(Part 1 of 3) Conversation with Aditya Puri, managing director of HDFC Bank, India, on – banking products which led to the financial crisis – defending HDFC Bank’s conservative service offering and balance sheet – financial services in India today
Here is the transcript of the video.
1. Strategies in universal banking
Emmanuel Daniel (ED): I am very pleased to be able to speak with Mr Aditya Puri, the managing director of HDFC Bank, one of the leading private sector banks, a leader in market share on a number of consumer banking fronts, but also a universal bank and a proxy for the Indian economy. Thank you very much for speaking to us today.
Aditya Puri (AP): Very good. Thank you.
ED: HDFC the organisation, and HDFC the bank—give us a sense of what is this bank and how is that associated with the HDFC group.
AP: HDFC is a shareholder in HDFC Bank. They own 23%. We are run separately as two separate organisations. But since it’s the same brand, we have an arrangement on housing loans, whereby we sell an HDFC housing loan, and they process those loans for us. And we buy back 70% of what we originated. That is the only deal inter-company we have. The bank has an independent board and an independent management. HDFC has two members on that board.
ED: And in the time of that relationship, you have now grown from strength to strength, and you are a full?fledged universal bank in your own standing. Give us a sense of your leadership of this institution. If you look at the balance sheet of the institution, it looks like a defensive balance sheet: one which is very focused on liabilities, very under?leveraged, you might say, and also very focused on the organic business rather than on generating returns to treasury and all the good stuff that makes banking today. Is that partially because India is so successful that you don’t need to put a stress on your balance sheet in that way?
AP: Let me backtrack a bit. Firstly, we believe banking is conservative business. This new-fangled banking, which nobody understood, led a lot of people into trouble. Thank God we didn’t have the intellectual capability to understand it (at the time).
So banking in our view has remained and will remain a relatively simple proposition. The moment you transform banking into leading the real economy into a life of its own, not related to a client or not regulated or depending upon basis risk, that’s no longer banking. And especially I think that flourished because you had very low capital requirement and you didn’t have a problem. Most mathematical models say “other things be equal” but whenever you have a problem, other things are not equal. So even they fail.
Now, coming back to HDFC Bank, I won’t say we are conservative, but I would say we are prudent because it’s not our money. It’s the depositors’ money, and we’d like them to sleep peacefully at night. So we are focused on balancing risk and reward.
We clearly define our target market. If we are not getting the risk and reward, we will not grow for growth’s sake. However, in any activity that we participate in, we want to be in the top three. So risk and reward, clear definition of the target market that we will do, extremely focused on good execution and customer service, and we believe a brand is built at multiple levels. Of course, it’s built through advertising, but it’s also built with the experience with the customer, every time he touches you.
ED: Tell me, it’s easy to talk about these values today now that you are on top of the hill. Was there a time when you were the underdog during the time when India was only just taking off and all the different players were fighting for market share, there was a lot of price war, there was destruction along the way, which then eventually made you the king of the hill. Was there a time when you felt like you were the underdog?
AP: We never felt that we were the underdog. We did feel that time is an excellent judge. And having been in banking, you know banking is never a one?way street. And you cannot take risks which are not commensurate with rewards because then you will not be able to provide for the delinquencies that will come up. These things normally happen in an economy where supply exceeds demand. And when people get desperate to grow, then they take risks which are not commensurate with reward.
In India, fortunately, demand for financial services will exceed supply for the next ten years. So consequently, any irrational behaviour was probably the thinking that you will gain something too fast, but it was totally unnecessary because we, underdog or overdog, grew at 30% compounded from the day we started, between 25–30% compounded.
So we saw no reason at all to burn the candle at both ends in terms to take a high risk with a lower return and then not get the required return on equity. And in retail what clearly happens is you can’t predict when you will get a default, but a default on the product will come.
ED: Give us a sense of the competition in India’s market in your words. How do you see competition in financial services in India today?
AP: I think the competition is intense. However, I think there is no need for irrational competition. I get these comments like, “Retail banking is risky in India.” Absolutely not. When demand exceeds supply, how can it be risky if you’ve got your systems right? It’s risky if you don’t have the right target market, you don’t have the right systems, and don’t follow the right processes. So the competition is intense. It passed through a period of irrationality. Today, I think it’s very rational but intense competition.
ED: And who would you put as some of your honourable competitors in that sense, other institutions that you look at to benchmark whether you are on the right track?
AP: I think State Bank of India has done a very good job. I think Standard Chartered Bank is doing well. ICICI Bank slowed down because they had to readjust something that they gave as stated policy. So we have different competitors for different segments. In the retail space today we only really have State Bank as major competition, and we are leaders by far. In the corporate space, we have State Bank and ICICI and Chartered. And on transaction banking, I would say it’s Corporation Bank, State Bank, ICICI Bank, Standard Chartered Bank and Citi.
ED: We know a lot about your retail banking business, but we hear very little about your corporate banking and your transaction banking business. I want to come back to that in a second.
The question I want to ask before that is: you seem to be succeeding on the deposit side of your business very well. In fact, if you look at it activity wise, your bank is going further down the line, maybe because of the brand or the perception or maybe because of the service that you’re providing, I’m not sure which, but why do you think that you are succeeding on the current account savings account (CASA) side of your business?
AP: Two things we have to understand about CASA. CASA and HDFC Bank are embedded into our business model. We are the number one player in transaction banking; that means we collect and make payments for all sections of the economy. So the corporates, the stock exchange, the commodities, agriculture, micro enterprise—for all these guys—when you collect and pay and you’re the largest, then you are left with an involuntary float. So as long as our transaction banking business grows, the float will grow.
Well, 55% of the settlement on the stock exchange happens through HDFC Bank. The stock market grows, our float grows; 65% of the settlement on the commodity exchange happens on HDFC Bank. We’re the number two collector of income tax for the government. That adds to the float.
In addition, on the retail side, we’ve got specific products aimed at making it convenient for the retail customer to bank with us. We are number two to State Bank and RTDS. We are not number two in size. RTDS is, so it just shows the quality of service that we get. So our average balances on the savings that come because of penetration are about two and a half times anybody else.
So there’s this question that investors have been asking me forever: others are also coming in, when are you going to lose? The fact of the matter is, you can’t just walk in. You have to become the largest in transaction banking. You have to be in the stock exchange. You have to be in commodities. You have to have products that are aimed at the shopkeeper, products that are aimed at the individuals. And your CASA has to flow as a consequence. It’s not something you can go and bid for, and that is why, as we grow, we’ve not had pressure in the proportion of our CASA.
ED: And where are you taking this multiple capabilities, these multiple cannons, as it were? What’s the end game as you define it for yourself in order to make sure that you don’t lose market share?
AP: What has happened is we doubled our distribution in the last 18 months—more than doubled. We were 725 branches. We’re close to 2,000 branches now. Our products we’ve taken to all the branches. We’ve substantially changed our operating systems. We changed our technology systems. We were the first to introduce a data warehouse almost eight years back, which has affected the way we do our credit, the way we do our marketing—every single customer, we have profitability for.
We have segmented our customers. Similarly, for instance, on the corporate side, we’ve got what we call supply chain management for some of the largest corporates. The vendors deal with us. The corporate deals with us. The dealer deals with us. And we intelligently file transfer back into his SAP system so it’s closely linked with us.
We are leaders in the movement from paper to electronic means of money transfer.
So as we move forward, we add new customers, but we continue to penetrate our existing customers with excellent execution and good technology. And we’re getting more and more embedded into their business.
ED: At the same time there comes a point when you need to start looking at the business from the customer end and whether they get an integrated service and so on. Is there a focus in terms of defining your customers a lot more clearly?
AP: Absolutely. You hit it on the head. You have to move from a product to a customer focus, which we did about three years back. The customer wants one stop delivery. He wants convenience. He wants the cheapest, and yet he wants the best. More importantly, I want stickiness, and I want to have the ability to anticipate certain needs. So when he was going into a SAP conversion, we were doing the conversion along with him so that we got integrated into his conversion. And we fed it just like a division.
Now today, every single customer in the bank we know the profitability for. It is available for every person who deals with the customer. When I used to tell people, “Why don’t you cross sell?” Now, if you walk into a branch and if somebody comes to cross sell and you already hold the gold card, and he said, “Do you want a gold card?” You would say, “What a stupid bank. He doesn’t even know I hold gold card.” The moment any customer service person presses a button, your entire relationship comes: how you are to be priced, what are the products you have, and what are you supposed to be sold.
ED: That said, is there a temptation now that you’re clearly on the road to putting the customer proposition together, that you’ve been sitting on so much CASA and you’re under leveraged in that sense—there’s always a temptation for your treasury people to come in and say, “Why don’t we do something more with this?” “Why don’t we move into markets?” for example. And you’ve got all the different distribution points. You have access to the capital markets and so on. Is it a temptation, or is it something that you consciously avoid?
AP: You see, what we have done is we avoid substantial position taking. But as far as dealing for the customers is concerned, we are one of the market leaders in foreign exchange derivatives. But that is customer based and finding a solution for the customer. We’re not a major player in position-based FX service.
ED: Your treasury people—are they home?grown, or do you also go out and get good people?
AP: Oh, they’re from everywhere. They’re from Citibank, they’re from Bank of America, they’re from Credit Suisse, they’re from Deutsche.
ED: In order to succeed in your bank, do they need to subscribe to a certain value system as a result?
AP: Yeah, don’t make a loss. I’m saying that facetiously. But the point is that you can bet some amount, but you don’t bet the bank. And the growth rate of the bank is not based upon your earnings. You know, Emmanuel, and the surprising part is if you look at people like Deutsche and Citi and all of them, they’ve been quoting at 0.8 times book, because they’re earnings are so sexy that only they understand them.
So the market is not giving you too much value for these earnings that you talk about. Please understand, it’s very good discussing in a banking conference, these earnings, but if the market doesn’t understand the predictability of these earnings, you will not get a multiple on your stock.
ED: But how do you keep the house in order? Of the different inflection points that you probably have as a CEO: you have your treasury guys, you have your product guys, you have your distribution guys, and you have the customer. How much time do you find that you have to spend on which of these elements to make sure that the house is in order?
AP: See, the house will be in order through systems. I must get a report on an exception. So the treasury has limits in terms of how much earnings they can bet, what the value at?risk is that they can take, the retail people have a probability of default, the operations people have to provide superlative service with a reduction in cost and turn-around time, etc.
So my maximum time is spent out in the market with the customers because that’s where the business is. Inside, I’m more on an exception basis. I am not the executor. I am the executor if you don’t perform as per guidelines and as per systems.
So we’ve got very clear systems. We’ve got very clear defined terms. We’ve got extremely good delegation. And my time is mainly with the customer—sitting, reviewing, setting the vision, jointly agreeing on strategy, and normally putting in position what we will do for the next two to three years.
2. Management of risk
ED: How would you describe the organisational structure of HDFC Bank and the governing structure, the sense of accountability at the different layers of the management team both in terms of ensuring risk management as well as in terms of just keeping up with the times and taking risks and moving on?
AP: See, there are three parts to it: 1) When we talked about corporate governance, we realise that everybody and his brother knows what good corporate governance is. The question is: How do you institutionalise it? So we actually got a corporate governance audit conducted and a rating on corporate governance, which meant that we had to institutionalise the role of the board, the role of the managing director, the role of each person down the line and what he can do and what he can’t do.
So there isn’t anything that he can deviate from without getting his boss’s signature. So the boss can’t tell him, “You do this.” He says, “Sure, I’ll do it. Can you give it to me in writing?” which means then it’s the boss’s neck on the line. So we institutionalise corporate governance.
Same thing goes for risk. In a lot of organisations you have risk reporting to the business manager. Now however much you may say that the business manager is professional, there is going to be some dilution of risk management. Because, to the business manager, his profit is what counts. That’s where he’s going to get his bonus from. So we’ve kept risk and marketing separate from day one.
Similarly on operations. Operations also don’t report to the business manager. Operations and risk actually report to me so that they have their independence. They are support functions but they’re not throw?away functions.
So each guy has a very clearly defined role, and the culture within the bank is also very clearly defined. You will be customer?focused. You will tell the customer what you deliver, and that’s how we build up our plan, you will deliver it time and time again. And you will innovate along with the customer. No integrity issues will be tolerated. Any deviation from policy you escalate, and there is a person who isauthorised to approve.
ED: The model sounds very interesting and very convincing in a way, but doesn’t that end up creating a structure where it’s kind of a divide and rule thing—where the CEO then becomes the most important orchestrator in that sense, so there’s a lot more power in you than there would be in another organisation where the CEO allows committees to work together, for example?
AP: Let me give you my point of view. When you hear the New York Philharmonic, how would you like two Zubin Mehtasconducting it?
ED: You don’t.
AP: You don’t like it, right? So the point is each one has to have his job, but that doesn’t mean you start mixing. So if you ask any of the people reporting to me, they will say one of the reasons they’re working for the bank is because they have the freedom to do what they want. But that freedom does not imply that you will forget corporate objectives. That freedom doesn’t imply that you will not work as a team. So my job is not to execute. My job is not to tell you what your job is. My job is to make sure that everybody is running to score a goal—not ours, the opposite team’s.
ED: Give us a sense of the governance at the board level. What’s the composition of your board, and what is the value that they provide you in terms of guidance, in terms of vision, in terms of mandates?
AP: See, as far as the board is concerned, we have two people from HDFC. The chairman is the ex?finance secretary of India and he was also India’s representative in the IMF. We have another board member who was the personal secretary to the prime minister. We have a person who’s an expert in agriculture. We have a person who’s in small scale. We have one of the most eminent chartered accountants, Bobby Parikh, who’s been with all the multinational companies and knows what needs to be done. We have another chartered accountant who’s been treasurer for some of the largest corporations in India.
So it’s a board that goes into detail. We present the budget to them. Our policies are presented to them. All product programmes are approved by them. Everything is discussed and only after we all agree—and all my management is present in all board meetings. So if corporate bank is presenting, I don’t present it. Corporate bank presents—but he, the head of Corporate Bank, sits as an invitee on all board meetings.
So the board is not dependent purely on what the CEO says. There’s not so much wasting—and internal audit reports to the chairman. So it’s a very open organisation when there are 14 invited members from management on every board meeting. And they present and talk so there is nothing hidden. And everything is discussed. We can go back and take further guidance from them. So the plan is approved by them. The chair policies are approved by them. Product programs are approved by them. And then there are periodic reviews.
3. On the Indian economy
ED: Final question: the Indian economy, the sustainability of the Indian economy, in the medium term—what is your reading of where the Indian economy is today? And to what extent is it sustainable given a number of the challenges that it’s facing and perhaps facing quite well because the challenges themselves are changing India in that regard? And what are some of your fears about the Indian economy?
AP: If you look at the Indian economy, fundamentally it’s dependent upon industry, services to a smaller extent, and agriculture. Or if you take the other side of it, it’s 55–56% consumption, about 20% investment, and the balance, government spending. So I think we over emphasise government spending to the outside world. And we over emphasise India being an investment story. India’s really a consumption story and it’s largely a private story. That’s one part of it which is why it continues to move.
Structurally for the medium and long term if you look at India, we have a young population. We have a high savings rate of 35% of financial intermediation. Could be better. We could have a debt market, and we could have a reduction in fiscal deficit, etc. So we have a high savings rate. We have a young population. We have low dependence on exports. We have a perfectly functioning banking system. And there are lots of improvements that are required, which, if we work on them, can only improve from here.
So I think growing at 8% is not a problem for India. Somewhere between 7.5–8.5% is not a problem. However, we would be foolish on our part not to aim at a 10% growth rate. I think everybody knows what needs to be done. The problem in the past has been the execution.
So if you look at the budget, it identifies a reduction in fiscal deficit. It identifies agriculture reforms that need to be done. It identifies that subsidies must move from general to specific subsidies so that the intended beneficiaries get them. It identifies health. It identifies education. It identifies corruption. So there’s nothing that has not been identified to reach the 10% growth rate, but we’ve not been very good at that.
ED: Honestly, why should we not be concerned about government deficits, the unspecified subsidies and also the unwillingness to wean in almost a third of the population on those subsidies, basically?
AP: I am now far more hopeful than I would have been two or three years ago.
ED: And why is that?
AP: First, you have to understand is the Right to Information Act that has been introduced, which allows the media—or any individual—to ask how this project is approved or who approved this, and assigns responsibility with deterrent action, which will substantially reduce corruption.
Second, if you see what Nandan Nilekani is doing in terms of the UID, once the UID is there and everybody has a bank account, then they will substitute food discounts with actual cash subsidies.
Third, a lot of the government is moving to e?governance, where the ability for petty corruption will get substantially reduced. Clearly they have identified how much fiscal consolidation there will be. And I believe that we have reached a stage where there is no alternative, the debt market is also necessity, a long?term debt market.
So I do believe that we will move higher and higher in our growth trajectory. I don’t think things will be sorted out overnight. But I would say in the next 18– 24 months you will see a lot more being sorted out.
In fact, what I would say is—and I want this in the proper perspective—I am thrilled with the intrusiveness of the media. We have a very noisy media, and sometimes that noise leads to confusion in terms of a democracy in transition. Don’t mistake that with the vibrancy of India.
So when you talk about somebody saying there’s corporate government deficits, for Christ’s sake, there’s a corporate government deficit in the world. We don’t have a monopoly on human frailty. So whenever there are licenses and all that, etc., etc., yes, I’m not saying there’s no corruption, that somebody from Goldman Sachs wanted to ask me about their corporate governance. And I said, “You have a drink and keep quiet, and that will be better for you.”
So I’m just saying we are defensive about corruption, but we may be a little too defensive. We don’t have a monopoly over human frailty. There’s corruption all over the world wherever there’s a shortage commodity, a license is to be issued, real estate permissions. That’s not to say we don’t need to weed it out, but I think we’re making progress.
