The current compliance level among Indian banks is insufficient to label the existing governance structure as “socially efficient”, according to a Reserve Bank of India (RBI) study.

This is despite Indian banks making impressive progress in adhering to the mostly mandatory corporate governance norms/standards in the last few years, per the Development Research Group study titled “Governance, Efficiency and Soundness of Indian Banks”.

Governance norms

The key policy implication stemming from the empirical outcomes is that inadequate regulatory adherence by banks with governance norms would be costlier and may have destabilising impact on the banking sector, noted the study put together by two academicians and three RBI officials.

The authors observed that private sector banks (PVBs) showed relatively better performance in adhering to governance norms during the study period (2009-2018). Notably, public sector banks (PSBs) stumbled in achieving greater compliance with the dimensions of board effectiveness, risk management and audit functions.

An assessment of policy priorities made by the study divulges that, on average, PSBs accord higher priority to disclosure and transparency, which is followed by the remuneration, and shareholders’ rights and information.

In contrast, private banks ascribe a greater focus on audit function, followed by risk management and board quality.

Bank soundness

On dimensions of bank soundness, PSBs amply focused on management efficiency, while PVBs zeroed in on management efficiency, followed by asset quality and profitability. These differences highlight asymmetries in the policy priorities of banks on governance and soundness across ownership groups, per the study.

Even the success of the recent consolidation wave in the public sector banking segment hinges upon how well newly emerged mega PSBs improve their governance structures, which is a great challenge, it added.

The authors emphasised that the degree of governance significantly explains bank soundness, and any regulatory non-adherence to selected governance principles would be costly and may undermine soundness of the Indian banking system.

Profit-efficient banks are sound enough to hold the capability of absorbing shocks, which may reduce destabilising effects. Therefore, to avoid the risk of bank failure in the long-run, business practices that assure sustainable profits with proportionate risk should be encouraged.

The study said lack of instantaneous recovery in bank soundness may be due to the detrimental effects of many potential exogenous and endogenous shocks to the system.

Govt involvement

The study suggested that government involvement offers the implied guarantee only up to a level, and beyond that, it does not necessarily translate into higher bank soundness. Additionally, a pervasive shift in the policy stance of regulators from deregulation to re-regulation since 2014 has compelled the banks to concentrate more on adherence to governance standards and other regulatory norms. When it comes to bank size, no stable relationship with soundness is observed.

The authors opined that better remuneration practices help the board in choosing compensation packages for executives that are connected to their performance, which lowers agency conflicts and enhance bank soundness.

Further, higher compliance on shareholders’ rights enhances the soundness of banks. At the same time, only reasonable and rational disclosures can protect the interest of the minority investors along with depositors, and circumvent precipitating the risk of being unsound.