Banks will be able to cut rates by March or Q1: Uday Kotak

The Reserve Bank of India has introduced liquidity coverage ratio (LCR) which requires  banks to hold significantly higher levels of liquidity compared to earlier times. In an exclusive interview to CNBC-TV18, Uday Kotak, Executive VC and MD of Kotak Mahindra Bank explains how banks have to now factor in LCR in their cost of funds which makes it difficult to pass on the rate cut benefits. He says it can be done by March or in the first quarter of new fiscal.

"In my sense March or early next quarter is when I see the possibility of rate cuts by banks. Either post Budget, therefore in the month of March. But keep in mind, March is again a busy month because of tighter credit policy. Banks will be reformulating their base rate policy. So either March or Q1 next year, I believe transmission should happen."

Speaking about the possibility of further rate cuts by the RBI, Kotak said the apex bank governor is a Booth School economist who will act on the basis of data. However, if situation remain the same as it is now, Kotak expects CPI to trend between 5.5 and 6 percent by December-end.

Below is the verbatim transcript of Uday Kotak’s interview with CNBC-TV18's Latha Venkatesh. Q: Before I get into the micros of your own game you are going to be hosting this conference Millennium Makers of India. This is a little different from the other investor conferences I have heard. What are you going to say or what are you going to seek in this conference? A: We are in a very interesting phase of India. I am a believer that a number of people have made India happen till now. So we call them the makers of India in the corporate sector and therefore the theme of the conference is Millennium Makers of India because I am a believer that a very significant portion of making of India is going to happen from here. Therefore this is a time to rejoice. Q: So it is mainly people who have made India this millennium? A: Correct and some of them will also be key architects for the future making of India. Q: Something important has happened in this fear of banking itself and of course the economy. You didn’t get a rate cut from the governor this week but then to be fair we just got one or two weeks back. What is your own sense, are we are likely to get many more rate cuts this year? A: Reserve Bank of India (RBI) under Governor Raghuram Rajan is what I would call as a purist RBI - approaches first data and this is Booth School economics, which is - I will act on the basis of data I get. Second, a very clear roadmap about what one can expect say 1.5-2 percent real rates therefore give me data on inflation, make it convincing and I am ready to move. Q: How would you therefore assess, do you see enough evidence? You are a veteran economy watcher as much as you are a market watcher, are you getting a sense that we have seminally conquered inflation and therefore you can reasonably expect rates? A: I think it is still early days but I do believe that the global deflationary pressure will help and if I was taking a call - end December, assuming nothing changes in the world, my bet on consumer price index (CPI) is between 5.5 percent and 6 percent. Q: So a couple of more rate cuts in that sense but you are not passing it on? A: We will certainly consider it but there are various other factors at play. Q: What is blocking the transmission? A: First is the RBI over the last few months has now introduced liquidity coverage ratio (LCR) which means banks have to hold significantly higher levels of liquidity compared to earlier times and there is a price for LCR. So banks now have to factor in the cost of LCR within its base rate calculations and to be fair to the RBI, they have allowed banks to come out with a new model for base rates based on the new facts, which are now required when base rate was originally introduced, there was no LCR. So we have to factor in LCR in our cost of funds. Q: Along with that you have also got some reduction in statutory liquidity ratio (SLR), two SLR cuts have come over the past several months? A: But look at SLR, LCR together. Q: How much have you to hold together with LCR and SLR? A: When SLR was 22 percent, LCR — effectively marginal standing facility (MSF), which was allowed was 7 percent that is 2+5. Which means 15 percent of SLR is not considered for LCR. Q: You think now you have to wait for SLR to fall significantly before base rates are cut? A: We are watching the situation, of course there is a 25 bps repo rate cut, which is important which has to translate to lower deposit rates, which we are seeing early signs of. If you look at retail deposit rates, which used to be at 9 percent for most banks, now they are 8.75 percent. The transmission has to happen and combined with that we have to factor in LCR in our new base rate calculation and post that we will be able to take a judgement call of when we can justifiably say that our cost of funds has sustainably come down. Q: For the system, when do you think money gets cheaper for -- when do equated monthly instalments (EMIs) fall for instance? A: In my sense March or early next quarter is when I see the possibility of rate cuts by banks. Either post Budget, therefore in the month of March. But keep in mind, March is again a busy month because of tighter credit policy. Banks will be reformulating their base rate policy. So either March or Q1 next year as things stand today I believe transmission should happen.Q: Let me come to the other big announcement at least for me that came from the credit policy that banks have been told that if a project is stalled and you change the promoter to a better one then you get two more years before that loan is marked as an non-performing loans (NPL), is this a revolutionary change? A: I think it is a good change but let us see which bank can remove which promoter. I think it is a space to watch and Indian promoters are also fighters. So it is going to be important to see whether this plays out. Q: The RBI seems to be empowering bankers to do whatever they can or they must to improve the functioning of their borrowers? The convertibility clause also is now going to be probably re-written to allow them to get an equity control? A: This is the first time I am seeing in Indian banking that the Central Banker is rightly saying that equity owners must take the first pain before the debt owners take the pain, which is back to my belief that we are seeing a pretty pure way of looking at things that equity owner first before lenders take the hit.    Q: Let me approach the same thing from a macro angle. The RBI has done this to enable bankers to get more power. They have also introduced the rule whereby you can restructure infrastructure loans in such a way that you only give for the first five years and then reset it for the next 25, along with all this, do you think infrastructure is getting out of the woods or is it going to take a long time? A: Not yet. It is going to take time and this time around I am a believer that between now and end of March, a lot of banks will restructure loans because this is the last window they have. I give credit to RBI for taking a position that no further restructuring from April 1 and beyond April 1, recognition of reality. Therefore in many ways, the stress situation, which was postponed over the last three-four years -- the day of reckoning is coming in 2015. Q: So we are likely to see a quantum leap in NPLs even in Q1 of FY16? A: In my view, early recognition for banks is important. The issue and the challenge is the next step particularly with state-owned banks recognising the reality on their balance sheet, how will they recapitalise themselves. Wherever they have got higher ownership, significantly higher than 51, they can go to the markets but what happens one year later or one and a half years later when you hit 51. Q: I am more interested in actually capex or growth taking off. As you say you are not seeing the stuck projects restarting anytime soon. Then where is the growth stimulus going to come from? A: My sense is there is a natural bottoming out in many sectors and as the RBI gradually reduces interest rates and banks start transmitting it we will see some floor to the downside in many sectors and at the same time this is an economy where there is a very large percentage of population whose consumption demands are increasing and the real challenge for the Indian economy is how do you move to an investment led GDP away from a consumption led GDP. Q: Therefore the Budget becomes important? Do you see the Budget being able to trigger investment in any fashion? A: I think the Budget can help and that is where the vision statement and architectural framework from the government is important. The issue at hand is who is going to make the big investments? Q: Do you see the government being able to – they have got some space with subsidies being released but the international community is very clear that we cannot renege on our fiscal deficit numbers. So, do you think the government will have the space? A: Government will have to figure out how to kick start investment. Government companies is one option, so NTPC, Coal India's of the world, how do you get the investment kick started. So, the government will have to take a lead. The second category which is the whole promoter driven and public private partnership model, has got significantly challenged. There is no easy solution and a lot of the Indian promoters have got their equity significantly eroded. So, where is the equity coming to support the next round? Frankly from the global side we may be getting portfolio investment but long-term FDI in infrastructure I am not seeing much of yet.Q: Just to start with one more macro element in your space, Jan Dhan. That is the big thing that the government has come with. Do you see it as game changing? A: It can become game changing if these accounts have funding and transactions. Q: That is if all these direct benefit comes through them. A: Absolutely, otherwise the banks have a significant cost of these accounts which need to be serviced. Therefore the key to this is flow and activity and finally, people must have surpluses to make it viable to have an operating bank account. I hope to see that. Q: So ultimately the economy has to grow, only then this clicks. A: Absolutely. Q: Something else which perhaps is going to expand financial inclusion or at least I hope it will is the payments bank concept and you are in it as a player, how have you understood it? Is that a game changer? A: We are very excited about the payments space and if you think about the traditional bank model, 20 percent of the customers produce 80 percent of the revenue and the long tail of 80 percent how do you first acquire and then how do you make them viable.  If you look at our bank, our challenge is how do we broad base the ability to be inclusive? For us the opportunity to invest with Bharti Airtel in the payment space was a great opportunity to really understand the inclusion space since Bharti has probably among the largest customer bases in this space. So, we are very excited about this but it is our way of learning in the inclusion space. Q: How do you see these telecom-bank JV’s? It’s not the only one, everybody is going down that route. Is this going to be more win for telecoms or more win for banks and also the cost because as your JV indicates, since the telecom guy is picking up 80 percent of the cost in your case, is it that the gain also will be theirs more? A: It’s not about who wins. It is about finally does the system win and can we reach out to a very large base which otherwise was not included. The key issue is, and I was told about a book called Long Tail, is how do you make a long tail profitable for all. That’s something which we want to learn. It has to be profitable for the country, for the customer and for the payment bank. Q: How much money are you putting in, in the first place, any idea? A: The current requirement of capital is Rs 100 crore and our share is 20 percent but we believe that the capital required for the business is higher so we will obviously be ready to put in more capital. The sense we have is that the payments bank space is a tremendous opportunity for us to reach out to customers which we as a bank would otherwise have found it very difficult to reach. Q: But the guy who I think will use the payment bank will be maybe your driver in Bombay and his relative in Alibaug or in Jhumri Telaiya. What will you sell to them? A: The point is if we have to really build the whole business of inclusive lending the payment bank cannot do the lending business. For us we believe that this is a great way for us to do inclusive lending over time. Therefore lending to weaker sections, reaching out to areas we would otherwise find it difficult to reach out to these customers. Q: Let me take only the insurance bit. What’s the next step now that you can get more foreign investments in insurance? Is that the place where we are going to see more initiatives? A: One is of course, as you know we have a strong presence in the life insurance business with our partners Old Mutual. The view at this stage is on the ordinance which the government has really announced, it’s a strong statement of intent but there is some issue about clarity that assuming a foreign partner bought during the ordinance period, yes he can hold it beyond the ordinance period, that is clear but if he tomorrow has to sell it to another foreigner, that may not be clear if the ordinance lapses. Therefore a lot of the global players would much rather have certainty of law. There may be a few, particularly the structured deals who may go ahead during the ordinance period but the regular foreign partners probably will wait.Q: How do you see the year panning out FY16, will that be a year where you will be able to come back to something like a 30 percent growth even if the industry grew at 15 percent? Do you expect industry loan growth at 15 percent and yours at 30 percent? A: We hope to complete our merger by end of March. So, hopefully we become one single combined entity. Our view is that this is a great time to be growing steadily like a marathon. It is something which I am a believer in marathon versus sprint. So, we think the foundation for a 10 year India marathon is firmly in place and we see ourselves growing from the point of view of say loans at roughly 2X nominal GDP. So, real plus inflation and 2X that is where we want to see ourselves growing over the next few years. Q: What about margins, do you think this will be the year when bank margins will improve because cost of money is coming down? A: I think bank margins will be reasonably stable but banks will have to really focus on not having disproportionate hit through credit costs. Q: For you NPL is not an issue? A: Fortunately for us we have been very cautious in the whole infrastructure lending space and we have the lowest restructured asset ratio in Indian banking. Q: When do you see the inflection point coming in Indian growth? It is not Q3 we are very clear and it doesn’t look like it is going to be this Q4 either. A: My view is that it is a much gradual trend line up. Therefore I do not see steroids, I see a gradual growth up and therefore marathon versus sprint. Q: How long will this dollar flow keep coming? How long will foreign investors keep the faith or have the patience? If you are saying it is going to be a very slow secular growth story will patience run out for the foreign investors? A: At this point of time I think the Indian debt is still at pretty high levels and therefore money is like water. It will chase yield and that is what is happening. Q: Last year USD 26 billion came in debt and only USD 16 billion came in equities. However this year as the interest rate cycle works out probably the attraction of debt will not be there. A: Interest rate cycle is working down gradually. So, there is a lot of opportunity.Q: But what about equity investors? A: Equity investors have a challenge depending on their horizon for investment. In the short run markets may be ahead of earnings and GDP growth. Therefore it really depends on how many years you are discounting. Q: How many years will you discount? A: In my view if you take a five to ten year bet you are okay, but if you are taking a three to six months it is tougher. Q: So you think that FY17 could be India’s big year? A: Watch. My sense is we would have done a damn good job if March 2016 we have a GDP of six percent. Then March 2017 can be pushed to six and half or seven and I would still want to believe that our five year average at six to six and half is a good average in a deflationary world.