Corporate Governance IN BANKING SECTOR

CORPORATE GOVERNANCE IN BANKING SECTOR
CHAPTER-1
INTRODUCTION
1.1 INTRODUCTION
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. Modern trade and commerce would almost be impossible without the
availability of suitable banking services. Indian banking industry, the backbone of the country
economy, has always played a key role in prevention the economic catastrophe from reaching
terrible volume in the country .The Indian banking system is among the healthier performers
in the world. 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. 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. Corporate Governance is now an issue and important factor that can be used as
tool to maximize wealth of shareholders of a corporate. Corporate Governance aims are the
Vision, Values and Visibility
Corporate Governance was brought in limelight through series of corporate failures such as
Enron and WorldCorn. These companies collapsed because of the corporate mis governance
and unethical practices they indulged in. Satyam scandal in India is also the case of corporate
mis-governance. Satyam case exposed the complete lack of accountability in the company
and raised questions on corporate governance practices of the country.
In a service industry like banking, corporate governance relates to the manner in which the
business and affairs of individual banks are directed and managed by their board of directors
and senior management. It also provides the o through which the objectives of the institutions
are set, the strategy for attaining them is determined and the performance of the institution is
monitored.
Corporate governance has at its backbone a set of transparent relationships between an
institutions management, its board, shareholders and other stakeholders. It, therefore, needs
to take into account a number of aspects such as, enhancement of shareholder value,
protection of shareholder rights, composition and role of board of directors, integrity of
accounting practices and disclosure norms and internal control system. In a service industry
like banking, corporate governance relates to the manner in which the business and affairs of
individual banks are directed and managed by their board of directors and senior
management. It also provides the structure through which the objectives of the institutions are
set, the strategy for attaining them is determined and the performance of the institution is
monitored.
Virtually every major industrialized country as well as the Organization for Economic Cooperation and Development and the World Bank has made efforts in recent years to refine
their views on how large industrial corporations should be organized and governed.
Academics in both law and economics have also been intensely focused on corporate
governance. Oddly enough, in spite the general focus on this topic, very little attention has
been given to the corporate governance of banks.
1.2DEFINITION AND MEANING OG CORPORATE GOVERNANCE

"Corporate governance involves a set of relationships between a companys 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." (OECD 2004)
The 1992 Report of the Committee on the Financial Aspects of Corporate Governance (Cadbury
Report) describes Corporate Governance as the system by which companies are directed and
controlled.
Wolfensohn, President, World Bank, has said that Corporate Governance is about promoting
corporate fairness, transparency and accountability
MEANING
Corporate Governance refers to the way a corporation is governed. It is the technique by
which companies are directed and managed. It means carrying the business as per the
stakeholders desires. It is actually conducted by the board of Directors and the concerned
committees for the companys stakeholders benefit. It is all about balancing individual and
societal goals, as well as, economic and social goals.
Corporate Governance is the interaction between various participants (shareholders, board of
directors, and companys management) in shaping corporations performance and the way it
is proceeding towards. The relationship between the owners and the managers in an
organization must be healthy and there should be no conflict between the two. The owners
must see that individuals actual performance is according to the standard performance. These
dimensions of corporate governance should not be overlooked
1.3 EVOLUTION OF CORPORATE GOVERNANCE IN BANKING

SECTOR
As prelude to institutionalize Corporate Governance in banks, an Advisory Group on
Corporate Governance was formed under the chairmanship of Dr. R. H. Patil. Following its
recommendations in March 2001 another Consultative group was constituted in November
2001 under the Chairmanship of Dr. A. S. Ganguly, with a view to strengthen the internal
supervisory role of the Boards in banks in India. This move was further reinforced by certain
observations of the Advisory group on Banking Supervision under the Chairmanship of Shri
M.S.Verma which submitted its report in January 2003. Keeping all these recommendations
in view and the cross country experience, the Reserve Bank initiated several measures to
strengthen the corporate governance in the Indian Banking Sector. The noteworthy minimum
benchmarks noted by the Group relate to the following
Strategies and techniques basic to sound corporate governance
Organizational structure to ensure oversight by board of directors and individuals not

involved in day to day running of business
Ensuring that the direct lines of supervision of different business areas are different
Ensuring independent risk management and audit functions
Ensuring an environment supportive of sound corporate governance
Role of supervisors
The issue pertaining to corporate governance becomes more critical on case of the banks
whose controlling power is linked with Government. Government ownership is one of the
primary issue that can have a direct impact on the quality of corporate governance. In India
almost 80% of the banking operations are under the control of the public sector banks
consisting of the nationalised banks, the State Bank of India and its subsidiaries. In Public
4
sector banks, the right of the private shareholders are considerably curtailed as their approval
is not required for paying dividend or formalising the annual accounts.
The importance of corporate governance issues in public sector banks is important due to two
principal reasons:
Firstly, they constitute a huge share of business in the banking industry in India
Secondly, it is highly unlikely that they are going to be phased out in due course.
Though the general principle of corporate governance is valid for the public sector entities,
but they simply cannot imitate the private sector banks in this respect. Things start getting
worse, when uncertainties looms involving ownership issues, and the public ownership being
treated as a transitional phenomenon. Further, expectation of change in ownership (dilution of
Government Stake) can result in the change of institutional structure of significance
difference. When Government is the owner, it is accountable to the political institutions,
which in turn may not have pure economic motives in mind. A mixed ownership structure can
bring the different objectives of shareholding on a common platform and help in reconciling
them. Issues relating to the separation of ownership and management in both private and
public sectors banks needs to be addressed, in contrast to the traditional Corporate
Governance issues stemming from the outside financial, in developing countries and
especially in India, things are a bit different. Here, the grueling question is not how the
outside financiers (shareholders) exert management control, but also as to how they can
(including minority shareholders) exercise control over the big inside shareholders
The most important development in the field of corporate governance and investor protection
in India has been the establishment of the securities and Exchange Board of India (SEBI) in
1992 and its gradual empowerment since then. The Basel committee in the year 1999 had
5
brought out certain important principles on corporate governance for banking organisations
which more or less have been adopted in India. Today the banks are governed by the Banking
Regulation Act, 1949; Reserve Bank of India Act, 1934; Foreign Exchange Management Act,
1999; Payment and Settlement Systems Act, 2007; other relevant Statutes and the Directives,
Prudential regulations and other Guidelines/ Instructions issued by RBI and other regulators
from time to time, including the regulations of SEBI regarding public issues and other
guidelines applicable to listed banking though there is scope for enhancing effective
implementation
1.4 RELATION OF CORPORATE GOVERNANCE IN BANKING

SECTOR
Globalization of financial markets necessitates some basic international standards of
corporate governance for financial institutions, it is also recognized that such uniform
international standards may result in different levels of systemic risk for different
jurisdictions because of differences in business customs and practices and institutional and
legal structures of national markets. Each country will therefore need domestic regulations
that prescribe specific rules and procedures for the governance of financial institutions that
address national differences in political economic and legal systems while adopting
international standards and principles.
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
6
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 depend on implementation of appropriate regulatory practices and supervision. Indeed
in a healthy banking system the regulators and 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 depositors 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.
CHAPTER-2
OBJECTIVES,NEED,IMPORTANCE AND ROLE OF CORPORATE
GOVERNANCE IN BANKING SECTOR
2.1 OBJECTIVE OF CORPORATE GOVERNANCE IN BANKING
SECTOR
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.
2.2 NEED OF CORPORATE GOVERNANCE IN BANKING SECTOR

Since banks are important players in the Indian financial system, special focus on the
Corporate Governance in the banking sector becomes critical.
The Reserve Bank of India, as a regulator, has the responsibility on the nature of
Corporate Governance in the banking sector.

To the extent that banks have systemic implications, Corporate Governance in the
banks is of critical importance.

Given the dominance of public ownership in the banking system in India, corporate
practices in the banking sector would also set the standards for Corporate Governance
in the private sector.

With a view to reducing the possible fiscal burden of recapitalising the PSBs,
attention towards Corporate Governance in the banking sector assumes added
importance.
Banks are critical components of the economy while providing finance for
commercial enterprises, basic financial services to a broad segment of the population
and access to payment systems. Banks in India are facing increasing competition,
within and outside India, both in terms of markets for its products and for sources of
fund.
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. In order to meet the statutory need of having sound Capital
Adequacy requirements, banks are accessing the Capital Market at regular intervals.
Hence the banks need to stimulate the interest of investors at all times. Investors
believe that a bank with good governance will provide them a safe place for
investment and also give netter returns. Good corporate governance is therefore an
important factor in a competitive environment. Investors, customers, employees and
vendors have all become more discerning and are demanding greater transparency and
fairness in all dealings. To attract and retain the commitment of investors, customers,
employees, Banks should ensure that they match the global benchmark in 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. It is of crucial importance therefore that have
strong corporate governance practices.

Banks, just like any other organization are incorporated entities. As a result of which,
the primary requirements of corporate governance apply to them as any other
incorporated entity. Added to this certain features that are very specific to banks, adds
on to the importance of Corporate Governance issues in banks.

Among other features, the most important one is the fact that banks form an integral
part of the economy of the country, and any failure in a bank might have a direct
bearing on the financial health of the country. Banks, help in channelizing the
peoples saving.
The capital structure of bank is unique in two ways. First, banks tend to have very
little equity relative to other firms. Second, banks liabilities are largely in the form of
deposits, which are available to creditors/depositors on demand, while their assets
often take the form of loans that have longer maturities. Thus, the principle attribute
that makes banks as financial intermediaries special is their liquidity production
function. By holding illiquid assets and issuing liquid liabilities, banks create liquidity
for the economy. The liquidity production function may cause a collective-action
10
problem among depositors because banks keep only a fraction of deposits on reserve
at any one time. Depositors cannot obtain repayment of their deposits simultaneously
because the bank will not have sufficient funds on hand to satisfy depositors at once.
This mismatch between deposits and liabilities becomes a problem in the unusual
situation of a bank run.

The second important driver of a good corporate governance stems from their funding
patterns. Banks, by their basic definition are highly leveraged financial institutions,
with the equity capital of the shareholders being reduced to a miniscule proportion of
loan capital in the form of borrowing and deposits of deposits from customers of the
bank. As a result of this, the stakeholders in banks, (mainly the depositors and
lenders) have a rightful claim of accountability from the banks and their boards.
The third important element in the Corporate Governance structure relates to the
control function. It is imperative to discuss the same in brief. Control functions in
banks deal with internal frauds as well as external frauds. The former relates to
situations where the banks own personnel indulge in corrupt and unethical practices.
The latter deals with situations where the customers of the bank try to seek for
malpractices. The incidents of the external frauds are so devastating that special
attention is being mandated both for their prevention as well as their post scenario
analysis. In this connection it is important to remind of the COSO framework that was
framed with this intention in mind.

Finally, failing to comply with stipulated norms can be one of the challenging issues
of Corporate Governance framework. With Banks being under intense watch of the
central bank as well as other regulatory bodies, it is a common observation, that most
failures (crashes) in banks have occurred due to compliance failure situations. With a
lot of reports and norms, being introduced (The Basel II norms being the latest of
them), failure to adhere to the regulatory norms have never reduced
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BASEL II Recommendation: The Basel Committee on Banking Supervision is a

committee, of banking supervisory authorities, established by the Central Bank Governors of
the G10 developed countries in 1975. The Committee in 1988 introduced the Concept of
Capital Adequacy framework, known as Basel Capital Accord, with a minimum capital
adequacy of 8 percent It also issued a consultative document titled The New Basel Capital
Accord in April 2003, to replace the 1988 Accord, which re-enforces the need for capital
adequacy requirements under the current conventions. This accord is commonly known as
Basel II and is currently under finalization. Basel II is based on three pillars:
Pillar 1 Minimum Capital Requirements
Pillar 2 Supervisory Review Process
Pillar 3 Market Discipline
2.3 IMPORTANCE OF CORPORATE GOVERNANCE IN BANKING

SECTOR
From a banking industry perspective, corporate governance involves the manner in which
their boards of directors and senior management govern the business and affairs of individual
banks, affecting how banks set their corporate objectives, run day-to-day operations, consider
the interests of various stakeholders, align corporate activities with the expectation that banks
will operate in a safe and sound manner and in compliance with applicable laws and
regulations and protect the interests of depositors.
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
12
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;
Improve the standards of lending; Protect the rights of minority shareholder and other
counterparts;
Strengthen their reputation and raise the level of investors and clients' trust
2.4 ROLE OF CORPORATE GOVERNANCE IN BANKING SECTOR

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. In the case of
traditional manufacturing corporations, the issue has been that of safeguarding and
13
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.
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. 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. At the initiative of the RBI, a consultative group,
aimed at strengthening corporate governance in banks, headed by Dr. Ashok Ganguli was set
up to review the supervisory role of Board of banks. The recommendations include the role
and responsibility of independent non-executive directors, qualification and other eligibility
criteria for appointment of non-executive directors, training the directors and keeping them
current with the latest developments. Some of the important recommendations on the
constitution of the Board are to participate in the meetings of the board regularly and ensure
that their participation is effective & contributory, They must study the reports submitted to
them by the management team and enquire about follow up reports on definite time schedule.
They should be actively involved in the matter of formulation of general policies, they should
14
be familiar with the road objectives of the bank, and the policies laid down by the govt. and
the changes in the various laws and legislations time to time. They should be loyal to the
bank and must remember that they should not reveal any information relating to any
constituent of the bank to anyone.
In the past, when banks considered the issue of how best to differentiate themselves from
their competition, Good Corporate Governance was undoubtedly not applied. Due to the
fallout from past corporate failures, more and more banks are looking at good corporate
governance from a new perspective. With Indian economic growth increase and major stock
Indices reaching record level, the time has come to position corporate governance as a
strategic force in Indian banks. Indian banks must drive growth and profitability while
continuing to focus on enhancing corporate governance practices. Indian government has
mandating corporate governance reforms at banks, can create the necessary infrastructure to
ensure the continued flow of investment into the region. Expanding global and regional
banks, such as State Bank of India, Bank of Baroda, Bank of India, Punjab National Bank,
ICICI Bank, HDFC Bank, Standard Chartered, HSBC, Citibank and others along with major
investments by large institutional investor, are enhancing corporate governance practices,
increasing competitiveness and permanently changing the competitive landscape of Indian
banking environment. Due to rapidly changing banking environment, Indian banks must
continue to implement strong corporate governance practices. They must now approach
corporate governance as a competitive differentiator in an environment of strong foreign
entrants and growing regional competitors.
Role of RBI In Promoting Corporate Governance:

The growing competitiveness and interdependence between banks and financial institutions
in local and foreign markets have increased the importance of corporate governance and its
15
application in the banking sector. Corporate governance in banks can be achieved through a
set legal, accounting, financial and economic rules and regulations. To make sure that the
competence and integrity in banking sector is maintained, the need for uniform standards of
the concept of governance in private and public sector is emphasized. The regulatory
framework implemented by the central bank can affect the overall well being of banking
sector.
CHAPTER-3
MEASURES TAKEN BY REGULATORS TOWAERDS CORPORATE
16
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 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. RBIs 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 emphasised 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 cooperative banks. RBI had advised Registrars of Co-operative Societies of the State
Governments in 1996 that the balance sheet and profit & loss account should be prepared
17
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.
BOARD OF DIRECTORS AND THEIR COMMITTEES:
At the initiative of the RBI, a consultative group, aimed at strengthening corporate
governance in banks, headed by Dr. Ashok Ganguli was set up to review the supervisory role
of Board of banks. The recommendations include the role and responsibility of independent
non-executive directors, qualification and other eligibility criteria for appointment of nonexecutive directors, training the directors and keeping them current with the latest
developments. Private sector banks, etc. it is unanimously accepted that the most crucial
aspect of corporate governance is that the organisation have a professional board which can
drive the organisation through its ability to perform its responsibility of meeting regularly,
retaining full and effective control over the company and monitor the executive management.
Some of the important recommendations on the constitution of the Board are:
Qualification and other eligibility criteria for appointment of non-executive directors,
Defining role and responsibilities of directors including the recommended "Deed of

Covenant" to be executed by the bank and the directors in conduct of the board functions.
Training the directors and keeping them abreast of the latest developments
18
MEASURES TAKEN
BY REGULATORS TOWARDS CORPORATE
GOVERNANCE
Reserve Bank of India has taken various steps furthering corporate governance in the Indian
Banking System. These can broadly be classified into the following three categories:
a) Transparency
b) Off-site surveillance
c) Prompt corrective action
Transparency and disclosure standards are also important constituents of a sound corporate
governance mechanism. Transparency and accounting standards in India have been enhanced
to align with international best practices. However, there are many gaps in the disclosures in
India vis--vis the international standards, particularly in the area of risk management
strategies and risk parameters, risk concentrations, performance measures, component of
capital structure, etc. Hence, the disclosure standards need to be further broad-based in
consonance with improvements in the capability of market players to analyse the information
objectively.
The off-site surveillance mechanism is also active in monitoring the movement of assets, its
impact on capital adequacy and overall efficiency and adequacy of managerial practices in
banks. RBI also brings out the periodic data on "Peer Group Comparison" on critical ratios to
maintain peer pressure for better performance and governance.
Prompt corrective action has been adopted by RBI as a part of core principles for effective
banking supervision. As against a single trigger point based on capita adequacy normally
19
adopted by many countries, Reserve Bank in keeping with Indian conditions have set two
more trigger points namely Non-Performing Assets (NPA) and Return on Assets (ROA) as
proxies for asset quality and profitability. These trigger points will enable the intervention of
regulator through a set of mandatory action to stem further deterioration in the health of
banks showing signs of weakness.
3.1SEBI GUIDELINES ON CORPORATE GOVERNANCE IN BANKS:

The Securities and Exchange Board of India (SEBI) had constituted a Committee on
Corporate Governance and circulated the recommendations to all stock exchanges for
implementation by listed entities as part of the listing agreement vide SEBIs circular
SMDRP/Policy/CIR-10/2000 dated February 21, 2000. However it had at that time exempted
body corporates such as public and private sector banks, financial institutions, insurance
companies and those incorporated under separate statute. SEBI has now suggested to RBI to
consider issuing appropriate guidelines to banks and financial institutions so as to ensure that
all listed companies would have uniform standards of corporate governance. As requested by
SEBI, it has now been proposed that the SEBI Committees guidelines may be taken up for
adoption by those commercial banks listed in stock exchanges so that they can harmonize
their existing corporate governance requirements with the requirements of SEBI, wherever
considered appropriate.
On a review by RBI of the existing corporate governance requirements in banks, it is

observed that many of the recommendations in regard to the following stand implemented in
banks and may not require further action towards implementation in respect of these
guidelines for the present.
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(a) Optimum combination of executive and non-executive directors in the Board

(b) Pecuniary relationship or transactions of the non-executive directors vis--vis the bank
(c) Independent Audit Committees, their constitution, chairmanship, power, roles,
responsibilities, conduct of business, etc
(d) Remuneration of Directors (in case of private sector banks)
(e) Periodicity /number of board meeting
(f)
Disclosure by management to the board about the conflict of interest
(g) Information to shareholders regarding appointment/re-appointment of directors, Display

of quarterly results/presentation to analysts on the website
h) Maintenance of office by non-executive Chairman.
(i) Reviewing with the management by the Audit Committee of the board the annual
Financial statements before submission to the Board, focusing primarily on:
Any changes in accounting policies and practices,
Major accounting entries based on exercise of judgment by management,
Qualifications in draft audit report,
Significant adjustments arising out of audit, compliance with accounting
standards,
Compliance with stock exchange and legal requirements concerning financial

statements, and The going concern assumption.
The Audit Committee of the board may look into the reasons for default in payment to
depositors, debenture holders, shareholders (non-payment of dividends) and creditors,
21
wherever there are any cases of defaults in payment. SEBI Committees recommendations on
other additional functions to be entrusted to the Audit Committee may be complied with by
the listed banks as per listing agreement.
As regards the appointment and removal of external auditors, the practice followed in banks
is more stringent than that recommended by the Committee and hence will continue. Further,
fixation of audit fee and also approval of payment for any other services are already subject
to the instructions of RBI. As regards recommendation for obtaining a certificate from
auditors regarding compliance of conditions of Corporate Governance, it may be stated that
the compliance of banks with RBI instructions is already being verified by the statutory
auditors. Therefore, a separate certificate from the auditors is not considered necessary.
With a view to further improving the Corporate Governance standards in banks, the following
measures are now recommended for implementation.
(a) In the interest of the shareholders, the private sector banks and public sector banks which
have issued shares to the public may form committees on the same lines as listed companies
under the Chairmanship of a non-executive director to look into redressal of shareholders'
complaints.
(b) All listed banks may provide un-audited financial results on half yearly basis to their
shareholders with summary of significant developments.
3.2 REASON FOR HIGH DEGREE OF OVER SIGHT

REASONS FOR HIGH DEGREE OF OVERSIGHT
There are three reasons for degree of government oversight in this sector.
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Firstly, it is believed that the depositors, particularly retail depositors, can not
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 customised 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 a run on the deposits and
putting the entire financial system in jeopardy.
3.3 MEASURES TAKEN BY BANKS TOWARDS IMPLEMENTATION

OF BEST PRACTICES
Prudential norms in terms of income recognition, asset classification, and capital adequacy
have been well assimilated by the Indian banking system. In keeping with the international
best practice, starting 31st March 2004, banks have adopted 90 days norm for classification of
NPAs. Also, norms governing provisioning requirements in respect of doubtful assets have
been made more stringent in a phased manner. Beginning 2005, banks will be required to set
aside capital charge for market risk on their trading portfolio of government investments,
which was earlier virtually exempt from market risk requirement.
Capital Adequacy: All the Indian banks barring one today are well above the stipulated
benchmark of 9 per cent and remain in a state of preparedness to achieve the best standards of
23
CRAR as soon as the new Basel 2 norms are made operational. In fact, as of 31 st March 2004,
banking system as a whole had a CRAR close to 13 per cent.
On the Income Recognition Front, there is complete uniformity now in the banking
industry and the system therefore ensures responsibility and accountability on the part of the
management in proper accounting of income as well as loan impairment.
ALM and Risk Management Practices At the initiative of the regulators, banks were
quickly required to address the need for Asset Liability Management followed by risk
management practices. Both these are critical areas for an effective oversight by the Board
and the senior management which are implemented by the Indian banking system on a tight
time frame and the implementation review by RBI. These steps have enabled banks to
understand, measure and anticipate the impact of the interest rate risk and liquidity risk,
which in deregulated environment is gaining importance
3.4 CODE OF BEST PRACTICES OF BANKS RBI GUIDELINES

The BPC relates to detailed procedural rules for entering into transactional relations
within the banks. The main objective is that such procedures, especially those in all
fraud-prone areas, should be well documented, compared with national and
international best practices, experimented with, and improved upon in the light of the
experience
gained.
What is essential for BPC ? : Preparation of BPC involves examination of all

procedures, processes, products, activities and systems, existing and future (as and
when a new product/process is introduced). It needs to be integrated with the overall
risk management strategy of the bank and should be considered as a part of the
strategy
to
mitigate
all
possible
24
operational
risk
losses.
RBI guidelines on compiling the BPC: Based on the recommendations of Mitra

Committee, RBI issued the following guidelines (Mar 15, 2004) for keeping in view
while preparing the BPC, so as to bring a certain minimum level of uniformity in
content
and
coverage
of
BPC.
Comprehensiveness : The BPC should be a comprehensive and homogenous

document. The consolidation and incorporation of circulars issued by the banks by
itself, does not constitute BPC. RBIs earlier instructions issued to banks relating to
the common fraud prone areas and their prevention, to be observed.
Recommendations of various committees : BPC should cover / highlight the
recommendations
of
the
Ghosh
Committee,
Mitra
Committee,
relevant
recommendations of the Narang Committee (large value frauds), Narasimham

Committee on Banking Reforms, recommendations of the Estimate Committee on
Prevention of Frauds in public sector banks, etc. advised to banks for implementation.
The BPC should also take into account the instructions of the CVC, if any, issued
from
time
to
time.
Minimum coverage : The BPC should, at a minimum, cover all the functional areas
like cash, safe custody of other valuables (DD/TT/LC/Guarantee forms, etc.), deposit
accounts, investment portfolio, credit portfolio, foreign exchange transactions,
treasury operations, bills portfolio, remittances, cash receipts and payments,
issue/payment of demand drafts, clearing transactions, government transactions, LCs/
Guarantees,
etc.
Prevention of loss to customers : BPC may incorporate practices that would help
prevention of losses to its customers and include suitable guidance to such customers.
Banks should, codify the precautions to be taken by customers and the same should be
publicised by placing on their website or through any other medium.
25
Revision : The BPC should be periodically revised and updated in the light of the
experience gained, fresh instructions from the Reserve Bank and suggestions made by
internal/external auditors.
Best Practices of Banking System In Corporate Governance: Good governance

can be built based on the business practices adopted by the board of directors and
management. Many bank failures in the past have been attributed to inadequate and
insufficient management which enabled the banks to accept low quality assets and assume
additional risks that extend beyond the level appropriate for the banks capacity[.
Important commandments for ensuring corporate governance in banks are:
Banks shall realize that the times are changing
Banks shall establish an Effective, Capable and Reliable Board of Directors
Banks shall establish a Corporate Code of Ethics for themselves
Banks shall consider establishing an office of the Chairman of the Board
Banks shall have an effective and Operating Audit Committee, Compensation

Committee and Nominating/ Corporate Governance Committee
Banks shall consider Effective Board Compensation
Banks shall disclose the information
Banks shall recognize that duty is to establish Corporate Governance Procedures that
will serve to enhance shareholder value
CHAPTER-4
26
IMPACT OF CORPORATE GOVERNANCE NORMS & POLICIES IN

BANKING SECTOR
The RBI move to strengthen Corporate Governance led to seminal changes in the bank
administration. The sustained profitability, lower level of non-performing assets, improved
return on assets etc are some of the laud indicators of the sustaining policy of operating sound
banking system. Moreover, the movement of share prices in the market, increased appetite of
investors to look at banks for investment in bank centric equity market further speaks of
broad market opinion of banks performance and reflection of market confidence. The
corporate governance framework in banks has been strengthened through regulation,
supervision and by maintaining constant interaction with the management. They cover
identification of responsibilities of the Boards of banks, disclosure and transparency in
published accounts, and shareholder and stakeholder rights and controls. The rating on
management (M) which has been introduced as part of the CAMELS (Capita, Asset Quality,
Management, Earnings, Liabilities and Systems) supervisory process takes into account the
working of the board and its committees including the Audit committee, effectiveness of the
management in ensuring regulatory compliance and adequacy of control exercised by the
head/controlling offices. This model has been further modified to include risk based
supervision. The new evolution is intended to manage influx of a range of financial risks
entering the market with their nuances.
Moreover, the audit function is an important element of the corporate governance process and
the independence of this function is crucial to good corporate governance. Audit Committee
of the Boards, constituted at the instance of RBI; performs the role of overseeing concerns
about internal controls and recommendations for their improvement. In order to ensure both
professionalism and independence of these committees, Chartered Accountant directors on
27
the boards of banks are mandatory members and the Chairman or Chief Executive Officer is
not to be part of the Audit Committee. Foreign banks are not insisted upon to have local audit
committee for their Indian branches. Their branches can have a compliance function that
reports to their head office on the branches compliance with RBI inspection findings and
features arising out of internal inspections and statutory audit. RBI has Nominee directors on
the boards of all PSBs and some of the old private sector banks. Further, the Government also
nominates directors on the boards of all PSBs. Of late, RBI has been withdrawing its
nominees from the boards of well-managed old private banks.
In order to improve the effectiveness of the non-official directors and bring in effective
corporate governance at the board level in banks, guidelines have been issued focusing the
attention of directors on certain areas such as (i) the prescribed calendar of reports / returns to
be placed before the Board / Managing Committee of the bank (iv) corrective action required
to be taken by the bank on issues of supervisory concern (v) adherence to the deadlines for
complying with various action points committed under Monitor able Action Plan during
discussions in Annual Financial Inspection findings as well as achievement of targets agreed
during Memorandum of Understanding (MOU) discussions with RBI. Further, the guidelines
also require the directors to keep watch on matters which come to the board of the banks as
also what should have come to the board and to inform the Department of Banking
Supervision on matters of supervisory concern.
Post reform period led to many banks accessing capital market to shore up their capital
adequacy ratio, an essential prescription of Basel-I then and Basel II now. Subscription of
banks equity is a function of public confidence which stems from governance policies. The
Red Herring Prospectus lodged by banks as required by the capital market regulator, the
Securities and Exchange Board of India (SEBI) reflects not only the numerical performance
28
of banks as enunciated in Section-I of this paper but is also an indicator of present and future
governance policies pursued by banks.
The movement of stock prices is a further reflection of demand and supply of bank shares in
the stock market. The entry of new Private Sector Banks and PSBs accessing capital market
opened up new opportunities to the investors. It was heartening to note that in the next few
years, the bank shares had picked up demand and popularity.
The spurt in the capital market index is a manifestation of investor opinion on the
performance, potential and standard of governance of banks. Though there may not be direct
correlation between market movement of bank shares and corporate governance policies, the
overall long run market opinion precipitates on this basis. Such practices form the
fundamental strength of the banks and their ethical commitments. As the risk perception
changes, volume of business goes up, new line of activities spur, competition heightens
further, the Corporate governance practices need to be fine tuned to meet the emerging
challenges.
Impact of Corporate Governance Policies in Banks:

Post reform period led to many banks accessing capital market to shore up their capital
adequacy ratio, an essential prescription of Basel-I then and Basel II now. Subscription of
banks equity is a function of public confidence which stems from governance policies. The
Red Herring Prospectus lodged by banks as required by the capital market regulator, the
Securities and Exchange Board of India (SEBI) reflects not only the numerical performance
of banks as enunciated in Section-I of this paper but is also an indicator of present and future
governance policies pursued by banks.
29
The movement of stock prices is a further reflection of demand and supply of bank shares in
the stock market. The entry of new Private Sector Banks and PSBs accessing capital market
opened up new opportunities to the investors. It was heartening to note that in the next few
years, the bank shares had picked up demand and popularity.
The spurt in the capital market index is a manifestation of investor opinion on the
performance, potential and standard of governance of banks. Though there may not be direct
correlation between market movement of bank shares and corporate governance policies, the
overall long run market opinion precipitates on this basis. Such practices form the
fundamental strength of the banks and their ethical commitments. As the risk perception
changes, volume of business goes up, new line of activities spur, competition heightens
further, the Corporate governance practices need to be fine tuned to meet the emerging
challenges.
CHAPTER-5
30
CORPORATE GOVERNANCE IN BANKING SECTOR AS PER

INDIAN SCENARIO
In the Indian context, the need for corporate governance has been highlighted because of the
frequently occurring scams since 1991 due to emergence of the concept of liberalisation. The
scams such as Harshad Mehta Scam, Ketan Parekh Scam, UTI Scam, Vanishing Company
Scam, Bhansali Scam and so on. In order to reduce the number the scams in the Indian
corporate world, there is a need to induct global standards. From the beginning of 1980s,
situation have changed in India. Wide range changes have taken place in both the law and
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 begun in India in 1991.
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 multifaceted subject.
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), Indias 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 given by SEBI the Narayana Murthy Committe, which also submitted
its report in 2002. Based on some of the recommendations 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.
One of the important theme of corporate governance deals with the issues of accountability
and fiduciary duty, essentially advocating the implementation of policies and mechanisms to
31
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. 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.
be impossible without the availability of suitable banking services. Indian banking industry,
the backbone of the countrys economy has always played a key role in preventing the
economic catastrophe from reaching terrible volume in the country. Hence the failure of
banks due to unethical or incompetent policies and management action is detrimental to the
shareholders, public depositors and the economy at large. Owing to this fact, a proper
corporate governance system is crucial for banks and other financial institutions.
CHAPTER-6
32
PROBLEMS AND KEY AREAS OF FAILUREOF CORPORATE

A banks 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.
1 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 (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;
33
the number of parties with a stake in an institutions activity complicates the governance of
financial institutions.
To sum up, depositors, shareholders and regulators are concerned with the robustness of
corporate governance mechanisms. The added regulatory dimension makes the analysis of
corporate governance of opaque banking firms more complex than in non-financial firms
(Wilson, Casu, Girardone, Molyneux, 2010).
In the case of banks therefore, corporate governance needs to be perceived as a need of such
conduct of an institution, which would force the management to protect the best interests of
all stakeholders and ensure responsible behaviour and attitudes (Tirole, 2001). Corporate
fairness transparency and accountability are thus the main objectives of corporate
governance, taking into account the corporate "democracy", which is the broad participation
of stakeholders (R.E. Basinger et al., 2005) .
One must have in mind that there is no one model of corporate governance adaptable to all
banks. Other goals, and therefore supervisory systems, will be in banks: private, cooperative
and state; in the local and global banks; universal banks and investment (etc.); though
priorities remain the same.
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 (BCBS, 2006, February):
define the objectives and goals;
lead current bank activities;
fulfill the obligation of accountability to shareholders and take into account the interests of
stakeholders;
34
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).
Shortcomings in the governance of large financial groups have indicated that these may
trigger (indirectly) systemic risks. Regulators and financial supervisors take action to ensure
an individual banks stability; in the case of systemically important banks this would result in
the pursuit of overall financial stability. The main issues of corporate governance matters
with specific systemic impact are: the gatekeepers (esp. auditors and credit rating
agencies), corporate values and codes of conduct of banks, risk management and internal
governance of banks managerial incentives to act in an appropriate manner, accounting (and
valuation) rules (E. Wymeersch, 2008, October).
Moreover, there is some scepticism about the effectiveness of the comply or explain
approach to corporate governance (FRC, 2011 December). Analysis of the statements on the
application of corporate governance indicates that a vast majority of companies did not
present an explanation of the reasons to withdraw from the application of certain rules or the
clarification is made with low quality information. This confirms the need for support
mechanisms employed by the regulator and the requirement that companies monitor
statements made by the regulator and take an appropriate response to the lack of or
insufficient explanation (D. Seidl, P. Sanderson, J. Roberts, 2012).
As pointed out by the European Commission, the "comply or explain" approach would work
much more effectively if specific monitoring bodies (such as regulatory bodies for securities,.
Financial Assets and Investing 50 stock exchanges or other bodies) were entitled to check
whether the available information (in particular the explanation) has an appropriate
informative value and is appropriately broad. It is emphasized, however, that these
35
institutions should not interfere with the content of the information disclosed or evaluate the
solutions adopted by the company it should still be a task left to the market (EC 2011, April
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. Effective corporate governance
practices are fundamental to gain and maintain this confidence (BCBS 2006, February). As
the recent Edelman trust barometer study shows, banks and financial services are the two
least trusted industry sectors (for the second year in a row).
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 crisis5 . This raises the question: Were the rules inadequate or
poorly implemented?
Analyses of the causes of the crisis lead to indicate several issues requiring a re-structuring
and strengthening of standards; these issues concern (Kirkpatrick, 2009, September, A.
Turner, 2009, March, D.Walker, 2009, November 26):
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;
36
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. In order to avoid a
similar financial crisis in the future, regulators of financial markets are planning to establish
standards for sealing the system in these areas.
CHAPTER- 7
CONCLUSIONS
37
The special nature of banking institutions necessitates a broad view of corporate governance
where regulation of banking activities is required to protect depositors. In developed
economies, protection of depositors in a deregulated environment is typically provided by a
system of prudential regulation, but in developing economies such protection is undermined
by the lack of well-trained supervisors, inadequate disclosure requirements, the cost of raising
bank capital and the presence of distributional cartels.
Due to 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. Also, in the Indian scenario, due to the
peculiar nature of bank holdings there are a lot of embedded conflicts. There exists a doubt as
to what standard should be applied while enforcing corporate governance in banks. Central
banks play an important role in this regard. The guidance paper issued by the Basel
Committee is of paramount significance in enforcing corporate governance standards in
various countries across the world.
As far as best corporate governance practices for banks are concerned, they may include
realization that the times are changing, establishing an effective, capable and reliable board of
directors, establishing a corporate code of ethics by the banks for themselves, considering
establishing an office of the chairman of the board, having an effective and operating audit
committee, compensation committee and nominating/ corporate governance committee in
place, considering effective board compensation, disclosing the information and recognizing
their duty to establish corporate governance procedures that will serve to enhance shareholder
value.
CHAPTER-8
BIBLIOGRAPHY
38
REFERENCES
Capiro G. Jr and Levine R., Corporate Governance of Banks: Concepts and International
Observations, paper presented in the Global Corporate Governance Forum Research
Network Meeting, April 5, 2002
Kohli S.S., Corporate Governance in Banks: Towards Best Practices, IBA Bulletin, pp.2931, 2003; also as seen in Mridushi Swarup, Corporate Governance in Banking Sector ,
IJMBS, pg 76-81, vol. 1, issue 2, june 2011
IBA Bulletin Journal of Indian Banks Association.
Dr. P. K. Srivastava, Banking Theory and practice, Himalaya Publishing House Mumbai,
10th edition, 2007.
Gorden-Natarajan, Banking Theory, Law and Practice, Himalaya Publishing House,
Mumbai, 2009.
RBI Bulletins - Different years,. RBI, Report on Trend and Progress of Banking in India,
various issues.
Report of the Cadbury committee on Financial aspects of corporate Governance Chartered
secretary, volume XXV11, Number5, May, 1997,pp.569-580
WEBSITES
www.Financeindia.org
.www.ifc.org
www.Bankersindia.com
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