India Ratings & Research (Ind-Ra) believes the Reserve Bank of India's in-principle approval of a bank license to IDFC (AAA/stable) will be beneficial to its credit profile in the long term, provided the transition is managed appropriately. However, the successful conversion from an infrastructure non-banking finance company into a commercial bank with a strong retail deposit franchise and a diversified loan book will be a major challenge.

Ind-Ra expects IDFC's profitability metrics to drop sharply in the near-to-medium term due to the regulatory requirements of maintaining a statutory liquidity ratio of 23%, cash reserve ratio of 4% and priority sector lending of 40%. 

Also, operating costs will increase significantly from a build-up of branch network and employee talent pool. Maintaining credit costs at low levels will be important as the company starts lending to non-infrastructure sectors, while the infrastructure sector is likely to continue to face a harsh operating environment.

Ind-Ra however expects the company to maintain a robust capital buffer, as its loan portfolio will be diversified to include new borrowers/loan products in which it has little experience. While the loan book will become more granular than before, the efficiency of risk management systems for the new business lines will be tested.

The company's access to retail funding through low-cost current and savings accounts and retail term deposits could help in diversifying its funding profile and reduce funding costs in the long-term. Nonetheless, building a retail deposit franchise will be a key management challenge, due to a competitive market environment and high requirements to open branches in non-urban areas.

IDFC's rating factors in its robust capital and profitability buffers, well-diversified funding, efficient risk management practices and close loan monitoring systems that have helped it contain credit losses at low levels. Its refinancing capabilities are underpinned by its healthy capitalisation, a track record of maintaining low credit losses and its linkages with government of India (a 17% stake). Ind-Ra will continue to evaluate the company's detailed strategies for its transition into a commercial bank and factor the impact into its ratings.

Shares of the company declined Rs 3.05, or 2.38%, to trade at Rs 124.95. The total volume of shares traded was 8,611,581 at the BSE (Thursday).