Are regulators becoming managers? Concerns grow over autonomy risks

The forex liability accounting fiasco of IndusInd Bank has attracted considerable media attention. Just days ago, the approval for the reappointment of the incumbent managing director (MD) for one year, instead of the requested three years, hogged headlines. Notably, the bank’s request for a three-year tenure was similarly curtailed to two years on the previous occasion. While successive truncated approvals and the fiasco may be a coincidence, it remains puzzling how an individual deemed unsuitable for a three-year term is considered suitable for a curtailed tenure. 

 

A similar situation unfolded in 2023 when the incumbent MD of Kotak Mahindra Bank resigned. The bank sought to appoint an interim MD from within for four months as the regular appointee was set to join thereafter. However, approval was granted only for two months, necessitating a fresh request for an extension to cover the remaining period. The rationale behind granting approval in two tranches instead of a single four-month term remains unclear.

 

Other financial regulators, such as the Securities and Exchange Board of India (Sebi) and the Insurance Regulatory and Development Authority of India (Irdai), follow similar practices. Regulated entities, such as market infrastructure institutions (MIIs) and insurance companies, are required to adhere to an extensive protocol for identifying suitable candidates and obtaining prior approval for the appointment of an MD well in advance of a vacancy. If the regulator is not satisfied with the proposed panel of candidates for any reason, it seeks additional names for wider choice. This protracted approval process often results in these critical entities operating without an MD for several months, sometimes as long as six months.

 

Regulators are increasingly asserting control over MD appointments by rejecting candidate panels submitted by regulated entities, curtailing proposed tenures, and altering remuneration structures. They approve the appointments of chairpersons, CEOs, executive directors, and independent directors of private sector entities, as well as their reappointments and term extensions. Thankfully, Sebi recently shelved a proposal to extend its regulatory oversight to the appointment of key managerial personnel, including the compliance officer, chief risk officer, chief technology officer, and chief information security officer of MIIs.

 

These entities in the private sector, governed by their boards, require critical appointees in place before vacancies arise. The public sector scenario presents its own challenges. In response to a parliamentary question, the government informed that 42 per cent of director positions on public sector bank boards are vacant. Such delays and vacancies are largely attributed to the appointment process, which requires approval from the Appointments Committee of the Cabinet, headed by the Prime Minister.

 

Notably, such appointments in a public sector bank or an insurance company do not require approval from the Reserve Bank of India/ Irdai. This suggests an implicit assumption that the shareholders and boards of directors in the private sector may fail to safeguard the interests of the market, unlike their public sector counterparts — a clear case of regulatory non-neutrality based on ownership. In any case, there is no clear correlation between the regulatory appointment process and the performance of regulated entities in either sector.

 

Notably, regulators participate in selection bureaus for appointing CMDs and whole-time directors of public sector banks and insurance companies. Some have their nominees, such as RBI representatives on bank boards, and former regulatory officials often join the boards of regulated entities without a cooling-off period. There are also instances where the same individual serves on the governing board of a regulated entity and the board of its regulator.

 

Such extensive involvement in the appointment process failed to prevent the reappointment of IndusInd Bank’s MD despite the forex fiasco looming beneath. This rather creates the perception that regulators are effectively managing these entities, exposing them to vicarious liability for governance lapses, and fostering a misleading belief that individuals appointed with regulatory approval are inherently deserving of their roles. These concerns call for a comprehensive institutional review of the regulator’s role in the governance and oversight of regulated entities.

 

With their mandate to maintain an orderly financial system and ensure well-functioning financial markets, financial sector regulators rightly assumed the role of vetting CEO-level appointees in certain regulated entities a few decades ago. To enhance trust in financial institutions, regulators introduced the “fit and proper” test, establishing the highest standards of integrity. Not only must financial service providers meet these standards to obtain registration, but their major shareholders and board members must also demonstrate their suitability to uphold trust and ensure sound governance. Initially, the “fit and proper” criteria referred to integrity, honesty, ethical behaviour, reputation, fairness, character of the individual, and absence of certain disqualifications like being a fugitive economic offender or wilful defaulter. Regulators took on the responsibility of screening and vetting candidates, as regulated entities might lack comprehensive information about a candidate’s background.

 

However, over time, the process has evolved with additional layers of scrutiny, shifting from a straightforward vetting procedure to an approval mechanism, though regulators may use different terminology. This expanded oversight now  covers not only new appointments but also extensions for incumbents who had already undergone regulatory vetting and approval.

 

The heightened role of the regulators in appointments within regulated entities is resulting in many unintended consequences. For instance, uncertainty over leadership impacts the entity’s business plans, raises questions about accountability for governance lapses, and creates moral hazards. It also poses the paradox of regulators having to act against individuals they recently deemed “fit and proper”. Furthermore, it has been reported that many talented and capable professionals are increasingly reluctant to join boards and leadership roles in heavily regulated entities. There has also been a significant talent drain from within these organisations in recent years. The market does not treat such uncertainties and disruptions too kindly in the case of listed entities.

 

The deregulation agenda in the financial sector should empower regulated entities to operate as responsible adults rather than treating them as perpetual infants. Regulatory oversight should serve as a safeguard, not a substitute for internal governance. Accountability must rest with the boards and management, with failures attracting stringent penalties. This balanced approach will foster sound governance and contribute to the long-term stability and resilience of the financial sector.

 

(Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd)

 

The author are, respectively,  former director, National Institute of Securities Markets, and  former chairperson, Insolvency and Bankruptcy Board of India