Monday, July 14, 2008

What were bank boards doing?

What were bank boards doing as the sub-prime crisis built up? What penalties do they face in banks that has suffered huge losses. Many CEOs have lost their jobs; not many directors have. One fact that took away my breath was mentioned in an FT report: nearly two thirds of bank boards were bereft of banking expertise.

So, who typically sat on these boards? Well, the mighty and the respectable, ex-CEOs of manufacturing firms, faces and names that have wide recognition. Is that good enough? I don't think so. I think it makes sense to have a minimum of finance and banking expertise on board boards. Here, India's Banking Regulation Act gets it absolutely right: at least 51% of board members must have expertise in specified areas: banking, economics, agricultural, small enterprises, etc.

The RBI also has norms for bank governance over and above the norms applicable to listed companies under clause 49. This is entirely appropriate: in many other countries too, governance for banks tend to be stiffer than for other firms or there are separate norms for governance for banks and for other companies.

Is having expertise on boards an insurance against failure? Not at all. Boards are limited by the information that management presents to them and the form in which these are presented. So, the best-intentioned boards may proved ineffective. But there is a more fundamental reason why boards are not as ineffective as one might like.

Most boards are clubby affairs. Those invited to serve as "independent" directors are pals of the CEO, they brush shoulders in the same watering holes and they are often retired people who value the handsome fees that many companies pay these days.

The atmosphere in boards is that of a mutual admiration society. CEOs pay ritualistic obeisance to the "sage guidance and wisdom" of boards in their annual statements- one retired CEO, whom I respect, told me there was not an iota of truth in this. Boards compliment management on their stewardship. Over sumptuous lunches and equally sumptuous snackes, top management and directors share jokes and anecdotes, there is a general air of conviviality. I mention this because, in this atmosphere, it is not done for an independent director to probe or to question. Bad form, old chap.

So, having expertise on bank boards is not enough. We need to ensure that there are enough directors who are independent of management, that is, they are not beholden to the management for their positions. This can happen only if financial institutions with equity stakes in the company and minority shareholders can directly elect a certain number of directors. The present concept of "independent" director, whereby management invites outsiders on to boards, is something of a farce. Alas, I don't see such a revolution happening in the near future.

More on this in my ET column, Banking's governance disaster.


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