A billionaire banker who built one of India’s most valued banks. A regulator, considered first among equals, not accustomed to having its diktats questioned. And the Banking Regulation Act, which gives the RBI its powers to regulate Indian banks, including Kotak Mahindra Bank.
These three elements have come together in one of the most significant challenges to the Reserve Bank of India’s authority in recent years.
As the Kotak Mahindra Bank versus the Reserve Bank of India dispute continues, two key issues have emerged — 1) Does the Banking Regulation Act give the regulator enough powers to curb economic rights of a private bank promoter? 2) Did the RBI move goal posts too often and not give adequate clarity to Kotak Mahindra Bank on what was expected from it and its promoters?
But beyond the precise matters of law, the battle has become one where the RBI claims its autonomy is being challenged, while Kotak Mahindra Bank argues that autonomy cannot be equated with carte blanche.
BloombergQuint has reviewed a copy of the response filed by the RBI and the rejoinder filed by Kotak Mahindra Bank. The details presented below are based on these documents, some of which were first reported in The Wire.
Autonomy ≠ Carte Blanche
Kotak Mahindra Bank had first filed a petition in December seeking relief from the RBI’s instructions that promoter Uday Kotak reduce his stake to 20 percent of the bank’s paid-up voting equity capital from the prevailing 29.7 percent.
The bank was hoping to meet this requirement by issuing preference shares but the regulator said no. And so the lender took the unusual step of going to court and filing a petition against the regulator’s decision.
Details of the bank’s petition are reported here: Kotak Mahindra Bank Petition Challenges RBI’s Power To Curtail Promoter Shareholding.
The RBI, in its response, said that the lender’s petition, if granted, could damage the regulator‘s authority and autonomy.
The petition, if granted, shall result in making inroads into the RBI’s autonomy and to permit the petitioners and others (whose actions the RBI is meant to regulate) to become regulators of their own selves. Not only will this turn banking policy, as reflected in the BR Act, on its head, but will in the respectful submission of the RBI, set an unhealthy precedent.RBI Response To Kotak Mahindra Bank Petition
Kotak, in its rejoinder, does not shy away from taking on the RBI’s assertion that its autonomy is being challenged.
It argues that the RBI draws its powers to regulate the banking sector from the BR Act. Kotak Mahindra Bank contends that the regulator cannot argue that it has “unlimited and unimpeachable” powers related to Indian banks and that it operates outside “statutory and constitutional limits”.
The contention (that RBI’s autonomy is being challenged) is not only unreasonable and incorrect but amounts to the RBI contending that it is entitled to carte blanche powers irrespective of the provisions of the BR Act, which contention is ex-facie misconceived.Kotak Mahindra Bank Rejoinder To RBI Response.
An email sent to the RBI seeking a response to Kotak’s rejoinder was not answered.
“Kotak Mahindra Bank has always respected Reserve Bank of India’s autonomy. The actions of the bank have been in accordance with the RBI's communications, the needs of the bank and the law. Having said this, we are unable to comment any further as the matter is sub judice", said Rohit Rao, chief communication officer, Kotak Mahindra Bank.
Section 12/12B vs Section 35A
Beyond the bluster, the matter boils down to the interpretation of two sections of the BR Act — 12/12B and 35A.
In its very first petition, Kotak Mahindra Bank had argued that Section 12/12B of the BR Act does not give the RBI powers to regulate economic rights of a bank promoter. What it does is allow the regulator to cap voting rights.
Section 12 lays down regulation of paid-up capital, subscribed capital and authorised capital and voting rights of shareholders. It says that no person holding shares in a banking company can exercise voting powers in excess of 10 percent, later revised up to 26 percent. It further states that no person can acquire more than 5 percent stake or voting rights in a bank without prior approval from the RBI.
Based on these provisions, the bank said that the requirement of RBI’s prior approval does not operate “retrospectively” as it is “concerned with imposing restrictions on fresh acquisitions of shares and not on existing holdings”.
The RBI dismissed this argument and said that these sections must be read within the broad framework of the BR Act.
...Section 35-A of the BR Act gives the RBI powers of the widest amplitude to issue directions both generally, or to any particular banking company, if the RBI deems this to be in a) public interest; b) in the interest of banking policy; c) to prevent the affairs of such company being run in a manner detrimental to the depositors; d) to secure the management of any banking company generally.RBI Response To Kotak Mahindra Bank Petition
Section 12, when read with Section 35-A, sufficiently empowers the RBI to regulate the share capital, shareholding and voting rights of any persons in relation to a banking company, the RBI said.
In its rejoinder, Kotak reiterates its arguments and Section 12/12-B form a “complete code” and the RBI’s powers under the BR Act are circumscribed by these provisions.
Changing Goal Posts
Kotak Mahindra Bank also argues that the RBI has changed goal posts for the appropriate level of promoter shareholding many times over the years.
The RBI’s thinking on promoter ownership has been governed by a need to ensure diversified ownership of banking institutions, which not only hold public deposits but are highly leveraged. However, the regulator has tweaked rules with each successive round of bank licences.
The specifics of change in licence conditions was detailed by BloombergQuint in this article: Kotak Mahindra Bank Fracas Revives Bank Ownership Debate.
Specifically, when a banking licence was granted to Kotak Mahindra Financial Ltd., a non-banking financial company, in 2001, the rules said that promoters needed to hold a minimum of 49 percent of the paid-up capital in the bank at any point in time. In 2012, the RBI issued a letter to the bank directing it to reduce its promoter stake to 20 percent of the paid-up capital within 10 years and to 15 percent within 12 years from the date of licensing.
Kotak contends that the RBI, in its communications, did not specify that the cap on promoter shareholding was linked to “paid-up voting equity capital”.
The RBI, in its reply, said that until 2018, when Kotak proposed to issue perpetual non-cumulative preference shares, it only had ordinary equity capital. It added that in the past the bank had agreed to reduce promoter shareholding in this equity capital base. As such, it cannot now argue that the RBI’s instructions were unclear.
Until the issuance of the PNCPS in August 2018, Petitioner No.1’s shareholding comprised only of ordinary equity capital. This meant that any and every dilution of such shareholding led to a corresponding dilution of voting rights.RBI Response To Kotak Mahindra Bank Petition
In its rejoinder, Kotak hits back saying that the RBI’s contention, if accepted, would mean that no person or banking entity would be able to confidently rely on communication from the regulator.
The RBI’s contention which amounts to contending that plain and clear words used by it can subsequently be said to carry an entirely different meaning, that too retrospectively, is ex facie arbitrary, unfair, unreasonable and illegal.Kotak Mahindra Rejoinder To RBI Response
Room For Middle Ground?
While a decision on the matter now rests with the court, a former senior official of the Reserve Bank of India said that it is time for the regulator to harmonise its various regulations related to bank ownership to give a clearer picture.
The regulator should also have a re-look at its thinking on the benefits of diversified ownership of banks and see if its earlier conclusions still hold, the person said speaking on condition of anonymity. He pointed to recommendations of the PJ Nayak committee.
The committee, in 2013, had recommended that promoter shareholders be allowed to hold up to 25 percent equity stake in a bank. It had argued that a promoter stake of 15 percent is too low and does not help the case of strong governance standards. The recommendation was not implemented.
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