Pratip Kar: Empowering public sector bank boards
The governance structure and boards of PSBs, including State Bank of India and its subsidiaries, are antiquated and no longer conducive to good governance. These must be changed
Pratip Kar
June 19, 2014
In more ways than one, the P J Nayak Committee Report on the governance of bank boards in India is different. Not only are the recommendations refreshingly bold, its findings are stated with unreserved candour. Tucked away as footnote number 41 of the report, is an interesting quotation from Adam Smith's 'An Inquiry into the Nature and Causes of the Wealth of Nations'.
"Frequently, a man of great fortune, sometimes even a man of small fortune, is willing to purchase a thousand pounds share in India stock merely for the influence which he expects to acquire by a vote in the court of proprietors. It gives him a share, though not in the plunder, yet in the appointment of the plunderers of India... Provided he can enjoy the influence for a few years, and thereby provide for a certain number of his friends, he cares little about the dividend, or even the value of the stock upon which his vote is founded."
The quotation is used in the report in the context of the selection of directors on the boards of public sector banks (PSBs). There are various ways of interpreting the quotation. But we must not miss the fundamental point - the power and influence even a man of small fortune acquired among friends and the society by owning a share of East India Company. We shall see how the situation is similar today for seats on PSB boards and the efforts made by aspirants to acquire those seats. Being on the board of a PSB gives an externally appointed director a sphere of influence, which works to the advantage of the director's personal area of work.
The governance structure of PSBs and the State Bank of India (SBI) and its subsidiaries has been frozen in the Bank Nationalisation Acts of 1970 and 1980, and the SBI Act. It is antiquated. These Acts lay down to the last detail the manner in which board positions are to be filled. The table shows that there are eight broad categories of directors. The important point to note from the table is not only the puzzlement of the relevance of many of the categories of directors in today's context, but that the entire board save the directors who are elected by the shareholders, all the other directors are either nominated or appointed by the government and clearly, there is no room for the bank boards or their chairmen to play any role in the selection of a director.
When a board is thrust on a PSB without any consultation with the chairman, the composition of such a board may well follow the given legislative structure, but the probability of that board having an optimal composition, with interests of the directors aligned to that of the bank, would be very low. On top of it, if as the Nayak Committee Report observes "some non-official directors are of poor quality or get on to the board with parallel agendas (as is now commonly alleged) the chairman then begins to view sections of the board as unhelpful to the interests of the bank". The ecology of the board room can then no longer remain pure.
The Acts, while delineating the different classes of directors, lay down the minimum qualification for each class in a very general way, without any reference to quality or competency. For example, the two Nationalisation Acts say that one director should be a qualified chartered accountant. So technically, all chartered accountants would qualify for appointment to a public sector bank. There is a selection process for the directors nominated by the government, but the government guidelines focus on professional qualification and not on competence. The report laments that "Sadly, even the elected shareholder directors generally owe their election to LIC, given LIC's dominance as a shareholder in most banks, and the perception is widespread that LIC's support is best managed through the government". Analysis of the boards of the PSBs shows that there are quite a few directors who have perfected the art of rotating for decades across boards of PSBs as shareholder directors. The motives behind such rotation are hardly altruistic or in the interest of public service. The concept of rotation is absent in private sector banks.
There is, therefore, ample justification for the apprehension expressed in the report that "Suspicion that a large proportion of directors get appointed on the basis of political allegiance also leads to intense scepticism that these banks will ever be run in the taxpayers' interest, with the goal of generating good financial returns". It is in this context that Smith's quotation in 1776 becomes relevant for PSBs in 2014.
Clearly, this situation needs to change. But no change in the composition and the governance structure of PSBs is possible without the repeal of the statutes. Following their repeal, the committee has suggested a three-phase process for the transfer of the government holding in PSBs to a Bank Investment Company (BIC) and the transitioning of powers from the government to the BIC, and then to the bank boards with the intent of fully empowering them. By carrying out this operation in three phases, the government would gradually distance itself from PSBs without losing any control.
The repeal of statutes is not an easy process and there is always an uncertainty on the time line. In the interregnum before these Acts are repealed and the legislation to activate BIC is passed by Parliament, the selection process of directors needs to be professionalise and depoliticised. The committee has suggested the constitution of Bank Boards Bureau (BBB) by a government order to advise on top bank management selection. The BBB should comprise senior or retired commercial bankers of high standing and have led banks, and chosen by the government in consultation with the Reserve Bank of India. As the appointments to the top management of banks will continue to require the concurrence of Appointment Committee of the Cabinet, it is desirable that BBB's recommendations be generally accepted by the government and there should be a public disclosure of all cases of recommendations made that are rejected by the Government.
The setting up of the BBB and BIC, and the necessary repeal of the four-decade old Nationalisation Acts, would need a strong political will and political mindset wedded to good governance. It is important to harken the words of Smith in 'Theory of Moral Sentiments': "The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it."
"Frequently, a man of great fortune, sometimes even a man of small fortune, is willing to purchase a thousand pounds share in India stock merely for the influence which he expects to acquire by a vote in the court of proprietors. It gives him a share, though not in the plunder, yet in the appointment of the plunderers of India... Provided he can enjoy the influence for a few years, and thereby provide for a certain number of his friends, he cares little about the dividend, or even the value of the stock upon which his vote is founded."
The quotation is used in the report in the context of the selection of directors on the boards of public sector banks (PSBs). There are various ways of interpreting the quotation. But we must not miss the fundamental point - the power and influence even a man of small fortune acquired among friends and the society by owning a share of East India Company. We shall see how the situation is similar today for seats on PSB boards and the efforts made by aspirants to acquire those seats. Being on the board of a PSB gives an externally appointed director a sphere of influence, which works to the advantage of the director's personal area of work.
The governance structure of PSBs and the State Bank of India (SBI) and its subsidiaries has been frozen in the Bank Nationalisation Acts of 1970 and 1980, and the SBI Act. It is antiquated. These Acts lay down to the last detail the manner in which board positions are to be filled. The table shows that there are eight broad categories of directors. The important point to note from the table is not only the puzzlement of the relevance of many of the categories of directors in today's context, but that the entire board save the directors who are elected by the shareholders, all the other directors are either nominated or appointed by the government and clearly, there is no room for the bank boards or their chairmen to play any role in the selection of a director.
When a board is thrust on a PSB without any consultation with the chairman, the composition of such a board may well follow the given legislative structure, but the probability of that board having an optimal composition, with interests of the directors aligned to that of the bank, would be very low. On top of it, if as the Nayak Committee Report observes "some non-official directors are of poor quality or get on to the board with parallel agendas (as is now commonly alleged) the chairman then begins to view sections of the board as unhelpful to the interests of the bank". The ecology of the board room can then no longer remain pure.
The Acts, while delineating the different classes of directors, lay down the minimum qualification for each class in a very general way, without any reference to quality or competency. For example, the two Nationalisation Acts say that one director should be a qualified chartered accountant. So technically, all chartered accountants would qualify for appointment to a public sector bank. There is a selection process for the directors nominated by the government, but the government guidelines focus on professional qualification and not on competence. The report laments that "Sadly, even the elected shareholder directors generally owe their election to LIC, given LIC's dominance as a shareholder in most banks, and the perception is widespread that LIC's support is best managed through the government". Analysis of the boards of the PSBs shows that there are quite a few directors who have perfected the art of rotating for decades across boards of PSBs as shareholder directors. The motives behind such rotation are hardly altruistic or in the interest of public service. The concept of rotation is absent in private sector banks.
There is, therefore, ample justification for the apprehension expressed in the report that "Suspicion that a large proportion of directors get appointed on the basis of political allegiance also leads to intense scepticism that these banks will ever be run in the taxpayers' interest, with the goal of generating good financial returns". It is in this context that Smith's quotation in 1776 becomes relevant for PSBs in 2014.
Clearly, this situation needs to change. But no change in the composition and the governance structure of PSBs is possible without the repeal of the statutes. Following their repeal, the committee has suggested a three-phase process for the transfer of the government holding in PSBs to a Bank Investment Company (BIC) and the transitioning of powers from the government to the BIC, and then to the bank boards with the intent of fully empowering them. By carrying out this operation in three phases, the government would gradually distance itself from PSBs without losing any control.
The repeal of statutes is not an easy process and there is always an uncertainty on the time line. In the interregnum before these Acts are repealed and the legislation to activate BIC is passed by Parliament, the selection process of directors needs to be professionalise and depoliticised. The committee has suggested the constitution of Bank Boards Bureau (BBB) by a government order to advise on top bank management selection. The BBB should comprise senior or retired commercial bankers of high standing and have led banks, and chosen by the government in consultation with the Reserve Bank of India. As the appointments to the top management of banks will continue to require the concurrence of Appointment Committee of the Cabinet, it is desirable that BBB's recommendations be generally accepted by the government and there should be a public disclosure of all cases of recommendations made that are rejected by the Government.
The setting up of the BBB and BIC, and the necessary repeal of the four-decade old Nationalisation Acts, would need a strong political will and political mindset wedded to good governance. It is important to harken the words of Smith in 'Theory of Moral Sentiments': "The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it."
The writer was a member of the P J Nayak Committee and a former executive director of Sebi. These views are personal
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