Clear and clear benefits from HDFC-HDFC Bank merger

The benefits for both entities are clear.

HDFC enjoys the benefit of low cost liabilities which are available only to commercial banks in the Indian financial sector. Apart from this, it also gets access to a full blown distribution network that HDFC Bank has built over the years. On its part, HDFC Bank gets a fully matured, long-term asset book that would not otherwise be available to it. As part of the understanding within the HDFC family, the bank was allowed to simply generate the loan and then pass the book on to its parent HDFC Ltd. This repetitive, short-term churn of housing properties may be good from the bank’s Treasury point of view, but the return on return is low and hence the return on equity. Asset books are like fine wines: they get better with age. In the initial years, the return is lower because the original cost is adjusted against the repayment. Once that stage is over, it’s net produce. Therefore, the merger allows for value retention in both the institutions.

But, beyond these obvious reasons, there is more to the merger.

The competitive landscape of the Indian financial sector is changing rapidly. There are many pieces in the air and a rough pattern is already emerging. One, the sale of Citi’s retail assets to Axis Bank alters the relative competitive strength of the sector. Of course, it will not be easy for Axis Bank as the integration of two different metrics of products, processes and people has its own challenges. But the nuclear button has been pushed and the rest of the players in the financial sector will have to adjust again.

Second, the amalgamation of the four big public sector banks is also nearing completion. While new-age private banks have traditionally been ahead of state-owned banks in the retail sector, the consolidated platform could allow some public sector banks to cut market share. A revamped and digital-enabled State Bank of India has already demonstrated the kind of aggression that a public sector bank is willing to adopt to capture additional retail market share.

Third, technology is the next challenge for which banks are already facing pressure from some Nifty fintechs and tech-savvy NBFCs. Both a stand-alone mortgage company as well as a full-service commercial bank would need to invest separately to get up to speed; A combined unit reduces the required outlay and allows synergies and some exploitation of the combined potential.

Finally, the market doesn’t view holding companies very benevolently, and HDFC’s market valuation is known to be holding company exemptions, something that upsets even a diversified company like Grasim Ltd. This also affected the bank. The merger, once done and dusted, would leave no holding company and allow the discovery of the true economic value of the merged entity.

The final word has not been said on this merger yet. A lot will unfold in the next 12-18 months as each regulator looks at the marriage profile. These issues – mandatory reserve requirements, priority sector tolerances, management structure, governance norms, technology integration, holding structure for insurance or mutual fund subsidiaries, among others – would contribute to determining the finer details of each merger, as well as Will also contribute to the overall assessment of the emerging institution.