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 1
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Chapter 1
INTRODUCTION
The Corporate Governance of Banks
The dominant model of corpora te governance in law
and economics i s tha t the corpora t ion i s a “complex se t of
expl ic i t and impl ic i t cont rac ts .” In o ther words , one
should v iew the corpora t ion as nothing more (or less) than
a se t of cont rac tua l a r rangements among the var ious
c la imants to the product and earnings genera ted by the
bus iness .
Every bus iness organiza t ion , inc luding the corpora t ion ,
represent nothing more than a par t icular ‘s tandard form’
cont rac t . The very jus t i f ica t ion for having d i f ferent type
of bus iness organiza t ions i s to permi t inves tors ,
ent repreneurs , and o ther par t ic ipants in the corpora te
enterpr ise to se lec t the organiza t ion des ign they prefer
f rom a menu of s tandard-form cont rac ts . The v i r tue of the
s tandard-form arrangement charac ter i s t ic of modem
corpora te enterpr ise to take advantage of an ar rangement
tha t su i t s the needs of inves tors and ent repreneurs in a
wide var ie ty of s i tua t ions . On a theore t ica l level , the
problems of corpora te governance resul t f rom the
exis tence of incomple te cont rac ts . The ru les of corpora te
governance are a imed a t resolving the gaps le f t in these
cont rac ts in ways consis tent wi th maximizing the va lue of
the f i rm. In the case of shareholders cont ingent cont rac ts
1
in the Uni ted Sta tes , these background ru les are ca l led
f iduciary dut ies . The economic jus t i f ica t ion for having
f iduciary dut ies i s s t ra ight forward: Fiduciary dut ies are
the mechanism invented by the legal sys tem for f i l l ing in
the unspeci f ied te rms of shareholders cont ingent
[cont rac ts ] . The presence of f iduciary dut ies a t tempts to
address these cont ingencies . In th is gap-f i l l ing ro le ,
f iduciary dut ies essent ia l ly ca l l on d i rec tors to work hard
and to promote the in teres ts of shareholders above the i r
own.
The duty of care requi res tha t d i rec tors exerc ise
reasonable care , prudence , and d i l igence in the
management of the corpora t ion . Direc tor l iabi l i ty for a
breach of the duty of care may ar i se in two discre te
contexts . F i rs t , l iab i l i ty may f low f rom “ i l l advised or
negl igent” dec is ion –making. Second, l iabi l i ty may be the
resul t of fa i lure of the board to moni tor in “c i rcumstances
in which due a t tent ion would , a rguably , have prevented
the loss .” ‘Signi f icant ly , in both c lasses of cases ,
d i rec tors a re ent i t led to re ly on informat ion, repor ts ,
s ta tement , and opinions prepared by the company’s
of f icers and di rec tors as wel l as outs ide consul tants .
Separat ion of Ownership and Control
The problem of corpora te governance i s rooted in the
Ber le-Means (1932) paradigm of the separa t ion of
shareholders ‘ownership and management’s cont ro l in the
modern corpora t ion . Agency problems occur when the
pr inc ipa l (shareholders) lacks the necessary power or
2
informat ion to moni tor and cont ro l the agent (managers)
and when the compensat ion of the pr inc ipa l and the agent
i s not a l igned. Severa l fac tors work to reduce these
pr inc ipa l -agency cos ts , the “market for managers”
penal izes management teams tha t t ry to advance the i r own
in teres t a t shareholders’ expense .
On poss ib le so lu t ion to the agency cos t problem is to g ive
shareholders d i rec t cont ro l over management . This i s the
case when management and shareholders are the same
par ty and cont ro l r ight automat ica l ly res t in the hands of
shareholders .
Al though these are potent ia l ly powerful concerns about
the ef fec t iveness of shareholder cont ro l , recent research
sugges ts tha t the more fundamenta l t rade-offs may guide
the des i red involvement of shareholders in corpora te
cont ro l . Burkhar t Gromb, and Panunzi (1997) , for example
show tha t d i rec t shareholder cont ro l may discourage new
in i t ia t ives on the par t of managers .
These observat ions are consis tent wi th rea l -wor ld
corpora te governance ar rangements , which a lmost wi thout
except ion l imi t d i rec t shareholder involvement . In some
cases –par t icular ly in the Uni ted Sta te- th is i t fac i l i ta te by
re la t ive ly d ispersed ownership .
Banks are organized in a var ie ty of ways , f rom s tand-
a lone corpora te ent i t ies and s ingle bank holding
companies to mul t ip le bank holding companies and the
pos t -Gramm- Leach –Bl i ley Act (GLBA) divers i f ied
holding company.
3
This d ivers i f ied s t ruc ture permi ts such holding companies
to reduce or e l iminate the f i rm- speci f ic r i sks associa ted
wi th the banks they own. The GLBA s igni f icant ly
enhanced th is d ivers i f ica t ion abi l i ty by permi t t ing bank
holding companies and cer ta in o ther res t r ic ted f i rms to
become a new ent i ty : a f inancia l holding company (FHC)
This d ispers ion of ac t iv i ty throughout the holding
company s t ruc ture a lso g ives incent ives to bank holding
companies to put more r i sky behavior in the i r federa l ly
insured banks .
Special Problems of Banks
The discuss ion so far has focused on a genera l overview
of corpora te governance . We now know turn to speci f ic
problems of banks and a t tempt to address why the scope of
the dut ies and obl iga t ions of corpora te of f icers and
di rec tors should be expanded in the case of banks . Our
argument i s tha t the specia l corpora te governance
problems of banks weaken the case for making
shareholders the exclus ive benef ic iar ies of f iduciary
dut ies . Our focus here i s on es tabl i sh ing why banks are
not l ike o ther f i rms and thus should be t rea ted d i f ferent ly .
The Liquidi ty Product ion Role of Banks
Many di f ferent types of f i rms extend credi t . S imi lar ly , a
var ie ty of non-bank f i rms most notably money market
mutual funds and non-bank credi t card companies , of fer
the equivalent of a check t ransac t ion account . What
d is t inguished banks f rom other f i rms i s the i r capi ta l
s t ruc ture , which i s unique in to ways . F i rs t , banks tend to
4
have very l i t t le equi ty re la t ive to o ther f i rms. Second,
banks , l iabi l i t ies a re la rge ly in the f rom of deposi t s ,
which are avai lable to the i r c redi tors /deposi tors on
demand, whi le the i r asse ts of ten take the f rom of loans
tha t have longer matur i t ies (a l though increas ingly ref ined
secondary market have mi t iga ted to same extent mismatch
in the te rm s t ruc ture of banks’ asse ts and l iabi l i t ies) .
Thus , the pr inc ipa l a t t r ibute tha t makes banks as f inancia l
in termediar ies ‘specia l ’ i s the i r l iquidi ty product ion
funct ion . By holding i l l iquid asse ts and i ssuing l iquid
l iabi l i t ies , bank crea tes l iquidi ty for the economy.
The l iquidi ty product ion funct ion may cause a col lec t ive-
ac t ion problem among deposi tors because banks keep only
a f rac t ion of deposi t s on reserve a t any one t ime.
Deposi tors because banks keep only a f rac t ion of deposi t s
on reserve a t any one t ime. Deposi tors cannot obta in
repayment of the i r deposi t s s imul taneously because the
bank wi l l not have suff ic ient funds on hand to sa t i s fy a l l
deposi tors a t once .
The Deposi t Insurance Fund
In the wake of the mass fa i lure of deposi tory ins t i tu t ions ,
Congress passed the Banking Act of 1933 es tabl i sh ing the
Federa l Deposi t Insurance Corpora t ion (FDIC) and giv ing
the federa l government the power to insure deposi t s in
qual i f ied banks . The crea t ion of federa l deposi t insurance
has been t remendously ef fec t ive in prevent ing bank runs
and keeping the fa i lure of individual banks f rom affec t ing
the la rger economy. Deposi t insurance “has succeeded in
5
achieving what had been a major objec t ive of banking
reform for a t leas t a century , namely the prevent ion of
banking panics .”
Despi te the pos i t ive ef fec t of FDIC insurance on
prevent ing bank runs , the implementa t ion of deposi t
insurance poses a regula tory cos t of i t s own-i t g ives the
shareholder and manager of insured banks incent ives to
engage in excess ive r i sk- taking.
The problem of mora l hazard i s exacerbated in s i tua t ions
where a bank i s a t of near insolvency. In such a s i tua t ion ,
the shareholders have a s t rong incent ive to increase r i sk
because they can a l loca te the i r losses to th i rd-par t ies
whi le s t i l l rece iv ing any gains tha t might resul t f rom the
r i sky behavior .
Asset Structure and Loyalty Problems
The presence of federa l insurance fund a lso increased the
r i sk of f raud and se l f -deal ing in the banking indust ry by
reducing incent ives for moni tor ing . In the 1980, i t was
es t imated tha t f raud and se l f -deal ing t ransac t ion were
“apparent” in as many as one- th i rd of today’s bank
fa i lures . 28 A s imi lar s ta t i s t ic shows tha t be tween 12990
and 1991, ins ider lending cont r ibuted to 175 of 286bank
fa i lures ,29 Such behavior , of course , i s a poss ib i l i ty in
any large f i rm, s ince i t i s ineff ic ient for owners to
moni tor a l l employees a t a l l t imes . These sor ts of
problems are par t icular ly acute in f inancia l ins t i tu t ions ,
however , because of the la rge por t ion of the i r asse t he ld
in h ighly l iquid form.
6
The same regula tory s t ruc ture tha t c rea tes a problems i f
excess ive r i sk- taking by banks a lso leads to a reduct ion in
the normal levels of moni tor ing wi th in the f i rm, resul t ing
in a h igher inc idence of bank fa i lures due to f raud.
Shareholders have an incent ive to moni tor to prevent f raud
and se l f -deal ing in banks , but such moni tor ing i s
notor ious ly ineffec t ive in many cases because individual
shareholders rare ly have suff ic ient incent ives to engage in
moni tor ing because of col lec t ion-ac t ion problems.
One might a rgue tha t FDIC insurance s imply replaces one
se t of c redi tors : deposi tors , wi th another se t of c redi tors :
s ta te and federa l regula tors . These o ther c redi tors might
more f inancia l ly sophis t ica te than rank-and – f i le
deposi tors and thus appear in a be t te r pos i t ion to conduct
the moni tor ing necessary to prevent bank f raud.
Regula tors have f ive main enforcement tools : cease and
des is t powers , removal powers , c iv i l money penal ty
powers , wi thdrawal or suspension of federa l deposi t
insurance power and prompt correc t ive ac t ions powers .
Cease and des is t powers genera l ly address both unsafe and
unsound banking as wel l as v io la t ions of the law or
regula t ions governing deposi tory ins t i tu t ions .
Federa l banking agencies a lso have to impose c iv i l
monetary penal t ies agains t a banking ins t i tu t ion and i t s
a f f i l ia tes . Prompt correc t ive-ac t ion powers are a lso
t r iggered by capi ta l requi rements , and these a l low
regula tors to reach every s igni f icant opera t ional aspect of
a bank. Fina l ly , the FDIC has the author i ty to revoke a
7
bank’s deposi tor insurance i f necessary , Never the less ,
replac ing pr iva te- sec tor c redi tors wi th publ ic-sec tor
regula tors as the f i rs t l ine of defense agains t bank f raud
and se l f -deal ing presents two problems. Pr iva te-sec tor
c redi tors have s t ronger incent ives than publ ic-sec tor
regula tors to moni tor c lose ly for f raud and se l f -deal ing .
8
Chapter 2
IS CORPORATE GOVERNANCE DIFFERENT FOR
BANK HOLDING COMPANIES ?
The governance s t ruc ture in banks should a im a t
enhancing Accountabi l i ty and ef f ic iency. Corpora te
governance in Banks i s d i f ferent f rom tha t of
manufac tur ing companies on account of number of fac tors
Governance reforms requi red for banks should be indust ry
Composi t ion and compared to the board in manufac tur ing
companies . Fur ther research on corpora te Governance in
banks would de termine the opt imal board Size tha t
maximizes shareholder va lue subjec t to the Const ra in ts
imposed on these f i rms.
Shle i fer and Vishny def ine corpora te governance as
dea l ing “wi th the ways tha t suppl iers of f inance to
corpora t ions assure themselves of ge t t ing a re turn on the i r
inves tment” i f managers opera te independent ly , they may
make f inancing, inves tment , and payout dec is ions tha t a re
de t r imenta l to shareholders . The governance of banking
f i rms may be d i f ferent f rom tha t unregula ted , non-
f inancia l f i rm for severa l reasons . For one , the numbers of
par t ies wi th a s take in an ins t i tu t ion’s ac t iv i ty compl ica tes
the governance of f inancia l ins t i tu t ions . As a resul t , the
board of d i rec tors of a banking f i rm is p laced in a cruc ia l
ro le in i t s governance s t ruc ture . Al though the boards of
BHCs are ass igned the same legal responsib i l i t ies as o ther
9
boards , regula tors have p laced addi t ional expecta t ions on
bank, as opposed to BHC boards tha t de l inea te the i r
responsib i l i t ies even fur ther .
These and other d i f ferences in the opera t ion of f inancia l
and non-f inancia l ins t i tu t ions have led many to v iew
regula tory overs ight of the indust ry as a subs t i tu te for
corpora te governance as less c r i t ica l to the conduct and
opera t ion of banking f i rms. Other argue tha t e f fec t ive
supervis ion could lead to board overs ight becoming a
more cr i t ica l e lement of banking f i rm governance tha t i s ,
these could be complementary forces .
Thus , a l though in non-f inancia l f i rm s tock opt ions may be
appropr ia te ins t ruments to provide incent ive for managers
to crea te va lue , as wel l as to protec t the credi tors of
d is t ressed companies ; the opt ions may conf l ic t wi th pol icy
objec t ives tha t seek to protec t the non-shareholding,
s takeholders , such as deposi tors and taxpayers in f inancia l
f i rms.
Resolut ion of a f inancia l ly d is t ressed condi t ion or
out r ight insolvency in the banking indust ry can a lso have
an impor tant e f fec t on top manager’s incent ive s t ruc tures .
In an unregula ted envi ronment , f inancia l d is t ress
genera l ly leads to reorganiza t ion and in most cases ; the
incumbent top manager i s g iven the oppor tuni ty to turn
the corpora t ion around.
Board Size and Composi t ion
An average of e ighteen d i rec tors makes up each BHC
board , a l though there i s a wide d is t r ibut ion of board s ize
10
in the sample (a minimum of e ight d i rec tors and a
maximum of th i r ty-s ix) . Over the sample per iod, i t i s
apparent tha t banking f i rm boards are becoming smal ler .
An average board in1999had 17 d i rec tors (median: 18) ,
down f rom 20.3 in 1986 (median: 20) . The t rend i s
cons is tent wi th the f inding of Adams and Mehran (2002) ,
who examine BHC board s ize over the 1959-99 per iods .
As Table 3 indica tes , an average S&P manufactur ing f i rm
had s ix fewer d i rec tors than an average BHC did over the
sample per iod. Booth , Cornet t , and Tehranian (2002) a lso
provide evidence tha t banks have la rger boards , us ing a
sample of the 100 larges t BHCs and the 10-0 la rges t
manufac tur ing f i rms in 1999.
Since such regula tory res t r ic t ion genera l ly apply to board
s t ruc ture a t the bank level and not the holding level ,
which i s the focus of th is s tudy, the regula tory
envi ronment a lone does not expla in BHC board s ize and
composi t ion However , regula t ion may have an indi rec t on
the s t ruc ture of BHD board to the extent tha t i t i s
inf luenced by the s t ruc ture of the board of the BHC’S lead
bank and other subs id iary banks .
CEO Compensat ion
The increased use of s tock opt ion in execut ive
compensat ion packages in banking fo l lows the pa t te rn of
o ther indust r ies even though the growth and level of s tock
opt ion use are s igni f icant ly lower than in manufac tur ing
f i rms.
11
One potent ia l explanat ion for the lower re l iance on s tock
opt ion in the banking indust ry found in smi th and wat ts
(1992) , who show tha t -growth indust r ies re ly less on
s tock-based compensat ion (a lso see Mehram [1992]) .
Smith and Wat ts sugges t tha t board can observe , moni tor ,
and evaluate the ac t ion of CEOs of f i rms and indust r ies
wi th low-growth oppor tuni t ies much eas ier than they can
in f i rms or indust r ies wi th h igh-growth oppor tuni t ies .
Thus , board in such indust r ies should re ly more on f ixed
ra ther than on s tock-based compensat ion .
Final ly , g iven the low s tock-re turn vola t i l i ty in the
banking indust ry , a l l e l se equal , the va lue of s tock opt ion
in banks wi l l be lower . To compensate the CEO for a
g iven dol lar va lue of granted opt ions , the bank has to g ive
a la rger number of opt ion re la t ive to those g iven by an
average manufactur ing f i rm.
CEO Ownership
CEO ownership across BHCs and manufactur ing f i rms may
di f fer for severa l reasons . One can argue tha t the smal ler
f low of opt ions to bank holding company CEOs leads to
smal ler ownership . There may a lso be are a mechanica l
i ssue inf luencing the percentage of ownership . S ince
BHCs are s igni f icant ly more leveraged and have more
asse ts than manufactur ing f i rm, ownership levels across
the two types of f i rms may not be comparable .
An impor tant ins ight of Modigl iani and in a word wi th
corpora te taxes i s tha t the case f low c la ims of an
ownership s take in an a l l -equi ty f i rm di f fer f rom those
12
associa ted wi th the percentage of equi ty ownership of an
ident ica l f i rm wi th a pos i t ive debt level .
Block Ownership
To compi le our s ta t i s t ics on b lock ownership , we re ly on
the CDA/Spect rum Ins t i tu t ional Holding Database of
Thomson Financia l . Ins t i tu t ional shareholding i s our
proxy for moni tor ing by b lockholders . However , the
corpora te governance l i te ra ture a lso emphasizes the
impor tance of the ident i ty of the ident i ty of b lockholders
and individuals , as opposed to jus t the s ize of ins t i tu t ion
holdings .
Bank-aff i l ia ted ins t i tu t ions are unl ike ly to moni tor the
BHC over the course of these ac t iv i t ies ; therefore , to
const ruc t our summary s ta t i s t ics on ins t i tu t ion holders , we
dele ted a l l bank-aff i l ia ted ins t i tu t ion f rom the l i s t of
ins t i tu t ion holders of our BHCs in a l l year . We a lso
examined the ident i ty of ins t i tu t ional holding shares of
manufac tur ing f i rms; however , found very few cases of
b lockholders tha t were af f i l ia ted wi th manufactur ing
f i rms.
13
Chapter 3
BASEL II AND ROLE OF PILLAR 2: ENSURING
HIGH STANDARDS OF CORPORATRE GOVERNANCE
A. The Basel Committee
The Basel Commit tee on Banking Supervis ion i s a
commit tee , of banking supervisory author i t ies , es tabl i shed
by the Centra l Bank Governors of the G10 developed
countr ies in 1975. The commit tee in 1988 in t roduced the
concept of capi ta l Adequacy Framework, Known as Base l
Capi ta l Accord , wi th a minimum capi ta l adequacy of 8
percent . This accord has been gradual ly adopted not only
in member countr ies but a lso in more one hundred o ther
countr ies , inc luding India .
B. Basel II : The New Basel Capital Accord
The commit tee i ssued a consul ta t ive document t i t led “The
New Basel Capi ta l Accord” in Apr i l2003, to replace the
1988 Accord , Which re-enforce the need for capi ta l
adequacy requi rements under the current condi t ions . This
accord i s commonly known as Base l I I and i s current ly
under f ina l iza t ion . Base l I I wi l l be appl ied on a
consol ida tes bas is to in ternat ional ly ac t ive banks .
However , supervisors are requi red to tes t tha t individual
banks are adequate ly capi ta l ized on a s tand – a lone bas is
a lso . Base l I I i s based on three Pi l la rs .
P i l la r 1 – Minimum Capi ta l Requirements .
Pi l la r 2 – Supervisory Review Process .
14
Pi l la r 3 – Market Disc ip l ine .
Pi l la r 1 d iscusses the ca lcula t ion of the to ta l minimum
capi ta l requi rements for c redi t , market and opera t ional
r i sks and mainta ins the level of minimum capi ta l adequacy
a t 8 percent . P i l la r 2discussed the key pr inc ip les of
supervisory review, r i sk management guidance and
supervisory t ransparency and accountabi l i ty wi th respect
to banking r i sks . P i l la r 3 complements Pi l la r 1 and 2 by
encouraging market d isc ip l ine through enhanced
disc losures by banks to enable market par t ic ipant ’s asses
the capi ta l adequacy of banks .
D. Enhancing Corpora te Governance in Banks
The Basel commit tee had i ssued, in August 1999, a
guidance paper ent i t led “Enhancing Corpora te Governance
for Banking Organiza t ions” to supervisory author i t ies
Worldwide to ass is t them in promot ing the adopt ion of
sound corpora te governance prac t ices by banks in the i r
countr ies . The key fea tures of th is guidance are d iscussed
here .
Importance of Corporate Governance for Banks
Banks are a c r i t ica l component of any economy. They
provide f inancing for commercia l enterpr ises , bas ic
f inancia l services to a broad segment of the popula t ion
and access to payments sys tems. From a banking indust ry
perspect ive , corpora te governance involves the manner in
which the i r boards of d i rec tors and senior managements
govern the bus iness and af fa i rs of individual banks ,
a f fec t ing how banks .
15
Set the i r corpora te objec t ive ;
Run day- to-day opera t ions ;
Consider the in teres ts of var ious s takeholders ;
Align corpora te ac t ives wi th the expecta t ion tha t
bank wi l l opera te in a safe and sound manner and in
compl iance wi th appl icable law and regula t ions ; and
Protec t the in teres t of deposi tors .
II . Sound Corporate Governance Pract ices for Banks
The Prac t ices ment ioned below are cr i t ica l to any
corpora te governance process in banks:
Establ i sh ing s t ra tegic objec t ives and a se t of corpora te
va lues communica ted throughout the organiza t ion .
St rong r i sk management funct ions independent of bus iness
l ines , in ternal cont ro l sys tems, in ternal and external audi t
funct ions and other cheeks and balance .
Specia l moni tor ing of r i sk exposures where conf l ic ts
of in teres ts a re l ike ly to be par t icular ly grea t ,
inc luding bus iness re la t ionships wi th borrowers
af f i l ia ted wi th the banks .
Set t ing and enforc ing c lear l ines of responsib i l i ty
and accountabi l i ty .
Ensur ing tha t banks’ board members are qual i f ied for
the i r pos i t ions , have a c lear unders tanding of the i r
ro le in corpora te governance and are not subjec t to
under inf luence .
Ensur ing tha t there i s appropr ia te overs ight by senior
management .
16
Ensur ing tha t compensat ion sys tems are consis tent
wi th the banks , objec t ives and cont ro l envi ronment .
Conduct ing corpora te governance t ransparent ly .
Flow of appropr ia te informat ion in ternal ly and to the
publ ic .
III . The Role of Supervisory Authori t ies in Ensuring
Effect ive Corporate Governance in Banks
Supervisors should be aware of the impor tance of
corpora te governance and i t s impact on corpora te
performance . Supervisors should be a t tent ive to any
warning s igns of de ter iora t ion in the management of the
banks ac t iv i t ies . They should consider i ssuing guidance to
banks on sound corpora te governance and the proact ive
prac t ices tha t need to be in p lace .
F. Corporate Governance for the Internal Rat ings-
based (IRB) Approach to Credit Risk as per Pert 2
Pi l lar 1
I IRB Approach [ In ternal Rat ing –based]
Internal r i sk ra t ings are an impor tant tool in moni tor ing
credi t r i sk . In ternal r i sk ra t ings should be adequate to
suppor t the ident i f ica t ion and measurement of r i sk f rom
a l l c redi t r i sk and capi ta l adequacy Subjec t to cer ta in
minimum condi t ion and disc losure requi rements , banks
tha t qual i fy for the IRB approach may re ly on the i r own
in ternal es t imates of r i sk components inc lude measures of
the probabi l i ty of Defaul t (PD) Loss Give defaul t (LGD)
the Exposure a t Defaul t (EAD) and ef fec t ive matur i ty .
17
G. The second pi l lar “supervisory review process”: I ts
role in Ensuring High Standards of Corporate
Governance
Par t 3 of Base l l l dea ls wi th the i r impor tance of
supervisory review, i t s key pr inc ip les , speci f ic i ssues to
be addressed under the supervisory review process and
supervisory t ransparency and accountabi l i ty i t se l f in
ensur ing ef fec t ive corpora te governance .
Importance of Supervisory Review
The supervisory review process of Base l l l i s in tended not
only to ensure tha t banks have adequate capi ta l to suppor t
a l l the r i sk in the i r bus iness , but a lso to encourage banks
to develop and use be t te r r i sk .
This in terac t ion i s in tended to fos ter an ac t ive d ia logue
be tween banks and supervisors such tha t when
def ic iencies are ident i f ied , prompt and decis ive ac t ion can
be taken to reduce r i sk or res tore capi ta l .
II Four Key principles of supervisory Review
Principle 1
The f ive main fea tures of such a r igorous process are as
fo l lows:
1. Board & Senior Management overs ight
A sound r i sk management process i s foundat ion for an
ef fec t ive assessment of the adequacy of a bank’s
capi ta l pos i t ion . The analys is of bank’s current and
fu ture capi ta l requi rements in re la t ion to s t ra tegic
objec t ives i s a v i ta l e lement of the s t ra tegic p lanning
process .
18
The bank’s board should ensure tha t management
es tabl i shes a f ramework for assess ing the var ious r i sks , to
the bank’s capi ta l and moni tor ing compl iance wi th
in ternal pol ic ies . I t should suppor t s t rong in ternal
cont ro ls and wri t ten pol ic ies and ensure tha t a re
ef fec t ive ly communica ted throughout the bank.
2. Comprehensive Assessment of Risk
All mater ia l r i sks faced by banks should be
addressed in the capi ta l assessment process . Whi le
not a l l r i sk can measured prec ise ly , an adequate and
comple te model should be developed es t imate the
var ious r i sk , such as , c redi t r i sk , opera t ional r i sk ,
in teres t ra te r i sk , l iquidi ty r i sk and o ther r i sk l ike
reputa t ion and s t ra tegic r i sk .
3. Monitoring and Report ing
The bank should es tabl i sh an adequate sys tem for
moni tor ing and repor t ing r i sk exposures in order to :
Evaluate the level and t rends of mater ia l r i sks and
the i r a f fec t on capi ta l levels ;
Evaluate the reasonableness of key assumpt ions used
in the capi ta l assessment measurement sys tem;
Determine tha t the bank hold suff ic ient capi ta l
agains t the var ious r i sk in compl iance wi th
es tabl i shed capi ta l adequacy goals ; and
Assess the i r fu ture capi ta l requi rement based on the
r i sk prof i le and make necessary adjus tments to the
s t ra tegic p lan .
4. Internal Control Review
19
The banks should regular review the fo l lowing aspects of
the i r sys tem of in ternal cont ro l to ensure wel l -ordered
conduct of bus iness : appropr ia teness of the capi ta l
assessment process ; ident i f ica t ion of la rge exposures and
r i sk concent ra t ions ; accuracy and comple teness of da ta
inputs in to the assessment process ; va l id i ty of scenar ios
used in the assessment process ; and s t ress tes t ing and
analys is of assumpt ions and inputs .
Principle 2
Review of Adequacy of Risk Assessment
Supervisors should assess the degree to which in ternal
ta rge ts and processes incorpora te a l l mater ia l r i sks faced
by the banks . Supervisors should a lso review the adequacy
of r i sk measures used in assess ing in ternal capi ta l
adequacy and the extent to which these r i sk measures are
used opera t ional ly in se t t ing l imi ts . Supervisors should
consider the resul t s of sens i t iv i ty analyses and s t ress tes ts
conducted by the banks and how these resul t s re la te to
capi ta l p lans .
Assessment of Capital Adequacy
Supervisors should review the banks processes to
de termine tha t the ta rge t levels of capi ta l chosen are
comprehensive and re levant to the current opera t ion
envi ronment , a re proper ly moni tored by senior
management , the composi t ion of capi ta l i s appropr ia te for
the banks’ bus iness and the extent to which the banks have
provided for unexpected events in se t t ing the i r capi ta l
levels .
20
Assessment of the control Environment
Supervisors should consider the qual i ty of the banks’
management informat ion sys tems; the manner in which
bus iness r i sk and ac t iv i t ies a re aggregated and
management’s record in responding to emerging or
changing r i sks . They should a lso consider the external
fac tors l ike bus iness cycle ef fec ts and the macroeconomic
envi ronment in de termining the capi ta l levels .
Supervis ion Act ion
Having carr ied out the review process descr ibed above,
supervisors should take appropr ia te ac t ions , such as those
se t out under Pr inc ipa ls 3 and 4 be low, i f they are not
sa t i s f ied wi th The resul t of the bank’s own r i sk
assessment and capi ta l a l loca t ion .
Principle 3
Supervis ion should requi re banks to opera te wi th a buffer ,
over and above the Pi l la r1 capi ta l requi rement , for a
number of reasons .
A large number of banks prefer to be h ighly ra ted by
in ternat ional ly recognized ra t ing agencies .
In the normal course of bus iness the type and volume of
ac t iv i t ies keep on changing as wel l as the d i f ferent r i sk
requi rements caus ing f luc tua t ions in the overa l l capi ta l
ra t io .
I t may be cos t ly for banks to ra ise addi t ional capi ta l
dur ing emergency need.
I f i t so happens , to fa l l be low minimum regula tory capi ta l
requi rements i s a mat ter of ser ious concern for banks .
21
Among other methods , the supervisors may se t t r igger and
targe t capi ta l ra t ios or def ine ca tegor ies above minimum
ra t ios for ident i fy ing the capi ta l iza t ion level of the banks .
III Speci f ic Issues to be Addressed under the
Supervisory
Review Process
1 . Interest Rate Risk
I f supervisors de termine tha t banks are not holding
capi ta l commensura te wi th the level of in teres t ra te r i sk ,
they must requi re the banks to reduce the i r r i sk , to hold a
speci f ic addi t ional amount of capi ta l or a combinat ion of
the two.
2. Operat ional Risk
The Supervisors should examine whether the capi ta l
requi rement genera ted by the Pi l la r 1 ca lcula t ion g ives a
cons is tent p ic ture of the individual bank’s opera t ional r i sk
exposure , for example , in compar ison wi th o ther banks of
s imi lar s ize and opera t ions .
3. Credit Risk
Stress Tests under IRB : A bank should ensure tha t i t has
suff ic ient capi ta l to meet the Pi l la r 1 requi rements and the
resul t s , in case of a def ic iency, of the credi t r i sk s t ress
tes t performed as par t of the Pi l la r 1IRB minimum
requi rements . Supervisors may review how the s t ress tes t
has been carr ied out and in case of a shor t fa l l , reac t
appropr ia te ly .
22
Residual r isks : Supervisors should requi re banks to have
in p lace appropr ia te and ef fec t ive wri t ten CRM pol ic ies
and procedures in order to cont ro l the res idual r i sks , such
as . Inabi l i ty to se ize or rea l ize in t imely manner col la tera l
p ledged, refusa l or de lay by a guarantor to pay and
ineffec t iveness of untes ted documenta t ion .
Securi t izat ion: Fur ther to the Pi l la r 1 pr inc ip le tha t banks
should take account of the economic subs tance of
t ransac t ions in the i r capi ta l adequacy determinat ion ,
supervisors should moni tor whether banks have done so
adequate ly . As a resul t , regula tory capi ta l t rea tments for
speci f ic secur i t iza t ion exposures may exceed those
speci f ied in
Pi l la r 1 . The supervisors wi l l have to address the key
i ssues involving secur i t iza t ion t ransac t ions such as
s igni f icance of r i sk t ransfer , market innovat ions ,
provis ion of impl ic i t suppor t , f i r s t loss credi t
enhancements , ca l l provis ions and ear ly amort iza t ion .
Chapter 4
23
BANK PERFORMANCE AND CORPORATE
GOVERNANCE
Financial Condit ion of US Banks
Last year was except ional in many respects , wi th the
Uni ted Sta tes s l ipping in to a recess ion, the September
te r ror is t a t tacks , the s tock market dec l ines , and a l l of the
re la ted events . In response , the Federa l Reserve reduced
in teres t ra tes a t every meet ing of the Federa l Open Market
Commit tee in 2001 and an addi t ional three t imes be tween
meet ing , for a to ta l of e leven ra te cutes accumula t ing to
475 bas is points .
The d i rec t e f fec t of the pas t year’s s t ressful events was
pa inful enough. In addi t ion , abus ive account ing and
corpora te governance prac t ices made condi t ions worse , as
la rge corpora te bankruptc ies imposed subs tant ia l losses on
inves tors , lenders , and employees .
Throughout th is per iod the US banking sys tem remained
s t rong, repor t ing cont inuing record earnings and
prof i tabi l i ty , despi te a s l ip in asse t qual i ty . Dur ing the
f i rs t ha l f of th is year , US insured commercia l banks
earned more than $44.5 b i l l ion and an annual ized re turn
on asse ts of 1 .37 percent .
Net in teres t income was the pr imary dr iver of increased
revenue, despi te a notable dec l ine in commercia l loan
volume. Loans loss provis ions remained re la t ive ly h igh by
24
the s tandards of most of the pas t decade but d ipped
notably f rom the second hal f of 2001. Net charge –offs ,
which were concent ra ted among commercia l loans of la rge
banks and credi t card specia l ty lenders , a l so dropped.
As noted current weaknesses appear to be la rge ly wi th in
the commercia l loan por t fo l ios of la rge regional and
money center banks ra ther than those of smal ler
ins t i tu t ions . Even the problems of la rge banks could be
v iewed as mi ld , however , g iven the shocks fe l t by many in
the i r cus tomer base . I f smal ler banks , genera l ly , a re not
see ing the commercia l loan weakness tha t some large
ins t i tu t ions are fac ing, which areas may present them wi th
he ightened r i sks?
Most Reserve Banks are repor t ing genera l ly weak
commercia l rea l es ta te markets , as fa i l ing companies
vacate of f ice and re ta i l space and renters in to s ingle
fami ly homes commercia l rea l es ta te credi t s a re s t i l l
per forming re la t ive ly wel l for th is s tage of the cycle , and
my comments are not in tended to sugges t a mater ia l
concern .
The second areas of potent ia l r i sk re la tes to in teres t ra tes .
For the indust ry overa l l , the Federa l Reserve’s in teres t
ra te cuts las t year cer ta in ly appear to have he lped bank
earnings , but they present management wi th new
chal lenges , too . Lower ra tes undoubtedly eased payment
pressures on many borrowers , and prevented fur ther
de ter iora t ion in the qual i ty of bank loan por t fo l ios .
25
Indeed, many banks have responded to the low ra tes by
sharply reducing the i r inves tments in Treasur ies and
shi f t ing funds in to mortgage-backed secur i t ies in the
search for h igher y ie lds . That banking organiza t ions and
inves tors genera l ly , should recognize tha t domest ic
in teres t ra tes are h is tor ica l ly low and tha t the poss ib i l i ty
for r i s ing ra te envi ronments should not be over looked.
Even s table ra tes could present increased r i sks , i f saving
and money market deposi t accounts f low out of banks as
quickly as they came in when equi ty markets dec l ined. At
some point , even loyal cus tomers- those on f ixed income,
in par t icular -may bl ink and take s teps to improve the i r
own yie lds .
Managing Risks
The heal th of f inancia l ins t i tu t ions today i s a lso a resul t
of improvement in the r i sk management process tha t has
been ongoing a t banks for years , increas ingly; the ent i re
r i sk management process has become data a t lower cos t ,
but a lso improved techniques for measur ing and managing
r i sks . Bank regula tors a re working to develop a more
modern in ternat ional approach to bank capi ta l - ca l led
Basel I I . Al though those s tandards , in the f i s t ins tance ,
a re be ing des igned to address changing prac t ices a t la rge ,
in ternat ional ly ac t ive banks , we can expect the lessons
learned about r i sks management to have much border
ef fec ts . In quant i fy ing credi t r i sk , la rge banking
organiza t ions a re taking the lead , measur ing a borrower’s
probabi l i ty of defaul t , the bank’s loss g iven defaul t and
26
i t s l ike ly exposure to the borrower a t the t ime of defaul t ,
tak ing in to considera t ion fu ture draw downs.
The grea ter of c redi t scor ing in re ta i l t ransac t ions
provides a s t ronger f ramework to asses r i sk and ensure
tha t loan pr ic ing ref lec ts the credi t qual i ty . Such tools
should perform even bet te r as the ef fec ts of the most
recent economic s lowdown are incorpora ted in to bank
s ta t i s t ics .
The measurement and management of in teres t ra te r i sk has
a lso improved grea t ly in recent years , perhaps par t icular ly
a t communi ty banks . Asse t l iabi l i ty commit tees a t banks
throughout the country now rout ine ly consider the resul t s
of models developed e i ther in ternal ly or by vendors to
ident i fy the market sens i t iv i ty of loans , inves tments , and
deposi t s .
Recent abuses of corpora te account ing prac t ices and other
mat ters provide good lessons in r i sk management as
bankers t ry to increase earning by cross- se l l ing more
products , g iven the dominant ro le of c redi t r i sk a t banks ,
to chief c redi t of f icer should ensure tha t pressures to
increase fee income do not lead to unacceptable levels of
c redi t r i sks .
Corporate Governance
Sound corpora te governance i s an essent ia l of a s t rong
r i sk management process . As banker and bank and bank
di rec tors ,you have speci f ic responsib i l i t ies to manage the
r i sk a t your f inancia l ins t i tu t ions and ef fec t ive ly oversee
the sys tems of in ternal cont ro ls Not only are the ac t iv i t ies
27
of cent ra l to credi t in termedia t ion , but , in th is country ,
banks found the i r ac t iv i t ies in par t wi th federa l ly insured
deposi t s . Those deposi t s a re the lowest – cos t source of
found tha t banks have , speci f ica l ly because of the
government guarantee .
In teragency pol icy holds boards of d i rec tors
responsib le for ensur ing tha t the i r organiza t ions have
an e f fec t ive audi t process and in ternal cont ro ls tha t
a re adequate for the na ture and scope of the i r
bus inesses . In ternal audi t i s a key e lement of
management’s responsib i l i ty to va l ida te the s t rength of a
bank’s in ternal cont ro ls .
In ternal cont ro ls a re the responsib i l i ty of l ine
management . Line managers must de termine the level
of r i sk they need to accept to run bus inesses and
must assure themselves tha t the combinat ion of
earnings , capi ta l , and in ternal cont ro ls i s suff ic ient to
compensate for the r i sk exposures . The resul t s of
these independent reviews should be rout ine ly
repor ted to execut ive management and boards of
d i rec tors . The level of independence form execut ive
management tha t a board can demonst ra te has , of
course , become a fa r more v is ib le and more
impor tant fac tor in evalua t ing corpora te governance .
Other provis ions of the ac t se t for th potent ia l ly
broad ranging s tandards a f fec t ing the way publ ic
companies compensate the i r execut ives and d i rec tors
and d isc lose the i r opera t ing resul t s . To s t rengthen the
28
ro le of outs ide audi tors , the ac t a l so l imi ts the non-audi t
work such f i rms may perform for audi t cus tomers and
crea tes an overs ight board to regula te and oversee audi t
work. Indeed, beyond legal requi rements , boards of
d i rec tors and managers of a l l f i rms should
per iodica l ly tes t where they s tand on bus iness
prac t ices . Ul t imate ly , of course , market correc t the i r
excesses , and in th is context markets inc lude both the
publ ic and pr iva te sec tors . Obviously , dur ing the pas t
year we have seen reac t ions not only form inves tors
and c redi tors , but a l so f rom law- makers and
regula tors , to observed fa i lures wi th in corpora te
boardrooms. Al l of the ac t ion af fec ts market prac t ice .
That inc ludes mainta in ing sound e th ica l prac t ices in
protec t ing the reputa t ions of your banks . As we have
seen f rom recent events , the market ’s response can
be harsh .
Qual i ty of Accounting Pract ices
Uncer ta in ty regarding the qual i ty of corpora te
account ing s tandards s t r ikes a t the hear t of our
capi ta l i s t sys tem and threa tens the e f f ic iency of
markets . Inves tors and lenders must be conf ident
tha t unders tand the r i sk they accept and tha t the i r
counterpar t ies a re p laying fa i r .
Informed and objec t ive profess ionals can legi t imate ly
d isagree on the bes t account ing s tandard to apply to new
types of t ransac t ions .That i s par t of the chal lenge of
keeping account ing s tandards current . The rapid pace of
29
business innovat ions makes i t impract ica l to have ru les in
p lace to ant ic ipa te every bus iness t ransac t ion .
At the core of such account ing pr inc ip les should be
profess ional s tandards tha t every corpora te accountants
and every outs ide audi tor must fo l lows. In par t , audi tors
should be requi red to ask themselves whether a
par t icular account ing method adequate ly represents the
economics of t ransac t ion and whether i t provides readers
wi th suff ic ient informat ion to evaluate the r i sks .
Rules a lone , however , do not ensure good f inancia l
repor t ing . At Enron and other companies , weak corpora te
governance’s prac t ices apparent ly permi t ted sham
t ransact ions and mis leading f inancia l repor t ing . Outs ide
audi tors e r red in t ry ing too hard to p lease an impor tant
c l ient .
In another example , the banking regula tors have jo in t ly
i ssued for comment new guidance re la ted to credi t s cards .
This guidance not only deals wi th unacceptable prac t ices ,
but a lso c lar i f ies tha t revenue recogni t ion of fees b i l led to
cus tomers should the expected abi l i ty to col lec t those
fees .
Chapter 5
30
THE ROLE OF THE CENTRAL BANK IN
PROMOTING CORPORATE GOVERNANCE
The growing compet i t iveness and in terdependence
be tween Banks and f inancia l ins t i tu t ions in loca l and
fore ign markets have increased the impor tance of
corpora te governance and i t s appl ica t ion in the banking
sec tor . Corpora te governance in Bank can be achieved
through a se t of legal , account ing Financia l and economic
and in tegr i ty in banking sec tor i s Mainta ined, the need
for uni form s tandards of the concept of governance in
pr iva te and publ ic sec tor banks in emphasized.
The g lobal iza t ion process and the l ibera l iza t ion of money
markets have changed the ideas and vis ions of f inancia l
ins t i tu t ions a l l over the wor ld . Banks and f inancia l
ins t i tu t ions in loca l and fore ign markets have acqui red a
new spi r i t of compet i t iveness .
Governance in the banking sec tor i s achieved through a
se t of legal , account ing, F inancia l and economic ru les and
regula t ions . These ru les and regula t ions d i rec t the
Management , govern performance , and ass is t in car ry ing
out the responsib i l i t ies of the Sector .
Corpora te governance i s impor tant because i t prohibi t s
corrupt ion , ensures in tegr i ty and a lso ensures . Corpora te
governance i s impor tant as wel l to benef i t and learn f rom
the f inding of the audi tors and f inancia l cont ro l le rs and to
unders tand the i r overs ight ro le .
31
Role of central Bank
Over the las t years , the cent ra l bank of Egypt has adopted
a number of measures tha t a re consis tent wi th pr inc ip les
se t by the Basel commit tee on banking supervis ion . these
measures are wi th in the legal and regula tory f ramework
of the ro le of the cent ra l bank In the area of prudent ia l
regula t ion and ef fec t ive survei l lance of the da i ly
opera t ions of banks .
Set t ing a percentage of l iquidi ty and reserves for banks i s
cons idered a prudent ia l mechanism and not a requi rement
tha t h inders banking ac t iv i ty . Over the las t years , some
were compla in ing tha t banks are h indered by an e levated
percentage of legal reserves , and tha t i s the reason for the
l iquidi ty cr i s i s . Bankers know very wel l how to manage
the i r banks; the cent ra l banks i s here to ass is t the bankers ,
a t the same t ime t r igger the warning Bel l should such a
s i tua t ion ar i se .
The cent ra l bank of Egypt a lso emphasizes the measure of
loan concent ra t ion a t the level of each bank. Loan
concent ra t ion i s not re la ted to the loan provided to one
c l ient . Current ly the law se ts the exposure l imi t to each
c l ient a t 30 percent . We a lso have loan concent ra t ion
l imi ts for fore ign banks . The res t r ic t ion i s tha t a l l
Egypt ian money or a l l Egypt ian money or a l l Egypt ian
or ig ina ted money should not be deposi ted a t fore ign
representa t ion banks .
However connect ions re la ted to more than one ac t iv i ty
wi l l lead a bank to be exposed to problems tha t have
32
been avoided to connected lending las t November 2002
There wi l l be a conf l ic t of in teres t . You cannot be a
borrower and a shareholder in the same t ime. Cer ta in ly ,
there wi l l be conf l ic ts of in teres t be tween your pos i t ion as
a shareholder who wants to pursue the maximum prof i t
and a borrower The same to the member of the boards of
d i rec tors . We emphasize tha t the member of the board of
d i rec tors . We emphasize tha t the member of board of
d i rec tors should not be a borrower f rom the same bank;
o therwise th ings wi l l be mixed up and there wi l l be
conf l ic t of in teres ts .
Direc t conf l ic t of in teres t , each non-execut ive board
member should s ign a cer t i f ica t ion and submit i t to the
board of the bank sa t ing tha t he has no conf l ic ts of
in teres t and tha t he wi l l re f ra in f rom mixing h is pr iva te
work or bus iness and his work as a board member .
I t i s advisable tha t audi t commit tees have three non-
execut ive board members . Commit tee members should be
g iven power and author i ty to review the bank’s
performance , works , d isc ip le , and manuals , and the extent
of the i r compl iance to the manuals .
The repor t of the audi t ing commit tee should be avai lable
for the whole board for revis ion and the f inding should be
presented by the head of the audi t ing commit tee .
I f the bank’s audi t ing commit tees fo l low in ternat ional ly
recognized s tandards and prac t ice , I th ink tha t there wi l l
be some sor t of adherence to the d isc ip l ine .
33
The es tabl i shment of inspect ion commit tee or depar tment
i s not the i ssue; the i ssue i s these depar tment of
inspect ion commit tees or depar tments i s not the ef fec t ive .
I f inspect ion commit tees submit the i r repor t to the
chai rman of the board of d i rec tors , we should say tha t th is
i s wrong. These commit tees need to submit repor ts and
make i t s informat ion avai lable to the ent i re board of
d i rec tors , and not to the chai rman or execut ive d i rec tor .
I th ink there i s no cont radic t ion be tween the in ternal
inspect ion depar tments and in ternal audi t ing commit tees .
Infec t ion depar tments have a da i ly responsib i l i ty to check
compl iance wi th manuals .
Shareholders Rights
I t i s very impor tant tha t the shareholders have the
convic t ion to take and to g ive . In many cases , we f ind tha t
shareholders in companies not to speak of banks are
in teres ted only to no about the i r d iv idends . I f we assume
tha t th is i s the r ight th ink to do than, there cont ro l l ing
ro le i s absent . Some shareholders want only to rece ive
decedents has inves tors but a re not aware tha t they have
cont ro l l ing and supervisory ro le
Shareholders need to under take the i r supervisory ro le
wi th in a l l ins t i tu t ions . We as a supervisory ins t i tu t ion for
the banking sec tor should perform our ro le so , i f there i s
in ternal cont ro l a t the banking via corpora te governance
and external cont ro ls f rom the cent ra l bank, th is would be
very benef ic ia l to the country .
34
I f we look a t the cont ro l fac tor ins ide the banks boards
and make a l ink be tween members of the banks boards of
d i rec tors and the i r ownership we might d iscover tha t a
speci f ic shareholder might cont ro l the banks management
and cont ro l i t s dec is ions . Ownership might be 49 percent
in a speci f ic ins t i tu t ions and other ownership might be 20
or 21 percent and be consider i t a s i s te r company and not
an af f i l ia ted company. In the coming per iod, we are
concerned wi th new bank laws and we wi l l make sure tha t
the concept of cont ro l leads to qual i ty and not to
monopoly . Monopoly of thought and monopoly of
leadership in the bank in a wrong di rec t ion or leading the
board in a wrong di rec t ion wi l l be g iven enough
considera t ion .
Corpora te governance cr i te r ia can not be ef fec t ive i f i t i s
only on paper . Proper , sound, and ef fec t ive corpora te
governance cr i te r ia a re those tha t incorpora te a
punishment and reward sys tem. The cent ra l bank’s abi l i ty
to implement i t s pol ic ies and decis ions wi th in the banking
sec tor serve as a correc t ive and disc ip l inary mechanism.
The bank’s board of d i rec tor and i t s genera l assembl ies
a lso need to be commit ted to under taking correc t ive
measures when necessary .
Chapter 6
35
PUBLIC SECTOR BANKS AND GOVERNANCE
CHALLENGEGS
Historical Concept
India had a fa i r ly wel l developed commercia l banking
sys tem in exis tence a t the t ime of independence in
1947.The Reserve Bank of India (RBI) was es tabl i shed in
1935.Whi le the RBI became a s ta te-owned ins t i tu t ion f rom
January 1 , 1949, the Banking Regula t ion Act was enacted
in 1949 providing a f ramework of regula t ion and
supervis ion of commercia l banking ac t iv i ty . The f i rs t s tep
towards the na t ional iza t ion of commercia l banks was the
resul t s of a repor t (under the aegis of RBI) by` the
Commit tee of Direc t ion of Al l India Rura l Credi t Survey
(1951) which t i l l today i s the locus c lass ics on the subjec t
.Thus the Imper ia l Bank was taken over by the
Government and renamed as the Sta te Bank of India (SBI)
the July 1 , 1955 wi th the RBI acqui r ing overr id ing
subs tant ia l holding of shares . A number of e rs twhi le banks
owned by pr ince ly s ta tes were subs id iar ies of SBI in
1959.
To meet theses concerns , in 1967, the Government
in t roduced the concept of soc ia l cont ro l in the
banking indust ry . The scheme of soc ia l cont ro l was
a imed a t br inging some changes in the management
and d is t r ibut ion of c redi t by the commercia l banks .
Pol i t ica l compuls ion then par t ia l ly a t t r ibuted to
inadequacies of the soc ia l cont ro l , led to the
36
Government of India na t ional iz ing, in 1969, 14
major scheduled commercia l banks the needs which
had deposi t s above a cut -off s ize . The objec t ive was to
serve be t te r the needs of development of the economy in
conformi ty wi th na t ional pr ior i t ies and objec t ives .
From the f i f t ies a number of exclus ive ly s ta te-owned
development f inancia l ins t i tu t ion (DFIs) were a lso se t up
both a t the na t ional and s ta te level , wi th a lone except ion
of Indust r ia l Credi t and Inves tment Corpora t ion of India
( ICICI) which had minor i ty pr iva te share holding.
Reform Measures
The major chal lenge of the reform has been to in t roduce
e lements of market incent ive as a dominant fac tor
gradual ly replac ing the adminis t ra t ive ly coordinated
p lanned ac t ions for development . Such a paradigm shi f t
has severa l d imensions , the corpora te governance be ing
one of the impor tant e lements . The evolut ion of corpora te
governance in banks , par t icular ly in PSBs, thus ref lec ts
changes in monetary pol icy , regula tory envi ronment , and
s t ruc tura l t ransformat ions and to some extent , on the
charac ter of the se l f - regula tory organiza t ions funct ioning
in the f inancia l sec tor .
Pol icy Environment
During the reform per iod, the pol icy envi ronment
enhanced compet i t ion and provided grea ter oppor tuni ty for
exerc ise of what may be ca l led genuine corpora te e lement
in each bank to replace the e lements of coordinated
ac t ions of a l l ent i t ies as a “ jo in t fami ly” to fu l f i l l
37
predetermined Plan pr ior i t ies . The measures taken so far
can be summarized as fo l lows.
Fi rs t , grea ter compet i t ion has been infused in the banking
sys tem by permi t t ing ent ry of pr iva te sec tor banks
(9 l icences s ince 1993) , and l ibera l l icens ing of more
branches by fore ign banks and the ent ry of new fore ign
banks . With the development of a mul t i - ins t i tu t ional
s t ruc ture in the f inancia l sec tor non-bank in termedia t ion
has increased, banks have had to improve ef f ic iency to
ensure surviva l .
Second, the reforms accorded grea ter f lexib i l i ty to the
banking sys tem to manage both the pr ic ing and quant i ty of
resources . There has been a reduct ion in s ta tu tory
preempt ions to less than a th i rd of commercia l banks
resources . Valuat ion of banks’ inves tments i s a l so a t tuned
to in ternat ional bes t prac t ices so as to appropr ia te ly
capture market r i sks .
Thi rd , the RBI has moved away f rom micro-regula t ion to
macro-management . RBI has replaced de ta i led individual
guidel ines wi th genera l guidel ines and now leaves i t to
individual banks’ boards to se t the i r guidel ines on credi t
dec is ions .
Four th , to s t rengthen the banking sys tem to cope up wi th
the changing envi ronment , prudent ia l s tandards have been
imposed in a progress ive manner .
F i f th , an appropr ia te legal , ins t i tu t ional , technologica l
and regula tory f ramework has been put in p lace for the
development of f inancia l markets . There i s now increased
38
volumes and t ransparency in the pr imary and secondary
market opera t ions . Development of the Government
Secur i t ies , money and forex markets In teres t ra te channel
of monetary pol icy t ransmiss ion i s acqui r ing grea ter
impor tance as Compared wi th the credi t channel .
Regulatory Environment
Prudent ia l regula t ion and supervis ion have formed a
cr i t ica l component of the f inancia l sec tor reform
programme s ince i t s incept ion , and India has endeavored
to in ternat ional prudent ia l norms and prac t ices .
The Banking Regula t ion Act 1949 prevents connected
lending ( i .e . lending by banks to d i rec tors or companies in
which Direc tors a re in teres ted . )
Per iodica l inspect ion of banks has been the main
ins t rument of supervis ion , though recent ly there has been
a move toward supplementary ‘on-s i te inspect ions’ wi th
‘off -s i tes survei l lance’ . The sys tem of ‘Annual Financia l
Inspect ion’ was in t roduced in1992, in p lace of the ear l ie r
sys tem of Annual Financia l Review/Financia l Inspect ions .
A high powered Board for Financia l Supervis ion (BFS) ,
compris ing the Governor of RBI as Chai rman, one of the
Deputy Governors as Vice-chai rman and four Direc tors of
the cent ra l board of RBI as members was const i tu ted in
1994, wi th the mandate to exerc ise the Power of
supervis ion and inspect ion in re la t ion to the banking
companies , f inancia l ins t i tu t ion and non-banking
companies .
39
A supervisory s t ra tegy compris ing on- s i te inspect ion ,
of f–s i te moni tor ing and cont ro l sys tems in ternal to the
banks , based on the camels (capi ta l adequacy, asse t
qual i ty , management , earnings , l iquidi ty and sys tems and
cont ro ls ) methodology for banks have been ins t i tu ted . The
RBI has ins t i tu ted a mechanism for c r i t ica l analys is of the
ba lance sheet by the banks themselves and the
presenta t ion of such analys is before the i r boards to
provide an in ternal assessment of the heal th of the bank.
Keeping in l ine wi th the merging regula tory and
supervisory s tandards a t in ternat ional level , the RBI has
in i t ia ted cer ta in macro level moni tor ing techniques to
assess the t rue heal th of the supervised ins t i tu t ions . The
format of ba lance sheets of commercia l banks have now
been prescr ibed by the RBI wi th d isc losure s tandards
on v i ta l performance and growth indica tors , provis ions ,
ne t NPAs, s ta f f product iv i ty , e tc . appended as ‘notes of
accounts’ . These proposed addi t ional d isc losure norms
would br ing the d isc losure s tandards a lmost on par wi th
the in ternat ional bes t prac t ice .
Structural Environment of Banking
The nat ional ized banks are enabled to d i lu te the i r equi ty
of Government of India to 51 percent fo l lowing the
amendment to the Banking Companies (Acquis i t ion &
Transfer of Under takings) Acts in 1994, br inging down the
minimum Government’s shareholder to 51 percent in
PSBs. RBI’s shareholding in SBI i s subjec t to a minimum
of 55 percent .
40
The divers i f ica t ion of ownership of PSBs has made a
qual i ta t ive d i f ference to the funct ioning of PSBs s ince
there i s induct ion of pr iva te shareholding and a t tendant
i ssues of shareholder’s va lue , as ref lec ted by the market
cap , representa t ion on board , and in teres ts of minor i ty
shareholders . There i s representa t ion of pr iva te
shareholder when the banks ra ise capi ta l f rom the market .
The governance of banks res ts wi th the board of d i rec tors .
In the l ight of deregula t ion in in teres t ra tes and the
grea ter autonomy given to banks in the i r opera t ion , the
ro le of the board of d i rec tors has become more
s igni f ica t ions .
Dur ing the years , Board has been requi red to lay down
pol ic ies in cr i t ica l a reas such as inves tments , loans , asse t -
l iabi l i ty management , and management and recovery of
NPAs. As par t of th is process , severa l Board level
commit tees inc luding the Management Commit tee are
requi red to be appointed by banks .
Government in t roduced a Bi l l in Par l iament to omi t the
mandatory provis ions regarding appointment of RBI
nominees on the Boards of publ ic sec tor banks and ins tead
to add a c lause to enable RBI to appoint i t s nominee on
the boards of publ ic sec tor banks i f the RBI i s of the
opinion tha t in the in teres t of the banking pol icy or in the
publ ic in teres t or in the in teres t of the bank or deposi tors ,
i t i s necessary so to do.
Appointment of Chai rman and Managing Direc tors and
Execut ive Direc tors of a l l PSBs i s done by Government .
41
The Naras imham Commit tee I I had recommended tha t the
appointment of Chai rman and Managing Direc tor should
be le f t to the Boards of banks and the Boards themselves
should be e lec ted by shareholders
Appointment as wel l as removal of audi tors in PSBs
requi res pr ior approval of the RBI. There i s an e labora te
procedure by which banks se lec t audi tors f rom an
approved panel c i rcula ted by the RBI. In respect of
pr iva te sec tor banks , the s ta tu tory audi tors a re appointed
in the Annual Genera l Meet ing wi th the pr ior approval by
the RBI.
Self Regulatory Organizat ions
India has had the d is t inc t ion of exper iment ing wi th Sel f
Regula tory Organisa t ion (SROs) in the f inancia l sys tem
s ince the pre- independence days . At present , there are
four SROs in the f inancia l sys tem- Indian Banks
Associa t ion ( IBA), Fore ign Exchange Dealers Associa t ion
of India (FEDAI) , Pr imary Dealers Associa t ion of India
(PDAI) and Fixed Income Money Market Dealers
Associa t ion of India (FIMMDAI) .
The IBA es tabl i shed in 1946 as a voluntary associa t ion of
banks , s t rove towards s t rengthening the banking indust ry
through consensus and co-ordinat ion . S ince
na t ional iza t ion of banks , PSBs tended to dominate IBA
and developed c lose l inks wi th Government and RBI.
Of ten , the reac t ive and consensus and coordinated
approach border on car te l i sa t ion . To i l lus t ra te , IBA had
42
worked out a schedule of benchmark service charges for
the services rendered by member banks , which were not
mandatory in na ture , but were be ing adopted by a l l banks .
Responding to the impera t ives caused by the changing
scenar io in the reform era , the IBA has , over the years ,
re focused i t s v is ion , redef ined i t s ro le , and modif ied i t s
opera t ional modal i t ies .
Tentat ive Issues and Lessons
Corpora te governance in PSBs i s impor tant , not only
because PS Bs happen to dominate the banking
indust ry , but a l so because , they a re unl ike ly to exi t
f rom banking bus iness though they may ge t
t ransformed. To the extent there i s publ ic ownership
of PS Bs , the mul t ip le objec t ives of the government
as owner and the complex pr inc ipa l - agent
re la t ionships cannot be wished away. PS Bs cannot be
expected to b l indly mimic pr iva te corpora te banks in
governance though genera l pr inc ip les a re equal ly
va l id . Compl ica t ions a r i se when there i s a widespread
fee l ing of uncer ta in ty of ownership and publ ic
ownership i s t rea ted as t rans i t ional phenomenon. The
ant ic ipa t ion or threa t of change in ownership has
a lso some impact on governance , s ince expected
change i s not mere ly of owner but the very na ture of
owner . Mixed ownership where government has
cont ro l l ing in teres t i s an ins t i tu t ional s t ruc ture tha t
poses i ssues of s igni f icant d i f ference be tween one se t
of owners who look for commercia l re turn and
43
another who seeks something more and di f ferent , to
jus t i fy ownership .
The most impor tant chal lenge faced in enhancing
corpora te governance and in respect of which there
has been s igni f icant though par t ia l success re la tes to
redef in ing the in ter re la t ionships be tween ins t i tu t ion
wi th in the broadly def ined publ ic sec tor i e . ,
government ,RBI and PSBs and PSBs to move away f rom a
model of p lanned development . )
The cent ra l bank a lso had to move away f rom shar ing the
n i t ty gr i t ty of developmenta l schemes wi th government
involving micro regula t ion , to a more equi table t rea tment
of a l l banks as regula tor and s tandards .
Another noteworthy aspect of enhancing corpora te
governance i s narrowing of gap be tween PSBs and
other banks in te rms of the pol icy , regula tory and
opera t ing envi ronment , apar t f rom some changes in
ownership s t ruc tures wi th a t tendant consequences . The
PSBs as hundred percent owned ent i t ies wi th no
share va lue quoted in s tock exchanges accounted for
over three quar ters of banking bus iness seven years
ago, whi le they now account for less than a
quar ter .
Random Thoughts
44
The Indian exper ience provokes some thoughts on a few
fundamenta l i ssues in regard to PSBs and corpora te
governance . F i rs t , i s publ ic ownership compat ib le wi th
sound corpora te governance as genera l ly unders tood?
Since var ious corpora te governance s t ruc tures exi t s in
d i f ferent countr ies . Government ownership of a bank,
unless government happens to have such a s take pure ly as
a f inancia l inves tment for re turn , necessar i ly has to have
the ef fec t of a l te r ing the s t ra tegies and objec t ives as wel l
as s t ruc ture of government . Government as an owner i s
accountable to pol i t ica l ins t i tu t ions which may not
necessar i ly be compat ib le wi th pure ly economic
incent ives .
The mixed ownership br ings in to sharper focus the
d ivergent objec t ives of shareholding and the i ssues of
reconci l ing them, especia l ly when one of the owners i s
government . In such a s i tua t ion , one can argue tha t as
long as the pr iva te shareholder i s aware of the specia l
na ture of shareholding, there should be no conf l ic t . I t
o ther words , The idea of mainta in ing publ ic sec tor
charac ter of a bank whi le government holds a minor i ty
shareholding i s an in tens i f ied and modif ied vers ion of
“golden share” exper iment of UK. The ques t ion could s t i l l
be as to whether such a mixed ownership of organiza t ion ,
par t icular ly for banks which are in case genera l ly under
in tense regula t ion and supervis ion .
45
Chapter 7
BEST PRACTICES OF CORPORATE GOVERNANCE
IN BANKS
Financia l fa i lures l ike Enron. WorldCom have eroded fa i th
in the corpora te sec tor genera t ing unprecedented shocks in
the s tock markers a l l over the wor ld . Many individual and
Corpora te inves tors have become conservat ive in the i r
Inves tment dec is ions they demand higher degree of
scrut iny Of a corpora te’s f inancia l d isc losure and
s t r ingent Disc losure norms to avoid such i r revers ib le and
I r recoverable scandals in the fu ture . Consequent ly , the
board Rooms are compel led to pay grea ter a t tent ion to
the i r Rela t ionship wi th the s takeholders and the
t ransparency of the i r f inancia l s ta tements . Legis la t ive and
regula tory i ssues have a lso been made more s t r ingent to
boost inves tor Conf idence . The audi t process has a lso
been reviewed thoroughly wi th c lear guidel ines the focus
on corpora te Dut ies and responsib i l i t ies .
Importance of Corporate Governance in Banks
Corpora te Governance i s par t icular ly impor tant for banks
because Banks p lay a dominant ro le in f inancia l sys tems
and economic growth. Banks are the main source of
f inance for a major i ty of f i rms as access of f inancia l
markets i s subjec t to compl iance wi th cumbersome
regula tory requi rements . They are the main deposi tor ies
for the economy’s saving. They ac t as the cus todian of the
country’s l iquid reserves . Thus the banking sys tem
46
deserves much a t tent ion to bui ld a s t rong, re l iable and
s table f inancia l sys tem in a country .
Good governance can be bui l t based on the bus iness
prac t ices adopted by the board of d i rec tors and
management . Many bank fa i lures in the pas t have been
a t t r ibuted to inadequate and ineff ic ient management which
enabled banks to accept low qual i ty asse ts and assume
addi t ional r i sks tha t extended beyond the level appropr ia te
for the banks’ capaci ty .
Some of the key e lement tha t i s ident i f ied to be a par t of
a good governance sys tem a t the individual bank level :
Management wi th h igh in tegr i ty , adequate and exper ience;
A comprehensive in ternal informat ion cont ro l sys tem to
ensure the decis ions i f the bank are col lec t ive decis ion;
Prudent c redi t appra isa l mechanism thereby l imi t ing the
r i sk exposure ; and Effec t ive external and in ternal audi t
procedures to es tabl i sh adherence to the pol ic ies and
regula t ions and no specia l t rea tment i s a l lowed on any
par t icular dec is ion .
Ten Commandments of Corporate Governance
We can enumerate the commandments for ensur ing bank
corpora te governance .
I . Banks shal l real ize the t imes are changing
The issue of corpora te governance had not been g iven the
requis i te a t tent ion in the pas t unt i l the advent of some
economic and f inancia l c r i ses in the la te ‘90s . Times are
changing now, and even smal les t banks need to focus on
corpora te governance res t ruc tur ing. This i s because of the
47
apparent lack of in tegr i ty and values in the opera t ion
some large corpora t ions l ike World Com and Enron.
II . Banks shal l establ ish an ef fect ive capable and
re l iable board of directors
Establ i sh ing an ef fec t ive , capable and re l iable board of
d i rec tors requi res involving wel l qual i f ied and successful
individuals wi th in tegr i ty . This impl ies tha t a major i ty of
banks of board of d i rec tors should be t ru ly outs ide
independent d i rec tors . Here , “ independence” refers to the
individual not working for the bank and he/she not having
mater ia l re la t ionship wi th the bank. The board should se t
a long- term s t ra tegy, pol icy and values for the
organiza t ion . Never the less , the bank should not
micromanage the ins t i tu t ion .
III . Banks shal l establ ish a corporate code of e thics
for themselves
Corpora te e th ics and values should be es tabl i shed a t the
top and should be used to govern the opera t ions of the
company both f rom a long- term and a shor t - te rm view
point . Unless th is exerc ise i s accompl ished, execut ive
management cannot ant ic ipa te tha t the rank and f i le
employees wi l l fo l low such a code on the i r own.
IV. Banks shal l consider establ ishing an Off ice of
the Chairman of the Board
Many banks are a l ready examining th is idea of
es tabl i sh ing Off ice of the Chai rman of the Board . Such an
Off ice wi l l be made to repor t to the board and wi l l ac t as
48
the board’s eyes and ears on a da i ly bas is in connect ion
wi th the funct ions of the bank.
V. Banks shal l have an ef fect ive and operat ing
audit committee , compensat ion committee and
nominat ing/corporate governance committee
The audi t commit tee , compensat ion commit tee and
nominat ing commit tee should be composed of a l l
independent , outs ide d i rec tors of the bank who opera te
independent ly . These commit tees should have access to
a t torneys and consul tants pa id for by the bank other than
the bank’s cus tomary counsel and consul tants . This
independence of the commit tees wi l l ensure any bias in
the in ternal audi t commit tee’s dec is ions .
VI. Banks shal l consider the ef fect ive board
compensat ion
Fair compensat ion should be pa id to the d i rec tors . Thei r
remunera t ion should be commensura te wi th the r i sks they
take . The bank should a im to appoint a h ighly qual i f ied
d i rec tor and take appropr ia te measures to re ta in them
wi th the organiza t ion as i t normal ly does wi th o ther
employees .
VII. Banks shal l require cont inuing educat ion for
directors
The f inancia l services indust ry i s now fac ing a number or
chal lenges due to many technology innovat ions .
Therefore , i t becomes impera t ive for the banks to educate
the i r d i rec tors to meet the growing needs of the indust ry .
49
Cont inuing educat ion should be g iven equal impor tance
a long wi th o ther parameters out l ined above.
VIII . Banks shal l establ ish procedures for board
success ion
The presence of qual i f ied members on the board i s a very
crucia l i ssue . So a bank should have a c lear ly speci f ied
se t of ru les regarding i ssues of success ion to the board .
The bank should pose a ques t ion are as fo l lows:
a ) Does the bank have a mandatory re t i rement age tha t i s
ac tua l ly enforced?
b) Does a se l f appra isa l process exis t to f ree the board of
the non-product ive d i rec tors?
c) Does the bank have a p lan to mainta in a fu l ly s ta f fed
board of d i rec tors wi th capable people , no mat ter what
the age i s as i t moves forward?
IX. Banks shal l d isc lose , d isc lose and disc lose the
information
Banks wi l l f ind tha t d isc losure wi l l be quicker and more
burdensome than i t was in the pas t . This may be through
quar ter ly le t te rs to the shareholders or o ther types of
communica t ion .
X. Banks shal l recognize tha t duty i s to es tabl i shed
corpora te governance procedures tha t wi l l serve to
enhance shareholder va lue
50
The pr imary objec t of the board of d i rec tory i s to
maximize the shareholder’s weal th . The s t ra tegy adopted
to achieve th is objec t ive should now encompass corpora te
governance procedures and should be des igned wi th long-
term value for the shareholder in focus .
Key Elements of Best Pract ices in Corporate
Governance
The Key e lements ident i f ied are :
1 . A s t rong independent board of d i rec tors ,
2 . Independent Commit tees ,
3 . Char ter -based Commit tees than ru le-based,
4 . Code of conduct or e th ics ,
5 . Transparent account ing prac t ices ,
6 . Direc tor or ienta t ion program and an ongoing
t ra in ing.
Steps taken in India to Improve Corporate Governance
in Indian Banks.
A consul ta t ive group of Direc tors of banks and f inancia l
ins t i tu t ions was se t up by the Reserve Bank of India to
review the supervisory ro le of the Boards of banks and
f inancia l ins t i tu t ions and to obta in feedback on the
funct ioning of the Boards v is -à-vis compl iance ,
t ransparency, d isc losures , audi t commit tees , e tc .
These recommendat ions were based on in ternat ional bes t
prac t ice as enuncia ted by the Basel Commit tee on banking
supervis ion , o ther commit tee and advisory bodies . But
51
sui table amendments were made in these in ternat ional
s tandards to su i t the Indian scenar io .
Recommendations of the Advisory Group
Direc tors of a l l banks both publ ic and pr iva te sec tor banks
should exerc ise due d i l igence wi th respect to the i r
su i tabi l i ty to the pos t they hold by way of qual i f ica t ions
and technica l exper t i se .
The Government shout be guide by cer ta in broad “f i t
and proper norms for the nominat ion of the
Direc tors . The cr i te r ia sugges ted by Bank of
In ternat ional Set t lements can be adopted as a
guidel ine to ar r ive a t an appropr ia te se t of norms.
For assess ing in tegr i ty and sui tabi l i ty fac tors such as
cr iminal records , f inancia l pos i t ion , c iv i l ac t ion
under taken to pursue personal debts , re fusa l of
admiss ion to or expuls ion f rom profess ion bodies ,
sanct ion appl ied by regula t ion to s imi lar bodies and
previous ques t ionable bus iness prac t ices , e tc , should
be considered.
The appointment / nominat ion of independent / non-
execut ive d i rec tors to the Boards of banks should
be taken f rom a pool of profess ional and ta lented
people to be prepared and mainta ined by the
country’s Centra l Bank, Reserve Bank of India .
Any vio la t ion of the norm should be not i f ied to the
RBI.
In the current context of banking becoming more
complex and knowledge – based , there i s an
52
urgent need for making the boards of banks
more contemporar i ly profess ional by induct ing
technica l ly and specia l ly qual i f ied individual .
While the exis t ing regula t ion of appoint ing
exper ts f rom d i f ferent sec tors such as
agr icul ture , SSI , e tc can be cont inued , e f for ts
should be a imed a t combining i t wi th the need
based representa t ion of sk i l l s such as market ing ,
technology and sys tems, r i sk management , s t ra tegic
p lanning , t reasury opera t ions , c redi t recovery , e tc .
The independent and non- execut ive d i rec tors
should ra ise c r i t ica l ques t ions re la t ing to bus iness
s t ra tegy , house keeping and in ternal cont ro l
sys tems and o ther impor tant aspects of the
funct ioning of the bank and inves tor re la t ions
in the meet ing of the board .
In the pr iva te sec tor banks where promoter
d i rec tors may ac t in concer t , the independent /
non- execut ive d i rec tors should provide e f fec t ive
checks and ba lances to ensure tha t the bank
does not bui ld up exposures to ent i t ies
connected wi th the promoters or the i r
associa tes .
The remunera t ion of the d i rec tors should be
increased to the comparable levels of
in ternat ional s tandards to encourage them towards
mainta in ing in tegr i ty in the i r per forming the
dut ies .
53
The of f ice of the cha i rman and the d i rec tor
should be separa ted in respect of la rge s ized
publ ic sec tor to br ing in more focus in
render ing the i r dut ies .
The informat ion furnished to the board should
be adequate and comple te to enable the
members of the Board to take meaningful
dec is ions .
Uniform code and procedure should be adopted
for recording the proceedings of the Board
meet ings in banks and f inancia l ins t i tu t ions .
The board should be informed per iodica l ly of
the exposures of a bank to s tockbrokers and
market - makers and o ther sens i t ive sec tors such
as rea l es ta te e tc .
All banks should g ive impor tance to appoint ing
a qual i f ied Company Secre tary as the Secre tary
to the Board and a l so appoint a Compl iance
Off icer for moni tor ing and repor t ing
compl iance wi th regula tory and account ing
requi rements .
The Audi t commit tee should comprise
independent / non-execut ive d i rec tors and the
Execut ive Direc tors should only be a permanent
invi tee .
54
CONCLUSION
Corpora te governance thus has become a topic in teres t to
Many audiences inc luding the corpora te d i rec tors , the
cent ra l banks and other regula tory author i t ies . Like many
issues , even CG has become an in teres t ing i ssue tha t
a t t rac ted publ ic a t tent ion in the wake of corpora te
scandals l ike Enron. Governance i ssue genera l ly centers
a round accountabi l i ty of the par t ies involved in dec is ion-
making in a bank or any organiza t ion . Libera l iza t ion and
deregula t ion , and vola t i l i ty in the f inancia l markets a re
the major fac tors tha t have t r iggered an in teres t in the
i ssue of corpora te governance . I have made an a t tempt to
in t roduce the reader the concept , i ssues and perspect ives
of corpora te governance in the f inancia l sec tor in genera l
and banks in par t icular . I have t r ied to g ive br ief
in t roduct ion on the corpora te governance prac t ices in