IDFC Bank and Capital First announced on Saturday the approval of a merger to create a combined entity that would benefit from the former’s strong presence in infrastructure and the latter’s sizeable retail presence. It is a deal that makes sense in many ways. There are also plenty of unwritten cues in it for Shriram Group and its strategic investor, Ajay Piramal, IDFC Bank’s original interest.

The failure of that proposed merger of IDFC Bank and Shriram Group’s financial entities is the backstory to the new deal. And it is a backstory that ends with a lot of questions related to Shriram Group.

To understand this better, let us cut back to July 10, 2017. IDFC was facing questions and doubts from analysts on the exclusivity agreement it signed with Shriram Group on July 8 to evaluate a group-wide merger. Answering them were Sunil Kakar, then group chief financial officer, IDFC, and Rajiv Lall, MD and CEO, IDFC Bank.

Under the proposed merger, the retail financing business under Shriram City Union Finance would be absorbed by IDFC Bank and the transport finance business under Shriram Transport Finance Company would remain a standalone NBFC subsidiary of IDFC Limited. The life and general insurance business too was to become a subsidiary of IDFC Limited. In short, Kakar and Lall had a complex deal to sell to the analysts. Sidenote: it was six days before Kakar’s elevation to MD and CEO of IDFC Limited.

The analysts expectedly had pointed questions. Amit Ganatra, senior equity fund manager at Invesco India Asset Management, asked if the merger would be carried out in phases, given the complexities involved. “So for example, Shriram City Union Finance merger was allowed and Shriram Transport Finance structure was not allowed then, can part of the transaction go through?”

Lall replied that they were conceiving it as “one composite scheme of amalgamation”. “It can cut both ways but on balance it is our judgment that this is the simplest way of going about it because it requires one-time regulatory approval by all concerned and one-time board approval for the entire scheme which will become effective all at once,” he said.

But that did not settle the matter. Mumbai-based Jigar Walia, research head of OHM Stock Broker, asked if there would be a series of transactions. Specifically, he asked if Shriram City Union Finance can be brought into IDFC's fold first, and then consider Shriram Transport Finance Company at a later time, or vice versa.

While IDFC’s Kakar elaborated on the time frame for due diligence and to decide on swap ratios, he called it a composite scheme where “everything will happen together”.

Later on July 14, Fitch Ratings put out a note that the proposed merger would have no immediate impact on Shriram Transport's ratings. It said that “the structure itself may encounter stiff regulatory challenge”. Fitch said regulatory approval from the Reserve Bank of India would be a big hurdle to the proposed merger.

"The RBI had previously taken the view that banks cannot undertake any business activity through a separate entity that can be done within the bank; and the proposed structure of having a non-bank financial institution alongside the bank could be a significant barrier to the merger,” Fitch said. “While the managements believe that the RBI's on-tap bank licensing guidelines issued in 2016 take a more considered view on this aspect, we believe the central bank has not fundamentally altered its stance.”

Besides the regulatory hurdles, Piramal’s 20% stake in Shriram Capital, and sub-10% stakes in Shriram Transport Finance Company and Shriram City Union Finance also had to be considered. While Piramal has been bullish about financial services, and Piramal Enterprises has sizable business interests independent of Shriram Group, the “composite scheme” of the proposed IDFC Shriram merger was bound to raise eyebrows. Was the composite merger an ideal exit route for Piramal or did he want to align the Piramal Enterprises’ financial services business interest with that of the merged IDFC-Shriram combination? Analysts were not sure.

Eventually, the deal fell through, forcing IDFC Bank to look for other options. Now with the bank finding the right option in Capital First, and not many other private banks seeking to absorb an NBFC, save for the key ones, Shriram Group may have to restructure its operations beforehand to make itself attractive. Perhaps merging all their respective finance businesses to create a bigger entity might do the trick.