Lure of lucre

Public-sector banks need robust rewards and penalties

Revelations about the malfeasance on the part of the now suspended chairman and managing director of Syndicate Bank in his dealings with Bhushan Steel may have come as a shock to many. But to observers of public-sector banks, the allegation that he took bribes in order to provide more credit to a stressed borrower may not sound so outrageous. Now that a number of other bank chairpersons are also coming under the scanner, some questions arise: is such conduct widespread? And, if so, what are its causes? Only a realistic assessment of the mix of incentives that bank chairmen operate with will lead to possible remedies to a problem that seriously threatens financial stability by eroding public trust in banks.

The assessment must start with the obvious. Public-sector bankers are paid far, far less than their private-sector counterparts, particularly if some adjustments are made for the size of the balance sheet being managed. This is all too obvious in the disclosures made in annual reports and splashed across the business media. A former chairman of a large public-sector bank is reported as having said that his driver earns more than him on account of overtime. Exaggerated as this may be, particularly when the cost-to-company is taken into account, it highlights the huge differences in incentives faced by comparable talent in the public and private sectors, which is not just confined to banks. Seriously underpaying senior management increases the temptation to be corrupt. Singapore's decision to pay its top bureaucracy market-linked salaries explicitly acknowledged this problem. But this is only part of the story. The lack of a proper incentive structure is reinforced by slack governance and political-bureaucratic interference. Nominee directors appointed by the government on bank boards are reputed to use their positions to earn rents. Even if not all of them do this, how can a board, whose members succumb to temptations, scrutinise and judge the chairman and other senior managers? The problem is undoubtedly compounded by the substitutability between political-bureaucratic patronage and hard cash. Well-connected borrowers under stress can use their network to put pressure on bank chairpersons to ease up. When a chairperson sees this happening, why should he not accept an offer from a not so well-connected borrower to pay hard cash up front?

In short, the incentive and governance structure of public-sector banks is such that it should be surprising that incidents like this are not exposed more often. Both need to be remedied, of course, and if the causes proffered above are acceptable, then the solutions are straightforward. First, senior bank managers must be compensated appropriately and given a clearly earmarked tenure during which their performance must be judged against transparent and objective yardsticks. Second, the appointment of bank boards must be done in the true spirit of corporate governance, as opposed to the patronage system that currently exists. An independent and transparent appointment process is desperately needed. Third, the opportunity for politicians and bureaucrats to use leverage must be institutionally constrained. The governance reform measures recently suggested by the P J Nayak committee are certainly of relevance here. Public sector or not, banks are businesses and must be run with robust reward, penalty and governance systems.