Why did HDFC decide to merge with HDFC Bank now?

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A customer walks outside an HDFC Bank branch in Mumbai July 17, 2013. India’s HDFC Bank Ltd posted on Wednesday a 30 percent rise in first-quarter net profits, in line with expectations, boosted by higher fee income and credit growth. REUTERS/Danish Siddiqui (INDIA – Tags: BUSINESS) – RTX11P4B

HDFC-HDFC Bank merger has been in the news for a while. In fact, back in 2015, HDFC Chairman Deepak Parekh had said his firm could consider a merger with HDFC Bank provided circumstances are in favour. But, the wait for the merger got longer with the parent putting the idea on the backburner saying the regulatory environment is not conducive.

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Parekh had said that the merger makes sense provided there is no loss of value for shareholders and considering the business synergy between two institutions.

But, there is a question on the timing of the merger; why did they choose to do it now?

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One key reason could be the emerging regulatory approach of the banking regulator to NBFCs. The benefit of continuing as an NBFC is nearly absent now compared with the older times.

The Reserve Bank of India (RBI) has been tightening regulations on the NBFC sector over years, grouping these entities into different categories based on size and interconnectedness and making capital norms stricter.

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As per an RBI discussion paper released early last year, these layers bracket NBFCs according to their asset size and systemic interconnectedness.

The bigger ones are grouped in the upper layer while stringent regulations will apply to the middle layer as well. The top layer is reserved for companies that are perceived to carry elevated risks akin to the banks under the prompt corrective action (PCA) framework.

Also Read | HDFC, HDFC Bank merger to create third-largest company in India

If these proposals are accepted as regulations, the top 25-30 NBFCs will have to gradually embrace bank-like regulations. That will minimise the benefit of lighter regulation they have enjoyed so far. NBFCs in the upper layer will have to comply with common equity Tier 1 capital regulations like commercial banks.

They need to maintain a 9 percent CET1 ratio. That apart, these NBFCs will have to comply with large exposure framework and listing regulations.

Clearly, the trigger for the new scale-based approach for NBFCs was aimed at disincentivizing non-banks from growing too big after the IL&FS and DHFL episodes. The regulator doesn’t want a parallel set of financial institutions growing in the financial system at par with the size of banks but enjoying lighter regulation. Also, the RBI wants to bring down the number of NBFCs in the banking system.

For HDFC, which is an NBFC, it makes sense to be part of the bank given the regulatory approach.

So, in a sense, what has aided the merger is the phased regulations from the Reserve Bank of India (RBI) which has bridged the gap of regulations between banks and non-banking finance companies. Larger NBFCs and banks aren’t very different from a regulatory perspective in terms of scrutiny and capital ratio requirements. Also, as Parekh said in the merger statement, a booming mortgage lending market offers opportunities for home loan lenders.

The Jagdishan factor?

HDFC Bank insiders say compared with the previous boss of the bank, Aditya Puri, his successor Sashidhar Jagdishan was more lenient to the idea of merger. Puri exited the bank in October, 2020. Jagdishan took charge as the new chief in October. “The change in leadership made it easier for the parent to proceed with the merger. At least that’s what the talk is,” said the insider who didn’t wish to be named.

Then there are other factors as well.

Obviously, the merger gives HDFC access to cheaper deposits as well. An NBFC typically raises funds at a higher rate from investors and money markets while a bank has access to public deposits that come at a much cheaper rate through current, savings accounts. That is certainly a beneficial factor for the merger.

What about investors? Prima facie, the deal looks good for investors.

As per the announcement today, every HDFC shareholder will get 42 shares of the bank for every 25 shares they hold.

“Looking from the shareholder’s perspective, it is a positive measure. Because, the shareholders of HDFC Ltd, who was having a holding company discount issue will benefit because the holding company discount will disappear. And for shareholders of HDFC Bank too, the synergy of the combined entity will benefit them,” said J N Gupta, former executive director at the Securities and Exchange Board of India (SEBI).

With the parent finally merging the bank, the resultant entity will emerge as a powerhouse in the Indian banking industry. The window for cross selling products and leveraging the strength of the combined balance sheet will give advantage to the combined entity.

Bigger money muscle

The merged entity, with a larger balance sheet will enable HDFC to turn even more aggressive in the market. It will be only second to the country’s largest lender, State Bank of India (SBI) across all parameters. The combined entity will have a market cap of Rs 12.8 lakh crore and a balance sheet of Rs17.87 lakh crores. It will enable the HDFC Bank to undertake larger underwriting at scale.

HDFC Bank, on a standalone basis, had total advances of Rs 12.7 lakh crore while HDFC had Rs5.25 lakh crore. Of its total advance book, HDFC has 77 percent of its loans in the individual loan category. HDFC Bank, which has 28 percent of its loan book in retail and 26 per cent in corporate, can have the advantage of HDFC’s home loan clients joining the bank’s customers.

It also gives opportunities in cross selling of different products in the unsecured loan segment, insurance, credit cards to HDFC’s existing customers.

When will the merger process be completed?

There is still some time ahead. The merger, as guided by the parent, is expected to get completed by the second or third quarter of financial year 2024. The scheme of amalgamation will need approvals from SEBI, RBI, Insurance Regulatory and Development Authority (IRDAI) and Competition Commission of India (CCI). It will also require approvals from National Company Law Tribunals and finally will be filed with ROC.

With the HDFC-HDFC Bank merger, another giant is born in the Indian financial sector. SBI, the largest in terms of assets in the Indian banking industry, gets a bigger competitor.

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