The corporate governance of banks

Chapter 1
INTRODUCTION
The Corporate Governance of Banks
The dominant model of corporate governance in law
and economics is that the corporation is a “complex set of
explicit and implicit contracts.” In other words, one
should view the corporation as nothing more (or less) than
a set of contractual arrangements among the various
claimants to the product and earnings generated by the
business.
Every business organization, including the corporation,
represent nothing more than a particular ‘standard form’
contract. The very justification for having different type
of business organizations is to permit investors,
entrepreneurs, and other participants in the corporate
enterprise to select the organization design they prefer
from a menu of standard-form contracts. The virtue of the
standard-form arrangement characteristic of modem
corporate enterprise to take advantage of an arrangement
that suits the needs of investors and entrepreneurs in a
wide variety of situations. On a theoretical level, the
problems of corporate governance result from the
existence of incomplete contracts. The rules of corporate
governance are aimed at resolving the gaps left in these
contracts in ways consistent with maximizing the value of
the firm. In the case of shareholders contingent contracts
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in the United States, these background rules are called
fiduciary duties. The economic justification for having
fiduciary duties is straightforward: Fiduciary duties are
the mechanism invented by the legal system for filling in
the unspecified terms of shareholders contingent
[contracts]. The presence of fiduciary duties attempts to
address these contingencies. In this gap-filling role,
fiduciary duties essentially call on directors to work hard
and to promote the interests of shareholders above their
own.
The duty of care requires that directors exercise
reasonable care, prudence, and diligence in the
management of the corporation. Director liability for a
breach of the duty of care may arise in two discrete
contexts. First, liability may flow from “ill advised or
negligent” decision –making. Second, liability may be the
result of failure of the board to monitor in “circumstances
in which due attention would, arguably, have prevented
the loss.” ‘Significantly, in both classes of cases,
directors are entitled to rely on information, reports,
statement, and opinions prepared by the company’s
officers and directors as well as outside consultants.
Separation of Ownership and Control
The problem of corporate governance is rooted in the
Berle-Means (1932) paradigm of the separation of
shareholders ‘ownership and management’s control in the
modern corporation. Agency problems occur when the
principal (shareholders) lacks the necessary power or
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information to monitor and control the agent (managers)
and when the compensation of the principal and the agent
is not aligned. Several factors work to reduce these
principal-agency costs, the “market for managers”
penalizes management teams that try to advance their own
interest at shareholders’ expense.
On possible solution to the agency cost problem is to give
shareholders direct control over management. This is the
case when management and shareholders are the same
party and control right automatically rest in the hands of
shareholders.
Although these are potentially powerful concerns about
the effectiveness of shareholder control, recent research
suggests that the more fundamental trade-offs may guide
the desired involvement of shareholders in corporate
control. Burkhart Gromb, and Panunzi (1997), for example
show that direct shareholder control may discourage new
initiatives on the part of managers.
These observations are consistent with real-world
corporate governance arrangements, which almost without
exception limit direct shareholder involvement. In some
cases –particularly in the United State-this it facilitate by
relatively dispersed ownership.
Banks are organized in a variety of ways, from stand-
alone corporate entities and single bank holding
companies to multiple bank holding companies and the
post-Gramm- Leach –Bliley Act (GLBA) diversified
holding company.
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This diversified structure permits such holding companies
to reduce or eliminate the firm- specific risks associated
with the banks they own. The GLBA significantly
enhanced this diversification ability by permitting bank
holding companies and certain other restricted firms to
become a new entity: a financial holding company (FHC)
This dispersion of activity throughout the holding
company structure also gives incentives to bank holding
companies to put more risky behavior in their federally
insured banks.
Special Problems of Banks
The discussion so far has focused on a general overview
of corporate governance. We now know turn to specific
problems of banks and attempt to address why the scope
of the duties and obligations of corporate officers and
directors should be expanded in the case of banks. Our
argument is that the special corporate governance
problems of banks weaken the case for making
shareholders the exclusive beneficiaries of fiduciary
duties. Our focus here is on establishing why banks are
not like other firms and thus should be treated differently.
The Liquidity Production Role of Banks
Many different types of firms extend credit. Similarly, a
variety of non-bank firms most notably money market
mutual funds and non-bank credit card companies, offer
the equivalent of a check transaction account. What
distinguished banks from other firms is their capital
structure, which is unique in to ways. First, banks tend to
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have very little equity relative to other firms. Second,
banks, liabilities are largely in the from of deposits,
which are available to their creditors /depositors on
demand, while their assets often take the from of loans
that have longer maturities (although increasingly refined
secondary market have mitigated to same extent mismatch
in the term structure of banks’ assets and liabilities).
Thus, the principal attribute that makes banks as financial
intermediaries ‘special’ is their liquidity production
function. By holding illiquid assets and issuing liquid
liabilities, bank creates liquidity for the economy.
The liquidity production function may cause a collective-
action problem among depositors because banks keep only
a fraction of deposits on reserve at any one time.
Depositors because banks keep only a fraction of deposits
on reserve at any one time. Depositors cannot obtain
repayment of their deposits simultaneously because the
bank will not have sufficient funds on hand to satisfy all
depositors at once.
The Deposit Insurance Fund
In the wake of the mass failure of depository institutions,
Congress passed the Banking Act of 1933 establishing the
Federal Deposit Insurance Corporation (FDIC) and giving
the federal government the power to insure deposits in
qualified banks. The creation of federal deposit insurance
has been tremendously effective in preventing bank runs
and keeping the failure of individual banks from affecting
the larger economy. Deposit insurance “has succeeded in
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achieving what had been a major objective of banking
reform for at least a century, namely the prevention of
banking panics.”
Despite the positive effect of FDIC insurance on
preventing bank runs, the implementation of deposit
insurance poses a regulatory cost of its own-it gives the
shareholder and manager of insured banks incentives to
engage in excessive risk-taking.
The problem of moral hazard is exacerbated in situations
where a bank is at of near insolvency. In such a situation,
the shareholders have a strong incentive to increase risk
because they can allocate their losses to third-parties
while still receiving any gains that might result from the
risky behavior.
Asset Structure and Loyalty Problems
The presence of federal insurance fund also increased the
risk of fraud and self-dealing in the banking industry by
reducing incentives for monitoring. In the 1980, it was
estimated that fraud and self-dealing transaction were
“apparent” in as many as one-third of today’s bank
failures. 28 A similar statistic shows that between 12990
and 1991, insider lending contributed to 175 of 286bank
failures,29 Such behavior, of course, is a possibility in
any large firm, since it is inefficient for owners to
monitor all employees at all times. These sorts of
problems are particularly acute in financial institutions,
however, because of the large portion of their asset held
in highly liquid form.
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The same regulatory structure that creates a problems if
excessive risk-taking by banks also leads to a reduction in
the normal levels of monitoring within the firm, resulting
in a higher incidence of bank failures due to fraud.
Shareholders have an incentive to monitor to prevent fraud
and self-dealing in banks, but such monitoring is
notoriously ineffective in many cases because individual
shareholders rarely have sufficient incentives to engage in
monitoring because of collection-action problems.
One might argue that FDIC insurance simply replaces one
set of creditors: depositors, with another set of creditors:
state and federal regulators. These other creditors might
more financially sophisticate than rank-and – file
depositors and thus appear in a better position to conduct
the monitoring necessary to prevent bank fraud.
Regulators have five main enforcement tools: cease and
desist powers, removal powers, civil money penalty
powers, withdrawal or suspension of federal deposit
insurance power and prompt corrective actions powers.
Cease and desist powers generally address both unsafe and
unsound banking as well as violations of the law or
regulations governing depository institutions.
Federal banking agencies also have to impose civil
monetary penalties against a banking institution and its
affiliates. Prompt corrective-action powers are also
triggered by capital requirements, and these allow
regulators to reach every significant operational aspect of
a bank. Finally, the FDIC has the authority to revoke a
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bank’s depositor insurance if necessary, Nevertheless,
replacing private- sector creditors with public-sector
regulators as the first line of defense against bank fraud
and self-dealing presents two problems. Private-sector
creditors have stronger incentives than public-sector
regulators to monitor closely for fraud and self-dealing.
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Chapter 2
IS CORPORATE GOVERNANCE DIFFERENT FOR
BANK HOLDING COMPANIES?
The governance structure in banks should aim at
enhancing Accountability and efficiency. Corporate
governance in Banks is different from that of
manufacturing companies on account of number of factors
Governance reforms required for banks should be industry
Composition and compared to the board in manufacturing
companies. Further research on corporate Governance in
banks would determine the optimal board Size that
maximizes shareholder value subject to the Constraints
imposed on these firms.
Shleifer and Vishny define corporate governance as
dealing “with the ways that suppliers of finance to
corporations assure themselves of getting a return on their
investment” if managers operate independently, they may
make financing, investment, and payout decisions that are
detrimental to shareholders. The governance of banking
firms may be different from that unregulated, non-
financial firm for several reasons. For one, the numbers of
parties with a stake in an institution’s activity complicates
the governance of financial institutions. As a result, the
board of directors of a banking firm is placed in a crucial
role in its governance structure. Although the boards of
BHCs are assigned the same legal responsibilities as other
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boards, regulators have placed additional expectations on
bank, as opposed to BHC boards that delineate their
responsibilities even further.
These and other differences in the operation of financial
and non-financial institutions have led many to view
regulatory oversight of the industry as a substitute for
corporate governance as less critical to the conduct and
operation of banking firms. Other argue that effective
supervision could lead to board oversight becoming a
more critical element of banking firm governance that is,
these could be complementary forces.
Thus, although in non-financial firm stock options may be
appropriate instruments to provide incentive for managers
to create value, as well as to protect the creditors of
distressed companies; the options may conflict with policy
objectives that seek to protect the non-shareholding,
stakeholders, such as depositors and taxpayers in financial
firms.
Resolution of a financially distressed condition or
outright insolvency in the banking industry can also have
an important effect on top manager’s incentive structures.
In an unregulated environment, financial distress
generally leads to reorganization and in most cases; the
incumbent top manager is given the opportunity to turn
the corporation around.
Board Size and Composition
An average of eighteen directors makes up each BHC
board, although there is a wide distribution of board size
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in the sample (a minimum of eight directors and a
maximum of thirty-six). Over the sample period, it is
apparent that banking firm boards are becoming smaller.
An average board in1999had 17 directors (median: 18),
down from 20.3 in 1986 (median: 20). The trend is
consistent with the finding of Adams and Mehran (2002),
who examine BHC board size over the 1959-99 periods.
As Table 3 indicates, an average S&P manufacturing firm
had six fewer directors than an average BHC did over the
sample period. Booth, Cornett, and Tehranian (2002) also
provide evidence that banks have larger boards, using a
sample of the 100 largest BHCs and the 10-0 largest
manufacturing firms in 1999.
Since such regulatory restriction generally apply to board
structure at the bank level and not the holding level,
which is the focus of this study, the regulatory
environment alone does not explain BHC board size and
composition However, regulation may have an indirect on
the structure of BHD board to the extent that it is
influenced by the structure of the board of the BHC’S lead
bank and other subsidiary banks.
CEO Compensation
The increased use of stock option in executive
compensation packages in banking follows the pattern of
other industries even though the growth and level of stock
option use are significantly lower than in manufacturing
firms.
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One potential explanation for the lower reliance on stock
option in the banking industry found in smith and watts
(1992), who show that-growth industries rely less on
stock-based compensation (also see Mehram [1992]).
Smith and Watts suggest that board can observe, monitor,
and evaluate the action of CEOs of firms and industries
with low-growth opportunities much easier than they can
in firms or industries with high-growth opportunities.
Thus, board in such industries should rely more on fixed
rather than on stock-based compensation.
Finally, given the low stock-return volatility in the
banking industry, all else equal, the value of stock option
in banks will be lower. To compensate the CEO for a
given dollar value of granted options, the bank has to give
a larger number of option relative to those given by an
average manufacturing firm.
CEO Ownership
CEO ownership across BHCs and manufacturing firms may
differ for several reasons. One can argue that the smaller
flow of options to bank holding company CEOs leads to
smaller ownership. There may also be are a mechanical
issue influencing the percentage of ownership. Since
BHCs are significantly more leveraged and have more
assets than manufacturing firm, ownership levels across
the two types of firms may not be comparable.
An important insight of Modigliani and in a word with
corporate taxes is that the case flow claims of an
ownership stake in an all-equity firm differ from those
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associated with the percentage of equity ownership of an
identical firm with a positive debt level.
Block Ownership
To compile our statistics on block ownership, we rely on
the CDA/Spectrum Institutional Holding Database of
Thomson Financial. Institutional shareholding is our
proxy for monitoring by blockholders. However, the
corporate governance literature also emphasizes the
importance of the identity of the identity of blockholders
and individuals, as opposed to just the size of institution
holdings.
Bank-affiliated institutions are unlikely to monitor the
BHC over the course of these activities; therefore, to
construct our summary statistics on institution holders, we
deleted all bank-affiliated institution from the list of
institution holders of our BHCs in all year. We also
examined the identity of institutional holding shares of
manufacturing firms; however, found very few cases of
blockholders that were affiliated with manufacturing
firms.
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Chapter 3
BASEL II AND ROLE OF PILLAR 2: ENSURING
HIGH STANDARDS OF CORPORATRE GOVERNANCE
A. The Basel Committee
The Basel Committee on Banking Supervision is a
committee, of banking supervisory authorities, established
by the Central Bank Governors of the G10 developed
countries in 1975. The committee in 1988 introduced the
concept of capital Adequacy Framework, Known as Basel
Capital Accord, with a minimum capital adequacy of 8
percent. This accord has been gradually adopted not only
in member countries but also in more one hundred other
countries, including India.
B. Basel II: The New Basel Capital Accord
The committee issued a consultative document titled “The
New Basel Capital Accord” in April2003, to replace the
1988 Accord, Which re-enforce the need for capital
adequacy requirements under the current conditions. This
accord is commonly known as Basel II and is currently
under finalization. Basel II will be applied on a
consolidates basis to internationally active banks.
However, supervisors are required to test that individual
banks are adequately capitalized on a stand – alone basis
also. Basel II is based on three Pillars.
Pillar 1 – Minimum Capital Requirements.
Pillar 2 – Supervisory Review Process.
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Pillar 3 – Market Discipline.
Pillar 1 discusses the calculation of the total minimum
capital requirements for credit, market and operational
risks and maintains the level of minimum capital adequacy
at 8 percent. Pillar 2discussed the key principles of
supervisory review, risk management guidance and
supervisory transparency and accountability with respect
to banking risks. Pillar 3 complements Pillar 1 and 2 by
encouraging market discipline through enhanced
disclosures by banks to enable market participant’s asses
the capital adequacy of banks.
D. Enhancing Corporate Governance in Banks
The Basel committee had issued, in August 1999, a
guidance paper entitled “Enhancing Corporate Governance
for Banking Organizations” to supervisory authorities
Worldwide to assist them in promoting the adoption of
sound corporate governance practices by banks in their
countries. The key features of this guidance are discussed
here.
Importance of Corporate Governance for Banks
Banks are a critical component of any economy. They
provide financing for commercial enterprises, basic
financial services to a broad segment of the population
and access to payments systems. From a banking industry
perspective, corporate governance involves the manner in
which their boards of directors and senior managements
govern the business and affairs of individual banks,
affecting how banks.
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• Set their corporate objective;
• Run day-to-day operations;
• Consider the interests of various stakeholders;
• Align corporate actives with the expectation that
bank will operate in a safe and sound manner and in
compliance with applicable law and regulations; and
• Protect the interest of depositors.
II. Sound Corporate Governance Practices for Banks
The Practices mentioned below are critical to any
corporate governance process in banks:
Establishing strategic objectives and a set of corporate
values communicated throughout the organization.
Strong risk management functions independent of business
lines, internal control systems, internal and external audit
functions and other cheeks and balance.
• Special monitoring of risk exposures where conflicts
of interests are likely to be particularly great,
including business relationships with borrowers
affiliated with the banks.
• Setting and enforcing clear lines of responsibility
and accountability.
• Ensuring that banks’ board members are qualified for
their positions, have a clear understanding of their
role in corporate governance and are not subject to
under influence.
• Ensuring that there is appropriate oversight by senior
management.
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• Ensuring that compensation systems are consistent
with the banks, objectives and control environment.
• Conducting corporate governance transparently.
• Flow of appropriate information internally and to the
public.
III. The Role of Supervisory Authorities in Ensuring
Effective Corporate Governance in Banks
Supervisors should be aware of the importance of
corporate governance and its impact on corporate
performance. Supervisors should be attentive to any
warning signs of deterioration in the management of the
banks activities. They should consider issuing guidance to
banks on sound corporate governance and the proactive
practices that need to be in place.
F. Corporate Governance for the Internal Ratings-
based (IRB) Approach to Credit Risk as per Pert 2
Pillar 1
I IRB Approach [Internal Rating –based]
Internal risk ratings are an important tool in monitoring
credit risk. Internal risk ratings should be adequate to
support the identification and measurement of risk from
all credit risk and capital adequacy Subject to certain
minimum condition and disclosure requirements, banks
that qualify for the IRB approach may rely on their own
internal estimates of risk components include measures of
the probability of Default (PD) Loss Give default (LGD)
the Exposure at Default (EAD) and effective maturity.
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G. The second pillar “supervisory review process”: Its
role in Ensuring High Standards of Corporate
Governance
Part 3 of Basel ll deals with their importance of
supervisory review, its key principles, specific issues to
be addressed under the supervisory review process and
supervisory transparency and accountability itself in
ensuring effective corporate governance.
Importance of Supervisory Review
The supervisory review process of Basel ll is intended not
only to ensure that banks have adequate capital to support
all the risk in their business, but also to encourage banks
to develop and use better risk.
This interaction is intended to foster an active dialogue
between banks and supervisors such that when
deficiencies are identified, prompt and decisive action can
be taken to reduce risk or restore capital.
II Four Key principles of supervisory Review
Principle 1
The five main features of such a rigorous process are as
follows:
1. Board & Senior Management oversight
A sound risk management process is foundation for an
effective assessment of the adequacy of a bank’s
capital position. The analysis of bank’s current and
future capital requirements in relation to strategic
objectives is a vital element of the strategic planning
process.
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The bank’s board should ensure that management
establishes a framework for assessing the various risks, to
the bank’s capital and monitoring compliance with
internal policies. It should support strong internal
controls and written policies and ensure that are
effectively communicated throughout the bank.
2. Comprehensive Assessment of Risk
All material risks faced by banks should be
addressed in the capital assessment process. While
not all risk can measured precisely , an adequate and
complete model should be developed estimate the
various risk, such as, credit risk, operational risk,
interest rate risk, liquidity risk and other risk like
reputation and strategic risk.
3. Monitoring and Reporting
• The bank should establish an adequate system for
monitoring and reporting risk exposures in order to:
• Evaluate the level and trends of material risks and
their affect on capital levels;
• Evaluate the reasonableness of key assumptions used
in the capital assessment measurement system;
• Determine that the bank hold sufficient capital
against the various risk in compliance with
established capital adequacy goals; and
• Assess their future capital requirement based on the
risk profile and make necessary adjustments to the
strategic plan.
4. Internal Control Review
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The banks should regular review the following aspects of
their system of internal control to ensure well-ordered
conduct of business: appropriateness of the capital
assessment process; identification of large exposures and
risk concentrations; accuracy and completeness of data
inputs into the assessment process; validity of scenarios
used in the assessment process; and stress testing and
analysis of assumptions and inputs.
Principle 2
Review of Adequacy of Risk Assessment
Supervisors should assess the degree to which internal
targets and processes incorporate all material risks faced
by the banks. Supervisors should also review the adequacy
of risk measures used in assessing internal capital
adequacy and the extent to which these risk measures are
used operationally in setting limits. Supervisors should
consider the results of sensitivity analyses and stress tests
conducted by the banks and how these results relate to
capital plans.
Assessment of Capital Adequacy
Supervisors should review the banks processes to
determine that the target levels of capital chosen are
comprehensive and relevant to the current operation
environment, are properly monitored by senior
management ,the composition of capital is appropriate for
the banks’ business and the extent to which the banks have
provided for unexpected events in setting their capital
levels.
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Assessment of the control Environment
Supervisors should consider the quality of the banks’
management information systems; the manner in which
business risk and activities are aggregated and
management’s record in responding to emerging or
changing risks. They should also consider the external
factors like business cycle effects and the macroeconomic
environment in determining the capital levels.
Supervision Action
Having carried out the review process described above,
supervisors should take appropriate actions, such as those
set out under Principals 3 and 4 below, if they are not
satisfied with The result of the bank’s own risk
assessment and capital allocation.
Principle 3
Supervision should require banks to operate with a buffer,
over and above the Pillar1 capital requirement, for a
number of reasons.
A large number of banks prefer to be highly rated by
internationally recognized rating agencies.
In the normal course of business the type and volume of
activities keep on changing as well as the different risk
requirements causing fluctuations in the overall capital
ratio.
It may be costly for banks to raise additional capital
during emergency need.
If it so happens, to fall below minimum regulatory capital
requirements is a matter of serious concern for banks.
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Among other methods, the supervisors may set trigger and
target capital ratios or define categories above minimum
ratios for identifying the capitalization level of the banks.
III Specific Issues to be Addressed under the
Supervisory
Review Process
1. Interest Rate Risk
If supervisors determine that banks are not holding
capital commensurate with the level of interest rate risk,
they must require the banks to reduce their risk, to hold a
specific additional amount of capital or a combination of
the two.
2. Operational Risk
The Supervisors should examine whether the capital
requirement generated by the Pillar 1 calculation gives a
consistent picture of the individual bank’s operational risk
exposure, for example, in comparison with other banks of
similar size and operations.
3. Credit Risk
Stress Tests under IRB: A bank should ensure that it has
sufficient capital to meet the Pillar 1 requirements and the
results, in case of a deficiency, of the credit risk stress
test performed as part of the Pillar 1IRB minimum
requirements. Supervisors may review how the stress test
has been carried out and in case of a shortfall, react
appropriately.
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Residual risks: Supervisors should require banks to have
in place appropriate and effective written CRM policies
and procedures in order to control the residual risks, such
as. Inability to seize or realize in timely manner collateral
pledged, refusal or delay by a guarantor to pay and
ineffectiveness of untested documentation.
Securitization: Further to the Pillar 1 principle that banks
should take account of the economic substance of
transactions in their capital adequacy determination,
supervisors should monitor whether banks have done so
adequately. As a result, regulatory capital treatments for
specific securitization exposures may exceed those
specified in
Pillar 1. The supervisors will have to address the key
issues involving securitization transactions such as
significance of risk transfer, market innovations,
provision of implicit support, first loss credit
enhancements, call provisions and early amortization.
Chapter 4
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BANK PERFORMANCE AND CORPORATE
GOVERNANCE
Financial Condition of US Banks
Last year was exceptional in many respects, with the
United States slipping into a recession, the September
terrorist attacks, the stock market declines, and all of the
related events. In response, the Federal Reserve reduced
interest rates at every meeting of the Federal Open Market
Committee in 2001 and an additional three times between
meeting, for a total of eleven rate cutes accumulating to
475 basis points.
The direct effect of the past year’s stressful events was
painful enough. In addition, abusive accounting and
corporate governance practices made conditions worse, as
large corporate bankruptcies imposed substantial losses on
investors, lenders, and employees.
Throughout this period the US banking system remained
strong, reporting continuing record earnings and
profitability, despite a slip in asset quality. During the
first half of this year, US insured commercial banks
earned more than $44.5 billion and an annualized return
on assets of 1.37 percent.
Net interest income was the primary driver of increased
revenue, despite a notable decline in commercial loan
volume. Loans loss provisions remained relatively high by
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the standards of most of the past decade but dipped
notably from the second half of 2001. Net charge –offs,
which were concentrated among commercial loans of large
banks and credit card specialty lenders, also dropped.
As noted current weaknesses appear to be largely within
the commercial loan portfolios of large regional and
money center banks rather than those of smaller
institutions. Even the problems of large banks could be
viewed as mild, however, given the shocks felt by many in
their customer base. If smaller banks, generally, are not
seeing the commercial loan weakness that some large
institutions are facing, which areas may present them with
heightened risks?
Most Reserve Banks are reporting generally weak
commercial real estate markets, as failing companies
vacate office and retail space and renters into single
family homes commercial real estate credits are still
performing relatively well for this stage of the cycle, and
my comments are not intended to suggest a material
concern.
The second areas of potential risk relates to interest rates.
For the industry overall, the Federal Reserve’s interest
rate cuts last year certainly appear to have helped bank
earnings, but they present management with new
challenges, too. Lower rates undoubtedly eased payment
pressures on many borrowers, and prevented further
deterioration in the quality of bank loan portfolios.
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Indeed, many banks have responded to the low rates by
sharply reducing their investments in Treasuries and
shifting funds into mortgage-backed securities in the
search for higher yields. That banking organizations and
investors generally, should recognize that domestic
interest rates are historically low and that the possibility
for rising rate environments should not be overlooked.
Even stable rates could present increased risks, if saving
and money market deposit accounts flow out of banks as
quickly as they came in when equity markets declined. At
some point, even loyal customers- those on fixed income,
in particular-may blink and take steps to improve their
own yields.
Managing Risks
The health of financial institutions today is also a result
of improvement in the risk management process that has
been ongoing at banks for years, increasingly; the entire
risk management process has become data at lower cost,
but also improved techniques for measuring and managing
risks. Bank regulators are working to develop a more
modern international approach to bank capital- called
Basel II. Although those standards, in the fist instance,
are being designed to address changing practices at large,
internationally active banks, we can expect the lessons
learned about risks management to have much border
effects. In quantifying credit risk, large banking
organizations are taking the lead, measuring a borrower’s
probability of default, the bank’s loss given default and
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its likely exposure to the borrower at the time of default,
taking into consideration future draw downs.
The greater of credit scoring in retail transactions
provides a stronger framework to asses risk and ensure
that loan pricing reflects the credit quality. Such tools
should perform even better as the effects of the most
recent economic slowdown are incorporated into bank
statistics.
The measurement and management of interest rate risk has
also improved greatly in recent years, perhaps particularly
at community banks. Asset liability committees at banks
throughout the country now routinely consider the results
of models developed either internally or by vendors to
identify the market sensitivity of loans, investments, and
deposits.
Recent abuses of corporate accounting practices and other
matters provide good lessons in risk management as
bankers try to increase earning by cross- selling more
products, given the dominant role of credit risk at banks,
to chief credit officer should ensure that pressures to
increase fee income do not lead to unacceptable levels of
credit risks.
Corporate Governance
Sound corporate governance is an essential of a strong
risk management process. As banker and bank and bank
directors ,you have specific responsibilities to manage the
risk at your financial institutions and effectively oversee
the systems of internal controls Not only are the activities
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of central to credit intermediation, but ,in this country ,
banks found their activities in part with federally insured
deposits. Those deposits are the lowest – cost source of
found that banks have, specifically because of the
government guarantee.
Interagency policy holds boards of directors
responsible for ensuring that their organizations have
an effective audit process and internal controls that
are adequate for the nature and scope of their
businesses. Internal audit is a key element of
management’s responsibility to validate the strength of a
bank’s internal controls.
Internal controls are the responsibility of line
management. Line managers must determine the level
of risk they need to accept to run businesses and
must assure themselves that the combination of
earnings, capital, and internal controls is sufficient to
compensate for the risk exposures. The results of
these independent reviews should be routinely
reported to executive management and boards of
directors. The level of independence form executive
management that a board can demonstrate has, of
course, become a far more visible and more
important factor in evaluating corporate governance.
Other provisions of the act set forth potentially
broad ranging standards affecting the way public
companies compensate their executives and directors
and disclose their operating results. To strengthen the
28

role of outside auditors, the act also limits the non-audit
work such firms may perform for audit customers and
creates an oversight board to regulate and oversee audit
work. Indeed, beyond legal requirements, boards of
directors and managers of all firms should
periodically test where they stand on business
practices. Ultimately, of course, market correct their
excesses, and in this context markets include both the
public and private sectors. Obviously , during the past
year we have seen reactions not only form investors
and creditors, but also from law- makers and
regulators, to observed failures within corporate
boardrooms. All of the action affects market practice.
That includes maintaining sound ethical practices in
protecting the reputations of your banks. As we have
seen from recent events, the market’s response can
be harsh.
Quality of Accounting Practices
Uncertainty regarding the quality of corporate
accounting standards strikes at the heart of our
capitalist system and threatens the efficiency of
markets. Investors and lenders must be confident
that understand the risk they accept and that their
counterparties are playing fair.
Informed and objective professionals can legitimately
disagree on the best accounting standard to apply to new
types of transactions .That is part of the challenge of
keeping accounting standards current. The rapid pace of
29

business innovations makes it impractical to have rules in
place to anticipate every business transaction.
At the core of such accounting principles should be
professional standards that every corporate accountants
and every outside auditor must follows. In part, auditors
should be required to ask themselves whether a
particular accounting method adequately represents the
economics of transaction and whether it provides readers
with sufficient information to evaluate the risks.
Rules alone, however, do not ensure good financial
reporting. At Enron and other companies, weak corporate
governance’s practices apparently permitted sham
transactions and misleading financial reporting. Outside
auditors erred in trying too hard to please an important
client.
In another example, the banking regulators have jointly
issued for comment new guidance related to credits cards.
This guidance not only deals with unacceptable practices,
but also clarifies that revenue recognition of fees billed to
customers should the expected ability to collect those
fees.
Chapter 5
30

THE ROLE OF THE CENTRAL BANK IN
PROMOTING CORPORATE GOVERNANCE
The growing competitiveness and interdependence
between Banks and financial institutions in local and
foreign markets have increased the importance of
corporate governance and its application in the banking
sector. Corporate governance in Bank can be achieved
through a set of legal, accounting Financial and economic
and integrity in banking sector is Maintained, the need
for uniform standards of the concept of governance in
private and public sector banks in emphasized.
The globalization process and the liberalization of money
markets have changed the ideas and visions of financial
institutions all over the world. Banks and financial
institutions in local and foreign markets have acquired a
new spirit of competitiveness.
Governance in the banking sector is achieved through a
set of legal, accounting, Financial and economic rules and
regulations. These rules and regulations direct the
Management, govern performance, and assist in carrying
out the responsibilities of the Sector.
Corporate governance is important because it prohibits
corruption, ensures integrity and also ensures. Corporate
governance is important as well to benefit and learn from
the finding of the auditors and financial controllers and to
understand their oversight role.
31

Role of central Bank
Over the last years, the central bank of Egypt has adopted
a number of measures that are consistent with principles
set by the Basel committee on banking supervision .these
measures are within the legal and regulatory framework
of the role of the central bank In the area of prudential
regulation and effective surveillance of the daily
operations of banks.
Setting a percentage of liquidity and reserves for banks is
considered a prudential mechanism and not a requirement
that hinders banking activity. Over the last years, some
were complaining that banks are hindered by an elevated
percentage of legal reserves, and that is the reason for the
liquidity crisis. Bankers know very well how to manage
their banks; the central banks is here to assist the bankers,
at the same time trigger the warning Bell should such a
situation arise.
The central bank of Egypt also emphasizes the measure of
loan concentration at the level of each bank. Loan
concentration is not related to the loan provided to one
client. Currently the law sets the exposure limit to each
client at 30 percent. We also have loan concentration
limits for foreign banks. The restriction is that all
Egyptian money or all Egyptian money or all Egyptian
originated money should not be deposited at foreign
representation banks.
However connections related to more than one activity
will lead a bank to be exposed to problems that have
32

been avoided to connected lending last November 2002
There will be a conflict of interest. You cannot be a
borrower and a shareholder in the same time. Certainly,
there will be conflicts of interest between your position as
a shareholder who wants to pursue the maximum profit
and a borrower The same to the member of the boards of
directors. We emphasize that the member of the board of
directors. We emphasize that the member of board of
directors should not be a borrower from the same bank;
otherwise things will be mixed up and there will be
conflict of interests.
Direct conflict of interest, each non-executive board
member should sign a certification and submit it to the
board of the bank sating that he has no conflicts of
interest and that he will refrain from mixing his private
work or business and his work as a board member.
It is advisable that audit committees have three non-
executive board members. Committee members should be
given power and authority to review the bank’s
performance, works, disciple, and manuals, and the extent
of their compliance to the manuals.
The report of the auditing committee should be available
for the whole board for revision and the finding should be
presented by the head of the auditing committee.
If the bank’s auditing committees follow internationally
recognized standards and practice, I think that there will
be some sort of adherence to the discipline.
33

The establishment of inspection committee or department
is not the issue; the issue is these department of
inspection committees or departments is not the effective.
If inspection committees submit their report to the
chairman of the board of directors, we should say that this
is wrong. These committees need to submit reports and
make its information available to the entire board of
directors, and not to the chairman or executive director.
I think there is no contradiction between the internal
inspection departments and internal auditing committees.
Infection departments have a daily responsibility to check
compliance with manuals.
Shareholders Rights
It is very important that the shareholders have the
conviction to take and to give. In many cases, we find that
shareholders in companies not to speak of banks are
interested only to no about their dividends. If we assume
that this is the right think to do than, there controlling
role is absent. Some shareholders want only to receive
decedents has investors but are not aware that they have
controlling and supervisory role
Shareholders need to undertake their supervisory role
within all institutions. We as a supervisory institution for
the banking sector should perform our role so, if there is
internal control at the banking via corporate governance
and external controls from the central bank, this would be
very beneficial to the country.
34

If we look at the control factor inside the banks boards
and make a link between members of the banks boards of
directors and their ownership we might discover that a
specific shareholder might control the banks management
and control its decisions. Ownership might be 49 percent
in a specific institutions and other ownership might be 20
or 21 percent and be consider it a sister company and not
an affiliated company. In the coming period, we are
concerned with new bank laws and we will make sure that
the concept of control leads to quality and not to
monopoly. Monopoly of thought and monopoly of
leadership in the bank in a wrong direction or leading the
board in a wrong direction will be given enough
consideration.
Corporate governance criteria can not be effective if it is
only on paper. Proper, sound, and effective corporate
governance criteria are those that incorporate a
punishment and reward system. The central bank’s ability
to implement its policies and decisions within the banking
sector serve as a corrective and disciplinary mechanism.
The bank’s board of director and its general assemblies
also need to be committed to undertaking corrective
measures when necessary.
Chapter 6
35

PUBLIC SECTOR BANKS AND GOVERNANCE
CHALLENGEGS
Historical Concept
India had a fairly well developed commercial banking
system in existence at the time of independence in
1947.The Reserve Bank of India (RBI) was established in
1935.While the RBI became a state-owned institution from
January 1, 1949, the Banking Regulation Act was enacted
in 1949 providing a framework of regulation and
supervision of commercial banking activity. The first step
towards the nationalization of commercial banks was the
results of a report (under the aegis of RBI) by` the
Committee of Direction of All India Rural Credit Survey
(1951) which till today is the locus classics on the subject
.Thus the Imperial Bank was taken over by the
Government and renamed as the State Bank of India (SBI)
the July 1, 1955 with the RBI acquiring overriding
substantial holding of shares. A number of erstwhile banks
owned by princely states were subsidiaries of SBI in
1959.
To meet theses concerns, in 1967, the Government
introduced the concept of social control in the
banking industry . The scheme of social control was
aimed at bringing some changes in the management
and distribution of credit by the commercial banks.
Political compulsion then partially attributed to
inadequacies of the social control, led to the
36

Government of India nationalizing, in 1969, 14
major scheduled commercial banks the needs which
had deposits above a cut-off size. The objective was to
serve better the needs of development of the economy in
conformity with national priorities and objectives.
From the fifties a number of exclusively state-owned
development financial institution (DFIs) were also set up
both at the national and state level, with a lone exception
of Industrial Credit and Investment Corporation of India
(ICICI) which had minority private share holding.
Reform Measures
The major challenge of the reform has been to introduce
elements of market incentive as a dominant factor
gradually replacing the administratively coordinated
planned actions for development. Such a paradigm shift
has several dimensions, the corporate governance being
one of the important elements. The evolution of corporate
governance in banks, particularly in PSBs, thus reflects
changes in monetary policy, regulatory environment, and
structural transformations and to some extent, on the
character of the self-regulatory organizations functioning
in the financial sector.
Policy Environment
During the reform period, the policy environment
enhanced competition and provided greater opportunity for
exercise of what may be called genuine corporate element
in each bank to replace the elements of coordinated
actions of all entities as a “joint family” to fulfill
37

predetermined Plan priorities. The measures taken so far
can be summarized as follows.
First, greater competition has been infused in the banking
system by permitting entry of private sector banks
(9licences since 1993), and liberal licensing of more
branches by foreign banks and the entry of new foreign
banks. With the development of a multi- institutional
structure in the financial sector non-bank intermediation
has increased, banks have had to improve efficiency to
ensure survival.
Second, the reforms accorded greater flexibility to the
banking system to manage both the pricing and quantity of
resources. There has been a reduction in statutory
preemptions to less than a third of commercial banks
resources. Valuation of banks’ investments is also attuned
to international best practices so as to appropriately
capture market risks.
Third, the RBI has moved away from micro-regulation to
macro-management. RBI has replaced detailed individual
guidelines with general guidelines and now leaves it to
individual banks’ boards to set their guidelines on credit
decisions.
Fourth, to strengthen the banking system to cope up with
the changing environment, prudential standards have been
imposed in a progressive manner.
Fifth, an appropriate legal, institutional, technological
and regulatory framework has been put in place for the
development of financial markets. There is now increased
38

volumes and transparency in the primary and secondary
market operations. Development of the Government
Securities, money and forex markets Interest rate channel
of monetary policy transmission is acquiring greater
importance as Compared with the credit channel.
Regulatory Environment
Prudential regulation and supervision have formed a
critical component of the financial sector reform
programme since its inception, and India has endeavored
to international prudential norms and practices.
The Banking Regulation Act 1949 prevents connected
lending (i.e. lending by banks to directors or companies in
which Directors are interested.)
Periodical inspection of banks has been the main
instrument of supervision, though recently there has been
a move toward supplementary ‘on-site inspections’ with
‘off-sites surveillance’. The system of ‘Annual Financial
Inspection’ was introduced in1992, in place of the earlier
system of Annual Financial Review/Financial Inspections.
A high powered Board for Financial Supervision (BFS),
comprising the Governor of RBI as Chairman, one of the
Deputy Governors as Vice-chairman and four Directors of
the central board of RBI as members was constituted in
1994, with the mandate to exercise the Power of
supervision and inspection in relation to the banking
companies, financial institution and non-banking
companies.
39

A supervisory strategy comprising on- site inspection,
off–site monitoring and control systems internal to the
banks, based on the camels (capital adequacy, asset
quality, management, earnings, liquidity and systems and
controls) methodology for banks have been instituted. The
RBI has instituted a mechanism for critical analysis of the
balance sheet by the banks themselves and the
presentation of such analysis before their boards to
provide an internal assessment of the health of the bank.
Keeping in line with the merging regulatory and
supervisory standards at international level, the RBI has
initiated certain macro level monitoring techniques to
assess the true health of the supervised institutions. The
format of balance sheets of commercial banks have now
been prescribed by the RBI with disclosure standards
on vital performance and growth indicators , provisions,
net NPAs, staff productivity , etc. appended as ‘notes of
accounts’. These proposed additional disclosure norms
would bring the disclosure standards almost on par with
the international best practice.
Structural Environment of Banking
The nationalized banks are enabled to dilute their equity
of Government of India to 51 percent following the
amendment to the Banking Companies (Acquisition &
Transfer of Undertakings) Acts in 1994, bringing down the
minimum Government’s shareholder to 51 percent in
PSBs. RBI’s shareholding in SBI is subject to a minimum
of 55 percent.
40

The diversification of ownership of PSBs has made a
qualitative difference to the functioning of PSBs since
there is induction of private shareholding and attendant
issues of shareholder’s value, as reflected by the market
cap, representation on board, and interests of minority
shareholders. There is representation of private
shareholder when the banks raise capital from the market.
The governance of banks rests with the board of directors.
In the light of deregulation in interest rates and the
greater autonomy given to banks in their operation, the
role of the board of directors has become more
significations.
During the years, Board has been required to lay down
policies in critical areas such as investments, loans, asset-
liability management, and management and recovery of
NPAs. As part of this process, several Board level
committees including the Management Committee are
required to be appointed by banks.
Government introduced a Bill in Parliament to omit the
mandatory provisions regarding appointment of RBI
nominees on the Boards of public sector banks and instead
to add a clause to enable RBI to appoint its nominee on
the boards of public sector banks if the RBI is of the
opinion that in the interest of the banking policy or in the
public interest or in the interest of the bank or depositors,
it is necessary so to do.
Appointment of Chairman and Managing Directors and
Executive Directors of all PSBs is done by Government.
41

The Narasimham Committee II had recommended that the
appointment of Chairman and Managing Director should
be left to the Boards of banks and the Boards themselves
should be elected by shareholders
Appointment as well as removal of auditors in PSBs
requires prior approval of the RBI. There is an elaborate
procedure by which banks select auditors from an
approved panel circulated by the RBI. In respect of
private sector banks, the statutory auditors are appointed
in the Annual General Meeting with the prior approval by
the RBI.
Self Regulatory Organizations
India has had the distinction of experimenting with Self
Regulatory Organisation (SROs) in the financial system
since the pre-independence days. At present, there are
four SROs in the financial system- Indian Banks
Association (IBA), Foreign Exchange Dealers Association
of India (FEDAI), Primary Dealers Association of India
(PDAI) and Fixed Income Money Market Dealers
Association of India (FIMMDAI).
The IBA established in 1946 as a voluntary association of
banks, strove towards strengthening the banking industry
through consensus and co-ordination. Since
nationalization of banks, PSBs tended to dominate IBA
and developed close links with Government and RBI.
Often, the reactive and consensus and coordinated
approach border on cartelisation. To illustrate, IBA had
42

worked out a schedule of benchmark service charges for
the services rendered by member banks, which were not
mandatory in nature, but were being adopted by all banks.
Responding to the imperatives caused by the changing
scenario in the reform era, the IBA has, over the years,
refocused its vision, redefined its role, and modified its
operational modalities.
Tentative Issues and Lessons
Corporate governance in PSBs is important, not only
because PS Bs 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 PS Bs, the multiple objectives of the government
as owner and the complex principal- agent
relationships cannot be wished away. PS Bs 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 ownership and public
ownership is treated as 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
43

another who seeks something more and different, to
justify ownership.
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 institution
within the broadly defined public sector i e.,
government ,RBI and PSBs and PSBs to move away from a
model of planned development.)
The central bank also had to 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 standards.
Another noteworthy aspect of enhancing corporate
governance is narrowing of gap between PSBs and
other banks in terms of the policy, regulatory and
operating environment, apart from some changes in
ownership structures with attendant consequences. The
PSBs as hundred percent owned entities with no
share value quoted in stock exchanges accounted for
over three quarters of banking business seven years
ago, while they now account for less than a
quarter.
Random Thoughts
44

The Indian experience provokes some thoughts on a few
fundamental issues in regard to PSBs and corporate
governance. First, is public ownership compatible with
sound corporate governance as generally understood?
Since various corporate governance structures exits in
different countries. Government ownership of a bank,
unless government happens to have such a stake purely as
a financial investment for return, necessarily has to have
the effect of altering the strategies and objectives as well
as structure of government. Government as an owner is
accountable to political institutions which may not
necessarily be compatible with purely economic
incentives.
The mixed ownership brings into sharper focus the
divergent objectives of shareholding and the issues of
reconciling them, especially when one of the owners is
government. In such a situation, one can argue that as
long as the private shareholder is aware of the special
nature of shareholding, there should be no conflict. It
other words, The idea of maintaining public sector
character of a bank while government holds a minority
shareholding is an intensified and modified version of
“golden share” experiment of UK. The question could still
be as to whether such a mixed ownership of organization,
particularly for banks which are in case generally under
intense regulation and supervision.
45

Chapter 7
BEST PRACTICES OF CORPORATE GOVERNANCE
IN BANKS
Financial failures like Enron. WorldCom have eroded faith
in the corporate sector generating unprecedented shocks in
the stock markers all over the world. Many individual and
Corporate investors have become conservative in their
Investment decisions they demand higher degree of
scrutiny Of a corporate’s financial disclosure and
stringent Disclosure norms to avoid such irreversible and
Irrecoverable scandals in the future. Consequently, the
board Rooms are compelled to pay greater attention to
their Relationship with the stakeholders and the
transparency of their financial statements. Legislative and
regulatory issues have also been made more stringent to
boost investor Confidence. The audit process has also
been reviewed thoroughly with clear guidelines the focus
on corporate Duties and responsibilities.
Importance of Corporate Governance in Banks
Corporate Governance is particularly important for banks
because Banks play a dominant role in financial systems
and economic growth. Banks are the main source of
finance for a majority of firms as access of financial
markets is subject to compliance with cumbersome
regulatory requirements. They are the main depositories
for the economy’s saving. They act as the custodian of the
country’s liquid reserves. Thus the banking system
46

deserves much attention to build a strong, reliable and
stable financial system in a country.
Good governance can be built based on the business
practices adopted by the board of directors and
management. Many bank failures in the past have been
attributed to inadequate and inefficient management which
enabled banks to accept low quality assets and assume
additional risks that extended beyond the level appropriate
for the banks’ capacity.
Some of the key element that is identified to be a part of
a good governance system at the individual bank level:
Management with high integrity, adequate and experience;
A comprehensive internal information control system to
ensure the decisions if the bank are collective decision;
Prudent credit appraisal mechanism thereby limiting the
risk exposure; and Effective external and internal audit
procedures to establish adherence to the policies and
regulations and no special treatment is allowed on any
particular decision.
Ten Commandments of Corporate Governance
We can enumerate the commandments for ensuring bank
corporate governance.
I. Banks shall realize the times are changing
The issue of corporate governance had not been given the
requisite attention in the past until the advent of some
economic and financial crises in the late ‘90s. Times are
changing now, and even smallest banks need to focus on
corporate governance restructuring. This is because of the
47

apparent lack of integrity and values in the operation
some large corporations like World Com and Enron.
II. Banks shall establish an effective capable and
reliable board of directors
Establishing an effective, capable and reliable board of
directors requires involving well qualified and successful
individuals with integrity. This implies that a majority of
banks of board of directors should be truly outside
independent directors. Here, “independence” refers to the
individual not working for the bank and he/she not having
material relationship with the bank. The board should set
a long-term strategy, policy and values for the
organization. Nevertheless, the bank should not
micromanage the institution.
III. Banks shall establish a corporate code of ethics
for themselves
Corporate ethics and values should be established at the
top and should be used to govern the operations of the
company both from a long-term and a short-term view
point. Unless this exercise is accomplished, executive
management cannot anticipate that the rank and file
employees will follow such a code on their own.
IV. Banks shall consider establishing an Office of
the Chairman of the Board
Many banks are already examining this idea of
establishing Office of the Chairman of the Board. Such an
Office will be made to report to the board and will act as
48

the board’s eyes and ears on a daily basis in connection
with the functions of the bank.
V. Banks shall have an effective and operating
audit committee, compensation committee and
nominating/corporate governance committee
The audit committee, compensation committee and
nominating committee should be composed of all
independent, outside directors of the bank who operate
independently. These committees should have access to
attorneys and consultants paid for by the bank other than
the bank’s customary counsel and consultants. This
independence of the committees will ensure any bias in
the internal audit committee’s decisions.
VI. Banks shall consider the effective board
compensation
Fair compensation should be paid to the directors. Their
remuneration should be commensurate with the risks they
take. The bank should aim to appoint a highly qualified
director and take appropriate measures to retain them
with the organization as it normally does with other
employees.
VII. Banks shall require continuing education for
directors
The financial services industry is now facing a number or
challenges due to many technology innovations.
Therefore, it becomes imperative for the banks to educate
their directors to meet the growing needs of the industry.
49

Continuing education should be given equal importance
along with other parameters outlined above.
VIII. Banks shall establish procedures for board
succession
The presence of qualified members on the board is a very
crucial issue. So a bank should have a clearly specified
set of rules regarding issues of succession to the board.
The bank should pose a question are as follows:
a) Does the bank have a mandatory retirement age that is
actually enforced?
b) Does a self appraisal process exist to free the board of
the non-productive directors?
c) Does the bank have a plan to maintain a fully staffed
board of directors with capable people, no matter what
the age is as it moves forward?
IX. Banks shall disclose, disclose and disclose the
information
Banks will find that disclosure will be quicker and more
burdensome than it was in the past. This may be through
quarterly letters to the shareholders or other types of
communication.
X. Banks shall recognize that duty is to established
corporate governance procedures that will serve to
enhance shareholder value
50

The primary object of the board of directory is to
maximize the shareholder’s wealth. The strategy adopted
to achieve this objective should now encompass corporate
governance procedures and should be designed with long-
term value for the shareholder in focus.
Key Elements of Best Practices in Corporate
Governance
The Key elements identified are:
1. A strong independent board of directors,
2. Independent Committees,
3. Charter-based Committees than rule-based,
4. Code of conduct or ethics,
5. Transparent accounting practices,
6. Director orientation program and an ongoing
training.
Steps taken in India to Improve Corporate Governance
in Indian Banks.
A consultative group of Directors of banks and financial
institutions was set up by the Reserve Bank of India to
review the supervisory role of the 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.
These recommendations were based on international best
practice as enunciated by the Basel Committee on banking
supervision, other committee and advisory bodies. But
51

suitable amendments were made in these international
standards to suit the Indian scenario.
Recommendations of the Advisory Group
Directors of all banks both public and private sector banks
should exercise due diligence with respect to their
suitability to the post they hold by way of qualifications
and technical expertise.
• The Government shout be guide by certain broad “fit
and proper norms for the nomination of the
Directors. The criteria suggested by Bank of
International Settlements can be adopted as a
guideline to arrive at an appropriate set of norms.
• For assessing integrity and suitability factors such as
criminal records, financial position, civil action
undertaken to pursue personal debts, refusal of
admission to or expulsion from profession bodies,
sanction applied by regulation to similar bodies and
previous questionable business practices, etc, should
be considered.
• The appointment / nomination of independent / non-
executive directors to the Boards of banks should
be taken from a pool of professional and talented
people to be prepared and maintained by the
country’s Central Bank, Reserve Bank of India.
Any violation of the norm should be notified to the
RBI.
• In the current context of banking becoming more
complex and knowledge – based , there is an
52

urgent need for making the boards of banks
more contemporarily professional by inducting
technically and specially qualified individual.
• While the existing regulation of appointing
experts from different sectors such as
agriculture, SSI, etc can be continued , efforts
should be aimed at combining it with the need
based representation of skills such as marketing ,
technology and systems, risk management , strategic
planning , treasury operations, credit recovery , etc.
• The independent and non- executive directors
should raise critical questions relating to business
strategy , house keeping and internal control
systems and other important aspects of the
functioning of the bank and investor relations
in the meeting of the board.
• In the private sector banks where promoter
directors may act in concert , the independent /
non- executive directors should provide effective
checks and balances to ensure that the bank
does not build up exposures to entities
connected with the promoters or their
associates.
• The remuneration of the directors should be
increased to the comparable levels of
international standards to encourage them towards
maintaining integrity in their performing the
duties.
53

• The office of the chairman and the director
should be separated in respect of large sized
public sector to bring in more focus in
rendering their duties.
• The information furnished to the board should
be adequate and complete to enable the
members of the Board to take meaningful
decisions.
• Uniform code and procedure should be adopted
for recording the proceedings of the Board
meetings in banks and financial institutions.
• The board should be informed periodically of
the exposures of a bank to stockbrokers and
market- makers and other sensitive sectors such
as real estate etc.
• All banks should give importance to appointing
a qualified Company Secretary as the Secretary
to the Board and also appoint a Compliance
Officer for monitoring and reporting
compliance with regulatory and accounting
requirements.
• The Audit committee should comprise
independent / non-executive directors and the
Executive Directors should only be a permanent
invitee.
54

CONCLUSION
Corporate governance thus has become a topic interest to
Many audiences including the corporate directors, the
central banks and other regulatory authorities. Like many
issues, even CG has become an interesting issue that
attracted public attention in the wake of corporate
scandals like Enron. Governance issue generally centers
around accountability of the parties involved in decision-
making in a bank or any organization. Liberalization and
deregulation, and volatility in the financial markets are
the major factors that have triggered an interest in the
issue of corporate governance. I have made an attempt to
introduce the reader the concept, issues and perspectives
of corporate governance in the financial sector in general
and banks in particular. I have tried to give brief
introduction on the corporate governance practices in
some of the Asian banks and Indian banks.
55

BIBLIOGRAPHY
CORPORATE GOVERNANCE IN BANKS
AN INTRODUCTION
EDITED BY: V. SUBBULAKSHMI
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The corporate governance of banks

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The corporate governance of banks