The first issue concerns ownership. There is typically a divergence between the interests of shareholders and of depositors. Shareholders want profits to be maximized by taking on greater risk; depositors have an overriding preference for the safety of their deposits and hence for lower risk. At the same time, depositors have little say in the governance of banks whereas the shareholders" say is very pronounced. Within the shareholder group, the extent of control exercised by promoter shareholders too is an important determinant of the effectiveness of corporate governance. As some recent instances demonstrated, such excessive influence of promoters can turn the board into a mouthpiece of the promoter to the detriment of the interests of all other stakeholders.
Another way to look at the issue of ownership is in terms of public vs. private ownership. If banks are publicly owned, issues of conflict of interest between shareholders and depositors get mitigated. Public ownership of banks would also inspire confidence in the financial system. On the other hand, an important question is whether effective and autonomous corporate governance is compatible with public ownership of banks. The question arises because publicly owned banks render accountability to the government and to the democratic institutions. The government judges them on criteria quite different from those used by the market. How can we resolve this dilemma? Is it possible to stay with public ownership but still give near total autonomy to the boards? Is it, in particular, possible to cede the power to appoint the CEO to the board, but make the board accountable to the government and the shareholders for the performance of the bank?
Diversified ownership and 'fit and proper' status of shareholders are other important determinants of corporate governance. The Reserve Bank"s guidelines on ownership and governance in private sector banks, issued in February 2005, were aimed at ensuring that ownership and control of banks are well diversified. The Reserve Bank has been consistently following up with banks having concentrated ownership to ensure adherence to the prescribed limits in a time bound manner. Similarly, to ensure 'fit and proper" status of large shareholders, acknowledgement from Reserve Bank is mandatory for any acquisition of shares in private sector banks resulting in a shareholding of 5 per cent or more of the total paid up capital of the bank. Having said that, it must be acknowledged that evaluating 'fit and proper" is far from being a science; it involves a considerable amount of judgement. Moreover, 'fit and proper" is a one time exercise, not repeated unless new information comes in. These limitations need to be recognized.
Another issue in ownership of banks, one that we highlighted in our Discussion Paper on new bank licences, is whether corporates should be made eligible to promote banks. International experience in this regard is varied. There are persuasive arguments both for and against the proposal. The strongest point in favour is that corporates can bring in the capital as also business experience and managerial competence. By far the biggest apprehension is about self-dealing - that corporates will use the bank as a private pool of readily available funds.
There are, of course, both statutory and regulatory checks against self-dealing. For example, the Banking Regulation Act expressly prohibits banks from lending to directors on the board and to entities in which they are interested. Regulations also prohibit lending to relatives of directors without the prior approval or knowledge of the board. Directors, who are directly or indirectly interested in any loan proposal, are required to disclose such interest and to refrain from participating in the discussion on the proposal.
As much as these prescriptions are extensive, there are still gaps. For instance, if a corporate has an interest in a bank as a promoter or a shareholder, but has no position on the board, then there is no prohibition on the bank lending to the corporate. This opens up opportunities for self-dealing. Another apprehension that was raised during the public debate on the Discussion Paper was that it is not easy for supervisors to prevent or detect self-dealing because banks can hide related party lending behind complex company structures or through lending to suppliers of the promoters and their group companies. As we contemplate allowing corporates to promote banks, there is need for changes in statutes and regulations to address these concerns.