Nayak Committee to Review Governance of Boards of Banks in India submitted its report to RBI

The committee to review Governance of Boards of Banks in India on 13 May 2014 submitted its report to Reserve Bank of India (RBI). The committee was constituted under the chairmanship of P. J. Nayak. He is a former Chairman and CEO of Axis Bank.

Committee has submitted list of recommendations:

• The Report projected the capital requirements till March 2018 in order that provisions are prudent, there is adequate balance sheet growth to support the needs of the economy, and capital is in line with the more demanding requirements of Basel 3.

• The financial position of public sector banks is fragile, partly masked by regulatory forbearance. Forbearance delays, but does not extinguish, the recognition of this fragility. Capital is significantly eroded with the proportion of stressed assets rising rapidly.

• The boards are disempowered, and the selection process for directors is increasingly compromised. Board governance is consequently weak. It is unclear that the boards of most of these banks have the required sense of purpose, in terms of their focus on business strategy and risk management, in being able to provide oversight to steer the banks through their present difficult position.

• The onus of remedying this situation through radical reform lies primarily with the Central Government. In the absence of such reform, or if reform is piecemeal and non-substantive, it is unlikely that there will be material improvement in the governance of these banks. This could impede the Government's objective of fiscal consolidation. The fiscal cost of inadequate reform will therefore be steep.

• The Report proposed that the Government distances itself from several bank governance functions which it presently discharges. For this purpose it recommends that the Bank Nationalisation Acts of 1970 and 1980, together with the SBI Act and the SBI (Subsidiary Banks) Act, be repealed, all banks be incorporated under the Companies Act, and a Bank Investment Company (BIC) be constituted to which the Government transfers its holdings in banks. The Government's powers in relation to the governance of banks should also be transferred to BIC.

• The process of board appointments, including appointments of whole-time directors, needs to be professionalised and a three-phase process is envisaged.

• Governance difficulties in public sector banks arise from several externally imposed constraints. These include dual regulation, board constitution, wherein it is difficult to categorise any director as independent; significant and widening compensation differences with private sector banks, leading to the erosion of specialist skills; external vigilance enforcement though the CVC and CBI; and limited applicability of the RTI Act.

• The Report proposed the need for wide-ranging human resource policy changes. These would encompass getting younger people into top management, for which a demographic opportunity has now arisen, and which would thereby lead to longer tenures; and succession planning.

• There is also a need to envision afresh the process of countering corruption through a redesign of the existing process of vigilance enforcement. The Report argues that present modalities are damaging and erode the ability of the banks to compete strategically, besides being only weakly effective in combating corruption.

• Governance issues in private sector banks originate from an altogether different set of concerns. There are issues which arise from ownership constraints stipulated by RBI, which could misalign the interests of shareholders with those of the management. In several other jurisdictions, these constraints are less rigid.

• In order to permit certain kinds of investors to take larger stakes, it is proposed that a category of Authorised Bank Investors (ABIs) be created, comprising all diversified funds which are discretionally managed by fund managers and which are deemed fit and proper.

• It is proposed that an ABI be permitted a 20 per cent equity stake without regulatory approval, or 15 per cent if it also has a seat on the bank board. All other financial investors should be permitted upto 10 per cent.

• The Report proposes increasing the continual stake ceiling to 25 per cent. It also proposes that for distressed banks, private equity funds - including sovereign wealth funds - be permitted to take a controlling stake of upto 40 per cent.

• The Report also proposed that the principle of proportionate voting rights should constitute part of the regulatory bedrock that fosters good governance.

• RBI should attempt to diversify boards in banks where independence is not visible, by mandating prior RBI approval for directors in such banks. RBI should also mandate a separation between board oversight and executive autonomy.

Terms of reference of the committee

The terms of reference of the committee include to analyse the representation on banks’ boards to see whether the boards have the appropriate mix of capabilities and the necessary independence to govern the institution, and to investigate possible conflicts of interest in board representation, including among owner representatives and regulators.