corporate governance of banks

1. AMITY UNIVERSITY HARYANA
CORPORATE GOVERNANCE
ASSIGNMENT
ON THE TOPIC
“CORPORATE GOVERNANCE OF BANKS”
SUBMITTED TO:
MR. Jelis Subhan
Faculty, Amity Law School
SUBMITTED BY:
Nikhil Kumar Tyagi
Student LL.M (2014-15)
Amity Law School

2. Table of Contents
S.No Particulars Page No.
1. List of Abbreviations used 1
2. Introduction 2
3. Historical Background 3
4. Corporate Governance for Banks 4
5. The Specificity of the Corporate Governance of Banks 5
6. Role of RBI in Corporate Governance of Banks in India 6
7. Banking Regulation Act, 1949 and Corporate
Governance
7
8. International Standards of Corporate Governance for
Banks and Financial Institutions
7
9. Conclusion 9
10. References 10

3. 1
List of Abbreviations Used
Abbreviations Full Forms
BFS Board of Financial Supervision
CII Confederation of Indian Industry
CAMELS Capital Adequacy, Asset quality, Management, Earnings, Liquidity and
System and Controls
OECD Organisation for Economic Co-operation and Development
ICSI The Institute of Company Secretaries of India
SEBI Securities Exchange Board of India
RBI Reserve Bank of India

4. 2
1. Introduction
Corporate governance is the acceptance by management of the inalienable rights of
shareholders as the true owners of the corporation and of their own role as trustees on behalf
of the shareholders. It is about commitment to values, about ethical business conduct and
about making a distinction between personal and corporate funds in the management of a
company.
Corporate governance deals with laws, procedures, practices and implicit rules that determine
a company’s ability to take managerial decisions through its claimants—in particular, its
shareholders, creditors, customers, the State and employees. Good corporate governance
involves a commitment of a company to run its businesses in a legal, ethical and transparent
manner - a dedication that must come from the very top and permeate throughout the
organization. That being so, much of what constitutes good corporate governance has to be
voluntary. Law and regulations can, at best, define the basic framework - boundary conditions
that cannot be crossed. Although “corporate governance” still remains an ambiguous and
misunderstood phrase, particularly in India. There is no unique structure of “corporate
governance” in the developed world; nor is one particular type unambiguously better than
others. Thus, one cannot design a code of corporate governance for Indian companies by
mechanically importing one form or another as some of the Indian corporate houses thinks to
do and Indian corporates can no longer afford to ignore better corporate practices. As India
gets integrated in the world market, Indian as well as international investors will demand
greater disclosure, more transparent explanation for major decisions and better shareholder
value.
Most of the Indian Corporates misunderstood the concept of corporate governance as just the
compliance of the company law prevailing in the country. But in actual, it’s not just the
compliance of company law that corporate governance requires but it’s a self-regulatory
concept rather than compliance of few laws to avoid penalties. The quantity, quality and
frequency of financial and managerial disclosure, the extent to which the board of directors
exercise their fiduciary responsibilities towards shareholders, the quality of information that
management share with their boards, and the commitment to run transparent companies that
maximize long term shareholder value cannot be legislated at any level of detail. Instead, these
evolve due to the catalytic role played by the more progressive elements within the corporate
sector and, thus, enhance corporate transparency and responsibility. The basic fundamentals
for which Corporate Governance has started are as listed in this slide:
Transparency: A company is required to transact their business in a manner which is highly
transparent and their books of accounts should reflect the same.

5. 3
Accountability: Corporate Governance ensures the accountability of Board of Directors or
senior management to the various stake holders within and outside the company.
Control: To protect the interest of the shareholders the Apex monitoring body i.e. SEBI exercise
control over the management of company through various compliances.
Trusteeship: Board of directors must act as the trustees of the stakeholders and Good
Corporate Governance ensures the same.
Ethics: Good ethical practices are the mainstay of any successful corporate governance and
ensures fairness in all its activities.
2. Historical Background
It is believe that the World wide privatization wave, Mergers and takeovers, deregulation and
capital market integration, Scandals and failures at major corporations are some of the strong
reasons that imitated debate over Corporate Governance all over the world. In 1991 the
Government of United Kingdom appointed the Cadbury committee with a broad mandate to
“address the financial aspects of corporate governance”. The committee was chaired by Sir
Adrain Cadbury, CEO Cadbury Confectionery. In December 1992 the committee issued its
report, the cornerstone of which was the code of Best practice, which presents the committee’s
recommendations on the structure and responsibilities of corporate boards of Directors.
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 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 disappearing with investors’ money. 25 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.

6. 4
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 Committee on International Financial Standards and Codes also submitted its
own recommendations in 2001. 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.
3. Corporate Governance for Banks
Nowhere is proper corporate governance more crucial than for banks and financial institutions.
Given the pivotal role that banks play in the financial and economic system of a developing
country, bank failure owing to unethical or incompetent management action poses a threat not
just to the shareholders but to the depositing public and the economy at large. Understanding
this issue, the World Bank was one of the earliest economic organizations to study the issue of
corporate governance and suggest certain guidelines. The World Bank report on corporate
governance recognizes the complexity of the concept and focuses on the principles such as
transparency, accountability, fairness and responsibility that are universal in their applications.
Corporate governance is concerned with holding the balance between economic and social
goals and between individual and communal goals. The governance framework is there to
encourage the efficient use of resources and equally to require accountability for the
stewardship of those resources. The aim is to align as nearly as possible, the interests of
individuals, organizations and society. The foundation of any corporate governance is
disclosure. Openness is the basis of public confidence in the corporate system and funds will
flow to those centers of economic activity, which inspire trust. This report points the way to
establishment of trust and the encouragement of enterprise. It marks an important milestone
in the development of corporate governance.
Two main features set banks apart from other business – the level of opaqueness in their
functioning and the relatively greater role of government and regulatory agencies in their
activities. The opaqueness in banking creates considerable information asymmetries between
the “insiders” – management – and “outsiders” – owners and creditors. The very nature of the
business makes it extremely easy and tempting for management to alter the risk profile of
banks as well as siphon off funds. It is, therefore, much more difficult for the owners to
effectively monitor the functioning of bank management. Existence of explicit or implicit
deposit insurance also reduces the interest of depositors in monitoring bank management
activities.

7. 5
It is partly for these reasons that prudential norms of banking and close monitoring by the
central bank of commercial bank activities are essential for smooth functioning of the banking
sector. Government control or monitoring of banks, on the other hand, brings in its wake, the
possibility of corruption and diversion of credit of political purposes which may, in the long run,
jeopardize the financial health of the bank as well as the economy itself. The reforms have
marked a shift from hands-on government control interference to market forces as the
dominant paradigm of corporate governance in Indian banks. Competition has been
encouraged with the issue of licenses to new private banks and more power and flexibility have
been granted to the bank management both in directing credit as well as in setting prices.
4. The specificity of the corporate governance of banks
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:
i) 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.
ii) 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;
iii) 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 behavior management (take increased risk) which expose well -being of
stakeholders of the bank (in particular the depositors and owners);
iv) between the bank and its clients there are fiduciary relationships raising additional
relationships and agency costs;
v) 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;
vi) the number of parties with a stake in an institution’s activity complicates the
governance of financial institutions.

8. 6
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 behavior and attitudes. Corporate fairness,
transparency and accountability are thus the main objectives of corporate governance.
One must have in mind that there is no one model of corporate governance adaptable to all
banks. Other goals, and therefore supervisory systems, will be in banks: private, co-operative
and state; in the local and global banks; universal banks and investment (etc.); though priorities
remain the same.
5. Role of RBI in Corporate Governance of Banks in India
RBI is the central bank in India. Banks in India are regulated by RBI. The RBI has moved to a
model of governance by prudential norms rather from that of direct interference, even allowing
debate about appropriateness of specific regulations among banks. Along with these changes,
market institutions have been strengthened by government with attempts to infuse greater
transparency and liquidity in markets for government securities and other asset markets. This
market orientation of governance disciplining in banking has been accompanied by a stronger
disclosure norms and stress on periodic RBI surveillance. From 1994, the BFS inspects and
monitors banks using the “CAMELS” approach. Audit committees in banks have been stipulated
since 1995. Greater independence of public sector banks has also been a key feature of the
reforms. Nominee directors – from government as well as RBIs – are being gradually phased off
with a stress on Boards being more often elected than “appointed from above”.
There is increasing emphasis on greater professional representation on bank boards with the
expectation that the boards will have the authority and competence to properly manage the
banks within the broad prudential norms set by RBI. Rules like non-lending to companies who
have one or more of a bank’s directors on their boards are being softened or removed
altogether, thus allowing for “related party” transactions for banks. The need for professional
advice in the election of executive directors is increasingly realized. As for old private banks,
concentrated ownership remains a widespread characteristic, limiting the possibilities of
professional excellence and opening the possibility of misdirecting credit. Corporate
governance in co-operative banks and NBFCs perhaps need the greatest attention from
regulators. Rural co-operative banks are frequently run by politically powerful families as their
personal entity with little professional involvement and considerable channeling of credit to
family businesses. It is generally believed that the new private banks have better and more
professional corporate governance systems in place.

9. 7
6. Banking Regulation Act, 1949 and Corporate Governance
In India banks are subject to the Banking Regulation Act, 1949.Therefore it is very important to
refer it for corporate governance in Banks. For the proper transparency and better composition
of board of the banking institutes/companies the Act needs some amendments and the
principle of corporate governance should be incorporated within the Act to make it mandatory
for the banks to follow it, instead of giving the option of voluntary compliance.
7. International Standards of Corporate governance for banks and financial institutions
OECD
The liberalization and deregulation of global financial markets led to efforts to devise
international standards of financial regulation to govern the activities of international banks
and financial institutions. An important part of this emerging international regulatory
framework has been the development of international corporate-governance standards. The
OECD has been at the forefront, establishing international norms of corporate governance that
apply to both multinational firms and banking institutions. In 1999, the OECD issued a set of
corporate governance standards and guidelines to assist governments in their efforts to
evaluate and improve the legal, institutional, and regulatory framework for corporate
governance in their countries. The OECD guidelines also provide standards and suggestions for
“stock exchanges, investors, corporations, and other parties that have a role in the process of
developing good corporate governance.” Such corporate-governance standards and structures
are especially important for banking institutions that operate on a global basis. To this extent,
the OECD principles may serve as a model for the governance structure of multinational
financial institutions.
In its most recent corporate governance report, the OECD emphasized the important role that
banking and financial supervision plays in developing corporate-governance standards for
financial institutions. Consequently, banking supervisors have a strong interest in ensuring
effective corporate governance at every banking organization. Supervisory experience
underscores the necessity of having appropriate levels of accountability and managerial
competence within each bank. Essentially, the effective supervision of the international banking
system requires sound governance structures within each bank, especially with respect to
multi-functional banks that operate on a transnational basis. A sound governance system can
contribute to a collaborative working relationship between bank supervisors and bank
management.

10. 8
Basel Committee
The Basel Committee on Banking Supervision (Basel Committee) has also addressed the issue of
corporate governance of banks and multinational financial conglomerates, and has issued
several reports addressing specific topics on corporate governance and banking activities . The
Basel Committee adopted the Capital Accord in 1988 as a legally non-binding international
agreement among the world’s leading central banks and bank regulators to uphold minimum
levels of capital adequacy for internationally-active banks. The New Basel Capital Accord (Basel
II) contains the first detailed framework of rules and standards that supervisors can apply to the
practices of senior management and the board for banking groups. Bank supervisors will now
have the discretion to approve a variety of corporate-governance and risk-management
activities for internal processes and decision-making, as well as substantive requirements for
estimating capital adequacy and a disclosure framework for investors. For example, under Pillar
One, the board and senior management have responsibility for overseeing and approving the
capital rating and estimation processes. Senior management is expected to have a thorough
understanding of the design and operation of the bank’s capital rating system and its evaluation
of credit, market, and operational risks. Members of senior management will be expected to
oversee any testing processes that evaluate the bank’s compliance with capital adequacy
requirements and its overall control environment. Senior management and executive members
of the board should be in a position to justify any material differences between established
procedures set by regulation and actual practice. Moreover, the reporting process to senior
management should provide a detailed account of the bank’s internal ratings -based approach
for determining capital adequacy.

11. 9
8. Conclusion
Weak and ineffective corporate governance mechanisms in banks are pointed out as the main
factors contributed to the 2008 financial crisis, because of which even Lehman Brothers was
collapsed. In India Satyam scandal is the best example for eye opening and since then
regulatory authorities have become more serious about Corporate Governance. In India CII,
SEBI, RBI and professional institutes like ICSI and ICAI are the main stakeholders of banking
sector in India. These institutes have setup different committees to study and recommend the
most suitable and best techniques for “Good Corporate Governance”. ICSI even setup a
Corporate Governance Award which given away every year to one corporate house for
implementing and following best practices of Corporate Governance. The globalization of
financial markets necessitates minimum international standards of corporate governance for
financial institutions that can be transmitted into financial systems in a way that will reduce
systemic risk and enhance the integrity of financial markets . The principles of corporate
governance for financial institutions, as set forth by the OECD and the Basel Committee, are
also have been influential in determining the shape and evolution of corporate-governance
standards in many advanced economies and developing countries and India is one of them. But
I am of the view that many more changes are required for the best practice of corporate
governance in Banks in India, especially in Regional Rural banks and Co-operative banks.

12. 10
References
 Banking Regulation Act, 1949
 SEBI Consultative Paper on Review of Corporate Governance Norms in India
 ICSI Recommendations to strengthen Corporate Governance Framework
 Report of Narayana Murthy Committee on Corporate Governance
 Corporate Governance of Banks – A survey by The Netherland Bank NV
 Desirable Corporate Governance – A code, CII
 IIMB Management Review, the journal of the Indian Institute of Management,
Bangalore
 Rejesh Chakrabarti, Corporate Governance in India –Evolution and Challenges, Collage
of Management, Atlanta (USA)
 Monika Marcinkawska, Corporate Governance in Banks, University of Lodz, Poland
 Rajat Deb, Journal of Business Management & Social Science Research, Vol. 2, No. 5,
May 2003
 Websites refered:
i) www.icsi.edu
ii) www.sebi.gov.in
iii) www.iibf.org
iv) www.ciionline.org
v) www.rbi.org
vi) www.mca.gov.in