Banking on governance

Nayak Committee's report on public sector banks is a crucial step

The report of the Committee to Review Governance of Boards of Banks in India, chaired by P J Nayak, was released on Tuesday. It has made several recommendations that risk being viewed as radical by the powers that be. Typically, this would lengthen the odds of the recommendations being accepted. However, the timing of the report brings its views into play in a particularly atypical situation. The new government will, of course, be looking to do new and different things. But, more importantly, as the report itself highlights, public sector banks in India are caught in a triple whammy: deteriorating asset quality, massive capital requirements stemming from Basel III norms, and a complete lack of strategic manoeuvrability, given their current governance and management structures. While the report addresses issues relating to the governance of private banks as well, its most significant recommendations could put the entire public sector banking system on to a new, sustainable performance and risk management trajectory.

The committee shares the widespread perception that excessive and misdirected government control is at the heart of the problem. Consequently, it believes that reducing the government equity stake to minority levels and then empowering boards and managements to function within the performance and accountability frameworks of typical corporate organisations is the best way for these banks to get themselves out of the three-way trap. Obviously, this cannot be achieved overnight. The report proposes an elaborate transition process, with overall ownership and oversight first being transferred to an entity manned by prominent retired bankers, then on to a holding company run by finance professionals recruited from the market and, finally, to the bank boards themselves, with the companies being run by increasingly empowered and appropriately compensated professionals. The committee recognises the opportunity to effect these transitions being provided by the demographic transition in the sector, which will see significant attrition at the senior and middle levels over the next five years. This creates the space to dramatically restructure hierarchies and roles.

In the larger context of financial sector reform, which Reserve Bank of India Governor Raghuram Rajan has set so much store by, this is the third in a series of reports - following the Nachiket Mor and Urjit Patel Committee reports - blueprinting significant changes in the system. Like the previous two, its recommendations are worth serious consideration; they do offer the government a way out of an increasingly difficult situation, which does no good for anybody. However, like the other two, this report is also likely to step on a number of toes, perhaps even more so. No organ of the state has offered as much opportunity for patronage and populism as the public sector banks. The power to appoint and fire chairpersons and appoint so-called independent directors; to influence lending decisions; to open branches in all manner of locations, and so on - these are the factors that have helped push the system to the state that it is in today. These privileges will not be easily surrendered. Dr Rajan must fully exploit the atypical situation that will prevail for some time to push through the several reform initiatives that he has taken in the first few months of his term. Otherwise, he risks his legacy being one of promising starts but dashed hopes.