Kotak Mahindra Bank's Golden Run

CHARLES LEWIS, founder of American luxury brand — Tiffany, once sent an exquisite diamond stickpin to John Pierpont Morgan, the founding father of U.S.' biggest financial powerhouse, JP Morgan.

An accompanying note with the box read: "My dear Mr. Morgan. Knowing your exceptional taste in stickpins, I have sent this rare and exquisite piece for your consideration. Due to its rarity, it is priced at $5,000. If you choose to accept it, please send a man to my offices tomorrow with your check for $5,000. If you choose not to accept, you may send your man back with the pin."

The next day, Tiffany was surprised to receive the box with a note: "Dear Mr. Tiffany. The pin is truly magnificent. The price of $5,000 may be a bit rich. I have enclosed a cheque for $4,000. If you choose to accept, send my man back with the box. If not, send back the check and he will leave the box with you." Though the bid was attractive, Charles was convinced of his quote, and chose to send back the runner.

Pondering over whether he had done the right thing, Charles opened the box and was surprised to find a $5,000 check with a note that read: "Just checking the price."

Substitute the terms, "price" and "value", in this profound parable about price discovery with "risk" and "return", you have the guiding philosophy of Asia's billionaire private financier, Uday Kotak, who runs the fourth-largest private sector bank (by market cap) worth ₹3.65 lakh crore. What the business of banking and its resultant fiduciary responsibility mean for the bespectacled banker, who is slated to retire by the year-end, is quite evident when he tells Fortune India: "Let's assume you start a new bank with ₹10 as equity capital and ₹100 in deposits. Keep out the statutory obligations and assume the bank lends ₹110. Now, if ₹5 doesn't come back, the bank won't have the capital and if ₹10 doesn't come back, it's bankrupt. The first charge of loss is always on equity. Hence, in banking, how you run the business to protect equity holders' money is the ultimate insurance of protecting depositors' money."

There you have it — a lesson in Finance 101.

Not surprising that the 64-year-old son of a cotton trader with a master's degree in business management has built a rock-solid lending franchise by sticking to the risk-return matrix without unduly obsessing about growth (size). That philosophy and growth consistency ensured the bank retain its top position among mid-sized banks for the second consecutive year of Fortune India-Grant Thornton Bharat study, even as majority of the six-member jury voted in favour of Kotak as the "Financier of The Year."

In fact, in his first-ever interaction with the media, Shivanand Mankekar, the Jamnalal Bajaj Institute of Management Studies' former professor of finance — whom Kotak holds in high esteem for introducing him to the world of finance and valuation — tells Fortune India, "Uday Kotak is among those handful of people in finance for whom I have the highest regard. Though we do not meet very often, he keeps reminding me how my lessons have stayed on with him. But the knowledge which a teacher imparts to his students is akin to planting a seedling, and it's up to the student to nurture it into a robust tree, something which Uday has done par excellence."

Incidentally, amid the bad loan crisis at ICICI Bank in 2017, Kotak Mahindra Bank's (KMB) market cap had eclipsed that of ICICI. But since then, ICICI's market cap has bounced back to ₹6.47 lakh crore against KMB's ₹3.65 lakh crore. But Kotak is unperturbed about the changing market stakes — forever willing to sacrifice growth at the altar of profit. The industry calls this conservatism, but Kotak sees it otherwise. "It's not conservatism. It's about a very deep entrepreneurial view of risk and return. If I take so much risk, I must make a commensurate return. This is true globally — banks horribly misprice risk and return," says Kotak. In fact, Kotak was the only Indian banker who went vocal when Credit Suisse got sold to UBS for $3 billion, a 60% discount to its stock value. "$600 bn balance sheet sold for $3 bn equity value… A signal for all bankers and stakeholders, when risk return matrix is overtaken by obsession with size," his tweet read.

Picking a leaf from the journey of behemoths such as JP Morgan and Goldman Sachs for creating enduring legacies by putting their family names, Kotak, when he ventured out in 1985 as a non-bank finance firm, roped in Anand Mahindra since he believed finance was all about trust, and having an established industrialist onboard would give him the much-wanted credibility. "How are you going to ensure financial institutions, which are on the bedrock of trust, outlive individuals over a long period of time? Just look at JP Morgan. How long has it been in business? You create institutions to last and at the same time evolve and change," points out Kotak. Two decades later since becoming a bank, Kotak has not only lived up to his name but etched Mahindra's name for posterity even as the industrialist exited the bank for good.

Over the decades, while most of its peers have grown at a faster clip, with ICICI Bank's advances at ₹10.19 lakh crore, more than 3x that of Kotak Mahindra Bank's (KMB) ₹3.25 lakh crore book, Kotak believes size — ₹4.90 lakh crore standalone balance sheet — is an outcome of chasing the right opportunities and pricing credit right. "The ultimate objective of sustainable growth is creation of value. For value, you need relevance (in size). But you should not obsess over size for size's sake. Being the largest does not necessarily mean the best," says Kotak.

Mankekar believes people often mistake Kotak's "risk-understanding" as "risk-aversion". "He is a visionary who knows how to measure and price risk. Combined with tremendous patience and the maturity of waiting for the right balls to play his shots, has helped Uday make a mark of his own," says the 70-year-old professor, who himself is a prolific investor in public and private markets.

In fact, while the bank in the current fiscal has gone slow on corporate credit, it has been ramping up its unsecured retail portfolio. In Q4 FY23, the corporate loan portfolio grew by just 1%. President K.V.S Manian attributed it to the significant amount of irrational pricing. "We have seen BBB (rated) entities get the same pricing as AA ones," he said during the earnings call. The irrational pricing is also because mutual funds have turned to be a lender of the alternative resort. "If a corporate gets loans 5 basis points cheaper from a mutual fund, they'll take the money there and rightly so. They're going to make sure that they put you on a competitive platform. So that is fair on their part. But the question is what are the risks you are taking for the returns you're making?" says Kotak.

Despite analyst concerns over unsecured lending, the bank is comfortable about faster growth in this segment with joint MD Dipak Gupta saying the contribution to the overall book will rise to mid-teens from the current 10%. Justifying the management's view, Kotak says, "You can chase growth by pricing it in your return. If I give a personal loan at 15% against 8%, then for the same risk, I've got 700 bps margin. But if I price it at 8%, I don't have the cushion. I'm very supportive of growth, but we must price risk properly and the danger in banking is finally the classic agency issue — other people's (depositors') money."

With a capital adequacy ratio of 21.80% and gross NPA ratio falling to 1.78% from 2.34% in FY22, Kotak is rearing to go. "We are at a time when it is almost like Goldilocks in Indian banking," says Kotak.

While real GDP growth was 7.2% for FY23, the share of real gross fixed capital formation in real GDP increased to an 11-year high of 35.3%, resulting in significant capex push in the economy. But this public capex engine of growth has largely been led by government spending. Although there are signs that the global and domestic rate hike cycle may be coming to an end, elevated inflationary indicators suggest rate cuts may take its time coming. The positive news is that fresh investment announcements by India Inc. in FY22 grew more than three-fold to ₹8.08 lakh crore compared with last year, according to Goldman Sachs. However, the big push has largely come from the steel sector. "The investment cycle is coming back. But I agree with the finance minister when she says that India Inc. needs to get its animal spirits back in full form," says Kotak.

In FY23, overall credit grew 15% against 9.7% in FY22, largely driven by the retail credit, which surged 20.6%. Though there is a general expectation that the current year could see a moderation of credit growth, Rahul Jain, co-head of Asia Financials Research, Goldman Sachs, is bullish. "While the expectations going into the financial year were for slower credit growth at 11-13%, partly also due to the base effect, the current data continues to remain strong with credit growing at over 15% YoY," says Jain.

But given that the return ratio of India Inc. (excluding financials) has come off from its high double digits to low single digits, the heavy lifting would largely be confined to the government. Kotak, though, believes that with a good GDP growth rate and reasonable demand, the environment is much better. "The demand is reasonable, GDP growth is strong, inflation is under reasonable control, interest rates have plateaued, fiscal deficit is in check, and we have political stability. What more can you ask for?" says Kotak.

Within corporates, there seems to be a growing opportunity to ramp up MSME credit. According to RBI data, bank credit to MSMEs (as of December 2022) stood at ₹21.5 lakh crore across 2.13 crore loan accounts, an over 1% year-on-year growth over nine months of last fiscal. "I see a very large opportunity in SME, both large and small," says Kotak. Jain of Goldman Sachs, too, believes private banks have an edge in SME lending. "Private banks have been growing at a relatively faster rate, as seen in Q1FY24, partly owing to strong momentum in retail and MSME lending where a lot of capacity has been built by private banks," says Jain.

KMB's stock has been compounding return at 30% since 2003 against 15% for the Sensex. It continues to be the most expensive banking franchise at 4.5x estimated P/B, significantly higher than HDFC Bank (3.7x) and ICICI Bank (3.3x). While the big question about KMB has always been on the unlocking of value of its other businesses (asset management, insurance and securities), the bank prefers an integrated firm approach to battle cyclicality. It's a facet of the bank that Kotak proudly wears up his sleeve. "Only 70% of the consolidated profits come from banking, 30% come from other businesses. Which means we are a much more holistic financial services model in addition to the bank," says Kotak.

In FY23, consolidated PAT rose 23% YoY to ₹14,925 crore and in Q4 it was up 17% YoY to ₹4,566 crore. Kotak paints the big picture when he says, "The consolidated (Q4) PBT works out to ₹25,000 a year on an annualised basis … that's serious cash flow on a 21.8% capital adequacy."

While an unfortunate accident cut short Kotak's cricketing career, as a banker he has timed his every move. As Mankekar puts it succinctly: "Using an analogy from cricket, Uday is the 'The Wall' of Indian banking, who can always be depended upon to make the most prudent decisions without any pressures of growth/size, and this has led to him steadfastly navigating the bank through the cycles." Now, as his two-decade long inning draws to a close, it's only apt that the epithet, "The Wall", goes to the destiny's child of Indian banking.