Why the RBI should not select bank chiefs

The central bank's role in selecting bank chiefs will give rise to conflicts of interest

Selecting the chief executives of public sector banks was always a challenge. Even as India's financial sector went through some dramatic changes over the past two decades, which led to a vastly different environment in which these banks operated, essentially nothing changed as far as appointing their leaders was concerned. They were chosen out of a tightly bound pool of executives - those who had made the cut to become executive directors a few years before. These, in turn, had been picked out of serving general managers in the banks. And so on. Lateral entry, a process that might have helped at least some of these banks strengthen their competitive positions, was stubbornly rejected. Of course, from a large pool of middle managers, it is quite reasonable to expect that at least some outstanding candidates would make their way up to the corner office, and so it was. But the deeper question this raises is whether this very restricted process of selection and appointment served the banking system and, by extension, the national interest, in the best possible way.

The recent arrest of the chairman and managing director of a public sector bank on corruption charges has brought the whole appointment process into the spotlight. In the aftermath of this episode, the appointments of several chief executives were nullified and the process has been re-started. It might have been expected that this opportunity to completely revamp the entire process would have been taken advantage of. Instead, what has now been mandated is basically more of the same. Instead of the finance secretary chairing the committee, the governor of the Reserve Bank of India (RBI) will now do it. But other than that, the new appointments will come from exactly the same cohort of people that the previous ones did. To make matters worse, the new committee will have to pick from people who the previous committee might have considered not worthy of being appointed in the first place! It is impossible to see how this change is going to make matters better than before.

One specific concern is the enhanced role of the RBI in the process. By no reasonable logic should the banking regulator be directly involved in appointing the chief executives of banks that come within its purview. This responsibility lies solely with the shareholders, like it should in any well-governed company. In the case of the banks, the finance ministry can legitimately run the process. But the regulator's role should be confined to scrutiny of the candidates' "fit and proper" credentials. Involving the regulator directly in the selection process, and, that too, in the chairperson's role, makes it complicit in the event that an appointee turns out to be a bad egg. A conflict of interest arises when the regulator imposes sanctions on a bank and holds the chief executive accountable. Questions will be inevitably raised about whether the sanctions were too mild, or, even, whether the right choice was made in the first place. In short, the response of the government to the corruption scandal is way too inadequate. Bringing in outside talent, raising compensation along with accountability standards and adopting standard governance procedures relating to appointments are things that must be done if public sector banks are to have any chance of remaining competitive.