IDFC Bank: A Bank In A Hurry

Will the proposed merger really help IDFC Bank morph into a true universal bank?

An IDFC Bank branch at Bandra Kurla Complex, Mumbai, India. (Source: IDFC Bank’s official twitter handle)
An IDFC Bank branch at Bandra Kurla Complex, Mumbai, India. (Source: IDFC Bank’s official twitter handle)

IDFC Ltd, among the more successful infrastructure lenders in the country, was one of 26 entities that applied for a banking licence in 2013. It was one of only two (Bandhan Financial being the second) that managed to pass the many rounds of scrutiny that each licence-aspirant was subjected to by the Reserve Bank of India (RBI). The fact that IDFC got the nod to launch a universal bank was partly due to its diversified ownership, but it was as much a testament to the track record established by the organisation since its inception in 1997.

In 2014, when the in-principle approval for a banking licence was granted, analysts had questioned whether launching a universal bank is the best way forward for IDFC Ltd. The organisation had deep expertise in infrastructure credit, which could be leveraged for corporate lending, but had no experience at all of retail lending in India. In contrast, Bandhan Financial had a clear retail client base which it could develop as it moved from being a microlender to a bank.

But Rajiv Lall, who was then chairman of IDFC Ltd., was convinced that converting to a universal bank was the way to go and so IDFC Bank was launched in October 2015. The strategy articulated by Lall at the time was three-fold:

  • Building a corporate bank by leveraging existing relationships.
  • Building a tier-1 city-focused retail business.
  • Building a ‘bharat banking’ franchise which depends heavily on the use of technology.

In the 20-odd months that the bank has been operational, it has not gone far in achieving these goals. To be sure, 20 months is hardly enough time to judge the success of a new banking business. The assessment has been necessitated by the bank’s decision to merge it’s businesses with those of the Shriram Group. We’ll return to that but first a stock-taking of IDFC Bank’s standalone business as it stands before the merger.

According to an investor presentation published on the bank’s website, it had 1.4 million customers as of March 2017. Close to a million of these have been on-boarded after the acquisition of Grama Vidiyal Microfinance. This essentially means that the bank has had little success in building its own retail customer base both in urban and rural markets.

In terms of its business profile, the bank in a press release issued after fiscal 2017 earnings said that “one-fourth of the IDFC Bank’s funded credit was retailised”. This, however, appears to include so-called credit investments (corporate bond investments) which have jumped from Rs 3,114 crore in March 2016 to Rs 17,165 crore in March 2017. Advances alone increased by only about 8 percent over fiscal 2017, which was its first full financial year in operation.

On the deposits side, IDFC Bank had current account and savings account (CASA) deposits equal to only 5.2 percent of all deposits. The best in class retail lender, HDFC Bank, has a CASA ratio of 48 percent.

The short point here is that IDFC Bank is far from shedding its infrastructure lending past and morphing into a universal bank. A fact that is reflected in the valuation gap between IDFC Bank and its peers.

IDFC Bank: A Bank In A Hurry

Now comes the proposed merger with the Shriram Group, which IDFC Bank hopes will help it make this transition to a universal bank in one-shot. But will it?

The first counter argument to this is the fact that the none of the Shriram entities have a retail deposit base. This means that while the bank will add retail assets, it will still struggle to build a liabilities base. Lall told BloombergQuint that he disagreed with this assessment. “This is exactly the right sequencing for us,” Lall said in an interaction on Saturday. He explained that since IDFC Bank started its journey as a listed bank, it is under continuous earnings pressure, which needs to be tackled through the ‘retailisation’ of the bank’s balance sheet since corporate lending remains weak.

“But this deal is not just about buying assets. It gives us an opportunity to gain access to 10 million customers through whom we can now develop a much larger retail liabilities franchise,” Lall said.

This process, however, may get complicated by the plan to continue with the Shriram brand name even after the merger is complete. At a press conference on Saturday, Lall, Ajay Piramal, chairman of Shriram Capital, and R Thyagarajan, founder of the Shriram group of companies, all said that the Shriram brand will coexist with the IDFC Bank.

If that is the case, will IDFC Bank end up being identified more as a distributor of Shriram products rather than the parent entity? Convincing these customers of Shriram products to then shift their deposits to an entity named IDFC Bank may not be an easy task.

The identity crisis does not end with the liabilities side.

The merged asset book of IDFC Bank will carry legacy infrastructure loans, initially extended by IDFC Ltd., along with a large chunk of SME (small and medium medium enterprise) loans and gold loans that constitute Shriram City Union Finance’s business. The merged lender will not get the transport finance portfolio since Shriram Transport Finance will be held by IDFC Ltd and not IDFC Bank. So, you essentially get a lender which has a large corporate portfolio, a significant small enterprises portfolio and a gold loan book. Each of these business segments brings with it its own set of vulnerabilities.

It will take some doing for IDFC Bank to balance out its asset and liabilities book in a manner that it can claim to be a true universal bank.

Macquarie Capital Securities described the proposed merger well.

It “seems like a confluence of desperation of IDFC Bank to acquire some financial company to grow (they have been able to achieve little organically) and aspiration of Piramal group, which now owns ~15% in Shriram entities, to get a banking license”.