Whether it is a review of ownership structure or the governance structure of banks, it’s clear RBI does them soon to quell the many concerns that have risen in India’s banking industry

Early this month, shares of Bandhan Bank Ltd fell 20% after the Reserve Bank of India (RBI) barred it from opening new branches without its approval, besides freezing the salary of its chief executive officer. The central bank’s strictures were in response to Bandhan Bank’s failure to meeting its ownership norms. RBI’s rules require the bank to bring the promoter holding down to 40%, which is roughly half of where it currently stands.

Not long ago, Kotak Mahindra Bank Ltd, too, found itself in a bind after trying to meet ownership norms by selling non-convertible preference shares, instead of diluting the promoter’s equity stake using traditional methods. RBI, however, communicated later that the preference share issue will not count for its promoter stake dilution requirements.

These run-ins with the central bank have again brought to the fore the question of ownership norms in Indian banks. Indeed, it is high time there is a review of the policy on bank ownership. But an equally important discussion that is needed is on governance norms, especially so in light of the severe mismanagement that has come to light at a number of banks.

For one, the current policy view that widely held banks are better-placed than promoter-led banks is in serious question. ICICI Bank Ltd and Axis Bank Ltd are widely held, but are in a mess. In contrast, Kotak Bank is held up as an example to show that promoters with enough skin-in-the-game ensure their banks are well run.

J.R. Varma of Indian Institute of Management, Ahmedabad, (IIMA) has blogged that low ownership caps have entrenched incumbent managements at banks and stock exchanges, and ensured they are immune to shareholder discipline. The caps also remove the threat of a hostile takeover, which is one of the best ways to get good governance, he told this newspaper in August. As such, incompetent incumbent managers are tolerated for unduly long periods of time, until the regulator decides to step in and remove them.

Indeed, if and when the government opens up to the idea of privatizing banks, buyer interest will be limited unless the regulator allows ownership of a sizeable stake by a strategic investor.

There is some academic literature that suggests that ownership concentration results in better management of capital and liquidity at banks, although most studies in this regard may not be relevant to the Indian context.

Talking of the Indian context, a parallel is found in the exchange industry, where Financial Technologies (India) Ltd, the erstwhile promoter of Multi Commodity Exchange of India Ltd (MCX), was forced to sell its stake after the Forward Markets Commission said it was not fit and proper to run exchanges.

Apart from the skin-in-the-game argument, those who bat in favour of higher ownership caps say that promoters will work in the best interest of the institution because of reputation concerns. This certainly didn’t keep MCX’s erstwhile promoters in check. But, on the other hand, within the exchange industry, the problems at widely held National Stock Exchange of India Ltd show that low ownership caps alone are not the answer for good governance either.

In this backdrop, reviewing the ownership structure of banks is no panacea and, indeed, will not help unless it’s preceded by reforms in the governance structure of banks. The board of directors of banks facing charges of mismanagement were clearly found wanting. With no signs of any serious consequences for any of them, it’s not clear how RBI plans to address this elephant in the room. Venkatesh Panchapagesan, associate professor of finance, IIM-Bangalore, says that building the board capability of banks is an imperative, and should precede all other strategic measures the regulator may take to strengthen the banking industry.

And if RBI’s plan for good governance primarily involves intervening directly, such as it has done with leadership changes at Axis Bank Ltd and Yes Bank Ltd, it had better have a framework that helps it do so at a stage when the damage is minimal. Of course, this should be the last resort. But whether it is a review of ownership structure or the governance structure of banks, it’s clear that RBI does them soon to quell the many concerns that have risen in India’s banking industry. A weakened banking industry eventually results in a weakened economy. To ignore the call for a review of its rules will be reckless.