Housing Development Finance Corporation (HDFC) on Monday, 4 April, announced that its Board had approved a merger between HDFC Bank and HDFC Ltd, in a landmark deal in the country's financial sector.
After the merger becomes effective, the subsidiaries and associates of HDFC Ltd will be transferred to HDFC Bank.
The merger aims to bring about an expansion in the balance sheet of the company and increase its net-worth, as well as accelerate the pace of credit growth in the Indian economy, the company's chairman Deepak Parekh said.
The transaction is set to be completed within the next 12-18 months.
We explain to you the mechanics behind the merger, which has been termed by experts as "largest and most transformational" in India's financial services sector.
Merger Between HDFC, HDFC Bank: Benefits, Challenges & Market Impact of the Deal
1. Why is the Merger Taking Place Now?
Speaking on the merger between the two entities, Ira Dugal, Executive Editor at BloombergQuint, said that while there was speculation for years that there would be a merger between the two entities, there is a combination of reasons why the decision was taken now.
Three factors in particular seem to have led to the decision to merge.
The first was a change in regulations for Non-Banking Financial Companies (NBFC’s) and Housing Finance Companies (HFC's).
"Over the last few years there have been accidents in the NBFC and the housing finance sector. The Dewan Housing Finance Corporation (DHFL) for instance had failed. After that, the Reserve Bank of India had tightened its regulations for NBFCs and housing finance companies. You’re now starting to see those regulations converge," Dugal said, adding that it was less beneficial for HDFC Ltd to stay an HFC and not be part of a bank.
The second factor was that interest rates in the economy were at "multi-decadal lows" .
Any time these two entities would decide to merge, there would be large requirements to meet statutory ratios such as the Cash Reserve Ratio (CRR), which banks have to keep aside, or the Statutory Liquidity Ratio, which is the amount that banks put in government securities, Dugal said.
"So if HDFC comes into the banking sector, they will have to raise more capital. Now that capital is currently coming at a good cost because interest rates in the economy are at multi-decadal lows, it also helps them to some extent," she added.
The final reason that influenced the decision was related to a change in personalities who were involved in the merger conversation.
Aditya Puri, who was the long-time CEO of HDFC Bank and is now retired, was never entirely in favour of the merger, Dugal said.
Similarly, Deepak Parekh, who has been the chairman of HDFC Ltd for years, is getting on in age, as is Keki Mistry, who ran the HDFC Ltd franchise and is its vice-chairman.
"So a merger at this point solved a problem of succession for HDFC Ltd. It also came in at a time when there is a new CEO at HDFC Bank who has a long runway to make sure it works," Dugal emphasised.
Sashidhar Jagdishan was made the CEO of HDFC Bank in October 2020.
Expand2. How Do the Two Entities Benefit?
While speaking about the advantages for the two financial entities accruing from the merger, Dugal said that the transaction was more beneficial to HDFC Ltd as compared to HDFC Bank.
HDFC Ltd will see a number of benefits. "Firstly, cost of funds will fall because banks tend to have lower costs of funds, as they take deposits from people like us," she said.
The second benefit is that they would now have the opportunity to cross-sell products as a result of the merger, which would create of a plethora of options for customers.
"HDFC’s customers are mostly sold home loans. When they go into the HDFC bank-fold with the same set of relationship managers or branches, you can cross-sell all sorts of products to them, like retail loans, personal loans, credit cards and small business loans," Dugal said, adding that customers as a result would have a a wider range to choose from.
For HDFC Bank, however, the merger represented a double-edged sword.
While they certainly benefit from taking on HDFC Ltd's customers, to whom they can cross-sell, HDFC Bank will have to "take on the burden of high SLR's and CRR's, which is going to depress their returns a little," Dugal explained.
In addition, they will also have to worry about integrating branches and employees over the next 12-18 months, she said, adding that a lot of management bandwidth will have to go into this at a time when a new credit cycle is potentially starting.
Expand3. What Are the Challenges Posed by the Merger?
While the deal was praised from different quarters of India's financial sector, there are significant challenges to successfully concluding the merger and maintaining its long-term efficiency.
The biggest challenge will be in getting approvals.
"So many businesses are being merged – insurance, asset management, banking etc. So, getting approvals from regulators will be the most challenging aspect of this deal," Dugal said.
Secondly, HDFC Ltd’s employees are largely used to selling home loans. When they come into the banking fold, "they will have to get used to an entirely different set of products and processes, posing a significant challenge," she added.
A third challenge had to do with running branches and creating a viable strategy for their smooth and long-term functioning.
"Even though the management said that there would be no need to rationalise or shut down branches, there would still have to be a re-mapping of the branch strategy," Dugal emphasised.
Expand4. How Will It Impact the Financial Services Market?
The merger is set to change the game in the highly-competitive financial services market. HDFC Bank, which was already the second largest bank and the largest private sector bank in India, is set to expand its net-worth even further, and create greater competition in an already cut-throat market.
"The merger will make HDFC nearly two times the size of ICICI Bank," Dugal said, adding that the latter will be left wondering whether they should look around for other assets in the market to try and gain scale.
However, whether this will happen or not still remains unknown as there aren’t that many assets or banks up for sale in the Indian market, Dugal explained.
The merger will also require the merged entity to be more nimble than usual, given the highly competitive landscape of the Indian financial sector.
However, the merger will certainly compel competitor banks to look at the scale of HDFC Bank and "wonder how they will catch up".
Expand5. How Have Industry Players Reacted to the Merger?
On Monday, shares of HDFC and HDFC Bank settled with nearly 10 percent gains amid news of the proposed merger. On Tuesday, however, the HDFC twins witnessed a drop in the markets, with stocks settling nearly 3 percent lower, and ended up among the top losers on both the benchmark indices.
HDFC Chairman Deepak Parekh has said that the merger will not only strengthen the entity against its competitors but also make its offerings more competitive.
But how have industry experts react to the merger?
Speaking to Moneycontrol, Ajay Piramal, chairman of Piramal Group termed the merger a "tremendous event", adding that it is a culmination of Parekh's contribution to the Indian financial services industry.
Samir Bahl, CEO, Investment Banking, Anand Rathi Advisors termed the merger the "largest and most transformational" in India's financial services sector.
"Further, this merger enables confidence in the Indian economy and looks for a brighter long-term picture beyond the ongoing Russia-Ukraine conflict and the rising inflationary concerns," said Naveen Kulkarni, Chief Investment Officer at Axis Securities.
S&P Global Ratings said that the merger would give HDFC Bank a booster shot, adding that the merged entity would be better placed to raise funds at competitive rates, reported BloombergQuint.
(At The Quint, we are answerable only to our audience. Play an active role in shaping our journalism by becoming a member. Because the truth is worth it.)
Expand
Why is the Merger Taking Place Now?
Speaking on the merger between the two entities, Ira Dugal, Executive Editor at BloombergQuint, said that while there was speculation for years that there would be a merger between the two entities, there is a combination of reasons why the decision was taken now.
Three factors in particular seem to have led to the decision to merge.
The first was a change in regulations for Non-Banking Financial Companies (NBFC’s) and Housing Finance Companies (HFC's).
"Over the last few years there have been accidents in the NBFC and the housing finance sector. The Dewan Housing Finance Corporation (DHFL) for instance had failed. After that, the Reserve Bank of India had tightened its regulations for NBFCs and housing finance companies. You’re now starting to see those regulations converge," Dugal said, adding that it was less beneficial for HDFC Ltd to stay an HFC and not be part of a bank.
The second factor was that interest rates in the economy were at "multi-decadal lows" .
Any time these two entities would decide to merge, there would be large requirements to meet statutory ratios such as the Cash Reserve Ratio (CRR), which banks have to keep aside, or the Statutory Liquidity Ratio, which is the amount that banks put in government securities, Dugal said.
"So if HDFC comes into the banking sector, they will have to raise more capital. Now that capital is currently coming at a good cost because interest rates in the economy are at multi-decadal lows, it also helps them to some extent," she added.
The final reason that influenced the decision was related to a change in personalities who were involved in the merger conversation.
Aditya Puri, who was the long-time CEO of HDFC Bank and is now retired, was never entirely in favour of the merger, Dugal said.
Similarly, Deepak Parekh, who has been the chairman of HDFC Ltd for years, is getting on in age, as is Keki Mistry, who ran the HDFC Ltd franchise and is its vice-chairman.
"So a merger at this point solved a problem of succession for HDFC Ltd. It also came in at a time when there is a new CEO at HDFC Bank who has a long runway to make sure it works," Dugal emphasised.
Sashidhar Jagdishan was made the CEO of HDFC Bank in October 2020.
How Do the Two Entities Benefit?
While speaking about the advantages for the two financial entities accruing from the merger, Dugal said that the transaction was more beneficial to HDFC Ltd as compared to HDFC Bank.
HDFC Ltd will see a number of benefits. "Firstly, cost of funds will fall because banks tend to have lower costs of funds, as they take deposits from people like us," she said.
The second benefit is that they would now have the opportunity to cross-sell products as a result of the merger, which would create of a plethora of options for customers.
"HDFC’s customers are mostly sold home loans. When they go into the HDFC bank-fold with the same set of relationship managers or branches, you can cross-sell all sorts of products to them, like retail loans, personal loans, credit cards and small business loans," Dugal said, adding that customers as a result would have a a wider range to choose from.
For HDFC Bank, however, the merger represented a double-edged sword.
While they certainly benefit from taking on HDFC Ltd's customers, to whom they can cross-sell, HDFC Bank will have to "take on the burden of high SLR's and CRR's, which is going to depress their returns a little," Dugal explained.
In addition, they will also have to worry about integrating branches and employees over the next 12-18 months, she said, adding that a lot of management bandwidth will have to go into this at a time when a new credit cycle is potentially starting.
What Are the Challenges Posed by the Merger?
While the deal was praised from different quarters of India's financial sector, there are significant challenges to successfully concluding the merger and maintaining its long-term efficiency.
The biggest challenge will be in getting approvals.
"So many businesses are being merged – insurance, asset management, banking etc. So, getting approvals from regulators will be the most challenging aspect of this deal," Dugal said.
Secondly, HDFC Ltd’s employees are largely used to selling home loans. When they come into the banking fold, "they will have to get used to an entirely different set of products and processes, posing a significant challenge," she added.
A third challenge had to do with running branches and creating a viable strategy for their smooth and long-term functioning.
"Even though the management said that there would be no need to rationalise or shut down branches, there would still have to be a re-mapping of the branch strategy," Dugal emphasised.
How Will It Impact the Financial Services Market?
The merger is set to change the game in the highly-competitive financial services market. HDFC Bank, which was already the second largest bank and the largest private sector bank in India, is set to expand its net-worth even further, and create greater competition in an already cut-throat market.
"The merger will make HDFC nearly two times the size of ICICI Bank," Dugal said, adding that the latter will be left wondering whether they should look around for other assets in the market to try and gain scale.
However, whether this will happen or not still remains unknown as there aren’t that many assets or banks up for sale in the Indian market, Dugal explained.
The merger will also require the merged entity to be more nimble than usual, given the highly competitive landscape of the Indian financial sector.
However, the merger will certainly compel competitor banks to look at the scale of HDFC Bank and "wonder how they will catch up".
How Have Industry Players Reacted to the Merger?
On Monday, shares of HDFC and HDFC Bank settled with nearly 10 percent gains amid news of the proposed merger. On Tuesday, however, the HDFC twins witnessed a drop in the markets, with stocks settling nearly 3 percent lower, and ended up among the top losers on both the benchmark indices.
HDFC Chairman Deepak Parekh has said that the merger will not only strengthen the entity against its competitors but also make its offerings more competitive.
But how have industry experts react to the merger?
Speaking to Moneycontrol, Ajay Piramal, chairman of Piramal Group termed the merger a "tremendous event", adding that it is a culmination of Parekh's contribution to the Indian financial services industry.
Samir Bahl, CEO, Investment Banking, Anand Rathi Advisors termed the merger the "largest and most transformational" in India's financial services sector.
"Further, this merger enables confidence in the Indian economy and looks for a brighter long-term picture beyond the ongoing Russia-Ukraine conflict and the rising inflationary concerns," said Naveen Kulkarni, Chief Investment Officer at Axis Securities.
S&P Global Ratings said that the merger would give HDFC Bank a booster shot, adding that the merged entity would be better placed to raise funds at competitive rates, reported BloombergQuint.
(At The Quint, we are answerable only to our audience. Play an active role in shaping our journalism by becoming a member. Because the truth is worth it.)