Unease in the corner room

A fortnight ago, Shyam Srinivasan got a fresh three-year term until September 2024 at the helm of The Federal Bank. The Reserve Bank of India’s (RBI’s) nod put an end to speculation: “will he, won’t he—get to stay on?” He had been on (two) consecutive one-year extensions. The arc lights are now on Vishwavir Ahuja of RBL Bank and Murali M. Natrajan of DCB Bank—both are on a year’s lifeline. Uday Kotak of Kotak Mahindra Bank, whose stint ended on December 31, 2020, got an extension until end-December, 2023. Just in time. But nobody’s sure of their fate after that.

The tenures of private banks’ managing directors (MDs) and chief executive officers (CEOs) have been a bone of contention since the RBI’s June 2020 ‘Discussion paper on Governance in Commercial Banks in India’. Until then, it had been taken for granted that, but for the untoward, they will continue to be at their desks as long as they wished. In the past, they have, except those accused of misdemeanours such as ICICI Bank’s Chanda Kochhar and YES Bank’s Rana Kapoor, who were nudged out. But a circular issued on April 26 this year imposed a cap of 12 years and 15 years, on the stints of promoter and professional CEOs, respectively, in private banks. It has put those in the corner rooms at considerable unease.

Not just that. Helmsmen feel that the ground under their feet has been cut, as the RBI has gone a step ahead and curtailed the CEO’s powers. Chief risk officers, chief compliance officers, chief vigilance officers, and human resource heads will now report to the board, not the bank CEO. Their one-on-one meetings will be with the board committees—without the CEO’s presence. This is seen as out of kilter with the Banking Regulation Act, 1949 (BR Act), which says: “The management of the whole of the affairs of a banking company shall be entrusted to an MD who shall exercise his powers subject to the superintendence, control, and direction of the board of directors.”

It’s the worst-kept secret in the banking industry. Top management of private banks (including the newer small finance banks) are jittery. Such far-reaching changes come at a time when asset-stress levels in banks have soared due to the pandemic.

Analysts fear gaps in accountability. Who would be responsible for any failures or misadventures at the bank: the board, the directors, the committees and its members or the CEO? And how? “It is unclear what the roles and responsibilities of the executive management are; what the roles and responsibilities of the board are; and even what the responsibilities of the RBI as a supervisor are,” says Amit Tandon, founder and MD of Institutional Investor Advisory Services.

In particular, the lack of uniformity in extensions to CEOs has caused dissonance. At this rate, by 2023, almost all private bank chiefs of the past decade will have to bid adieu. The lack of visibility over tenures has caused embarrassment to incumbents and boards as large institutional shareholders have sought clarity on succession plans before they supply fresh capital. With private banks supplying credit at a fast pace (they raised ₹65,000 crore of capital last year, three times the money invested by the centre in state-run banks), the uncertainty can trip up flow of credit and hurt the economy.

All this can have a critical fallout as a vibrant banking sector is vital for India’s ambitious goal of a $5-trillion economy. If private bank bosses are kept on their toes due to what they consider to be a “selective application of regulations” by the RBI, it can hurt India Inc. Especially, the flow of credit as managements grapple with regulatory and succession concerns; and stay distracted from business lines.

Different Strokes, Different Folks

Srinivasan’s got a new three-year lease (his second one-year term was to end on September 22 this year), but Ahuja (whose term ended on June 29) and Natrajan (on April 28), are breathing heavy. As for Kotak, he would complete more than 20 years as promoter-boss by end-December, 2023. He got an extension before the April 26 circular. Srinivasan, Ahuja, and Natrajan would complete 14, 12, and 13 years. None of them responded to Fortune India’s queries on the issue. The short point: all of them were on the cusp when it came to their tenures. But the regulatory treatment accorded varied.

It’s not to grudge somebody the good tide in their fortunes, but the perception holds (rightful or not) among incumbents—and widely shared by senior personnel reporting into them and their boards—that they have little visibility at the steering wheel. It has led to red faces all around.

It’s not that tenure has become contentious after the governance code. It’s been foregrounded now; and will remain a headache for future corner-room occupants. The RBI’s April 26 circular says: “MD and CEO or whole-time director (WTD) who is also a promoter/ major shareholder, cannot hold these posts for more than 12 years. However, in extraordinary circumstances, at the sole discretion of the RBI such MD and CEO, or WTD may be allowed to continue up to 15 years.”

That’s like a toss at the start of a cricket match.

According to former Securities and Exchange Board of India (Sebi) chairman M. Damodaran, who is now chairman of proxy advisory firm Excellence Enablers: “The question ‘how long is too long’ needs to be addressed, and a policy framework put in place. There should be no difference in tenures of promoter and non-promoter CEOs. And within the private sector, there should be a uniform policy, rather than deciding on different terms for different bank CEOs.

Behind the Thinking

The failure of internal controls at Punjab National Bank; Kochhar at ICICI Bank leaving under a cloud; blowouts at Infrastructure Leasing & Financial Services, Dewan Housing Finance Corporation, YES Bank, and Punjab and Maharashtra Co-operative Bank—all showed the RBI in poor light. They came at a substantial cost to the public exchequer. It would not be misplaced to assume these triggered the regulator’s response.

Should CEO tenures be “age-neutral”? Former deputy governor N.S. Vishwanathan—one of the most powerful ever to hold this post in the 86-year history of the RBI— gives an insight into the thinking within the top echelons of the banking regulator: “You have a maximum age of 70 and another for tenure at 15 years. If someone becomes a CEO at 50, the person can continue till 65; and if onboarded at 55, then the mandatory exit will be at 70.” He elaborates: “It is not a question of whether a long-serving CEO is still competent or not, but over time a personal - ity cult can develop, and people on the board may not ask the right questions of the occupant;” and, “If and when it happens in a bank, the outcome will be more debilitating. Once this principle is accepted, the question is whether 15 is the right age limit or could it be more or less. I feel 15 years is reasonable.”

Incidentally, global bank regulators do not cap CEO tenure—shareholders decide. Some of the largest banks in the world have had long-standing CEOs. Jamie Dimon has been CEO at America’s largest bank JPMorgan Chase since 2005. His overall tenure has been longer than 16 years. He was the CEO of Bank One in 2000—the fifth-largest bank. JPMorgan Chase acquired Bank One in July 2004. Richard Fairbank has been CEO and chairman of Capital One since 1995. And Societe Generale’s CEO Frederic Oudea has been in charge for 13 years.

This line does not fly with India’s banking regulator though. A top regulatory source says: “We are a bank-led savings and credit economy. Our banks are retail deposit-driven. Not like in the developed markets where the wholesale money markets are central, and you have large, well-informed institutional players.” While you can argue the merits of this on either side of the debate, it is important to flash back.

In the run-up to finding successors for both Aditya Puri at HDFC Bank and Romesh Sobti at IndusInd Bank, the RBI felt a proper succession plan could have been put in place well in advance. Puri had been at the helm for 25 years; Sobti, a tad over a decade. Neither of them had formally sought an extension from the RBI to their respective tenures. But back-channel talks with the RBI had been on. These centred on the age limit for WTDs on private bank boards—whether this could be upped to 75 from 70 to bring it in align - ment with the Companies Act (2013). Sobti was the senior of the duo—he turned 70 on March 23, 2020; Puri on October 26, 2020 (both stepped down on these dates eventually).

Their hopes may have been rooted in the earlier RBI decision to peg the retirement age of private bank chiefs at 70 in September 2014 from 65— when the Companies Act (2013) replaced the one enacted in 1956. This had been contrary to the P.J. Nayak Committee’s (set up to ‘Review Governance of Boards of Banks in India’ in 2014) recommendation of 65 as the ceiling. The beneficiaries of the RBI’s go-easy were Sobti and Puri. What would have an increase in the age limit to 75 meant? It would not only have aligned the RBI’s requirements with that of the Companies Act but would have been the requisite first step for the duo to continue to be on the boards (assuming that the authorities were inclined to give them another term). It’s surmised that the RBI may have taken the view that another extension would have made for bad optics, and seen as privileging only two individuals.

RBI governor Shaktikanta Das’ cutting remark (quoting Sunil Gavaskar!) sent home the message: “You must retire when people ask why, and not why not.” That brings succession into the picture. According to K.V. Kamath, former MD & CEO of ICICI Bank, a well-run organisation has a leadership cone that is developed with thought and attention over time. It would, therefore, always have a group of leaders who could be potential CEOs going forward. And it is important to ensure that this group comprises of talent which is well-tested and leaders have a long tenure in front of them. “Succession planning is not a last-minute effort, but is a process which starts almost immediately after a new leader takes over and culminates when the incumbent is about to leave,” he says, and adds: “This is easier said than done.

Now Boarding

A board seat at private banks may have been coveted a few years ago. But over the past two years, it has been tough to onboard top-class independent directors. Many banks have sought extended timelines to get suitable candidates. The back story is that the RBI’s Department of Banking Supervision had in late 2018 started to “sensitise” bank boards on the liability of independent directors under the Prevention of Corruption Act, Companies Act, and the Criminal Procedure Code if they are found wanting in the discharge of their duties.

Private banks’ boards are now “executive” in nature— it is felt that regulatory norms are being shaped after being singed by misconduct like at ICICI Bank or YES Bank. It has put additional burden on independent directors, some of whom have informally conveyed to the banks’ senior management that they may have to revisit their position. A few have sounded North Block as well. Their stance: It’s not for them to take on executive roles; they have day jobs as well.

“We need to address this such that the right balance is found between the executive management who are managing the bank and board oversight,” notes Vimal Bhandari, executive vice chairman and CEO of Arka Fincap; and an independent director at RBL Bank.

Kamath is of the view that board members have a primary fiduciary responsibility and not just for setting strategy as was thought for long. Given that, and the complexities inherent in modern business, certain functions assumed importance. Amongst these first came audit, then compliance and, thereafter came risk. Not to forget compensation and remuneration. All these are now under specific board committees and some of them meet in-camera without the CEO. The board also meets auditors in-camera.

“Is the relationship then adversarial? It ought not to be, and the CEO needs to have the humility to accept this,” says Kamath. “A purist would say this transgresses the functional separation between the board and management. However, a more important point is what happens when there is a control failure under the scenario where a function—audit, compliance, or risk—reports to the board? Indeed, this needs careful thought.”

Banking Regulation Act in the Plot

The BR Act has imposed enormous restrictions. For instance, not less than 50% of directors are to be drawn from specific professional pools. It also fixes limits on conflict of interest areas. The intense scrutiny of independent directors on banks’ boards plus the far lower levels of compensation payable to them have made hiring good hands tougher. The RBI doesn’t permit part-time directors of banks to be paid remuneration other than sitting fees—even though the Companies Act allows up to 1% of a firm’s profit to be paid in commissions. The range for independent directors at private banks is between ₹20,000 and close to ₹1 lakh per sitting. Interestingly, shadow banking players have no such curbs!

The Act also requires the board of directors to have special knowledge in one or more areas such as accountancy, agriculture and rural economy, banking, co-operation, economics, finance, law, small-scale industry, etc.

Directors are not to have substantial interest in, or be connected with, whether as an employee, manager, or managing agent with any company, or any firm, which carries on any trade, commerce, or industry and which, in either case, is not a small-scale industrial concern, the Act states. They can’t be proprietors of any trading, commercial or industrial concern, not being a smallscale industrial concern.

Points out Narendra Murkumbi—the youngest ever independent director to sit on a bank board at 35 years (he was appointed to ICICI Bank’s board in January 2006). “An issue that needs to be rethought is common directorships. To an extent, a company where the bank’s independent director is a promoter or a whole-time director can’t have a lending relationship with a bank is fair. But that independent directors of a company also can’t be on the board of any bank that lends to that company reduces considerably the supply of qualified candidates.”

Private banks have made it known to the RBI that even when they appoint “people of repute” many of them are not able to bring their expertise to bear, or the same may not be relevant for the times. Technology has reshaped banking, and this may call for a need to have a much younger lot of directors. The Companies Act (2013) prescribes a minimum age of 21 for directors, but as the Nayak Committee observed: “For private banks, RBI has imposed a different set of constraints. The minimum age is stipulated as 35. It is unclear why a separate regulatory filter for a minimum age is needed.”

“It is tough to get top-quality directors as it is; and on top of this, you have regulations both on CEO tenures and how they are to interact with board committees. Let us be clear; there is a shortage of top-quality people,” says a candid S.C. Garg, former secretary in the Department of Economic Affairs, Ministry of Finance.

What Is It Adding Up To?

The RBI’s ‘Report on Trend and Progress of Banking in India 2018-19’ referred to the sharp fall in both incremental and outstanding credit of state-run banks. This was because nearly a dozen state-run banks were sent under the RBI’s prompt corrective action framework for slipping up on key financial parameters in the preceding years. It led to a bonanza for private banks in 2016-17—their share in incremental credit shot up to almost 100%! Given that capital concerns will continue to haunt state-run banks and the pressure on the fisc, the centre can’t continue to pour money into them; and therefore, the move to privatise these banks.

With the RBI and regulated entities seemingly ranged against each other, is there a case to revisit The Financial Sector Legislative Reforms Commission’s suggestion of March 2011—that there be an appellate tribunal for all the regulators including the central bank? As of date, the Securities Appellate Tribunal sits over Sebi, the Insurance Regulatory and Development Authority of India, and the Pension Fund Regulatory and Development Authority. For the bankruptcy mechanism, there is the National Company Law Appellate Tribunal.

Query Garg if the issue cropped up during his stint in North Block, and he says: “It would have been raised with the Department of Financial Services, but even then, it would have come to me. It never came up because it was seen as being too drastic a step,” he explains.

Vishwanathan sees it differently. He feels the issue is one of demarcating the limits of an appellate body. “Maybe, matters like monetary penalties could get appealed against. But we must be careful in extending this to regulatory actions including and more particularly say when the RBI has cancelled a banking licence,” he says. That’s because “Banks’ status in the financial ecosystem is different, not only because they are custodians of public trust, but also by virtue of their being part of the payments and settlement system.”

A lot rides on the RBI and the way it treats regulated entities; and the way this impacts the ease of doing banking business. The central bank is expected to come out with guidelines for another lot of private bank licences following the report submitted by its internal working group (IWG). There are non-banking financial companies (NBFCs) with banking ambitions. There is also the revised regulatory framework for NBFCs (the draft of which was released subsequent to the IWG’s report) which is in the works. And the privatisation of three state-run banks. While the governance code framework may have affected only private banks, for now, its secondary effects will impact a bigger audience.

Over to Mint Road!