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