MC interview| Shrinking regulatory arbitrage key driver for HDFC-HDFC Bank merger, says Deepak Parekh

Deepak Parekh

The key driver for the merger of Housing Development Finance Corporation Ltd (HDFC) and HDFC Bank Ltd was the shrinking arbitrage between Non-Banking Financial Companies (NBFCs) and banks in terms of Reserve Bank of India (RBI) regulations, says HDFC chairman Deepak Parekh.

“Every new RBI policy entailed tightening of regulations for NBFCs,” Parekh told Moneycontrol in an exclusive interview on January 27. “So, the flexibility and the light-touch regulation that an NBFC enjoyed was fast disappearing, and rightly so, because a number of NBFCs had collapsed and some had even taken public deposits,” the veteran banker said.

On April 4, 2022, HDFC, India’s largest mortgage lender, announced that it would merge with HDFC bank in a $40 billion deal.

“The overall process of merger till final NCLT (National Company Law Tribunal) approval could take 7-8 months after the shareholders’ approval. We believe that the merger could be completed a few months ahead of schedule by one to two quarters," HDFC Bank’s chief financial officer (CFO) Srinivasan Vaidyanathan said after the announcement.

With the merger in place, HDFC Bank can eye a bigger and larger role within the banking sector and the economy as a whole.

The merger, which is expected to conclude in the second quarter of 2023, will give HDFC access to over Rs 16.7 trillion rupees in funds including low-cost current and savings account deposits and time deposits of the bank.

Parekh said the merger made sense before the full implementation of the RBI’s regulations on NBFCs. Once completed, the combined entity will emerge as a stronger organisation with a large customer base, Parekh said.

RBI regulations for NBFCs

Parekh highlighted that the merger was important before the completion of the full implementation of the RBI regulations for NBFCs.

"Banks have to maintain SLR (Statutory Liquidity Ratio), CRR (Cash Reserve Ratio) and have priority-sector loan limits, which NBFCs do not have. But, NBFCs are now required to maintain a Liquidity Coverage Ratio (LCR),” he said.

SLR is the minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold, government bonds or other approved securities.

CRR is the share of a bank’s total deposits that is mandated by the RBI to be maintained with the central bank as reserves in the form of liquid cash.

LCR refers to the proportion of highly liquid assets held by financial institutions to ensure their ability to meet short-term obligations.

Further Parekh said the classification of NBFCs by RBI hinted at risk factors stemming from the large NBFCs, one of them being HDFC.

The RBI has put in place a process for classifying all NBFCs into three broad categories—the upper, middle, and base layers. The mandate is that upper-layer NBFCs include the large ones that can pose a systemic risk to the financial system, Parekh said.

“These NBFCs now have to follow bank-like regulations. So, in a way, it made sense to do the merger ahead of the full implementation of these new regulations," Parekh added.

A bigger opportunity for combined entity

Parekh said apart from the regulations, the scope of a bigger business opportunity also inspired the company to work on the merger.

Explaining this point, Parekh said the bank is a big player in retail credit, but its retail portfolio is a short-duration one of around 18 months. HDFC bank does not give mortgage loans because this is HDFC’s core business. With the merger happening, this issue can be addressed, Parekh said.

“Now, as a combined entity, the bank will get long-term mortgage loans which will increase the duration of the retail portfolio. Further, with a larger customer base, the bank will be able to do a lot more cross-selling of products." the veteran banker said.

Inflation and rate hikes

To fight inflation, the RBI in the current rate hike cycle has increased the repo rate by 225 basis points. The repo rate is the rate at which RBI lends short-term funds to banks. One basis point is one- hundredth of a percentage point.

On how NBFCs guided the rate hike scenario, Parekh said: “We have to take care of so many, many moving parts and the RBI rightly articulated that it will rein in inflation, but would also keep in mind economic growth considerations.”

With inflation beginning to ease, Parekh said that central banks around the world have stopped their mega rate hikes.

“Even globally, with inflation beginning to ease a bit, I think the days of jumbo interest rate hikes by central banks are behind us now,” Parekh said.