Banking Central | Big, corporate-led NBFCs need to make a choice

Last week, the biggest news in Indian banking was the rather unexpected (if one looks at the timing) announcement on the merger of HDFC (Housing Development Finance Corporation) with HDFC Bank. No one had a hint of the timing of the merger although there have been discussions for many years.

In an exclusive interaction with Moneycontrol soon after the announcement, HDFC Chairman Deepak Parekh revealed the real reason for the timing of the merger. He said it didn’t make sense for India’s largest mortgage lender to remain as an NBFC as the regulatory benefits of continuing as an NBFC is near absent now.

The constraint HDFC faced was that the RBI, over the last few years, removed the arbitrage between a bank and an NBFC, Parekh said. Also, for NBFCs to raise large sums of money is not easy, said the iconic banker. In an earlier column, this writer had highlighted the regulatory disadvantages of big NBFCs after a recent set of rule changes by the RBI.

The crucial point here is that the reasons that prompted the merger of HDFC—a giant in the NBFC family with over Rs 5 lakh crore asset size—is applicable to other large NBFCs as well. HDFC could have continued even with tighter regulations; it has deep-pockets and experienced leadership. Still, it made the choice to become a bank. That being the backdrop, what’s the fate of other big NBFCs?

These NBFCs too will face the same hurdles as Parekh alluded to—rising cost of capital and RBI treatment akin to banks—that will eventually force them to take a call on their future existence.

So, what is likely to happen now? There is a tricky path ahead for corporate-promoted NBFCs. Let me explain: By virtue of their size, these NBFCs will have to comply with bank-like regulations. That leaves them with zero regulatory arbitrage in continuing with the existing format. But, even if these corporate-NBFCs wants to convert to banks with the current ownership structure, the RBI’s stated approach doesn’t permit that; that’s the tricky part. The RBI has clearly said it wants corporates to have an arm’s length approach with financial services entities dealing in public money.

So chances for a corporate-promoted NBFCs to get a new bank licence is nil. The RBI doesn’t like corporate promoted banks fearing potential conflict of interests in the future. It doesn’t want powerful corporate promoters to misuse banks they float for own funding needs.

That leaves them with the only possible option—rejig their ownership structure and make shareholding spread across different parties. In simpler words, corporate promoters will have to gradually let go of their long-preserved majority ownership in big NBFCs or get ready to comply with tougher regulations.

This is a choice each company needs to make. I believe eventually the market competition and powerful regulatory compulsions will force most of them embrace the first option - restructure the ownership structure and then seek a bank permit.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)