The announcement of the creation of a specialised Bank Boards Bureau (BBB) in the recent Indian Union budget is likely to have a positive effect on corporate governance at state-owned Indian banks, says Fitch Ratings.

However, this move, alongside various other smaller policy changes over the past year, have been limited in scope, lacking in detail and other significant governance reforms requiring legislation remain to be passed. As such, it remains uncertain as to what extent the current reform drive will catalyse meaningful change in bank governance over the long term.

Government has taken steps to improve management at public sector banks since the publication of a Reserve Bank of India (RBI) committee report reviewing and making recommendations on bank board governance standards in May 2014. New leadership appointments at four public sector banks in December 2014 adopted the recommendation to split the roles of the chairman and managing director. In another first for India, a further five public banks have opened their recruitment process for managing director and chairman to candidates from the private sector.

The announcement of the BBB in the latest budget is complementary to these changes in the appointment process of senior leadership at public sector banks. The establishment of the BBB could speed up the appointment process, which has remained very slow despite the recent changes. This has left several public banks without managerial oversight for extended periods of time.

Fitch maintains that there continues to be a high degree of uncertainty over whether more substantive reforms will be passed. Reducing and changing the structure of state ownership of public sector banks, repealing legislation which enacts public banks as statutory bodies, and creating a uniform bank licensing regime for all banks irrespective of ownership, were all part of the original RBI recommendations in May 2014. However, these also face potentially significant political hurdles to passage.

Ultimately, the RBI's recommendations directly target the reduction of government influence in the management of public sector banks. That said, government is likely to continue to exert considerable influence on state-owned banks over the near term unless more substantive reforms are put in place.

High levels of government influence at public sector banks have been a key factor in directing lending for development and social objectives. Public banks account for the bulk of stressed assets, and are facing significant capital shortfalls over the next several years as a result.