IDFC: now comes the hard part
IDFC Ltd’s transition to a bank will be painful. Meeting the requirements of cash reserve ratio (CRR) and statutory liquidity ratio (SLR) and ensuring that 40% of its loans go to the priority sector will lead to a decline in return ratios. The requirement of 60% dilution of the holding company structure in the third year of operations poses another set of challenges.
Investing in government securities and maintaining zero interest deposits with the Reserve Bank of India (RBI) will pull down both the return on equity and return on assets. IDFC will probably have to shovel the money into the Rural Infrastructure Development Fund (RIDF) as even the existing banks find it difficult to meet priority sector loan requirements. That will be a low-yielding asset returning 5-6% compared with the current 12.3% on infrastructure loans. In its current loan book about 80% are infra loans, amounting to approximately Rs.54, 000 crore, which don’t qualify for the priority sector.
ICICI Securities Ltd also pointed out that last year the absorption in the RIDF was Rs.20,000 crore, much lower than Rs.30,000 crore or so which IDFC would need when it becomes a bank. IDFC, on Wednesday, won RBI’s in-principle sanction for a banking licence.
The ability to raise deposits, increasing leverage (grow its assets to several more times it’s underlying equity) and diversification in its loan book, are certain advantages in becoming a bank, which will shield it from the vagaries of economic cycles to some extent. But it is not going to be easy.
It will take time for IDFC to raise low cost current account and savings account (Casa) deposits as revealed from the experiences of the last set of new private banks such as Kotak Mahindra Bank and Yes Bank Ltd. As shown by the studies of Boston Consulting Group on productivity in the Indian banking sector, IDFC’s current strength—term lending—will also not be amenable in quickly raising Casa deposits.
To a great extent it also depends on the business plan of the company and the amount of retail business the bank will seek. Overinvestment in building branch and ATM networks and chasing retail assets in an overcrowded market with limited experience are risks investors should watch out for.
At present, the IDFC stock is trading at 1.15 times its estimated book value for fiscal 2015. When compared with other new private banks such as Yes Bank and ING Vysya Bank Ltd, the valuation appears cheap. However it would likely take 3-4 years to payback the investors depending not only on what route IDFC takes in terms of holding structure, retail strategy etc., but also on regulatory forbearance.
Source: Live Mint
Assets, ATM, Boston Consulting Group, CASA, CRR, Equity, government securities, ICICI Securities Ltd, IDFC Ltd’s, Indian banking sector, Infrastructure loans, ING Vysya Bank Ltd, Investors, Kotak Mahindra Bank, RBI, RIDF, Rural Infrastructure Development Fund, SLR, Statutory liquidity ratio, Yes Bank Ltd, Zero interest deposits
