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An Insider's Perspective on Matters Financial

by D N Ghosh; Oxford University Press, New Delhi, 2007

An Insider’s Perspective on Matters Financial

T T Ram Mohan

hen it comes to the financial sector and corporate governance, D N Ghosh has seen it all. He has been with the finance ministry, he was chairman of the State Bank of India, he is now chairman of ICRA and he has sat on several boards. This book is a collection of essays written over time, but it also includes some written especially for the volume. The author addresses a wide range of issues related to the four themes under which the essays have been grouped: globalisation, the character of global finance, the Indian financial sector and corporate governance. A great deal of what he says is unexceptionable and indeed part of the consensual wisdom.

Areas of Disagreement

Perhaps it is best that I begin with the ideas with which I find myself disagreeing most with the author. These are in the two essays related to Indian banking in the section on the financial sector, “Adjusting to Globalisation”. At least one of them, ‘Governance Culture and Adaptive Efficiency’ seems to have been overtaken by events. The author identifies the two priority areas in banking as changing the legal structure for debt recovery and changing the governance paradigm in public sector banks (PSBs).

It appears that the essay was penned before the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 came into being. The author’s observation that Asset Reconstruction Funds (ARF) ought to be the principal means for addressing bad debts, which reflects the thinking in the 1990s, sounds somewhat jaded in the light of experience.

Banks realised that transferring their debts to such funds would mean taking huge hits in their profit and loss accounts. They found it more prudent to go after bad debts themselves – and ended up doing a

Economic & Political Weekly january 12, 2008

book review

Governance and Accountability: Essays on the Indian Financial and Corporate Sectors

by D N Ghosh; Oxford University Press, New Delhi, 2007; pp viii + 257, Rs 595.

great job. The improving economic environment in the last four or five years has also done wonders for banks’ bad debts. With other areas of opportunity crying out for attention and with their balance sheets having been strengthened, banks now find it expedient to go through the ARF route. So, yes, ARF is an idea whose time has come, but this was not true when it was propounded. In this respect, as in many others, the reformers’ enthusiasm for a particular reform has turned out to be somewhat premature. In any case, the tackling of bad debts is no longer the terri fying issue it seemed at the advent of reforms.

Let me turn now to the question of govern ance. Everybody “knows” what is right for public sector enterprises – they need to be given more autonomy, decisions must be left to boards manned by professionals with impeccable credentials and the government must be largely a passive investor. Ghosh makes this point forcefully himself. I am not at all sure.

Institutional Activism

We know from the literature on governance and also from our experience with corporations in recent years that boards are effective where there are dominant institutional investors. It is unwise to count on professionals brought in by management to discharge the monitoring function. To say “leave it to the board” to decide matters means little because, more often than not, boards are willing instruments in the hands of management. This is especially so in a context where independent members of the board can earn huge sums as commission and stock options.

We do not yet have a culture of institutional activism in India. If we were to leave matters to the boards on ONGC, BHEL and SBI, we will, in effect, be investing professional managers with huge authority with

out commensurate checks and balances. If professionals in a public sector company mess up, it is the political authority that will be ultimately responsible. This is a risk that no government can take, least of all in the financial sector.

In the present scheme of things, it is the government as dominant owner that alone can fulfil the monitoring function through its nominees and through the concerned ministry itself. That is why insulating boards of PSBs from bureaucratic and political interference must remain a pipedream and indeed that is why, despite decades of pontification from commentators, the ground reality remains unchanged.

It is far better to accept government monitoring – the expression is preferable to “interference” – as a given and to ask how this can be made consistent with the performance of PSBs. We have some experience in how to do so because we had some positive results in the post-reform period. Diluting government ownership and bringing in institutional and retail investors through listing makes a world of difference. So does better regulation and imposition of prudential norms.

Competition a Spur

Competition itself acts as a spur to performance as employees, a constituency that Ghosh views with some disfavour, themselves realise that salvation lies in doing a better job. Balancing purely political appointees with professionals is also useful – perhaps the regulator can lay down in even more stringent terms a desirable composition of bank boards. These are more practical lines on which we can proceed in terms of improving governance at PSBs. No point in chasing the chimera of government withdrawal from bank boards.

The important thing is not to be fixated on notions about the various interest groups in a PSE necessarily coming in the way of better performance. Ghosh refers to the “fiasco” at


UTI arising from the configuration of interest groups. It was clear, following the problems at UTI, that systems and processes needed to be improved and this did happen.

But, in retrospect, did we indeed have a “fiasco” at UTI? The tilt towards equities, especially public sector equities, that came in the way of UTI meeting dividend expectations has since yielded handsome gains to the unit to which these holdings were moved. We need a fresh evaluation of the investment decisions taken at UTI before the crisis erupted. I would reckon that the judgment would not be unfavourable.

Consolidation No Answer

The challenge of PSBs getting ready to meet greater competition, especially foreign competition, remains. Ghosh’s prescription, apart from greater autonomy for bank boards, is consolidation amongst PSBs. I have serious reservations about this proposal because, among other things, it will complicate the human resource development (HRD) problem in banks which, in my view, is the biggest challenge for PSBs.

Ghosh cites my paper on the subject and here I do not wish to add to what I have said therein. What is required is a serious dialogue amongst government, bank management and unions on how exactly the HRD challenges are to be addressed. The scope for improving efficiency on the existing base is so large that it makes little sense to argue that banks need to consolidate in order to improve efficiency. I would say: get your acts together first in your present situation. There is room for consolidation among cooperative banks, old private sector banks and, perhaps, some PSBs. But, in general, talk of consolidation among PSBs is an irritating distraction at this point.

National Champions

Which brings me to a somewhat related piece in the collection, one on national champions, which figures in the section on globalisation. After weighing the familiar arguments creating national champions (it will breed protectionism, it may be used to prop up state enter prises or existing private businesses, etc), Ghosh sees a role for national champions in three sectors: the financial sector, small enterprises and infrastructure finance.

In the financial sector, Ghosh thinks national champions are needed as a bulwark against various vulnerabilities to which an economy is exposed through its financial sector. But he does not spell out these requirements in concrete terms. We may need domestic mutual funds to act as a stabilising force in the face of potential unstable foreign institutional investment (FII) flows. What would be the argument in the banking sector? One would be the difficulty in regulating foreign banks, especially given the small size of their Indian operations in relation to their global operations. There could be other arguments but the case needs to be made rigorously.

It is not clear why we require national champions amongst small enterprises. Ghosh talks about employment generation and inclusive growth, but this is the old argument of small enterprises per se, it does not translate into an argument for national champions in this sector.

Ghosh laments the demise of the develop ment financial institutions (DFIs) – these could have developed into national champions, he contends. This contention is also a little difficult to swallow. In the deregulated environment, DFIs had ceased to be viable propositions and they could have been sustained only through subsidies in one form or another. Moreover, infrastructure finance, it could be argued, could be better provided through a developed debt market and this is where we should have focused more. Lastly, much of infrastructure development must be driven by state investment and it not clear that financing by DFIs could have made possible the scale of infrastructure investment that we are now talking about.

Financial Celebrities

This is not the only place where Ghosh highlights an issue without providing an appropriate response himself. In another essay, “Financial Celebrities and Regulatory Vigilance”, Ghosh holds forth on how Mammon has come to be enthroned in the financial world. He mentions George Soros as an example of the sort of power and wealth that financial celebrities have come to command. He also mentions in the same breath, Parmalat, the Italian company, that collapsed due to fraud although Parmalat does not belong to the financial sector.

If the suggestion is that powerful per sonalities at the helm of financial organisations are a regulatory threat, that is not quite borne out by recent experience. It is hard to argue, for instance, that Warren Buffet is threat of any sort. It is, perhaps, truer to say that financial organisations are more threatened by lesser minions or by industry practices that turn out, with the benefit of hindsight, to be questionable in many ways – sub-prime lending and securitisation would be a case in point. Ghosh’s remedy for the problem of financial celebrities, greater regulatory vigilance, is not something one can quarrel with but the problem is that celebrities are precisely the ones that regulators are loath to confront. Ghosh does tend to allow his moral indignation to get the better of himself at times.

Whether regulators can stay ahead of rogue operators in the commercial world is an issue that Ghosh again addresses in the section on corporate governance. He takes us through the Enron disaster. Ghosh notes that this was a case, not just of regulatory failure, but also of corporate governance. So, how do we address lax corporate governance? Ghosh’s checklist of “dos and don’ts” is quite unexceptionable. Management must accept that the board has a role to play. Boards must be empowered to access the relevant information. Independent board members must be suitably educated. The posts of chairman and CEO must be split. And so on. These are now part of the accepted lore, so to speak, of corporate governance.

Challenge of Practice

The difficulty arises, as always, when it comes to practice. Independent directors, chosen by management (or promoters) and handsomely compensated through fees, commission and stock options, cannot be expected to exercise necessary independence. Ghosh rightly points out that it is only nominees of financial institutions who can serve as a counterbalancing force, but this proposition has simply not be entertained by the corporate world. The reality, as most people would acknowledge, is that the corporate world has embraced the forms of corporate governance but the substance remains elusive.

Ghosh writes with sincerity and conviction. He does raise all the right questions. But one may not always agree with his answers.


january 12, 2008 Economic & Political Weekly

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