Thursday, May 29, 2014

Report on Governance of Banks

Historically, the governance of banks has received greater (and somewhat different) attention when compared to governance of companies carrying on other forms of business. This is because banks deal with depositors’ funds and their actions or misdeeds can cause a more severe strain on the economy as a whole. Hence, while banks that are established as companies (and listed on the stock exchanges) are covered by the regular corporate governance norms prescribed for listed companies, they are also subject to additional governance requirements imposed by the banking regulator. Hence, the governance norms focus beyond merely the enhancement of shareholder interests, but extend to incorporating other interests such as depositors, the financial markets, the economy and the general public.

It is in this background that one needs to view the recommendations of a committee under the chairmanship of Mr. P.J. Nayak that was tasked by the Reserve Bank of India (RBI) to review the governance of bank boards in India. The committee issued its report earlier this month. The report identifies the ills that afflict the current system of governance in India’s banking sector and seeks to make suggestions for overhaul of the system, many of which are quite radical in nature. Overall, the report is quite detailed and well-researched, and is the result of a meticulous study that is supported by extensive data collection.

The report differentiates public sector banks from those in the private sector. In a scathing attack on public sector banks, it points to their significant weakening in recent years. Apart from excessive governmental control, the other factors are multiple layers of regulation and the lack of stringent governance norms and practices. In doing so, the committee seems to proceed on the basis of a correlation between governance and performance, and impliedly establishing better governance norms and practices as a measure to streamline performance. The committee’s principal solution to public sector bank governance is an overhaul of the holding structure of such banks. Currently, public sector banks are owned directly by the government. What the committee proposes is to establish a Bank Investment Company (BIC) as an intermediate holding company that holds shares in various public sector banks. While the committee makes this reform proposal, it has also suggested a phased introduction of the BIC, perhaps a sign of recognition that establishing such a model in the Indian context may be time consuming, and other measures may need to be put in place in the interim.

The idea of introducing an intermediate holding company structure is an interesting one. This idea draws inspiration from the models followed in Singapore, the UK and Belgium. For instance, shares in DBS (as well as several other government-linked companies) in Singapore are held by Temasek. Several banks and other state-owned enterprises (SOEs) in China are held by an intermediate entity called SASAC that is also billed as the world’s largest controlling shareholder. Such an intermediate holding structure would distance the public sector banks from direct government control and infuse a greater amount of independence and professionalization. While this idea is attractive in paper, several questions and complexities would arise in its implantation, as discussed here. Nevertheless, it is an idea worth considering. If the pilot efforts is successful for the banking sector, it could possibly be replicated for other public sector undertakings as well.

Private banks call for a different treatment. From a regulatory standpoint, they are subject to shareholding caps as well as voting caps that deny significant control to any individual shareholder or group. The committee recommends the creation of a new category of investors referred to as Authorised Bank Investors (ABIs), who can invest up to 20% shares in a bank without regulatory approval (or 15% in case the ABI seeks a board seat on the bank).

Finally, the committee makes several recommendations on board structure and performance, including board independence, tenure, separation of chief executive and chair, maximum age and the like. These requirements are in addition to those prescribed by clause 49 of the listing agreement that are applicable to all listed companies.

In all, the committee’s recommendations are quite focused and in some ways prescriptive, while some may be somewhat radical in nature requiring greater overhaul. Their acceptability would depend on whether there exists sufficient political will and momentum to push through such drastic reforms (which will not only require regulatory changes by the RBI but also statutory amendments through the legislative process), or whether the path of adopting incremental changes will be taken.

1 comment:

Somasekhar Sundaresan said...

Thanks for the perfect summary. The report can be accessed at: