Making bank boards accountable

Intro: Recent fissures in corporate governance make a strong case for regulators to move beyond supervision of operational aspects

By Author Dr K Srinivasa Rao   |   Published: 16th Nov 2018   12:12 am Updated: 15th Nov 2018   11:22 pm

The increasing atrophy in corporate governance (CG) standards in the banking and financial system is fast eroding stakeholder’s wealth. Its impact is vitiating business sentiments. The resultant impact on liquidity crunch and rise in call money rates in banks and non-banking financial companies (NBFCs) may eventually have a debilitating impact on the economy. Recently, the Reserve Bank of India (RBI) relaxed liquidity norms to ease the strain in the financial markets and allowed more bank to lend to NBFCs, which are facing an asset-liability mismatch. It is estimated the move could free up as much as Rs 50,000 crore for lending to the NBFC sector as it grapples with refinancing maturing commercial paper and short-term loans.
But when the entire saga of failure of Infrastructure Leasing & Financial Services (IL&FS) to sustain its business model is concerned, it clearly points towards protracted indifference in corporate governance that escaped the regulatory lens. It is difficult to assess its immense collateral damage to the financial system. The share value of even well-performing NBFCs has substantially eroded in the capital market mayhem that followed the fallout. Many NBFCs have been swept in the IL&FS imbroglio and it will take many years to restore orderliness. Risk management strategies of NBFCs were not adequate to insulate the systemic risks.

NBFCs’ Crisis

Earlier, the RBI had cancelled the licences of 368 NBFCs during the half-year ending June 2018 for failing to meet regulatory norms. But looking at the recent damaging trends and their far-reaching consequences, another 1,500 NBFCs reeling in the aftermath of IL&FS crisis may face the RBI axe. Similarly, the RBI has taken tough measures even against some private banks. It has dissipated the myth of many financial entities, which have often taken regulatory forbearance for granted and created impasse. Call to emulate best governance practices of private sector banks is turning out to be a myth.

Recently, Bandhan Bank was the sufferer of such procrastination in corporate governance by failing in regulatory compliance. It is supposed to pare down promoter’s shareholding to 40% in 3 years, 20% in 10 years and to 15% in 12 years. These conditions are part of the licence and well in the knowledge of the bank requiring capital planning right from inception. But it went in for an initial public offering (IPO) only in March 2018 bringing down promoter holding merely to 82.28% from 89.62% , far below the target. While each case has independent merit in the perception of the regulator, Bandhan Bank was perhaps driven by the fact that the RBI may go soft on the stake dilution criteria, as it had granted a five-year extension to Kotak Mahindra Bank in 2015 resetting new deadlines for compliance.

But instead, the RBI imposed operational restrictions on Bandhan Bank (i) preventing it from opening new branches at its discretion and (ii) freezing remuneration of its MD & CEO at the current level. Consequently, its stock prices suffered a huge loss of 46% until now. Bandhan Bank shares went down from a high of Rs 741 recorded on August 9, on BSE intra-day trade. It then nosedived to Rs 369.15 during intraday trade on October 26. In the melee, the extent of erosion of stakeholder wealth can be well imagined. Its further impact on business operations cannot be ruled out.

RBI’s Tough Stance

The weakness in corporate governance practices in public sector banks is often attributed to the duality of regulation and the RBI has been demanding more autonomy to deal with them. But the series of exposure of slackness in corporate governance in some of the leading private banks is disappointing. Ever since the Supreme Court pronounced that managing directors and full-time directors of even private banks are ‘public servants’ for the purpose of Prevention of Corruption Act (PCA) 1988, RBI’s outlook on private banks is changing.

Unlike for PSU bank, the RBI is empowered to deal with the tenure of heads of private banks. The denial of extension of tenure of MD & CEO of Axis Bank and capping the tenure of MD & CEO of YES Bank up to January 31, 2019, show the stern mind of the central bank to provide a clean leadership to private banks. It also ensured a seamless change in the leadership of ICICI Bank. But the loss of stakeholder value due to such instances can undermine the image of these mighty entities. Serious introspection into what led to such situations will be essential as they can precipitate only over a period of time.

Fit and Proper

In the evolving corporate governance practices, more rigour in ‘fit and proper’ criteria in terms of knowledge, experience and domain competence at the time of inducting board members may be necessary. Similarly, grooming them, training and prescribing a specific performance review system for non-executive board members might be needed to ensure proper guidance to the top management.

The boards must be sensitised to respect the established ethics, moral standards, work culture and value systems nurtured in the specific organisation built over decades. More focus on aligning risk management, application of technology with evolving business needs must be built into the framework. There must be a closer interface and increased data sharing between the top management and the board as a systemic tool to improve proactive management and intervention. The management audit of banks must be well in the regulatory glare.

Moving beyond the rigour of risk-based supervision, the RBI may have to calibrate a different matrix to evaluate the corporate governance standards. It may be a distinct exercise to test the responsiveness of the board towards evolving business dynamics. In this context, it may also be necessary to assess the impact of separation of the position of chairman and managing director & CEOs in PSU banks on the quality of corporate governance. It was implemented as part of a 7-pronged reform package introduced as ‘Indradhanush’ in August 2015.

The recent instances of fissures in corporate governance practices highlight that regulatory agencies may need a firm grip on board functioning moving beyond the supervision of operational aspects. This can be achieved through an added oversight of corporate governance in banks and NBFCs. Carving out a separate audit of corporate governance by regulators may help in the resurrection of ailing financial entities.

(The author is Director, National Institute of Banking Studies and Corporate Management, Noida)