[By Rohan Aneja]

The author is a student at Rizvi Law College, Mumbai

The Reserve Bank of India (“RBI”) issued Guidelines for the entry of new banks in the Private Sector dated January 3, 2001 (“2001 Guidelines”) which required promoter contribution to be a minimum of 40% of the paid-up capital of the bank at any point of time with a 5 year lock-in period from the date of license; any excess of 40% had to be diluted within 1 year of commencing operations. The RBI revised the minimum promoter shareholding to 49% vide notification dated June 7, 2002. Pursuant to these guidelines, Kotak Mahindra Bank (“KMB”) was issued its license on February 6, 2003, with its promoter stake at 49%.

Regulatory Dispute

It is after this point that the RBI issue the Ownership and Governance Guidelines dated February 28, 2005, which capped the shareholding of any single / group of related entities to 10% of the paid-up capital and required any existing entity holding more than 10%. This was done to indicate a timetable for the reduction of the holding to the permissible level. KMB was asked to comply with the guidelines and it disputed the same on the grounds that it was contrary to the terms on which KMB’s license was granted. After several correspondences, KMB accepted RBI’s proposed timeline to reduce the promoter stake.

Meanwhile, the RBI issued the revised Ownership and Governance Guidelines dated February 23, 2013 (“2013 Guidelines”) which provided that Promoter / Promoter Group will be permitted to set up a bank only through a wholly-owned Non-Operative Financial Holding Company (“NOFHC”). The restrictions on ownership were 40% of the total paid-up voting equity capital with a 5-year lock-in period, followed by a reduction of 20% within 10 years and 15% within 12 years from the commencement of operations. The RBI has also issued a Master Direction on Ownership in Private Sector Banks dated May 12, 2016, which permitted promoter/promoter group of all existing banks, shareholding in line with what has been permitted in 2013 Guidelines on licensing of universal banks, which is 15%.

In 2016, KMB refused to comply with the above timeline since it merged with ING Vysya Bank, whereby its promoter shareholding reduced to 33.6%. Thus, the RBI extended the timeline to achieve a 30% reduction by June 30, 2017, 20% by December 31, 2018, and 15% by March 31, 2020.

Issue of PNCPS

On August 2, 2018, KMB, in an attempt to circumvent the RBI Guidelines, issued perpetual non-cumulative preference shares (“PNCPS”) worth INR 500 crore with a dividend of 8.10%, at which point its promoter shareholding which stood at 30% would be reduced to 19.7%.  The issue was pursuant to the Master Circular on Basel III Capital Regulations dated July 1, 2015, which classify PNCPS as Additional Tier 1 Capital that does not have any put options but does have a call option after 5 years with RBI approval. Thus, assuming the equity base remains the same after 5 years and KMB decided to use the call option, the promoter stake would revert to 30%.

The purpose of diluting the promoter shareholding to 15% was to avoid concentration of control with the promoters and as such the issue of PNCPS did not meet the promoter holding dilution requirement. KMB argued that the shares were perpetual, non-convertible, non-redeemable preference shares which do not carry any voting rights and are non-cumulative, essentially a mid-way between debt and equity. Moreover, KMB obtained RBI permission to amend its Memorandum and Articles to issue the PNCPS.

Legal Dispute and Settlement

The RBI issued a Show Cause Notice (“SCN”) dated October 29, 2018, to KMB on the grounds that KMB has not submitted a proposed plan for reducing the promoter shareholding as per the timelines. KMB replied to the SCN vide letter dated November 2, 2018, stating that it is without jurisdiction and not maintainable in law. On December 10, 2018, KMB filed a Writ Petition against the RBI before the Bombay High Court challenging the SCN as well as the restrictions on promoter shareholding, contending that the terms on which the license was granted cannot be altered and any changes in the Guidelines run prospectively. KMB withdrew the Writ Petition on January 30, 2020.

KMB and the RBI reached a settlement whereby the promoters voting rights will be capped at 20% of paid-up voting equity share capital until March 31, 2020, and at 15% from April 1, 2020, which aligns with the 2013 Guidelines as well as Section 12(1) of the Banking Regulation Act, 1949 (“BR Act”). Further, promoter shareholding would be diluted to 26% within 6 months and promoters will not purchase any further paid-up voting equity shares till the percentage of promoters’ shareholding reaches 15% or such higher percentage as the RBI may then permit. On June 2, 2020, Uday Kotak sold 56 million shares held by him in KMB for INR 6,900 crore through a block deal which reduced his stake from 28.93% to 26.1%. This leaves a dilution of the excess 0.01% stake to comply with the settlement.

Conclusion

Although the issue of PNCPS was well within the bounds of the RBI Guidelines and Section 12(1)(ii)(b) of the BR Act, it violated their spirit as the promoter control over KMB would not be effectively reduced. In the SCN, the RBI could only challenge the issue of PNCPS without submitting the roadmap to RBI, and not the issue itself. If KMB succeeded before the Bombay High Court, the RBI would have likely challenged the circumvention of the Guidelines before the Supreme Court. Thus, the cap of 15% on promoter voting rights and the dilution of Uday Kotak’s stake to 26% was an acceptable compromise.