Why The HDFC Bank Merger Is Another Marker Of India's Inevitable Rise

The merger of HDFC Limited with HDFC Bank has been a major event for the banking industry in India, but its significance goes far beyond India.

And not only because the merger will create the fourth largest global bank by market capitalisation, after JP Morgan, Industrial and Commercial Bank of China Limited and Bank of America, HDFC Bank is now larger than Citibank, HSBC, Bank of China and Wells Fargo with a post-merger market valuation of around $170 billion.

This event is of huge significance to the emergence of India in the world, for HDFC Bank is proof that the Indian financial sector has not only come of age, but also is better regulated than some of the world’s more celebrated markets overseen by the likes of the US Fed or the European Central Bank.

Even as US and European banks are sinking and merging with stronger banks (Silicon Valley Bank, Signature Bank, First Republic and Credit Suisse come to mind) out of compulsion, the merger of HDFC with its bank is about strength marrying strength. And while Chinese banks are huge, the same cannot be said about the quality of their balance-sheets in a party-controlled economy.

The rise of HDFC Bank in the global league tables is thus as significant as the rise of Reliance in domestic telecom and retail, and Tata Consultancy and Infosys in software services.

The former two are built on the strengths of India's rising economy, the latter on the world's.

Second, while the merger will have short-term costs, especially because the liabilities (deposits) raised on behalf of the mortgage lender (ie, HDFC Ltd) will need to be covered by investments in zero-interest cash reserve ratio (CRR) and low-return statutory liquidity ratio (SLR), the merged bank’s CEO, Shashidhar Jagdishan, has gone on record to say that the resultant synergies will help the bank double in size every four years.

Jagdishan, quoted by The Indian Express, said: “The runway for financial services and mortgage, which are so underserved and under penetrated, is going to be very large. HDFC Bank – the combined entity – with a large and growing distribution and customer franchise, more than adequate capital, a healthy asset quality and profitability, will be best positioned to capture growth. The pace at which we aim to grow, we could be creating a new HDFC Bank every four years!” That’s a doubling.

Few global banks are in any position to do that even in twice the timeframe. So the next time one of their banks need a bailout, some regulator may well want to look at HDFC Bank as white knight.

Says a Bloomberg report on the merger: “HDFC Bank has consistently outperformed its peers in garnering deposits and the merger offers another chance to grow its deposit base by tapping the existing customers of the mortgage lender. Some 70 percent of those customers do not have accounts with the bank. Arvind Kapil, retail head at the bank, last month said he plans to get them to open a savings account. The lender will be able to offer in-house home loan products to its clients as only 2 percent of them had a mortgage product from HDFC Ltd, according to a presentation when the merger was announced.”

To be sure, the merger is the result of not just the opportunity, but a contradiction that could not have continued forever.

First, as a bank promoted by a mortgage lender (ie, HDFC), HDFC Bank could not visibly start massive lending for homes. The best it could do was to get HDFC to offer the loan and then get it to assign some of the assets to the bank for a fee.

This situation could not have continued if the interests of the bank’s shareholders had to be protected. It would not have made sense for a retail bank to steer clear of the most retail of loan offerings, a home loan.

Second, HDFC has been facing competition from the non-bank sector in advancing housing loans, and overall loan growth has been slowing down. The prospect of new non-banks entering the consumer and housing loans business (Reliance Financial Services being one of them), made the decision to merge easier.

It did not make sense for two financial giants from the same stable to compete with one another or slow down the other, when banks have the advantage of raising endless deposits to fund loan growth.

Third, the synergies are obvious, for HDFC’s customers can be encouraged to bank with the merged entity, even as the bank’s existing customer base can be leveraged for extending home loans. 

Fourth, the most important reason for the merger is scale: With 120 million customers, 8,300 branches and 1.7 lakh employees, a bank that can maintain its return on assets at 2 per cent and grow the loan book at 18-20 per cent is clearly a winner.

As the fastest growing large economy in the world, HDFC Bank can clearly grow well above the nominal economic growth rate of 11-12 per cent in a country which is urbanising fast, and where the middle class is expanding rapidly.

As an article in the Harvard Business Review by Vijay Govindarajan, Rajendra Srivastava, Anup Srivastava and Aman Rajeev Kulkarni notes, India’s middle class could almost double from the 2019 figure of 28.5 percent to 53.8 percent in 2030. The middle class is defined broadly as people drawing anything from $6,700 to $40,000 per annum. In purchasing power parity terms, this would work out to anywhere between $22,700 to $136,000 in the US. A 25 percent rise in the size of the middle class means adding more than the current population of the European Union on India’s large population base. This is the economic underpinning of the rise of HDFC Bank, and its expected future growth trajectory.

But the caveats are important too.

One, the merger process must be handled with care, and one cannot rule out the exit of important senior executives if they sense opportunities elsewhere. Attrition should be kept to manageable levels.

Two, in the short term, there will be higher borrowing costs as more deposits have to be raised at high cost to meet regulatory requirements.

Also, over three years, HDFC Bank will need to lend 40 per cent of its net credit to the priority sector, where the returns are either lower or subject to more defaults. This will put pressure on margins.

Three, HDFC Bank will face a lot more competition not only from non-banks, but also fintechs, including the likes of payment banks like Paytm, or payment facilitators like Google and PhonePe.

It is interesting to note that no big bank in India has the kind of market share in UPI payments as these three. Clearly, the mainstream banks have to play catchup to stay in the same.

But the bottomline is this: HDFC Bank has arrived in the big global league, and the reason is simple: it has married first-rate execution capabilities to delivering the kind of products that India needs.

This is why even as a Citibank has packed up and sold its consumer banking business to Axis Bank, HDFC Bank is hitting the accelerator.

HDFC Bank’s merger is a sign that the India story is now becoming unstoppable. Only politics can mess it up.

(Disclosure: The author owns personally significant investments in both HDFC and HDFC Bank).