A radical overhaul of bank governance

Corporate governance today is something like the “values” one hears about all the time — it’s something one preaches to others without caring to practise it oneself. 

Much of the Reserve Bank of India’s 74-page discussion paper, Governance in Commercial Banks in India, sounds like one long sermon. There is plenty about the “culture and values” a bank is supposed to have and the board’s role in ensuring these percolate down the line. 

There is banal stuff on the board’s role in managing conflicts of interest, overseeing senior management performance, the composition of the board and its various committees. The paper expatiates on the sterling qualities board members are required to possess.

All this has been said ad nauseam and it forms the staple of countless workshops and training programmes on corporate governance. If only sermons could transform, we should be living in a corporate governance paradise. The prosaic truth is that corporate governance just doesn’t happen. Decades after the corporate governance movement began, boards remain decorative bodies that tend to rubber stamp decisions taken by management. This is bad anywhere. At banks, it is unaffordable.

The challenge is not in spelling out the board’s responsibilities — these are well known. Nor does it lie in getting the right people on to bank boards — if anything, boards suffer from an excess of eminence. The challenge is to translate intent and eminence into results. This calls for a serious departure from existing practices. It is only when you get to page 55 of the RBI paper that you realise — surprise, surprise— that the RBI indeed intends precisely such a departure. The RBI would like to move authority for four key positions in a bank— chief risk officer (CRO), chief compliance officer (CCO), head of internal audit (HIA) and chief of internal vigilance (CIV)— to appropriate sub-committees of the board. The risk management committee of the board will have authority over the CRO and CCO. Authority over the HIA and CIV will vest with the audit committee of the board. 

The RBI proposes that the selection, oversight, appraisal and, where necessary, removal of these four functionaries shall vest with the respective committees of the board. By implication, the bank’s CEO will have no control over them. 

This is indeed a radical change in governance. One wonders whether such a regime obtains anywhere in the world. No doubt, the RBI has concluded that problems at banks have to do with these four functionaries not doing their jobs well enough. It believes that having them report to the CEO has rendered them dysfunctional. 

And yet moving all authority for these four officers to the board looks dicey. It requires a higher order of commitment on the part of the board altogether. Many bank boards may not be equipped to perform the responsibilities the RBI would like to cast on them. If there is a lapse or failure on the part of any of these officers, the board ends up being compromised. Do the concerned board committees have to resign in that event, destabilising the board in consequence? 

We need to distance the four functionaries from the CEO without having the board get too deeply involved in operations. Here’s a compromise. Let management appoint these persons, with the board being represented on the selection committee. Oversight and appraisal may be shared by the CEO and the board— the CEO may make his recommendations and the board may have the right to approve. Removal should be the prerogative of the board. Let us try out the compromise for some time. The RBI is right in sensing that the balance of power between the board and the CEO needs to shift in favour of the former. However, it may be wise to hasten slowly.

If the board has to show a different order of commitment, it is important to compensate the board properly. We don’t have to mimic the compensation levels of private, non-bank boards. But a substantial improvement in compensation is certainly required, at least in the public sector. The RBI may propose minimum total compensation for bank board members (say, Rs 2 million) and for the chairman (say, Rs 2.5 million). A few other suggestions for the RBI:

Board composition: The promoter or management should not appoint all independent directors. There is a case for allowing institutional investors the right to collectively nominate at least one member on the board.

Accountability:  The minutes must name the directors who contribute to discussions. This makes them more accountable.

Board evaluation: Members evaluating each other often amounts to little more than mutual back-scratching. Board evaluation must be entrusted to an outside agency.

Disclosure: The annual report must provide the total compensation of CEOs and full-time directors, including the value of stock options.

Executive compensation: CEOs must not be allowed to encash all of their holdings of their bank’s shares while in office. They must be required to hold on to at least one-third of their holdings at the time of demitting office. 

The RBI’s basic instinct is right. Governance reform at banks requires an overhaul of the governance architecture, not just minor tweaks to the present structure. Boards cannot be allowed the prerogative of the harlot through the ages- power without responsibility.

The writer is a professor at IIM Ahmedabad