Opinion: HDFC Merger Will Leave India's Banks Gasping

When the remaking of India's socialist financial landscape began in 1993, very few people believed in the project - some of the 40 applications to set up new private-sector banks were so frivolous that they were written on postcards.

Three decades later, things are far more serious. Finance in the most-populous nation is moving into a higher gear. Of the two big changes expected this year, one has just occurred and created a juggernaut bigger than Morgan Stanley. The other splash may see the birth of India's own Ant Group Co., a digital-lending powerhouse being set up by the country's wealthiest tycoon.

These disruptions are taking place on the strength of a much larger consuming class that finance has helped create along the way. But is it big enough to sustain the industry's latest makeover? The test will come in the deposits market.

Among the more serious aspirants for a banking license in 1993 - one that didn't send in its application on a postcard - was Housing Development Finance Corp., then a 16-year-old specialist mortgage lender in a country where the culture of debt-financed homeownership was still in its infancy. After nearly three decades of spectacular growth, HDFC Bank Ltd. finally swallowed up its parent, HDFC, on July 1. The combined entity, as HDFC investors' stakes are swapped for shares in the bank over the next few days, will have a market value of $173 billion.

What's more, the juggernaut is showing no sign of slowing down. To sustain its 20% pace of annual asset expansion, the bank will need stable funding. Suresh Ganapathy, head of financial services research in India at Macquarie Group Ltd.'s brokerage unit, estimates that the newly bulked-up HDFC Bank will go after as much as 20% of the banking system's incremental deposits over the next three to four years. This could be highly destabilizing, at a time when the overall industry is gasping for liquidity.

India's extreme income inequality has an impact on banking. Individual savings, which account for three-fifths of deposits, are heavily skewed toward top earners. At the bottom of the pyramid, there are practically no savings. But this rather narrow affluent class is currently grappling with a post-pandemic surge in inflation and trying to protect its living standards with debt. Higher interest rates, however, mean paying more to lenders for mortgages and other consumer credit. What's left of the surplus at the family level is going into mutual funds in search of better returns - and only then entering the banking system. As a result, the liquidity sources for banks have become more institutional and retail deposits are stagnant, a point that Mumbai-based analyst Harsh Vardhan, a former Bain & Co. partner, made recently.

The data show this shift: As much as 12.5% of the incremental deposit growth this fiscal year is coming from a money-market instrument. The share of the so-called certificates of deposit was just 6.4% two years ago, according to India Ratings & Research. With credit growth outpacing deposits by 3 percentage points, the unit of Fitch Group expects increased competition among banks to grow their resource-mobilization franchise.

That contest is bound to become keener as HDFC Bank looks for low-cost, sticky deposits to fund the loan book it has inherited from HDFC. That's the whole point of this marriage. The shock waves that emanated from the sudden 2018 collapse of IL&FS Group, a prominent Mumbai-based infrastructure financier, toppled several institutions and made it clear that shadow banks with a concentrated exposure to one industry - real estate, in the case of HDFC - would be safer as banks. That way, they wouldn't have to depend on fickle wholesale funding. Access to state-insured retail deposits and the central bank's emergency liquidity lines made the HDFC-HDFC Bank merger a compelling proposition.

This year's other big development in Indian finance is a demerger - a spinoff. In May, shareholders of Reliance Industries Ltd., the country's most valuable conglomerate, approved splitting a new consumer-finance unit  into a separate company with its own stock-market listing soon.

When it comes to acquiring new borrowers at a low cost, tycoon Mukesh Ambani's Jio Financial Services Ltd. will have a ready cachet of more than 400 million subscribers of his dominant telecom business. Additionally, Reliance operates India's largest retail chain, and has ambitious plans to compete against the likes of Unilever Plc in general merchandise trade, where the No. 1 ingredient for a successful mom-and-pop store is credit for working capital. Ambani's low-income customers may also need financing for Jio Bharat, a sub-1,000-rupee ($12) phone he's launching this week for beta trials with unlimited voice calls and 14 gigabytes of data for 123 rupees a month. The device can also stream videos from Reliance's JioCinema and make payments. With good execution, Jio Financial will be a panopticon, with a near-complete view of Indian consumers' (and merchants') spending and ordering behavior.

Thus, the overall banking system will face twin challenges. On the liability side of their balance sheet, lenders will have to fight for deposits against a bank growing so fast that the market believes it to be worth more than Morgan Stanley, HSBC Holdings Plc or Citigroup Inc. On the asset side, lending models that run on limited credit-bureau data will have to take on Jio Financial's superior, Ant Group-style pricing engine.

Whether the industry can digest the two near-simultaneous disruptions will ultimately depend on the growth of India's middle class. For clues, watch the deposits market. A deeper reservoir of household savings will show that incomes are percolating beyond a narrow elite, making more of the country's 1.4 billion people creditworthy. A shallow pool will mean otherwise.

Disclaimer: These are the personal opinions of the author.

(Except for the headline, this story has not been edited by NDTV staff and is published from a syndicated feed.)