The Fundamentals of Corporate Governance

This article, based on a discussion at Egon Zehnder’s Director Development Program, explores the changing landscape of corporate governance for board directors of India’s top public sector banks, insurance companies and financial institutions. The panelist, O. P. Bhatt, former Chairman of SBI, in a conversation facilitated by Namrita Jhangiani, Partner at Egon Zehnder, outlined his thoughts on what makes an effective board director, and how that role has evolved as new technologies, responsibilities, and world events shape companies’ relationship to their shareholders and the wider stakeholder community.

O. P. Bhatt emphasized the importance of the composition and dynamics of the board: "Those who comprise the board, where they come from, what is their moral compass, what is their value system, what is the ethical system that they espouse, what kind of team they make, whether they can work collaboratively, whether they can together look forward and discuss, argue, fight, but come to some consensus. This is what is important in any decision making."

Noting that decision-making is rarely done by single individuals but by groups, he added: "When you have to make a decision in a group where there are a large number of people, and when those decisions are going to be impactful and powerful, it is important that the decision-making process is such that it generates more and more ideas rather than more and more heat."

Bhatt outlined three primary duties for board members:

1. Duty of care: "How involved you are in your role, how you define this new role, what do you think that this new role entails, and what is it that you think that you have to do to be able to do justice to this role?"
2. Duty of candor: Emphasizing the importance of transparency and openness in board discussions, Bhatt stated, "You have to have this ability to be completely transparent, completely open in the interest of the board, in the interest of decision making, in the interest of the company." He noted that candor is crucial when facing issues like fraud, technology challenges, or economic pressures, and that board members must speak up even if it means opposing management or other board members.
3. Duty of loyalty: Stressing that board members must prioritize the interests of the company above all else, Bhatt explained, "Your supreme loyalty, your paramount loyalty when you sit around that board table is to the company whose board you are serving. It is not to the chair, it is not to the CEO, it is not to your fellow colleagues, it's not to any other power outside the board, be it the government or the regulator, whatever it is. It is complete loyalty to the company." This duty requires board members to be free of conflicts of interest and to make decisions that are in the best interest of the company, even if it means setting aside personal or external loyalties.

Understanding and managing technological risks is crucial, according to Bhatt: "There are many banks who have a multiplicity of vendors, dozens of them, 30, 40, 50 vendors. For some small thing there is one vendor, for some other things there are other vendors."

He emphasized the need for thorough audits and understanding of IT systems: "You have to get yourself educated on these things by the bank that you're serving to understand how good they are."

Highlighting the critical role of cybersecurity, Bhatt noted: "Most banks have a fairly reasonable insurance against that in terms of whatever they do to have a firewall around their systems. But now what is increasingly happening is that there are ways of hacking the system, not in the normal way but there are some AI-enabled methods that can bypass all these things and just go inside and take out data."

Additionally, he stressed the necessity for directors to be proactive in their roles, continuously educating themselves and ensuring they uphold the core principles of corporate governance to effectively lead their organizations. Bhatt also mentioned the importance of minimizing the footprint of IT service providers and ensuring robust controls are in place to mitigate risks.

Corporate responsibility plays a critical role, especially for financial institutions. Bhatt stated, "Businesses are a force for good. Every individual in society cannot survive without the services provided by hundreds or thousands of businesses."

He highlighted the concept of conscious capitalism, where stakeholders extend beyond shareholders to include the entire community: "There is an increasing awareness towards society, saying that your stakeholder is not merely the shareholder, but the definition of the stakeholder has expanded to comprise the entire universe."

In India, corporate social responsibility (CSR) is mandated by law, requiring companies to allocate 2% of their profits to CSR activities. Bhatt pointed out that some institutions spend on CSR in ways that indirectly benefit their own interests. He urged directors to ensure that CSR efforts are genuinely aimed at serving society: "Directors need to exercise their minds to see that CSR is done for the right causes, in the right way, and serves the society outside the institution."

Communication and leading by example are essential to instill culture throughout an organization. Bhatt stated, "It's conversation, a series of conversations, one-to-one, one to many, many to many. It's a series of guided conversations with a purpose, with openness to a transfer of thoughts."

He also highlighted the significance of setting an example: "For example, on Monday morning there was zero pendency. There was not a single paper, no file, nothing pending with me. This set a standard for others to follow."

Leaders must be aware of their influence: "When you're in an important role, like a board member or a leader, CEO, whatever you do is being watched by millions of people. People are learning from it, learning to like and emulate you, or learning to hate and distrust you."

Bhatt discussed the unique challenges faced by public sector banks, especially when implementing government schemes that may not be profitable. He explained, "State Bank of India was formed in 1955 through an Act of Parliament to outreach to rural India. This is embedded in the policy, sanctioned by both the Reserve Bank of India and the government."

He acknowledged the difficulties but also the progress made: "There has been tremendous progress over time, all the public sector banks including the private sector banks, and cost-effectiveness technology has come to help in a very big way."

Continuous education for directors and the value of external inputs are crucial. Bhatt noted, "Standard Chartered Bank was very good in this regard. In India, it is sporadic, some do it, some don't."

He emphasized the need for domain knowledge and the role of external experts. "External experts can add more value during strategy meetings, providing insights on economy, technology, future trends, or geopolitics."

Awareness of competition is essential for board members. Bhatt stated, "Hundred percent they should look at the competition. They should know what is happening around them. Their eyes and ears should be wide open."

Understanding competition is crucial for strategic planning: "You should know so much about the competition, then you should be able to educate the CEO and the other senior officials."

Bhatt outlined three key opportunities for board members to challenge management constructively:

1. Strategy sessions: "When the company executives say that this is a strategy for the next three years or five years, that is one place where you can put all these thoughts and questions."
2. Budget discussions: "The next place where you can agree, disagree, or contribute in a similar fashion but more focused would be around the budget discussion."
3. Performance reviews: "In some companies, the directors get to review the performance every month. There is a lot of information available at that time."

Maintaining a relationship with regulators is important. Bhatt shared, "The idea is to hear from the regulator what are the pain points of your institution."

Informal conversations with regulators can provide valuable insights: "Some small nugget of information can come which could be disturbing, which could be important, which you can use when you go back to the institution."

When it comes to compliance, balancing it with strategic planning is necessary, Bhatt highlighted. “There is no institution anywhere in the world which doesn't have to be compliant to something or the other,” he explained, adding: “Compliance is very important because if you're not compliant, not only are you violating the law of the land, you are also giving a bad name to the institution.”