HDFC Bank-HDFC merger: Regulatory changes for NBFCs proved decisive

Regulatory changes by the Reserve Bank of India (RBI) aimed at narrowing the arbitrage enjoyed by non-banking financial companies (NBFCs) proved to be the decisive factor in the amalgamation of mortgage financier HDFC into HDFC Bank, India’s largest private sector lender.

On Monday, HDFC and HDFC Bank announced their boards had approved an all-stock amalgamation of the former into the latter, subject to regulatory approvals. At present, HDFC is the parent company of the bank.

Over the years, the RBI has been harmonising regulations between NBFCs and banks in the wake of the many defaults in the shadow banking space. They started with Infrastructure Leasing & Financial Services (IL&FS) going bust.

The RBI has come up with scale-based regulations for the NBFC sector, wherein large ones will be subject to greater scrutiny akin to that of the banks. Further, the RBI harmonised income recognition and non-performing asset (NPA) classification norms for NBFCs, which was seen as another step to bring the regulation of NBFCs at par with that of banks. It introduced the liquidity coverage ratio (LCR) for NBFCs, whereby NBFCs not taking deposits but with an asset size of Rs 10,000 crore and deposit-taking NBFCs irrespective of asset size are mandated to maintain a liquidity buffer in terms of the LCR.

The LCR is the proportion of high liquid assets set aside to meet short-term obligations.

Recently, the RBI asked NBFCs in the upper and middle layers to implement the “Core Financial Services Solution (CFSS)” by September 30, 2025, a system akin to the Core Banking Solution used by banks.

Also, the RBI has indicated that large NBFCs with an asset size of over Rs 50,000 crore may look at converting into banks.

Alluding to the changes in the regulatory framework, Deepak Parekh, chairman, HDFC, on Monday said: “Over the last few years there have been certain regulatory changes for banks and NBFCs, which have considerably reduced the barriers to a potential merger. The last three years have seen a host of guidelines issued by the RBI on harmonising the regulation between banks and NBFCs.”

Suresh Ganapathy, associate director, Macquarie Capital, said in a note: “The fact that the RBI has killed all arbitrage that was there in the NBFC sector by harmonising norms, by introducing LCR norms and keeping higher capital levels, means that increasingly it is going to get difficult for them to operate and maintain same levels of profitability as in the past.”

Other factors in the merger were the reduced gap in liquidity requirements between banks and NBFCs, a low interest regime, and banks having the option of investing in priority sector lending (PSL) certificates as against direct lending to agriculture and micro, small and medium industries in the past. The combination of the statutory liquidity ratio (SLR) and cash reserve ratio (CRR) for banks was 27 per cent earlier. It is now 22 percent (18 per cent SLR and 4 per cent CRR).

According to Emkay Research, the merger would call for an additional SLR/CRR burden of Rs 1.02 trillion and PSL of Rs 1.17 trillion (assuming the CRR/SLR/PSL ratios for the merged entity stay similar to those of HDFC Bank), leading to a net cost drag of Rs 2,000 crore, a 7 basis point impact on the net interest margin (NIM), and earnings per share (EPS).

Macquarie Research in a note said the profit and loss impact of SLR/CRR requirements on HDFC’s funding, as well as due to PSL requirements, could be Rs 3,200 crore (i.e. 6 per cent of the merged pro forma profit after tax).

Commenting on the rationale of the merger Keki Mistry, vice-chairman and chief executive order, HDFC, on Monday had said, “It’s (merger) something that we have evaluated over the years. In the past, it did not make sense for a variety of reasons. One is, at that time, the CRR, SLR requirement was a lot higher than what it is now. Secondly, interest rates are significantly lower than what they used to be.”

Addressing the additional PSL burden, Sashidhar Jagdishan said, “We will fulfil our priority sector requirements by moving the affordable through the rural and distribution network”.