There is a point in time when we look back and feel a particular situation could have been handled differently. For Uday Kotak, his biggest mistake was in believing what The Wall Street Journal and Financial Times had to say about the global financial crisis in 2008. “I became very cautious. It made me feel that the world is coming to an end. If I had not read those papers, I would have been bolder with my expansion between 2008 and 2011,” admits Kotak during a chat on leadership with R. Gopalakrishnan, management expert and former director of Tata Sons.
Kotak’s nervousness back then was understandable, as it was only his fifth year into banking post the conversion of Kotak Mahindra Finance, the non-banking financial company, in 2003. Having lived through the turbulent ’90s, Kotak’s dilemma was in differentiating between the lessons of history he had to keep in mind versus the baggage of history he had to shed. But in deciding to play it safe, the bank’s liability franchise — the source of cheap fuel for banks — took a hit for a longer period of time. The bank’s average CASA (current account, savings account) ratio was stuck at 30% between FY08 and FY13.
Due to step down from an executive role by the end of 2023, Kotak shared in the chat the lesson he learnt from the 2008 episode: “Don’t let your instincts get curbed by what other people say.”
In fact, a year before the pandemic, Kotak had struck a cautionary note about the slowing economy.“…even strong boats must remember the lesson of the Titanic — considered unsinkable when she was built. Before she hit the iceberg, she was moving at a great speed, leading to a tremendous collision which overwhelmed her safety mechanisms.” Reflecting that concern, the bank’s total unsecured retail lending, which includes consumer loans, credit cards, microfinance loans, consumer durable loans, shrank from 7.5% of its FY20 balance sheet to 5.8% in FY21.
It was during the pandemic-ridden FY21 that the lessons learnt in the past came in handy — the bank, with a loan book size of ₹2.74 lakh crore (as of December 2021), chose to play it safe again — but only in businesses where it felt it had to. For instance, the bank went slow on its unsecured lending portfolio but built its secured retail loans. But the big change was evident in the way Kotak ramped up its liability franchise with the CASA ratio hitting an all-time high of 60%.
From 8 million customers in March 2017 when 811, the bank’s ambitious digital bank account was launched, to 30.7 million (including 811 users) as of December 2021, the bank added 22.7 million customers in five years — at a CAGR of 30.26%. What’s pertinent to note is that the bank’s customer addition gathered pace in Q3FY22 — from 8 lakh in 3QFY21 to 21 lakh. As of December 2021, ₹57,097 crore was parked in current accounts, and ₹125,822 crore in savings accounts. In fact, over FY19-FY21, deposit growth at 11.4% outpaced that of loans, which grew at 4.3%. The other big advantage from a high CASA is that in the event of interest rates moving up, the bank’s net interest margins (NIMs), currently at 4.6%, will continue to be robust.
Dipak Gupta, joint managing director, reveals that over the past several years and, especially during the pandemic, the management’s efforts were directed at ensuring the right quality of liabilities. “Once you onboard a deposit customer, the relationship is practically lifelong. So, you first need to attract deposit customers before you can start offering products and services to them,” says Gupta.
Though the bank stayed away from growing its unsecured lending portfolio, its home loan portfolio grew 12.8% in FY21, secured consumer banking loans rose 10%. “It’s not that we’re scared of taking risks. When you look at our stressed assets portfolio, bought from other banks, you might say we are the highest risk takers in the industry. But we are willing to take risks after understanding them and believe the pricing must justify the risk,” says Gupta.
By January 2021 after having built a massive engine for liabilities, the bank began looking at building assets. The tack changed from just customer acquisition to customer engagement. Gupta believes while on the deposit side the engagement tends to be lazy as the probability of a customer leaving is low, on the asset side, a banker needs to aggressively reach out to customers. “Asset business is an outcome of the head (logical customer thinking), whereas the liability franchise comes from the heart, as there is a lot of emotion, trust and comfort involved,” says Gupta.
Within the retail lending business, home loans saw a greater push. Shanti Ekambaram, group president, consumer banking, is responsible for over Rs 106,000-crore advances book, comprising home loans & loan against property (LAP), consumer bank working capital, personal loans, credit cards, consumer durables financing and business loans. In March 2021, the bank slashed home loan rates to 6.65%, making it one of the lowest priced players in this segment. In fact, the momentum has continued in the nine months of FY22, as the mortgage book grew 38% YoY. “In the December quarter the growth (in mortgages) was 12% (Q-o-Q), probably one of the highest in the industry,” mentions Ekambaram. As of December 2021, the home loans & LAP portfolio stood at ₹68,871 crore.
While the merger of HDFC and HDFC Bank is expected to give the combined entity an edge in the mortgages business especially among private sector banks, Ekambaram is not reading too much into the development. “While distribution width and low-cost funds are important in the mortgages business, in today’s digital world, how you leverage technology to scale business and think differently matters. Also the home loan market is a deep and wide market with sub-segments between ₹10 lakh and ₹10 crore,” she says. Within unsecured retail, the bank is building its credit cards business by leveraging on its upgraded tech platform. “We had one of our best quarters with the acquisition of 3.9 lakh credit cards in Q3. Bulk of the sourcing has come from existing customers,” adds Ekambaram.
The bank now wants to milch the trust factor and get up, close and personal with its customers digitally. Without revealing the money being spent on tech initiatives, Ekambaram mentions the bank will continue to invest in technology, analytics and capacity enhancements to grow the consumer assets businesses. “Technology will be a key for us considering that over 97% (Q3 ended December 2021) of our saving account transaction volumes were in digital or non-branch modes,” she says. The bank currently has 1,647 branches and 2,609 ATMs.
Even as the bank is revving up its retail engine, KVS Manian, who oversees corporate, institutional, investment banking and private banking, points out that at the top end of corporates, represented by conglomerates, growth was driven more by credit substitutes than by advances. “We have successfully managed excellent asset quality across cycles. Many of the larger banks have taken large write-offs on their corporate loan books, which we have not had to,” says Manian, who is also on the Operating Management Committee that oversees Kotak Mahindra Group’s growth charter. The bank’s asset quality improved sequentially with a drop in gross non-performing assets (NPAs) from ₹7,126 crore in Q3FY21 to ₹6,983 crore in Q3 FY22. The GNPA/NPA ratio stood at 2.71%/0.79%, against 3.19% and 1.06% in Q2FY22. “Our corporate book may not see the fastest growth but we have been growing at a consistent pace. So, over a period of time our averages tend to be closer to 15%,” says Manian.
Over the past one year, instead of direct lending, Kotak saw a greater demand for credit substitutes, a type of lending wherein the bank subscribes to corporate bonds or non-convertible debentures of top rated corporates. “As an alternative to lending as loans, we have frequently invested in bonds of companies. In terms of risk management, it is better when you have bonds as you can manage exposures by selling them any time you want, unlike loans,” says Manian. As of December 2021, the credit substitutes portfolio stood at ₹21,634 crore.
What makes the bank stand out is also the fact that it has a strong bouquet of financial services that allows it to make a holistic offering to corporates. “Lending is usually the least RoE (return on equity) product in a relationship. We keep the RoE on our corporate banking business higher through cross-sell of multiple products such as transaction banking, cash management, payments, collections, trade finance, investment banking, equity brokerage, wealth management and so on. This also helps us in building a comprehensive corporate franchise,” adds Manian. For instance, the bank on the investment banking side caters to conglomerates such as the Tatas, Bharti, Aditya Birla Group, Godrej Group and the likes. Manian explains there are three ways to grow — make very large loans, but they are low on pricing and don’t augur well for RoE, second, go slower in the corporate portfolio, and third, be selective on loans but build a comprehensive multi-product relationship with a focus on client-level profitability. “Being selective is the game we play,” says Manian.
Not surprising then that the bank currently has the highest net profit margin of 21.6% among all domestic scheduled commercial banks. “We measure risk adjusted return on capital in each relationship and make sure that we make the right profits in the relationship. It is easy to lend ₹5,000 crore more by lending very cheap for a 15-20 year tenure. But we don’t like very long loans because we don’t like to take that kind of asset-liability mismatches. So, we want to make RoEs within those risk management principles that we follow,” says Manian.
As of December 2021, while the corporate banking and SME portfolio constitute ₹87,089 crore of the total lending book, the commercial vehicle/construction equipment, agri divisions, tractor finance make up for ₹55,516 crore. D. Kannan, who heads the commercial banking business, points out that while in agri finance, demand for credit, both working capital and capex in SME and agri value chain, continues to be good, the bank has maintained its leadership position in the tractor financing segment. It saw a 21% jump in its SME segment to ₹18,994 crore during Q3 FY22.
For now, the bank is sitting pretty with a high capital adequacy ratio, with 22.3% and 21.4% CAR and Tier 1 ratio, respectively, second only to Bandhan Bank. At the peak of the pandemic, in May 2020, the bank raised ₹7,400 crore through a qualified institutional placement. Putting the fund-raise in context, Jaimin Bhatt, president & group CFO, says, “In turbulent time, it is good to have capital as a buffer.”
While the bank continues to power two-third of the group’s profits, the rest comes from other businesses. In FY21, subsidiaries contributed 30% to the bank’s consolidated profit after tax. The strong performance continued in FY22 as well, with other lending entities, including Kotak Prime ending Q3 with a profit of ₹254 crore and Kotak Mahindra Investment a profit of ₹111 crore, thereby contributing 12% of the consolidated PAT of ₹3,403 crore. The continued buoyancy in the capital market resulted in Kotak Securities recording a ₹270-crore profit and Kotak Mahindra Capital (the investment banking arm) posting ₹103 crore in profit. The life insurance business, which saw a negative first quarter in FY22, contributed ₹247 crore to Q3 profit. Mutual fund businesses brought in close to ₹150-crore profit, accounting for 5% of consolidated PAT. “At the end of the day, the size and breadth comes from the bank. Non-bank businesses will have periods when they will do well, like in the past few years. This has been due to the tailwinds in the capital market. The bank however, is the primary engine, which gets opportunities to keep growing all the time,” explains Bhatt.
Unlike the HDFC group, which has unlocked value in a lot of its diverse businesses, in the case of Kotak, the wealth unlocking is yet to play out. The potential value creation that the group holds is reflected in the market as the stock enjoys the highest P/B ratio (4.8) in its category and the second-highest among all listed banks next only to AU Small Finance Bank. “One of the key differentiators is that the Kotak Bank shareholder is effectively the owner of all other group businesses as the subsidiaries are 100% owned,” says Bhatt.
Even as investors are awaiting cues from the management, Gupta says the focus will be on strengthening the core banking business with an emphasis on building the digital stack. “Today, every customer has the branch on their mobile. The mobile is the biggest branch. Hence, being the Godzilla is not necessarily going to be a big advantage. At Kotak, in the coming years, you will see and hear a lot more from young engineers and data scientists and less from grey-haired people in the ranks,” says Gupta.
But the big change will be in 2024, when the grey-haired promoter-CEO will make way for a new successor after a 17-year stint. Will the transition change the bank’s DNA? Will the new CEO be more aggressive? For now, only Kotak and the board have the answers.