Government of India Volume I: Analysis and Recommendations

ANNEXES
14. Regulators must look at compensation policy and structure and its impact upon
incentives and the ability of the bank to perform adequate risk management. The
focus of supervisors should be upon the incentive implications of the compensation
structure. There is a case for rules that require compensation to be spread
over longer horizon, with provisions for claw back of payments in certain cases.
While there is some thinking on framework for compensation in private and foreign
banks, the same needs to be extended to PSBs. The legal and regulatory framework
for compensation should give the BOD and shareholders the ability to push PSBs
towards more rational compensation structures, given the deep links between the
problems of risk management, operational controls of PSBs, and the flaws of compensation
structure.
15. The notion of fit and proper for the boards of banks needs to be reviewed. The WG
recommends removing the restriction on directors on Boards of banks also being
directors of other enterprises. However, the Managing Director (MD) would not be
allowed to occupy a board position in group companies/entities.
16. Further, this WG recommends that Section 20(1)(b) of the BR Act, which places restrictions
on loans and advances by the BOD, must be confined to only loans and
advances made to private limited companies or to entities where the director has
substantial interest. For the purposes of this recommendation, the entities in which
the director is deemed to be substantially interested must be in line with standards
used for related party transactions under the Companies Act and accounting standards.
This recommendation is broadly in line with the recommendations of the
Committee on Financial Sector Assessment (CFSA) (2009). Referring to the definition
of “substantial interest” in Section 5(ne) of the BR Act, the CFSA was of the view
that,
“this quantitative stipulation (Rs. 5 lakhs or 10% of the paid up capital
of a company) has proved to be very low because of inflation and also
growth in size of banking companies. It is felt that the quantitative ceiling
of Rs. 5 lakhs should be removed and an appropriate percent of the paidup
capital be stipulated”
Hence the definition of substantial interest needs to be revised upwards.
17. With respect to PSBs, the BOD, must be given greater powers to nominate members
of the appointment committee and the compensation committee of the BOD.
18. On governance arrangements, the WG recommends that uniform rule of law must
be followed by banks irrespective of ownership. This includes:
(a) Separating the position of chairman and managing director in case of PSBs as
well.
(b) BODs of PSBs must play the same role as any other BOD, with the same stipulations
as any other type of bank.
(c) Fully complying with the listing norms (SEBI stock exchange rules) in case of
listed entities.
19. This WG recommends that the current mode of operations of banks under Bank
Subsidiary Model (BSM) is inadequate and there should be a shift towards the FHC
model as a preferred model for financial sector in India. The FHC model mitigates
the risks spilling over to the bank from other entities in the group.
20. Subsidiaries of banks should only do business that could have been done purely
within the bank. If insurance cannot be done by a bank, it should not be done by
the subsidiary of a bank.
21. Further, capital of banks should not be allowed to take any risks apart from banking
risks, and mechanisms must be put in place through which resources from the
FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION 185