The Committee to Review Governance of Boards of Banks in India (P.J.

Nayak Committee)
submitted a report recently. Its terms encompass all categories of banks and if its
recommendations are implemented, it would fundamentally change the face of state owned
banks, while making incremental changes in the governance of private banks.
The present composition of the boards of public sector banks (PSB) could theoretically be termed
as a model in corporate governance. The boards represent diversity (except on gender) and
multiple public interests. A typical PSB bank has three directors representing minority (nongovernment) shareholders' interests; three directors who are expected to represent societal
interests; a director each representing the union government, workmen, officers, and regulator
(RBI). In addition an independent chartered accountant is appointed as a director and the person
usually heads the audit committee. The bank also has three or four whole-time directors including
the Chairman and Managing Director (CMD).
While the above composition looks good, there is still a huge problem. This problem is about the
process of identifying individuals to represent these diverse interests. The Nayak committee
rightly identifies it. It terms the boards as "non-independent" except for the shareholder
directors. The process of the election of even these so called "independent" directors may also
show that they are largely nominees of the government, albeit through a different process. They
are elected by shareholders excluding the government. The non-government share-holding in
many of the banks are substantially held by institutions indirectly controlled by the government insurance companies, financial institutions etc. These institutions largely select the "independent"
directors as well. We thus have a situation where the public sector banks end up not having a
semblance of good corporate governance.
The Nayak committee needs to be complimented for taking the bull by its horns and addressing
the issue of process squarely. While arguing for fundamental changes in the way the public sector
banks function, the committee presents a compelling case by examining the performance of these
banks in comparison with the private sector counterparts. The committee, starts its report by
pressing the alarm bells on the performance of these banks; moves to analyse what cripples them;
and then addresses the issue of governance. The of governance of bank boards is not a standalone issue that could be tinkered by recommending some changes here and there, but has to be
examined comprehensively.
The
committee
touches
upon
three
significant
issues:
(a) Examining the most significant pain points that stymie the performance of PSBs; the perverse
incentives in the current structure because State ownership, but also because of operational
controls by the State. The committee thinks that the State should continue as an investor;
intervene on issues of larger public good through policies in consultation with RBI and ensure
that these policies affect the private banks and PSBs equally; and keep completely off operational
control. The solution offered is elegant: It suggests that the government reduce its stake in the
banks to just about less than 50% which takes the banks out of the tyranny of vigilance, right to
information (RTI) while keeping the State as the dominant shareholder and not losing ownership
based control.

(b) Examining aspects affecting the leadership in being effective in the banks, the committee
rightly identifies the problem in the process of appointing the Chairman and whole time
Directors, and their tenures.
Management effectiveness would be addressed if the above issues are taken care of. The third
important issue that the committee touches upon is the process of governance and the
transitional arrangements:
(c) The committee suggests a radical and an involved model of moving all the government
shareholding in PSBs to a special vehicle similar to a holding company. This structure would have
the basic function of protecting the commercial interests of the State. This committee will have
the power also to make appointments of whole-time directors and directors that represent the
state, while the rest of the independent directors would be inducted through the process of
identification of skill gaps and through a nomination process of the board.
On governance of private banks, the big issue that the committee identifies is about the nature of
investors and suggests that there be a "fit and proper" criteria even for institutional investors that
would be eligible to appoint their representatives on the board. These investors are termed as
Authorised Bank Investors. This concept is not well argued. It is not clear from the report why the
fit-and-proper criteria that is to be applied to board members have to be applied to the investors
themselves. The committee also suggests that the position of the Chairman and Managing
Director of banks be split without offering any plausible explanation. Given that Nayak himself
vehemently opposed the splitting of these positions when he was at the helm of Axis Bank (then
UTI Bank) we are curious to know why he had a change of heart when it came to the committee.
The committee has suggested a fixed term of 5 years for the chairman/managing director of a
bank and a term of 3 years for a whole-time director. While the committee has done some
detailed analysis to arrive at their recommendations through the report, we do not find the same
rigour in analysis of the HR situation of the PSBs. Do the banks (or the banking sector) have the
talent pool that is experienced enough (people in their 50s) to occupy these positions that fall
vacant and serve out the terms that the committee has suggested?
This report is insightful, constructive and radical in its approach. However, accepting these
recommendations needs political will. We are not sure that the ball lobbed into the court of the
Government - by a committee appointed by RBI can find instantaneous resonance. We hope that
the new government has the will to address these issues and reform the governance and
management of banks, particularly PSBs.

The report of an RBI-appointed committee under the chairmanship of former Axis Bank head P.J. Nayak that reviewed issues of
governance in banks was released just before the announcement of the parliamentary election results. There is a risk of the
report getting lost in the abundance of official and non-official recommendations and suggestions on financial sector reform that
are now available to the new government. On the other hand, the committees report might well be the blueprint that a new
government that is keen on reform might consider adopting, albeit with modifications. The report has already become
controversial, with major bank trade unions threatening to go on strike against its key recommendations that are centred on the
dilution of government ownership in public sector banks (PSBs) to 50 per cent of their paid-up capital, and the revamping of
their boards. No one doubts that PSBs suffer from external constraints flowing from dual regulation by the Finance Ministry and
the government. They also face severe restrictions in being subject to external vigilance by the Central Vigilance Commission
and the Central Bureau of Investigation. Corporate governance has suffered because of weak board supervision and excessive
government interference. These in turn have resulted in policy objectives rather than commercial considerations dictating
business decisions. There has been a lack of transparency in appointing top managers of PSBs. Most of them are not able to
stand up to government interference and this has largely contributed to weak governance. PSBs lag behind private banks with
respect to a wide range of parameters such as profitability and asset quality.
An immediate task before the government as the majority owner stake-holder in these banks is to find very large amounts of
capital to take care of their impaired assets and also meet the international capital adequacy norms following their shift to BaselIII, which is imminent. The Nayak Committee has proposed that the government stake in the banks be transferred to a separate
bank investment company which will be professionally managed and be able to raise resources. A separate category of authorised
bank investors (ABIs) will be allowed to own up to 20 per cent of a private bank without regulatory approval. On the face of it,
recommendations such as this are not for the PSBs, but they will be applicable once the government brings its stake down to 50
per cent or below. It is therefore not surprising that many, even those who are not on the side of the bank unions, see the report
as a push towards bank privatisation. It is precisely on that score that the report, though well-intentioned, needs a great deal of
deliberation.
Keywords: Public sector banks, PSB disinvestment, government stake dilution, RBI Governor, Raghuram Rajan, Axis bank exChairman, P. J. Nayak, Nayak panel report, bank privatisation, All-India Bank Employees Association, AIBEA