Banking Sector Reforms

The HDFC Ltd.-HDFC Bank Merger


From UPSC perspective, the following things are important :

Prelims level : Bank merger and nationalization

Mains level : Banking sector reforms

Mortgage lender HDFC Ltd. and India’s largest private sector bank HDFC Bank on Monday announced a mega-merger.

Impact of the move

  • Under the terms of the deal, which is one of the biggest in the Indian financial sector, HDFC Bank will be 100% owned by public shareholders.
  • Existing shareholders of HDFC Ltd. will own 41% stake in HDFC Bank.
  • Post-merger HDFC Ltd. will no longer be a separate mortgage lender, it will get folded into the bank.

What are the terms of the merger?

  • The merger has to go through a series of regulatory approvals.
  • It has to get approval from the shareholders of both companies.
  • At this moment what has been announced by the two entities is that its an all-share deal, so there’s no cash transaction involved.
  • The terms of the share swap are such that shareholders of HDFC Ltd. will receive 42 shares of HDFC Bank for every 25 shares they hold in HDFC Ltd.

What happens to existing customers and employees?

  • As far as customers are concerned, HDFC Ltd.’s customers will become the bank’s customers as well.
  • As for employees, HDFC Bank is planning to absorb and retain all the employees.
  • Neither of the entities are very heavy on employee numbers and have been fairly conservative in their employee sizes.

What is the rationale behind this merger?

  • HDFC have largely had a fairly conservative lending culture, both reasonably customer-friendly, customer-centric, culturally, there wouldn’t be a big challenge.
  • The evolution of the regulatory framework for the NBFC (non-banking financial company) industry has been gradually moving closer, to harmonise with the banking sector’s regulatory framework.
  • Earlier, NBFCs had a fairly different and a far more loose sort of framework for lending and deposits.
  • This led to issues in the industry with some NBFCs struggling and going under or being taken over by others.
  • As Basel III norms for capital adequacy are in place, the NPA (non-performing asset) book is very closely monitored.

What is in it for HDFC Ltd. and HDFC Bank?

  • Post-merger, the mortgage lender, HDFC Ltd., gets access to HDFC Bank’s CASA (current and savings accounts) deposits, which are lower cost funds.
  • For the mortgage lending business, the capital cost will come down. As the capital cost comes down, automatically it will have the ability to lend at a finer rate.
  • For HDFC Bank, every home loan customer can be tapped to become a bank customer.

Impacts of the deal

  • It’s possible that we might see more NBFCs seeking to merge with banks.
  • There is already talk of the number of banks coming down.
  • So in some ways, this merger may be a precursor to what is going to happen in the state-run banking space, where the government has said it is going to reduce the number of public sector banks.

Back2Basics: Basel Accords

  • They refer to the banking supervision Accords (recommendations on banking regulations)—Basel I, Basel II and Basel III—issued by the Basel Committee on Banking Supervision (BCBS).
  • They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland and the committee normally meets there.
  • These are a set of recommendations for regulations in the banking industry.
  • India has accepted Basel accords for the banking system.

Let’s revise them:

[1] Basel I

  • In 1988, BCBS introduced capital measurement system called Basel capital accord, also called as Basel 1.
  • It focused almost entirely on credit risk. It defined capital and structure of risk weights for banks.
  • The minimum capital requirement was fixed at 8% of risk-weighted assets (RWA).
  • RWA means assets with different risk profiles.
  • For example, an asset backed by collateral would carry lesser risks as compared to personal loans, which have no collateral. India adopted Basel 1 guidelines in 1999.

[2] Basel II

  • In June ’04, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of Basel I accord.
  • The guidelines were based on three parameters, which the committee calls it as pillars:
  • Capital Adequacy Requirements: Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.
  • Supervisory Review: According to this, banks were needed to develop and use better risk management techniques in monitoring and managing all the three types of risks that a bank faces, viz. credit, market and operational risks.
  • Market Discipline: This need increased disclosure requirements. Banks need to mandatorily disclose their CAR, risk exposure, etc to the central bank. Basel II norms in India and overseas are yet to be fully implemented.

[3] Basel III

  • In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008.
  • A need was felt to further strengthen the system as banks in the developed economies were under-capitalized, over-leveraged and had a greater reliance on short-term funding.
  • Also the quantity and quality of capital under Basel II were deemed insufficient to contain any further risk.
  • Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive.
  • The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.


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