RBI Pushes for Massive Governance Reforms of Banks

Posted On - 29 June, 2021 • By - Souvik Ganguly

On 27 May 2021, the Reserve Bank of India (RBI) published its annual report for 2020-21 disclosing that in the last three years 22,864 banking frauds have been reported involving a gargantuan amount of over INR 3.95 trillion (~USD 53 billion). Be it the 2020 ICICI Bank-Videocon bribery for loan scam, the 2019 Punjab and Maharashtra Co-operative Bank crisis or the 2018 Nirav Modi and Gitanjali Gems-Punjab National Bank scam, poor corporate governance is the common ground for such occurrences. Investigations have revealed involvement of not only mid-level employees, but also of the senior most management of the banks. It is concerning that such instances of irregularity within the banking system have reoccurred in multiple cases since 2018 demonstrating a lack of effectiveness of existing corporate governance structures at the highest echelons of Indian banks.

RBI has recently relooked at the corporate governance guidelines for banks in India. On 11 June 2020, RBI published a discussion paper on governance of commercial banks which compiles recommendations made by ‘Basel Committee on Banking Supervision, the guidelines from RBI Circular of March 1992 on Do’s and Don’ts for directors, the provisions of Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations) and the Companies Act, 2013, and other RBI circulars. On 26 April 2021, RBI issued a circular on Corporate Governance in Banks – Appointment of Directors and Constitution of Committees of the Board (Circular) which aims to bolster the governance regime of the banking sector in India.

The Circular revises provisions related to appointment of a bank’s chairperson, tenure of directors, and constitution of committees in relation to private sector banks, small finance banks and wholly owned subsidiaries of foreign banks. Banks have time till 01 October 2021 to comply with the revised provisions. Notably, the Circular is not applicable to branches of foreign banks. Here it would be prudent to point out that the Circular has limited applicability to nationalized banks. The Circular would only apply to nationalized banks to the extent it is not inconsistent with provisions of the specific laws applicable to the nationalized bank. Under the State Bank of India Act, 1955, (SBI Act), the directors of State Bank of India (other than managing director) can hold office for up to three years with an option of reappointment and a cap of six years on holding the office without a break. In this instance, the provision under the SBI Act is more protective for stakeholders than the Circular. As the provision with respect to appointment term of directors (other than managing director) under the Circular and the SBI Act are inconsistent, the provision of the SBI Act will continue to apply to the State Bank of India.

Appointment of chairperson of the Board of Directors (Board)

The Circular aims to enhance the independence of the Board by emphasizing the role of independent non-executive directors. The ability of an independent Board to ‘stand apart’ from inappropriate influences, to be free of managerial manipulations, and to be able to make correct and unbiased decision on a given issue, are key governance measures to protect stakeholders from frauds and scams. Building on this, banks will now be required to ensure that the chairperson of the Board is an independent director. If a bank does not have a designated chairperson then all meetings of the Board will be presided over by an independent director.

Banks such as HDFC Bank, Kotak Mahindra Bank, ICICI Bank, etc., which are listed on Indian stock exchanges, are required to comply with the Listing Regulations in respect of quorum requirements. Under the Listing Regulations, the quorum for every Board meeting of the top two thousand equity listed companies, which includes RBL Bank, DCB Bank, ICICI Bank, etc., shall be one-third of the total strength of the Board or three directors, whichever is higher, including at least one independent director. Compared to the Listing Regulations, the Circular has a slightly higher requirement of independent directors in the quorum. The Circular provides that the quorum for the Board meetings of banks shall be one-third of the total strength of the Board or three directors, whichever is higher, with at least half of the directors attending the meetings to be independent directors. So, while the Listing Regulation mandates that at least one of the minimum number of directors required for holding the Board meeting must be an independent director, the Circular raises the threshold and pushes for an independent director majority or at-least parity on the Board to foster independent decision-making in banks and to mitigate conflicts of interest that may arise.

Constitution of committees under the Board

Banks, in comparison to other companies, need to provide protection to a much broader pool of stakeholders, particularly depositors who do not usually have the possibility to influence the banks’ business decisions. This requires a much deeper involvement of the Board in strategic issues and risk oversight, as it must fully understand the risks the bank is exposed to and be able to monitor them effectively. This can be done through committees which provide necessary and effective support to the Board on matters related to audit, risk management, nomination and renumeration, stakeholder relationship, etc.

The Circular provides for mandatory three specialized board committees viz the audit committee, the risk management committee, and the nomination and renumeration committee, and also specifies the composition of these committees as well the qualification of its members. Under the Listing Regulations a listed bank is required to constitute audit committee, the risk management committee, and the nomination and renumeration committee and these committees are required to convene meetings once each year. The Circular mandates that all banks will be required to constitute an audit committee and the risk management committee (with meetings at least once every quarter) and nomination and renumeration committee (with meetings as required).

The Circular also calls for a distinct chairperson of each committee to prevent any interference of one chairperson into the chairmanship of other committees. This will decentralize the functions of audit, risk management, and nomination of directors, thereby preventing one-sided decisions of an autocratic management.

Age, tenure, and remunerations of non-executive directors

Under the Listing Regulations, no person can be appointed or continue as a non-executive director of a listed company after attaining the age of seventy-five years, unless a special resolution is passed justifying the reason for such appointment. The Circular now caps the age of non-executive directors of banks to seventy-five years post which no person will be allowed to continue in such position. Also, the total tenure of a non-executive director has been confined to eight years with an option of reappointment after a cooling period of three years. During the cooling period, the person can be appointed as a director in another bank.

At present, banks in private sector pay only sitting fees to non-executive directors, and no other remuneration is paid to them. To enable the banks to attract and retain professional and qualified non-executive directors to the Board, it is necessary that the non-executive directors are appropriately compensated. The Circular allows banks to pay renumeration to a non-executive director (other than the chairperson of the Board) to a maximum of INR 2,000,000 (Indian Rupees Two Million) per annum.

Tenure of managing director, whole-time directors and CEO

The Banking Regulation Act, 1949 allows for appointment of managing director or whole-time directors of banks for a maximum tenure of five years at a time. Banks may reappoint such individuals for another term not exceeding five years on each occasion, but not earlier than two years before expiry of their current term.

The Circular now reins back the total term of the managing director and CEO and whole-time directors by providing that such an office cannot be held for more than fifteen years. Thereafter, the individual will be eligible for reappointment as managing director and CEO or whole-term director in the same bank, if considered necessary and desirable by the Board, after a cooling period of three years. During this three-year cooling period, the individual shall not be appointed or associated with the bank or its group entities in any capacity, either directly or indirectly.

Managing director and CEO or whole-time director who is also a promoter/ major shareholder cannot hold these posts for more than twelve years. However, RBI may allow such individuals to continue up to fifteen years in extraordinary circumstances and at RBI’s sole discretion. The Circular clarifies that those banks where the managing director and CEOs or whole-time directors have already completed their twelve / fifteen years tenure as on date of issuance of the Circular and had their terms extended, such managing director and CEOs or whole-time directors will be allowed to complete the remainder of their current term.

The new guidelines under the Circular will impact the current heads of several banks like Kotak Mahindra Bank, DCB Bank, City Union Bank, Federal Bank and RBL Bank, where they have been holding such post for more than ten years. In the case of Kotak Mahindra Bank, Mr. Uday Kotak, the promoter and also the managing director and CEO since 2003, who was reappointed on 01 January 2021 for a period of three years, will not be eligible for reappointment once his current term expires on 31 December 2023. However, he will continue to remain a stakeholder in the bank. The intent of the RBI is to separate ownership and management to ensure that a system of checks and balances is in place, and that unprejudiced decision are taken in the best interest of the bank.

Our thoughts

The intent of the Circular is for banks to have a Board which is independent of the management and enriched with appropriate balance of skill, experience, and knowledge. The independent directors will be given the power to monitor and guide the Board committees relating to audit, risk management and nomination of other able and qualified directors, thereby improving corporate credibility and accountability.

The Circular also places several checks and balances when it comes to the term of directors and managing directors of the banks, especially when such managing directors are also promoters of the bank. It can be argued that an excessively long tenure of the executive directors may likely result in governance issues and the banks will be better benefited from changes at a regular interval for induction of new energy with a fresh perspective. Overall, the Circular seeks to enhance bank governance standards in India, especially in the aftermath of recent scams. It strongly focuses on the Board and the various committees under the Board, whose duties and responsibilities find specific treatment. Ultimately, the efficacy of implementation of these guidelines will depend on timely enforcement by RBI.

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