CORPORATE GOVERNANCE and banks

CORPORATE GOVERNANCE & BANKS

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EXECUTIVE SUMMARY

The banking scenario in India is changing fast to keep pace with the

international banking practice. As a result, the banks in India have been asked to

meet specific standards such as capital adequacy norms, classification of assets

and income recognition Norms etc.

The main objective of this project is to introduce about the corporate

governance and how the corporate governance workout in the Indian Banking

Sector. This project would also provide fundamental concepts to understand

about the corporate governance and Indian Banking System. The project covers

emergence of the concept of corporate governance, the manner in which it is

relates with banking sector, its various issues, constituents and how it is being

implemented in the banking sector. The focuses mainly on some specific

aspects of codes of corporate governance and is application in the banking

sector.

Though outcomes of good corporate governance remains same

irrespective of nature of business, type of ownership, quality of management,

business/legal regulations, and political environment, but the means to achieve

this good governance differs a lot based on the factors mentioned above. Some

of the parameters that may influence corporate governance include ownership

structure, board philosophy, industry segment, and maturity of business,

management process, level of competition, international business participation,

and size of the company.

Lot of effort is being put both nationally and internationally in understanding

and suggesting good practices that can improve governance of banking sector.

In India also several initiatives have been taken up in understanding nuances of

banking sector governance.


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INDEX

SR.

NO.

TOPIC PAGE NO.

1] CORPORATE GOVERNANCE

[MEANING, DEFINATION AND

CONCEPT]

2] CORPORATE GOVERNANCE IN BANKS

3] NEED OF CORPORATE GOVERNANCE

IN BANKS

4] SCOPE OF CORPORATE GOVERNANCE

IN BANKS

5] MEASURES TAKEN BY RBI FOR

IMPLEMENTATION OF CORPORATE

GOVERNANCE IN BANKS

6] PROTECT INTEREST OF INVESTOR

AND CONSUMER

7] ADVANTAGES OF CORPORATE

COVERNANCE IN BANKS

8] CHALLENGES OF CORPORATE

COVERNANCE IN BANKS

9] CORPORATE GOVERNANCE IN INDIAN

BANKING SECTOR

10] RECOMMENDATION

11] CONCLUSION

12] WEBLIOGRAPHY/BIBLIOGRAPHY


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CHAPTER 1

CORPORATE GOVERNANCE: A CONCEPTUAL ANALYSIS

“Corporate Governance” has become one of the most commonly used phrases

in the current global business vocabulary. This raises the question, “is corporate

governance is a vital component of successful business or is it simply another

fad that will fade away over time”? Nations around the world are instigating far

reaching programmers’ for corporate governance reform, as evidenced by the

proliferation of corporate governance codes and policy documents, voluntary

and mandatory, both at the national and supranational level. We believe that the

present focus on corporate governance will be maintained into the future and

that, over time, corporate governance issues will grow in importance, rather

than fade into insignificance. The phenomenal growth of interest in corporate

governance has been accompanied by a growing body of academic research.

Modern business world demands quality, ethics and excellence, properly

injected into the organization at the level of person, process and product [PPP].

To cope with this change core competency is identified and leveraged for

success and all this is made possible through corporate governance. Corporate

Governance is an instrument for strengthening the overall effectiveness of

corporate enterprise in thecorporate world and helps to optimize the goals

of corporate entities within the boundary of corporate environment. It is an

important component in a long term perspectives of companies and has a

leading species of large genus namely, National Governance, Human

Governance, Societal Governance, Economic Governance and Political

Governance.

Corporate Governance includes the policies and procedures, which is

usually adopted by a company in achieving its objectives in relation to its

shareholders, employees, customers and suppliers, regular authorities and

community at large. Corporate Governance usually establishes a structural

framework, which makes a healthy and competitive company with self –

clearing and competitiveness by some strategies, transparency, motivation and

social orientation. Corporate Governance plays an integral part to the very

existence of a company/ organization/ Banking Sector/ Corporate Entity. It

inspires and strengthens investor’s confidence by insuring company’s


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commitment to higher grow and profits [ICSI, 2003]. The further need of

corporate governance includes: Protecting the rights of shareholders, making

confidence among the stakeholders, strengthening the Board of Directors,

providing autonomy and responsibility to the Board of Directors, providing

protection to the financial and other lending institution, and to keep

sustainability – economic, environment and social. Corporate Governance is a

means of overcoming these problems, as it seeks to minimize the malpractices

by the companies by establishing the system, where more information about the

transactions of the companies or decisions taken by the management is available

to the shareholders and the public. In a corporate governance system, Board of

Director is the sole authority for merging the companies.

DEFINITIONS

“Corporate governance is a field in economics that investigates how to

secure/motivate efficient management of corporations by the use of incentive

mechanisms, such as contracts, organizational design and legislation. This is

often limited to the question of improving financial performance, for example,

how the corporate owners can secure that the corporate managers will deliver a

competitive rate of return”,. www.encycogov.com, mathiesen [2002].

“Corporate governance deals with the way in which supplier of finance to

corporation assure themselves of getting a return on their investment”, the

journal of Finance Shleifer and vishny [1997]

“Corporate governance is the system by which business corporations are

directed and controlled. The corporate governance structure specifies the

distribution of rights and responsibilities among different participants in the

corporations, such as, the board, the managers, shareholders and the other

stakeholders, spells out the rules and procedures for making decisions on

corporate affairs. By doing this, it also provides the structure through which the

companies objectives are set, and the means of attaining those objectives and

monitoring performance”, OECD, April 1999.

“Corporate governance is about promoting corporate fairness,

transparency and accountability”. Wolfensohn, President of World Bank.

http://www.encycogov.com/


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Corporate Governance is concern with the values, vision, visibility

(VVV). It is about the value orientation of the organization, ethical norms for its

performance, direction of development and social accomplishment of the

organization and the visibility of its performance and practices. In Indian

banking sector the corporate governance takes more vital role for their

governance and growth. Due to Liberalization, Privatization, Globalization and

Information Technology currently changing Indian Banking radically, corporate

governance takes more crucial role for their framework. Corporate governance

of banks is an essential element of a county’s governance architecture. It can

have systematic financial stability implication and shape the pattern of credit

distribution and overall supply of financial services. Hence the necessity and

importance of enforcing effective corporate governance in the banking sector.


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GOOD CORPORATE GOVERNANCE

Role and powers of Board

Good governance is decisively the manifestation of personal beliefs and

values which configure the organizational values, beliefs and actions of its

Board. The Board as a main functionary is primarily responsible to ensure value

creation for its stakeholders. The absence of clearly designated roles and powers

of Board weakens accountability mechanism and threatens the achievements of

organizational goals. Therefore, the foremost requirement of good governance is

the clear identification of powers, roles, responsibilities and accountability of

the Board, CEO, and the chairman of the Board. The role of the Board should

be clearly documented in a Board Charter.

Legislation

Clear and unambiguous legislation and regulations are fundamental to

effective corporate governance. Legislation that requires continuing legal

interpretation or is difficult to interpret on a day-to-day basis can be subject to

deliberate manipulation or inadvertent misinterpretation.

Management environment

Management environment includes setting-up of clear objectives and

appropriate ethical framework, establishing due processes, providing for

transparency and clear enunciation of responsibility and accountability,

implementing sound business planning, encouraging business risk assessment,

having right people and right skills for the jobs, establishing clear boundaries

for acceptable behavior, establishing performance evaluation measures and

evaluating performance and sufficiently recognizing individual and group

contribution.


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Board skills

To be able to undertake its functions efficiently and effectively, the board

must possess the necessary blend of qualities, skills, knowledge and experience.

Each of the directors should make quality contribution. A board should have the

following skills, knowledge and experience. Operational or technical expertise,

commitment to establish leadership, financial skills, legal skills and knowledge

of government and regulatory requirement.

Board appointments

To ensure that the most competent people are appointed in the board, the

board position should be filled through the process of extensive search. A well-

defined and open procedure must be in place for reappointments as well as for

appointment of new directors. Appointment mechanism should satisfy all

statutory and administrative requirements. High on the priority should be an

understanding of skill requirements of the Board particularly at the time of

making a choice for appointing a new director. All new directors should be

provided with a letter of appointment setting out in detail their duties and

responsibilities.

Board induction and training

Directors must have a broad understanding of the area of operation of the

company’s business, corporate strategies and challenges being faced by the

Board. Attendance at continuing education and professional development

programs is essential to ensure that directors remain abreast of all

developments, which are or may impact on their corporate governance and other

related duties.


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Board independence

Independent Board is essential for sound corporate governance. This goal

may be achieved by associating sufficient number of independent directors with

the Board. Independence of directors would ensure that there are no actual or

perceived conflicts of interest. It also ensures that the Board is effective in

supervising and, where necessary, challenging the activities of management.

The Board need to be capable of assessing the performance of managers with an

objective perspective. Accordingly, the majority of Board members should be

independent of both the management team and any commercial dealing with the

company.

Board meetings

Directors must devote sufficient time and give due attention to meet their

obligations. Attending Board meetings regularly and preparing thoroughly

before entering the board room increases the quality of interaction at board

meetings. The Board meetings are the forums for Board decision-making. These

meetings enable directors to discharge their responsibilities. The effectiveness

of Board meetings is dependent on carefully planned agendas and providing

relevant papers and materials to directors sufficiently prior to Board meetings.

Also in the present scenario, Board meeting through modern means of

communication like tele-conferencing, video conferencing may be expressly

allowed under law.

Board Resources

Board members should have sufficient resources to enable them to

discharge their duties effectively. It includes an access for director to

independent legal and professional advice at the company’s expense. The cost

of supporting the Board should be transparent and reported.


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Code of conduct

It is essential that the organization’s explicitly prescribe norms of ethical

practices and codes of conduct are communicated to all stakeholders and are

clearly understood and followed by each member of the organization. Systems

should be in place to periodically measure, evaluate and if possible recognize

the adherence to code of conduct.

Strategy setting

The objectives of the company must be clearly documented in a long-

term corporate strategy including an annual business plan together with

achievable and measurable performance targets and milestones.

Business and community obligation

Though basic activity of business entity is inherently commercial yet it

must also take care of community’s obligations. Commercial objectives and

community service obligation should be clearly documented after approval by

the Board. The stakeholders must be informed about the proposed and on-going

initiatives taken to meet the community obligations.

Financial and operational reporting

The Board requires comprehensive, regular, reliable, timely, correct and

relevant information in a formand of a quality that is appropriate to discharge its

functions of monitoring corporate performance. For this purpose, clearly

defined performance measures-financial and non-financial should be prescribed

which would add to the efficiency and effectiveness of the organization. The

reports and information provided by the management must be comprehensive

but not so extensive and detailed has to hamper comprehension of the key

issues. The report should be available to Board members well in advance to

allow inform decision-making. Reporting should include status report about the

state of implementation to facilitate the monitoring of the progress of all

significant Board approved initiatives.


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Monitoring the Board performance

The Board must monitor and evaluate its combined performance and also

that of individual directors at periodic intervals, using key performance

indicator beside peer review. The Board should establish an appropriate

mechanism for reporting the results of Board’s performance evaluation results.

Audit committees

Audit committee is an inter alia responsible for liaison with the

management; internal and statutory auditors, reviewing the adequacy of internal

control and compliance with significant policies and procedures, reporting to

the Board on the key issues. The quality of audit committee significantly

contributes to the governance of the company.

Risk management

Risk is an important element of corporate functioning and governance.

There should be a clearly established process of identifying, analyzing and

treating risks, which could prevent the company from effectively achieving its

objectives. It also involves establishing a link between risk-return and

resourcing priorities. Appropriate control procedures in the form of risk

management plan must be put in place to manage risk throughout the

organization. The plan should cover activities as diverse as review of operating

performance, effective use of information technology, contracting out and

outsourcing. The Board has the ultimate responsibility for identifying major

risks to the organization, setting acceptable level of risk and ensuring that the

senior management has taken steps to detect, monitor and these risks. The

Board must satisfying itself that appropriate risk management system and

procedure are in place to identify and manage risks. For this purpose, the

company should subject itself to periodic external and internal risk reviews.


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CHAPTER 2

EVOLUTION OF CORPORATE GOVERNANCE IN

BANKING SECTOR

There is complete uniformity now in the banking industry and the system

therefore ensures responsibility and accountability on the part of the

management in proper accounting of income as well as loan impairment. At the

initiative of the regulators, banks were quickly required to address the need for

Asset Liability Management followed by risk management practices. Both these

are critical areas for an effective oversight by the Board and the senior

management which are implemented by the Indian banking system on a tight

time frame and the implementation review by RBI. These steps have enabled

banks to understand measure and anticipate the impact of the interest rate risk

and liquidity risk, which in deregulated environment is gaining importance.

Prudential norms in terms of income recognition, asset classification, and

capital adequacy have been well assimilated by the Indian banking system. In

keeping with the international best practice, starting 31st March 2004, banks

have adopted 90 days norm for classification of NPAs. In addition, norms

governing provisioning requirements in respect of doubtful assets have been

made more stringent in a phased manner. Beginning 2005, banks will be

required to set aside capital charge for market risk on their trading portfolio of

government investments, which was earlier virtually exempt from market risk

requirement. All the Indian banks barring one today are well above the

stipulated benchmark of 9 per cent and remain in a state of preparedness to

achieve the best standards of CRAR as soon as the new Basel 2 norms are made

operational. Reserve Bank of India has taken various steps furthering corporate

governance in the Indian Banking System. These can broadly be classified into

the following three categories: Transparency, Off-site surveillance and Prompt

corrective action. However, there are many gaps in the disclosures in India vis-

à-vis the international standards, particularly in the area of risk management

strategies and risk parameters, risk concentrations, performance measures,

component of capital structure, etc. Hence, the disclosure standards need to be

further broad-based in consonance with improvements in the capability of

market players to analyze the information objectively. The off-site surveillance

mechanism is also active in monitoring the movement of assets, its impact on

capital adequacy and overall efficiency and adequacy of managerial practices in

banks. RBI also brings out the periodic data on “Peer Group Comparison” on


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critical ratios to maintain peer pressure for better performance and governance.

There are three major challenges facing governance ratings in India: Firstly

there does not seem to be a clear objective in relation to the capital markets. The

second challenge is that there is insufficient accumulated knowledge on

corporate governance and a great amount of fluidity in the theory at present and

the third challenge is to assign weightings to the companies in the context of

global markets. The rating agencies need to reflect on these while the regulator

refrains from putting pressure to initiate a rating system for corporate

governance.

The RBI Advisory Committee on Corporate Governance has defined

Corporate Governance as “the system by which business entities are monitored,

managed and controlled. The Board of Directors occupies a pivotal place in the

scheme of Corporate Governance”. The advisory group on banking supervision”

has emphasized the need for enhanced transparency and disclosures in respect

of various aspects of board’s constitution and functioning. Beginning with the

composition of the Board of Directors and elaborating their various functions

and duties, the corporate governance code prescribes the procedures that make

the functioning of Board more effective. These are:

1. As representatives of various stakeholders, it is the moral responsibility

of Board of Directors to ensure that the company does not undermine

moral and ethical issues in the lure of profits.

2. It is imperative for the Board to keep itself aware of the happenings in the

company rather than performing perfunctory duties.

3. Through its various committees, the board should keep its fingers on the

pulse of the activities besides inspecting the activity of the company. The

audit committee, compensation committee, nominations committee,

credit committee, risk management committee are the various sub-groups

of the board that ensure that the company sticks to the corporate

governance mechanisms.

4. The Board is accountable for the action of the company. It act as a

governing body that controls and channelizes the resources into

productive and morally right ways. It is the responsibility of the Board to

ensure that proper governance practices are in place in the company. It

has to keep track of the going on in the company through active

involvement at the strategic and policy-making levels.


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5. The existence of outside independent directors enables the board to make

an objective evaluation of company’s activities. Their position as

members of the board gives them access to information which will not be

otherwise available to outsiders. The independent directors are in a better

position to stipulate a course of action. To increase the effectiveness of

directors some of the experts have suggested the insurance of these

directors for the risk they take in providing guidance or taking certain

decisions.

6. The board has the duty to ensure that the management performs its duties

with regard to day-to-day affairs within legal, moral and ethical bounds.

7. Board is not to act as a kind of director. It should set goals for itself and

evaluate its performance. It will set an example for other to follow.

8. Board should be broad based. The directors should bring independent

judgment to bear on issues of strategy, performance, resource planning

and standards of conduct. They should be conversant with the banking

business.

9. The board should have following committees, namely, audit committee,

compensation committee, nominations committee, credit committee, risk

management committee.

10. There should be an agreed procedure for directors to seek professional

advice where considered necessary.


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CHAPTER 3

NEED OF CORPORATE GOVERNANCE IN BANKS

Banks and development financial institutions of India, particularly DFI’s

have important role in governance of companies and where they have their

nominee directors. The role of these nominee directors is to protect the interest

of the institution and also as a member of the board be responsible as any other

director. However, in certain instances where irregularities have been detected,

the role of nominee directors has attracted attention. however, it is felt in

general that theses nominee directors have a duty to act in the larger public

interest. Banking is clearly a very special sub-set of corporate governance with

much of its management obligations enshrined in law or regulatory codes.

Governance is also a curiously two-side issue for banks since their funding and,

often, ownership of other companies makes them a significant stakeholder in

their own right. Governance in bank is a considerably more complex issue than

in

i] Most countries including members of the International Monitory Fund

[IMF]have experienced problems within their Banking community from

time to time. The fact that these problems can still occur after the

introduction and indeed implementation of both national and international

standards and regulation gives the subject of corporate governance of

banks crucial importance.

ii] It is necessary to have a clear idea, to anyone in financial management,

whether micro or macro and interest in good market practice that banks

are extremely important for development of a successful economy;

indeed the corporate governance of such institution is integral to that

development.


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iii] Banks are in unique position of effectively collecting a allowing the use

of fund in given manner of enterprise. Where such funds are used in

proper and consistent manner, this can lead to stable market, lower the

cost of capital and accordingly stimulate growth in an economy as whole.

iv] Corporate Governance Guidelines to the bankers [i.e. directors and

senior management of the banks] to allocate capital efficiently, to expert

good and effective Corporate Governance in their own institutions and

also to promote good practices for their costomers. This ultimately helps

to generate built in discipline in the relations bank and their costomers.

v] Corporate Governance provides proper attention towards weak or

improper supervision of banks which can have the disproportionate effect

of destabilizing a county’s economy and indeed reducing market

confidence.

vi] Corporate governance check on the various banking crises which are

reasons for crippling economies, destabilized governments and in a macro

sense, held back the development of less sophisticated economies and

emerging nations and this results in intensified poverty.


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CHAPTER 4

SCOPE OF CORPORATE GOVERNANCE IN BANKS

I] Banks operates in a different manner to generate corporation in the

delivery of their business and their position in the market. Accordingly, it is

important to create, either willingly or through regulations, a degree of

transparency to allow for customer & market confidence.

II] Banks are generally even in emerging economy, heavily regulated when

compared toother corporations.

III] Banks have:

A wide definition of ‘stakeholders’.

Mechanism to avoid the issue of “systematic risk.”

Additional regulation and compliance issues.

The interests of depositors requiring protection.

The need for strong internal control and risk management.

Particular issues of related party transaction

IV] Corporate governance from a banking industry perspective also deals

with, among other factors the manner in which the business andattendees of

individual institutions are governed by their boarding of directory and senior

management which affects how banks:


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A] Set corporate objectives

Cadburry report is a basic foundation for all the entries to prepare the basic

norms w.r.t. corporate governance practices.

B] Run on a day to day basis.

C] Meet the obligations of accountability, both internally and externally.

D] Align – corporate activity and behavior.

E] Protect the interests of depositors and other customers.


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CHAPTER 5

MEASURES TAKEN BY RBI FOR IMPLEMENTATION OF

CORPORATE GOVERNANCE NORMS IN BANKS

Series of efforts being made by two independent regulatory bodies in a

last few years to accomplish harmonism of regulations policies and guidelines

made applicable to the regulated entities. RBI has advised, on the suggestion

from the SEBI that the Indian commercial banks (both public & private sector).

Which are listed on the stock exchanges should adopt the guidelines of SEBI

committees on corporate governance. They are as follows:

A] Optimum combination of executive and non-executive directors in the

board.

B] Pecuniary relationship or transactions of the non executives directors vis-

à-vis the bank.

C] Independent adult committees, their constitutions, chairmanship, power,

role &responsibilities conduct of business etc

D] Remuneration of directors,

E] Periodicity/ no. of board meetings

F] Disclosure by management to the board about the conflict of interest.

G] Information/ reappointments of directors, display the quarterly results/

presentations to analysis on websites.

H] Maintenances of office by non-executive chairman

I] reviewing with the management by the audit committee of the board the

annual financial statement before submission to the board, focusingprimarily

on:


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Any changes in accounting policies and practices

Major accounting entities based on exercise the judgement of

managements.

Qualifications in draft audit report

Significance adjustments arising out of audit compliance with standards

The going concern assumptions.

III] The audit committee of the board may look into the reasons for default in

payments to deposits debenture shareholders (non payment of dividend) &

creditors wherever there are cases of default s in payment.

SEBIcommittee’s recommendations on other additional functions to be

interested to the audit committee complied with by the listed banks as per listing

agreements.

IV] As regards the appointment and removal external auditors, the practice

followed in banks is more stringent that the recommendations of the committee

and hence will continue as it is.

V] With the view to further improve corporate governance standards in

banks, the following new measures are recommended:

A] In the interest of the stakeholders, the private sector and public sector banks

which have issued shares to the public may form committees on the same lines

as listed companies under the chairmanship of non- executive director to look

into redressal of shareholders complaints.

B] All listed banks may provide in audited financial results on half yearly banks

to their shareholders with summary of significant development.


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CHAPTER 6

PROTECTION OF INTEREST OF INVESTORS AND

CUSTOMERS

In today’s competitive business world the businessmen have to deal with

several stake holders, one of them is customers. Corporate needs to think

carefully about their approach to customer service and make sure about its

awareness about customers legal rights. Proper respect towards customer’s

rights helps the corporate to build a good reputation and can retain their custom.

1] Customers key rights when buying or hiring goods

Businessmen or entrepreneurs must provide proper attention towards

following rights:

The goods must match the description which company or business gives

to them for example, if you say a computer has an 80 GB hard drive it

can’t be 40 GB.

The goods must be of satisfactory quality- It means they must be of a

standard that any ‘reasonable person’ would regard as satisfactory. They

should be safe, work properly, and have no defects in their appearance or

finish.

The goods must be fit for the purpose specified. It says that, they should

be capable of doing what they are meant for. For example, a watch

should tell the time and if the customer said they wanted to use it while

swimming and you didn’t say it was unsuitable, it should be able to

perform this task.


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2] Customers rights to reject goods and claim refunds.

If customer’sbelief that goods hired or purchased from businessman is not

as described fit for their purpose, or of satisfactory quality, they can reject them.

Except where they are hiring or purchasing in the course of business and the

fault is so slight it would be unreasonable to do so.

3] Customers key rights when buying services:

The customer is entitled to the service defined in the contract you make

with them.

According to supply of goods and services Act every business must have

to carry out work with reasonable skill and care. Provide the service

within reasonable amount of time and at reasonable price.

There should not be any discrimination among customer on any grounds.

4] Customer’s rights with credit and financial product and services

Customers can make a claim against both the supplier and the credit

provider for faulty goods.

Since 1 Oct. 2008, every business has to provide regular statements

during the lifetime of the credit agreement.

Protection of consumers against different unethical practices

A] Price:

1. Bid rigging

2. Dumping

3. Predatory pricing

4. Price discrimination

5. Price fixing


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B] Product:

1. Inferior quality

2. Adulteration

3. Faulty weight

4. Defective

C] Place:

1. Lengthy supply chain

2. Share of commission of every distribution agent in price of the

commodity

3. Hoarding

D] Promotion:

1. Misleading advertisement

2. Fake offers

3. Wrong information by salesperson

Under the consumer protection act 1986, a consumer or customer is

guaranteed following rights:

a) Rights to be protected against the marketing of goods and services which

are hazardous to life and property.

b) Right to be informed about the quality, quantity, potency, purity, standard

and price of goods and services.

c) Right to be assured.

d) Right to be heard.

e) Right to seek redressal against unfair trade practices.

f) Right to consumer protection.


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The Advantages of Corporate Governance in

Banks

The potential of Corporate Governance to propel a business to greater

commercial success is not generally well known. When you speak to those in

business about how Corporate Governance works, you often get vague

responses relating to policy, systems and processes that are established in an

organization. But that explanation does not do justice to the subject of

Corporate Governance. If a business is determined to grow (especially in the

current lack luster business environment) then they should seriously think about

introducing proper Governance into their organization.

1. Role clarity for the owners and management team

Governance permits managers and owners to delineate their roles and

separate the issues of ownership (shareholding) from the management of

the business. This usually facilitates faster decision making as it allows

managers and owners to choose which ‘hat’ to wear depending on the

issue or matter at hand.

2. Purposeful strategic direction

Corporate Governance relies on the company defining and following a

definitive strategic direction. This enables the owners and/or management

to apply the right resources to the most beneficial opportunities. In turn

this typically leads to the quicker achievement of company goals, while

minimizing wasted resources on less important activities.


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3. Retention of staff

Motivation increases when employees/staff are part of a business that has

a well-defined and communicated vision and direction. This can improve

staff retention which can become especially important when it comes to

attracting and retaining senior talent.

4. Improved relationships with the bank

Corporate Governance enables robust and regular financial and

management reporting. The resulting systematic approach to producing

data will foster confidence in your business from your funders/banks as

well as your investors. Improved access to capital can be another flow-on

benefit from sound Corporate Governance.

5. Improvement in profitability

Governance often leads to improved reporting on performance. This

means managers and owners are better equipped to make higher quality

decisions that can drive an increase in sales and margins and a reduction

in costs


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CHAPTER 8

CHALLENGES OF CORPORATE GOVERNANCE IN BANKS

There are several reasons for the absence of sufficient corporate governance

mechanism in the Indian banking sector:

1. Multiplicity of regulations:

Banks are governed by multiple enactments. For instance, private banks

are governed both by the companies Act, 1956 and the banking

companies’ regulation Act and Bank nationalization Act, 1969 [amended

in 1982]. The state Bank of India and its associates are governed by the

state Bank of India Act, 1955 [amended in 1997]. The Regional Rural

Banks are regulated by RRB Act, 1975, the co-operative banks by

cooperative banking regulation Act, 1949 and Banking Laws [cooperative

societies] Act, 1965. The RBI advisory group has opined that all the

banks should be brought within the purview of a single act which

prescribes the various practices to be followed by one and all.

2. Lack of synchronization among various corporate various corporate

governance norms:

Three different committees in India have dealt with the subject of

corporate governance. These are: the Kumar Mangalam Birla committee

report, 2000 that had been constituted by SEBI; CH Report, 1998 and the

RBI Advisory Committee Report, 2001. There is no synchronization of

the regulations. Each Report has dwelt on specific issues. It would be

better if a common code is prescribed after harmonizing the

recommendations of various committees.


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3. Qualitative V. Quantitative:

Banking norms are quantitative the Qualitative. Governance depends

more on quality of adherence to the norms in addition to quantitative

yardsticks.

4. Mix-up between ownership role and regulatory role:

In most of the financial institutions, the RBI has been a majority

shareholder as well as regulator. Narsimhan committee on banking

reforms raised the question as to whether regulator should be owners in

the context of State Bank of India. Recently RBI has vacated its majority

ownership role in Securities Trading Corporation of India Ltd. And

discount and Finance House of India and is in the process of divestment.

There is also no justification for a regulator like RBI to be represented on

the board of those regulated.

5. Mismatch between ownership pattern and board level

representation: previously, when government used to be the majority

shareholder in many of the financial institutions, it could have a majority

representation on its board. With diversified ownership, private

shareholders have begun to be given board level representation. But

private shareholders representation is not commensurate with the extent

of their shareholding. For instance, even with the 40 per cent

shareholding private shareholders’ representation on the board may not

exceed 10 to 15 per cent of the total board membership.


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6. Lackof transparency in selection of board members:

It is anybody’s guess as to what are the considerations that weigh in

government’s mind in making board level appointments. To have truly

professional directors, there should be a process of transparent search.

7. Board accountability:

Accountability of directors in public sector banks is another aspect on

which processes have to be put in the place. Directors must be made

aware as to what they are expected to do on the board. Their actual

performance should be monitored and kept in view while reappointing

them.

8. Lack of timely appointment of directors:

sometimes, it takes a number of years for the government to reconstitute

the board of some of the public sector banks.

9. Political boards:

Very often, board level appointments in financial institutions are based on

political considerations. Board appointments must remain stable and

unaffected by political developments. In many cases, whole of the board

has got replaced overnight.


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CHAPTER 9

Corporate Governance in Indian Bank Case Study: State Bank of

India

1. INTRODUCTION

The issue of corporate governance has come up mainly in the wake up of

economic reforms characterized by liberalization and deregulation. According

to OECD, the corporate governance structure specifies the distribution of rights

and responsibilities among different participants in the corporation, such as, the

board, managers, shareholders and other stakeholders and it also spells out the

rules and procedures for making decisions on corporate affairs. Corporate

governance is exclusively of board of directors in a manner that it becomes a

way of organizational life and not merely written rules or regulations or code of

ethics. Ethics and transparency are cardinals of corporate governance.

2. WORLD SCENARIO

The seeds of modern corporate governance were probably sown by the

Watergate scandal in the USA. Subsequent investigations by US regulatory and

legislative bodies highlighted control failures that had allowed several major

corporations to make illegal political contributions and bribe government

officials. While these developments in the US stimulated debate in the UK, a

spate of scandals and collapses in that country in the late 1980s and early 1990s

led shareholders and banks to worry about their investments. Several companies

in UK which saw explosive growth in earnings in the 1980s ended the decade in

a memorably disastrous manner. In May 1991, the London Stock Exchange set

up a committee under the chairmanship of Sir Arian Cadbury to help raise the

standards of corporate governance and the level of confidence in financial


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reporting and auditing by setting out clearly what it sees as the respective

responsibilities of those involved and what it believes is expected of them. The

committee investigated accountability of the board of directors to shareholders

and to the society. It submitted its report and the associated „code of best

practices in December 1992 wherein it spelt out the methods of governance

needed to achieve a balance between the essential powers of the board of

directors and their proper accountability. Contemporary corporate governance

started in 1992 with the Cadbury report in the UK. Cadbury was the result of

several high profile company collapses and was concerned primarily with

protecting weak and widely dispersed shareholders against self-interested

directors and managers.

3. INDIAN SCENARIO

The corporate governance initiative in India was not triggered by any

serious nationwide financial, banking and economic collapse. The initiative in

India was driven by The Confederation of Indian Industry. In December 1995,

CII set up a task force to design a voluntary code of corporate governance. The

final draft of this code was widely circulated in 1997. In April 1998, the code

was released. It was called “Desirable Corporate Governance: A Code”.

Following CII‟s initiative, the Securities and Exchange Board of India (SEBI)

set up a committee under Kumar Mangalam Birla to design a mandatory-cum-

recommendatory code for listed companies. The Birla Committee Report

submitted in February 2000 and it was approved by SEBI in December 2000.

The report became mandatory for listed companies through the listing

agreement and implemented according to a rollout plan. Following CII and

SEBI, the Department of Company Affairs (DCA) modified the companies Act

1956, to incorporate specific corporate governance provisions regarding

independent directors and audit committees.


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4. OBJECTIVES AND METHODOLOGY

The objective of the research paper is to evaluate the corporate governance

practice in banking sector through a case study of the State Bank of India. For

evaluation purpose, this research paper divided into two parts. Based on

different elements of and with the help of secondary data, this work has

analyzed and evaluated the practice of corporate governance in State Bank of

India. In the first part, the concepts of corporate governance like evolution of

corporate governance in world and Indian scenario, role and importance of

corporate governance in banking sector has been discussed. The second part

analyses the practice of corporate governance as determined in State Bank of

India with the help of elements like board practices, stakeholders and

transparent disclosure of information.

5. CORPORATE GOVERNANCE IN INDIAN BANKING SECTOR

The corporate governance practice is important for banks in India because

majority of the banks are in public sector, where they are not only competing

with one another but with other players in the banking system. Further, with

restrictive support available from the government for further capitalization of

banks, many banks may have to go for public issues, leading to

transformation of ownership. The banks form an integral part of the

economy of the country and any failure in a bank might have a direct bearing

on the financial health of the country. The Basel committee on banking

supervisory authorities was established by the Central Bank Governors of the

G10 developed countries in 1975. The Basel committee in the year 1999 had

brought out certain important principles on corporate governance for

banking organizations which, more or less have been adopted in India. The

minimum impact of recession on Indian economy was because of strong and

effective nature of banking sector in India.


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6. CORPORATE GOVERNANCE IN STATE BANK OF INDIA

State Bank of India is the country’s largest commercial bank in terms of

profits, assets, deposits, branches and employees. With over 200 years of

existence, State Bank group has a presence in 33 countries and extensive

network of more than 18,000 branches and 26,000 plus ATMs and 100 million

accounts across the country. The only Indian Bank to feature in the Fortune 500

list, SBI has 5 Associate banks and 7 Subsidiaries arguably the largest in the

world. With millions of customers across the country, SBI offers a complete

range of banking products and services with cutting edge technology and

innovative banking model. State Bank of India is committed to the best

practices in the area of corporate governance. The sound corporate governance

practice in State Bank of India would lead to effective and more meaningful

supervision and could contribute to a collaborative working relationship

between bank management and bank supervisors. Based on different elements

like boards practices, stakeholder’s services and transparent disclosure of

information the practice of corporate governance in state bank of India was

assessed.

7. BOARD PRACTICES

Central Board The central board of directors was constituted according to

the SBI Act 1955. The bank’s central board draws its powers from and carries

out its functions in compliance with the provisions of State Bank of India Act &

Regulations 1955. Its major roles include, among others, overseeing the risk

profile of the bank; monitoring the integrity of its business and control

mechanisms; ensuring expert management, and maximizing the interests of its

stakeholders. The central board has constituted seven board level committees.


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7.1. Audit Committee of the Board: ACB provides direction as well as

oversees the operation of the total audit function in the bank. Total audit

function implies the organizational, operational, quality control of internal audit

and inspection within the bank, follow-up on the statutory audit and compliance

with RBI inspection. It also appoints statutory auditors of the bank and reviews

their performance from time to time.ACB reviews the banks financial, risk

management, IS audit policies and accounting policies of the bank to ensure

greater transparency.

7.2. Risk Management Committee of the Board: RMCB was constituted to

oversee the policy and strategy for integrated risk management relating to credit

risk, market risk and operational risk.

7.3. Shareholders’/Investors’ Grievance Committee of the Board : SIGCB

was formed to look into the redressal of shareholders‟ and investors‟

complaints regarding transfer of shares, non-receipt of annual report, non-

receipt of interest on bonds/declared dividends, etc.

7.4. Special Committee of the Board for Monitoring of Large Value

Frauds: The major functions of the committee are to monitor and review all

large value frauds with a view to identifying systemic lacunae, if any, reasons

for delay in detection and reporting, monitoring progress of CBI / Police

investigation, recovery position and reviewing the efficacy of remedial action

taken to prevent recurrence of frauds.

7.5. Customer Service Committee of the Board: CSCB was constituted to

bring about ongoing improvements on a continuous basis in the quality of

customer service provided by the bank.


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7.6. IT Strategy Committee of the Board: With a view to tracking the

progress of the bank’s IT initiatives, the SBI‟s central board constituted a

technology committee of the board. The committee has played a strategic role in

the bank’s technology domain.

7.7. Remuneration Committee of the Board: It was constituted for evaluating

the performance of whole time directors of the bank in connection with the

payment of incentives, as per the scheme advised by Government of India. It is

found that in SBI, these committees are providing effective professional support

in the conduct of board level business in key areas.

8. STAKEHOLDERS SERVICES

The SBI strongly believes that all stakeholders should have access to

complete information on its activities, performance and product initiatives.

8.1. Shareholders: The SBI is providing different types of services and

facilities to the shareholders. Share transfers in Physical form are processed and

returned to the shareholders within stipulated time. SBI has the distinction of

making uninterrupted dividend payment to the shareholders at an increasing rate

for many years. In accordance with the SEBI guidelines on green initiative in

corporate governance, SBI is issuing annual report in electronic form to

shareholders who opt for receiving the same in electronic form through their e-

mails. To meet various requirements of the investors regarding their holdings,

the Bank has a full-fledged department i.e. shares and bonds department and

shares and bonds cells at the 14 local head offices.

8.2. Customers: With a large network and number of branches throughout

India and abroad SBI is providing different types of services and facilities to the

customers.


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8.2.1 ATMs: State Bank group has in its stable, variants of ATMs. The number

of ATMs of the SBI group was 25,005 in March 2011 and they increased to

27,286 in March 2012. The number of ATMs of SBI was 20,084 in 2011 and

they are 22,141 in 2012. The total debit cards issued by SBI were 728 lakhs in

2011 and they increased to 910 lakhs in 2012.

8.2.2 Mobile Banking: There were 10.13 lakh registered mobile customers in

2011 and they increased to 36.45 lakhs in 2012. The customers were using the

service with more than 1.20 lakhs daily transactions, around 46% of which are

financial transactions amounting to Rs. 2.45 crores. SBI has launched mobile

technology based prepaid payment services under the brand name of State Bank

Mobi Cash.

8.2.3 Internet Banking: Internet banking service is available through

www.onlinesbi.co.in for both retail and corporate customers of the bank. The

number of customers in March 2011 was 62.57

8.2.3 Lakhs in March 2012. The number of transactions during 2010-2011 was

1437.46 lakhs and in 2011-12 it increased to 2610.32 lakhs.

8.2.4 Foreign Offices: The SBI is operating 173 branches in 34 countries,

including 2 OBUs in India to run their operations on a common banking

applications software, with their databases connected to a central data centre

backed up by a synchronized disaster recovery site. All foreign offices use

internet banking channel and 130 ATMs at various locations abroad cater to the

bank’s overseas customers with most of the ATMs connected to the centralized

ATM switch in India.


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8.2.5 Customer Complaints: The number of complaints received from the

customers during the year 2010-11 was 30,904 and they increased to 462,381

during 2011-12.

8.3. Employees: The SBI had a total permanent staff strength of 2,15,481 in the

March, 2012. Of this, 80,404 (37.32%) were officers, 95,715(44.42%) were

clerical staff and the remaining 39,362 (18.26%) were sub-staff. It has been

decided to recruit 9500 new clerical staff during the year 2012-13 to meet the

growing business needs of the bank. The SBI has transferred Rs. 49,518 crores

to the SBI employee’s pension fund trust from the special provision account,

during the year 2011-12. An amount of Rs. 4531.83 crores is recognized as an

expense towards the provident fund scheme of the bank. The bank has

implemented a defined contribution pension scheme (DCPS). The contributions

of the bank of Rs. 452.47 crores have been retained as a deposit with the bank

and earn interest at the same rate as that of the current account of provident

fund. An amount of Rs. 4531.33 crores (previous year 4775.74 crores) is

provided towards long term employee benefits.

8.4. Society: The executive committee of the central board has approved a

comprehensive policy for corporate social responsibility in August 2011.

During the year 2011-12 the SBI has spent Rs. 71.18 crores for various social

service activities like supporting education (Rs. 35.33 crores), Healthcare (Rs.

15.03 crores) and donations (Rs. 5.50 crores).


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9. DISCLOSURE AND TRANSPARENCY

Disclosure and transparency are the important pillars of a corporate

governance framework enabling adequate information flow to various

stakeholders and leading to informed decisions. The SBI was implementing all

the provisions of corporate governance and disclosure in the important and

confidential information. Table 1 shows confidential information of SBI as a

part of transparent disclosure of information.

9.1 Primary Business Segment Information of SBI

In the primary segment the treasury segment includes the entire

investment portfolio and trading in foreign exchange contracts and derivative

contracts; the corporate /whole sale banking segment comprises the lending

activities of corporate accounts group, mid-corporate account group and

stressed assets management group and the retail banking segment comprises of

branches in national banking group, which primarily includes personal banking

activities including lending activities to corporate customers. This segment also

includes agency business and ATMs.


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Table: 1 SBI Primary / Geographic Business Segments during 2011-12 (Rs. In

crores)

Business

Segment

1.Primary Business Segment 2.Geographic Segments 1 or 2

Segments

Total Treasury Corporate

/Whole

sale

Banking

Retail

Banking

Domestic Foreign

Revenue 23,874

(21,665)

42,773

(32,935)

54,091

(42,062)

1,14,080

(91,086)

6,659

(5,576)

1,20,739

(96,662)

Segment

Assets

3,35,016

(3,10,524)

3,94,421

(3,81,320)

5,95,182

(5,22,699)

11,55,176

(10,82,387)

1,80,342

(1,41,348)

13,24,621

(12,14,544)

Segment

Liabilities

1,96,222

(1,62,149)

3,81,202

(3,67,495)

6,28,479

(5,85,015)

10,71,225

(10,17,401)

1,80,342

(1,41,348)

12,05,903

(11,14,659)

Figures in brackets are for previous year.

9.2 Secondary Geographic Segments information of SBI

In this segment domestic operations are branches/ offices having

operations in India. Foreign operations are branches/offices having operations

outside India and offshore banking units having operations in India.

The table-1 explains the revenue, assets and liabilities based on primary

business segment with explaining treasury, corporate/wholesale banking and

retail banking. The geographic segment explains domestic and foreign areas

performance during 2010-11 and 2011-12.

9.3 Earnings per share of SBI

The basic earnings per share are computed by dividing the net profit after tax

by the weighted average number of equity shares outstanding for the year. The

net profit in 2010-11 was Rs. 8264.52 crores and it increased to Rs. 11,707.29


Page | 39

crores in 2011-12. Basic earnings per share in 2010-11 are Rs. 130.16 and it

increases to Rs. 184.31 in 2011-12.

9.4 Details of Different Provisions and Contingencies

The provisions and contingencies of SBI during 2011- 12 are explained in

table 2. The total provisions are Rs. 17,071.05 crores in 2010-11 and they

increased to Rs. 19,866.25 crores during 2011-12.

Table: 2 Provisions and Contingencies (Rs. in crores)

Provisions 2011-2012 2010-2011

Current Tax 6,335.37 5,709.54

Deferred Tax 455.93 976.82

Depreciation on

Investments

683.28 646.75

Non-Performing Assets 11,494.10 8,415.44

Restructured Assets 51.76 376.65

Standard Assets 978.81 976.60

Total

19,866.25 17,071.05

9.5 Details of Concentration of Advances, Exposures & NPAs

Information of SBI: Table 3 demonstrates the concentration of deposits,

advances, exposures and NPAs information during 2010-11 and 2011-12.

The table explains the operational weaknesses in the SBI regarding issue

of advances to twenty largest borrowers, concentration of exposure with

twenty largest borrowers and concentration of NPAs with four NPA

accounts.


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Table: 3 Concentration of Advances, Exposures & NPAs (Rs. in crores)

Particulars 2011-2012 2010-2011

Concentration of

Advances (Twenty

Largest Borrowers)

83,199.80 65,236.21

Concentration of

Exposures (Twenty

Largest Borrowers )

2,13,774.62 2,07,277.40

Concentration of NPAs

(Four NPA Accounts)

2,931.51 730.27

10. FINDINGS AND CONCLUSION

The study found that, the SBI is implementing all the provisions of corporate

governance according to the RBI/GOI directions. It is found that State Bank of

India, the country’s largest commercial bank, performed well in every aspect in

terms of profits, assets, deposits, branches, employees and services to

customers. The study found that the SBI conducted different board meetings

regularly to provide effective leadership, functional matters and monitors bank’s

performance.

It is found that the SBI established clear documentation and transparent

management processes for policy development, implementation, decision-

making, monitoring, control and reporting. Even though the SBI is showing

good performance and implementing provisions of corporate governance, some

lapses have to be rectified for increasing the performance. The SBI is operating

nearly 10 crores of customer accounts. Among them the net banking operating

customers are 89.63 lakhs, mobile banking operating customers 36.45 lakhs,

customers using ATMs are 910 lakhs. Though the customers operating e-


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banking are increasing every year, they are using e-banking for normal or

minimum services. It is suggested that consumer service committee must take

initiative steps to increase online banking services through customer awareness

programs and internet banking training programs. It decreases customer’s

pressure on branches and it is useful to reduce customers waiting time in all

branches. The study found that customers complains are increased during the

year 2011-12 (4, 62,381) when compared to the previous year 2010-2011

(30,904). Consumer service committee must take initiative steps to satisfactorily

address customers‟ complaints.

The study found that, concentration of advances to twenty largest borrowers

increased from Rs. 65,236 crores in 2010-2011 to Rs. 83,199 crores in 2011-

2012 indicating credit risk. It is suggested that the credit risk management

should take necessary steps to minimize risks.

The study found that concentration of exposures to twenty largest borrowers

has increased from Rs. 2, 07,277.40crores in 2010-11 to Rs. 2, 13,774.62 crores

in 2011-12 indicating credit risk. It is suggested that the central board should

take immediate action to reduce the concentration of exposures. It is found that

the concentration of NPAs total exposure to top four NPA accounts was Rs.

730.27 crores in 2010-11 and it is increased to Rs. 2,931.51 crores in 2011-21

indicating credit risk. It is suggested that the credit risk management should take

necessary steps to avoid this type of concentration of NPAs. The SBI is

conducting different types of social services activities in different sectors like

education, healthcare and other areas as a part of social responsibility.

The amount spent for this purpose was Rs. 71.18 crores only. It is suggested

that the amount must be increased for social service activities to draw public

attention. Finally, this study concluded that, the corporate governance practice

in the State Bank of India should improve for best investment policies,


Page | 42

appropriate internal control systems, better credit risk management, better

customer service and adequate automation in order to achieve excellence,

transparency and maximization of stakeholder’s value and wealth.


Page | 43

Recommendations

The important features of the financial sector which have a bearing

on the corporate governance structure include:

1. Dominance of the public sector ownership in the financial sector whether

by bank or the development financial institutions.

2. Shift away from external micro-regulation by the RBI to the internal

regulation.

With the advent of economic liberalization, the ownership pattern in

many public sector financial intermediaries is undergoing a change. The

governments are gradually reducing its stake in these institutions. It has made

many of this institution to approach the market for funding support. Before

mobilizing the public investments, they must convince prospective investors

that they are worth investing.

Many areas which require corporate governance practices in the banking

sector can be found in narasimham committee reports (committee on financial

system and committee on banking sector reform). Following suggestions

therefore may be kept in view for reforming the corporate governance system in

the Indian banking sector:

1. The board of directors, two third should be non-executive directors

and majority of them should be independent of the institutions as well

as government.

2. Of the directors, two third should be non-executive directors and

majority of them should be independent of the institutions as well as

government.

3. Non-executive directors should be appointed for an initial term of

three years and reappointed for a maximum of three additional years.


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4. The role of chairman and chief executive should be separated and the

chairman should ideally be a non-executive director. The appointment

of chief-executive and other whole-time directors should be made by

the board with the help of a nomination committee comprising of

majority of non-executive directors. The nomination committee could

have a nominee of the government or any institutional shareholder

having a stake of more than 26 per cent.

5. The credit/investment committee of board should have a fair number

of independent directors.

6. Audit committee comprising of independent non-executive directors

should be made compulsory.

7. The compensation committee of the board consisting of non-executive

directors And headed by a chairman should be the final authority to

decide the compensation payable to the staff.

8. The financial institution should be brought under the regulatory and

supervisory ambit of the reserve bank.

9. The management should be accountable only to general body of

shareholders.

10. The regulatory practices should be aligned with international practices

after making suitable modifications.


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CONCLUSION

In the present corporate world, corporate governance has takes significant

role due to globalization and liberalization. The issue of corporate governance

in banking sector is more complex significance because of certain factors. It is

opined that the success of corporate governance in Indian banking sector depend

upon well-constructed financial sector reform in line with corporate

reconstructing. A piece-meal approach to such a vital sector of the economy

would be of serious consequences. What is urgently required is to observe and

well document of corporate governance rules and regulations. It helps the

banking sector by an effective means of investors protection, fund raising

ability, maximize shareholders value and finally, integrating Indian banking

system with the world economy.

Corporate governance initiatives for banks become imperative for the

following issues:

Banking sector has strong linkage with real sector of the economy and

they are a major source of funding and payment to all types of

economic activities.

Banking sector has mixed ownership in the form of nationalized

banks, private sector banks, foreign banks and other financial

institutions. The recent entry in capital markets and followed changes

in the ownership of banks necessitate changes in the reporting and

governance standards.

RBI would continue the central monitory regulator in the economy

through more independence and would be given in the Prime Lending

Rate (PLR), operational areas and diversification opportunities

available to the individual banks. This helps to enhance the

profitability of the banks.


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In times of distress, banks are generally given access to the ‘safety

net’ arrangements by the RBI or the government of India. This safety

net arrangement is expected to protect the payment system and the

interest of the depositors. The systemic dimensions of these measures

are also vital to the financial health of the economy.

Banks are highly leveraged entities and their success/failures would

have impact on the monitory sector of the economy.

The emerging corporate governance guidelines for banks would play

vital role in fulfilling broader expectation of the society.

CORPORATE GOVERNANCE and banks

Education

corporate governance

corporate governance

corporate governance

corporate governance

corporate governance

good governance

economic governance

political governance