HDFC twins joining up is a merger of equals but beware the regulatory costs

(Representative image)

India’s largest housing finance company HDFC will merge into subsidiary HDFC Bank which is the country’s most valuable private sector bank through an amalgamation scheme, the stock exchanges were informed today.

On the face of it, the merger is indeed of equals and is a win-win in terms of balance sheet heft, cost synergies and market share. It will also open up space for foreign institutional investors to buy HDFC Bank shares.

That said, there are key regulatory costs here that both the companies will need to carefully assess. The most critical of these are cash reserve ratio, statutory liquidity ratio and priority sector lending norms.

The Reserve Bank of India (RBI) requires banks to set aside four percent of their net time and demand liabilities as CRR and invest 18 percent of NDTL into government bonds under SLR. Further, banks and non-bank finance companies (NBFCs) are required to maintain high quality liquid assets under liquidity coverage ratio norms.

Analysts believe that the merged entity will need to raise funds from the market or steadily build the excess liquidity on the balance sheet to meet the regulatory requirements. Estimates of fundraising are currently Rs 60,000-70,000 crore. To be sure, the management of both the companies have expressed confidence in meeting regulatory requirements.

Nearly 35 percent of HDFC’s borrowings are retail deposits and these would be taken into consideration for calculating regulatory ratios after the merger. In a management call, Keki Mistry, vice chairman of HDFC, said that both the CRR and SLR have been brought down over time and therefore it is easier now than before for the merged entity to meet these.

Yet another factor is the required priority sector lending norms that banks need to adhere to. The RBI requires banks to lend 40 percent of their adjusted net bank credit to agriculture and allied activities, small businesses and affordable housing among others covered under the priority sector.

The combined entity will have a loan book of Rs 18 lakh crore, of which 27 percent would be home loans. Given that HDFC’s large book will get merged, the share of priority sector loans would come down and HDFC Bank would need to meet the norms after the merger. Sashidhar Jagdishan, managing director and chief executive officer of the bank, said that the lender would resort to buying priority sector lending certificates (PSLC) initially to meet the norms. “We have a fair amount of strategies to meet enhanced requirement of the priority sector,” he said in the call.

As such, the companies have requested the regulator to give them time to meet the norms. It remains to be seen whether the RBI will give an extended timeline for the merged entity to tick all the regulatory boxes.