“We are in the midst of Swachh Bharat in the financial sector”

How do you see the banking sector evolving over the next five years?

I think the financial service space in India is going through a catharsis — a very significant change in both scope and direction. Digital is redefining financial services in more ways than one. It’s much more about customer-centricity, customer convenience and deploying cutting-edge technology. We no longer have the luxury of a customer who sticks around for long, because he/she is much more demanding and much less tolerant. Secondly, for the first time, financial services are under massive attack from non-financial players. The dramatic change in technology and customer behaviour has stripped the financial players of their cocoon. Therefore, at Kotak Bank we have taken a very clear view that the future business model will be ‘phygital’ — which is physical plus digital. One does not need the density of physical presence as seen in the past. We don’t need 10,000 branches. We have about 1,500 branches right now, and would probably look at 2,000 in total, because that will complement our digital presence. There may be a time in the future, when a physical branch may or may not be required, but as of today, the customer would like to see some physical presence. So the ‘phygital’ model is very important for our plan for the future. It is in this context that we launched the 811 programme (which invites people to open a zero-balance, digital account), a massive shift from the physical to the digital world, which is giving us significant growth in our customer base. Obviously, we need to make the customer much more engaged and, over time, significantly profitable as well. This is our front-end investment, which is creating immediate cost pressure but building a very strong base for our future.

Is the current crisis in the financial sector any different from the past?

As I see, financial services experience an interesting 10-year cycle. You saw the sector go through the throes of risk in 1998, then in 2008, and now in 2018, which is now spilling over to 2019. So, the fragility of the sector from a risk management point of view keeps coming. And I believe the financial sector appears to be glamorous, but is fundamentally very fragile. In fact, it is the toughest of all businesses and with significant costs to society in case of a failure. Therefore, we are obsessed about managing risks and protecting stakeholders capital, and it is here that most of us slip up or make mistakes.

Does the traditional banking industry really have a moat that will ensure its sustenance for a long time?

I think that will go the day Google becomes a bank. The good news is Google does not want to become a bank because the constraints of banking are something that Google may not be ready to accept and that will ensure our survival. I also believe that, finally, there is always a tension between customer convenience and levels of risk control you need, particularly in banking. Let me give the example of the hotel industry. When we enter a hotel, each of us goes through a security check. There was a time when hotels could not do it because of customer inconvenience, but today we accept it due to risks such as terrorism. We agree to these control mechanisms for our own safety. So, in many ways, we have to strike the right balance between customer convenience and controls, which is in the long-term interest of the ecosystem. It is this balance that will protect banking. What I believe is that banking will remain. Whether banks will, or not, I don’t know. 

You mentioned Google, but not Amazon?

It could be any of the tech giants — Google, Amazon or Alibaba. What I mean is these companies are getting amazing insights into the consumers. Google and Amazon are entering each other’s territory through Alexa (app operates on Android as well). There is a convergence happening. The one that is relatively more focused on privacy is Apple. It was commendable when the company refused to give FBI some consumer’s details. Finally, customer privacy is an important aspect of how we see the future. 

If big tech is not in the fray, will the new entrants be fringe players?

Don’t underestimate fintech. It takes one or a few bright ideas to dramatically change how this business is run. Also, I would be concerned about ecosystem players, for example, say the way the payments business is going away to players such as PhonePe, Amazon Pay or Google Pay, and now, WhatsApp. So, we are going to see disruption in how business moves away from traditional banks. Be on your guard, be very alert and be very ready to disrupt yourself into a future, which is very exciting, but will come with its own challenges.

Given India’s ecosystem, retail has always been a more profitable business against wholesale. Is that the resting ground for conventional banks?

The best approach is to look at risk-adjusted return. It does not matter if it’s retail or wholesale, if you are getting returns worth the risk. You will see a flip-flop in the levels of risk in both kinds of banking. But what really distinguishes some banks is focus on low-cost and stable deposit base. We were able to build a sound base due to this single-minded focus. I would focus on the liability side, which is more retail, but look at the risk-return on the asset side.

There was a time in India, when wholesale money was really cheap, and banks like ICICI built their business rapidly by relying on wholesale funding. Now with the government pushing for lower interest rates, would you think wholesale funding would be a better option to rely on, especially for a bank with a clean balance sheet like Kotak?

Stable money is the answer, not easy or tight money. No bank should deviate from that. In a country like India when savings rates are falling, there should be more savers' money in the bank. Do not go with the trend, stick to this philosophy.

Kotak 811 was when the bank's digital initiative truly began. Will Kotak be leading the digital disruption in the marketplace?

We keep asking ourselves how we can disrupt our own profit pool. We have a cushy business that is churning out huge profit. You have to be ready to disrupt it willingly rather than letting the marketplace do that. Just like the Holy Trinity in Hinduism, you need the three gods in your ecosystem – Bhrama (the creator), Vishnu (the preserver) and Mahesh (the disruptor or destroyer). One should constantly be focused on creation, new opportunities and creative destruction. All the three gods should be working together.

Over the past five years, where has Shiva (disruptor) operated in the context of business? Were there any big calls that you had to take?

We merged several internal divisions over the past five years. For instance, when heavy commercial vehicles lending became high-risk, we dramatically cut volume. Similarly, when we burnt cash after launching the credit card business, instead of shutting it down, we decided to redefine the strategy. Then, Kotak credit cards were sold only through internal channels.

What is your approach towards inorganic growth?

We are open to inorganic growth if there are major synergies, cost synergies. Our fundamental philosophy is based on value and not size alone. Take the case of BSS Microfinance acquisition – it was a small company, but extremely valuable to us with the right culture. Today, we are scaling up our micro finance business, a decision that came much after the acquisition because we believe in the scope to scale up this business.

So you don’t necessary need to acquire a bank?

Yes, absolutely.  Look back at insurance, Old Mutual was our partner with 26% stake, which we bought back in October 2017, and it became a 100% Indian insurance company. It has been hugely lucrative for our shareholders and, as you know, we have the highest margins in banking. Value accretion, creation of sustainable value, is who we are.

What did you mean when you called 2019 ‘a year of cleansing’ in your annual report?

I believe we are in the middle of a Swachh Bharat mission in the financial sector. Back in 2008-09, 2010 and 2011, problems in the real-estate sector would spill over to the financial sector. But, today, it’s the other way around. This two-way flow is resulting in intense challenges for the financial sector right now. So, this year and the next will see a cleansing process, after which, we will come out stronger.

Where do you see the downside in the NBFC sector?

In the financial sector, there are three critical parts – first and the most important is solvency, second is governance and third is liquidity. There is too much noise about liquidity, when in fact some cases are actually linked to solvency because fundamentally the network may be eroded; and governance, for when the money has moved out of the operating entity. Hence, the issue of ‘liquidity’ in many cases is an issue of solvency and governance.

Will there be more mortalities or consolidation?

Consolidation can happen through two methods — mortality and combinations. And it is an inevitable part of a free market. If the system is well regulated, the marketplace will have its own winners and losers. In that context, if you look at an IL&FS-like situation, while the equity has eroded, we have been able to protect the underlying assets. So, there will be a combination of buyers for individual resolution of assets, but we may see challenges to the sustainability of the institution. And that’s what I mean by combination versus mortality.

What about the troubles in the real-estate sector?

In many metros, real estate was becoming unaffordable. Therefore, an average person could not buy a home on steep installments. The sector needed a shake-up on the fundamental value of homes. The silver lining is it will boost affordable housing and you can also see an ‘Uber-Ola-like’ phenomenon in this space. The younger generation is far more open to leasing a home. Hence, there is a lot of capacity in the market, and the newer generation is going to use that. We will see better capacity utilisation, but some demand in the short run may reduce.

But, do you believe that real estate is still far from becoming a good financial commercial asset since yields continue to be very low?

Yes, the capacity of existing homes has to correct to a level where yields start inching up. So, we are beginning to see economics come in, in addition to the emotions attached to buying a home. This is similar to what is happening in the auto industry, though here we need to know if the demand change is structural or cyclical.

Has the risk receded or is there another minefield set to blow up?

Investors, creditors, everyone depends on fiduciaries such as auditors and rating agencies. They have a huge responsibility towards free markets and protection of individual savers. It’s here that the bar has to be raised. If an entity has overvalued an asset by 30-40%, an investor or creditor loses money. What is the accountability of that valuer and who is regulating this industry? Policy-makers and practitoners must work together to stop this from becoming a systemic issue.

In this whole cycle, how do you see the role of the government and its ability to contain any catastrophic event?

I believe the government is in a delicate position. The financial sector is evolving towards a freer market, but it’s better regulated — this is a transition phase. Take the case of the mutual fund industry. Most savers who invest in mutual funds or debt funds do not realise that it’s a security investment, not a fixed deposit. They may expect a higher rate of return, but even debt securities come with some risk. The government and regulators are responsible for educating these investors. I do believe that a free but well-regulated market is the answer to India’s sustainable capital formation.