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Bank licences to corporates: Reserve Bank for strong rules

Special Correspondent
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Guidelines on CEO compensation are being finalised

Reserve Bank of India Governor D. Subbarao (centre), FICCI Vice-President and HSBC India Country Head Naina Lal Kidwai (right) and State Bank of India Chairman Pratip Chaudhuri at a conference in Mumbai on Tuesday. — PHOTO: PAUL NORONHA
Reserve Bank of India Governor D. Subbarao (centre), FICCI Vice-President and HSBC India Country Head Naina Lal Kidwai (right) and State Bank of India Chairman Pratip Chaudhuri at a conference in Mumbai on Tuesday. — PHOTO: PAUL NORONHA

The Reserve Bank of India on Tuesday cautioned the banking community against self-dealing by corporate promoters and shareholders, who use banks as a private pool of readily available funds and called for changes in statutes and regulations to stem the practice.

“As we contemplate allowing corporates to promote banks, there is need for changes in statutes and regulations to address these concerns,” said RBI Governor D. Subbarao, while inaugurating the FICCI-IBA conference on ‘Global banking: paradigm shift' on the theme ‘Productivity Excellence', here.

Dr. Subbarao said, “If a corporate has an interest in a bank as a promoter or a shareholder, but has no position on the board, then there is no prohibition on the bank lending to the corporate. This opens up opportunities for self-dealing.”

The issues, he said, was critical as “it is not easy for supervisors to prevent or detect self-dealing because banks can hide related party lending behind complex company structures or through lending to suppliers of the promoters and their group companies.”

The RBI Governor's comments came at a time when many corporate houses were hoping to enter the banking business with the new guidelines for banking licences. The RBI Governor exhorted the banking fraternity to engage with and seek corrective action on five key areas of corporate governance — bank ownership; accountability, transparency and ethics; compensation; splitting the posts of chairman and CEO of banks; and corporate governance under financial holding company structure.

He said there was typically a divergence between the interests of shareholders and of depositors. Shareholders want profits to be maximised by taking on greater risk; depositors have an overriding preference for the safety of their deposits and hence for lower risk. At the same time, depositors have little say in the governance of banks whereas the shareholders' say is pronounced.

Within the shareholder group, the extent of control exercised by promoter shareholders too is an important determinant of the effectiveness of corporate governance. On the issue of accountability, transparency and ethics, the RBI Governor said that while over the years, “we have tried to align our transparency and disclosure standards to global best practices, we need to address critical questions such as is the voice of independent directors always independent? Do bank CEOs countenance criticism from the board?  Are boards succumbing to ‘group think' and abandoning their responsibility for independent judgement?  It is only through such soul searching that corporate governance of banks can improve its effectiveness.”

Dr. Subbarao said the RBI was in the process of finalising the guidelines relating to compensation of whole-time directors/CEOs/risk takers and control staff. The guidelines were scheduled to be implemented from 2012-13.

On the question of splitting the posts of chairman and CEO of banks the banking regulator noted that the moot question was whether the principle of separation of the posts of chairman of the board and CEO should be extended to public sector banks. “An important criterion for deciding on this will be to what extent we will be able to lay down and enforce strict eligibility criteria for the position of the chairman of the board of a public sector bank. We will discuss this issue with the Government,” he pointed out.

The RBI Governor said that while the Shyamala Gopinath Working Group appointed by the RBI has recommended that the financial holding company (FHC) model should be pursued as a preferred model for the financial sector in India, “We must recognise that regardless of the corporate structure, banks cannot be totally insulated from the risks of non-banking activities of their affiliates. In moving to a new regime, we must also contend with legacy issues relating to existing conglomerates. Any framework to harmonise them under the FHC model will require a new legislation and new regulatory architecture.”


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