Year: 1989. Venue: The Oberoi Hotel, Mumbai. Scene: A 33-year-old candidate is trying to figure out if he really should join a relatively unknown financial firm. The 30-year-old interviewer, a first-generation budding entrepreneur, in turn, is trying to judge if the candidate has enough spunk to be taken on board. Twenty-three years later, C Jayaram is happy to have taken up the offer — after a second meeting, though — to team up with Uday Kotak in 1990. “Having worked for ICICI and Sanmar group in the past, I took up the job thinking I wouldn’t stick around beyond five years. And here I am, about to retire this December, after spending more than two decades with the organisation,” says 57-year-old Jayaram, who started off with a pay of less than ₹1 lakh per annum and today draws a little over ₹2 crore annually as the joint managing director of Kotak Mahindra Bank.
Just like Jayaram, had you as an investor stayed on with Kotak over the years — ever since Kotak Mahindra Bank went public in 1992 in its earlier avatar as a non-banking financial company (NBFC) — an investment of ₹1 lakh would be worth over ₹40 lakh today, a CAGR of about 23% over 21 years. But just as every financial product advertised today carries a disclaimer in small print, here’s one for Kotak in this instance: since the share price data was available only from May 1995, the returns are based on adjusted closing price of ₹18 [May 2, 1995], while the last traded price was ₹726, as on June 21.
The institution has grown over the years
through alliances and timely diversifications
But, one way or the other, there is no denying that 54-year-old Uday Kotak has successfully managed to transition his business from operating on the fringes of the financial services landscape to emerge as the country’s fourth-largest private sector bank by market cap. An achievement his father, Suresh Kotak, is amply proud of. Sitting in his second-floor office at Navsari Building in Fort, just 3 km away from the central business district of Nariman Point that houses his son’s headquarters, the 80-year-old still oversees the family’s traditional cotton trading business. “As a father I am happy enough to see that Uday has achieved whatever he had set out to do,” says the senior Kotak, who continues to live with his son in a joint family set-up.
Interestingly, it was the very confines of a cosy family business that Uday chose to move away from when he completed his MBA from Jamnalal Bajaj Institute in 1982. “There are both challenges and positives in a family business. While the ability to work with your own people as partners is an extremely important lesson in a family business, the flip side is that at times meritocracy may not matter,” says Kotak, who ventured out on his own with an office space of 300 sq ft within the Navsari Building premises. And the rest, as they say, is history.
Having been exposed to the family business, especially on the financial side, Kotak was quick to spot an anomaly. Those days, banks used to borrow money at 6% from depositors and lend it at around 17% to corporates. It was pretty evident that the banks were making a killing on the spreads and the situation just needed someone smart enough to exploit it.
“Nobody asked the common sense question, ‘Why?’” says Kotak, who got an opportunity when one of his batchmates from Jamnalal joined Nelco. The Tata group company needed working capital and Kotak struck a deal: at 16%, he promised Nelco cheaper funds than banks and convinced his friends and associates to lend money at 12% since there was no risk in lending to a Tata group company. “We narrowed the spread to 4 percentage points,” says Kotak. Next on the cards was a product where the NBFC would take a bill guaranteed by banks to other banks for refinance. Lastly, in those days there was a concept called trust funds, where Kotak pooled investor monies to invest in bills.
In 1985, there was a turning point in the business when, on the advice of friend and mentor Sidney Pinto of Grindlays, Kotak decided to start a professional business of his own. Around the same time he met Anand Mahindra, who too had started off his journey at his own family business and was then the general manager (commercial) at group firm, Mahindra Ugine Steel.
“Anand had just come back from business school in the US and he understood that the financial services revolution was just beginning in India. I approached him with a proposition on bill discounting, saying we would be able to fund it in 48 hours, which, in those pre-technology days, was pretty fast. That is how the relationship began,” recalls Kotak. Impressed by Uday’s financial skills and drive, Mahindra offered to be his partner and investor. In early 1986, Mahindra put in a couple of lakh rupees in his personal capacity into the company. That’s when Kotak urged Mahindra to back the business by putting his name on it. “If you believe in yourself and the business, you should put your family name on the line,” Uday told Mahindra, and thus was born a new entity, Kotak Mahindra. The move paid off as the business suddenly enjoyed more credibility among clients and investors.
To Kotak’s credit, he was also quick to spot and make the most of changing trends. Around the early 1990s, foreign banks had started offering car loans, a relatively new concept in India. Jayaram, who was instrumental in spearheading Kotak’s car finance business, recalls the rationale behind the same. “In those days, NBFCs were borrowing funds at 16-18% and were enjoying obscene internal rates of return of around 30% on car loans. It was too good an opportunity to miss,” he says. But the going was far from easy as car dealers were not keen on entertaining relatively smaller NBFCs. That’s when Kotak Mahindra changed the rules of the game. “Due to limited availability, customers had to order cars and wait for months for delivery. We would order popular cars in the company’s own name and then offer loans to customers to buy the cars without any waiting period. Customers did not mind the high cost of funding and were more than happy to get the car of their choice, which was almost always Maruti. Dealers, too, were happy with the situation as the strategy ensured a quantum jump in bookings,” recalls Jayaram. Soon, Kotak Mahindra became a leading player in the business.
Rural branch cost structure is unsustainable
Another turning point that marked the group’s entry into the securities business was scripted at an unusual venue. At Anil Ambani’s wedding in 1991, during a conversation with Pradip Dalal’s son, Rikeen, Kotak expressed his desire to take over Ficom, one of India’s largest financial retail marketing networks, as Rikeen was not keen on continuing with the business and wanted to focus on his manufacturing operations (Ficom Organics). “We fleshed out the [₹50-lakh] deal right there as I could see the power of retail distribution,” recalls Kotak, who went public a year later and diversified into investment banking and consumer finance. It was around this time that Falguni Nayar from AF Ferguson joined the group. “Back then, as a financial consultant with AF Ferguson, I had done a report on the financial sector and was impressed by the way Uday had managed to grow his business. While most NBFCs then were mostly into leasing, Kotak and Alpic Finance were the only two major players focused on bill discounting,” says Nayar, who quit in 2012 as managing director, Kotak Investment Banking, to start her own e-commerce venture, Nykaa.
A big fillip to the investment banking business and an important milestone in Kotak’s history was its tryst with Goldman Sachs. In 1993, when the Indian market was thrown open to foreign investors, Kotak met Hank Paulson and Jon Corzine in Hong Kong for a dinner meeting at the invitation of Mark Evans, who was the Asia head of Goldman Sachs. The duo wanted to understand the new market. Paulson visited India a couple of years later and in 1996, Goldman Sachs picked up 25% stake in Kotak’s investment banking and securities ventures. Interestingly, Paulson and Corzine were so impressed with Kotak that they wanted to hire him, till Evans told them, “Uday wants to build a business in India and is happy to partner, but not be taken over.”
Even as the Goldman alliance took shape, Kotak went ahead with yet another joint venture, this time with Ford Motor Credit. The alliances in a way proved to be a learning curve for Kotak. “What I really liked about Goldman was its very strong one-firm culture, which is why, though it may have had different verticals, there was phenomenal communication and integration between them vis-à-vis the customer.”
While JVs were one part of the story, Kotak was clearly seeking a bigger role in the financial services business. In 1998, the group entered the asset management space and, in 2000, teamed up with Old Mutual for life insurance. Though Kotak clearly is highly opportunistic, he is also equally nimble-footed in adapting to the changing business environment.
By the late 1990s, NBFCs were the flavour of the season and there were over 4,000-odd players spread across the country. But Kotak was able to see the big picture quite early. “We were getting very uncomfortable with the macro scene then — rates were high, companies were struggling to repay and the economy was slowing down. So we started to bring down our book dramatically. Only 1% of NBFCs survived that downturn and we were lucky to be one of those,” he says.
More than luck, it was also a calculated strategy by Kotak Mahindra that ensured its survival. The NBFC shrunk its business, thus keeping non-performing assets (NPAs) in check. Between 1997 and 1999, net NPAs were down to 3% of total assets from the earlier 5.51%. More importantly, it had a healthy capital adequacy of 25% as on March 31, 1999. The learning from that phase has since stuck with Kotak. “There is a very thin line between conviction and foolhardiness. If you are ready to back your conviction, go for it, but the risk is that if you are foolhardy, your conviction will hit you back. Making that distinction is very important.”
Having realised that the NBFC model wouldn’t work anymore, Kotak wanted a more conventional banking model to further growth. This was at a time when, after several decades, the Reserve Bank of India was issuing new banking licences as part of the financial sector reforms. Among a clutch of NBFCs, Kotak was the only player and also the country’s first company to bag a bank licence, marking the biggest inflection point in the group’s history.
In 2003, Kotak Mahindra Finance became a commercial bank. A year later, it got a strategic investor in well-known PE player Warburg Pincus, which had by then started exiting its investment in Bharti Airtel. Between 2004 and 2005, Warburg sold off its Bharti stake, generating $1.83 billion on its original investment of $290 million. Warburg paid ₹75 crore ($14.9 million) for an initial 2.75% stake in Kotak Mahindra Bank, marking its maiden and largest investment in the financial services market.
Dalip Pathak, advisor at Warburg Pincus, who was instrumental in making the deal happen, recalls the series of events that led to the investment. “It was Rajesh Khanna, the then-partner for Warburg Pincus in India, who introduced Uday to me. At that point, India was, and in fact still is, the most under-banked market and we were keen to invest in a financial institution with high potential. We found Uday to be smart, focused on shareholder value and someone we could get along with. It was a pretty easy decision to make,” says Pathak, who is now based in London. The private equity firm went on to extend its stake via multiple investment tranches and soon became the second-largest shareholder in the group after Uday Kotak himself, with almost 10% holding.
At that time, the bank was primarily a capital markets-focused player looking to transform itself into a full-service integrated financial services firm. While benign wholesale money market rates helped the bank in the initial period between 2003 and 2005 on the liability side, a vibrant capital and investment banking business meant that Kotak Mahindra Bank had enough capital as cushion. By FY06, with the economy on the growth path and the markets showing signs of buoyancy, Kotak chose to buy out Goldman from the investment banking venture. “We worked very hard for 10 years to get them excited about the Indian market. By the time they got excited, the discussion was about control,” says Kotak. And as Jayaram puts it, “We wanted to be in control of our destiny.” The parting was amicable, though, with Kotak paying ₹333 crore for buying out Goldman Sachs’ 25% stake each in Kotak Mahindra Capital and Kotak Securities.
By FY07, investment banking had become a powerful business, comprising a chunk of the bank’s profits. “In a short period of time, Kotak managed to create significant shareholder value. But more importantly, when the global downturn hit, his bank was well capitalised and prepared for the volatility that ensued,” says Pathak. If the bank had weathered the meltdown, it was to Kotak’s credit that he had chosen to be prudent in the go-go days. “Uday did not succumb to temptation even as peer banks, especially foreign ones, were aggressively offering derivatives products to corporate clients and taking away business. After the tide went out we all knew who was swimming naked,” says Nayar.
Back to basics
Over the years, the bank managed to offset share of capital
markets business with the core advances business
The reason Kotak is a prudent banker is because he clearly understands the core nature of the business. “Equity is a very small portion of the total balance sheet of banks but bankers start thinking they have control and ownership over all assets. The truth is: they don’t, it is other people’s money.” That learning has meant that Kotak continues to correctly gauge the evolving landscape. As of FY13, the core financing business accounts for 85% of profits against capital markets, which made up for 54% of the profits in FY08. The steady growth in consumer lending also helped offset the decline in revenues from investment banking and other verticals.
More importantly, unlike peers that were aggressively funding infrastructure projects, Kotak chose to stay away from the sector as a lender but continued to make money off infra companies as an investment banker. “From an investment banking perspective, you need to offer what investors want, but as a lender you need to decide if it makes sense for you. During FY08, there was exuberance around the Indian infrastructure story — the media believed it, policy makers believed it, investors wanted it, so we brought some of these companies to the public markets. Equities are like spices — it’s up to the consumers to decide how much spice they want in their food, and as a cook I need to offer them that. But as a banker, I need to decide how much spice is good for me,” points out Kotak. The result: today even as the banking sector is creaking under the weight of bad loans following the economic downturn, net non-performing assets as of FY13 are just 0.53% of total assets. Little wonder then, that Pathak thinks Kotak has a good commercial sense and the ability to take risks without being brash. “Taking risks is an inherent part of business but managing risk takes considered judgement, which he has.”
If Kotak Mahindra Bank has managed to become a financial powerhouse over the past two decades, it is also owing to its founder’s ability to inspire trust and loyalty from his core team, which has stayed on for more than 10-15 years. A lot of that has to do with his personality — he is universally held to be a genuinely warm person. “His biggest strength is his humility. In fact, he is more humble than his father,” says the senior Kotak. But more than humility, Kotak’s knack of nurturing and encouraging talent is commendable. “The latitude I’ve got from the day I joined the organisation has only gotten better over the years,” says Jayaram, who has been instrumental in spearheading several new businesses at the bank. An alumnus of IIM Calcutta, he is in charge of the group’s wealth management business, oversees international subsidiaries and the group’s alternate asset management business.
Nayar, too, has pleasant memories of her initial days at Kotak. She quit in 1993 after just six months with the group to move to London with her husband, Sanjay Nayar, who was then with Citibank. Those days, Kotak was establishing overseas operations and had just opened an office in Dubai. In a manner of speaking, instead of losing out to Citibank, ahead of seniors Kotak entrusted Nayar with the work of setting up the organisation’s office in London, which was then home to big investors like Jardine Fleming, which were early investors in emerging markets, especially India. In that sense, Kotak has always been good at judging talent.
At 54, he is still relatively young and not surprisingly, has no plans to retire any time soon. But the biggest challenge that insiders and industry observers feel the organisation faces is that there is no leadership pipeline at the bank — the list begins and ends with Uday Kotak. According to an industry veteran, “Though Uday always had a core team, each of them has pretty much worked in silos and they don’t have a 360-degree view of the financial services business like he has.”
Warburg Pincus’ Pathak, though, does not see any reason to worry in this regard. “A good manager always has a succession plan even if he does not make it public. That is something that Uday should always have at the back of his mind. Fortunately, there is no dearth of talented Indian bankers.”
Sum of parts
Kotak Mahindra Bank has created a niche for itself in the private banking space in less than a decade. But given that its core business of banking is the biggest driver of profitability, how well and effectively the bank will be able to monetise its other businesses is a big question. While none of the financial services verticals are loss-making, their contribution is not meaningful, either. Kotak, however, has a different perspective to that. “Between 2003 and 2008, nobody wanted bank deposits and instead were open to trying different products. Today, the customer’s perception, needs, the way he or she is looking at the world has changed. So, we took the call that we needed to make our model appropriate to serve customers better. They may not want it today but the cycle may change tomorrow,” he explains.
India ranks way down on financial inclusion
His views resonate with the investor community as well, which believes there is embedded value in the bank’s current structure. “The beauty of India is that there is opportunity everywhere. Therefore, there are many parts to Kotak’s business. But I am sure he knows where to focus, as the bulk of his wealth is tied up in the bank. Having said that, we must not forget that the other businesses are synergistic as well,” points out Pathak.
If that was indeed the case, why did Warburg Pincus choose to cash out of the bank? “We are value-adding financial investors and not strategic investors. When we have had a good run, it is time to move on in a manner that is not destabilising, and return money to our investors,” explains Pathak. The fund sold its last tranche of 3.6% stake in the bank in March 2012 for ₹1,404 crore. Vishal Mahadevia, managing director of Warburg Pincus India, was then quoted as saying that the fund had been selling its stake through a series of tranches dating back to 2011 and that the decision was not driven by a temporary jump in financial markets.
The way ahead
Kotak believes the future of banking will be led by three key drivers, which the group will focus on: digital, affluent customers and non-urban India. “We are also grappling with the big question about how digital will take shape. How will customers behave, will they want branches or opt for net banking? And, how do you bet for the future? Say, we want to invest ₹100, how do you skew it in the future,” says Kotak. Today, 18% of the bank’s customers use net banking. Not surprisingly, the bank is pushing forward in the digital domain and has launched its new mobile banking application for smartphones and tablets. Last year, it launched an online securities trading platform across all digital devices. “Cell phones are leading the transformation and I believe banks have to really focus on improving security and focus on the mobile and online space,” adds Kotak.
That ties in well with his second driver for growth: affluent customers. Kotak believes the rising affluence in the country will result in demand for a superior customer proposition. Even when Kotak was converted into a bank, it continued to target relatively affluent customers instead of chasing a vast retail franchise. High-ticket customer accounts helped the bank ensure its profitability was never compromised. In fact, it has been the most consistent wealth creator. According to Motilal Oswal’s Wealth Creation study, Kotak Bank heads the list of the top 10 consistent wealth creators. Over FY07 and FY12, the bank managed to improve its RoE from 15% to 18%, while that of HDFC Bank stayed constant at 19%.
As always, Kotak continues to be one step ahead in the game. The bank has been quick to take advantage of deregulation of savings accounts. Within days of the RBI freeing up saving rates, the bank decided to launch a campaign offering savings rates of 6%. So, it is not surprising that savings account deposits have more than doubled to ₹7,500 crore against ₹3,500 crore at the time of the Reserve Bank of India’s move. Kotak wants to now increase the share of current account-saving account (Casa) — the source of low-cost funds for banks — from the current 29% to 40% in a bid to further improve his return ratios.
Coming to the third piece of his strategy — the focus on non-urban India — Kotak is adopting a more asset-led strategy. “We just launched a series of lending products for non-urban India. Besides tractor financing, we’ve moved to mass housing for smaller ticket sizes and are sprinkling out presence through gold loans. We believe liability in these parts of the country will follow the lending product rather than just chasing the liability product because the ticket size is relatively small. So, lending product will be the driver for us in non-urban India,” explains Kotak.
Uday Kotak is not one to follow the crowd or get swayed by the flavour of the season. Realising that developing a deposit franchise is an expensive proposition, he clearly sees merit in lending products. “By funding a tractor purchase, you will be turning around a rural farmer’s financial future. I think the big issue in non-urban India is inadequacy of access to money for fulfilling aspirations. If you don’t provide tools to enable a person to create value, how will he ever make money?” questions Kotak, who is also critical of no-frills savings accounts for the poor. “Just by opening accounts with ₹100 balance, how are we improving the life of that person?” says Kotak, when asked about the central bank’s grouse that banks, private and public, are not channeling small savings from rural areas.
Even as the industry grapples with what will be the right model for banking, it will have to contend with fresh competition as corporates enter the turf for the first time over the next two years. In the same vein, the central bank, in its effort to ensure diversified shareholding structures, has asked banks such as Kotak Mahindra to reduce promoter holdings of over 40% to 20% by 2018. But Kotak is far from perturbed. “While we became a bank in 2003, the growth of our private sector peers took off post-2003. I hope the potential entry of new banks is a tipping point for our next round of growth,” Kotak sums up.