A new governance framework for banks

The current crisis in the banking sector provides a good opportunity to clean up the mess and put the house in order

The recent banking scams have led to an understandable sense of outrage as it involves issues of propriety and governance.

The irony is that what started off as a problem with PSBs, which had the critics and private bankers argue for privatisation – has come a full circle with the focus now shifted to private banks. As this story involves several elements — the government, central bank, banks and other stakeholders — this is a good opportunity to get the house in order.

Any kind of financial crisis offers an opportunity for introspection where rules can be reformulated to bring them in sync with the new order. It is necessary to continuously revisit systems, laws and practices and bring them up to date.

But it should be highlighted that none of the irregularities witnessed recently has involved any loss to any deposit holder and even the share prices have reverted to their arithmetic mean.

The banking scams have brought to focus not just the lack of transparency in the functioning of banks but also that of audit and inspection practices.

Also the allocation of responsibility for identifying and ensuring remedial action is nebulous and needs to be delineated now.

There is now a blame game on, where the question is — why has a concerned party not looked at a certain aspect of the controversy?

The debate has taken on a moral tone, but the questions raised cannot be refuted or dodged. But certain clear lines of thought can be put down and the new rules can be formulated so that there is less ambiguity in future.

Banks’ perspective

Let us look at the issue from the point of view of banks. First, in a private bank who is to uphold the moral responsibilty?

Is it the CEO, or executive Board members or the non-executive Board members? This issue is important because whenever there is a conflict of interest, it has to be clear as to which executives are to be held accountable.

Now if it is the CEO who is accountable, then does that imply that none of his relatives can have any credit dealings with the concerned bank?

This seems unreasonable and one way to get around this problem would be to disclose the financial dealings of the relatives, if any, in the Annual Report or the bank’s web site.

By making such disclosures upfront, the bank can ensure that no questions are raised in future.

Hence greater transparency is the key to avoiding such ‘conflict of interest’ issues.

Second, the performance of bankers has come under the lens now which was never the case before. Can the central bank or the government have a say in the salary package of a private company? The answer is probably ‘no’ because in the private sector Boards take a call on this issue.

There are no penalties for the government officials non-performance and their tenures are safe. If regulators fix or approve pay packages of the regulated, then that should hold good for all industries. So whenever companies make losses, the regulators should hold back bonuses – but this doesn’t seem reasonable.

What happens then in the telecom, power or petroleum sectors? Therefore, this should also be debated and the rules must be clearly laid out.

CEO tenure

Third, the tenure of the CEO is always open to debate. Allowing anyone to carry on for more than a term of say five years is a call taken by shareholders or Boards.

But allowing such extensions also lead to creation of power centres affecting the grooming of second rung leaders.

Ironically in PSBs, CEOs have short terms as they get their positions closer to retirement while in private banks they begin their tenures at an early age – and can often get a stint of more than a decade before they retire.

This is also an issue that needs to be looked at as it has given rise to controversies in recent times.

Regulator’s perspective

From the regulator’s side, the issues that need to be addressed are:

First, the responsibility of the Boards should be clear on issues of governance and any deviance from regulation or conflict of interest should be discussed at this level.

Second, the presence of a nominee director of the regulator on the Board, though controversial, is justified as he is the ‘ear of the public’ and ensures that all compliances are in order.

Third, when audit reports are carried out on banks, the lacunae or important findings should be made public so that everyone is aware of them. It can be put up on the web site of the regulator or the concerned bank.

This is one way of ensuring that banks become complaint.

Fourth, as a practice of good governance, the regulators too should disclose on their web sites the names of the relatives of the senior officials who are employed with the regulated entities. This will add to transparency in operations of the system.

Lastly, any deficiencies in compliance should be reviewed within a specified period of time and highlighted to the public so that it puts pressure on the bank to perform. Therefore, as was in the case of a bank where audit had pointed out that the core banking system did not capture the SWIFT data and no action was taken, it should have been made known to all.

Otherwise the purpose of audit and inspection becomes a closed affair which remains hidden until a crisis emerges.

So this is the right time to take the necessary action in revising the rules and regulations concerning the functioning of banks, their boards and CEOs.

Rather than getting over obsessed with moral issues, a practical way would be to strengthen the regulatory framework and review it every two years based on the banks’ response. More importantly it has to be revisited periodically – maybe every 3-5 years.

The writer is Chief Economist, CARE Ratings. Views are personal

Source - The Hindu Business Line