Betting Big On Banking

With the Reserve Bank of India issuing new banking licenses, the issued companies are set to launch their banking operations in the near future and enter into the considerably matured and rather competitive banking business. The Indian banking system consists of 26 public sector banks, 20 private sector banks, 43 foreign banks, 56 regional rural banks, 1,589 urban cooperative banks and 93,550 rural cooperative banks in addition to cooperative credit institutions. The Indian banking sector’s assets reached USD 1.8 trillion in FY14 from USD 1.3 trillion in FY10, with 70 per cent of it being accounted by the public sector.

The rising incomes are expected to enhance the need for banking services in rural areas and therefore drive the growth of the sector. The recent Jan Dhan Yojana has also proved to be a blockbuster in the banking industry. The RBI has relaxed its branch licensing policy and is allowing banks to set up new branches in Tier II to Tier VI centers without prior approval. The motive behind this approach by the RBI is to spread the reach and focus of the banking services to the non-banked population of India.

About IDFC

IDFC, an infrastructure lending major, is in the process of transformation and is ready to start banking activities from October 1, 2015. IDFC was incorporated on January 30, 1997 in Chennai and was set up on the recommendations of the Expert Group on Commercialisation of Infrastructure Projects under the chairmanship of Rakesh Mohan. The company is into financial intermediation for infrastructure projects and services, adding value through innovative products to the infrastructure value chain or asset maintenance of existing infrastructure projects. IDFC’s growth has been driven by the substantial investment requirements of the infrastructure sector in India combined with the growth in Indian economy over the last several years.

Understanding the Business

IDFC provides financial assistance to various segments such as power, roads, ports, telecommunications, information technology, urban infrastructure, healthcare, education infrastructure, food and agri-business infrastructure, healthcare and tourism. Its services include senior debt financing through debentures, mezzanine products, subscribing to preference capital or debts, proprietary equity, private equity and debt capital. The core business at IDFC Project Finance is lending to infrastructure projects. The business is capital-intensive and focuses on managing the loan book. While this creates a base income stream it also provides a bridge to clients to build larger and wider customer engagement. To complement IDFC’s Project Finance & Investment Banking Division, financial markets’ group operations have assumed greater importance vis-a-vis the overall franchise and contribute significantly to IDFC’s income stream.

Transition into Banking

IDFC got its banking license in April last year and the RBI granted approval for bank branches to the company on July 24, 2015. However, a transformation of the entire structure of IDFC has to be made to comply with the new banking regulations. The new corporate structure will have two subsidiaries like non-operative financial holding company (NOFHC) and IDFC Foundation. The company has received shareholders’ approval for demerger of its financial undertaking into IDFC Bank. Each IDFC shareholder will get 1 share of IDFC Bank. The bigger challenge is to create a framework for the new enterprise, build a technology-enabled set-up and establish an HR structure.

IDFC is going to kick-start its banking operations from October 1, 2015. The bank has a binary strategy; one set of branches will be in the metropolitan region and another will be in rural areas. It will launch 20 branches out of which 15 will be in three districts of Madhya Pradesh viz. Hoshangabad, Khandwa and Harda having population of less than 10,000. The remaining branches will be in Delhi and Mumbai. The IDFC Bank will also benefit from the newly issued payment bank licenses on August 19, 2015 by the RBI. The bank will be partnering with a Norwegian telecom company, Telenor, as a minority shareholder in payment banking.
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A Universal Bank

As a part of its corporate strategy, IDFC aims to be a universal bank. The company will primarily provide term loans to its customers. The company will also diversify its product offerings by undertaking private equity and investment banking. IDFC, being a non-banking financial institution especially dedicated to infrastructure, had limited the scope of its products. However, after winning banking license, at first instance the IDFC aims to strengthen its existing relationship by offering its other product offerings such as working capital loans for cash management, trade finance, bank guarantees, and letters of credit, and thereby diversify its revenue stream. Secondly, the company aims to go beyond its traditional infrastructural sector. And finally, the company has a strategy to move into the mid-market and SME space.

Three Pillars of Banking

Wholesale banking will be the key pillar for IDFC’s forthcoming banking venture. The company has set a clear strategy to cater to its existing customer base and deepened its relationship by offering other products and services than term lending. Hence the company will prioritize to diversify its revenue stream by offering various products and services such as working capital lending, cash management, transaction banking, foreign exchange services and fee-based services of all kinds. This strategy will enable the IDFC Bank to start generating significant profits from the start of its operations.

The second pillar for the bank will be rural banking by way of increasing financial inclusion in rural India. The company has a clear determination to spread its branch network in Tier VI cities, much ahead than the regulatory requisite of a mere 25 per cent. The company believes that its rural banking operations will be highly profitable with an early payback period as the investment amount required is much lower compared to urban areas. Though the return of the equity will be moderate, the absolute numbers from rural banking will contribute substantially to the overall profit in the coming few years.

Retail banking (urban banking) will be its third pillar. Interestingly, the company has planned its retail banking operations in a phased manner. It is planning to diversify revenue and generate profit from corporate banking and invest in retail banking. The primary focus of retail banking will be to build a liabilities’ base with a bulk of savings and current accounts from the retail side. IDFC’s retail banking will start with home loans and focus on affordable housing, which will be eligible for priority sector lending. More interestingly, the automotive and credit card business will not be part of its operation as of now. Though the bank will take 10 odd years to establish itself, technology will be the key to lower dependence on the branches compared to any other existing bank.

Focus on Technology

Considering the changing customer behavioural patterns, IDFC will focus on the technological front to provide customer-friendly services at their finger tips. The company assumes that the number of people who don’t want anything to do with branches is growing rapidly. Hence, the company’s management wants to avoid a situation in which the bank spends crores of rupees in building a large branch network but finds that in five years nobody is using it because everybody has switched to smartphones.

Furthermore, IDFC has entered into a partnership with FSS (Financial Software & Systems) on June 17, 2015. FSS is a global leader in payment technology and transaction processing. The partnership will give a technology advantage to IDFC with services ranging from payment processing, card management, reconciliation to payment gateway for e-commerce, and Aadhaar-enabled payments for financial inclusion.

Bharat Banking

IDFC has come up with an innovative idea to increase financial inclusion in rural India in the form of Bharat Banking. This will revolutionize rural banking by servicing the community rather than have people coming to the bank. An analogous concept to a microfinance institution, it will help take banking services to the interior parts of India. No doubt there will be branches in rural India but these will just function as a base for housing loan officers and customer service managers. Banking executives will deliver banking services to the community at their doorsteps using handheld devices.

Institutional Holding

The expected demerger after the restructuring of IDFC as per regulatory norms will give foreign institutional investors (FIIs) considerable headroom to increase their shareholding in the bank. Currently there is limited room for FIIs’ participation which has fallen to almost 22 per cent, considerably at a lower level compared to the stipulated limit of 49 per cent. Increased participation by FIIS will help the bank to raise capital as per its need to grow further.

Financials

On the financial front, IDFC posted good results year-on-year for a 10-year CAGR period wherein its total income stood at 25.08 per cent and net profit was 15.88 per cent. The company’s CAGR for book value per share stands at 16.83 per cent and the CAGR for earning per share is 11.76 per cent over the same period. In FY15, IDFC’s operating income grew by 9 per cent to Rs 4,064 crore against Rs 3,735 crore in FY14. However, the net interest income (NII) decreased by 3 per cent to Rs 2,633 crore as against Rs 2,704 crore on a yearly basis, including increase in income from loan and decrease in income from the treasury.

The non-interest income increased by 32 per cent to Rs 1,323 crore compared to Rs 1,002 crore on a YoY basis. The total income increased by 9.89 per cent to Rs 9,640 crore compared to Rs 8,772 crore. The EBITDA increased by 3 per cent to Rs 7,860 crore. This year the company’s other income rose by 82.6 per cent. The net profit stood at Rs 1,707 crore in FY15 against Rs 1,803 crore on a yearly basis. In the recent quarterly result one could see some pressure on asset quality with the percentage of gross non-performing assets (NPAs) to gross advances increasing to 1.52 per cent in Q1 FY16 from 0.64 per cent in the June quarter a year ago. In the same period, the percentage of NPAs to net advances also increased to 0.99 per cent from 0.43 per cent.

Conclusion

Being a pure infrastructural lending player, IDFC is all set to transform the Indian banking sector. The company is fully prepared to execute, strategize and plan from the first day of launching its banking services. With service facilitation to customers and focus on technology focus, IDFC is confident of generating profits from its banking operations. The company has good financials since the last 10 years. With its ever increasing CAGR for sales and profits, the return ratios are higher too. Now, after getting a banking license, in our opinion, this will serve as an opportunity to build new competitive advantages for IDFC. This makes IDFC a good investment opportunity for long-term growth.