'Governance in Banks: Driving Sustainable Growth and Stability'
Inaugural Address by Shri Shaktikanta Das, Governor
at the Conference of Directors of Banks
organised by the Reserve Bank of India for Public Sector Banks
on May 22, 2023 in New Delhi and Private Sector Banks on May
29, 2023 in Mumbai
I am very happy to be here in this maiden Conference of the Directors
in the Boards of Banks organised by the Reserve Bank of India. At the
outset, I would like to acknowledge the key role played by the Banks in
the process of economic development of our country. Over the years
and especially in the recent period, Banks have been able to maintain
financial and operational resilience in the face of extreme stress
originating from the COVID-19 pandemic, the continuing war in Europe
and the banking sector crisis in certain advanced economies (AEs).
2. Today our banking sector stands out as strong and stable with CRAR
at 16.1 per cent, Gross NPA at 4.41 per cent, Net NPA at 1.16 per cent
and Provision Coverage Ratio at 73.20 per cent at the end of December
2022. It is in times such as these that complacency may set in. We
have to bear in mind that risks often get overlooked or forgotten when
things are going well. Therefore, Boards of Directors of Banks and their
senior management should maintain constant vigil on external risks and
build-up of internal vulnerabilities, if any.
3. In the last few years, the Reserve Bank has significantly
strengthened regulation and supervision of the entire financial sector.
We have issued guidelines on governance in banks and also
rationalised the regulatory architecture for Banks, NBFCs (including
MFIs) and UCBs. Our supervisory approach and methods have
become much stronger and deeper. Our priority is protection of
depositors'
money and ensuring a robust financial sector for the country
to progress. As you are aware, banks do their business primarily with
depositors'
money and it is, therefore, the responsibility of Boards of
Directors and Managements of Banks to keep the interest of depositors
uppermost in their mind.
4. I would like to take this opportunity to convey our expectations from
the Boards of Directors of banks and explain the multi-dimensional
responsibility of individual directors1. My colleagues in the Reserve
Bank and I also intend to have first-hand feedback from you on how to
ensure that the Indian banking system remains resilient and future
ready even in the face of risks and uncertainties. The entire effort has
to be collaborative between the Bank Boards and the Reserve Bank.
Let me now specifically dwell upon our expectations from Bank Boards
one by one.
I. Governance and Stability
5. A robust governance structure is the first and the most important
requirement for ensuring stability of a bank as well as sustainable
financial performance. According to the Basel Committee on Banking
"the quality of governance and management is
Supervision (BCBS)2,
probably the single most important element in the successful operation
of a financial institution".
Similarly, a study conducted by the Reserve
Bank researchers3, based on comprehensive econometric analysis,
has shown that bank stability is strongly predicated upon the
governance structure in the banking system.
6. With this objective in mind, the Reserve Bank has issued guidelines4
listing out seven critical themes which need to be discussed in the
Board meetings. These themes are business strategy, financial reports
and their integrity, risk, compliance, customer protection, financial
inclusion and human resources. The Reserve Bank has also issued
guidelines5 on appointment of chairperson and conduct of meetings of
the board; composition of important committees of the board; age,
tenure and remuneration of directors; and appointment of the whole-
time directors (WTDs). It is, however, a matter of concern that despite
these guidelines on corporate governance, we have come across gaps
in governance of certain banks, with the potential to cause some degree
of volatility in the banking sector. While these gaps have been
mitigated, it is necessary that Boards and the managements do not
allow such gaps to creep in. We have been engaging with some of you
on these issues at the individual level, but I thought it would be more
effective if we engage with all the Directors together. It is the joint
responsibility of the Chairman of the Board and the Directors, both
whole time as well as non-executive or part time Directors, to ensure
robust governance in banks.
II. Ensuring requisite qualification and expertise in the Board
7. The Banking Regulation Act prescribes certain qualifications for
appointment as Directors in the Board of Banks. Additionally, the
Reserve Bank has issued guidelines on the 'Fit and Proper' criteria for
the Directors. The objective is that Board members should have
requisite expertise and demonstrate competence and integrity. For this,
it is of utmost importance that the Directors keep themselves updated
material changes in the bank's
with internal environment as well as the
external factors that have a bearing on the bank. A balanced
combination of skills, diversity and expertise commensurate with the
size, complexity and risk profile of a bank is what will drive it towards
sustainable resilience. These skills should be enhanced by ongoing
orientation programmes for the Directors. Directors must exercise care,
prudence and diligence in the discharge of their functions. Duty of
loyalty implies an undivided and unselfish loyalty to the Bank and
demands that there shall be no conflict between duty and self-interest6.
III. Objective and Independent Board
8. Individual Directors should not have any conflict of interest which
may hamper their objectivity and independence. It is the responsibility
of the Board to ensure that policies are in place to identify potential
conflicts of interest and deal with them. In this respect, it is necessary
that directors are
'independent' truly independent; that is, independent
not only of the management but also of controlling shareholders while
discharging their duties. They have to always remember that their
loyalty is to the bank and no one else. Directors should keep watch on
actual or potential related party transactions. They are expected to ask
pertinent questions and obtain the required information from the
management before taking decisions. I am not advocating any
confrontation, but only stressing the need for the required level of
alertness among all directors.
IV. Role of Chairperson, Board Committees and Managing
Director/Chief Executive Officer
9. The role of Chairperson is akin to the captain of a ship. For the
chairperson to be able to navigate the Board discussions and functions
in the right direction, he/she should possess the requisite experience,
competencies and personal qualities. Chairpersons should encourage
open and honest discussions which, at times, can be critical of the
proposals recommended by the management. Fostering an
environment where dissenting views can be freely expressed and
-
discussed is what will ensure objectivity an absolute necessity for
long-term sustainable performance of a bank.
10. The MD & CEO is expected to function under the overall
supervision, direction and guidance of the Board and at the same time,
maintain independence in performance of duties. At times, however, we
have noticed the dominance of CEOs in Board discussions and
decision making. It has been seen in such cases that Boards are not
asserting themselves. We would not like this type of situation to
develop. At the same time, there should not be a situation where the
CEO is inhibited from doing his duties. Directors and CEOs should,
therefore, foster an atmosphere of free and fair discussions in Board
Meetings.
V. Tone from the Top; Corporate Culture and Value System
11. The larger purpose of the Board is to provide clear and consistent
direction to the banks. The focus areas for any Board should be that of
corporate
approving and overseeing implementation of the Bank's
values, policies and strategic objectives. Setting the correct tone at the
top is a primary step in building a conducive corporate and risk culture
as well as ethical behaviour among the rank and file. It is the
responsibility of the Board to ensure that the processes and systems in
the bank facilitate effective decision-making and good governance,
which should also percolate down within the Bank. These are not
abstract concepts. These are necessities which would help in building
public trust and confidence on Banks.
12. The importance of public trust in the banking system, as exemplified
in the recent bank failures in the United States, also needs to be
appreciated. This was a classic case wherein public trust in certain
banks evaporated suddenly. Further, in this digital age, it took only a
few hours to transfer billions of dollars held as deposits in a bank to
other institutions, leading to a severe liquidity crisis. The monitoring of
information appearing in various media, including social media, has
therefore become very important for any bank. In fact, such cases have
been observed in India, too, in a few Banks in the past. We had to
advise the CEOs to interact with the media immediately to set out the
facts correctly. There have been instances when the Reserve Bank had
to issue press statements to assuage concerns and prevent potential
panic. In this kind of milieu, it is upon the Banks and their Boards to
assiduously build sound corporate culture and value system within the
organisation.
VI. Quality of Information
13. Our supervisory assessments have revealed that, sometimes, the
information being put up to the Board was laden with gaps and material
inaccuracies. Further, the agenda notes which the Boards were
reviewing did not capture all the relevant information which made their
review either ineffective or partially effective. We have come across
instances of agenda papers not being circulated well in advance. There
were also instances of only power point presentations being circulated
as agenda notes. These power point presentations are like a guided
tour, and Directors should clearly look beyond a guided tour.
14. It is the responsibility of the Senior Management to provide material
information to the Board in a timely, accurate and understandable
manner so that the Boards can take informed decisions. Care should
be taken to avoid voluminous notes and information overwhelming the
Directors with superfluous data. On the other hand, the Board also has
a responsibility to seek as much relevant information as required for it
to satisfactorily reach a decision.
VII. Effective oversight of Senior Management
15. Senior Managements in banks like any other corporate entity are
accountable for implementing the Board decisions and ensuring that
the risks assumed by the bank are within the risk appetite approved by
the Board. An effective Board of Directors also evaluates the
performance and compensation of the Senior Management.
16. A compensation structure which does not distinguish between
prudent risk taking and excessive risk taking often results in a culture
of indifference towards risk taking. Banks need to rethink their internal
accountability structures to ensure that prudent risk taking is rewarded
and imprudent decisions are discouraged.
17. Employees cannot be rewarded for increasing short-term profits
without adequate recognition of the risks and long-term consequences.
In this regard, the Reserve Bank has issued guidelines on
Compensation of Whole Time Directors/ Chief Executive Officers/
Material Risk Takers and Control Function staff of private sector banks.
The underlying idea is that the compensation structure should promote
bank's
long-term performance and be in line with the business and risk
strategy, objectives, values and incorporate measures to prevent
conflicts of interest.
VIII. Business Model and Conduct
18. Business models of Banks are expected to be robust and prudent.
In this context, Boards need to pay specific attention to the asset liability
management (ALM) in the Banks, as suboptimal ALM can lead to
serious liquidity risks and destabilising effects on the Bank itself. The
recent developments in the banking sector in the USA bear ample
testimony to this. These developments in the USA have also
demonstrated that aggressive growth strategies with disproportionate
or excessive focus on the bottom lines and/or market capitalisation
often leads to build up of vulnerabilities. Banks should exercise caution
and prudence in their growth strategies, pricing of products and portfolio
composition. Over-aggressive growth, under-pricing or over-pricing of
products both on the credit and deposit sides, concentration or lack of
adequate diversification in deposit/credit profile can expose the banks
to higher risks and vulnerabilities. From time to time, the Reserve Bank
has engaged with certain banks on the need to make suitable
adjustments in their business strategies where it was observed that
over-aggressive growth in certain business segments (be it in
credit/deposits) were creating avoidable vulnerabilities. Problems or
risks can come from one corner of the balance sheet which might
appear insignificant in the beginning. Let me emphatically state that the
Reserve Bank does not interfere in commercial decision making of the
banks, but only gives them a nudge to address potential risks and
vulnerabilities. It is expected of banks that they put in place robust risk
management policies and practices to address the risks associated with
their business model/strategy.
19. Another area of focus for the Board should be the adoption of fair
practices and customer protection, including in the context of growing
digital lending. Quick and effective redress of customers grievances
bank's
reflect the efficacy of a overall functioning.
20. Here, I would like to mention that we have also issued guidelines
regarding outsourcing of functions to third-party agencies. The
arrangements with these third-party agencies should be very clear,
specific and well-defined. In outsourcing of critical functions, including
technology services, if an incident occurs, the banks cannot shift the
blame to the third parties because the primary responsibility of ensuring
operational resilience is on the banks and not on the third parties.
Therefore, it is for the banks to have suitable arrangements and
agreements in place with the service providers to ensure that they
function according to the policies and expectations of the individual
banks.
IX. Integrity and Transparency of Financial Statements
21. One of the critical areas where the role of Directors is very
significant is in ensuring the integrity of financial statements published
by the bank. We have come across instances where so called smart
accounting methods were adopted to artificially boost the financial
performance of the bank.
22. During the course of our supervisory process, certain instances of
using innovative ways to conceal the real status of stressed loans have
also come to our notice. To mention a few, such methods include
two lenders together to evergreen each other's loans by sale
bringing
and buyback of loans or debt instruments; good borrowers being
persuaded to enter into structured deals with a stressed borrower to
conceal the stress; use of Internal or Office accounts to adjust
borrower's repayment obligations; renewal of loans or disbursement of
new / additional loans to the stressed borrower or related entities closer
to the repayment date of the earlier loans; and similar other methods.
We have also come across a few examples where one method of
evergreening, after being pointed out by the regulator, was replaced by
another method. Such practices beg the question as to whose interest
such smart methods serve. I have mentioned these instances to
sensitise all of you to keep a watch on such practices.
23. The Board of Directors, especially the Audit Committee of the Board
(ACB), should bestow close attention on the accounting policies
followed by the banks and implement preventive controls to preclude
smart or aggressive accounting practices. The Board or the ACB should
engage with the Statutory Central Auditors of the bank to ensure that
their financial reporting is transparent and prudent.
X. Independence of Assurance Functions; risk management,
compliance and internal audit
Under the 'three lines of defence' model,
24. Management and
business functions form the first line while risk management and
compliance form the second line. Internal Audit forms the third line of
-
defence. The assurance functions risk management, compliance and
-
internal audit collectively assist the Board as well as the management
to gauge whether the business operations of the bank are being run in
conformity with the policies and strategies laid down by the Board. RBI
has issued detailed guidelines for ensuring quality and independence
of governance and assurance functions. The Board as well as the Risk
and Audit committees of the Board should ensure that risk
management, compliance and internal audit functions have adequate
independence and stature within the organisation to function
effectively.
25. It is important that the Assurance functionaries have a right of direct
access to the Board of Directors or its committees. Moreover, the
assurance functionaries should have the independence to
constructively challenge the business functions for establishing a
strong compliance and risk culture. The assurance functions should
also be at the same pedestal as the business functions. The Reserve
Bank has issued detailed guidelines in this regard for ensuring quality
and independence of the assurance functions. Banks may also subject
their assurance functions for independent external evaluation, so that
there is an added layer of confidence to all the stakeholders.
Conclusion
26. Let me now conclude. On behalf of the Reserve Bank, I have
enumerated a 10-point charter in my address today. The safety and
soundness of the banking system relies critically on effective corporate
governance which helps to build an environment of trust, long-term
stability and business integrity of banks. Governance frameworks can
be pictured as a complex mesh of nuts and bolts holding the financial
pillars of capital, assets, deposits and investments in place and keeping
the structure of the bank upright. Raising financial resources would not
be a constraint for banks with robust governance frameworks as they
can command a governance premium. This premium in turn will be
driven by quality of leadership at the top.
27. As a Regulator and Supervisor, the Reserve Bank has taken
several measures to ensure sound corporate governance in banks. The
Banks themselves have taken steps to face the recent headwinds and
exhibited remarkable resilience. The leadership and governance in
in the nation's journey so far and we
banks have played a vital role
believe that together we can drive a growth which is sustainable and a
financial system which is resilient, stable and inclusive.
Thank you.