RBI goes for massive governance reforms in commercial banks — Key recommendations

Overall, the proposals in the discussion paper seek to enhance bank governance standards in India, especially in the aftermath of recent cases that garnered considerable public attention and criticism.

RBI goes for massive governance reforms in commercial banks — Key recommendations

Recently RBI released a discussion paper on ‘Governance in Commercial Banks in India’. High-profile instances involving governance failures in certain banks have called into question the adequacy of the existing legal regime for ensuring good governance in commercial banks. Internationally, the question of governance norms in banks is treated differently given the complex nature of functions performed by banks in comparison to other businesses, which make them critical for allocation of resources in the economy, protection of consumer interests and maintenance of financial stability.

The stated objective of the discussion paper is to align the current regulatory framework on bank governance with global best practices, including the guidelines issued by the Basel Committee on Banking Supervision and the Financial Stability Board. To this end, it adopts international standards for bank governance into the general corporate governance framework in India comprising the Companies Act, 2013, and the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Requirements, 2015. Broadly, these governance norms focus on responsibilities of the board of directors, board structure and practices, and include aspects of risk management, internal audit, compliance, whistle-blowing, vigilance, disclosure and transparency.

A critical concern that has come to the fore through the recent episodes of lapses in bank governance is concentrated promoter-shareholding and governance risks associated with that. Accordingly, one of the most radical proposals in the discussion paper relates to the separation of ownership from the management to “reinforce a culture of professional management” at commercial banks. The paper recommends a ten-year limit on the tenure of a whole-time director (WTD) or CEO representing a promoter or significant shareholder. It is clear this measure is expected to complement RBI’s regulatory framework mandating limits to promoter-shareholding and associated voting rights.

Notably, RBI also constituted an internal working group to review the extant regulatory guidelines relating to ownership and control in private sector banks, which is expected to submit its report by September 30, 2020. Although this issue is important, the assumption that deeper connections between the management and the owners necessarily lead to mismanagement needs to evaluated carefully and recalibrated to ensure balanced reforms. It must be noted that the governance risks attributable to such connections might be relevant for government-owned banks as well.

Other key recommendations in the paper can be summarised as follows: (1) the majority of a commercial bank’s board must comprise of independent directors (a standard higher than that prescribed under the Companies Act and the SEBI Regulations); (2) the chairperson of the board must be an independent director; (3) chairpersons of crucial board committees (the audit committee, the risk management committee and the nomination and remuneration committee) must be independent directors who are not chairpersons of any other board committee; and (4) the tenures of non-promoter CEOs and WTDs should be limited to 15 years.

While reposing faith in independent directors for balancing the interest of all the stakeholders seems reasonable, in order to make the reform effective, the appointment process for independent directors also needs to be re-evaluated to limit the role of controlling-shareholders. Further, the liability regime for directors on the boards of banking companies should also be revisited to balance the rights and liabilities of the directors depending on the nature of functions performed by them.

Overall, the proposals in the discussion paper seek to enhance bank governance standards in India, especially in the aftermath of recent cases that garnered considerable public attention and criticism. Ultimately, the efficacy of implementation of norms as prescribed will depend on adequate enforcement, amongst other things. As regards the issue of concentrated ownership and control patterns of private banks, the findings of the report of the working group and their inter-play with the recommendations proposed in the discussion paper will also have to be considered to formulate a comprehensive and effective governance framework for commercial banking in India.

While the recommendations outlined in the discussion paper are likely to have a far-reaching impact, RBI must exercise caution to ensure that the reforms balance the interests of all the stakeholders and do not come at the cost of discouraging investments and entrepreneurship in the Indian banking industry.