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The RBI has finally approved the HDFCB–HDFCL merger structure, providing significant relief on the PSL front while allowing for an increased stake in the insurance business and paving way for the merger by July-Sep 2023. However, some clarifications from the RBI are still pending. Key takeaways:

* No relaxation on CRR, SLR and LCR, as expected, but the drag is largely manageable: The merged entity will have to comply with CRR, SLR and LCR norms from day one, as expected. We believe the merged entity will be largely compliant on CRR in FY24E, while additional requirement in FY25E will be minimal at Rs128bn (assuming 6% CRR maintenance vs. the current regulatory requirement of 4.5%). While on the SLR front, the additional requirement for FY24E/25E on the merged balance sheet will be Rs275bn/Rs295bn, which also looks manageable and should be margin positive given the recent increase in G-Sec yields is >7%. However, the bank runs a relatively lower LCR at 116%, which we believe needs to be ramped up.

* Staggered PSL requirement to ease drag on margins, regulatory compliance: The RBI has allowed the bank to achieve PSL target (40% of ANBC) on the back book in a staggered manner over three years (1/3rd each year) over FY25-27E instead of 1 yr (FY25E), which would have been onerous and practically difficult for the bank, given the size of PSL requirement. As per our calculations, the bank could be partly compliant in the first year factoring the existent PSL book with HDFCL, while bank would now get enough time to organically build balance PSL (for eg housing loans or Buying IBPC/PTC) instead of buying low yielding RIDF bonds. Thus, the staggered build-up of PSL with relatively better-yielding book will reduce the drag on margins by 5bps in FY25E and ease the burden of regulatory compliance to some extent.

* Permission to increase stake in HDFC Life and HDFC Ergo to reduce the drag on these subsidiaries’ valuations: The permission to increase the promoter’s stake in the insurance business to >50% is positive for the bank, which otherwise would have to be reduced to ~30% from the current holding of 48.6% in HDFC Life and 49.98% in HDFC Ergo. We believe this is also positive for the bank, as the risk of such a large stake dilution would have hurt the stock price and consequently the value for the bank. However, HDFC will have to increase the stake before the effective date, either by an open market purchase or a private placement.

* Allowed LAS book till maturity; stake to be reduced in HDFC Credila: The RBI has permitted loan against shares for promoter contribution of >Rs2mn to individual customers to run for its existing maturity. The RBI has asked the bank to reduce its stake in HDFC Credila to <10% within 2 years of the effective merger date, which we believe should not be an issue. However, there is no clarity on the merger of HDB Financials (HDFCB’s subsidiary) engaged in the lending business). The bank will also seek clarification from the RBI on the treatment of the land finance portfolio and grandfathering of HDFCL’s borrowings.

* Retain BUY: We believe the special dispensation on PSL and insurance subsidiaries’ stake is certainly positive for the bank, while grandfathering of liabilities too should be allowed once bank crystalizes the liability around the merger date and re-approaches for the clarity on the same. Post RBI’s clarification and regulatory concerns around the merger’s structure should ease and focus should shift to liability/margin management, where we believe the bank has a healthy track record. Post-merger, the in-house mortgage business will help the bank to accelerate growth and deliver higher RoEs, once the regulatory drag is behind. We retain BUY with a TP of Rs2,050/share.

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