Corporate governance issues in banking - Dr Sanjiv Agarwal - Article published in Business Advisor, dated August 25, 2014 http://www.magzter.com/IN/Shrinikethan/Business-Advisor/Business/

1. Volume VIII Part 4 August 25, 2014 11 Business Advisor
Corporate governance issues in banking
Dr Sanjiv Agarwal
Banks play a vital role in the economy, and the
continued strength and stability of the banking system
is a matter of general public interest and concern, both
in regard to its linkages with the real sector and for
providing a payment and settlement system.
Banks are highly leveraged organisations. Banks can
continue to fund their operations only so long as they
enjoy the confidence of the financial markets.
Depositors‟ protection and public policy considerations of banks lead to a
comprehensive regulatory and supervisory framework. It has been
recognised that banks lead to a comprehensive regulatory and supervisory
framework.
There is a need to attach importance to qualitative standards such as
internal controls and risk management composition and role of the Board
and disclosure standards so much so that -
 Corporate governance is one of the most critical issues that banks have
to pay attention to, in all earnest.
 Good corporate governance of banks is the sine qua non of a sound
banking system. Corporate governance in banks is of crucial value to the
various stakeholders, viz, the depositors, creditors, customers,
shareholders, employees and society at large.
 Adequate disclosure and transparency are two key pillars of a corporate
governance framework in a bank.
 Unlike companies, there is an external dimension to the issue of
corporate governance in banks. It is not just shareholders interest, but
that of depositors too which is involved.
 Banks are custodians of public wealth, and there must be a system of
internal checks and balances to ensure that this interest is safeguarded.
Hallmarks of good governance in banks
 Enhancing the value for all stakeholders, including depositors.
 A well understood corporate vision/ mission statement codifying its
values, ethos and culture.
 A broad-based Board, comprising specialist directors, with independent
dispositions.
 Establishment of relevant committees of the Board, with their roles
clearly defined, to oversee functions of the bank in critical areas.
 Setting standards for good banking practices to:

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a) Ensure a transparent and fair relationship between the customers
and the bank.
b) Institute a comprehensive risk management system.
c) Proactively eliminate customer complaints and evolve a scheme for
redressed of the grievances (of customers, particularly retail
depositors and borrowers), and
d) Institute systems and processes to ensure compliance with the
statues and laws concerning banking.
 A clearly enunciated code of conduct for dealing with all the stakeholders
 Effective systems of internal control, monitoring and vigilance
mechanism.
Corporate governance issues confronting banks and way forward
 At present, corporate governance in Indian banks is governed by
following three set of guidelines/ regulations –
 Provisions of the Companies Act, 1956/ 2013 (in case of corporate
entities);
 Clause 49 of SEBI‟s Listing Agreement (in case of listed entities);
 RBI master circular.
There is a need to revisit/ review these different guidelines and come out
with a single comprehensive set of guidelines which is acceptable to all
regulators.
A committee of bankers/ professionals/ IBA/ regulators may be framed for
drafting the draft set of guidelines.
 Present composition of Board structure in banks requires a complete
overhaul in changed business environment/ financial world. There could
be a two-pronged strategy, for public sector banks and private sector
banks.
While private sector ought to be provided with enough autonomy and
independence with checks and balances, this could be done through
government nominee (in form of independent director or professional)
and RBI nominee on Boards coupled with independent management
audit of banks.
For public sector banks, MoF and RBI should frame a comprehensive
Corporate Governance/ Business Code for implementation.
RRB‟s and co-operative banks should also be encouraged to function
professionally by broad basing of Board.
 PSU Boards could be made two-tier Board, a „senior Board‟ (like central
Board) and an „executive Board‟ -
a) Having a good corporate governance framework could be best or
adequately addressed by having a two-layered Board.

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b) All policy level decisions could be taken by central Board, directions
given and oversight functions carried out.
c) Executive Board could be headed by the managing director and be
made responsible for performance.
d) Central Board may have at least 50 percent non-official/ independent
directors including RBI nominee/ Government nominee directors.
e) Executive Board may have Board members comprising managing
director, 2 executive directors, officers/ staff representatives and one
non-official director.
f) While executive Board can meet on a monthly basis, central Board
may meet at least once in a quarter.
 PSU Boards should be revamped/ restructured so as to ensure the
following :
a) Position of chairman/ chairperson and managing director/ COO are
separated.
b) Both, chairman and COO/ managing director should be executive and
independent of each other.
c) Accountability/ ownership of performance shall vest with the
managing director.
d) There is a mandatory whistleblower mechanism in place.
e) Board composition should be such that people from varied fields,
professions and experience are represented on the Board, chosen with
utmost caution, prudence and transparency, keeping in mind the
talent, experience and performance only. It should not become a
platform for retired bankers/ bureaucrats/ academicians.
f) With changing times, Board should have diversity in experience, skills
and gender. There should, inter alia, be at least one person drawn
from –
(i) Economic background;
(ii) Financial expert;
(iii)Management/ legal expert;
(iv)Risk management/ IT expert;
(v) Trade/ industry/ agriculture;
(vi)Woman director.
If necessary, Board size may be increased to about 15-18 in number.
 Board level committees should also have following three committees –
(i) Corporate governance committee;
(ii) Compliance management committee;
(iii)Corporate social responsibility committee.

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Most of the Board committees must have an independent director as
chairperson and majority of members as non-executive directors.
 It should be ensured that in all public sector banks –
a) There should be a whole-time qualified company secretary employed
as secretary to the Board;
b) One of the general managers/ chief general managers should be
designated as CFO (chief financial officer) of the bank;
c) There should be separate senior officers designated as –
(i) Chief risk officer,
(ii) Chief compliance officer,
(iii)Chief vigilance officer.
d) An annual independent compliance management audit due diligence
is carried out.
e) Corporate governance policy and compliance policy are in place, are
annually reviewed by Board and performance evaluated.
f) Corporate governance audit must be conducted by or separate
professionals who are well conversant with corporate governance
principles, polices, practices and framework rather than the routine
audit conducted by statutory auditors. There is no legal bar that only
statutory auditors can do this.
ICSI has a post-membership qualification course on corporate governance
and such professionals may be involved.
 It has been seen that PSU banks have 50-80 internal committees which
results in a sheer wastage of time, resources and money, and decisions
are delayed without any one taking the responsibility. It must be ensured
that increasing the number of committees is discouraged, and
independent, judicious and prudent decision-making is encouraged.
 In group banking (for example, State Bank of India including its
associate banks), policies and decision-making is usually not
independent but is forced upon. This is to the extent that all policies are
replica of policies adopted by parent bank without proper application of
independent mind and even without ascertaining whether it is
applicable, reasonable or relevant for the associate bank. Similarly, for
all major decisions/ investments/ policy issues, such banks look at
parent bank which makes the Boards of associate bank weak and in
effect non-functional. The independent Board members, being in
minority, are helpless, except for getting their dissent recorded, at best.
Not only this, bigger loan syndications also suffer from the same problem
and once the project is appraised by parent bank, others fall in line, blindly
at times.
 Donations/ charities/ philanthropic expenses are rampant in banks
based upon personal choices of top management. There should be a

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broad parameter based criteria for expenditure, more so when, under the
new Companies Act, 2013, there is a mandatory requirement of 2% of net
profits as corporate social responsibility (CSR) to be spent. This may
encourage help MoF in its objectives including financial inclusion and
banking facilities outreach.
 Training and induction of Board members, at least for those coming from
non-banking background must be made compulsory. It should be
ensured that Board members attend at least 75 percent of the meetings
and their performance is evaluated independently as well as peer-
reviewed.
 Presently public sector banks have elected directors. These directors are
elected by shareholders for a period of three years but such directors are
not allowed to be on Boards of banks after serving a period of six years
(i.e. two terms). There should be no bar on appointment or election of
individuals as director of the bank based upon number of years served.
This only blocks the right talent to be channelised into the right use and
deprives the banking sector use such talent. This ought to be reviewed
subject to checks and balances.
 It should be ensured that mutual funds and institutional investors
actively participate in general meetings and also vote thereat.
Conclusion
All said and done, effective corporate governance in Indian banking industry
is a necessity irrespective of size, profitability or non-performing assets
(NPA) level in the banks.
However, there is a lot of improvement required in choosing right persons
for the position of directors in the banks, particularly in cases where the
Government nominates, and where they are elected by shareholders.
Banks in India need to look at larger and macro-level issues in order to
match global practices which are considered best the world over. Bank also
ought to learn from past experiences and failures in appraisals, banking
system collapse abroad and issues of corruption, integrity and performance
benchmarking
(Dr Sanjiv Agarwal is Partner, Agarwal Sanjiv & Company, Jaipur)
Effective corporate governance in Indian banking industry is
a necessity, irrespective of size, profitability or non-
performing assets (NPA) level in the banks.