Governance reforms in banks: The Nayak Committee Report

The Committee to Review Governance of Boards of Banks in India (P.J. Nayak Committee) submitted a report recently. Its terms encompass all categories of banks and if its recommendations are implemented, it would fundamentally change the face of state owned banks, while making incremental changes in the governance of private banks.

The present composition of the boards of public sector banks (PSB) could theoretically be termed as a model in corporate governance. The boards represent diversity (except on gender) and multiple public interests. A typical PSB bank has three directors representing minority (non-government) shareholders' interests; three directors who are expected to represent societal interests; a director each representing the union government, workmen, officers, and regulator (RBI). In addition an independent chartered accountant is appointed as a director and the person usually heads the audit committee. The bank also has three or four whole-time directors including the Chairman and Managing Director (CMD).

While the above composition looks good, there is still a huge problem. This problem is about the process of identifying individuals to represent these diverse interests. The Nayak committee rightly identifies it. It terms the boards as "non-independent" except for the shareholder directors. The process of the election of even these so called "independent" directors may also show that they are largely nominees of the government, albeit through a different process. They are elected by shareholders excluding the government. The non-government share-holding in many of the banks are substantially held by institutions indirectly controlled by the government - insurance companies, financial institutions etc. These institutions largely select the "independent" directors as well.  We thus have a situation where the public sector banks end up not having a semblance of good corporate governance.

The Nayak committee needs to be complimented for taking the bull by its horns and addressing the issue of process squarely. While arguing for fundamental changes in the way the public sector banks function, the committee presents a compelling case by examining the performance of these banks in comparison with the private sector counterparts. The committee, starts its report by pressing the alarm bells on the performance of these banks; moves to analyse what cripples them; and then addresses the issue of governance. The of governance of bank boards is not a stand-alone issue that could be tinkered by recommending some changes here and there, but has to be examined comprehensively.

The committee touches upon three significant issues:
(a) Examining the most significant pain points that stymie the performance of PSBs; the perverse incentives in the current structure because State ownership, but also because of operational controls by the State. The committee thinks that the State should continue as an investor; intervene on issues of larger public good through policies in consultation with RBI and ensure that these policies affect the private banks and PSBs equally; and keep completely off operational control. The solution offered is elegant: It suggests that the government reduce its stake in the banks to just about less than 50% which takes the banks out of the tyranny of vigilance, right to information (RTI) while keeping the State as the dominant shareholder and not losing ownership based control. 

(b) Examining aspects affecting the leadership in being effective in the banks, the committee rightly identifies the problem in the process of appointing the Chairman and whole time Directors, and their tenures.

Management effectiveness would be addressed if the above issues are taken care of. The third important issue that the committee touches upon is the process of governance and the transitional arrangements:

(c) The committee suggests a radical and an involved model of moving all the government shareholding in PSBs to a special vehicle similar to a holding company. This structure would have the basic function of protecting the commercial interests of the State. This committee will have the power also to make appointments of whole-time directors and directors that represent the state, while the rest of the independent directors would be inducted through the process of identification of skill gaps and through a nomination process of the board.

On governance of private banks, the big issue that the committee identifies is about the nature of investors and suggests that there be a "fit and proper" criteria even for institutional investors that would be eligible to appoint their representatives on the board. These investors are termed as Authorised Bank Investors. This concept is not well argued. It is not clear from the report why the fit-and-proper criteria that is to be applied to board members have to be applied to the investors themselves. The committee also suggests that the position of the Chairman and Managing Director of banks be split without offering any plausible explanation. Given that Nayak himself vehemently opposed the splitting of these positions when he was at the helm of Axis Bank (then UTI Bank) we are curious to know why he had a change of heart when it came to the committee.

The committee has suggested a fixed term of 5 years for the chairman/managing director of a bank and a term of 3 years for a whole-time director. While the committee has done some detailed analysis to arrive at their recommendations through the report, we do not find the same rigour in analysis of the HR situation of the PSBs. Do the banks (or the banking sector) have the talent pool that is experienced enough (people in their 50s) to occupy these positions that fall vacant and serve out the terms that the committee has suggested?

This report is insightful, constructive and radical in its approach. However, accepting these recommendations needs political will. We are not sure that the ball lobbed into the court of the Government - by a committee appointed by RBI can find instantaneous resonance. We hope that the new government has the will to address these issues and reform the governance and management of banks, particularly PSBs.

(The author is a Visiting Faculty, Centre for Public Policy, Indian Institute of Management, Bangalore.) mssriram@gmail.com