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.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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