RBI puts bank boards on notice

Source: The post is based on the article “RBI puts bank boards on notice” published in Business Standard on 9^th June 2023.

Syllabus: GS 3 – Indian Economy – Money & Banking

Relevance: About the recent meeting of the RBI governor

News: Recently, the RBI governor held a conference with private as well as public sector banks’ directors.

What are the excerpts of the meeting?

The RBI Governor expressed confidence in the resilience of the Indian banking system, due to the implementation of various initiatives.

For instance, the RBI has implemented established a dedicated vertical for supervisors and a college of supervisors.

Furthermore, the central bank has ensured a degree of independence for key assurance functions in banks, such as risk management, compliance, and internal audit, through a system of dual reporting to the CEO and the board.

The RBI’s off-site surveillance, which requires banks to upload raw data to the RBI, has been beneficial in providing an overall view of risks at individual banks and within the system.

Further, the Annual Financial Inspection report and the Risk Assessment Report (RAR), which the RBI submits to banks, have been crucial at pointing out areas of concern.

Now, the major problem areas highlighted in the RAR is resolved within a few weeks or months of submission of the report instead of taking too much time.

Moreover, the RBI governor presented a 10-point charter for bank boards. Out of which, there were few important issues that require serious consideration.

What were the important issues highlighted by the RBI governor?

Dominance of CEOs: The RBI governor has said that the dominance of the CEO is the central problem of governance in bank boards.

He gave the example of the failure of the Royal Bank of Scotland (RBS) during the global financial crisis. Despite having a high-profile board with the necessary skills, the board was unable to prevent the disastrous decisions made by the CEO.

Further, it becomes difficult for directors to challenge a CEO especially if he or she has a track record of performance. Therefore, directors worry that they may derail a performing CEO.

Composition of Board Member: Board members are often selected from a limited pool of individuals, including former CEOs, retired bureaucrats, and other professionals.

They have good relations with the CEOs. Due to which, they find it difficult to challenge the decisions made by the CEOs.

Further, directors often receive significant compensation, and the CEO plays a crucial role in the renewal of their terms. This creates a situation where directors do not find it suitable in challenging the CEOs.

Hence, to address the issue, it is necessary to have at least one or two directors whose selection is independent of the CEO and the promoter. 

Changing the experts: Currently, the board members include experts from the small-scale sector and agriculture specialists.

However instead of including these experts, the regulator should focus on three areas of expertise: banking, audit, and risk management. 

What can be the way ahead?

The RBI governor highlighted the concerns and shortcomings in the banking system.

He urged boards to value the system of a bank and make it into a healthy corporate sector as it directly impacts the institution’s reputation, stability, and long-term viability.