HSBC takes an option on India

British bank gambles on rule change through acquisition of UTI Bank stake.

HSBC's agreement last week to acquire a stake in UTI Bank took the market by surprise but represents another shrewd move by the world's local bank. The 14.72% stake cost HSBC $66.42 million and comes with a three-month option to buy a further 5.37% at the same price per share.

At just 1.6x book value that looks like a good deal for HSBC. Needless to say, it would rather control the bank outright, but given the Reserve Bank of India's restrictions on foreign ownership of private banks HSBC is doubtless content to get its foot in the door and wait to see if the rules change further down the line, as it has done in China by buying an 8% stake in Bank of Shanghai and a 10% interest in Ping An Insurance.

"HSBC has said in the past that it's not very keen to buy into banks with ownership restrictions," says Sunil Garg, a bank analyst at Fox-Pitt Kelton. "But what they are doing here, and what they have done in China, is buying a cheap option. And one that has very little material effect on their balance sheet."

Indeed, HSBC bought the shares at Rs90 each but they quickly soared 20% higher than the acquisition price on news of the agreement. And if, as expected, the restrictions are eventually rolled back the bank will be well placed to fast-track its expansion in India. In fact, the wheels of government are already creaking in HSBC's direction - Indian lawmakers are now considering a bill to extend foreign banks' ownership rights from 49% to 75%.

With 200 branches concentrated in India's main metropolitan areas UTI Bank would present HSBC with a good opportunity to move out of its current niche - corporate and high-end consumer clients - and into mass distribution.

However, for the time being at least, control remains in the hands of UTI's existing chairman, PJ Nayak. HSBC says its interest is only as a financial investor. "We will not become actively involved in the day-to-day operations of UTI," says a spokesman for the bank.

HSBC may be able to benefit from UTI Bank's distribution capabilities even without management control. It is expected to start rolling out products to Chinese customers through its mainland partners soon and a similar strategy in India might be employed.

Besides foreign ownership rules there are some other obstacles that foreign banks may like to see changed before committing serious money to India. For instance, the requirement on commercial banks to make cheap loans to so-called priority sectors is considered onerous, as are rural obligations that force insurance providers to sell a minimum percentage of policies to the rural poor.

Nevertheless, stock market investors are gambling that the acquisition will prompt more foreign banks to invest in India and their confidence has driven share prices up across the sector. The leading targets are considered both by investors and analysts to be IDBI, Global Trust Bank, Bank of Punjab, South Indian and IndusInd Bank, with plenty of others also in the running: Bank of Rajasthan, Karnataka Bank, Karur Vysya Bank and Federal Bank among others.

Citibank was once rumoured to be interested in a stake in UTI Bank, but analysts agree that its strategy in India, centred on credit cards rather than mortgages and car loans, does not warrant a large branch network, which would involve tangling with priority sector lending and other headaches. Some of the European banks, such as ABN AMRO and ING Vysya Bank, are thought to be more keen to acquire stakes in local banks.

Standard Chartered, still the biggest foreign player in the market, is not desperate to make further in-roads after buying Grindlays Bank in 2000. As Garg puts it: "It would be nice, but it's not mission-critical."

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