The boards of banks should hold the management accountable for its actions, and should replace it if it does not meet expectations, M Rajeshwar Rao, deputy governor of the Reserve Bank of India (RBI), said in an interaction with board members of banks.
“Boards should appraise the performance of management objectively and ensure that they are held accountable for their actions. If the management is not meeting expectations, boards should take suitable action, including replacing the management, to improve the bank's governance and risk management,” Rao said in his speech at the conference of the directors of banks. The RBI had organised the conference for public sector banks on May 22 in New Delhi and private sector banks on May 29 in Mumbai.
The copy of Rao’s speech was uploaded on the RBI website on Monday.
Rao said the boards of banks should set clear expectations for the management in terms of risk management and corporate governance. He added that the management should be required to regularly report risk management. “This reporting should include information on the bank's risk appetite, risk exposures, and risk mitigation strategies,” he said.
The deputy governor said boards should ensure that the management is transparent about the banks’ financial performance / statements and risk management practices so that trust with stakeholders is built and investors are able to assess the various risks associated with banks.
He said boards must ensure a suitable policy framework to assess effectiveness, in accordance with their strategies and risk profiles. The effectiveness must be tracked at all levels – individual director, committee, and the overall board.
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On the subject of remuneration, he said that bank boards, through the nomination and remuneration committees, must ensure that the management’s remuneration is not only tied to short-term profits but also takes into account long-term materialisation of risks, and that appropriate ex-ante and ex-post checks for assessment are built into the compensation systems.
According to Rao, there are two key challenges in ensuring sound corporate governance in banks.
“First, the banks are placed at a higher pedestal vis-à-vis other financial or non-financial entities due to their unique role,” he said. “Second, the most important stakeholder for the bank, i.e. depositors, tend to be diversified, diffused, and passive.” He added that this is a challenge the board of directors have to address to ensure that the management’s incentives are aligned with the interest of depositors and other stakeholders.