PSB Goverance

Crisis in PSBs - I: What is the Responsibility of the Government as the Owner?

Moneylife Digital Team
29 July 2019

The government-owned, or public sector banks (PSBs), which are under severe stress, require an urgent surgical strike. Bulging non-performing assets (NPAs), increasing frauds, and declining credit to the key sectors is worrying. Moneylifehas laid bare many of the frauds and misdemeanours of the commercial banks that included Syndicate Bank (2014), Bank of Baroda (2015), Punjab National Bank (2017), to mention a key few. The free ride of businessmen started eroding confidence in banks due to questionable lending practices in PSBs.

 The rot goes deep. For example, what are the answers to these questions?

1. All limits above Rs5bn should be sanctioned by the board duly overseen by the risk management committee. Banks also have internal audits, statutory audits and financial inspection of banks by the Reserve Bank of India (RBI) annually. Then how were such limits sanctioned without due diligence of directors on the boards of top-12 defaulting companies referred to the Insolvency and Bankruptcy Code (IBC) in 2017? What role did various committees play during the currency of the loan?

2. Even after the roles of managing director (MD) and chairman are separated, why couldn’t the non-executive chairman provide the required guidance to the board in enforcing accountability and transparency?

3. Why did the banks fail in due diligence of directors of the companies to which they sanctioned loans? It was noticed in several cases that the directors held suspicious transactions with other boards or companies but did not go on record as such. Integrity of the borrowers was taken for granted, going by the way banks nurtured the accounts.

4. Why and how were the banks allowed to hold the accounts with recovery actions far beyond 90 days in regard to all the major corporate advances?

5. When the RBI is represented on the board and with data on non-performing assets (NPAs) and corporate advances and the analytics of the financial stability reports coming out every quarter, why could it not contain the contagion of NPAs?

6. Why couldn’t the RBI director on the board insist on the audit committee to steer clear of acts that led to prompt corrective action (PCA)?

7. All the banks are subject to risk based supervision by the RBI. Then how could the banks manage such supervision and yet hide the processes that led to the frauds that surfaced later?

8. What is the role played by the nominee director of government of India in the board approvals and the NPA status of the bank concerned? 

9. Did the board of any bank give a strategic direction to the MD and monitor such direction subsequently?

10. When government of India (GoI) directed merger of associate banks with State Bank of India (SBI) or later the merger of two other PSBs with Bank of Baroda, fait accompli, the boards passed a resolution favoring the mergers and the consequences and the impacts on customers and other stakeholders were hardly discussed and there were also no voices of either concern or dissent. The role played by independent directors becomes significant in such situations. 

Clearly PSBs are facing a huge goverance deficit. Year after year, volumes involved in frauds have only increased, notwithstanding the existence of internal chief vigilance officer, external vigilance commission, system audit, risk audit, stock audit, concurrent audit, and annual internal inspections by the banks’ own audit team, external statutory audit, forensic audit and the annual audit of the bank by the RBI approved chartered accountant firm. PNB fraudsters successfully hoodwinked all of them. 

The question is: What is the role of the owner, regulator and controller of PSBs? The government has announced recapitalisation to the extent of Rs211,000 crore to meet the regulatory capital requirement once Basel III becomes operational (Basel III implementation date has since been extended to April 2019 from April 2018).

The present finance minister, sailing with the wind, again provided another Rs70,000 crore capitalisation in the next nine months.

Many experts feel that good (taxpayers’) money is flowing to the bad (crooks) with no accountability.

Although the government seemed to recognise the need for reforms, it fell short of introducing the structural changes suggested in the report. At the root of the rot lies poor governance and the absence of ethics. Ethics took a hard beating and governance is in utter disarray against the backdrop of unlearnt lessons of similar past offences, both within the bank and outside. Bad banking has now become a major concern of the body politic. 

It is the boards that should make the difference between the most successful and the unsuccessful corporate, whether in banking or elsewhere. Managerial efficiency, risk management systems and efficient governance require urgent attention. 

The Financial Times had held a series of debates in 2013 on better boards and corporate governance. The strong message that emanates from the debates is that fewer rules and more significant consequences for breaking them would make a lot of sense. Further, it is not good to have one-size-fits-all approach to corporate governance and the organisations should be empowered to craft their own systems of governance.

Narasimham Committee-1 made some significant recommendations regarding governance that would require a re-visit.

Ownership Issues

SBI has its chairman, MDs and deputy MDs (DMDs) as members of its board. PSB boards have been reconstituted in line with the recommendation of PJ Nayak committee with MD and non-executive chairman as two separate positions with both of them requiring the approval of the RBI. 

MD of PSBs are selected by banks board bureau (BBB) since 2015. BBB proved not so effective with long delays in filling the top positions of several banks and overbearing influence of ministry of finance (MoF) in the selection process. SBI post-merger and PSBs have individual shareholders who include even employees and retired employees of the banks as minority shareholders. This status involves the issue of protecting the interests of minority shareholders as well.  

Ownership, governance and regulation have created inconvenient compromises in the PSBs. The roles of owner and regulator combined in GoI have a built-in conflict. The presence of RBI in banks’ boards is further conflict of interest. The Narasimham Committee -1 recommended 25 years ago that RBI should dissociate itself from bank boards. This obvious step has still not been taken.

The role and functions of the ethics committee have not been well defined. The board should have full authority for appointment of statutory auditors with no role for the RBI. But going by the experience of the failures of banks such as the Global Trust Bank Ltd, RBI decided that the auditor firm should be from its approved list. 

The GoI has a strong lock on the banking sector but talks of competition in banks, independence and autonomy. It plants its officials from the finance ministry as directors on PSB boards. At best, these nominated directors carry the proceedings with their own interpretation to the ministry, and such interpretation may cause some unintended consequences to the banks they serve. 

How Do We Avoid Conflict of Interest?

A governance code could have guidelines for the management on its behaviour patterns because it is they who are running the institution and making the day-to-day decisions and their behaviour will be of greater consequence to the functioning of the bank than that of the board that meets at pre-determined intervals. The ‘comply and explain’ requirements should be very clear and unambiguous. Non-negotiable rules would lessen the complexity of corporate governance from the investors’ perspective. 

In India, unlike in some European two-tier boards and unlike in UK, the boards of PSBs, provide for employee representatives too on boards from the workers and officers.

Although several PSBs in the wake of financial sector reforms allotted shares to their employees it is not necessary that the workmen directors need be shareholders. Systems of governance should be focused on empowering front-line staff—rather than trying to keep them in check, even the  debates in Financial Times concluded.

Though stakeholders’ interests should weigh more than those of the shareholders, it is the lack of ownership culture among this set of non-executive directors (NEDs) that results in their performance below the expectations of the group they represent and that should cause worry. This constituency of stakeholder on the board needs careful treatment and nurturing. Employees and pensioners would be a growing constituency and they should have a place in the board as part of minority interests’ protection. 

Audits and Audit Committees

Banks that complain of multiple audits interfering with their business could not justify the concern due to the alarming rise in financial irregularities and poor credit risk management. Systems have become vulnerable to intrusions putting the banks to losses not seen before. Therefore, system audits have assumed critical importance. 

The complexities of the systems are on the increase with increasing role for them—both in operational and instructional matters. There is a growing trend of addressing any customer grievance only through an instruction embedded in the system. Almost all banks have been generating only e-circulars. The employees and managers hardly go through them save exceptions – those in the regional/zonal/head/central offices. The ability of the banks to put them to institutional learning periodically is also dwindling. Learning mechanisms seem to have been severely impaired. This leads to unnerving top management not generally admitted in public but discussed internally. The board has a responsibility through the HR (human resource) committee to resolve such a dilemma. 

Need for an Independent Director with knowledge of Technology 

The world over, technology risks and cyber risks are overcrowding the banks and financial institutions. Michael Bloch et al of McKinsey in their "Elevating Technology to the Boardroom Agenda Report (2012)" insists that the boards call for periodic reviews of technology’s long-term role in the industry by pushing the IT jargon the background and bringing in the right people to the board meetings for discussions on technology adoption. 

Leveraging technology savvy board members and strengthening technology governance structure by delegating the related risk issues to the board committee that oversees the risk management portfolio are some of the key suggestions worthy of consideration.

Good Governance Requires More Than Rule Fixes

Universal banking that permitted the banks to take to finance housing, real estate, retail loans, and sell third-party products, like insurance, mutual funds, pension funds etc, followed by digital banking, has made banking a non-core activity with overwhelming incentives for performing non-banking functions. 

Banks insure their own assets with the general insurance companies. Bank employees are expected to handle the banking products of deposit, credit and investments and not insurance and mutual fund products. 

Boards were silent spectators when the banks were measuring executive and employee performance based on the earnings on third-party products. 

During 2018, MoF directed the banks not to pass on any incentive for selling third-party products to any employee or executive and the benefit of such business should be accounted for in the profit of banks. Thereafter, PSBs started refocusing on banking business. Performance evaluation criteria should be overseen by the board. Boards, therefore, have a serious challenge in HR management oversight.

RBI should approve those directors on bank boards who are of impeccable integrity and unquestionable character, with no role conflict at any point of time.

The ‘fit and proper’ criteria prescribed by the RBI need revision. It is desirable that the selected person should be asked to give a two-page write up on his knowledge of the board functioning; his intended contribution, and his relationships with the other directors on the board and of his views on the present management, as a third eye from the published data and information, as obtaining with the Netherland banks. 

This statement can be reviewed by the regulators who may even seek clarifications where necessary before confirming the appointment. Knowledge and culture are two different aspects though synchronisation would enhance the value of the person. Such a write-up from the prospective director, therefore, can help in self-assessment of the director and performance assessment of the board itself eventually.

The annual general meetings (AGM) should not end up as the presentation of the audited statement of accounts to the general body; it should have group discussions of the shareholders on wide ranging issues like the strategies, risk appetite and risk culture in the organisation. In the alternative, it is also worthwhile to have board retreats for two days annually for self-evaluation and the way forward prior to the AGM and have at the AGM a synopsis of the discussions in the retreats,  as a guide for future.

It is the banks that could alone answer these questions as board documents are confidential. The best way to prevent such transactions is to strengthen corporate governance by the regulators/supervisors at once disassociating themselves from being on the boards of all categories of banks.

*The Author is an economist and Risk Management specialist. These series of articles are the abridged version of the NIBM Conference (July5-6, 2019) Paper on “Good Corporate Governance – the Best way for resolving the Indian Banking Crisis”. The views are personal.