Top-flight PSB boards needed for resilience

Asset quality of lenders has improved, but financial resilience in a system is best built in good times. It is time for the RBI to press the governance accelerator

Earlier this year, the Reserve Bank of India (RBI) brought renewed focus to corporate governance at banks with Governor Shaktikanta Das laying down a 10-point charter. The poor quality of information – material inaccuracies, missing facts, and the delayed circulation of agenda papers that often take the shape of “guided tour” — came in for censure. The dominance of chief executive officers (CEOs) in board discussions and lack of activism of both the boards and chairmen to ensure an environment for free discussions — besides evergreening of loans – attracted the Governor’s wrath.

Effective regulation, good internal controls and effective boards are critical for financial resilience. Governance standards, therefore, must be top-flight. However, the RBI’s push for differentiated bank licensing has posed problems, as governance standards at small finance banks (SFBs) and payment banks (PBs) are subpar and their models look unviable. They need to be wound down at the earliest through mergers with universal banks: Action that can be encouraged to fulfil the niche role for which these institutions were created. Several SFBs’ and non-banking financial companies’ board appointments and their functioning have been affected by those currying favour. The governance of urban cooperative banks (UCBs) is even worse with no independent directors.

The biggest problem for corporate governance is the tardy treatment the subject begets at public sector banks (PSBs). The dozen PSBs — post-merger — still account for about 59 per cent of the total balance sheet size of scheduled commercial banks. Yet, their governance standards remain disappointing.

The P J Nayak committee had  suggested sweeping reforms. However, its recommendations were implemented only in part with a weak heart and a clever mind to scuttle any material progress on the issue. The suggested holding company model never took off. The interim solution in the form of the Banks Board Bureau (BBB) was rendered ineffectual by continued bureaucratic interventions that left de facto control with the Department of Financial Services. Consequently, selection of top executives and other PSB board members, by and large, is still sans professionalism. And the backdrop against which the Financial Services Institution Bureau (FSIB) was created to replace the BBB after the latter was declared an incompetent authority by a court makes it even harder for the new avatar to establish its credibility.

It’s time to unleash a new wave of governance reforms at PSBs.

First, FSIB should be accorded statutory autonomy, giving it teeth instead of its present recommendatory role. Second, the RBI and the Finance Ministry should reach an understanding on widening PSB boards to enhance collective expertise. At present, PSBs typically have two part-time non-official directors, and three-four shareholder directors who in practice are not the shareholders’ choice.

 They hardly have accountability on a par with independent directors of non-financial firms nor bring in expertise to various board committees. Third, RBI needs to be legally empowered to bring PSB regulation on a par with private banks. And fourth, PSB board transparency needs to be enhanced. While private bank boards must disclose skills, expertise, competencies and remunerations of their board members, such information is sketchy at best for PSBs.

Also, PSBs don’t disclose adverse observations by the board and the regulator. The RBI itself can consider publishing an annual report giving its assessment of governance. Lastly, the remuneration of PSB board members as well as of private banks can be made transparent on a cost-to-company basis and raised to attract talent.

The governor has rightly warned against complacency even as asset quality has improved. Resilience is best built in good times. Countercyclical capital buffers can be activated when credit growth has been over 15 per cent year-on-year for a full year. F­­issures like evergreening of retail loans — especially by PSBs— is a wake-up call and requires the RBI to press the governance accelerator.

The writer is Professor of Practice (Economics) at IIM Kozhikode and former executive director, RBI. V­iews expressed are personal. The column has been edited for space.