Transcript Market Failures

Improving the Governance of India’s
Public Sector Banks
Presentation by : Dr. R. H. Patil
Chairman The Clearing Corporation Of India Ltd.
At
India’s Financial Sector Conference GOA,
November 1 - 2, 2002
Financial Fragility
 In Asia Japan and China are interesting cases
 Chinese situation more serious than Japanese ownership matters
 China’s banks insolvent. Japan NPA’s at $ 1.25 trillion
or 8% of GDP 30%of advances ($518bn)
 Indian scene less alarming because of high SLR/CRR
as also financial sector smaller in relation to GDP
 Post deregulation experience mixed : Successes and
Failure in both sets
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Special Features
 Corporate Governance in Financial Sector poses
special problems.
 Unlike the real sector, the resources can get tainted very fast
and with less visible signs.
 Vulnerability because entities are highly leveraged.
 Bulk of the literature on CG discusses the issues from non
financial sector perspectives
 Even BIS skirts the issues of ownership and lays emphasis
on risk management etc
 Possibly because it accepts the OECD Principles
 Unitary vs two – tiered board structure
 RISKS that FINANCE SECTORS OFTEN BECOMES PONZI
SCHEME SECTOR
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Ownership & Management
 A priori ownership should not matter.
 Experience shows high vulnerability irrespective of
ownership character
 Critical factors are Quality of CG and transparency
 Quality of CG is crucially dependent on quality of
board.
 Conflicts of interest in private sector ownership difficult
to avoid. It is not only taking loans to group companies
that is the risk. But business strategies may also be
biased against certain industries/sector/business
groups
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Constitution of PSB Boards
 The BR Act & the Bank Nationalisation Act Determine
Composition of Boards of PSB’s
 Not Less Than 51% of the Board Members having Practical
Experience in Accountancy, Agriculture, Rural Economy,
Banking, Co-operation, Economics, Finance, Law, SSI, etc.
 Of these not less than 2 with practical experience in Agriculture,
Rural economy, Co-operation, & SSI
 Shareholder Directors in PSB’s in proportion to Issued Capital,
but with Limit of 6 Nominees
 Selection Process of shareholder directors is Akin to That of
Family Controlled Companies
 Boards of BSBs & SBI constituted by GoI in Consultation With
RBI
 CMD & EDs Appointed by the GoI
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Public Sector Banks
Layered, hierarchical, principal-agent structure.
Civil servants often act as agents & Labour
unions step in to establish, “proprietary right”.
Boards should be empowered with Government
transparently issuing guidelines, directives etc
Government should shift from controlling
management
actions
to
monitoring
performance results.
Adopt arms-length approach and give full board
autonomy
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REASONS FOR POOR
PERFORMANCE OF BANKS
 As per the Banking Companies Act Powers of “General
Superintendence, Direction and Management” vest with
the Board
 But There in No Board Accountability Since Board not
Empowered De Facto
 Invariably Board Dominated by the GoI & the RBI
Directors who are more Equal
 Govt Often Going Beyond the Act viz., Policy Matters
Involving Public Interest (Sec 8). Govt Controls even
Selection & Promotion of Senor-level PSB staff
 Govt Has Total Control Over Banks & Boards Play
Invariably a Convenient/Marginal Role
 Day-to-day Control Saps Initiative and Entrepreneurship
on the Part of Management & the Board
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INADEQUACIES IN APPOINTMENT
OF BOARD MEMBERS
 Necessary to Effect Amendments to Statues to Improve CG.
Until then
 Introduce Desirable & Doable Practices for Enhancing CG
 Have Three Full-time Directors Since Banking Is a Complex
Business
 Chairman Should Not also be MD—Hence Separate the Posts
of Chairman & MD
 Boards Should Have Nomination Committees to Recommend
Induction of Independent Directors
 The Appointment Process should become more Professional
Rather Than Political
 Board should have Supervisory Committee, Remuneration
Committee, Audit Committee, Nomination Committee,
Shareholder Redressal Committee & Risk Management
Committee
 Scrap Sec 20 of the BR Act to enable professionals to Join
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Boards
BOARDS BE NEED BASED RATHER
THAN REGULATION BASED
 Banking More Complex & Knowledge-based Needing Board
Members Who Are More Contemporarily Professional,
Technically & Specially Qualified
 Blend of Historical Skill Set & New Skills Set (Technology,
Risk Mgt, Treasury Operations, Strategic Planning, etc.)
 Ganguli Cmt recommends Panel of Directors Should Be
Prepared by RBI, while Patil Adv Grp Wants a Group of
Eminent Persons to Do the Job
 Boards Should Be Distanced from the Mof-GoI so that
Boards are Truly in Charge of Governance
 Both RBI & GoI Should not Appoint their Officials on the
Boards of Banks Since it has Created Asymmetric
Distribution in Power Among Board Members
 Improve Board Remuneration to Contemporary Standards to
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attract Qualified & Competent Persons
Constitution of Board
 Set up Independent Selection Board ( ISB ) of
eminent persons – more like UPSC
 Decisions of ISB should be final and Government
only to issue appointment of CEO’s.
 ISB to prepare a panel for other board positions
 Initially Constitute Boards and later Appointments
Committees of the boards to fill subsequent
vacancies.
 ISB to supervise subsequent process and adopt
policy of management by exception
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Regulatory Clarity
 Government to give up multiple roles – owner ,
manager, quasi-regulator and sometimes super
regulator.
 Introduce equality among board members.
 Audit Committee to concentrate on audit of
management policies, internal control mechanism,
risk management policies and implementation
effectiveness.
 RBI should remain only as regulator and not
appoint the nominees on the boards.
 Do away with the system of directors representing
sectional interests.
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The board should fulfil certain key
functions, including:
 Reviewing and guiding corporate strategy, major
plans of action, risk policy annual budgets and
business plans; setting performance criteria/goals
 Selecting, compensating, monitoring and, when
necessary, replacing key executives and overseeing
succession planning.
 Reviewing key executive and board remuneration
and ensuring a formal and transparent board
nomination process.
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Monitoring Financial Activities
 Monitoring and managing potential conflicts of
interest of management, board members and share
holder, including misuse of corporate assets and abuse
in related party transactions.
 Ensuring the integrity of the corporation’s accounting
and financial reporting systems, including independent
audit, and that appropriate systems of controls are in
place , in particular systems for monitoring risk,
financial controls, and compliance with the law.
 Monitoring the effectiveness of the governance practice
under which it operates and making changes as needed
 Overseeing the process of
disclosure
and
communications.
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Transparency & Objectivity
 The board should be able to exercise objective judgement
on corporate affairs independent, in particular, from
management.
 Board should consider assigning a sufficient number of
non-executive board members capable of exercising
independent judgement to tasks where there is a potential
for conflict of interest. Example of such key
responsibilities are financial reporting, nominations and
executive and board remuneration.
 Board members should devote sufficient time to their
responsibilities.
 In order to fulfil their responsibilities, board members
should have access to accurate, relevant and timely
information.
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THANK YOU
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