Is regulatory tightening of NBFCs the reason behind HDFC and HDFC Bank merger?

The Rs 55 lakh crore non-banking finance companies or NBFC sector has been under the regulatory lens of the Reserve Bank of India (RBI) ever since the failure of large institutions like IL&FS and SREI, Dewan Housing, Reliance Capital, et al.

There are over 10,000 NBFCs which creates a risk of sort for the entire financial system and which is yet to fully recover from the post-2008 financial crisis. Frequent crises -- bank and NBFC failures, Covid, and the latest being the Russia-Ukraine conflict -- is threatening the stability of the financial system.

The NBFC sector, which is about one-fourth of the banking industry in terms of assets, has very close linkages with banks and insurance as they borrow funds from these sectors. The question then: are regulatory tightening and the new regulatory framework for NBFCs the reason behind HDFC Ltd’s reverse merger with the HDFC Bank? We take a look.

NBFC Regulatory tightening by RBI

Over the last few years, the RBI has been tightening the regulatory framework for NBFCs, which has narrowed the gap with the banking regulatory framework. The RBI last year came out with new scale-based regulations for the NBFC sector, which would be applicable from October this year. Under the new framework, the regulatory structure has four layers based on size, activity, and perceived riskiness.

NBFCs, in the lowest layer, are put under Base Layer followed by the middle layer and the upper layer. The top layer is expected to be empty and will be known as NBFC-Top Layer. HDFC Ltd as the largest NBFC was falling under the upper layer. That meant enhanced regulatory requirements. “The top 10 eligible NBFCs in terms of their asset size will always reside in the Upper Layer, irrespective of any other factor," RBI had said at the time of new regulations.

Reduction in SLR rates

The Statutory Liquidity Ratio or SLR is a minimum percentage of deposits mobilised from the public that a bank has to keep in liquid cash and other government securities for easy liquidity and also the safety of depositors' money. In the last three decades, the SLR for banks has been reduced from 38.5 per cent in 1991-92 to 22 per cent. Earlier, the higher SLR under a banking platform was a big stumbling block as the mortgage lender will have to park higher money for its deposits as SLR.

NBFC NPA recognition norm at par with banks

The RBI has also harmonised income recognition and asset classification practices at banks and NBFCs. The RBI has issued new guidelines for NBFCs that they must classify loans as NPAs if they are not serviced for more than 90 days. Earlier, the maximum period was 180 days. Many large NBFCs follow the 90 days limit, but the 180 days limit provided them with a huge runaway for not classifying loans as bad loans in case there are any delinquencies.

Deepening of affordable housing bond market

The affordable housing segment is gathering momentum on the back of policy support from the government. There is a huge interest from private equity, banks and foreign investors in this segment. The deepening of the affordable housing bond market provides the merged entity with a huge advantage to reach out to investors with a much larger balance sheet.

Lesser burden on priority sector

Over the years, the mortgage provider has built a good portfolio of affordable housing. The lower ticket size of HDFC Limited's rural housing network and affordable housing lending is likely to qualify HDFC Bank as priority sector lending. The group says that it will also enable a higher flow of credit into priority sector lending, including agriculture.

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