Governance, management and operational issues of public sector banks need to be resolved to secure quick reforms. Instead, the government is all set to pursue some grand design
The Narendra Modi government wants a comprehensive overhaul of public sector banks (PSBs), which account for more than 70 per cent of assets in India’s troubled banking sector. It’s hard to quarrel with the idea: what could be more attractive than a revamped and shining public sector? It is important, however, to focus on what can be achieved quickly. The government must do what it takes to revive bank lending and private investment at the earliest rather than pursue ‘reforms’ that would keep PSBs in limbo for an extended period.
There are three sets of issues in PSBs: governance, management and operational issues. The key governance issues concern the composition and functioning of the board. The important management issue is the selection of the CEO. The operational issues are the resolution of non-performing assets (NPAs) and the infusion of capital in banks. It’s useful to take stock of where we are and where the government intends to go.
Separation of roles
The government is moving in the direction suggested by the P.J. Nayak committee’s May 2014 reporton bank governance. For starters, it has decided to separate the roles of the chairman and managing director (CMD) in all PSBs except the State Bank of India. Bank chairmen will be selected by a panel headed by the Reserve Bank of India Governor.
The case for separation of roles — that there was too much concentration of powers in the hands of the CMD — is not very persuasive. Bank boards have one representative each of the government as well as the RBI. They also have two or more executive directors as well as representatives of both officers and workers of the bank. It is not true that the CMD could act as he or she liked.
The Nayak committee had wanted the roles to be separated at the end of a three-phase period. The committee reckoned that PSBs by then would have acquired substantial autonomy, and that the power to appoint chairmen, independent directors and the CEO would have devolved fully to the boards. The government has chosen to separate the two roles at the very beginning.
There are two dangers in doing so. First, however distinguished the panel that will select the chairman, it is always possible for the government to influence the chairman once he or she is appointed. The result would be to pit a political appointee against the CEO who has to deliver results. Second, the chairman may have his or her own agenda; this would render the CEO ineffective. It would have been better to defer the separation of roles until PSB boards had begun to function effectively with independent directors.
Now that the decision to separate the roles has been taken, it is vital to strengthen the boards. The Nayak committee argued that PSBs do not have independent directors at all. They have directors nominated by the government – these, the committee stated, cannot be said to be independent. They also have directors elected by shareholders. Since it is Life Insurance Corporation of India that calls the shots as an important shareholder, the shareholder directors are not independent either.
“PSBs improved their performance after bank reforms commenced in 1993-94 and continued up to 2010-11 ”
Further, the Nayak committee contended that private banks did better when it came to having independent directors. This contention must be strongly refuted. Directors on the boards of private banks are chosen by the promoter or management and are therefore hardly independent of either. If anything, the PSBs are a little better off: a government-appointed independent director is not beholden to the CEO for his appointment and hence can act independently of the CEO.
There is an unresolved issue of governance in India: can a director appointed by the dominant shareholder — whether government or a private owner or management — be said to be truly independent? As this issue is not likely to be addressed in a hurry, the best we can do until then is ensure that independent directors have the credentials to add value to the board. The government proposes to achieve this by setting up a Bank Boards Bureau (BBB) as recommended by the Nayak committee. The BBB will select CEOs, independent directors and bank chairmen. It will consist of three former bankers, two eminent professionals and the Secretary of the Department of Financial Services.
The Finance Ministry, through its website, has invited applications for the post of independent director. Some of the best people are unlikely to send in applications; they will join only if invited. The BBB will need to scout for talent. According to some reports, the Prime Minister’s Office will first vet candidates for the post. It will then send a shortlist to the BBB which will make the final selection.
When Chief Minister of Gujarat, Mr. Modi got politicians removed from the boards of these enterprises and replaced them with professionals of repute. The Chief Minister’s Office played a key role in selecting independent directors for these enterprises. This approach resulted in better boards and improved performance. Why not replicate this approach at the Centre instead of creating another body for the purpose?
Management issue
Next, the management issue. A professional body to select CEOs for PSBs is by no means a novel idea. In the past, we had an Appointments Board which was headed by the RBI governor and included eminent professionals and a Finance Ministry official. Yet, this distinguished body was not able to get appointments of bank CEOs right. The political will to let the Board do its job was absent. It was the Finance Ministry that decided the appointments.
The BBB’s outcomes cannot be very different unless the government is willing to let it function independently. And if the government is willing to let go, why not stay with the Appointments Board? If the government can entrust the selection of bank chairmen to a panel headed by the RBI governor, why not do the same for CEOs and independent directors?
The Finance Ministry has thrown open the CEO’s job in five leading PSBs to private sector professionals. The initial response, it appears, was not satisfactory. Some requirements have since been relaxed so that there is wider pool of applicants. Flexibility in respect of pay has been promised, meaning the appointee will not be governed by PSB pay scales.
The government seems to have bought the contention of the Nayak committee that PSBs have not performed, and a huge gap between private and public sector performance has opened up because the public sector lacks the right talent and the right incentives. These are both dubious propositions.
PSBs improved their performance after bank reforms commenced in 1993-94 and continued up to 2010-11. If there has been a deterioration since, it is mainly for two reasons. First, PSBs got into infrastructure financing in a way in which private banks did not. Second, the selection of the CEO went wrong in many cases. Getting the choice of CEO right is half the battle won. Incentives can be addressed in due course.
Infusion of capital
Finally, the operational issues in PSBs need to be quickly resolved. The issue of stalled projects is being addressed. Lenders will have to write down some of their loans and promoters have to take a hit with bank loans getting converted into equity. At the same time, the government must infuse more capital into PSBs. This is one area in which banking policy has disappointed the most.
PSBs cannot be expected to perform unless they are given the necessary capital. They need about Rs. 20,000 crore by way of government equity every year for the next five years. In 2014-15, the new government promised Rs. 11,200 crore and ended up infusing Rs. 6,990 crore in nine PSBs. In 2015-16, it proposes to provide Rs. 7,940 crore. Who so? Because the government wants underperforming banks to improve their performance first before asking for more capital. Such an approach is seriously flawed. Improvement in performance will follow infusion of capital; it cannot precede the latter. That, after all, was the logic behind the bailout of banks that failed in the sub-prime crisis.
The government can bring out a sea change in PSBs by doing just three things: appointing the right CEOs, backing them with the requisite capital and bringing independent directors of competence and stature on board. These can be done expeditiously with the existing mechanisms and the existing talent in PSBs. It is more important right now to secure quick outcomes in banking than to pursue some grand design.
(T.T. Ram Mohan is a professor at IIM Ahmedabad.)
