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India’s largest private lender HDFC Bank’s $40 billion acquisition of its biggest shareholder could face regulatory hurdles due to the stake it would give the bank in the insurance sector, Reuters reported quoting analysts.

The Reserve Bank of India, which acts as regulator for the financial industry, wants banks to limit ownership stakes in insurance companies, Reuters reported.

HDFC Bank’s proposed merger with HDFC Ltd will create an entity with a combined balance sheet worth $237 billion and will include the target’s insurance and other financial subsidiaries.

SIZE OF ENTITY

HDFC Life and HDFC ERGO are among the leading life and general insurance companies in the private sector, and analysts say the RBI is unlikely to be comfortable with the size of the insurance operations the deal will give the bank.

HDFC Bank’s management said on Monday that they have asked the regulator for clarity on complying with its rules, but analysts believe it may not be easy to come by, the Reuters report said.

“Considering there are lot of subsidiaries that need to be merged, there could be some regulatory overhang, particularly in the insurance business where the central bank is not very comfortable with banks increasing their stake,” said an analyst at a domestic brokerage house.

One way of folding the subsidiaries into HDFC Bank could be to create a holding company structure, but that could have a negative impact on the balance sheet in the short term, analysts said, Reuters reported.

HIGHER COST, TAXES

“If a holding company structure is enforced then the equation changes. Cost goes up as stamp duties and taxes will go up,” Macquarie said in a note on Tuesday.

In the short term, return on equity (RoE), a key financial metric, will also go down as a result of meeting certain regulatory requirements, the Macquarie note said.

As a shadow bank – a finance company outside the scope of traditional banking regulation – HDFC Ltd has a higher cost of funds compared to the bank.

POST MERGER

Post merger, the entity may therefore, in the short term also see a higher cost of funds, which could affect its margin, said a portfolio manager at a retail brokerage firm, Reuters reported.

“Due to this and other ambiguities regarding the deal and the performance, the stock may not see a big valuation re-rating immediately,” he added.

If it clears the hurdles to a deal, HDFC Bank will shrink the gap in size with state-run lender and bigger rival State Bank of India, and pull further away from peers such as ICICI Bank and Axis Bank.

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India today