Banking Central | What’s the message from HDFC twins' merger to NBFCs?

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At this point, there is a serious question India’s shadow banks ask themselves: What’s the way ahead?

The fact that the Reserve Bank of India (RBI) has been sending an unmistakable signal to this category of companies was clear for a while now. The choice given to NBFCs was either to stay within a certain size and comply with bank-like regulations (for bigger ones) or choose to become banks.

But here too, there was a catch; the RBI doesn’t want corporate-owned NBFCs to wear the hat of a bank. This made the whole scenario tricky. But, the big eye-opener came when the long-awaited-yet-surprising (going by the timing) announcement of merger by Housing Development Finance Corporation (HDFC) and HDFC Bank on April 4.

What invited attention was Deepak Parekh’s initial comments after the merger announcement. Parekh, a veteran in Indian banking, didn’t hesitate to admit that a primary reason or one of the main reasons why HDFC chose to merge with the bank was vanishing regulatory arbitrage. Parekh cited rising cost for NBFCs to raise funds and tight regulations on NPA (non-performing assets) and capital adequacy stipulated by the RBI for NBFCs.

To be sure, HDFC, being the largest mortgage lender with deep pockets, could have continued as an independent entity but still it chose to merge citing the likely tough scenario going ahead. So, what’s the big takeaway from Parekh's comments to other NBFCs?

NBFCs need to rethink their industry positioning going ahead. The primary reason why many NBFCs chose to be so—the benefit of lighter regulations vis-à-vis banks—no longer exists. That's a major point to ponder for other NBFCs, not just the mid and smaller ones but also for the bigger ones. The RBI has grouped NBFCs into multiple layers depending on their size and interconnectedness.

The upper layer falls in the category that are essentially no different from banks in terms of most regulations. It is reserved for companies that are perceived to carry elevated risks akin to banks under the prompt corrective action (PCA) framework.

The regulator on November 12 also came out with a clarification on upgrading of assets that resulted in a rise in reported gross NPAs of most non-banks in Q3FY22. It makes sense for this segment of NBFCs to become banks for future growth and ease of compliance. Becoming a bank will give them access to cheaper funds and freedom to grow business as they wish to.

As Moneycontrol reported in this story, some analysts have already begun hinting on serious consolidation. They say for all practical reasons, it makes sense for mid-sized ones to merge with banks. This will enable them to grow further as well as for regulatory compliance. In an exclusive interview with Moneycontrol over the week end, Parekh yet again alluded to the tight RBI regulations for NBFCs and agreed that the central bank is worried about rising number of failures in NBFC space which leaves it with no other options but to act tough.

Going ahead, we will likely see significantly less number of NBFCs in the mid and large segment. Large scale consolidation in the NBFC industry is now very much a possibility. Only the corporate-owned ones may continue in the current form. Others may have to restructure ownership and business model. Some may opt for consolidation and rest try to become banks. A clearer picture will emerge over the next few years.

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