[op-ed snap] The real bank crisis

Note4students

Mains Paper 4: Ethics | Corporate governance, Work culture

From UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Importance of a credible and vigilant management board in banks as well as other private insititutions


Context

Corporate governance dwindling at banks

  1. Recent decisions by the Reserve Bank of India on the various cases relating to the management at private sector banks brings into focus the role of the boards of private sector banks in India
  2. If the banking regulator has to put its foot down against the considered opinion of the board, it may be an indication that things have gone too far

Suggestions for better management

  • Boards must realise that real independence from the management is as important as the perception of independence as seen by outsiders
  1. In the recent ICICI case, there was a push from the independent directors — who were worried about the damage their reputation would have to suffer
  • Boards of private sector banks need to realise that oversight over the quality of financial reporting remains an important responsibility of the board
  1. Board oversight is needed on the quality of the loan asset portfolio, as under-reporting of NPAs and other stressed assets influences the integrity of financial reporting
  2. The successive lines of defence against financial misreporting are the bank CEO, bank auditors, bank audit committee, bank board, and the RBI supervisors
  3. The lack of board oversight can provide strong incentives to senior management to indulge in ever-greening of assets and RBI supervisors represent the final line of defence against financial misreporting on asset quality
  • Board members must realise that there is a significant information asymmetry between them and the senior management
  1. The management has the best information about the company
  2. In contrast, despite their best efforts at reading between the lines, board members must realise that they meet once in a few weeks and get informed about the bank through the agenda papers for the board and board committee meetings
  3. Board members in banks have to be extremely vigilant, especially about asset quality
  4. Not getting reappointed to the board cannot be worse than the significant reputational damage that a board member can suffer from being associated with negative events in the firm
  • When compared to the boards of firms led by professionals, boards of entrepreneur-led banks need to be particularly focused on ensuring credibility and independence
  1. In an entrepreneur-led bank, a general, albeit incorrect, perception can prevail that the board members need to toe the line to remain in the management’s good books
  2. As a result, any instance of the board being perceived to have not acted independently can significantly damage its credibility
  3.  If the board commands little credibility then there is a serious issue of board independence and, therefore, of governance in the bank

Way forward

  1. Given recent events, boards of private sector banks need to retrieve lost ground
  2. Independent and credible boards can guide the path for this
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