India's Wager on Jio and Economic Growth in Shadow Banking, as China Faces Downturn

22 Aug, 2023

India's Wager on Jio and Economic Growth in Shadow Banking, as China Faces Downturn

Not all shadow banking entities share the same fate. Just as nonbank lenders in China grapple with a liquidity crisis due to their ties to troubled property developers, their counterparts in India are forging ahead with increased momentum.

The trajectories of these financial players, especially those not reliant on state-backed deposits, are beginning to diverge within these neighboring economies. In India, Jio Financial Services Ltd, led by Mukesh Ambani. marked its entry into the stock market on Monday, following its spin-off from Reliance Industries Ltd., Ambani's flagship company. The stock experienced a 5% drop on its initial trading day, primarily due to uncertainty surrounding the new venture's direction. Nonetheless, the significant valuation of $19 billion indicates that investors hold high expectations.

All eyes are on the strides made by Bajaj Finance Ltd. As the current market leader, valued at two and a half times its untested rival, the company boasts nearly four decades of operation and aims for a 29% to 31% growth in assets during the current fiscal year. The combined value of Bajaj Finance and Jio exceeds that of the State Bank of India, the nation's largest deposit-taking institution.

This disparity is starkly evident when compared to China. Shadow banking gained traction in the People's Republic around 2010 when Beijing grew wary of the credit bubble it had fostered as a buffer against the Global Financial Crisis. Chinese banks navigated the ensuing regulatory constraints by acquiring beneficial interests in trusts and labeling them as "amounts due" or "financial accounts available for sale" — anything except a loan requiring capital.

These trusts, which also sourced funds directly from affluent investors and corporate treasuries, went on to lend to local government entities, property developers, and other borrowers unable to secure traditional credit. However, as Chinese banks have recently severed their connections to these products, a downturn in real estate is jeopardizing their nonbank issuers.

As my colleague Shuli Ren recently explained, a trust product can reach its maturity before the residential projects it funded are completed or sold. The numerous missed payments by Zhongrong International Trust, the first to issue overseas bonds, have stirred global investor concerns about contagion risks, even though such concerns may be exaggerated.

A comparable shadow banking crisis hit India's economy hard five years ago. Following the collapse of the IL&FS Group in 2018 — the entity supporting, owning, and operating infrastructure assets — credit to real estate developers nearly dried up. This event triggered a series of additional bankruptcies. Even Housing Development Finance Corp., the country's largest specialized mortgage lender, navigated the turmoil by merging with its offspring, HDFC Bank Ltd., a deposit-taking institution.

However, these tumultuous times are now in the past. The rapidly digitizing consumer economy is unveiling new growth avenues for financial institutions, particularly those capable of merging "fin" with technology. While bank deposits remain stagnant at the lower rungs of the economic ladder, nonbank entities can tap into the surplus savings of affluent households and corporations in pursuit of higher yields. In a scenario dubbed the "blue-skies scenario" by Investec Securities, Jio Financial could amass a loan portfolio worth up to 1 trillion rupees ($12 billion) by 2030, yielding a 6.5% return on assets.

When reasonable leverage is applied, this could translate to a return on equity of around 25%, a feat that Bajaj is already achieving with over $32 billion in assets. On a global scale, very few banks of this size boast such profitability.

What will propel this growth? Data. Bajaj embarked on its journey four decades ago by financing purchases of two- and three-wheelers manufactured by the family's primary firm. Ambani has a significantly shorter runway to work with. He commands India's largest retail chain and heads its leading telecom company, which spearheaded the digitization that he is now aiming to monetize.

Furthermore, Ambani is funneling the cash flows from his legacy petrochemical business into endeavors spanning from affordable phones and laptops to his own branded soaps and soft drinks. Every link within his extensive supply-chain network has connections with small businesses in need of financial support. Consumers are increasingly inclined to buy now and pay later. With India's highly digitized payment ecosystem, thanks to the Unified Payments Interface, integrating credit is merely another step. The indigenous Paytm app facilitated over $600 million in third-party loans on its platform just last month, representing a 148% surge from the previous year.

Could Jio Financial become India's answer to Ant Group Co., the giant founded by Jack Ma that was reined in by China? It's possible, even with the potential to surpass it in size and consumer behavior insights. The world never witnessed Ant at its zenith, as its Hong Kong IPO was abruptly halted in 2020. After authorities mandated Ant to open its payment app to competitors and sever "improper links" directing users toward more profitable services like lending, Ant's exceptional standing diminished.

In comparison, India's regulatory approach toward national champions is likely to be more accommodating. While both nations' financial systems have long been dominated by banks, India's unfolding future may reduce the prominence of deposit-taking institutions, particularly smaller, government-controlled banks lacking technological advantages. Such entities might become liquidity providers, seeking opportunities to participate in lending ventures alongside successful online platforms in order to offer competitive rates to savers.

As long as India's shadow banks remain cautious not to overly engage with a single asset class like real estate, there seems to be no insurmountable obstacle ahead.