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The ICFAI University

HDFC’S BUSINESS MODEL

“We have looked at the concept of a universal bank, single entity but realized it
makes more sense to have separate legal entities with HDFC on the top, holding
equity in each” Mr. Keki Mistry, M.D., HDFC1.
“I do not agree that a single product company cannot be a successful company. One
example of the most successful company today in the financial sector is the HDFC”.
Mr. Janaki Ballabh, ex-Chairman, State Bank of India.2

INTRODUCTION
Housing has been an important item on the national agenda of the Government of India over the
years. In the year 1998, the government declared ‘housing for all’ as a priority area and set a target
of constructing two million houses every year. According to the National Building Organization
(NBO), as in March 2003, the total housing shortfall was established to be
19.4 million units, of which 12.76 million units were in rural areas and 6.64 million units in urban
areas3. According to Housing Development and Finance Corporation (HDFC), every rupee spent
on housing was estimated to lead to a 78 paise increase in gross domestic product 4. Housing has
been a visible output, which reflected the progress of the country. It has been a vital sector of the
national economy that generated jobs, taxes and wages that positively influenced the quality of
life.
In the late 1990s, globally there was a trend of mergers and consolidation. According to ‘Top Ten
Banking and Securities Industry Outlook’ report published by Deloitte Consulting, during 1998,
the global banking and securities industry saw an exceptional rise in mergers and acquisitions. It
was established t-[[[[‘’[]]hat 455 M&As worth $365 billion took place in the industry. The major
Mergers and Acquisitions took place in Europe and America. The merger of Swiss Bank with
Union Bank of Switzerland to form UBS, Citicorp and Travellers Group to form CitiGroup and
Nations Bank and Bank of America to form New Bank of America have created some of the
largest banks in the world5. The motive behind these mergers was the possibility and opportunity to
cross-sell their products. Another goal was to adapt technology from the other businesses rather
than spending time and money to develop it themselves. The trend of consolidation affected even
the Indian markets. With a motive to exploit the synergies brought by universal banking, Industrial
Credit and Investment Corporation of India Ltd (ICICI Ltd) reverse merged with its subsidiary
ICICI Bank in the year 2002, creating the second largest bank in India with total assets worth
Rs1,00,000 crores. According to the ICICI Bank’s 2002-2003 Annual Report, the merger
combined the large capital base of ICICI Ltd., with the strong deposit raising capability of ICICI
Bank. This gave the new entity, ‘ICICI Bank Ltd.’, an opportunity to increase its market share in
banking fees and commissions, while lowering the overall cost of funding. However, HDFC the
leading housing finance company in terms of deposits and loan disbursements positioned itself as a
group of companies with each company offering specific products to a specific set of customers
(Exhibit 1). It wanted to generate synergies of universal banking by cross-selling its products
1
Mistry, Keki, “Core Competence Key for HDFC”, Hindu Business line, February 22, 2002.
2
‘Round Table’, www.businessstandard.com, July 24, 2003.
3
Shankaran, Sanjiv, ‘ Housing finance: Nesting becomes a lucrative business’, www. blonnet. com,
April 28 2002.
4
Ibid
5
‘A hard task to sell mergers to customers’, www.btimes.co.za , May 30, 1999.
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across its subsidiaries. As of October 2003, HDFC was India’s largest housing finance company
with an asset size of Rs.28,000 crores and cumulative loan disbursements of Rs.43,520 crores. Its
outstanding loan portfolio covered around one million dwelling units, 75 % of which were
disbursed to ‘individuals’6.

HDFC AND ITS SUBSIDIARIES

HDFC was set up on 17th October 1977 as a public limited company. The primary objective of
HDFC was to enhance residential housing stock in the country through the provision of housing
finance in a systematic and professional manner, and to promote home ownership. Another
objective was to increase the flow of resources to the housing sector by integrating the housing
finance sector with the overall domestic financial markets7. HDFC’s source of funds included term
loans from banks and insurance companies, retail deposits from individuals and trusts, non-
convertible debentures, bonds from domestic debt markets, floating rate notes from international
debt markets, multilateral loans from USAID, Asian Development Bank (ADB) and mortgage
backed securities. Since its inception in 1977, the company maintained a consistent growth in its
operations (Exhibit 2). Over a span of 25 years, HDFC became a pioneer in housing finance in
India. As in June 2003, the company financed 2.2 million housing units. HDFC registered a steady
improvement in its financial performance due to a constant demand for housing loans. In
particular, in early 2000, its performance has been noteworthy compared with the problems that
surrounded the rest of the financial sector. During 2002-2003, despite increased competition, loan
business continued to be strong, and recorded an increase of 36% over the previous year. During
this period loan approvals amounted to Rs.11,732 crores representing a growth of 30% and
disbursements amounted to Rs.9,951 crores, representing an increase of 31% (Exhibit 3).
The belief that a financial entity should cash in on its strengths to offer all kinds of financial
services under one umbrella made HDFC diversify into other sectors. HDFC, with these
philosophy co-promoted financial intermediaries in banking, real estate services, asset
management, securities trading, life Insurance, general Insurance and BPO services. In the year
1994, HDFC Bank was set up, as the wholly owned subsidiary of HDFC8. The wholesale banking
group of HDFC Bank provided its corporate and institutional clients an array of commercial
banking products and transactional services. The retail-banking group extended financial products
including deposit products, loans, credit cards, debit cards, bill payment services, third-party
mutual funds and investment advisory services. The treasury group managed its balance sheet,
including its maintenance of reserve requirements and its management of market and liquidity risk.
The treasury group also provided advice and execution services to its corporate and institutional
customers with respect to their foreign exchange and derivatives transactions. In addition, the
treasury group sought to optimize profits from its proprietary trading, which principally
concentrated on Indian government securities. Over a period, the Bank recorded a significant
growth. For the year 2001, Finance Asia Magazine adjudged HDFC Bank as the ‘best managed
private bank in India’. In a short span of nine years, the bank set up a network of over 243
branches spread over 131 cities across the country9. Despite the intensified competition, the bank
recorded a consistent growth. During 2002-2003, the bank’s revenues and business volume grew
in all the three segments – Wholesale Banking, Treasury and Retail Banking. The total assets of
the company stood at Rs.30,424 crores as in March 2003 up from Rs.23,787 crores in the same
period during previous year. During this period, the company made loan approvals of Rs.5,460
crores and disbursed loans amounting to Rs.4,560 billion. By the end of the second quarter 2003,
the total number of retail accounts touched 3.6 million up from 2.8 million in September 200210.
HDFC Asset Management Company (AMC) was set up in the year 1999. HDFC AMC was set up
as a subsidiary with HDFC holding 60.1% of the company and Standard Life Investments (SLI),
the rest. In March 2003, HDFC AMC signed an agreement with Zurich Insurance Company to

6
Shankaran, Sanjiv, ‘HDFC: Avoid Fresh Exposures’, www.blonnet.com, December 15, 2002.
7
‘Objectives and Background’, www.hdfc.com/we_corporateprofile.asp
8
“About Us” – www.hdfcbank.com.
9
“About Us” – www.hdfcbank.com
10
‘Wholesale banking, low cost of funds boost HDFC Bank’s Q2 net – First-half profit at Rs 224
crores’, www.thehindubusinessline.com, October 11 2003.

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acquire Zurich Asset Management Company (I) Ltd while its asset management business. As of
April 2003, the assets managed by HDFC Mutual Fund and Zurich India stood at Rs.107.78
billion. For the financial year 2003, HDFC earned a profit before tax of Rs.224.5 million as against
Rs.95.6 million for the year ended 2002.
HDFC Securities was set up as a subsidiary to provide customers with these services. Its objective
was, to become a ‘one-stop’ solution for all investment needs of the customer. HDFC Securities
Limited (HDFCsec) was promoted by the HDFC Group, with equity participation from HDFC
Bank, HDFC and Chase Capital Partners & associates. HDFC Securities extended broking services
to domestic investors and NRIs, on the National Stock Exchange and the Bombay Stock
Exchange. HDFCsec helped its customers allocate, select and manage investments wisely, and
also supported them with the highest standards of service, convenience and hassle-free trading
tools.
In September 2000, HDFC launched an online portal, hdfcrealty.com. ‘Hdfcrealty’ was set up to
provide a range of real estate services for its customers over the net. It was designed as an
organized electronic marketplace for properties that provided an entire gamut of real estate service
such as buy, sale or lease of housing properties. The portal made available the most professional,
transparent, and efficient service to the real estate customers.
HDFC Standard Life Insurance Company Limited was a joint venture between HDFC Ltd., and
Standard Life Assurance Company. HDFC Standard Life Insurance offered a wide range of
insurance and pension plans namely Endowment Assurance Plan and Money Back Plan. These
were customized to suit individual needs by adding optional benefits such as Critical Illness
Benefit, Accidental Death Benefit and more. Since its inception, the company showed a consistent
performance. HDFC Standard Life Insurance Company crossed Rs. 5,000 crores in cumulative
insurance coverage during 2002-2003. For the financial year ended March 31, 2003 the premium
generated from new business was Rs.132 crores compared to Rs. 36 crores in the previous year.
On 30th January 2001, State Bank of India (SBI), HDFC, Dun & Bradstreet Information Services
India Private Limited (D&B) and TransUnion International Inc. (TransUnion) signed an agreement
to establish Credit Information Bureau (India) Limited (CIBIL) – with shareholding percentages in
the proportion of 40:40:10:10 respectively. D&B and TransUnion, who were the technology
partners, were well known in the area of credit information business. CIBIL gathered credit related
information regarding individual and corporate/commercial borrowers, maintained a database of
this information and sold that information in the form of credit reports to a closed user group
(credit grantors) for a price. CIBIL had many Scheduled Commercial Banks, Financial
Institutions, Housing Finance Companies (HFCs) recognised by National Housing bank as its
members. As of 2002, it had 53 banks accounting for over 90% of the total credit outstanding
amongst the commercial banks, seven HFCs accounting for over 70% of the total credit
outstanding amongst the HFCs and six FIs accounting for over 90% of the total credit outstanding
amongst the FIs. Data sharing was to be based on the Principle of Reciprocity, the basic elements
of which was that reports could be obtained from the bureau only if data was contributed i.e. a user
had to be a data provider.
HDFC made a foray into general insurance with HDFC Chubb General Insurance Company Ltd
(HCGICL). HCGICL was a joint venture between HDFC (74% stake) and Chubb Corporation
(24% stake), a leading property & casualty insurer of US with $ 30 billion in assets. HCGICL was
set up in the year 2002, with a capital of Rs. 101 crores. The company offered Auto Insurance,
Group Travel Insurance, Commercial Insurance, which included fire and marine insurance
products.
According to a McKinsey Report, the global IT enabled service industry is expected to have a
turnover of $180 billion by 2008. Out of this, the Indian market size is expected to be around $
17.6 billion. HDFC made a foray into IT Enabled Services by setting up Intelenet Global Services,
a joint venture between HDFC and Tata Consultancy Services (TCS), India. For the financial year
2003, the company registered revenue of Rs 217.5 million and its revenues are expected to rise up
to Rs 1.5 billion by the year 200411.

11
‘About us, Intelenet Global services’, http://www.hdfc.com/we_associated.asp.

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HDFC’S CORE COMPETENCIES

HDFC as a housing finance company had certain benefits over other financial institutions.
HDFC’s cost of funds was lower than that of commercial banks. Commercial banks have mainly
three sources of funds – savings accounts, current accounts and term deposits. A savings account
consists of money deposited by individuals and is considered to be cheaper and relatively stable.
On the other hand, the current account deposits are volatile, as they are comprised of deposits from
the corporate sector. As for term deposits, the cost incurred on mobilizing deposits by banks is
comparatively higher than that of HDFC. Further, banks incurred high cost of funds as they had to
meet statutory requirements such as Cash Reserve Ratio (CRR)12, Statutory Liquidity Ratio
(SLR)13 and extend services for retail clients. In the recent past, HDFC raised money from the debt
markets at rates comparable with those paid by leading banks. In the year 2002, it raised Rs 150
crores for five years at 7.05 %. During the year 2002, the average cost of funds raised by HDFC
was around 7 %. In comparison, the average cost of funds raised by SBI, which was considered the
biggest competitor to HDFC in housing finance, was around 6.6 %14.
HDFC took little interest rate risk on the loans extended to its customers. Loans given on floating
rate15 basis of interest were funded by an equivalent amount of floating rate16 interest liability.
Fixed rate interest borrowings were used to fund fixed rate interest loans. So, whether interest rates
came down or went up, the company’s profit margins remained stable.
A portion (7% of HDFC borrowing as in June 2003) of HDFC funding was from International
Financial Institutions and this entire fund was swapped17 into Indian rupees, which was exposed to
a very minimum risk of foreign exchange. As all the foreign currency borrowings were swapped
into Indian rupees, both the borrowings and the loans were in rupees. The international lines of
credit extended by foreign financial institutions were much cheaper when compared to funds
raised from the domestic markets. In the year 1988, HDFC entered into an agreement with the
Bank of India whereby HDFC would receive fixed rate counterpart rupee funds in lieu of US
dollars deposited with Bank of India in New York. Over a period, it became the channel for the
international lines of credit extended by the foreign financial instititutions to fund housing
development projects in India. In 1985, HDFC entered into an agreement with USAID (United
States Agency for International Development) under which a sum of $25 million was borrowed
from the US Capital Market in 1986-1987. In the year 1989, Kreditanstalt fur Wiederaufbau of
Germany, sanctioned a line of credit of DM 25 million to fund loans disbursed by HDFC for low
cost housing project directed to economically weaker sections18. In June 2003, HDFC signed a loan
agreement for $200 million with International Finance Corporation, Washington.
HDFC had little credit risk. HDFC’s total non-performing loans were 0.81 % of the total assets. A
provision of 100% was made against these assets and hence, their NPAs were zero on a net basis.
As of February 2002, HDFC enjoyed the lowest cost-income ratio in Asia. Its expenses constituted
just around 14% of its net interest income whereas for commercial banks, the ratio was above
50%. HDFC’s total expenses incurred, amounted to only 0.51% of its total assets while for other
banks it was between 2.3 and 3 percent.

HDFC AS A SINGLE PRODUCT COMPANY

ICICI Bank was a pioneer in universal banking in India. It has been operating as an integrated unit,
offering different kinds of financial services. On the other hand, HDFC, which was keen to
generate synergies of universal banking, has been operating as a group of companies 19. It
positioned itself as a ‘single product company’20 offering services to specific group of customers. It
offered a range of financial services and products from various companies within the group. The
12
Cash Reserve Ratio is the portion of commercial bank deposits to be maintained as cash with RBI.
13
Statutory Liquidity ratio is the portion of commercial bank deposits to be maintained as liquid assets
i.e., cash, gold or any Government approved securities such as bonds issued by DFIs.
14
Srivastava, Vikram, ‘HDFC: A problem of plenty’, www.rediff.com, October 21 2002.
15
A floating rate of interest is one that fluctuates according to the market lending.
16
A fixed rate of interest means that the rate of interest on the loan amount remains unchanged for
the entire duration of the loan agreement, irrespective of the change in the interest rates in the economy.
17
A currency swap involves the exchange of loan in one currency for a loan in another currency. In
this case both principal and interest payments are swapped. It does not include the legal swapping of
actual debts but an agreement to meet the uncertainties under loan or lease agreements.
18
‘HDFC, Company Background’, www.indiainfoline.com.
19
‘ICICI’s key is integration’, www.businessline.com, October 25 2001.
20
‘HDFC’ model was to maintain separate companies with each company offering specific products
targeting specific set of customers.

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idea of separate companies was to allow each company to specialize in their core competencies.
Further, each division such as commercial banking, stock broking, and insurance has different
regulators and they have different capital requirements to be met. Mr. Keki Mistry, MD HDFC,
opined that dealing with multiple regulatory bodies that govern banking, capital markets and the
insurance sector was one of the impediments21 for conversion into a universal bank22.
Globally, almost two thirds of mergers that took place in mid 1990s have failed to add value to
shareholders23. Citibank and Travelers group, considered, as one of the largest mergers in history
was a failure. In this case, there was an asset-liability mismatch as the short-term funds were used
to fund long-term loans. They opted for a de-merger within four years. Experts opine that the
chances for a merged entity to succeed and create synergies between their operations are not
always good, as has been noticed in the recent past. Moreover, many business issues, especially in
‘bank assurance model’ such as nature of lending and operating culture of the merging companies
form different.
Gemini Consulting financial head Jay Karumarante observed that with mergers, banks were able to
manage industry risks by diversifying into different businesses and products 24. According to
analysts there were certain advantages in opting for mergers. The merged entity could get access to
low-cost funds procured by both the institutions and expanded reach in the form of large customer
base. While disadvantages included blocking large amount of funds to meet the requirements of
the RBI, in terms of maintaining the stipulated CRR and SLR25.
According to Parekh, HDFC generated synergies by cross-selling its products across its
subsidiaries. HDFC Chubb General Insurance Company utilized the HDFC network to cross sell
its home insurance products. It utilized HDFC and HDFC Bank’s database to cross-sell its
accident insurance products. HDFC distributed mutual funds through its network and acted as
investor service centre. It’s recent cross-selling initiatives included introduction of a wide range of
special benefits for new housing loan customers such as life insurance coverage at attractive
prices, lower minimum balance requirements for savings accounts at HDFC Bank, standing
instructions for direct payment of monthly installments on housing loans, free credit card and
lower interest rates for consumer loans from HDFC Bank. Mr Keki Mistry opined that cross selling
would help leverage the infrastructure and technological strengths of the HDFC group companies,
thereby providing a wide range of products and services from a customer-centric perspective.
On many occasions, the management of HDFC reiterated that it had no plans of transforming into
a universal bank. Mr. Keki Mistry stated in a report that he felt that there was no advantage in
merging HDFC with HDFC bank26. He opined that if HDFC were to opt for universal banking,
there was a danger of facing an asset-liability mismatch by channeling short-term funds from the
savings and current accounts into the housing sector, which typically have longer tenures. Mr.
Deepak Parekh, in the Annual General Body Meeting, 2003 stated that HDFC and HDFC Bank as
separate institutions had performed well and both registered healthy growth of 20% and 25% in
profits over the previous years, respectively. He also stated that all the subsidiaries as separate
institutions performed well and there was no need for a merger or a consolidation. He felt that
though the group stayed as separate companies it was able to derive all the benefits of universal
banking. As he put “There is no cause for a merger for the sake of merger, or merger to create a
universal bank. No such necessity or fact exists.” said Deepak Parekh, Chairman HDFC27.

21
In India, Asset Management Companies were regulated by SEBI, Housing Finance Companies by
the National Housing Bank, Commercial Banks by RBI and insurance companies by the Insurance
Regulatory and Development Authority (IRDA).
22
Menon Shyam G, Venkataraman Latha, ‘Core Competence key for HDFC’,
http://www.blonnet.com/2002/02/22/stories
23
Vedpuriswar, Chowdary, Nagendra, Madhav, Phani, “Beware of Mergers of Convenience”,
www.economictimes.com, January 4 2002.
24
‘A hard task to sell mergers to customers’, www.btimes.co.za, May 30 1999.
25
‘Housing Development Finance Corporation’, www.biz.yahoo.com, July 19 2003.
26
‘HDFC no to universal banking’, http://www.domain-b.com, October 18 2001.
27
“Round Table-Business standard Banking Annual 2002” - Business Standard, July 24 2003

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Exhibit 1
HDFC and its subsidiaries

Source: Conrad D Souza, ‘HDFC presentation on housing finance’, Housing Finance Seminar-
Karachi, August 2003.
Exhibit 2
HDFC Performance during 1997 – 2003
(Rs. in Crores)
1997 1998 1999 2000 2001 2002 2003
Income:
Operating Income 1263.53 1436.91 1746.87 2013.35 2376.53 2692.42 2967.32
Other Income 1.8 7.77 5.86 2.2 5.82 7.74 8.3
Total Income 1265.33 1444.68 1752.73 2015.55 2382.35 2700.16 2975.62
Expenditure:
Interest & Financial 855.49 982.07 1250.47 1436.95 1689.61 1871.24 1969.8
Charges
Operating &
Administrative 56.13 60.69 63.59 74.21 91.41 106.16 129.09
Expenses
Interest and Operating 0.72046027 0.721793 0.749721 0.749750 0.747589 0.73232 0.7053622
5 1 9 7 6 7
Expenses to total
income
Profit before 353.71 401.92 438.67 504.39 601.33 722.76 876.73
Depreciation
& Tax
Depreciation 40.82 50.56 49.77 43.58 45.68 31.83 25.7
Profit Before Tax 312.89 351.36 388.9 460.81 555.65 690.93 851.03
Tax 65 58 55 59 82 110.92 160.74
Profit After Tax 247.89 293.36 333.9 401.81 473.65 580.01 690.29

Source: Capitaline 2000

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Exhibit 3
Operating Highlights of HDFC
Rs in crores
2001-02 2002-03 % change
Loan Approvals
Current Year 9041.25 11731.6 30
Cumulative 40135.81 51867.4 29
Loan Disbursements
Current Year 7616.56 9950.87 31
Cumulative 33569.57 43520.4 30
Source: hdfc.com

Effective rates on Home Loans

1999 2000 2003
Annual income 4,20,000 4,20,000 4,20,000
Total tax payable 1,38,600 1,47,200 1,38,600
Maximum deduction for interest allowed 30,000 75,000 1,50,000
Deduction on principal 10,000 20,000 20,000
Loan amount 17,00,000 17,00,000 17,00,000
Interest 14.50% 13.25% 9.00%
Tenor (years) 15 15 15
EMI per Rs.1,00,000 1,391 1,307 1,034
Total amount paid per year 2,83,764 2,66,628 2,10,936
Interest component 2,46,500 2,25,250 1,53,000
Principal repaid 37,264 41,378 57,936
Net taxable income 3,80,00 3,25,000 2,50,000
Total tax paid 1,25,400 1,14,075 82,500
Total amount saved 13,200 33,345 56,100
Effective interest paid on home loan 2,33,300 1,91,905 96,900
Effective interest on home loan 13.72% 11.29% 5.70%
Source: Conrad D Souza, ‘HDFC presentation on housing finance’, Housing Finance Seminar-
Karachi, August 2003.

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