Birth of a goliath

Policymakers and industrialists in India have repeatedly bemoaned the lack of world-scale banks to finance the building of infrastructure and industrial growth needed to attain a $5 trillion economy. Public sector bank mergers, driven by convenience, have failed to meet this objective, yielding just one world-scale bank in State Bank of India. It is thus good to see the consolidation being taken forward by a well-respected private sector group, based purely on commercial considerations. The merger of housing finance leader Housing Development Finance Corporation Ltd. (HDFC) with HDFC Bank is expected to create a banking goliath with a ₹17.8 lakh crore loan book, ₹3.3 lakh crore net worth and nearly ₹50,000 crore in annual profits with strong capital adequacy and asset quality ratios. Though the combined entity will not match SBI in size (₹26.6 lakh loans) it will narrow the yawning gap between SBI and its next largest competitor.

Several factors appear to have swung the verdict in favour of this merger now. Worried about the stability of NBFCs after the IL&FS and DHFL debacles, RBI has significantly narrowed the regulatory arbitrage between NBFCs/HFCs and commercial banks, subjecting the former to tight capital adequacy, NPA recognition and liquidity norms at par with banks. HDFC on its part has been facing the heat on its yields and spreads from banks striving to expand their home loan portfolios. The merger will allow HDFC to tap into HDFC Bank’s low-cost deposits while diversifying into new segments. For HDFC Bank struggling with sluggish corporate credit offtake and customer additions, HDFC’s readymade book of salaried borrowers offers lucrative cross-selling opportunities. For instance, according to HDFC chairman Deepak Parekh, just 30 per cent of HDFC’s customers are account-holders in HDFC Bank. Post-merger, HDFC Bank will transition from a predominantly corporate lender to one with an over 50 per cent exposure to retail and mortgage loans. The financial goliath resulting from this merger will also enjoy vastly improved access to capital, with a sizeable weight in bellwether stock indices and easier access to bond markets. That HDFC Bank will need to make room for higher statutory reserve ratios and priority sector mandates on the acquired HDFC book is a pain point. But this is positive for borrowers and depositors.

The merger will throw up the usual challenges that come with a marriage between two such marquee names. HDFC and HDFC Bank are home to some of the best leadership talent in the financial sector, which could give rise to succession and integration issues. RBI and other financial market regulators will need to contend with the birth of a new too-big-to-fail entity that could pose systemic risks. Unlike SBI, post-merger HDFC Bank will be widely held by public shareholders, with neither the government nor a private sector promoter having skin-in-the-game. The HDFC group’s credo is conservative banking that always puts shareholder returns first, so it is moot if it will expand into areas such as long-term infrastructure financing which comes with high risks and asset-liability mismatches. Therefore, the merger offers no reason for India’s policymakers to rethink their idea of specialised project financing institutions.

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