Banks’ Boards should appraise the performance of management objectively and ensure that they are held accountable for their actions, according to M Rajeshwar Rao, RBI Deputy Governor.
“If management is not meeting expectations, Boards should take suitable action, including replacing the management, to improve the bank’s governance and risk management,” he said at a recent Conference of Directors of Banks.
Rao observed that RBI looking at the “twin peaks” model for regulations — prudential regulation and conduct regulation — through the prism of governance with equal emphasis on the conduct of business through prudence.
“It’s no doubt essential for the management to deliver good performance, but more importantly, this should be achieved by adhering to acceptable customer and market conduct and best corporate governance practices,” he said.
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He noted that RBI often comes across matters of conduct not getting the priority or attention of the Board which they should be getting.
“Customer service, customer conduct, ethical employee behaviour, data privacy, and cyber security are critical and important issues which assume even greater relevance in times of innovation, change, and business disruptions.
“Good or rather best practices in these areas are the key soft pillars which build the edifice of a successful financial institution, more so in these challenging times,” Rao said.
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Therefore, there is a need to reflect on the role and expectations from the governance architecture — the Board and its Committees, the Independent Directors and the assurance functions in banks and other financial institutions on these issues.
“In fact, the Board should drive a culture where the expectation would be to go beyond baseline compliance to regulatory and legal requirements and aim for higher, best-in-industry standards,” the Deputy Governor said.
To this end, the Board must ensure a suitable policy framework for its own assessment regarding effectiveness and composition, in accordance with their strategies and risk profiles, both at the aggregated and dis-aggregated levels.
Rao emphasised that the classic three lines of defence are clearly under the remit of the Board with the audit being an independent check and supervision being the final line of defence/ oversight.
“Here the governance framework set out by the Board should ensure that the three lines of defence do the job as expected – much like in the game of football, where the forwards, the midfielder and the defenders should collectively keep the ball in play and ensure that the supervisor as a goalkeeper is not engaged,” he said.
Coming to the link between regulation and governance, Rao observed that the regulators usually decide the regulatory perimeter and guide the regulated entities so that there are no accidents and surprises.
“While it is for the regulators to issue instructions that enjoin upon banks to adopt the best practices insofar as governance is concerned, it is for the Board to set the strategic direction, engage with management, and conduct review of key policies and frameworks.
“The Boards should manage alignment of performance with pay as well as enforce accountability to ensure adherence to the best practices while achieving the objectives set for the bank by the Board,” he said.