India Transformed

by Rakesh Mohan

  Two key lessons emerged for HDFC—first, that trust is the single-most important component in a financial business. Second, that the only product patent a financial institution can have in a competitive market is quality customer service.

  The Opening Up of the Banking Sector: A Turning Point

  In the period post the nationalization of banks and up until 1993, the Indian banking system had regressed considerably. Tongue in cheek, it was often said that bankers did not do banking; they merely carried out orders of the powers that be.

  Today, there is much lament about the state of the banking sector with the build-up of non-performing loans and stressed assets, particularly in public-sector banks. However, reflecting back on the pre-liberalization era, one realizes that back then, banks did not fix any interest rates—they were all mandated. There were no prudential norms, no regulations on capital adequacy or rules for non-performing loans. Even opening a bank branch would take months after seeking the approval of the RBI.

  Clearly, the turning point was the opening up of the banking sector to private players in 1993. There was an advertisement in newspapers calling for potential applicants. This aroused my curiosity and I thought it would be a good idea to apply for a bank licence. There was a time period of three months to make the application. The threshold entry limit was high, with a minimum capital requirement of Rs 1 billion. At that time, HDFC’s net worth was around Rs 3 billion. I was convinced that the time was right for HDFC to have some diversification in its business. However, when the proposal to apply for a bank licence was placed before HDFC’s board of directors, the initial rejection took me aback.

  The argument put forth was that HDFC was a single-product company, with no experience in banking. Some board members asked as to why a well-established company should risk its reputation by venturing into a business it had no expertise in. Needless to say, it took a lot of convincing to get the board to agree to just put in an application. The board finally consented and we agreed that HDFC would have to tap an external talent pool if we did get a licence. In short, HDFC Bank almost did not happen—but that is history now.

  In 1993, there were over forty aspiring applicants for a banking licence—some were even fictitious, having sent in their application on a postcard! The chairman of the committee appointed by the RBI to grant the licences was S.S. Marathe, who was also a member on RBI’s board.

  One of the conditions stipulated for getting a licence was that the head office of the bank would have to be in a city other than Mumbai. HDFC took its chances and requested for the head office to be in Mumbai. To our surprise, it was the first to receive a bank licence. Marathe mentioned to me that HDFC’s application was the best and hence we were allowed our preference of having the head office in Mumbai.

  The RBI articulated that an arm’s-length relationship needed to be maintained between HDFC and HDFC Bank. There could be no lines of credit or any form of lending by the latter to the former. The objective of launching the bank was that HDFC had developed relationships with a number of corporates over the years, but as a housing finance company it could not lend to them like banks do. Initially, it was envisaged that the bank would focus exclusively on wholesale banking activities. This idea, however, had to be abandoned soon. There was a recognition that the key to survival was going to be the ability to ramp up low-cost current-and savings-account deposits. Thus began the journey towards building up the bank’s retail lending portfolio. This strategy has held the bank in good stead over the years as across the Indian banking system, non-performing loans in retail finance sector has remained low.

  HDFC Bank had a competent team in place and laid a great deal of emphasis on capitalizing on technology and putting in place automated processes and systems to improve the overall customer experience.

  The key beneficiary of opening up banking to the private sector was clearly the customer. With competition increasing, public-sector banks had to raise the bar of customer service. Competition also gave the impetus to public-sector banks to embrace automation and computerization.

  Towards the late 1990s, against the backdrop of an industrial slowdown, banks recognized that if they needed to remain profitable, they would have to focus on growing their retail portfolio. By this time, the typical Indian consumer had a higher disposable income, rising aspirations and was considerably less debt averse. As banks started focusing on growing their home loan portfolios, there was a shift from fixed-rate mortgages to floating rates. Banks also concentrated on growing other retail loans such as consumer, auto, credit card and personal loans. With increased competition, retail finance in India transformed into a buyer’s market.

  Insurance Joint Ventures: A Game Changer

  During the same period when the banking sector was opened up to the private sector, there was also the recognition of the need to bring in reforms in the insurance sector. In 1993, under the chairmanship of R.N. Malhotra, a committee was set up to make recommendations on the insurance sector. I was fortunate to have been a member of this committee. It did a lot of groundwork, field visits and surveys to understand the sector better. I recall working over many weekends—both on Saturdays and Sundays—with several visits to New Delhi and long meetings at the office of the Life Insurance Corporation (LIC).

  After a great deal of hard work, the report was submitted in January 1994, with a clear recommendation that private players be allowed in the sector. Given the fact that insurance expertise was lacking in the country, the committee made a strong case for allowing foreign companies to enter India, preferably through joint ventures with Indian partners. The committee also recommended the setting up of the Insurance Regulatory and Development Authority (IRDA), which would be the autonomous body to regulate and develop the sector.

  Unfortunately, the report turned out to be more contentious than it was anticipated to be. While the Union’s protectionist and xenophobic attitude was not surprising, there was resistance to various other recommendations as well. The report highlighted the need to desist from the indiscriminate practice of recruiting agents who were not trained to sell insurance products. There was a need for greater transparency on commissions and other emoluments being paid out. The committee also recommended that funds of insurance companies be invested more dynamically to include non-government securities. Like most politically sensitive issues, the report was put into cold storage for several years.

  At HDFC, we remained hopeful that the sector would eventually open up, but reconciled ourselves to the fact that it would take time. We were fortunate that our identified life insurance partner, Standard Life Plc, UK, was very patient while waiting for the sector to open up. During this period of waiting, HDFC and Standard Life Investments joined hands in another venture, HDFC Asset Management Company Limited, which went on to become one of India’s largest mutual funds.

  While a lot of groundwork was already being done to prepare for the life insurance company’s launch, it was only in the year 2000 that HDFC Life became the first private life insurance company to be registered by the insurance regulator, IRDA.

  With the opening up of the sector, many joint ventures fructified. But the sector was beset with many teething troubles. There was a lot of mis-selling of insurance products, and the regulatory environment was shaky. There were too many regulatory changes happening too frequently which created instability for the business. Much of these issues are now well behind us.

  Life insurance is a long-gestation business and a capital guzzler in the initial years. Due to Indian accounting norms, life insurance companies incur accounting losses initially as commission expenses are charged upfront in the year in which they are incurred, while the corresponding income is recognized over the entire life of the policies issued. The mismatch between expenses and income magnified the initial losses. Further, the passing of the legislation to increase foreign direct investment (FDI) in the insurance sector from 26 per cent to 49 per cent took longer than anticipated. As a result, it was the domesti
c partner who had to contribute a larger share to fund the growth of these companies. It took almost a decade for the stronger life insurance companies to break even. Over this long period, however, considerable value had been built up in these companies. This is also evident from the fact that the market share of LIC has steadily reduced from a monopolistic position up until 2000 to around 52 per cent currently.

  On the non-life insurance side, HDFC in 2002 entered into a joint venture with Chubb Global Financial Services Corporation, one of the largest property-casualty insurers in the US. It was with this joint venture that one recognized that in business, while one does not just need a partner for technical expertise, a meeting of minds is important. Chubb was extremely cautious and reluctant to underwrite business in India while other private non-life insurance players were already growing at a fast clip. The need for a changed strategy was repeatedly discussed across the table. When it bore no fruit, the only finality was for the partners to mutually part ways in 2007.

  This was the first joint venture that failed since the insurance sector was opened up. Fortunately, HDFC had the wherewithal to buy out Chubb’s stake, but the company had lost much ground. We were extra-cautious in identifying our new partner. The key concern was finding a partner who would share our long-term commitment to grow the business in India.

  Five months after the fallout with the first partner, the ball started rolling again when HDFC entered into a new joint venture with ERGO International AG, a Munich Re subsidiary. The timing was fortuitous with the new partnership being signed in New Delhi in the presence of the German Chancellor Angela Merkel and the then prime minister Manmohan Singh. With the right partner in place, it was business as usual once again.

  The HDFC Group of Companies

  From being a single-product company, HDFC has diversified into a financial conglomerate with interests spread across banking, insurance, asset management, rural housing finance, property venture funds and education finance in twenty-five-years’ time. Each of these businesses runs as separate, legal entities.

  The objective of setting up various companies was to enable a customer to avail himself of a variety of financial products and services under the HDFC umbrella. While setting up all the HDFC group companies, HDFC has never charged for the use of its brand name. The only condition laid down is an oral commitment that the HDFC name is to be used carefully, always keeping in mind that the brand name is synonymous with trust and quality customer service.

  HDFC’s strategy over the years has been to diversify into new businesses as and when regulatory changes come about. Another key policy reform that has helped the financial sector has been the liberalization of the FDI regime. Though FDI limits vary for different financial sectors, the reform has helped garner large investments.

  HDFC as the parent company holds investments in its subsidiary and associate companies and also carries out mortgage finance business. Each of the group companies has different sectoral regulators. The regulatory environment is certainly more vigilant and evolved today. But, for a financial conglomerate dealing with multiplicity of regulators, there are inherent challenges. Further, constraints within the existing regulatory, legal and taxation framework continue to impede the creation of an efficient holding company structure or for the merging of entities within the group.

  Growth within the HDFC group of companies has been achieved through a combination of the organic and the inorganic. The underlying philosophy in every acquisition that the HDFC group has undertaken is that the sum of the whole should always be greater than its parts. Mergers and acquisitions in India entail dealing with challenges of multiple regulatory approvals and a complex legal system. Integration comes with its own set of challenges but experience demonstrates that a judicious handling of human resources is of utmost importance.

  Beyond Wealth Creation

  If one looks at the composition of the Bombay Stock Exchange Sensex over two and a half decades, there has been a vast transformation. Out of thirty stocks that were part of the Sensex in 1992, only seven companies still form a part of the Sensex today. If the stock market is considered to be the barometer of an economy, it is surprising that twenty-five years ago, there were no banking stocks in the Sensex. Today, financial stocks dominate the Sensex.

  In 1992, HDFC’s market capitalization was Rs 3.15 billion and all the shares were held domestically. Today, HDFC’s market capitalization is Rs 2.2 trillion and the foreign shareholding stands at 77 per cent. Taking the combined market capitalization of the three listed entities within the HDFC group, it is in excess of Rs 5.6 trillion ($85 billion). Clearly, vast shareholder wealth has been created in the financial sector in the post-liberalization era. The next stage of value creation in the financial sector will come from insurance companies, many of which are on the anvil of listing.

  While considerable value has been built up in HDFC and its group companies, what has been equally gratifying is the fact that HDFC has enabled millions of Indians to become proud homeowners. At the turn of the liberalization era in 1991, HDFC had cumulatively financed 0.12 million housing units. By 2016, HDFC had cumulatively financed over 5.5 million housing units. Housing finance in India is a volume-driven business. Today, outstanding housing loans stand at over Rs 3 trillion ($45 billion).

  A People-driven Business

  It is important for employees to feel a sense of ownership in the company they work for. This is what enables employees to give their best. When the company does well, the employees as shareholders prosper. I do not think any of us from the start-up team at HDFC ever imagined we would grow at the pace we did and eventually diversify into becoming a financial conglomerate. I am often asked this question by many—what was it that HDFC did differently from others?

  No doubt, we had the first-mover advantage. In our initial years, with no other competitor, we had the leeway to learn from the mistakes we made on the way. But I think it is the culture and people that made the difference. Right from the inception of HDFC, the founder chairman H.T. Parekh believed in an open-door policy and developed a work environment that encouraged feedback, irrespective of hierarchy. Most people who joined HDFC in its early years have stayed on and thus the attrition rate is low. People tend to stay on in their jobs if they are treated well and if they value and appreciate the culture of the management. For HDFC, a value-driven culture of honesty and integrity override all other considerations. The senior management has always believed that the demonstrative effect has to start at the top and it is the role of the senior management to ensure that the values and culture of the organization percolate to all levels.

  Macro Assessment of Twenty-five Years of Financial Reforms

  The opening up of various financial sectors by allowing the entry of private players has been one of the greatest success stories under the reform agenda. The setting up of a number of supporting financial institutions such as rating agencies and credit bureaus has also helped deepen the financial markets. HDFC had the privilege of being a promoter of the Credit Rating Information Services of India Limited, the country’s first rating agency, and the Credit Information Bureau (India) Limited, India’s first credit bureau.

  For a highly under-penetrated financial market like India, there is enough space to accommodate several new and differentiated players. The thrust towards financial inclusion portends well when it comes to deepening the markets and targeting different customer segments. Competition is beneficial for the development of financial markets as long as the players are not irrational and desist from practices such as rampant undercutting of interest rates, merely to garner market share.

  When it comes to customers, greater options and choice have meant that they are being increasingly demanding. But this also ensures that the bar for quality customer service keeps rising. Regulators too have become increasingly vigilant to minimize mis-selling of financial products and services, and have made timely interventions to curtail business practices that are deemed unfair towards customers. I
n the current regulatory milieu, one is more confident that the days of dodgy and fly-by-night financial players are now well behind us.

  India’s favourable demographic profile, growing disposable incomes, better job opportunities and the rising middle class augur well for the growth of retail finance in the country. Banks and financial institutions are already reorienting their strategies as younger customers lean towards digitization and mobile-banking transactions. Quite evidently, in a post–economic-reform era, the key differentiator between winners and the others in the financial sector have been those who consciously imbibed a strong culture of customer empathy, integrity and transparency.

  To conclude, there remain several challenges in the Indian financial sector such as reducing the build-up of non-performing assets, particularly in public-sector banks, deepening the debt markets and finding optimal solutions and institutional mechanisms to sustainably fund long-term infrastructure projects. The Indian financial system has never been short of solutions, though often the obstruction has come by way of a lack of consensus and the will to bite the bullet.

  Despite these challenges, the Indian economy has never been on such a firm footing as it is today. Twenty-five years ago, perhaps out of compulsion rather than choice, India undertook ‘big bang’ reforms. Today, India is comfortable with an ‘incremental’ reform approach. The pace of reforms adopted by a country is always a debatable issue. What is of significance is that India at present has the leeway to make its own choice regarding the pace of reforms. Besides the optimism of being the world’s fastest-growing major economy, there is a growing consensus that India’s best is still to come.

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  INDIAN BUSINESS: LAUNCHED ON A NEW TRAJECTORY

  24

  Changes and Challenges: Corporate India since 1991