Today, it is indeed hard to imagine how primitive the Indian financial system was just a quarter of a century ago. Several economic reforms and liberalisation measures were ushered in as a result of the balance-of-payments crisis in 1991…To better understand the impact of the economic reforms on a financial institution like the Housing Development Finance Corporation Limited (HDFC), it is useful to reflect on the origins of the institution.
HDFC was set up in 1977 as India’s first retail housing finance company. At that time, it was akin to a start-up. The only difference was that unlike most startups, which are largely set up by young entrepreneurs, this one was a post-retirement venture by the founder, HT Parekh. He was 65 years old and had retired as the executive chairman of ICICI.
A year after HDFC was set up, I joined the company. I had spent the initial years of my career as an investment banker. Changing tracks after that to join a start-up may well have been risky.
No one in India had so far attempted to finance individuals for their housing needs. Access to long-term finance was difficult and no foreclosure norms existed. At that time, most Indians were extremely debt averse…HDFC remained the only housing finance player in India till the late 1980s…HDFC also promoted four other housing finance companies. In effect, HDFC created competition for itself!
In fact, commercial banks did not focus on growing their retail portfolios till the late 1990s.
The challenge of growing the housing finance business predominantly concerned raising adequate long-term resources. During the 1980s, HDFC had successfully tapped long-term international funding from the World Bank (guaranteed by the Government of India), International Finance Corporation and the United States Agency for International Development (USAID) under the housing guarantee programme.
On the domestic front, funding mainly came from commercial banks, state insurance companies and the Unit Trust of India. The business of HDFC was a simple one—borrowing wholesale funds and lending them to retail customers at a fixed rate of interest, typically earning a modest spread of around 2%.
However, in 1990, the Gulf War came as a rude shock for the Indian economy…To curtail rising double-digit inflation rates, the Reserve Bank of India (RBI) raised interest rates sharply…For a lending institution like HDFC, which was dependent on wholesale funds, the RBI’s actions were stifling…HDFC knew that it could not afford to renege on its home loan commitments. It just had to find new avenues of raising resources.
At this critical juncture, HDFC realised that it had, over the years, built up a strong brand name, synonymous with quality customer service and trust. HDFC decided to capitalise on this goodwill by raising retail deposits.
The turning point
In the period post the nationalisation of banks and up until 1993, the Indian banking system had regressed considerably. Tongue in cheek, it was often said that bankers did not do banking; they merely carried out orders of the powers that be…reflecting back on the pre-liberalisation era, one realises that back then, banks did not fix any interest rates—they were all mandated. There were no prudential norms, no regulations on capital adequacy or rules for non-performing loans. Even opening a bank branch would take months after seeking the approval of the RBI. Clearly, the turning point was the opening up of the banking sector to private players in 1993.
There was an advertisement in newspapers calling for potential applicants. This aroused my curiosity and I thought it would be a good idea to apply for a bank licence. There was a time period of three months to make the application. The threshold entry limit was high, with a minimum capital requirement of Rs1 billion. At that time, HDFC’s net worth was around Rs3 billion. I was convinced that the time was right for HDFC to have some diversification in its business. However, when the proposal to apply for a bank licence was placed before HDFC’s board of directors, the initial rejection took me aback.
In short, HDFC Bank almost did not happen—but that is history now. In 1993, there were over 40 aspiring applicants for a banking licence—some were even fictitious, having sent in their application on a postcard! The chairman of the committee appointed by the RBI to grant the licences was SS Marathe, who was also a member on RBI’s board. One of the conditions stipulated for getting a licence was that the head office of the bank would have to be in a city other than Mumbai. HDFC took its chances and requested for the head office to be in Mumbai. To our surprise, it was the first to receive a bank licence. Marathe mentioned to me that HDFC’s application was the best and hence we were allowed our preference of having the head office in Mumbai.
Beyond wealth creation
If one looks at the composition of the Bombay Stock Exchange Sensex over two-and-a -half decades, there has been a vast transformation. Out of 30 stocks that were part of the Sensex in 1992, only seven companies still form a part of the Sensex today. If the stock market is considered to be the barometer of an economy, it is surprising that 25 years ago, there were no banking stocks in the Sensex. Today, financial stocks dominate the Sensex.
In 1992, HDFC’s market capitalisation was Rs3.15 billion and all the shares were held domestically. Today, HDFC’s market capitalisation is Rs2.2 trillion and the foreign shareholding stands at 77%. Taking the combined market capitalisation of the three listed entities within the HDFC group, it is in excess of Rs5.6 trillion ($85 billion). Clearly, vast shareholder wealth has been created in the financial sector in the post-liberalisation era.
At the turn of the liberalisation era in 1991, HDFC had cumulatively financed 0.12 million housing units. By 2016, HDFC had cumulatively financed over 5.5 million housing units. Housing finance in India is a volume-driven business. Today, outstanding housing loans stand at over Rs3 trillion ($45 billion).
The best is yet to come
To conclude, there remain several challenges in the Indian financial sector such as reducing the build-up of non-performing assets, particularly in public-sector banks, deepening the debt markets and finding optimal solutions and institutional mechanisms to sustainably fund long-term infrastructure projects. The Indian financial system has never been short of solutions, though often the obstruction has come by way of a lack of consensus and the will to bite the bullet.
Despite these challenges, the Indian economy has never been on such a firm footing as it is today. Twenty-five years ago, perhaps out of compulsion rather than choice, India undertook “big bang” reforms. Today, India is comfortable with an “incremental” reform approach. The pace of reforms adopted by a country is always a debatable issue. What is of significance is that India at present has the leeway to make its own choice regarding the pace of reforms. Besides the optimism of being the world’s fastest-growing major economy, there is a growing consensus that India’s best is still to come.
Deepak Parekh is the chairman of the Housing and Development Finance Corporation of India. This excerpt, used with permission from Penguin India, is from the chapter Institution-building in the Financial Sector: The HDFC Experience, which Parekh wrote in the book India Transformed, edited by Rakesh Mohan.
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