An economic mega-merger that is all in the family

After 45 years of business, the housing contractor for millions of Indians is moving with his 28-year-old banker descendant. The joint family agreement makes sense for both Housing Development Finance Corp. as well as for HDFC Bank Ltd. Mortgages will become more competitive as lenders are pressured to set interest rates at benchmarks that are not under their control, such as the central bank’s repurchase rate. In addition, since India’s mini-Lehman in 2018, regulators have disapproved of the very large to failure monoline financiers who do not have access to cheap and guaranteed bank liquidity.

The announcement that HDFC Bank will make a total bid for 100% of the parent HDFC has attracted attention due to its size: The $ 60 billion transaction is the second largest in the world so far this year. The enthusiastic response of investors to the long-awaited deal suggests that the bank’s increased capitalization could push it to the $ 200 billion mark, competing with China Construction Bank Corp., which is the fourth largest in the world.

Assuming no assets are disposed of during consolidation, the balance sheet will exceed Rs 25 trillion ($ 340 billion). Although this is half the weight of the government-controlled Bank of India, it is still a large number for a private bank with a relatively newer vintage. HDFC Bank was created during the 1990s to reshape India’s Soviet-style economy. For an international size comparison, divide the value of the enlarged company assets into rupees by 22 – the value of the dollar modified for the purchasing power parity. A $ 1 trillion bank in a country with $ 10 trillion in gross domestic product adjusted for PPP is ranked ahead of Wells Fargo & Co., which has a $ 2 trillion balance sheet in the US $ 23 trillion economy.

HDFC Bank CEO Sashidhar Jagdishan is confident the acquisition will not sacrifice flexibility. “Elephants can also dance,” he says. But sluggishness has become an issue in the bank. In late 2020, the Reserve Bank of India banned it for eight months for digital issues and new credit cards due to frequent technology outages. Thanks to its low-cost deposits, net interest margins remained at around 4%, while for HDFC, the mortgage lender, they are 1.5 percentage points lower and fall for a decade. However, the bank earns slightly lower return on assets than the 2% + collected by its most efficient parent. As CEO of the enlarged entity, Jagdishan needs to reduce costs and innovate technology. It should also make the bank more relevant to Gen Z customers, who want banking to be as intuitive as food delivery applications.

The oldest mortgage lending institution is not a champion of digital technology. But he is proud of the quality of his assets. Low-cost middle-class mortgage lenders are usually a safe credit risk for everyone, but HDFC 77-year-old Deepak Parekh, who will step down after the merger, also has a reputation for being a good builder of construction loans.

These wholesale loans increase asset returns, but are vulnerable to credit shocks such as the one caused by the September 2018 collapse of infrastructure financier IL&FS Group. Following this disaster, Dewan Housing Finance Corp. became the first specialist monogram lender to go bankrupt with an RBI-appointed administrator at its helm. The central bank later took control of Reliance Capital Ltd., the financial company of former tycoon Anil Ambani.

Policy makers would like systemically important lenders to become licensed depository institutions with access to central bank liquidity taps. Investors seem to want that too: HDFC’s historic valuation advantage over HDFC Bank has almost disappeared from the IL&FS crisis.

More than half of home buyers in India are HDFC customers. This dominance can only be reduced as external pricing criteria make it easier for borrowers to compare and change interest rates from banks. However, HDFC Bank’s strong franchise on current and low-cost savings accounts could provide a solid home for the parent’s home loan as well as for wholesale lending. In addition, cross-selling of banking products to those seeking mortgages will give Jagdishan an extra lever against rivals such as ICICI Bank Ltd., which is turning a new leaf after a disastrous course of improper corporate lending.

For a long time, every new foreign investor coming to India had an initial shopping list with two shares: HDFC and HDFC Bank. This is due to the duo’s reputation for good corporate governance and elegant execution. Indeed, no deposit institution in the world trusts savers more and enjoys a larger number of investors than HDFC Bank. But all this is in the mirror. Banking in India is changing. The so-called Consolidated Payment Interconnection, a six-year public utility program, has revolutionized smartphone-based payments. As the two HDFC elephants begin their dance, they must be careful – not only with other banks, but also with fintech competitors trying to regulate both lenders and borrowers.

More from the Bloomberg Opinion:

• Banks in India have changed but not banks: Andy Mukherjee

• Banks must counter Fintech in India: Andy Mukherjee

• Banks are not sweating yet the reversal of the yield curve: Davies & Levin

This column does not necessarily reflect the views of the editorial board or Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He was previously a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

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