Don't waste the bank scam crisis

Think out of the box and bring in serious changes in the governance of public sector banks

It is a welcome crisis: scams are tumbling out of the closet at banks. That a crisis is welcome may sound very odd. They allegedly involve several billions of depositors’ money, and indeed taxpayers money (since it is the state that has kept pumping money into public sector banks). Yet, crises are welcome for they are the harbingers of long-term reform measures — whatever the colour of the political parties in power.
 
Four years ago, when one government was on the verge of going away and another was poised to take charge, a committee set up by the Reserve Bank of India under the chairmanship of Dr P J Nayak, submitted its report. The Committee made very specific recommendations for long-term reform incorporate governance in the banking sector, with particular regard to addressing the ominously-growing spectre of non-performing assets in banks. (Disclosure: the author was a member of this committee.)
 
The report documented the breakdown in the governance of public sector banks. This was attributed to these banks being governed by outdated legislation that nationalised them — outdated because new company law that governs all companies has marched light years ahead of what had been thought about in the 1960s and later when banks were nationalised. The report empirically pointed out how the deep micro-management by their shareholder (government of India) rendered governance not just ineffectual but also wasteful, with the attention of the board of directors mandatorily being spent on issues that the government insisted the boards of directors must discuss, ignoring the real need for what needed the boards’ immediate attention. Of course, how the boards of directors must be populated was also picked on, and the need for professional search and selection was underlined.
 

The report called for a phased reduction of government stake to minority ownership. A key recommendation was to first hold the entire government stake in public sector banks in a wholly-owned holding company owned by the government and to over time dilute government stake in the holding company to a minority. Meanwhile, a Bank Boards Bureau, an agency that was possible to set up within the scope of existing legislation, to search and select who may staff the boards of directors of banks, was recommended. The Bank Boards Bureau would be the precursor to what would be the board of directors of the holding company.
 
The report was part of what was discussed in the very first meeting between the then Reserve Bank of India governor and the new Prime Minister. The reception to the recommendations was warm. Great expectations were built up about how a new government with a new mandate would be able to take some critical long-term decisions. “Gyan sangams” were held and an “Indradhanush” (a seven-point programme) was born. A Bank Boards Bureau was formed, chaired by Vinod Rai, the go-to guy for all matters of reform, him having been the propriety auditor of all government functioning as the Comptroller and Auditor General of India. The mandate and role of the Bureau was nowhere near what the Nayak Committee Report envisaged —its role was envisaged as a panacea of all that is evil with banking.
 
There was no sign of reducing government stake in banks. The government moved in the opposite direction — one of the seven points of Indradhanush was to infuse ~700 billion of fresh money into public sector banks. There was no sign of setting up a holding company. Media reports talked of setting up one holding company for every public sector bank — a clear indication that someone somewhere had decided to kill the idea. There had been a lot of hope that was riding on the fact that under the earlier National Democratic Alliance (NDA) government before the two terms of the United Progressive Alliance (UPA), a Bill had been tabled in Parliament to bring government stake in public sector banks down to 33 per cent (that Bill lapsed) but all that hope was simply dashed.
 
Today, we have one banking scam after another coming out of the closet in rapid succession. In less than two months, the new year has already turned into an annus horribilis for the state-owned segment of the banking sector. There can be no better time than now to initiate bold measures of reform. The utterly non-impactful nature of the labyrinthine architecture of micro-management by government in its role as a shareholder of public sector banks has been exposed. Greater dosage of an expired medicine can never turn into a cure of a long-standing ailment.
 
It is time to think out of the box and bring in serious changes in governance of public sector banks. The holding company model needs immediate execution. Dilution of government stake to minority by infusion of private equity funds into banks will ensure a disciplined and tyrannical turnaround of these banks — a case study of how the Centurion Bank was turned around with this route is readily available in recent banking history. It is time to embrace the fact that we must not let this crisis of scams go waste.
 
The author is an advocate and independent counsel. Tweets @SomasekharS