Description
100 marks banking project
Corporate governance in banks
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CHAPTER 1: INTRODUCTION OF CORPORATE
GOVERNANCE IN BANKS.
1.1-INTRODUCTION:
Corporate governance is the set of processes, customs, policies, laws and
institutions affecting the way a corporation is directed, administered or
controlled. Corporate governance also includes the relationships among the
many stakeholders involved and the goals for which the corporation is
governed. The principal stakeholders are the shareholders, management and
the board of directors. Other stakeholders include employees, suppliers,
customers, banks and other lenders, regulators, the environment and the
community at large.
Corporate governance is a multi-faceted subject. An important part of
corporate governance deals with accountability, fiduciary duty, disclosure to
shareholders and others, and mechanism of auditing and control. In this
sense, corporate governance players should comply with codes to the overall
good of all constituents. Another important focus is economic efficiency,
both within the corporations (such as the best practice guidelines) as well as
externally (national institution frameworks). In this “economic” view, the
corporate governance system should be designed in such a way as to
optimize results, as well as to detect and prevent frauds. Some argue that the
firm should act not only in the interest of shareholders but also of all the
stakeholders.
Governance makes decisions that define expectations, grant power, or verify
performance. It consists either of a separate process or of a specific part of
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the management or leadership processes. Sometimes people setup a
government to administer these processes and systems. In the case of a
business or a non-profit organization, governance develops and manages
consistent, cohesive policies, processes and decision-rights for a given area
of responsibility. For example, managing at a corporate level might involve
evolvic policies on privacy, on internal investment, and on the use of data.
Corporate governance includes the processes through which corporations
objectives are set and pursued in the context of the social, regulatory and
market environment. Governance mechanisms include monitoring the
actions, policies and decisions of corporations and their agents. Corporate
governance practices are affected by attempts to align the interests of
stakeholders.
Interest in the corporate governance practices of modern corporations,
particularly in relation to accountability, increased following the high-profile
collapses of a number of large corporations during 2001–2002, most of
which involved accounting fraud; and then again after the recent financial
crisis in 2008. Corporate scandals of various forms have maintained public
and political interest in the regulation of corporate governance.
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Word- origin:
The word Governance derives from the Latin origins that suggest the notion
of “steering”. One can contrast this sense of “steering” a group or society
with the traditional “Top-Down” approach of governments “driving”
society. Distinguish between governance’s “power to” and governments
“power over”.
1.2-Definition:
Corporate governance has also been more narrowly defined as "a system of
law and sound approaches by which corporations are directed and controlled
focusing on the internal and external corporate structures with the intention
of monitoring the actions of management and directors and thereby,
mitigating agency risks which may stem from the misdeeds of corporate
officers."
One source defines corporate governance as"the set of conditions that shapes
the ex post bargaining over the quasi-rents generated by a firm." The firm
itself is modelled as a governance structure acting through the mechanisms
of contract. Here corporate governance may include its relation to corporate
finance.
According to the Cadbury Committee (UK) “Corporate Governance is a
system by which companies are directed and controlled.”
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The Confederation of Indian Industry (CII) has defined Corporate
Governance as “Laws, procedures, practices and implicit rules that
determine a company’s ability to take managerial decisions vis-à-vis its
claimants in particular its shareholders, creditors, the state and employees.”
The OECD Principles of Corporate Governance states:
"Corporate governance involves a set of relationships between a company’s
management, its board, its shareholders and other stakeholders. Corporate
governance also provides the structure through which the objectives of the
company are set, and the means of attaining those objectives and monitoring
performance are determined."
Good governance should provide proper incentives for the board
management to pursue objectives that are in the interest of the company and
shareholders and should facilitate effective monitoring thereby encouraging
firms to use resources efficiently.
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Who is involved in corporate governance
The Tripod
Three entities: Management, the Board of Director, Shareholders play an
important role to ensure good corporate governance. They need to
understand their roles properly and act in harmony with each other.
Corporate governance tripod
Management Board of directors
Shareholders
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? The management: The CEO is responsible for actually running
the business. He/She has to ensure integrity if the fiscal and
managerial controls to maintain a high level of trust of both
employees and public.
? The Board of Directors: The directors should be accountable to
shareholders and responsible for managing successful and productive
relationships with the corporation’s stakeholders. The directors of the
board are required to act in what they believe to be in the best interests
of the company, regardless of specific view expressed by individual
(even controlling) shareholders.
? The shareholders: They own the company and they require timely
information about performance and results. The shareholders should
also be informed about the rights, rules and procedures governing
them and enabling them to participate effectively.
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1.3-MODELS OF CORPORATE GOVERNANCE
Different models of corporate governance differ according to the variety of
capitalism in which they are embedded. The Anglo-American "model" tends
to emphasize the interests of shareholders. The coordinated or
Multistakeholder model associated with Continental Europe and Japan also
recognizes the interests of workers, managers, suppliers, customers, and the
community. A related distinction is between market-orientated and network-
orientated models of corporate governance.
1) Continental Europe
Some continental European countries, including Germany and the
Netherlands, require a two-tiered Board of Directors as a means of
improving corporate governance. In the two-tiered board, the Executive
Board, made up of company executives, generally runs day-to-day
operations while the supervisory board, made up entirely of non-executive
directors who represent shareholders and employees, hires and fires the
members of the executive board, determines their compensation, and
reviews major business decisions.
2) India
The Securities Exchange Board of India Committee on Corporate
Governance defines corporate governance as the "acceptance by
management of the inalienable rights of shareholders as the true owners of
the corporation and of their own role as trustees on behalf of the
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shareholders. It is about commitment to values, about ethical business
conduct and about making a distinction between personal & corporate funds
in the management of a company."
3) United States, United Kingdom
The so-called "Anglo-American model" of corporate governance emphasizes
the interests of shareholders. It relies on a single-tiered Board of Directors
that is normally dominated by non-executive directors elected by
shareholders. Because of this, it is also known as "the unitary system".
Within this system, many boards include some executives from the company
(who are ex officio members of the board). Non-executive directors are
expected to outnumber executive directors and hold key posts, including
audit and compensation committees. In the United Kingdom, the CEO
generally does not also serve as Chairman of the Board, whereas in the US
having the dual role is the norm, despite major misgivings regarding the
impact on corporate governance.
In the United States, corporations are directly governed by state laws, while
the exchange (offering and trading) of securities in corporations (including
shares) is governed by federal legislation. Many US states have adopted the
Model Business Corporation Act, but the dominant state law for publicly
traded corporations is Delaware, which continues to be the place of
incorporation for the majority of publicly traded corporations. Individual
rules for corporations are based upon the corporate charter and, less
authoritatively, the corporate bylaws.
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1.4-PRINCIPLES
Principle 1: Responsibilities of the Board.
The board has overall responsibility for the bank, including approving and
overseeing the implementation of the bank’s strategic objectives, governance
framework and corporate culture. The board is also responsible for providing
oversight of senior management. The members of the board should exercise
their “duty of care” and “duty of loyalty” to the bank under applicable
national laws and supervisory standards. This includes actively engaging in
the major matters of the bank and keeping up with material changes in the
bank’s business and the external environment as well as acting in a timely
manner to protect the long-term interests of the bank.
Principle 2: Board qualifications and composition.
Board members should be and remain qualified, individually and
collectively, for their positions. They should understand their oversight and
corporate governance role and be able to exercise sound, objective judgment
about the affairs of the bank. The board must be suitable to carry out its
responsibilities and have a composition that facilitates effective oversight.
For that purpose, the board should be comprised of a sufficient number of
independent directors.
The board should be comprised of individuals with a balance of skills,
diversity and expertise, who collectively possess the necessary qualifications
commensurate with the size, complexity and risk profile of the bank.
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Principle 3: Board’s own structure and qualification.
The board should define appropriate governance structures and practices for
its own work, and put in place the means for such practices to be followed
and periodically reviewed for ongoing effectiveness. The board should
structure itself in terms of leadership, size and the use of committees so as to
effectively carry out its oversight role and other responsibilities. This
includes ensuring that the board has the time and means to cover all
necessary subjects in sufficient depth and have a robust discussion of issues.
The board should maintain appropriate records (e.g. meeting minutes or
summaries of matters reviewed, recommendations made and decisions
taken) of its deliberations and decisions.
Principle 4: Senior management.
Under the direction and oversight of the board, senior management should
carry out and manage the bank’s activities in a manner consistent with the
business strategy, risk appetite, incentive compensation and other policies
approved by the board. Senior management consists of a core group of
individuals who are responsible and accountable to the board for effectively
overseeing the day-to-day management of the bank. The organization and
procedures and decision-making of senior management should be clear and
transparent and designed to promote effective management of the bank.
This includes clarity on the role and authority of the various positions within
senior management, including the CEO. Members of senior management
should have the necessary experience, competencies and integrity to manage
the businesses and people under their supervision.
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Principle 5: Compliance.
The bank’s board of directors is responsible for overseeing the management
of the bank’s compliance risk. The board should approve the bank’s
compliance approach and policies, including the establishment of a
permanent compliance function. An independent compliance function is a
key component of the bank’s second line of defense. This function is
responsible, among other things, for promoting and monitoring that the bank
operates with integrity and in compliance with applicable, laws, regulations
and internal policies. Compliance starts at the top. It will be most effective in
a corporate culture that emphasizes standards of honesty and integrity and in
which the board of directors and senior management lead by example.
Principle 6: Internal Audit.
The internal audit function provides independent assurance to the board and
supports board and senior management in promoting an effective
governance process and the long-term soundness of the bank. The internal
audit function should have a clear mandate, be accountable to the board, be
independent of the audited activities and have sufficient standing, skills,
resources and authority within the bank. The board and senior management
should recognize and acknowledge that an independent and qualified
internal audit function is vital to an effective governance process.
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Principle 7: Disclosure and transparency.
The governance of the bank should be adequately transparent to its
shareholders, depositors, other relevant stakeholders and market participants.
Transparency is consistent with sound and effective corporate governance.
As emphasized in existing Committee guidance on bank transparency, it is
difficult for shareholders, depositors, other relevant stakeholders and market
participants to effectively monitor and properly hold the board and senior
management accountable when there is insufficient transparency. The
objective of transparency in the area of corporate governance is therefore to
provide these parties with the information necessary to enable them to assess
the effectiveness of the board and senior management in governing the bank.
Principle 8: Risk identification, monitoring and controlling.
Risks should be identified, monitored and controlled on an ongoing bank-
wide and individual entity basis. The sophistication of the bank’s risk
management and internal control infrastructure should keep pace with
changes to the bank’s risk profile, to the external risk landscape and in
industry practice. The bank’s risk governance framework should include
policies, supported by appropriate control procedures and processes,
designed to ensure that the bank’s risk identification, aggregation, mitigation
and monitoring capabilities are commensurate with the bank’s size,
complexity and risk profile. Risk identification should encompass all
material risks to the bank, on- and off-balance sheet and on a group-wide,
portfolio-wise and business-line level.
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Principle 9: The role of supervisors.
Supervisors should provide guidance for and supervise corporate governance
at banks, including through comprehensive evaluations and regular
interaction with boards and senior management, should require improvement
and remedial action as necessary, and should share information on corporate
governance with other supervisors. The board and senior management are
primarily responsible for the governance of the bank, and shareholders and
supervisors should hold them accountable for this. This section sets forth
several principles that can assist supervisors in assessing corporate
governance and fostering good corporate governance in banks. Supervisors
should have processes in place to fully evaluate a bank’s corporate
governance.
1.5-Internal corporate governance controls.
Internal corporate governance controls monitor activities and then take
corrective action to accomplish organizational goals. Examples include:
1) Monitoring by the board of directors:
The board of directors, with its legal authority to hire, fire and compensate
top management, safeguards invested capital. Regular board meetings allow
potential problems to be identified, discussed and avoided. Whilst non-
executive directors are thought to be more independent, they may not always
result in more effective corporate governance and may not increase
performance. Different board structures are optimal for different firms.
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Moreover, the ability of the board to monitor the firm's executives is a
function of its access to information. Executive directors possess superior
knowledge of the decision-making process and therefore evaluate top
management on the basis of the quality of its decisions that lead to financial
performance outcomes, ex ante. It could be argued, therefore, that executive
directors look beyond the financial criteria.
2) Internal control procedures and internal auditors:
Internal control procedures are policies implemented by an entity's board of
directors, audit committee, management, and other personnel to provide
reasonable assurance of the entity achieving its objectives related to reliable
financial reporting, operating efficiency, and compliance with laws and
regulations. Internal auditors are personnel within an organization who test
the design and implementation of the entity's internal control procedures and
the reliability of its financial reporting.
3) Balance of power:
The simplest balance of power is very common; require that the President be
a different person from the Treasurer. This application of separation of
power is further developed in companies where separate divisions check and
balance each other's actions. One group may propose company-wide
administrative changes, another group review and can veto the changes, and
a third group check that the interests of people (customers, shareholders,
employees) outside the three groups are being met.
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4) Remuneration:
Performance-based remuneration is designed to relate some proportion of
salary to individual performance. It may be in the form of cash or non-cash
payments such as shares and share options, superannuation or other benefits.
Such incentive schemes, however, are reactive in the sense that they provide
no mechanism for preventing mistakes or opportunistic behavior, and can
elicit myopic behavior.
5) Monitoring by large shareholders and/or monitoring by banks and
other large creditors:
Given their large investment in the firm, these stakeholders have the
incentives, combined with the right degree of control and power, to monitor
the management.
1.6-External Corporate Governance Controls.
External stakeholders play an important role in ensuring proper corporate
governance processes in a business organization. Some of the key external
corporate governance controls include:
1) Government regulations.
Government regulations are the most effective external controls on the
governance of a company. Companies are required to comply with these or
face penalties for violations. Most corporate governance regulatory
requirements are based on the OECD Principles of Corporate Governance.
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2) Media exposure.
Media scrutiny of the workings and processes of a company ensures, to a
certain degree, the proper governance in an organization. Whistleblowers
often expose wrongdoing within a company to the government and media
organizations.
3) Market competition.
Companies with the best corporate governance practices have the best
standing in the market. Reputation, credibility and positive public perception
all play a vital role in boosting a company’s image and thus help it trump its
competition and best its peers.
3) Takeover activities.
Takeover activities lay a company’s internal processes and workings open to
public scrutiny. Both government regulators and the media will focus on the
internal policies and governance structures, thus acting as an effective
external control.
4) Public release and assessment of financial statements.
The public release of financial statements by listed companies exposes them
open to assessment or scrutiny by regulators, investors, members of the
public and so on. This acts as an external control as companies have to be
scrupulous and careful about the details included in these statements and in
ensuring that they are properly prepared and audited.
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1.7-Need for corporate governance.
Banks constitute the largest financial intermediaries around the world and
possess stupendous powers of leverage. Unlike in the corporate world,
authorities like RBI and the government play a direct role in bank
governance through bank regulation and supervision. This role is justified by
the need to ensure systemic stability, financial stability and deposit insurance
liability considerations.
Banks enjoy the benefit of high leverage with the downside protection of
deposit insurance which weakens their incentives for strong management
monitoring. While a ubiquitous form of corporate control and concentrated
ownership will raise new barriers to effective corporate governance, large
investors may manipulate the firm contrary to the broad interests of the bank
and other stakeholders.
Large shareholders may arrange loans for firms they own or business
transactions to profit themselves at the expense of the bank and thereby shift
the bank to higher risk activities in which they benefit on the upside, but the
bank bears the brunt of failure. Who controls management? Boards or bank
supervisors? Regulatory and supervisory systems that foster more accurate
information disclosure and empower private investors legal rights
substantially boost banking system and profitability.
The current trends lay stronger emphasis on risk measurement and
management. Bank supervision should help shareholders. Supervisors must
make the boards the main locus of accountability and assess board
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effectiveness. Banks are important stakeholders of corporations. Their
actions can affect corporate performance both positively and negatively.
Their influence as lenders should complement effective shareholder
monitoring.
Although information asymmetries plague all sectors, this problem is more
difficult in finance. In product or other service markets, purchasers part with
their money in exchange for something new. In finance, money is exchanged
for a ‘promise to pay’ in the future. Also, in many products or service
markets, if the object sold - from a car to a haircut - is defective, the buyers
often find out relatively soon.
However, loan quality is not readily observable for quite some time and can
be hidden for extensive periods.Banks and non-bank financial intermediaries
can also alter the risk composition of their assets more quickly than most
non-financial industries. Moreover, banks can readily hide problems by
extending loans to clients that cannot service previous debt obligations.
1) Changing Ownership Structure:
In recent years, the ownership structure of companies has changed a lot.
Public financial institutions, mutual funds, etc. are the single largest
shareholder in most of the large companies. So, they have effective control
on the management of the companies. They force the management to use
corporate governance. That is, they put pressure on the management to
become more efficient, transparent, accountable, etc.
They also ask the management to make consumer-friendly policies, to
protect all social groups and to protect the environment. So, the changing
ownership structure has resulted in corporate governance.
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2) Importance of Social Responsibility:
Today, social responsibility is given a lot of importance. The Board of
Directors has to protect the rights of the customers, employees, shareholders,
suppliers, local communities, etc. This is possible only if they use corporate
governance.
3) Growing Number of Scams:
In recent years, many scams, frauds and corrupt practices have taken place.
Misuse and misappropriation of public money are happening everyday in
India and worldwide. It is happening in the stock market, banks, financial
institutions, companies and government offices. In order to avoid these
scams and financial irregularities, many companies have started corporate
governance.
4) Indifference on the part of Shareholders:
In general, shareholders are inactive in the management of their companies.
They only attend the Annual general meeting. Postal ballot is still absent in
India. Proxies are not allowed to speak in the meetings. Shareholders
associations are not strong. Therefore, directors misuse their power for their
own benefits. So, there is a need for corporate governance to protect all the
stakeholders of the company.
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5) Globalization:
Today most big companies are selling their goods in the global market. So,
they have to attract foreign investor and foreign customers. They also have
to follow foreign rules and regulations. All this requires corporate
governance. Without Corporate governance, it is impossible to enter, survive
and succeed the global market.
6) Takeovers and Mergers:
Today, there are many takeovers and mergers in the business world.
Corporate governance is required to protect the interest of all the parties
during takeovers and mergers.
7) SEBI:
SEBI has made corporate governance compulsory for certain companies.
This is done to protect the interest of the investors and other stakeholders.
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1.8-OBJECTIVES OF CORPORATE GOVERNANCE.
Poor corporate governance may contribute to bank failures, which can pose
significant public costs and consequences due to their potential impact on
any applicable deposit insurance systems and the possibility of broader
macroeconomic implications such as contagion risk and impact on payment
systems. In addition, poor corporate governance can lead markets to lose
confidence in the ability of a bank to properly manage its assets and
liabilities, including deposits, which could turn, trigger a bank run air
liquidity crisis. Generally, banks occupy a delicate position in the economic
equation of any country such that its performance invariably affects the
economy of the country.
? Objectives of corporate governance are to establishing strategic
objectives and a set of corporate values that are communicated
throughout the banking organization;
? Setting and enforcing clear lines of responsibility and accountability
throughout the organization;
? Ensuring that board members are qualified for their positions, have a
clear understanding of their role in corporate governance and are not
subject to undue influence from management or outside concerns;
? And ensuring that compensation approaches are consistent with the
bank's ethical values, objectives, strategy and control environment.
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CHAPTER 2-HISTORY OF CORPORATE
GOVERNANCE.
Robert E. Wright argues in Corporation Nation that the governance of early
U.S. corporations, of which there were over 20,000 by the Civil War, was
superior to that of corporations in the late 19th and early 20th centuries
because early corporations were run like "republics" replete with numerous
"checks and balances" against fraud and usurpation of power of managers or
large shareholders.
In the 20th century in the immediate aftermath of the Wall Street Crash of
1929 legal scholars such as Adolf Augustus Berle, Edwin Dodd, and
Gardiner C. Means pondered on the changing role of the modern corporation
in society. From the Chicago school of economics, Ronald Coase introduced
the notion of transaction costs into the understanding of why firms are
founded and how they continue to behave.
US expansion after World War II through the emergence of multinational
corporations saw the establishment of the managerial class. Studying and
writing about the new class were several Harvard Business School
management professors: Myles Mace (entrepreneurship), Alfred D.
Chandler, Jr. (business history), Jay Lorsch (organizational behavior) and
Elizabeth MacIver (organizational behavior). According to Lorsch and
MacIver "many large corporations have dominant control over business
affairs without sufficient accountability or monitoring by their board of
directors."
In the 1980s, Eugene Fama and Michael Jensen established the principal–
agent problem as a way of understanding corporate governance: the firm is
seen as a series of contracts.
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Over the past three decades, corporate directors’ duties in the U.S. have
expanded beyond their traditional legal responsibility of duty of loyalty to
the corporation and its shareholders.
In the first half of the 1990s, the issue of corporate governance in the U.S.
received considerable press attention due to the wave of CEO dismissals
(e.g.: IBM, Kodak, Honeywell) by their boards. The California Public
Employees' Retirement System (CalPERS) led a wave of institutional
shareholder activism (something only very rarely seen before), as a way of
ensuring that corporate value would not be destroyed by the now
traditionally cozy relationships between the CEO and the board of directors
(e.g., by the unrestrained issuance of stock options, not infrequently back
dated).
In the early 2000s, the massive bankruptcies (and criminal malfeasance) of
Enron and WorldCom, as well as lesser corporate scandals, such as Adelphia
Communications, AOL, Arthur Andersen, Global Crossing, Tyco, led to
increased political interest in corporate governance. This is reflected in the
passage of the Sarbanes-Oxley Act of 2002. Other triggers for continued
interest in the corporate governance of organizations included the financial
crisis of 2008/9 and the level of CEO pay.
There have been several major corporate governance initiatives launched in
India since the mid-1990s. The first was by the Confederation of Indian
Industry (CII), India‘s largest industry and business association, which came
up with the first voluntary code of corporate governance in 1998. The
second was by the SEBI, now enshrined as Clause 49 of the listing
agreement. The third was the Naresh Chandra Committee, which submitted
its report in 2002. The fourth was again by SEBI — the Narayana Murthy
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Committee, which also submitted its report in 2002. Based on some of the
recommendation of this committee, SEBI revised Clause 49 of the listing
agreement in August 2003.Subsequently, SEBI withdrew the revised Clause
49 in December 2003, and currently, the original Clause 49 is in force.
2.1- The CII Code:
More than a year before the onset of the Asian crisis, CII set up a committee
to examine corporate governance issues, and recommend a voluntary code of
best practices. The committee was driven by the conviction that good
corporate governance was essential for Indian companies to access domestic
as well as global capital at competitive rates. The first draft of the code was
prepared by April 1997, and the final document (Desirable Corporate
Governance: A Code), was publicly released in April 1998. The code was
voluntary, contained detailed provisions, and focused on listed companies.
a) Desirable Disclosure:
Listed companies should give data on high and low monthly averages of
share prices in a major stock exchange where the company is listed; greater
detail on business segments, up to 10% of turnover, giving share in sales
revenue, review of operations, analysis of markets and future prospects.
Major Indian stock exchanges should gradually insist upon a corporate
governance compliance certificate, signed by the CEO and the CFO.If any
company goes to more than one credit rating agency, then it must divulge in
the prospectus and issue document the rating of all the agencies that did such
an exercise. These must be given in a tabular format that shows where the
company stands relative to higher and lower ranking.
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2.2- Kumar Mangalam Birla committee
Report and Clause 49:
While the CII code was well-received and some progressive companies
adopted it, it was felt that under Indian conditions a statutory rather than a
voluntary code would be more purposeful, and meaningful. Consequently,
the second major corporate governance initiative in the country was
undertaken by SEBI. In early 1999, it set up a committee under Kumar
Mangalam Birla to promote and raise the standards of good corporate
governance. In early 2000, the SEBI had accepted and ratified key
recommendations of this committee, and these were incorporated into
Clause 49 of the Listing Agreement of the Stock Exchanges.
a) The constitutions of Committee:
The committee has identified the three key constituents of corporate
governance as the shareholders, the Board of Directors and the Management.
Along with this the committee has identified major 3 aspects namely
accountability, transparency and equality of treatment for all shareholders.
Crucial to good corporate governance are the existence and enforceability of
regulations relating to insider information and insider trading.
These matters are currently being examined over here. The committee had
received good comments from almost all experts‘ institutions, chamber of
commerce Adrian Cadbury – Cadbury Committee etc.
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2.3-Naresh Chandra Committee Report:
The Naresh Chandra committee was appointed in August 2002 by the
Department of Company Affairs (DCA) under the Ministry of Finance and
Company Affairs to examine various corporate governance issues. The
Committee submitted its report in December 2002. It made
recommendations in two key aspects of Corporate Governance: financial
and non-financial disclosures: and independent auditing and board oversight
of management.
2.4-NarayanaMurthy Committee report on Corporate
Governance:
The fourth initiative on corporate governance in India is in the form of the
recommendations of the Narayana Murthy committee. The committee was
set up by SEBI, under the chairmanship of Mr. N. R. Narayana Murthy, to
review Clause 49, and suggest measures to improve corporate governance
standards. Some of the major recommendations of the committee primarily
related to audit committees, audit reports, independent directors, related
party transactions, risk management, directorships and director
compensation, codes of conduct and financial disclosures.
a) Confederation of Indian Industry (CII) Taskforce on
Corporate Governance:
History tells us that even the best standards cannot prevent instances of
major corporate misconduct. This has been true in the US - Enron,
WorldCom, Tyco and, more recently gross miss-selling of collateralized
debt obligations; in the UK; in France; in Germany; in Italy; in Japan; in
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South Korea; and many other OECD nations. The Satyam-Maytas Infra-
Maytas Properties scandal that has rocked India since 16th December 2008
is another example of a massive fraud.
b) Corporate Governance voluntary guidelines 2009:
More recently, in December 2009, the Ministry of Corporate Affairs (MCA)
published a new set of ?Corporate Governance Voluntary Guidelines
2009, designed to encourage companies to adopt better practices in the
running of boards and board committees, the appointment and rotation of
external auditors, and creating a whistle blowing mechanism. The guidelines
are divided into the following six parts:
i) Board of Directors.
The board of directors is the first level of supervision over the activities of
the bank and its management. The board is ultimately responsible for the
activities and results of the bank, for the maintenance of stability and
financial soundness. The powers and rules of the board are specified in the
law and the statute of a bank. The mode of operation should be specified in
the rules of procedure of the board. The core competences of the board
forming the foundations of the bank activities include: approving and
overseeing the strategic objectives of the bank and its corporate values,
overseeing the work of the management board and the determination of the
scope of the obligations and liability of the management members, the
establishment of guidelines for the acceptable level of risk, overseeing the
introduction of the management system (consisting at least of the system of
Corporate governance in banks
28
risk management and internal control system), and assessment of the
adequacy and effectiveness of the system.
ii) Audit Committee of the Board.
? Is required for systemically important banks. For banks of large size,
risk profile or complexity it is strongly advised. For other banks it
remains strongly recommended.
? Is required to be distinct from other committees.
? Should have a chair who is independent and is not the chair of the
board or any other committee.
? Should be made up entirely of independent or non-executive board
members.
? Should include members who have experience in audit practices and
financial literacy at banks.
The audit committee is responsible, among other things, for:
? The financial reporting process.
? Providing oversight of and interacting with the bank’s internal and
external auditors.
? Approving, or recommending to the board or shareholders for their
approval, the appointment 15 compensation and dismissal of external
auditors;
? Reviewing and approving the audit scope and frequency.
Corporate governance in banks
29
iii) Auditors.
The statutory responsibilities of the auditor fundamentally require the
following:
? Duty to make certain inquiries.
? Duty to make a report to the company on the accounts examined.
? Duty to make a proclamation in terms of the provisions set.
? Detection and Prevention of Fraud.
? Duty to report fraud.
? Duty as to substantial precision.
iv) Secretarial Audit.
Secretarial audit will definitely lead to better corporate governance as the
scope of it includes examining the board processes and practices, as also
reporting on compliances. The new Company Act 2013 with the focus on
transparency entails extensive and detailed disclosures. Secretarial audit
validates such disclosures.
v) Institution of mechanism for Whistle Blowing.
A whistleblower is a person who exposes any kind of information or activity
that is deemed illegal, dishonest, or not correct within an organization that is
either private or public. The information of alleged wrongdoing can be
classified in many ways: violation of company policy/rules, law, regulation,
or threat to public interest/national security, as well as fraud, and corruption.
Those who become whistleblowers can choose to bring information or
allegations to surface either internally or externally. Internally, a
whistleblower can bring his/her accusations to the attention of other people
Corporate governance in banks
30
within the accused organization. Externally, a whistleblower can bring
allegations to light by contacting a third party outside of an accused
organization. He/She can reach out to the media, government, law
enforcement, or those who are concerned. Whistleblowers also face stiff
retaliation from those who are accused or alleged of wrongdoing.
The SEBI had made it mandatory that all listed companies should create a
mechanism for employees to report to the management concerns about any
unethical behavior, fraud or violation of the code of conduct.
Prevention of insider trading
The SEBI Regulations 2002 define 'insider' "as any person who, is or was
connected with the company or is deemed to have been connected with the
company, and who is reasonably expected to have access to unpublished
price sensitive information in respect of securities of the company, or who
has received or has had access to such unpublished price sensitive
information". As defined under the Act, the definition of insider information
is driven by the notion that a person in a fiduciary position should not use
the privileged information for his or her own advantage.
The practical limitation of the 'person-connected' approach is chiefly the
practical difficulties of ensuring that all people who trade on inside
information are caught. It may be quite difficult for the prosecution to show
the existence of a 'connection', even when they can show that the secondary
insider in question has been dealing and using the information. If
prosecution fails to prove it, any person can escape. Rather than personnel
connection based approach information based approach be adopted to
prevent insider trading.
Corporate governance in banks
31
CHAPTER 3: CORPORATE GOVERNANCE IN
BANKS.
Banking system plays a very important role in the economic life of the
nation. The health of the economy is closely related to the soundness of its
banking is now an essential part of our economic system. The Indian
banking system is among the healthier performers in the world. In the
liberalized economic environment and integration of the country, in to world
market the corporate sector in India at present cannot ignore the importance
of Corporate Governance. The Corporate Governance philosophy of banks
has to be based on pursuit of sound business ethics and strong
professionalism that aligns the interests of all stakeholders and the society.
Strengthening of public confidence in banks is a vital requirement.
Staying focused on fundamentals, adoption of utmost professionalism,
conformity to prescribed norms of lending & investment, adherence to sound
banking principles & ensuring optimum capital efficiency are vital for
success & continued survival of banks. The conclusion is that sound
Corporate Governance would lead to effective & more meaningful
supervision and could contribute to a collaborative working relationship
between bank management & bank supervisors. Banks need to ensure good
Corporate Governance in order to achieve excellence, transparency & for
maximization shareholders value & wealth. With elements of good corporate
governance, sound investment policy, appropriate internal control systems,
better credit risk management, focus on newly-emerging business,
commitment to better customer service, adequate automation and proactive
Corporate governance in banks
32
policies, banks will definitely be able to grapple with these challenges and
convert them into opportunities.
From the perspective of banking industry, corporate governance also
includes in its ambit the manner in which their Board of Directors governs
the business and affairs of individual institutions and their functional
relationship with senior management. This is determined by how banks:
? set corporate objectives (including generating economic returns to
owners);
? run the day-to-day operations of the business and;
? consider the interests of recognized stakeholders i.e., employees,
customers, suppliers, supervisors, governments and the community
and
? Line up corporate activities and behaviors with the expectation that
banks will operate in a safe and sound manner, and in compliance
with applicable laws and regulations; and of course protect the
interests of depositors, which is supreme.
For ensuring good corporate governance, the importance of overseeing the
various aspects of the corporate functioning needs to be properly understood,
appreciated and implemented.
There are four important forms of oversight that should be included in the
organizational structure of any bank in order to ensure the appropriate
checks and balances:
? Oversight by the board of directors or supervisory board;
? Oversight by individuals not involved in the day-to-day running of
the various business areas;
? Direct line supervision of different business areas; and
Corporate governance in banks
33
? Independent risk management and audit functions. In addition to
these, it is important that the key personnel are fit and proper for their
jobs.
3.1-HOW IT IS DIFFERENT
Banks are different from other corporate in important respects, and that
makes corporate governance of banks not only different but also more
critical. Banks lubricate the wheels of the real economy, are the conduits of
monetary policy
transmission and constitute the economy‘s payment and settlement system.
By the very nature of their business, banks are highly leveraged. They accept
large amounts of uncollateralized public funds as deposits in a fiduciary
capacity and further leverage those funds through credit creation. The
presence of a large and dispersed base of depositors in the stakeholders
group sets banks apart from other corporate.
Banks are “special” as they not only accept and deploy large amount of
uncollateralized public funds in fiduciary capacity, but they also leverage
such funds through credit creation. The role of banks is integral to any
economy. They provide financing for commercial enterprises access to
payment systems and a variety of retail financial services for the economy at
large. The integral role that banks play in the national economy is
demonstrated by the almost universal practice of states in regulating the
banking industry and providing in many cases a government safety net to
compensate depositors when banks fail. The large number of stakeholders
whose economic well-being depends on the health of the banking system
depends on implementation of appropriate regulatory practices and
supervision. Indeed in a healthy banking system the regulators and
Corporate governance in banks
34
supervisors themselves are stakeholders acting on behalf of society at large.
As regulators we do not act on behalf of shareholders or individual
customers but on behalf of groups such as depositor’s policyholders or
pension fund members who rely on the continued solvency of regulated
institutions for their financial security but who are themselves not well
placed to assess financial soundness.
Banks unlike insurance companies are highly leveraged entities and asset
liability mismatches are an inherent feature of their business. Consequently,
they face a wide range of risks in their day-to-day operations. Any
mismanagement of risks by these entities can have very serious and drastic
consequences on a stand-alone basis which might pose a serious threat for
financial stability. This dimension further strengthens our premise that
effective risk management systems are essential for financial institutions and
emphasizes the need for these to be managed with great responsibility and
maturity. Good corporate governance, therefore, is fundamental to achieve
this objective.
Corporate governance in banks
35
3.2-REGULATIONS AND CORPORATE GOVERNANCE
OF BANKS
Bank regulations are a form of government regulation which subject banks
to certain requirements, restrictions and guidelines. This regulatory structure
creates transparency between banking institutions and the individuals and
corporations with whom they conduct business, among other things.
Regulation has historically had a significant role in the evolution of
corporate governance principles in the banking industry. However, to
believe on this basis that good regulation can offset bad corporate
governance will be patently wrong. Regulation can complement corporate
governance, but cannot substitute for it.
The crisis has triggered a swathe of financial reforms to mitigate some of the
known risks revealed by it. Understandably, these reforms also encompass
corporate governance. Several countries have effected major structural
changes to improve the functioning of their financial institutions, to ensure
the robustness of their risk management systems and to make their
operations more transparent.
By far the most notable has been the Dodd-Frank Act in the United States
which, among other things, aims to induce greater transparency with regard
to the board and the top management positions and their compensation.
Corporate governance in banks
36
3.3-IMPORTANCE OF CORPORATE GOVERNANCE IN
BANKS.
Banks are a critical component of the economy while providing financing
for commercial enterprises, basic financial services to a broad segment of
the population and access to payment systems. The importance of banks to
national economies is underscored by the fact that banking is, almost
universally, a regulated industry and that banks have access to government
safety nets. It is of crucial importance therefore that banks have strong
corporate governance practices.
Banks are also important catalysts for economic reforms, including
corporate governance practices. Because of the systemic function of banks,
the incorporation of corporate governance practices in the assessment of
credit risks pertaining to lending process will encourage the corporate sector
in turn to improve their internal corporate governance practices.
Importance of implementing modern corporate governance standards is
conditioned by the global tendency to consolidation in the banking sector
and a need in further capitalization.
Best corporate governance practices will enable banks to:
? Increase efficiency of their activities and minimize risks;
? Get an easier access to capital markets and decrease the cost of
capital;
? Increase growth rate;
? Attract strategic investors;
? Improve the standards of lending;
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37
? Protect the rights of minority shareholder and other counterparts;
? Strengthen their reputation and raise the level of investors and clients'
trust.
Prerequisites for Good Governance.
There are some pre-requisites for good corporate governance. They are:
? A proper system consisting of clearly defined and adequate structure
of roles, authority and responsibility.
? Vision, principles and norms which indicate development path,
normative considerations and guidelines and norms for performance.
? A proper system for guiding, monitoring, reporting and control.
3.4-EVOLUTION OF CORPORATE GOVERNANCE IN
BANKS.
Let briefly sketch the evolution of corporate governance of banks in India. In
the pre-reform era, there were very few regulatory guidelines covering
corporate governance of banks. This was reflective of the dominance of
public sector banks and relatively few private banks.
That scenario changed after the reforms in 1991 when public sector banks
saw a dilution of government shareholding and a larger number of private
Corporate governance in banks
38
sector banks came on the scene. How did these changes shape the post
reform standards of corporate governance.
First: The competition brought in by the entry of new private sector banks
and their growing market share forced banks across board to pay greater
attention to customer service. As customers were now able to vote with their
feet, the quality of customer service became an important variable in
protecting, and then increasing, market share.
Second: Post-reform, banking regulation shifted from being prescriptive to
being prudential. This implied a shift in balance away from regulation and
towards corporate governance. Banks now had greater freedom and
flexibility to draw up their own business plans and implementation strategies
consistent with their comparative advantage.
The boards of banks had to assume the primary responsibility for overseeing
this. This required directors to be more knowledgeable and aware and also
exercise informed judgment on the various strategy and policy choices.
Third: Two reform measures pertaining to public sector banks - entry of
institutional and retail shareholders and listing on stock exchanges - brought
about marked changes in their corporate governance standards. Directors
representing private shareholders brought new perspectives to board
deliberations, and the interests of private shareholders began to have an
impact on strategic decisions. On top of this, the listing requirements of
SEBI enhanced the standards of disclosure and transparency.
Corporate governance in banks
39
Fourth: To enable them to face the growing competition, public sector
banks were accorded larger autonomy. They could now decide on virtually
the entire gamut of human resources issues, and subject to prevailing
regulation, were free to undertake acquisition of businesses, close or merge
unviable branches, open overseas offices, set up subsidiaries, take up new
lines of business or exit existing ones, all without any need for prior
approval from the Government. All this meant that greater autonomy to the
boards of public sector banks came with bigger responsibility.
Fifth: A series of structural reforms raised the profile and importance of
corporate governance in banks. The ‘structural’ reform measures included
mandating a higher proportion of independent directors on the boards;
inducting board members with diverse sets of skills and expertise; and
setting up of board committees for key functions like risk management,
compensation, investor grievances redressal and nomination of directors.
Structural reforms were furthered by the implementation of the Ganguly
Committee recommendations relating to the role and responsibilities of the
boards of directors, training facilities for directors, and most importantly,
application of ‘fit and proper ’norms for directors.
Corporate governance in banks
40
CHAPTER 4: CORPORATE GOVERNANCE IN
TODAY’S CONTEXT.
4.1-Corporate Governance in today’s context:
According to Milton Friedam, “Corporate Governance is to conduct the
business in accordance with owner’s or shareholders desires, which
generally will be to make as much money as possible” but this context is
based on marked maximization that underpins shareholder capitalism.
But this context was further expanded by J.Wolfensohn, President, World
Bank, has said that “Corporate Governance is about promoting corporate
fairness, transparency and accountability.
Even the Experts at Organization of Economic Co-Operation and
Development (OECD) have defined “Corporate Governance” as the system
by which business corporations are directed and controlled, it means
according to them it is a structure which specifies the distribution of rights
and responsibilities among different participants in the corporation.
But today the concept of corporate governance has taken a new dimension
and it runs as follows,
“Corporate governance is the application of best management practices,
compliance of law in true letter and spirit and adherence to ethical standards
for effective management and distribution of wealth and discharge of social
responsibility for sustainable development of all stakeholders”.
Corporate governance in banks
41
4.2-Corporate Governance in Indian Context:
In the Indian context, the need for corporate governance has been
highlighted because of the scams occurring frequently since the emergence
of the concept of liberalization from 1991 such as the Harshad Mehta Scam,
Ketan Parikh Scam, UTI Scam, Vanishing Company Scam, Bhansali Scam
and so on. In the Indian corporate scene, there is a need to induct global
standards so that at least while the scope for scams may still exist, it can be
at least reduced to the minimum.
From the beginning of 1980s, situations have changed in India. There have
been wide-ranging changes has taken place in both the laws and the
regulations in the field of corporate law and the capital market. As a result of
several scams in India a need has arisen to bring reforms, in response to that,
reforms began in 1991 in India. The most important event in the field of
investor protection in
India was the establishment of Securities and Exchange Board of India
(SEBI) in 1992. Corporate governance is a multi-faceted subject. An
important theme of corporate governance deals with issues of accountability
and fiduciary duty, essentially advocating the implementation of policies and
mechanisms to ensure good behavior and protect shareholders. Another key
focus is the economic efficiency view, through which the corporate
governance system should aim to optimize economic results, with a strong
emphasis on shareholders welfare.
In India the concept of corporate governance is gaining importance because
of two reasons.
? After liberalization, there has been institutionalization of financial
markets, FIIs and FIs became dominant players in the stock markets.
Corporate governance in banks
42
The market began to discriminate between wealth destroyers.
Corporate governance is a critical by product of market discipline.
? Another factor is the increased role being played by the private sector.
Companies are realizing that investors love to stay with those
corporate that create values for their investors.
This is only possible by adopting fair, honest and transparent corporate
practices.
4.3-Corporate Governance in Public Sector Banks
A substantial chunk of Indian Banking sectors still remains under the control
of public sector banks despite the strong wave of Globalization,
Liberalization and privatization and entrance of private and foreign banks in
the arena. The major shareholding of the public banks with the Government
the reasons for such ownership may include solving the severe informational
problems inherent in developing financial systems, aiding the development
process or supporting the vested interests and tributional cartels.
Banks have been making pivotal contributions over the years to nation’s
economic growth and development. Government-owned (Public Sector)
banks have played a major role in economic development. During the last
few years, these institutions are slowly getting “corporative” and
consequently corporate governance issues in banks assumes greater
significance in the coming years.
Considering the importance of banking sector the practice of corporate
governance and how it helps banking industry in India in terms of bringing
more transparency and overall growth of banking sector.
Corporate governance in banks
43
Basel Committee has underscored the need for the banks to establish the
strategies and to become accountable for executing as well as implementing
them. The existing legal institutional framework of public sector banks is not
aligned with principles of good corporate governance. The bureaucratic
hassles, red tapes and de motivated work culture add further fuel to the fire.
So far banks have been burdened with “social responsibility “ and compelled
to tow the line of thinking dictated by the political party in power, healthy
banking policies will not be able to become the top priority.
Monopoly of PSB in banking business had protected them from competition
and bank Managements have thereby became complacent.
Corporate Governance in PSBs is important, not only because PSBs happen
to dominate the banking industry, but also because, they are unlikely to exit
from banking business though they may get transformed. To the extent there
is public ownership of PSBs, the multiple objectives of the Government as
owner and the complex principal-agent relationships cannot be wished away.
PSBs cannot be expected to blindly mimic private corporate banks in
governance though general principles are equally valid. Complications arise
when there is a widespread feeling of uncertainty of the ownership and
public ownership is treated as a transitional phenomenon. The anticipation or
threat of change in ownership has also some impact on governance, since
expected change is not merely of owner but the very nature of owner. Mixed
ownership where government has controlling interest is an institutional
structure that poses issues of significant difference between one set of
owners who look for commercial return and another who seeks something
more and different, to justify ownership. Furthermore, the expectations, the
reputation risks and the implied even if not exercised authority in respect of
the part-ownership of government in the governance of such PSBs should be
Corporate governance in banks
44
recognized. In brief, the issue of corporate governance in PSBs is important
and also complex. From the banking industry perspective, the attributes of
corporate governance provide guidelines to the directors and the top level
managers to govern the business of banks. These guidelines relate to how
banks establish corporate aims, carry out their daily activities, and take into
account the interest of stakeholders and making sure that the corporate
activities are in tune with the public expectations that banks will function in
an ethical and legal manner thereby protecting the interest of its depositors
(Basel Committee, 1999). All these broad issues relating to governance
apply to other companies also, but they assume more significance for banks
because they deal with public deposits directly.
Banks' philosophy for Corporate Governance should lay emphasis on the
cardinal values of 'fairness', 'transparency' and 'accountability', as enunciated
by World Bank, for performance at all levels, thereby, enhancing the
shareholders' value and protecting the interest of the stakeholders.
The Banks consider themselves as trustee of its shareholders and should
acknowledge its responsibility towards them for creation and safeguarding
shareholders' wealth. Banks should continue its pursuit of achieving these
objectives through the adoption and monitoring of corporate strategies,
prudent business plans, monitoring of major risks of the banks business and
pursuing the policies and procedures to satisfy its legal and ethical
responsibilities. Hence, banks should aim at enhancing the long term
shareholder value while protecting the 'interest of shareholders, customers
and other in line with international best practices.
Corporate governance in banks
45
CORPORATE GOVERNANCE OF STATE BANK OF
INDIA.
To enhance management transparency and Corporate Governance, SBI
holdings recognizes that one of its most crucial management task is to build
and maintain an organizational structure capable of responding quickly to
the changes in the business environment as well as a fair management
system that emphasis interest of the shareholders.
State Bank of India is committed to the best practices in the area of
Corporate Governance. The bank believes that good Corporate Governance
is much more than complying with legal and regulatory requirements. Good
governance facilitates effective management and control of business, enables
the bank to maintain high level of business ethics and to optimize the value
for all its stake holders.
The objectives can be summarized as:
? To enhance shareholder value
? To protect the interest of shareholders and other stakeholders
including customers, employees and society at large.
? To ensure transparency and integrity in communication and to make
available full, accurate and clear information to all concerned.
? To ensure accountability for performance and to achieve excellence at
all levels.
? To provide corporate leadership of highest standard for others to
emulate.
Corporate governance in banks
46
4.4-Corporate Governance in Private Sector Banks.
Private sector banks have entered niche areas, listed their scrip and being
market driven they have been more transparent in their functioning. They
have also been more tech savvy, growth oriented and have less of NPAs.
Private sector banks has to conform with standard of good banking practices
such as
? Ensuring a fair and transparent relationship between the customer and
bank;
? Instituting comprehensive risk management system and its adequate
disclosure;
? Proactively handling the customer complaints and evolving scheme of
redressal for grievances;
? Building systems and processes to ensure compliance with the statutes
concerning banking.
CORPORATE GOVERNANCE PRACTICES IN ICICI
BANK
Corporate Governance policies of ICICI Bank recognize the accountability
of the board and the importance of its decisions to all their constituents,
including customers, investors, employees and the regulatory authorities.
The functions of the board and the executive management are well defined
and are distinct from one another. They have taken a series of steps
including the setting up of sub committees of the board to oversee the
functions of executive management.
Corporate governance in banks
47
The board’s role, functions, responsibility and accountability are clearly
defined. In addition to its primary role of monitoring corporate performance,
the functions of the board include:
? Approving corporate philosophy and mission
? Participating in the formulation of strategic and business plan
? Reviewing and approving financial plans and budgets.
? Monitoring corporate performance against strategic and business
plans including overseeing operations
? Ensuring ethical behavior and compliance with laws and regulations.
? Formulating exposure limits
? Keeping shareholders informed regarding plans, strategies and
performance.
Recent Steps Taken by Banks in India for Corporate
Governance
? Induction of non-executive members on the Boards
? Constitution of various Committees like Management Committee,
Audit Committee, Investor’s Grievances Committee, ALM
Committee etc.
? Gradual implementation of prudential norms as prescribed by RBI,
? Introduction of Citizens Charter in Banks
? Implementation of “Know Your Customer” concept.
The primary responsibility for good governance lies with the Board of
Directors and the senior management of the bank.
Corporate governance in banks
48
4.5-Corporate Governance in Co-operative Banks.
For the co-operative banks in India, these are challenging times. Never
before has the need for restoring customer confidence in the cooperative
sector been felt so much. Never before has the issue of good governance in
the co-operative banks assumed such criticality. The literature on corporate
governance in its wider connotation covers a range of issues such as
protection of shareholders rights, enhancing shareholders value, Board
issues including its composition and role, disclosure requirements, integrity
of accounting practices, the control systems, in particular internal control
systems.
Corporate governance especially in the co-operative sector has come into
sharp focus because more and more co-operative banks in India, both in
urban and rural areas, have experienced grave problems in recent times
which has in a way threatened the profile and identity of the entire
cooperative system. These problems include mismanagement, financial
impropriety, poor investment decisions and the growing distance between
members and their co-operative society.
The purpose and objectives of co-operatives provide the framework for co-
operative corporate governance. Co- operatives are organized groups of
people and jointly managed and democratically controlled enterprises. They
exist to serve their members and depositors and produce benefits for them.
Co-operative corporate governance is therefore about ensuring co-operative
relevance and performance by connecting members, management and the
employees to the policy, strategy and decision-making processes.
Corporate governance in banks
49
CHAPTER 5: CORPORATE GOVERNANCE
MECHANISM.
Banks play a pivotal role in the financial and economic system of any
country.RBI plays a leading role in formulating and implementing corporate
governance norms for India’s banking sector.
The ambit encompasses safeguarding and maximizing the shareholders’
value, upholding retail depositors’ risk and stabilizing the financial system
so as to conserve the larger interests in public. This role becomes important
in view of the fact that in Indian bank assets often lack transparency and
liquidity because most bank loans, unlike other products and services, are
customized and privately negotiated.Banks are ‘special’ as they not only
accept and deploy large amount of uncollateralized public funds in a
fiduciary capacity, but they also leverage such funds through credit
creations. They are also important for smooth functioning of the payment
system.
In case of instability of one bank owing to incompetent or unethical
management, the entire financial system and the economy may be impacted
adversely. As one bank becomes unstable, there may be a heightened
perception of risk among depositors for the entire class of such banks,
leading to early liquidation and exposing the entire financial system to
choas. In such a situation, the interest of borrowers (corporate, retail, etc)
may also be affected in terms of availability of credit, recall of credit lines
and loss in valuation of mortgaged assets.
Corporate governance in banks
50
Two main features set banks apart from other business- the level of
opaqueness in their functioning and the relatively greater role of government
and regulatory agencies in their activities. The opaqueness in banking
creates considerable information asymmetries between the “insiders” –
management and “outsiders” – owners and creditors. The very nature of the
business makes it extremely easy and tempting for management to alter the
risk profile of banks as well as siphon funds.
The Reserve Bank of India performs corporate governance function under
the guidance of the Board for Financial Supervision (BFS). Primary
objectives of BFS is to undertake consolidated supervision of the financial
sector comprising commercial banks, financial institutions and non-banking
finance companies.
BFS was constituted in November 1994 as a committee of the Central Board
of Directors of the Reserve Bank of India. The Board comprises of four
directors of RBI from central board and is chaired by Governor. The Board
is required to meet normally once every month. It considers inspection
reports and other supervisory issues placed before it by the supervisory
departments.
The BFS oversees the functioning of Department of banking Supervision
(DBS), Department of Non-banking Supervision (DNBS) and Financial
Institutions Division (FID) and gives directions on the regulatory and
supervisory issues.
BFS inspects and monitors banks using the “CAMELS” (Capital adequacy,
Asset quality, Management, Earnings, Liquidity and Systems and controls)
approach. BFS through the Audit Sub-Committee also aims at upgrading the
quality of the statutory audit and internal audit functions in banks and
financial institutions.
Corporate governance in banks
51
5.1-Corporate governance mechanisms followed by RBI
are a three-pronged approach:
1) Disclosure and Transparency.
Disclosure and transparency are the main pillars of a corporate governance
framework enabling adequate information flow to various stakeholders and
leading to informed decisions. Accounting standards in India in all sectors
including banking sector have been enhanced to align with international best
practices.
2) Off-site surveillance.
The off-site surveillance mechanism monitors the movement of assets, its
impact on capital adequacy and overall efficiency and adequacy of
managerial practices in banks. RBI promotes self-regulation and market
discipline among the banking sector participants and has issued prudential
norms for income recognition, asset classification, and capital adequacy.
RBI brings out periodic data on ‘Peer Group Comparison’ on critical ratios
to maintain peer pressure on individual banks for better performance and
governance.
3) Prompt corrective action.
Prompt Corrective Action is a supervisory mechanism implemented as a part
of Effective Banking Supervision in terms of Basel II requirements. It is
based on a pre-determined rules based structure of early intervention
whereby benchmark ratios for three parameters –Capital Adequacy Ratio,
Non-Performing Assets Ratio and Return on Assets are determined. Any
Corporate governance in banks
52
breach of these trigger points is considered as early warning on the financial
health of the banks and appropriate mandatory or discretionary action is
initiated by the RBI.
THE SPECIAL PLACE OF BANKING
The banking sector is not necessarily totally corporate. Some part of it is, of
course, but a segment of banks is mostly government owned as statutory
corporations or run as cooperatives – just like your bank. Banking as a sector
has been unique and the interests of other stake holders appear more
important to it than in the case of non-banking and non-finance
organizations. In the case of traditional manufacturing corporations, the
issue has been that of safeguarding and maximizing the shareholders? value.
In the case of banking, the risk involved for depositors and the possibility of
contagion assumes greater importance than that of consumers of
manufactured products.
Further, the involvement of government is discernibly higher in banks due to
importance of stability of financial system and the larger interests of the
public. Since the market control is not sufficient to ensure proper
governance in banks, the government does see reason in regulating and
controlling the nature of activities, the structure of bonds, the ownership
pattern, capital adequacy norms, liquidity ratios, etc.
Corporate governance in banks
53
REASONS FOR HIGH DEGREE OF OVERSIGHT
There are three reasons for degree of government oversight in this sector.
? Firstly, it is believed that the depositors, particularly retail depositors,
cannot effectively protect themselves as they do not have adequate
information, nor are they in a position to coordinate with each other.
? Secondly, bank assets are unusually opaque, and lack transparency as
well as liquidity. This condition arises due to the fact that most bank
loans, unlike other products and services, are usually customized and
privately negotiated.
? Thirdly, it is believed that that there could be a contagion effect
resulting from the instability of one bank, which would affect a class
of banks or even the entire financial system and the economy. As one
bank becomes unstable, there may be a heightened perception of risk
among depositors for the entire class of such banks, resulting in arun
on the deposits and putting the entire financial system in jeopardy.
5.2-ROLE OF THE GOVERNMENT AND THE
REGULATOR.
Regulators are external pressure points for good corporate governance. Mere
compliance with regulatory requirements is not however an ideal situation in
itself. In fact, mere compliance with regulatory pressures is a minimum
Corporate governance in banks
54
requirement of good corporate governance and what are required are internal
pressures, peer pressures and market pressures to reach higher than
minimum standards prescribed by regulatory agencies. RBI’s approach to
regulation in recent times has some features that would enhance the need for
and usefulness of good corporate governance in the co-operative sector. The
transparency aspect has been emphasized by expanding the coverage of
information and timeliness of such information and analytical content.
Importantly, deregulation and operational freedom must go hand in hand
with operational transparency.
In fact, the RBI has made it clear that with the abolition of minimum
lending rates for co-operative banks, it will be incumbent on these banks to
make the interest rates charged by them transparent and known to all
customers. Banks have therefore been asked to publish the minimum and
maximum interest rates charged by them and display this information in
every branch. Disclosure and transparency are thus key pillars of a corporate
governance framework because they provide all the stakeholders with the
information necessary to judge whether their interests are being taken care
of. We in RBI see transparency and disclosure as an important adjunct to the
supervisory process as they facilitate market discipline of banks. Another
area which requires focused attention is greater transparency in the balance
sheets of co-operative banks.
The commercial banks in India are now required to disclose accounting
ratios relating to operating profit, return on assets, business per employee,
NPAs, etc. as also maturity profile of loans, advances, investments,
borrowings and deposits. The issue before us now is how to adapt similar
disclosures suitably to be captured in the audit reports of co-operative banks.
RBI had advised Registrars of Cooperative Societies of the State
Corporate governance in banks
55
Governments in 1996 that the balance sheet and profit & loss account should
be prepared based on prudential norms introduced as a sequel to Financial
Sector Reforms and that the statutory/departmental auditors of co-operative
banks should look into the compliance with these norms.
Auditors are therefore expected to be well-versed with all aspects of the new
guidelines issued by RBI and ensure that the profit & loss account and
balance sheet of cooperative banks are prepared in a transparent manner and
reflect the true state of affairs. Auditors should also ensure that other
necessary statutory provisions and appropriations out of profits are made as
required in terms of Co-operative Societies Act / Rules of the state
concerned and the bye-laws of the respective institutions.
5.3-OTHER CORPORATE GOVERNANCE MECHANISMS.
Apart from working under the jurisdiction of RBI,listed banks, Non banking
finance companies and other financial intermediaries are governed by
SEBI’s clause 49 on corporate governance.
Clause 49 of the Equity Listing Agreement consists of mandatory as well as
non-mandatory provisions. Those which are absolutely essential for
corporate governance can be defined with precision and which can be
enforced without any legislative amendments are classified as mandatory.
Others, which are either desirable or which may require change of laws are
classified as non-mandatory. The non-mandatory requirements may be
implemented at the discretion of the company. However, the disclosures of
the compliance with mandatory requirements and adoption (and compliance)
/ non-adoption of the non-mandatory requirements shall be made in the
section on corporate governance of the Annual Report.
Corporate governance in banks
56
Gist of Cause 49 is as follows:
Mandatory provisions comprises of the following:
? Composition of Board and its procedure - frequency of meeting,
number of
independent directors, code of conduct for Board of directors and senior
management;
? Audit Committee, its composition, and role;
? Provision relating to Subsidiary Companies;
? Disclosure to Audit committee, Board and the Shareholders;
? CEO/CFO certification;
? Quarterly report on corporate governance;
? Annual compliance certificate.
Non-mandatory provisions consist of the following:
? Constitution of Remuneration Committee
? Dispatch of Half-yearly results
? Training of Board members
? Peer evaluation of Board members
? Whistle Blower policy
As per Clause 49 of the Listing Agreement, there should be a separate
section on Corporate Governance in the Annual Reports of listed companies,
with detailed compliance report on Corporate Governance. The companies
should also submit a quarterly compliance report to the stock exchanges
within 15 days from the close of quarter as per the prescribed format. The
Corporate governance in banks
57
report shall be signed either by the Compliance Officer or the Chief
Executive Officer of the company.
CORPORATE GOVERNANCE IN BANKS:
5.4-PROBLEMS AND REMEDIES.
Weak and ineffective corporate governance mechanisms in banks are
pointed out as the main factors contributing to the recent financial crisis.
Deep changes in this area are necessary to reinforce the financial sector
stability.
A bank’s failure to follow good practices in corporate governance and the
lack of effective governance are among the most important internal factors
which may endanger the solvency of a bank.
Corporate governance in banks differs from the standard (typical for other
companies), which is due to several issues:
? Banks are subject to special regulations and supervision by state
agencies (monitoring activities of the bank are therefore mirrored);
supervision of banks is also exercised by the purchasers of securities
issued by banks and depositors ("market discipline","private
monitoring");
? The bankruptcy of a bank raises social costs, which does not happen
in the case of other kinds of entities’ collapse; this affects the behavior
of other banks and regulators;
? Regulations and measures of safety net substantially change the
behavior of owners,managers and customers of the banks; rules can be
counterproductive, leading to undesirable behaviour management
Corporate governance in banks
58
(take increased risk) which expose well-being of stakeholders of the
bank (in particular the depositors and owners);
? Between the bank and its clients there are fiduciary relationships
raising additional relationships and agency costs;
? Problem principal-agent is more complex in banks, among others due
to the asymmetry of information not only between owners and
managers, but also between owners, borrowers, depositors, managers
and supervisors;
? The number of parties with a stake in an institution’s activity
complicates the governance of financial institutions.
In the banking sector corporate governance is therefore a way of business
and affairs of the bank by the management and the board, affecting how
they;
? Define the objectives and goals;
? lead current bank activities;
? Fulfill the obligation of accountability to shareholders and take
into account the interests of stakeholders;
? Apply the requirement to operate safely and to ensure a good
financial situation and compliance with applicable regulations;
? Protect the interests of depositors (and other clients and
creditors).
5.5-Key areas of failure of corporate governance in banks.
The confidence of the public (in a bank and the entire banking system) is
necessary for a proper functioning of the financial system and economy.
Corporate governance in banks
59
Effective corporate governance practices are fundamental to gain and
maintain this confidence Trust is a basic prerequisite for a proper
functioning of banks, therefore it is necessary to carry out fundamental
reforms that will bring inner harmony and allow the recovery of the public
trust. Therefore, an in-depth analysis of the recent crisis causes should be
done. Particularly considering that the rules of proper conduct of banking
business exist and are being implemented, but it is mainly the deficiencies in
corporate governance which are to blame for the recent financial crisis.
Analyses of the causes of the crisis lead to indicate several issues requiring a
re-structuring and strengthening of standards, these issues concern;
? The role, tasks and responsibilities of the board, as well as its size,
organization and composition (members) and the functioning of this
body and the assessment of its work;
? Control of bank risk exposure;
? Evaluation of executives and its incentive pay;
? Transparency of the bank supervisory board that allows for the
assessment of its activities (both by institutional and private
monitoring);
? Ownership structure of banks and the role of institutional investors.
The analysis of main failures of corporate governance in banks
suggests that in order to repair and strengthen the system:
? Banks ought to reduce their risk exposure significantly, build a
stronger capital base; banks should concentrate on typical banking
activities and reduce the scale of other operations.
Corporate governance in banks
60
? Bank directors (both: executive and non-executive) should bear
personal responsibility for banks’ activities and risk;
? Banks’ executives remuneration should be linked to performance and
risk exposure;
? Non-executive directors engagement should be stronger – they should
devote more time and commitment to perform their oversight
function;
? Regulators and market supervisors should strengthen banks’
transparency allowing for the effective market discipline, professional
bodies should promote best practice in disclosure and motivate banks
to publish more informative reports;
? The accountability of external and internal auditors should be stronger
and they should be obliged to report any observed non-compliance to
supervisors;
? “Comply or explain” rule used in corporate governance area, being a
sort of a “soft law” should be strengthened by the monitoring function
performed by financial market and the supervisor should verify
whether the disclosed information is reliable and sufficient;
? In particularly important areas in which banks persistently do not
comply with corporate governance best practices, supervision should
make formally binding rules; one should keep in mind, however, that
this should not lead to excessive growth of regulation because it
would harm the competition.
Corporate governance in banks
61
CHAPTER 6: CASE STUDY
Corporate Governance in Banking Sector: Corporate
Governance at Royal Bank of Canada.
Case Details:
Case Code: CGOX009
Period : 2004
Organization: Royal Bank of Canada
Industry : Financial Services
Countries : Canada
Abstract:
Royal Bank of Canada (RBC), the largest financial services group in
Canada, has one of the best boards in Canada. It has received the Overall
Award of Excellence for corporate reporting from the Canadian Institute of
Chartered Accountants.
RBC has received top scores in four categories: (1) Annual Reporting; (2)
Corporate Governance Disclosure; (3) Electronic Disclosure; and (4)
Sustainable Development Reporting.
The case examines the best practices in corporate governance that RBC has
adopted, with special reference to board composition, board responsibilities,
board structure, board committees and directors'' compensation.
Corporate governance in banks
62
Introduction:
Royal Bank of Canada (RBC), headquartered in Toronto, Ontario, was the
largest financial services group in Canada. In 2003, it ranked #337 in the
Fortune Global 500 and #80 in Forbes Global 2000 and had a market
capitalization of C$41.6 billion and an asset base of C$413 billion. ($ 1.0 =
C$ 1.31108).
On 26th November 2003, RBC received the Overall Award of Excellence
for corporate reporting at the CICA. The Judging panels5 presented RBC
with top scores in four categories: 1) Annual Reporting, 2) Corporate
Governance Disclosure, 3) Electronic Disclosure and 4) Sustainable
Development Reporting.
In August 2003, the Canadian Business magazine ranked RBC as the second
best board in Canada. RBC had been ranked No.1 in 2001. RBC had adopted
what observers considered many best practices in corporate governance.
RBC's directors (in 2001) had to hold at least $100,000 in stock and had to
stand for re-election every year.
Any re-pricing of the stock options was not approved. The board published
the attendance of each director at the Board and Committee meetings. The
bank also scored high grades on the 'independence' of its directors. Out of
the 19 directors standing for election, in 2002, only one director represented
the bank's management. RBC had also decided to split the offices of the
CEO and the Chairman.
In 2001, had launched a Subsidiary Governance Office (SGO) in order to
enhance governance practices in its subsidiaries. It installed sophisticated
software that allowed quick and easy access to up-to-date information on all
parts of its global network.
Corporate governance in banks
63
Excerpts:
Business Segments:
RBC operated in five major business segments: 1) RBC Banking, 2) RBC
Insurance, 3) RBC Investments, 4) RBC Capital Markets and 5) RBC Global
Services. RBC Banking was the bank's largest contributor to the net income
(51% of net income in 2003).
Corporate Governance Code:
RBC had attempted to comply with the corporate governance guidelines of
Toronto Stock Exchange (TSX).
The Board of Directors (Board) had also taken note of the US Sarbanes-
Oxley Act (SOX), as well as the New York Stock Exchange's (NYSE)
corporate governance listing guidelines.
The Board of Directors:
The Board consisted of an independent chairman, independent directors and
two executive directors and had in place four committees consisting only of
independent directors. The Corporate Governance and Public Policy
Committee (CGPC) had developed categorical standards of 'independence'
with respect to the US's NYSE Corporate Governance listing Standards, in
addition to the 'unrelated' standard as specified by the TSX Corporate
Governance Guidelines.
Corporate governance in banks
64
Board Composition:
RBC did not permit more than two Board members from management. The
President and Chief Executive Officer (CEO) of the bank, Gordon M. Nixon
and the Chairman Emeritus of RBC Centura Banks Inc., Cecil W. Swell Jr.,
represented the management. The bank complied with provisions of the
Canadian Bank Act (Bank Act) and the TSX Guidelines with regard to
directors being affiliated with or related to the bank. The CGPC, with advice
from outside consultants, recommended the candidates suitable for
nomination to the Board and continuously reviewed the composition and
mandates of all the committees.
Board Responsibilities:
The Board responsibilities included succession planning, evaluation of
management performance, review and execution of major business
decisions, review and approval of corporate financial goals and operational
plans, identification of risks, supervision of communications and public
disclosure, and assessment of the effectiveness of the bank's internal controls
and management information systems.
Board Committees:
Committees of the Board consisted solely of independent and unrelated
directors. The Board delegated specific tasks to these committees.
Audit Committee:
Five independent directors and a chairman represented AC and held 11
meetings in 2003.
Corporate governance in banks
65
Conduct Review and Risk Policy Committee (CRPC).
CRPC consisted of five members and a Chairman and reviewed the credits
to the directors or the entities in which they were partners, directors or
officers.
Directors – Compensation:
RBC regarded attractive compensation as a primary tool to attract, retain and
motivate independent directors with skills and commitment to enhance
shareholder value. CGPC and HRC were responsible for designing the
compensation structure for all independent directors and executive directors
& senior officers respectively.
Corporate Disclosure:
RBC emphasized excellence and timeliness in its communications. The
investor relations staff provided information to existing and potential
investors and responded to all inquiries.
Concluding Notes:
RBC had its share of bitter experiences despite all the steps it had taken to
embrace high standards of corporate governance. In 2000, RT Capital
Management, the pension management division of RBC was involved in a
high-profile trading scandal.
Corporate governance in banks
66
CONCLUSION.
Banks and financial sector being a highly service oriented sector, making
corporate governance effective is a great challenge. More so, when the
driving force of commercial banks is to grab the opportunity, trading profits
with only focus on profitability.Banking sector is the key for monetary
conditions in a country. Due to the special nature of the activities carried on
by the banks, they face a lot of problems as far as the area of corporate
governance is concerned.
In the Indian scenario, due to the peculiar nature of bank holdings there are a
lot of embedded conflicts.Corporate Governance is now identified and
acknowledged as a powerful tool to generate trust and confidence in an
institution. The trend in the world of targeting governance practices in the
banking sector to be at the cutting edge of prevailing practices worldwide is
a significant step in the right direction and should continue to be so in the
future as well.India has one of the best Corporate Governance legal regimes
but poor implementation. SEBI has carved out a certain more stringent
provisions relating to listed companies as a condition of the Listing
Agreement.
Finally this study concluded that, the corporate governance practices in the
banking and financial sector in India should improve for best investment
policies, appropriate internal control systems, better credit risk management,
better customer service and adequate automation in order to achieve
excellence, transparency and maximization of stakeholder’ value and wealth.
Corporate governance in banks
67
BIBLIOGRAPHY.
Books:
1. Corporate Governance in Banking-A Global Perspective, by B.E.
Gup,Edward Elgar Publishing.
2. Corporate Governance: Principles, Policies and Practices, by A. C.
Fernando
Pearson Education India, 2009 - Business & Economics
URL’s:
1.http://borjournals.com/Research_papers/May_2013/1266M.pdf
2.https://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=793
3.http://iica.in/images/RBI_and_Gatekeepers_of_corporate_governance.pdf
4.http://sbsquare.com/images/Corporate Governance in Banking
%20Sector%20in%20India.pdf
doc_766651112.pdf
100 marks banking project
Corporate governance in banks
1
CHAPTER 1: INTRODUCTION OF CORPORATE
GOVERNANCE IN BANKS.
1.1-INTRODUCTION:
Corporate governance is the set of processes, customs, policies, laws and
institutions affecting the way a corporation is directed, administered or
controlled. Corporate governance also includes the relationships among the
many stakeholders involved and the goals for which the corporation is
governed. The principal stakeholders are the shareholders, management and
the board of directors. Other stakeholders include employees, suppliers,
customers, banks and other lenders, regulators, the environment and the
community at large.
Corporate governance is a multi-faceted subject. An important part of
corporate governance deals with accountability, fiduciary duty, disclosure to
shareholders and others, and mechanism of auditing and control. In this
sense, corporate governance players should comply with codes to the overall
good of all constituents. Another important focus is economic efficiency,
both within the corporations (such as the best practice guidelines) as well as
externally (national institution frameworks). In this “economic” view, the
corporate governance system should be designed in such a way as to
optimize results, as well as to detect and prevent frauds. Some argue that the
firm should act not only in the interest of shareholders but also of all the
stakeholders.
Governance makes decisions that define expectations, grant power, or verify
performance. It consists either of a separate process or of a specific part of
Corporate governance in banks
2
the management or leadership processes. Sometimes people setup a
government to administer these processes and systems. In the case of a
business or a non-profit organization, governance develops and manages
consistent, cohesive policies, processes and decision-rights for a given area
of responsibility. For example, managing at a corporate level might involve
evolvic policies on privacy, on internal investment, and on the use of data.
Corporate governance includes the processes through which corporations
objectives are set and pursued in the context of the social, regulatory and
market environment. Governance mechanisms include monitoring the
actions, policies and decisions of corporations and their agents. Corporate
governance practices are affected by attempts to align the interests of
stakeholders.
Interest in the corporate governance practices of modern corporations,
particularly in relation to accountability, increased following the high-profile
collapses of a number of large corporations during 2001–2002, most of
which involved accounting fraud; and then again after the recent financial
crisis in 2008. Corporate scandals of various forms have maintained public
and political interest in the regulation of corporate governance.
Corporate governance in banks
3
Word- origin:
The word Governance derives from the Latin origins that suggest the notion
of “steering”. One can contrast this sense of “steering” a group or society
with the traditional “Top-Down” approach of governments “driving”
society. Distinguish between governance’s “power to” and governments
“power over”.
1.2-Definition:
Corporate governance has also been more narrowly defined as "a system of
law and sound approaches by which corporations are directed and controlled
focusing on the internal and external corporate structures with the intention
of monitoring the actions of management and directors and thereby,
mitigating agency risks which may stem from the misdeeds of corporate
officers."
One source defines corporate governance as"the set of conditions that shapes
the ex post bargaining over the quasi-rents generated by a firm." The firm
itself is modelled as a governance structure acting through the mechanisms
of contract. Here corporate governance may include its relation to corporate
finance.
According to the Cadbury Committee (UK) “Corporate Governance is a
system by which companies are directed and controlled.”
Corporate governance in banks
4
The Confederation of Indian Industry (CII) has defined Corporate
Governance as “Laws, procedures, practices and implicit rules that
determine a company’s ability to take managerial decisions vis-à-vis its
claimants in particular its shareholders, creditors, the state and employees.”
The OECD Principles of Corporate Governance states:
"Corporate governance involves a set of relationships between a company’s
management, its board, its shareholders and other stakeholders. Corporate
governance also provides the structure through which the objectives of the
company are set, and the means of attaining those objectives and monitoring
performance are determined."
Good governance should provide proper incentives for the board
management to pursue objectives that are in the interest of the company and
shareholders and should facilitate effective monitoring thereby encouraging
firms to use resources efficiently.
Corporate governance in banks
5
Who is involved in corporate governance
The Tripod
Three entities: Management, the Board of Director, Shareholders play an
important role to ensure good corporate governance. They need to
understand their roles properly and act in harmony with each other.
Corporate governance tripod
Management Board of directors
Shareholders
Corporate governance in banks
6
? The management: The CEO is responsible for actually running
the business. He/She has to ensure integrity if the fiscal and
managerial controls to maintain a high level of trust of both
employees and public.
? The Board of Directors: The directors should be accountable to
shareholders and responsible for managing successful and productive
relationships with the corporation’s stakeholders. The directors of the
board are required to act in what they believe to be in the best interests
of the company, regardless of specific view expressed by individual
(even controlling) shareholders.
? The shareholders: They own the company and they require timely
information about performance and results. The shareholders should
also be informed about the rights, rules and procedures governing
them and enabling them to participate effectively.
Corporate governance in banks
7
1.3-MODELS OF CORPORATE GOVERNANCE
Different models of corporate governance differ according to the variety of
capitalism in which they are embedded. The Anglo-American "model" tends
to emphasize the interests of shareholders. The coordinated or
Multistakeholder model associated with Continental Europe and Japan also
recognizes the interests of workers, managers, suppliers, customers, and the
community. A related distinction is between market-orientated and network-
orientated models of corporate governance.
1) Continental Europe
Some continental European countries, including Germany and the
Netherlands, require a two-tiered Board of Directors as a means of
improving corporate governance. In the two-tiered board, the Executive
Board, made up of company executives, generally runs day-to-day
operations while the supervisory board, made up entirely of non-executive
directors who represent shareholders and employees, hires and fires the
members of the executive board, determines their compensation, and
reviews major business decisions.
2) India
The Securities Exchange Board of India Committee on Corporate
Governance defines corporate governance as the "acceptance by
management of the inalienable rights of shareholders as the true owners of
the corporation and of their own role as trustees on behalf of the
Corporate governance in banks
8
shareholders. It is about commitment to values, about ethical business
conduct and about making a distinction between personal & corporate funds
in the management of a company."
3) United States, United Kingdom
The so-called "Anglo-American model" of corporate governance emphasizes
the interests of shareholders. It relies on a single-tiered Board of Directors
that is normally dominated by non-executive directors elected by
shareholders. Because of this, it is also known as "the unitary system".
Within this system, many boards include some executives from the company
(who are ex officio members of the board). Non-executive directors are
expected to outnumber executive directors and hold key posts, including
audit and compensation committees. In the United Kingdom, the CEO
generally does not also serve as Chairman of the Board, whereas in the US
having the dual role is the norm, despite major misgivings regarding the
impact on corporate governance.
In the United States, corporations are directly governed by state laws, while
the exchange (offering and trading) of securities in corporations (including
shares) is governed by federal legislation. Many US states have adopted the
Model Business Corporation Act, but the dominant state law for publicly
traded corporations is Delaware, which continues to be the place of
incorporation for the majority of publicly traded corporations. Individual
rules for corporations are based upon the corporate charter and, less
authoritatively, the corporate bylaws.
Corporate governance in banks
9
1.4-PRINCIPLES
Principle 1: Responsibilities of the Board.
The board has overall responsibility for the bank, including approving and
overseeing the implementation of the bank’s strategic objectives, governance
framework and corporate culture. The board is also responsible for providing
oversight of senior management. The members of the board should exercise
their “duty of care” and “duty of loyalty” to the bank under applicable
national laws and supervisory standards. This includes actively engaging in
the major matters of the bank and keeping up with material changes in the
bank’s business and the external environment as well as acting in a timely
manner to protect the long-term interests of the bank.
Principle 2: Board qualifications and composition.
Board members should be and remain qualified, individually and
collectively, for their positions. They should understand their oversight and
corporate governance role and be able to exercise sound, objective judgment
about the affairs of the bank. The board must be suitable to carry out its
responsibilities and have a composition that facilitates effective oversight.
For that purpose, the board should be comprised of a sufficient number of
independent directors.
The board should be comprised of individuals with a balance of skills,
diversity and expertise, who collectively possess the necessary qualifications
commensurate with the size, complexity and risk profile of the bank.
Corporate governance in banks
10
Principle 3: Board’s own structure and qualification.
The board should define appropriate governance structures and practices for
its own work, and put in place the means for such practices to be followed
and periodically reviewed for ongoing effectiveness. The board should
structure itself in terms of leadership, size and the use of committees so as to
effectively carry out its oversight role and other responsibilities. This
includes ensuring that the board has the time and means to cover all
necessary subjects in sufficient depth and have a robust discussion of issues.
The board should maintain appropriate records (e.g. meeting minutes or
summaries of matters reviewed, recommendations made and decisions
taken) of its deliberations and decisions.
Principle 4: Senior management.
Under the direction and oversight of the board, senior management should
carry out and manage the bank’s activities in a manner consistent with the
business strategy, risk appetite, incentive compensation and other policies
approved by the board. Senior management consists of a core group of
individuals who are responsible and accountable to the board for effectively
overseeing the day-to-day management of the bank. The organization and
procedures and decision-making of senior management should be clear and
transparent and designed to promote effective management of the bank.
This includes clarity on the role and authority of the various positions within
senior management, including the CEO. Members of senior management
should have the necessary experience, competencies and integrity to manage
the businesses and people under their supervision.
Corporate governance in banks
11
Principle 5: Compliance.
The bank’s board of directors is responsible for overseeing the management
of the bank’s compliance risk. The board should approve the bank’s
compliance approach and policies, including the establishment of a
permanent compliance function. An independent compliance function is a
key component of the bank’s second line of defense. This function is
responsible, among other things, for promoting and monitoring that the bank
operates with integrity and in compliance with applicable, laws, regulations
and internal policies. Compliance starts at the top. It will be most effective in
a corporate culture that emphasizes standards of honesty and integrity and in
which the board of directors and senior management lead by example.
Principle 6: Internal Audit.
The internal audit function provides independent assurance to the board and
supports board and senior management in promoting an effective
governance process and the long-term soundness of the bank. The internal
audit function should have a clear mandate, be accountable to the board, be
independent of the audited activities and have sufficient standing, skills,
resources and authority within the bank. The board and senior management
should recognize and acknowledge that an independent and qualified
internal audit function is vital to an effective governance process.
Corporate governance in banks
12
Principle 7: Disclosure and transparency.
The governance of the bank should be adequately transparent to its
shareholders, depositors, other relevant stakeholders and market participants.
Transparency is consistent with sound and effective corporate governance.
As emphasized in existing Committee guidance on bank transparency, it is
difficult for shareholders, depositors, other relevant stakeholders and market
participants to effectively monitor and properly hold the board and senior
management accountable when there is insufficient transparency. The
objective of transparency in the area of corporate governance is therefore to
provide these parties with the information necessary to enable them to assess
the effectiveness of the board and senior management in governing the bank.
Principle 8: Risk identification, monitoring and controlling.
Risks should be identified, monitored and controlled on an ongoing bank-
wide and individual entity basis. The sophistication of the bank’s risk
management and internal control infrastructure should keep pace with
changes to the bank’s risk profile, to the external risk landscape and in
industry practice. The bank’s risk governance framework should include
policies, supported by appropriate control procedures and processes,
designed to ensure that the bank’s risk identification, aggregation, mitigation
and monitoring capabilities are commensurate with the bank’s size,
complexity and risk profile. Risk identification should encompass all
material risks to the bank, on- and off-balance sheet and on a group-wide,
portfolio-wise and business-line level.
Corporate governance in banks
13
Principle 9: The role of supervisors.
Supervisors should provide guidance for and supervise corporate governance
at banks, including through comprehensive evaluations and regular
interaction with boards and senior management, should require improvement
and remedial action as necessary, and should share information on corporate
governance with other supervisors. The board and senior management are
primarily responsible for the governance of the bank, and shareholders and
supervisors should hold them accountable for this. This section sets forth
several principles that can assist supervisors in assessing corporate
governance and fostering good corporate governance in banks. Supervisors
should have processes in place to fully evaluate a bank’s corporate
governance.
1.5-Internal corporate governance controls.
Internal corporate governance controls monitor activities and then take
corrective action to accomplish organizational goals. Examples include:
1) Monitoring by the board of directors:
The board of directors, with its legal authority to hire, fire and compensate
top management, safeguards invested capital. Regular board meetings allow
potential problems to be identified, discussed and avoided. Whilst non-
executive directors are thought to be more independent, they may not always
result in more effective corporate governance and may not increase
performance. Different board structures are optimal for different firms.
Corporate governance in banks
14
Moreover, the ability of the board to monitor the firm's executives is a
function of its access to information. Executive directors possess superior
knowledge of the decision-making process and therefore evaluate top
management on the basis of the quality of its decisions that lead to financial
performance outcomes, ex ante. It could be argued, therefore, that executive
directors look beyond the financial criteria.
2) Internal control procedures and internal auditors:
Internal control procedures are policies implemented by an entity's board of
directors, audit committee, management, and other personnel to provide
reasonable assurance of the entity achieving its objectives related to reliable
financial reporting, operating efficiency, and compliance with laws and
regulations. Internal auditors are personnel within an organization who test
the design and implementation of the entity's internal control procedures and
the reliability of its financial reporting.
3) Balance of power:
The simplest balance of power is very common; require that the President be
a different person from the Treasurer. This application of separation of
power is further developed in companies where separate divisions check and
balance each other's actions. One group may propose company-wide
administrative changes, another group review and can veto the changes, and
a third group check that the interests of people (customers, shareholders,
employees) outside the three groups are being met.
Corporate governance in banks
15
4) Remuneration:
Performance-based remuneration is designed to relate some proportion of
salary to individual performance. It may be in the form of cash or non-cash
payments such as shares and share options, superannuation or other benefits.
Such incentive schemes, however, are reactive in the sense that they provide
no mechanism for preventing mistakes or opportunistic behavior, and can
elicit myopic behavior.
5) Monitoring by large shareholders and/or monitoring by banks and
other large creditors:
Given their large investment in the firm, these stakeholders have the
incentives, combined with the right degree of control and power, to monitor
the management.
1.6-External Corporate Governance Controls.
External stakeholders play an important role in ensuring proper corporate
governance processes in a business organization. Some of the key external
corporate governance controls include:
1) Government regulations.
Government regulations are the most effective external controls on the
governance of a company. Companies are required to comply with these or
face penalties for violations. Most corporate governance regulatory
requirements are based on the OECD Principles of Corporate Governance.
Corporate governance in banks
16
2) Media exposure.
Media scrutiny of the workings and processes of a company ensures, to a
certain degree, the proper governance in an organization. Whistleblowers
often expose wrongdoing within a company to the government and media
organizations.
3) Market competition.
Companies with the best corporate governance practices have the best
standing in the market. Reputation, credibility and positive public perception
all play a vital role in boosting a company’s image and thus help it trump its
competition and best its peers.
3) Takeover activities.
Takeover activities lay a company’s internal processes and workings open to
public scrutiny. Both government regulators and the media will focus on the
internal policies and governance structures, thus acting as an effective
external control.
4) Public release and assessment of financial statements.
The public release of financial statements by listed companies exposes them
open to assessment or scrutiny by regulators, investors, members of the
public and so on. This acts as an external control as companies have to be
scrupulous and careful about the details included in these statements and in
ensuring that they are properly prepared and audited.
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17
1.7-Need for corporate governance.
Banks constitute the largest financial intermediaries around the world and
possess stupendous powers of leverage. Unlike in the corporate world,
authorities like RBI and the government play a direct role in bank
governance through bank regulation and supervision. This role is justified by
the need to ensure systemic stability, financial stability and deposit insurance
liability considerations.
Banks enjoy the benefit of high leverage with the downside protection of
deposit insurance which weakens their incentives for strong management
monitoring. While a ubiquitous form of corporate control and concentrated
ownership will raise new barriers to effective corporate governance, large
investors may manipulate the firm contrary to the broad interests of the bank
and other stakeholders.
Large shareholders may arrange loans for firms they own or business
transactions to profit themselves at the expense of the bank and thereby shift
the bank to higher risk activities in which they benefit on the upside, but the
bank bears the brunt of failure. Who controls management? Boards or bank
supervisors? Regulatory and supervisory systems that foster more accurate
information disclosure and empower private investors legal rights
substantially boost banking system and profitability.
The current trends lay stronger emphasis on risk measurement and
management. Bank supervision should help shareholders. Supervisors must
make the boards the main locus of accountability and assess board
Corporate governance in banks
18
effectiveness. Banks are important stakeholders of corporations. Their
actions can affect corporate performance both positively and negatively.
Their influence as lenders should complement effective shareholder
monitoring.
Although information asymmetries plague all sectors, this problem is more
difficult in finance. In product or other service markets, purchasers part with
their money in exchange for something new. In finance, money is exchanged
for a ‘promise to pay’ in the future. Also, in many products or service
markets, if the object sold - from a car to a haircut - is defective, the buyers
often find out relatively soon.
However, loan quality is not readily observable for quite some time and can
be hidden for extensive periods.Banks and non-bank financial intermediaries
can also alter the risk composition of their assets more quickly than most
non-financial industries. Moreover, banks can readily hide problems by
extending loans to clients that cannot service previous debt obligations.
1) Changing Ownership Structure:
In recent years, the ownership structure of companies has changed a lot.
Public financial institutions, mutual funds, etc. are the single largest
shareholder in most of the large companies. So, they have effective control
on the management of the companies. They force the management to use
corporate governance. That is, they put pressure on the management to
become more efficient, transparent, accountable, etc.
They also ask the management to make consumer-friendly policies, to
protect all social groups and to protect the environment. So, the changing
ownership structure has resulted in corporate governance.
Corporate governance in banks
19
2) Importance of Social Responsibility:
Today, social responsibility is given a lot of importance. The Board of
Directors has to protect the rights of the customers, employees, shareholders,
suppliers, local communities, etc. This is possible only if they use corporate
governance.
3) Growing Number of Scams:
In recent years, many scams, frauds and corrupt practices have taken place.
Misuse and misappropriation of public money are happening everyday in
India and worldwide. It is happening in the stock market, banks, financial
institutions, companies and government offices. In order to avoid these
scams and financial irregularities, many companies have started corporate
governance.
4) Indifference on the part of Shareholders:
In general, shareholders are inactive in the management of their companies.
They only attend the Annual general meeting. Postal ballot is still absent in
India. Proxies are not allowed to speak in the meetings. Shareholders
associations are not strong. Therefore, directors misuse their power for their
own benefits. So, there is a need for corporate governance to protect all the
stakeholders of the company.
Corporate governance in banks
20
5) Globalization:
Today most big companies are selling their goods in the global market. So,
they have to attract foreign investor and foreign customers. They also have
to follow foreign rules and regulations. All this requires corporate
governance. Without Corporate governance, it is impossible to enter, survive
and succeed the global market.
6) Takeovers and Mergers:
Today, there are many takeovers and mergers in the business world.
Corporate governance is required to protect the interest of all the parties
during takeovers and mergers.
7) SEBI:
SEBI has made corporate governance compulsory for certain companies.
This is done to protect the interest of the investors and other stakeholders.
Corporate governance in banks
21
1.8-OBJECTIVES OF CORPORATE GOVERNANCE.
Poor corporate governance may contribute to bank failures, which can pose
significant public costs and consequences due to their potential impact on
any applicable deposit insurance systems and the possibility of broader
macroeconomic implications such as contagion risk and impact on payment
systems. In addition, poor corporate governance can lead markets to lose
confidence in the ability of a bank to properly manage its assets and
liabilities, including deposits, which could turn, trigger a bank run air
liquidity crisis. Generally, banks occupy a delicate position in the economic
equation of any country such that its performance invariably affects the
economy of the country.
? Objectives of corporate governance are to establishing strategic
objectives and a set of corporate values that are communicated
throughout the banking organization;
? Setting and enforcing clear lines of responsibility and accountability
throughout the organization;
? Ensuring that board members are qualified for their positions, have a
clear understanding of their role in corporate governance and are not
subject to undue influence from management or outside concerns;
? And ensuring that compensation approaches are consistent with the
bank's ethical values, objectives, strategy and control environment.
Corporate governance in banks
22
CHAPTER 2-HISTORY OF CORPORATE
GOVERNANCE.
Robert E. Wright argues in Corporation Nation that the governance of early
U.S. corporations, of which there were over 20,000 by the Civil War, was
superior to that of corporations in the late 19th and early 20th centuries
because early corporations were run like "republics" replete with numerous
"checks and balances" against fraud and usurpation of power of managers or
large shareholders.
In the 20th century in the immediate aftermath of the Wall Street Crash of
1929 legal scholars such as Adolf Augustus Berle, Edwin Dodd, and
Gardiner C. Means pondered on the changing role of the modern corporation
in society. From the Chicago school of economics, Ronald Coase introduced
the notion of transaction costs into the understanding of why firms are
founded and how they continue to behave.
US expansion after World War II through the emergence of multinational
corporations saw the establishment of the managerial class. Studying and
writing about the new class were several Harvard Business School
management professors: Myles Mace (entrepreneurship), Alfred D.
Chandler, Jr. (business history), Jay Lorsch (organizational behavior) and
Elizabeth MacIver (organizational behavior). According to Lorsch and
MacIver "many large corporations have dominant control over business
affairs without sufficient accountability or monitoring by their board of
directors."
In the 1980s, Eugene Fama and Michael Jensen established the principal–
agent problem as a way of understanding corporate governance: the firm is
seen as a series of contracts.
Corporate governance in banks
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Over the past three decades, corporate directors’ duties in the U.S. have
expanded beyond their traditional legal responsibility of duty of loyalty to
the corporation and its shareholders.
In the first half of the 1990s, the issue of corporate governance in the U.S.
received considerable press attention due to the wave of CEO dismissals
(e.g.: IBM, Kodak, Honeywell) by their boards. The California Public
Employees' Retirement System (CalPERS) led a wave of institutional
shareholder activism (something only very rarely seen before), as a way of
ensuring that corporate value would not be destroyed by the now
traditionally cozy relationships between the CEO and the board of directors
(e.g., by the unrestrained issuance of stock options, not infrequently back
dated).
In the early 2000s, the massive bankruptcies (and criminal malfeasance) of
Enron and WorldCom, as well as lesser corporate scandals, such as Adelphia
Communications, AOL, Arthur Andersen, Global Crossing, Tyco, led to
increased political interest in corporate governance. This is reflected in the
passage of the Sarbanes-Oxley Act of 2002. Other triggers for continued
interest in the corporate governance of organizations included the financial
crisis of 2008/9 and the level of CEO pay.
There have been several major corporate governance initiatives launched in
India since the mid-1990s. The first was by the Confederation of Indian
Industry (CII), India‘s largest industry and business association, which came
up with the first voluntary code of corporate governance in 1998. The
second was by the SEBI, now enshrined as Clause 49 of the listing
agreement. The third was the Naresh Chandra Committee, which submitted
its report in 2002. The fourth was again by SEBI — the Narayana Murthy
Corporate governance in banks
24
Committee, which also submitted its report in 2002. Based on some of the
recommendation of this committee, SEBI revised Clause 49 of the listing
agreement in August 2003.Subsequently, SEBI withdrew the revised Clause
49 in December 2003, and currently, the original Clause 49 is in force.
2.1- The CII Code:
More than a year before the onset of the Asian crisis, CII set up a committee
to examine corporate governance issues, and recommend a voluntary code of
best practices. The committee was driven by the conviction that good
corporate governance was essential for Indian companies to access domestic
as well as global capital at competitive rates. The first draft of the code was
prepared by April 1997, and the final document (Desirable Corporate
Governance: A Code), was publicly released in April 1998. The code was
voluntary, contained detailed provisions, and focused on listed companies.
a) Desirable Disclosure:
Listed companies should give data on high and low monthly averages of
share prices in a major stock exchange where the company is listed; greater
detail on business segments, up to 10% of turnover, giving share in sales
revenue, review of operations, analysis of markets and future prospects.
Major Indian stock exchanges should gradually insist upon a corporate
governance compliance certificate, signed by the CEO and the CFO.If any
company goes to more than one credit rating agency, then it must divulge in
the prospectus and issue document the rating of all the agencies that did such
an exercise. These must be given in a tabular format that shows where the
company stands relative to higher and lower ranking.
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25
2.2- Kumar Mangalam Birla committee
Report and Clause 49:
While the CII code was well-received and some progressive companies
adopted it, it was felt that under Indian conditions a statutory rather than a
voluntary code would be more purposeful, and meaningful. Consequently,
the second major corporate governance initiative in the country was
undertaken by SEBI. In early 1999, it set up a committee under Kumar
Mangalam Birla to promote and raise the standards of good corporate
governance. In early 2000, the SEBI had accepted and ratified key
recommendations of this committee, and these were incorporated into
Clause 49 of the Listing Agreement of the Stock Exchanges.
a) The constitutions of Committee:
The committee has identified the three key constituents of corporate
governance as the shareholders, the Board of Directors and the Management.
Along with this the committee has identified major 3 aspects namely
accountability, transparency and equality of treatment for all shareholders.
Crucial to good corporate governance are the existence and enforceability of
regulations relating to insider information and insider trading.
These matters are currently being examined over here. The committee had
received good comments from almost all experts‘ institutions, chamber of
commerce Adrian Cadbury – Cadbury Committee etc.
Corporate governance in banks
26
2.3-Naresh Chandra Committee Report:
The Naresh Chandra committee was appointed in August 2002 by the
Department of Company Affairs (DCA) under the Ministry of Finance and
Company Affairs to examine various corporate governance issues. The
Committee submitted its report in December 2002. It made
recommendations in two key aspects of Corporate Governance: financial
and non-financial disclosures: and independent auditing and board oversight
of management.
2.4-NarayanaMurthy Committee report on Corporate
Governance:
The fourth initiative on corporate governance in India is in the form of the
recommendations of the Narayana Murthy committee. The committee was
set up by SEBI, under the chairmanship of Mr. N. R. Narayana Murthy, to
review Clause 49, and suggest measures to improve corporate governance
standards. Some of the major recommendations of the committee primarily
related to audit committees, audit reports, independent directors, related
party transactions, risk management, directorships and director
compensation, codes of conduct and financial disclosures.
a) Confederation of Indian Industry (CII) Taskforce on
Corporate Governance:
History tells us that even the best standards cannot prevent instances of
major corporate misconduct. This has been true in the US - Enron,
WorldCom, Tyco and, more recently gross miss-selling of collateralized
debt obligations; in the UK; in France; in Germany; in Italy; in Japan; in
Corporate governance in banks
27
South Korea; and many other OECD nations. The Satyam-Maytas Infra-
Maytas Properties scandal that has rocked India since 16th December 2008
is another example of a massive fraud.
b) Corporate Governance voluntary guidelines 2009:
More recently, in December 2009, the Ministry of Corporate Affairs (MCA)
published a new set of ?Corporate Governance Voluntary Guidelines
2009, designed to encourage companies to adopt better practices in the
running of boards and board committees, the appointment and rotation of
external auditors, and creating a whistle blowing mechanism. The guidelines
are divided into the following six parts:
i) Board of Directors.
The board of directors is the first level of supervision over the activities of
the bank and its management. The board is ultimately responsible for the
activities and results of the bank, for the maintenance of stability and
financial soundness. The powers and rules of the board are specified in the
law and the statute of a bank. The mode of operation should be specified in
the rules of procedure of the board. The core competences of the board
forming the foundations of the bank activities include: approving and
overseeing the strategic objectives of the bank and its corporate values,
overseeing the work of the management board and the determination of the
scope of the obligations and liability of the management members, the
establishment of guidelines for the acceptable level of risk, overseeing the
introduction of the management system (consisting at least of the system of
Corporate governance in banks
28
risk management and internal control system), and assessment of the
adequacy and effectiveness of the system.
ii) Audit Committee of the Board.
? Is required for systemically important banks. For banks of large size,
risk profile or complexity it is strongly advised. For other banks it
remains strongly recommended.
? Is required to be distinct from other committees.
? Should have a chair who is independent and is not the chair of the
board or any other committee.
? Should be made up entirely of independent or non-executive board
members.
? Should include members who have experience in audit practices and
financial literacy at banks.
The audit committee is responsible, among other things, for:
? The financial reporting process.
? Providing oversight of and interacting with the bank’s internal and
external auditors.
? Approving, or recommending to the board or shareholders for their
approval, the appointment 15 compensation and dismissal of external
auditors;
? Reviewing and approving the audit scope and frequency.
Corporate governance in banks
29
iii) Auditors.
The statutory responsibilities of the auditor fundamentally require the
following:
? Duty to make certain inquiries.
? Duty to make a report to the company on the accounts examined.
? Duty to make a proclamation in terms of the provisions set.
? Detection and Prevention of Fraud.
? Duty to report fraud.
? Duty as to substantial precision.
iv) Secretarial Audit.
Secretarial audit will definitely lead to better corporate governance as the
scope of it includes examining the board processes and practices, as also
reporting on compliances. The new Company Act 2013 with the focus on
transparency entails extensive and detailed disclosures. Secretarial audit
validates such disclosures.
v) Institution of mechanism for Whistle Blowing.
A whistleblower is a person who exposes any kind of information or activity
that is deemed illegal, dishonest, or not correct within an organization that is
either private or public. The information of alleged wrongdoing can be
classified in many ways: violation of company policy/rules, law, regulation,
or threat to public interest/national security, as well as fraud, and corruption.
Those who become whistleblowers can choose to bring information or
allegations to surface either internally or externally. Internally, a
whistleblower can bring his/her accusations to the attention of other people
Corporate governance in banks
30
within the accused organization. Externally, a whistleblower can bring
allegations to light by contacting a third party outside of an accused
organization. He/She can reach out to the media, government, law
enforcement, or those who are concerned. Whistleblowers also face stiff
retaliation from those who are accused or alleged of wrongdoing.
The SEBI had made it mandatory that all listed companies should create a
mechanism for employees to report to the management concerns about any
unethical behavior, fraud or violation of the code of conduct.
Prevention of insider trading
The SEBI Regulations 2002 define 'insider' "as any person who, is or was
connected with the company or is deemed to have been connected with the
company, and who is reasonably expected to have access to unpublished
price sensitive information in respect of securities of the company, or who
has received or has had access to such unpublished price sensitive
information". As defined under the Act, the definition of insider information
is driven by the notion that a person in a fiduciary position should not use
the privileged information for his or her own advantage.
The practical limitation of the 'person-connected' approach is chiefly the
practical difficulties of ensuring that all people who trade on inside
information are caught. It may be quite difficult for the prosecution to show
the existence of a 'connection', even when they can show that the secondary
insider in question has been dealing and using the information. If
prosecution fails to prove it, any person can escape. Rather than personnel
connection based approach information based approach be adopted to
prevent insider trading.
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31
CHAPTER 3: CORPORATE GOVERNANCE IN
BANKS.
Banking system plays a very important role in the economic life of the
nation. The health of the economy is closely related to the soundness of its
banking is now an essential part of our economic system. The Indian
banking system is among the healthier performers in the world. In the
liberalized economic environment and integration of the country, in to world
market the corporate sector in India at present cannot ignore the importance
of Corporate Governance. The Corporate Governance philosophy of banks
has to be based on pursuit of sound business ethics and strong
professionalism that aligns the interests of all stakeholders and the society.
Strengthening of public confidence in banks is a vital requirement.
Staying focused on fundamentals, adoption of utmost professionalism,
conformity to prescribed norms of lending & investment, adherence to sound
banking principles & ensuring optimum capital efficiency are vital for
success & continued survival of banks. The conclusion is that sound
Corporate Governance would lead to effective & more meaningful
supervision and could contribute to a collaborative working relationship
between bank management & bank supervisors. Banks need to ensure good
Corporate Governance in order to achieve excellence, transparency & for
maximization shareholders value & wealth. With elements of good corporate
governance, sound investment policy, appropriate internal control systems,
better credit risk management, focus on newly-emerging business,
commitment to better customer service, adequate automation and proactive
Corporate governance in banks
32
policies, banks will definitely be able to grapple with these challenges and
convert them into opportunities.
From the perspective of banking industry, corporate governance also
includes in its ambit the manner in which their Board of Directors governs
the business and affairs of individual institutions and their functional
relationship with senior management. This is determined by how banks:
? set corporate objectives (including generating economic returns to
owners);
? run the day-to-day operations of the business and;
? consider the interests of recognized stakeholders i.e., employees,
customers, suppliers, supervisors, governments and the community
and
? Line up corporate activities and behaviors with the expectation that
banks will operate in a safe and sound manner, and in compliance
with applicable laws and regulations; and of course protect the
interests of depositors, which is supreme.
For ensuring good corporate governance, the importance of overseeing the
various aspects of the corporate functioning needs to be properly understood,
appreciated and implemented.
There are four important forms of oversight that should be included in the
organizational structure of any bank in order to ensure the appropriate
checks and balances:
? Oversight by the board of directors or supervisory board;
? Oversight by individuals not involved in the day-to-day running of
the various business areas;
? Direct line supervision of different business areas; and
Corporate governance in banks
33
? Independent risk management and audit functions. In addition to
these, it is important that the key personnel are fit and proper for their
jobs.
3.1-HOW IT IS DIFFERENT
Banks are different from other corporate in important respects, and that
makes corporate governance of banks not only different but also more
critical. Banks lubricate the wheels of the real economy, are the conduits of
monetary policy
transmission and constitute the economy‘s payment and settlement system.
By the very nature of their business, banks are highly leveraged. They accept
large amounts of uncollateralized public funds as deposits in a fiduciary
capacity and further leverage those funds through credit creation. The
presence of a large and dispersed base of depositors in the stakeholders
group sets banks apart from other corporate.
Banks are “special” as they not only accept and deploy large amount of
uncollateralized public funds in fiduciary capacity, but they also leverage
such funds through credit creation. The role of banks is integral to any
economy. They provide financing for commercial enterprises access to
payment systems and a variety of retail financial services for the economy at
large. The integral role that banks play in the national economy is
demonstrated by the almost universal practice of states in regulating the
banking industry and providing in many cases a government safety net to
compensate depositors when banks fail. The large number of stakeholders
whose economic well-being depends on the health of the banking system
depends on implementation of appropriate regulatory practices and
supervision. Indeed in a healthy banking system the regulators and
Corporate governance in banks
34
supervisors themselves are stakeholders acting on behalf of society at large.
As regulators we do not act on behalf of shareholders or individual
customers but on behalf of groups such as depositor’s policyholders or
pension fund members who rely on the continued solvency of regulated
institutions for their financial security but who are themselves not well
placed to assess financial soundness.
Banks unlike insurance companies are highly leveraged entities and asset
liability mismatches are an inherent feature of their business. Consequently,
they face a wide range of risks in their day-to-day operations. Any
mismanagement of risks by these entities can have very serious and drastic
consequences on a stand-alone basis which might pose a serious threat for
financial stability. This dimension further strengthens our premise that
effective risk management systems are essential for financial institutions and
emphasizes the need for these to be managed with great responsibility and
maturity. Good corporate governance, therefore, is fundamental to achieve
this objective.
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35
3.2-REGULATIONS AND CORPORATE GOVERNANCE
OF BANKS
Bank regulations are a form of government regulation which subject banks
to certain requirements, restrictions and guidelines. This regulatory structure
creates transparency between banking institutions and the individuals and
corporations with whom they conduct business, among other things.
Regulation has historically had a significant role in the evolution of
corporate governance principles in the banking industry. However, to
believe on this basis that good regulation can offset bad corporate
governance will be patently wrong. Regulation can complement corporate
governance, but cannot substitute for it.
The crisis has triggered a swathe of financial reforms to mitigate some of the
known risks revealed by it. Understandably, these reforms also encompass
corporate governance. Several countries have effected major structural
changes to improve the functioning of their financial institutions, to ensure
the robustness of their risk management systems and to make their
operations more transparent.
By far the most notable has been the Dodd-Frank Act in the United States
which, among other things, aims to induce greater transparency with regard
to the board and the top management positions and their compensation.
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36
3.3-IMPORTANCE OF CORPORATE GOVERNANCE IN
BANKS.
Banks are a critical component of the economy while providing financing
for commercial enterprises, basic financial services to a broad segment of
the population and access to payment systems. The importance of banks to
national economies is underscored by the fact that banking is, almost
universally, a regulated industry and that banks have access to government
safety nets. It is of crucial importance therefore that banks have strong
corporate governance practices.
Banks are also important catalysts for economic reforms, including
corporate governance practices. Because of the systemic function of banks,
the incorporation of corporate governance practices in the assessment of
credit risks pertaining to lending process will encourage the corporate sector
in turn to improve their internal corporate governance practices.
Importance of implementing modern corporate governance standards is
conditioned by the global tendency to consolidation in the banking sector
and a need in further capitalization.
Best corporate governance practices will enable banks to:
? Increase efficiency of their activities and minimize risks;
? Get an easier access to capital markets and decrease the cost of
capital;
? Increase growth rate;
? Attract strategic investors;
? Improve the standards of lending;
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37
? Protect the rights of minority shareholder and other counterparts;
? Strengthen their reputation and raise the level of investors and clients'
trust.
Prerequisites for Good Governance.
There are some pre-requisites for good corporate governance. They are:
? A proper system consisting of clearly defined and adequate structure
of roles, authority and responsibility.
? Vision, principles and norms which indicate development path,
normative considerations and guidelines and norms for performance.
? A proper system for guiding, monitoring, reporting and control.
3.4-EVOLUTION OF CORPORATE GOVERNANCE IN
BANKS.
Let briefly sketch the evolution of corporate governance of banks in India. In
the pre-reform era, there were very few regulatory guidelines covering
corporate governance of banks. This was reflective of the dominance of
public sector banks and relatively few private banks.
That scenario changed after the reforms in 1991 when public sector banks
saw a dilution of government shareholding and a larger number of private
Corporate governance in banks
38
sector banks came on the scene. How did these changes shape the post
reform standards of corporate governance.
First: The competition brought in by the entry of new private sector banks
and their growing market share forced banks across board to pay greater
attention to customer service. As customers were now able to vote with their
feet, the quality of customer service became an important variable in
protecting, and then increasing, market share.
Second: Post-reform, banking regulation shifted from being prescriptive to
being prudential. This implied a shift in balance away from regulation and
towards corporate governance. Banks now had greater freedom and
flexibility to draw up their own business plans and implementation strategies
consistent with their comparative advantage.
The boards of banks had to assume the primary responsibility for overseeing
this. This required directors to be more knowledgeable and aware and also
exercise informed judgment on the various strategy and policy choices.
Third: Two reform measures pertaining to public sector banks - entry of
institutional and retail shareholders and listing on stock exchanges - brought
about marked changes in their corporate governance standards. Directors
representing private shareholders brought new perspectives to board
deliberations, and the interests of private shareholders began to have an
impact on strategic decisions. On top of this, the listing requirements of
SEBI enhanced the standards of disclosure and transparency.
Corporate governance in banks
39
Fourth: To enable them to face the growing competition, public sector
banks were accorded larger autonomy. They could now decide on virtually
the entire gamut of human resources issues, and subject to prevailing
regulation, were free to undertake acquisition of businesses, close or merge
unviable branches, open overseas offices, set up subsidiaries, take up new
lines of business or exit existing ones, all without any need for prior
approval from the Government. All this meant that greater autonomy to the
boards of public sector banks came with bigger responsibility.
Fifth: A series of structural reforms raised the profile and importance of
corporate governance in banks. The ‘structural’ reform measures included
mandating a higher proportion of independent directors on the boards;
inducting board members with diverse sets of skills and expertise; and
setting up of board committees for key functions like risk management,
compensation, investor grievances redressal and nomination of directors.
Structural reforms were furthered by the implementation of the Ganguly
Committee recommendations relating to the role and responsibilities of the
boards of directors, training facilities for directors, and most importantly,
application of ‘fit and proper ’norms for directors.
Corporate governance in banks
40
CHAPTER 4: CORPORATE GOVERNANCE IN
TODAY’S CONTEXT.
4.1-Corporate Governance in today’s context:
According to Milton Friedam, “Corporate Governance is to conduct the
business in accordance with owner’s or shareholders desires, which
generally will be to make as much money as possible” but this context is
based on marked maximization that underpins shareholder capitalism.
But this context was further expanded by J.Wolfensohn, President, World
Bank, has said that “Corporate Governance is about promoting corporate
fairness, transparency and accountability.
Even the Experts at Organization of Economic Co-Operation and
Development (OECD) have defined “Corporate Governance” as the system
by which business corporations are directed and controlled, it means
according to them it is a structure which specifies the distribution of rights
and responsibilities among different participants in the corporation.
But today the concept of corporate governance has taken a new dimension
and it runs as follows,
“Corporate governance is the application of best management practices,
compliance of law in true letter and spirit and adherence to ethical standards
for effective management and distribution of wealth and discharge of social
responsibility for sustainable development of all stakeholders”.
Corporate governance in banks
41
4.2-Corporate Governance in Indian Context:
In the Indian context, the need for corporate governance has been
highlighted because of the scams occurring frequently since the emergence
of the concept of liberalization from 1991 such as the Harshad Mehta Scam,
Ketan Parikh Scam, UTI Scam, Vanishing Company Scam, Bhansali Scam
and so on. In the Indian corporate scene, there is a need to induct global
standards so that at least while the scope for scams may still exist, it can be
at least reduced to the minimum.
From the beginning of 1980s, situations have changed in India. There have
been wide-ranging changes has taken place in both the laws and the
regulations in the field of corporate law and the capital market. As a result of
several scams in India a need has arisen to bring reforms, in response to that,
reforms began in 1991 in India. The most important event in the field of
investor protection in
India was the establishment of Securities and Exchange Board of India
(SEBI) in 1992. Corporate governance is a multi-faceted subject. An
important theme of corporate governance deals with issues of accountability
and fiduciary duty, essentially advocating the implementation of policies and
mechanisms to ensure good behavior and protect shareholders. Another key
focus is the economic efficiency view, through which the corporate
governance system should aim to optimize economic results, with a strong
emphasis on shareholders welfare.
In India the concept of corporate governance is gaining importance because
of two reasons.
? After liberalization, there has been institutionalization of financial
markets, FIIs and FIs became dominant players in the stock markets.
Corporate governance in banks
42
The market began to discriminate between wealth destroyers.
Corporate governance is a critical by product of market discipline.
? Another factor is the increased role being played by the private sector.
Companies are realizing that investors love to stay with those
corporate that create values for their investors.
This is only possible by adopting fair, honest and transparent corporate
practices.
4.3-Corporate Governance in Public Sector Banks
A substantial chunk of Indian Banking sectors still remains under the control
of public sector banks despite the strong wave of Globalization,
Liberalization and privatization and entrance of private and foreign banks in
the arena. The major shareholding of the public banks with the Government
the reasons for such ownership may include solving the severe informational
problems inherent in developing financial systems, aiding the development
process or supporting the vested interests and tributional cartels.
Banks have been making pivotal contributions over the years to nation’s
economic growth and development. Government-owned (Public Sector)
banks have played a major role in economic development. During the last
few years, these institutions are slowly getting “corporative” and
consequently corporate governance issues in banks assumes greater
significance in the coming years.
Considering the importance of banking sector the practice of corporate
governance and how it helps banking industry in India in terms of bringing
more transparency and overall growth of banking sector.
Corporate governance in banks
43
Basel Committee has underscored the need for the banks to establish the
strategies and to become accountable for executing as well as implementing
them. The existing legal institutional framework of public sector banks is not
aligned with principles of good corporate governance. The bureaucratic
hassles, red tapes and de motivated work culture add further fuel to the fire.
So far banks have been burdened with “social responsibility “ and compelled
to tow the line of thinking dictated by the political party in power, healthy
banking policies will not be able to become the top priority.
Monopoly of PSB in banking business had protected them from competition
and bank Managements have thereby became complacent.
Corporate Governance in PSBs is important, not only because PSBs happen
to dominate the banking industry, but also because, they are unlikely to exit
from banking business though they may get transformed. To the extent there
is public ownership of PSBs, the multiple objectives of the Government as
owner and the complex principal-agent relationships cannot be wished away.
PSBs cannot be expected to blindly mimic private corporate banks in
governance though general principles are equally valid. Complications arise
when there is a widespread feeling of uncertainty of the ownership and
public ownership is treated as a transitional phenomenon. The anticipation or
threat of change in ownership has also some impact on governance, since
expected change is not merely of owner but the very nature of owner. Mixed
ownership where government has controlling interest is an institutional
structure that poses issues of significant difference between one set of
owners who look for commercial return and another who seeks something
more and different, to justify ownership. Furthermore, the expectations, the
reputation risks and the implied even if not exercised authority in respect of
the part-ownership of government in the governance of such PSBs should be
Corporate governance in banks
44
recognized. In brief, the issue of corporate governance in PSBs is important
and also complex. From the banking industry perspective, the attributes of
corporate governance provide guidelines to the directors and the top level
managers to govern the business of banks. These guidelines relate to how
banks establish corporate aims, carry out their daily activities, and take into
account the interest of stakeholders and making sure that the corporate
activities are in tune with the public expectations that banks will function in
an ethical and legal manner thereby protecting the interest of its depositors
(Basel Committee, 1999). All these broad issues relating to governance
apply to other companies also, but they assume more significance for banks
because they deal with public deposits directly.
Banks' philosophy for Corporate Governance should lay emphasis on the
cardinal values of 'fairness', 'transparency' and 'accountability', as enunciated
by World Bank, for performance at all levels, thereby, enhancing the
shareholders' value and protecting the interest of the stakeholders.
The Banks consider themselves as trustee of its shareholders and should
acknowledge its responsibility towards them for creation and safeguarding
shareholders' wealth. Banks should continue its pursuit of achieving these
objectives through the adoption and monitoring of corporate strategies,
prudent business plans, monitoring of major risks of the banks business and
pursuing the policies and procedures to satisfy its legal and ethical
responsibilities. Hence, banks should aim at enhancing the long term
shareholder value while protecting the 'interest of shareholders, customers
and other in line with international best practices.
Corporate governance in banks
45
CORPORATE GOVERNANCE OF STATE BANK OF
INDIA.
To enhance management transparency and Corporate Governance, SBI
holdings recognizes that one of its most crucial management task is to build
and maintain an organizational structure capable of responding quickly to
the changes in the business environment as well as a fair management
system that emphasis interest of the shareholders.
State Bank of India is committed to the best practices in the area of
Corporate Governance. The bank believes that good Corporate Governance
is much more than complying with legal and regulatory requirements. Good
governance facilitates effective management and control of business, enables
the bank to maintain high level of business ethics and to optimize the value
for all its stake holders.
The objectives can be summarized as:
? To enhance shareholder value
? To protect the interest of shareholders and other stakeholders
including customers, employees and society at large.
? To ensure transparency and integrity in communication and to make
available full, accurate and clear information to all concerned.
? To ensure accountability for performance and to achieve excellence at
all levels.
? To provide corporate leadership of highest standard for others to
emulate.
Corporate governance in banks
46
4.4-Corporate Governance in Private Sector Banks.
Private sector banks have entered niche areas, listed their scrip and being
market driven they have been more transparent in their functioning. They
have also been more tech savvy, growth oriented and have less of NPAs.
Private sector banks has to conform with standard of good banking practices
such as
? Ensuring a fair and transparent relationship between the customer and
bank;
? Instituting comprehensive risk management system and its adequate
disclosure;
? Proactively handling the customer complaints and evolving scheme of
redressal for grievances;
? Building systems and processes to ensure compliance with the statutes
concerning banking.
CORPORATE GOVERNANCE PRACTICES IN ICICI
BANK
Corporate Governance policies of ICICI Bank recognize the accountability
of the board and the importance of its decisions to all their constituents,
including customers, investors, employees and the regulatory authorities.
The functions of the board and the executive management are well defined
and are distinct from one another. They have taken a series of steps
including the setting up of sub committees of the board to oversee the
functions of executive management.
Corporate governance in banks
47
The board’s role, functions, responsibility and accountability are clearly
defined. In addition to its primary role of monitoring corporate performance,
the functions of the board include:
? Approving corporate philosophy and mission
? Participating in the formulation of strategic and business plan
? Reviewing and approving financial plans and budgets.
? Monitoring corporate performance against strategic and business
plans including overseeing operations
? Ensuring ethical behavior and compliance with laws and regulations.
? Formulating exposure limits
? Keeping shareholders informed regarding plans, strategies and
performance.
Recent Steps Taken by Banks in India for Corporate
Governance
? Induction of non-executive members on the Boards
? Constitution of various Committees like Management Committee,
Audit Committee, Investor’s Grievances Committee, ALM
Committee etc.
? Gradual implementation of prudential norms as prescribed by RBI,
? Introduction of Citizens Charter in Banks
? Implementation of “Know Your Customer” concept.
The primary responsibility for good governance lies with the Board of
Directors and the senior management of the bank.
Corporate governance in banks
48
4.5-Corporate Governance in Co-operative Banks.
For the co-operative banks in India, these are challenging times. Never
before has the need for restoring customer confidence in the cooperative
sector been felt so much. Never before has the issue of good governance in
the co-operative banks assumed such criticality. The literature on corporate
governance in its wider connotation covers a range of issues such as
protection of shareholders rights, enhancing shareholders value, Board
issues including its composition and role, disclosure requirements, integrity
of accounting practices, the control systems, in particular internal control
systems.
Corporate governance especially in the co-operative sector has come into
sharp focus because more and more co-operative banks in India, both in
urban and rural areas, have experienced grave problems in recent times
which has in a way threatened the profile and identity of the entire
cooperative system. These problems include mismanagement, financial
impropriety, poor investment decisions and the growing distance between
members and their co-operative society.
The purpose and objectives of co-operatives provide the framework for co-
operative corporate governance. Co- operatives are organized groups of
people and jointly managed and democratically controlled enterprises. They
exist to serve their members and depositors and produce benefits for them.
Co-operative corporate governance is therefore about ensuring co-operative
relevance and performance by connecting members, management and the
employees to the policy, strategy and decision-making processes.
Corporate governance in banks
49
CHAPTER 5: CORPORATE GOVERNANCE
MECHANISM.
Banks play a pivotal role in the financial and economic system of any
country.RBI plays a leading role in formulating and implementing corporate
governance norms for India’s banking sector.
The ambit encompasses safeguarding and maximizing the shareholders’
value, upholding retail depositors’ risk and stabilizing the financial system
so as to conserve the larger interests in public. This role becomes important
in view of the fact that in Indian bank assets often lack transparency and
liquidity because most bank loans, unlike other products and services, are
customized and privately negotiated.Banks are ‘special’ as they not only
accept and deploy large amount of uncollateralized public funds in a
fiduciary capacity, but they also leverage such funds through credit
creations. They are also important for smooth functioning of the payment
system.
In case of instability of one bank owing to incompetent or unethical
management, the entire financial system and the economy may be impacted
adversely. As one bank becomes unstable, there may be a heightened
perception of risk among depositors for the entire class of such banks,
leading to early liquidation and exposing the entire financial system to
choas. In such a situation, the interest of borrowers (corporate, retail, etc)
may also be affected in terms of availability of credit, recall of credit lines
and loss in valuation of mortgaged assets.
Corporate governance in banks
50
Two main features set banks apart from other business- the level of
opaqueness in their functioning and the relatively greater role of government
and regulatory agencies in their activities. The opaqueness in banking
creates considerable information asymmetries between the “insiders” –
management and “outsiders” – owners and creditors. The very nature of the
business makes it extremely easy and tempting for management to alter the
risk profile of banks as well as siphon funds.
The Reserve Bank of India performs corporate governance function under
the guidance of the Board for Financial Supervision (BFS). Primary
objectives of BFS is to undertake consolidated supervision of the financial
sector comprising commercial banks, financial institutions and non-banking
finance companies.
BFS was constituted in November 1994 as a committee of the Central Board
of Directors of the Reserve Bank of India. The Board comprises of four
directors of RBI from central board and is chaired by Governor. The Board
is required to meet normally once every month. It considers inspection
reports and other supervisory issues placed before it by the supervisory
departments.
The BFS oversees the functioning of Department of banking Supervision
(DBS), Department of Non-banking Supervision (DNBS) and Financial
Institutions Division (FID) and gives directions on the regulatory and
supervisory issues.
BFS inspects and monitors banks using the “CAMELS” (Capital adequacy,
Asset quality, Management, Earnings, Liquidity and Systems and controls)
approach. BFS through the Audit Sub-Committee also aims at upgrading the
quality of the statutory audit and internal audit functions in banks and
financial institutions.
Corporate governance in banks
51
5.1-Corporate governance mechanisms followed by RBI
are a three-pronged approach:
1) Disclosure and Transparency.
Disclosure and transparency are the main pillars of a corporate governance
framework enabling adequate information flow to various stakeholders and
leading to informed decisions. Accounting standards in India in all sectors
including banking sector have been enhanced to align with international best
practices.
2) Off-site surveillance.
The off-site surveillance mechanism monitors the movement of assets, its
impact on capital adequacy and overall efficiency and adequacy of
managerial practices in banks. RBI promotes self-regulation and market
discipline among the banking sector participants and has issued prudential
norms for income recognition, asset classification, and capital adequacy.
RBI brings out periodic data on ‘Peer Group Comparison’ on critical ratios
to maintain peer pressure on individual banks for better performance and
governance.
3) Prompt corrective action.
Prompt Corrective Action is a supervisory mechanism implemented as a part
of Effective Banking Supervision in terms of Basel II requirements. It is
based on a pre-determined rules based structure of early intervention
whereby benchmark ratios for three parameters –Capital Adequacy Ratio,
Non-Performing Assets Ratio and Return on Assets are determined. Any
Corporate governance in banks
52
breach of these trigger points is considered as early warning on the financial
health of the banks and appropriate mandatory or discretionary action is
initiated by the RBI.
THE SPECIAL PLACE OF BANKING
The banking sector is not necessarily totally corporate. Some part of it is, of
course, but a segment of banks is mostly government owned as statutory
corporations or run as cooperatives – just like your bank. Banking as a sector
has been unique and the interests of other stake holders appear more
important to it than in the case of non-banking and non-finance
organizations. In the case of traditional manufacturing corporations, the
issue has been that of safeguarding and maximizing the shareholders? value.
In the case of banking, the risk involved for depositors and the possibility of
contagion assumes greater importance than that of consumers of
manufactured products.
Further, the involvement of government is discernibly higher in banks due to
importance of stability of financial system and the larger interests of the
public. Since the market control is not sufficient to ensure proper
governance in banks, the government does see reason in regulating and
controlling the nature of activities, the structure of bonds, the ownership
pattern, capital adequacy norms, liquidity ratios, etc.
Corporate governance in banks
53
REASONS FOR HIGH DEGREE OF OVERSIGHT
There are three reasons for degree of government oversight in this sector.
? Firstly, it is believed that the depositors, particularly retail depositors,
cannot effectively protect themselves as they do not have adequate
information, nor are they in a position to coordinate with each other.
? Secondly, bank assets are unusually opaque, and lack transparency as
well as liquidity. This condition arises due to the fact that most bank
loans, unlike other products and services, are usually customized and
privately negotiated.
? Thirdly, it is believed that that there could be a contagion effect
resulting from the instability of one bank, which would affect a class
of banks or even the entire financial system and the economy. As one
bank becomes unstable, there may be a heightened perception of risk
among depositors for the entire class of such banks, resulting in arun
on the deposits and putting the entire financial system in jeopardy.
5.2-ROLE OF THE GOVERNMENT AND THE
REGULATOR.
Regulators are external pressure points for good corporate governance. Mere
compliance with regulatory requirements is not however an ideal situation in
itself. In fact, mere compliance with regulatory pressures is a minimum
Corporate governance in banks
54
requirement of good corporate governance and what are required are internal
pressures, peer pressures and market pressures to reach higher than
minimum standards prescribed by regulatory agencies. RBI’s approach to
regulation in recent times has some features that would enhance the need for
and usefulness of good corporate governance in the co-operative sector. The
transparency aspect has been emphasized by expanding the coverage of
information and timeliness of such information and analytical content.
Importantly, deregulation and operational freedom must go hand in hand
with operational transparency.
In fact, the RBI has made it clear that with the abolition of minimum
lending rates for co-operative banks, it will be incumbent on these banks to
make the interest rates charged by them transparent and known to all
customers. Banks have therefore been asked to publish the minimum and
maximum interest rates charged by them and display this information in
every branch. Disclosure and transparency are thus key pillars of a corporate
governance framework because they provide all the stakeholders with the
information necessary to judge whether their interests are being taken care
of. We in RBI see transparency and disclosure as an important adjunct to the
supervisory process as they facilitate market discipline of banks. Another
area which requires focused attention is greater transparency in the balance
sheets of co-operative banks.
The commercial banks in India are now required to disclose accounting
ratios relating to operating profit, return on assets, business per employee,
NPAs, etc. as also maturity profile of loans, advances, investments,
borrowings and deposits. The issue before us now is how to adapt similar
disclosures suitably to be captured in the audit reports of co-operative banks.
RBI had advised Registrars of Cooperative Societies of the State
Corporate governance in banks
55
Governments in 1996 that the balance sheet and profit & loss account should
be prepared based on prudential norms introduced as a sequel to Financial
Sector Reforms and that the statutory/departmental auditors of co-operative
banks should look into the compliance with these norms.
Auditors are therefore expected to be well-versed with all aspects of the new
guidelines issued by RBI and ensure that the profit & loss account and
balance sheet of cooperative banks are prepared in a transparent manner and
reflect the true state of affairs. Auditors should also ensure that other
necessary statutory provisions and appropriations out of profits are made as
required in terms of Co-operative Societies Act / Rules of the state
concerned and the bye-laws of the respective institutions.
5.3-OTHER CORPORATE GOVERNANCE MECHANISMS.
Apart from working under the jurisdiction of RBI,listed banks, Non banking
finance companies and other financial intermediaries are governed by
SEBI’s clause 49 on corporate governance.
Clause 49 of the Equity Listing Agreement consists of mandatory as well as
non-mandatory provisions. Those which are absolutely essential for
corporate governance can be defined with precision and which can be
enforced without any legislative amendments are classified as mandatory.
Others, which are either desirable or which may require change of laws are
classified as non-mandatory. The non-mandatory requirements may be
implemented at the discretion of the company. However, the disclosures of
the compliance with mandatory requirements and adoption (and compliance)
/ non-adoption of the non-mandatory requirements shall be made in the
section on corporate governance of the Annual Report.
Corporate governance in banks
56
Gist of Cause 49 is as follows:
Mandatory provisions comprises of the following:
? Composition of Board and its procedure - frequency of meeting,
number of
independent directors, code of conduct for Board of directors and senior
management;
? Audit Committee, its composition, and role;
? Provision relating to Subsidiary Companies;
? Disclosure to Audit committee, Board and the Shareholders;
? CEO/CFO certification;
? Quarterly report on corporate governance;
? Annual compliance certificate.
Non-mandatory provisions consist of the following:
? Constitution of Remuneration Committee
? Dispatch of Half-yearly results
? Training of Board members
? Peer evaluation of Board members
? Whistle Blower policy
As per Clause 49 of the Listing Agreement, there should be a separate
section on Corporate Governance in the Annual Reports of listed companies,
with detailed compliance report on Corporate Governance. The companies
should also submit a quarterly compliance report to the stock exchanges
within 15 days from the close of quarter as per the prescribed format. The
Corporate governance in banks
57
report shall be signed either by the Compliance Officer or the Chief
Executive Officer of the company.
CORPORATE GOVERNANCE IN BANKS:
5.4-PROBLEMS AND REMEDIES.
Weak and ineffective corporate governance mechanisms in banks are
pointed out as the main factors contributing to the recent financial crisis.
Deep changes in this area are necessary to reinforce the financial sector
stability.
A bank’s failure to follow good practices in corporate governance and the
lack of effective governance are among the most important internal factors
which may endanger the solvency of a bank.
Corporate governance in banks differs from the standard (typical for other
companies), which is due to several issues:
? Banks are subject to special regulations and supervision by state
agencies (monitoring activities of the bank are therefore mirrored);
supervision of banks is also exercised by the purchasers of securities
issued by banks and depositors ("market discipline","private
monitoring");
? The bankruptcy of a bank raises social costs, which does not happen
in the case of other kinds of entities’ collapse; this affects the behavior
of other banks and regulators;
? Regulations and measures of safety net substantially change the
behavior of owners,managers and customers of the banks; rules can be
counterproductive, leading to undesirable behaviour management
Corporate governance in banks
58
(take increased risk) which expose well-being of stakeholders of the
bank (in particular the depositors and owners);
? Between the bank and its clients there are fiduciary relationships
raising additional relationships and agency costs;
? Problem principal-agent is more complex in banks, among others due
to the asymmetry of information not only between owners and
managers, but also between owners, borrowers, depositors, managers
and supervisors;
? The number of parties with a stake in an institution’s activity
complicates the governance of financial institutions.
In the banking sector corporate governance is therefore a way of business
and affairs of the bank by the management and the board, affecting how
they;
? Define the objectives and goals;
? lead current bank activities;
? Fulfill the obligation of accountability to shareholders and take
into account the interests of stakeholders;
? Apply the requirement to operate safely and to ensure a good
financial situation and compliance with applicable regulations;
? Protect the interests of depositors (and other clients and
creditors).
5.5-Key areas of failure of corporate governance in banks.
The confidence of the public (in a bank and the entire banking system) is
necessary for a proper functioning of the financial system and economy.
Corporate governance in banks
59
Effective corporate governance practices are fundamental to gain and
maintain this confidence Trust is a basic prerequisite for a proper
functioning of banks, therefore it is necessary to carry out fundamental
reforms that will bring inner harmony and allow the recovery of the public
trust. Therefore, an in-depth analysis of the recent crisis causes should be
done. Particularly considering that the rules of proper conduct of banking
business exist and are being implemented, but it is mainly the deficiencies in
corporate governance which are to blame for the recent financial crisis.
Analyses of the causes of the crisis lead to indicate several issues requiring a
re-structuring and strengthening of standards, these issues concern;
? The role, tasks and responsibilities of the board, as well as its size,
organization and composition (members) and the functioning of this
body and the assessment of its work;
? Control of bank risk exposure;
? Evaluation of executives and its incentive pay;
? Transparency of the bank supervisory board that allows for the
assessment of its activities (both by institutional and private
monitoring);
? Ownership structure of banks and the role of institutional investors.
The analysis of main failures of corporate governance in banks
suggests that in order to repair and strengthen the system:
? Banks ought to reduce their risk exposure significantly, build a
stronger capital base; banks should concentrate on typical banking
activities and reduce the scale of other operations.
Corporate governance in banks
60
? Bank directors (both: executive and non-executive) should bear
personal responsibility for banks’ activities and risk;
? Banks’ executives remuneration should be linked to performance and
risk exposure;
? Non-executive directors engagement should be stronger – they should
devote more time and commitment to perform their oversight
function;
? Regulators and market supervisors should strengthen banks’
transparency allowing for the effective market discipline, professional
bodies should promote best practice in disclosure and motivate banks
to publish more informative reports;
? The accountability of external and internal auditors should be stronger
and they should be obliged to report any observed non-compliance to
supervisors;
? “Comply or explain” rule used in corporate governance area, being a
sort of a “soft law” should be strengthened by the monitoring function
performed by financial market and the supervisor should verify
whether the disclosed information is reliable and sufficient;
? In particularly important areas in which banks persistently do not
comply with corporate governance best practices, supervision should
make formally binding rules; one should keep in mind, however, that
this should not lead to excessive growth of regulation because it
would harm the competition.
Corporate governance in banks
61
CHAPTER 6: CASE STUDY
Corporate Governance in Banking Sector: Corporate
Governance at Royal Bank of Canada.
Case Details:
Case Code: CGOX009
Period : 2004
Organization: Royal Bank of Canada
Industry : Financial Services
Countries : Canada
Abstract:
Royal Bank of Canada (RBC), the largest financial services group in
Canada, has one of the best boards in Canada. It has received the Overall
Award of Excellence for corporate reporting from the Canadian Institute of
Chartered Accountants.
RBC has received top scores in four categories: (1) Annual Reporting; (2)
Corporate Governance Disclosure; (3) Electronic Disclosure; and (4)
Sustainable Development Reporting.
The case examines the best practices in corporate governance that RBC has
adopted, with special reference to board composition, board responsibilities,
board structure, board committees and directors'' compensation.
Corporate governance in banks
62
Introduction:
Royal Bank of Canada (RBC), headquartered in Toronto, Ontario, was the
largest financial services group in Canada. In 2003, it ranked #337 in the
Fortune Global 500 and #80 in Forbes Global 2000 and had a market
capitalization of C$41.6 billion and an asset base of C$413 billion. ($ 1.0 =
C$ 1.31108).
On 26th November 2003, RBC received the Overall Award of Excellence
for corporate reporting at the CICA. The Judging panels5 presented RBC
with top scores in four categories: 1) Annual Reporting, 2) Corporate
Governance Disclosure, 3) Electronic Disclosure and 4) Sustainable
Development Reporting.
In August 2003, the Canadian Business magazine ranked RBC as the second
best board in Canada. RBC had been ranked No.1 in 2001. RBC had adopted
what observers considered many best practices in corporate governance.
RBC's directors (in 2001) had to hold at least $100,000 in stock and had to
stand for re-election every year.
Any re-pricing of the stock options was not approved. The board published
the attendance of each director at the Board and Committee meetings. The
bank also scored high grades on the 'independence' of its directors. Out of
the 19 directors standing for election, in 2002, only one director represented
the bank's management. RBC had also decided to split the offices of the
CEO and the Chairman.
In 2001, had launched a Subsidiary Governance Office (SGO) in order to
enhance governance practices in its subsidiaries. It installed sophisticated
software that allowed quick and easy access to up-to-date information on all
parts of its global network.
Corporate governance in banks
63
Excerpts:
Business Segments:
RBC operated in five major business segments: 1) RBC Banking, 2) RBC
Insurance, 3) RBC Investments, 4) RBC Capital Markets and 5) RBC Global
Services. RBC Banking was the bank's largest contributor to the net income
(51% of net income in 2003).
Corporate Governance Code:
RBC had attempted to comply with the corporate governance guidelines of
Toronto Stock Exchange (TSX).
The Board of Directors (Board) had also taken note of the US Sarbanes-
Oxley Act (SOX), as well as the New York Stock Exchange's (NYSE)
corporate governance listing guidelines.
The Board of Directors:
The Board consisted of an independent chairman, independent directors and
two executive directors and had in place four committees consisting only of
independent directors. The Corporate Governance and Public Policy
Committee (CGPC) had developed categorical standards of 'independence'
with respect to the US's NYSE Corporate Governance listing Standards, in
addition to the 'unrelated' standard as specified by the TSX Corporate
Governance Guidelines.
Corporate governance in banks
64
Board Composition:
RBC did not permit more than two Board members from management. The
President and Chief Executive Officer (CEO) of the bank, Gordon M. Nixon
and the Chairman Emeritus of RBC Centura Banks Inc., Cecil W. Swell Jr.,
represented the management. The bank complied with provisions of the
Canadian Bank Act (Bank Act) and the TSX Guidelines with regard to
directors being affiliated with or related to the bank. The CGPC, with advice
from outside consultants, recommended the candidates suitable for
nomination to the Board and continuously reviewed the composition and
mandates of all the committees.
Board Responsibilities:
The Board responsibilities included succession planning, evaluation of
management performance, review and execution of major business
decisions, review and approval of corporate financial goals and operational
plans, identification of risks, supervision of communications and public
disclosure, and assessment of the effectiveness of the bank's internal controls
and management information systems.
Board Committees:
Committees of the Board consisted solely of independent and unrelated
directors. The Board delegated specific tasks to these committees.
Audit Committee:
Five independent directors and a chairman represented AC and held 11
meetings in 2003.
Corporate governance in banks
65
Conduct Review and Risk Policy Committee (CRPC).
CRPC consisted of five members and a Chairman and reviewed the credits
to the directors or the entities in which they were partners, directors or
officers.
Directors – Compensation:
RBC regarded attractive compensation as a primary tool to attract, retain and
motivate independent directors with skills and commitment to enhance
shareholder value. CGPC and HRC were responsible for designing the
compensation structure for all independent directors and executive directors
& senior officers respectively.
Corporate Disclosure:
RBC emphasized excellence and timeliness in its communications. The
investor relations staff provided information to existing and potential
investors and responded to all inquiries.
Concluding Notes:
RBC had its share of bitter experiences despite all the steps it had taken to
embrace high standards of corporate governance. In 2000, RT Capital
Management, the pension management division of RBC was involved in a
high-profile trading scandal.
Corporate governance in banks
66
CONCLUSION.
Banks and financial sector being a highly service oriented sector, making
corporate governance effective is a great challenge. More so, when the
driving force of commercial banks is to grab the opportunity, trading profits
with only focus on profitability.Banking sector is the key for monetary
conditions in a country. Due to the special nature of the activities carried on
by the banks, they face a lot of problems as far as the area of corporate
governance is concerned.
In the Indian scenario, due to the peculiar nature of bank holdings there are a
lot of embedded conflicts.Corporate Governance is now identified and
acknowledged as a powerful tool to generate trust and confidence in an
institution. The trend in the world of targeting governance practices in the
banking sector to be at the cutting edge of prevailing practices worldwide is
a significant step in the right direction and should continue to be so in the
future as well.India has one of the best Corporate Governance legal regimes
but poor implementation. SEBI has carved out a certain more stringent
provisions relating to listed companies as a condition of the Listing
Agreement.
Finally this study concluded that, the corporate governance practices in the
banking and financial sector in India should improve for best investment
policies, appropriate internal control systems, better credit risk management,
better customer service and adequate automation in order to achieve
excellence, transparency and maximization of stakeholder’ value and wealth.
Corporate governance in banks
67
BIBLIOGRAPHY.
Books:
1. Corporate Governance in Banking-A Global Perspective, by B.E.
Gup,Edward Elgar Publishing.
2. Corporate Governance: Principles, Policies and Practices, by A. C.
Fernando
Pearson Education India, 2009 - Business & Economics
URL’s:
1.http://borjournals.com/Research_papers/May_2013/1266M.pdf
2.https://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=793
3.http://iica.in/images/RBI_and_Gatekeepers_of_corporate_governance.pdf
4.http://sbsquare.com/images/Corporate Governance in Banking
%20Sector%20in%20India.pdf
doc_766651112.pdf