Bank Boards' Role In Governance

With the benign neglect of corporate governance in banking and major changes in ownership of public sector banks on the anvil, the matter has become one of extreme urgency. There is little genuine comprehension of the subject in the government, in the central bank, in the banks, in academic circles and among scribes. It is unanimously recognised that what semblance there is of governance is clearly inadequate and there should be a quantum jump in our understanding of the subject. It is also recognised that there is a deep-rooted malady in this area. Now if the malady is in the head, that is precisely where the change has to take place. A meaningful system of corporate governance in Indian banking can only take place in a top-down approach and it is for this reason that it is necessary to give early attention to various aspects of banks' boards -- their set-up, their functioning and their accountability.

 

We need to clear the misconception that transparency is the be all and end all of corporate governance in banking. It is much more complex than that. Transparency per se is very important and necessary but corporate governance in banking goes far beyond that. As Lee Hsien Loong, chairman of the board of directors of the Monetary Authority of Singapore and Deputy Prime Minister puts it, relationships between shareholders, the board of directors, management and other stakeholders must all be configured in a way that encourages sound and rigorous banking practices and strengthens corporate performance. To be an effective instrument of corporate governance, the board of directors must act independently and participate actively in shaping the strategies of the bank. The board should decide on issues in the best interest of the banks, its depositors, and all its shareholders and the board should exercise effective oversight on management. This cannot obviously be done with big brother (government) looking continuously over the shoulder thereby having an over-bearing influence on day-to-day operations. It is of interest to note that in the US, the Fed inspects the minutes of banks' board to determine if all board members are active and participate in discussions on important matters.

If we benchmark the functioning of bank boards in India against international best practices of corporate governance and disclosure we sadly have a long way to go. It hardly needs to be mentioned that much of this has to do with the structuring of the banks' boards. It is unheard of anywhere else in the world that the regulator and the government each have a nominee on the board and brave is a bank that would do anything contrary to the wishes of these two nominees. The other members are meant to broad-base the board to represent other interests in the economy but these posts become sinecures for patronage.

The present public sector bank legislation contains provisions for the election of directors depending on the extent of private sector ownership. By and large the very limited experiment so far has worked well. For instance, the induction of persons of the eminence of I G Patel and others has brought about a quantum jump in the deliberations of the State Bank of India board. But while this is satisfactory on a limited basis, the question arises as to how the bulk of boards of banks should be constituted once government becomes a minority shareholder. This raises some vital issues especially as under the extant legislative/regulatory framework there are restrictions on the voting powers of a single party. This could become a hurdle in the constitution of bank boards as banks migrate from the public to the private sector. This issue would need to be resolved early to ensure that too dispersed an ownership pattern also does not become a hurdle in good corporate governance and that otherwise good strategic partners are not dissuaded from taking a stake in a bank.

It is pertinent to note that in the corporate world election of directors is an accepted procedure, but limiting the voting rights of large holders does not necessarily lead to good corporate governance. What needs to be considered is the unfettered right of a shareholder to vote in accordance with his shareholding while electing directors. Once this is done, the board of directors could be subject to a considerable degree of accountability. Suppression of facts or misinformation could then be made a criminal offence and it would not be a case where board directors can claim to be mere decorative pieces without power or responsibility. Equally there is a real danger that the board management can pass into the hands of clearly unsuitable persons. To deal with this it is not necessary to take away the rights of shareholders. It is here that the regulator/supervisor should have adequate powers to use the standard fit and proper criteria which would be an adequate safeguard.

A practice which has evolved in many systems is of a nominating committee within the board which screens and ascertains the availability of suitable candidates who then seek election. It is the task of the nominating committees to ensure that only the most competent and qualified individuals, who can contribute actively to the bank and discharge their responsibilities to the stakeholders, are appointed to the boards. One is aware that this sounds somewhat like a restricted club of the elitist but that is what the real world is. The important point is that the onus of any problems in the bank come down so heavily on the members of the boards that only very capable persons agree to be members of the boards and free loaders living on patronage are weeded out.

It is important to have a periodic rotation under which a part of the board retires every year and there are well defined limits to re-election. The chaos under which the entire board is reconstituted at one go are far too well-known in the public sector banks as well as in the Reserve Bank of India.

It is essential that apart from the elected directors, the board should nominate full-time working directors. It is in this connection that it is highly desirable to have a chairman who is full time and attends to the overall issues of accountability of the board and a managing director who would be in charge of the day-to-day running of the bank. The board of directors is just not the right agency to decide on the granting of loans; this should quite appropriately be the function of a committee of top executives. Under such a system, the board of directors becomes the real supervisor of the bank and the regulator/supervisor would in a sense become a backstop.

It is clear that board management is going to go through a metamorphosis in India and we are just about to take the first baby steps in corporate governance in the banking sector. As financiers of the corporate sector, banks have a lot of catching up in the area of corporate governance. For once, industry is far far ahead of its financier.