Hetal Dalal

The debate between the Reserve Bank of India (RBI) and Kotak Mahindra Bank (KMB) now rests on the intent of the regulation vs. the letter of law. KMB alleges that it has met RBI’s requirement of dilution by issuing perpetual non-cumulative preference shares (PNCPS), thus reducing promoter stake in the bank’s paid-up capital. Yet, RBI contends that the regulatory objective is a dilution in the equity share capital (not paid-up capital, which includes preference share capital). RBI and KMB have a legitimate point of view, yet both cannot be right. While the battle has been taken to the court, the looming uncertainty is not good for stakeholders.

Although RBI is well within its rights to decline Kotak Mahindra Bank’s (KMB) assertions of having met the regulatory requirements to reduce promoter shareholding to below 20 percent by 31 December 2018, its argument is weak. After articulating the requirement as a reduction in “paid-up share capital” it cannot change it to “paid-up equity voting capital”, that too after the fact. Even so, one cannot deny that RBI has, in the past, been accommodating KMB and Uday Kotak in allowing periodic extensions to its diktat of reducing promoter holding in the bank.

KMB trades at a premium because investors have an expectation of trustworthy behaviour, one that is steady, predictable, and performance-driven. Therefore, KMB’s sudden change in stance to reducing promoter equity by leveraging the nuances of language in the regulation (with the courts now deciding on its legality) disappointed RBI and surprised the bank’s stakeholders. Further, the bank had chalked out a path to reduce promoter holding and had submitted this to RBI—the premise being a reduction in equity share capital. Investors too were aware of the planned reduction—and this spurred conjecture of more acquisitions after ING Vysya Bank. For KMB to take the matter to the court is unlike its previous behaviour—neither KMB nor Uday Kotak are known to be confrontational, and certainly not with the principal regulator.

Dilution of promoters’ equity balances the voting rights of minority shareholders vis-à-vis the controlling shareholder, thus ensuring that a bank’s corporate governance standards are not subject to the will and intent of its controlling shareholder. Investors need not look any further than public sector banks to experience the impact of a controlling shareholder on governance quality and performance. The government of India (GoI), through its own shareholding and that of public sector insurance companies, effectively controls over 85 percent of the voting rights in most public sector banks. For private sector banks, promoter holding is significantly lower—on 31 December 2018, promoter holding aggregated 30.01 percentin KMB, 26.54 percent in HDFC Bank, and 16.79 percent in IndusInd Bank. By and large, private sector banks have reported stronger performance and lower non-performing assets (NPAs) than public sector banks over the past few years.

As banks raise capital to grow and maintain their capital adequacy levels, their promoters’ equity will dilute naturally. Uday Kotak’s equity has been diluted over the years through acquisitions, capital raises, and stake sales to meet RBI regulations. Asking promoters to bring their equity down to a stipulated threshold within a specified time frame is forcing their hand. It may lead to undesirable acquisitions, or a risky growth strategy. KMB’s investors too do not want a forced reduction of promoter equity—they would rather have Uday Kotak’s skin in the game, the more the better. Neither Uday Kotak nor KMB’s board seems to be in a hurry to reduce promoter equity without value creation, just to meet regulatory requirements.

RBI has muted the voting power of promoters in private sector banks by capping voting rights of promoters at 15 percent. But there are two unanswered questions on the capping of voting rights.

One, having capped the voting rights of promoter equity in banks, RBI must explain how the dilution of promoter equity—whether it is in KMB, IndusInd Bank, or Bandhan Bank—will incrementally benefit the bank and its stakeholders. Since the dilution of equity share capital and the capping of voting rights have the same outcome in terms of control, RBI needs to explain why it chooses to adopt both approaches instead of just one.

Two, there needs to be an alignment between the voting rights cap and the minimum promoter shareholding requirement. While the voting rights of promoters in private sector banks is currently capped at 15 percent, the Banking Regulations Act 1949 allows RBI to increase the cap to 26 percent. If the regulatory thought is that promoters of banks can exercise their voting rights up to 26 percent, compelling Uday Kotak to reduce his stake to 15 percent in KMB is perhaps unfair—more so when promoter holding in some of the other private sector banks is above the 15 percent threshold. The voting cap does not apply to public sector banks: GoI votes to the full extent of its shareholding in public sector banks.

In this battle between KMB (and Uday Kotak) and the RBI, investors are increasingly getting nervous with the overhang of the court’s verdict and possible penalties levied by RBI on KMB (just as RBI did for Bandhan Bank). The battle is helping no one at this stage. The only saving grace, perhaps, is that the courts will set jurisprudence on the matter and help guide banks on the way forward.

Hetal Dalal works at Institutional Investor Advisory Services India Limited (IiAS). Kotak Mahindra Bank is one of IiAS’ shareholders. These are her personal views. Twitter: @hetal_dalal