Corporate Governance in Banks

The global economic crisis which started in the year 2007 has compelled political authorities in many countries to examine the role played by banks in causing the mayhem.Predictably, the main focus has been on limitations of corporate governance in banks and other financial institutions. In the UK, the Chancellor of the Exchequer appointed in February 2009 Sir David Walker, a former financial services regulator, to carry out a thorough review and to make recommendations for improving what should be the first line of defence against economic meltdown, namely corporate governance. The Chancellor lamented that standards of corporate governance were not healthy enough to check the reckless risk-chasing indulged in by bank executives.

Report and its significance : Sir David Walker released a Consultation Document titled "A review of Corporate Governance in UK banks and other financial industry entities" on 16 July 2009. This is a comprehensive report incorporating preliminary recommendations on various aspects of governance including 1) Board size, composition and qualification, 2) Functioning of the Board and evaluation of its performance, 3) the role of institutional shareholders, 4) Risk Governance and 5) Remuneration.

Expectedly, the report has already attracted criticism from various quarters. It is worthwhile studying the report with the twin objectives of knowing (a) whether recurrence of a similar crisis in future can be prevented and (b) relevance of the report to India. It is note-worthy that after meeting the chiefs of major banks in connection with First Quarter Review of Monetary Policy for the year 2009-10, the Governor of Reserve Bank of India issued a press statement wherein he emphasised the importance of governance in following words: "A big medium term challenge is to improve the investment climate and expand the absorptive capacity of the economy by giving a big thrust to Governance reforms , without which it is difficult to inspire the trust and confidence of potential investors". Earlier on 1st July 2009, RBI issued a master circular on corporate governance which inter-alia states," The need for good corporate governance has been gaining increased emphasis over the years. Globally, companies are adopting the best corporate practices to increase the investors' confidence as also that of other stakeholders". It is clear therefore that RBI is keen to benchmark governance standards of Indian banks with global best practices. Hence, studies on corporate governance in the UK and other countries are relevant for our country also.

Sir David Walker has observed that it is clear that governance failures contributed materially to excessive risk-taking in the lead up to the financial crisis. He is further of the opinion that weaknesses in risk management, Board quality and practices, control of remuneration and exercise of ownership rights need to be addressed in the UK and INTERNATIONALLY to minimise the risk of a recurrence. However, he acknowledges that better governance alone will not guarantee that there will be no repetition of the recent highly negative experience for the economy and for society as a whole but will make a rerun of these events materially less likely. In other words, corporate governance is a necessary but not sufficient condition for preventing global economic crises.

The report contains 39 recommendations ; the more significant among them are discussed below with relevance to India.
Role of non-executive directors : The report recommends that in order to ensure that NEDs (non-executive directors) have the knowledge and understanding of the business to enable them to contribute effectively, the Board should provide "thematic business awareness sessions" on a regular basis which may be reviewed by the chairman every year. Indian experience in this regard is different. Non-executive directors in our banks ( and other industries also) are generally well versed with the particular business. Unfortunately, they feel obligated to promoters or appointing authorities and this psychological nexus has prevented the non-executive directors from maximising their contribution. It speaks ill of corporate governance that banks' top managements take active interest in election of their favoured candidates as representatives of shareholders. Such "favoured" non-executive directors cannot be expected to be objective in their role. It is high time that RBI admonished banks suitably in this regard.

Chairman and the Board : The report expects the chairman to commit a substantial portion of his time, probably not less than two-thirds, to the business of the entity. In India, chairpersons of public sector banks are full time appointees. The governance problem here is that the same person wears two hats, one as an executive and the other as the chair of policy-making Board. RBI is advising private banks to split the post of Chairman-cum-Managing Director. This has already been done in some private sector banks. It is to be seen how much time is spared by non-executive chairman for affairs of the bank.

External assessment of Board's effectiveness : One salubrious recommendation proposes a formal and rigorous evaluation of Board's performance with external facilitation of the process. This is very much desirable for effective governance though the modus operandi may pose many challenges. In India, effectiveness of Boards of banks is assessed by RBI through AFI (Annual Financial Inspection). This is done mainly from regulatory viewpoint. In addition, banks may pro-actively subject themselves to assessment by professional bodies like National Institute of Bank Management. This becomes all the more desirable because corporate governance should not be treated merely as a regulatory requirement. It is useful for a bank as competitive strength to enlarge its business because depositors and borrowers trust a well-governed bank much more than a bank which is lackadaisical in governance.

Expectations from institutional investors : The report explicitly expects institutional investors to play a sustained role rather than act as traders in equity. Sir David wonders, "Should we make it easier for long-only institutions to exert influence by having different weighted voting shares? Should shareholders get more voting oomph if they have held stock for a year?" This is a suggestion worth studying in the Indian context also. Institutions should be encouraged to play a more dynamic role in ensuring corporate governance. RBI will need to take a second look at ceiling on voting rights which is acting as a dampener to more active participation by institutions.

Transparency promotes better governance. The report expects fund managers and institutions to disclose their voting record ; it is also suggested that policies in respect of voting should be disclosed on their websites. A similar initiative in our country will help institutions like the LIC to avoid getting into governance issues in investee companies.

Risk Management : Management of risk is an integral part of corporate governance.It is a matter of pride for RBI and commercial banks in India that proposals made by Sir David Walker are already practised here.For example, the report suggests establishment of a Board-level Risk Committee separate from Audit Committee. This has already taken firm roots among banks in India. It is to the credit of RBI that it recognised long time back that Risk Committees need to be forward -looking unlike Audit Committees which are essentially backward-looking and therefore it advised commercial banks to set up separate Risk Committees.

The report also recognises the need for a Chief Risk Officer (CRO) who should partivipate in the risk management and oversight process at the highest level on an enterprise-wide basis and have a status of total independence from individual business units. Removal of CRO from office would require Board's prior approval. The Risk Committee should have access to external inputs to its work as a means of taking full advantage of relevant experience elsewhere.

It merits observation that though risk management system is well in place in Indian banks, there is a need for better coordination among banks so that they can learn from one another's mistakes instead of being forced to "reinvent the wheel".

Importance of risk management in banks and financial institutions cannot be over-emphasised. Weakness in risk management in banks - both commercial and central banks - was a major causative factor for financial meltdown. Though banks in India have weathered the storm without much systemic impact, RBI should not let its guard down but instead should learn from the experience of other countries. In this exercise, reports of various committees in different countries which study the economic malaise provide us food for thought.

Conclusion: Sir David Walker's consultative document addresses a plethora of issues impacting corporate governance in banks. RBI can use this as a sounding board to initiate serious discussions on governance. Since our central bank has already taken many credible steps to bolster corporate governance in banks, Indian banking system can easily become a pioneer in promoting healthy corporate practices.

Corporate Governance : Sir David Walker's Report

Sir David Walker has submitted "A review of corporate governance in UK banks and other financial industry entities " with 39 recommendations. He has done this at the instance of prime minister of UK. The report is interim in nature and will be followed by the final version in November.

Any report on corporate governance will attract myriad eyeballs ; therefore, we can look forward to widespread support and criticism of the report in the next few weeks. There are 5 recommendations covering Board size, composition and qualification, 8 on functions of the Board and evaluation of its performance, 9 on the role of institutional shareholders, 5 on Risk Governance and the maximum of 12 recommendations on Remuneration.

Some recommendations are path-breaking and are worthy of study and early implementation . For example, it is proposed that the Board should undertake a formal and rigorous evaluation of its performance with external facilitation. A commendable idea whose time has come ! All pay should be linked to performance (who can take exception to this Biblical statement?) and the payout of bonuses for top earners , i.e. those earning more than the median pay of executive directors, should be staggered over five years. Sir David claims that the recommendations on remuneration are "as tough or tougher than anything to be found elsewhere in the world". Obviously he has not studied the Indian Companies Act as it existed a decade back.

It is strange that the report recommends creation of a new role of Chief Risk Officer (is there no such person in British banks now?) answerable only to the Board as well as a new Risk Committee (why new?). It is recommended that the Board should establish a Board Risk Committee separately from the Audit Committee. Surprising that CRO, Risk Committee etc. are not yet institutionalised in the UK.

Expectedly, there is a lot of bloodletting on the role of non-executive directors (NED). NEDs , it is recommended, should spend more time doing their jobs - between 30 and 36 days a year - and have more professional and structured support including regular " business awareness sessions". Will it solve the problem? NEDs were derelict not because they were ignorant of business but because they were "obliged" to the promoters.

Institutional shareholders should comply or explain non-compliance with Shareholders' Code. Chairman should face re-election every year. Would not facilitating recall be a better tool?

Sir David hopes that the standards and disclosures recommended will set benchmarks for initiative and emulation elsewhere. One need not be a cynic to comment that there are benchmarks aplenty already but practices are woefully falling short.

It is interesting that Sir Christopher Hogg, Chairman of Financial Reporting Council, is presently undertaking a consultation on the Combined Code on corporate governance for all listed companies. Hence, we will soon be treated to another

well-written and highly readable report.

"How the mighty fall"

Jim Collins, the author of "Built to last" and "Good to great", has now written "How the mighty fall" which amply attempts to correct the unwarranted optimism of earlier books. His categorical observation in the new book that "Whether you prevail or fail, endure or die, depends more on what you do to yourself than on what the world does to you" indicates that he is into oriental literature of late.

He diagnoses five stages in deep descent of companies from glory to shambles. The stages are hubris, undisciplined growth, denial of risk and peril, urge for transformational acquisitions and finally death. Is the author trying to preempt criticism of his earlier works? Good tactics ! I believe that the new book's title best describes the predicament of the author also.

Robert S. McNamara

Robert Strange (yes, his middle name is indeed Strange) McNamara is no more. He contributed enormously to the success of Ford Motors and to statistical management. But he will be remembered more for the messy Vietnam war. He was Secretary of Defense under J F Kennedy and L B Johnson. He has been held atleast partially responsible for the ignominious Bay of Pigs invasion and Vietnam blunder.

An MBA from Harvard, he pioneered what may be christened as misanthropic misadventures. Vietnam war which resulted in mortality of millions was the military equivalent of economic meltdown. His successor MBAs from Harvard have ensured over-financialisation of economy resulting in economic apocalypse.

Judicial somersault on political interference

Justice Reghupathi's open-court reference to ministerial pressure on him has taken an expected anticlimactic turn. He has informed the High Court Chief Justice that no union minister directly spoke to him. Hon. CJ of the Supreme Court who was earlier vociferous against political pressure has now softpedalled the issue saying there is nothing to suggest that the minister had called the judge.

It is not difficult to conclude that there has been intense pressure to ease the minister off the hook and the judiciary is only all too willing for rapprochement. The denouement of this judicial-political farce was never in doubt though the modus operandi has been amateurish. Assuming that the minister did not speak to the judge, is it the end of the matter? Is Justice Reghupathi now convinced there was after all no pressure on him and that he was only paranoid? Is the CJI certain that nothing is amiss? Is the Prime Minister satisfied that his ministers are squeaky -clean?

Politics behind the budget

It was expected that the budget would be focussing on reforms since the anti-reform communists are not a hindrance to UPA any longer. Surprisingly, the 90-minute budget speech was laconic on reforms. Divestment which is considered as a main indicator of reforms was soft-pedalled. Trinamool Congress is happy about this. Apparently Trinamool Congress has taken the place of its bete-noire, the Marxists. As they say, the more politics changes , the more it remains the same. The announcement regarding funds allocation for Mumbai drainage improvement is aimed at upcoming state elections in Maharashtra. The budget has also announced a grant of Rs.50 crore to the Punjab University. Is it because our PM was a student and also a Professor there?

Budget 2009-10

The budget presented by Pranab Mukherjee today has been humourless and disappointingly bereft of Tagore quotes. Quotes from Kautilya are neither here nor there. Stock market also is not humoured. However, the negative reaction of Stock Indices has been overdone and we can expect a sharp pullback even in the course of the day today.

Changes in direct taxes are revenue-neutral whereas indirect taxes are amended to fetch Rs.2000 crore more. This from an economic viewpoint is regressive. Fiscal deficit of 6.8% will not permit reduction in interest rates. Treasury profits of banks will be hit.

In retrospect, this was an eminently expectable budget though few expected such a budget.