What has been happening in the banking sector during the past six years should have been a matter for serious introspection and concrete corrective actions by the Union government to clean the proverbial Augean stables. There was hope in 2015, when a conclave of top executives of banks called ‘gyansangam’ was held, followed by the announcement of a package of measures called indradhanush.
Recapitalisation was one measure to enable the ailing public sector banks (PSBs) to shore up their capital. More importantly, the government announced that improving corporate governance would be a major area of reform in the years to follow. The report of the PJ Nayak Committee on Corporate Governance (2014) was to be a starting point of such reforms.
As a sequel to this, Banks Board Bureau (BBB) was set up in March 2016 with Vinod Rai, former Comptroller & Auditor General (CAG) of India as the chairman with six members. Although it did not have an explicit mandate on measures required to tone up the ailing PSBs, it started off in right earnest and took certain initiatives on its own to cover critical areas in the functioning of PSBs. Through meetings with the political bosses, bureaucrats, bankers, RBI officials and Indian Banks’ Association, BBB itself tried to evolve a mandate for reforming the banks. Its compendium of recommendations (CoR) submitted in March 2018 a few days before Vinod Rai demitted his office, provided a broad framework for reforms so urgently needed.
Parallel to this, the government went ahead with the plan of consolidating PSBs. Through three rounds of mergers, 28 PSBs have been consolidated into 12. The first two mergers respectively of SBI group, and of Bank of Baroda have not yet yielded the claimed benefits to the anchor banks. The latest round is still a work-in-progress; it will be too optimistic to expect that miracles will happen during the next two years. The process itself is incomplete as the candidates left out of the merger exercises are not in good shape, which makes another round of mergers probable. Reports have also appeared that some of them may be privatised.
In the meantime, there is virtually no progress in the area of corporate governance in PSBs. On the contrary, the government has taken two disjointed measures, namely, increasing the number of executive directors to four and creating a new tier of top executives designated as chief general managers making the PSBs top-heavy. Their respective roles have not been spelt out, leaving the job to the boards.
The boards continue to remain truncated as most of the PSBs do not have the full complement of directors. Two of the six big banks have no chairmen; in none of them have the mandatory officers’ and workmen’s directors been appointed during the past four years. Punjab National Bank, the largest PSB after SBI, has only eight directors; so also, the Bank of India and the Indian Bank. (See the table given at the end). Such ad-hocism is not consistent with the objective of corporate governance.
RBI’s New Proposal
Meanwhile, a new discussion paper on bank governance (DPG) put in the public domain by RBI attempts to bring the issue to the limelight once again. The DPG is a good starting point for a thorough rethink on the kind of reforms the PSBs should be subjected to in the years ahead.
The principal thrust of the proposals is on making the banks board-driven, as it ideally should be. Greatly influenced by the recommendations of Basel Committee on Banking Supervision (2015) and drawing from the inputs of CoR of BBB, RBI has laid down a road map for overhauling the current system of governance in PSBs.
The board of directors is given a range of responsibilities beyond its conventional role. At present its role is limited to giving broad directions to the bank as recommended by the top management led by the managing director and chief executive officer (MD/CEO) and in conformity with the policy and administrative guidelines issued by the government and regulatory requirements stipulated by RBI.
According to the DPG, specially constituted sub-committees of the board will be given a dominant role of policy-making, implementing, monitoring and evaluating with the help of designated top executives. The scope for conflict of interest between revenue generation and control functions and the consequent vulnerabilities is sought to be reduced by clearly laying down the respective responsibility areas.
Three committees will be assigned crucial roles in the proposed structure: the risk management committee (RMB), the audit committee (ACB) and the remuneration and compensation committee (RCB).
Each one of them would be headed by a non-executive director with independent directors as their members. Four designated officials will be in charge of specific areas of responsibilities and they will be answerable to these committees. The chief risk officer (CRO), the chief compliance officer (CCO), the head-internal audit (HIA) and, chief-internal vigilance (CIV) who would ideally be one rank below the executive director (ED), will carry out the mandates of the committees and the board, and provide the necessary support to discharge their roles.
The board will also be responsible for selecting and appointing directors representing different interests. A board can have a maximum of 15 directors with a majority being independent directors. All meetings of the board must have a majority of independent directors.
Three Levels of Defence
DPG identifies three levels of defence for the banks—one at the front level which runs the business, the second at the controlling unit level addressing the risks and the third one looking after inspection and vigilance.
The first line of defence comprises the business units which are manned by the field staff. They are expected to carry out the business of the bank in conformity with the mandate given by the board in its ‘risk appetite statement’ (RAS), which, in conventional lexicon, implies lending policy and guidelines. They are also accountable for managing the risks. It is the board’s responsibility to evolve and promote an efficient risk culture in the bank to be followed, among others, by the front-line staff.
The second level of defence is provided by the controlling units at different levels. It includes the risk management and compliance functions. The former will oversee the risks and monitor the activities of the first line. The compliance function will monitor the compliance with the policies and guidelines issued by the government, the regulator and the bank’s board.
The third level of defence comprises the internal audit and the vigilance functions. They would be independent of the first line and will assess if the operations are in conformity with the policy laid down by the board. The proposal underlines the need for suitably trained and competent staff in these functions.
As mentioned earlier, the DPG stresses on the need to segregate revenue generating functions from control functions to avoid conflicts of interest which may result in costly compromises.
For achieving all these, the board is required to evolve a code of ethics, conduct and values, and also a whistle-blower policy. The DPG wishes that the board promote a strong culture of adhering to limits and managing risk exposures.
Feasibility of the Proposals
While it is difficult to quarrel with the intent of RBI, the paper overlooks certain ground realities in the State-owned banking sector today. These issues are broadly as under:
a. The power to appoint the directors and their terms of appointment;
b. The level of autonomy of the board;
c. The constitution of the committees;
d. The roles of the designated officials;
e. The absence of a human resource management (HRM) policy.
Although RBI claims that the new guidelines will be applicable to PSBs, the bank boards have no say in the selection and appointment of any director. Their appointment, terms of appointment and remuneration—all come under the government as the majority shareholder. Even after their appointment, all directors are not treated on par. The nominees of the government and the RBI are always one rung above the rest of the lot; often the MD, the government and RBI directors work in tandem; what they say is taken as gospel by the rest. With four EDs, one MD, two nominees of the government and RBI and two representatives of the employees, independent directors cannot have a majority. As a result, the concept of the autonomy of the board remains as an ideal.
The DPG’s suggestion to make the different committees autonomous also suffers from a practical difficulty. Although the Bank Nationalisation Act (1970) provides for appointing 15 directors other than the MD, the number of so-called independent directors will be only five. As it is, in most large PSB boards, the extant vacancies range from three to eight. Where are the independent directors who are supposed to head each of the three major committees (RMB, ACB and RCB)? The quorum for the meeting of a committee is three. Unless the government quickly fills up the vacancies in the boards, abiding by this proposal is impractical. Further, in PSBs which are listed, there is a provision to appoint shareholder directors. In most case, these directors are sponsored by the institutional shareholders like the Life Insurance Corporation (LIC) which have substantial shareholdings. Their loyalty will be to the institution with whose support they earned their positions on the boards. All these factors raise a huge question mark on the expected autonomy of the directors.
The DPG proposes that the head of each of the key functions - risk management, compliance, internal audit and vigilance must be an official one rank below that of the ED of the bank. S/he is expected to report directly to the respective board committee. In principle it is laudable. But given the hierarchical structure of reporting in PSBs can an executive bypass the ED and the MD to report to the board? Our institutional culture is yet to reach that level of sturdy independence.
HRM Policy Missing
While it recognises the front-line officials as the first and crucial line of defence, in formulating the RAS, the DPG has not spelt out any role to the people who are responsible to implement it, although they are important stakeholders. As a result, the extant ‘top-down’ approach continues. If the implementing organ of the bank has to be a meaningful line of defence, the guidelines need to be internalised. That sense of internalisation can be developed when there is a two-way communication between the board and the operating staff.
To work within the framework of a strong risk culture proposed in the DPG, the staff constituting the first line of defence require a new orientation on the implications of the risks. They need adequate training on their role so that they develop skills of decision making and deepen their knowledge of credit appraisal. If this is taken care of, the second and the third lines of defence can discharge their roles effectively. Such an orientation calls for a long-drawn process of HRM. The DPG is silent about this need.
The DPG overlooks the entire gamut of HRM policy on which depends the due discharge of their role. Manpower selection, training, placement, career planning, succession plan, skill and attitude building and the culture of ethics- all these form part of a comprehensive HRM policy. Till now this is entirely regulated by two external agencies- the government which issues periodic guidelines on HR matters and the Indian Banks’ Association which signs agreements with the industry level employee unions.
Succession and leadership planning have virtually been non-existent in the PSBs for years. This is borne out by the following facts about the top-level positions in many PSBs:
a. Despite recommendations by several committees, the CEOs have had brief tenures—some of them for as short as 15 months and most of them between two to less than three years. They hold the office till the age of 60. Such short tenures leave very little scope for them to take major policy decisions; even if they take certain initiatives, they would not be there to do the follow up. A new CEO can fix an ambitious goal knowing fully well that achieving it is not his/her look out!
b. Many EDs too have had less than two years’ tenure to superannuate pre-empting their elevation as MDs.
c. A lot of top executives who constitute the feeder cadre for selection of EDs and MDs have less than five years term left. If they have not put in one year in the feeder cadre and are not left with residuary service of two years, they cannot participate in the process for selection of EDs. Consequently, executives with long experience become unsuitable for higher responsibility because their age is against them.
This situation is the cumulative result of three government decisions taken over the past 30 years. One, the restriction on recruitment imposed in the 1980s, two, introduction of a voluntary retirement scheme in the beginning of this century and three, after three recent rounds of mergers, easing out surplus staff through exit options. The combined effect of all such measures is that today PSBs have a severe shortage of experienced and knowledgeable staff at the middle and senior levels. This cannot be corrected through short term measures like lateral recruitment from outside or creating a new tier of top executives like CGMs. A long-term policy covering training, placement, career progression and performance-incentives and rotation is essential to build up a dynamic, culture-driven workforce.
Until the government gives full autonomy to the bank boards on matters of HRM, the goals of building an institutional culture of ethics and accountability will remain a pipedream. The employees as important stakeholders can get a sense of involvement if their role is acknowledged both in form and substance. The very fact that the concept of participative management embodied in sections 9 (3)(e) and (f) of BNA is not being followed by the present government is an indicator of the wide gap between the claim and reality in the PSBs.
As of now, given the current preoccupation of the government on more serious issues, it will be optimistic to expect serious governance reforms in the State-owned banks. And they will, sadly, continue to bleed.
This would certainly result in the EDs and MD taking the Independent Directors seriously and reduce the overarching importance given only to the Govt and RBI's nominee Directors.
With this implemented over a certain initial few years without dilution it would gradually transition the PSBs to be more Board driven.
Ultimately a culture is built by values, policies, practices and precepts.