Kotak's IT slap-down points to a system weakness

It's hard to believe that the technology gaps of India's banks stop at Kotak Mahindra KOTAKBANK. On Wednesday, the regulator barred the $44 billion lender from sourcing new customers through digital channels and issuing fresh credit cards for an unspecified period. Shares plunged 13%. The move punishes the bank for failing to upgrade its IT backbone in step with its rapid growth.

It's a rude welcome for new CEO Ashok Vaswani, who took over in January from founder Uday Kotak. The RBI has used strong language to chastise the bank for its "serious deficiencies", significant outages and "far from satisfactory" outcomes from a two-year effort to improve its IT resilience.

The RBI's punishment is biting because it targets growth when banks are struggling to source deposits, currently growing at over 12%, as fast as loans growing at 16%. Kotak relies heavily on online and mobile banking for acquiring new business. Its 811 app, christened for November 8, 2016, when Prime Minister Narendra Modi cancelled high-value banknotes to curb black money, brought in 72% of new savings deposits in the 12 months to end-March 2023. The app also was used to cross-sell 59% of the bank's credit cards, business loans and consumer loans.

Kotak's rich valuation was already slipping away. Before Thursday's crash, the stock had fallen 2.5% over the past year as the institution grappled with its leadership succession, underperforming a 13% rise in the Nifty Bank index during the same period. Kotak's price-to-book value for full year 2025 could fall to below two times from 2.5 times currently, according to analysts at Macquarie.

Yet the rest of the sector is overpriced too, if digital weaknesses are widespread as seems increasingly apparent. A 2020 ban on HDFC Bank HDFCBANK issuing new credit cards and launching digital initiatives took 15 months to be fully lifted. Both Kotak and HDFC got dinged hot on the heels of the departure of long-time CEOs. In January, the RBI ordered Paytm PAYTM to stop all transactions in its payments bank except interest payments, cashbacks and withdrawals because of non-compliance and supervisory concerns.

The problem isn't unique to India. Singapore's DBS was banned in November from activities including M&A for repeated tech failures. Yet if HDFC's punishment wasn't sufficient to prompt Kotak to up its game, the RBI may yet need to unleash tougher punishments. That could jeopardise credit growth in the fast growing emerging market.

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CONTEXT NEWS

The Reserve Bank of India on April 24 barred Kotak Mahindra Bank from onboarding new customers through its online and mobile banking channels. The regulator also directed the bank to stop issuing fresh credit cards. Kotak shares fell 13% in morning trade on April 25.

Kotak was found deficient in its IT risk and information security governance for two consecutive years and was, in subsequent assessments, deemed non-compliant with remedial plans issued by regulator for the years 2022 and 2023, the RBI said in a statement.

The regulator said it had been in continuous high-level engagement with the bank on strengthening IT resilience for the past two years but the outcomes were "far from satisfactory".

Kotak has taken measures for adoption of new technologies to strengthen its IT systems and will continue to work with the regulator to resolve remaining issues as soon as possible, the bank said in a statement.