Mumbai: Uday Kotak, vice-chairman and managing director of Kotak Mahindra Bank Ltd, sees pretty good credit demand despite the perception of a slowdown. He is, however, not comfortable in taking a big exposure to the infrastructure sector where execution is a problem. “I would much rather give loans on tractors and commercial vehicles to people in Bharat where we think the payment culture is much better than some parts of corporate India," he said in an interview. Edited excerpts:

In August last year, Kotak Bank sold 4.5% stake to Sumitomo Mitsui Banking Corp. (SMBC)for 1,366 crore. What have you done with the money?

It was new money into the bank and the purpose of it was to really leverage this for further growth of the bank, combined with building a relationship with a Japanese financial institution. We are making significant progress in terms of building the relationship with SMBC, including in the area of asset management. We are also jointly sponsoring an infrastructure fund.

Signs of slowdown: Kotak says his expectation for the real economy is about 7.5% GDP growth, down from 8.5%. Abhijit Bhatlekar/Mint

You are quite small. Even Yes Bank Ltd, a greenfield bank which got a licence around the same time when you converted your then 18-year-old lease finance and bill discounting firm into a bank, is larger than Kotak Bank in terms of assets.

I think you should look at our consolidated balance sheet, which is well in excess of 75,000 crore, significantly larger than Yes Bank. Our approach to banking is very different from the traditional banks, or even some of the new banks. We do not necessarily go out and write single-cheque, large-ticket loans. We have traditionally built our asset base in a number of areas, which most banks don’t like to be in. We are one of the largest financiers in tractors; 20% of our balance sheet is agriculture loans; we are pretty significant in commodity financing. We are also one of the larger players in commercial vehicles and construction equipment.

What’s your business model?

Our entire approach to the banking and financial services business is risk-adjusted returns. We believe that in most parts of the world and including pockets in India, banking tends to mis-price risk. Our approach is to get into a segment and build that if we believe that on a risk-adjusted basis we will get our RoA (return on assets) and RoE (return on equity).

What’s the difference between Kotak Bank and others?

There are three or four significant differences. One, we came from an era of NBFC (non-banking financial company) and we have tried to preserve the good aspects of that era. I think NBFCs have developed specializations in verticals like commercial vehicles, tractors, cars, construction equipment, etc., and we have preserved the asset side of the balance sheet beyond becoming a bank. Our internal mantra is we would like to build a business model, which borrows from India and lends to Bharat.

To be politically correct?

No, that’s how the business model is working. We are extremely focused on building some of the assets which are going into mid-India, semi-urban and rural, and that’s our DNA. We are building a retail bank and a lot of the deposit base is still in urban India.

Borrow from India and lend to Bharat is not a nice political statement. It’s in fact something which we genuinely believe in and practice...

Your net interest margin (NIM) of 5.6% is the highest among Indian banks.

There are three or four parts of NIM. First, it comes from our legacy as an NBFC, which is very vertical focused. That is actually coming from a deep DNA or focus on risk-adjusted returns. About two-thirds of our balance sheet is retail where NIM is higher, but our operating costs are also higher. You have to look at NIMs along with the operating cost. The third point is that our capital adequacy is high and this means we have interest-free money to add to our NIM.

Finally, there are certain accounting issues. Let me give you an example—if you give a loan and you charge upfront fee, is it interest or fee? It depends on how an accounting view of some of these items are taken. We have been booking this as (interest) income and that is perfectly legitimate.

Two-thirds of your book is retail. Isn’t that risky?

We think it’s a safer business rather than giving big-ticket concentrated infrastructure loans today when there is a question mark on execution of infrastructure projects. I would much rather give loans on tractors and commercial vehicles to people in Bharat where we think the payment culture is much better than some parts of corporate India.

How has been the credit demand?

We found credit demand to be pretty good despite the perception of a slowdown. For the current year, we see the growth broadly in the range of around the 30% mark. We have to watch the year and see how the economy grows, but we think that if the broader credit demand of the economy is about 20%, we should grow at around 30%. This is achievable by us and our business model enables us to get these levels of growth, and we think that the fundamental real economy is in a reasonable shape.

Aren’t you seeing any signs of a slowdown?

I think there are some aspects of the economy slowing a bit. My expectation for the real economy is about 7.5% GDP growth, down from 8.5%, but I think it’s a pause, as India takes a deep breath and figures out how it goes from here.

Are corporations going slow in lifting loans?

You need to divide the borrowers into two-three parts. The first is anything to do with projects and infrastructure—there’s a huge amount of execution challenges. The entire area of brownfield investment is going on.

You seem to have reservations about infrastructure projects.

We are cautious about concentrated large-ticket loans, particularly to greenfield infrastructure. That caution comes not so much from the point of view of the businesses, but from the governance and execution challenges which India faces today.

Are you seeing borrowers asking for loan restructuring because of project delays?

We haven’t faced that problem because our exposure is so low. As a bank, we don’t like the culture of debt restructuring. It’s wrong whether it is in Greece or corporate India.

Are you ready to set up the infrastructure fund with SMBC?

We believe that the infrastructure space in the next 12-18 months will actually reach the bottom and get better, and that’s the time when we think investment opportunities will come. Therefore, it’s a good time to be setting up an infrastructure fund. If you are too early you made the wrong investments, if you are too late you miss the bus.

You have reservations about infrastructure loans, but comfortable floating a private equity fund in the space.

There are two aspects. We spoke about mis-pricing risk. If you are doing debt lending to infrastructure companies with equity kind of risks, it is a bad trade. If it’s an equity risk, you must get equity returns. We think as the cycle corrects, there will be opportunities in infrastructure which will be equity risks for equity kind of returns. If I am taking equity risks, I don’t want to be lending fixed rate money.

In equities, you price the risk. As far as debt is concerned, if the markets get more sophisticated where for the levels of risks that you take you get the debt returns, we will certainly look at it. It’s back to a philosophy of risk-adjusted returns.

What kind of return?

It depends on levels of risks and also at what stage of evolution of the infrastructure financing cycle you are entering. If you are taking project risks, which is the first three-four years of a project, your returns on that debt will be very different from an annuity risk, post a project having being completed. We will be in the business in the next 12 months.

Has the interest rates peaked?

We think we are close to the peak. We will peak at probably around 8%. It will happen between now and October.

You have been talking about acquisitions for the past one year. When will you walk the talk?

In every interview of mine this is a question which is asked and rather than me responding to the question, let me do the walk and then do the talk. This is something which we would like to do. If we get an opportunity which is interesting, at the right price and on the right terms, we will look at it very seriously. We are eager,?but not desperate. When you look at the Indian banking scene, there is a lot out there, but the choices are pretty clear. There are three or four choices which we looked at.

Looking at old private banks in south India?

For us the acquisition field is in three areas—banking, broking, asset management. We are looking at this entire space and not necessarily only at banks. Of course, banking is our first choice, but we are also open to broking and asset management.

You can buy portfolios also.

For us, the branch distribution is important. We are looking at buying distribution and not just assets.

Promoter stake in Kotak Mahindra Bank is about 46% even though the Reserve Bank of India ownership norms capped the promoter stake at 10%...

Firstly, when we became a bank in 2003, the licensing condition was that the promoters shall hold a minimum of 49% for a minimum period of five years. Therefore, till 2008, we were obliged by our licensing condition to hold 49%, required by the policy regime in 2003.

Post 2003, there was a change in philosophy and thinking. Based on that, you saw ownership and governance guidelines of 2005. If you go through the ownership and governance guidelines along with the guidelines of 2004, you will see they provide for ownership higher than 10%, up to 30% and above 30%, subject to the criteria being fulfilled. Nowhere the guidelines say that the ownership has to be 10% at all situations. And, therefore, if you combine the fact that we were obliged by the licensing condition to hold a minimum of 49% along with the broader context of the ownership and governance guidelines, we believe that 10% norm is not cast in stone.

The wind is again changing. Based on newspaper reports we understand that new banks’ promoter ownership will be at 40%, to be diluted over time. We believe that at the heart of the whole concept of ownership and governance and promoter guidelines is how well the financial institutions are governed.

Besides banking, you also own a business newspaper. What is your plan for that?

I don’t own it; the family owns it. We believe that it’s a good investment and since you come from another business newspaper, I am sure you would agree with that.

What’s happening in broking?

At this stage, the three pockets of financial sectors which are going through challenges are securities, asset management and life insurance. We think that this process is coming out of the fact that there were low barriers to entry, lots of players coming in both global and local, and fragmentation of the industry. At the same time, from a regulatory point of view, you saw pressure coming on these segments with reduction in margins of the business. If you have more players, margins of the business come down because of regulatory pressures. In the next 12-24 months, all these three industries will go through a phase of consolidation. It can happen two ways—either by acquisition or mortality. I think we will see both these.

In first six months of the calendar year 2011, the Sensex slipped 8%. What’s your take on the second half?

Two major factors will determine the movement of equities and the real economy—the price of oil and the trajectory of interest rates. If oil settles at around $100 (Rs 4,450 today) a barrel, or even in the range of $100-105, and if policy rate peaks at 8%, these two would be bullish factors for the market. Assuming that these events happen between now and March 2012, my view is that the Sensex will be in a range of 17,000 and 20,000-21,000.

This is an edited transcript of an interview that was first telecast on Bloomberg UTV on Thursday.