Uday Kotak’s letter to Shareholders

Dear Friend,

As I write this note, the world is on the edge about the future of Euro zone. ”Grexit” is the new terminology. A global bank has announced a US$ 2 bn treasury loss on trading credit derivatives. Facebook is having trouble with its post IPO phase. The business of money is truly “fragile, handle with care”.

I am reminded of my early days, when I was taught the first principles of finance: if you put in ` 10 of equity and borrow ` 100, you can lend out ` 110. However, if just ` 5 of loans out of the ` 110 go bad, you lose 50% of your equity, and it takes just ` 10 of assets going bad to bankrupt you!

It is quite surprising how global finance had missed this basic principle, their vision blurred perhaps by the jargon of risk weights, tier II capital, et al. We have seen financial institutions with less than 2 to 3 % equity, i.e. effective debt equity ratio of 40 and 50 times, positioning themselves as masters of global finance. And that is what has brought the financial sector down on its knees. It is important that banks focus both on “return on equity” as well as on “return of equity”.

It is only now that the importance of an “Arjuna’s eye” kind of focus on risk and risk management is gaining centre stage, along with the importance of “Financial Stability” as the core of what the financial sector and financial institutions need to focus on and be evaluated for.

Also, over the years, I have found banks focusing more on the P&L than on the Balance Sheet. In fact, particularly for banks, the Balance Sheet is more important, and P&L is only a derivative of the Balance Sheet.

It is through this lens that we look at the Indian economy, financial sector and Kotak.

The Indian economy has valid reasons to complain about the global economy and policy. Global financial policy of easy money is leading to unintended market outcomes, that too without achieving the intended economic outcomes. In terms of market outcomes we are seeing bubbles in bond markets and commodities. Both need to burst, and my view is that they will, sooner rather than later.

But India’s macro challenges are more than just global headwinds. High oil and high gold imports, combined with a relatively high-cost and inefficient domestic sector impacting commensurate export competitiveness have caused a high current account deficit of 4% of GDP.

Second, the inability of the fisc. to pass on higher oil costs is one of the main reasons for a higher fiscal deficit of 5.9% at the centre and around 9% for India consolidated.

And third, the much debated governance deficit challenges. It is critical to get the balance right between good politics and good economics.

The outcome for India macro is 20% more depreciation of currency in less than a year, and slowdown in growth to between 6 and 7%. While, this leads to short term challenges, I feel that some of the pain is priced in and with a little wind from the policy front, India has the ability to bounce back in due course of time.

That brings me to India’s financial sector. One of the most important challenges in the banking sector is its ability to define and price risk. The sector very often takes equity type risks for debt level returns. Also, a few large companies particularly in sensitive sectors like infrastructure, have a disproportionate slice of banks’ balance sheets. Therefore, concentration risk is real for Indian banks. Further, a well intended measure of smoothening cash flows through restructuring runs the risk of becoming a tool for ‘ever greening’.

Against this backdrop, how are we at Kotak running the firm?

First of all we have ensured higher equity to absorb potential shocks. We are at about 16% core equity excluding any Tier-II etc. Further, we are doing our best to imagine potential risks and have a game plan to manage them.And we are continuing to build. The big focus is on building a stable and low cost liability base. We have embraced the policy measure on savings deregulation and are seeing a positive customer response. We intend to make progress on Government accounts which are now open for all banks to pursue.

On the advances side we grew at about 30%, and would like to continue a good growth trajectory. But if we spot red lights, we will not hesitate to step on the brakes as well.

Our non-financing businesses like securities, investment banking, asset management and life insurance are going through their structural and cyclical challenges. But, we believe that their time too will come, and we are positioning ourselves to become internally stronger in this interim period.

The other internal focus is around technology, quality, lower people churn and continuity, superior customer experience leading to excellence, and all this at reasonable costs. On the external side, we are more open to inorganic growth opportunities than we have been in earlier times.

I look forward to building a stable and long term institution, focused on customer delight. Of course, if I may paraphrase Robert Frost just a bit, we have “miles to go before we sleep”.

Best wishes,


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