Did you know, 80% of all Indians that live in the Middle East, are from the state of Kerala? The stereotype truly fits and has been a long-standing story, with NRIs making up for more than 20% of the state’s GDP when they send money back.
With so many of our Mallu friends crowding the streets of the Middle East, and sending precious oil money back home to Kerala, a small Trivandrum-based regional bank called Federal Bank soar in popularity.
Federal Bank is so strong in the NRI game, that it commands a market share of 30% of all foreign funds being deposited in Kerala, and a 20% market share in foreign remittances in the entire country. This took Federal Bank from being a penny stock throughout the 1990s and early 2000s to becoming a known regional bank by the 2010s, sending the stock 10x.
But you know what else Federal Bank has a strong game in? Believe it or not - digital banking! Over the last decade, it has not only devised the fastest digital account-opening process, but also become the backbone for most new-age credit card issuers, neo-banks and digital lenders.
Will the mallu-to-mobile transformation further 10x Federal Bank?
The Mallu to Mobile Transformation
While the NRI-wave worked well for Federal Bank, ambitions at the bank were to breakout of being a regional bank, and become a known nationalised player. In 2011, Federal Bank brought in just the right man for the job - Shyam Shrinivasan.
He identified 3 ways to turn Federal Bank from a small pre-independence era bank, to a name that could define what banking could be.
Throttle harder on the NRIs
The NRI opportunity had been working well for Federal Bank by default, thanks to the trends in Kerala. Federal Bank chose to rise to the occasion by offering attractive cross-border remittance services, and exclusive care to those clients.
Federal Bank’s offered some of the highest deposit rates in the industry (0.5-1% higher than larger banks like HDFC and ICICI), which made it the default choice for NRI, in addition to the fact that interest is tax free on NRI deposits.
NRI deposits now make up 25-28% of total deposits as opposed to around 12% in FY10, and have grown more than 10x to Rs. 76,394 crore in FY23, from Rs. 7,350 crore in FY10.
Aggressive Nation-Wide Expansion
During the course of the last 12 years, the banked population of India went from 44% of total population to 78%, whether that was through government initiatives or banks taking it upon themselves to capitalise on that opportunity.
Federal Bank aggressively tapped into the market and went on a spending spree. From FY10 to FY18, branches and ATMs grew rapidly towards 1,252 branches (2x the number in FY10) and 1,696 ATMs (2.7x the number in FY10) across the country.
The bank expanded geographically, and stepped out of home turf to make its brand known, and presence felt across the country.
Leading the Digital Way
The bank realised pretty early on that being digitally-forward was the future, and took steps to transform itself and stand out amongst its traditional banking peers.
It was prompt on automating painful paperwork and processes to open bank accounts and apply for credit cards via their app/website, making it an end-to-end 5 minute ordeal (which is rare for a bank that is perceived to be regional).
Over the last 5 years, its digital-first approach has shown magnificent results:
80-90% of transactions and new account openings happen digitally for Federal Bank now, versus 50% in FY18
Digital Transaction volumes have gone up nearly 10x to Rs. 18,000 crore a month in March 2023, from Rs. 2,000 crore a month in March 2018
Feddy, an AI chatbot launched by Federal Bank answers more than 70% of all daily customer queries (as high as 5,000 a day)
The Next Leg of Growth
Despite doing well for itself in digital banking, Federal Bank, like all its traditional peers, faced the threat from neo banks. Wait, what are neo banks?
Neo banks are basically companies that offer banking services on a cooler interface. But since banking licenses aren’t just handed over to any Tom, Dick and Harry, they need to partner with existing banks.
Existing banks offer APIs to neo banks, which neo banks build a cool interface on top of. So while you see a fancy expense tracker and round-up investing option on your neo bank app, the underlying bank account is with a traditional bank.
Neo banks have risen to popularity across the globe as traditional banks find it hard to transform themselves, or even adopt methods of growth that new companies can. Recognising the opportunity and limitations, Federal Bank chose a unique route to make the most of the rise of neo banks, while also not burning copious amounts of cash.
The Bank for Neo Banks
Federal Bank upped its tech stack and offered APIs to most promising neo banks. It dominates the space, being among the top 4 preferred banks in the country with more than 75 partnerships, especially with large names like Jupiter and Fi Money.
data as of September, 2023
These partnerships are so promising that Federal Bank expects them to contribute to 25% of its incremental deposit growth, and nearly 50% on the lending side.
Other large traditional banks like HDFC Bank and SBI have not been active on partnerships and have focused towards building their own digital assets.
This route tends to fail because of a legacy mindset, lower appetite to adopt new means of customer acquisitions, protection of old ways, and traditional structures; leaving little competition for Federal Bank on its chosen route.
Toh Phir Problem Kya Hai?
Kuch nahi! All seems to truly be hunky dory with this massive turnaround story. Just take a look at the numbers yourself:
Supernormal growth, improved management of loan book, and insane tailwinds - yet the bank is trading at a 1-year forward P/BV of 1.3x. For context:
Regional peer City Union Bank trades at 1.6x, despite being 1/4th Federal Bank’s size in terms of deposits and loan book
national peers like IDFC First Bank trade at 2.2x, with loan book sizes and potential being fairly at par
The neo banking opportunity can provide massive upside in terms of a business upgrade and perception for Federal Bank given the fact that it already has access to almost 50% of the top 4 neobanks (5 million+ subscriber base), and with India at a 1% penetration rate in neobanking across the country (while countries like the USA and UK are at 5-6%).
As it matures, the neo banking play has potential to not just drive industry-leading growth, but also result in industry-leading valuations.
From mallu to neo, Federal Bank has truly “understood the assignment” and transitioned to being something much greater than its previous self, pre-Shrinivasan. Investors can only hope that valuations also match this new-found identity!
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