Capping Tenures And Compensation, RBI Tries To Dodge Shadows Of The Past
One circular at a time, RBI is trying to clean-out some of what was found in the corners of the last credit cycle.
As we read this, the Indian banking system is preparing for another barrage of bad loans to hit. This, even before the debris of the previous asset quality cycle was cleared.
From a distance it will look like one long bad loan cycle, which started in 2013 and will now, perhaps, stretch out over the next few years.
But there are reasons to segregate the two asset quality cycles. For one, it will help in understanding what ills of the previous cycle we have managed to correct and what will be carried with us into the next cycle.
The past cycle was a consequence of the heady days of infrastructure lending. We all know that. But those days were also characterised with what seems to follow banking booms. The star bankers, the large compensation packages, the boards that left the ambitions of managements and promoters unchecked. India had it all, maybe not across the sector, but in different crevices.
The Governance Goal-Post
The most recent set of suggestions put out by the RBI is intended to strengthening board governance. While it was always the case on paper, the regulator reiterates that message in its latest paper.
“The board of a bank has overall responsibility for the bank, including culture, governance framework and approving as well as overseeing management’s implementation of the bank’s strategic objectives. Directors have responsibilities to the bank’s overall interests, regardless of who appoints them.”
It goes on to prescribe what it believes is the ideal composition of bank boards, the role of the chairman, of various board committees and such.
But recognising that both the promoter and the chief executive have an outsized influence on a bank, the RBI has thrown in a suggestion that has immediately turned contentious.
The regulator suggests that the tenure of owner-chief executives be limited to 10 years. Professional CEOs should be allowed a maximum tenure of 15 years.
While the first suggestion will immediately bring the most recent Yes Bank experience to mind, there have been other instances where promoter-managers have run banks aground. Global Trust Bank and Bank of Rajasthan are two other recent examples. Beyond banks, and in the realm of non-bank lenders, Dewan Housing Finance comes to mind.
The same holds true for professional chief executives, particularly in banks with dispersed shareholding. Chanda Kochhar of ICICI Bank and Ravi Parthasarthy of IL&FS seemed to wield all-encompassing powers at their respective institutions, with boards failing to provide a counter-balance.
The critics will point of the fact that for every Yes Bank there is a Kotak Mahindra Bank. And for every Chanda Kochhar, there is an Aditya Puri. That’s undoubtedly true.
But the regulator is attempting to de-risk the system and this is one way of doing it.
The debate on this specific provision has just begun and will undoubtedly continue for some time before a final set of rules emerges.
The broader point is that this is part of a wider canvas of correctives the RBI is trying to bring in.
After issuing a discussion paper in February 2019, the RBI finalised new rules governing banker salaries in November 2019.
The significant change made there was ensuring that at least half of total compensation for bank top executives is variable pay and that variable pay, including stock options, is capped at 300% above the fixed pay.
The payout of the variable component was staggered out based on financial performance of the bank. All banks were asked to include a claw-back clause linked to any divergences in asset quality reporting.
The message – you will be held responsible for poor performance and poor governance even after you have stepped down.
Isolating The Risk Function
Between both the governance and the compensation circulars, there has been a change in the structuring of the risk function.
So, for instance, in the governance guidelines the RBI suggests that the risk management function and its functionaries shall “be accountable and report only to the Risk Management Committee Of The Board”. This committee in turn will be made up of only non-executive directors.
It also reiterates that risk management officials should not be involved in revenue generation and should clearly articulate the risk capacity of the bank, within which business must be conducted.
The circular on compensation also had provisions to isolate the risk function from pulls and pressure of a bank’s growth ambitions. It asked that risk staff be compensated in a manner that is independent of the business areas they oversee. The compensation of these officials should be more fixed than variable, but with a large enough variable linked to the risk performance of the bank.
Since the RBI is attacking some of these questions one at a time, the next question the regulator will apply its mind to is bank ownership.
India’s private bank ownership rules are a jumble. Different rules have been used in different licencing rounds over the years. Even within banks licenced at about the same time, there appear to be differences, as has become evident recently. While Kotak Mahindra Bank’s promoter has been allowed to retain 26% in the lender, IndusInd Bank’s promoters appear to have been asked to limit their shareholding to 15%. The reasons for this are not in public domain.
The debate here is whether banks are better run with diversified ownership or concentrated ownership. And what is the extent of promoter ownership that should be permitted. A more defined ‘fit and proper’ criteria for bank promoters may also be needed.
The RBI, on Friday, said it has set up a working group, which will look into “ownership, governance and corporate structure in private sector banks, taking into account key developments over the years which have a bearing on the issue.”
Beyond Private Banks
Finally, while a lot of the RBI’s efforts have been focussed on private banks, it has also attempted to bring change within public sector banks and cooperative banks. To the extent possible within the confines of government ownership (in the case of the former) and dual state control (in the case of the latter).
For PSU banks, a new set of rules governing boards were issued in August 2019. It appears those rules will only have a significant impact over the years as board tenures expire.
Through circulars issued in December 2019 and January 2020, the RBI also tightened exposure norms and the supervisory action framework for cooperative banks. In February this year, the government cleared amendments to the Banking Regulation Act to give the RBI more powers over this segment of banking.
The RBI must also now turn its lens towards systemically important NBFCs. The experience of the last two years has taught us that these entities can do as much systemic damage as private lenders even if they don’t hold the large public deposits.
This column has been updated to incorporate the announcement of an internal working group of the RBI to review private bank ownership rules.
Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.