Sector Update | 22 November 2020

Sector Update | Financials

Financials

Technology

RBI releases the Report of the

Internal Working Group to Review

Extant Ownership Guidelines and

Corporate Structure for Indian

Private Sector Banks

RBI report on private sector banks’ ownership

Market share gains to accelerate for private sector banks

We view the RBI’s Internal Working Group (IWG) report related to the ownership of

private sector banks as progressive in nature. a) Suggestions for corporate/industrial

houses on how to get a banking license and b) allowing NBFCs (even belonging to industrial

houses) above asset sizes of INR500b to get banking licenses would increase healthy

competition, making the banking system more efficient, reducing intermediation cost, and

ultimately increasing credit penetration in the system. Over the last five years, private

sector banks have rapidly gained market share to ~30% (2020) from ~18% (2015), and we

see this trend accelerating at a faster pace now. M&A opportunities may also increase in

the system as corporates with deep pockets may adopt this route rather than building

from scratch. Fit and proper criteria, increased surveillance on group entities, the

maximum allowed promoter shareholding, and regulatory cost of CRR, SLR, etc. have been

the key considerations thus far for applying and granting banking licenses. It remains to be

seen how corporate India, NBFCs, and the RBI would approach the matter this time

around, once final guidelines are out. Prima facie, we see IDFC Ltd, Bajaj Finance, L&TFH,

Equitas, and Ujjivan to be key beneficiaries.

Long-awaited opportunity for corporate/industrial houses

NBFCs with greater than INR500b

asset size (1HFY21, INR b)

One of the key suggestions in the report is to provide an opportunity for

corporate/industrial houses to get a share of the growing banking system pie. Apart

from 2013 guidelines, the RBI has thus far been averse to corporate/industrial

houses getting banking licenses. Even in the ‘on tap’ universal banking license

guidelines of 2016, corporate/industrial houses were not allowed to participate.

Some of them have a good understanding of the asset side via their NBFC arms. If

allowed, they would give strong competition to incumbents and may come up with

innovative solutions with no legacy baggage. We may see greater damage on the

CASA / retail liability front, especially at inefficient banks, as these entities have a

strong ecosystem and enjoy high levels of trust among people.

NBFCs’ proven business model on the asset side; fixing the liability side

NBFCs with assets sizes of INR500b+ and operating history should be given banking

licenses. Even entities promoted by corporate/industrial houses are eligible for the

same. In 2016, as per on tap licensing guidelines, NBFCs promoted by industrial

Source: MOFSL, Company; Note: Consol.

loans for ABCL, FY20 data for Tata Capital

houses were not eligible. The report is also silent on the requirement (part of 2013

guidelines) of a maximum of 40% of total assets/revenues of the group coming from

non-financial services. We believe certain NBFCs (including those promoted by

industrial houses) have created niche capabilities, increased credit penetration in

the system, and done a great job on the asset side. Even regulations for large-sized

NBFCs are coming on par with banks now. Banking licenses may resolve the issues

on the liability side – NBFCs had to suffer multiple shocks from events such as the

GFC, Taper Tantrum, the demonization, the IL&FS crisis, and the COVID-19

pandemic. Considering shallow bond markets, dependence on banks for such

entities is very high.

Research Analyst: Nitin Aggarwal

(Nitin.Aggarwal@MotilalOswal.com) |Himanshu

Taluja

(Himanshu.Taluja@motilaloswal.com)

Alpesh Mehta

(Alpesh.Mehta@MotilalOswal.com)

|

Yash Agarwal

(Yash.Agarwal@motilaloswal.com)

Investors are advised to refer through important disclosures made at the last page of the Research Report.

22 November 2020

1

Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Sector Update | Financials

Reduction in intermediation cost; regulatory requirements remain a drag

If NBFCs were given banking licenses, this would reduce overall cost of funds for

them, which may ultimately be passed on to the customer. CRR of 3% and SLR of

18% remains a drag; however, they have come down significantly from 2013 (4.75%

CRR and 24% SLR). Even expansion cost has reduced significantly owing to

technological advancement. Furthermore, with continued liability crisis-related

episodes, companies have sharply increased their liquid assets on the balance sheet

to 10–18% of borrowings v/s earlier levels of 3–5%. Even the capital requirement

from rating agencies is going up. Compliance with overall PSL may not be a big

challenge, but they may need some concessions on sub limits. We see the

regulatory requirement impact on near-term profitability to be a lesser

consideration this time around. However, compliance with other requirements

would remain a big concern. For example, Tata Sons withdrew its application in

2013 citing this as a key reason.

Clearing the air on ownership structure

The stance on promoters’ ownership has not been consistent across licensing

guidelines by the RBI. The report clearly states promoters should hold at least 40%

stake in the first five years and reduce it to sub-26% over the subsequent ten years

(cumulatively 15 years). It also provides a level playing field to existing banks where

promoter ownership is 15% or below – it states they should be given the

opportunity to raise stake to 26%. This should be a positive for entities such as IIB,

HDFCB/HDFC Ltd, etc. Furthermore, it suggests a maximum of 15% ownership for

non-promoter entities v/s 10% currently (5% via the automatic route and 5%

through RBI approval).

NOFHC suggestion more practical – legal reforms important

From 2013, the RBI introduced the Non-Operating Financial Holding Company

(NOFHC) structure for new banking licenses for entities with interest in the other

businesses and to ring fence the Banking business. Incrementally, the RBI is

concerned about entities increasing stake in their own non-banking financial

ventures or trying to acquire other financial services businesses with majority

ownership. The report suggests NOFHC is not required in case there is no other

business in the group. Accordingly, we see the possibility of a collapse in the holding

company structure for Equitas, Ujjivan, IDFC First Bank (if IDFC sells the MF

business), etc. Even for existing businesses such as ICICIBC, HDFCB, AXSB, and KMB,

the NOFHC structure should only be pushed if there is tax-neutral status at NOFHC.

Market share shift to accelerate

Overall, we see the trend of a market share shift to accelerate (30% in 2020 v/s 18%

in 2015) at a faster pace if the suggestions are implemented. Corporate/Industrial

houses with deep pockets, a large ecosystem, and strong trust among people may

give a tough time to incumbents, especially inefficient players. Overall,

intermediation cost is expected to reduce and credit penetration to rise at the

system level. Players such as PAYTM, FINO, etc. may come up with innovative

solutions soon as IWG recommends a shorter period of three years (v/s five years)

to convert into small finance banks (SFBs) from payments banks. The overall system

is the crossroads where cost efficiency and the ability to generate high retail

liabilities and best-in-class services would be the key going forward. We see M&A

opportunities to also rise going forward.

22 November 2020

2

Sector Update | Financials

Key recommendations by Internal Working Group

Cap on promoters’ stake recommended to increase to 26% in the long run

(15 years)



The cap on promoters’ stake in the long run (15 years) may be raised from the

current level of 15% to 26% of the paid-up voting equity share capital of the

bank.

This would be a positive for IIB as the promoter (Hinduja Group) showed

interest to the RBI in raising stake in the bank. We further estimate that at

current market price, promoters could infuse up to ~INR100b to increase stake

up to ~26% in the bank v/s 14.68% currently. Overall, this recommendation is a

positive move toward being ‘fair to all’ after allowing Mr. Uday Kotak to

maintain up to 26% stake in the bank. This may also cement Kotak Bank’s

promoter shareholding requirement case.

Exhibit 1:

Key promoter-driven banks’ shareholding

Key promoter-driven banks (%)

IIB

KMB

AUBANK

DCB

Promoter Stake (%)

14.68%

26.05%

29.00%

14.88%

Source: MOFSL, Company

NOFHC recommendation











NOFHC should continue to be the preferred structure for all new licenses to be

issued for universal banks.

However, NOFHC may be mandatory only in cases

where the individual promoters / promoting entities / converting entities have

other group entities.

Banks currently under the NOFHC structure may be allowed to exit from such a

structure if they do not have other group entities.

While banks licensed before 2013 may move to an NOFHC structure at their

discretion, once the NOFHC structure attains a tax-neutral status,

all banks

licensed before 2013 shall move to the NOFHC structure within five years from

the announcement of the tax-neutrality.

Banks should not be permitted to form/acquire/associate with any new entity

[subsidiary, JV, or Associate (>20% stake – signifying significant influence or

control)] or make fresh investments in existing subsidiaries/JVs/associates for

any financial activity.

However, banks may be permitted to make total investments in a financial or

non-financial services company, not a subsidiary/JV/associate, up to 20% of the

bank’s paid-up share capital and reserves.



We believe the recommendation to allow banks (currently under the

NOFHC structure) to exit from a holding structure – if they do not have

any other group businesses/entities – would be a positive as it removes

the two-layered structure and benefits the shareholders of Equitas

Holdings, Ujjivan Financial Services, and IDFC Ltd. (if they sell the MF

business). Furthermore, exiting a holding company structure also

removes a key overhang to reduce promoter stake to 40% within five

years of the commencement of banking operations in both Equitas and

Ujjivan.

22 November 2020

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Sector Update | Financials



Moreover, the RBI made it very clear that banks with other group entity

businesses would have to move to the NOFHC structure only once tax-

neutrality is achieved. Furthermore, the RBI would engage with the govt.

to ensure that

tax provisions treat the NOFHC as a pass-through structure as

this could otherwise lead to taxation issues.

Exhibit 2:

Current timelines to reduce promoter stake in both Equitas and Ujjivan

Regulatory timelines

Date of commencement of operations

Timeline by which the SFB should be listed

Timeline by which the promoter shareholding

has to be reduced to at least 40%

Current Promoter shareholding

Equitas SFB

4th Sept 2016

4th Sept 2019

4th Sept 2021

82%

Ujjivan SFB

1st February 2017

31st January 2020

31st January 2022

83%

Source: MOFSL, Company

Exhibit 3:

Current holdco discount in both Equitas & Ujjivan

Current M-CAP (INR m)

Holding Company

% shareholding in SFB

Proportionate value, INR m

Holding company M-CAP

Holdco discount

Equitas SFB

37,676

82%

30,913

18,064

-42%

Ujjivan SFB

58,241

83%

48,515

30,258

-38%

Source:MOFSL, Company

Allow banking licenses for large corporates and well-run large NBFCs









The recommendations are to allow large corporate/industrial houses and well-

run large NBFCs (asset size >INR500b) to open or convert into a bank.

Overall,

we believe these recommendations have come at a time when there have

been issues with many banks such as YES Bank and Lakshmi Vilas Bank.

Furthermore, many PSBs do not have enough capital and are struggling with

asset quality challenges; therefore, there is a need to bring more private

banking entities to support the govt. vision to reach a USD5t economy.

In 2013, when the RBI had allowed corporate entities to apply for a banking

license, none of the corporates were able to meet the stringent criteria set by

the central bank. Hence, we will have to wait for the final guidelines and

observe the approach adopted by industrial houses / large corporates (and the

RBI) this time around to open or convert into a bank

On the other hand, we see some of the large NBFCs such as Bajaj Finance and

L&T Financial Services as strong candidates to meet the banking license criteria

– given their strong track record and corporate governance practices adopted

over the last few years. In 2013, MMFS did not apply for a license citing an

impact on profitability due to regulatory cost; however, this has been reduced

significantly this time around.

Furthermore, the RBI recommendation to allow payments banks to convert into

SFBs with three years of track record would be a positive move for the sector as

there is still major banking under-penetration in the rural & semi-urban regions.

We believe payments banks such as Paytm and FINO could be disrupters due to

their large customer bases and technological capabilities v/s existing SFBs.

22 November 2020

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Sector Update | Financials

Exhibit 4:

Deposit market share trends: Sharp market share

gains toward private banks

Private banks

PSU banks

Others

Exhibit 5:

Incremental deposit market share trends between

PSBs and private banks

Private banks

PSU banks

Source:MOFSL, Company

Source:MOFSL, Company

Exhibit 6:

CASA market share trends: Private banks’ CASA market share improved to 27%

v/s 18% in FY10

Private banks

9%

9%

8%

8%

7%

7%

PSU banks

5%

6%

6%

Others

5%

5%

67%

7%

66%

7%

66%

76%

74%

75%

75%

75%

74%

74%

74%

73%

71%

70%

15%

17%

16%

18%

18%

19%

20%

20%

22%

24%

25%

27%

28%

27%

Source:MOFSL, Company

Exhibit 7:

Loan market share trends: PSBs’ consistent

market share loss in loans

Private banks

6%

3%

5%

3%

3%

PSU banks

4%

6%

6%

Others

4%

6%

5%

Exhibit 8:

Incremental loan market share trends between

PSBs and private banks

Private banks

PSU banks

21% 16%

79% 77% 77% 76%

61%

79% 84%

49% 44% 40%

66% 62% 61%

76% 78% 76% 77% 76% 75% 69% 67%

30% 32% 34%

18% 19% 19% 20% 21% 22% 25% 27%

21% 23% 23% 24%

39%

51% 56% 60%

Source:MOFSL, Company

Source:MOFSL, Company

22 November 2020

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Sector Update | Financials

Exhibit 9:

NBFCs with greater than INR500b asset size (1HFY21, INR b)

5,413

1,357

1,094

1,093

833

783

767

705

CIFC

572

MUTH

569

ABCL

HDFC

BAF

LTFH

SHTF

Tata

Capital

MMFS

PIEL

Source: MOFSL, Company; Note: Consol. loans for ABCL, FY20 data for Tata Capital

Exhibit 10:

Promoter shareholding in NBFCs with >INR500b asset size

95%

73%

70%

64%

56%

52%

52%

46%

26%

Tata

Capital

MUTH

ABCL

LTFH

BAF

MMFS

CIFC

PIEL

SHTF

Source:MOFSL, Company

Other recommendations

Increased capital requirement for licensing new banks



The minimum initial capital requirement for licensing new banks would be

enhanced, as follows:

a)

Universal bank:

The initial paid-up voting equity share capital / networth

required to set up a new universal bank would be increased from INR5b to

INR10b.

b)

Small finance bank:

The initial paid-up voting equity share capital /

networth required to set up a new SFB would be increased from INR2b to

INR3b.

c)

UCBs transitioning to SFBs:

The initial paid-up voting equity share capital /

networth should be INR1.5b, which has to be increased to INR3b in five

years.



Listing requirement:

Earlier, SFBs were required to list ‘within three years upon

achieving a networth of INR5b’ or ‘six years from date of commencement of

operations’, whichever was later. This has been revised to ‘six years from the

date of reaching networth equivalent to prevalent entry capital requirement

prescribed for universal banks (proposed INR10b)’ or ‘ten years from the date

of commencement of operations’, whichever is earlier. This would be a positive

for the other seven non-listed SFBs.



Increase in cap of 15% for non-promoter shareholders

in the bank would

further attract long-term investors in the sector.

22 November 2020

6

Sector Update | Financials

Evolution of banking license norms in India

Exhibit 11:

The evolution of bank licensing in India

Licensing requirement

1993

Capital requirement

Minimum required paid-up capital of

INR1b

2001

Minimum required paid-up capital

increased from INR1b to INR2b, which

was further increased to INR3b within

three years of commencement of the

business.

Two banks given licenses under these

guidelines: Kotak Bank & YES Bank

2013

Initial minimum paid-up voting equity

capital / networth was increased to

INR5b

Two banks given license under these

guidelines: IDFC First Bank & Bandhan

Bank

Banks

10 new private banks given licenses:

ICICI Bank, HDFC Bank, Axis Bank,

Global Trust Bank, Bank of Punjab,

IndusInd Bank, Centurion Bank, IDBI

Bank, Times Bank, and DCB

Promoter contribution

NOFHC

Other requirements

Minimum of 40% of the paid-up capital The NOFHC was to initially hold a

to be locked in for five years

minimum of 40% of the paid-up voting

equity share capital, which would

remain locked in for five years from the

date of commencement of the

business. Furthermore, it has to bring

this down to 40% within three years

from the commencement of the

business.

Mandatorily set up through a wholly-

owned Non-Operative Financial

Holding Company (NOFHC)

Banks were not allowed to be

Bank was required to maintain 13%

promoted by a large

CRAR for first three years from the

corporate/industrial house

commencement of operations.

Source: RBI

Exhibit 12:

10 SFBs received licenses: key guidelines

License requirement

PSL requirement

Capital requirement

Promoter contribution

Listing requirement

Licensed SFBs

Key guidelines

SFBs are required to extend 75% of ANBC.

The minimum paid-up equity capital for SFBs was INR1b (2014

guidelines), which was increased to INR2b (2019 guidelines).

Minimum of 40% of the paid-up capital for five years was gradually

brought down to 30% in 10 years and 26% in 12 years.

Mandatory listing for SFBs within three years of reaching networth of

INR5b

Ten SFBs were licensed under these guidelines – AUBANK, Equitas,

Ujjivan, Janalakshmi, Capital SFB, ESAF, Utkarsh & Suryoday

Source: RBI

Exhibit 13:

Licensing guidelines for payments banks issued in Nov’14

Requirement

Scope of the activities

Eligible promoters

Capital requirement

Promoter contribution

Listing requirement

Payment banks names

Payment Banks

Acceptance of demand deposits up to INR100k; cannot undertake

lending activities

NBFCs, corporate business correspondents (BCs), mobile telephone

companies, supermarket chains, real sector cooperatives that are

owned and controlled by residents

The minimum paid-up equity capital for Payments Banks – INR1b

Minimum of 40% of the paid-up capital locked in for five years

Mandatory listing within three years of reaching networth of INR5b

11 payments banks got licensed – Airtel Payments Bank Ltd; India Post

Payments Bank Ltd; FINO Payments Bank Ltd; Paytm Payments Bank

Ltd; Jio Payments Bank Ltd; NSDL Payments Bank Ltd

Source: RBI

22 November 2020

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Sector Update | Financials

NOTES

22 November 2020

8

Sector Update | Financials

Explanation of Investment Rating

Investment Rating

Expected return (over 12-month)

BUY

>=15%

SELL

< - 10%

NEUTRAL

< - 10 % to 15%

UNDER REVIEW

Rating may undergo a change

NOT RATED

We have forward looking estimates for the stock but we refrain from assigning recommendation

*In case the recommendation given by the Research Analyst is inconsistent with the investment rating legend for a continuous period of 30 days, the Research Analyst shall within

following 30 days take appropriate measures to make the recommendation consistent with the investment rating legend.

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Specific Disclosures

1 MOFSL, Research Analyst and/or his relatives does not have financial interest in the subject company, as they do not have equity holdings in the subject company.

2 MOFSL, Research Analyst and/or his relatives do not have actual/beneficial ownership of 1% or more securities in the subject company

3 MOFSL, Research Analyst and/or his relatives have not received compensation/other benefits from the subject company in the past 12 months

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8 MOFSL has not received compensation for other than investment banking/merchant banking/brokerage services from the subject company in the past 12 months

9 MOFSL has not received any compensation or other benefits from third party in connection with the research report

10 MOFSL has not engaged in market making activity for the subject company

22 November 2020

9

Sector Update | Financials

********************************************************************************************************************************

The associates of MOFSL

may have:

-

-

-

-

financial interest in the subject company

actual/beneficial ownership of 1% or more securities in the subject company

received compensation/other benefits from the subject company in the past 12 months

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Registration Nos.: Motilal Oswal Financial Services Limited (MOFSL)*: INZ000158836(BSE/NSE/MCX/NCDEX); CDSL and NSDL: IN-DP-16-2015; Research Analyst:

INH000000412. AMFI: ARN - 146822; Investment Adviser: INA000007100; Insurance Corporate Agent: CA0579;PMS:INP000006712. Motilal Oswal Asset Management Company

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Research & Advisory services is backed by proper research. Please read the Risk Disclosure Document prescribed by the Stock Exchanges carefully before investing. There is no

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* MOFSL has been amalgamated with Motilal Oswal Financial Services Limited (MOFSL) w.e.f August 21, 2018 pursuant to order dated July 30, 2018 issued by Hon'ble National

Company Law Tribunal, Mumbai Bench.

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