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This article is written by Harsha Aswani, pursuing a Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho

Introduction

Before 1949, the provisions of Part-XA of the Indian Companies Act, 1913 (as amended in 1936) governed the banking companies in India. However, the provisions of the company law kept the interests of shareholders on a higher pedestal and paid no heed to the interests of depositors, who are one of the major stakeholders in a banking company. To address this inadequacy as well as to ensure a sound and balanced development of the Indian banking sector, separate legislation, known as the ‘Banking Companies Act, 1949’ came into force. In 1965, this Act was renamed as ‘The Banking Regulation Act, 1949’, and was extended to include co-operative banks.

Later in 1969 and 1980, fourteen and six private sector banks, respectively, underwent nationalisation, and to govern the same, a new Act named, “The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970” (as amended in 1980) was introduced. 

Both the Act of 1949 (as amended in 2020) and the Act of 1970 (as amended in 1980) became the statutory basis for supervising and regulating the banking structure in India.

The collective body of directors known as the Board of Directors in any company is responsible for its management.  Along the same lines, , Section 7 read with Section 9 of the 1970 Act empowers the Central Government, after consulting with the RBI, to constitute the “Board of Directors” of the nationalized banks in India, while the directors on the Board of the private sector banks are appointed according to Section 10A of the 1949 Act

Ensuring the interest of the depositors has always been the utmost priority of these legislations, however, the rampant bank-related frauds in the banking industry tell an entirely different story. Therefore, to address this issue and to enhance corporate governance on all levels of the banking sector, the RBI on April 26, 2021, issued a Master Circular on ‘Corporate Governance in Banks− Appointment of Directors and Constitution of Committees of the Board.’ The circular focuses on increasing the involvement of independent directors in the board of directors of the banking company to ensure independent and unbiased decision-making, which would benefit the interest of all the stakeholders in the bank, but most importantly is expected to be fruitful for the depositors of the banks in India.

For a better understanding of the concept, this article shall begin by giving a brief overview of the type of directors in a banking company. It would then discuss the provisions dealing with the appointment of directors under the two Acts and the new changes introduced by RBI in 2021.

Directors in a banking company

There are broadly two categories of directors in a banking company−

  1. The Executive Directors, such as the Whole-time Directors and the Managing Directors/CEO; 
  2. The Non-Executive Directors, such as the Independent Directors.

The executive directors are appointed in a dual capacity− firstly , as the company’s employee, and second as members of the board of directors. Their responsibility is to bring an insider’s perspective while managing the day-to-day operations of the company.

On the contrary, non-executive directors are not involved in the daily management of the company. They are appointed to the board for their experience, expertise, and personal qualities. Their responsibility is−

  • to bring an outsider’s perspective and objectivity while designing plans and policies for the company, separate from the management.
  • to independently assess the company’s overall performance;
  • to strategize the business policies;
  • to have an oversight of risk management;
  • to hold the executive directors and the other board members, accountable; and
  • to balance the needs of the stakeholders, and if required, to consider the needs of the company’s stakeholders like the depositors before that of the management.

Appointment of directors in the banking companies

Appointment of directors under the Banking Companies Act, 1970

Section 7 of the Act empowers the Central Government to constitute, in consultation with the RBI, the first board of directors of the nationalized banks, consisting of a maximum of seven persons. The board of directors shall hold the office until the Central Government prepares the scheme under the provision of Section 9 of the Banking Companies Act for the constitution of a new board of directors.

Section 9 empowers the Central Government to prepare a scheme for the constitution of a new board of directors of the Banking Company. The Companies Act, 2013 prescribes the appointment of a maximum of 15 directors on its board. On the same line, section 9 has laid down the composition of such board of directors, which is as follows−

  1. A maximum of five whole-time directors. The whole-time Directors are appointed by the Central Government, after consultation with the RBI, on a full-time basis to manage the whole of the affairs of the banking company.
  2. One Director being an official of the Central Government. He is nominated by the Central Government, and is prohibited from occupying the position of Director in any other corresponding bank;
  3. One Director having expertise and experience in the regulation or supervision of commercial banks. The Central Government nominates the director on the recommendation of the RBI.
  4. One Director from among the employees of the bank, nominated by the Central Government. He must fall within the definition of ‘workmen’ under Section 2(s) of the Industrial Disputes Act, 1947.
  5. One Director from among the employees of the bank, nominated by the Central Government, after consultation with the RBI. Such a person must not fall within the ambit of ‘workmen’ under Section 2(s) of the Industrial Dispute Act, 1947.
  6. One Director, being a Chartered Accountant for at least fifteen years. After consultation with the RBI, the Central Government nominates such a director for the appointment.
  7. A maximum of six directors shall be nominated by the Central Government from the following persons, elected by the shareholders of the banking company, amongst , depending on the capital issued-
  1. One Director, if issued not more than 16% of the total paid-up capital;
  2. Two Directors, if issued more than 16% but less than 32% of the total paid-up capital;
  3. Three Directors, if issued more than 32% of the total paid-up capital;

These persons must hold special knowledge or practical experience in any of the following matters−

  • Agriculture and rural economy;
  • Banking;
  • Co-operation;
  • Economics;
  • Finance;
  • Law;
  • Small-scale industry
  • Any other matters which are deemed useful in the opinion of the RBI for the management of the bank.

Apart from this, the provision also mandates such persons to be able to represent the interest of the depositors, farmers, workers, and artisans.

The directors appointed under Section 9 of the Banking Companies Act are also required to satisfy the status of “fit and proper” as specified by the RBI in its master direction on “Reserve Bank of India (‘Fit and Proper’ Criteria for Elected Directors on the Boards of PSBs) Directions, 2019 (as updated in 2020).”

It is important to note that these directions apply to public sector banks. To determine the “fit and proper” criteria, these directions prescribe the constitution of a “Nomination and Remuneration Committee” consisting of at least 3 non-executive directors from the Board of Directors so appointed, out of which one-half must be independent directors, who must include at least one member from the “Risk and Management Committee” to carry out due diligence for determining the eligibility and status of the potential candidates for directorship.

To ensure fair, unbiased, and independent decisions, any director nominated by the Central Government shall not be part of the Committee. The Committee shall be chaired by a non-executive director, who could very well be nominated by the Board from amongst its members. 

Additional eligibility criteria

The master direction also prescribes the eligibility criteria for the appointment of directors on the board:

  1. The candidate must be between 35 to 67 years of age on the cut-off date for submission of nominations;
  2. He must at least be a graduate;
  3. He must possess special knowledge or practical experience as laid down under section 9 of the Banking Companies, Act 1970;
  4. Their tenure of office would be of 3 years from the date of appointment, and the director shall be eligible for re-appointment. However, it is important to note that no such director shall hold the office for a period exceeding 6 years, whether continuously or intermittently;
  5. He must not be a member of any other bank, or financial institution, or RBI, or NOFHC.
  6. He must not have served as an elected member of any category in any bank, financial institution, RBI, or insurance company, for 6 years, whether continuously or intermittently;
  7. He must not be involved in stock-broking;
  8. He must not be an MP or an MLA or a member of Municipal Corporations, Municipality or other local bodies;
  9. He must not be involved in any activities in conflict with the business interest of a bank;
  10. He must not be in any professional relationship either with a bank or NOHFC holding any other bank;
  11. He must not be a defaulter of any lending institution, law enforcement agency, or regulatory/supervisory agency.

Documents required before assuming the office of director

The master directions also mandate obtaining the following documents from the director before he assumes his office:

  1. A Deed of Covenant executed in the prescribed format.
  2. A simple declaration, on 31st March of every year, affirming the information provided during appointment hasn’t undergone any change;
  3. If any change in information about the director occurs, the bank is mandated to obtain a fresh annexure in the prescribed format incorporating all the changes.

Appointment of directors under The Banking Regulation Act, 1949

Section 10A of the Banking Regulation Act, 1949 prescribes a model for the appointment of directors on the board of private sector banks. It provides that−

  1. A minimum of at least 51% of the total number of the members of the board must possess special knowledge or practical experience in any of the following matters−
  • Accountancy;
  • Agriculture and rural economy;
  • Banking;
  • Co-operation;
  • Economics;
  • Finance;
  • Law;
  • Small-scale industry;
  • Any other matter deemed useful in the opinion of the RBI.

Further, the proviso to clause (2)(a) of Section 10A mandates having a minimum of two persons out of the total 51% of the members of the board who  possess special knowledge or practical experience in either agriculture or  rural economy, or co-operation, or small-scale industry.

  1. Such members of the Board of directors must not possess a substantial interest in or in connection with the employee, manager, or managing agent of:
  • Any company. However, this provision does not apply to section 8 companies, known as Charitable Companies, under the Companies Act, 2013 (the earlier Section 25 of the Companies Act, 1956).
  • Any firm (excluding a small-scale industrial concern), carrying on a trade, commerce, or industry.
  1. Such board members must also not hold any propriety in any trading, commercial or industrial concern. This shall exclude a small-scale industrial concern.
  2. No director, except the chairman or the whole-time director, holds office for a period exceeding 8 years.
  3. The Chairman or the whole-time director, if removed from office, shall cease to be the director of the company, and become ineligible for reappointment as the director of such banking company until a cooling period of 4 years expires from the date the directorship ceases.

If any of the above conditions are not complied with, the RBI has the power to direct the banking company for the reconstitution of a new board, as per the prescribed requirements. Further, Section 10 of the Banking Regulation Act, 1949 has prescribed certain additional prohibitions on the employment of certain persons in the banking company, which includes−

  1. No banking company is allowed to appoint a managing agent for managing the affairs of the company;
  2. A person adjudicated as an insolvent;
  3. A person who has either suspended his payment or has compounded with his/her creditors;
  4. A person convicted for the offence of moral turpitude by the criminal court;
  5. A person whose remuneration, whether whole or in part, forms a commission or share in the profits of the company.
  6. A person whose remuneration is in excess as per RBI;
  7. A person who is a director of any other banking company, not being the subsidiary bank, or a Charitable company registered under Section 8 of the Companies Act, 2013 (the earlier section 25 of the Companies Act, 1956);
  8. A person who is involved in any other business or vocation;

Control over management or directors

Section 36AA of the Banking Regulation Act empowers the Reserve Bank of India to remove any managerial or other personnel from the office, by way of a written order, if it deems fit in the interest of−

  • The public;
  • The banking company; and
  • The depositors.

The person so removed can appeal against the decision of the RBI before the Central Government, whose decision shall be final. Section 36 ACA also empowers the RBI, in consultation with the Central Government, to pass a written order for superseding the Board of Directors, if the RBI so desires in the interest of the banking company as well as its depositors, for 6 months, which can exceed the time period up to a  total of 12 months.

Considering the objective of the statutes and the rising cases of bank frauds that have compromised the interest of the banking company as well as the interest of its depositors, the RBI prepared and published its “Annual Report for 2020-2021”, on May 27, 2021. This report disclosed that over the past three years from 2018 to 2021, India has witnessed almost 22,864 banking frauds involving an amount of INR 3.95 trillion (or its equivalent, USD 53 billion). While investigating all the cases, the report blamed the poor corporate governance at all levels of the banks− be it at the hands of the mid-level employees or the senior-most management of the banks, to be the major reason.

This forced RBI to reconsider the corporate governance guidelines issued by it, and on the format of the Corporate Principles of “Basel Committee on Banking Supervision, 2015” read with−

  • The 1992 RBI Guidelines on “Do’s and Don’ts for Directors”; 
  • The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015;
  • The Companies Act, 2013; and
  • Other RBI Circulars,

The RBI released a discussion paper on “Governance of Commercial Banks”. After several discussions, and the feedback received on the paper, the RBI, on April 26, 2021, issued a new Master Circular on “Corporate Governance in Banks− Appointment of Directors and Constitution of Committees of the Board”  to enhance the corporate governance in the banks by increasing the involvement of non-executive “Independent Directors” in the Board as well as on the Committees of the banks. The independent directors, as the name suggests, work independently towards the policing and strategizing of the policies of the banking companies. It is expected that the involvement of these independent directors, separate from the management of the company, would ensure holistic and unbiased decision-making, and improve the governance regime of the banking sector.

Brief highlights of the Master Circular on Corporate Governance in Banks, 2021

Applicability

This Circular shall apply to −

  1. All private sector banks, including SFBs (Small Finance Banks);
  2. Wholly owned subsidiaries of Foreign Banks. However, it shall not apply to foreign banks operating as branches in India;
  3. SBI and nationalized banks, so far as it is consistent with the provisions of the special statutes governing these banks;

Applicability for the local area banks, payment banks, and regional rural banks would be notified separately.

Chairperson of the Board and meetings

The Circular has emphasized the appointment of an “Independent non-executive director” as the Chairperson of the Board, who is required to “stand apart” from all managerial influences and manipulations, to arrive at an unbiased decision to protect the interest of the stakeholders from any banking scams and frauds.

The quorum decided for the board meetings is one-third of all the members of the board, or three directors, whichever is higher. Here, also RBI has mandated the involvement of independent directors and has laid down that at least half of the directors attending the board meeting shall be independent directors.

Committees of the Board

Banks, unlike companies and corporations, are required to render protection to a broader pool of stakeholders, including internal, external as well as depositors, who typically do not have a say in the decisions of the banks. Therefore, the Board is required to deeply analyze and monitor the strategic issues and risk oversight the banks are exposed to. To ensure the effectiveness of this process, the Circular has laid down the constitution of three mandatory committees, to audit the finances, assess the risks, nominations, and remunerations, management, stakeholder relationship, etc., in the banking companies−

  1. Audit Committee of the Board (ACB) 

It shall comprise only non-executive directors having expertise in finances. The meetings of this committee shall be chaired by independent directors, and he shall neither be a member of ACB, nor any other committee of the board, whether or not having the power to sanction credit exposures, nor shall he chair any other committee. This also shows how the RBI has attempted to increase the involvement of independent directors, having authority to audit the finances of the bank, without being influenced by people in the management, or exposed to any financial threats. Risk Management Committee of the Board (RMCB) This committee shall also consist of a majority of non-executive directors having expertise in risk management. The chair of the committee would be held by an independent director, who shall not chair the board as well as the committee of the board.

  1. Nomination and Remuneration Committee of the Board (NRC) 

The circular mandates only non-executive directors to be part of this committee. It shall be chaired by an independent director, who must not hold the chair of the board. It can be seen that all these committees are mandated to have a distinct chairperson, who would be an independent director. During the meeting, if the independent director is absent, the meeting shall be presided by another independent director. The circular has mandated a higher requirement of independent directors in the quorum as well, which banks like Kotak Mahindra, HDFC, ICICI are required to follow along with the SEBI (Listed Regulations), as these banks are listed on Indian stock exchanges. The appointment of independent directors having experience and expertise in their respective fields is expected to introduce several checks in the decision-making of the board, leading to higher credibility and accountability. 

Age and tenure of Directors

Higher tenure of executive directors is bound to amplify governance issues; therefore, the circular has attempted to benefit the banks by capping the age and tenure of non-executive and executive directors.

  • Non-Executive Directors

Age: Capped at 75 years, beyond which no person shall be allowed to hold the office;

Tenure: Capped at 8 years, with an option of re-appointment, provided the director shall serve a cooling period of three years. 

  • Executive Directors [Managing Director or Whole-Time Director]

Age: Capped at 70 years, beyond which no person shall be allowed to continue in office.

Tenure: Capped at 15 years, with an option of re-appointment in the same bank, after serving a cooling period of three years. 

Conclusion

Every company has a collective body of persons, known as the “Board of Directors”, who are responsible for managing, controlling, and directing the affairs of the company. They are expected to act towards the interest of the stakeholders of the company, which are usually the shareholders, by way of strategizing their business decisions and having an oversight towards risk management. 

However, when it comes to Banking companies, the pool of stakeholders broadens to include depositors, whose protection becomes even more prominent, considering they do not generally influence the business decisions of a bank. With this perspective, the two Acts, the Banking Regulation Act, 1949 and the Banking Companies Act, 1970 were introduced. These Acts along with the RBI guidelines lay down in detail the requirements for the appointment of directors in the public as well as private sector banks.

While the objective of these legislations was to balance the interest of all the stakeholders in the bank, however, the recurring banking frauds in the country had put the most important bank-stakeholder, “the Depositors” in a compromising position. To cure the same, the Reserve Bank of India has released a Master Circular on ‘Corporate Governance in Banks” and has attempted to improve the governance of banks at all levels, from top to bottom. Though it is yet to see the efficacy of how these guidelines are implemented and enforced by RBI; however, so far, the proposed structure seems to enrich the corporate credibility and accountability of management towards its decisions, which might hopefully enable the depositors to see the light at the end of the tunnel. 

References


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