Fix the governance of public sector banks

Reports emerging about the Gyan Sangam suggest that the government is serious about empowering public sector banks (PSBs) by fixing issues relating to governance.

Some believe that PSBs are unnecessarily being made to look like villains by comparing them with private sector banks. The argument being that from the period 1997 to 2009, PSBs performed very well when compared to private sector banks. In this context, we should note that if private sector banks are used for comparing favourably the performance of PSBs during the period 1997 to 2009, it is then appropriate to use the same private sector banks for unfavourable comparisons now as well. According to advocates of this view, the current mess is because PSBs responded to the government’s call to lend to infrastructure projects, sick airlines, etc. Therefore, the government should first decide whether they want PSBs to make good profit or participate in nation building. Addressing structural problems in PSBs can come later.

However, we must recognize that governance issues are papered over during good times. Therefore, it is dangerous to use the relative good performance of PSBs during 1997 to 2009 to advocate that structural reform is not necessary. Across several crises, be it the Asian financial crisis or the recent global financial crisis, evidence suggests very clearly that governance concerns get glossed over during good times and get highlighted only during bad times. Fixing governance issues in PSBs is therefore important to avoid another cycle of bad performance following a crisis.

Consider some evidence of governance issues in PSBs as highlighted by the Reserve Bank of India (RBI) committee on governance of bank boards. PSB boards focus on tactical issues rather than discussing issues relating to strategy/risk. Board deliberations are driven from the vantage point of compliance rather than business economics. Monitoring of measurable disaggregated business goals in relation to targets is nominal. Worsening of asset quality has been a key area of concern in PSBs. And yet there is a general absence of a calibrated discussion in boards of the sectors within which the greatest stress has emerged, and implications this might have for further loan growth in those sectors. Recoveries through the Debt Recovery Tribunals and under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act are inadequately discussed, and progress in bringing stressed assets back to health are also insufficiently analysed. Scenario analysis through stress-testing is conspicuous by its absence, and specific plans for meeting worst case scenarios find no mention. Little attention is devoted to the design of risk mitigation mechanisms, including whether the risk function should be invested with greater autonomy, including in matters of credit risk.

Sample some of the trivial issues that receive as much attention such as the policy for producing stressed assets: the taxi fare reimbursement policy for employees, the purchase of office premises at Bhopal, provision of leased residential accommodation to officers in six different locations, the details of a lecture by a bank’s chairman and managing director at a college, extensive coverage of the finance minister’s visit to the bank, discussion of disciplinary action against manager-level employees, location of ATMs etc.

In contrast, in some private sector banks, the level of discussion on strategic issues is impressive. The chief executive officer presents an analysis of the challenges inherent in the near-term, measures taken to cope with recent macroeconomic challenges, review of business strategy, risk and the development of talent. The focus is on substance rather than form.

Do these differences in board conduct stem from the government asking PSBs to serve its developmental goals such as the financing of infrastructure projects or sick airlines? Unlikely! The above differences derive from disempowered boards, which itself stem from the systemic manner in which previous governments have emasculated the boards of PSBs. In fact, whether banks are serving their commercial interests or undertaking projects towards nation building, emphasis on strategic business aspects as well as a forward-looking analysis of risk are essential building blocks for good performance.

In fact, the solution proposed by the Nayak committee is that developmental goals in an emerging economy such as India should be serviced not only by PSBs but also by private sector banks. Under the new Companies Act, all companies, irrespective of whether they are government-owned or private-owned, have to manually undertake spending towards corporate social responsibility. Along similar lines, then why PSBs and private sector banks can’t be mandated to serve developmental goals equally? In fact, the priority-sector guidelines require both PSBs and private sector banks to direct subsidized lending to specific sectors. Similarly, be it infrastructure financing or financial inclusion, the government as the sovereign has the right to decide legislatively that all banks have to serve these developmental goals. Thus, setting the objectives of banks in emerging countries such as India should not be confused with the issue of reforming PSBs so that they can compete with the private sector banks on a level playing field.

However, unless the boards are empowered, the governance problems that get ignored during good times would come back to bite during bad times irrespective of whether they serve commercial interests or those of nation building. Therefore, the recent resolve demonstrated by the government in reforming PSBs should be commended and supported.

Krishnamurthy Subramanian teaches finance at the Indian School of Business and was a member of the P.J. Nayak Committee on governance of bank boards.

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