Sometime in late 2017, billionaire diamantaire Nirav Modi walked into the office of the chief executive officer (CEO) and managing director of a large Indian private bank in Mumbai with two of the bank’s directors in tow. The meeting did not last long. No, Modi—who has drilled a big hole in the balance sheet of India’s second largest government-owned bank, Punjab National Bank—was not looking for fresh funds for any of his companies. He was exploring ways to replace part of his existing bank loans with a fresh facility to bring down the cost of funds. The private banker did not oblige him. After Modi left his room, the CEO told the two directors not to arrange another meeting with Modi, if they really cared for their board seats.
The CEO of a government-owned bank might have reacted in a different way. Probably, the banker would have asked his general manager (credit) to look into Modi’s proposal. He would have done this not because he is corrupt but he would have found it difficult to disappoint the directors of his bank who had brought Modi to him. Besides, other banks have exposure to Modi’s companies and it is only logical that his bank, too, should lend (cynics call this “herd mentality”). Also, it’s not easy to say no to a person whose diamond jewellery designs have been flaunted by celebrities like Kate Winslet and Rosie Huntington-Whiteley on the Hollywood red carpet and advertised by Indian film star Priyanka Chopra.
For most public sector banks (PSBs), it is a cultural issue, inseparable from the lack of corporate governance. What are the reasons behind this and how to solve it? While many believe privatization is the panacea for this set of banks which roughly have 70% share of the assets in the Indian banking industry, here is a list of issues that influence the culture and governance structure in PSBs. It is indicative and not exhaustive and does not include other issues relating to inefficiency in project appraisal, risk management, monitoring, pressure from the government to give loans to certain sectors and invest time and resources in non-banking work, et al.
The quality of boards: Even though all government-owned banks are listed on bourses, they do not need to have one-third of their directors independent, as stipulated by the capital markets regulator. The quality of PSB boards is not uniform; most directors lack vision and many are there to broker loan deals for the borrowers and not guide the senior management with vision.
The quality and tenure of the CEO: Till recently, the appointment process for managing directors and executive directors of these banks was opaque, and it was influenced by industrial houses, political parties in power and bureaucrats.
The relatively short tenure at the top also queers the pitch as the CEO needs time to understand a bank and act (typically, the person comes from another bank). With no skin in the game, the bosses often follow an easy out. The new CEO spends the first couple of quarters in cleaning up the book. This leads to losses for the bank, and the message goes to investors that the previous CEO did not do a proper job; but the incumbent repeats the “mistakes” of his predecessor while leaving with a happy note, announcing hefty profits. The cycle goes on.
The regulation is not ownership neutral: The Banking Regulation Act, 1947, which lays down norms for all banking companies in India, is not entirely applicable to government-owned banks. The Reserve Bank of India (RBI) does not appoint the chairman, managing director and other directors of a bank board. The regulator also cannot dismantle a board and remove the CEO. As a result of this, there is no accountability either of the board or the senior management.
Poor pay structure of the executives of PSBs: It comes in the way of hiring the right talent and keeping them wedded to ethics. For the record, up to the middle management, the officers in public sector banks are better looked after than their private peers in terms of remuneration, perks and job security; but at the top level, private banks pay many times more. At least two banks—State Bank of India and Bank of Baroda—have proposed to pay stock options to their employees, but the government has not cleared the proposals.
The list can go on. Various theories have been doing the rounds on how to tackle misgovernance. To start with, if we address just two things, we can cure many of the ills that plague PSBs. At the root of the governance problem in such banks is the way transfers and promotions are done across all layers. Bank officers at different levels are routinely blackmailed to toe the line of their proximate bosses—if they do not look after or look into certain accounts favourably, they run the risk of being transferred to a place not to their liking and/or miss the next promotion.
Typically, the managing director drops a hint to the concerned general manager for sanctioning a loan or a general manager implicitly tells a deputy general manager or an assistant general manager to do so. This system of dropping hints and tacit influence for loan approvals percolates down the line. This is done verbally, over phone, without any paper trail. If such requests are not respected, the junior officer may lose the next promotion or get transferred to a remote place where his family would hate to relocate and his career would take a beating. Only those officers who do not care for such occupational hazards stick to the rules and keep the banks going. Most get sucked into the system, which breeds corruption.
There are seven scales of bank officers at public sector banks; at the top is the general manager (scale VII). For a general manager’s appointment, generally, interviews are conducted by the managing director of a bank, the government and/or the RBI nominee on its board or any other director and a couple of senior bankers from the industry. For a deputy general manager (scale VI), the interview is conducted by the managing director, executive director (ED), a senior general manager and two external representatives. For an assistant general manager (scale V), the interview is conducted by one ED and two general managers.
A written examination, interview and the annual performance report decide the fate of the candidates, with their weightage varying at different levels of appointment. Those who do not listen to their bosses on sanctions of loan proposals get poor performance appraisals and the interview can always be managed with the directors and the external experts being handpicked by the managing directors and executive directors.
Transfers are done for three reasons—promotion, business exigencies and as a disciplinary action. At the senior level, an executive can be transferred within a month of a new posting because of exigencies. For other levels, there is a transfer policy which varies from bank to bank. Typically, at the middle level, one can be transferred once in three years, and a junior officer can stay put at one location for as long as seven years, but not at one branch.
Those who face disciplinary action are generally posted at the headquarters, or a bank’s administrative office. At the senior level, non-performance can always lead to transfers, and herein lies the catch. Those who do not toe the line of bosses are typically branded as non-performers and get the stick.
Finally, if an honest officer is neither afraid of being transferred nor of losing promotion, the fear of vigilance is always there to scare him.
An anonymous letter to the chief vigilance officer of the bank, drafted by the boss, can finish one’s career. It’s not difficult to find a hole or two among the hundreds of commercial decisions that an officer takes while sanctioning loans.
Privatization and amendment to the Banking Regulation Act to empower RBI can wait. If the government—the majority owner of these banks—and RBI institutionalize a mechanism to ensure an objective, transparent and merit-based transfer and promotion policy in public sector banks, a bulk of the cultural and governance problems will vanish into the blue.
An apocryphal story
The problem of corporate governance in public sector banks reminds me of an apocryphal story. Once upon a time, there was a king who loved walking on the streets but didn’t like the idea of making his feet dirty. So, he announced a hefty award for the person who could solve his problem.
The first person appeared on the scene with millions of brooms. His efforts to make the country dust-free went in vain even as the cloud of dust that formed over the kingdom made the king sick.
The second aspirant for the award ended up killing millions of goats and sheep, but still couldn’t cover half of the roads with their skin.
Finally, a cobbler entered the royal court, carrying 2 sq. ft of hide in his bag. He measured the king’s feet and within hours stitched a pair of sandals. Now, the king could roam around on the dusty roads with ease. The government and RBI should cover the king’s feet instead of trying to make the kingdom dust-free. If the bank officers are allowed to perform without fear or favour by their proximate bosses, the bulk of the problem is solved.
Here is a caveat: The culture of influencing “subordinates” to sanction loans to undeserving borrowers is rampant in PSBs but not all banks suffer from it. There are banks where fair and transparent systems and processes are in place. Also, not listening to the boss when it comes to favouring a particular borrower is not the only reason for an honest banking officer missing his promotion.
Here is how a chief manager (scale IV) of a PSB once lost his promotion. Busy managing a large branch in a coastal town, the officer got a phone call from his ED, informing the arrival of the latter’s daughter and son-in-law. The chief manager (who was never told but expected to arrange the couple’s stay and a vehicle for sight-seeing) did not “act” on the phone call and paid the price for it. However, this probably is not unique to banks alone—all government-owned companies have this culture. That’s, however, a separate story.