How governance can serve as fire alarm

Weak boards that fail to ask the right questions, related-party transactions that slip through unchecked, or risk committees that exist only in name are just some examples of governance failure that can have a lasting impact on the financial soundness of an institution.

When governance weakens, trust erodes long before the numbers show stress. This is exemplified by the trust deficit that the financial services ecosystem has experienced over the past two decades. Once confidence in an institution is shaken, liquidity crises get exacerbated and show up as solvency crises, forcing the regulators to step in.

Shapers of governance

The architecture of governance in Indian finance is not uniform—it is shaped by the mandates of the regulators.

The Reserve Bank of India (RBI) focuses on prudential soundness and systemic stability. Its interventions, from capping the tenure and compensation of bank CEOs to mandating independent compliance functions, aim to prevent the build-up of risks within institutions.

The Securities and Exchange Board of India (SEBI) works to uphold transparency and market integrity. Its reforms around independent directors, related-party transactions, and ESG (environmental, social and governance) disclosures reflect an attempt to build investor confidence while making boards more accountable.

The Insurance Regulatory and Development Authority of India (IRDAI) balances consumer protection with solvency. Its push for stronger risk committees and policyholder-centric disclosures reflects the need for insurers to be governed not only as financial institutions but also as custodians of public trust.

Together, they signal that governance is not optional but central to trust and resilience. Which is why it must be treated as a leading precursor of financial health. This principle is reflected in measures such as:

The RBI’s emphasis on chief compliance officers, board accountability, and a culture of risk awareness;

The RBI’s directive that compliance heads should report directly to the board, reinforcing the paramount importance of governance, undiluted by operational pressures;

The scale-based regulatory framework explicitly linking governance obligations to systemic importance in the case of non-banking financial companies (NBFCs)—larger entities carry a greater responsibility, as governance failures at scale can transmit shocks across the financial system;
SEBI’s tightening of related-party norms and scrutiny of disclosures, demonstrating a shift towards pre-emptive governance in the capital markets. Investors, both domestic and global, read these measures as signals of India’s commitment to credibility and trustworthiness as a deep market.

While the regulators continue to define and focus on governance, the responsibility for driving the principles into action rests with the board of directors of the institutions. The board’s responsibility is not the easiest, fulfilling its oversight role without getting into the execution responsibilities. The board should constantly be on the lookout for culture degradation within the organisation and act promptly when it smells a fire.

Policy priorities

Policies should mandate governance as a forward-looking measure for stability. The important components include:

• Tracking board independence, audit quality and risk oversight, alongside financial ratios, as part of early warning systems;
• Converging governance reporting across banks, NBFCs and insurers to enable fair comparison and assessment of contagion risks within the financial services ecosystem;
• Assessing board responses to shocks such as cyber breaches, ESG gaps, group defaults, and risk failures;
• Treating weak oversight with the same severity as weak capital buffers.

Ultimately, governance can serve as an effective leading indicator only if a symbiotic relationship exists between regulators and regulated entities. A collaborative and consultative approach will go a long way in helping achieve this objective.

This article first appeared in The Hindu Businessline on 10 November 2025.

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