Last Monday, April 28, IndusInd Bank Ltd’s deputy chief executive officer resigned. A day later, its managing director and CEO followed suit, “owning moral responsibility” for “various acts of omission/commission”. The bank’s chief financial officer had resigned in January
This spate of resignations at the top was triggered by discrepancies in the accounting of derivative transactions. The deputy CEO was heading the bank’s global market division of which derivatives portfolio is a part.
Investigations are on to ascertain the impact on the bank’s balance sheet.
In a separate incident, an inspection by the Reserve Bank of India (RBI) in February uncovered a massive fraud: Misappropriation of Rs 122 crore from the cash reserves of New India Co-operative Bank. A former general manager had allegedly siphoned off the money between 2019 and 2025, with help from a few accomplices. He confessed to stealing cash from the bank’s vault.
Ahead of that, in November 2024, during a routine inspection, housing finance regulator, National Housing Bank, discovered discrepancies in Aviom India Housing Finance Ltd’s mutual fund investments, indicating inflated cash balances. A forensic audit revealed a significant accounting fraud.
RBI Governor Sanjay Malhotra says such incidents should be viewed as “episodes” that can occur in a financial system, which has a large number of players. Deputy Governor Swaminathan J says the RBI never wastes a crisis. Whenever such failures happen, it takes risk-mitigation measures and directs the boards to ensure proper forensic and accountability studies to identify who is accountable, and “actions will play out”.
Accounting mismatches and outright fraud are the two dominant trends that run through these three incidents. They also raise multiple questions on internal control, quality of audit and supervision, the selection process, the RBI approval of a bank CEO’s appointment, and the role of senior management as well as the board when it comes to governance.
The search for IndusInd Bank’s CEO is on. The nomination and remuneration committee of a bank’s board, of which the chairman is a member, selects the CEO with the help of an external head-hunting agency. The agency steps in when internal candidates are not found suitable or the RBI wants someone from outside.
Unless there are strong reasons for not continuing with the incumbent CEO, which is the case at IndusInd, the board prefers continuity. Normally, the board trusts the CEO to not do anything wrong. There could be an error of judgment, but typically they refuse to see malafide intentions behind decisions that go wrong.
Under the Banking Regulation Act, RBI’s “prior” approval is a must for a CEO’s appointment and reappointment. The central bank can seek the CEO’s removal as well. Apart from solvency, the Act does not specify what qualities a CEO should possess, but it does point out disqualifying characteristics.
When the list of prospective candidates reaches the RBI, the regulator’s primary focus is on compliance, not competence. Since the board has cleared the names, the RBI doesn’t get into the relative merit of the candidates. If recommendation No 1 is “fit and proper”, the regulator clears the candidate’s name even though he or she might be inferior to No 2 or No 3 in professional competence.
That’s in normal circumstances. There are, of course, instances where the regulator has chosen No 2, or even rejected the list altogether and opted for someone outside of it. The position of a bank’s chairman is critical. The person could be the promoter’s stooge or a fiercely independent professional. There are instances of a non-executive chairman being more involved in the bank’s running than an executive chairman, creating problems for the CEO.
There is no ceiling on the size of a bank’s board, but at least 50 per cent of its members have to be independent directors. For private banks, the RBI has laid down norms for the selection of directors based on their qualification, expertise, record, and integrity. At least 51 per cent of them need to have specialised knowledge in areas of accountancy, agriculture and rural economy, banking, cooperation, economics, finance, law and small-scale industry, and so on.
The board plays a critical role in the running of a bank, but the buck stops at the MD and CEO. Section 10B of the Banking Regulation Act makes it clear that the management of a private bank’s affairs is “entrusted”’ to an MD, who exercises her powers, “subject to the superintendence, control and direction of the board of directors”.
Section 36ACA of the Banking Regulation Act empowers the RBI to supersede a bank’s board of directors – “in public interest or for preventing the affairs of any banking company being conducted in a manner detrimental to the interest of the depositors”. But this is only for a period not exceeding six months. The supersession of the board can be extended up to a year.
In the not-so-distant past, episodes involving the ICICI Bank Ltd and Yes Bank Ltd shed light on the role of the board of banks, the CEO, corporate governance, and also the regulator’s inability in keeping a tab on what’s happening in a bank.
There are many ways to restore the perceived erosion of governance standards in Indian banks, both private and public. One such option could be appointing governance officers. Their task is very different from that of ethics officers, which some Indian companies, including banks, have started appointing. But then, a bank’s company secretary is, to a large extent, its governance officer. Are they doing their job properly?
In June 2020, the RBI released a discussion paper on governance in commercial banks. The objective was to align the current regulatory framework with global best practices while keeping in mind the context of the domestic financial system. In April 2021, it issued a circular revision provisions related to many things, including appointment of chairman, tenure of directors, consititution of various committees, among others.
Returning to the RBI’s role in detecting accounting deviations or other anomalies, let’s accept that inspection is not an audit. Theoretically, every bank has three lines of defence to protect the balance sheet: Internal control, risk management, and audit. All three have failed in the IndusInd Bank episode. The responsibility must be shared among the CEO, management, the board, and the auditors.
We can keep referring to American energy company Enron Corporation, which went bankrupt in 2001, and say frauds can happen anywhere, but it’s time the RBI changed the focus of inspection. Till the last decade, inspecting the quality of assets topped its priority list; now, the focus should shift to different layers of governance, including compliance and quality of board.
It’s also time to take a fresh look at laws related to financial crime. There have been many instances of fraud and mismanagement – more since the early 1990s, when the sector opened up. Many senior bankers have been arrested and faced trials, but how many of them were convicted?
Finally, does the resignation of senior bankers taking moral responsibility draw the curtains on such episodes?
Imagine a situation: A speeding car hits a passerby, injuring her seriously. The owner – we don’t know whether he was driving the car or sitting in the front seat with the seatbelt on – goes home, enjoys a hearty lunch, and an afternoon nap.
In the evening, when TV channels flash the news of the passerby’s death, the conscience-pricked owner leaves his coffee unfinished, walks up to the nearest police station and takes moral responsibility.
Why didn’t he do so immediately after the accident? If he wasn’t driving, why did he allow the driver to cross the speed limit?
Only exemplary action by the RBI can prevent such episodes in the future. Swaminathan has promised that “actions will play out”. Let’s wait and watch.
PS: Last week’s column dealt with the state of affairs in health insurance, and I promised to take a close look at Irdai’s “Insurance for All” mission this week. The latest development in the banking sector forced me to change the subject. Wait for next week please.
This column first appeared in Business Standard. The writer, a Consulting Editor of Business Standard, is a Senior Adviser of Jana Small Finance Bank.
Writes Banker’s Trust every Monday in Business Standard.
Latest book Roller Coaster: An Affair with Banking
Twitter: TamalBandyo
Website: https://bankerstrust.in
