Governor is right: RBI should not have nominees on PSB boards

There was much to answer for when Reserve Bank of India Governor Urjit Patel met the Parliamentary Standing Committee on Finance earlier this week. The committee, which has among its members former Prime Minister Manmohan Singh, raised a lot of queries on wide-ranging issues — from the impact of demonetisation to trust in the Indian banking system. The most important issue that came up was the regulation of public sector banks (PSBs) in the context of the Nirav Modi scandal, which cost Punjab National Bank Rs123 billion. The financial mess that PSBs find themselves in was another related point that attracted a lot of questions. The reason is obvious: Of the 21 PSBs, only two have posted profits in 2017-18, with the combined losses of the others touching Rs873 billion in the previous financial year. Gross non-performing assets of the banking system were Rs8.31 trillion at the end of December 2017. Mr Patel, however, sought to rebut the notion that the RBI had failed in its duty to properly regulate PSBs. Instead, he blamed poor decision-making by bank boards, and asked for more powers to regulate PSBs.

Mr Patel argued rightly that the RBI should not have any nominee on PSB boards in order to avoid possible conflicts of interest with its supervisory role. This is a valid suggestion from the governor. The RBI’s remit should be in charge of bank supervision, and not operations. As of now, the RBI nominates a director to each PSB board — and if there are special concerns, it could nominate more than one. Such nominees can be either serving or retired executives. The Narasimham committee on banking sector reforms in the 1990s had recommended the RBI should relinquish its seats on the boards of banks. The P J Nayak Committee in 2014 had also looked into the matter of governance in bank boards and argued that the withdrawal of RBI nominees from PSB boards should be done in a phased manner. That seems to be the most sensible way forward as the PSB boards will need time to adjust to a new regime.

Mr Patel also reiterated his demand for more legislative powers to effectively regulate state-owned banks. His plea to make banking regulatory powers ownership-neutral is valid as the RBI should be able to exercise the same supervisory powers over state-owned banks as over private sector banks. In the absence of such powers, the RBI cannot remove or appoint chairmen and managing directors of PSBs and cannot force a merger or trigger a liquidation of PSBs.

 It also has limited legal authority to hold PSB boards accountable when it comes to strategic direction, risk profiles, assessment of management and compensation. The key constraint is legislative — PSBs are “corporations” and not “banking companies” and are outside the ambit of the Banking Regulation Act, 1949. The government has resisted the process so far as it feels that the presence of RBI nominees improves the working of PSB boards, and their withdrawal may not be appropriate at the current juncture. However, it is time the government sheds its reluctance and facilitates the process to allow the RBI to ring in the changes, starting with pulling out the central bank’s nominees from PSB boards.