The board should set the tone on governance

Financial institutions have limited choice. The central bank is increasingly looking at governance while evaluating the effectiveness of the board and senior management

The twin meetings of the boards of banks with the Reserve Bank of India (RBI) to discuss governance have not come a day too soon (the first with state-run banks will be held today in New Delhi, with the one with private banks on May 29 in Mumbai). The RBI and the Securities and Exchange Board of India have issued several directions on governance, some based on recommendations of expert committees. While governance has become a buzzword across India Inc, its implementation has left much to be desired.

From my four decades of handling compliance, I can firmly say that governance comes from within, and not from external directions. Financial institutions, however, have limited choice now — the banking regulator is increasingly looking at governance while evaluating the effectiveness of the board and senior management.

Governance is a key parameter that determines the supervisory rating of the institution. The message is loud and clear — all your financial ratios would mean nothing if governance is poor. So, what should financial institutions do to get this right?

The board should set the tone. The board, though inundated with a huge number of agenda items, should give time to overseeing implementation of the right frameworks, seek the right dashboards and ask the right questions. While it approves the policies, it also has responsibility to satisfy itself about the processes to implement them.

I often find that while policies and processes are great, the practices followed make the implementation ineffective. The CEO should, in every senior management meeting, emphasise the zero-tolerance policy for wrong behaviour.

Governance is about getting the basics right. Are front-liners truly acting as the first line of defence? I used to say that I would be the happiest person if the compliance and risk departments are done away with — as every employee is a compliance and risk manager. Are the second and the third lines effective? Do the scorecards for performance evaluation capture the governance element? Is there a robust consequence management framework? Is the exercise of delegation of powers — financial and non-financial — monitored adequately? Is good behaviour recognised adequately? Is transparency encouraged? Are the executive forums functioning properly, or are they merely a case of form over substance?

The ability to say ‘no’ is critical to building a culture of good governance. It is not about not taking a decision — as a ‘no’ is also a decision. In my experience, CEOs do listen to a ‘no’, but managers are hesitant to say so.

The RBI should examine implementing something similar to the ‘Senior Managers and Certification Regime’ (SM&CR) in the United Kingdom and Singapore. The emphasis here is as much on individual accountability as that of the institution. The RBI could consider expanding the ‘material risk takers’ concept to bring in a SM&CR tailored to our financial sector.

The regime makes it clear that if you have the authority to make decisions that can significantly impact the financial institution’s safety, you are subjected to effective risk governance and standards of conduct. Studies in the UK show that SM&CR had a positive impact on individual conduct. There is no published data for Singapore.

If I go back and wear my supervisor’s hat, I would view conduct-risk as the biggest in financial institutions. Regulated entities should remember that no amount of capital can address this risk. The need of the hour is for both individual responsibility and collective accountability. That is where the senior managers and the board play a complementary role.

As Governor Shaktikanta Das says, “ultimately, the strength of a banking system depends on the strength of its corporate governance”. 

The writer is the founder and designated director of Duvvuru & Reddy LLP, and a member of the Advisory Group of the Regulatory Review Authority set up by the RBI