Kotak Mahindra Bank

Company Profile

REPORT BY: MISS. ANSHIKA SINGH

MBAVignana Jyothi Institute of

Management

Kotak Mahindra BankCompany Analysis

Contents

K o t a k M a h i n d r a B a n k – I n t r o d u c t i o n .

INTRODUCTION

GROUP STRUCTURE

PORTER’S FIVE FORCE MODEL

BANKING BUSINESS MODEL

KOTAK MAHINDRA BANK BUSINESS MODEL

SWOT ANALYSIS

Kotak Mahindra Bank has a well-diversified business covering the commercial vehicle, consumer financing (cars, home and personal loans), capital market financing, corporate finance and asset reconstruction segments. The Kotak group also has a presence in car financing through Kotak Mahindra Prime Limited, now a

100 per cent subsidiary of the bank (after the exit of Ford Motor Credit Company from the earlier joint venture). The group has strong presence in fee based businesses linked to the capital markets such as investment banking through Kotak Mahindra Capital Company Ltd and in institutional and retail brokerage and portfolio management services through Kotak Securities Limited. Both companies are now ultimate 100 per cent subsidiaries of the bank after the buy out of Goldman Sachs from both the joint ventures by paying a consideration of Rs. 323 crore in March

2006. The Kotak group has a reasonable presence also in life insurance (through Kotak Mahindra Old Mutual, a 74:26 joint-venture with Old Mutual) and asset management (through Kotak Mahindra Mutual Fund). Kotak Mahindra Bank converted itself into a commercial bank (from its earlier constitution as a NBFC) in

2002-03 in order to provide a more comprehensive range of financial services to its customers. The bank is predominantly a retail bank with about 80 per cent of its assets in retail advances. On the corporate side, the bank is focusing on a fee- based income strategy to cross-sell the basket of products and solutions available across the Kotak group.

The group has a net worth of around Rs. 3,100 crore, employs around 9,600 people in its various businesses and has a distribution network of branches, franchisees, representative offices and satellite offices across 300 cities and towns in India and offices in New York, London, Dubai and Mauritius.

G r o u p S t r u c t u r e

B r i e f H i s t o r y

The Kotak Mahindra Group was born in 1985 as Kotak Capital Management Finance Limited. This company was promoted by Uday Kotak, Sidney A. A. Pinto and Kotak & Company. Industrialists Harish Mahindra and Anand Mahindra took a stake in 1986, and that's when the company changed its name to Kotak Mahindra Finance Limited.

I n d i a n B a n k i n g S e c t o r

P o r t e r ’ s F i v e f o r c e s M o d e l

Threat of entry:

Existing firms have strong presence and recognition. The majority stake in Public sector banks is being held by the government of India. This reduces the credit risk for lenders and depositors to a considerable extent. Due to collapse of a few private sector banks (and even co-operative banks for that matter), creates a virtual barrier to entry for the private and foreign players.

The industry is capital intensive, which acts as a barrier to entry.

India is a fast growing nation and many foreign banks are coming here to reap benefit out of it, which is a big threat to existing banks. Further liberalization of banking sector for foreign participants is expected post 2009. A slew of banks are in the foray which include global biggies like Royal Bank of Scotland, Switzerland's UBS, US-based GE Capital and Credit Suisse Group.

Access to distribution channels and economies of scales of established players in the market also increases barrier to entry. As we will see ahead that banking business model is a volume game.

Reforms and policies of government are the major determinant for deciding the level of entry barrier in the Indian banking industry.

Overall, entry barrier is moderate in this industry.

Bargaining power of buyers:

Bargaining power in this industry for corporates would largely depend on its credit ratings. Big corporate and companies who have big transactions between them as well as various services may have enormous bargaining

power if their credit rating is high.

Individual buyers (retailers) have good bargaining power due to

immense competition among financial sector entities.

Agricultural credit forms a reasonable part of a bank’s credit and due to government support (part of priority sector advances), customers of these segment have good bargaining power more so during good monsoons.

Bargaining power of suppliers:

High during periods of tight liquidity. Trade unions in public sector banks can be anti reforms. Depositors may invest elsewhere if interest rates fall.

Main supplier of money in the banking industry is retailers and corporate. Bargaining power depends on the interest rate which is determines by the demand and supply of money in the market.

Inter-bank market (money market) is also considered to be the supplier. In times when demand of money is high, costs of funds are high and vice versa.

Bargaining power of the suppliers also depends on risk-return characteristics of the alternate investment products. A recent study conducted by CRISIL, explained that banks are facing tough competition from alternate investment sources like Mutual Funds, Equity, IPO’s, Gold and Real Estate investments.

Threat of substitutes:

Substitutes for banks are local moneylenders and hundiwalas, financial companies and NBFC’s. Local moneylenders and hundiwalas come under unorganized sector. Finance companies and NBFC’s come under organized sector. Unorganized sector in India has vast coverage in small villages and towns but due to increasing network of banks and their reliability, the unorganized sector is decreasing its business. The cost of funds for banks is cheaper and therefore, can price its loans cheaper. Thus, overall power of substitute is less than moderate.

Competitive Rivalry

Banking industry has two things to capitalize on. One is economies of scale and other spread margin. For achieving economies of scale, a large market share is needed and due to number of players there is intense competition. Presence of many Indian and foreign banks and their strive for higher market share will increase the competitive rivalry among existing players. Due to a large number of players, the industry is seeing and can foresee a lot of mergers and takeovers. Also, PSU banks are banking on their volumes and vast branch network make more money from lending activities. Private sector banks are offering various innovative products and variety of quick services lead to an inevitable marketing war between the banks

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B a n k i n g B u s i n e s s M o d e l

The primary business of a bank is to accept deposits (current, savings and term deposits) from their branches and lend short term and medium term loans. Long term loans are generally avoided by banks due to Asset Liability mismatch and also interest rate risk. However, banks do lend long term with interest rate resets build in the loan agreement. Bank accepts deposits from households and has to pay interest on these deposits. The bank then uses these deposits to lend loans for which it charges interest from the corporate and retail borrowers. Banks pay negligible interest on current account deposits, 4% on savings account deposits. Interests on term deposit depend on the prevailing interest rate which is determined by the demand and supply of money in the market. On the other hand, Banks lends to corporates and retail borrowers based on the prevailing interest rate structure, demand and supply of credit in the market, the risk involved determined by the internal and external credit risk appraisal mechanism etc. banks thus have an advantage over other financial institutions, non-deposit taking NBFC’s in the form low cost deposits mobilized by the banks better known as CASA deposits or current and savings account deposits. However, banks make notional interest losses as they can’t lend the whole amount as per their discretion.

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K o t a k M a h i n d r a B a n k – T h e B u s i n e s s M o d e l

Having looked at the profile of the banking sector in brief, let’s now understand the business model of Kotak Mahindra Bank.

Operating profits in banking would mean Net Interest Income.NII is essentially the difference between the bank’s interest revenues and its interest expenses. This parameter indicates how effectively the bank conducts its lending and borrowing operations (in short, how to generate more from advances and spend less on deposits).

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I n t e r e s t R e v e n u e s : -

Interest on loans:

Since banking operations basically deal with ‘interest’, interest rates prevailing in the economy have a big role to play. So, in a high interest rate scenario, while banks earn more on loans, it must be noted that it has to pay higher on deposits also. But if interest rates are high, both corporates and retail classes will hesitate to

borrow. But when interest rates are low, banks find it difficult to generate revenues from advances. While deposit rates also fall, it has been observed that there is a squeeze on a bank when bank rate is soft. A bank cannot reduce interest rates on deposits significantly, so as to maintain its customer base, because there are other avenues of investments available to them (like public savings scheme, mutual funds, equities,).

Since a bank lends to both retail as well as corporate clients, interest revenues on advances also depend upon factors that influence demand for money. Firstly, the business is heavily dependent on the economy. Obviously, government policies (say reforms) cannot be ignored when it comes to economic growth. In times of economic slowdown, corporates tighten their purse strings and curtail spending (especially for new capacities). This means that they will borrow lesser. Companies also become more efficient and so they tend to borrow lesser even for their day-to- day operations (working capital needs). In periods of good economic growth, credit offtake picks up as corporates invest in anticipation of higher demand going forward.

Credit to non-agricultural sector: Corporate Lending:

Banks have a great opportunity of increasing lending to this sector as one of the problems of this sector has been lack of funds. This As stated earlier, banks accept deposits from the public & deploy it for various purposes, one of them being providing various types of finances to industrial & service sector. Banks have come up with various facilities like Cash-credit, Bank Overdraft, Letter of Credit, Long term Loans, Working Capital Loans, Venture financing, Export Credit etc.

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Small and Medium Scale Enterprises:

Small and medium enterprises (SME) are likely to be the key drivers of this growth, as the initial phase of the uptick in the capital expenditure cycle appears to be spurring greater borrowings from SMEs. Traditionally, SME’s in the past have always lacked adequate access to capital market and bank finance. Banks have been hesitant to lend to this sector because of the historical high levels of NPL levels in the Loans to the SSI segment. However, SME’s as a segment are much broader than SSIs and offer a viable deployment avenue for banks. Infact, some of the private sector banks have already started lending aggressively to this sector. Also, risk can be better gauged with the advent of credit rating of SME’s done by credit rating agencies. This help banks better price credit risk and generate high risk-adjusted returns.

Retail Lending

Retail finance is one of the fastest growing segments for Indian Banks .It consists of over 30% of the average system advances. Housing loans, Educational loans (For Public Sector Banks), Auto Loans, Personal Loans, retail trading loans are some of the product offered in the banking sector. Retail Housing forms about half of all incremental loans disbursed by the Indian Banking sector. Housing demand is expected to remain given the persistent demand-supply gap in this sector. Despite stiff competition and thin margins, lending to the retail sector has remained viable for the banks due to low NPL.s, better risk adjusted returns, and increased operating efficiencies.

Housing Loans:

Kotak provides housing loans to salaried individuals, Self Employed non-professional (SENP). It also provides Loans against property, Loans to commercial property i.e. loans to shop owners, Balance transfer. The housing loan department is divided into three categories: Credit appraisal, sales, Legal and Technical. Loans are sourced by the sales department. They are they appraised by the credit appraisal department with the help of legal and technical department. The legal and technical department of Kotak is in-house and not outsourced as in case of few other banks. Kotak is very conservative and cautious while sanctioning housing loans. Only if all the requirements are fulfilled, The loan will be disbursed. Also, the loan to Security value is also kept at less than one, while

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is far less than the industry. Kotak therefore has very good asset quality and thus the chances of loans defaulting in this segment are very less. Kotak also does not give fixed interest loan currently and disburses on Floating Rate loans. The Interest rates charged by Kotak in the various categories is as follows:

Car Finance. (Done by Kotak Mahindra Prime Ltd)

Profile: Kotak Mahindra Prime Limited (KMP) is a car finance company, engaged in retail financing of new and used passenger cars, multi-utility vehicles through loan, hire purchase and lease contracts and inventory and term funding to car dealers. In 2005, the Kotak Mahindra Group ownership in KMP increased to 100% following the acquisition of 40% stake held by Ford Credit International (FCI). Subsequently, in 2006, KMP also bought the entire retail car finance portfolio of Ford Credit Kotak Mahindra. During the year the company undertook new initiatives and renewed its focus on fee based income. The Company started financing against securities, acquired a retail car portfolio, entered into securitization and assignment transactions and also acquired non performing assets.

I n t e r e s t e x p e n s e s :

A bank’s main expense is in the form of interest outgo on deposits and borrowings. This in turn is dependent on the factors that drive cost of deposits. If a bank has high savings and current deposits, cost of deposits will be lower. The propensity of the public to save also plays a crucial role in this process. If the spending power for the populace increases, the need to save reduces and this in turn reduces the quantum of savings.

Deposits: -

Banks fund their lending operations primary through deposits: Deposits with SCB’s are classified into three categories:

Current Deposits: -Current deposits are maintained by the business class to meet short term contingencies. No interest is payable by banks on such deposits.

Savings Deposits: -Savings deposits are deposits maintained by the households. RBI.

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O t h e r I n c o m e s o u r c e s

P r i m a r y D e a l e r ( n o w u n d e r t h e b a n k ) a n d I n v e s t m e n t

B a n k i n g u n d e r K o t a k M a h i n d r a C a p i t a l C o m p a n y ( K M C C ) Profile: KMCC’s business consists of two main parts - (a) Franchise business (fee based), conducted under the trade name of Kotak Investment Banking, and (b) Principal business (fund based). KMCC is a full service Investment Bank and an approved Primary Dealer (PD).

The core activities of a Primary Dealer include dealing, underwriting and broking services in G-Sec, corporates, PSUs, FI bonds or debentures, dealing in interest rate derivatives, leading in the call/term/repo/CBLO market, investing in Commercial paper, certificate of deposits, security receipts and debt mutual funds. Non Core activities of classified by the RBI circular feature investment or trading in equity and equity derivatives market, investment in units of equity oriented mutual funds, underwriting public issues of equity, M&A advisory, portfolio and private equity management services. RBI has now allowed banks to run Primary dealership business departmentally. Besides the savings in capital running the PD business as a department entitles the bank to utilize the securities purchased through primary dealership activities as part of statutory liquidity ratio requirement.

S t r e s s e d A s s e t b u s i n e s s :

Asset reconstruction business is one of the key focus areas of the Bank, and the Bank has a pre-eminent position in the industry. The Bank purchases distressed assets and portfolios from other banks and financial intermediaries and helps in the resolution of the non performing loans. The Bank has made significant investments in buying stressed asset portfolios, the economic benefits of which will accrue over the next few years. Risk level is high but the returns are great. Salient Features of this business are as follows:

K o t a k S e c u r i t i e s :

Profile: Kotak Securities Ltd. Kotak Securities Ltd. has been the largest in IPO distribution. In its individual investors division, Kotak securities, provides with broking and research services to Individual Investors. On the other hand, the institutional business division, brings

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“A Kotak Securities Electronic Search service (AKSESS), primarily covers secondary market broking.

It caters to the needs of foreign and Indian institutional investors in Indian equities (both local shares and GDRs). The division also has a comprehensive research cell with sectoral analysts covering all the major areas of the Indian economy.

Kotak Securities has 195 branches servicing more than 2,20,000 customers and a coverage of 231 Cities. Kotaksecurities.com, the online division of Kotak Securities Limited offers Internet Broking services (in Equity, Derivatives) and also Insurance, online IPO and Mutual Fund Investments. The portfolio Management Services provide top class service, catering to the high end of the market.

A s s e t M a n a g e m e n t

Kotak Mahindra Asset Management Company and Kotak Mahindra

Trustee Company

An Asset management company basically pools money from investors, invests it in the capital market and other asset class, generates returns and distributes these returns back to the investors after deducting fund management charges. The opening up of this sector has seen a number of players setting shops in this industry. Making money in this business depends a lot on launching innovative products, widespread distribution/ reach to the investors and providing superior returns. This also makes the mutual fund industry depend on the state of the capital market.

It can be observed that when the stock markets are booming, fund managers are able to provide superior returns. Hence, Revenues from this business will make it dependent on the state of the capital market. Downturn in the revenues may follow with a downturn in the equity markets. Asset management is not a significant contributor in revenues to Kotak Mahindra bank, but has a good potential going forward. From the investment market point of view, growing income levels provide a great opportunity. However, the savings and investment pattern of Indian investors is highly skewed in favor of fixed income ‘savings’ rather than market linked ‘investment’. This trend is expected to change with strong market intermediaries like mutual funds playing a significant role in facilitating retail investors to participate in market linked

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investments and relatively lower interest rate environment. Indian mutual fund industry is evolving, in terms of breadth and depth.

K o t a k M a h i n d r a O l d M u t u a l L i f e I n s u r a n c e L t d .

Kotak Mahindra Old Mutual Life Insurance is 74: 26 joint venture of the Bank with Old Mutual plc. Kotak Life offers life insurance, deferred annuity and employee benefit products to individuals and groups. The business is distributed through three distribution channels viz. Tied Agency, Alternate Channels and Group Insurance. The business is value-driven with a focus on long-term shareholder value and an aspiration to meet policyholder expectations.

Introduction of new products and focus on service delivery were primary drivers to this result. Consumer confidence in the private sector has substantially improved over the years, and going by the current trends, it is expected that the private sector will improve upon the perceived value to the consumer. Private sector insurance companies continued to garner a higher market share at 28.6% .

Swot Analysis of Kotak Mahindra

Strength

Despite losing market share over the last four years, kotak Mahindra bank’s investmentbanking and stock broking franchises are amongst the best in india. KMB has one of the most stable top management teams with almost the entire top management team being employed with the bank for more than a decade. A diverse business model across lending,asset management, capital market and insurance help the company to capture the entire value chain in the financial service sector and help maintain entire growth.

KMB is a market leader in car and commercial vehical finance with stronge appraisal skill in these businesses (as evidence by its low NPAs).

KMB has negligible exposer to stressed sector such as power infra aviation and textile.

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Weaknesses

KMB has a weak franchise. Its CASA ratio is amongst the lowest for Indian banks. When it comes to sticky saving deposites, KMB is weaker still with SA at 16% of total depositesand 9%of its total liabilities.

KMB has a weak presence in corporate banking (it is essentially a retail bank on ‘asset’ side of the balance sheet). However, increasingly the company is focusing on corporate banking.

KMB is heavily reliant on the interbank market on the ‘liability’ side of the balance sheet.

Opportunities

KMB has the opportunity to strengthen its liability franchise by increasing its CASA deposite (through widning of its branch network).

The recent deregulation of the saving rate by the RBI gives KMB an opportunity to tap new customers and strengthen it’s CASA base.

It has the opportunity to diversify on the asset side of the balance sheet by increasing market share in corporate banking.

KMB can use its presence across asset management; capital market and insurance to cross sale its products.

Threats

Convergence of regulation for NBFCs in line with banks could affect profitability of the company by 6%-7% giventhat 27% of its lending business is through a NBFC which has lower regulatory obligations than banks (no slr requirement, no CRR requirement, lower employee expenses and easy branch expenses).

Continued weakness in non leading businesses (Insurance,Asset management and capital markets) could affect KMBs earning growth if the leading business is unable to maintain its momentum.