Customers use a Union Bank of India ATM, as security guards talk in front of a Bank of Baroda ATM in Mumbai, India. (Photographer: Adeel Halim/Bloomberg)

Fixing Governance Problems Of Indian Public Sector Banks

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Emma Arbuthnot, the British judge hearing the Vijay Mallya extradition case in London reportedly observed recently, “it was ‘blindingly obvious’ that rules were being broken by Indian banks that sanctioned some of the loans to his erstwhile Kingfisher Airlines.” But, nearer home, to the bank boards, regulators, and the government as controlling owners, such errant behaviour seems to have been lost in their blind spots, neurologically speaking! One could legitimately ask where the banks’ directors were when scams of massive proportions had been perpetrated right under their watch, over several years. The unfortunate reality is that, by and large, very little of such purposeful surveillance and prudential stewardship can likely ever happen in Indian public sector banks, as presently structured.

The Ills Of Controlled Corporations

‘Controlled Corporations’ are, broadly, those which have owners with sizeable (though not necessarily majority) shareholding that enables them to control directly or indirectly the management and operations of the company; controllers tend to subserve their self-interest, usually at the expense of non-controlling shareholders and other stakeholders. By definition, public sector corporations including banks are majority-owned by the State and thus are subject to State control and intervention in policies and operations of the entities.

Controllers can (and do) pack the board with directors who would not act ‘difficult’ when decisions or initiatives—not necessarily in the interests of the company or other shareholders—are put up for board approval.

Controllers can (and usually do) ‘capture’ the board through a variety of carrot and stick approaches.

Very few individuals would care to jeopardise their personal interests by crossing swords with the controlling shareholders whose wishes they tend to see as their commands!

Also Read: No Banking Regulator Can Prevent All Frauds, Says RBI Governor

The Trojan Factor Within

Banks’ core business revolves around money which, by any definition, is the lowest hanging fruit for anyone with mala fide designs to grab. So internal control systems have to be robust, and the top executive management and the board have to be reassured constantly that appropriate control mechanisms were not only in place but were also being followed. The biggest challenge to any control system is the exercise of management override of systems. This happens when management, at any level, breaches system requirements on grounds with ulterior motives. Sometimes such overrides may be genuinely in the interests of business; but they should be documented, flagged, and ratified as appropriate exceptions. If such an ‘Override Monitoring System’ is not in place, or not effectively followed, then the entity is clearly heading for trouble. An effective board would want to have reported to it (or to one of its committees) such exceptions and how they were dealt with. It is doubtful if such regular reporting mechanisms exist in most cases.

At the board level, if such ratification requests (for example, loans sanctioned beyond delegated authority) are too frequent and too many, as often is the case, it should ring alarm bells to the directors that the board approved controls are nonchalantly ignored by management, and can spell disaster. 
Finance Minister  Arun Jaitley chairing the meeting with the heads of public sector banks, in New Delhi on June 12, 2017. (Photograph: PIB)
Finance Minister Arun Jaitley chairing the meeting with the heads of public sector banks, in New Delhi on June 12, 2017. (Photograph: PIB)

Also Read: Disagree With Patel’s Arguments On Regulatory Structure Of State-Owned Banks, Says Yashwant Sinha

Can These Problems Be Fixed?

Indeed, yes if there is strong political will. There are so many vested interests benefiting from the prevalent chaotic maze in this area, that resistance to reforms will be quite high. The principal thrust should be to empower the board by creating an enabling environment and then holding the board ruthlessly accountable for the bank’s governance and performance. Here are some key initiatives to bring about the desired change:

  • The government should refrain from appointing directors except for maybe one nominee; all other directors should be chosen and put up for election by the shareholders on the recommendations of the Nomination Committee of the board.
  • Except the Managing Director/CEO and other whole-time directors, all others should qualify as ‘fit and proper’ independent directors per listed company norms.
  • All directors (including any proposed by the government, besides the one nominee) should be put up for approval of shareholders; to be elected, the candidates should receive the affirmative support of a majority of all the shareholders voting, including a majority of the non-controlling shareholders.
  • The position of CEO and board chair should be separated in all public sector banks; the board chair should qualify as an independent director; the CEO/Managing Director should be proposed by the nominations committee, in consultation with (and not necessarily with concurrence of) the controlling shareholder and the appointment should be approved by a majority of all shareholders including a majority of non-controlling shareholders as in the case of independent directors.
The board members should elect one independent director among themselves as the board chair to hold office in line with SEBI norms.
  • The board should be fully responsible for governance in line with the best practices and also in consonance with the business principles agreed with the controlling shareholder (to be conspicuously displayed on the bank’s website and included in annual reports to shareholders),and be accountable to the shareholders for performance in full compliance with all applicable laws and regulations.
  • Internal audit and control mechanisms—including effective monitoring of risk management in accordance with the policies approved by the board—should be instituted and regular feedback and assurance mechanisms put in place.
  • The delegation of financial authorities should be adequate for the smooth and competitive conduct of business with any deviations in practice being brought to the board for consideration and approval.
Given the advances in communications technology, transactions beyond the delegated authority of the executive should be tabled in video meetings of the board or its specified committee of independent directors for consideration and approval.

Also Read: Government May Revaluate Bank Recap After PNB Fraud

Bank-Government Interface

It is not anybody’s case that the government, as the controlling shareholder, shouldn’t have anything to do with its promoted entities. On the contrary, like any other parent body, the government should lay down requirements for information and review and share them with the management and the board. Day-to-day interference and influencing managerial decisions are what is sought to be drastically minimised if not altogether eliminated. The government should set an example of how a controlling shareholder should interact with its controlled companies, for the private sector to emulate. This may not happen all at once, but at least baby steps could be initiated towards reaching the objective, over say a couple of years.

N Balasubramanian is Founding and Former Chairman of the Indian Institute of Management Bangalore Centre for Corporate Governance and Citizenship. He was an adjunct/visiting professor at IIM Ahmedabad and Bangalore.

The views expressed here are those of the author’s and do not necessarily represent the views of Bloomberg Quint or its editorial team.

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