The incoming Government will have to undertake radical reform measures, including privatisation, to improve governance in public sector banks as their financial position is fragile, a Reserve Bank of India panel has suggested.
The Committee to Review Governance of Boards of Banks in India, headed by PJ Nayak, former Chairman and CEO, Axis Bank, has recommended that the Government distance itself from several bank governance functions.
The character of BIC’s business would make it resemble a passive sovereign wealth fund.
The Government and the BIC should sign a shareholder agreement which assures BIC of its autonomy and sets its objective in terms of financial returns from the banks it controls.
Given the lower productivity, steep erosion in asset quality and demonstrated uncompetitiveness of PSBs over varying time periods, the committee felt that recapitalisation of these banks will impose significant fiscal costs.
Two options “If the governance of these banks continues as at present, this will impede fiscal consolidation, affect fiscal stability and eventually impinge on the Government’s solvency,” the committee said.
Consequently, the Government has two options. The first is to privatise these banks and allow their future solvency to be subject to market competition, including through mergers.
The second is to design a radically new governance structure that would better ensure their ability to compete successfully, so that repeated claims for capital support from the government, unconnected with market returns, are avoided.
Pointing to the several external constraints imposed on PSBs which are inapplicable to their private sector counterparts, the committee suggested that the Government and the RBI rapidly eliminate or significantly reduce these constraints.
Otheriwse, managements of these banks will continue to face erosion in competitiveness, it said.
The external constraints include dual regulation by the finance ministry and the RBI, the manner of appointment of directors, the short average tenures of Chairmen and Executive Directors, compensation constraints, external vigilance enforcement and applicability of the Right to Information Act.
Bank investors The RBI should also designate a specific category of investors in banks as Authorised Bank Investors (ABIs), defined to include all funds with diversified investors which are discretionally managed by fund managers .
ABIs would include pension funds, provident funds, long-only mutual funds, long-short hedge funds, exchange-traded funds and private equity funds (including sovereign wealth funds). They would exclude all proprietary funds (including those which are hedge funds or set up by corporates), non-banking finance companies and insurance companies.
A single ABI should be permitted a maximum 20 per cent investment stake in a bank without regulatory approval, provided it possesses no right to appoint a board director.
For promoter investors, other than ABIs, it is proposed that the continual stake ceiling be raised to 25 per cent (from 15 per cent).
An ABI which is given board representation, and thereby exercises a measure of influence, should be permitted a lower 15 per cent maximum investment limit without regulatory approval.
For banks identified by the RBI as distressed, the committee suggested that private equity funds, including sovereign wealth funds, be permitted to take a controlling stake of up to 40 per cent.