Mahabharat is full of backstories and sub plots. One such story is that of King Yayati. The king had to suffer old age in his youth. He could circumvent this by passing on the old age to one of his sons to regain his youth. Yayati offered to make the son who volunteered as his heir apparent. Despite the incentive, only his youngest son, Puru, volunteered.
The merger of HDFC Limited and HDFC Bank have a lot of similarities with this story.
The 46-year-old entity had the ability to compete with even a five-year-old or the latest entrant in the housing finance market, yet decided it was time to pass on the baton. On one hand the regulations were becoming tighter, removing the juice of operating as a non-bank mortgage lender. The declining interest rate scenario, which prevailed for almost three years, between 2019 and 2022, heightened competition from banks across various segments of NBFCs, particularly for housing financiers. The corporation had its own succession issues as well.
Therefore, what happened on April 4, 2022, was meant to happen at some point. What is remarkable is that a merger of this nature and magnitude concluded in just about a year, and well ahead of the timelines.
Icentives
As for the incentives, HDFC Bank will enjoy an immediate surge in the book and gain access to home loans, which it never operated on its own. It also gets a head-start as one of the largest player in the mortgages business. Likewise, HDFC Bank can have direct hold on other financial services as well.
That said, advantages and disadvantages are two sides of the same coin. Along with the inheritance is higher regulatory oversight, tighter business operations, which may necessitate the bank to let go off certain factors.
The subsidiaries, too, may not be spared. When the merger was announced, it was believed that HDFC and its subsidiaries were just getting a new home and that it would be business as usual. But can that happen? Here’s how and why life may not be the same for HDFC and its key subsidiaries, such as HDFC Life Insurance, HDFC Asset Management Company, HDFC Ergo, and others.
Housing business
HDFC’s loan book was at about ₹6,20,507 crore in FY23. This can be bifurcated into 83 per cent of pure retail loans and the rest as wholesale exposures, which is a tightly regulated business for banks to operate. However, the profitability (or spread) of the retail business is lower than the wholesale business — 1.92 per cent versus 3.62 per cent — resulting in a combined spread 2.29 per cent. A direct implication of the merger would mean a hit on the overall net interest margin (NIM) for HDFC Bank becoming inevitable. At a time when most private banks were kicking at NIM upwards of 4.5 per cent, for HDFC Bank it stood at just a few shades above 4 per cent in FY23.
This might have a rub-off even on HDFC because its entire business will now get crunched into about 38 per cent of the bank’s total loan book. From allocation of capital, investments, funds for doing the business and manpower, everything could take a different dimension in its new house under the HDFC Bank banner.
More importantly, with HDFC Bank venturing the housing finance space organically by itself for the first time since its inception in 1994, it may have to compete with the peers on pricing, positioning and even on product segmentation, a battle that HDFC won and established many years ago. In that sense, it is a restarting of the housing finance business for people who have move into a new house, and for the bank, making inroads into a new business that is pretty much well-established for its peers.
Other subsidiaries
There was a time when HDB Financial Services, the non-bank arm of HDFC Bank, was growing faster than the bank itself albeit at a much lower base. Today, its growth is a lot more calibrated compared to what was five years back, whether one would attribute it to the pressures during Covid or the competition that it is facing from banks. Unlike a non-bank holding company operating various subsidiaries, in a banking structure, the functioning of subsidiaries is usually different. Right from the quantum of stake a bank can hold in its subsidiaries to the amount of capital that can be deployed into them and, finally the nature of transactions between the bank and its subsidiaries, could be up for a closer watch, thanks to the overreaching regulatory and supervisory powers of the Reserve Bank of India.
Interestingly, HDFC’s life insurance and asset management businesses are folding into HDFC Bank at a time when both are facing challenges in reclaiming their top spots in the pecking order. Perhaps, if they were best left to operate as HDFC Limited’s subsidiaries, their fight back to the top may be easier as their accountability and answerability would have been largely be restricted to their board, including the representatives of HDFC Limited in their respective boards. Now, they would have an additional layer of indirect responsibility to the banking regulator as well.
The good part, though, is that at present neither of them require capital or monetary support from HDFC Bank. Yet, being listed, both are vulnerable to overhang with respect to their new parent’s prescribed permissible holding limit in non-lending businesses. This remains a grey area for the banking sector and has been approached on a case-to-case basis so far.
In HDFC Life’s case, the overhang pertaining to its holding company stake kept the stock depressed for over a year. Whether the subsidiaries of HDFC Bank get some respite after the merger needs to seen. Also, one of the reasons why most of HDFC’s subsidiaries haven’t faced much criticism on mis-selling is also partly because the necessity to jointly operate with HDFC Bank hasn’t been very demanding like other bank-led businesses. Will that change once they become subsidiaries?
While lot has been talked about the implications of the banking business after the mega merger, the fact is that almost every facet of the group may undergo changes. FY24 will reveal how the new dynamics unravels.