Corporate Governance in Indian Banks under the RBI Framework

Corporate governance matters more in a bank than in any other company, for a reason that is structural rather than moral. In an ordinary company the shareholders supply most of the money and therefore have most to lose, so their control of the board is a reasonable proxy for the interests at stake. In a bank the shareholders supply a small fraction and the depositors supply the rest, yet the depositors have no vote, no seat and no information. The governance framework exists to fill that gap, and it does so by requiring independence inside the board and by placing a regulator outside it.

1. Why the ordinary company law model is not enough

Figure 1: The chain of accountability in a bank

1. The interests are asymmetric. A shareholder whose stake is a small share of the balance sheet captures the whole of the upside of a risky strategy and bears only a fraction of the downside. The rest falls on depositors and, through deposit insurance and resolution, on the public.
2. The information is asymmetric. The quality of a loan book is not visible from outside and often not from inside, and it takes years to emerge. A board that does not actively look will not be told.
3. The failure is contagious. A badly governed manufacturer harms its own shareholders. A badly governed bank can take others with it, which is why the regulator has a seat in the governance structure that it does not have elsewhere.

2. The statutory framework

• Section 10A requires that not less than fifty one per cent of the total number of directors consist of persons with special knowledge or practical experience in accountancy, agriculture and rural economy, banking, cooperation, economics, finance, law, small scale industry and other useful fields, and that not less than two have special knowledge of agriculture and rural economy, cooperation or small scale industry. It also caps a director's continuous tenure at eight years.
• Section 10B requires a banking company to have a whole time chairman or a managing director, and provides for the appointment with the approval of the Reserve Bank.
• Section 35B requires the previous approval of the Reserve Bank for the appointment, re-appointment or termination of a chairman, managing director or whole time director, and for any amendment to the terms, and caps the term of appointment at five years at a time.
• Section 36AA empowers the Reserve Bank to remove a chairman, director, chief executive or other officer or employee, in the public interest or to prevent the affairs of the bank being conducted detrimentally, after an opportunity of making a representation.
• Section 36ACA empowers the Reserve Bank to supersede the board of a banking company and appoint an administrator, for a period not exceeding twelve months in the aggregate.

3. The governance framework of 2021

The Reserve Bank's instructions on corporate governance in banks, appointment of directors and constitution of committees of the board, issued on 26 April 2021, supply the detail. They apply to private sector banks, including small finance banks and wholly owned subsidiaries of foreign banks; they do not apply to the branches of foreign banks; and they apply to the State Bank of India and the nationalised banks only so far as they are not inconsistent with the statutes that constitute them. Banks were given until 1 October 2021 to comply.

Figure 2: Whom the framework governs, and how far

The board and its chair

• The chair of the board must be an independent director, and in his absence another independent director presides. A non-independent chair already in office may complete the current term.
• The quorum is one third of the total strength of the board or three directors, whichever is higher, and at least half of the directors present must be independent.
• The upper age for a non-executive director, including the chair, is seventy five years.
• The total tenure of a non-executive director is eight years, and re-appointment is possible only after a gap of at least three years. The gap does not prevent appointment as a non-executive director of a different bank.
• A bank may pay a non-executive director fixed remuneration of up to thirty lakh rupees a year, in addition to sitting fees and reimbursement of expenses. The ceiling was twenty lakh rupees under the instructions of 2021 and was raised by the Reserve Bank on 9 February 2024.

The committees

Every committee requires a quorum of three, members with the prescribed qualification or expertise, and an independent director as chair.

• The Audit Committee of the Board comprises only non-executive directors and meets at least once a quarter. Its chair may not be a member of any committee of the board which sanctions credit exposures, which prevents the person reviewing the accounts from having approved the lending they record.
• The Risk Management Committee of the Board has a majority of non-executive directors and meets at least once a quarter.
• The Nomination and Remuneration Committee comprises only non-executive directors and meets as required. The chair of the board may not chair this committee, which prevents the person who leads the board from controlling who joins it and what they are paid.

The chief executive

• The upper age for a Managing Director and Chief Executive Officer or a whole time director in a private sector bank is seventy years, and a board may fix a lower retirement age.
• The maximum total tenure is fifteen years, after which re-appointment is possible only after a minimum gap of three years and subject to other conditions.
• Where the chief executive or whole time director is a promoter or a major shareholder, the total tenure is capped at twelve years, which the Reserve Bank may in its sole discretion extend to fifteen. Adherence to agreed milestones is considered at each re-appointment within that period.
• A cooling off period of three years applies after the tenure ends, during which the person may not be appointed to or associated with the bank or its group entities in any capacity, directly or indirectly.

4. Compensation

A compensation structure that rewards the upside of a risk without exposing the recipient to its downside is itself a governance failure, because the risk matures long after the bonus is paid. The Reserve Bank's guidelines on compensation accordingly require that the variable portion of a whole time director's or material risk taker's pay be substantial but capped as a proportion of fixed pay, that a prescribed share of variable pay be deferred over several years, that a share be paid in non-cash instruments linked to the bank's performance, and that malus and clawback provisions apply, so that deferred pay may be withheld or recovered if the risk crystallises. The Nomination and Remuneration Committee administers all of this.

5. The public sector problem

The framework of 2021 applies to public sector banks only so far as it is not inconsistent with their constituting statutes, and that qualification conceals a structural difficulty that the Committee to Review Governance of Boards of Banks in India, chaired by P. J. Nayak and reporting in 2014, set out at length.

1. Boards of public sector banks are constituted under schemes made under the Nationalisation Acts and the State Bank of India Act, 1955, with nominee directors of the Government and the Reserve Bank and a prescribed composition. The board therefore does not choose itself.
2. Appointments of chief executives were made through a governmental process on short tenures, often of two or three years, which is not long enough to be accountable for a credit cycle.
3. The banks are subject to vigilance, right to information and audit by the Comptroller and Auditor General in a way private banks are not, which the committee found discouraged commercial judgement without improving it.
4. The committee's recommendation was structural: repeal the constituting statutes, incorporate the banks under the general company law, and transfer the Government's holding to a Bank Investment Company holding it at arm's length, with boards appointed professionally and chief executives on longer terms.

6. Quick Revision

1. The chair of the board must be an independent director.
2. The audit committee has only non-executive directors, and its chair may not sit on a credit sanctioning committee.
3. The chair of the board may not chair the nomination and remuneration committee.
4. A promoter chief executive is capped at twelve years, extendable to fifteen at the Reserve Bank's sole discretion.
5. A three year cooling off follows a chief executive's tenure, covering group entities as well.
6. Variable pay is deferred, partly in non-cash instruments, and subject to malus and clawback.
7. The framework yields to the constituting statutes of public sector banks.
8. The Nayak Committee recommended repeal of those statutes and a bank investment company, which was not implemented.

7. Frequently Asked Questions

Why must the chair of the board be an independent director?

Because the chair sets the agenda, controls the flow of information to the board and decides how much time a difficult question receives. A chair who is also an executive, or who represents the promoter, is in a position to manage the board rather than to be accountable to it, and the questions a bank board most needs to ask are precisely the ones management would rather not answer. The requirement is reinforced by the quorum rule, under which at least half the directors present must be independent, so that an independent chair is not outnumbered in the room.

Why is a promoter chief executive capped at twelve years when a professional gets fifteen?

Because the discipline that limits a professional does not operate on a promoter. A professional chief executive serves at the pleasure of a board that can decline to re-appoint him, and his tenure is in that sense already constrained. A promoter who is also the chief executive is the dominant shareholder of the company whose board would have to remove him, and the practical probability of that happening is low. A fixed statutory style limit is therefore the only effective constraint, and the Reserve Bank retained a discretion to extend to fifteen years so that a well-run institution is not disrupted.

What is the point of a cooling off period?

To make the departure real. Without it, a chief executive whose tenure has expired can move to the chair of the same board, to an advisory role, or to a group company, and continue to direct the institution through the successor he helped choose. The three year cooling off under the 2021 framework is drawn widely for that reason: it prevents appointment to or association with the bank or its group entities in any capacity, directly or indirectly. The same reasoning produces the three year gap before a non-executive director may return.

Why does the audit committee chair have to stay off credit committees?

Because the audit committee's function is to examine the accounts, and the largest judgements in a bank's accounts are about whether loans will be repaid and how much has been provided against them. A person who sat on the committee that sanctioned those loans would be reviewing his own decisions, and the natural human disinclination to find that one's own judgement was wrong is exactly what the provision removes. It is a specific application of the general principle that control functions must not report to, or be staffed by, the business they examine.

Why has the Nayak Committee's main recommendation not been implemented?

Because it cuts against the statutory basis of public sector banking. Repealing the Nationalisation Acts and the State Bank of India Act, 1955 and incorporating the banks under the general company law would end their character as statutory corporations. That would reopen how far they are treated as the State under Article 12, change the status of their employees, alter the reach of the vigilance and right to information regimes, and require the Government's shareholding to be transferred to a holding company. Each of those consequences has defenders as well as critics, and together they amount to a political decision about what public sector banking is for, rather than a technical reform the regulator could carry out on its own.

What replaced the Banks Board Bureau?

The Financial Services Institutions Bureau, constituted in 2022. The Banks Board Bureau had been set up in 2016 as the first attempt to professionalise the selection of whole time directors and non-executive chairpersons of public sector banks, taking that function out of the ordinary governmental appointment process. Its competence to make selections beyond the banks, in particular for public sector insurers, was questioned in litigation, and the successor body was constituted with an express remit covering public sector banks, public sector insurers and financial institutions. Both are second best answers to the problem the Nayak Committee identified, since neither changes who owns the banks or under what statute their boards are constituted.

8. Related Topics and Provisions

• Management of banking companies and removal of directors
• Ownership, control and the licensing of private sector banks
• Public sector banks and the statutes that constitute them
• Banking sector reform and the Narasimham Committees
• Inspection, supervision and penalties under the Banking Regulation Act, 1949
• Cyber security, outsourcing and operational risk in banks