In New Delhi’s bureaucratic circles, there is the story of a former Cabinet Secretary who had to step down during Rajiv Gandhi’s government after it emerged that he had failed to disclose that he had rented out his house in the NCR to a state-owned bank. As recently as in 2016, the chief of a state-owned bank was eased out just four days ahead of his scheduled retirement because he had allegedly occupied two houses — one in Pune where his bank was headquartered, the other in Mumbai where had worked earlier. Over the past few days, following The Indian Express report on the case involving the husband of ICICI Bank CEO Chanda Kochhar and the Videocon Group — which is now being investigated by the CBI and CBDT — questions of alleged impropriety and conflict of interest have been raised.
Why is conflict of interest such an important issue in the financial sector? For good reason: banks or financial entities, which are granted a licence by the banking regulator, can leverage and lend the public deposits that they mobilise. It is a business to which trust and confidence are central, and any erosion of which can lead to a run on deposits — as has happened earlier in India and elsewhere in the world. This is why banking is one of the most tightly regulated of sectors — the Reserve Bank has its own set of rules, apart from those laid down by the Companies Act on related party transactions. It is also why the RBI has something called “fit and proper” criteria — norms to assess whether a senior person is not just qualified, but also fit, to sit on a Board of a bank.
The regulator’s restrictions on lending to Directors and their relatives are based on the Banking Regulation Act. One of the provisions says that the Chairman, Managing Director or other Director who is directly or indirectly concerned with or interested in any proposal should disclose his or her interest to the Board when the proposal is discussed. That person should not be present at the meeting unless his or her presence is required by other Directors for the purpose of eliciting information, but even then, he or she shall not vote on the proposal.
The RBI put these restrictions on key management personnel after serious concern was expressed in Parliament over unethical quid pro quo arrangements. The reference was to instances of certain banks informally cutting deals to extend loans to each other’s Directors and relatives in excess of sanctioned limits and in violation of rules. The regulator then defined the scope of a relative of the key management personnel, such as spouse, father, mother, stepmother, son, stepson, son’s wife, daughter, stepdaughter, daughter’s husband, brother, stepbrother, brother’s wife, sister, stepsister, sister’s husband, brother including stepbrother of spouse, and sister including stepsister of spouse.
Proposals for credit facilities to relatives of senior officers of the bank sanctioned by the appropriate authority must be reported to the board, and no officer or any committee comprising an officer as member, can sanction any credit facility to his or her relative. “Such a facility shall ordinarily be sanctioned only by the next higher sanctioning authority. Credit facilities sanctioned to senior officers of the financing bank should be reported to the Board,” says the RBI’s master circular.
It is the job of the compliance departments of banks and other listed firms to ensure that these disclosures have been made and potential conflicts of interest flagged, and all rules on related party transactions have been followed.
Many individuals and firms including banks have walked a thin line on these rules on conflict of interest and ethical governance practices. There have also been many who, while serving on bank Boards, have been outstanding in ensuring compliance. The CEO of a state-owned bank once refused to handle a note relating to dues from a firm because his son had worked there a few years previously. Many Board members of banks have declined to sit in on discussions on loan proposals if they involved a subsidiary of a group firm where the person was on the Board.
Over the past few years, as public sector banks have faced a barrage of criticism because of their pile of bad loans and, recently, because of the discovery of frauds, comparisons have been made with some of India’s top private banks, not just in terms of operational efficiency and lower bad loans, but also on governance. That reputation has been dented over the last week in what will now play out as a public-versus-private bank ethical practices or standards — an addition to the debate on the possible privatisation of state-run banks. Recent events also shine a light on the quality of bank Boards and on storied names and their governance, and on the supervision of these lenders. Indeed, there is buzz about a top private bank where the Directors approved a resolution for increasing their fees only for the CEO to slip in a resolution to increase stock options.
While it would be unfair to prejudge some of the cases now in the spotlight, there is a possibility of the debate on the ugly side of capitalism — under attack in the West — playing out in India as well. If probe agencies or regulators indeed find any wrongdoing by senior key management persons in a case of conflict of interest or quid pro quo, demands could be raised for a rolling back of some stock options granted to them. The Indian banking sector is at a crossroads for a variety of reasons, and issues of governance present a formidable challenge for it.