HDFC, IDFC Mergers Come Amid Tightening Of Regulatory Norms For NBFCs

In the last one week, the completion of HDFC-HDFC Bank merger and the announcement of similar scheme of arrangement for IDFC Ltd and IDFC First Bank have been the major highlights for the Indian banking sector.

Expected to create a financial behemoth, the completion of HDFC merger marked a new beginning for the group as well as the Indian banking sector. It is expected that the merged entity will be the fourth largest bank globally in terms of market capitilisation. Just two days after this merged entity hit the market, IDFC First Bank in a regulatory filing informed about its proposed merger with parent entity IDFC Ltd, subject to approval of several regulators. 

Both the banks have stressed upon how the decision to merge will smoothen their operations and strengthen their businesses. While HDFC Bank said that it will help in diversifying their loan portfolio and improve funding position, IDFC First Bank said the merger will help shareholders “unlock” value of their investment. 

The merger of these entities also comes amid the changing regulatory norms on non-banking financial companies (NBFCs) in the last few years. One of the reasons cited by both the businesses was streamlining their regulatory filing process. IDFC First Bank said in its filing, “[The merger] will also lead to unification and streamlining of the regulatory compliances of both, IDFC Limited and IDFC First Bank.”

After announcing HDFC merger last year, the then chairman of the mortgage lender had said that the final nudge for the move was given by tightening of RBI’s regulations on NBFCs. The rumours of the merger of two entities had been around for a while. In 2014, when an RBI notification had allowed banks to issue long-term bonds to raise funds for infrastructure and housing projects, the rumours about the possible merger had heatened up. However, while the merger did not materialise then, the announcement came as the RBI increased regulatory scrutiny of NBFCs. 

Experts believe that for the last few years RBI has been trying to harmonise the regulations of NBFCs to bring them in line with those of banks as it was believed that the former were loosely regulated. Kaitav Shah, Banking Analyst at Anand Rathi Brokerage, says that the central bank has significantly strengthened NBFC regulations. “If we look at banks and NBFCs, generally banks are considered safer due to the RBI being there as a backstop. Now, what the central bank has done is brought both regulations in line to improve the scrutiny of NBFCs.”

The focus on the health of NBFCs had increased after several defaults by NBFCs following the fall of Infrastructure Leasing and Financial Services (IL&FS). Karan Gupta, Director at India Ratings & Research, says a string of failures of NBFCs during this time cautioned the RBI and since then it has been increasing its oversight on NBFCs. 

In its financial stability report of 2019, RBI had acknowledged that solving the losses of banking system due to failure of NBFCs was crucial as failure of large NBFCs can cause losses comparable to those caused by big banks. This called for greater surveillance over large NBFCs, according to RBI. 

The importance of NBFCs in the overall financial landscape has increased in the last decade. According to a report published in December 2021 by Crisil and Assocham, the share of NBFCs in overall credit pie increased from 12 per cent in March 2008 to 18 per cent in March 2020. 

To keep a better check, RBI introduced several changes in how NBFCs were regulated. Last year, the central bank introduced scale-based regulations which divided them into four layers on the basis of their size and activity. It had also changed how NPAs were identified at NBFCs that were into lending business. They were asked to classify NPAs exactly after 90 days from the overdue date instead of starting 90 days cycle from end of the month in which the overdue date fell. 

Given how RBI was pushing to improve the regulatory framework for these entities, it is not surprising that the former HDFC chairman termed it as a ‘nudge’ to finally complete the merger. For IDFC, Shah says it made sense for the firm to have their non-lending financial activities under the bank’s book and not have separate entity altogether which would help the firm streamline their regulatory process. Talking about streamlining operations, Gupta says, “This message of RBI to simplify organisational structure has been playing out over a period of time to banks and NBFCs as it would help the central bank keep a check on them.”

Experts on the subject also stress that while the need to smoothen regulatory compliances might have been a consideration for these firms, the impact on businesses and shareholders would have been the major factor in their final decision of going ahead with the merger. As HDFC and IDFC Ltd are two very different kind of NBFCs, the individual dynamics of their respective businesses would also have played a role.