Sector Update | 22 November 2020 Sector Update | Financials TechnologyFinancials

RBI releases the Report of the Internal Working Group to Review RBI report on private sector ’ ownership Extant Ownership Guidelines and Market share gains to accelerate for private sector banks Corporate Structure for Indian 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 One of the key suggestions in the report is to provide an opportunity for NBFCs with greater than INR500b corporate/industrial houses to get a share of the growing banking system pie. Apart asset size (1HFY21, INR b) 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 ([email protected]) |Himanshu Taluja ([email protected]) Alpesh Mehta ([email protected]) | Yash Agarwal ([email protected])

22 NovemberInvestors 2020 are advised to refer through important disclosures made at the last page of the Research Report. 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 (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 , 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 (%) Promoter Stake (%) IIB 14.68% KMB 26.05% AUBANK 29.00% DCB 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 3 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 Equitas SFB Ujjivan SFB Date of commencement of operations 4th Sept 2016 1st February 2017 Timeline by which the SFB should be listed 4th Sept 2019 31st January 2020 Timeline by which the promoter shareholding 4th Sept 2021 31st January 2022 has to be reduced to at least 40% Current Promoter shareholding 82% 83%

Source: MOFSL, Company

Exhibit 3: Current holdco discount in both Equitas & Ujjivan Equitas SFB Ujjivan SFB Current M-CAP (INR m) 37,676 58,241 Holding Company % shareholding in SFB 82% 83%

Proportionate value, INR m 30,913 48,515 Holding company M-CAP 18,064 30,258 Holdco discount -42% -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 and . 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 . 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 4 Sector Update | Financials

Exhibit 4: Deposit market share trends: Sharp market share Exhibit 5: Incremental deposit market share trends between gains toward private banks PSBs and private banks Private banks PSU banks Others Private banks PSU banks

4% 4% 4% 4% 4% 4% 5% 5% 5% 6% 6%

30% 33%

46%

58% 59%

73% 68% 78% 79% 80% 68% 82% 70% 73% 74% 78% 89% 79% 78% 79% 79% 79%

11% 21% 20% 22% 18% 27% 67% 41% 70% 54% 42% 28% 27% 25% 22% 20% 18% 17% 17% 17% 16% 16% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

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 PSU banks Others 9% 9% 8% 8% 7% 7% 6% 5% 6% 5% 5% 7% 7%

73% 71% 70% 67% 66% 66% 76% 74% 75% 75% 75% 74% 74% 74%

25% 27% 28% 27% 15% 17% 16% 18% 18% 19% 20% 20% 22% 24% FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Source:MOFSL, Company

Exhibit 7: Loan market share trends: PSBs’ consistent Exhibit 8: Incremental loan market share trends between market share loss in loans PSBs and private banks Private banks PSU banks Others Private banks PSU banks 6% 3% 5% 3% 3% 4% 6% 6% 4% 6% 5% 21% 16% 49% 44% 40% 61% 66% 62% 61% 77% 76% 76% 78% 76% 77% 76% 75% 69% 67% 79% 77% 79% 84% 51% 56% 60% 30% 32% 34% 39% 18% 19% 19% 20% 21% 22% 25% 27% 21% 23% 23% 24% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Source:MOFSL, Company Source:MOFSL, Company

22 November 2020 5 Sector Update | Financials

Exhibit 9: NBFCs with greater than INR500b asset size (1HFY21, INR b)

5,413

1,357 1,094 1,093 833 783 767 705 572 569

HDFC BAF LTFH SHTF Tata MMFS PIEL CIFC MUTH ABCL Capital 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 MUTH ABCL LTFH BAF MMFS CIFC PIEL SHTF Capital 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) : 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 2001 2013 Capital requirement Minimum required paid-up capital of Minimum required paid-up capital Initial minimum paid-up voting equity INR1b increased from INR1b to INR2b, which capital / networth was increased to was further increased to INR3b within INR5b three years of commencement of the business. Banks 10 new private banks given licenses: Two banks given licenses under these Two banks given license under these ICICI Bank, HDFC Bank, , guidelines: Kotak Bank & YES Bank guidelines: IDFC First Bank & Bandhan Global Trust Bank, Bank of Punjab, Bank IndusInd Bank, Centurion Bank, IDBI Bank, Times Bank, and DCB Promoter contribution 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. NOFHC Mandatorily set up through a wholly- owned Non-Operative Financial Holding Company (NOFHC) Other requirements 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 Key guidelines PSL requirement SFBs are required to extend 75% of ANBC. The minimum paid-up equity capital for SFBs was INR1b (2014 Capital requirement guidelines), which was increased to INR2b (2019 guidelines). Minimum of 40% of the paid-up capital for five years was gradually Promoter contribution brought down to 30% in 10 years and 26% in 12 years. Mandatory listing for SFBs within three years of reaching networth of Listing requirement INR5b Ten SFBs were licensed under these guidelines – AUBANK, Equitas, Licensed SFBs Ujjivan, Janalakshmi, Capital SFB, ESAF, Utkarsh & Suryoday

Source: RBI

Exhibit 13: Licensing guidelines for payments banks issued in Nov’14 Requirement Payment Banks Acceptance of demand deposits up to INR100k; cannot undertake Scope of the activities lending activities NBFCs, corporate business correspondents (BCs), mobile telephone Eligible promoters companies, supermarket chains, real sector cooperatives that are owned and controlled by residents Capital requirement The minimum paid-up equity capital for Payments Banks – INR1b Promoter contribution Minimum of 40% of the paid-up capital locked in for five years Listing requirement Mandatory listing within three years of reaching networth of INR5b 11 payments banks got licensed – Airtel Ltd; India Post Payment banks names Payments Bank Ltd; FINO Payments Bank Ltd; Ltd; Ltd; NSDL Payments Bank Ltd

Source: RBI

22 November 2020 7 Sector Update | Financials

N O T E S

22 November 2020 8 Sector Update | Financials

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22 November 2020 9 Sector Update | Financials

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Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. Each recipient of this document should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult its own advisors to determine the merits and risks of such an investment. The investment discussed or views expressed may not be suitable for all investors. Certain transactions -including those involving futures, options, another derivative products as well as non-investment grade securities - involve substantial risk and are not suitable for all investors. No representation or warranty, express or implied, is made as to the accuracy, completeness or fairness of the information and opinions contained in this document. The Disclosures of Interest Statement incorporated in this document is provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alternations to this statement as may be required from time to time without any prior approval. MOFSL, its associates, their directors and the employees may from time to time, effect or have effected an own account transaction in, or deal as principal or agent in or for the securities mentioned in this document. They may perform or seek to perform investment banking or other services for, or solicit investment banking or other business from, any company referred to in this report. Each of these entities functions as a separate, distinct and independent of each other. The recipient should take this into account before interpreting the document. This report has been prepared on the basis of information that is already available in publicly accessible media or developed through analysis of MOFSL. The views expressed are those of the analyst, and the Company may or may not subscribe to all the views expressed therein. This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject MOFSL to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. Neither the Firm, not its directors, employees, agents or representatives shall be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. The person accessing this information specifically agrees to exempt MOFSL or any of its affiliates or employees from, any and all responsibility/liability arising from such misuse and agrees not to hold MOFSL or any of its affiliates or employees responsible for any such misuse and further agrees to hold MOFSL or any of its affiliates or employees free and harmless from all losses, costs, damages, expenses that may be suffered by the person accessing this information due to any errors and delays. Registered Office Address: Motilal Oswal Tower, Rahimtullah Sayani Road, Opposite Parel ST Depot, Prabhadevi, -400025; Tel No.: 022 71934200/ 022-71934263; Website www.motilaloswal.com.CIN no.: L67190MH2005PLC153397.Correspondence Office Address: Palm Spring Centre, 2nd Floor, Palm Court Complex, New Link Road, Malad(West), Mumbai- 400 064. Tel No: 022 7188 1000. 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 Ltd. (MOAMC): PMS (Registration No.: INP000000670); PMS and Mutual Funds are offered through MOAMC which is group company of MOFSL. Motilal Oswal Wealth Management Ltd. (MOWML): PMS (Registration No.: INP000004409) is offered through MOWML, which is a group company of MOFSL. Motilal Oswal Financial Services Limited is a distributor of Mutual Funds, PMS, Fixed Deposit, Bond, NCDs,Insurance Products and IPOs.Real Estate is offered through Motilal Oswal Real Estate Investment Advisors II Pvt. Ltd. which is a group company of MOFSL. Private Equity is offered through Motilal Oswal Private Equity Investment Advisors Pvt. Ltd which is a group company of MOFSL. 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 assurance or guarantee of the returns. Investment in securities market is subject to market risk, read all the related documents carefully before investing. Details of Compliance Officer: Name: Neeraj Agarwal, Email ID: [email protected], Contact No.:022-71881085. * 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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