The Vision statement of the bank is : To Build a World-Class Bank in India, guided by Ethics, Powered by Technology, and Be a force for Social Good.
The management goes on to explain what each of these words in the vision statement mean for them.
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“To Build” : To create a world class bank is an opportunity few people get in their lifetimes. Our employees could get opportunities to work in “world-class” organizations, but “building” one is something else.
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“a world-class bank” : For a country as large and diverse as India, and a country set to be world’s third largest economy by 2030, there are few “world-class” banks in India. And when we say world-class, we means banks of global scale and profitability, on the cutting-edge of innovation, providing amazing customer service, highest levels of corporate governance, generate high return on equity, and enjoying international respect and admiration. We aspire to be on that list, and are passionate about building such a bank. We have already sown the seeds for such a bank.
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“with ethics and customer-first values” : We advise our product teams to design products in such a way that it is meant to be sold to our “near and dear” ones. We make products with transparent pricing and fees.
IDFC First Bank Ltd was created by the merger of Erstwhile IDFC Bank and Erstwhile Capital First in 2018. IDFC Bank started its operations as a bank after demerger from IDFC Ltd, an infrastructure Financing Development Financial Institution. While Capital First was a successful consumer and MSME financing entity since 2012 with strong track record of growth, profits and asset quality. On merger, the bank was renamed IDFC First Bank.
HOW DOES A BANK WORK & MAKE MONEY?
A Bank is a financial institution that safely holds deposits, lends money, and facilitates transactions.
Customers deposit money in savings accounts, current accounts and Fixed deposits and the bank pays certain amount of interest on those deposits.
Banks use these deposits to give out loans at much higher interest rates to businesses, individuals and the government. It’s all a calculated risk, because some of the lenders will default on their credit. This system is crucial for our economic system because it provides resources for people to buy things like houses or for industries to expand their businesses and grow. So banks take fund that unused by savers, and turn them into funds society can use to do stuff. Banks also facilitate transactions and payments like through providing services like UPI, credit/debit cards, fund transfers and forex transactions, for which they charge a small fee.
MARKET OPPORTUNITY
The size of the total addressable market or opportunity with each private bank can be estimated by the fact that the total deposits in the Indian banking universe have been estimated to be around 200lac cr of which currently IDFC First bank has a roughly 1% market share with 1.8lac cr in retail deposits. Out of the total of 200lac cr of deposits only about 34lac cr is estimated to be in the form of CASA deposits while 176lac cr is as term deposits, IDFC First would command a market share in casa deposits of about 2.6%. An investor would also appreciate the fact that such growth in deposits is increasing at a CAGR of about 9.5% or in other words it doubles every 7-8yrs.
The total advances in the banking system of India stood at Rs. 160lac cr which was 20% more than the previous year. Taking IDFC banks total advances, its share in the Indian advances market would come to a meagre 1.25% again suggesting a vast room for growth both at the country level and also to increase its market share within that. Also an investor should take cognizance of the fact that the growing urbanization in India, together with rising consumer aspirations augers well the banking system in the country.
MANAGEMENT
While talking about the management of any business I am usually more attentive and cautious, because as already very beautifully said by Warren Buffett, that “you can’t make a good deal with a bad person”, which underscores the importance of integrity in business. He believes that no matter how good a deal looks, it won’t turn out well if the other party isn’t trustworthy.
I would completely agree with Warren Buffett, that while an investor is evaluating a bank for investment decision, his sole and primary analysis should begin and end with analyzing the management & the DNA or the culture of the bank, as that would be the legit litmus test of transparency, integrity and ethical ethos of the people lending out money to make a profit, since a bank does not report each individual lending transaction done by them over the course of the year, which makes it hard as an investor looking from outward to gauge the creditworthiness of borrowers and has to rely on the integrity of the promoters.
The MD & CEO of the Bank Mr. V. Vaidyanathan – who has worked with Citibank and ICICI Bank since 2000-2010. He then acquired a stake in an existing listed small wholesale NBFC, concluded a Leveraged Management Buyout of the company, recapitalized the company by raising fresh equity, and founded Capital First as a new entity and brand. He then went on to build a Retail + MSME financing business and turned around the company from loss of 16crs in 2010 to a profit of 327cr in 2018. Retail AUM grown consistently at a CAGR of 29% from 935cr to 32623cr. The market cap of the company going up by 10x, which later merged with IDFC Bank and he became the MD & CEO.
Also an investor would appreciate reading from the annual reports of the company that Mr. Vaidyanathan, had cut his compensation during COVID period by about 30% bringing it down to about 4.5crs, with no increment for the next 2yrs and in the last financial year ie.,FY24 has now bumped to 5.3crs, but which I feel is now justified keeping in mind the performance of the bank so far, which only goes to show an investor of the alignment of interest of the management with that of the various stakeholders of the company.
Reminded of another passage from the letters to shareholders written by Warren Buffet on the selection of directors of the board. He says, The requisites for board membership should be business savvy, interest in the job, and owner-orientation. Too often, directors are selected simply because they are prominent or add diversity to the board. That practice is a mistake.
And while going through the list of board of directors of the bank an investor would observe that majority of the directors of the bank would well perfectly fit that description, or rather maybe in my view they surely do.
Namely
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Mr. Aashish Kamat who has over 24yrs of experience in the banking and financial services space, 6yrs in public accounting and 2yrs in private equity. Was the country head for UBS India from 2012 to 2018, Regional CFO for Asia Pacific at JP Morgan based out of Hong Kong. And was in New York, where he was Global Controller for the Investment Bank at JP Morgan and Bank of America as Global CFO for the IB and Consumer & Mortgage Products. He is currently an Independent Director and Chairperson of Audit Committee at IDFC First Bank.
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Mr. Pravin Vohra who was worked with SBI for over 23yrs at various senior-level positions in business as well as technology both in India and abroad. In late 1990s he was serving as Vice-President of Corporate Services at Times Bank. In Jan 2000, he moved to the ICICI Bank group, where he headed several functions like the Retail Technology Group and Technology Management. From 2005-2012 he was President and Group CTO at ICICI Bank. Currently, an independent director and chairperson of IT Strategy Committee and Fraud Monitoring Committee at IDFC First Bank.
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Mr. S Ganesh Kumar – the Executive Director of RBI associated for the last 3decades. His recent responsibilities included the entire gamut of Payment & Settlement Systems, the creation and development of strategic plans for the Bank and taking care of external investments and managing the foreign exchange reserves. He was also associated with the Institute for Development and research in Banking Technology. He had a key role in the establishment of new institutions such as the National Payments Corporation of India, The Reserve Bank Information Technology Pvt Ltd and the Indian Financial technology And Allied Services. He was also associated with the National Cyber Security Council of the Government of India, and in the framing of the Payment and Settlement Systems Act of the country. Currently an independent director of IDFC First Bank, while also the chairperson of the Risk Management Committee & a member of the Audit committee, Willful Defaulters or Non Cooperative Borrower Review Committee and IT Strategy Committee.
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Mr. Pradeep Natarajan – who has been in a leadership position with IDFC First Bank for 5yrs since December 2018, and is currently the Head of Retail Banking of the Bank. Prior to this role Mr. Natarajan has had stints in reputed organizations such as Standard Chartered Bank, Dell India, Religare Macquarie Wealth Management and Capital First Ltd where held leadership roles.
Such kinds of profiles of people heading relevant and serious board committees at the bank assures an investor of transparency in dealings, assistance of accomplished business stalwarts which is another testament for continued success and strength in the business model of IDFC First. The only thing I personally felt not in alignment, was the interest of the board with that of the shareholders, due to the presence of decent fixed salaries received by the board members, to the tune of about 50-60lacs per year (which to my mind, sort of eludes the entire concept of the board being independent, I mean, just imagine a person receiving such kinds of remuneration from an institution, why the hell would he want to go against the CEO and lose his job? Rather he would want to ensure, more cooperation with the CEO so he could land similar jobs with other public companies), and also the fact that none of the board members are holding any material investment in the bank in terms of the shares held by them in personal capacity, except for Pradeep Natarajan – who is also the executive director and Head of Retail Banking division of the bank holds about 25.48lac shares of the bank and Mr. Pravin Vohra serving as an independent director of the bank and the chairman of the Fraud Monitoring Committee of the bank who holds 7,10,000 shares.
Also the already established track record of the MD & CEO at Capital First which saw Net NPA of less than 1% all through the period from 2010-2018, going through varying cycles of the economy, right from the start of the global financial crisis, general elections in India and the defeat of the congress party, demonetization, RERA, the introduction of GST, and collapse of largest housing finance companies. Which tells me that he is well tuned with the vagaries of the economic cycles and has established good standards of credit appraisal due to which such feat was possible by him at Capital First.
Another fact to be kept while evaluating the management of this bank is at the time of merger, Mr. V Vaidyanathan had laid out some guidance that the bank should be able to achieve under a period of 5yrs starting from an extremely low base & he had been able to achieve most of them under the said time frame.
Another thing that stands out working in favor of the management is their upfront and candid approach while speaking with minority shareholders or analysts, which is quite evident from their recent concalls and an investor while going through them would appreciate the management coming out with detailed answers and honest feedback about the business condition and way ahead, which provides comfort to an investor. Like when an investor would go through their Q3FY25 conference call, the management detailed about their recent issues in dealing with the Microfinance business which has been going through a rough patch and the management addressed the issue in detail with comments, like, So we have a provisioning policy whereby in MicroFinance Institution, we charge off 75% at 90days past due and at 120 days past due we charge off 100%. So our methodology in all products, including this product is to be really upfront about everything. Because 90 days past due, 75% charge off is very stiff. It’s not only hitting us on the credit cost, but income is also coming down because it’s an amazingly profitable product. So to that extent, income is coming down. It’s a bit of a double whammy, because suddenly now we also have credit cost coming & no income coming from that line because the book is coming down. The growth in income will be even slower than this year because the microfinance business is gone and it has to reset itself. This statement coming from the management tells an investor, that the management is focused on building the institution for the long-term and does not really care about what happens in a quarter or two. They also look to be very much focused on the long-term economics of the underlying business and in doing the same with integrity.
While explaining the vision statement for the bank the management has also highlighted some examples of their customer first philosophy in action. Some of them have been highlighted below for an investor to take note.
a. Monthly Credits : We have started “monthly” credit of interest on savings accounts, against the industry practice of quarterly credits. So, our customers earn “interest on interest” monthly on their savings account. To the best of our knowledge, no large bank with a universal bank license has ever done this.
b. Low, Dynamic APR for revolvers : APR is Annual Percentage Rate on credit card revolvers has always been about 3.49% per month, that’s about 42% per annum. So if you carry forward any balances or if you miss your payment by mistake, you pay at 42% per annum for that month. And by the way, 40% of card holders do end up paying these rates. Either customers are insensitive to APR or don’t know about it.
c. Cash Withdrawal interest rates : If you withdraw emergency cash from the ATM on your credit card you normally pat Rs250 as one-time fee PLUS interest rate of 42%pa from Day 1 of withdrawal. We felt this was rather high. We charge you Rs. 250 and charge no interest till next payment due date. Yes, you read this right, no interest till next payment due date.
d. Customer First : Where there is a misunderstanding, our instruction to the service team is “credit the customer first” and fix the root cause of the issue.
e. No Fine Print Banking : We don’t follow fine-print banking hoping customer won’t notice certain terms or charges. We don’t appreciate product managers who talk that language when designing products.
f. We don’t pressurize our employees to “somehow” sell high-margin products to meet fee targets. The list of our “Customer First” features is long.
So what we are building is a bank that’s clean from within.
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“Ethical” is the means we want to use in dealing with everyone. There is no point becoming highly profitable if not earned the clean way.
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And “Digital” is the medium we want to use. The seal looks as follows (image on screen)
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Coding the DNA : By making this seal and sharing with employees, we are attempting to code the DNA of our employees. That’s because we are an early stage bank and the DNA code we build will affect the long term conduct of our employees. This also becomes an internal check and balance among employees for good conduct as expected of them.
The management in another instance on Corporate governance said : Corporate governance is the key element of our business model. We main high standards of corporate governance in terms of accounting and business practices, disclosure levels, prudent risk management, internal financial control, regulatory compliance etc. guided by our Board of Directors. The first priority of our Board is corporate governance, and all material matters are discussed and resolves transparently. The board is focusing on all strategic issues including strategy, risk management, business environment, business planning, regulatory compliance, people, internal control functions, and so on, and the experience, diversity and maturity of the Board has already been established by us.
Management on Culture has been quoting :
- Long-run thinking : The first norm we follow is to keep our focus on the long run. All our metrics may not yet compare well with other banks as we are an early-stage bank, hence the pressures of public commentary, earnings, analyst reviews, stock price, quarterly reporting, investor pressure etc. could be immense. And we must face you every quarter publicly. At the same time, we know that band-aids and shortcuts to earnings to please stakeholders will mess up our culture and foundation. Such short-cuts will get coded into the genes and business model. Hence, keeping in mind our vision to build a world-class bank, we have been focusing on buildings a strong foundation and a strong business model on which future growth can be built sustainably.
We know that we are on to a wonderful model, and I am confident that if we stay the course and play with a straight bat, we will meet all aspirations of investors and other stakeholders. Hence, no matter the pressure, we communicate our strategy to all stakeholders I simple terms, stick to the plan, and deliver on the stated strategy. I am confident that with this approach, results will follow, it’s only a matter of time.
- Customer-First Bank : One of the core tenets of our culture is to be a customer-first bank. Let me explain with examples. There are many features of our products that are customer friendly, that we publicize widely, like say, paying monthly interest on savings account, not charging premature FD breakage charges for senior citizens etc. But our real meaning on customer-first goes beyond that – it’s how we deal with them when they are not looking. This is key.
Let us say we give rewards points to our customers for spending on our credit cards. World over, card issuers introduce frictions in redemption process so the actuarial cost of rewards points to the bank is lesser. Instead, we flash the reward points earned by the customer upfront on the app’s login screen itself. We then took it one step further . We allowed customers to redeem their points against their next online purchase through a payment gateway and not insist on our product e-catalogues. Then we made our rewards points evergreen, so we don’t extinguish rewards points earned by customers who forgot to redeem them in time. So, customers get their benefits even when they are not looking. Another example, we earn fees when a customer inadvertently spends over the limit, but instead of making money through this line item, we proactively start sending them messages when they reach 80% credit limit utilization, and thus they save on fees.
This customer-friendly philosophy cuts cross the bank’s products. On the savings account side, there are many services for which we avoid billing our customers, say for issuing a statement of account from the branch, or non-home branch transaction charges and many more. Over time, IDFC First Bank customers may appreciate our Bank when they understand our ethos. We truly care for our customers.
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Near Dear Test : We tell our employees to only design products and services which we can sell to our family members. And we take this test rather literally. Because we encourage our employees to ask their near and dear ones to open accounts with the Bank. So, our service, and charges therein, will be experienced by our near and dear ones too.
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Work Culture : We are constantly attempting to build an organization with lesser conflicts, more coordination, and hire employees with appropriate intellect, hard work, drive, and commitment to the organization.
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Better Service Standards : Upon going through the annual reports of the company an investor realizes the importance the management places on exceeding the level of customer service within the organization, which becomes evident from his reading this short excerpt where the management launched an organization-wide mass initiative (You Can)raise to the power of X, to improve customer service. Under this initiative, the management trained 22,000 employees on culture, on soft skills, launched recognition program for outstanding employees, established processes for root-cause analysis, complaint management, product knowledge, increased empowerment, and opened multiple gates for customers to access us(through website, app and WhatsApp).
As an example on customer experience, the management shares, that in November 2023, during a visit to review our customer service at the contact center, they observed that the bank was receiving around 75,000 calls a month from customers regarding Average Minimum Balance charges. Upon investigation, it was revealed that if a customers balance was 0 and if the customer owes the bank AMb charges of say 250rs for non-maintenance of balances, the bank was marking a lien on the account to the extent of AMB charges due. Whenever any credit was received to the customer’s account, the bank would first deduct the amount due to them. This led to a reduced balance to that extent, which in turn made the customer fall below AMB again, and even causing his or her EMI’s to bounce for loans taken from elsewhere.
The management immediately decided to stop lien marking customer accounts for AMB. This change was implemented in Jan 2024, and the number of calls to the contact center fell sharply. If there is balance, they take the AMB, if not, they let it pass, they don’t sweep-in the fees from the next credit to the account.
#BeingFriendly – Another campaign undertaken by the management to inculcate customer-friendly behavior with employees. The initiative involved mailer communication, training module, and engagement activities. And now the management looks forward to launching the #beingFreidnyl Guidebook – a reference guide for colleagues that will help them to achieve the mission to become the most customer-centric bank.
The management also shares a story from a ‘coffee table book’ – a collection of stories of employees of the bank who went out of their way to serve customers, which goes like about an employee by the name of Jerry Pinto, a branch manager at Sangli, a metropolitan town in Maharashtra who went out of his way to take one of his customers who was experiencing a vertigo attack while on the road to his home, to the hospital and getting him vetted.
All of the above examples and excerpts from management commentary tells an investor something about the prevalent culture or DNA of the promoters and thus in turn of the bank. An investor through the above information must also keep in mind the customer-friendly approach and policies in all the products. Which is also the competitive advantage of the bank vis-à-vis other players in the banking ecosystem. Plus helps an investor have faith and confidence on the energy, integrity and intelligence of the promoters.
BUSINESS ANALYSIS
Key Achievements of the bank since merger in 2018 have been
(Investor PPT Q3FY25, Page 8,16,17,18,19)
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Building Essential infrastructure : Since the time of the merger of the bank, the number of branches setup has gone from 206 in December-2018 to 944 as of March 24. While the number of ATM’s are up from 112 to 1164 during the same period. (In order to have retailised the bank ie, attract more liabilities or deposits which form the raw material for a bank to be able to then lend it further to customers, by way of savings accounts, current account, term deposits, fixed deposits etc which the bank has performed exceptionally well.)
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Retail deposits of 10kcr stand at 1.8lac cr which form about 65% of the total liabilities of the bank, growing at 30% YOY (The focus of the current management on increasing share of retail deposits in the liability profile of the bank is due to the fact that retail deposits are more granular, sticky, stable and low cost in nature as compared to wholesale deposits or borrowings through institutions, while this has enabled the bank to reduce it’s cost of deposits/ cost of funds, it has also help strengthen the banks balance sheet making it more immune to an asset-liability mismatch – due the long-term sticky nature of such deposits, while at the same time the management has been able to use those deposits to its advantage by way of reducing the market borrowings which has helped them bring down the cost of funds and increased its margin profile.) The deposit growth of the bank has been phenomenal & shows the trust the bank has been able to garner with customers in the country, be it through their customer service, better technology, the aura of their branches.
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CASA Ratio of 13% at 47 now growing at 30% on a YOY basis. (Higher CASA deposits can enable the bank to offer attractive rates for loans and still maintain profitability than their peers due to lower cost of funds for CASA deposits. And since retail customers frequently use CASA accounts for transactions, banks can cross-sell other financial products like credit cards, loans, investments products etc)
Though a bank also needs to utilize other funding sources since maturity of different products and loans must be matched and products like an FD, Term Deposit or even issuance of bonds offers bank’s the ability to tap into long term loans along with providing more stability of funding needs.
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On merger the bank had a loan book of 1lac cr, which current stands at 2lac cr in 2024. (Although now the loan book is well diversified into over 25 product segments with no single business category contributing over 15% of the entire loan book. Some higher share of loan book categories include Loan against property at 12%, Home Loan, Business banking & Kisan Credit Cards, all of which combined constitute about 30% of the loan book – which is entirely backed by mortgaged – hence providing security to the bank against defaults)
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Net Interest Margin of 3% at 6% now.
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The Core Operating Profit went from .51%(750crs) in 2019 to 2.25%(6030cr) as of 2024 – while at the same time maintaining a strong asset quality with Gross Non-Performing Assets of 1.8-1.9% and Net NPA at 0.6-0.8%.
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The bank has been able to continuously run down its legacy borrowings from 57000crs in 2018 to about 11800cr in 2024, constituting about 14% of total liabilities now down from about 48% in 2018, while at the same time reducing the cost of funds for the bank by 1.3%
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Decreased the credit to deposit ratio at the bank from 169% in 2018 to 100.2% in 2024, which typically signals an investor that the bank is competent enough to raise deposits instead of debt to satisfy its loan obligations. Higher deposit growth also signals to an investor that it’s customers are happy with the brand, products and service, otherwise why would they stick with the bank and deposit money.
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The bank is already on path to achieve a 2% ROA profile – the NIM’s are already in the 6% range, because of which the operating profit as a % to average loan book is already in the 4.7% range, assuming a credit cost guided by the management at 1-1.5%, it comes to around 3.2% pre-tax, assuming a tax rate at 25% equates to about 2.2% post tax ROA profile. The only thing now required is the cost-to-income of the various other businesses to eventually come down with scale and start generating profit.
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Deposit per branch in the mid-tier segment private banks are between the 120-130cr mark, examples taken are IndusInd Bank and AU Small Finance Bank, while IDFC delivers 200crs per branch, which is in the league of the major private sector banks in the country. And this ability to raise deposits at scale is a key capability of the bank and tells an investor quite something about the bank’s continued and unwavering focus on transparency, trust, customer obsession/first focus, an exceptional online/offline experience, customer service, technology and word-of-mouth business. With 944 branches, they have raised 1.93lac cr retail deposits, while at industry rates they would have had to put up additional 950 branches to achieve the same figure, one branch setup costs 2cr approx. resulting in 1900cr in savings.
The Bank has also launched and scaled up many new businesses in the areas of loans, deposits, fee-based products and payment solutions to become a full service universal bank with diversified streams of income. Although most of the businesses are in their early stage of lifecycle and losing money as of date, in the long run they should provide stable profit streams as they scale, since investments are needed in the initial stages to set up people, technology, marketing, distribution, which have enabled the bank to now offer a full suite of services under one roof. And doing so in the initial stages of setting up a bank is really crucial since one cannot be telling the customer that hey open a savings account with us, have fixed deposit with us, but for credit cards please go to some other bank. You cannot build a full relationship with the customer and even the customer would not feel great about dealing with such a bank and then the question of building a big successful bank of the future goes out of the mind of the consumer and he gets drawn to competitors.
While reading further into the Annual report an investor comes across this exceptional piece written by the MD & CEO where he has detailed out their 10 step framework while evaluating credit capacity of a borrower which includes some key metrics that makes an investor feel secure about the culture of lending at the institution – including a combination of physical checks where necessary, and new-age technologies and digital ecosystems. The processes have multiple checks and balances and include
- Biometric KYC : Whereby the management accesses UIDAI to fetch the customer’s photograph and other details to validate their identity through fingerprint or iris scan.
- NSDL Verification : Accessing NSDL to compare the PAN name with the name from Biometric KYC.
- NPCI Validation : which performs an IMPS penny drop to validate the repayment bank account, matching the name with the biometric KYC aadhaar.
- Credit bureau access : Whereby the company retrieves customer behavior, repayment trends, credit lines etc from bureaus like CIBIL, Equifax, Experian or CRIF.
- Demographics : collection such information as age, residence etc from the application.
- Product financed : getting information about the product financed, say MSME, business, brand being purchased etc from the digital application form.
- Cash flow checks and scorecards : which involves analysing bank statements, GST records, or credit bureau cash flow estimates. Calculating loan eligibility based on average bank balances to ensure customer can afford the EMI.
- Fraud detection : using algorithms to identify potential fraud by the customer, intermediary or employee.
- Fraud monitoring systems : using advanced fraud monitoring tools to estimate probability of fraudulent intention.
- Field verifications : conducting residence checks, office address checks, reference verification, lifestyle checks and business activity checks, aided by digital tools like geo-tagging.
- Legal checks : checking for legal cases, disqualification of directors etc.
- Financial Analysis : analyzing financial ratios for soundness of the borrower or borrowing entity in case of a corporate or MSME.
- Property evaluation : evaluating the title deed and collateral for legality, validity and enforceability.
- Vaahan access : accessing vaahan for vehicle registrations and depository information.
- Personal discussion : conducting personal discussions where necessary (physical or video)
- Electronic mandate : the company sets up an electronic mandate for repayment authenticated with Aadhaar OTP
Post evaluation of such stringent parameters and checks 40-60% of the applications the bank receives are still rejected. Following such stringent and prudent processes while leveraging the digital ecosystem enables the bank to diversify its loan book across demographics and credit profiles, while at the same time keeping a check on NPA. Also lending across a wide spectrum of credit profiles allows the bank to earn higher NIMS’s.
COMPETITIVE ADVANTAGE
Another fundamental question that might pop up in an investors mind is that since there are already so many banks to deal with, then why would people prefer dealing with one particular bank, and the answer to that lies in the fact that though a banking business is surely a commodity business, to a large extent, since the lower the cost of borrowings for a particular individual or entity or in other words the better the deal one gets while buying goods or taking a loan for personal reason, the individual would surely go ahead with that particular bank offering such a deal. Although only the bank with the least cost of funds themselves ie., the bank raising deposits/funds to lend out at the least possible interest rate can offer such deals in return to prospective borrowers. And to attract the lowest possible cost of fund/deposit for a bank means to attract the right mix of CASA deposits, wherein the savings account offers the least amount of interest rate, while the current account is zero cost, giving out no interest. Now while attracting saving account deposits in the initial phase is mostly a game of offering the highest interest rates on those accounts, but unless the bank offers a reasonable level of service, trust, features and technology those deposits don’t usually remain very sticky. And once the customer is able to gain trust on the bank reputation, is getting reasonable service and technology with the institution then it becomes very difficult for one to switch since by that time he is already familiar and in tune with the login method, his id and password, and has already managed most of his payees and other synced other investments and insurance products with his bank account so much so that it becomes almost impossible for him to make that switch. The switching cost in terms of opening another bank account, re-managing his payees, his investments, insurance agencies and other related items with the new bank account is too much for the individual, that, he chooses to not make the switch altogether. Which in-turn forms an important part of the competitive advantage that a legacy bank has in relation to a startup bank.
On the other hand if one considers the savings bank account deposits with public sector banks this concept becomes a little bit harder to understand at first since, they are in control of a majority of public retail deposits despite the fact that they pay out lower rates on these accounts when compared with private banks, offer service levels not even close to that of the private majors, lag behind years in terms of technology but still garner majority of the public deposit base. But that primarily is due to the fact that these individuals feel a greater sense of trust primarily because of the long established tenure of such banks in the country and two, because of the nationalized tag of such banks which offers them a sense of security in case of any fraudulent activity or in case of solvency issues with the bank itself since the Deposit Insurance and Credit Guarantee Corporation (DICGC) insures deposits up to 5lac rs per account across all banks. While this applies to private banks too, still the government owned status of PSB’s reinforces trust in this safety net. And also because of culture and generational trust – that is, that, the trust in PSB’s is often habitual, reinforced by decades of reliance on PSB’s for savings, pensions and loans, making the switching cost to move to a private institution a higher cost for them, this phenomenon is especially true in the rural and semi-urban areas of the country, while more private sector banks are dominant in the urban areas.
The competitive advantage therefore, for a bank like IDFC First or any other private sector bank, lies in :
- Transparency
- Addressing issues head-on
- Generate Trust
- Attractive customer friendly products
- Technology
- Exceptional mobile experience
- Culture
- Customer service
- Motivated Employees
Which we have already discussed in the management analysis section.
PRE-MORTEM / RISKS TO THE BUSINESS MODEL
Despite all of the above factors working in favor of the management and the bank so far there still could be several issues that can come in the way of the bank moving forward and an investor should be cognizant of those as well. Including
- High exposure to retail loans could become riskier if the economy slows down, resulting into job losses or reduced incomes which could eventually lead to a spike in loan defaults.
- A major challenge for any bank is bad loans, if the bank fails to maintain strict credit assessment, it could face a surge in NPA’s, thereby affecting profitability.
- Since a financial institution is levered something like 8-10times its equity base, it means that even if 10% of its loan book goes bad, that event alone could lead to wipe off of its entire equity and lead to losses for shareholders.
- Though IDFC First bank has a better technology, customer experience, UI and UX standards today, the giants in the banking industry dominate with larger market shares in the private banking sector and hence IDFC First may struggle to compete with them in the future.
- The cost-to-income ratio of the bank currently is on a higher side as compared to other established banks, meaning it spends a lot more on operations and hence earns less profits, the failure to improve margins could lead to investor dissatisfaction and hence underperformance in stock price.
- A large part of retail deposits with the bank is retail term deposits or in other words fixed deposits done by retail investors to the tune of about 99000crs in the total deposit base of 193,000cr, which tend not to be so sticky, since they are always hunting for highest interest rates in the market and can prove to be non-sticky for IDFC First also, resulting in serious outflows of its deposit base. Also, all kinds of deposits are a signal of customer trust placed in the institution by way of money deposited, and hence, any kind of disruption to that trust could lead to a loss in those deposits which form a critical raw material for any financial institution, since without the money the organization would have no means to lend to any one or invest anywhere.
- The current CEO & MD Mr. V. Vaidyanathan has been a driving force in the bank’s transformation till date and any change in leadership or strategic missteps could weaken investor and customer confidence.
VALUATION
At the current earnings of about 3000crs in the last fy2024, an investor is getting a yield of about 6.6% taking a market cap of 45000crs. Which is the same as one would get in a 10yr bond of the Indian government, with one caveat which is that with the government bond an investor would not get any growth prospects, which makes the 6.6% yield on IDFC First bank an attractive proposition since it comes with exponential growth embed in the future.
Also if an investor values IDFC First bank on the price-to-book multiple, taking a market cap of 45000crs and book value of about 37800crs, the multiple is about 1.2times, again not cheap, while at the same time not very expensive, keeping in mind the management quality, the quality of the earnings reported by the management and future growth.
