All that is needed is political courage to clean up PSBs' governance

It is important to take a close and hard look at how to clean up poor and ineffective governance of public sector banks

The last edition of this column spoke about the unaddressed vital reform of ownership of public sector banks that is holding back governance of these institutions to a body of law and an era that is out of sync with the legal regime that governs private sector banks. Meanwhile, a vibrant controversy has broken out with the Reserve Bank of India’s (RBI) governor and the Bank Boards Bureau chief publicly airing their views on the issue. The RBI governor’s lament about not having full powers to sack public sector bank boards does appear self-serving but does not deserve to be dismissed as wholly irrelevant.

Is fraudulent activity in any bank, public of private, a cause for introspection on what went wrong, and how it could have been prevented better by the regulator? Unconditionally, yes. Is the absence of power in the hands of the RBI to dismiss the Board of Directors the only reason for the fraud? No. Would the fraud not have occurred if the RBI had that power? Not at all — frauds could take place in private sector banks too despite the RBI having the power to approve or sack the CEO.  

Illustration by Binay Sinha

Frauds can take place in any institution, regardless of how the institution is owned. However, how the institution is governed indeed has a role in whether it is prone to frauds. If frauds are rampant in public sector banks, despite bank employees being regarded as “public servants”, and despite government ownership resulting in stringent and draconian oversight of the central investigation and vigilance agencies, it would be reasonable to conclude that the model is indeed flawed, and needs to be fixed. Therefore, the biggest risk to a real systemic clean-up is a dismissal of any discussion on the need to reform ownership and governance of public sector banks, by branding the point as an excuse or justification of occurrence of fraud in these banks.

Therefore, what the RBI governor says, dual oversight of public sector banks is correct.  It would of course be self-serving to suggest that this naturally means the RBI has no responsibility to bear, and that aspect would be incorrect.  However, it is important to ensure that the duality of responsibility has to be cleaned up. As the saying goes — no man can serve two masters.  In the collision of multiple truths, the clash of ideology in the approach to regulation, ownership and governance, can lead to losing sight of the important, overwhelmed by the immediate.  

The immediate often trumps the important, but it is really important to take a close and hard look at how to clean up poor and ineffective governance of public sector banks, and the approach of treating the board of directors as policemen instead of strategic overseers. This government has many firsts to its credit in being resourceful with law-making — promulgating presidential ordinances to bring in substantive law; and effecting serious amendments to laws by embedding them in Money Bills (obviating the need to get the amendments cleared by the Rajya Sabha). The resourcefulness needs to be brought to bear with public sector banks.

The pace with which new law on fugitives is being piloted ought to be repeated with cleaning up state ownership of public sector banks and the attendant governance shortcomings.  At the least, a simple legislation to convert each of the public-sector banks into a public limited company governed by the newly-introduced (now nearly four years old) company law should be passed, which would bring each of these institutions under the more effective, uniform and standard norms of corporate governance that are applicable to private sector banks as well.  Without this measure, simply building up a Bank Boards Bureau with an extremely ambiguous role — ranging from the non-performing assets problem to being the search-and-selection agency for staffing bank boards — would be of no consequence.

The next step would be to dilute state ownership in these banks to a minority holding. The vigilance and investigation oversight of these banks would need to end — they have failed to contain the scale of fraud on these banks, and worse, they have ended up terrorising honest bank officials into becoming indecisive, further hurting the interests of the bank. Bank officials involved in the credit appraisal and sanctioning function are known to trip before they rise up the ranks with their career records being spoilt by vigilance and corruption cases, leading to a vacuum in the leadership and a lack of available bandwidth for senior management.

The implicit sovereign guarantee underlying every public-sector bank is borne out by each of the banks being recapitalised with sovereign money. The capital market regulator is again issuing a series of exemption orders exempting the government from having to make an open offer under the takeover regulations upon infusing more funds into these banks, whose shares are listed on stock exchanges. Resolution of weak banks and spreading the commercial pain of bank failure across its depositors is a political hot potato only because of this implicit guarantee. Therefore, sovereign funding of these banks through new capital could come the next time with strings attached — the legislative changes discussed above. Since it would involve state funding, they would in fact be Money Bills. All that is needed now is political courage.

The author is an advocate and independent counsel. Tweets @SomasekharS