The Hindu Business Line : Corporate governance and central banks

Central banks have the incentive to adopt the international best practices of corporate governance because financial communities often perceive such methods as a prelude to making the central banks independent and accountable. Impliedly, the central banks would then establish credibility with the market participants, says A. Vasudevan.

DISCUSSIONS on corporate governance in India tend to centre on the organised private sector corporate entities. There has, however, been very little discussion on the governance of financial regulators, and on the institutions/bodies that they finance and own.

Among the financial regulators, the most important is the central bank. The question often posed is: Who regulates the regulator? This, however, becomes irrelevant once the central banks provide the lead by adopting such principles and practices of corporate governance as are relevant to their operations.

Central banks have the incentive to adopt the international best practices of corporate governance because the financial communities, both at home and abroad, often perceive such practices as a prelude to making the central banks independent and accountable. Impliedly, the central banks would then establish credibility with market participants.

The international best practices for the central banks have been codified and the standards provided as part of the OECD's Core Principles on Corporate Governance and the IMF Code of Good Practices on Transparency in Monetary and Financial Policies. The IMF's Financial Sector Assessment Programmes (FSAPs) and the Reports on Observance of Codes and Standards (ROCSs) provide insights about the issues connected specifically with central bank transparency and corporate governance.

As early as September 2000, the Reserve Bank of India came out with an Advisory Group Report on the Core Transparency Principles concerning monetary and financial policies. It has subsequently provided a consolidated account of the recommendations of advisory groups on a variety of financial standards.

The RBI has also presented in its Annual Reports of recent years, in pursuance of corporate governance, the evolving accounting policies and fairly detailed data about some of the items pertaining to its balance sheet (for example, the contingency reserves, asset development reserve, balances in the currency and gold revaluation account and exchange equalisation account).

The Annual Reports also contain accounts of the working of the departments in different functional areas of the apex bank. The RBI has also placed on its Web site a number of reports on several aspects of its operations and intended actions (for example, the reports on instruments of sterilisation and liquidity adjustment facility).

As part of good corporate governance, the RBI follows the best practices relating to risk management — foreign currency, interest rate, liquidity and credit risks. It is, however, necessary to make it clear that the operational and reputation risks are fully addressed.

It would be most instructive, especially for academics, if the RBI were to bring out a technical paper on the various techniques and models that it considers in its approach to risk management. Similarly, a technical paper on how it conducts internal audit and resolves conflict of interests as also on financial disclosures that are in line with the accounting standards would help provide better clarity on this issue.

Besides, a paper providing an explicit statement of its principal policy objectives — for example, its monetary policy — and an account of how the central bank assigns responsibilities within its organisation for realising its stated objectives would greatly help improve the knowledge on central banking. It would be most interesting if the operating costs relating to obtaining information in pursuit of monetary policy objectives and in achieving them were also to be disclosed.

Bank governance also requires that central banks put in place a structure for facilitating external monitoring of performance. As the Annual Report of the RBI is already in the public domain, this issue could be taken care of with some elaboration of the working of the central bank in the Annual Reports.

The RBI could supplement the Annual Report with reporting of its income and expenditures periodically — maybe once a month, initially — and providing periodic reviews — preferably half-yearly — of actual expenditure against department plans and budgets. Such reports should, however, contain the methodology that is followed in determining the targets or benchmarks in the department plans and budgets.

Regarding the directors on the RBI's board — a crucial point of corporate governance — it is the government that appoints them on the basis of their experience and expertise in certain chosen areas. This needs to be supplemented by information on how the bank would utilise the directors' expertise and whether the directors would devote sufficient time and energy to help the central bank realise its objectives.

The above aspects of central bank governance could be initially addressed in the Annual Report for 2004-05. The Annual Report, as it is presently structured, provides an account of the working and operations of the RBI but it is overshadowed by the part that reviews the developments in the economy.

Ideally, the Annual Report should deal only with the RBI's operations. It could, however, be released along with a separate document on the Bank's annual review of the economy as considered and approved by the directors. Such a procedure would eliminate any impression that the review of the economy represents the view of the management, as the management is only an agent of the principal, namely, the board of directors.

To be consistent, the central bank would need to ensure that corporate governance principles for the institutions that are supported by it are strictly followed.

In addition to the information the central bank provides in the Annual Reports about its investments in shares of subsidiaries/associate institutions, it could also provide information about the expenditure incurred or costs borne on account of these institutions and the two academic bodies owned by it.

On this point, it is necessary to note that financial subsidiaries strive for business growth and profits, unlike academic bodies, and should abide by the corporate governance principles, like all financial institutions outside the RBI's support structure. In the case of academic bodies, however, there is no clarity about the accountability of their governing councils.

Commitment to corporate governance as a value would require the Bank to exercise care while appointing the Chairmen/Directors of academic bodies. The RBI should not merely go by the official positions of the persons while appointing them but also closely examine the suitability of their academic qualifications and expertise. There are, after all, not many a Bill Gates (a school dropout) who could be on these councils.

In the case of economic research, we are fortunate to have plenty of talented economists, of whom the RBI Governors in recent years could be reckoned as the most competent. In the case of institutions that are concerned with the New Economy areas, however, the situation is different and the qualification-cum-expertise criterion should therefore be followed with rigour.

It is only then that the Chairmen/Directors will be able to appreciate and, perhaps, ask searching questions on the research conducted to advance knowledge of new technologies in these institutions by highly qualified persons in the areas of mathematics, programming, computer engineering and quantum physics.

Besides, the Chairmen/Directors should devote sufficient time for advancing operationally relevant research and academic activities. It is only then that the new technology institutions could hope to become centres of excellence.

Corporate governance principles and practices should also be applied for other financial regulators, including the Ministry of Finance, with some orientation consistent with their functional areas of activity. It is necessary that such `other' regulators have in place user-friendly Web sites and post on them the actions they have taken as regulators to implement the principles.

Such transparency practices would enhance investor confidence and provide incentive for flows of foreign capital, both direct and portfolio investment. Besides, they would help to foster stability, improve efficiency in resource allocation and enhance growth prospects.

(The author, a former Executive Director of the Reserve Bank of India can be accessed at asurivasudevan@hotmail.com)

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