RBI must exit bank boards: Financial Express 16th May 2014

The issue of governance of bank boards has come to the forefront given the state of public sector banks (PSBs), in particular. The P J Nayak committee, set up by RBI to recommend a way forward, has brought out a rather interesting report. A lot of what has been said will find takers but the important question is whether or not the government would be willing to give the space that is being asked for. While the committee has spoken about all that should be done, a simpler solution would be for the government to bring down its holding in PSBs to 49%. This way, it will still have representation on the board, but the organisation would be free to operate professionally. Thus, while recommendations have been made to lower government stake which will help the fiscal balances, it presupposes that this model would not be acceptable and suggests a new governance structure. The bold assumption is that the government would be willing to change the way in which it works through the banks. The committee has made several suggestions on restructuring of PSBs’ boards. Again there are recommendations of setting up new structures to oversee existing structures. It talks of a Bank Investment Committee (BIC) to handle all government investments in PSBs. This would mean creating a company, having a CEO, a board and other office bearers subject to the same pressures as the PSBs. Further, it suggests the creation of a Bank Boards Bureau (BBB) for selection of managements of PSBs. As there is a staff structure drawn up for BBB, it would run into the same problem where the selection of personnel for this board to select members of PSB managements would be driven by vested interests. A simpler solution would be just to let the UPSC select those eligible. This way, the best would come in, instead of those who are simply close to the government. The board is a very powerful concept as it provides direction and guidance for any organisation. A recommendation made on the ‘skills’ of members of the board merits discussion considering that most of these directors are also on boards of other non-PSB companies in the private sector. The committee talks of enhancing their skills as often the quality of board deliberations was not up to the mark. This means that the committee believes that they may not be competent and could be out of touch with the latest developments in the industry. At the same time, the committee puts a maximum age of 70 years for part-time directors. The question is how do we ensure that such skill enhancement takes place for persons who have retired from active work life but have the experience to deliver value in board meetings. The committee also links this with better remuneration for directors of banks that are presently out of the ambit of the 1% sharing of profit that holds under the Companies Act. By providing a return that goes beyond the sitting fees, which is even lower for the PSBs, there would be incentive for the directors to enhance skill-sets. At another level, the committee talks of having younger persons in the management. Here it presupposes that age is superior to experience, which can be sweeping as there is little evidence here. In fact, banking is a conventional business which works on the basis of managing risk of deposit holders, and anecdotal experience shows that age and maturity work better in running commercial banking as against investment banking where there is need for more adrenalin. The committee also wants PSBs to get away from a dualistic regulatory structure, which means that the government should cease to issue any regulatory instructions to them. This creates an ideological conflict because being the majority shareholder, the government, would have the right to exercise control while the best practices of governance would not give a nod. Even in the private sector, in an owner-driven company, the owning family tends to have the last word in the operations of the company. In that case, why not the same for a PSB? The committee rightly recommends that RBI should step down from the board of banks, which makes a lot of sense. Having a regulator on the board of the regulated actually makes the regulator a part of all actions, which raises ambiguity when it comes to inspection as all decisions have implicitly been approved by the regulator. However, in the same breath, it also recommends that the directors on board of old private banks should be approved by RBI. Given that we are trying to keep the government and RBI away from the functioning of banks, this step does look a bit out of place. An innovative suggestion, though a tough one to enact, relates to punitive action for evergreening. This goes to the extent of divesting the deviants of their jobs and taking back the stock options given. The rationale is that managements evergreen to make their balance sheets look good, and then walk away with good bonuses and stock options. Two questions arise here. The first is how is one going to prove today that a restructured loan is not an act of evergreening? All such decisions go through an entire chain—the CEO, audit committee, board, auditors, etc—before being passed. Therefore, identification will always be a challenge. The second issue is that, once detected, how one could penalise someone who has retired or left the organisation. This was the main challenge during the financial crisis where the decision takers of securitisation deals were no longer a part of the organisation when the catastrophe struck. Hence, they could not be penalised. On the whole, the committee has done a fairly commendable job and stirred the pot. The options have been provided but it looks like that it is finally up to the government to take a call on how much it is willing to loosen the rope.