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After HDFC: Should RBI review the ownership rules for private banks?

Updated: Oct 4, 2018

India Inc and financial markets woke up to some unexpected news on Tuesday morning. HDFCNSE Chairman Deepak Parekh, the doyen of Indian financial services industry and a well-respected institution builder, barely scraped through in a vote to appoint him as director on the board of the company founded by his uncle, HT Parekh, nearly four decades ago. Nearly a quarter of HDFC shareholders voted against his appointment and only a slight change in voting intentions would have been enough for Mr Parekh to be voted out of the board. In the end, that did not happen and Mr Parekh continues to be chairman of HDFC Ltd. HDFC shares fell on Tuesday, but a major upheaval was averted in India’s biggest mortgage lender and the single-largest shareholder in India’s most valuable bank.

But the episode raises some uncomfortable questions about the role of foreign proxy advisory firms, the processes they follow and their relationship with many FIIs who either on their own or collectively own significant stakes in Indian companies. Given the fact that a chunk of FIIs almost came close to voting out a successful industry veteran, it is also probably a good time to examine whether the ownership rules relating to private banks need to be changed or tweaked in the absence of a large promoter and the possibility that a bunch of small shareholders can unite to cause big changes in board composition or block management plans.

But first, let us recap what happened. One or more foreign proxy advisory firms had told their clients before Monday’s shareholders meet to vote against the resolution to reappoint certain directors including Mr Parekh. One such firm is ISS Proxy Analysis and Benchmark Policy Voting Recommendations. It told its clients that Mr Parekh is on the board of eight public companies and raised concerns about whether he will be able to discharge his fiduciary duties. Some other agencies are also believed to have made similar recommendations.

Now, this may sound a little strange in India, but some foreign institutional clients blindly follow the recommendations of such advisory companies. This also happens because voting is often done by a custodian who acts on behalf of many clients. What seems to have happened in the HDFC case is that some offshore funds followed the advice of such firms and voted against Mr Parekh.

The logic of too many directorships is valid, but whether this should apply to Mr Parekh in the case of HDFC, which has been built largely by him, is an entirely different point. If the problem with Mr Parekh is too many directorships, couldn’t he have been asked to resign posts in other firms which may not need his services? Mr Parekh can well do without being director in companies such as Siemens, GlaxoSmithKline Pharma and DP World. These companies can hire someone else equally capable, but HDFC may still need the services of Mr Parekh given the role he has played in building the firm. Why did the proxy advisory firms and funds focus only on his HDFC role and not on his role in other companies? Why could they not have urged him to quit other directorships and focus on HDFC if workload is an issue?

We may never know the answers to these questions, but it gives us some idea of the rigid, impractical approach adopted by some foreign funds and advisory firms. Western models of governance and rules of the number of directorships are fine, but they cannot be implemented across the world in an unthinking, rigid manner. It is a bit like asking Jamie Dimon to quit JP Morgan because he has other directorships or responsibilities in government bodies.

Having said that, another important point needs to be made. Some foreign funds have been complaining for years about the age problem in the HDFC board and the absence of succession planning. They have pointed out that the average age of the HDFC board is very high and there is a need to bring in younger people. They have also complained that Mr Parekh and the board have not given any thought to succession planning. These are valid criticisms and HDFC and Mr Parekh should bear quite a bit of blame for this. Mr Parekh has now started talking about succession planning, but this should have been done years ago.

Shareholder activism does not have a successful track record in India. A few years ago, many domestic mutual funds were angry with Maruti for allowing Suzuki to set up the Gujarat plant in a 100% subsidiary. But nothing came out of it and Maruti ended up having its way. India Inc, regulators, the government and the investing public at large need to be prepared for a new world in which such activism will increase. The role of proxy advisory firms, both foreign and local, will become more important. In the light of Monday’s HDFC vote, it may probably be a good time for RBI re-examine whether we need such onerous ownership rules for Indian private sector banks. An entrepreneur, promoter puts in a tremendous amount of work in building a bank to a certain size, but ends up losing control as RBI forces him to cut his stake down to 10%.

The RBI’s intentions may be noble, but the need for such a drastic reduction in a promoter’s equity should be examined again. Why should this be 10% and not 20 or 25%, a level which helps a promoter establish a measure of control? Such wide public distribution rules may give the impression of fairness but actually ends up creating a situation where a group of shareholders, small and big, could team up to disrupt plans or force unwanted board changes. Such rules may end up putting too much powerin the hands of a small minority when the need of the hour is not aggressive activism but clear-headed, smart thinking and execution. A bank’s CEO or MD cannot be changed without RBI’s approval, but a small recalcitrant minority can play spoilsport in other areas. A promoter, either directly or indirectly, needs to establish some control to implement his or her ideas and vision and that’s missing when it comes to some of India’s biggest wealth creators, private banks and financial companies.



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