KOTAK MAHINDRA BANK

The recent ban on acquiring new customers online and the issue of credit cards has put a spanner in the operations of the bank. Given that the timeline for its operational turnaround is uncertain, the stock has lost its appeal

Kotak Mahindra Bank is one of the largest private sector banks in India with over 37 years of experience operating in the banking and financial service sector. The bank has around 1,948 branches spread across India serving more than 5 crore customers. For the latest FY24, the bank reported revenue of around ₹56,237 crore and was able to generate a net profit of about ₹18,213 crore. India’s 13th richest person, Uday Kotak is the promoter of the bank. He has played a significant role in the evolution of the Indian banking sector. Recently, in September 2023, he resigned as Managing Director and CEO of the bank and now serves as a Non-Executive Director.

RBI Regulatory Action
The bank has been in the news recently due to regulatory action taken by the Reserve Bank of India (RBI), the regulatory body for the Indian banking system. The RBI has banned the bank from acquiring new customers for its online and mobile banking channels. The RBI has also restricted the bank from issuing new credit cards to its customers. This decision was taken after assessing the Kotak Mahindra Bank’s operations for the past two years. The RBI found the bank to be deficient in its IT risk and information security governance. Before taking action, the RBI had demanded an explanation, which the bank failed to provide.

Estimated Recovery
The first line of action for Kotak Mahindra Bank would be to improve its IT systems, following which it will have to undergo an external audit and submit a report to the RBI for the ban to be lifted. A similar regulatory ban was imposed by the RBI on India’s largest private sector bank, HDFC Bank,in December 2020. It took around nine months for HDFC Bank to upgrade its operations. As regards Kotak Mahindra Bank, it is difficult to predict its release from the ban but in our opinion it may take around the same time as in the case of HDFC Bank.

Regulatory Action Fallout
According to recent data, a majority of the bank’s new customers were being on-boarded through online channels, mainly from Kotak 811. The current disuse of this online channel may hamper the bank’s growth plan in acquiring new customers. Meanwhile, its credit card business had been one of the fastest-growing business segments and in Q4FY24 the credit business grew by almost 44 per cent annually. It may be assumed that the restriction over issue of new credit cards will be of significant impact. However, the good part is that this segment accounts for only 3.7 per cent of its advances. As of now, the investment required to improve its IT system will lead to a further increase in the cost to income ratio, which is already at a higher level as compared to its peers.

Operational Mix
According to the bank’s Q4FY24 results, a majority of the revenue for the bank came from consumer activities with 23 per cent from commercial business, 22 per cent from corporate banking, 7 per cent from small and medium-sized enterprises and the rest 2 per cent from other activities. Credit cards, retail microfinance and loans for commercial vehicles and construction equipment remained the bank’s fastest growth business segments. On the deposits side, savings accounts, current accounts and term deposits constituted 28.7 per cent, 16.8 per cent and 54.5 per cent, respectively.

The asset quality ratios for the given periods show an improvement in the bank’s non-performing assets (NPAs). The gross non-performing assets (GNPAs) decreased from ₹6,302 crore in December 2023 to ₹5,275 crore in March 2024, indicating a reduction in the total amount of non-performing loans. The gross NPA ratio also decreased from 1.73 per cent to 1.39 per cent, suggesting a lower proportion of non-performing loans to total advances.

The net NPA ratio remained stable at 0.34 per cent, indicating a consistent level of net non-performing loans after deducting provisions. The provision coverage ratio (PCR) decreased slightly from 80.60 per cent to 75.90 per cent, but it continues to maintain a high level of provisions held against potential losses from NPAs. Overall, the trends in these ratios suggest an improvement in the bank’s asset quality and lower risk exposure to non-performing loans.

The key financial ratios for the bank over the specified periods exhibit a mixed performance. The CASA ratio declined from 52.80 per cent in March 2023 to 45.50 per cent in March 2024, indicating a decrease in low-cost deposits. Its net interest margin (NIM) also decreased from 5.75 per cent to 5.28 per cent, suggesting a narrower spread between interest earned and interest paid. On a positive note, the bank’s return on assets (ROA) improved from 2.76 per cent to 2.92 per cent, indicating enhanced profitability from assets.

The return on equity (ROE) also increased from 15.04 per cent to 16.85 per cent, reflecting higher returns on shareholder equity. The decline in CASA and NIM may pose challenges, possibly due to changes in deposit composition or interest rate dynamics. However, the improved ROA and ROE signify a positive trend in profitability, showcasing the bank’s ability to generate profits from its assets and equity.

The bank’s CAR decreased from 23.30 per cent in March 2023 to 21.80 per cent in March 2024. The CET I also decreased from 22.30 per cent in March 2023 to 20.70 per cent in March 2024. The decreasing leverage ratios suggest a potential weakening in the bank’s capital adequacy and ability to absorb losses. This trend may raise concerns about the bank’s financial stability and risk management practices. Nonetheless, it is quite above the regulatory requirement.

Valuation
The bank is currently trading at a price-to-book of 3.01 times, which is at a higher level when we compare it with its peers.

Potential Risk
After the RBI ban, Joint Managing Director K V S Manian resigned from the bank. He had worked with Kotak Mahindra Bank for more than 29 years. Manian’s resignation does not necessarily have a link with the RBI ban on the bank. However, this exit by a senior executive might trigger more resignations. Due to the regulatory action by the RBI, the bank is forced to rely on physical branches to acquire new customers. This can lead to an increase in operating costs for the bank, thus impacting its financial performance in the short term. It may also lead the bank to lose its market share in the highly competitive Indian banking and financial services sector.

Conclusion
Kotak Mahindra Bank’s stock is trading at a premium compared to its peers. The RBI’s ban on new credit cards and online customer acquisition presents challenges that will affect profitability and growth. Investors should exercise caution due to uncertainties over the timeline for the removal of the RBI ban, potential operational shifts, and increased costs. We believe a fresh investor should not enter the stock unless the regulatory hurdle is resolved. Hence, our recommendation is AVOID.