India-based IDFC FIRST Bank posted its highest ever profit in Q1 2022 of Rs3.43bn ($45.7m) and is perhaps emerging as one of the most dramatic turnaround success stories in Indian banking. Formed by the merger of India’s leading infrastructure financing promoted Bank and Capital First, a leading technology-led NBFC in the second half of 2019’s fiscal year, IDFC FIRST Bank started with a string of losses for six consecutive quarters until December 2019.

Incredibly, the merged entity turned itself around in its third year after two rounds of fund raising, a differentiated retail strategy, new technologies, digitisation, expansion of branch network, a successful rebranding exercise and a customer-first approach. With a capital adequacy now at 16.8 percent and profitability improving, the bank appears set for growth. World Finance spoke to V. Vaidyanathan, Managing Director & CEO of IDFC FIRST Bank, who earlier led retail banking at ICICI bank, later launched an NBFC, before merging with IDFC Bank and taking over the combined entity as the MD & CEO.

It’s been three years since the merger with Capital First. What has been the progress?
Our bank has made tremendous progress. We have laid the foundation for a highly successful megabank of the future. Our CASA (current and savings account) ratio grew from under 10 percent to 50 percent, our capital adequacy has grown to 16.8 percent and our business model is clear. Now we are all set for growth. We are building a new age digital bank that is agile and highly scalable. This new avatar will be prominently visible to all very soon.

Your loan book has grown at only six percent since merger. That’s rather slow in a growing country. Can you explain?
The erstwhile IDFC Bank was formed by de-merging the assets and liabilities from IDFC Limited into a commercial bank. As it was a new bank, it didn’t have CASA. Capital First was an NBFC, and had no retail deposits either. So, assets plus assets make more assets. Neither had retail liabilities. So on merger, we had a large loan book of Rs1.04trn ($14bn) but very low retail deposits of only Rs104bn ($1.4bn). So, we slowed down our overall loan growth by moderating legacy wholesale book but growing the granular retail book.

How was the balance sheet funded, and how has it changed since?
Because our bank had recently acquired a commercial banking license at merger, we were largely funded by wholesale deposits, certificates of deposits and institutional borrowings including legacy long term borrowings. I’ve been around long enough in banking to know never to take chances on the liabilities side. We wanted to first secure a highly stable and diversified liabilities base before growing loans. What if short tenor certificate of deposits didn’t roll over? What if corporates withdrew deposits in a crisis? I’ve seen these situations before in the industry, and never wanted to take chances. So, on merger, we first raced to the door to raise public deposits in the 2020 fiscal year and we grew deposits 84 percent CAGR (compound annual growth rate) between the merger quarter until March 2022.

We grew CASA ratio from under 10 percent to 50 percent in the last three years. By the time COVID-19 struck in March 2020, we had already retired almost all of our certificates of deposits in a hurry, had lesser corporate deposits and swam through the pandemic comfortably. I would say managing liquidity proactively before the crisis was the biggest success we have had.

But how did customers place deposits, even while you were making losses all through the 2018–19 and 2019–20 fiscal years?
Our corporate governance and positive image came in very handy here. In fact, both IDFC Bank and Capital First were always seen as entities with high corporate governance. We lived up to it even under extreme circumstances. Every quarter of 2020 we posted large losses, primarily due to incremental provisions on stressed legacy wholesale accounts, but we were always straightforward with the public.

We want to build a world class bank in India, with three key themes: ethical, digital and social good

We called out the specific accounts that had gone bad by name, in a transparent manner without resorting to complicated client-confidentiality clauses. So, the public trusted us. We never postponed the recognition of an issue whether it was legacy infrastructure, Dewan Housing, Reliance Capital, or our exposure of Vodafone Idea. More important, along with our earnings releases, we described the future business model with great clarity and simplicity. The incremental business model was giving us strong ROE (return on equity) of 18–20 percent, and we broke down the components of the incremental business model line by line for explanation. People got confidence from all this.

Can you expand on the role that corporate governance played in stabilising the bank?
In our case, it played an immense role. One thing was the transparent disclosures and accounting of pre-merger accounts which I talked about. But more importantly, our board members have between 30–40 years of work experience mostly in financial services, and they have worked at senior positions, most of them in multinational corporations. They are extremely cautious and conservative about corporate governance. In fact, I can say corporate governance is their number one agenda. All our important committees are headed by independent directors. Coming back to disclosures, we disclose more than the regulatory requirements or conventional market disclosures.

Can you share the incremental business model with us?
Our business model is easy to understand. We have developed immense capabilities for financing small entrepreneurs and retail consumers at scale, using technology. We have maintained low gross NPA (non performing assets) of less than 1.9 percent, and low net NPA of less than one percent for a decade. The COVID-19 year apart, not in a single quarter in 12 years did we have any fluctuation on this trend. On the retail side, despite moving to lower yielding, safer assets and prime home loans, we are making ROE of about 18–20 percent. On the corporate banking side, we have not had any new NPA since merger, and our ROE is about 14 percent. The Indian retail credit to GDP is just about 15 percent, which can grow manifold to 70–80 percent over the next few decades, on a growing base. We have unlimited space for growth. We have launched and scaled many new businesses like wealth management, CMS, FASTag and so on.

Are these economics reflecting in the profitability of the bank?
The operating profits for the first half of the 2019 fiscal year, combining both IDFC Bank and Capital First, was Rs5.51bn ($73m), annualised to Rs11.01bn ($146m). In 2020, this grew 60 percent to Rs17.64bn ($235m). Then, during 2021, it grew only eight percent to Rs19.09bn ($254m) as it was pandemic affected. But the moment COVID-19’s second wave wore off in 2022, operating profits grew 44 percent from Rs19.09bn in 2021 to Rs27.53bn ($367m) in 2022. So, in summary, while our loan book has grown at a three-year CAGR of six percent, our operating profits have grown at three-year CAGR of 36 percent. So that explains the power of our incremental profitability model. We expect operating profit to grow at 45 percent CAGR again over the next two years.

Do you provide guidance to the market on earnings?
Not just earnings, at the time of the merger in 2019, we provided 2024–25 guidance on all key metrices, including deposits, loan book, asset quality, returns. Every quarter, we report our performance against that guidance. I’m happier to say that on every single metric we are on track, and confident of meeting them despite the pandemic interruption.

What is the core culture that you are building in the bank?
We are a new bank and we are coding our employees’ DNA to think ‘customer first’ at all times. We were the first universal bank in India to launch monthly interest credit on savings accounts. We stripped most of the fees that banks usually charge on one count or another. Our credit cards have differentiated offerings like dynamic pricing, comparatively lower rates and fees, better ease of usability, truly customer first. You might think this is not beneficial to shareholders. But you’d be mistaken, as in our current construct, customers are automatically drawn to us from word of mouth and our retention rates are high.

What is the role the vision statement plays in building the culture?
We went over the vision statement over and over to get it right. Our vision statement effectively says we want to build a world class bank in India, with three key themes: ethical, digital and social good. ‘Ethical’ is the means by which we wish to deal with everyone. ‘Digital’ is the medium we want to use. ‘Social-good’ is the purpose of our existence. We tell our employees to earn income the clean way. We made a seal on this and shared with our employees, so it stays on their table.

What is the next stage for the bank?
We have made significant investments in building a quality technology stack for scalability. Our products are great. The culture is good. Our mobile app is great. Our asset quality is proven. Our capital adequacy is strong. We tick all boxes, barring one. We are low on profitability, but we’ll fix this soon. Our trajectory of profits is strong. By 2023’s exit quarter we believe we will cross double digit ROE, and then on to the next milestone of 16 percent ROE. It will happen. We will be a world class, technology led bank with high teens ROE. We will tick the profitability box soon, and remain strong.