HDFC Bank's Appetite For Loans To The Underserved Could Weigh On Peers

Banking regulations require all banks to devote 40% of their lending—measured by a metric labelled adjusted net bank credit—to priority sector loans. While HDFC Bank, like other banks, is required to comply with the norms, non-bank lenders such as HDFC are exempt.

With HDFC Bank’s overall asset size at Rs 24.6 lakh crore and HDFC’s at Rs 7.26 lakh crore at the end of March, the expansion in the PSL requirement is a tall order.

To help it along, though, the bank has been granted a regulatory relaxation by the RBI for three years from the merger announcement to meet the requirement.

But the sustained demand from HDFC Bank is expected to spill over into the route banks take to meet their shortfalls on priority sector loans—buying such loans from other lenders or investing in qualified instruments such as priority sector lending certificates and rural infrastructure development funds.

"Almost 10% of their (HDFC Bank's) priority sector loans come through inorganic way, that part will continue," said Pranav Gundlapalle, senior research analyst at AllianceBernstein. While the bank’s PSL loans may improve, it is tough to meet all of it organically, he said.

For its part, HDFC Bank is looking at it with an outlook beyond the regulatory needs to be fulfilled.

"Agriculture is the biggest profit pool," Rahul Shukla, group head of commercial and rural banking at HDFC Bank, told BQ Prime.

Requirements under PSL also include sub-targets for banks under categories such as agriculture, microenterprises, and lending to weaker sections of society.

• Total requirement—40% of ANBC or CEOBE, whichever is higher.

• Agriculture—18% of ANBC or CEOBE, whichever is higher, with 10% prescribed for small and marginal farmers

• Micro enterprises—7.5% of ANBC or CEOBE, whichever is higher.

• Weaker sections—12% of ANBC or CEOBE, whichever is higher.

CEOBE stands for Credit Equivalent of Off-Balance Sheet Exposures.

HDFC Bank has a "sustainable surplus", on micro-enterprise loans, Shukla said, adding that the bank also plans to ramp up its lending to economically weaker sections, including small and marginal farmers. While the bank will continue to use the inorganic route to meet requirements, the thrust is on doing it via their own reach and network, Shukla said.

Loans to weaker sections—especially small and marginal farmers—are the hardest to come by and there is rush each year to meet the requirement, a banker at a rival private bank said on the condition of anonymity.

With demand for inorganic assets expected to stay elevated due to the appetite from HDFC Bank and sustained credit growth at the systemic level, this route will also get pricier. 

The PSL fulfilment cost for the entire sector itself is expected to rise with room for PSL certificates alone to see a price rise of about 100 basis points, Gundlapalle said. PSLCs allow banks sitting on surplus priority sector loans to sell certificates to banks that haven’t met their targets, in exchange for a fee. 

The cost of PSLCs for the agricultural sub-sector ranges between 2-3% of the amount certificates issued, while on average the cost comes to about 1%.

"We believe the operating expense is more towards medium to long term investments—both digital and physical. This would mean near cost/income ratio will remain high i.e. 40%+ levels and may start tapering over the next 18 months," Sameer Bhise, executive director at JM Financial, said.

An increased reliance on PSLC purchases to meet the requirements can also raise a bank's cost-to-income ratios. For HDFC Bank, though, the four year period granted by RBI to meet requirements on the combined book should keep the impact contained, according to analysts BQ Prime spoke with.

The total trading volume of priority sector lending certificates stood at Rs 6.62 lakh crore in FY22, denoting a year-on-year growth of 12.4%, according to RBI's annual report for FY22. Among the four PSLC categories, the highest trading was observed in PSLC-general and PSLC-small and marginal farmers with the transaction volumes being Rs 2.70 lakh crore and Rs 2.29 lakh crore, respectively in FY22, the annual report noted.

Agricultural sector PSLCs are typically in short supply as well and in case of a shortage, banks may be obligated in to put money in the RIDF. This can further impact their cost-to-income ratios negatively as the RIDF only yields a return of 4%.

While there has long been a premium that lenders with PSLs to spare can earn, there has been no sustained increase in it so far, a second private banker said on the condition of anonymity.

"In our view, some sub segments may see pricing pressures rather than a blanket increase for all. HDFC Bank is also generating significant PSL assets on its own now i.e. over 36% vs. over 30%, three years back," Bhise said. Effectively, higher spends could be restricted to some sub segments, he added.

“Goal number one, is to go organically build and distribution reach that we are going after,” Srinivasan Vadiyanathan, chief financial officer at HDFC Bank, told analysts in a conference call held on April 15.

On the organic side of things though, the complexity has increased after the introduction of district-wise weights, the second private banker quoted above said. The weightage system became applicable FY22 onwards and was introduced by RBI with aim to better geographical disparities in credit flow.

Under PSL, a higher weight of 125% is assigned to incremental priority sector credit in districts where the credit flow is comparatively lower, meaning the per capita PSL is less than Rs 6,000. A lower weight of 90% is assigned to the same in districts where the credit flow is comparatively higher, meaning the per capita PSL is greater than Rs 25,000.

Put simply, if a bank continues to push its expansion into districts that have already benefitted, it will get a lower advantage on its PSL requirements as opposed to wading into completely under-penetrated districts which are rewarded with a higher weightage.

HDFC Bank's emphasis on the organic route is buoyed by its asset quality track record in the segment and its extensive reach, Shukla said. HDFC Bank generates a majority of its PSL loans from the commercial and rural banking segment.

The aggressive branch expansion by HDFC also stands to benefit the bank in meeting its PSL requirements, Gundlapalle said. But expansions also carry a cost burden.

In many ways, the PSL loan demand from banks resembles a tub nearly full of water. And the elevated demand on account of the HDFC-HDFC Bank merger resembles adding two to three buckets more leading to a spillover.

Just how well HDFC Bank does on the organic front and on tapping new pools or borrowers could sizeably impact how pricey it makes the priority sector lending targets for banks at large.