Srikanth Vadlamani, Vice President - Senior Analyst, Moody's Investors Service
Last Tuesday, a working group appointed by the Reserve Bank of India (RBI) recommended measures to improve public sector banks' corporate governance, including significantly increasing the autonomy of these banks' boards. These measures, if implemented, would be credit positive for public-sector banks because they would address a key credit weakness.Poor corporate governance, characterized by poor board supervision and excessive government interference, is a structural credit weakness of Indian public-sector banks. Government interference has meant that policy objectives, rather than commercial factors, have dictated some business decisions at public-sector banks. Moreover, the quality of the top management at these banks has been hampered by a non-transparent appointment process, relatively short tenures and a lack of accountability. The effects of this weak governance have become apparent as India's economy has weakened, with public-sector banks' performance lagging that of private-sector banks in terms of asset quality and profitability.
The working group's recommendations seek to improve governance by putting distance between the government and public-sector banks' management. Chief among the recommendations is to reduce the government stake in public-sector banks to less than 50%, which involves repealing a law that now prohibits the government's interest in public-sector banks from falling below 51%. The group also recommends transferring the government's stake in the banks and its governance over the banks to a newly created bank investment company (BIC). Once the banks complete the process of recruiting fully independent boards, the BIC would transfer many of its oversight powers to the bank boards, leaving the BIC to operate primarily as an investor rather than as an owner. The group proposed that the BIC would have a fair amount of autonomy from the government, with objectives rooted it generating returns on its investments in the banks.
The working group also proposed improving the board-appointment process, including banks' chairmen and executive directors. In the first phase, appointments would be conducted by a bank boards bureau (BBB) comprising former senior bankers, but eventually this function would go to the BIC before it ultimately goes to each bank board.
Another proposal calls for the banks to no longer be subject to scrutiny from India's Central Vigilance Commission, Central Bureau of Investigation and the Right to Information Act. The fear of being subject to probes by these external government agencies inhibits these banks from taking commercial risks that they deem acceptable and slows down decision-making. In addition, the proposal calls for government to end its practice of issuing regulations applicable only to public-sector banks.
Although we do not think it is likely that the government would allow its stake in public-sector banks to fall below 50%, there is a higher probability that the government would implement a watered down version of these recommendations. Even such an outcome would be credit positive for public-sector banks.
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