Promoter’s Stake in Private Banks and Kotak Mahindra Bank’s Preference Share Issue

[Anirudh Goyal and Vishal Hablani are 4thand 3rdYear B.A.L.L.B. (Hons.) students respectively at West Bengal National University of Juridical Sciences, Kolkata]

The Reserve Bank of India (“RBI”) on 14 August 2018 took the view that the recent issue of preference shares by Kotak Mahindra Bank to dilute the stake of Uday Kotak, the promoter of bank, does not meet the regulatory norms. The bank on 2 August 2018 issued non-convertible perpetual non-cumulative preference shares worth Rs. 500 crore. The issue was made in order to comply with the RBI guidelines to bring down Uday Kotak’s stake in the bank to 20 percent from the previously held 30.03 percent stake. After the issue, the stake came down to 19.7 percent of the bank’s paid-up capital.

Banking licenses were issued to Kotak Mahindra Bank and Yes Bank in 2001 and 2004 respectively. These were pursuant to RBI’s 2001 guidelines, which provided for issuing banking license to private players. The guidelines were revised in the year 2013. During the intervening period, no banking license was issued to any other private player.Among the key features, the guidelines required that the bank should be set up only through a wholly owned non-operative financial holding company (“NOFHC”), holding not less that 40 percent of the paid-up voting equity capital. Since the RBI was of the opinion that a promoter with higher stakes will run the banks better, the guidelines mandated the promoter’s stake to be locked-in for a period of five years. Further, the shareholding of the NOFHC was to be reduced to 15 percent of the paid-up voting equity capital within 12 years from the date of commencement of business. In March 2016, the RBI further issued modified guidelines that again addressed the ownership caps on promoter’s stake in private banks in light of the 2013 guidelines.

After the 2013 guidelines came into force, the RBI had asked Kotak Bank to bring down promoter’s shareholding to 40 percent and 30 percent by September 2014 and December 2016 respectively. Further, in 2017, the Bank was asked to cut down the promoter stake to 20 percent by December 2018 and finally to 15 percent by March 2020. To meet the regulatory norms, Uday Kotak, who held around 43 percent, sold 2.5 crore shares to bring down his shareholding to 39.76 percent. In further compliance with RBI directive, the bank sold shares to qualified institutional investors and other domestic and foreign investors in the open market to reduce the promoter stake to 29.79 percent. However, as already stated earlier, when the bank was asked to bring down the promoter stake to 20 percent, it issued non-convertible perpetual non-cumulative preference shares worth Rs. 500 crores.

It must be taken into consideration here that the intent behind the guidelines was to dilute promoter’s majority stake in the bank with a view to strengthening corporate governance. However, the purpose could have been only achieved if the stake would have been brought down in the paid-up equity voting share capital, as was endorsed by the RBI in its February 2013 and March 2016 guidelines.

Even though it is being argued that from the legal point of view Uday Kotak has met the ownership cap on promoter’s shareholding in a private bank as stipulated by the RBI, some, however, feel that it has not been carried out within the spirit of law. This is because he still owns 30.03% of the equity voting capital, which gives him substantial ‘control’ in the bank’s management affairs. Preference shares are counted as a part of paid-up capital, but do not carry any voting rights in general apart from certain exceptional circumstances, and thus in no way limit promoter’s control.      

Stand Taken By  Kotak Mahindra Bank

According to the stand taken by the Kotak Mahindra Bank management, the conditions of the licence issued by the RBI do not refer to paid-up equity voting capital. As per the license conditions, the promoter was required to dilute his stake in the paid-up capital to 15 percent. The conditions do not refer to the requirement of reduction in paid-up capital with voting shares.

The management also argued that preference shares are mid-way between debt and equity. The shares are perpetual, non-voting, non-convertible and non-cumulative in nature. According to the Basel III Capital Regulations, such shares are regarded as Tier I capital subject to fulfilment of certain criteria.

Why an Attempt was made to Circumvent the Guidelines?

Recently, the HDFC bank chairman-cum-promoter Deepak Parekh survived a close vote on 31 July 201, when 22.64 percent of the shareholder votes were cast against the resolution for his reappointment on the board. The reason for such a close vote can be attributed to the influence exercised upon the shareholders by the foreign proxy advisory firms. The shareholders (foreign institutional clients) seeking advice from these types of firms were advised to vote against the resolution because Mr. Parekh is already on the board of eight listed companies, which raised concerns on whether he would be able to effectively discharge his fiduciary duties. The reason put forth to vote against the resolution is sound; however, the question here is – was it possible to achieve the purpose in some other manner?The answer to this question is of relevance, considering Mr. Parekh’s invaluable contribution in building the bank. Instead of jeopardising his position in the HDFC bank’s board, he might have been asked to give the directorship in other companies, considering the work load.

The RBI’s policy to keep a cap on promoter’s shareholding prima facieseems to be a promising move, considering corporate governance issues in the banking arena. However, if we take into consideration Mr. Deepak Parekh’s appointment on the HDFC bank’s board, it gives us an indication that the rules regarding maximum shareholding cap might end up giving a substantial amount of power in the hands of small minority shareholders. This paves the way for a possibility wherein these small group of shareholders might collude to bring drastic or unwanted changes in the board’s decision(s).     

Uday Kotak had also raised concerns against the view that was advocated by foreign proxy advisory firms to vote against Mr. Parekh’s appointment on the board. Through a public statement, he emphasised on the domestic regulation of these firms, wherein he observed – “Voting through global proxy advisory services leads to concentration of voting power in the hands of a few global agencies and questions the very basis of well-run widely held companies and diversified ownerships”. The view taken by Uday Kotak is an indicator that explains why the Kotak Mahindra Bank did not go for the issue of equity shares to bring down promoter’s stake in the bank.

Conclusion

Even though the step taken by the Kotak Mahindra Bank has failed to pass the legal muster at the first instance, the controversy has sparked further debate with respect to the cap on promoter’s stake in private banks. Moreover, the controversy has thrown light on the requirement of introducing domestic regulations for foreign proxy advisory firms. Nevertheless, it would be interesting to see whether it is possible to reconcile promoter’s interest in case domestic regulations for foreign proxy advisory firms are introduced in near future.

Anirudh Goyal & Vishal Hablani

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