IDFC, the infrastructure finance company, which on Tuesday decided to apply for new banking license is all prepared to meet Reserve Bank of India's norms relating to new banking licenses, the most important step being the creation of a non-operating holding finance company (NOHFC), says Vikram Limaye, MD & CEO of IDFC.
IDFC will also be required to bring all its financial services operations under NOHFC as per the RBI guidelines. The company offers financial services including investment banking, broking, asset management and infrastructure funds and private equity funds.
IDFC's current business, which is mainly infrastructure lending does not qualify under RBI's key requirement of priority sector lending. "We have very little in terms of priority sector loans that would qualify under RBI norms today. But obviously, we will grow the priority sector book if we get a banking license and will comply with RBI's guidelines on PSL norms," Limaye stressed.
On being asked about an option of acquisition in the banking space, Limaye said that it would be too premature to talk about as the company would first focus on meeting RBI's guidelines.
Below is the verbatim transcript of Limaye's interview
Q: In all your previous interactions with us, you have indicated that IDFC is not interested in a banking license, so what brought about the turnaround?
A: It has been sometime that we have been saying including on our quarterly earnings calls that we would be applying for a banking license. So from that standpoint, we have already made our intentions quite clear for the last several months that we would be applying for a banking license.
Q: Have you all thought through how you will structure it, which will be the non-operative holding company and which will be the one that will operate the license, I would assume IDFC – the listed entity – will operate the license, so it becomes IDFC Bank so to speak?
A: I think the guidelines are quite clear that any promoter of a bank will have to establish non-operating financial holding company. So we will have to be compliant with the RBI guidelines for bank licenses and we will need to establish a non-operating holding finance company with IDFC being the promoter.
Q: The bank will obviously be an unlisted entity which IDFC, the parent company, will own through the non-operative holding company?
A: That is correct. That is the structure that RBI has specified in its guidelines.
Q: Will there be any businesses of IDFC which IDFC cannot operate because the rules also stipulate that the group should not offer any service which the bank ought to offer, so will there be some kind of a demerger of some of your businesses into the bank?
A: Today, we operate several businesses including a large lending business. We have an investment banking and broking business and asset management business and an alternatives business, which is focused on infrastructure funds and private equity funds etc. So, all these businesses are financial services businesses, which would be under the non-operating holding financial company (NOHFC) structure and obviously would be separated from the bank, which would largely hold the lending business.
Q: So you first demerge all these businesses into an entity and then the holding company owns it two levels lower below the non-operative holding company?
A: Basically the non-operating holding company is supposed to own all the financial services businesses of the promoter. So we will obviously have to get the NOHFC to hold all the businesses that we are in.
Q: Currently what portion of your lending can be constituted as priority sector lending (PSL) and how is the company planning to meet the mandated requirements?
A: Right now we are an infrastructure financial company (IFC). So we have to comply with all the regulations surrounding IFCs including, the volume of assets that need to be in infrastructure which is 75 percent. So largely all our lending is to infrastructure, but infrastructure does not qualify as a priority sector today. So we have very little in terms of priority sector loans that would qualify under RBI’s norms today. But obviously, we will grow the priority sector book if we get a banking license and will comply with RBI’s guidelines on PSL norms.
Q: Suppose you got the license in January or February, you get 18 months to implement it and from thereabout 18 months to comply for priority sector for I would assume cash reserve ratio (CRR) and statutory liquidity ratio (SLR) also you get 36 months?
A: No, CRR, SLR you have to comply on the date when the bank becomes operational. PSL you get incremental time.
Q: So would it mean therefore that in that second year of operation, your entity will face a drain in terms of margins and in terms of profits because your current book will have to comply with SLR and CRR?
A: It is quite clear that if you think about banking you have to think about it from a longer-term perspective. We fundamentally believe in the longer-term growth story of India. If you believe in that you have to believe that banking is an attractive and the right place to be in. So if there is a temporary dip in profits or in returns I think that would be more than compensated by the longer-term prospects of being in banking.
So when we comply with all the CRR, SLR and priority sector norms, there will certainly be a temporary dip in profits and returns but I do not think that is the way we are thinking about it because we have always thought about any business that we get into from a long-term perspective. So, we are quite confident that from a long-term perspective this is the right decision for the organization.
Q: I will just read out what one of the analysts had to say, “IDFC will face the biggest challenges as it will involve rolling out a new vertical deep into rural areas at an early stage. Hence we do not rule out they are looking at acquisitions to jumpstart the process”, is that something which perhaps will be under consideration?
A: I think it is too premature to talk about all of that. We have to first apply for the banking license, which is end of this month and then depending on how things evolve we will have to try and figure out what our strategy would be in terms of growing the bank and being compliant with all of RBI’s regulations. It is too premature to talk about acquisitions of what we would do in order to grow our business.
Q: Certainly, you are not going to buy a microfinance institution (MFI) or non-banking financial company (NBFC) till you get your license in hand but it would be worthwhile asking you whether after you get the license in hand, this would be an option to buy NBFCs with big branches or buy MFIs with branches?
A: The point is after you become a bank for three years, the RBI regulations are quite clear that you are not permitted to get into any kind of merger or acquisition etc. So I think from that standpoint we will have to be complaint with whatever RBI’s guidelines are.
Q: After you set up the bank, isn’t it? After you get the license and set up the bank, you have 18 months?
A: It is premature to talk about what our strategy would be 18 months from now and what we would do in order to build the bank etc. So I do not want to get into that at this point in time because it is too early for us to outline what that would be.
Q: What is the public shareholding in IDFC?
A: We are a diversified company in terms of shareholding. Other than the government of India which owns about 17 percent, rest is all owned by various foreign direct investment/foreign institutional investors (FDI/FII).
Q: You do not have to do anything to your shareholding, you just directly set up the NOHFC?
A: There is nothing that we need to do in terms of bringing down any specific shareholder or anything. So from that standpoint, there is no individual shareholder that gets impacted because of the bank license. Obviously our foreign shareholding is 54 percent and RBI’s guidelines require us to be compliant in terms of bringing that shareholding down to 49 percent 18 months after we got the bank license. So there is enough time to do that.
Q: You would do that by issuing fresh shares, I would assume since you have to raise capital for the bank?
A: There are multiple ways in which that could be done. So the limited point is that if we get a bank license, we will have to comply with RBI’s guidelines and those guidelines require your foreign shareholding to be less than 50 percent.
Q: Once transition into a bank, longer-term growth story will be quite strong but at least in the near-term if you could give us some idea about what the earnings impact could be as you have to meet all the CRR, SLR requirements etc?
A: I am not going to be discussing details of what the financials of the bank would look at this point in time. As I said obviously CRR, SLR, priority sector norms would have an impact on the near-term profitability of the entity but as I said, the plan is from a longer-term perspective this would be right thing to do. From a long-term perspective, given where we are and we are starting out with size and scale and a lot of other things in terms of relationships capital etc that we believe that the long-term prospect for IDFC in the banking segment are very strong and very attractive.
Q: Is there an outside chance that IDFC perhaps will ask for a concession on the priority sector lending norms?
A: No, we are saying that we will be compliant with RBI guidelines which today required being in compliant within a year of starting of bank.
Q: There have been some statements coming in from the government on public-private-partnership (PPP) project especially on the road projects, it appears that now they are because of several contractors or several bidders moving away from the PPP projects, they are looking at allowing them to sell equity upfront as soon as the financial closure is achieved. These are just breaking news that we got yesterday, still not fleshed out completely but do you think that this will bring back the bidders into the picture, does that solve their problem?
A: I am not sure that this is all finalised and actually completely approved by everybody who needs to sign off on this. This has been discussed for sometime now not only in terms of allowing infrastructure developers to exit projects but also in terms of the premium that some of the infrastructure developers had committed to paying being more back-ended. So, there is still a difference of opinion in terms of whether this would be approved or not within government. If it has been ironed out, it would be a positive in terms of freeing up cash flow for developers to think about new projects and from that standpoint it is certainly a positive from a developer perspective to try and free up his equity in order to commit to new projects.
Q: You think that backdating the equity that they have to bring is a better idea than allowing them to sell the equity upfront because you may not find buyers now?
A: Yes and no, it is not about trying to do something based on where we are in the cycle or what is available today. I think from a policy perspective, you have to make the right decision in terms of what the right framework is for developers to participate in infrastructure projects and how they are able to churn their equity, so that they are able to commit the new project.
Q: Would both be good options allowing people to sell off their equity or backdating the premiums, which would be a better option or are both good options?
A: It does not have to be one or the other. I think the second option that you talked about backdating the equity was also being done in the framework where government would be net present value (NPV) neutral. So from an economic perspective, the government was not going to be any worse off and the balance was that by delaying the equity contribution from developers, it would allow them to potentially bid for more projects. So it was trying to strike a win-win in terms of helping out developers commit to new projects and at the same time keeping the government neutral from an economic perspective.
Q: As a lender you would be comfortable for the equity came in so late, would you not worry about the commitment of the promoters since he is not bringing his equity upfront but you are putting your debt money in?
A: You have to look at what the framework is and when the equity comes in and how much of it is backdated as well as the real prospects for the project. Ultimately, if it is a good project and a strong project, there is no reason why the developer would not want to get his economic return from the project. Ultimately you have to get comfortable with the project and the project cash flows. I think the financial engineering aspect of it obviously needs to be thought through so there is enough governance that make sure that the developers also tied into the projects and interests are aligned. So from that standpoint it has to be a robust enough framework that aligns everybody’s interest to making sure that the project works.
Q: So many projects are stuck in power, I want to ask you if the period of decay and stalling and deterioration is over and if anything constructive is happening on the ground?
A: The reality is that there are still uncertainties that remain to be resolved. So, I would say that the way I would characterize it is that the deterioration has kind of flattened out for the simple reason that over the last 12-18 months or maybe even slightly longer than that, there are very few new projects that people have committed to. So to that extent the stock of projects that people are focused on hasn’t grown in any significant way over the last 18 months. The existing project that people have the issues that they are facing and they are trying to resolve are known issues and have been discussed and debated for sometime. So to that extent, at least you have your arms around what the magnitude of the problem is because that problem hasn’t been growing for the last 18 months.
So to that extent, yes, you have much better handle on what the size of the problem is. I do not think the uncertainties have been resolved to a point where I can say that things are back and sentiment is back and confidence is back and people are now looking at new projects etc. That is clearly not happening because the uncertainty is surrounding power etc remain. You do not have a resolution on coal or on pricing of power etc. So until some of those uncertainties are resolved, you will not see sentiment come back and you will not see developers thinking about new projects.