Pros & Cons of having Regulator nominee on the board of PSU Banks

24 August 2018: Following members participated in the e-panel knowledge sharing discussions-

• Mr Sugata Dutta, Former Chief General Manager, Bank of India
• Dr R Bhaskaran, Former Chief Executive Officer, Indian Institute of Banking Finance
• Mr Manian KVS, President- Corporate & Investment Bank at Kotak Mahindra Bank
• Mr Hemant Kaul, Former Executive Director, Axis Bank
• Mr Aneish Kumar, Managing Director & Country Executive, Bank of NewYork Mellon
• Mr Madhav Nair, Country Head — India Mashreqbank
• Mr Manish Khera, Former MD & CEO –Fino, Airtel Payment Bank
• Ms Praveena Rai, Former Regional Head of Payments, Asia Pacific HSBC
• Mr Neeraj Chandra, Head of Operations & Technology, Abu Dhabi Commercial Bank
• Mr P B Prakash, Head-Financial Institutions Group, Indusind Bank
• Mr Prasanna Divekar, Former Head NRI Business, Overseas Offices, HDFC Bank
• Mr Sandeep Todi, Co-founder & CMO, Remitr
• Mr Rajiv Rai, Chief Digital Officer at Edelweiss
• Mr K Aayush Mazumdar, CMO, MeraEvents
• Many other CEO/CXO Bankers & Fintech professionals on FIAKS Forum

FIAKS Community Questions

What are the pros & cons of having a Regulator (RBI) nominee on the board of PSU banks? The government is reported to be against RBI withdrawing its nominees from the boards of Public Sector Banks. In fact, P J Nayak committee that reviewed governance on the bank board had endorsed the principle that RBI as a regulator and supervisor of the banks should not be on the bank boards.

Snapshot Of FIAKS Community Discussions

Chatting on this subject, a FIAKS community expert said that the RBI directors on banks boards would mean a clear conflict of interest between a Regulator and the Regulated. In earlier days of regulated banking, it was okay as banks would require guidance in matters concerning social banking. But with banks having matured and in fact often having regulatory transgressions, RBI should step back from banks boards

The question posed to the senior bankers that all the PSU banks are government-owned. How can the owner not have its nominee? What damage is done so far by the RBI nominated directors? Is it a capability issue? Is it an integrity issue? What’s the concern?

Adding to this question, an example was given of VC/PE/Angel invested firms. It was said that investor invests in the businesses and would like the business to be run properly to achieve the investment objective. Hence, they appoint their nominees on board of these companies. Why this logic can’t be applied to PSU banks where ownership is of the government?

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Responding to question, a member replies that if there is a regulatory breach, then the regulator becomes a party to it. That’s where the conflict lies. The government can have other nominees on board but the Regulator cannot also be regulated by self. Agreeing to this, a senior banker adds that since the government owns the majority stake in these banks, they must also accept full responsibility for their functioning and misdeeds. They need to find capable executives who can run the banks and stop intervening in its functioning and not have RBI representatives on the board. It only means conflict. RBI directors have failed as we have seen in all these years. They have never red-flagged the unjustifiably large exposures to delinquent companies. So instead of having them, why not let them do what they are good at? Which is to inspect and oversee banks to ensure they are not flouting the rules and regulations.

If the concern of the Government is to have someone with Regulatory background as their nominee, they can always nominate senior ex-regulators. Such persons could show the regulatory viewpoints to the Board, without RBI getting trapped in the decisions as a Regulator. There is a clear need to raise the standard of bank boards to fix their lending and governance issues.

Nobody is questioning the need for Government nominees. The debate is why should the nominees be from the RBI?

Register and read the entire discussions

In Australia, Commonwealth Bank initially was the Regulator as well as a commercial bank. Its Regulator part was taken out. Having a Regulator on Banks board is akin to banks nominating their employees as directors of borrower entities. Clear clash of interests. Banks do make such nominations, but only on boards of companies facing problems where banks large sums are facing jeopardy. It’s more like a policeman staying inside your house

Since banks now have a Chairman, a position created with a view of strengthening the independence of the board and enhancing its oversight over the management, it’s fair to do away with RBI nominees.

It was highlighted that the Government, unfortunately, has these conflict of interest situations created due to historical factors — they are making rules and abiding by. But the institutions they create cannot replicate this obfuscation of boundaries. Earlier, RBI used to have holdings in SBI which were taken over by the government.

The nominees of the Regulator are a part of the Board. The Regulator will be conflicted while reviewing Board decisions where it’s nominees were also part of the decision making process.

An attempt was made to explain problem statement in the fintech language of how the transactions are authorized. It was said that every transaction has a maker & a checker. The maker and the checker can’t be the same person. But this fundamental element is completely missing. PSU Banks are Government-owned banks. A Regulator is a government employee and its role is of a checker. By having RBI nominee on the board, Government is trying to make regulator do both the job of maker & checker which is incorrect.

On many occasions, there is a tension between the interests of the Government and the Regulator. That’s a good thing and it keeps the country’s direction and financial stability balanced. An example of that in a bank is that the credit is independent of operations. However, if you go high enough, independence will end — they will at some point report to the same guy at the head office or region. But that does not mean that using that argument we can say that operations and sales guy can be the credit decisions guy. A similar situation arises in cases of the Judiciary and SEBI.

Coming in support of government, an argument was presented that the RBI practically underwrites all banks — private or public. All depositors have secured up to Rs. 1 lac, which in India would mean 99% of customers or citizens. Concurrently, the RBI “licenses” a bank since they also carry contagion risk. the risk is systemic and far higher than investment risk that a VC carries. So the RBI having a nominee on Board is fully justified. In fact, it’s better for banks too, if nothing else then in the case of their own mistakes of error or policy, plausible deniability goes away from the RBI as they had their nominee on Board.

Reacting to this, an intellectual comments that, by that logic, should SEBI, Customs, Excise, and Tax guys also have their nominees on all big or high-risk companies? Being a Regulator and being on the board just don’t go together. Banks pay for this insurance-covering deposits up to 1 lakh. Managing systemic risk is a key role of the regulator, so what is this point all about? Creating structures with ambiguous accountability is a big issue, and the thought that banks will like it so they can avoid accountability is a dangerous path to tread (which PSUs already have, unfortunately).

What is a conflict of interests? It is a situation when your action in a particular capacity will directly impact yourself or your inner circle in a different capacity. In this case of RBI nominees on Board, there is no such realistic probability. Actually, there will be greater accountability if RBI has it’s representative on bank boards as they can’t say we were hamstrung by external factors. We can’t approach Government-run banks as we approach normal commercial organizations because of implicit Government guarantee enjoyed by these institutions. When RBI nominees sit on board he/she will have the onus to ensure RBI’s advices are followed and implemented. To such an extent, it will be a union of interests rather than conflict. Of course, all this is created by Government ownership of banks. The government should spin-off all commercial and corporate banking to private banks and convert existing banks to pure inclusive banking entities.

A leader of the community supported RBI nominee on boards and said that it is very old-school thinking which is not necessarily bad. The question is has it been effective in the past and is there a better way to monitor PSU banks? Regardless of the director on board, the reporting and compliance requirements should be enough and should be strengthened if at all. Another area that needs to be looked into is a branch audit, which is done by CA firms. This can be improved and tech-enabled so that the reconciliation between banks and risks such as multilateral loans, etc. can be better reported and monitored.

CEO/executive directors and independent directors are appointed by the GOI. RBI director and shareholders director that are selected by the GOI make up the board. So does it matter if the RBI withdraws? Banks are run by master circulars and the entire HR policy comes from the GOI. Can the board really take any decision independently? Governance word does not apply to Government and bank boards.

The real issue is how banks came under PCA despite the RBI directors being on the Board. How does a wrong NPA gets approved? So the RBI would like to withdraw? It is not about regulatory power but effectiveness. RBI failed as a regulator spectacularly in stopping telltale signs of large value frauds.

Primary conflict of interest is in the Government owning banks. Banks by nature are risk-taking entities while the government running is rooted in rule-based administration. Since privatisation of PSU banks is not politically feasible, we should look for running these banks strictly on well-defined social objectives.

A FIAKS community expert and a senior official said that whether the Government owns the banks or not, a case for RBI nominee on the board does not exist unless it is a troubled bank and RBI as a regulator has a nominee with a defined protocol on what he will oppose or support on the board. There is no case for an RBI nominee on behalf of the government, the owner of the bank. How can the owner appoint the regulator representative to represent the owner? Government as the owner can appoint their nominees and keep RBI out of this. It is altogether a different matter whether the government should own banks. Even assuming they believe that private banks will not meet social objectives, they can own 1/2 banks and run them with well-defined socio-economic objectives. They need not own 75% of the industry.

Conclusion

Ms. Anuradha Panditrao, Founder of Forum of Industry & Academic Knowledge Sharing (FIAKS) acknowledges and thanks the contributions of the FIAKS Community members in creating intellectual pull by participating in the discussions. She summarized discussions with the following points:

• The government can take an approach to have someone with the regulatory background as their nominee, they can always nominate senior ex-regulators. Such officials could show the regulatory viewpoints to the Board, without RBI getting trapped in the decisions as a Regulator.
• Another area that needs to be looked into is the branch audit which is done by the CA firms. It can be improved and tech-enabled so that the reconciliation between banks and risks, such as multilateral loans, can be better reported and monitored.
• Government as the owner can appoint their nominees, and keep the Regulator (RBI) out of this.
• However, if the Regulator is the board nominee then their own mistakes of error or policy, plausible deniability goes away from the RBI.