The quantum of NPAs in the banking sector has soared to over Rs 8 lakh crore, and 90% of these are on the books of PSBs.
The quantum of NPAs in the banking sector has soared to over Rs 8 lakh crore, and 90% of these are on the books of PSBs. In response, the government has enacted the bankruptcy code, and announced infusion of Rs 2.11 lakh crore of capital in PSBs. To ensure accountability, recapitalisation has been linked to metrics such as responsible banking, deepening financial inclusion, etc. While these measures will partially help resolve the problem at hand, there are several fault lines in our corporate governance model that continue to adversely affect PSBs.
*Lack of detailed financial reporting: High quality information for all stakeholders is a key pillar of corporate governance and helps prevent agency problems. Initially, the companies were required to share detailed balance sheets with their shareholders. But in the early 1990s, certain interest groups successfully lobbied with the ministry of corporate affairs to dilute this requirement in favour of abridged financials on the grounds that the cost of printing and mailing detailed physical accounts, in many cases, exceeded the dividend payout.
Thus began the era of information asymmetry, which continues to this date, even though technological advances have negated all these challenges. It is ironic that while even the government has been compelled to become more transparent under the Right to Information, Indian companies have somehow gotten away and continue to conceal the inconvenient.
The first sign of poor corporate governance is the personal use of corporate assets by promoters and/or executives. From the abridged reporting requirements prescribed, it is difficult to identify any such preferential use. For instance, the potential loss had Raymond allocated apartments in JK Building at less than 90% of the market value to the Singhania family would have gone unnoticed if the stakeholders were to rely only on Raymond’s financial reports.
Are loan repayments being made on time? Has there been any breach of a compliance requirement that can result in heavy fines? Abridged balance sheets keep the shareholders in the dark about all such potential red herrings.
Detailed financial disclosures allow all the NPAs to be tracked since there will be accountability, and informed lenders and shareholders will raise questions if funds are diverted fraudulently. It is time for the Prime Minister to drive this change personally as the concerned regulators—RBI, SEBI and MCA—have not been able to curtail this menace.
*Lack of accountability of independent directors: Both the Companies Act and SEBI recognised the need for people on boards that are free from any kind of influence or bias. These members are expected to use their expertise to improve the overall functioning of companies. Independent directors can only be implicated for offences committed with their knowledge, attributable through board processes, connivance or negligence. This lack of accountability is the reason behind the limited impact independent directors have had on the boards. The problem appears even graver when we take into account the fact that most independent directors on boards of big companies are former bureaucrats.
Initially, financial institutions had representatives on the board of directors. But the powerful bureaucracy hunting for post-retirement freebies muscled out the professionals from the board. While there is a bar of one year before which a retired civil servant can take up a corporate job, there is no restriction on a civil servant either joining a board as a corporate director or providing consultancy to a company—both these routes have been exploited by companies to return favours obtained from bureaucrats in the flag end of their careers. To protect interests of lenders and shareholders, there is an urgent need to make independent directors’ accountability at par with rest of the board members. The board must provide detailed rationale to all shareholders for appointing a person as an independent director and details of his/her findings and observations on corporate functioning including points of dissent.
*Inadequate PSB board engagement: As required by law, the boards of PSBs meet four times a year. The Uday Kotak Committee recommended it to be enhanced to five times a year. But given that PSBs are facing exceptional challenges—overseeing NPA resolution, reviewing portfolio for further asset quality deterioration and need to focus on customer experience—it is proposed that PSB boards should go beyond the requirements and meet at least six times a year. This proposal might be pushed back on the ground that many of the board members might not be able to find the desired time on account of sitting on several other boards. However, this, in itself, is a major fault line as it can result in board interlock or conflict of interest. Given the impact of PSBs on the economy, an exception should be made under the Companies Act to prohibit PSB board members to take up any other board membership. Remuneration of PSB members should be revised accordingly.
*Lack of customer-centricity: Retail customers are a consistent source of profits for PSBs. The primary reason they continued to bank with PSBs was the implied sovereign guarantee for their deposits. But they have now started to prefer private sector banks, and new customer acquisition by PSBs has slowed down considerably—the reason is poor customer service. While all PSBs have committees to address concerns of shareholders and staff, there is a lack of focus at the board level on customer interests, experience, grievances. To stay competitive, PSBs must set up a customer relationship committee at the board level to drive the message of customer service and customer centricity across banks.
*Lack of transparency in key appointments: Until mid-2016, the appointment of senior officials in PSBs was done exclusively by the Appointments Committee comprising of the PM, home minister and finance minister, without any formal inputs from subject matter experts. These appointments were prone to lobbying.
With the objective of bringing transparency to appointments process, the government set up the Banks Board Bureau (BBB) as an autonomous body for recommending appointments of senior officials in PSBs. But since the members of BBB are appointed by the government, it still does not completely eliminate the possibility of government intervention. To ensure transparency, there should be a collegium comprising of equal number of members from both the government and the opposition to recommend the board members.
Of late, PSBs have shown strong intent to resolve the NPA crisis by making use of the tools made available to them under the bankruptcy code. However, there are several constraints beyond the control of PSBs that affect their efficiency. It is incumbent upon policy-makers to identify systemic issues ailing our PSBs, bite the bullet, and ensure that we put an end to the precedents of taxpayer bailouts of PSBs in India.
By Akhil Arora, Master of Laws from University of Chicago Law School