A Deep Dive into the MUFG-Shriram Deal-

Before MUFG’s investment in Shriram Finance, SMBC also made headlines as they acquired a 20 percent stake in Yes Bank for about 13,483 crore rupees. This was the largest cross-border investment in the Indian banking sector, which was defeated by MUFG on the Shriram Finance deal.

Why are japanese banks betting big on indian banks and NBFCs?

Macro interpretation: As Japan is home to the world’s oldest population and a shrinking workforce, for a big bank, population density is a key driver for their credit demand. Due to the shrinking population, there is low demand for personal loans, mortgage loans, and corporate expansion loans. Big banks like MUFG and SMBC are filled with excess liquidity but face low credit demand, which is forcing them to make a demographic shift towards global economies for higher-yield assets.

So, MUFG can’t grow its loan book more than the Japanese GDP. MUFG was forced to move beyond its nation and look out for economies having good credit demand and demographic stability. India has a rising workforce population with robust credit demand in all sectors, including business loans (MSMEs), personal loans, home loans, and corporate loans. Therefore, by buying a 20 percent stake in an Indian NBFC, they are not only buying a piece of their balance sheet but also the long growth ahead with a rising population and credit demand.

For the past decade, Japan has been a country with nearly 0 interest rates where you can borrow Yen at a very cheap rate, characterized by Yield Curve Control (YCC) and a negative interest rate policy. But the BOJ increased its short-term interest rate for the first time in 2024 by 0.75 percent, which is still very low compared to global economies. This makes big banks in Japan feel NIM pressure very regularly as the cost of deposits is nearly zero and the yields on loans are very thin. So, big banks have been looking around the globe for high-yield assets. If we compare it to India, it provides a very high spread which is equivalent to 7-8 percent.

So, the yield arbitrage will be the soul of the deal. The borrowing cost of Yen is very low and the application of this fund is at a very high-yield asset. Even after accounting for hedging costs, the profit expectation is very powerful, which will in return boost the Return on Equity (ROE) for MUFG.

For decades, Japanese banks had substantial exposure in China. But as the geopolitical concerns between Japan and China are rising, banks were forced to look for better alternatives. Also, China is facing a decline in domestic consumption which would directly impact the credit demand in the country. It is acting as a good “China+1” for India. MUFG’s strategy is to have a long-term partnership with India because it is offering safe capital deployment compared to other emerging markets due to improving regulatory clarity.

As India’s Credit-to-GDP ratio is around 60 percent, which is below the 100 percent of other advanced economies, it offers headroom for expansion in credit growth. As we all know, the major indicators such as population growth and a rate-cut environment are all in favor of credit expansion, which will give MUFG’s India investment an edge over other emerging markets.

By investing in India’s largest NBFCs, they get direct and deep-rooted access to the retail and vehicle lenders of the country. We will dig deeper into why MUFG chose Shriram Finance.

Why did MUFG choose an NBFC over a traditional Bank?

It is basically due to the ownership regulation/cap in traditional banks. This means even if the FDI investment in a bank is capped at 74 percent, voting rights are capped at 26 percent (or even 10 percent in some cases) regardless of the shareholding to prevent concentration risk. For a big foreign bank like MUFG who seeks board membership and strategy alignment, there was a disconnect due to this. Whereas in the case of NBFCs, FDI investment can be up to 100 percent, which can assure MUFG to increase its stake in Shriram Finance in the near future. NBFCs offer you a bank-like exposure with an investment like a corporate.

Why are foreign institutions interested in Indian banks?

We have recently seen a lot of deals taking place in the Indian banking ecosystem.

We have recently seen a lot of deals taking place in the Indian banking ecosystem.

A decade ago, the Indian banking industry was going through a tough phase of defaults in corporate loans, bad loans, and huge collapses around IL&FS and DHFL. This forced the RBI to come up with regulatory reforms and tighter supervision and eventually cleaned up the balance sheet of banks, which resulted in gaining confidence in the banking sector again. Now, the banking sector is much more transparent and leaner, which boosted the confidence of FDI to invest heavily in India.

Also, India is a very unpenetrated market in the case of credit growth because most of the borrowing is still done through uncredited sources. This is where FDI saw a huge opportunity as India is an economy which has rising consumption, rapid urbanization, and a drive towards premiumization which would boost credit growth for both banks and NBFCs. We’re seeing demand in retail, housing, and corporate loans. India is also growing at a rate of 8.2 percent which will further increase optimism around FDI investment. Despite concerns over FDI outflows and a weakening rupee, the Indian banking sector is seeing a turnaround with 15 billion dollars of capital inflows this year as compiled by Bloomberg. One more crucial factor which I see is the mass penetration of UPI (Unified Payment Interface) which makes it very easy for people to borrow, lend, and transact. This also shows the strong digital ecosystem that India possesses. So, by buying stakes in Indian banks they are directly buying time and scale at once which are massively penetrated in India. Also, for generating alpha, India is acting as a safe haven during global turmoil that is taking place affecting global financial and supply chain crises.

Why is it good for India?

India’s dream to have one of its banks in the top 10 global banks around the world can only be fulfilled if there is a lot of infusion of funds, which can further strengthen the balance sheet of big banks. As India’s long-term story is intact, they need a high infusion of deposits and funds to carry out the credit growth in India. Through global banks increasing stakes, they also bring more refined risk management strategies and guidance which can further encourage state-level banks to grow more.

The government is also figuring out regulatory reforms through which they can push FDI investments more without compromising the essential characteristics of a bank and the decision-making ability of their boards.

WHY DID MUFG CHOOSE SHRIRAM FINANCE?

Let’s just think from the perspective of the MUFG team. While they might have been exploring options for investment in the Indian NBFC space, they would most likely go with the four largest market capitalization companies for better liquidity. So, they would majorly have four options:

1. Bajaj Finance

2. Cholamandalam

3. Muthoot

4. Shriram Finance

So, if we look at or just screen it, Bajaj Finance must be looking expensive at a P/B of 5x, which is far more than that of other competitors. Then Cholamandalam must have been a good option, but valuation-wise Shriram was at a much sweeter spot. Whereas Muthoot had a concentration risk of gold loans. So, just by looking, we can say that Shriram Finance (P/B ratio – 2.8x) with valuation comfort was the best option. With an AUM exceeding INR 2.8 trillion, it offers the scale that can absorb MUFG’s large ticket size.

Product Mix SFL majorly operates in vehicle and MSME financing. But they are diversifying their loan book into two-wheeler loans, gold loans, and personal loans, which can act as a cushion to growth if there is a slowdown in the commercial vehicle industry. The portfolio yield is around 14-18 percent due to high-risk advances with a NIM of around 8 percent. And the gross NPAs are also manageable at 6 percent. So, with a great loan book, they are also getting valuation comfort. ROA and ROE are also significant. MUFG’s current presence is majorly in corporate and investment banking, due to which there is an overlap with their existing business in India, which is a positive for both ends.

Deal Structuring MUFG is buying shares on a preferential basis, which means injecting new capital into the business by buying new shares at an entry price of 840.9 per share. This is at a discount of 3 percent from the current market price. SFL’s debt-to-equity ratio will also go down, which will have a positive impact on the credit rating as they don’t need to raise funds/debt for approximately 3-4 years. So by direct infusion, SFL is in a good spot to borrow and lend more by leveraging a strong balance sheet. So, MUFG is funding the long growth story of SFL. The plan includes two board seats and minority protection rights (voting rights on key matters).

Strategic Play-

Liability Side: Right now, the biggest expense for SFL is interest, and MUFG’s biggest asset is cheap Yen deposits. So, by replacing a portion of domestic debt, they may pursue external commercial borrowing from MUFG to reduce their interest expense, which is a big positive.

Asset Side: As we know, MUFG serves auto majors (such as Suzuki, Toyota, and Honda) globally, which means that SFL can act as a financier for these OEM companies in rural areas. This is a big boost in its loan advances.

Conclusion MUFG’s acquisition of a 20 percent stake in Shriram Finance is just the start of a sector tailwind with heavy capital inflows through FDIs into the sector, which also brings global investor confidence. For Japan, it is the much-needed growth engine for their shrinking credit growth. We can clearly see the “Japanification” of the Indian finance sector.

We can clearly see the japanification of indian finance sector.