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 Talks to sell majority stakes in two Indian banks have attracted interest from foreign peers in Japan and the Middle East betting on a fast-growing economy, but tighter regulations and valuation concerns could curb their appetite, analysts and sources say.

The rare opportunity for foreign banks to take controlling stakes in a market dominated by state-owned banks comes as existing investors in Yes Bank and IDBI Bank look to divest their holdings.

Banking sector deals in India, especially those involving foreign entities, are rare. A full takeover of troubled Indian lender Lakshmi Vilas Bank by Singapore-based DBS Group in a regulatory-driven transaction in 2020 was the last major deal.

The top shareholders are looking to exit from the two banks about four years after they were roped in by the regulator and the government to help them recover from sharply worsening asset quality due to rampant lending that threatened their stability.

Private sector lender Yes Bank, in which shareholders are looking to sell a 51% stake, has drawn interest from Japan's Sumitomo Mitsui Banking Corp (SMBC) and Emirates NBD, Reuters has reported.

IDBI Bank, in which the Indian government and the Life Insurance Corporation are collectively selling a 60.72% stake, has seen Emirates, Canada's Fairfax Group, as well as local rival Kotak Mahindra Bank express interest.

The foreign interest in the two banks comes as the Indian economy is forecast to grow at 7.2% this year, making it one of the world's fastest-growing major economies.

Demand for bank credit, which includes corporate loans and mortgages, is growing at twice the expected economic growth pace and gross bad loans in the domestic banking sector are currently at multi-year lows of 2.8% of total assets.

Similar to other major markets, inbound banking sector deals are tightly scrutinized in India. Given the sector's importance and linkages with the broader economy, New Delhi is expected to field interest from bidders in countries it has good political ties with, analysts said.

"India's growth story is promising, and corporates are looking to expand their businesses," said Ashvin Parekh, managing director of Ashvin Parekh Advisory Services, which provides services to investors in banks.

"That is enticing these (foreign) players," Parekh said.

Despite those attractions, stricter rules related to capital requirements and ownership restrictions, and state domination with government-backed banks accounting for nearly 52% of the bank credit have weighed on foreign banks' operations in India.

Regulations in India also require that the largest shareholder of a local bank, termed as 'promoter' under Indian regulations, must their reduce shareholding to 26% over a 15-year period.

Foreign lenders, including HSBC and Standard Chartered, accounted for only 3.4% of the banking sector credit as of March 2024, less than half of the 8.4% share they held in March 2000, according to the central bank data.

'FIERCELY COMPETITIVE'

SMBC has been in advanced talks with Yes Bank and its lead investor State Bank of India over the past few weeks for the majority stake acquisition, said three sources with knowledge of the talks.

The core banking unit of Japan's No.2 banking group Sumitomo Mitsui Financial Group has sought Yes Bank operational data and its executives have met with the officials at the Reserve Bank of India (RBI), the central bank, said the sources.

Yes Bank was rescued by a consortium of local banks in 2020 after bad loans soared.

Emirates NBD is also in talks for a stake in Yes Bank. It is also participating in the stake sale process for IDBI Bank, said one of the three sources above and a fifth person familiar with the talks in India.

The government plans to invite financial bids for IDBI Bank by the end of this financial year, divestment secretary Tuhin Kanta Pandey told Reuters last month. IDBI Bank was rescued by the government in 2019.

RBI has approved Fairfax Financial, Emirates NBD, and Kotak Mahindra as potential bidders, Reuters reported earlier this month.

The sources declined to be identified as the talks were private.

Yes Bank and Kotak Mahindra did not comment on the deal talks. SMBC declined to comment. The RBI, IDBI Bank, Emirates NBD, and Fairfax did not respond to Reuters emails seeking comment.

HIGH VALUATIONS?

However, some potential bidders are expected to baulk at the high valuations of the targets, analysts say, clouding the prospects of the deals being sealed. It was not immediately clear known how soon the two deals will be finalised.

Yes Bank is currently valued at about $10 billion, and trading at 1.58 times the 12-month forward price-to-book value, according to LSEG, compared to the sector median price-to-book value of 1.45 times.

IDBI Bank trades at a 12-month trailing price-to-book value of 1.97 times, LSEG data shows.

The "legacy" of asset quality issues at the two banks would also feed into the cost of acquisition for the prospective foreign buyers, said independent research analyst Hemindra Hazari.

"The real problem, however, is that the Indian banking system is fiercely competitive," said Parekh. "A foreign player would need a significant amount of branch network, distribution and franchise to be able to sustain in the banking system."