Carte blanche to notify law requires reform

The provocative abuse of the power to choose when to put into effect a law passed by Parliament has reached a point where judicial intervention is warranted

By Somasekhar Sundaresan

It is a year since the Reserve Bank of India (RBI) picked specific cases of borrowers for action to be taken by banks to invoke the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC). Much ink will be spilled about the year gone by. This column will not add to it.

However, the workings of the IBC and its impact on other laws, presents a good opportunity to note an important aspect of law making in India — the practice of government arming itself with legislation made by Parliament, with full liberty given to the government to decide when any provision of the law may actually be brought into effect. The legacy of legislation preceding the IBC underlines the extreme limits to which this can be stretched.

Originally, insolvency proceedings for “sick industrial companies” was governed by the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA). In January 2003, the Companies Act, 1956 was amended to insert a Part VI-A titled “Revival and Rehabilitation of Sick Industrial Companies”. The government got Parliament to arm it with the power to notify such provision on such date as the government willed. Apart from provisions relating to setting up of tribunals, none of the provisions introduced into the 1956 company law to bring in an insolvency regime was notified into effect by the government.

In January 2004, a law to repeal the SICA was passed by Parliament, but this too empowered the government to notify the law as it chose and when it chose. Nothing happened for a decade. In 2013, new company law was introduced in the form of the Companies Act, 2013, again empowering the government to notify into effect various provisions on various dates as the government deemed fit. This law too contained provisions akin to Part VI-A of the 1956 Companies Act. Therefore, at this stage, two legislation governing company law, governing the same subject of insolvency was in existence but neither legislation was brought into effect. Finally, in May 2016, the IBC was passed by Parliament, again empowering the government to notify such provisions as it chose at such times as it chose.

The IBC contained provisions that would amend the law that had been passed to repeal the SICA — in other words, a law that had not been brought into effect was amended in its still-born state. The IBC also had provisions to delete the provisions introduced in the 2013 company law, but left out the provisions of the 1956 company law that is still on the statute book but not notified. Eventually, on November 1, 2016, through notifications, the provisions in the IBC that would amend the un-notified SICA repeal law were notified. On November 15, 2016, the government notified the provisions in the IBC that would delete the corresponding provisions in the 2013 company law (the 1956 law remained without notification). On November 25, 2016, the law repealing the SICA was notified to give it effect from December 1, 2016 — over 12 years after it was passed by Parliament. On November 30, 2016, the provisions of the IBC were notified with effect from December 1, 2016, to take over from the SICA.

Now, this tortuous journey of the law has other implications. A number of other legislation contained references to the SICA and its provisions — purely for example, exemptions from open offers in the Takeover Regulations and exemptions from delisting procedures under the Delisting Regulations. Not everyone is aware that the General Clauses Act provides that when a legislation is repealed and replaced, all references to the repealed legislation would automatically stand replaced in the eyes of the law by the newly introduced legislation. Therefore, the other regulatory authorities who are the authors of these legislation conduct a lot of activity proposing to amend their regulations to bring them in line with references to the new law; conducting debates over whether they should change the law; and handle voluminous unproductive work of dealing with procedures for making these changes.

The 2013 Companies Act in itself presented a piquant situation with the power given to the government to notify into effect such provisions as the government chose whenever it chose. When empowering itself with such a power, the government forgot to get Parliament to also empower the government with the power to notify the partial repeal of corresponding provisions of the 1956 Companies Act. Till date, enormous time, energy and monetary expense have been expended on litigation about how, in the absence of an explicit repeal of the old law, two provisions can or cannot co-exist and whether a provision can be said to have been “repealed by implication”.

Empowering the government to take its time to notify a law passed by Parliament is a practical feature, but equally, it is time those running Parliament gave thought to how they are abdicating their responsibility without seeking account of why a law has not been notified into effect despite being passed. The social conditions for which a law is introduced remain unaddressed when the notification is not effected — rendering the administration of the law completely arbitrary. Serious consequences have followed in welfare legislation due to this approach — cases in point being the law on domestic violence and the law prohibiting testing the gender of an unborn foetus.

The provocative abuse of the power to choose when to bring into effect a law passed by Parliament has reached a point where judicial intervention by a Constitutional Bench is warranted. In the past, the abuse of the promulgation of Ordinances by a state government had led to a limit of two times being imposed by the Supreme Court. The abuse of sticking the “money bill” label is another example of the courts being seized of such an issue. It is time to take a close hard look at how governments get Parliament to give them a “carte blanche” on use of this power.

This column was published under the title Without Contempt in all editions of Business Standard dated June 7, 2018

Surgical strike at a chronic ailment

Our regulators have to go beyond procedural reform and gaming of processes to improve rankings on Ease of Doing Business

By Somasekhar Sundaresan

It was a judgement waiting to be written. The conduct of the government in litigating on issues long-decided by courts and clogging the courts, even while mouthing platitudes about how the government must not indulge in frivolous litigation, has been called out by the Supreme Court in a crisp and precise judgement.

The seven-page order, imposing costs of Rs 100,000 on the government (yet again), is a must-read not only for every government department at the Centre and the states, but more importantly for every regulator that doubles up as civil courts and generates litigation by writing orders, even on closed issues, merely because the parties before it are different. Remarkably, in the order (passed in a government service litigation — titled Union of India & Others vs Pirthvi Singh & Others) the Supreme Court has pressed the right button by observing that India suffers badly in the World Bank’s Ease of Doing Business rankings primarily because of such conduct by government agencies.

A quick look at the facts would show what is regular and well-expected from the government, state agencies and regulators. The Supreme Court came to dismiss a bunch of appeals filed by the Union of India in December 2017. The very same issues came up again in a new appeal by the Union of India in 2018, and that appeal was dismissed in March 2018. When dismissing this appeal, the Supreme Court noted that the appeal in question was unnecessary and vexatious since many cases had already been decided in the same manner. To ensure this is taken seriously, costs of Rs 100,000 were imposed on the Central government.

The appeal now dealt with by the Supreme Court had agitated the same issue and was filed in March 2018. The government took no steps to withdraw the appeal despite the earlier misadventure having invited strictures and costs.

The judgement notes: “The Union of India must appreciate that by pursuing frivolous or infructuous cases, it is adding to the burden of this Court and collaterally harming other litigants by delaying hearing of their cases through the sheer volume of numbers. If the Union of India cares little for the justice delivery system, it should at least display some concern for litigants, many of whom have to spend a small fortune in litigating in the Supreme Court.”

The judgement quotes from a 2010 document titled, “National Litigation Policy” as part of a pompously-named “National Legal Mission to Reduce Average Pendency Time from 15 Years to 3 Years”. This document, made under the UPA government has been adopted by the current NDA government with a newer version in 2015, followed by an “Action Plan” formulated in 2017. One of the principles supposed to have been adopted is that the government would be an efficient and responsible litigant. One of the listed traits of an “efficient litigant” is that “bad cases are not needlessly persevered with” while a trait of a “responsible litigant” is “that litigation would not be resorted to for the sake of litigating”. Observing that that removal of unnecessary government cases would save valuable court time that could be spent in resolving other pending cases, the document notes that the “easy approach” of adopting the line of “let the court decide” must be eschewed.

The Supreme Court notes: “…under the garb of ease of doing business, the judiciary is being asked to reform. The boot is really on the other leg.” Having noted the Ease of Doing Business rankings (India ranks among the lowest in contract enforcement year after year, despite the gaming coupled with reform in other areas), the court has really touched upon a critical area. While government litigates blindly, regulatory agencies, that are mini-republics with the legislative, executive and judicial functions rolled up into one entity, are the worst. Regulatory agencies are themselves given the powers of the civil courts and they start the process of prosecuting and ruling all on their own. Often, the quasi-judicial rulings of regulators are upheld in appellate tribunals but many an order gets set aside. These are routinely appealed. Worse, even when earlier rulings are available, regulators persist with repeating their overruled rulings hoping that appeals to the higher courts (in most legislation, it is directly to the Supreme Court) would lead to different outcomes. Even when the court has not stayed the tribunal’s rulings, regulators continue to ignore appellate decisions. There are even cases where a newly appointed regulatory official wants to leave his mark and re-interprets decades-old jurisprudence, which despite failure in appeal, is further carried in appeal.

In the case at hand, the Supreme Court also noted that the government was blowing up money on 10 lawyers, including an Additional Solicitor General and a Senior Advocate, expending tax payers’ monies wastefully. This too is typical and par for the course with regulators. Engaging senior law officers of the government, and senior private lawyers with respectable names and standing, is the easiest way to project that the frivolous appeal has something unique on facts that would warrant ignoring earlier closed decisions, and overturn, at times, decades of jurisprudence. In the courts of many judges, appeals by regulators perceived to be “experts”, are admitted for the asking, while appeals by private litigants are put to a higher standard, often disposed of at the stage of admission — the wrong assumption being that regulators are more responsible in deciding what to appeal.

The apex court’s observations are a reminder of one serious facet of what ails the justice delivery system. Our regulators have to go beyond procedural reform and gaming of processes to improve rankings on Ease of Doing Business. Conducting a thorough 100-percent audit of all pending appeals filed by regulators to decide what ought to be withdrawn, would be a good way to start.

This column was published under the title Without Contempt in the editions of Business Standard dated May 24, 2018

Fugitive law can victimise the victim

By Somasekhar Sundaresan

The Presidential Ordinance on fugitive economic offenders is highly likely to be celebrated by the masses. Yet, its constitutional validity is suspect. It is yet another law that have the best intentions as its premise but can end up wreaking havoc on the innocent, who may well be victims of fugitives, but would pay the price for unintended consequences.

Here is how this law can cause grievous injury to the innocent. The most serious inroad into the rights of a person who may not be the fugitive but could well be the victim of the fugitive, is contained in the provisions on “disentitlement”. Under this provision, once an individual is declared to be a “fugitive economic offender”, any court in India may, at its discretion, disentitle any company from putting forward or defending any civil claim, if the individual authorised by the company to sue in its behalf, or any promoter of the company, or even any key managerial personnel or the company, or indeed any majority shareholder of the company has been declared a fugitive economic offender.

In other words, the company which would be injured because its promoter ran away, or indeed because its key managerial person ran away, could be the one facing the disentitlement from being able to pursue any civil claims. An example would make it good. Let’s say the managing director, or indeed, a promoter of a company is alleged to have committed a “scheduled offence” — these are offences listed in a schedule to this law — for which the person is issued a warrant and refuses to come back to India, civil courts could rule that no litigation for recovery of even legitimate dues owed to such a company cannot be pursued.

The principle underlying the concept of disentitlement is that one who does not subscribe to the rule of law in India may be denied the protections afforded by Indian law. However, this provision goes beyond the person rejecting the rule of law in India. It has the potential to cause serious injury to persons who may themselves be injured by the rejection of Indian law by the fugitive who has left the country. This would translate into a perverse incentive for law enforcers — grab the headlines and show stringency of action by hurting a company that is operating in India. This approach loses sight of the fact that those within reach are those who subscribe to Indian law and are seeking protection of the rule of law by filing legitimate claims. Likewise, it has no regard to the fact that the ransom of ill-treating those who are in India could have no coercive impact on the fugitive — her decision to turn fugitive would have already factored in the possibility of atrocities being heaped on the company she left behind.

The other perverse incentive endorsed by this law is that commercial counter-parties who have scant regard for the rule of law could start defaulting on their dues to a company whose promoter or key managerial personnel is declared a fugitive. Despite being a solvent company, the company the fugitive leaves behind would face a potential prohibition on the sovereign assurance that validly contracted promises given to the company must be enforced. Open doors, it is said, tempt even saints — once a company’s promoter or key managerial personnel is declared a fugitive, every person who has a contract with the company would be entitled to move applications before courts trying claims for enforcement by the company, asking for the discretion in the new law to be used to debar claims by the company.

To have any individual declared as a fugitive economic offender, an application has to be moved by the authorities asking the competent court to make the declaration that the person named in it is a fugitive. However, even while moving the application, the authority has the power to attach any property listed in the application, for 180 days. In other words, way before successfully getting a declaration that the person named is a fugitive, properties that may not even belong to the individual named, can be attached without any need for the attachment to be blessed by a court of law, so long as the property is identified in the application and the authorities have “reason to believe” that the property represents “proceeds of crime”.

Interestingly, the attachment would automatically run for 180 days without even a warrant. The non-fugitive person who owns the property would get just one week to file his say in the matter, which too would start after the attachment. Another provision in the law explicitly provides that the person other than the fugitive, whose property is so attached, would have to shoulder the burden of proving that the property was acquired without knowledge of it being proceeds of crime.

The term “proceeds of crime” is not just the fruits of criminal activity listed in the schedule to the law. It also includes “the value of such property” (meaning despite it being evident that the proceeds of crime were deployed elsewhere, anything equivalent in value may be chased and attached). Besides, “where such property is outside the country”, any other property “equivalent in value held within the country” would constitute “proceeds of crime”. Therefore, all one has to show is that the value of the benefits from “crime” is represented as part of the value of the property being attached regardless of whose hands the property resides in — it would be attached for 180 days, and it is for the owner of that property to show within a week that she did not have knowledge of such property being proceeds of crime.

Finally, what are the crimes listed in the schedule? Apart from the economic offences found in the Indian Penal Code, the provisions that would lead to a “scheduled offence” are generic provisions from company law where fraud is alleged, and inexplicably (following the footsteps of ill-advised amendments to the anti-money laundering law) even violations of takeover regulations. While offences such as insider trading and market manipulation are understandable members of the list of scheduled offences, listing violations of takeover regulations could simply mean that the state just gave itself a tool to come after businesses with a heavy hand if it so chooses.

This is not at all a comment about the colour of any political party in power. The listing of the takeover regulations as a scheduled offence in the law on money-laundering was done by the UPA government. The NDA government has now made it a scheduled offence under this law. In short, regardless of the party in power, you would do well to be careful and beware the long arm of the state.

This column was published under the title Without Contempt in the Business Standard editions dated May 10, 2018

The IBC requires more attention

Questions persist on the legal standard that insolvency professionals – particularly those who replace the authority of the boards of directors of insolvent companies – must follow
By Somasekhar Sundaresan

It is insolvency and bankruptcy season. Be it the first several pages of business newspapers or the cause lists of company law tribunals, the appellate tribunal and the Supreme Court benches hearing these matters, the Insolvency and Bankruptcy Code, 2016, is hogging the limelight.

Interpretation of the new law that is almost two years old is maturing with a slew of orders from the Supreme Court clarifying various nuances and steadily reducing the uncertainty over the multiple questions that adversarial litigation would obviously throw up. The season of attempts at resolution plans will eventually come to a close in a few months, and then the inevitable journey to liquidation will follow for those who have not been resolved.

It is time to take stock and review how the law has performed and what needs to be done to clean things up. The Insolvency and Bankruptcy Board of India (IBBI) has its task cut out in creating a professional class of insolvency professionals. Questions loom large on the legal standard that these professionals must follow, particularly those who replace the very authority of the boards of directors of insolvent companies. For example, the insolvency professional gets vested with the authority to run an insolvent company to the exclusion of the board of directors.However, when he runs the business (incidentally, no litigation against the company would lie since an insolvent would be protected by a moratorium that could last nine months), there is no clarity on the legal liabilities and obligations that need to be discharged. These need to be addressed — examples abound.

First, let’s say an insolvency professional is running a company that handles hazardous substance (like a Union Carbide), and a massive environmental tragedy takes place like it did in Bhopal in the 1980s. Would the defunct Board of Directors be liable or would the insolvency professional be liable? Would the provision of insurance coverage to such a company be covered by the mandatory continuance of essential utilities in the teeth of the moratorium that would prevent litigation to recover dues from the insolvent? These questions have no answers yet, and one seems to be waiting for judge-made laws to fill in the gaps.

Second, take the insolvency professional’s own approach to running an insolvent company pending exploration of a resolution process. What is her fiduciary duty to shareholders, creditors and stakeholders? Are decisions that are evidently negligent or reckless, or even worse, partisan, to be excused? Would a moratorium against the company afford protection to the resolution professional even if evidence of malpractice can be brought to bear? The degree of subjectivity in evaluation of resolution applicants continues to remain high. Some simple and evident resolutions of conflicts among resolution applicants such as conduct of a time-bound online auction that can be completed within hours, are not resorted to. The liability of resolution professionals in taking decisions remains an unaddressed area for the outcome. It is no solace to say that the IBBI can act against her punitively — it would be like saying a stock broker can cheat investors and the only recourse is for the capital market regulator to punish him.

Third, all laws are always drafted with a presumption of bonafides. There is an even bigger presumption of lenders’ actions being bonafide. Now, if that trust is belied, is there a fiduciary duty owed by the lenders to stakeholders, for their conduct to be judged? Committees of Creditors, the forum comprising the financial creditors can easily seek and obtain a rent for the position of power and decision-making they occupy. For example, in a technical insolvency (say a case of illiquidity rather than of insolvency), where literally no financial creditor takes a hair-cut on his entitlement to recover, would the resolution not take the form of an equity M&A transaction? Worldwide, bankers have not covered themselves in glory in the past 10 years, and the presumption of bonafides on their part, while vital, also requires checks and balances.

Fourth, the stigmatising of insolvency is the biggest threat to the long-term future of this law. It is one who is experienced with business failure that can work out solutions to deal with failure. By outlawing participation by anyone associated with any failure anywhere in the world, the new law has been struck a serious blow. The government’s intervention through a sweeping hasty and ill-conceived Presidential Ordinance late last year, passed into formal law without much debate early this year, stigmatising anyone with a history of business insolvency, is now the centre for a bulk of the litigation action. This column has written about it in the past and will therefore not repeat the arguments here. In an election year, getting this reversed may be a pipe dream, for politically, the tone in society has become too high-pitched for any politician to risk being seen as helping loan defaulters.

Finally, the infrastructure for the tribunals that handle these matters remains under strain. Members of the tribunals are working odd hours and are having to focus on the disposal of cases rather than on laying down quality jurisprudence. The only silver lining is that since the track of litigation is through the tribunal system and not the regular courts, the cases reach the Supreme Court much earlier than usual. Be that as it may, the system is creaking at the seams, and something has got to give that could threaten the very capacity of the state to deliver on the rule of law.

The central investigating agencies are licking their chops to get a slice of the action. The pressure to treat insolvency professionals as “public servants” is gradually mounting. If a purely private sector bank that is majority-owned by foreign shareholders can be made amenable to the jurisdiction of central investigating agencies, this front may present an easy battle for them to win. It is indeed time to contemplate on the next five years for this law, although it is only recently that a committee to amend the law has given its recommendations.

This was published in the Without Contempt column in the Business Standard edition dated April 26, 2018 

Crisis that will hurt bank resolution law

Without serious confidence building measures being taken, and articulated well to the common man, the environment appears ominous
By Somasekhar Sundaresan

It is a crisis of confidence — and that too in a sector that inspires the highest expectation of an intensity of promise by a regulated institution. What was in recent weeks a crisis involving the state of health of state-owned banks, is now threatening to spiral into an expanded crisis involving the state of affairs in private sector banks. With this environment, politically, one can kiss goodbye to the proposed law on resolution of failing banks.

The biggest part of the solution to a problem is to acknowledge there is one. Consider the symptoms:

  • The break-down of systems at Punjab National Bank that led to the discovery of the alleged Rs 110-billion scam involving issuance of guarantee-like instruments raised serious concerns about how vulnerable any bank could be;
  • The public spat between the Reserve Bank of India and the central government with each pointing fingers at the other about duality of control and the regulator not having teeth over appointments of key personnel in banks;
  • The absence of clarity of purpose for the Bank Boards Bureau and the publicly-evident communication breakdown between the bureau and the government, with speculation about whether the bureau would continue having any role at all;
  • The chief executives of ICICI Bank and Axis Bank, both in the private sector staying on the front-page news headlines for days on end – the first about an alleged conflict of interest and insinuated corruption and the other about alleged non-performance and absence of sanction for it; and
  • The growing allegations of abuse of powers by creditors in the resolution process under the newly-minted Insolvency and Bankruptcy Code – allegations range from approving related party contracts by resolution professionals, a lack of transparency in evaluation of resolution applicants, and monetising decision-making powers in selection of winners.

One of the fundamental assumptions across all laws is that banks conduct themselves with utmost honesty and good faith. This is why records kept by banks are given an on-the-face-of-it validity as “prima facie” evidence of facts. Bankers are second only to lawyers as keepers of clients’ confidence (with a lawyer, the relationship is privileged by law to allow for a sacred space of interaction to enable clients to avail of the protections under the law — that concept is itself being tested severely but should be the subject of a different edition of this column.

With banks’ ownership and governance being closely regulated, the intensity of promise held out by banks is of the highest order. A bank once formed, is next to impossible to wipe out. Legislation governing public sector banks prohibit proceedings by their promisees to wind them up. The government keeps infusing taxpayers’ funds into these banks to keep them afloat. The United Bank of India lived through years of uncertainty about its real core strength. A series of exemption orders are being passed by the Sebi, the capital market regulator, exempting the government from having to make an open offer to shareholders, when it infuses more funds into banks’ capital to shore them up — a luxury that is never accorded to other listed companies.

Private sector banks are like normal companies but are never wound up. Global Trust Bank was force-merged into Oriental Bank of Commerce. Centurion Bank was revived by RBI-supervised induction of private equity. Bank of Punjab and Lord Krishna Bank were merged into Centurion Bank in succession over the years, and this merged entity of stressed banks eventually merged into HDFC Bank. Times Bank, another struggling bank merged into HDFC Bank. To begin with, public sector banks came into existence only because private sector banks were nationalised, many of them amid concerns about them being run to ground.

In short, banks are special. Literally and for all practical purposes, a bank once formed, is indelible and cannot be obliterated. The man on the street trusts his savings with the banks on the foundation of this promise. A bank that becomes “systemically important” (substantially, determined by scale and size of its operations) would get covered by the proposed resolution law. Under this law, to “resolve” and save such an institution, the obligations of the banks can be altered and varied by law. The layman thinks that banks that are not covered by this law would protect his deposits, but once such a law is in, those not covered by such law may (at least theoretically) would not be considered to be “too big to fail”.

The proposed Financial Resolution and Deposit Insurance Bill is with a Parliamentary Committee for now. The environment in the banking sector is hardly conducive for this important and material reform to see the light of day. If banks are not seen living up to the honesty presumed of them (in India, bankers still carry a reputation despite the history of the United States and United Kingdom in the last decade) even the common man is bound to question how is savings are squandered on cronies of bankers and how he would lose out even more when a weak bank is resolved, or how money from the taxes paid by him would go back into the very same banks to keep them afloat. Without serious confidence building measures being taken, and articulated well to the common man, the environment appears ominous.

This column was published as Without Contempt in Business Standard editions dated April 12, 2018

All that is needed is political courage to clean up PSBs’ governance

It is important to take a close and hard look at how to clean up poor and ineffective governance of public sector banks

By Somasekhar Sundaresan

The last edition of this column spoke about the unaddressed vital reform of ownership of public sector banks that is holding back governance of these institutions to a body of law and an era that is out of sync with the legal regime that governs private sector banks. Meanwhile, a vibrant controversy has broken out with the Reserve Bank of India’s (RBI) governor and the Bank Boards Bureau chief publicly airing their views on the issue. The RBI governor’s lament about not having full powers to sack public sector bank boards does appear self-serving but does not deserve to be dismissed as wholly irrelevant.

Is fraudulent activity in any bank, public of private, a cause for introspection on what went wrong, and how it could have been prevented better by the regulator? Unconditionally, yes. Is the absence of power in the hands of the RBI to dismiss the Board of Directors the only reason for the fraud? No. Would the fraud not have occurred if the RBI had that power? Not at all — frauds could take place in private sector banks too despite the having the power to approve or sack the CEO.

Frauds can take place in any institution, regardless of how the institution is owned. However, how the institution is governed indeed has a role in whether it is prone to frauds. If frauds are rampant in public sector banks, despite bank employees being regarded as “public servants”, and despite government ownership resulting in stringent and draconian oversight of the central investigation and vigilance agencies, it would be reasonable to conclude that the model is indeed flawed, and needs to be fixed. Therefore, the biggest risk to a real systemic clean-up is a dismissal of any discussion on the need to reform ownership and governance of public sector banks, by branding the point as an excuse or justification of occurrence of fraud in these banks.

Therefore, what the governor says about dual oversight of public sector banks is correct. It would of course be self-serving to suggest that this naturally means the has no responsibility to bear, and that aspect would be incorrect. However, it is important to ensure that the duality of responsibility has to be cleaned up. As the saying goes — no man can serve two masters. In the collision of multiple truths, the clash of ideology in the approach to regulation, ownership and governance, can lead to losing sight of the important, overwhelmed by the immediate.The immediate often trumps the important, but it is really important to take a close and hard look at how to clean up poor and ineffective governance of public sector banks, and the approach of treating the board of directors as policemen instead of strategic overseers.

This government has many firsts to its credit in being resourceful with law-making — promulgating presidential ordinances to bring in substantive law; and effecting serious amendments to laws by embedding them in Money Bills (obviating the need to get the amendments cleared by the Rajya Sabha). The resourcefulness needs to be brought to bear with The pace with which new law on fugitives is being piloted ought to be repeated with cleaning up state ownership of and the attendant governance shortcomings.

At the least, a simple legislation to convert each of the public-sector banks into a public limited company governed by the newly-introduced (now nearly four years old) company law should be passed, which would bring each of these institutions under the more effective, uniform and standard norms of corporate governance that are applicable to private sector banks as well. Without this measure, simply building up a with an extremely ambiguous role — ranging from the problem to being the search-and-selection agency for staffing bank boards — would be of no consequence.

The next step would be to dilute state ownership in these banks to a minority holding. The vigilance and investigation oversight of these banks would need to end — they have failed to contain the scale of fraud on these banks, and worse, they have ended up terrorising honest bank officials into becoming indecisive, further hurting the interests of the bank. Bank officials involved in the credit appraisal and sanctioning function are known to trip before they rise up the ranks with their career records being spoilt by vigilance and corruption cases, leading to a vacuum in the leadership and a lack of available bandwidth for senior management.

The implicit sovereign guarantee underlying every public-sector bank is borne out by each of the banks being recapitalised with sovereign money. The capital market regulator is again issuing a series of exemption orders exempting the government from having to make an open offer under the takeover regulations upon infusing more funds into these banks, whose shares are listed on stock exchanges. Resolution of weak banks and spreading the commercial pain of bank failure across its depositors is a political hot potato only because of this implicit guarantee. Therefore, sovereign funding of these banks through new capital could come the next time with strings attached — the legislative changes discussed above. Since it would involve state funding, they would in fact be Money Bills. All that is needed now is political courage.

This column was published in Business Standard under the title Without Contempt in editions dated March 22, 2018

Don’t waste the bank scam crisis

Think out of the box and bring in serious changes in the governance of public sector banks

By Somasekhar Sundaresan 

It is a welcome crisis: scams are tumbling out of the closet at banks. That a crisis is welcome may sound very odd. They allegedly involve several billions of depositors’ money, and indeed taxpayers money (since it is the state that has kept pumping money into public sector banks). Yet, crises are welcome for they are the harbingers of long-term reform measures — whatever the colour of the political parties in power. Four years ago, when one government was on the verge of going away and another was poised to take charge, a committee set up by the Reserve Bank of India under the chairmanship of Dr P J Nayak, submitted its report. The Committee made very specific recommendations for long-term reform incorporate governance in the banking sector, with particular regard to addressing the ominously-growing spectre of non-performing assets in banks. (Disclosure: the author was a member of this committee.)

The report documented the breakdown in the governance of  This was attributed to these banks being governed by outdated legislation that nationalised them — outdated because new company law that governs all companies has marched light years ahead of what had been thought about in the 1960s and later when banks were nationalised. The report empirically pointed out how the deep micro-management by their shareholder (government of India) rendered governance not just ineffectual but also wasteful, with the attention of the board of directors mandatorily being spent on issues that the government insisted the boards of directors must discuss, ignoring the real need for what needed the boards’ immediate attention. Of course, how the boards of directors must be populated was also picked on, and the need for professional search and selection was underlined.

The report called for a phased reduction of government stake to minority ownership. A key recommendation was to first hold the entire government stake in in a wholly-owned holding company owned by the government and to over time dilute government stake in the holding company to a minority. Meanwhile, a Bank Boards Bureau, an agency that was possible to set up within the scope of existing legislation, to search and select who may staff the boards of directors of banks, was recommended. The Bank Boards Bureau would be the precursor to what would be the board of directors of the holding company.
The report was part of what was discussed in the very first meeting between the then Reserve Bank of India governor and the new Prime Minister. The reception to the recommendations was warm. Great expectations were built up about how a new government with a new mandate would be able to take some critical long-term decisions. “Gyan sangams” were held and an “Indradhanush” (a seven-point programme) was born. A Bank Boards Bureau was formed, chaired by Vinod Rai, the go-to guy for all matters of reform, him having been the propriety auditor of all government functioning as the Comptroller and Auditor General of India. The mandate and role of the Bureau was nowhere near what the Nayak Committee Report envisaged —its role was envisaged as a panacea of all that is evil with banking.

There was no sign of reducing government stake in banks. The government moved in the opposite direction — one of the seven points of Indradhanush was to infuse ~700 billion of fresh money into  There was no sign of setting up a holding company. Media reports talked of setting up one holding company for every public sector bank — a clear indication that someone somewhere had decided to kill the idea. There had been a lot of hope that was riding on the fact that under the earlier National Democratic Alliance (NDA) government before the two terms of the United Progressive Alliance (UPA), a Bill had been tabled in Parliament to bring government stake in down to 33 per cent (that Bill lapsed) but all that hope was simply dashed.

Today, we have one banking scam after another coming out of the closet in rapid succession. In less than two months, the new year has already turned into an annus horribilis for the state-owned segment of the banking sector. There can be no better time than now to initiate bold measures of reform. The utterly non-impactful nature of the labyrinthine architecture of micro-management by government in its role as a shareholder of has been exposed. Greater dosage of an expired medicine can never turn into a cure of a long-standing ailment.

It is time to think out of the box and bring in serious changes in governance of  The holding company model needs immediate execution. Dilution of government stake to minority by infusion of private equity funds into banks will ensure a disciplined and tyrannical turnaround of these banks — a case study of how the Centurion Bank was turned around with this route is readily available in recent banking history. It is time to embrace the fact that we must not let this crisis of scams go waste.

 

This column was published as Without Contempt in the March 8, 2018 editions of Business Standard