Author: Sh. Raghu Mohan
To serve on banks' board should not be a case of - highest time commitment, most risk, and least reward - as it is today in India," says Janmejaya Sinha, chairman of the Boston Consulting Group (India). Always a thankless job, it is increasingly being seen as not worth the while. It is felt that bank boards are being burdened with matters that should be in the domain of the professional management - annual inspections frequently ask why a matter was not referred to it. Often, board meetings are full-day affairs. A few independent directors (IDS) have informally conveyed to chairmen and comer-room occupants that they may have to revisit their positions; some reportedly raised it with North Block in their personal capacities. Point being that they don't want to be burdened with "executive roles", only with the "strategic." Is it fair?
"Having decided to be an ID on a bank, you can't then say the task is onerous. That said, their (as well of the board's) focus should be on the strategic, with operational issues being left to the professional management," says Injeti Srinivas, former chairman of the International Financial Services Centres Authority (and earlier, the corporate affairs secretary). "For IDs to be effective, the board memoranda should also be timely and of quality".
And in the last week of May, the Reserve Bank of India (RBI) hit the reset button on the gov- ernance template in its twin interactions with the boards of state-run and private banks. This first-of-its-kind outreach saw Governor Shaktikanta Das, enumerate a 10-point govern- ance charter; it will act as a guide in the new inspection cycle. While appointments to corner- rooms make it to the headlines, in future it is that of IDs which is to be keenly watched given the headaches which come with the role.
Widening the pool
Under Section 20 (1) of the Banking Regulation Act (1949), banks are prohibited from having a credit relationship with a company if an ID is drawn from it. Banks with a relationship with such a company have to get the exposures cleared by their boards. "The RBI is worried on conflicts of interests, and rightly so. However, it can consider other ways to address this like approval by the full board of the facilities already in place before an ID had joined the board”, says Ravi Duwuru, partner-Duvvuru & Reddy LLP, and member of the second Regulatory Review Authority.
"The current regulations stem from managing the conflict of interest and appear to have taken a sledgehammer to crack a nut," says Amit Tandon, founder and managing director of Institutional Investor Advisory Services. It assumes these conflicts can only be financial. "Conflicts can also happen when a person has the ability to influence another - an example is when a former bureaucrat or regulator is on the board."
A few things follow: A small pool of IDs has meant that boards are now packed with retired bankers, civil servants, and former RBI officials - some of whom may not be current on cutting-edge issues in banking and finance. In the case of state-run banks, another layer of complexity is that of serving RBI officials being on their boards - a clear case of conflict of interest.
According to Mridul Saggar, the duopoly or monopolistic characteristics of the major suppliers of IDs-which come from advisory firms which desist from a wider canvass or open recruitments as they get business from existing managements - has to be broken. Professor of Practice (Economics) at the Indian Institute of Management (IIM Kozhikode) and former executive director, RBI, he's of the view that these firms are motivated to push IDs not necessarily on the grounds of expertise and experience, but somebody of eminence and compliant to promoters and bank bosses.
"The Banks Board Bureau (BBB), for instance, may prepare a panel from which the promoter may select an individual. But the renewal of the individual's term would be determined by the BBB, not the promoter," says TT Ram Mohan, professor of Finance and Economics at IIM- Ahmedabad. He feels one must not over- emphasise the importance of 'domain expertise' in director selection. "The right questions must be asked of the management of the bank and, often, it doesn't take great expertise to ask those questions."
Asking too much of banks' board?
Senior bankers feel there's no way to fool-proof board decisions from going awry; it requires "a different kind of touch-and-feel expertise" given the variables. Dud loans are not the result of vested interests or poor underwriting skills - they also arise from sectoral policy changes or lack of it, such as the "policy paralysis" seen during the last years of United Progressive Alliance (2) government.
Saggar feels differently. That interest of suppliers of finance – whether they be minority shareholders or depositors – are not being sufficiently protected and cases of looting, tunnelling and corporate fraud are taking place at times quietly or brazenly. And there is data to go by with.
Take penalties. The RBI's 'Report on Trend and Progress of Banking in India for FY22' has it that during this period the major reasons for the imposition of penalties on banks were because of non-compliance with exposure and IRAC (income recognition and asset classifica- tion); frauds classification and reporting; and violation of cyber-security guidelines. There were 189 instances of penalties being imposed involving 65.32 crore, more than double the 61 and 31.36 crore in FY21. The average per instance penalty was the highest for private banks-up at 29.31 crore in 16 instances from *5.92 crore (3). And these figures don't capture what's happened in FY23.
When it comes to frauds, the RBI's Annual Report for FY21 noted that the average time lag between the date of occurrence of a fraud and its detection is 23 months. For large frauds (100 crore and above) it is 57 months. A two-decadal analysis by the Financial Stability Report' of June 2019 observed that between FY01 and FY18, frauds constituted 90.6 percent of what was reported in FY19, by value. In September 2019, deputy governor MK Jain, was blunt: "It will not be an exaggeration to say that some of the big losses suffered by banks on account of frauds could have been avoided if a good compliance culture was ingrained in the respective banks." It is not known if Mint Road will review fine amounts- make it really costly for banks. This may prove to be tricky in the case of state-run banks.
Then you have the perpetual peeve: a body for the banking sector, like the Securities Appellate Authority in the case of the Securities and Exchange Board of India. "I do not find much substance in this argument. The discussions before the panel of executive directors which is the final court of appeal within the banking regulator, are transparent and due consideration is given to the submissions," notes Duvvuru. He is for making it tougher: That the RBI should weigh something similar to the 'Senior Managers Certification Regime' in the United Kingdom (UK) and Singapore. The emphasis here is as much on individual accountability as that of the institution; and the regime makes clear that if you have the authority to make decisions which significantly impact a regulated entity (RE), you are subjected to effective risk governance and standards of conduct.
Impact of the new rites
India inc will have to pencil in Mint Road’s stress on the governance premium in bank lending.
The large and better run companies have the management bandwidth to take the changes emanating from the "governance reset" by RBI in their stride, but many at the bottom of the food chain could be adversely affected. What if, in their enthusiasm to secure a better governance premium, banks turn shy from lending to infrastructure? (The government has taken the lead for funding it now, but the private sector will have to take on the load at some stage); or for that matter, financial inclusion. Co-lending between banks and non-banking financial companies could turn itchy. Then you have environment, social and governance-based lending - an evolving area. How is the governance framework to incorporate this? The immediate impact from RBI's spell-out of the governance template could be on private banks. It has ram- ifications for consortium lending - private banks could refuse to buy the line of state-run banks on large credits. And if operational flexibility is hindered (as is being whispered by bankers), it can affect credit flow given the trade-offs involved.
According to Sinha, savings in India are primarily intermediated through banks - not equity markets - akin more to Japan and Europe, than the United States. The role of banks and their boards thus, become paramount for our growth as we strive to become a $5-trillion and then $7-trillion dollar economy. As technology and data disrupt industries, banks must attract such in-demand professionals to their boards, without regulation that limit their ability. "It is also sad that Indian regulators have such a prejudicial broad-brush view on Indian family businesses (called crony capitalists by a former RBI Governor) and their ownership of businesses, when they have been the bulwark of entrepreneurship."
Finance Minister Nirmala Sitharaman was spot on when she referred to the following in her Budget speech. Paragraph 99: To meet the needs of Amrit Kaal and to facilitate optimum regulation in the financial sector, public consultation, as necessary and feasible, will be brought to the process of regulation-making and issuing sub- sidiary directions. And Paragraph 100: To simplify, ease and reduce cost of compliance, financial sector regulator will be requested to carry out a comprehensive review of existing regulations. For this, they will consider suggestions from public and REs. Time limits to decide the application under various regulations will also be laid down.
The bank governance plot is set for interesting times.
Note: The views mentioned in the article are of the author and do not represent IICA’s stand / opinion on any issue.
(IICA duly acknowledge the authorship / ownership of the article and republishing the same only for educational purpose.)
