India’s financial destiny is at the crossroads: Uday Kotak

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This is a problem created over several years, cobwebs have settled, everything was justified on the grounds of public interest.

As Asia’s richest banker, Uday Kotak has an interesting job at a very interesting time in India’s financial history. The executive vice-chairman of Kotak Mahindra BankBSE 0.67 %leads the country’s most admired lender at a time when about $200 billion is stuck in bad loans in industries as diverse as steel and cement, infrastructure and textiles, with reverberations of India’s biggest banking fraud being felt across the financial system.

In an exclusive interaction with ET , Kotak discusses the financial stress in the broader economy, the fallout of the $1.8-billion PNB fraud, and the reforms needed to strengthen corporate governance and oversight in a country that now has among the highest non-performing assets (NPA) as a percentage of advances among the top-10 global economies. Edited excerpts: 

As a banker, how do you view the Punjab National BankBSE -1.09 % (PNB) fraud?
This goes back to deep fundamental issues about governance. In many ways, it reflects very poorly on how corporate India runs itself. It is a very poor reflection of the business ethics and values by which Indian business governs itself. It’s time for auditors to rise above where they are. Some time ago, the Prime Minister said that a signature must have value, and that value is a question mark right now. When I look at it from the corporate side, it is a very sad story of governance. I understand they wanted to go for a listing, which for whatever reason didn’t go through and the investing public of India was saved. As a banker, I am truly embarrassed with the state of Indian banking. It is really time for us to do the right things for having a huge fiduciary responsibility when we are dealing with other people’s money.

What must be done to fix the systemic glitches?
Deep down, it is about values; it is about culture; it is about rules, and we hope at some point of time we really focus on the quality of governance of companies — and in that context of broader India. The importance of processes, institutionalised frameworks is crucial. Too much of individualisation is the problem. How is it possible that one Nirav Moditakes all decisions and does whatever he wants? How are we creating appropriate structures of governance and when we are lending to such entities, the lenders should ask tough questions and why is that not happening? Is it competitive populism or is it something more? Yes, governance ultimately is in the hearts of people but if you put reasonable rules and processes and if they are followed in letter and spirit, you can avoid some of this.

In the Nirav Modi case, while the blame largely lies with PNB, is there a case of lax due diligence by counterparty banks?
I cannot talk about this specific case because I am not close enough. But I can tell you how we look at this. When we as a bank look at discounting under third party banks’ LC or guarantee or LoU… our internal process is that the credit of the underlying borrower must go through our credit approval process. We always look at the credit of the underlying borrower even if there is an underlying guarantee. We follow that religiously across all such exposures.

Where do public-sector banks go from here? Bad loans, lack of capital, and now questionable systems and practices…
We have a very big issue — a long-term systemic issue. We may have short term fixes, but in the long term, this systemic issue has to be addressed. There are two ways to do it — there should be a few PSU banks. I genuinely believe that State Bank of India should continue to be one of the prime banks of India but do we need so many banks in the public sector? Where are we going to get management teams for these banks? May be four PSU banks are fine. For the rest, we have to find an answer and that should be sooner rather than later.

Weren’t they supposed to serve public interest?
We nationalised banks in 1969. The public interest argument was… private banks are giving money only to big business as a result of which we will create state-owned banking that will give money to the broader society. Forty-nine years later, the bulk of the lending of public sector banks is to big business and that is what has gone down the drain. Therefore, if I ask a question and this has nothing to do with politics, this is for our nation and our future as citizens … all the policy makers who keep on using the word public interest … what public interest have we served over 49 years? And who is accountable for our money as citizens of India?

What is the solution?
This is a problem created over several years, cobwebs have settled, everything was justified on the grounds of public interest. But under that garb, we have actually given money to big business. It’s a tragedy. We need to ask ourselves: What is the shape and structure of Indian banking we want for the future? Who controls the so called diversified foreign ownership? It is two proxy advisors Glass Lewis and IIS. So, all foreigners vote in tandem on the advice of these two guys. Look at Catholic Syrian Bank, with 51% gone to a foreigner. If you take a fiveyear view, assuming you privatise, the KKRs and Bains will take it. We are at a very important crossroads of India’s financial destiny. Contingent equity risk of the Indian tax payer is the entire deposit base; every depositor expects the state to pay. FRDI bill or no bill, the state has to pay.

In all this mess, are we forgetting the economy?
I am positive about the economy. I am seeing the economy turn around. Micro India is looking better and we are clearly seeing macro getting tougher than before. If you take the first these years from 2014-17, you had a positive macro and a challenging micro. We now have a positive micro and a more challenging macro. Because of global interest rates, oil no longer is at $30-40 per barrel… Current account being a little adverse. I think fiscal deficit will be a challenge. Brownfield investment is coming, the loan growth is back and subject to, of course, how this current banking sector issues affect. But we are certainly seeing a better outcome right now.

You were a bit cautious about the equity markets and we have seen some sell-off. Is there still froth?
Earlier in January, I gave a signal that equity markets are over heated and small- and mid-caps will have to watch out. Now that has corrected 30-40%. I think we are getting to levels that are fundamentally better. It is very difficult to say what the equilibrium is because of the technical factors. But with the correction, markets will get healthier and then what will play is the view on global macro — US interest rates, oil, Indian macro and Indian politics.

What do you see in store for the Indian equity markets and the bond yields in the next one year?
Unless US interest rates move up a lot, I would be surprised if the 10-year went above 8%. Indian equity markets may see a little more volatility with potential corrections, which at some point of time will get healthier. Indian savers are still putting money in Indian equities which is a good sign and there are not too many options other than that. As interest rates get a little higher, investors move a little more to fixed income. But I would say, on a medium-term basis, I am still quite comfortable with Indian equities, subject to short-term volatility and corrections.

Who is going to lead the next level of economic growth?
Some amount of infrastructure is happening through roads, brownfield is happening and even if the haircuts through IBC are deeper than what people feel it will start de-clogging some of the capacities. My current view is haircuts on an average should be around 60-65% of the principal value. Of course there are exceptions like steel where hair-cuts will be smaller like 30%. I just hope there are no legal hurdles to the NCLT process. Roads, construction, auto, metals and commodities, the whole digital economy, and the consumer are still holding forth.

If you were to put you money into equities, where would you invest?
I will put money in financial services. There is enormous growth. If I take a 5-10 year view, as long as you manage your risks and as long as you are focused on doing the right things, it will work. We need to answer three questions in our financial services — governance, ownership and risk management. These three are fundamental to how the financial sector needs to be envisioned for the future.