Opinion: Lessons from Kotak Bank’s preference shares issue
Kotak Bank may have solved the issue of reducing promoters’ stake in bank
Last week, Kotak Mahindra Bank Ltd informed stock exchanges that it had met Reserve Bank of India’s (RBI’s) guideline on reducing promoter stake below 20% of its paid-up capital.
The bank’s promoters previously held 30.03% of the bank’s equity capital of Rs 953.16 crore. Their holding was brought down, not by issuing more equity shares, but by selling non-convertible preference shares worth Rs 500 crore. As a result, the bank’s paid-up capital has expanded to Rs 1,453.16 crore, bringing the holding of the promoter group to 19.7%.
Preference shares are considered as part of paid-up capital, and RBI’s guidelines refer to ownership caps as a percentage of paid-up capital. As such, Kotak Bank seems to have found a neat solution to the problem of reducing promoters’ ownership in the bank.
Critics of the move say that the bank and its promoters have followed the letter of the law and not the spirit behind it. Consider also Uday Kotak’s comments when he chaired a committee on corporate governance appointed by the Securities and Exchange Board of India (Sebi): “By and large, most leading corporates in India follow rules and regulations, and if their governance practices are put to test, they will likely stand scrutiny of the law. However, if one delves deeper, one could find that while the letter of the law may have been complied with, the spirit of regulations has not necessarily been embraced wholeheartedly.”
Venkatesh Panchapagesan, associate professor of finance, Indian Institute of Management (IIM) Bangalore, says, “Since Mr Kotak waxed eloquent about corporate governance and following the spirit of the law, he and his company must be held to a higher standard. It is clear that the preference share issue was done only to meet the letter of RBI’s ownership rules.”
Since the wording of RBI’s guidelines is vague, we can only guess what it exactly meant on ownership caps. But going by the common interpretation that it meant equity capital when it wrote paid-up capital, Kotak Bank would have needed to issue equity worth ₹1.25 trillion to meet the guideline. If the promoters had to sell their shares outright, it would have required a block deal of about ₹25,000 crore. The preference share issue is piddling in comparison, and with the central bank staying mum, almost everyone concerned seems happy with the nifty solution.
In this backdrop, some market participants say the real culprit is RBI, which didn’t frame its rules properly. If it had been explicit and used the words “equity” capital, like Sebi has done for ownership rules for stock exchanges, it would have removed the ambiguity. Based on this view, there are many who are sympathetic to what Kotak Bank has done. “They have merely done what any businessman would do,” is a common refrain.
Such a view is bolstered by the fact that RBI’s ownership caps haven’t really led to good governance. When we consider the mess in non-promoter-led banks such as Axis Bank Ltd and ICICI Bank Ltd, there is actually a case for the review of ownership norms.
“Apart from the skin-in-the-game argument for higher ownership caps, it should also be appreciated that one of the best ways to get good governance in a company is for it to be subject to the possibility of a hostile takeover. With the low ownership caps that exist today, the threat of hostile takeovers is gone, and the incompetence of incumbent managers could potentially get tolerated for long periods of time,” says J.R. Varma, professor of finance, IIM Ahmedabad. Another argument for higher caps is that there is already a cap on voting rights of a promoter, regardless of actual ownership.
Having said all this, when existing rules are onerous, the right approach would be to lobby for a change in rules, as market participants do in developed markets. A workaround solution can have all sorts of consequences. To start with, promoters of private banks who have already sold shares to meet ownership norms will rightfully feel short-changed.
And if Kotak Bank, let’s say, issues preference shares worth another ₹2,000 crore, that would mean promoter holding as a percentage of paid-up capital would fall well below 10%. If the promoters then buy equity shares to come back to the minimum levels permitted by RBI, that would mean they would have an over 51% stake in the company’s equity capital and also own the majority in terms of economic interest. Of course, this may be the last thing on the minds of Kotak Bank and its promoters.
But who is to decide where the line is drawn? Without doubt, the buck stops with the central bank. It needs to articulate what its rules really mean, and it also needs to explain the wisdom behind ownership caps in light of the mismanagement at widely held private banks.
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