HDFC Bank's $40 billion deal may face regulatory hurdles in insurance sector

India's largest private lender HDFC Bank's $40 billion acquisition of its biggest shareholder could face regulatory hurdles due to the stake it would give the bank in the insurance sector, analysts said.

HDFC Bank's management said that they have asked the regulator for clarity on complying with its rules, but analysts believe it may not be easy to come by.

"Considering there are lot of subsidiaries that need to be merged, there could be some regulatory overhang, particularly in the insurance business where the central bank is not very comfortable with banks increasing their stake," said an analyst at a domestic brokerage house.

One way of folding the subsidiaries into HDFC Bank could be to create a holding company structure, but that could have a negative impact on the balance sheet in the short term, analysts said.

In the short term, return on equity (RoE), a key financial metric, will also go down as a result of meeting certain regulatory requirements, the Macquarie note said.

As a shadow bank - a finance company outside the scope of traditional banking regulation - HDFC Ltd has a higher cost of funds compared to the bank.

Post merger, the entity may therefore in the short term also see a higher cost of funds, which could affect its margin, said a portfolio manager at a retail brokerage firm.

"Due to this and other ambiguities regarding the deal and the performance, the stock may not see a big valuation re-rating immediately," he added.

HDFC Bank shares fell as much as nearly 3 percent on Tuesday, while HDFC Ltd slipped more than 2 percent. Both stocks had surged around 10 percent on Monday.

If it clears the hurdles to a deal, HDFC Bank will shrink the gap in size with state-run lender and bigger rival State Bank of India, and pull further away from peers such as ICICI Bank and Axis Bank.