The United States (US) banking industry — the largest in the world with more than 5,000 banks — has proven the maxim that giant banks are made, not born. The four big US banks (Citigroup, Bank of America, JPMorgan Chase and Wells Fargo), comprising 40% of the total assets of the industry, are a conglomeration of multiple mergers since the 1990s of 35 separate companies, with Bank of America being the most active. India seems to be starting on that path as it seeks to build scale and credibility with its first — and biggest — mega-scale merger of the HDFC twins: HDFC Bank, and its promoter HDFC Ltd.
In 2019, I wrote that there are three defining companies which epitomise the Indian financial markets. Reliance for its innovative ability to create wealth by leveraging creative financial instruments; HDFC Group for its consistent prudence in the demanding area of financial sector lending and risk management; and Infosys for corporate governance. Among all the positives in favour of the deal, it is this aspect — consistent prudence — in HDFC’s DNA that will determine its ability to create a financial services behemoth.
Banks merge to create more efficient operations and build scale. While it is simple to view such mega deals from the prism of huge capital allocation, it is equally important to manage the perceptions of customers to such mergers as there is nothing more personal than personal finances. Recently, a 92-year-old asked me about the implications of the Axis-Citi deal as she had her life’s savings in Axis. Concerns around the level of customer service, relationships and fees are high, and mergers need to consider these aspects during the execution phase.
In theory, mergers extract synergies and provide a superior customer experience. However, in reality, mergers generally happen when either of the organisations has failed to achieve their financial goals and needs the help of the other to achieve them. I suspect that in HDFC’s case, the continuous underperformance in the markets played a significant role.
After Aditya Puri’s departure, it has been obvious that HDFC Bank’s new leadership would take a long while, if at all, to achieve the same momentum and zip it has always been valued for in the markets.
ICICI, in the interim, has been garnering market share, given its wider portfolio and a dynamic management team. The biggest gap in its portfolio of mortgages will be more than adequately filled by HDFC’s superlative portfolio though, in my view, the leadership issue will still have to be addressed over time as will the issue of stock underperformance.
Bank mergers are also determined by strategy and opportunity. From a strategy perspective, access to the lower cost of funds for a bank versus a non-bank financial company (NBFC), and filling the mortgage portfolio for the bank is a compelling argument, as is the diminishing regulatory arbitrage of NBFCs post ILFS. Similarly, the opportunity provided by being at the lower end of the credit cycle with interest rates just firming up is too providential to be missed. Apart from this, there is the regulatory opportunity of lower reserve requirement of 5% (the statutory liquidity ratio and cash reserve ratio at 22%) as compared to what it was six years ago.
In terms of constraints, the major ones revolve around capital and integration. Being an all-stock deal, external capital is not necessary except for enhanced regulatory reserve requirements. Additionally, goodwill creates a drag on capital ratios, which will not be the case in this merger. Integration, too, will be much easier, though not risk-free, as both entities share a generally compatible culture in terms of risk, governance and compliances and general outlook to deal profitability. Making a smooth transition from a brand communications and retail experience standpoint also plays a significant role in the success of mergers, which again, in this case of the HDFC twins, are closely aligned.
Coming back to the US, the “big four” hold over 40% of the banking industry assets and are approximately four times the size of the fifth-largest US bank holding company. In other words, in the well-oiled capitalist model, the big get bigger, leading to an immense concentration of profits. In India, the journey has just begun in the building of significant scale in banks. With the competition for deposits heating up, the scale will be immensely beneficial in this regard. As a data point in the US, the top three banks garnered $118 billion of new deposits versus just $55 billion by the top 20 regional banks.
The scale of changes in the Indian economy — as we transform from a middle-income country of $2,000 per capita income to an upper-middle-income country at $4,000 per capita income — is massive. And, only massive banks with scale can drive such transformations. The HDFC twins are positioning for this. The HDFC and HDFC Bank stocks have been slow laggards and have been underperforming the markets significantly in the last three years with a stock performance of 7% and 10% respectively, vs Sensex returns of 15.5%. But, as Lenin, said: “There are decades where nothing happens; and there are weeks where decades happen.” The first week of April could well have been one such week for the HDFC twins.
Prabal Basu Roy is a Sloan Fellow of the London Business School, non-executive director, and an adviser to chairmen of corporate boards The views expressed are personal
