HDFC bank: An unorthodox trendsetter

Global Finance, Mar 2001 by Chaze, Aaron

FEATURE HDFC BANK

The valuation disparity among Indian banking stocks is glaring. HDFC Bank, considered to be the premier bank in the country, trades at a price/earnings ratio of 35, while the range for all other banks, some of which even have excellent growth rates, are 6-23. The disparity lies in the perception of the bank. It is viewed as a trendsetter, an organization that has redefined how banking is done in India. It's merger last year with Times Bank sparked off a flurry of activity as others raced to shift strategies from organic growth to acquisition-led growth, something the Indian banking sector was not used to.

The cornerstone of HDFC business strategy has been its retail focus, first on the liability side in terms of deposits and now in assets.All banks focus on retail liabilities, but none did it to the extent that HDFC did. "Our focus has always been low-cost retail deposits. Corporate deposits tend to be very volatile and command a higher cost, hence our reticence toward it," says Paresh Sukhtankar, head of credit and market risk. Besides cost, this approach also reduced the volatility and price sensitivity in deposits, since corporate deposits typically tend to be parked at the short end and flowed out easily with changes in interest rates.

The bank's strategy-high growth with low risk-has been a great source of value to shareholders. In banking, growth is typically achieved with the risk of an expansion in nonperforming loans (NPLs). But HDFC Bank has proved it possible to achieve growth otherwise. It has managed to achieve a 40% year-to-year growth in assets while gross NPLs have been declining as a percentage of assets. It has specific provisions that cover 70% of its NPLs and has general provisions that are far in excess of statutory norms. "We are far more conservative than regulations require us to be," says Sukhtankar.

The bank has managed a low-risk growth model by practicing unorthodox banking. First, by staying focused on the top-rated corporations, servicing which was the traditional preserve of the foreign banks. Almost 70% of HDFC's corporate book now comprises the top-rated corporations. The yield is lower, but the risk is negligible, and the pressure on spreads is offset by the lower cost of funds, which is one of the lowest in the industry. Second, by using technology as a growth driver from the very beginning. Technology has enabled the bank to service customers through multiple channels: ATMs, mobile banking, internet banking, and phone banking-something other banks are now trying to match. Third, by focusing on stable streams of income. In an attempt to increase return on equity (ROE), most banks typically rely on treasury operations, which tend to increase the volatility of earnings. Instead, HDFC Bank has focused on earning higher fee income by offering value-added services such as cash management, custody services, and distribution of financial products. It has evolved into one of the largest clearing banks for the leading national stock exchanges and is also one of the largest custodians, with nearly half a million retail accounts.

In another trendsetting move the bank has decided to get aggressive on retail assets. The retail initiatives are through numerous products: loans against shares, car loans, personal loans, consumer-durable loans, and credit cards. Over the past one and a half years the retail assets have quickly grown to 15% of the total.

The bank expects to grow at 30% (twice the industry average) for the next three years but without compromising on either the quality of assets or the ROE, which it expects to maintain at 26%. "Growth will be coming from the retail side of the business and from products that do not require capital, such as custody services and cash management," says Sukhtankar. The approach has the advantage of lending greater predictability to its earnings as well as operating a low-risk business, ensuring that the premium remains richly deserved.

Aaron Chaze is a Mumbai-based contributor to Global Finance. E-mail: aarfer@bom3.vsnl