Corporate governance in banks: on the distant horizon

By C. R. L. Narasimhan

Conceptually speaking corporate governance has been in the news everywhere. In a practical sense too there is widespread interest though perhaps not the same extent of following for better corporate governance practices among Indian companies. As many would recall the publication of the Kumaramangalam Birla Committee report on the subject has generated considerable interest.

The time has come to emphasise the importance of corporate governance in the financial sector. The banking system especially is interestingly poised. The public ownership by far the dominant characteristic so far is being whittled down. The enabling legislation to reduce the Government's minimum equity stake in 19 public sector banks has been introduced recently. Whether it will become law during this session of Parliament is not certain, but the Government's intentions are clear.

From the standpoint of corporate governance the intentions matter even more than any legislative enactment. Along with the announcement to reduce Government equity, there were less noticed moves to revamp the banks' boards. The Government says it will retain the right to appoint the CEOs and other senior functionaries when after it ceases to hold a majority stake. However, the interests of other shareholders - in percentage terms they are expected to hold 67 per cent of the share capital - would demand better standards of management than ever before. Besides, as the Government says the main motivation for the move to dilute its minimum level of equity stake comes from the compulsions of increased capital adequacy that the banks have to meet. For most of them the only option is to access the capital market. That course looks improbable right now - most quoted public sector banks are commanding ridiculously low valuations. But even in that bleak scenario harping on corporate governance as a way to boost investor interest is the logical course.

A subject long presumed to have only a theoretical connotation is finally getting into the realm of practical banking. In its Report on Trend and Progress of Banking (November this year), the Reserve Bank of India has devoted considerable attention to this subject. Banks play an overwhelmingly important role in the financial system. The RBI as a regulator is naturally an interested party. From a systemic point of view too, corporate governance in banks becomes a vital issue. Also, the predominantly public sector nature of Indian banking means that the PSBs have to set appropriate standards for the private banks to follow. Finally, given that PSBs will also have to become market dependent their corporate governance practices should convey appropriate signals to the investors. Shareholders and investors should get the message that their money is safe with the banks.

Given that for banks the concept of stakeholder extends to many categories - depositors, borrowers, employees and shareholders. There is a need to interpret corporate governance as widely as possible. As the RBI says under corporate governance banks articulate corporate values, codes of conduct and standards of appropriate behaviour and also have systems and procedures to ensure compliance with them. The board sets the strategic objectives and corporate values of banks and specify transparent lines of responsibility and accountability that are communicated throughout the organisation. The board and the top management interact with each other at specified intervals for timely exchange of information on the bank's financial health and management practices.

A blueprint for action

Banking supervision and the quality of management play an integral role in a system of governance. The RBI says that the corporate governance structure needs to be transparent and consistent encouraging safe and sound banking on the one hand and the flexibility needed to face competition on the other. The RBI's advisory group on bank supervision has made a few valid points on corporate governance for banks: (a) Banks should obtain a certain minimum level of corporate governance. Thereafter, they should be asked to move towards attaining international standards within a specified time frame. (b) The trade unions and bank managements should work towards achieving a new arrangement on remuneration that should reflect performance. (c) A comprehensive risk management system to be in place within a maximum period of three years. (d) There should be a statutory prohibition on lending to large shareholders. At the moment there is a ban on lending to directors and connected parties. (e) Take steps to ensure that the value system inherent in corporate governance percolates to the lowest levels. (f) Great care to be taken in the composition of the bank's board: the calibre of the directors should be scrutinised and for greater transparency their qualifications disclosed in the balance sheet. (g) All round transparency and disclosure to enable a shift to the best practices.

On the question of whether corporate governance in banks is dependent on ownership patterns, the RBI Advisory Committee feels that it is not an important issue. However, it is certain that the corporate governance issues can never be divorced from the autonomy angle which PSBs have been craving for a long time but without any degree of success. The proposed dilution of equity by the Government will not further the cause of bank autonomy.

The Government proposes to retain the government character of the PSBs. A board whose key members including the CEO and EDs will be appointed by the Government cannot be expected to espouse better standards of governance. Clearly many more clarifications are needed before anyone even contemplates corporate governance for PSBs.

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Section  : Business
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