Improving bank governance

I have written earlier about how the collapse of big financial firms marks a disaster in governance. The world's leading bank boards did not have a grip on risk management, indeed many boards lacked banking expertise. FT carries an article that proposes radical overhaul of bank boards:

• Board should discuss risk exposures
• Boards should disclose their approach to managing risks

These two roles boards may be called upon to play even now even if they are not done properly. The author adds two more:

• The regulator should have the right to interview non-executive directors to discuss their risk assessments and publish transcripts of these- the idea of these "fiduciary risk reviews" is to give investors an idea of how conversant boards are with their firm's risks
• Regulators should have the right to appoint two or three public representatives as observers on boards so that the tax payer is represented in some way. These public representatives would report to the regulator on how well they think the board has handled risk.

What to make of these proposals? First, they would require a much higher degree of expertise on risk management than most boards today have. Secondly, non-executive directors undertaking such onerous responsibilities would have to be properly remunerated.

In India, I am glad to say, the basic framework for such mechanisms exists.The RBI requires bank boards to have a Risk Management Committee to monitor risks. The minutes of these meetings would be available to RBI inspectors. There is also room for public representatives on boards of public sector banks although these, more often than not, end up being hand-picked by management. There are also officer and employee representatives on PSB boards.

This entire structure, to my mind, is preferable to what the FT article oposes- interviews with non-executive directors conducted by the regualator seem inquisitorial and may not be productive. Besides, the article misses the point about board room reform: independent directors need to be truly independent.

This can happen only if some independent directors at least are appointed by institutional shareholders. You can't have an independent board if all the members are selected by management. It is the lack of independence on the part of the board, not so much lack of expertise, that explains there has been a governance failure in the financial sector.

We must have board members appointed by financial institutions and at least one by retail shareholders. Employee representation on the board is also a healthy check on management- after all, it is employees who best know what is going on in the bank.

Unless and until we have truly independent boards, corporate governance will remain pretty much a farce.