HDFC Bank's Secret to Consistent Success

Forbes India: Your bank grows at 30 percent every year. How do you do it?
PS: There’s nothing magical about a particular number. The rate at which you compound could be anything. We have not really ever had a particular number in that sense. What we’ve done consistently is grown at a pace a little faster than the banking system. We recognise that the banking system grows at a certain rate: That is a function of the growth of the economy and a certain multiple to that.

Traditionally, the banking system has grown at 2.5-3 times the real GDP growth. We have grown at some pace faster than that. When we were much smaller, we were growing at 7-10 percent faster than the system but in the last 5-10 years, we’ve been growing at somewhere between 4-5 or 3-6 percent faster than the banking system. Which means we are gaining market share. The important thing which we’ve done consistently is that the growth in market share or volumes has been achieved while maintaining a more balanced/stable net interest margin and within the bank’s asset appetite in terms of asset quality (within the bank’s risk appetite).

FI: On the link between interest rates cycles and profits.
PS: We’ve actually been through interest rate cycles. From the peak of where we have been to the trough of where we might have ever been, we might have had a large fall. But the reality is we’ve been through at least two to three interest rate cycles in the last 18 years and we’ve been through different monetary policy environments, either through the policy to growth, which was more accommodative, or an inflation control mode that the RBI was in. I think we have not necessarily positioned our balance sheet for a rising or declining interest rate scenario. We’ve tried to make it interest-rate-cycle proof. I think the evidence of that being reasonably successful is that through the interest rate cycles our net interest margin has been fairly stable. It’s not that we’ve gained when interest rates were going up or lost when it came down. First when you look at what would have happened when interest rates come down, obviously there is an impact on what is happening to your deposits and loans and what’s happening to your bond portfolio. 

FI: On stable interest margins and quality of assets.
PS: Both the higher margin and the stability of it, I would relate to the liability side and the asset side. On the liability side (which means on the deposit side), it’s clearly the fact that, one of course, we are a large deposit funded bank. We’re not large borrowers. Within that we have a higher proportion of transactional or current and savings accounts deposits which by their very nature are more stable and granular. They get to your customer base. From a cost of funds and stability of funds point of view, that helps. When you look at non-CASA (current account and savings account) deposits or fixed deposits, again we have a share of retail in them. We are less dependent on wholesale deposits or CDs (certificate of deposit) where rates tend to be a little more volatile depending on money market conditions. Clearly, the quality of the deposit franchise tends to give us a lower cost of funds and a more stable liquidity and stable and granular and less price sensitive liquidity. The other contributor to the margin is the composition of the loan book where we have very consciously maintained a certain balance between the wholesale and the retail portfolios. Right now, 54 percent of the loan book is retail and 46 percent is wholesale.
 
 
FI: How do you look at the new banks coming into the picture?
PS: For starters, the market is genuinely large and growing. The pace of growth will vary depending on how the economy is doing but even with a very sluggish GDP growth right now, the industry is going at 14 percent. There is enough opportunity for a fair number of banks to come in and participate in this growth. Now, if you take a step back, you will find that the Indian market itself is relatively underpenetrated from a banking perspective. Obviously, there are pockets that have high levels of concentration and there are large parts of the country where markets are underpenetrated. I don’t think that just by the fact that new players are coming in, changes things too much for the existing players, at least for the initial several years.

FI: How do you look at the non-urban growth for the bank?
PS: The requirement for you to reach out to Tier 3 and Tier 6 and unbanked areas has increased. If you look at the last three or four years in particular, a little before the financial dispersion became intense, we had seen this as a huge opportunity and started increasing our presence in these Tier 3 locations.

So if you look at the last three years for instance, we would have added somewhere close to 1,200-1,300 branches in semi-urban and rural areas. In fact, today, approximately 54 percent of our branches are in semi-urban and rural areas. This is clearly going beyond what the regulatory norms would require. The reason is quite simple. If you look at whatever growth the economy is going to achieve, you do have a trickledown effect of that from the larger metropolitan and urban areas into the semi-urban and rural areas.

FI: How does the costing work?
PS: It would tend to be, depending on location, a fraction of it. One of your major costs is rent. In an urban area, you might pay a couple of hundred rupees per square foot. In a really smaller location, you might be paying a tenth of that, Rs 15 – 20 per square foot. Physical costs thus tend to be much smaller. Costs are significantly lower but the business and market potential is also significantly lower. There is not too much difference for the time it takes for an urban, semi-urban, rural branch to break even. Typically, a branch in almost in any area takes two and a half to three years to breakeven. Branch metrics tend to drop as you go to smaller and smaller markets, but also your cost structure moves in tandem with the time it takes to break even. This requires a certain business model and a certain product range. If you are trying to make a branch viable by only doing a couple of products, it might take much longer.

FI: Over the last 20 odd years, PSU banks still have a market share of 70 percent. Why is that?
PS: If you look at retail credit example, at that time when we started, it was 3-4 percent of GDP; today it is in the low teens. What has been achieved is an increased coverage or increased penetration of banking services. On an incremental basis, in the growth, there has been a distinct shift in market share. But there is a large base that has always been there and therefore maybe the public sector bank segment, which was 90- odd percentage, is 70 percent today. You have strong banks within every segment. So to suggest that the public sector banks have lost market share, that doesn’t take away from the fact that you have banks in that segment who are doing really well and will continue to do very well.
 
FI: Banking at the end of the day is more about pricing than services. Depositors require services and borrowers require pricing.
PS: Currently, I don’t think the numbers stack up exactly that way: If you look at the borrowing side from the customer point of view, lending side from the bank’s point of view, pricing would be the overriding factor. If you look at it right now, the reality is that you have market share spread across public and private sector banks, you have various banks gaining market share on the back of better product, better service and not merely price. If you look at, for instance, retail loans, we have for the last several years been among the market leaders in most of the products.While we’re alwaysvery competitive, we may not always be the lowest among the interest rate. Because the customer is not just looking for interest rate—certainly interest rate is a factor—but he’s looking at the overall service level, the turnaround time. If Iwere to tell you that you have to buy a car and you get a loan the same day and this is the cost, as long as the cost is reasonable and everything is transparent, you might prefer that to somebody who says okay, maybe I’ll offer you 25 base points lower but it’ll take you eight days. So it’s a combination of service, convenience, brand, predictability.
 
FI: On freeing of deposit and its effect on profitability.
PS: It’ll be a conjecture but the only element of the deposit side that was not free was the savings account—the current account has been zero but the fixed accounts have been freed for a fair amount of time. On the deposit side, the FD rates have been free for the longest time. The fact that it may not have made a huge difference is evidenced in that fact that even after savings accounts have been deregulated, you have 98 percent of the banking system rates where the rates have not moved or changed. In every market, you will have players who will price products differently in every market there will be outliers. I will go back to my point earlier that bankers over the years have realised that pricing is certainly not such a key element in influencing a customer’s financial decision.
 
FI: What are the basic drivers of complete return on equity (ROE) for HDFC?
PS: When you look at the revenue side—looking at the ROEs and breaking it into your return on assets (ROA), in the banking industry because of capital adequacy requirements, there’s a certain acceptable minimum below which you don’t go from a gearing, capital adequacy point of view. As a result, your improvements in ROE have to necessarily come from your improvements in ROA. At the ROE side, if you look at the main drivers, the largest portion of revenue for a bank tends to be net interest income, which gets driven by your margins. As I mentioned earlier, I think that we managed a consistent growth rate in our assets and we have managed a healthier and more stable margin. That tends to be a good driver of net interest income. When it comes to non-funded revenues or the other income, we have focussed a lot more on customer-related revenue streams, so we look at fees, commissions etc. Those are a larger portion of our others incomes, rather than trading revenues. And again, we believe that is healthy because it tends to be more stable and less volatile and also grows customers and adds more products to customers.
 
FI: On lower concentration of loans in the infrastructure sector.
PS: It’s not that we haven’t participated in infrastructure. We have probably had a lower concentration of our loans in infrastructure. I’d say that risk management is also about deciding what you want to do and don’t want to do; be it with infrastructure or others segments and then doing it better. Yes, I think by avoiding certain types of projects and borrowers, you know you can lose less money and get less restricted assets.  So I don’t think our strategy has been to avoid taking risks. I think we have been taking risks, when we have understood those risks and wanted to take those risks, and that the risk was priced in. We have still been able to achieve system leading growth with a diversified book, with having done little bits and pieces of everything including infrastructure, but yes, I don’t think we have chased one segment merely because that was the flavour of the day.