MUMBAI  - Uday Kotak is gambling with his prized lender. Asia's richest banker is challenging an Indian regulatory requirement to cut his voting-capital stake in the bank he founded to 20 percent from around 30 percent by the end of December. The $32 billion Kotak Mahindra Bank can absorb the likely penalties, and the rule may be misplaced. Yet if Kotak has miscalculated, his bank could be forced into an unattractive deal.

When the bank won its licence to operate in 2003, Kotak knew he would have to reduce his stake to 49 percent of paid-up capital. The regulator, keen to ensure diversified ownership of private banks, has since made conditions more stringent.

The bank has diluted its founder in the past by issuing ordinary shares, which helped it fund growth. This year, though, Kotak issued non-voting preferred stock. But the regulator balked at this perceived violation of the spirit of the rules, saying those shares don't count in the calculation of the founder's interest.

The Reserve Bank of India's restrictions are ambiguous and arguably duplicative, because private bank owners are already subject to a 26 percent cap on voting rights. However, the decision to fight the RBI in court endangers the reputation for good governance enjoyed by Kotak, who runs one of the country's best-regarded banks and led the production of a key report into best practices for India Inc.

The regulator may not punish Kotak for now; the next court hearing is on Jan. 17. But it could freeze Uday Kotak’s pay or stop the bank opening new branches. Those measures whacked the smaller Bandhan Bank following similar ownership violations, but they wouldn't hurt its established rival. The risk for Kotak is that the RBI hands out a tougher penalty.

The simplest way for the bank to meet the rules would be if its founder sold part of his own stake. That would require an investor to plump $3.2 billion on a lender already richly valued at some four times book value.

If Kotak Bank raises capital by selling discounted stock, that would be unpopular, hurting returns for other shareholders. Meanwhile, any acquisition of the $22 billion Axis Bank or non-bank targets, which if paid for in shares would dilute the founder, will take time.

In testing the regulator, Kotak is betting against the Indian house. He's also betting his investors will keep the faith.

CONTEXT NEWS

- An Indian court on Dec. 17 refused to suspend a deadline for Kotak Mahindra Bank to reduce the stake owned by its founder and largest shareholder to 20 percent by the end of the year.

- On Dec. 10, Kotak Bank said it asked a Bombay court to support its claim that Uday Kotak had already reduced his stake to under 20 percent from around 30 percent. The lender issued preferred shares earlier in the year but the Reserve Bank of India said the issuance did not count towards the stakeholding target. The next court hearing is set for Jan. 17.

- Kotak and the central bank disagree on whether “paid up capital” or “voting equity capital” should be used to meet the regulatory requirements. Paid up capital includes preferred shares.

- Uday Kotak owns 29.7 percent of the bank’s ordinary equity capital. The RBI has previously ordered Kotak to reduce his stake to 15 percent by March 2020.

- On Dec. 7, Kotak Bank said it was unaware of any plans by Berkshire Hathaway to buy a stake in the lender after a local media report said the investor was looking to pick up a 10 percent stake.

- Kotak shares have risen around 22 percent in the year to date, valuing the bank at around $32 billion.

(Editing by Richard Beales and Katrina Hamlin)

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