Corporate Governance in Commercial Banks
CORPORATE
GOVERNANCE IN COMMERCIAL BANKS
(Edited version of this article appeared in business line on 24.05.2012. The link is
Reserve Bank of India
has informed that a Master Direction on governance in commercial banks, based
on the “Discussion Paper on Governance in Commercial banks in India”
(discussion paper), will be issued in due course. As an immediate measure, the
regulator issued operative guidelines with regard to appointments of MD &
CEO, WTD (Whole time Director), Chairperson, NEDs (Non-Executive Directors) and
composition of important committees like ACB, RMCB, NRC, etc.
A
brief on the Discussion Paper: In this regard, the
main objective of the discussion paper (according to RBI), is to align current
regulatory framework with global best practices, having due regard to the
relevant guidelines issued by BCBS, FSB and BBB (Banking Boards Bureau), while
being mindful of the context of domestic financial system. Though the aim of
corporate governance is to maximise return on the capital invested by the
shareholders, in financial intermediation, this objective is predominantly
realised through raising of financial resources from depositors and other debt
providers. Hence, financial
intermediation involves a grant of public policy and public utility privilege,
which comes with a higher order of accountability. Taking this factor into
account, the discussion paper set higher aspiration standards so that
implementation of such standards will create positive impact on the providers
of financial resources.
The paper recommended empowering
the board of directors to (i) set the culture and values of the organisation
(ii) recognise and manage conflicts of interest (iii) set the appetite for risk
and manage the risks with that appetite and (iv) improve the supervisory
oversight of senior management. Such an empowerment will enable to transmit the
“tone at the top” to “tone at the middle” and throughout the bank. The report
recommends well-defined organisational responsibilities for risk management,
referred to as ‘three lines of defence’.
-
First line of defence – Independent
robust finance function within the business unit
-
Second line of defence – An independent
risk management and compliance function to oversee, monitor and evaluate risk
activities in the business unit, and also given responsibility to play an
advisory role to promote risk culture within the business
-
Third line of defence – Internal Audit
and Vigilance function to provide objective assurance to the board on the
effectiveness of the bank’s first and second line of defence over the business
unit
Whether
Rosy Days are ahead? The discussion paper as well as
the recent circular on appointments of directors and constitution of important
committees gives much importance to the roles of independent and non-executive
directors in developing an efficient and effective ‘corporate governance model’
in banks. While the theory aspect looks sound for documentation purposes, the
spirit in implementation lies in how the written rules are practiced in
reality. Kumar Mangalam Committee, which submitted its report on corporate
governance in listed entities in 1999 (which paved the way for SEBI’s section 49 of the listing agreement) remarked
thus:
“The imperative for corporate governance lies not merely in drafting a
code of corporate governance but in practising it and the best results would be
achieved when the code is treated not as a mere structure, but a way of life”
How to achieve this?
Probably the regulator and the banks may have to bring qualitative changes in
the way the corporate governance recommendations are practiced in the
banks. I am looking at some of them.
1.
Board
Agenda: The role of Chairman and Managing Director has
been separated in many banks including PSBs following the recommendations of PJ
Nayak Committee, which submitted its report in 2014. The main aim of this move
was two. One to ensure that the meetings are conducted to take up items, which
are board driven and not senior management prepared. Second to devote the
precious time of the board on quality issues and not on rudimentary. (PJ Nayak emphasised that the board should
concentrate on business strategy, Financial Report and their integrity and Risk
only). If the annual reports published
by the public sector banks are any goby, one feels that the agenda items in the
board are even now management directed. Time taken for completion of calendar
of reviews is one example. Another is the income earned on non-core banking
activities like sale of third party products (insurance, mutual funds, etc.),
which form a miniscule of the total income in many banks especially PSBs. To
achieve this, significant level of staff strength is used. This business
strategy of the senior management is seen approved year after year by the board
of many banks, apparently without any major discussion.
2.
Role
of Directors:
Knowledge:
Attending a board meeting in a bank is totally different from attending similar
meetings in manufacturing, service oriented companies. Even among the finance
institutions, a bank is a different concept altogether. Independent and
non-executive directors (NED) join from different walks of life. They can only
be the members of the Audit Committee Board (ACB) that discusses the financial
and internal/external audit report before it is sent to the board for approval.
They form the majority in RMCB (Risk Management Committee Board), which takes
up the capital adequacy, liquidity needs apart from the policies to be drafted
on the various risks in the banks (operational, credit and market risks). Hence ‘orientation training’ prior to joining
the board and periodical ‘continuous education’ are absolute essentials.
Attitude and Involvement:
While imparting adequate training is necessary to those directors who come from
non-finance back ground, one also finds a lot of reputed names in bank boards,
who had a distinguished banking career with the regulator, major banks and
other financial institutions. Apart from supporting the MD & CEO in the
business strategies brought to the table, one expects them to play a proactive
role in evaluating the risk policies practiced, effectiveness of internal
control mechanisms and discussions with external/internal auditors, once a year
at least, on the concerns noticed. With due respects to all of them,
·
the happenings in a private bank, which
was rescued with investment plans from a group of public and private sector
banks last year (as directed by the regulator) and
·
the conflict of interest/ undue benefit
allegations cast on an MD & CEO of a large private bank two years back
did
not inspire the public that the reputed persons occupying the board, in those banks, played their role effectively.
3. Conflict of Interest: The
guideline says that whenever there is a conflict of interest, the board member
concerned shall refrain himself from voting. This should be changed and the
board member shall absent himself from the board proceedings, when the conflict
of interest issue is taken up by the board. Only in the absence of that member,
the other board members will feel encouraged to share their opinion in a more
forthright manner.
4. Audit Committee of the Board: ACB’s role flows directly from the board’s oversight function. It acts as a catalyst for effective financial reporting. Financial results of the banks have become more complex now. One can cite many instances of ACB meetings held by PSBs, without a qualified financial literate in such boards. This defeat the purpose of ACB, as even the well informed members who have only an understanding of financial matters might prove to be just novices before a well prepared CFO.
Quality
of Internal Audit and all forms of external audit reviews and remedial measures
thereof is another important function played by ACB. Asset Quality Review
conducted by RBI in 2015-16, which resulted in the commercial banks adding more
than Rs. 5 lac cr. in 2016-17, exposed not only the banks but the
ineffectiveness of internal/external audit and statutory auditors in
identifying hidden stressed assets and provisions thereon. Similarly, the huge divergences in GNPAs and
resultant provisions after conduct of RBI audit, in many banks, points to the
‘not-so-independent’ functions of the internal/external audit. Nothing is on record to suggest that the ACBs
of the concerned banks took note of such divergences and submitted their
recommendations for a comprehensive review of the ‘system- enabled’ NPA
identification process.
5. Risk Management Committee Board:
RMCB is responsible for framing policies on credit, operational and market
risks. It also manages the asset
liability mismatches through conduct of ALCO at regular intervals. The capital
needs and liquidity requirements are put up to RMCB. Along with the policies on
the various risks enumerated above, it also peruses an important document
called ICAPP (Internal Capital Adequacy Assessment Process) in the first
quarter of every year, which details the various stress scenarios and the
capital position of the bank in relation to risk weighted assets. All the
documents are reflection of text-book excellence, aligned in line with
regulatory prescriptions and are quite voluminous also. Majority of the members
are from NED/independent director category.
Most of the meetings of RMCB were conducted on the day/one day prior to
board meetings, in order to save travel costs in the past. Risk Management,
which is vital to the health and survival of the organisation, is not given the
importance it deserves. It is high time,
that the academically brilliant policies/reports are accompanied with user
friendly summary so that members of RMCB appreciate and make a better
understanding of the issues involved. Instances like Letter of Comfort fraud in
a single branch of a large PSB for Rs.11500 cr. brought to light that the ‘forexwing’
IT system and the ‘main’ IT system were not seamlessly integrated and the audit
trail in manual mapping was absent/faulty for so many years. It was a
revelation that RMCB was not aware of such an issue involving operational risk
or was not apprised properly by the senior management in the meetings.
6. Separation between board oversight
and executive autonomy in banks controlled by promoter directors: Last
year, appointment of MD & CEO recommended by the board and approved by RBI,
were rejected in the Annual General Meeting of shareholders in two private
banks. It was generally believed that promoter directors had an active role in
such instances. As the board’s oversight is likely to exceed defined borders
and may well encroach on management functions, the regulator shall make clear
mandate to separate board oversight and executive autonomy in banks controlled
by the promoters or holding a dominant share thereof.
Role
of the Government: PSBs continue to occupy a major space
in the banking business today, having more than 70% share in total deposits and
60% share in gross advances. In addition to the general corporate governance
practices governing the commercial banks, radical reforms are needed from the
government to make a material improvement in the governance of PSBs. It is
worthwhile to consider implementation of the following recommendations of P.J.
Nayak Committee to create a level playing field for PSBs to compete with
private players.
Ø Setting
up of a BIV (Bank Investment Company) to hold the equity stake of the
government in PSBs
Ø Dual
regulation (of both the government and RBI) in PSBs to be replaced by sole
regulation under RBI
Ø The
government’s pursuit of development objectives should be done in consultation
with RBI and shall be applicable to all the banks.
Ø Bank
Boards Bureau (BBB) to be empowered to recruit Chairman, MD & CEO, EDs and
other directors, instead of submitting recommendations to the government.
Ø RBI
should withdraw its directors from the PSBs
Ø External
Vigilance enforcement through CVC and CBI and applicability of RTI act should
be scaled down
V.Viswanathan
CGM Retd
State Bank Group
10th May
2021
The above article appeared in Business Line on 24th May 2021. The link is below
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