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RBI’s discussion paper on commercial banks

It is a well-known fact that the outcome of the board’s meeting is recorded in the minutes in accordance with Secretarial Standards. However, the paper suggests that the CEO needs to disclose the outcome of the board’s deliberations to the directors and the concerned personnel. Imposing such an obligation on the CEO is ignorant of the fact that the same is already captured in the minutes of the meeting and can be referred to by the directors and the like.

The growing size and frequent complexities in the banking sector posed grave threats to the corporate governance standards of banks in India. Further, there was a need for reforms to effectively regulate the role of the management and the promoters in banks to curb governance failures. Against this backdrop, RBI floated a discussion paper (paper) on June 11, 2020. At the outset, the paper is highly influenced by the reforms of the Basel Committee on Banking Supervision (BCBS) which is in consonance with global best practices. With this background, this article aims to analyze the reforms suggested by RBI to resolve the issues that exist in the governance of banks.

 Applicability of the provisions

 The paper states that the reforms suggested by it are not applicable to the banks where the government is the major shareholder or promoter i.e., where the government retains its instructions. This implies that whenever instructions are issued by the government, it will override the reforms which come into force based on the recommendations of the paper. Such a proposition put forth by RBI would be a major hindrance in the corporate governance of banks. The fact that the government is retaining its power to exercise control over banks where it has pecuniary interests is arbitrary and must be done away with. Further, this would give rise to a lopsided narrative wherein there is no level-playing field between the banks in which the government is not a major stakeholder and banks that are controlled by the government. Moreover, such a regressive measure suggested by RBI in favor of the government puts the rectitude of RBI’s reforms in peril.

Ambiguity in certain definitions

Corporate governance can be defined as a system of direction and control that mandates how a company’s board must conduct the operations of a company. However, it is necessary to point out that the paper has vaguely defined corporate governance as a set of relationships between the management, shareholders and other stakeholders of the company. While such a definition is adopted from the BCBS, it fails to effectively define the term. The author suggests that a much streamlined definition for corporate governance must be incorporated by the RBI in order to avoid any ambiguities in the interpretation of the same.

Further, it is evident that the term non-executive director (NED) is defined in an ambiguous manner as well since it has been defined as a member of the board who is devoid of responsibilities within the bank. This definition implies that NEDs have no responsibilities at all with respect to the management of the bank. Such a flawed implication about the role of the NEDs in banks must be revisited by RBI since such directors are obligated to perform non-executive functions within the bank. Essentially ruling out all the responsibilities of such directors who form a part of the board would be a major setback to the corporate governance of banks.

When it comes to the aspect of risks, the paper has laid down multiple definitions for the terms which are inextricably intertwined. For instance, ‘Risk Appetite’, ‘Risk Capacity’, ‘Risk Limits’ and ‘Risk Culture’ directly or indirectly deal with the same aspect, i.e., the amount of risk that a bank can take. Instead of delineating this definition into four different terms, an inclusive definition which encompasses all the four definitions can be brought under a single term to preclude any ambiguity. Similar treatment must be extended to to risk management as well, since it has unnecessarily been delineated into three different terms such as ‘Risk Management’, ‘Risk Governance Framework’ and ‘Risk Appetite Framework’ respectively. Including all the definitions under a single term would not only be easier to comprehend but also to implement for the banks.

Formation of board committees

The paper has suggested the formation of five different board committees. Firstly, an audit committee of the board (ACB) which shall be constituted only by NEDs. The meetings will be conducted with a quorum of three members of which two-thirds will comprise of independent directors. Further, the ACB will be chaired by an independent director who will not chair any other committee of the board. This is a sound reform since the paper also suggests that the chair will answer shareholder queries at the Annual General Meetings.

Secondly, a risk management committee of the board (RMCB) that shall be made up of three NEDs out of which two-thirds will be independent directors. Further, one of the independent directors needs to have risk management expertise. However, the author contends that it more desirable that all members of the board possess risk management expertise since it is the sole purpose of the committee. It is desirable that the chairperson and the chief executive officer are also members of the RMCB as their inputs on risk management can prove to be crucial for the risk management of the bank.

Thirdly, a nomination and remuneration committee (NRC) shall be made up of three non-executive directors of which atleast half will constitute independent directors. Further, one of the directors of the NRC needs to be a member of the RMCB. However, a clarification is needed on why such commonality of membership has been recommended only for the NRC and not for any other committees.

Fourthly, the stakeholders relationship committee for which the composition has not been mentioned in the paper. It is desirable that RBI provides suitable clarifications regarding the composition and the functions of this committee.

Fifthly, the committees of the board performing management function shall consist of directors who are not a part of any other committees. This board has been vested with the supervisory functions of the board and does not have anything to do with the management of the board.

 Disregarding the role of the CEO

It is a well-known fact that the outcome of the board’s meeting is recorded in the minutes in accordance with Secretarial Standards. However, the paper suggests that the CEO needs to disclose the outcome of the board’s deliberations to the directors and the concerned personnel. Imposing such an obligation on the CEO is ignorant of the fact that the same is already captured in the minutes of the meeting and can be referred to by the directors and the like.

Further, the CEO has been given the responsibility to prepare and circulate the agenda and the minutes of the meetings to the directors. This responsibility vests with the company secretary of the bank and equating the CEO’s responsibility to that of the company secretary is impractical as the CEO needs to look after other significant functions of the bank.

 Limit on the tenure of the CEO

The paper suggests that any major shareholder or promoter of the bank can hold the position of the CEO only for a term of 10 years whereas non promoters can hold the position for 15 years. Through this reform, RBI aims to put in place a robust governance framework for banks and ensures that ownership of the bank is separated from that of the management. The author contends that this is a sound reform suggested by RBI and can considerably improve the corporate governance structure of banks in India.

Less importance to company secretaries

The paper has failed to give significance to company secretaries as it provides for separate secretaries for each of the committees mentioned earlier. The author contends that the RBI must consider appointing the company secretary as the only secretary for all the committees owing to the similar compliance requirements and similar procedural mandates. Also, the expertise and experience of the company secretary in this regard must be taken into consideration by the RBI.

Moreover, the paper states that the company secretary needs to report to the chair of the board instead of the entire board. It is important to realize that the company secretary is a secretary to the entire board and not the chair alone. This suggestion by RBI is detached from the reality that the CEO is the head of the board and not the chair. Further, this also causes a disruption in the unity of command which vests with the CEO and not the chair. Therefore, it is advisable that the company secretary reports to the entire board as all members of the board play a significant role in the management of the bank.

Emphasis on the role of independent directors

 The paper suggests that independent directors must have an important role to play in the critical matters of the bank. This is evident from the fact that the majority of the bank’s board must consist of independent directors. Further, the paper also suggests that every meeting of the board must have a majority of independent directors. Also, the critical functions of the banks will now be handled by the sub-committees of the board that are headed by independent directors. Thus, this enables the independent directors to have an active role in the day to day operations of the bank.

 The author contends that RBI’s reform with respect to upholding the ‘independence’ of the independent directors is an essential reform for the good corporate governance of banks. The effective implementation of this reform will enable independent directors to voice their thoughts without being outshined by the higher management. Further, the independent directors can now play a key role in assisting the board to take informed and well-contemplated business decisions. Moreover, this reform can bring about a much needed change in the corporate governance of public sector banks where the nominee director’s actions is heavily dictated by the directions of the chairman, government nominee and the RBI representatives respectively.

Closing Remarks

 Overall, the discussion paper is well intended but suitable clarifications needs to be provided by RBI on certain aspects of the paper as pointed out by the author. Further, the ambiguity in certain reforms suggested by the RBI needs to be addressed adequately. The fact that the paper extends more responsibilities to the independent directors might create friction between them and the higher management and how this will play out in the banking sector remains to be seen.

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