RBI puts bank boards on notice

The central bank has tightened supervision but governance challenges at banks remain

The conference room at the five-star hotel is packed with around 200 private bank directors, chairmen and CEOs (a bad case of concentration risk, you might think). The Reserve Bank of India governor arrives at 10 am on the dot. Thereafter, the RBI’s first-ever interaction with the boards of private banks, which took place late last month, proceeds with almost Republic Day parade-like precision.

The addresses by the governor and two deputy governors stick to the allotted time.  So do the presentations by chief general managers and the open house interaction with executive directors. The seating arrangements have been thought through, with bank directors seated from the stage in descending order of the size of the bank. Tea breaks and the lunch break commence and close at the specified timings. There are no technical glitches, no disruptive movements into and out of the conference room, no annoying cross-talk. The programme closes at 5 pm as scheduled. Not many organisations understand that excellence in administrative arrangements is an essential facet of organisational excellence.

The RBI had had a separate interaction with public sector bank directors a week earlier, which is understandable as the governance issues in the two segments differ. The message in having discussions with both the segments should not be missed: Many governance issues in banks are ownership-neutral. 

RBI Governor Shaktikanta Das exuded confidence in the resilience of the Indian banking system. His confidence stems from a number of initiatives taken in recent years and the outcomes that have ensued. The RBI has in place a dedicated vertical for supervisors and it has also set up a college of supervisors. It has taken steps to ensure that those heading the key assurance functions in banks —risk management, compliance and internal audit—have a degree of independence through a system of dual reporting to the CEO and the board.

The RBI’s offsite surveillance, which requires banks to upload raw data to the RBI, has enabled the regulator to get a good picture of the build-up of risks at individual banks as well in the system. By tracking numbers across the system, the RBI can identify outliers and potential trouble spots. 

The Annual Financial Inspection report and the Risk Assessment Report (RAR), which the RBI submits to banks, have always been good at pointing out areas of concern. In the past, the RBI would wait until the next review for a bank to respond. A year can be long enough to sink a bank. The RBI seems to have learnt from recent experience. Its supervisors now insist that major problem areas highlighted in the RAR be resolved within a few weeks or months of submission of the report.

In his address, Mr Das outlined a comprehensive 10-point charter for bank boards. A couple of themes that Mr Das touched upon call for serious reflection on the part of all concerned.

The governor referred to the dominance of CEOs in board discussions and boards not asserting themselves. He observed that the RBI had noticed these tendencies “at times”. That is, perhaps, an understatement. The dominance of the CEO is the central problem of governance not just in bank boards but in any board.

The dynamics of the boardroom are such that this is a difficult problem to crack. The UK’s Financial Services Authority realised this in the course of a review it published in 2011 on the failure of the Royal Bank of Scotland (RBS) during the global financial crisis, the biggest failure in banking history. RBS had a high-profile board with the requisite skills. And yet the board was a mute witness to the disastrous course that the CEO embarked upon. 

It is difficult for directors to challenge a CEO especially if he or she has a track record of performance. A stellar record is no proof of infallibility. The CEO may have been right in the past but he could be wrong today. However, directors worry that they may derail a performing CEO.

The composition of the board renders the problem even more difficult. Directors are typically drawn from a small pool of ex-CEOs, retired bureaucrats, and other professionals. These are people who meet the CEO in the same clubs and are on back-slapping terms. It is more than a little awkward for such directors to actively challenge the CEO. 

Moreover, directors are often handsomely compensated and the CEO has a key role in the renewal of their terms. They have no particular incentives to challenge the CEO and every incentive instead to play along. To create true independence in the board, we need at least one or two directors whose selection is independent of the CEO and the promoter. The RBI has the stature and the clout to push through such a radical change.

Some less radical changes can also help. The current prescriptions for the inclusion of experts, such as small-scale sector and agriculture specialists, are far too onerous. There are only three areas of expertise that the regulator needs to insist on: Banking, audit and risk management. The importance of “domain expertise” in boards is overstated. The vital questions that need to be asked — and are not — are the simple, uncomplicated ones. Such as asking the CEO: What happens after you?

Mr Das urged boards to set the tone for the corporate culture and value system of a bank. The collapse of Credit Suisse in April should drive home the importance of his point. The bank was well capitalised and did not lack liquidity before its forced merger with Union Bank of Switzerland. Its problem was that it had got enmeshed in numerous controversies over the preceding several years. 

Following two bank failures in the US in March, depositors in Europe began to wonder which banks were vulnerable. They focused immediately on Credit Suisse whose culture was suspect. No amount of assurances to the public about capital and liquidity could save the bank thereafter. Having a culture that inspires confidence has become an imperative today for a bank’s survival.

Mr Das’s address was couched in polite terms and interspersed with a few pats on the back for those assembled. But the signals from the conference were clear enough. The RBI knows what the shortcomings in the system are, what areas need to be addressed, and what games some banks choose to play. It is now up to bank boards to pull up their socks. They have been put on notice.

ttrammohan28@gmail.com