Column: Nayak committee reforms a must now

Written by Amit Tandon | Updated: Jun 4 2014, 04:25am hrs
Reserve Bank of India recently published its Report of the Committee to review the governance of boards of banks in India (the PJ Nayak Committee Report). What are the Committees recommendations and will its recommendations get implemented

The Committee points out that the government does not have the money to inject the enormous amount of capital that the government-owned banks need between now and March 2018. Based on a scenario analysis, the Committee concluded that capital injection could vary from R2.10 lakh crore to R5.87 lakh crore. Given how large these figures are, the governments ability to achieve fiscal consolidation is impacted. So, either the public sector banks (PSBs) are privatised or, if the government wants to continue to own these banks, the focus needs to shift to design a radically new governance structure for these banks which would better ensure their ability to compete successfully.

A simple reality check suggests that the government cannot remain invested in its own banks. HDFC Bank just proposed raising R10,000 crore, which would result in an equity dilution of just 5.2%. But, if Bank of Baroda were to raise as much capital, the governments stake will get diluted by almost 25%. With Canara Bank, by 54% and Oriental Bank of Commerce, by over 100%.

But the Committee takes a more pragmatic view and assumes the government will want to remain invested in the 27 banks (including State Bank of India and its associate banks) that it currently owns. If it did not, this report would have been shelved by now. The Committee makes some compelling recommendations on how the government and RBI need to move ahead.

The Committee highlights how government ownership is impeding, not helping, PSBs in competing and growing. Regulation by both, the finance ministry (MoF) and RBI, board composition (to which I will turn to later), compensation levels, and finally, the overhang of the CAG, the CVC and the Right to Information Act are some of the issues that accompany government ownership. As the owner, the MoF feels compelled to exert direct control and lets the other statutory arms do so as well. It provides the needed cover from parliamentary questions and media scrutiny. But the key lesson from the recent financial crisis is that, irrespective of ownership, banks cannot be allowed to fail. A look at the recent history of bank failure in India echoes the same. But, will tying the banks in knots with excessive oversight and supervision serve the purpose Put a governance structure and framework in place and move on.

The manner of shareholding can make a difference. Inserting an intermediate Bank Investment Company (BIC) layers the ownership of banks from operations. This is seen as an intelligent layer (as opposed to a bureaucratic one) modelled on the UKs recent experience. The BIC will assume the role of appointing bank boards and CEOs and will hold the banks responsible to meet performance benchmarkswith great power, comes great responsibility. The BICs agenda will be aligned by ensuring that the BICs CEO and staff are incentivised based on the performance of the banks they run. The subtext of this structure is that once the shares of PSBs are transferred to the holding company, the historical regulations, including the State Bank of India Act 1955 and the Banking Companies (Acquisition and Transfer of Undertaking) Act 1970, will not remain relevant. It will be the Companies Act 2013 that will set the pace.

Moving to the Companies Act 2013 will imply that the board composition can be made more effective. Rather than have a government-appointed board, PSBs will have ones that are peopled with individuals with different and relevant skills and experience. This is the first step for the board to start functioning as a board should: reviewing the performance of the CEO, approving the annual budget, opining on strategy. The CEO too will have a say in the appointing of directors. Over a period of time, there will be a separation of roles between the Chairman and the CEO, with the CEO having a tenure that is sufficiently long to make meaningful directional changes.

An appropriately defined board agenda will help focus the boards attention. Using content-analysis methodology, the Committee points out that financial reporting and compliance are discussed the most, with far less attention being paid to risk and strategy. The committee points out that while private sector banks do not spend substantial time discussing risk either, they spend more time than PSU banks do. The Committee poses the question if this explains the negative correlation to NPAs (this comes with a caveat, though). They suggest that seven items should be brought to the board for discussion: business strategy, financial reports, risk, compliance, customer protection, financial inclusion and human resources. Any other item brought to the board should be by exception.

So, will the recommendations get accepted The Committee has been fortuitous with timing, with the report being made public as a new government came in. Fiscal pressures mean that the government has little choice but to act. One can argue about the specifics or quibble about the sequencing or the eventual timing of such moves, but the government will have to grasp the nettle.

The author is the MD of IiAS, a proxy advisory firm publishing data, research and opinions on corporate governance issues