Mahesh Kumar Jain: Governance in banks - driving sustainable
growth and stability
Speech by Mr Mahesh Kumar Jain, Deputy Governor, of the Reserve Bank of India, at
the conference of Directors of Banks, organised by the Reserve Bank of India for Public
Sector Banks on 22 May 2023 in New Delhi and Private Sector Banks on 29 May 2023
in Mumbai.
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Governor, Deputy Governor Shri M R Rao, colleagues from the RBI and distinguished
directors of banks.
Good morning. It is indeed an honour to be here to discuss a topic of utmost
importance: Governance in Banks - Driving Sustainable Growth and Stability. You are
seasoned professionals with expertise in your domains. Today, I intend to share some
insights from my experience both as a practitioner as well as supervisor.
2. We had three key objectives in mind for holding this conference. These are:
(i) The Governor emphasized the strength, stability, and resilience of the banking
system, achieved through collective efforts of the Government, RBI, and the banks.
While progress has been made, addressing downside risks is vital for India's journey
towards becoming a developed economy. Banks are needed to mobilise savings,
promote financial inclusion, facilitate job creation by supporting MSMEs, among others.
We would like to highlight the importance of strong governance and leadership which
are crucial for long-term health of the sector.
(ii) Secondly, the RBI has taken several initiatives in the recent past for strengthening
its supervisory processes. This conference gives an opportunity to provide an overview
of these initiatives and share some of the supervisory insights.
(iii) Thirdly, there has been an increasing focus on data analytics as a powerful tool for
assessing both idiosyncratic as well as systemic risks in banks. By leveraging large
volumes of data and advanced analytics techniques, it is possible to gain deeper
insights into risk profiles of banks and identify potential vulnerabilities. The intention is
to brief you on these initiatives so that banks can leverage on their own data analytic
capabilities to make data-driven risk management decisions, improve risk assessment
accuracy, and enhance their ability to anticipate risks.
Challenges
3. In the past decade, the banking sector has overcome numerous challenges.
However, complacency is not an option, as banks now face a dynamic environment
arising from technological disruptions, cybersecurity threats, evolving customer
expectations, global headwinds, and the need to attract and retain talent. Among these
challenges, three areas require particular attention which I shall briefly elaborate.
(a) Firstly, technology risk: The ongoing Fintech revolution in banking is bringing a
disruptive paradigm shift in the banking services. Banking services are now being
bundled with other financial and non-financial services and giving consumers the
convenience of accessing the full spectrum of financial products. Indeed, the pace of
technological changes is so rapid that banks will have to transform like technology
companies continuously innovating and investing in technological upgradations. The
risks of cyber-attacks, data breaches, and operational failures have also increased.
(b) Secondly, business risk. As the recent examples of some international bank failures
have demonstrated, banks get into trouble due to fundamentally flawed business
models. Sometimes banks follow inherently risky strategies with the confidence that
their bank has mitigating controls. However, their assumptions may not hold true either
due to internal control failure or due to exogenous factors. The Board plays a vital role
in independently assessing the business model and its attendant risks. It is important
for banks to carefully assess their own unique circumstances and capabilities, conduct
thorough analysis, and tailor their strategies accordingly. While it can be valuable to
learn from the experiences of other banks, adopting their strategies without considering
the specific context and requirements of the organization may lead to unfavourable
outcomes. Therefore, Boards should be cognizant of their business model and its
potential downsides, both in near term and in future.
(c) Thirdly, there is operational risk due to various factors such as high attrition, lack of
succession planning, skilling of staff, outsourcing, etc.
(i) Attrition and high employee turnover lead to loss of institutional knowledge,
disruption in services and increased recruitment costs. Similarly, lack of succession
planning, particularly for critical roles, can pose significant operational risks.
(ii) Ensuring that employees have the necessary skills and knowledge is imperative
to adapt to new technologies and business practices.
(iii) Risks also emanate from outsourcing, including potential loss of control over
critical operations, data security breaches, and increased dependency on
thirdparty providers.
(iiii) Banks also need to be careful about process risks where errors, inefficiencies
or breakdowns in operational processes can lead to financial losses, compliance
failures or customer dissatisfaction.
Operational risks stemming from ethical issues at the operating level can also have
significant repercussions for banks, including reputational damage, legal and regulatory
consequences, erosion of customer trust, and adverse financial impacts.
Role of the Board
4. The evolving nature of risks faced by the banking system necessitates the building
up of organizational resilience to adapt to the changing landscape and stay prepared for
future risks. Good governance is at the core of organisational resilience and effective
Boards are the starting point of good governance. While good corporate governance is
essential for all institutions, the governance structure and processes of the banks are
expected to be even more robust as banks and financial institutions are different from
other business entities in many ways.
i. Firstly, banks are allowed to raise substantial amounts of uncollateralized
deposits. Unlike other corporates, shareholders only provide 3 to 4 per cent of the
funds in banks and the predominant suppliers of finance are depositors.
ii. Secondly, banks perform the function of liquidity and maturity transformation
which makes their business inherently risky.
Such high leverage and maturity mismatch between assets and liabilities cannot be
sustained unless banks gain the trust of the depositors. Hence, the governance
structures and practices in the banks should prioritise depositors' interest and
maintaining their trust.
5. Effective governance requires a competent and independent Board effectively
overseeing the management by asking the right questions, formulating appropriate
strategies keeping in mind the risk appetite as well as establishing proper policies and
procedures.
6. I would urge Boards to actively engage in risk oversight, pursue a robust risk
management framework, monitor key risks, challenge management on risk-related
matters, and ensure the implementation of appropriate risk mitigation measures to
protect the bank's interests and stakeholders.
7. Another aspect that Boards must lay due emphasis on is compliance. Compliance in
letter and spirit is critical for banks to maintain the integrity of the financial system and
to promote ethical behaviour. Banks must ensure that their actions are compliant with
the intended purpose and principles of a law or regulation, and not just the literal or
technical interpretation. Compliance with the spirit of the law is essential for banks to
maintain their reputation, build trust with customers, and promote ethical behaviour.
8. Finally, it is important for banks to keep sustainability in mind. This means taking a
long-term view of the business and considering the impact of decisions on the bank's
financial health, reputation, and broader societal and environmental factors in future.
Role of Supervision
9. On its part, the Reserve Bank has initiated a series of steps to enhance the
soundness of the financial system by adopting a holistic approach towards addressing
the growing complexities and inter-connectedness, and to deal effectively with the
potential systemic risks.
10. In the past five years, there has been a significant strengthening of the Reserve
Bank's supervisory systems and shifting from an entity-based approach to a more
thematic and activity-based approach. Structural changes have been implemented to
enhance agility, flexibility, and specialization. A unified and harmonized supervisory
approach has been adopted for commercial banks, NBFCs, and urban cooperative
banks (UCBs), with a greater focus on identifying the root causes of vulnerabilities.
11. The Reserve Bank has deployed a wide array of tools to enhance the effectiveness
of Supervisory frameworks. These include an Early Warning System, Stress Testing
models, Vulnerability Assessments, Cyber Key Risk Indicators, conduct of Phishing and
Cyber Reconnaissance exercises, targeted evaluation of compliance with KYC/AML
norms, Micro-Data Analytics to analyse granular data, among others. We are also in the
process of adopting the use of Advanced Analytics, Artificial Intelligence and Machine
Learning on Supervisory Data for even better insights into operations of supervised
entities.
12. Supervisors often detect serious issues such as non-compliance, divergences from
IRACP norms, and gaps in internal controls and IT systems during their limited time at
the bank. However, it is reported that these concerns frequently surprise Directors when
presented in Risk Assessment and Off-site analytical reports. Boards should reflect on
why critical deficiencies go unnoticed despite having access to relevant data and
assessments, and work on building internal capabilities to identify and address such
issues at an early stage.
13. Sometimes supervision is viewed as intrusive. Let me clarify that supervision is
neither designed to be intrusive or punitive nor are supervisors the risk managers of
supervised entities. It should be appreciated that supervision is only the fifth line of
defence in banking, as it serves as an additional layer of oversight beyond the
traditional three lines of defence model (business operations, risk management and
compliance, and internal audit) and the fourth line of defence (external audit).
Supervision is forced to step in only when these lines fail.
Preparing for the Future
14. Before, I conclude, let me dwell upon the road ahead. The future of banking is
expected to be shaped by advancements in technology leading to greater business and
process automation, changing customer expectations, and evolving regulatory
landscapes.
15. To prepare for the future, Indian banks will need to focus on digital transformation,
enhance customer experience, adopt innovative technologies such as AI and
blockchain, invest in cybersecurity measures, look for opportunities to derive synergistic
benefits through collaboration with other players as well as upskilling their workforce to
meet the demands of the digital era. Additionally, they will need to prioritize risk
management, regulatory compliance, and sustainability to ensure long-term resilience
and competitiveness in the evolving banking landscape.
Conclusion
16. In conclusion, I would like to reiterate that the role of the Board of Directors in
ensuring sustainable growth and stability of the banking sector cannot be overstated.
As custodians of the interests of various stakeholders, including depositors,
shareholders, regulators, and the wider society, Boards must adopt a proactive and
strategic approach. Effective risk management, governance, and compliance practices
are essential in safeguarding the bank's reputation, financial stability, and long-term
viability. Moreover, the Board must ensure that the bank's business model, strategy,
and operations are sustainable and create long-term value for all stakeholders. Finally,
the Board must remain vigilant, adaptive, and continuously assess the bank's
performance, risks, and opportunities, and take timely and informed decisions. I urge all
Board members to embrace these principles to drive the bank towards sustainable
growth and stability, while safeguarding the interests of depositors and maintaining the
stability and integrity of the banking system all the time. Thank you.