CORPORATE GOVERNANCE WITH REFERENCE TO

IN BANKING SECTOR IN INDIA

Submitted by,

Tisha Roshan Thomas

For the LL.B. graduation at JSS Law College

Autonomous, Mysore

Under the supervision and guidance of,

Mr Jagadish A T
 CHAPTER 2

2.1. EVOLUTION OF CORPORATE GOVERNANCE:

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 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. These are
illustrated as follows:

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. Those 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.

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,

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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. 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. Corporate Governance has several
claimants – shareholders, suppliers, customers, creditors, the bankers, employees of company
and society. The committee for SEBI keeping view has prepared primarily the interests of a
particular classes of stakeholders namely the shareholders this report on corporate
governance. It means enhancement of shareholder value keeping in view the interests of the
other stack holders. Committee has recommended CG as company„s principles rather than
just act. The company should treat corporate governance as way of life rather than code.

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 nonfinancial disclosures: and independent auditing and
board oversight of management.

4. Narayana Murthy 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. 5. 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

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gros1s miss-selling of collateralized debt obligations; in the UK; in France; in Germany; in
Italy; in Japan; in 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.

6. 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

ii) ii) Responsibility of Board

iii) iii) Audit Committee,

iv) iv) Auditors

v) v) Secretarial Audit

vi) vi) Whistle Blowing mechanism

2.2. DEBUT OF CORPORATE GOVERNANCE IN INDIAN BANKS:

As a 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: basically, 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 of India

1
Jayanthi Sarkar, Subrata Sarkar, Corporate Governance in India, (Sage Publication India Pvt Ltd,2012).

4
initiated several measures to strengthen the corporate governance in the Indian banking
sector.

Indian banking system consists of Public/Private sector banks having a basic difference
between them as far as the Reserve Bank‟s role in governance matters relevant to banking is
concerned. The current regulatory framework ensures, by and large, uniform treatment of
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private and PSBs in so far as prudential aspects are concerned. However, some of the
governance aspects of PSBs, though they have a bearing on prudential aspects, are exempted
from applicability of the relevant provisions of the Banking Regulation Act, as they are
governed by the respective legislations under which various PSBs were set up. In brief,
therefore, the approach of RBI has been to ensure, to the extent possible, uniform treatment
of the PSBs and the private sector banks in regard to prudential regulations.

In regard to governance aspects of banking, the Reserve Bank prescribed its policy
framework for the private sector banks. It also suggested to the Government the same
framework for adoption, as appropriate, consistent with the legal and policy imperatives in
PSBs as well. Hence the endeavor is to maintain uniformity in policy prescriptions to the best
possible extent for all types of banks. Since role of Independent Directors form the basis for
effective implementation of corporate governance in banks, it is necessary to reproduce the
code of conduct prescribed under SCHEDULE IV [section 149(7)] as prescribed in
Companies Bill 2012 for the guidance to the companies.

History of sorts was made late on the evening of 8th August 2013 when the Rajya Sabha
(India‟s Upper House of Parliament) passed the Companies Bill, 2012; Lok Sabha (the
Lower House) had passed it earlier in December 2012. With this, India now has “a modern
legislation for growth and regulation of corporate sector in India,” which is expected to
“facilitate business-friendly corporate regulation, improve corporate governance norms,
enhance accountability on the part of corporates / auditors, raise levels of transparency and
protect interests of investors, particularly small investors.” This bill is applicable to
companies with a net worth of Rs. 500 crore or more; a turnover of Rs 1,000 crore or more;
and a net profit of Rs 5 crore or more during any financial year. Schedule VII of the Act,
which lists out the CSR activities, suggests communities to be the focal point.

2
Adrian Cadbury, Corporate Governance and Chairmanship, (Oxford University Press, new Delhi, 2002, 1st
Edition)

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On the other hand, by discussing a company’s relationship to its stakeholders and integrating
CSR into its core operations, the draft rules suggest that CSR needs to go beyond
communities and beyond the concept of philanthropy.

Corporate Governance Guidelines for Banks:

Effective corporate governance practices are essential to achieving and maintaining public
trust and confidence in the banking system, which are critical to the proper functioning of the
banking sector and economy as a whole. 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. 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 in turn trigger a bank run or liquidity crisis. Indeed, in addition to their
responsibilities to shareholders, banks also have a responsibility to their depositors.

Good corporate governance should provide proper incentives for the board and management
to pursue objectives that are in the interests of the company and its shareholders and should
facilitate effective monitoring. From a banking industry perspective, corporate governance
involves the manner in which the business and affairs of banks are governed by their boards
of directors and senior management, which affects how they function:

Set corporate objectives;

1. Operate the bank‟s business on a day-to-day basis.

2. Meet the obligation of accountability to their shareholders and take into account the
interests of other recognized stakeholders.

3. Align corporate activities and behavior with the expectation that banks will operate in a
safe and sound manner, and in compliance with applicable laws and regulations; 4. Protect
the interests of depositors.

Good governance is decisively the manifestation of personal beliefs and values, which
configure the organizational values, beliefs and actions of its Board. The Board as a main
functionary is primary responsible to ensure value creation for its stakeholders. The absence
of clearly designated role and powers of Board weakens accountability mechanism and
threatens the achievement of organizational goals. Therefore, the foremost requirement of

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3
good governance is the clear identification of powers, roles, responsibilities and
accountability of the Board, CEO, and the Chairman of the Board. The role of the Board
should be clearly documented in a Board Charter. 4

To sub-serve the above discussion, the following are the essential elements of good corporate
governance:

1. Transparency in Board‟s processes and independence in the functioning of Boards. The

Board should provide effective leadership to the company and management for achieving
sustained prosperity for all stakeholders. It should provide independent judgment for
achieving company's objectives.

2. Accountability to stakeholders with a view to serve the stakeholders and account to them at
regular intervals for actions taken, through strong and sustained communication processes.

3. Fairness to all stakeholders.

4. Social, regulatory and environmental concerns.

5. Clear and unambiguous legislation and regulations are fundamentals to effective corporate
governance.

6. A healthy management environment that includes setting up of clear objectives and

appropriate ethical framework, establishing due processes, clear enunciation of responsibility
and accountability, sound business planning, establishing clear boundaries for acceptable
behavior, establishing performance evaluation measures.

7. Explicitly prescribed norms of ethical practices and code of conduct are communicated to
all the stakeholders, which should be clearly understood and followed by each member of the
organization.

8. The objectives of the company must be clearly documented in a long-term corporate

strategy including an annual business plan together with achievable and measurable
performance targets and milestones.

3
John Farar, Pamela Hanrahan, Corporate Governance, (LexisNexis,2017).
4
Corporate Governance in Banking Sector- Indicating Transparency or Translucency, available at
https://journal.lawmantra.co ( last modified on April 5, 2015).

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9. A well composed Audit Committee to work as liaison with the management, internal and
statutory auditors, reviewing the adequacy of internal control and compliance with significant
policies and procedures, reporting to the Board on the key issues.

10. Risk is an important element of corporate functioning and governance, which should be
clearly identified, analyzed for taking appropriate remedial measures. For this purpose the
Board should formulate a mechanism for periodic reviews of internal and external risks.

11. A clear Whistle Blower Policy whereby the employees may without fear report to the
management about unethical behaviour, actual or suspected frauds or violation of company‟s
code of conduct. There should be some mechanism for adequate safeguard to employees
against victimization that serves as whistleblowers.

2.3. EVOLUTION OF CORPORATE GOVERNANCE OF BANKS IN

INDIA:

The researcher has sketched 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 sector
banks came on the scene. These were the changes that shaped 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
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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
5
All About Corporate Governance In The Banking Sector, available at https://blog.ipleaders.in (last modified
on January 28, 2017)

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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.

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.

Mandatory Recommendations of the SEBI’s Committee on Corporate Governance:

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 SEBI’s circular
SMDRP/Policy/CIR-10/2000 dated February 21, 2000.

A summary of the mandatory recommendations of the SEBI Committee as applicable to

banks is furnished here under:

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 1. The Committee recommends that a qualified and independent audit committee should be
set up by the board of a company.

2. The Committee recommends that the audit committee should meet at least thrice a year.
One meeting must be held before finalization of annual accounts and one necessarily every
six months.

3. The quorum should be either two members or one-third of the members of the audit
committee, whichever is higher and there should be a minimum of two independent directors.
4. Being a committee of the board, the audit committee derives its powers from the
authorization of the board.

The Committee recommends that such powers should include powers:

 To investigate any activity within its terms of reference.

 To seek information from any employee.
 To obtain outside legal or other professional advice.
 To secure attendance of outsiders with relevant expertise, if it considers necessary

5. The Committee recommends that the board should set up a remuneration committee to
determine on their behalf and on behalf of the shareholders with agreed terms of reference,
the company’s policy on specific remuneration packages for executive directors including
pension rights and any compensation payment.

6. The Committee therefore recommends that board meetings should be held at least four
times in a year, with a maximum time gap of four months between any two meetings. The
minimum information should be available to the board.

7. The committee recommends that a director should not be a member in more than 10
committees or act as Chairman of more than five committees across all companies in which
he is a director. Furthermore, it is a mandatory annual requirement for every director to
inform the company about the committee positions he occupies in other companies and notify
changes as and when they take place.

8. As a part of the disclosure related to Management, the Committee recommends that as part
of the directors’ report or as an addition thereto, a Management Discussion and Analysis
report should form part of the annual report to the shareholders.

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9. The committee recommends that disclosures be made by management to the, board
relating to all material financial and commercial transactions, where they have personal
interest, that may have a potential conflict with the interest of the company at large (for e.g.
dealing in company shares, commercial dealings with bodies which have shareholding of
management and their relatives etc.

10. The Committee recommends that information like quarterly results, presentation made by
companies to analysts may be put on company’s website 6r may be sent in such a form so as
to enable the stock exchange on which the company is listed to put it on its own website.

11. The Committee recommends that a board committee under the chairmanship of a
nonexecutive director should be formed to specifically look into the redressing of shareholder
complaints like transfer of shares, non-receipt of balance sheet, non-receipt of declared
dividends etc. The Committee believes that the formation of such a committee will help focus
the attention of the company on shareholders’ grievances and sensitize the management to
redressal of their grievances.

12. The Committee further recommends that to expedite the process of share transfers the
board

of the company should delegate the power of share transfer to an officer, or a committee or to
the registrar and share transfer agents. The delegated authority should attend to share transfer
formalities at least once in a fortnight.

13. The Committee recommends that there should be a separate section on Corporate
Governance in the annual reports of companies, with a detailed compliance report on
Corporate Governance. Non-compliance of any mandatory recommendation with reasons
thereof and the extent to which the non-mandatory recommendations have been adopted
should be specifically highlighted. This will enable the shareholders and the securities market
to assess for themselves the standards of corporate governance followed by a company.

2.4. CORPORATE GOVERNANCE AND THE GLOBAL BANKING

SCENARIO:

Banks are different from other companies in a variety of ways. The main point of difference
is the capital structure of banks and the liquidity creation function. Firstly, deposits made by
the depositors of the bank constitute the liabilities of banks. These are available on demand.

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Assets of the bank, on the other, have a comparatively longer maturity period. Therefore,
banks are able to create liquidity. Secondly, banks have very little equity as compared to
other organisations. Many differences in exist in banking corporate governance systems the
world over. Some of them have been elicited below.

1. United States of America

In the United States of America, banking regulation has essentially been the function of
federal and state banking regulators, the main objective being safety and soundness of the
banking system. The main doctrine of American corporate governance is that the duty of
managers and directors is to maximize firm value for shareholders.

2. United Kingdom:

Banking regulation in the United Kingdom is essentially the function of the Financial
Services Authority. It oversees the internal control and compliance systems of all banks. In
May 1991, a committee chaired by Sir Adrian Cadbury was established to make
recommendations to improve corporate control mechanisms for all companies in the United
Kingdom. The Committee published a final report in 1992. On 1 November 2003, a revised
Combined Code came into effect. The FSA follows this code.

3. United Arab Emirates

The banking sector in this region is characterised by family controlled banks. The main
regulatory bodies in the UAE corporate sector are the Ministry of Economy, the Central
Bank, and the Emirates Securities & Commodities Authority (ESCA). Regulatory authorities
have taken efforts to raise awareness of sound corporate governance practices and non-listed
organisations have also been subject to stringent corporate governance requirements.

4. Germany

The Deutsche Bundesbank is the central bank of the Federal Republic of Germany. Along
with the Federal Financial Supervisory Authority, the Bundesbank is responsible for
continuous oversight of the solvency, liquidity, corporate governance and risk management
systems of the banking sector in Germany.

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5. France

The Banque de France (Bank of France) is the regulatory authority in France and ensures the
implementation of the common monetary policy as defined central banks of the eurozone.
The French corporate governance code was first laid down in 1995 by a committee guided by
Marc Viénot.

6. Australia

Australia's banking regulatory authority is the Australian Prudential Regulation Authority

(APRA) Banks also have to provide information under the Anti-Money Laundering and
Counter Terrorism Financing Act 2008. The corporate governance framework is provided by
the Australian Securities Exchange (ASX) Corporate Governance Council.

Application Of Corporate Governance In The Banking Sector The Modern Context:

Corporate governance is evolutionary and ever-changing. Banks must innovate and adapt
their corporate governance practices in order to remain competitive. It may be noted here that
there is a basic difference between the private sector banks and public sector banks as far as
the Reserve Bank’s role in governance matters relevant to banking is concerned. The current
regulatory framework relating to prudential norms set up by the Reserve Bank of India gives
the same treatment to private banks and public sector banks. However, where governance
aspects are concerned, the Reserve Bank prescribes the policy framework only for private
sector banks. For public sector banks, it forwards suggestions based on the same framework
to the Government for consideration. The reforms have resulted in many changes to the
banking sector in India, including in the areas of corporate governance. Competition is being
encouraged as more and more banks are being issued licenses. Greater independence is being
given to boards of public sector banks. The nominee directors are being increasingly replaced
by independent directors. This is being done with a view to increase professional
representation on boards of public sector banks to increase the level of competence. Even
though regulatory bodies around the globe define standards for corporate governance, it is the
primary responsibility of the bank to develop sound corporate governance practices for itself.
In India, the need for better corporate governance and disclosure norms was felt due to the
string of scams and scandals that shook the country post 1990. Also, liberalization resulted in
massive international competition. This also forced companies and financial institutions to
adopt best standards. The Securities Exchange Board of India also made it compulsory for

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companies to adhere to norms mentioned in the Clause 49 of the Listing Agreement from
April 2001. Listed companies and banks in India are required to follow very strict guidelines
related to corporate governance. Indian corporate governance guidelines are amongst the
best in the world. However, corporate governance in India is followed in letter rather than in
spirit. Rampant corruption and inefficiencies of the legal system to combat and fight this
corruption has resulted in poor performance. However, the establishment of corporate
governance practices in the banking sector has been hindered by an inefficient legal
protection system and inadequate disclosure requirements. Also, in many countries, bank
corporate governance is often influenced by political intervention in the banking system. In
India, the partial divestment of public sector banks has not made any significant change to the
quality of corporate governance in public sector banks. The Government still plays a major
role in appointing members to boards of banks. Furthermore, in spite of greater autonomy
being given to banks, they still follow the directives issued by the government.

2.5. HISTORICAL BACKGROUND OF CORPORATE GOVERNACE

AN INDIAN BANKS:

Corporate governance is “the system by which companies are directed and controlled”. The
companies, markets and even banks use it for a better regulation of business. It also regulates
relationships between the management, the stakeholders and its board. The regulation of
relations are done in order to have a smooth flow of business matters and to maintain a
healthy relationship between the two.

It is not just a regulatory mechanism it enables a business, market, company or

bank to take better decisions. The key ingredient to the effectiveness of corporate governance
is the flow of information. It is based on the principle that the right information is provided to
the right people at the right time. There are two alternatives that can arise out of have
information in corporate governance, there can either be a lack of information which may
result in deformed decisions whilst too much information may lead to decision that do not
happen to focus on the issue at hand.

The cardinal principle of corporate governance is ethics and transparency. A

company gives utmost importance to its shareholders and corporate governance makes this
more likely so by letting shareholders decide how to run the business. Thus the root of
corporate governance is its stakeholders.

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 Banks have been introduced to corporate governance and it has been
discovered that the success of a good economy lies on good corporate governance. Corporate
governance is interrelated to good economic development. If done right corporate governance
encourages robust financial systems. Investor protection is key in good corporate governance,
a high level of protection for investor’s leads to a booming stock market and a higher firm
valuation. The banks will be able to allocate resources in an effective manner.

Banks play a crucial role in the flow of capital. The worst case of corporate
governance is when banks fail or deal with monetary loss in course of lending and borrowing
money, this is when banks fail the price of which has to be paid by the shareholders and the
whole economy in turn. In order to prevent such events the banks are imposed with legitimate
restrictions and obligations which leads to cascading effect in order to prevent such failures
and also to not have the entire economy pay the price for the collapse of a banking institution.
The rules and restrictions are mainly imposed on banks in order for the banks to act in a way
to promote confidence among the shareholders.

The topic of corporate governance is a vast subject that enjoys a long and rich history. It’s a
topic that incorporates managerial accountability, board structure and shareholder rights. The
issue of governance began with the beginning of corporations, dating back to the East India
Company, the Hudson’s Bay Company, the Levant Company and other major chartered
companies during the 16th and 17th centuries.

While the concept of corporate governance has existed for centuries, the
name didn’t come into vogue until the 1970s. It was a term that was only used in the United
States. The balance of power and decision-making between board directors, executives and
shareholders has been evolving for centuries. The issue has been a hot topic among academic
experts, regulators, executives and investors.

Corporate Growth Places Emphasis on Developing Corporate Governance:

After World War II, the United States experienced strong economic growth, which had a
strong impact on the history of corporate governance. Corporations were thriving and
growing rapidly. Managers primarily called the shots and board directors and shareholders
were expected to follow. In most cases, they did. This was an interesting dichotomy, since
managers highly influenced the selection of board directors. Unless it came to matters of
dividends and stock prices, investors tended to steer clear from governance matters.

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 In the 1970s, things began to change as the Securities and Exchange
Commission (SEC) brought the issue of corporate governance to the forefront when they
brought a stance on official corporate governance reforms. In 1976, the term “corporate
governance” first appeared in the Federal Register, the official journal of the federal
government.

In the 1960s, the Penn Central Railway had diversified by starting

pipelines, hotels, industrial parks and commercial real estate. Penn Central filed for
bankruptcy in 1970 and the board came under public fire. In 1974, the SEC brought
proceedings against three outside directors for misrepresenting the company’s financial
condition and a wide range of misconduct by Penn Central executives.

Around the same time, the SEC caught on to widespread payments

by corporations to foreign officials over falsifying corporate records. During this era,
corporations started to form audit committees and appoint more outside directors. In 1976,
the SEC prompted the New York Stock Exchange (NYSE) to require each listed corporation
to have an audit committee composed of all independent board directors, and they complied.
Advocates pushed to get governance right by requiring audit committees, nomination
committees, compensation committees and only one managerial appointee.

The 1980s Brought a Corporate Governance Reform Counter-Reaction:

The 1980s brought an end to the 1970s movement for corporate governance reform due to a
political shift to the right and a more conservative Congress. This era brought much
opposition to deregulation, which was another major change in the history of corporate
governance. Lawmakers put forth The Protection of Shareholders’ Rights Act of 1980, but it
was stalled in Congress.

Debates on corporate governance focused on a new project called the Principles of Corporate
Governance by the American Law Institute (ALI) in 1981. The NYSE had previously
supported this project, but changed their stance after they reviewed the first draft. The
Business Roundtable also opposed ALI’s attempts at reform. Advocates for corporations felt
they were strong enough to oppose regulatory reform outright, without the restrictive ALI-led
reforms. Businesses had concerns about some of the issues in Tentative Draft No. 1 of the
Principles of Corporative Governance. The draft recommended that boards appoint a majority
of independent directors and establish audit and nominating committees. Corporate advocates

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were concerned that if companies implemented these measures, it would increase liability
risks for board directors.

Law and economic scholars also heavily criticized the initial ALI
proposals. They expressed concerns that the proposals didn’t account for the pressures of the
market forces and didn’t consider empirical evidence. In addition, they didn’t believe that
fomenting litigation would serve a purpose in improving board director decision-making.

In the end, the final version of ALI’s Principles of Corporate Governance was so watered
down that it had little impact by the time it was approved and published in 1994. Scholars
maintained that market mechanisms would keep managers and shareholders aligned.

The “Deal Decade” Leads to Shareholder Activism:

The 1980s was also referred to as the “Deal Decade.” Institutional shareholders grabbed more
shares, which gave them more control. They stopped selling out when times got tough.
Executives went on the defensive and struck deals to prevent hostile takeovers.

State legislators countered takeovers with anti-takeover statutes at the state level. That,
combined with an increased debt market and an economic downturn, discouraged merger
activity. The Institutional Shareholder Services (ISS) was formed to help with voting rights.
Shareholders struck back with legal defenses, but judges often favored corporate decisions
when outside directors supported board decisions. Investors started to advocate for more
independent directors and to base executive pay on performance, rather than corporate size.

Financial Crisis of 2008:

By 2007, banks had been taking excessive risks and there was growing concern about a
possible collapse of the world financial system. Governments sought to prevent fallout by
offering massive bailouts and other financial measures. The collapse of the Lehman Brothers
bank developed into a major international banking crisis, which became the worst financial
crisis since the Great Depression in the 1930s. Congress passed the Dodd-Frank Wall Street
Reform and Consumer Act in 2010 to promote financial stability in the United States.

The fallout from the financial crisis has placed a heavier focus on best
practices for corporate governance principles. Boards of directors feel more pressure than

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6
ever before to be transparent and accountable. Strong governance principles encourage
corporations to have a majority of independent directors and to encourage well-composed,
diverse boards.

Advancements in technology have improved efficiency in governance

and they’ve created new risks as well. Data breaches are a new and real concern for
corporations. The first targets were banks and financial institutions. As these institutions have
bolstered their security measures, hackers have turned their efforts to smaller corporations
within a variety of industries, including governments.

Today’s boards of corporations and organizations of all sizes are finding that the best way for
them to protect themselves, their shareholders and stakeholders is to use technology to their
advantage by taking a total enterprise governance management approach. Diligent, a leader in
board management software, provides for their needs with Governance Cloud, a suite of fully
integrated and highly secure governance tools.

2.6. IN INDIA:

At independence, India inherited one of the world’s pooresteconomies but one which had a
factory sector accounting for a tenth of the nationalproduct; four functioning stock markets
(predating the Tokyo Stock Exchange) withclearly defined rules governing listing, trading
and settlements; a well-developed equityculture if only among the urban rich; and a banking
system replete with well-developedlending norms and recovery procedures.In terms of
corporate laws and financialsystem, therefore, India emerged far better endowed than most
other colonies. The 1956 Companies Act as well as other laws governing the functioning of
joint-stock companiesand protecting the investors’ rights built on this foundation.The
beginning of corporate developments in India were marked by the managingagency system
that contributed to the birth of dispersed equity ownership but also gave rise to the practice of
management enjoying control rights disproportionately greater thantheir stock ownership.
The turn towards socialism in the decades after independencemarked by the 1951 Industries
(Development and Regulation) Act as well as the 1956Industrial Policy Resolution put in
place a regime and culture of licensing, protection andwidespread red-tape that bred

6
Swami (Dr) Parthasarathy, Corporate Governance Principles, Mechanisms and Practice, (Bizantantra,2007, 1st
edition) .

18
corruption and stilted the growth of the corporate sector.The situation grew from bad to
worse in the following decades and corruption, nepotismand inefficiency became the
hallmarks of the Indian corporate sector. Exorbitant tax ratesencouraged creative accounting
practices and complicated emolument structures to beatthe system.In the absence of a
developed stock market, the three all-India development finance institutions (DFIs)– the
Industrial Finance Corporation of India, the Industrial

Development Bank of India and the Industrial Credit and Investment Corporation of India

Together with the state financial corporations became the main providers of long-term credit
to companies. Along with the government owned mutual fund, the Unit Trust of India, they
also held large blocks of shares in the companies they lent to and invariably had
representations in their boards. In this respect, the corporate governance system resembled
the bank-based German model where these institutions could have played a big role in
keeping their clients on the right track. Unfortunately, they were themselves evaluated on the
quantity rather than quality of their lending and thus had little incentive for either proper
credit appraisal or effective follow-up and monitoring. Their nominee directors routinely
served as rubber-stamps of the management of the day. With their support, promoters of
businesses in India could actually enjoy managerial control with very little equity investment
of their own. Borrowers therefore routinely recouped their investment in a short period and
then had little incentive to either repay the loans or run the business. Frequently they bled the
company with impunity, siphoning off funds with the DFI nominee directors mute spectators
in their boards. This sordid but increasingly familiar process usually continued till the
company’s net worth was completely eroded. This stage would come after the company has
defaulted on its loan obligations for a while, but this would be the stage where India’s
bankruptcy reorganization system driven by the 1985 Sick Industrial Companies Act(SICA)
would consider it “sick” and refer it to the Board for Industrial and Financial Reconstruction
(BIFR). As soon as a company is registered with the BIFR it wins immediate protection from
the creditors’ claims for at least four years. Between 1987 and 1992 BIFR took well over two
years on an average to reach a decision, after which period the delay has roughly doubled.
Very few companies have emerged successfully from the BIFR and even for those that
needed to be liquidated, the legal process takes over 10 years on average, by which time the
assets of the company are practically worthless. Protection of creditors’ rights has therefore
existed only on paper in India. Given this situation, it is hardly surprising that banks, flush
with depositors’ funds routinely decide to lend only to blue chip companies and park their

19
funds in government securities. Financial disclosure norms in India have traditionally been
superior to most Asian countries though fell short of those in the USA and other advanced
countries. Noncompliance with disclosure norms and even the failure of auditor’s reports to
conform to the law attract nominal fines with hardly any punitive action. The Institute of
Chartered Accountants in India has not been known to take action against erring auditors.
While the Companies Act provides clear instructions for maintaining and updating share
registers, in reality minority shareholders have often suffered from irregularities in share
transfers and registrations – deliberate or unintentional. Sometimes non-voting preferential
shares have been used by promoters to channel funds and deprive minority shareholders of
their dues. Minority shareholders have sometimes been defrauded by the management
undertaking clandestine side deals with the acquirers in the relatively scarce event of
corporate takeovers and mergers. Boards of directors have been largely ineffective in India in
monitoring the actions of management. They are routinely packed with friends and allies of
the promoters and managers, in flagrant violation of the spirit of corporate law. The nominee
directors from the DFIs, who could and should have played a particularly important role,
have usually been incompetent or unwilling to step up to the act. Consequently, the boards of
directors have largely functioned as rubber stamps of the management. For most of the post-
Independence era the Indian equity markets were not liquid or sophisticated enough to exert
effective control over the companies. Listing requirements of exchanges enforced some
transparency, but non-compliance was neither rare nor acted upon. All in all therefore,
minority shareholders and creditors in India remained effectively unprotected in spite of a
plethora of laws in the books.

Changes since liberalization:

The years since liberalization have witnessed wide-ranging changes in both laws and
regulations driving corporate governance as well as general consciousness about it. Perhaps
the single 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. Established primarily to regulate
and monitor stock trading, it has played a crucial role in establishing the basic minimum
ground rules of corporate conduct in the country. Concerns about corporate governance in
India were, however, largely triggered by a spate of crises in the early 90’s – the Harshad
Mehta stock market scam of 1992 followed by incidents of companies allotting preferential
shares to their promoters at deeply discounted prices as well as those of companies simply

20
 disappearing with investors’ money. These concerns about corporate governance stemming
from the corporate scandals as well as opening up to the forces of competition and
globalization gave rise to several investigations into the ways to fix the corporate governance
situation in India. One of the first among such endeavors was the CII Code for Desirable
Corporate Governance developed by a committee chaired by Rahul Bajaj. The committee
was formed in 1996 and submitted its code in April 1998. Later SEBI constituted two
committees to look into the issue of corporate governance – the first chaired by Kumar
Mangalam Birla that submitted its report in early 2000 and the second by Narayana Murthy
three years later. The SEBI committee recommendations have had the maximum impact on
changing the corporate governance situation in India. The Advisory Group on Corporate
Governance of RBI’s Standing.

2.7. KEY CONSTITUENTS OF CORPORATE GOVERNANCE:

Corporate governance contributes to the efficiency of firms enabling them to compete

internationally in a sustained way. Corporate governance plays an important role in
maintaining integrity in the organization and to manage the risk of the firm. It is a crucial
system which guides, monitors and controls the organizational functions.

The three important constituents of corporate governance are:

1. Board of Directors:
The board of directors, including the general manager or CEO (chief executive officer), have
very defined roles and responsibilities within the business organization. Essentially it is the
role of the board of directors to hire the CEO or general manager of the business and assess
the overall direction and strategy of the business. The CEO or general manager is responsible
for hiring all of the other employees and overseeing the day-to-day operation of the business.
Problems usually arise when these guidelines are not followed. Conflict occurs when the
directors begin to meddle in the day-to-day operation of the business. Conversely,
management is not responsible for the overall policy decisions of the business.

The board of directors selects officers for the board. The major office is the president or
chair of the board. Next there is a vice-president of vice-chair who serves in the absence of
the president. These positions are filled by board members. Next you usually have a secretary
and treasurer or combined secretary/treasurer. These positions focus on very specific

21
activities and may be filled by electing someone who is serving on the board of directors or
appointing someone who is not a member of the board of directors. The selection process is
often based on who is willing and who is the most qualified, although seniority may come
into play. Each board may have their own ways of handling those issues.
The seven points below outline the major responsibilities of the board of directors.

i) Recruit, supervise, retain, evaluate and compensate the manager. Recruiting, supervising,
retaining, evaluating and compensating the CEO or general manager are probably the most
important functions of the board of directors. Value-added business boards need to
aggressively search for the best possible candidate for this position. Actively searching
within your industry can lead to the identification of very capable people. Don’t fall into the
trap of hiring someone to manage the business because he/she is out of work and needs a job.
Another major error of value-added businesses is under-compensating the manager.
Managerial compensation can provide a good financial payoff in terms of attracting top
candidates who will bring financial success to the value-added business.

ii) Provide direction for the organization. The board has a strategic function in providing the
vision, mission and goals of the organization. These are often determined in combination
with the CEO or general manager of the business.

iii) Establish a policy based governance system. The board has the responsibility of
developing a governance system for the business. The articles of governance provide a
framework but the board develops a series of policies. This refers to the board as a group and
focuses on defining the rules of the group and how it will function. In a sense, it’s no
different than a club. The rules that the board establishes for the company should be policy
based. In other words, the board develops policies to guide it own actions and the actions of
the manager. The policies should be broad and not rigidly defined as to allow the board and
manager leeway in achieving the goals of the business.

iv) Govern the organization and the relationship with the CEO. Another responsibility of the
board is to develop a governance system. The governance system involves how the board
interacts with the general manager or CEO. Periodically the board interacts with the CEO
during meetings of the board of directors. Typically that is done with a monthly board
meeting, although some boards have switched to meetings three to four times a year, or

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maybe eight times a year. In the interim between these meetings, the board is kept informed
through phone conferences or postal mail.

v) Fiduciary duty to protect the organization’s assets and member’s investment. The board
has a fiduciary responsibility to represent and protect the member’s/investor’s interest in the
company. So the board has to make sure the assets of the company are kept in good order.
This includes the company’s plant, equipment and facilities, including the human capital
(people who work for the company.)

vi) Monitor and control function. The board of directors has a monitoring and control
function. The board is in charge of the auditing process and hires the auditor. It is in charge
of making sure the audit is done in a timely manner each year.

Governance Models:
A board of directors is a collection of individuals trying to operate as a group. Functioning as
a group is something many people are not comfortable with. So each board evolves with its
own culture. Each culture is dictated by the backgrounds of the individuals on the board.
However, there are several governance models of how a board of directors can function.
Examining and choosing the right model is important because it will impact the success of
the value-added business.

Below are four governance models. The board of directors must decide which model is best
for them.

1) Manager Focus – With this model, the manager dominates the board. We can all think of
situations where we have had one dominant individual in a group. In this case the board
functions are an advisory board and reacts to the views of the manager. It is essentially a
“rubber stamp” for the CEO. This model often emerges when you have a charismatic CEO
who is very dominant and proactive in running the organization. In most cases this is not a
good model for a value-added business.

2) Proactive Board – This model is of a proactive board that speaks as one voice. It speaks as
one voice for the board and often has a proactive manager that also speaks with one
combined voice for the organization. This is a good model because the manager and the

23
 board are on the same page and speak with a single voice. This model is proactive in taking
advantage of emerging opportunities and is especially valuable for entrepreneurial
businesses.

3) Geographic Representation – This model focuses on the members/investors whom the

board member represents. With this model, the board member feels that he/she has been
elected to the board to represent individuals in a geographic location or special interest group.
To better understand this model, think of an individual running for a political office and then
representing the interests of the individuals located in that geography. This is often found in
large boards, typically of 24 to 50 individuals. With a large group like this there is a
temptation for the directors to represent the interests of the members/investors in their
geographic area or special interest group rather than the best interests of the company. This is
not a model that works well for most value-added businesses.

4) Community Representation – In this situation the board member is representing the

community rather than the organization. An example of this is a school board where an
individual is elected to represent certain interests within the community.

These four models are ways in which the board and its organization function. Often the
directors who have previously been on boards where they have been chosen to represent a
certain group or have been a rubber stamp for the manager. So it is natural for a director to
think that this is how all boards function. But it is a good practice for boards to actively
investigate and discuss the models presented above and choose the right one for their
situation. This is usually a model where the directors are all active and present a single voice
of what is best for the organization. What is best for the organization will usually also be
good for the various members/investors and the stakeholders in the community.
2. Shareholders:

Stakeholder vs Shareholder?

The terms “stakeholder” and “shareholder” are often used interchangeably in the business
environment. Looking closely at the meanings of stakeholder vs shareholder, there are key
differences in usage. Generally, a shareholder is a stakeholder of the company while a
stakeholder is not necessarily a shareholder. A shareholder is a person who owns an equity
stock in the company and therefore holds an ownership stake in the company. On the other

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hand, a stakeholder is an interested party in the company’s performance for reasons other
than capital appreciation.

Stakeholder vs Shareholder :

Shareholder

A shareholder is any party, either an individual, company or institution that owns at least one
share of a company and, therefore with a financial interest in its profitability. Shareholders
may be individual investors who are saving part of their salaries in preparation for retirement
or large corporations and who hope to exercise a vote in the management of a company. If the
company’s share price increases, the shareholder’s value increases, while if the company
performs poorly and its stock price declines, then the shareholder’s value decreases.
Shareholders would prefer the company’s management to take actions that increase the share
price and dividends, and that improve their financial position.

Liquid Investments

The value of investments that shareholder’s hold in a company is usually liquid and can be
disposed of for a profit. Investors typically buy a portion of a company’s shares with the hope
that these shares will appreciate so that they earn a higher return on their investment. The
shareholder may sell part or all of his shares in the company, and then use the money to
purchase shares of another company or use the money in an entirely different investment.

Liability for the Company’s Debts

Although shareholders are owners of the company, they are not liable for the company’s
debts or other arising financial obligations. The company’s creditors cannot auction or hold
the shareholders liable for any debts that it owes them. However, in privately-held
companies, sole proprietorships, and partnerships, the creditors have a right to demand
payments and auction the properties of the owners of these entities.

Rights of Stakeholder vs Shareholder

Although shareholders do not take part in the day-to-day running of the company, the
company’s charter gives them some rights as owners of the company. One of these rights is
the right to inspect the company’s books and financial records for the year. If shareholders
have some concerns about how the top executives are running the company, they have a right

25
to be granted access to its financial records. If shareholders notice anything unusual in the
financial records, they can sue the company directors and senior officers. Also, shareholders
have a right to a proportionate allocation of proceeds when the company’s assets are sold
either due to bankruptcy or dissolution. They, however, receive their share of the proceeds
after creditors and preferred shareholders have been paid.

What is a Stakeholder?

A stakeholder is a party that has an interest in the company’s success or failure. A

stakeholder can affect or be affected by the company’s policies and objectives. Stakeholders
can either be internal or external. Internal stakeholders have a direct relationship with the
company either through employment, ownership or investment. Examples of internal
stakeholders include employees, shareholders, and managers. On the other hand, external
stakeholders are parties that do not have a direct relationship with the company but may be
affected by the actions of that company. Examples of external stakeholders include suppliers,
creditors, community and public groups.

Longevity

One of the characteristics of stakeholders in a company is longevity. Stakeholders cannot

easily decide to remove their stake in the company. The relationship between the stakeholders
and the company is bound by a series of factors that make them reliant on each other. If the
company is facing a decline in performance, it poses a serious problem for all the
stakeholders involved. For example, if the company’s operations are terminated, employees
will lose their jobs, and this means that they will no longer receive regular paychecks to
support their families. Similarly, the suppliers will no longer provide the company with
essential raw materials and products, and this results in not only a loss of income but also
forces the suppliers to look for new markets for their products.

Stakeholder vs Shareholder Corporate Social Responsibility

Traditionally, companies were only answerable to their shareholders. However, this scenario
has changed in recent years. Many corporations have started to accept the fact that, apart
from shareholders, the company is also answerable to many other constituents in the business
environment. For example, if a company is involved in business activities that take away the
green space within a community, the company must create programs that protect the social
welfare of the community and the ecosystem. The company may engage in tree-planting

26
 exercises, provide clean drinking water to the community and offer scholarships to members
of the community.

3. The Management.
Management involves identifying the mission, objective, procedures, rules and manipulation
of the human capital of an enterprise to contribute to the success of the enterprise. This
implies effective communication: an enterprise environment (as opposed to a physical or
mechanical mechanism) implies human motivation and implies some sort of successful
progress or system outcome. As such, management is not the manipulation of a mechanism
(machine or automated program), not the herding of animals, and can occur either in a legal
or in an illegal enterprise or environment. From an individual's perspective, management
does not need to be seen solely from an enterprise point of view, because management is an
essential function to improve one's life and relationships. Management is therefore
everywhere and it has a wider range of application. Based on this, management must have
humans. Communication and a positive endeavour are two main aspects of it either through
enterprise or independent pursuit. Plans, measurements, motivational psychological tools,
goals, and economic measures (profit, etc.) may or may not be necessary components for
there to be management. At first, one views management functionally, such as measuring
quantity, adjusting plans, meeting goals. This applies even in situations where planning does
not take place. From this perspective, Henri Fayol (1841–1925) considers management to
consist of six functions:
1) Forecasting
2) Planning
3) Organizing
4) Commanding
5) Coordinating
6) Controlling

 The important role in the system of the corporate governance is performed by the Board of
Directors. The board is accountable to the stakeholders and directs and controls the
management. It stewards the company, sets its strategic aim and financial goals and oversees
their implementation, puts in place adequate internal controls and periodically reports the
activities and progress of the company in a transparent manner to all the stakeholders.

27
 The important role of the shareholders is to hold the board accountable for the proper
governance of the company by enabling the board to provide them periodically the required
information in a transparent manner about the activities and progress of the company.
 The management has the responsibility to undertake the management of the organization in
terms of the direction provided by the board, to put in place adequate control systems and to
ensure their operation and to provide information to the board on a timely basis and in a
transpa7rent manner to enable the board to monitor the accountability of management to it.

2.7. 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. 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:

Establish 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.
Ensuring that compensation approaches are consistent with the bank's ethical values,
objectives, strategy and control environment.

2.8. THE SIGNIFICANCE OF CORPORATE GOVERNANCE IN THE BANKING

SCENARIO:

7
Dr. Srinivasa Rao Chilumuri, “Corporate Governance in Banking Sector: A Case study of State Bank of
India.” IOSR Journal of Business and Management (IOSR-JBM) (Feb. 2013).

28
The most important factor for any economy’s growth and development is ensuring effective
governance. This is because corporate governance promotes the efficient use of scarce
resources. It also makes these resources flow to those sectors or entities where there are
efficient production of goods and services and the return is adequate enough to satisfy the
demands of stake holders. In addition, corporate governance provides a broad mechanism of
choosing the best directors on board to govern these meagre resources. Various corporate
governance structures for banks exist in different countries Appreciating the diversity in
structure of corporate governance mechanisms across the world, the Basel Committee in
1999, recommended four important forms of oversight that should be included in the
organisational structure of any bank in order to ensure the appropriate checks and balances.
They are;

(i) Oversight by the board of directors or supervisory board.

(ii) Oversight by individuals not involved in the day-to-day running of the various business
areas

(iii) Direct line supervision of different business areas

(iv) Independent risk management and audit functions. The committee also emphasizes on
the importance of key personnel being fit and proper for their jobs.

The problems of poor corporate governance are matter of concern in most of the developing
and underdeveloped countries. The situation is same in India where corporate governance can
be useful in providing the appropriate structure in any system by placing right objectives and
goals in front of the organisation and helping the organisation to attain these goals. It helps to
provide a degree of confidence that is necessary for the proper functioning of a market
economy. Corporate governance in banks also boosts the confidence of investors. It reduces
the risk of capital outflow from an economy and at the same time, increases the flow of
capital in the economy. Subsequently, the cost of capital becomes lower for these banks. The
degree of adherence to the basic principles of governance by the banks at the corporate level
enhances the confidence of the investors of those banks as shareholders and potential
investors require access to regular and reliable information in detail for them to assess the
management. An adequate and strong disclosure therefore helps to attract capital and
maintain confidence of investors. High-quality communications reduce investors’ uncertainty
about the accuracy and adequacy of information being disseminated and thereby help the

29
firms to raise adequate capital at a competitive cost. Most countries have adopted financial
deregulation as a means of reform of national financial systems. Even then, banking
continues to be a completely regulated area.

There is no country around the globe that has adopted a complete laissez-
faire approach. The main reason for corporate governance assuming augmented significance
in our country has been globalisation, which has bought with it mounting competition.
Globalisation has made an impact on all companies and banks, public and private. Today,
banks face a more competitive global environment than other organisations. They are
instrumental in providing finance for commercial enterprises. They also provide basic
financial services to a broad segment of the population. Besides, some banks also make credit
and liquidity available in difficult market conditions. The corporate governance of banks is
different and unique from that of the other organisations. This is because the activities of the
bank are less transparent than other organisations. Thus, it becomes difficult for shareholders
and creditors to monitor the activities of the bank. The situation becomes even more difficult
when a major part of the share capital is with government. Additionally, banks also differ
from most other companies in terms of the complexity and range of their business risks, and
the consequences if these risks are poorly managed. The Banking Sector in India has
definitely not remained unaffected to the developments taking place worldwide. Enhancing
the level of corporate governance structure of Indian banks is imperative. The regulatory
bodies in India are the Reserve Bank of India and the Securities Exchange Board India.

The RBI prescribes prudential principles and norms. The RBI performs
the corporate governance function under the Board for Financial Supervision (BFS). The
BFS, in turn, supervises the working of the Department of Banking Supervision (DBS),
Department of non-Banking Supervision (DNBS) and Financial Institutions Division. The
SEBI is a regulatory authority regulating the securities market. Its authority extends up to
only companies listed in the two stock exchanges in India, namely the NSE (National Stock
Exchange) and BSE (Bombay Stock Exchange). The compliance of the corporate governance
code is mandatory for listed banks. The Banking System in India is becoming more and more
complex and open, and hence, it is at this juncture, that a need for qualitative standards is felt.
Qualitative standards include standards such as internal controls, composition and role of the
Board, disclosure standards and risk management. Such disclosure standards would put India
on par with international standards.

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 Recent developments have shown that inadequate corporate governance
standards in banks and financial institutions result into economic susceptibility. Detrimental
developments taking place in one bank or financial institution can generate similar cyclical
effects in other banks or financial institutions. Inadequate corporate governance arrangements
in banking systems include inadequately qualified and experienced bank directors, and
directors with significant conflicts of interest; insufficient understanding of the nature of
banking risks by a bank’ s directors and senior management; inadequate representation of
non-executive and independent directors on the board; inadequate risk management systems,
internal controls and internal audit arrangements; insufficient accountability of directors;
inadequate oversight of senior managers by boards of directors, and poor quality financial
reporting to the board; insufficient rights for shareholders.

Need for corporate governances in bank:

1. Since banks are important players in the Indian financial system, special focus on the
Corporate Governance in the banking sector becomes critical.

2. The Reserve Bank of India, as a regulator, has the responsibility on the nature of
Corporate Governance in the banking sector.

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

4. 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.

5. With a view to reducing the possible fiscal burden of recapitalizing the PSBs, attention
towards Corporate Governance in the banking sector assumes added importance.

CHAPTER 3

CORPORATE GOVERNANCE AND ITS ROLE IN PUBLIC,

IIIIIIIIIIIIIIPRIVATE AND COOPERATIVE BANKS.

3.1. CORPORATE GOVERNANCE AND COOPERATIVE BANKS:

31
 Urban Cooperative Banks are a key sector in the Indian Banking Industry.In recent years, this
sector has faced a lot of turmoil and turbulence,resulting in bankruptcy and closure of many
cooperative banks. The cooperative movement started in India with the enactment of
Cooperative Societies Act in 1904. The main objective of such cooperatives was to meet the
banking and credit requirements of people. Today, urban cooperative banks play an important
role in meeting the growing credit needs of urban as well as semi-urban areas of India. In
1966, the Banking Regulation Act was made applicable to UCBs. They flourished and grew
up to 2003-2004. However, their growth was cut short by inefficient and corrupt board
members, which led to gross mismanagement and finally decline in public confidence leading
to bankruptcy and closure. This decline in public confidence also led to massive large-scale
withdrawal of deposits from banks which remained functional. In India, SEBI, through the
Clause 49 of the Listing Agreement, requires all listed banks to adhere to corporate
governance regulations officially. Cooperative Banks, however, are not listed as they do not
trade in shares. This is the main difference between cooperative banks and other banks in the
banking sector. But the RBI has been making continuous efforts to see that cooperative banks
also maintain the highest standards of corporate governance. Most of the problems faced by
the cooperative banks can be attributed to corporate governance issues. Cooperative banks
should also take their own initiatives to improve the level of corporate governance
subsequently increasing public confidence. An important aspect of corporate governance is
the role of directors. The board should formulate a standardized code of conduct clearly
explaining the duties and obligations of each director. Immediate family members should not
be inducted on the board or in management at the same time. Also, no directors should have a
criminal background. All related party transactions should be reported.

3.2. CORPORATE GOVERNANCE AND BASEL NORMS:

The Basel Accord was first established in 1988 by the Basel Committee on Banking
Supervision under the Bank for International Settlements. The BISwas established on 17 May
1930 and is the world's oldest international financial organization. The Basel Committee was
established by the central-bank Governors of the Group of Ten countries in 1974. It meets

32
 regularly four times a year. It has four main working groups. The Basel Committee on
Banking Supervision provides a forum for regular cooperation on banking supervisory
matters. Its objective is to enhance understanding of key supervisory issues and improve the
quality of banking supervision worldwide. The Basel Accord was established to provide a set
of minimum capital requirements to banks. According to this accord, the banks would be
required to maintain a minimum capital requirement a propos the loans given out by them.
The 1988 Basel Accord also known as Basel I primarily focused on credit risk. The Central
Banks of several countries that have agreed to become signatories have been given the
responsibility of enforcing the provisions. In India, the Reserve Bank of India shoulders this
responsibility. The second of the Basel Accords, Basel II was first published in June 2004
and established in 2005. This accord widened the scope of Basel I by establishing capital
requirements for market risk and operational risk, in addition to credit risk. Basel II also
included provisions which allowed banks to use advanced statistical methods to compute
possible losses for which they were required to hold capital. Therefore, international banks
had an advantage as they could lower their capital requirements through the use of advanced
models. The third of the Basel Accords, Basel III was created in response to the flaws in
financial regulation which led to the crisis and also due to appeals for the reform of capital
adequacy and liquidity standards for banks. According to the Basel Committee Report of
1999, Banks have to maintain a certain level of transparency and disclosures in their
statements. The annual report should disclose a number of factors relating to the operations of
the banks such as accounting ratios, business per employee, related party disclosures and
information about NPAs.8

3.3. NEED OF CORPORATE GOVERNANCE IN COOPERATIVE BANK:

The need for corporate governance in developing, emerging and transitional economies not
only arises from resolving problems of ownership and control, but also from ensuring
transparency in achieving the desired goal of corporate governance. 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

8
Dr Rana Zehra Masood, “Corporate Governance in Indian Banking Sector International Journal of 360o
Management Review” Vol. 01, Issue 01, April (2013)

33
 sector. So the research identify the attributes of corporate governance and to what extent it is
being implemented in India„s banking sector. Good corporate governance practices must be
nurtured and encouraged to evolve as a matter of best practice. Appointment of various
committees at global level to address the issues and providing recommendations is need of
the hour. Cooperative organizational structure is very unique and innovative. Proper
understanding of cooperative culture, cooperative ethics, values and principles is essential to
evaluated Corporate Governance in the context of co-operatives. Empower banks through
information and best practices, e.g. through a code based on the OECD Principles and Basel
Committee Guidelines.

Problems of Governance in Co-Operative Banks in India:

 There is inadequate supervision over the proper utilization of loans.

 The Co-operative banks have failed to mobilize adequate deposits.
 The main reason for backwardness of co-operative bank in mounting over dues lack of
trained staff etc.
 Efficient and effective is again a where the co-operative banks have failed to make any real
progress.
 Regional imbalance in terms of structural strength and flow of finance to members for
agricultural production.
 One of most important factor is high amount of overdue. Another factor is co-operative banks
have not at all encouraged the habit of saving among the people.
 Thus the sound of healthy grand of co-operative credit have weakened due to gross miss-
management and miss use of power of co-operative by elite rural peoples at the cost of pool
and needy weaker section of the society.9

These guidelines have been developed taking into account the work which has been
undertaken extensively by several jurisdictions through many task forces and committees
including but not limited to the United Kingdom, Malaysia, South Africa, Organization for
Economic Cooperation and Development (OECD) and the Commonwealth Association for
Corporate Governance.

3.4. IMPLICATIONS OF CORPORATE GOVERNANCE IN

COOPERATIVE BANKS:
9
Mallikarjun M. Maradi, Corporate Governance Practices in Selected Co-Operative Banks at Vijayapur
City,Vol 7, Issue 3, Ver III.

34
1) Board Dynamics: There are number of principles/dynamics that are essential for good
corporate governance practices of which have been identified as representing critical
foundation and virtues of good corporate governance practices.
2) Directors Remuneration: The directors remuneration should be sufficient to attract and retain
directors to run the company effectively and should be approved by shareholders.
3) Best Practices relating to the Board of Directors and Board Committees: The board of
directors should assume a primary responsibility of fostering the long-term business of the
corporation consistent with their fiduciary responsibility to the shareholders. Every public
listed company should be headed by an effective board to offer strategic guidance, lead and
control the company and be accountable to its shareholders.
4) Balanced Board Constitutes an Effective Board: The board of directors of every banking
company should reflect a balance between independent, non-executive directors and
executive directors.
5) Remuneration of the Directors: The board of directors of every banking company should
appoint a remuneration committee or assign a mandate to a nominating committee consisting
mainly of independent and non-executive directors to recommend to the board the
remuneration.
6) Best Practices relating to the Position of Chairman and Chief Executive: Every banking
company should as a matter of best practice separate the role of the chairman and chief
executive in order to ensure a balance of power and authority and provide for checks and
balances.
7) Best Practices relating to the Conduct at Annual General Meetings: The Board of a public
listed company should ensure that shareholders right of full participation at annual general
meetings are protected by giving shareholders.
8) Best Practices Relating to Accountability and the Role of Audit Committees: Shall represent
the recommended best practice relating to the role and constitution of audit committees by
public listed companies. The board shall establish an audit committee of at least three
independent and non-executive directors who shall report to the board. The chairman of the
audit committee should be an independent and non-executive director.
9) Supply and Disclosure of Information: The board should be supplied with relevant, accurate
and timely information to enable the board discharge its duties.10

10
Dr. Sunil Kumar, “THE OUTLINE OF CORPORATE GOVERNANCE IN CO-OPERATIVE BANKS IN
INDIA”, Vol 8, 2017

35
3.5. CORPORATE GOVERNANCE AND PUBLIC SECTOR BANKS:

Coming to the aspect of the government owned banks, it becomes extremely difficult to
manage a proper corporate governance framework. As far as the regulators enforcing the
governance is concerned, government is virtually effectively not allowed to act as a monitor
in case of such state owned banks. The government combines in itself the role of owner,
regulator and sovereign. Where the government acts as both the owner as well as the
regulator, the issue of conflicts of interest persists.

Jalan states, that the crucial issue that India as a country has to debate is whether corporate
governance is compatible with public ownership, which makes the system accountable to
political institutions and not to the economic institutions or even regulators; or whether there
could be a via media wherein there could be public ownership without government or
political control or whether there need to be a change in the corporate structure so that it is
possible to make the boards responsible for appointment of CEOs, and make the board
appointments less discretionary on the part of the Government in power. Jalan, however does
not give any conclusive views on the matter and the debate as of today is still broadly open.
He however suggests the need for better internal checks and balances, better auditing, better
transparency, better enforcement of policies, better action over non performing assets and
timely action against frauds in the interim.

Reddy notes, that government, as an owner, is accountable to political institutions in terms of

broader socio-economic objectives and hence, its goals may not necessarily be compatible
with purely economic incentives. He further goes on to state that mixed ownership, with the
government as a major shareholder, brings into sharper focus the possible divergent
objectives of share-ownership in a bank and issues relating to the rights of minority
shareholders; the problem he feels gets more complex when public ownership is exercised
through separate legislation and not under the company law, normally applicable to other
competing entities.

Looking at the Indian context, historically the legal as well as policy framework has always
emphasized co-ordination in the interest of national development as per the 5-year plan
priorities with the result, the issue of corporate governance became subsumed in the overall
development framework. To that extent each bank, even after nationalisation, maintained its
distinct identity, and the governance structure as incorporated in the concerned legislations

36
provided for a formal structure of relationship between the Reserve Bank, government, board
of directors and management. The role of the Reserve Bank as a regulator became essentially
one of being an extended arm of the government so far as highest priority was accorded to
ensuring coordinated actions in regard to activities particularly of public sector banks.

An Advisory Group on Corporate Governance, under the Chairmanship of Dr. R. H. Patil,

which had submitted its report in 2001 made detailed assessment and gave recommendations
on corporate governance mechanisms of Indian banks to bring them on par with international
practices had also focused on public sector banks. It had recommended that, all the banks are
brought under a single Act so that the corporate governance regimes do not have to be
different just because the entities are covered under multiple Acts of the Parliament or that
their ownership is in the private or public sector. Noting that merely diluting the government
holding in public sector banks will not make a significant difference, it pointed to the
inequality among the various board members of the public sector banks with the nominees of
the Reserve Bank and Government are treated to be superior to other directors. It
recommended that parity should be brought on this front and that constitution of the board be
reformed. As regards the role of the Reserve Bank, it was recommended that in its roles as
the regulator the RBI does not need to have representation on the bank boards, given the fact
that it leads to conflicts of interests with its regulatory functions. Further, any policy
measures to protect banks that are less careful in their lending policies at the cost of tax
payers’ money need to be tempered in such a way that they do not encourage profligate
lending by banks. These are among the more significant recommendations as regards public
sector banks.

In 2001, a Consultative Group of Directors of Banks and Financial Institutions under the
Chairmanship of Dr. A.S. Ganguly was constituted to review the supervisory role of boards
of banks and financial institutions and to obtain feedback on the functioning of the boards
vis-à-vis compliance, transparency, disclosures, audit committees etc. and make
recommendations for making the role of board of directors more effective. The group made
its recommendations very after a comprehensive review of the existing framework as well as
of current practices and benchmarked its recommendations with international best practices
as enunciated by the Basel Committee on Banking Supervision, as well as of other
committees and advisory bodies, to the extent applicable in the Indian environment. It
recommended inter alia, the exercise of due diligence in the appointment of directors of all

37
banks, public or private sector in regard to their suitability for the post by way of
qualifications and technical expertise; the Government, it was recommended while
nominating directors on the Boards of public sector banks should be guided by certain broad
“fit and proper” norms for the Directors. The office of the Chairman and Managing Director
was recommended to be separated in respect of large sized public sector banks. This
functional separation, it was felt will bring about more focus on strategy and vision as also
the needed thrust in the operational functioning of the top management of the bank.

Reddy in numerous occasions have emphasized on the importance of corporate governance in

public sector banks, not only because they 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 such banks, the multiple objectives of the government
as owner and the complex principal-agent relationships cannot be ignored. And they cannot
be expected to blindly mimic private corporate banks in governance though general principles
are equally valid. Furthermore, the expectations, the reputational risks and the implied even if
not exercised authority in respect of the part-ownership of Government in the governance of
such banks should be recognised.

He further identifies, as the most important challenge faced in enhancing corporate

governance and in respect of which there has been significant though partial success relates to
redefining the interrelationships between institutions within the broadly defined public sector
i.e., government, the Reserve Bank and public sector banks to move away from “joint family”
approach originally designed for a model of planned development. As part of reform the
government he feels has to differentiate, conceptually and at the policy level, its role as
sovereign, owner of banks and overarching supervisor of regulators including the Reserve
Bank. The central bank he feels has to (and has already done so to some extent) move away
from sharing the nitty gritty of developmental schemes with government involving micro
regulation, to a more equitable treatment of all banks as regulator and supervisor. The large
publicly owned non-financial enterprises Reddy argued need to recognize the need for a more
commercial and competitive approach with banks including public sector banks in raising of
and deployment of funds and for achieving this he advocates a narrowing of gap between

38
 public sector banks and other banks in terms of the policy, regulatory and operating
environment.11

3.6. CORPORATE GOVERNANCE IN PRIVATE BANKS:

Banks are “special” as they not only accept and deploy large amount of un- collateralized
public funds in fiduciary capacity, but they also leverage such funds through credit creation.
The banks are also important for smooth functioning of the payment system. In view of the
above, legal prescriptions for ownership and governance of banks laid down in Banking
Regulation Act, 1949 have been supplemented by regulatory prescriptions issued by RBI
from time to time. On July 2, 2004, RBI issued draft guidelines on ownership and governance
in private sector banks in India. These guidelines were placed in the public domain for wider
debate and feedback. The RBI issued final policy guidelines on 28th February 2005 after
taking into account the feedback received. It is considered necessary to lay down a
comprehensive framework of policy in a transparent manner relating to corporate governance
in the Indian private sector banks as described below. The broad principles underlying the
framework of policy relating to corporate governance of private sector banks would have to
ensure that:

(i) The ultimate ownership and control of private sector banks is well diversified. Well-
diversified ownership minimizes the risk of misuse or imprudent use of leveraged funds , it is
no substitute for effective regulation.
(ii) (ii) The directors and the CEO who manage the affairs of the bank are ‘fit and proper’ as
indicated in circular dated June 25, 2004 and observe sound corporate governance principles.
(iii) Private sector banks have minimum capital/net worth for optimal operations and systemic
stability.
(iv) The policy and the processes are transparent and fair.

• Minimum capital:

The capital requirement of existing private sector banks should be on par with the entry
capital requirement for new private sector banks prescribed in RBI guidelines of January 3,
2001, which is initially Rs.200crore, with a commitment to increase to Rs.300crore within

11
Corporate Governance in The Banking Sector, available at https://www.lawteacher.net, last modified on 02
Feb 2018.

39
 three years. In order to meet with this requirement, all banks in private sector should have a
net worth of Rs.300crore at all times. The banks which are yet to achieve the required level of
net worth will have to submit a time-bound programme for capital augmentation to RBI.
Where the net worth declines to a level below Rs.300crore, it should be restored to
Rs.300crore within a reasonable time.

• Shareholding:

(i) The RBI guidelines on acknowledgement for acquisition or transfer of shares issued on
February 3, 2004 will be applicable for any acquisition of shares of 5 per cent and above of
the paid up capital of the private sector bank.
(ii) In the interest of diversified ownership of banks, the objective will be to ensure that no
single entity or group of related entities has shareholding or control, directly or indirectly, in
any bank in excess of 10 per cent of the paid up capital of the private sector bank. Any
higher level of acquisition will be with the prior approval of RBI and in accordance with the
guidelines of February 3, 2004 for grant of acknowledgement for acquisition of shares.
(iii) Where ownership is that of a corporate entity, the objective will be to

ensure that no single individual/entity has ownership and control in excess of 10 per cent of
that entity. Where the ownership is that of a financial entity the objective will be to ensure
that it is a well established regulated entity, widely held, publicly listed and enjoys good
standing in the financial community.

(iv) Banks (including foreign banks having branch presence in India)/FIs should not acquire
any fresh stake in a bank’s equity shares, if by such acquisition, the investing bank’s/FI’s
holding exceeds 5 per cent of the investee bank’s equity capital as indicated in RBI circular
dated July 6, 2004.

(iv) As per existing policy, large industrial houses will be allowed to acquire, by way of strategic
investment, shares not exceeding 10 per cent of the paid up capital of the bank subject to
RBI’s prior approval. Furthermore, such a limitation will also be considered if appropriate,
in regard to important shareholders with other commercial affiliations.
(v) In case of restructuring of problem/weak banks or in the interest of consolidation in the
banking sector, RBI may permit a higher level of shareholding, including by a bank.

40
 • Directors and Corporate Governance:

(i) The recommendations of the Ganguly Committee on corporate governance in banks have
highlighted the role envisaged for the Board of Directors. The Board of Directors should
ensure that the responsibilities of directors are well defined and the banks should arrange
need-based training for the directors in this regard. While the respective entities should
perform the roles envisaged for them, private sector banks will be required to ensure that the
directors on their Boards representing specific sectors as provided under the Banking
Regulation Act, are indeed representatives of those sectors in a demonstrable fashion, they
fulfill the criteria under corporate governance norms provided by the Ganguly Committee and
they also fulfill the criteria applicable for determining ‘fit and proper’ status of Important
Shareholders (i.e., shareholding of 5 per cent and above) as laid down in RBI Circular dated
June 25, 2004.
(ii) As a matter of desirable practice, not more than one member of a family or a close relative
(as defined under Section 6 of the Companies Act, 1956) or an associate (partner, employee,
director, etc.) should be on the Board of a bank.
(iii) Guidelines have been provided in respect of 'Fit and Proper' criteria for directors of banks by
RBI circular dated June 25, 2004 in accordance with the recommendations of the Ganguly
Committee on Corporate Governance. For this purpose a declaration and undertaking is
required to be obtained from the proposed / existing directors
(iv) Being a Director, the CEO should satisfy the requirements of the ‘fit and proper’ criteria
applicable for directors. In addition, RBI may apply any additional requirements for the
Chairman and CEO. The banks will be required to provide all information that may be
required while making an application to RBI for approval of appointment of Chairman/CEO

• Due diligence process:

The process of due diligence in all cases of shareholders and directors will involve reference
to the relevant regulator, revenue authorities, investigation agencies and independent credit
reference agencies as considered appropriate. 12

• Transition arrangements:

12
Corporate Governance: A Study on Indian Banking Sector, available at http://www.i-scholar.in/index.php
( last modified on January 4, 2017).

41
(i) The current minimum capital requirements for entry of new banks is Rs.200crore to be
increased to Rs.300crore within three years of commencement of business. A few private
sector banks that have been in existence before these capital requirements were prescribed
have less than Rs.200crore net worth. In the interest of having sufficient minimum size for
financial stability, all the existing private banks should also be able to fulfill the minimum net
worth requirement of Rs.300crore required for a new entry. Hence any bank with net worth
below this level will be required to submit a time bound programme for capital augmentation
to RBI for approval.
(ii) Where any existing shareholding of any individual entity/group of entities is 5 per cent and
above, due diligence outlined in the February 3, 2004 guidelines will be undertaken to ensure
fulfillment of ‘fit and proper’ criteria.
(iii) (iii) Where any existing shareholding by any individual entity/group of related entities is in
excess of 10 per cent, the bank will be required to indicate a time table for reduction of
holding to the permissible level. While considering such cases, RBI will also take into
account the terms and conditions of the banking licenses.
(iv) Any bank having shareholding in excess of 5 per cent in any other bank in India will be
required to indicate a time bound plan for reduction in such investments to the permissible
limit. The parent of any foreign bank having presence in India, having shareholding directly
or indirectly through any other entity in the banking group in excess of 5 per cent in any other
bank in India will be similarly required to indicate a time bound plan for reduction of such
holding to 5 per cent.
(v) Banks will be required to undertake due diligence before appointment of directors and
Chairman/CEO on the basis of criteria that will be separately indicated and provide all the
necessary certifications/information to RBI.
(vi) Banks having more than one member of a family, or close relatives or associates on the
Board will be required to ensure compliance with these requirements at the time of
considering any induction or renewal of terms of such directors.
(vii) Action plans submitted by private sector banks outlining the milestones for compliance with
the various requirements for ownership and governance will be examined by RBI for
consideration and approval.

• Continuous monitoring arrangements:

42
(i) Where RBI acknowledgement has already been obtained for transfer of shares of 5 per cent
and above, it will be the bank’s responsibility to ensure continuing compliance of the ‘fit and
proper’ criteria and provide an annual certificate to the RBI of having undertaken such
continuing due diligence.
(ii) Similar continuing due diligence on compliance with the ‘fit and proper’ criteria for
directors/CEO of the bank will have to be undertaken by the bank and certified to RBI
annually.
(iii) RBI may, when considered necessary, undertake independent verification of ‘fit and proper’
test conducted by banks through a process of due diligence.13

CHAPTER 4

ROLE OF SEBI AS A DIRECTOR OF CORPORATE GOVERNANCE :

Securities and Exchange Board of India was formed after the Indian parliament passed
Securities and Exchange Board of India Act, 1992 in response to financial Services
Assessment program, a program developed by the World Bank and International Monetary
Fund observes and reports on global financial systems. The Indian government wanted to
establish a strong financial atmosphere and securities market with a regulator promoting the
latest in corporate governance standards. SEBI sets standards in which the securities market
must operate, protecting the rights of issuers and investors. SEBI has power to investigate
circumstances where market or its players have been harmed and can enforce govern
standards with directives. An appeal process in place ensures accountability and
transparency. SEBI may terminate from the securities list any company that does not comply
with its governance standards and regulation. Main aim of its origin was to curb the
malpractices such as Lack of transparency in the trading operations and prices charged to
clients, Poor services due to delay in passing contract notes or not passing contract notes,
Delay in making payments to clients or in giving delivery of shares, Persistence of odd lots
and refusal of companies to stop this practice of allotting shares in odd lots, Insider trading by
agents of companies or brokers rigging and manipulating prices, unofficial premium on new
issue, violation of rules and regulations of stock exchange and listing requirements. Due to

13
Understanding the Role of Corporate Governance in Financial Institutions: A Research Agenda, available at
https://www.law.ox ( last modified on 27 Mar 2017)

43
 these malpractices the customers started losing confidence and faith in stock exchange. Many
high profile corporate governance failure scams like the stock market scam, the UTI scam,
Ketan Parikh scam, Satyam scam, which was severely criticized by the shareholders, called
for a need to make corporate governance in India transparent as it greatly affects the
development of the country. Effective corporate governance is only key to regain the trust of
investors and safeguard their interest.

4.1. ORIGIN:

SEBI was formed after the Indian Parliament passed the Securities and Exchange Board of
India Act, 1992 in response to the Financial Services Assessment Programme, a program
developed by the World Bank and International Monetary Fund that observes and reports on
global financial systems. The Indian government wanted to establish a strong financial
atmosphere and securities market with a regulator promoting the latest in corporate
governance standards. Functions SEBI sets governance standards in which the securities
market must operate, protecting the rights of issuers and investors. SEBI has power to
investigate circumstances where the market or its players have been harmed and can enforce
governance standards with directives. An appeal process in place ensures accountability and
transparency. SEBI may terminate from the securities list any company that does not comply
with its governance standards and regulations.

4.2. PILLARS OF EFFECTIVE CORPORATE GOVERNANCE :

The important elements of good Corporate Governance are:

 Transparency
 Accountability
 Disclosure
 Equity
 Fairness
 Rule of Law
 Participatory

4.3. SEBI ROLE IN CORPORATE GOVERNANCE:

To make corporate governance more effective the SEBI since its setup in 1992 has taken up
number of initiatives, appointed various committees and has brought amendments to the

44
Clause 35B and the Clause 49 of listing agreement. Here the SEBI’s role in corporate
governance is illustrated through norms and provisions as stated these two clauses; the Clause
35B and the Clause 49 of listing agreement. SEBI norms and guidelines under Clause 35B
and 49 of the listing agreement for effective Corporate Governance: Since its establishment,
SEBI has taken initiatives to align Indian corporate governance practices with the global
standards adopted in advanced economies. The recent amendments to Clause 35B and 49 of
the listing agreement make Governance more effective and rigorous in protecting the interest
of all stakeholders. The amended Clause 49 of listing agreement is in alignment with the new
Companies Act, 2013. This clause is applicable to listed companies but as per SEBI
clarification, in future this clause will be applicable to non-listing companies also.

4.4. CLAUSE 35B:

Under the revised clause 35B, the issuer has agreed to provide e-voting facility in respect of
all shareholders' resolutions, to be passed at General Meetings or postal ballot facilities to
International Journal of Pure and Applied Mathematics Special Issue 220 shareholders. The
company has to send notices of meeting to all members, auditors of the company and
directors by POST or Registered e-mail or Courier and the same be placed on the official
website of the company. The notice of meeting should also mention that the company is
providing facility for voting by electronic means and postal ballot facilities to members.
Through this provision large number of shareholders can participate in the selection of board
members.

4.5. BOARD COMPOSITION:

This sub-clause specifies optimum composition of BOD where at least 50% of board
members are non-executive directors and there must be one women director in the board.
Again it states that if the Chairman is an executive director, half the Board must comprise of
Independent directors. However if the Chairman is a nonexecutive director then 1/3rd board
members be independent directors.

4.6. RESTRICTIONS ON INDEPENDENT DIRECTORSHIP:

45
Under the Revised Clause, no person can be an independent director of more than seven
listed companies. If any person is serving as a whole time director in any liste14d company,
then he/she shall not be the independent director of more than three listed companies. The
tenure of independent director will be five years which is in accordance with provisions of
new Companies Act, 2013. The proposed amendment to clause 49 of listing agreement also
contains drastic modifications regarding the nonexecutive directors’ compensation and
disclosures.

4.7. STOCK EXCHANGES:

Economic Functions and Growth and history of the development of Indian Corporate Law
has been marked by interesting contrasts. At independence, India inherited one of the world's
poorest economy but which had a manufacturing sector accounting for a tenth of the national
product, four functioning stock markets with clearly defined rules governing listing, trading
and settlement, a well-developed equity culture among urban rich; a banking system replete
with well-developed lending norms and recovery procedures. In terms of corporate laws and
financial system, therefore, India emerged for better endowed than most other colonies. The
Companies Act, 1956 as well as laws governing the functioning of joint stock companies and
protecting the investor rights built on this foundation. Good Corporate Governance practices
enhance company's value and stakeholders trust resulting into robust development of capital
market, the economy and also help in the evolution of a vibrant and constructive
shareholder's activism. The ministry of corporate affair has examined committee reports as
well as suggestions received from the various stakeholders on the issue related to corporate
governance. Keeping in mind that the subject of corporate governance may go well beyond
the law and that there are inherent limitations in enforcing many aspects of corporate
governance through legislative and regulatory means, it has been considered necessary that
set of voluntary guidelines called Corporate Governance Voluntary 2009 which are relevant
in the present context are prepared and disseminated for consideration and adoption by
corporate.6 In today's corporate world, few individuals are getting ridiculously rich from
nothing and nowhere. Greed and aplenty opportunities around paves way for undesired action
from miscreants, despite the social responsibility and corporate governance mechanism
vogue. CSR, corporate governance, social responsibility, whatsoever they are christened as,

14
Ashok Kumar Dixit(ed), Chartered Secretary, Corporate Governance ( Ashok Kumar Dixit, New Delhi,
November ,2018).

46
are all just on the paper for sake of compliance. A legal or illegal loophole is ever sought
after to quench the never ending thirst for abnormal gains. Many investor have faith in the
ability of code of ethics to meaningfully influence corporate behaviour and prevent corporate
mishaps code of ethics alone are unable to influence corporate behaviour and prevent
corporate misdemeanours. If the code of ethics are supported by everyone in an organization
and are continually updated and monitored, they can set a sound framework for division
making and risk management. The complexity of corporate governance means that no one
they or model of society is likely to be sufficient for understanding, evaluating or designing
governance structure. Another aspect to have in mind is that corporate governance is not the
panacea for the resolution of group or individual problem within the firm.8 In the aftermath
of economic liberalization and the subsequent establishment of the Securities and Exchange
Board of India an upsurge in enthusiasm for protection of interest of shareholder rights was
gaining ground and corporate governance was one of the system in corporate management
decided by central government and the SEBI. No specific definition of what is Corporate
Governance is available in any reports of committee which examined the feasibility of
introducing this system in corporate sector. The objectives of the companies in the corporate
sector established and financed by the promoters at large, is to other products and services to
the society and after meeting the obligations to the govt, in the form of taxes and socially
desirable regulations, distribute the profits to the financial stakeholders. In view of the
Regulatory Provision brought by SEBI in the listing agreement, which requires the
companies to have a majority of the independent director many companies said to have raised
objections as to how management control of the company should be vested in hands of
majority of independent director who have no financial state in the ventures. The Stock
Exchange are the exclusive centres for trading of securities. The regulatory framework
favours them heavily by almost banning trading of securities outside exchange. History of
Stock Exchange Stock Exchange is a market place where industrial securities like equity
shares, preference shares, debentures and bonds of listed public limited companies and the
govt, securities are traded. The members of the exchange trade in listed securities on the floor
of stock exchange on their own behalf of their client. The stock exchange is a prime
institution in the security market and is a specialist market place. Its main function is to
provide the mechanism for the exchange of securities which already existed at that fair and
equitable price. The stock exchange not only helps the business undertaking in private sector,
but also the govt, for raising and management of public debt. It is to the government not only
in times of peace but also in times of war. It is also indispensable for the proper functioning

47
of the private corporate enterprises. It provides mobility to capital and direct flow of capital
into profitable and successful enterprises. It is a performance index or a barometer of general
economic development or economic growth of a country. In 1955, the then Finance Minister
in the Lok Sabha made following observation. The economic services which are well
constituted and efficiently run securities market can render to a country with large private
sector, operating under the normal incentives and impulses of private enterprises are
considerable.

In the first place it is only an organized securities market which can provide sufficient
marketability and price continuity for shares, so necessary for the needs of the investor.

Secondly, it is only such a market that can provide a reasonable measure of safety and fair
dealing to the buying and selling of securities.

Thirdly, through interplay of demand for the supply of securities a properly organized stock
exchange assists in a reasonably correct evaluation of securities in term of their real worth.
Lastly through such evaluation of securities, the stock exchange helps in the ordered flow and
distribution of saving as between different types of competitive investment. Stock Market is
the backbone of capital market. India has established various committees for development of
security market.

(l)Alley Stock Exchange Enquiry Committee, 1923,

(2) Morrison Enquiry Committee, 1936,

(3) Departmental Committee, 1948,

(4)Gorwala Committee, 1951,

(5) Patel Enquiry Committee in 1984,

(6)Pherwan Committee in 1991,

(7) Hussain Committee, 1993

were appointed to check speculation Committee Reports and Capital Market Atley
Committee 1924 has observed that the native share and Stock Brokers Association of
Bombay is voluntary association of those who deal in stocks and shares and securities of the
like nature. The present members are more than 400. The object of this association appears to

48
be the protection of the interests of members and the provision of a market place wherein the
members of the association and through them the public may buy and sell stocks, shares and
like securities. Rules and regulations have been drawn up from time to time for the guidance
of the members of the association and a building has been acquired as a market place in Dalai
street. The committee was constituted by Government Resolution No. 2628 in the Finance
Department, dated 14th September 1923. The term of reference were to inquire into the
constitution, government customs, practices, rules, regulations and methods of business of the
Native Share and Stock Brokers Association of Bombay and to investigate any such
complaints of the public and to make any inquiries with reference to any of the aforesaid
matter or any matter pertaining to the aforesaid association as the committee may deem
proper and thereafter with view to protect the investing public against the interest or irregular
control of business, to formulate such committee as deem proper. Committee has also
recommended that the stock and share market is a vital factor in the today's economic life of
progressive nature, order and confidence are essential elements in its continued prosperity
and growth. The aims and objectives of the association are set out in Article XV of the
Article of Association and primary aims and objectives of the association are set out in the
first clause.

These are:

1. To support and protect the character, status and interest of brokers in dealing in stocks and
shares and other like securities in Bombay.

2. To promote honourable practices.

3. To suppress the malpractices.

4. To settle dispute among brokers.

5. To decide the question of usage and courtesy in conducting brokerage business.

But we think that in the absence of undue protection, the realization of its inherent risks will
keep such business in some measure proportionate to the real needs of the market. Securities
Contracts (Regulation) Act, 1956. This Act was enacted to prevent undesirable transactions
and to check speculation in the securities by regulating the business of dealing therein. Any
stock exchange, which is desirous of being recognised, may make an application in the
prescribed manner to the Central Government. Every application shall contain such

49
 particulars as may be prescribed, and shall be accompanied by a copy of the bye-laws of the
stock exchange for the regulation and control of contracts as well as a copy of the rules
relating in general to the constitution of the stock exchange, and in particular to;

firstly, the governing body of such stock exchange, its constitution and powers of
management and the manner in which its business is to be transacted;15

secondly, the powers and duties of the office bearers of the stock exchange;

thirdly, the admission into the stock exchange of various classes of members, the
qualifications for membership, and the exclusion, suspension, expulsion and re- admission of
members there from or there into;

fourthly, the pr requires that the period should be extended, it may, by like notification
extend the given period from time to time. Securities and Exchange Board of India Act,16
1992 This Act was enacted to protect the interests of investors in securities and to promote
the development of, and to regulate, the securities market and for matters connected therewith
or incidental thereto. For this purpose, the SEBI (the Board), by regulation, specify:-

(i) the matters relating to issue of capital, transfer of securities and other matters incidental
thereto; and (b) the manner in which such matters shall be disclosed by the companies. No
stock-broker, sub-broker, share transfer agent, banker to an issue, trustee of trust deed,
registrar to an issue, merchant banker, underwriter, portfolio manager, investment adviser and
such other intermediary who may be associated with securities market shall buy, sell or deal
in securities except under, and in accordance with, the conditions of a certificate of
registration obtained from the Board in accordance with the regulations made under this Act.
No depository, participant, custodian of securities, foreign institutional investor, credit rating
agency, or any other intermediary associated with the securities market as the Board may by
notification in this behalf specify, shall buy or sell or deal in securities except under and in
accordance with the conditions of a certificate of registration obtained from the Board in
accordance with the regulations made under this Act. Further, no person shall sponsor or
cause to be sponsored or carry on or caused to be carried on any venture capital funds or
15
Corporate Governance: A Study on Indian Banking Sector, available at http://www.i-scholar.in/index.php (
last modified on January 4, 2017).

16
Corporate Governance in Banking Sector- Indicating Transparency or Translucency, available at
https://journal.lawmantra.co ( last modified on April 5, 2015).

50
collective investment scheme including mutual funds, unless he obtains a certificate of
registration from the Board in accordance with the regulations. Every application for
registration shall be in such manner and on payment of such fees as may be determined by
regulations. The Board may, by order, suspend or cancel a certificate of registration in a
prescribed manner, as may be determined by regulations under this Act. However, no order
shall be made unless the person concerned has been given a reasonable opportunity of being
heard.

Today corporate governance is an essential tool and mechanism for the very survival and
success of corporate in the new economic environment. No doubt at all, in this vibrant
volatile economic environment, the market Regulator SEBI has greater role and power to
make companies to follow the corporate governance standards but it alone cannot enforce and
monitor the compliance to corporate governance standards companies. It is the duty and
responsibility of all the stakeholders to ensure that the corporate governance norms are
followed by the companies in their operations. It is needed to create awareness among the
shareholders and other stakeholders on corporate governance norms and practices. Then the
corporate entities should adopt ethical business practices. The corporate practices in India
emphasize the functions of audit and finances that have legal, moral and ethical implications
for the business and its impact on the shareholders. Amendments introduced by SEBI in
Clause 49 roved innovative measures to appropriately balance legislative and regulatory
reforms for the growth of the enterprise and to increase foreign investment. The rules and
regulations are measures that increase the involvement of the shareholders in decision making
and introduce transparency in corporate governance, which ultimately safeguards the interest
of the society and shareholders. Corporate governance safeguards not only the management
but the interests of the stakeholders as well and fosters the economic progress of India in the
roaring economies of the world.17

12 Report of the Committee on Corporate Governance- available at https://www.sebi.gov.in (last modified on

Oct 5, 2017).

51
 CHAPTER 5

RBI AS A GUARDIAN OF CORPORATE GOVERNANCE

5.1. CORPORATE GOVERNANCE IN INDIA:

There are so many committees who worked in the field of corporate governance like, ‘Kumar
Mangalam Birla Committe’, the ‘Report of the Committee on Corporate Affairs and
Governance’ by ‘Naresh Chandra Committee’, the ‘ Report of the SEBI committee on
Corporate Governance’ by ‘Narayan Murti Committee’ commented on corporate
governance. They described the concept of corporate governance in stead of defining and
giving the meaning of it.

“Corporate governance is about ethical conduct in business. Ethic is concerned with the code
of values and principles that enables a person to choose between right and wrong and
therefore select for alternative course of actions.”18

“Corporate governance is beyond the realm of law. It seems from the cultural and mindset of
management and cannot be regulated by legislation alone. It is about openness, integrity and
accountability.” 19

Since its independence in 1947, India’s corporate governance regime has witnessed two
distinct eras. The first is the pre-1991 era which is embodied in company law that was
inherited from the British. Company law was substantially overhauled about a decade after
independence when it took the form of of the Companies Act, 1956. During this era, the
focus was predominantly on the manufacturing sector. The banks and development financial
institutions took up large shareholdings in companies. During the era, due to concentrated
ownership of shares, the controlling shareholders which were primarily business families or
the State, continued to extent great influence over companies at the cost of minority
shareholders. Governance structures were opaque as financial disclosure norms were poor.

18
Governance in Banks and Financial Institutions , available at https://www.rbi.org (last modified on Mar 20,
2013)

19
Governance in Banks and Financial Institutions , available at https://www.rbi.org (last modified on Mar 20,
2013)

52
Signs of change however, rapidly emerged with the 1991 reforms through economic
liberalisation that led to a new era in Indian corporate governance. The year 1992 witnessed
the establishment of the securities and Exchange Board of India (SEBI), the Indian securities
market regulator. In 1998, a National Task Force constituted by the Confederation of Indian
Industry (CII) recommended a Code for “Desirable Corporate Governance” which was
voluntarily adopted by few companies. However, there are some existing proposals to reform
some of the corporate governance provisions after the amendment took place relating to
independent directors under the Company (Amendment) act, 2008. The pending Companies
Bill, 2012, already passed in India’s lower house of parliament in December of 2012, the
Companies Bill is expected to become law by the end of 2013.

In India the motivating factors behind the corporate governance drive are those, (1) the
internationalization of Indian Capital Markets , and (2) Cross-listing by Indian Companies.

5.2. GATE-KEEPERS OF CORPORATE GOVERNANCE:

The corporate governance mechanism everywhere depends on the general legal, contractual
and enforcement process in any jurisdiction, rather than being left to the process of self-
regulations and individual commitments. Corporate Governance and enforcement mechanism
are closely linked as they form integrated framework of linkages to protect the interest of all
stakeholders.

Stock-exchange and capital market regulations function as powerful agents for instilling good
governance, specially in a country like India where capital market are going through process
of transformation. A contribution of good regulations and efficient gate-keeping would kead
to the development of strong capital markets.

Gate-keepers are individuals institutions or agencies that are interposed between investors
and managers/owners, in order to play a role of a watchdog to help reducing the agency cost.
Institutions like Reserve Bank of India (RBI) , Stock Exchange Board of India (SEBI) , and
individual like Comptroller Audit General (CAG) and others in their capacity as auditors and
analysts can act as gate-keepers.

53
5.3. RBI- RESERVE BANK OF INDIA:

The financial sector is very commonly referred to as the lifeblood of an economy. In a

developing economy, a completely hands off approach may not be ideal, the central bank
could contribute substantially to build rebust institutions and mechanisms by stipulating
norms and requirements and enforcing corporate governance and financial reporting
requirements.
Traditionally, central banks have performed the roles of currency authority, banker to the
government and other banks, lender of last resort, supervisor of banks and exchange
management authority.

Supervisory
and
Regulatory
role
banker's
Custodian of
bank and
Foreign
lender of
Reserves
last resort
Reserve
Bank of
India

Controller of Banker to
credit Government

Promotional
functions

54
 Milton Friedman defines central bank relations with the government as being comparable to
the relation between the judiciary and the government.

Rolf Hassae says that the central bank independence are three types: (i) independence in
personal matters, (ii) financial independence and (iii) policy independence. Inflation in an
economy of a country and central bank independence are inversely related.

Central bank functions in India have been carried out by the Reserve Bank of India (RBI)
since independence, when it took over the erstwhile Imperial bank of India that had been
fomed in 1935. RBI was originally set up to regulate the issue of currency, maintain foreign
exchange reserves to enable monetary stability and generally to operate the currency and
credit system in the country.

The board mandates of RBI currently is to –

(i) Stimulate economic growth by controlling monetary expansion
(ii) Including market adjustments in interest rate structures
(iii) Maintain internal price stability by monitoring inflationary pressures
(iv) Develop the banking and financial sectors and to perform a proper regulatory role

5.4. RESERVE BANK OF INDIA (RBI) AND CORPORATE

GOVERNANCE:

Banks play a pivotal role in the financial and economic system of any country. RBI plays
leading role in formulating and implementing corporate governance.

Two main features set banks apart from other businesses- the level of opaqueness in their
functioning and the relatively the greater role of the government and regulatory agencies in
their activities. The opaqueness in banking creates considerable information asymmetries
between the ‘insiders’, that is the management and ‘outsiders’ , that is , the owners and
creditors. RBI performs the corporate governance function under the guidance of the Board
of the Financial Supervision (BFS). The primary objective of BFS is to undertake

55
consolidated supervision of the financial sector compromising commercial banks, financial
institutions and non-banking financial companies. It was constituted in November 1994 as a
Committee of the Central Board of Directors of RBI.

BSF inspects and monitors banks by using the ‘CAMEL’ ( Capital Adequecy, Asset Quality,
Management, Earnings, Liquidity, and Systems and Controls) Approach. Through the Audit
Sub-Committee BFS also aims to upgrade the quality to the statutory audit nd functions in
banks and financial institutions.

The corporate governance mechanism as followed by Reserve Bank of India :-

RBI followed three catagories to govern the corporate sectors. They are: (i) Disclosure and
transparency , (ii) Off-site surveillance, (iii) Prompt Corrective Action.

Disclosure and transparency constitute the main pillars of the corporate governance
framework. They supply an adequate form of information to the stakeholders and lead to
inforemed decisions. Off-site surveillance mechanism monitors the movement of assets and
its impact on capital adequacy and overall efficiency and adequency in 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 the periodic data on “Peer Group Comparison”. Promt
Corrective Supervision (PCS) is a supervisory mechanism implemented as a part of
Electronic Banking Supervision. It is based on pre-determind rule based structure of early
intervension where the benchmark ratios for three parameters – Capital Adequacy Ratio,
Non-performing asset Ratio, and Return on Assets, are determined. Any breach of these
points is considered as warning and RBI initiates appropriate measures to overcome that.

56
 Corporate
Governance
RBI's corporate Promt
complience
Governance Corrective
Action results in
Mechanism
Shareholders'
wealth

Elective Triggers
banking CAR, NPA,
Supervision ROA

Apart from working under the jurisdiction of RBI as mentioned above, listed banks, NBFCs,
and other financial intermediaries are governed by SEBI’s Clause 49 on Corporate
Governance. Additionally RBI has also issued various circulation and notifications that
provide guidelines on :
(i) Composition, Qualification, Independence and Remuneration of Board of Directors
(ii) Roles, Responsibilities and Training of Executive Directors.
(iii) Resolution of Conlict of Interst in case of related party transaction
(iv) Constitution of Nomination Commitee, Risk Management Committee and Audit Committees.

One of the inspection and monitoring tools used by the BFS is the quality of audit (both
statutory and internal) conducted on the banking sector. The Comptroller and Auditor
General (CAG) of India and the Institute of Chartered Accountants of India (ICAI) prepared a
list of auditors and such names are approved by RBI and the private banks can choose theirs
auditors from that list.

57
 As aregulator of the banking sector, RBI has an immerse bearing on the corporate sector as
well as in the entire economy of India in terms of rates of interest, foreign exchange, and anti-
money laundering, among other things, as written below.

POLICY EFFECTS
1 Monetary Policy determines the Rapo It determines the cost of borrowing of
Rate, Bank rate, Cash Reserve Ratio, the corporate sectrs affecting
Statutory liquidatory Ratio profitability, capital budgeting
decisions and creation of production
capacities depending upon the credit
availability among other things.
2 Monetary Policy It controls the inflationary pressures
on both capital assets and the price of
consumable goods.
3 Interventions in the Foreign Exchange It reduces the currency risk in volved
Market in marketing payment of imports,
repayment of loans and thereon.
4 Export/Import Regulations Export proceeds should be realized
with in twelve months of the date of
the export, which encourages time-
bound collections.
5 Regulation of Investment in Indian RBI has imposed sectoral cap and
Companies by Foreign Institutional statutory and statutory ceiling for
Investors, Non-Residential Investors, corporate. These approavla
and the Persons of Indian Origins via determines the investible funds in
the Portfolio Investment Scheme. Indian Corporate Sector.
6 Guidelines for Indian Direct It affects business strategic
Investment in join ventures and wholly expansions decisions, foreigh
owned subsidiaries abroad technology sourcing, and resource
availability and export market
development.
7 External Commercial Borrowings The borrower must obtain a Loan
Register Number from RBI with the

58
 prior approval from RBI.
8 Guidelines for issuance of Foreign
It can be issued upto $550 milion under
Currency Convertable Bonds the automatic approval route. RBI’s
approval is required.
9 Anti –monetary Laundering Corporates have to fulfil bank
account norms.

5.5. GUIDELINES ESTABLISHED BY RBI FOR GOOD CORPORATE

GOVERNANACE:
As it is evident, the need for good corporate governance has been gaining increased emphasis
over the years. Globally, companies are adopting best corporate practices to increase the
investors confidence as also that of other stakeholders. Corporate Governance is the key to
protecting the interests of the stake-holders in the corporate sector. Its universal applicability
has no exception to the Non-Banking Financial Companies (NBFCs) which too are
essentially corporate entities. Listed NBFCs which are required to adhere to listing agreement
and rules framed by SEBI on Corporate Governance are already required to comply with
SEBI prescriptions on Corporate Governance.

In order to enable NBFCs to adopt best practices and greater transparency in their operations
following guidelines are proposed for consideration of the Board of Directors of all Deposit
taking NBFCs with deposit size of Rs 20 crore and above and all non-deposit taking NBFCs
with asset size of Rs 100 crore and above (NBFC-ND-SI).

1. Constitution of Audit Committee

In terms of extant instructions, an NBFC having assets of Rs. 50 crore and above as per its
last audited balance sheet is already required to constitute an Audit Committee, consisting of
not less than three members of its Board of Directors, the instructions shall remain valid.

In addition, NBFC-D with deposit size of Rs 20 crore may also consider constituting an Audit
Committee on similar lines.

2. Constitution of Nomination Committee

59
 The importance of appointment of directors with ‘fit and proper’ credentials is well
recognised in the financial sector. In terms of Section 45-IA (4) (c) of the RBI Act, 1934,
while considering the application for grant of Certificate of Registration to undertake the
business of non-banking financial institution it is necessary to ensure that the general
character of the management or the proposed management of the non-banking financial
company shall not be prejudicial to the interest of its present and future depositors. In view of
the interest evinced by various entities in this segment, it would be desirable that NBFC-D
with deposit size of Rs 20 crore and above and NBFC-ND-SI may form a Nomination
Committee to ensure ‘fit and proper’ status of proposed/existing Directors.

3. Constitution of Risk Management Committee

The market risk for NBFCs with Public Deposit of Rs.20 crore and above or having an asset
size of Rs.100 crore or above as on the date of last audited balance sheet is addressed by the
Asset Liability Management Committee (ALCO) constituted to monitor the asset liability gap
and strategize action to mitigate the risk associated. To manage the integrated risk, a risk
management committee may be formed, in addition to the ALCO in case of the above
category of NBFCs.

4. Disclosure and transparency

The following information should be put up by the NBFC to the Board of Directors at regular
intervals as may be prescribed by the Board in this regard:

 progress made in putting in place a progressive risk management system, and risk
management policy and strategy followed
 conformity with corporate governance standards viz. in composition of various committees,
their role and functions, periodicity of the meetings and compliance with coverage and
review functions, etc.

5. Connected Lending

The Bank has received suggestions in the matter with reference to paragraph 2(vi) of the
circular dated May 8, 2007 containing instructions on connected lending. The suggestions are
being studied and the instructions contained in paragraph 2 (vi) of the said circular will

60
 become operational after final evaluation of the suggestions and modifications, if any
considered necessary.

NBFCs shall frame their internal guidelines on corporate governance, enhancing the scope of
the guidelines without sacrificing the spirit underlying the above guidelines and it shall be
published on the company’s web-site, if any, for the information of various stakeholders.20

5.6. INSTANCES CORPORATE GOVERNANCE MALFUNCTION IN

INDIA:

In the recent years light has been shed on certain cases of “ Corporate Governance gone
wrong”, these cases help enlighten us about the ill effects of bad corporate governance.
Certain instances are discussed below.

1. THE ICICI BANK FIASCO:

21
On Thursday, 24 January, the CBI registered an FIR in connection with alleged
irregularities in the Rs 3,250 crore ICICI Bank-Videocon loan case. The investigating agency
also named Chanda Kochhar, former CEO of ICICI bank, as accused in the loan case.

The storm however has been brewing since March 2018 with ICICI Bank and Kochhar, being
in the spotlight for all the wrong reasons. After supporting Kochhar for months, the bank, on
18 June, 2018 sent Kochhar on an indefinite leave, till the completion of an independent
probe into the allegations made against her.

Additionally, independent activist and whistleblower Arvind Gupta had also levelled
allegations of ‘quid pro quo deals’ by Kochhar, alleging that the Ruia brothers of the Essar
group got undue favours from the bank for “round-tripping” investments into her spouse
Deepak Kochhar’s NuPower Group.

THE UNFOLDING OF EVENTS:

The alleged events were conspired by Chanda Kochhar and her husband Deppak Kochhar
along with Videoconn promoter Venugopal Dhoot. The original preliminary enquiry was

20
Reserve Bank of India, available at https://www.rbi.org.in ,( last modified on July 1, 2013)

21
Breaking Down Chanda Kochhar’s ‘Improprieties’ at ICICI Bank, available at https://www.thequint.com,
( last modified on January 25,2019.)

61
registered on allegations that ICICI Bank sanctioned about Rs 3,250 crores to Trend
Electronics Ltd, Century Appliance Ltd, Kail Ltd, Value Industry Ltd and Evan Fraser and
Co India Ltd. All companies belonged to Videocon promoted by Dhoot.
The officials of ICICI Bank sanctioned these credit facilities to the companies in violation of
Banking Regulation Act, RBI guidelines and credit policy of the bank. It was alleged that as
per quid pro quo Dhoot invested 64 crore in Nupower Renewables Ltd in 2008 through
Supreme Energy Private Ltd and also transferred SEPL to Pinnacle Energy Trust managed by
Deepak Kochhar by a circuitous route between 2010 and 2012.22
A year later in January 2009, Dhoot resigned as NRPL director and transferred his around
25,000 shares to Deepak Kochhar. In March 2010, NRPL secured a loan of Rs 64 crore from
a company called Supreme Energy Private Limited, which was owned by Dhoot. By end of
March 2010, Supreme Energy took majority control of NRPL with Deepak Kochhar retaining
only 5 per cent. Almost eight months later, Dhoot transferred his entire holding in Supreme
Energy to his associate Mahesh Chandra Punglia. Around two years later, Punglia transferred
his entire stake in Supreme Energy to Deepak Kochhar's Pinnacle Energy for Rs 9 lakh.

Serious questions have surfaced around the business partnership between Dhoot and Deepak
Kochhar especially in the light of the bank's massive loan to the sinking company. Gupta told
India Today, "We need to know why Deepak Kochhar and Dhoot formed a joint venture and
then why did he [Dhoot] leave it. We need to know who are the real people behind the
Mauritian company DH Renewables."

What aroused Gupta's suspicions was a flow of foreign funds to NRPL around the same time.
ICICI Bank lent close to Rs 4,000 crore to the Videocon Group between 2010 and 2012, and
DH Renewables pumped Rs 325 crore and Rs 66 crore into NRPL. ICICI Bank lent Rs 3,250
crore to five Videocon companies in April 2012 and quickly followed it by another loan of Rs
660 crore to a shell company on the Cayman Islands. ICICI has denied a quid pro quo in what
is now a bad loan of Rs 3,250.

The bank's board stood by the CEO insisting that forensic audit isn't necessary for every loan
and that Kochhar never headed the credit committee that sanctioned Rs 3,250 crore to

22
Malpractice & Malfunction- Corporate Governance Woes, https://www.peoplematters.in ,
( last modified on July 16, 2018)

62
 Videocon. Both Deepak Kochhar and Dhoot also denied wrongdoing. Deepak Kochchar
rejected allegations of share transfers to NRPL.23
2. AIR ASIA:
There are two sides to Tony Fernandes, global chief of Malaysia’s low-fare carrier AirAsia
Berhad and the country’s most popular businessman: one is of flamboyance, coolness, easy
camaraderie and accessibility, and another is of a ruthless businessman with a penchant to
control what he gets into, often earning the ire of his partners.
Fernandes, also, takes reckless decisions and lands in trouble (it has been of the regulatory
kind in India). He also elevates people and close associates as randomly and as instinctively
as he chooses to abandon them. These characteristics mark his maverick moves, which at
times lead to beautiful but often disastrous results. Here are two instances of AirAsia’s
branding activities to elucidate the point. Exhibit A. In 2015, AirAsia painted one of its
aircraft with Andy Warholstyle murals of Bo Lingam, its deputy CEO. The words, “Bo
Rocks”, were painted on the plane. It was a touching gesture, an endorsement of Lingam,
Fernandes’ closest aide and and confidant, who joined as ground operations manager in 2001
and slogged his way up to be second-incommand. It also underlined Fernandes’ qualities as a
generous leader and colleague.
Exhibit B. Last month, a decision to have a plane sport the livery Hebatkan Negaraku (Make
My Country Greater), the slogan of Malaysia’s former PM Najib Razak’s party Barisan
Nasional, landed Fernandes in deep trouble. He was criticised for supporting a politician who
was under fire for alleged wrongdoin Razak was defeated by a four-party alliance led by
Mahathir Mohamad in the historic May elections. Fernandes posted a video apologising for
supporting Razak, saying he “buckled” under pressure from the former government. He said
he was trying to “appease” Razak who, Fernandes alleged, wanted to remove former trade
minister Rafidah Aziz, a Mahathir supporter, as non-executive independent chairman of the
airline’s long-haul subsidiary AirAsia X. The government and the company were also at
loggerheads over the introduction of 120 cheap promotional flights, he added in his apology
video.
While Razak is currently tangled in accusations of money laundering, Fernandes’ support of
the previous government could have possible got him off on the wrong foot with the
Mahathir government. The relations have yet to thaw.

23
ICICI Bank CEO Chanda Kochhar under fire over Rs 3,250 crore loan to Videocon Group, available at
https://www.businesstoday.in ( last modified on March 30, 2018).

63
Ironically, it was Prime Minister Mohamad, who had, in an earlier stint, practically handed
over the then defunct airline to Fernandes - for just 25 cents in 2001. F Fernandes took it over
and turned it around to one of the most aggressive low-cost carriers in the world.
The second story, which highlights Fernandes¡¦ aggressive, going-for-broke trait, also has
strange thematic parallels with his predicament in India. Two successive governments and
Fernandes' conflict with them.
However, the crisis in India is much more serious. It won't be solved with an apology video
on social media by Fernandes. The implications are dire. Last week, the Central Bureau of
Investigation (CBI) named him, his colleagues and suspected aides in an FIR alleging
criminal conspiracy with government officials to change rules to get overseas flying rights.
Fernandes has been summoned by the CBI to appear before its officials on June 6. According
to sources, the Enforcement Directorate, too, is in the process of filing a case of money
laundering against those named in the CBI FIR.
BLAME GAME :
AirAsia applied for a flying licence during the previous UPA government. It started flying in
July 2014, two months after the current BJPled National Democratic Alliance (NDA) came to
power. The government relaxed the overseas flying rules in 2016.
Fernandes himself hasn't made any statement on the issue, save for a tweet blaming the media
for getting the facts wrong. He didn't allude to the FIR at all. Trade pundits have already
estimated a loss of RM300 million to AirAsia Berhad in the remote eventuality of AirAsia
India shutting down.
AirAsia Berhad and Tata Sons own 49% each in AirAsia India. The rest is owned by non-
executive director R Venkataramanan, a Tata Trusts managing trustee, also named in the FIR,
and chairman S Ramadorai.
There is a long-standing accusation of Rs 22 crore being paid to two fictitious companies -
Singaporean and Indian - from AirAsia India where no service was documented as received.
The FIR alleges that the money was paid as bribe to government officials.
There are alleged meetings with government officials, lobbying for licence and change in
rules. There have been investigations on related transactions between AirAsia India and
companies affiliated to AirAsia Berhad like a lessor and an insurer. The jury is out on this -
and will be for some time.

At the heart of the ongoing controversy are issues that reflect Fernandes' signature working
style. There is a contentiou brand licence agreement between AirAsia Berhad and its Indian

64
joint venture that mandates that in lieu of using the AirAsia brand, AirAsia India has to
consult it for almost all operational decisions right down to promotional fares. There should
be a "preference" to AirAsia Group companies while outsourcing functions. All of the
Malaysian carrier's existing agreements with group companies should be upheld.
The document also says that Fernandes "will provide input and approve annual budgets for
each airline within AirAsia Group including the licensee (AirAsia India)". India's aviation
regulator - the Directorate General of Civil Aviation - gave it a clean chit in February 2017
after a court directed an examination of it the previous year.
But that hasn't stopped the CBI and the ED from going over it with a fine-tooth comb and
finding several issues in it that fall foul of foreign investment norms in India.
People close to the matter have said Fernandes wielded a controlling hand over AirAsia
India's decisions. At many board meetings, he had reportedly made it clear that AirAsia
Berhad would make decisions on several aspects regarding AirAsia India, including its
revenue management. This was supposedly done in the presence of all board members.
Leaked emails have shown that Fernandes asked key management personnel at AirAsia India
to not interfere when they had flagged issues such as payments - some of them related to
lease rentals, maintenance reserves and outsourcing of support functions for finance,
accounting and HR - at higher than market rates.
Emails from a former AirAsia India board member, Bharat Vasani, revealed that corporate
governance issues had cropped up at the airline as early as 2014 when it started flying.
Issues of fierce control in decision-making have affected Fernandes' other airline ventures. In
2013, Japan's All Nippon Airways (ANA) dissolved a joint venture with AirAsia on on
differences over cost-control measures and customer service. Each sides critiqued the other's
style of functioning.
"ANA clearly told Tony that he couldn¡¦t run things his own way," says a Kuala Lumpur-
based analyst who did not want to be named.
LEGAL RAP :
The other, more curious aspect points towards Fernandes' idiosyncrasy in choosing people.
The seeds of the ongoing investigation can be found in a Deloitte forensic report a couple of
years back. It had raised practically all issues of irregular transactions that are now being
highlighted.

The only difference was that all the findings primarily pinned one man: AirAsia India's first
CEO Mittu Chandilya. Months before the launch of the Indian airline, Fernandes had

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 announced the shortlisting of Chandilya in a tweet. "A very smart boy from the South,
Madras.
An amazing CV...will impress all," he wrote. The appointment of Chandilya surprised all. He
has MBA degrees from INSEAD in France and Singapore and from Tsinghua University in
Beijing and had gone to school in India but he had never worked in the country or with an
airline before. A part-time model, he was previously the head of the services practice for
Asia-Pacific at executive search firm Egon Zehnder. He quit Air Asia in 2016 and is currently
the CEO of Adani Group's logistics business.
Chandilya seemed to have a great rapport with Fernandes, often bantering with him at press
conferences to give his Indian joint venture money to buy more planes.
However, the forensic investigation, commissioned by the company's promoters themselves,
said all irregular transactions were directed by Chandilya. It insinuated that Chandilya had
used the lobbying services of individuals - chosen to push for AirAsia's licence - to advance
his personal ambitions, including the setting up of a badminton team.

The CBI FIR all but obliterates Chandilya's name from the case except to say that he was
pressured by promoters , primarily Fernandes and his colleagues, to direct these transactions.

Fernandes' supporters and AirAsia's lawyers, however, repeatedly hark back to the Deloitte
report that names Chandilya. His detractors cite the brand licence agreement and Fernandes'
penchant for c ontrol and say that none of this would have happened without his go-ahead
The Kuala Lumpur headquarters of AirAsia is a floor above its check-in counter at the
airport. During a Chinese Lunar Festival, Fernandes donned the garb of Laughing Buddha,
wearing a red, open-chested robe and. He went around as AirAsia passengers checked in. The
Chinese among the passengers touched his belly for good luck through the year.24
3. FORTIS HEALTHCARE:
Since September19, when Fortis Healthcare India announced it was buying the overseas
healthcare business of its promoters, Malvinder and Shivinder Singh, its stock price has
tumbled 25% in a market that is down 3.5%.

24
Double trouble: AirAsia CEO Tony Fernandes faces tough time both in India and Malaysia, available at
https://economictimes.indiatimes.com , (last updated on June 03, 2018).

66
Investment analysts have expressed concerns over this $665-million intra-group transaction,
notably fairness of pricing for shareholders of the listed company, basis of valuation, standard
of disclosand related-party dealings. “We have corporate governance concerns over this
company,” said Rashesh Shah, an analyst with ICICI Direct, who downgraded the stock to
‘hold’ from ‘buy’ after the transaction price was announced on November 1.

“Everyone is surprised by this announcement (the transaction).” Between November 2010

and August 2011, the Singh family bought six overseas assets through Fortis Healthcare
International, a Singapore-registered company in which they own 100%. This (the Singapore
company) will be our vehicle of growth for our international healthcare businesses,”
Malvinder told ET on October 12, 2010, adding that the family did not route the geographical
diversification through Fortis India because it did not want to increase its debt.

But, in September 2011, in a U-turn in strategic intent, the promoters decided to group their
international healthcare assets under Fortis India, in which they own 81%. It was the “perfect
time” because the international business had attained “equal size and scale” as the Indian
entity, Malvinder Singh, executive chairman of Fortis India, had told this paper on September
19. Announcing the pricing on November 1, Malvinder said the deal was done on a “no-profit
basis” to the promoters. Shailesh Haribhakti, whose accounting and advisory firm valued the
transaction, seconded this view. “To the best of my knowledge, the promoters recorded no
profit on this transaction,” Haribhakti, chairman of BDO India said.

However, calculations by ET on the basis of information available in the public domain show
that Fortis International paid $550 million to acquire its six assets. By this calculation, at
$665 million, the listed Indian entity is paying $115 million, or 20%, more to buy the unlisted
entity owned by its promoters.

“The question is whether there is an appreciation or depreciation in the value of assets after it
was bought (to justify the 20% premium),” said SP Tulsian, an investment advisor who tracks
Fortis Healthcare India. “Outsiders won’t be able to tell.”

Issue 1: Different versions of cost:

67
A corporate presentation made by Fortis India in November 2011 on the deal does not state
the price Fortis International paid for each of those six acquisitions.

ET pieced together the $550-million figure on the basis of information released by the
company via three avenues: regulatory filings by Fortis International, Fortis India and the
acquired companies, company presentations and press releases (See table).

Haribhakti valued international business

Vishal Bali, chief executive officer of Fortis India, differed with ET’s figure of $550
million.” The actual amount paid (by Fortis International for the six buys) is $580 million,”
he said.

Bali also justified the mark-up being paid by Fortis India.” The rest ($85 million) is the
infrastructure cost in running the Singapore operations and additional investments made in
the assets.” Bali declined to share details of the capital investments made by Fortis
International after the acquisitions or the cost of running the Singapore operations. Another
Fortis group official, who did not want to be identified, said this included legal expenses
incurred during the six buys, establishment costs and employee salaries, but he did not know
the break-up. Haribhakti & Co, an affiliate of BDO International, valued the international
business for Fortis India.

Shailesh Haribhakti did not elaborate on the valuation methodology or process, citing client
confidentiality. According to the November 2011 Fortis India presentation, after it decided to
buy Fortis International, the company formed a sub-committee of independent directors to
determine the purchase price. The committee, “after evaluating proposals from leading
valuation agencies”, appointed Haribhakti & Co. Haribhakti & Co, in fact, valued Fortis
International at $695.7 million. The sub-committee of independent directors recommended
the same price. Gurcharan Das, an independent director in Fortis India, did not respond to an
email query. However, the promoters lowered this figure to $665 million, all cash. “My
respect for this family (Fortis) went up several notches as they left whatever value created for
the minority shareholders,” Haribhakti told ET. On November 1, Malvinder announced the
final deal price and said Fortis India expected to close the transaction by mid-December.

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On November 16, Fortis Healthcare announced the resignation of its then chief financial
officer, Yogesh Sareen, without stating any reasons for his departure.

Issue 2: Different versions of enterprise value:

The only valuation detail given in the Fortis India corporate presentation is the ‘enterprise
value’ of Fortis International. This essentially states how much it would cost a company to
buy Fortis International lock, stock and barrel, and has been under-stated.

The presentation shows the enterprise value of Fortis International at $938 million: purchase
consideration of $665 million, debt of $148 million and ‘minority interest’ of $125 million.
The minority interest is the value of the stake not held by Fortis International in its six assets.

For example, in the Australian company Dental Corporation, Fortis International holds
58.1%. The enterprise value projected by Fortis India to value the minority interest is
different from that used to value the majority interest.
So, while the majority interest was based on the valuation report submitted by Haribhakti &
Co, the minority interest is taken at book value. So, for example, for Primary Healthcare, the
purchase consideration was S$266 million. Of this, the book value was S$87 million and the
remaining S$179million was goodwill.

A book value calculation, in this case, would work out to S$87 million, thereby reducing the
overall valuation of Fortis International. A common metric used by analysts to assess the
price of a company is how many times it is that of its EBITDA (earnings before interest, tax,
depreciation and amortisation).

According to the Fortis India corporate presentation, for the year ended March 2011, the
EBITDA of Fortis International was $51.5 million. At an enterprise value of $938 million,
the EBITDA multiple works out to 18.

If the minority interest is not computed using book value, but on the price paid by Fortis
India, the enterprise value would increase by at least $168 million to $1.1billion. Or, an
EBITDA multiple of 21.

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According to Shah of ICICI Direct, this is on the higher side. “I am not sure whether Fortis
International can be valued at this level,” he said. “Many of its hospitals are located in mature
markets where growth may not cross 10% a year. Even at 12.5-13 times EBIDTA, it’s at a
premium.”

In October 2009, when Fortis India bought 10 Wockhardt hospitals for Rs909 crore, it paid a
valuation of 8-9 times EBITDA. Fortis India did not respond to an email query on why it
used book value to calculate minority interest.

BP Inani, a chartered accountant with Swan Finance, a corporate finance and management
consultancy firm, said the usual practice is to value minority interest using the same
parameter at which the controlling interest is valued. “If the minority interest is valued at X
while the controlling interest is valued at 2X, somebody has to justify why such a difference
arose,” he said.

“The valuation report is a final report to establish the arm’s length concept so that minority
shareholders are not at a disadvantage,” says Tulsian. “Questions need to be raised on the
methodology adopted by the valuers and investment bankers.”

Issue 3: One valuer or two?

The appointment of valuers for cross-country deals, such as this one, is covered under the
Reserve Bank of India’s guidelines by the Foreign Exchange Management Act (Fema).

Under Fema, an Indian company buying a foreign one for more than $5 million must have it
valued by a category-I merchant banker certified by capital market regulator Sebi. Asked if
there was any valuer other than Haribhakti & Co, Fortis India CEO Bali said Enam Securities
also valued the deal. “T“Their numbers were more or less the same (as Haribhakti & Co),” he
added.

However, the Fortis India presentation of November mentions only Haribhakti & Co being
appointed by the sub-committee of independent directors. Shriram Subramanian, who advises

70
institutional investors on how they should vote on specific company resolutions, has not
studied the Fortis deal.

However, he says, the concept of independent valuers is weak in India. “They tend to agree
with what the promoters want,” says the MD and founder of InGovern Research Services.

“To make the valuation more effective, the market regulator should ask for at least two
independent valuations, preferably from two different viewpoints — one from an audit firm
and another from consulting or investment banking firms.”

Issue 4: Intra-group loan:

The fourth concern relates to a Rs 395-crore loan from Fortis India that may have ended up in
Fortis International, perhaps on terms unfavourable to the listed company. This loan goes
back to May 2010, when Fortis India was involved in a bidding war for Parkway Holdings, a
Singapore-based healthcare company.

A 100% subsidiary of Fortis India to the Luxembourg Stock Exchange, where the money was
raised, the FCCB proceeds would go towards increasing its stake in Parkway. The same
month, after the FCCB issue, Fortis India gave a Rs395-crore loan to Fortis Mauritius.

In July 2010, RHC Healthcare Pte Ltd, a Singapore-registered firm, submitted a bid to
increase the Fortis group’s shareholding in Parkway. As per the bid document, Fortis
Mauritius held 49% in RHC Healthcare while the rest was with another promoter entity. In
other words, the first tranche of Parkway shares was bought through an entity 100% owned,
directly or indirectly, by Fortis India. But in the second round, Fortis India was reduced to a
minority shareholder (49%) whereas another promoter entity held 51%.

Fortis did not win Parkway. Subsequently, RHC Healthcare underwent two name changes to
become what is now Fortis International — the company that is now beingbought by Fortis
India for $665 million. Between July 2010 and March 2011, while they bought four
companies, the promoters took full control of the Singapore entity.

71
The question is what happened to the Rs395-crore loan given by Fortis India to Fortis
Mauritius, supposedly for the Parkway bid and from the FCCB issue? The Fortis India 2010-
11 annual report shows that, as of March 31, 2011, that loan had not been rbeen repaid to it.

On the same date, the last available data, the annual return of Fortis International, the 100%
promoter-owned entity in Singapore, shows a pending loan of S$121.2 million ($93 million)
from a “related company”. Is this the FCCB money? Fortis Healthcare declined to respond to
an email query on the FCCB loan.

If it is the FCCB money, it’s a case of a listed company funding promoter ambitions, that too
on terms unfavourable to shareholders of the listed entity. As per the annual return of Fortis
International, it is paying an interest rate of 4.4% on this loan. However, Fortis India is
paying FCCB holders an interest rate of 5%. In other words, if the $93 million is the FCCB
money, Fortis India extended the loan to a promoter entity below its cost price.25

4. Nirav Modi-PNB scandal:

Diamonds are rare, so are the chances of a diamantaire defrauding a bank of more
than Rs 11,300 crore. PNB's Brady House branch, less than a kilometer away from the
swanky Nirav Modi diamond boutique in Kala Ghoda has become the epicenter of
one of the largest banking fraud detected in the country.

Until a few days ago, Nirav Modi, the man at the centre of biggest scam at India's
second largest public sector lender could be seen hobnobbing with Hollywood A-
listers or cutting ribbons to open his upmarket diamond stores at some of the priciest
locations across the world.

Modi, who grew up in Antwerp, the world's diamond capital, has his eponymous
jewellery store on Madison Avenue in New York. The jewellery designer also boasts
Bollywood star Priyanka Chopra as his brand ambassodor. According to Forbes,
Wharton-dropout Nirav Modi has a net worth of $1.73 billion. He is said to have

25
Fortis Healthcare hit by governance issues; share down 25% since intra-group deal, available at
https://economictimes.indiatimes.com, (last modified on Dec 12, 2011).

72
learned the tricks of the trade from his maternal uncle Mehul Choksi who is also the
CMD popular jewellery brand Gitanjali Gems.

In 2010, Modi became the first Indian jeweller to be featured on the cover of
Sotheby's and Christie's auction catalogues. Modi's jewels also fetched a whopping Rs
60 crore at the Christie's auction way back in 2010. But Modi's ambitious plan to have
100 boutique retail stores worldwide by 2025 seems to have been cut short following
the allegations of one of India's biggest banking fraud.

Union Minister Ravi Shankar Prasad said that the government had seized assets worth
Rs 1,300 crore belonging to Nirav Modi besides initiating revocation of his passport.
A lookout notice against the Surat-born diamond jewellery designer has already been
issued by the CBI.

The fraud, incidentally, is 49 times the net profit posted by PNB for quarter ending
December 31, 2017 and more than twice the amount that PNB got under bank
recapitalisation plan.

PNB FRAUD

Billionaire jeweller Nirav Modi allegedly acquired fraudulent letters of undertaking

from one of its branches for overseas credit from other Indian lenders.

The Enforcement Directorate (ED) on Thursday conducted raids on jeweller Nirav

Modi's properties in Mumbai, Surat and Delhi. A case of money laundering has also
been lodged against Nirav Modi and others.

In a statement issued to exchanges, Punjab National Bank on Wednesday said it has

detected some fraudulent and unauthorised transactions (messages) in one of its
branch in Mumbai for the benefit of a few select account holders with their apparent
connivance.

"Based on these transactions other banks appear to have advanced money to these
customers abroad. In the Bank these transactions are contingent in nature and liability

73
arising out of these on the Bank shall be decided based on the law and genuineness of
underlying transactions," it said.

PNB has suspended 10 officers over the Rs 11,400 crore scam and referred the matter
to CBI for investigation. According to media reports, Nirav Modi left the country on
January 1 weeks before the CBI received complaint from PNB on January 29.

His brother Nishal, a Belgian citizen, also left the country on January 1, while wife
Ami, a US citizen, and business partner Mehul Choksi, the Indian promoter of
Gitanjali jewellery chain, departed on January 6.

MODUS OPERANDI
The Punjab National Bank in a letter on February 12 warned the other banks by
revealing the modus operandi used by bank officials of PNB's Brady House branch.

In the letter, PNB said, "It was found through SWIFT trail that one 'junior level'
branch official unauthorisedly and fraudulently issued Letter of Undertakings (LoUs)
on behalf of some companies belonging to Nirav Modi Group viz. Solar Exports,
Stellar Diamonds and Diamond R US for availing buyers credit from overseas
branches of Indian banks."

None of the transactions were routed through the CBS system, thus avoiding early
detection of fraudulent activity, it added. The bank also cautioned of a similar modus
operandi used by the same branch official in companies belonging to Gitanjali Gems
Ltd, promoted by Mehul Choksi viz. Gitanjali Gems, Gili India and Nakshatra while
issuing LOUs.

In case of LoUs, it has been found that at the time of issuing LoUs for a smaller
amount by SWIFT, the transaction was routed throuth the CBS system but
subsequently, amendments were made in these LoUs by substantially enhancing the
amount of LoUs and transmitted through SWIFT without routing these enhancements
through CBS.

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LOUs were opened in favour of overseas branches of Indian banks for import of
pearls for a period of one year, for which as per RBI guidelines, the total time period
allowed is 90 days from the date of shipment. Union Bank of India, Allahabad Bank
and Axis Bank are said to have offered credit based on letters of undertaking (LOUs)
issued by PNB.

Among those named is a deputy manager, Gokulnath Shetty, who was posted at PNBs
foreign exchange department in Mumbai since March 31, 2010. He had allegedly
along with another official Manoj Kharat fraudulently issued LoUs to these firms
without following prescribed procedure or making entries in the banking system,
avoiding detection of transactions.

DETECTION

When Nirav Modi companies asked for LoUs for raising buyers' credit after the
retirement of the PNB employee involved in the scam, the Punjab National Bank
sought 100 per cent cash margins for issuing LoUs. This was contested by the Nirav
Modi firms, saying they had availed of the facility from as early as 2010.

NIRAV MODI SAGA

Nirav Modi, his wife Ami, brother Nishal and Mehul Choksi are partners in
Diamonds R US, Solar Exports and Stellar Diamonds, which has shops in foreign
locations such as Hong Kong, Dubai, and New York.

Modi, who had figured in the Forbes list of richest Indians, moved to India in 1990.
The Nirav Modi store in New York shares space with legendary brands such as
Chanel, Hermes, Prada and Gucci, and the designer is known to be shelling out a
whopping $1.5 million a year as rental for the store. The store launch was graced by
celebrity guests such as US presidential contender Donald Trump, Hollywood actress
Naomi Watts and leading model Coca Rocha. Modi even walked the Red Carpet at
the Oscars alongside Kate Winslet, who was adorned in a Nirav Modi jewel.

75
 Thereafter, he has opened stores on the Old Bond Street in London, Hong Kong and
Macau.26

26
Nirav Modi case: How PNB was defrauded of Rs 11,400 crore, available at https://www.businesstoday.in ,
( last available at March 15, 2018 ).

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 CHAPTER 6
SUGGESTIONS AND CONCLUSIONS

The need for corporate governance has arisen because of the increasing concern about the
non-compliance of standards of financial reporting and accountability by boards of directors
and management of corporate inflicting heavy losses on investors. The failures of these
multinational giants bring out the importance of good corporate governance structure making
clear the distinction of power between the Board of Directors and the management which can
lead to appropriate governance processes and procedures under which management is free to
manage and board of directors is free to monitor and give policy directions.

In India, SEBI realised the need for good corporate governance and for this purpose
appointed several committees such as Kumar Manglam Birla Committee, Naresh Chandra
Committee and Narayana Murthy Committee.

6.1. SUGGESTIONS FOR PUBLIC 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. 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

77
complex principalagent 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 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.

6.2. SUGGESTIONS FOR PRIVATE 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.

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6.3. SUGGESTIONS FOR COOPERATIVE BANKS:

A good system of corporate governance in India has long being recognized as important for
the domestic economy, in that it can raise efficiency and growth; particularly when stock
markets are playing an increasingly significant role in financing investment. CG has
implications for the functioning of the Indian financial system in term of; better allocation of
capital over time, ability of Indian firms to raise funds overseas and complete internationally
reducing the likelihood of a domestic financial crises as well as an external payments crisis;
and lying a strong foundation for further opening of capital account. As India embarks on a
high growth trajectory; larger current account. Deficits will come about, an effective CG
system will insure that these larger current account deficits can be financed with longer term
and less speculative funds, reducing the chances of an external crisis in the future, even as
capital inflows increase and remaining capital account restrictions are slowly phased out. The
next section deals with some structural features related financial and legal systems of the
economy which have contributed to poor corporate governance practices in India. Certain
suggestions to improve them are:

The co-operative banks should change their establishment (under the cooperative
societies Acts of different states) to either as joint stock companies under the
companies act 2013, or as public corporations under separate acts of parliaments.
This bank is also need organized on a unitary basis, whereas every cooperatives bank
which is a scheduled bank is entitled to avail of the refinance facilities from the
Reserve Bank.
The co-operative banks have to be functions over a wide area which is not limited by
the boundaries of particular state or district.
Its branches are scattered all over the country.
The co-operatives mustbe governed by all sections of the banking regulation
act,1949, and fully controlled by RBI.
Co-operatives bank function on sound business as well as provide cheap credit
facilities and advance to small entrepreneurs and other who are engaged in
agicultural and non-agricultural activities.

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6.4. SHEDING LIGHT ON THE RESEARCH QUESTIONS:

Corporate Governance exists in all institutions and they have been laid down with certain
guidelines only after the implementation of which are known as Good Corporate Governance.
Certain research questions had been placed in Chapter 1. Good Corporate Governance has
been explained in the earlier chapters but light will be shed on risk manangement while
answering the research questions.

6.4.1. ROLE OF GOOD CORPORATE GOVERNANCE (GCG)

BANKING SECTOR TO SUPPORT IMPLEMENTATION OF RISK
MANAGEMENT:

Risk may be defined as ‘possibility of loss’, which may be financial loss or loss to the image
or reputation. Banks like any other commercial organisation also intend to take risk, which is
inherent in any business. Higher the risk taken, higher the gain would be. But higher risks
may also result into higher losses. However, banks are prudent enough to identify, measure
and price risk, and maintain appropriate capital to take care of any eventuality. The major
risks in banking business or ‘banking risks’, as commonly referred, are listed below:

 Liquidity Risk

 Interest Rate Risk

 Market Risk

 Credit or Default Risk

 Operational Risk

1. LIQUIDITY RISK:

Liquidity Risk The liquidity risk of banks arises from funding of long-term assets by short-
term liabilities, thereby making the liabilities subject to rollover or refinancing risk (Kumar et
al., 2005). It can be also defined as the possibility that an institution may be unable to meet its
maturing commitments or may do so only by borrowing funds at prohibitive costs or by
disposing assets at rock bottom prices

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 2. INTEREST RATE RISK:
Interest Rate Risk arises when the Net Interest Margin or the Market Value of Equity
(MVE) of an institution is affected due to changes in the interest rates. In other words,
the risk of an adverse impact on Net Interest Income (NII) due to variations of interest
rate may be called Interest Rate Risk (Sharma, 2003). It is the exposure of a Bank’s
financial condition to adverse movements in interest rates.
3. MARKET RISK:
The risk of adverse deviations of the mark-to-market value of the trading portfolio,
due to market movements, during the period required to liquidate the transactions is
termed as Market Risk (Kumar et al., 2005). This risk results from adverse
movements in the level or volatility of the market prices of interest rate instruments,
equities, commodities, and currencies. It is also referred to as Price Risk.
4. CREDIT OR DEFAULT RISK:
Credit risk is more simply defined as the potential of a bank borrower or counterparty
to fail to meet its obligations in accordance with the agreed terms. In other words,
credit risk can be defined as the risk that the interest or principal or both will not be
paid as promised and is estimated by observing the proportion of assets that are below
standard. Credit risk is borne by all lenders and will lead to serious problems, if
excessive. For most banks, loans are the largest and most obvious source of credit
risk. It is the most significant risk, more so in the Indian scenario where the NPA level
of the banking system is significantly high (Sharma, 2003). The Asian Financial
crisis, which emerged due to rise in NPAs to over 30% of the total assets of the
financial system of Indonesia, Malaysia, South Korea and Thailand, highlights the
importance of management of credit risk.
5. OPERATIONAL RISK:
Basel Committee for Banking Supervision has defined operational risk as ‘the risk of
loss resulting from inadequate or failed internal processes, people and systems or
from external events’. Thus, operational loss has mainly three exposure classes
namely people, processes and systems. Managing operational risk has become
important for banks due to the following reasons –
1. Higher level of automation in rendering banking and financial services
2. Increase in global financial inter-linkages27

27
Risks and Risk Management in the Banking Sector, available at http://shodhganga.in .

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All these risks may be kept at bay through Good Corporate Governance, thereare
certain guidelines to good corporate governance, they are:
1. Transparency in Board’s processes and independence in the functioning of Boards.
The Board should provide effective leadership to the company and management for
achieving sustained prosperity for all stakeholders. It should provide independent
judgment for achieving company's objectives.
2. Accountability to stakeholders with a view to serve the stakeholders and account to
them at regular intervals for actions taken, through strong and sustained
communication processes.
3. Fairness to all stakeholders.
4. Social, regulatory and environmental concerns.
5. Clear and unambiguous legislation and regulations are fundamentals to effective
corporate governance.
6. A healthy management environment that includes setting up of clear objectives and
appropriate ethical framework, establishing due processes, clear enunciation of
responsibility and accountability, sound business planning, establishing clear
boundaries for acceptable behavior, establishing performance evaluation measures.
7. Explicitly prescribed norms of ethical practices and code of conduct are
communicated to all the stakeholders, which should be clearly understood and
followed by each member of the organization.
8. The objectives of the company must be clearly documented in a long-term
corporate strategy including an annual business plan together with achievable and
measurable performance targets and milestones.
9. A well composed Audit Committee to work as liaison with the management,
internal and statutory auditors, reviewing the adequacy of internal control and
compliance with significant policies and procedures, reporting to the Board on the key
issues.
10. Risk is an important element of corporate functioning and governance, which
should be clearly identified, analyzed for taking appropriate remedial measures. For
this purpose the Board should formulate a mechanism for periodic reviews of internal
and external risks.
11. A clear Whistle Blower Policy whereby the employees may without fear report to
the management about unethical behaviour, actual or suspected frauds or violation of

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 company’s code of conduct. There should be some mechanism for adequate safeguard
to employees against victimization that serves as whistle-blowers.28

6.4.2. OBSTACLES FACED BY BANK IN IMPLEMENTING GOOD

CORPORATE GOVERNANCE (GCG) AS AN EFFORT TO SUPPORT
THE IMPLEMENTATION OF RISK MANAGEMENT.

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 (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. 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-

28

83
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. 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).29

Key areas of failure of corporate governance in banks is 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. 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 crisis. 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 are:

• 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.

29
The rights of stakeholders and active collaboration with them are also emphasized in the principles of OECD -
OECD (2004) Principles of Corporate Governance. It is even emphasized that balancing the interests of all
stakeholders positively affects the stability of banks, eliminating (or reducing) potential conflicts - K. Zalega
(2003, July).

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ENHANCING CORPORATE GOVERNANCE IN BANKS – WHAT HAS BEEN DONE
SO FAR:

These issues have become the subject of numerous decision-making bodies, part of the
above issues have been addressed in the new regulations and guidelines, in relation to many
other processes creating new legislation is still in progress. Among the global guidelines
further initiatives are set by the Basel Committee. Banking Supervision should be indicated.
First of all, sectoral "good practices" must be indicated, taking into account the specificities
of the banks. General rules intended to improve corporate governance in banks were updated
by BCBS in October 2010. The current version of the document contains 14 rules in 6 areas:
• supervisory board practices

• senior management

• risk management and internal control

• compensation policy

• complex or opaque corporate structures

• disclosure of information and transparency.

An extension of these documents is guidelines for the internal audit function in banks that
formulate 20 rules relating to the issue: supervisory expectations relative to the internal audit
function, a function for internal audit of the institution of the supervisory board, the
supervisory assessment of the internal audit function. Also the issue of remuneration of the
top executives of banks was included in the Basel guidelines – the document formulates
principles for remuneration and methodology for standards assessment. In addition, the
ongoing work must be indicated: some new regulations have already been developed and
implemented. As soon as in February 2009, the Group of experts chaired by Jacques de
Larosière recommended creating a European system of financial supervision.

6.4.3. EFFORTS TAKEN BY LAW MUST OVERCOME OBSTACLES IN

THE BANK THAT HELP IN IMPLEMENTATION OF GOOD
CORPORATE GOVERNANCE:

85
We all are aware of Satyam scam which is the India’s Biggest corporate scam. The scam is
all about corporate governance and it is regarded as the ‘Debacle of the Indian Financial
System’. Ever since this scam the concern for good corporate governance has increased
phenomenally. The Cadbury Committee defined Corporate Governance as “the system by
which companies are directed and controlled” in its report called Financial Aspect of
Corporate Governance published in the year 1992. In general words Corporate Governance
means set of rules and regulations by which an organization is governed, controlled and
directed. It is conducted by the Board of Directors or the concerned committee for the benefit
of the company’s stakeholders. Below are mentioned certain laws that help in implementing
Good Corporate Governance within a legal framework,

1 THE COMPANIES ACT, 2013:

The new Companies Law contains many provisions related to good corporate governance like
Composition of Board of Directors, Admitting Woman Director, Admitting Independent
Director, Directors Training and Evaluation, Constitution of Audit Committee, Internal
Audit, Risk Management Committee, SFIO Purview, Subsidiaries Companies Management,
Compliance center etc. All such provisions of new Company Law are instrumental in
providing a good Corporate Governance structure.

Few provisions are:-

1. Section 134, which mandates to attach a report to every Financial statement by Board
of Directors containing all the details of the matter including the statement containing
director’s responsibility.

2. Section 177, which requires Board of Directors of every listed company or any other
class of committee to constitute an Audit Committee. It also provide the manner to
constitute the committee.

3. Section 184, which mandates the Director disclose his interest in any company or
companies, body corporate, firms, or other association of Individuals. The director is
required to disclose any such interest at the first meeting of the board and if there is
any change in the interest then the first meeting held after such change.

2. SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) GUIDELINES

86
SEBI is a regulatory authority established on April 12, 1992. SEBI was established with the
main purpose of curbing the malpractices and protecting the interest of its investors. Its main
objective is to regulate the activities of Stock Exchange and at the same time ensuring the
healthy development in the financial market. In order to ensure good corporate governance
SEBI came up with detailed Corporate Governance Norms.

As per the new rules the companies are required to get shareholders approval for RPT
(Related Party Transactions), it established whistle blower mechanism, clear mandate to have
at least one woman director in the Board and moreover it elaborated disclosures on pay
packages.

Clause 35B of the Listing Agreement is being amended by the regulatory authority. Now as
per the amended clause, Listed companies are required to provide the option of e-voting to its
shareholders on all proposed or passed at general meetings. Those who do not have access to
e-voting facility, they should be provided to cast their votes in writing on Postal Ballot. There
was the need to amend the provision so that the provisions of the listing agreement can be
aligned with the provisions of Companies Act, 2013. By doing so an additional requirement
can be provided to strengthen the Corporate Governance norms in India with respect to Listed
companies.

Clause 49 of the Listing Agreement was also amended by SEBI in order to strengthen the
Corporate Governance framework for Listed companies in India. The revised clause forbids
the independent directors from being eligible for any kind of stock option. Whistle blower
policy is also added in the revised clause whereby the directors and employees can report any
unethical behavior, any fraud or if there is violation of Code of Conduct of the company. By
the amendment Audit Committee is also enhanced, now it will include evaluation of risk
management system and internal financial control, will keep a check on inter-corporate loans
and investments. The amendment now requires all the companies to form a policy for the
purpose of determination of ‘material subsidiaries’ and that will be published online.

1. SEBI (Issue of Capital and Disclosure Requirements) regulation, 2009. This

Regulation contains provisions for public issue wherein the issuer shall satisfy the
conditions mentioned under the regulation, it also contains provisions regarding
restriction on right issue. It also contains provisions regarding listing of Securities on

87
 stock exchange wherein in-principle is to be obtained by the issuer from recognised
stock exchange.Part A of schedule XI of this regulations talks about disclosure in Red
Herring prospectus, Shelf prospectus, and Prospectus wherein it is the duty of issuer
to ensure that all material information and reports were submitted prior to the issue.It
also makes it very clear that underwriting obligations would not be restricted to any
kind of minimum subscription level but it would be applicable to the whole issue. All
such rules are instrumental in ensuring good corporate governance.

2. SEBI (Listing obligations and Disclosure Requirements), 2015. The LODR

Regulations were notified with the aim of simplifying the existing provisions of
listing agreements for different segment of capital markets like convertible and non-
convertible debt securities, equity shares etc. it requires all listed entities to make
disclosure and abide by the provisions of these regulations. Listed entities shall ensure
that directors, KMP or any other person related to the company shall adhere to the
responsibilities assigned to them under this regulation. The intent here is to ensure
that once the shares of a company is listed on a Stock Exchange they are easily
accessible to the normal public. The company secretary who will be the ‘Compliance
Officer’ of the company shall ensure compliances and should also provide the
‘Compliance certificate’ to Stock Exchanges. Listed companies shall have a policy for
‘Preservation of Documents’ approved by Board.

3. SEBI (Prohibition of Insider Trading) Regulations,2015. Insider trading per se is not a

violation of Law but what is prohibited is trading by an insider on the basis of Non-
public information. To prevent such trading SEBI came up with this regulation. Under
this, the restriction is corporate insiders who arrive at trading decisions by using the
price sensitive information directly or indirectly. Under this the disclosure mandated
at two different levels, one is the immediate disclosure of material facts while the
other is regarding disclosure of transactions undertaken. While the former prevents
insider trading, the latter reveals the insider trading. Under this Insiders may be
restricted from dealing in securities for a specific time period in order to prevent them
taking advantage of any material information before the shareholders or public. A
condition can be imposed upon the insiders to obtain a prior approval before dealing
in securities of a company.

88
 4. SEBI came up with many other regulations like Regulation on Fraudulent and Unfair
Trade Practices, Regulations on Substantial Acquisition of Shares and Takeovers,
Issue of Sweat Equity etc. The main aim behind coming up with such Regulation,
rules etc is to ensure good corporate governance in a company.

2 Standard Listing Agreement of Stock Exchanges

It is for all those companies whose shares are listed on Stock Exchange. All companies are
required to file the listing agreement of the Stock exchange where its shares are listed.

3 Accounting standards issued by the ICAI (Institute of Chartered Accountants of India)

ICAI is a statutory body established by Chartered Accountants Act, 1949. It issues

accounting standards for disclosure of financial information. Section 129 of the Companies
Act, 2013 states that financial statements of a company shall comply with the accounting
standards notified under section 133 of the Act. it also states that the financial statement shall
give true and fair view of the state of affairs of the company. Section 133 states that Central
government may prescribe the accounting standards as recommended by ICAI. accounting
standards are provided so that good corporate governance can be ensured in a company.
Some accounting standards issued by ICAI are: Disclosure of Accounting policies followed
in preparation of Financial statement, Determination of values at which the inventories are
carried in a financial statement, cash flow statements for assessing the ability of an enterprise
in generating cash, standard to ensure that appropriate measurement bases are applied to
provisions and contingent liability, standard prescribing accounting treatment of cost and
revenue associated with construction contracts.

4 Secretarial standards issued by ICSI (Institute of Company Secretaries of India)

It is an autonomous body constituted by the Company Secretaries Act, 1980. It is a body to

regulate and develop the profession of Company Secretaries in India. It issues secretarial
standards as per the provision of the Companies Act,2013. Section 118(10) of the Companies
Act states that every company shall observe secretarial standards specified by Institute of
Company Secretaries of India with respect to General and Board meetings.

1. Secretarial standard-1 on Meeting of the Board seeks to prescribe a set of principles

for conducting meetings of Board of Directors. These principles are equally

89
 applicable to the meetings of committees as well.SS-1 principles are applicable to the
Meeting of Board of Directors of all companies except one person company.

2. Secretarial standard-2 prescribes a set of principles for conducting and convening

general meetings. This standard also deals with the procedure for conducting e-voting
and postal ballot. SS-2 is applicable to all types of General meetings of all companies
except one person company incorporated under the act. The principles in SS-2 are
applicable mutatis-mutandis to meetings of creditors and debenture holders moreover
it also prescribes that any meeting of members or creditors or debenture-holders of a
company under the direction of CLB (Company Law Board), NCLT (National
Company Law Tribunal) or any other authority shall be governed by the provisions of
this standard.

 Setting up IEPF (Investor Education and protection Fund) for protection of the
interest of the investors and promoting investors awareness.
 Empowering investors with the help of VO’s, NGO’s, Investor Associ 30ation
etc by educating them and providing relevant information.
 Launching websites like www.investorhelpline.in and Setting up NFCG
(National Foundation for Corporate Governance) in partnership with ICAI,
ICSI, CII with the vision to foster the culture of good governance and to set a
framework related to best practices, ethics and processes. Under NFCG a core
group on Corporate Governance norms is constituted for Institutional
Investors and ID’s. Core group on Corporate Social responsibility is also
constituted under NFCG.

As per the SEBI committee the objective of Corporate Governance is maximization of

shareholders wealth and at the same time protecting the interest of other shareholders. As per
the Report on Corporate Governance initiative in India by OECD (Organization for economic
Co-operation and Development) the Government has renamed the Ministry to “Corporate
Affairs” from “Company Affairs”. The vision behind renaming the Ministry is to become a
part for initiating Corporate Reforms in the country by ensuring Good Governance and
Enlightened regulation and to facilitate effective investor protection and Corporate
functioning.

30
Corporate Governance in the Banking Sector: Issues & Challenges, available at
http://siteresources.worldbank.org .

90
Development of rules and norms is an important step but only the first step to ensure good
corporate governance. Journey is long but serious efforts from Indian government and SEBI
will always remain instrumental in dealing with the problem of Corporate Governance.
Amendment brought in the Companies Act, various initiatives taken up by the government,
standards issued by ICAI and ICSI provides a regulatory framework for curbing the
malpractices and ensuring the rights of the investors.31

6.5. CONCLUSION:

Banks form a crucial link in a country’s financial system and their wellbeing is imperative for
the economy. The significant transformation of the banking industry in India is clearly
evident from the metamorphism of the financial markets. Globalisation has bought with it
greater competition and consequently greater risks. In such scenario, implementation of good
corporate governance practices in banks can ensure them to cope with the changing
environment.

Globalization and liberalization is sweeping across the sectors of economy and banking
industry is not an exception. In this era of revolutionary changes, banks shall confront various
risks and managing these risks shall be the future challenges of banks. In competitive
business environment, organizations that adopt good corporate governance and best practices
will be able to survive and attain sustainable growth levels. Public Sector Banks need greater
functional autonomy in a deregulated environment. Such autonomy, however, needs to be
accompanied by greater accountability on the part of their boards to the stakeholders. A
Corporate Governance Policy shall serve as an effective instrument for achieving this
goal.The success of corporate governance rests on the awareness on the part of the banks of
their own responsibilities. While law can control and regularize certain practices, the ultimate
responsibility of being ethical and moral remains with the banks. It is this enlightenment that
would bring banks closure to their goals. The following aspects require special mention while
judging the standard of corporate governance in a banking institution:

a) Constitution of the Board of directors

b) Transparency

31
Regulatory framework for Corporate Governance in India, available at https://blog.ipleaders.in (last modified
on May 12, 2017).

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 c) Policy formulation

d) Internal controls

e) Committees of the Board

By fixing prudential standards, the regulators can improve the corporate governance and RBI
has already taken a no. of steps during the recent years to enhance the usefulness of good
corporate governance. However, there is lot, which the banks themselves have to do, since
adherence to prudential norms is the minimum level of compliance and banks have to achieve
higher standards for good governance. The success of corporate governance lies in
minimizing the regulatory norms and adoption of voluntary codes.

However, while Banking has become complex and it has been recognized that there is a need
to attach more importance to qualitative standards such as internal controls and risk
management, composition, role of the board and disclosure standards in cooperative banks.
The success of corporate governance rests on the awareness and responsibilities of banks.
While law can control and regularize certain practices, the ultimate responsibility of being
ethical and moral remains with the cooperative banks. However, while all this looks good on
paper, it runs into considerable difficulty during implementation.

It has been highlighted how banks are different from other corporates and how this casts
larger and more complex responsibilities on their corporate governance. It also briefly traced
the changes in the Indian banking structure following the reforms in 1991 and how this has
had important implications for corporate governance. The findings from primary research
were quite satisfactory because the respondents were quite categorical in highlighting the
attribute of good corporate governance. It was a qualitative analysis that reflects the
prevalence of corporate governance practices in Indian Banking sector. The outcome of
secondary research analysis has already established the fact that good corporate governance is
a reality and Indian Banking sector has left no stone unturned to achieve this. Corroborating
this outcome of secondary research, primary research was aimed at to draw significant insight
into it. The outcome of primary research also reflected the sheer sincerity of senior bank‘s
executive to take this mission forward to the zenith of success. However, while Corporate
Governance has emerged as a potential force for the success of

banking sector, most of the executives find it difficult to specify the degree of
implementation of good Corporate Governance practices. Not surprisingly, the executives are

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very much concerned about the integrity of accounting statements and quality of transparency
and disclosures and feel that selective leak of sensitive information and dubious accounting
practices have been the biggest concerns from the Corporate Governance perspective.
The research on corporate governance in Indian Banking Sector produced some important
results. Banking has become complex and it has been recognized that there is a need to attach
more importance to qualitative standards such as internal controls and risk management,
composition and role of the board and disclosure standards. Corporate Governance has
become very important for banks to perform and remain in competition in the era of
liberalization and globalization. The success of corporate governance rests on the awareness
on the part of the banks of their own responsibilities. While law can control and regularize
certain practices, the ultimate responsibility of being ethical and moral remains with the
banks. It is this enlightenment that would bring banks closure to their goals. However, while
all this looks good on paper, it runs into considerable difficulty during implementation. The
difficulty is compounded given the fact that there are easier ways, which give faster returns
that are no less valuable because they are acquired through questionable means

93