The State Bank took another step on 28th December, 2016 to streamline the functioning of financial institutions by revising the definition of their independent directors and raising their minimum number from 25 percent to 33 percent with effect from 31st March, 2018. The definition of an independent director has been revised in order to ensure that he or she is not connected or does not have any other relationship, whether pecuniary or otherwise, with a bank or a DFI, its associated companies, subsidiaries, holding company or directors. The test of independence would principally emanate from the fact whether such a person can reasonably be perceived as being able to exercise independent business judgement without being subservient to any form of conflict of interest. A lot of qualifications have been prescribed for the person to be eligible as an independent director. These include the provisions that he or she was not an employee/external auditor/consultant/legal advisor of the bank/DFI within the last three years, had no material business relationship within a bank or a DFI either directly or indirectly within the last three years, had not received any remuneration, etc, from a bank or a DFI in the last three years, was not a close relative of a bank's or a DFI's promoters and had not served on the board for more than three consecutive terms. According to the circular, the banks/DFIs were advised to ensure that one-third of their board of directors comprise of independent directors in line with the revised instructions by the stipulated date. However, existing independent directors may continue till March 31, 2018 or by the expiry of their terms whichever is earlier. Besides, a separate meeting of independent directors of a bank or a DFI has been suggested at least one in a year.

It is quite clear that the new rules about independent directors have been prescribed against a certain background and with a special purpose. It is the responsibility of every central bank to strengthen the good governance regime in the banking industry through continuously revising its regulatory instructions to cope with the domestic challenges and stay abreast with best international practices. The confidence of the central bankers and the banking community was, however, shaken in the aftermath of 2006-2008 global financial crisis which witnessed a number of heads rolling and a number of institutions closing. One could attribute a number of reasons to the unfolding financial crises but a closer relationship between the banks' directors and their mutual pecuniary interests was certainly one of causes of the problem. In an effort to ward off the possibility of a repeat of this unfortunate experience, most of the countries have since revised their regulatory instructions focusing on the enhanced role of independent directors. Coming back to Pakistan, the global financial crisis did not hit the financial sector of the country in a very negative way due to a lack of banks' exposure to derivative products and mortgaging financing. Also, most of the banks rely mostly on investment in gild-edged, risk-free securities for earning their incomes. Nonetheless, it was the responsibility of the SBP to ensure stability and the soundness of the banking industry for all times to come by providing adequate guidance and prescribing a stringent regulatory regime. As such, it has been considered necessary to issue instructions to banks and DFIs accordingly. The new instructions are of course aimed at checking the possibility of any collusion and have more independent views on the running of a financial institution. Proffering of fresh ideas to strengthen the institutions could be another possibility. Also, independent members would be more inclined to reduce the profit rates of equity holders and raise the deposit rates which would be in the long-term interest of the country. SBP needs to walk a tight line and strike a delicate balance by separating the management and board of directors. It has so far failed to achieve this objective because of a nuanced relationship between powerful directors and the government of the day. Rules and regulations should be for everyone, fair and non-challengeable. We also appreciate the revised definition of an independent director which is more explicit, exhaustive and stringent and could help rule out the possibility of appointing 'yes men' or close associates on banks' boards who could always be persuaded to nod their heads in agreement. However, while the new circular of the SBP has been issued with a very noble objective, it could be plausibly argued that a mere increase of 8 percent in the number of independent directors may not be enough to effect the desired difference in the management of financial institutions.

Copyright Business Recorder, 2017