost. If you are starting afresh, you can hire people from Pudukottai. You can hire young women in Pudukottai, who don’t want to move anywhere else and say we will train you, you want to work in your own community. We will facilitate due to technology and that becomes a completely different value proposition. That is the advantage for a newcomer.

The whole purpose of setting up IDFC was to exclusively fund infrastructure. Now with your becoming a bank, will your focus on infrastructure itself come down, will it suffer?

I don’t think it will suffer. But in relative terms it will be less. As the great John Maynard Keynes used to say, when the facts change, then I reserve the right to change my mind. Just because IDFC was set up to do only infrastructure, doesn’t necessarily mean that that would be true for eternity. I think what the reality of the experience has taught us is that a monoline financial services business in a country as complex as ours and subject to so much regulatory risk, is a dangerous thing to build from a risk management perspective. In financial services, diversification is critical to long term stability and sustainability and, therefore, a bank, the logic for a bank is incontrovertible.

But there are others, for instance, IL&FS, continues to be in infrastructure…

They have never had an ambition to be listed. They have become basically a small, niche player. If you want to go to two lakh crores and have an impact of that kind, it is a very different approach. Niche players can remain small. No problem. But if your ambition is no longer to be a niche player, and to become larger and more significant, then diversification becomes key.

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