HDFC Bank: Moving to a Higher Orbit

To go from good to great requires transcending the curse of competence. It requires the discipline to say, “Just because we are good at it — just because we are making money and generating growth — doesn’t necessarily mean we can become the best at it.” The good-to-great companies understood that doing what you are good at will only make you good; focusing solely on what you can potentially do better than any other organisation is the only path to greatness.

That’s how author and leadership expert, Jim Collins, encapsulates the making of a great company in his book, Good to Great. Though published 21 years back, the lessons from the book are timeless, more so in the context of the winner of Fortune India-Grant Thornton Bharat’s inaugural annual study of India’s Best Banks for 2022.

HDFC Bank needs no introduction. The 27 year old is the country’s biggest private sector lender by assets (₹20.68 lakh crore) and the largest bank in India by market capitalisation (₹7.45 lakh crore). But as the saying goes — beauty lies in the eyes of the beholder — what constitutes good for some, might be great for others. For an investor, a 25% compound annual growth rate since 1995 is great, for a customer the bank will be good, and for the regulator, ahem, the bank is just a domestically systemically important bank, just as State Bank of India and ICICI Bank.

As a domestically systemically important bank, an entity is not only subjected to higher capital requirements but also rigorous regulation. Call it travesty of fate that in all the years that Aditya Puri was at the helm, the bank had not come under regulatory wrath. But in the run-up to his retirement in October 2020, a series of snags — November 2018 (mobile app crash), December 2019 (firewall security issue) and November 2020 (data centre power outage), besides the auto loan scandal in July 2020, meant the new CEO had his hands full.

Hardly a month after the 55-year-old Sashidhar Jagdishan took charge, in December 2020, the regulator barred the bank from new product launches and sourcing of new credit card customers till it fixed its digital chinks. Jagdishan, who has been with the bank since 1996, in all humility acknowledged the concern of the regulator and was candid enough to admit to shareholders and customers that the rap was a good thing to have happened.

Instead of engaging in a PR overdrive, Jagdishan chose to stay away from the limelight and went about fixing the problem. His efforts paid off — the regulator in August 2021 lifted the ban on credit card issuances and, finally, this March, paved the way for the bank to embark on its Digital 2.0 initiatives.

Unlike his predecessor who was more outgoing, Jagdishan prefers reticence. “I believe institutions are built by a team, not an individual,” he tells Fortune India.

That cultural approach complemented a strong risk management, enabling the bank to grow at a remarkable pace over the years. It is hardly surprising that despite the regulatory rap, the market cap of the bank grew 30.4% between FY19 and FY21. It was also the most valuable bank with a marketcap of ₹8.23 lakh crore at the end of FY21. The growth momentum continued with the loan book surging 20.8% to ₹13.7 lakh crore in FY22.

By acing five of the six parameters in the study, the bank has grabbed the top spot among the country’s largest banks with balance sheet size in excess of ₹5 lakh crore, and in doing so Jagdishan has emerged as the “Banker of the Year.”

HDFC Bank’s success has come largely on the back of retail loans, which constitute 39% of its loan book. In the initial years, corporate loans were in vogue and only in the late 2000s, retail came of age. Not only did the bank build a strong liability franchise by tapping into the emerging salaried class, but also sired the same customer base with products such as personal loans, credit cards, and auto loans. The strategy fetched rich dividends as infrastructure-focused lenders were hit by bad loans in the subsequent downturn, whereas HDFC Bank stood out unscathed with its pristine book.

But owing to the regulatory curbs and the pandemic, the share of retail loans has fallen from 55% in 2019, with the wholesale book making up for the remainder. Kaizad Bharucha, executive director and also responsible for wholesale banking, mentions the portfolio composition is a reflection of the demand environment and not an outcome of targeting a particular mix. “In FY21, in the initial phase, a lot of corporates with minimal borrowings decided to stay liquid because of the uncertainty and raised money from the system amid a contraction in retail demand. So, it was a combination of working capital, medium-term loans, and borrowings under the long-term repo operation. Besides, we were able to build on our relationships with PSUs as well. We just chose to participate.” In FY22, the bank opened 8.7 million new liability relationships. The other change in the corporate portfolio is the warming up to the infrastructure sector, which the bank has traditionally stayed away from. “We’ve got the much-required seasoning by participating in this space over the past 8-10 years, but our engagement is predominantly through working capital loans besides loan syndication through the investment banking side,” says Bharucha.

While the bank sees scope for credit growth in sectors such as chemicals, pharma and industrials, it is also looking at the renewables space. Despite the excitement around energy alternatives, Bharucha says the bank will play it by the ear. “We are only going to back a well-entrenched sponsor who has a strong financial standing. We are not going to fund those trying to jump onto the bandwagon because they fancy their chances,” he adds.

It is this blend of prudent lending and strong risk management that has also ensured superior profitability. According to the study, HDFC Bank is the most profitable among all domestic scheduled commercial banks. Its return ratios, return on assets (RoA) of 1.97% and return on equity (RoE) of 16.6%, are the best, complemented by a net interest margin (NIM) of 4.2%, which is again the best among the top 10 banks. In terms of operating efficiency, the cost to income ratio has also come down substantially over the past decade from 49.7% to 36.9% in FY22. With a contingent provision at ₹11,100 crore, high provision coverage ratio of 73% and common equity tier I ratio of 16.7%, the bank’s balance sheet is in a reasonably strong position. As per the study, HDFC Bank’s capital adequacy ratio of 18.79% is the second best, next only to ICICI Bank.

Analysts, however, feel its risk-averse stance is in divergence with large private banks. Rakesh Kumar of Systematix Institutional Research points out that within retail credit, the composition of credit cards, personal loans and high-yielding secured retail credit have shrunk. But despite losing market share in the cards business owing to the embargo, the bank is now making a comeback. As of March 2022, it had 16.5 million cards in circulation with 8.2 lakh cards issued in Q4. The momentum has continued as 21.8 lakh cards got sold in the seven months of the current fiscal.

Bharucha points out that with consumption trends improving, retail credit will also pick up. “I don’t think we want to do anything unduly stupid just to have a certain mix. So, we will stick to our philosophy of being prudent across the entire lending spectrum,” he says.

Not being stupid is also showing in the asset quality as gross non-performing asset (NPA) was 1.17% and net NPA was 0.32%, as of March 2022. Though the bank has a restructured book of ₹15,700 crore as of March 2022, 84% of the customers had good Cibil score with nil delinquency at the time of restructuring. According to Arvind Kapil, country head, unsecured, home, mortgage and working capital loans, besides catering majorly to the salaried class, the strategy of not playing the pricing game has also helped. “We have a certain yield band that we are comfortable with. As a market leader we won’t drag the pricing down just to grow. When you don’t undercut, the market also doesn’t get corrupted or spoiled,” says Kapil.

In the near future, the bank, with a 69 million customer base and over 6,300 branches, wants to make deeper inroads into existing geographies, in what it calls kilometre expansion. The bank’s two main unsecured products are personal loans, targeted at the salaried class, where the average ticket size is ₹4 lakh, and business loans, usually in the range of ₹10 lakh, and availed by traders, retailers or kirana owners. But Kapil says growth will be judicious. “A lot will depend on whether you have the right kind of valuer and infrastructure in place so as to avoid the risk of quality dilution.” To ensure quality of the book, the bank is targeting government accounts, both at the Central and state level. “The government opportunity in unsecured loans is similar to the public sector versus private sector arbitrage in banking that was prevalent 25 years ago,” says Kapil.

Even as the bank looks to tap into the growing urban affluence, the hinterland is also coming into play. Rahul Shukla, who heads commercial banking (MSMEs) and rural banking (including agriculture), says, “The bank will double the coverage of villages it serves from 100,000 to 200,000 in the coming years.” One of the tailwinds that the bank is riding on to grow its credit in the heartland are government schemes. “With more than 25 government schemes in play, it is possible for the bank to go out and lend,” says Shukla. Ditto with MSMEs, where the bank wants to improve its coverage to 625 districts, thanks to GST and digitisation resulting in better assessment of a borrower’s creditworthiness.

To capitalise on the growth opportunities, it has also revamped its IT architecture (including Cloud) to ensure scalability, on-demand capacity, and a fail-safe backup for faster uptime in case of outages (disaster recovery). According to insiders, the regulatory rap helped the management overhaul its monolithic framework. Otherwise, given the pace of growth, there would have been trouble down the road. “We would have had problems three to five years down the line because the way consumer behaviour is changing, I don’t think we would have been able to manage the volumes,” says the executive.

Putting the digitalisation initiative in context, Parag Rao, group head, payments business, consumer finance, digital banking and information technology, says, “It’s like upgrading and refurbishing an A380 that is airborne at 35,000 feet, carrying its full cargo load with 500 passengers on-board.”

While the first phase of the overhaul focused on digitising processes at the backend, the second phase is all about paving the way for customisation and product innovation. “The regulator’s message for the bank is that since they see us as a large bank and a prime contributor to the economy, they want our investment (in technology) to outpace our growth,” says Rao. The management has not revealed the money spent on “hollowing the core”, but the bank has created a componentised micro services architecture for retail and corporate banking solutions, giving it the freedom and flexibility to decide when to deploy or upgrade a component depending on customer needs. Over the next 18 months all existing applications will move to the new architecture. Between June and September, HDFC Bank is set to unveil a slew of retail products, including relaunching its payments app PayZapp. However, the diktat from the CEO’s office is clear — there will be no rush to launch as the product will have to go through rigours of testing. “You would expect a product to take five-seven months to launch, but it does take time as we need to ensure that these work on scale,” says Kapil. On the anvil are a one-click auto loan — an end-to-end loan approved and disbursed in 30 minutes — and also a 10-second loan product for non-account holders. “For the non-account holder product, Cibil will be the input, but our analytics will determine the quantum of funding based on aggregation of his accounts,” adds Kapil.

It seems business as usual at the bank, but come FY24, when the merger with parent HDFC is likely to fructify, it will be in a different league. The combined entity will be a ₹18 lakh crore (loan book) behemoth. Jagdishan has gone on record to state that cross-selling of opportunities will increase as 70% of HDFC customers do not deal with the bank, while 80% of HDFC Bank customers do not have mortgages, indicating low penetration of the mortgage book. “Of our 69 million customer base, 5 million have taken housing loans from other banks. That itself is ₹15 lakh crore...! Just imagine, if I start penetrating that, I can create another HDFC Bank,” believes Jagdishan. For HDFC, the gain will come from the access to the bank’s low-cost funding franchise. Besides, the combined entity’s larger balance sheet will enable the bank to make larger ticket loans. Over a period of time, HDFC’s branches will be converted into full-fledged bank branches.

While the bank never had a mortgage book and was largely sourcing for the parent, after the merger, the mortgages business might be run as a separate unit. “Mortgages will be a huge piece and there is always the option to run it as a separate business. But I cannot comment with clarity as the merger is still in the works,” says Kapil.

In the merger, one of the challenges will be the integration of IT systems. However, it’s unlikely to put any pressure on the bank’s existing network. A bank’s technology architecture is of a higher intensity compared with that of an NBFC since the RBI has direct access to a bank’s system, whereas NBFCs provide data to the regulator on a need basis. At best, the integration part might need an upgrade to synchronise HDFC’s systems with that of the bank’s core banking solution. Every year, on average, the bank spends ₹200-250 crore towards maintenance and upgrade of its IT network, hence, the tech integration is unlikely to pose a serious challenge as the group’s other NBFC, HDB Financials, runs its operations on a similar tech stack.

For Jagdishan, the coming years will be a defining one as the new entity will not have the stalwarts from the NBFC, especially Deepak Parekh as he is 77 years old and RBI rules do not allow anyone above 75 to be on the board of a bank.

It will not be an easy journey as the banking landscape will undergo a transformational disruption. But then as Collins mentions in his book, a company doesn’t shift from “Good to Great” overnight, but achieves excellence by pushing a giant heavy flywheel in one direction, turn upon turn, building momentum until a point of breakthrough, and beyond.

For HDFC Bank, the flywheel has already started spinning.