Rating Rationale

Key Rating Drivers & Detailed Description

Strengths:

Strong support from the parent given its strategic importance: YSIL is an important wholly owned subsidiary of YBL and complements the bank's product offerings by providing a platform for services related to capital markets and financial products distribution to the latter's customers. These services strengthen the business franchise of the bank and support the bank’s efforts towards increasing their low-cost retail deposit base. The company also helps strengthen the bank's relationships with its clients. Furthermore, there is strong operational and managerial integration between YBL and YSIL. The latter benefits from the well-spread retail franchise and nationwide branch infrastructure of the parent. The bank shares its technology platform and risk management practices with the company. The board of YSIL comprises senior leadership from the bank, which ensures adequate supervision and oversight of its performance. The bank is committed to providing both funding and capital assistance to YSIL on an ongoing basis to support growth over the medium term. CRISIL Ratings believes the operational, managerial, and financial linkages, shared brand name and sole ownership of YSIL by YBL imply a strong moral obligation on the parent to support the company both on an ongoing basis and in the event of distress.

Adequate risk management systems: Risk management and monitoring systems are adequate to mitigate risks arising from uncertainties inherent in the retail broking business. For online broking, a three-in-one model is followed wherein the client’s bank, dematerialisation and trading accounts are inter-linked. The risk management framework for the margin funding business is also adequate, which includes aspects such as higher margin requirements, limited number of allowed scrips and stock and sector exposure limits across the company as a whole. The company has been investing in strong information technology architecture. Back-office operations are centralised, and the system allows real-time monitoring of all trades and executions.

Adequate capitalisation: Capitalisation is adequate for the current scale of operations, as reflected in networth of Rs 243 crore as on December 31, 2023, as against Rs 125 crore as on March 31, 2023. Gearing improved to 2.3 times as on December 31, 2023 (2.7 times as on March 31, 2023), helped in part by capital infusion of Rs 100 crore from the parent in the second quarter of fiscal 2024. Because of the nature of the business, borrowing is largely to meet margin requirement at exchanges and for the margin trade funding business. Networth will remain adequate over the medium term.

Weaknesses:

Modest earnings profile: The earnings profile was modest as indicated by net profit of Rs 18 crore in fiscal 2023 and return on equity of 16%. For the first nine months of fiscal 2024, the company reported net profit of Rs 19 crore. The earnings profile is reasonably diversified with broking and fee income and margin trading facility (MTF) book generating ~45% and ~32% of the income, respectively. However, cost to income ratio was elevated at 90% in fiscal 2023 and 96% in fiscal 2022. This is attributable to high employee expenses, which account for ~66% of the operating expenses as well as investments in technology infrastructure. While there may be some upside in operating efficiency from the transfer of the investment banking business out of YSIL in the second half of 2024, the ability to rationalise expenses as business scales up will remain a key monitorable.

Exposure to intense competition and risks associated with capital market-related businesses: The businesses of YSIL are confined to the capital market industry, which is intensely competitive with multiple players offering low-cost products. The broking industry has seen a huge transformation in the past decade, with technology-based discount brokers entering and dominating the market. YSIL has been taking steps to diversify its offerings with focus on distribution of financial products.

The company's broking business remains exposed to economic, political, and social factors that drive investor sentiments. Owing to the cyclical nature of the business, brokerage volumes and earnings are highly dependent on the level of trading activity in capital markets. This makes earnings and profitability volatile.

Susceptibility to regulatory changes: Over the past couple of years, the broking industry has witnessed a dynamic regulatory environment. With the objective of enhancing transparency, limiting misuse of funds and safeguarding investor interests, Securities and Exchange Board of India (SEBI) has introduced several changes, including margin pledge/re-pledge mechanism, daily client collateral reporting and disclosure, collateral allocation at clearing corporations by brokers and upfront margin collection for intraday positions. Recently, SEBI has approved blocking of funds facility for trading in secondary markets and non-usage of client deposits for availing bank guarantees, which aim to prevent misuse of client funds, broker defaults and consequent risk to investor capital. This is similar to the Application Supported by Blocked Amount (ASBA) facility available for the primary market, which ensures movement of money only when an allotment happens.

With increasing compliance, associated costs are expected to increase. CRISIL Ratings understands that most top brokers, as well as some mid-sized companies such as YSIL, have streamlined their systems in accordance with the revised regulations. Fundamentally, while these revised regulations will benefit the broking industry in the long term by increasing transparency and lowering risks for customers, the changes increase the compliance costs for brokers and require them to adapt their business models to keep pace.