The planned new US law regulating banking and financial services firms puts severe restraints on their functioning and profitability. Since Indian software companies derive most of their revenues from this segment, will it impact them?

The Obama-led US administration is up in arms against the unbridled and reckless growth of US financial services giants. The banking and financial service sector in the US is in the midst of a regulatory turmoil that will see its wings being clipped to some extent if the proposed reforms become law. Already, the US House of Representatives has passed a package of sweeping reforms to the financial system and it now awaits the approval of the US Senate, which will decide the matter on 12th July.

Would the headwinds in the US regulatory climate have any bearing on Indian software companies? It is common knowledge that the fortunes of software or IT-ITeS companies in India are intricately intertwined with those of companies and financial institutions in the US. For instance, India's largest and most reputed software services company Infosys derives more than 90% of its revenues from the US. Revenue growth from North America for Infosys is correlated with US GDP growth by 98%, reports research firm BRICS Research. And almost 35-40% of their revenues are derived from the banking, financial services & insurance (BFSI) segment.

There is a concern that, with the anticipated clamp-down on the freedom of financial institutions, it would lead to a shrinkage in the size of the BFSI segment in the US and also Europe. This would also force such institutions to cut down on costs to stay competitive. This could have a bearing on the business of Indian IT services companies.

Saumil Parekh, managing director of PIMCO recently remarked, "The way things are progressing in the US and Europe, we believe financial sectors will be forced to become smaller as a percentage of their respective economies." 

PIMCO, in its Secular Outlook had pointed out that the rising trends of re-regulation and de-globalisation are slowly manifesting themselves into 'state capitalism'. They had stated that balance sheet deleveraging-in combination with structural imbalances-is forcing markets to take that back seat.

Prakash Diwan, head-institutional business, Networth Stock Broking, believes that earnings won't get dramatically impacted, but the earnings profile will undergo a change. "While the immediate impact of the austerity drive triggered by the US administration could potentially inhibit the growth of the BFSI segment, it may not necessarily and significantly reduce the kind of business opportunities for IT vendors within the operations of the BFSI segment."

Mr Diwan feels that as companies in this area tighten their belts and reduce expansionary spends, there would be a constant emergence of other opportunities for IT service providers. He further believes that this potential contraction in business could be offset by the Obama administration's ambitious drive to improve its service delivery within the healthcare value chain. "So what the BFSI takes, the healthcare segment could give, in the broader sense," said Mr Diwan, adding that he expects the more dextrous players to switch to the newer opportunities within the emerging healthcare segment, amongst other opportunities.

A BRICS Research report states that these regulatory changes would impact earnings growth of US companies and force them to reduce cost to maintain profitability. This presents an opportunity for Indian IT companies by leveraging offshore cost advantages. Commenting on the impact of the Healthcare Bill on US pharma companies, the BRICS report says, "We believe the pressure to cut costs and show profitability growth by way of aggressive outsourcing of IT functions will only go up. There may be additional demand for IT services as the Act will bring 32 million more Americans under healthcare products and services."

Rohit Anand, IT sector analyst at Pioneer Investcorp Ltd, agrees that these reforms will be coupled with some opportunities as well. "Implementing these reforms will require some sort of investment in IT infrastructure from US companies. If their business is impacted, then the resulting cost pressure may bring about an increase in outsourcing requirement."

Another IT sector analyst, Pralay Das of Elara Capital said, "I don't believe this shrinkage will come about overnight; but if it happens, it will definitely put more pressure on costs, translating into a need to save on costs and therefore more outsourcing to India."