Hdfc Bank (HDB) Risk Analysis

Our performance and the quality and growth of our assets are dependent on the health of the overall Indian economy. In addition to inflation, interest rates, external trade and capital flows, the COVID-19 pandemic, and in particular its domestic impact, has been an important driver for India’s growth trajectory in fiscal year 2022. While we experienced solid growth in the first half of fiscal year 2021, the impact from the pandemic on India affected the quality of our loan portfolio. Our gross non-performing loans as a percentage of our total loan portfolio decreased from 1.8 percent in fiscal year 2021 to 1.3 percent in fiscal year 2022. While a successful vaccination drive could improve growth prospects, a significant proportion of Indian adults are yet to be vaccinated. An increase in the number of COVID-19 cases and any future wave may slow or halt any future economic recovery. In 2020, global GDP contracted by 3.1 percent, but in 2021, global GDP grew by 6.1 percent, as COVID-19-related disruptions eased. However, global growth is likely to slow down again in 2022 due to increasing geo-political tensions and elevated inflation levels. In addition, interest rate hikes by central banks to control inflation could hurt growth and investment sentiments. In India, while gross FDI flows stood at US$ 83.6 billion in fiscal year 2022 compared to US$ 82 billion in fiscal year 2021, the portfolio segment recorded a net outflow of US$ 17.2 billion in fiscal year 2022. We believe that with normalization of liquidity conditions and removal of the accommodative monetary policy stance across the globe, foreign portfolio flows in India could remain weak, as investors are expected to prefer lower risk assets in uncertain times. We believe that overall bank credit growth is likely to increase in fiscal year 2023 from 8.6 percent in fiscal year 2022 (end of period) and 5.6 percent in fiscal year 2021 (end of period), although there could be variations from segment to segment. Industry credit growth could improve with the extension of ECGLS (Emergency Credit Guarantee Line Scheme) and PLI (Production) schemes. Additionally, the Government’s large CAPEX plan could provide support to the industrial credit. In particular, credit to large corporates could increase in the absence of intermediaries. If inflation remains high, however, low profit margins could limit the industrial credit demand. Moreover, lending to the retail segment could slow as rising living cost could limit discretionary spending. The impact of the COVID-19 pandemic is likely to be prolonged in certain sectors of the Indian economy, including hospitality and civil aviation, which could adversely affect the Bank’s operations in those areas. Moving ahead, economic growth could be negatively impacted if geo-political tensions remain or even escalate and commodity prices rise further. A stronger than expected slowdown in the economy might adversely impact credit growth and the level of non-performing and restructured loans. If the Indian economy growth prospects deteriorate, our asset base may erode, which would result in a material decrease in our net profits and total assets which could materially adversely affect our business, results of operations and financial position. See also “—The COVID-19 pandemic or similar public health crises may have a material adverse effect on our business, financial condition and results of operation”.

Public health crises such as the COVID-19 pandemic or similar outbreaks have, and may continue to, adversely impact our business. On March 11, 2020, the COVID-19 outbreak was declared a pandemic by the WHO and led to the implementation of various responses, including government-imposed quarantines, travel restrictions, “stay-at-home” orders and similar mandates for many individuals to substantially restrict daily activities and for many businesses to curtail or cease normal operations. India, our main place of business, is in the group of countries most affected by the COVID-19 pandemic. In 2021, India experienced a “second wave” of COVID-19, including a significant surge of COVID-19 cases following the discovery of a “double mutant” coronavirus variant in the country. The delta variant was significantly more virulent than other coronavirus variants, resulting in a significant increase in COVID-19 cases and related deaths. By December 2021, the then new omicron variant started spreading in India. With improved vaccination rates, however, its impact was less severe than of previous waves. Moving forward, there continues to be significant uncertainty relating to the further progression of other waves. Due to the COVID-19 pandemic, all major central banks, including the United States Federal Reserve, implemented bond purchase programs and decreased interest rates in 2020. However, as a result of the availability of vaccines, improving economic conditions and a sharp rise in inflation many central banks have started raising rates. Additionally, while many central banks have already slowed/ended bond purchases, the United States Federal Reserve has started reducing its balance sheet from June 2022. In India, taking into account inflationary pressure, the RBI hiked the policy repo rate in May 2022 and June 2022. See also “—Financial and political instability in other countries may cause increased volatility in the Indian financial market”. To reduce the impact of the pandemic on Indian borrowers, on March 27, 2020, the RBI announced COVID-19-related regulations, which included permission for financial institutions to extend a three-month moratorium on term loan repayments due between March 1, 2020 and May 31, 2020. This was later renewed for a second period from June 1, 2020 to August 31, 2020. In May 2021 and June 2021, as a result of the resurgence of the COVID-19 pandemic in India, the RBI issued an additional set of measures, permitting lending institutions to offer a limited window to individual borrowers and small businesses to implement resolution plans in respect of their credit exposures while classifying the same as “Standard”, and therefore not in default, subject to certain specified conditions. With respect to individuals who have availed themselves of business loans and small businesses where resolution plans were implemented in accordance with the terms of the circular dated August 2020 described above, lending institutions are permitted, as a one-time measure and until September 30, 2021, to review the working capital sanctioned limits and/or drawing power based on a reassessment of the working capital cycle and reduction of margins, without being classified as a restructuring. In August 2020 and May 2021, the RBI also issued guidelines for the restructuring of existing loans to micro, small and medium enterprises classified as “Standard”, without resulting in a downgrade in the asset classification, subject to certain conditions. These guidelines were further amended in June 2021 to increase the limits from Rs. 250 million to Rs. 500 million. During fiscal year 2020 and fiscal year 2021, the Bank implemented the loan-restructuring packages announced by RBI on account of the COVID-19 situation which grant temporary extensions in repayment obligations to the borrowers without any interest or financial concessions. The total balance outstanding of such restructured loans as of March 31, 2022 was Rs. 239.8 billion. Interest on the term loans continues to accrue during the moratorium and the resulting increase in the interest burden may adversely affect our customers’ ability to repay their loans, which could adversely affect our profitability. Similarly, the RBI permitted financial institutions to grant deferments with respect to interest payments on working capital facilities between March 31, 2020 and August 31, 2020. At the financial institutions’ discretion, the interest accumulated during the deferment period may be converted to a funded interest term loan (“FITL”). Furthermore, the RBI also announced that with respect to non-performing loans, for which a lender’s 180-day resolution period had not expired by March 1, 2020, an additional 180-day resolution period would begin from the date on which the original resolution period was set to expire. There can be no assurance that customers who are granted a moratorium will be able to resume their regular repayment schedule following the end of the moratorium. In accordance with RBI guidelines, we have also waived certain fees for customers. In addition, in response to the pandemic, the RBI also reduced the repo rate by 40 basis points to 4.0 percent in May 2020, which has been increased to 4.90 percent in June 2022. See also “Our business is particularly vulnerable to interest rate risk, and volatility in interest rates could adversely affect our net interest margin, the value of our fixed income portfolio, our treasury income and our financial performance”. In its circulars dated April 17, 2020 and December 4, 2020, the RBI notified banks that they should continue to conserve capital to support the economy and absorb any potential losses and, accordingly, directed banks to not make any further dividend payouts from the profits pertaining to fiscal year ended March 31, 2020. On April 22, 2021, the RBI permitted commercial banks to again pay dividends relating to the profits for fiscal year ended March 31, 2021, subject to the quantum of the dividend not exceeding fifty percent of the amount determined in accordance with the dividend payout ratio prescribed by the RBI. The RBI has also directed all banks to ensure they continue to meet the applicable minimum regulatory capital requirements following any dividend payments. When declaring the dividend, the board of directors of the bank is required to consider the current and projected capital position of the bank compared to the applicable capital requirements and the adequacy of provisions, taking into account the economic environment and the outlook for profitability. The impact of COVID-19, including changes in customer behavior and pandemic fears and restrictions on business and individual activities, has led to significant volatility in global and Indian financial markets and a significant decrease in global and local economic activity. While there has been a gradual recovery in economic activity, it was slow due to another of wave of COVID-19 infections and disruptions caused by the Russia-Ukraine war. In fiscal year 2022, real GDP was just 1.5 percent above pre-pandemic levels (fiscal year 2020). This has led to a decrease in loan originations, sale of third-party products, use of credit and debit cards by customers, and the efficiency of our debt collection efforts and the waiver of certain fees. The slowdown in economic activity and rising input cost have also significantly affected the business of many of our customers and could result in financial distress for our customer base. Moreover, the continued volatility in global and Indian financial and capital markets could adversely affect our corporate customers’ ability to access debt markets, their cost of funds and other terms of any new debt, which, alongside the economic slowdown, may lead to a rise in the number of customer defaults and consequently an increase in provisions for credit losses. See also “—We have high concentrations of exposures to certain customers and sectors and if any of these exposures were to become non-performing, the quality of our portfolio could be adversely affected and our ability to meet capital requirements could be jeopardized”. Similarly, such market volatility, or a downgrade in our credit rating, may negatively affect our ability to access capital. We have implemented remote working arrangements for the majority of our employees, which may result in decreased employee productivity and efficiency and exacerbate certain IT-related risks, including an increased risk of cybersecurity attacks and the unauthorized dissemination of confidential information about us or our customers. COVID-19 may also lead to significant increases in employee absenteeism, including due to illness, quarantines and other restrictions related to the pandemic. Even where such restrictions are eased, we may still elect to continue our remote working arrangements, for example in the event of an outbreak of COVID-19 among our employees, as a preventive measure to contain the spread of the virus and protect the health of our workforce, or as a strategic measure. The extent to which the COVID-19 pandemic will continue to impact our business, financial condition and results of operation, as well as our regulatory capital and liquidity ratios, will depend on future developments, including the emergence of new mutants of COVID-19. Subsequent outbreaks that necessitate lockdown measures could prolong the economic impact of the COVID-19 pandemic. Even if the number of new COVID-19 cases were to significantly decrease, the negative effects on Indian and global economic conditions may persist into the future. In addition, disruptions related to the Russia-Ukraine crisis pose a major threat to the global growth outlook. Elevated commodity prices and monetary tightening by major central banks could hurt global demand, which could also adversely affect exports in India. The level of economic activity may slow further in the short term, due to changes in social norms, changes in customer and corporate client behavior and the macroeconomic business environment. India, where a substantial portion of our operations is located, continues to be subject to regulatory, social and political uncertainties.

India has experienced natural calamities such as earthquakes, floods and droughts in the past few years. The extent and severity of these natural disasters determine the size and duration of their impact on the Indian economy. In particular, the agricultural sector, which constituted approximately 19 percent of India’s GDP in fiscal year 2022 (in current price terms), is particularly sensitive to certain climatic and weather conditions, such as the level and timing of monsoon rainfall. Prolonged spells of below or above normal rainfall or other natural calamities, including those believed to be exacerbated by global or regional climate change, could adversely affect the Indian economy and, in turn, negatively impact our business, especially our rural portfolio. Similarly, global or regional climate change in India and other countries where we operate could result in change in weather patterns and frequency of severe weather like droughts, floods and cyclones, which could affect the local economy in the countries where we operate and negatively impact our operations in those countries. Public health epidemics could also disrupt our business. In fiscal year 2010, there were outbreaks of swine flu, caused by the H1N1 virus, in certain regions of the world, including India and several countries in which we operate. After having adversely affected business prospects in fiscal year 2021, restrictions related to the second COVID-19 wave and emergence of the omicron variant posed challenges to business operations, such as weekend restrictions, travel restrictions and social distancing. Although most such restrictions have been eased, in the event of another wave of infections, economic growth may slow down more than expected. This could in turn adversely affect our business and the price of our equity shares and ADSs.

We engage in business with customers and counterparties from diverse backgrounds. In light of United States, Indian, EU and other sanctions, it cannot be ruled out that some of our customers or counterparties may become the subject of sanctions. Such sanctions may result in our inability to gain or retain such customers or counterparties or receive payments from them. In addition, the association with such individuals or countries may damage our reputation or result in significant fines. This could have a material adverse effect on our business, financial results and the prices of our securities. These laws, regulations and sanctions or similar legislative or regulatory developments may further limit our business operations. In June 2021 one of our individual customers was designated by the United States as a Specially Designated Global Terrorist (“SDGT”) under Executive Order 13224. We provided several banking, credit and brokerage products and services to this customer, which had been initiated prior to the customer’s designation. With respect to this customer, during the period covered by this report, we blocked five accounts, a credit card, a brokerage account and an investment services account, and terminated two outstanding loans and access to a safe deposit box. We intend to continue blocking this customer’s accounts while he remains designated as an SDGT. Revenue and net income generated in connection with the above-described products and services in the year ended March 31, 2022 were negligible relative to our overall revenue and net income. Notwithstanding the above case, if we were determined to have engaged in activities targeted by certain United States, Indian, EU or other statutes, regulations or executive orders, we could lose our ability to open or maintain correspondent or payable-through accounts with United States financial institutions, among other potential sanctions. In addition, depending on socio-political developments, even though we take measures designed to ensure compliance with applicable laws and regulations, our reputation may suffer due to our association with certain restricted targets. The above circumstances could have a material adverse effect on our business, financial results and the prices of our securities.

In India, our equity shares are traded on the BSE Limited (the “BSE”) and National Stock Exchange of India Limited (the “NSE”). BSE and NSE rules, in connection with other applicable Indian laws, require us to report our financial results in India in Indian GAAP. Because of the difference in accounting principles and presentation, certain financial information available in our required filings in the United States may be presented differently than in the financial information we provide under Indian GAAP. Additionally, we make available information on our website and in our presentations in order to provide investors a view of our business through metrics similar to what our management uses to measure our performance. Some of the information we make available from time to time may be in relation to our unconsolidated or consolidated results under Indian GAAP or under U.S. GAAP. Potential investors should read any notes or disclaimers to such financial information when evaluating our performance to confirm how the information is being presented, since the information that may have been prepared with a different presentation may not be directly comparable. The Ministry of Corporate Affairs, in its press release dated January 18, 2016, had issued a roadmap for implementation of Indian Accounting Standards (“IND-AS”) converged with International Financial Reporting Standards as issued by the International Accounting Standards Board (“IFRS”) with certain carve-outs for scheduled commercial banks, insurance companies and non-banking financial companies (the “Roadmap”). This Roadmap required such institutions to prepare IND-AS-based financial statements for the accounting periods commencing on or after April 1, 2018, and to prepare comparative financial information for accounting periods beginning April 1, 2017 and thereafter. The RBI, in its circular dated February 11, 2016, required all scheduled commercial banks to comply with IND-AS for financial statements for the same periods stated above. The RBI did not permit banks to adopt IND-AS earlier than the above timelines. The RBI circular also stated that the RBI will issue instructions, guidance and clarifications, as and when required, on the relevant aspects of the implementation of IND-AS. In April 2018, the RBI deferred the effective date for implementation of IND-AS by one year, by which point the necessary legislative amendments were expected to have been completed. The legislative amendments recommended by the RBI are under consideration by the Government of India. Accordingly, the RBI, in its circular dated March 22, 2019, deferred the implementation of IND-AS until further notice. In conjunction with the implementation of IND-AS for our local Indian results, we may adopt IFRS for the purposes of our filings pursuant to Section 13 or 15(d) of, and our reports pursuant to Rule13a-16 or 15d-16 under, the Exchange Act. Should we choose to do so, our first year of reporting in accordance with IFRS would be the same as the accounting period for IND-AS, which is dependent on instructions to be issued by the RBI for the implementation of IND-AS. For our first year of reporting in accordance with IFRS, we would be permitted to file two years, rather than three years, of statements of income, changes in shareholders’ equity and cash flows prepared in accordance with IFRS. The new accounting standards are expected to change, among other things, our methodologies for estimating allowances for probable loan losses and classifying and valuing our investment portfolio, as well as our revenue recognition policy. It is possible that our financial condition, results of operations and changes in shareholders’ equity may appear materially different under IND-AS or IFRS than under Indian GAAP or U.S. GAAP, respectively. Further, during the transition to reporting under the new standards, we may encounter difficulties in the implementation of the new standards and development of our management information systems. Given the increased competition for the small number of IFRS-experienced accounting personnel in India, it may be difficult for us to employ the appropriate accounting personnel to assist us in preparing IND-AS or IFRS financial statements. Moreover, there is no significant body of established practice from which we may draw when forming judgments regarding the application of the new accounting standards. There can be no assurance that the Bank’s controls and procedures will be effective in these circumstances or that a material weakness in internal control over financial reporting will not occur. Further, failure to successfully adopt IND-AS or IFRS could adversely affect the Bank’s business, financial condition and results of operations.

There is a difference between the level of regulation and monitoring of the Indian securities markets and the activities of investors, brokers and other participants and that of markets in the United States and other developed economies. The SEBI and the stock exchanges are responsible for improving disclosure and other regulatory standards for the Indian securities markets. The SEBI has issued regulations and guidelines on disclosure requirements, insider trading and other matters. There may, however, be less publicly available information about Indian companies than is regularly made available by public companies in developed economies.

We operate in a highly regulated environment in which the RBI extensively supervises and regulates all banks. Our business could be directly affected by any changes in policies for banks in respect of directed lending, reserve requirements and other areas. For example, the RBI could change its methods of enforcing directed lending standards so as to require more lending to certain sectors, which could require us to change certain aspects of our business. In addition, we could be subject to other changes in laws and regulations, such as those affecting the extent to which we can engage in specific business, those that reduce our income through a cap on either fees or interest rates chargeable to our customers, or those affecting foreign investment in the banking industry, as well as changes in other government policies and enforcement decisions, income tax laws, foreign investment laws and accounting principles. Laws and regulations governing the banking sector may change in the future and any changes may adversely affect our business, our future financial performance and the price of our equity shares and ADSs.

The RBI is empowered under the Banking Regulation Act to impose penalties on banks and their employees in order to enforce applicable regulatory requirements. During 2019, we received two separate fines for non-compliance with certain RBI directives. In its order dated February 4, 2019, the RBI imposed a monetary penalty of Rs. 2.0 million on us for failing to comply with the RBI’s KYC and AML standards, as set out in their circulars dated November 29, 2004 and May 22, 2008. In its order dated June 13, 2019, the RBI imposed a monetary penalty of Rs. 10 million on us for failing to comply with the KYC, AML and fraud reporting standards, following an investigation into bills of entry submitted by certain importers. The penalties were imposed under Section 47A(1)(c) and Section 46(4)(i) of the Banking Regulation Act, 1949. We have since implemented corrective action to strengthen our internal control mechanisms so as to ensure that such incidents do not repeat themselves. See “Supervision and Regulation—Penalties”. In 2020, the Bank received one fine for non-compliance with RBI regulations. In its order dated January 29, 2020, the RBI imposed a monetary penalty in the amount of Rs. 10 million on the Bank for failure to undertake ongoing due diligence with respect to 39 current accounts which had been opened by customers of the Bank to participate in an initial public offering, but where the transactions effected were disproportionate to the declared income and profile of the customers. This penalty was imposed by the RBI using the powers conferred under the provisions of Section 47A(1)(c) read with Section 46(4)(i) of the Banking Regulation Act 1949. The Bank has since strengthened its internal control mechanisms so as to ensure that such incidents are not repeated. The RBI, through its letter dated December 4, 2020, imposed a monetary penalty of Rs. 0.1 million on the Bank for the failure to settle transactions in Government securities in the Subsidiary General Ledger which led to a shortage in the balance of certain securities in the Bank’s Constituent Subsidiary General Ledger account on November 19, 2020. The Bank has since enhanced its review mechanism to ensure that such incidents do not recur. SEBI, through its order dated January 21, 2021, levied a penalty of Rs. 10.0 million on the Bank for alleged noncompliance with a SEBI interim order dated October 7, 2019 issued against BRH Wealth Kreators Ltd. (“BRH”). The penalty was levied for the sale of securities pledged by BRH Wealth Kreators Ltd to the Bank, to recover amounts outstanding under recalled credit facilities the Bank had extended to BRH. The Bank filed an appeal against the SEBI order in the Securities Appellate Tribunal (“SAT”) on February 8, 2021. The SAT through its interim order dated February 19, 2021, stayed the operation of the SEBI order dated January 21, 2021 and, through its final order dated February 18, 2022, allowed the Bank’s appeal and quashed SEBI’s order. On May 27, 2021, the RBI levied a penalty of Rs. 100 million against the Bank for the marketing and sale of third-party non-financial products to the Bank’s auto loan customers, after concluding that this was in contravention of Section 6(2) and Section 8 of the Banking Regulation Act 1949. The penalty, which was imposed by the RBI using the powers conferred under the provisions of Section 47A(1)(c) read with Section 46(4)(i) of the Banking Regulation Act 1949, has been paid by us. In May 2020, following an internal inquiry arising from a whistle-blower complaint, we had determined that certain employees received unauthorized commissions from a third-party vendor of GPS products, with whom we had an agreement to offer GPS devices to our auto loan customers. The personal misconduct of these employees was in violation of our code of conduct and governance standards. We have taken disciplinary action against the employees involved, including separation of services of certain employees, discontinued sale of such third-party non-financial products, and taken certain other remedial actions. We cannot predict the initiation or outcome of any further investigations by other authorities or different investigations by the RBI. The penalties imposed by the RBI have generated adverse publicity for our business. Such adverse publicity, or any future scrutiny, investigation, inspection or audit which could result in fines, public reprimands, damage to our reputation, significant time and attention from our management, costs for investigations and remediation of affected customers, may materially adversely affect our business and financial results.

Sections 1471 through 1474 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”) (provisions commonly known as “FATCA” or the Foreign Account Tax Compliance Act), impose (a) certain reporting and due diligence requirements on foreign financial institutions (“FFIs”) and (b) potentially require such FFIs to deduct a 30 percent withholding tax from (i) certain payments from sources within the United States and (ii) “foreign passthru payments” (which is not yet defined in current guidance) made to certain FFIs that do not comply with such reporting, and due diligence requirements or certain other payees that do not provide required information. We, as well as relevant intermediaries such as custodians and depositary participants, are classified as FFIs for these purposes. The United States has entered into a number of intergovernmental agreements (“IGAs”) with other jurisdictions which may modify the operation of this withholding. India has entered into a Model 1 IGA with the United States for giving effect to FATCA, and Indian FFIs, including us, are generally required to comply with FATCA based on the terms of the IGA and relevant rules made pursuant thereto. Under current guidance it is not clear whether or to what extent payments on ADSs or equity shares will be considered “foreign pass-thru payments” subject to FATCA withholding or the extent to which withholding on “foreign pass thru payments” will be required under the applicable IGA. However, under current guidance, even if withholding were required pursuant to FATCA with respect to payments on ADSs or equity shares, such withholding would not apply prior to two years after the date on which final regulations on this issue are published. Investors should consult their own tax advisers on how the FATCA rules may apply to payments they receive in respect of the ADSs or equity shares. Should any withholding tax in respect of FATCA be deducted or withheld from any payments arising to any investor, neither we nor any other person will pay additional amounts as a result of the deduction or withholding.

We face strong competition in all areas of our business, and some of our competitors are larger than we are. We compete directly with large public and private sector banks, some of which are larger than we are based on certain metrics such as customer assets and deposits, branch network and capital. These banks are becoming more competitive as they improve their customer services and technology. In addition, we compete directly with foreign banks, which include some of the largest multinational financial companies in the world. See “—We may face increased competition as a result of revised guidelines that relax restrictions on foreign ownership and participation in the Indian banking industry, and the entry of new banks in the private sector which could cause us to lose existing business or be unable to compete effectively for new business”. In addition, new entrants into the financial services industry, including companies in the financial technology sector, may further intensify competition in the business environments, especially in the digital business environment, in which we operate, and as a result, we may be forced to adapt our business to compete more effectively. There can be no assurance that we will be able to respond effectively to current or future competition or that the technological investments we make in response to such competition will be successful. Due to competitive pressures, we may be unable to successfully execute our growth strategy and offer products and services (whether current or new offerings) at reasonable returns and this may adversely impact our business. If we are unable to retain and attract new customers, our revenue and net income will decline, which could materially adversely affect our financial condition. See “ Business—Competition”.