Dec 11, 2018

Governance vs control in banks: Would be prudent to have minimum promotors’ ownership

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The IL&FS crisis has once again put the issue of governance at the forefront of discussion in the financial services sector. Each time a case of mis-governance erupts, clamour grows for having more stringent governance norms, with the belief that additional regulations will deter future such events.

RBI has, over the years, issued guidelines relating to ownership of banks, believing that diversification of ownership is the primary pillar on which governance can be improved. It is implicit in this assumption that ownership is synonymous with voting rights.

In 1991, the Narasimham Committee recommended that new players should be allowed, towards creating a competitive environment in the Indian banking space. In January 2001, guidelines for new private banks were issued. Since then, shareholding and ownership norms have undergone multiple changes. In January 2001, RBI mandated minimum 40% stake of the sponsor at the time of granting banking licence that has to be locked-in for a period of 5 years, and any stake over and above 40% was queried to be diluted within 1 year of its commencement of banking business. In February 2013, RBI issued guidelines that specified norms for new private banks—asking the licensee to hold a minimum 40% of paid-up voting equity capital of the bank with a lock-in period of 5 years from the commencement of banking business and then queried to reduce the shareholding to 15% within 12 years of the commencement of banking business. In August 2016 guidelines, RBI included existing banks with the dilution norms and issued ‘on-tap’ licensing of universal banks in the private sector, whereby promoters were directed to finally reduce their holding to 15% within 15 years of the commencement of banking business.

The guidelines so framed have primarily focused on diversified ownership for the promoters, with a belief that such an ownership structure will lead to better governance.

It has been recognised widely, including by RBI, that ‘banks are special’ as they not only accept and deploy large amounts of uncollateralised public fund in fiduciary, but also leverage such funds through credit creation. The fiduciary responsibility of running an institution, particularly a bank, is vested primarily with the board of directors (and not shareholders), under the regulation and supervision of the banking regulator. Hence it is crucial that enough control is exercised on the constitution and functioning of the board and key management. Under the Indian corporate law, as with most other countries, it is the shareholders who vote by majority for a director to be appointed. Hence, the shareholders’ role is limited to voting. Thus, if control needs to be exercised on who gets appointed, as far as shareholders are concerned, one should ensure there is no ‘squatting’ by an owner. This is effectively achieved in two ways: one with a cap on voting rights, and two with the number of directors such owner can appoint. RBI has, for long, recognised that ‘control’ over operations of a management needs to be monitored, and hence the evolving policies and guidelines relating to management and board structures of banks.

Prohibiting the promoters not to hold more than 15% in private banks opens the doors to other scattered investors to invest. Globally, most banking jurisdictions require banks to be widely held and there are no separate limits for promoters’ shareholding. In the US, UK, Germany, Japan and China, there is no maximum cap over shareholding of promoters.

Also, due to the bevy of ownership prescriptions, at times contradictory and ambiguous, as well as different yardsticks for banks licensed under different conditions, even some of the well-run banks are faced with an insurmountable requirement: of diluting owner stakes by as much as the entire market capitalisation of these banks, which is practically impossible.

Against this backdrop, there is a need to revisit the guidelines related to ownership norms in the Indian private sector banking sector and it would be a prudent idea to have a minimum level of promoters’ ownership, which is in consonance with the voting cap of 26%, so as that promoters have a ‘skin in the game’ for greater accountability at all times.

The author is Pavan Kumar Vijay, Founder, Corporate Professionals Group

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