Specialist in Indian Banking and Economic Research

Hemindra Hazari

Is a Securities & Exchange Board of India (SEBI) registered research analyst with over 25 years experience in the Indian capital markets with a specialization in banking and economy research and has managerial experience of establishing profitable equities business, leading and mentoring analysts.  He has worked with prominent foreign and domestic capital market firms such as UBS, Societe Generale, HSBC, ASK Raymond James  and Karvy Stock  Broking and is a regular guest on business media channels and is respected for his non-consensus view on stocks and the market.

RBI Paper on Corporate Governance: Can the Regulator Outsource Its Duties to the Bank Boards?

RBI Abides by Latest Guidelines from Kotak Mahindra Bank, Extends CEO’s Tenure to 20 Years

RBI’s IWG Recommends Foxes Be Put in Charge of Chicken Coops: Cites Foxes’ Experience & Expertise

Battle Lines Drawn As BABA Builds Out First/Last-Mile Capacity; But Who Will Fund 75+ Bn CNY CapEx?

Thematic (Sector/Industry)

On January 7, 2021 the Reserve Bank of India (RBI) <a href="https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12011&amp;Mode=0" target="_blank" rel="noopener">issued</a> instructions to commercial banks to safeguard the independence and competence of the internal audit function, and laid down norms for the functioning of the department and the appointment of the head of internal audit. While it is a positive development that the RBI has laid down a policy which banks have to follow for this vital function, a critical omission, as compared with the proposal in its own discussion paper on <a href="https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=19613" target="_blank" rel="noopener">governance</a>, was that the head of internal audit needed to be one level below executive directors or the Chief Executive Officer (CEO).As the heads of business verticals are normally executive directors or one level below executive directors, it is imperative that the heads of control functions such as risk, audit, compliance and vigilance are at the same seniority, or even senior to the business heads. This was specifically mentioned in RBI’s discussion paper on governance, but for some inexplicable reason it was omitted in this important circular.In all formal, hierarchical organisations, staff grades play a vital role in commanding respect and authority. When a control-head is a rank lower than the business head vertical which has to be monitored, the former is inherently in a disadvantageous position and can be rendered ineffective in that role. This is despite the control head reporting to the sub-committee of the board or reporting to the CEO or executive director, but with the reviewing authority being the Board. The reason is that the sub-committees of the board that deal with control functions are staffed with independent directors who are mandated to meet at least once a quarter, while the control heads are meeting their business heads far more regularly, and hence, when the business head is senior, that individual can exert his authority over the control head. In addition, it is always a healthy practice for staff, especially seniors, to be rotated between business and control functions, so that they get the necessary exposure to both sides of the business. When the control head is junior to the business head, there remains a possibility that in the future the former maybe posted to a business vertical where the business head is the individual’s boss, and hence the control head would be reluctant to go against a business head if he was junior to him.In all organisations where the chain of command is hierarchical, it is necessary that control function heads are always at par and preferably senior to business vertical heads, so that the desired control functions can be effectively implemented. In banks, which deal with unsecured public funds and are highly leveraged, it was imperative for the RBI to have formalised such an arrangement. Having control heads report to sub-committees of the board may on paper assure the control function of independence, but it needs to be made more effective in practice by having control heads to be, at the minimum, the same seniority as the business heads.

On January 7, 2021 the Reserve Bank of India (RBI) issued instructions to commercial banks to safeguard the independence and competence of the internal audit function, and laid down norms for the functioning of the department and the appointment of the head of internal audit. While it is a positive development that the RBI has laid down a policy which banks have to follow for this vital function, a critical omission, as compared with the proposal in its own discussion paper on governance, was that the head of internal audit needed to be one level below executive directors or the Chief Executive Officer (CEO).As the heads of business verticals are normally executive directors or one level below executive directors, it is imperative that the heads of control functions such as risk, audit, compliance and vigilance are at the same seniority, or even senior to the business heads. This was specifically mentioned in RBI’s discussion paper on governance, but for some inexplicable reason it was omitted in this important circular.In all formal, hierarchical organisations, staff grades play a vital role in commanding respect and authority. When a control-head is a rank lower than the business head vertical which has to be monitored, the former is inherently in a disadvantageous position and can be rendered ineffective in that role. This is despite the control head reporting to the sub-committee of the board or reporting to the CEO or executive director, but with the reviewing authority being the Board. The reason is that the sub-committees of the board that deal with control functions are staffed with independent directors who are mandated to meet at least once a quarter, while the control heads are meeting their business heads far more regularly, and hence, when the business head is senior, that individual can exert his authority over the control head. In addition, it is always a healthy practice for staff, especially seniors, to be rotated between business and control functions, so that they get the necessary exposure to both sides of the business. When the control head is junior to the business head, there remains a possibility that in the future the former maybe posted to a business vertical where the business head is the individual’s boss, and hence the control head would be reluctant to go against a business head if he was junior to him.In all organisations where the chain of command is hierarchical, it is necessary that control function heads are always at par and preferably senior to business vertical heads, so that the desired control functions can be effectively implemented. In banks, which deal with unsecured public funds and are highly leveraged, it was imperative for the RBI to have formalised such an arrangement. Having control heads report to sub-committees of the board may on paper assure the control function of independence, but it needs to be made more effective in practice by having control heads to be, at the minimum, the same seniority as the business heads.

Why Did the RBI Drop Its Own Proposal Safeguarding the Independence of the Internal Audit in Banks?