Banker’s trust: New risk factors in banking system

Banker's trust: New risk factors in banking system

On 1 March, Chennai-based Indian Bank was listed on the Bombay Stock Exchange at a 15.38% premium over its offer price of Rs91. The stock price has come down to Rs85 in line with the general bearish trend in the market but the foreign institutional investors’ stake in the bank has gone up from less than 7% on the day of listing to about 10%.

Indian Bank has the dubious distinction of posting the largest-ever net loss by any bank in this country in 1996 that wiped out its entire net worth. Despite that, it had a good debut on bourses. This is because of liberal capital infusion by the government that owns the bank and a string of enterprising chief executive officers (CEOs) who have cleaned its balance sheet and put it back on the rail.

Two key aspects that an investor looks for before putting in money in any stock are the quality of a firm’s management and its track record. K.C. Chakrabarty, CEO of the Indian Bank, who has taken the bank to the market, is now set to take over as the chairman of the Punjab National Bank. This is a wonderful example of rewarding a CEO for doing a good job. After all, the chairman of a smaller bank must be promoted to head larger banks as otherwise there is no motivation to perform. But the investing community are probably betting as much on the ability of Indian Bank’s CEO to take the bank forward as its past performance.

To be fair to the government, it is promoting the existing executive director of Indian Bank, M.S. Sundara Rajan, to the chairman’s post, thereby maintaining continuity at the top management. However, this does not alter the fact that the appointment process of public sector bank (PSB) CEOs has no framework and, as a result of this, both the banks as well as the investment community often get hurt.

Sixteen of the 19 PSBs are listed entities with the government’s stake in these banks varying between 51.9% and 80%. The only rule that is uniform for the selection of bank CEOs and executive directors is a two-year residual service. This means, unless one has two years of service left to retire, he/she cannot be considered for the top job. This apart, there is no other norm that cannot be broken or created, depending on the whims and fancies of the government. For instance, an executive director’s wait to lead a bank can be as brief as six months or as long as two years or even more. Similarly, one can head a large bank only after heading a relatively smaller bank or can even directly be made the head of a very large bank, depending on one’s equations with certain quarters of the government.

Often the focus is on the career of the bankers and not the health of a bank. Two former CEOs of a Mumbai-based bank were shifted to relatively larger banks after short stints even though the bank has not been in pink of health. How does the government choose CEO of a bank? Well, a high-powered Appointments Board consisting of the governor of the Reserve Bank of India, one deputy governor, secretary of economic affairs, and two external members including a management expert, nominates CEOs and the executive directors.

At the first stage, a committee of the board selects the executive directors from among the senior general managers of the industry. It also interviews the executive directors for selecting the chairmen of big and small banks. Once the committee recommends the right candidates, the Appointments Board finalizes the names of the prospective executive directors and chairmen. These names then go to the finance ministry and, finally, get the nod of the Prime Minister’s Office. The clearance from the Central Vigilance Commission for any appointment is mandatory.

The interviews normally do not last beyond 10 to 15 minutes, and it is needless to say that the process is not transparent. Committee members of the board justify the brief interface as they need to meet anywhere between 80 and 100 general managers over two to three days to pick up the executive directors. An important input for the chairman’s selection is the confidential report of the chairman of a bank on his deputy—the executive director. The performance appraisal report is, however, a subjective analysis and it does not rate the executive directors on any scale. Then there are political pulls and the backings of various industrial groups that are always looking for comfort in the credit appraisal skill of certain senior bankers.

Once the chairman is appointed, nobody keeps a tab on his performance. The board of a bank often lacks the expertise to judge a CEO’s performance as it does not have the right kind of independent directors on it. The listing norms, framed by the Securities and Exchange Board of India, demand that 50% of the board of a listed entity should consist of independent directors but PSBs, governed by the banking laws of the country, are not subject to the listing norms of the capital market regulator.

To make matters worse, the government has brought down the number of shareholders’ representatives in a bank but the size of its board remains the same.

Bank CEOs have been using the shareholders’ director “quota" to raise the quality of the board by bringing in experts. But there are instances when shareholders’ directors follow CEO when he moves from one bank to another. There is also one instance when a director was made a shareholders’ nominee after his term expired on the board. So, CEOs could develop as much vested interest as the government. To that extent, both the board as well as CEO (in some banks) are the greatest risk factors for the Indian banking system. The only way this could be tackled is by making them accountable. But, more about that next Monday.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to