RBI’s new paper places too much onus on bank boards to ensure good governance

Continuing with its regulatory response to the crises that have rocked Indian banks, the Reserve Bank of India has put out a discussion paper to flesh out the governance structure at commercial banks and institute new checks and balances on their business, compliance and risk management functions. Taking the view that being in the financial intermediation business makes a bank accountable not just to its shareholders but also depositors, the RBI is seeking to put the onus of governance mainly on bank boards and their senior management teams. This paper recommends the ideal composition of bank boards, sets hard limits on top manager tenures and lays down specific responsibilities for board-constituted committees.

To ensure that bank employees cutting across hierarchy are aware of their priorities, the paper proposes that boards set the ‘tone at the top’ for correct behaviour and formulate written policies on code of conduct. While a top-down approach is in order, written codes have proved hardly any deterrent to misbehaviour in the past. The more concrete prescriptions are those requiring board members to disclose conflicts of interest upfront and to refrain from related party dealings, except where they can prove arm’s length. Specifying that the chairpersons on bank boards be independent directors, and that top managers from the risk and compliance functions report directly to the board instead of the CEO, are good steps to ensure that they are not hijacked by profit motives. But based on the YES Bank débâcle, the RBI also appears to be correlating weak bank governance directly with CEO tenure. It has proposed a maximum tenure of 10 years for promoters functioning as bank CEOs and 15 years for professionals in this role. The link however is quite tenuous, with many well-governed banks (Kotak Mahindra Bank and HDFC Bank, for instance) featuring CEOs with long tenures. If a 10-year limit is deemed essential to prevent excessive concentration of power in the promoter-CEO, it isn’t clear why a professional CEO must be allowed 15 years. This proposal reflects the RBI’s lack of policy clarity on whether higher promoter skin-in-the-game or professional management leads to better governance.

Overall, there’s also the question of whether the RBI is attempting to shift too much of its own supervisory responsibilities for good governance on to bank boards. The bank’s Nomination and Remuneration committee is now expected to vet its directors and prospective CEOs for ‘fit and proper’ criteria and the Audit Committee is expected to oversee vigilance functions. While insisting on some accountability from boards is welcome, stretching the concept too far can lead to conscientious individuals shying away from taking up board positions. Apart from attempts to tone up internal governance, depositor confidence can only be shored up by evidence that the RBI is willing to introspect on its own role and plug the yawning gaps in its supervisory framework that allowed so many crises to crop up.