Uday Kotak is stepping down as the boss of Kotak Mahindra Bank at the end of this year. But the drama has already begun.

What do we mean?

Well, that’s what we’re going to find out in today’s Finshots.

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The Story

A couple of weeks ago, Uday Kotak probably penned his last letter to the shareholders of the bank. And LiveMint says he took a parting shot at the Reserve Bank of India:

“I feel the financial sector players risk becoming more robotic, curbing the entrepreneurial flair since the fear of making a mistake overrides the joy of creation and development. While we need ‘Arjuna’s eye’ on risk management, we must prevent bureaucratization of financial services.”

Who’s Arjuna here?

Well, maybe it’s simply a reference to the archer from the epic Mahabharata, who had a single-minded focus on his target. Or…

It could be a veiled reference at the RBI Governor Shaktikanta Das who’d said: “No one can match the prowess of Arjuna, but our constant effort is to keep an Arjuna’s eye on inflation.”

You decide what Uday Kotak was referring to.

But what we can say is that the relationship between the central bank and Kotak Mahindra Bank has been on thin ice for a long time.

So let’s take it from the top, shall we?

Uday Kotak is probably the longest-serving CEO of a financial services brand in India.

He has been the CEO of Kotak Mahindra Bank since it set up shop in 2003. Actually, scratch that. He’s been the CEO of the group since 1985. That’s when Kotak Mahindra Finance was set up as an NBFC. And when the RBI allowed NBFCs to transform into banks in 2001, Uday Kotak jumped at the opportunity and applied for a banking licence. And by 2003, Kotak Mahindra became the first NBFC-turned-bank.

Now back then, the RBI had some rules in place. They told promoters to hold at least 49% of the bank’s paid-up capital for a period of 5 years. It was to ensure that the promoters had skin in the game. That way, if the promoters messed with public deposits, it would hurt them too.

And Uday Kotak obliged. In fact, he held more than what the RBI mandated.

But in 2008, the RBI wrote a letter to Kotak Mahindra Bank saying that even after 5 years, the bank hadn’t reduced the shareholding to 49% as prescribed. And then it also asked the bank to provide a roadmap on how it would reduce the promoter shareholding to 10%.

Now this was completely out of left field. And Kotak Mahindra Bank was confused. It wrote back to the RBI. It said that the only rule when it got the banking licence was that the promoters had to hold a minimum of 49%. Not the maximum. So that’s all that it was doing. It didn’t realize that it had to cut down the shareholding. Also, it didn’t understand where on earth this 10% limit was also coming from.

And with that, there was some frostiness brewing between Kotak Mahindra Bank and the RBI.

Now we won’t get into everything that transpired. But over the next few years, there was a lot of back and forth. The bank and the regulator exchanged more than 35 letters debating the reduction of promoter stake between 2008 and 2018. And even though the bank accused the RBI of constantly rewriting the rules, it slowly began diluting the promoter stake anyway. Not as quickly as the RBI wanted, but it was happening.

But in 2018, things finally reached a tipping point.

Kotak Mahindra Bank finally agreed to the RBI’s demands. The regulator wanted the promoter stake to be cut to 20% that year. The bank said yes, but it would do it its way — it would issue preference shares. Think of preference shares as a type of equity share without voting right. Rather, they come with some special dividend rights.

But the RBI wasn’t happy. They wanted the bank to issue equity shares.

And that was the final straw.

Kotak Mahindra Bank did something no bank had done before. It took the RBI straight to the Bombay High Court. And it even decided to strike at the heart of the RBI — it questioned the central bank’s powers. It wanted to know whether the regulator actually had the right to unilaterally decide promoter shareholding in banks.

The RBI didn’t initially back down. They said that it was within its rights to amend rules. They gave a point-by-point rebuttal to all of the bank’s claims. They even pointed out how the bank had earlier tried to be ingenious and creative when it came to showing shareholding pattern between promoters.

Creative how? you ask.

See, there’s one thing we didn’t mention in all this. Kotak Mahindra Bank actually owes its name to Anand Mahindra too. Yup, the current chairperson of the Mahindra and Mahindra conglomerate actually lent his family name to Uday Kotak right when things were getting off the ground. He was a promoter in the bank as well.

But when the RBI asked the bank to reduce its promoter holding to 49%, Kotak Mahindra Bank simply declassified Anand Mahindra and his family as a promoter in 2009. The bank claimed that Mahindra had diluted his stake significantly and that he shouldn’t be a promoter anymore. That meant the promoter shareholding would automatically drop to 48.50% in the books. It would be in line with what the RBI wanted.

But the RBI was having none of that. They said that the only way that Anand Mahindra would be a non-promoter was if the bank actually dropped ‘Mahindra’ from its name. And well, we all know that didn’t happen.

Now while that’s an interesting anecdote, maybe the RBI was still a tad bit worried. Maybe they realized that if the court ruled against them, it wouldn’t be a good look for credibility. So they shook hands and settled the case.

They allowed Uday Kotak to hold a 26% stake in the bank. It was far higher than the 15% that was prescribed for other bank promoters. It was a win for Kotak. But the relationship had soured.

And this finally brings us to today. Unfortunately the frosty relations between RBI and Kotak Mahindra doesn't seem to have gotten any better.

See, the RBI has rules that prevent a promoter-CEO from running the show for too long. 15 years is the upper limit after extensions. Now while Uday Kotak has been at the helm for much longer than that, the RBI’s rules has finally forced him to step down.

But even then, the bank seems like it just can’t resist taking on the RBI. It found a loophole.

The thing is that RBI’s rules don’t say anything about whether CEOs can be appointed to the board after retirement. So in April, the bank simply announced Uday Kotak as a non-executive director. It didn’t need the RBI’s approval.

You can bet that didn’t make the RBI too happy.

And maybe this explains why Bloomberg reported that the RBI is trying to nudge the bank to choose an outsider as its next CEO. While the RBI can’t force Kotak into this, you can see why the central bank might be worried. If Uday Kotak is still on the board and his protege is running the show, he could still drive the bank from the back seat. And that’s not something the RBI wants.

So yeah, if you read anything about Uday Kotak and the RBI taking digs at each other in the next few months, you know how it came to be.

Until then…

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Correction: We've changed the word mythology to "epic" in referencing the Mahabharata to more accurately represent the nature of the poem.