Governance Issues in Public Sector Banks and PJ Nayak Committee Report

The banking sector in India is dominated by public-sector banks (PSBs) with government being the majority stake holder in them. In recent years, the Public Sector banks have been suffering with multiple problems of non-performing assets (NPAs), large over-dues; competition, performance, political pressures and so on. In this context, the former RBI governor Raghuram Rajan had constituted the P.J. Nayak committee In January 2014 under Shri P.J Nayak, former Chairman and CEO, Axis Bank, and Former Country Head, Morgan Stanley India.

Terms of Reference

The core terms of reference for the committee were based on governance, management and operational issues in the public sector banks. These included:

• To look into various problems related to bank boards – such as standards of specification, policy, legal etc. and to suggest what needs to be done.
• To examine the working of bank boards and issues of strategy, growth, governance and risk management in banks.
• To review the RBI guidelines on Government Ownership in banks.
• Analyze the work, conflict of interest and independence in the bank boards and make suggestions towards the same.
• To assess the fit and proper criteria for directors and their tenures.
• To examine board compensation guidelines.

Key Recommendations

The committee found that the key “governance” issues include the composition and functioning of the board; the key management issue is selection of the CEO; and the key operational issues are handling the bad loans and infusion of capital in banks. The key recommendations are as follows:

The PSBs must have independent directors

Since the private banks do better when it comes to independent directors, the public sector banks also must have “independent directors”. These independent directors should be elected by the shareholders.

The parliament must repeal the old laws

The committee recommended repealing the Bank Nationalisation Acts of 1969 and 1980, the State Bank of India Act, and SBI (Subsidiary Banks) Act.

The Government share should come below 50%

To reduce the government’s shareholding in banks to less than 50 per cent in order to provide a level playing field to public and private sector banks.

BBB should be free of government interference

The committee recommended that the Bank Board Bureau (BBB), which will decide on management and board-level appointments in public sector banks should only comprise of senior bankers, with no government involvement in decision making.

Assessment of Recommendations

The PSBs must have independent directors

The Nayak committee pointed out that PSBs have no independent directors. The directors are nominated by the government and thus cannot be said to be independent. Further, there are directors elected by shareholders but since LIC is one of the largest shareholders, such directors also cannot be called independent.  Comparing this with private banks, the committee said that private banks do better towards this.

However, this recommendation is still to be taken up by the government. We note here that the current government had started the exercise of separating the role of CMDs and CEOs but there is no progress towards having independent directors elected by shareholders as of now.

The Government share should come below 50%

There are several arguments put by committee towards bringing government share below 50%. Firstly, with reduction of government’s share below 50% in Public Sector Banks, banks will be freed from external vigilance by the Central Vigilance Commission, the Right to Information Act (RTI), and from government constraints on employee compensation. Secondly, the government’s share below 50% would end the government’s diktat in several loan waiver announcements, thus ending vote bank politics. Thirdly, this will bring PSBs on par with private sector banks in terms of supervisory restrictions and will allow the banks to function more efficiently and effectively on commercial considerations.

BBB should be free of government interference

To improve the Governance of Public Sector Banks (PSBs), the Government has set up an autonomous Banks Board Bureau. The Bureau recommends for selection of heads – Public Sector Banks and Financial Institutions and help Banks in developing strategies and capital raising plans. The committee recommended to make it free from political interferences.  Since there was too much concentration of powers in the hands of the chairman and managing director (CMD), the government took first step and decided to separate the roles of the chairman and managing director (CMD) in all PSBs except the State Bank of India. Bank chairmen will now be selected by a panel headed by the Reserve Bank of India Governor.

Recommendations: Critical Assessment

The Nayak Committee recommendation to reduce government’s share holding in PSBs and distance government from banks governance will induce indirect privatisation of banks and may hinder public trust on banks. The committee also recommended that the board of directors should take the responsibility for implementing its own vigilance mechanism and liberate the banks from grasp of CVC-CAG-RTI. Firstly, the board of directors will find it too difficult to arrange the incentive for an effective vigil mechanism. Secondly, Vigilance and RTI mechanisms enforce accountability of government towards public, and builds up public trust on banks and its employees. So, diluting the mechanism may not be a good idea.