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The Prudent Banker

Amid slow growth and poor governance in financial services, Kotak Mahindra Bank continues to steer ahead with a clear growth strategy.

V Keshavdev

It was May 1991. Salomon Brothers, the legendary Wall Street firm, found itself en-snared in a scandal where trader Paul Mozer had been submitting illegal bids for US Treasury Securities, attempting to corner the market by breaching the individual bid-ding limit. Warren Buffett, who had a $700 million investment in Salomon Brothers, stepped in to untangle the knots. The firm avoided bankruptcy and was, eventually, acquired by Travelers Group. It seemed like history was repeating itself when Uday Kotak, managing director and CEO, Kotak Mahindra Bank was sought out by the government to steer the beleaguered term-lending institution IL&FS, teetering under a pile of debt. The only difference: Uday Kotak had no ownership interest in the firm.

It is just that the 60-year-old banker has become the government’s go-to man to resolve a financial crisis that sent shock waves in the financial markets. The street shaved off3.5 trillion in market cap between August 2018, when the crisis began, and by end of September when a new board was set up. Kotak’s immaculate reputation as a prudent banker built over the past three decades made him the obvious choice.

In the world of finance, or in fact everywhere, reputation counts for a lot. “Lose money for the firm and I will be understanding, lose a shred of reputation for the firm and I will be ruthless,” Buffett famously said during the 1991 hearing, recounting his message to Salomon employees, after he took over as interim chairman. Kotak has neither lost money, nor his reputation since he began his career.

Kotak’s exalted status today, of course, had humble beginnings. Starting off as a one man army organising financing for companies through bill discounting, Kotak has grown steadily in India’s financial sector that has seen several ups and downs with a fairly poor survival rate. Several private financial firms of yesteryears simply shut shop, while many state-owned banks survived, thanks only to the benevolence of the government.

Kotak, on the contrary, quite like Buffett, has built a highly profitable business, following capital preservation as the bedrock. Kotak’s guiding philosophy has been ‘return of capital is much more important than return on capital,’ re-iterated in this year’s annual report.

It’s a virtue the market values highly. Kotak Mahindra Bank’s stock trades at a price-to-book value of 4.95x, one of the highest in the banking sector. Yet, the best is probably still to come as the bank shifts to a higher gear.

THE NON-BANK BANK

Despite having converted to a bank way back in 2003, Kotak Mahindra Bank continued to push ahead its existing legacy businesses, including auto loans, securities, investment banking and asset management with gusto, rather than plunging headlong into branch banking or writing large cheques to borrowers as conventional banks did. In those initial years, analysts did not even count Kotak as a serious bank for the same reason. “When we were relatively new in the banking business, attracting savings account customers seemed like a daunting task,” says Kotak. On the lending side, it chose to make safer bets providing working capital finance, trade finance and writing smaller cheques to creditworthy customers. Essentially, it continued to do brisk business, growing steadily without diluting its return ratios, choosing its playing field carefully.

In 2006, he took a contrarian stance that was stunning. While prominent investment bankers sold their business to foreign partners, rattled by the might of global players and the changing complexion of India’s corporate sector in favour of global companies, Kotak decided to do exactly the opposite — buy out the stake from foreign partner Goldman Sachs rather than selling out. That move was not just a demonstration of his confidence and faith in the investment banking and securities business – it was emboldened by the “universal banking” model that the world was veering towards.

On the loans side, several fledging private sector banks such as ICICI Bank and Axis Bank were gaining heft lending to corporates during the bullish years till 2008, but Kotak Bank displayed little aggression. The bank continued to restrict its lending to short-duration loans rather than long-duration ones or infrastructure projects.

Kotak has always had a nose for profitable deals, but has also been wary when needed. “We are paranoid about risk. We always assess what could do wrong before taking a call. Something that is too good to be true is just that.” Kotak cites the example of a trade in Himachal Futuristic that was brought to him about two decades ago.

During the dotcom boom, Himachal Futuristic along with Global Telesystems, DSQ Software, Pentafour were favoured by many a punter. Around that time, Kotak was offered a transaction that seemed lucrative. Since those days trade settlement took nearly a week, the counterparty wanted to sell a block of HFCL shares to Kotak which could then sell the same in the market. For an immediate payment, the client was willing to pay 1% flat – that would have meant a compounded return of nearly 6070% per annum, a very lucrative offer. Kotak loved the deal but let it pass, recognising the risk: what if the buyer on the other side was related to the seller and it ended up being a circular trade? Kotak could then be implicated in a stock manipulation case. And that is exactly what happened. The deal was done by another global bank, which was later banned by the regulator from the securities market for two years.

Kotak’s conservative stance has always paid off. It did in a big way in 2008 as the credit crunch post the collapse of Lehman Brothers went global. Sectors such as power and infrastructure were badly hit, and overall economic growth was plummeting. With the entire banking sector paralysed by bad loans, Kotak had a field day. The bank’s bad loans, including stressed assets, stood at 2.39% in crisis-ridden FY-09, but was down to 1.73% by FY10. Its advances grew 25% to 208 billion that year, and the bank clocked its then highest consolidated profit of 13 billion.

It just went to prove that the bank’s integrated approach was the best model as the cyclicality of the capital-markets businesses was offset by steady growing annuity from the financing and asset management businesses. In fact, by FY11, 75% of the bank’s earnings came from the financing business, 10% from the asset management and life insurance businesses, while the contribution of the capital markets business fell to 15% from 55% in FY08.

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July 19, 2019

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