CHAPTER 1 INTRODUCTION TO BANK

Definition
Banking is accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheques, draft and order or otherwise. Bank is defined as a person who carries on the busSiness of banking. Banks also perform certain activities which are ancillary to this business of accepting deposits and lending. Since Banking involves dealing directly with money, governments in most countries regulate this sector rather stringently. Banking in India was defined under Section 5(A) as any company which transacts banking, business and the purpose of banking business defined under Section 5(B),accepting deposits of money from public for the purpose of lending or investing, repayable on demand through cheque/draft or otherwise. In the process of doing the above-mentioned primary functions, they are also permitted to do other types of business referred to as Utility Services for their customers (Banking Regulation Act, 1949).

TYPES OF BANKS
There are various types of banks which operate in our country to meet the financial requirements of different categories of people engaged in agriculture, business, profession, etc. on the basis of functions, the banking institutions in India may be divided into the following types:

A.

CENTRAL BANK

A bank which is entrusted with the functions of guiding and regulating the banking system of a country is known as its Central Bank. Such a bank does not deal with the general public. It acts essentially as Governments banker; maintain deposit accounts of all other banks and advances money to other banks, when needed. The Central Bank provides guidance to other banks whenever they face any problem. It is therefore known as the bankers bank. The Reserve Bank of India is the central bank of our country. The Central Bank maintains record of Government revenue and expenditure under various heads. It also advises the Government on monetary and credit policies and decides on the interest rates are also determined by the central bank. Another important function of the Central Bank is the issuance of currency notes, regulation their circulation in the country by different methods. No other bank than the central bank can issue currency.

B.

COMMERCIAL BANK

Commercial Banks are banking institutions that accept deposits and grant short-term loans and advances to their customers. In addition to giving shortterms loans, commercial banks also give medium-term and long-term loan o business enterprises. Now-a-days some of the commercial banks are also providing housing loan on a long-term basis to individuals. There are also many other functions of commercial banks, which are discussed later in this lesson.

C.

DEVELOPMENT BANK

Business often requires medium and long-term capital for purchase of machinery and equipment, for using latest technology, or for expansion and modernization. Such financial assistance is provided by Development Banks. They also undertake other development measures like subscribing to the shares and debentures issued by companies, in case of under subscription of the issue by the public. Industrial Finance Corporation of India (IFCI) and State Financial Corporations (SFCs) are examples of development banks in India.

D.

CO-OPERATIVE BANK

People who come together to jointly serve their common interest often form a co-operative society under the Co-operative Societies Act. When a cooperative society engages itself in banking business it is called a Cooperative Bank. The society has to obtain a license from the Reserve Bank of India before starting banking business. Any co-operative bank as a society

is to function under the overall supervision of the Registrar, Co-operative Societies of the State. As regards banking business, the society must follow the guidelines set and issued by the Reserve Bank of India.

E.

SPECIALISED BANK

There are some banks, which cater to the requirements and provide overall support for setting up business in specific areas of activity. EXIM Bank, SIDBI and NABARD are examples of such banks. They engage themselves in some specific area or activity and thus, are called specialized banks. i. ii. iii. Export Import Bank of India (EXIM Bank) Small Industries Development Bank of India (SIDBI) National Bank for Agricultural and Rural Development (NABARD)

BANKING REGULATION ACT, 1949

The Banking Regulation Act was passed as the Banking Companies Act 1949 and came into force 16.03.49. Subsequently it was changed to Banking Regulations Act 1949 01.03.66. Summary of some important sections is provided here under. 1. Banking means accepting for the purpose of lending or investment of deposits of money from public repayable on demand or otherwise and withdrawable by cheque, drafts order or otherwise 5(i) (b). 2. Banking company means any company which transacts the business of banking 5(i) (c). 3. Transact banking business in India 5(i) (e). Demand liabilities are the liabilities which must be met on demand and time liabilities means liabilities which are not demand liabilities 5(i) (f).

4. Secured loans or advances means a loan or advance made on the security of asset the market value of which is not at any time less than the amount of such loan or advances and unsecured loan or advances means a loan or advance not secured 5(i) (h). 5. Defines business a banking company may be engaged in like borrowing, lockers, letter of credit, traveler cheques, mortgages etc 6(1). 6. States that no company shall engage in any form of business other than those referred in Section 6(1) & 6(2). 7. For banking companies carrying on banking business in India to use at least one word bank, banking, banking company in its name (7). 8. Restrictions on business of certain kinds such as trading of goods etc. (8). 9. Prohibits banks from holding any immovable property howsoever acquired except as acquired for its own use for a period exceeding 7 years from acquisition of the property. RBI may extend this period by five years (9). 10.Prohibitions on employment like Chairman, Directors etc (10). 11.Paid up capital, reserves and rules relating to these (11&12). 12.Banks not to pay any commission, brokerage, discount etc. more than 2.5% of paid up value of one share (13). 13.Prohibits a banking company from creating a charge upon any unpaid capital of the company. (14) Section 14(A) prohibits a banking company from creating a floating charge on the undertaking or any of the company without the RBI permission. 14.Prohibits payment of dividend by any bank until all of its capitalized expenses have been completely written off (15). 15.To create reserve fund and 20% of the profits should be transferred to this fund before any dividend is declared (17(1)).

16.Cash reserve - Non-scheduled banks to maintain 3% of the demand and the time liabilities in a current account with RBI (18). 17.Permits banks to form subsidiary company for certain purposes (19). 18.No banking company shall hold shares in a company, whether as pledge, mortgagee or absolute owners of amount exceeding 30% of its own paid up share capital + reserves or 30% of the paid up share capital of that company whichever is less 19(2). 19.Restrictions on banks to grant loan to person interested in management of the bank (20). 20.Power to Reserve Bank to issue directive to banks to determine policy for advances (21). 21.Every bank to maintain percentage of its demand and time liabilities by way of cash, gold, unencumbered securities 25%-40% as on last Friday of 2nd preceding fortnight (24). 22.Return on unclaimed deposits (10 years and above) (26). 23.Every bank has to publish its balance sheet as on 31st (29). 24.Balance sheet is to be got audited from qualified auditors (30(i)). 25.Publish balance sheet and auditors report within 3 months from the end of period to which they refer. RBI may extend the period by further three month (31). 26.Prevents banks from producing any confidential information to any authority. 27.RBI authorized to undertake inspection of banks (35). 28.Amendment carried in the Act during 1983 empowers Central Government.

Headquarters Coordinates

Mumbai Maharashtra 18.93337 N 72.836201 E Coordinates: 18.93337 N 72.836201 E

Established Governor Central Bank of Currency ISO 4217 Code Reserves Base borrowing rate Base deposit rate Website

1 April 1935

Duvvuri Subbarao India Indian Rupee INR US$300.21 billion (2010) 7.25% 6.25% rbi.org.in

The Reserve Bank of India (RBI) is the central banking institution of India and controls the monetary policy of the rupee as well as US$300.21 billion (2010)[1] of currency reserves. The institution was established on 1 April 1935 during the British Raj in accordance with the provision of the Reserve Bank of India Act, 1934[2] and plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union.

RESERVE BANK OF INDIA

The Reserve Bank of India (RBI) was established through the Reserve Bank of India Act, 1934 and it commenced its operations on April 1, 1935. It was established as a private shareholders bank, then it was nationalized in 1949, and it became fully owned by the Government of India, it draws its powers and responsibilities through other legislations also such as the Banking Regulation Act, 1949. The RBI has over the years been responding to changing economic circumstances and these organizational developments.

Functions of Reserve Bank of India

The Reserve Bank of India Act of 1934 entrust all the important functions of a central bank the Reserve Bank of India.

Bank of issue
The bank has the sole right to issue bank notes of all denominations. The Reserve Bank has a separate Issue Department which is entrusted with the issue of currency notes.

Banker to Government
The second important function of the Reserve Bank of India is to act as Government banker, agent and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India excepting that of Jammu and Kashmir. The Reserve Bank has the obligation to transact government business, via. To keep the cash balances as deposits free of interest, to receive and to make payments on behalf of the government and to carry out their exchange remittances and other banking operations. The

Reserve Bank of India helps the government both the Union and the states to flow new loans and to manage public debt.

Controller of credit
The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations. The Reserve Bank of India is armed with many more powers to control the Indian money market. Every bank has to get a license from the Reserve Bank of India to do banking business within India; the license can be cancelled by the Reserve Bank of certain stipulated conditions are not fulfilled. Every bank will have to get the permission of the Reserve Bank before it can open a new branch. Each scheduled bank must send a weekly return to the Reserve Bank showing, in detail, its assets and liabilitie.

CHAPTER 2 CORPORATE GOVERNANCE IN BANKS

INTRODUCTION
Corporate Governance is a set of processes, customs, policies, laws and institutions affecting the way of corporation is directed, administered or controlled. Corporate Governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management and board of directors. Other stakeholders include employees, suppliers, customers, banks other lenders, regulators, the environment and the community at large. Corporate Governance is a multi-faceted subject. An important part of corporate governance deals with accountability, fiduciary duty, and disclosure to shareholders and others, mechanism of auditing and control. In this sense, corporate governance players should comply with codes to the overall good of all constituents. Another important focus is economic efficiency, both within the corporations (such as the best practice guidelines) as well as externally (national institutions frameworks). In this economic view, the corporate governance system should be designed in such a way as to optimize results, as well as to detect and prevent frauds. Some argue that the firm should act not only in the interest of the shareholders but also off all the other stakeholders. Governance makes decision that the define expectations, grant power, or verify performance. It consists either of a separate process or of a specific

10

part of the management or leadership processes. Sometimes people setup government to administer these processes and systems. In the case of a business or a nonprofit organization, governance develops and manages consistent, cohesive policies, processes and decision-rights for a given area of responsibility. For example, managing at a corporate level might involveevolic policies on privacy, on internal investment, and on the use of data.

WORD-ORIGIN
The word Governance derives from Latin origins that suggest the notion of steering. One can contrast this sense of steering a group or society with the traditional Top-Down approach of governments driving society. Distinguish between governances power to and governments power over.

DEFINITION
Corporate Governance deals with the ways in which suppliers of finance to Corporations assure themselves of getting a return on their investment.

(Shleifer and Vishny)

Corporate Governance is about is about promoting corporate fairness. Transparency and accountability.

(J Wolfensohn)

11

(President of the World Bank quoted by an article in Financial Times, June 21st 1999)
The OCED has defines corporate governance as involving an asset of relationships between a companys management, its board, its shareholder and other stakeholders. Corporate governance also provides the structures through the objectives of the company are set, and the means of attaining those objectives and monetary performance. Good governance should provide proper incentives for the board management to pursue objectives that are in the interest of the company and shareholders and should facilitate effective monitoring thereby encouraging firms to use resources efficiently.

MEANING OF CORPORATE GOVERNANCE

Corporate governance is typically perceived by academic literature as dealing with problems that results from the separation of ownership and control. From this perspective, corporate governance would focus on: the internal structure of BOD; the creation of independent committees rules for disclosures of information to shareholders and creditors; and control of the management. An adequate institutional and legal framework is in place in India for effectively implementing a code of sound corporate governance in banks. The statutes have build-in legal provisions that prohibit or strongly limit activities and relationships that diminish the quality of corporate governance in banks; they have been advised to place before their board of directors the report of consultative group of directors of banks and setup to review the supervisory role of boards of banks. The recommendations include the responsibility of the BOD, role and responsibility of independent of

12

independent and non-executive directors, fit and proper norms for nomination of directors in private sector banks, etc. The banks were advised to adopt and implement the recommendations on the basis of the decisions taken by their board. Transparency and disclosures standards are also important constituents of a sound corporate governance mechanism. Transparency and accounting standards in India have been enhanced to align with international best practices. However, there are many gaps in the disclosures in India visa-avisa the international standards, particularly in the areas of risk management strategies and practices, risk concentrations, performance measure, 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.

TYPES OF GOVERNANCE
1. Global Governance 2. Project Governance 3. Information Technology Governance 4. Fair Governance

13

HISTORY
In the 19TH century, state corporation laws enhanced the rights of corporate boards to govern without unanimous consent of shareholders in exchange for statutory benefits like appraisal rights, to make corporate governance more efficient. Since that time, and because most large publicly traded corporations in the US are incorporated under corporate administration friendly Delaware law, and because the USs wealth has been increasingly derivative and dissipated. The concerns of shareholders over administration pay and stock losses periodically has led to more frequent calls for corporate governance reforms. In the 20th century in the immediate aftermath of the Wall Street Crash of 1929 legal scholars such as Adolf Augustus Berle, Edwin Dodd, and Gardiner C. means pondered on the changing role of the modern corporation in society. Berle and Means monography. The modern Corporation and Private Property(1932,Macmillan) continuous to have a profound influence on the conception of corporate governance in scholarly debates today. In the early 2000s the massive bankruptcies (and criminal malfeasance) of Enron and WorldCom, as well as lesser corporate debacles, such as Aelphia Communications, AOL, Arthur Anderson, global Crossing, Tyco, and, more recently, Fannie Mae and Freddie Mac, led to increased shareholder and governmental interest in corporate governance. This culminated in the passage of the Sarbanes-Oxley Act of 2002. But, since then, the stock market has greatly recovered, and shareholder zeal has waned accordingly.

14

PARTIES TO CORPORATE GOVERNANCE

Parties involved in corporate governance include the regulatory body(e.g. the chief executive officer, the board of directors, management and shareholders). Other stakeholders who take part include suppliers, employees, creditors, customers, and the community at large. All parties to corporate governance have an interest, whether direct or indirect, in the effective performance of the organization. Directors, workers and management receive salaries, benefits and reputation, while

shareholders receive capital return. Customers receive goods and services; suppliers receive compensation for their goods and services. In return these individuals provide value in the form of natural, human, social, and other forms of capital. A key factor in an individuals decision to participate in an organization e.g. through providing financial capital and trust that they will receive a fair share of organizational returns. If some parties are receiving more than their fairer turn then participants may choose to not continue participating leading to organizational collapse.

OBJECTIVES
1. To build an environment of trust and confidence amongst these having competition and conflicting interest. 2. To enhance shareholders value and protect the interest of stakeholders by enhancing the corporate performance and accountability. 3. To have system and procedures which are transparent and which inform the stakeholders about the working of corporations.

15

CHAPTER 3 PRINCIPLES OF CORPORATE GOVERNANCE

Rights and equitable treatment of shareholders:
Organization should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings.

Interest of other stakeholders:

Organizations should recognize that they have legal and other obligations to all legitimate stakeholders.

Role and responsibility of board:

The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to r and challenge management performance. It needs to be of sufficient size and have appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. The key roles of chairperson and CEO should not be held by the same person.

Integrity and ethical behavior:

Ethical and responsible decision making is not only important for public relations, but it is also a necessary element in risk management and avoiding lawsuits. Organization should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is

16

important to understand, though, that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. Because of this many organizations establish Compliance and Ethics programs to minimize the risk that the firm steps outside of ethical and legal boundaries.

Disclosures and transparency:

Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with the level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the companys financial reporting. Disclosures of material matters concerning the organizations should be timely and balanced to ensure that all investors have access to clear, factual information.

INTERNAL CONTROLS

CORPORATE

GOVERNANCE

Internal corporate government controls monitor activities and then take corrective action to accomplish organizational goals. Examples include:

Monitoring by the board of directors:

The board of directors, with its legal authority to hire fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. While nonexecutive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase

17

performance. Different board structures are optimal for different firms. Moreover the ability of the board to monitor the firms executives is a function of its access to information. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. It could be argued therefore, that executives directors look beyond the financial criteria.

Remuneration:
Performance-based remuneration is designed to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares and share options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behavior and can elicit myopic behavior

EXTERNAL CONTROLS

CORPORATE

GOVERNANCE

External corporate governance controls encompass the controls external stakeholders exercise over the organization. Examples include: Competition Debt covenants Demand for and assessment of performance information (especially financial statement)

18

 Government regulations Managerial labour market Media pressure Takeovers

Telephone tapping

OVERVIEW GOVERNANCE

OF

BANK

CORPORATE

Corporate governance for banking organizations is arguably of greater importance than for other companies, given the crucial financial intermediation role of banks in an economy, the need to safeguard depositors funds and their high degree of sensitivity to potential difficulties arising from ineffective corporate governance. Effective corporate governance practices, on both a system-wide and individual bank basis, are essential to achieving and maintaining public trust and confidence in the banking system, which are critical to the proper functioning of the banking sector and economy as a whole. Bank failures can pose significant public costs and consequences due to their potential impact on deposit insurance mechanisms and the possibility of border macroeconomic implications, such as contagion risk and impact on payment systems. Indeed, banks and other financial companies may lose large amounts of money in a short period in the case of events such as fraud.

19

In addition, poor corporate governance can lead markets to lose confidence in the ability of a bank to properly manage its assets and liabilities, including deposits, which could in turn trigger a liquidity crisis or a run on deposits. Banks also typically have access to confidential customer information, which can potentially be misused by employees for personal gains. Moreover, review and analysis of the investments, activities, risk exposures and financial statements of banks may in some cases be more complex than such reviews of other companies for several reasons, including the unrated, borrower specific nature of a banks loan portfolio, as well as valuation challenges. In light of these sensitivities, minimum standards of corporate governance for banks should therefore be more ambitious than for nonfinancial firms. The OCED principles define corporate governance as involving a set of relationships between a companys management, its board, its shareholders, an other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interest of the company and its shareholders and should facilitate effective monitoring. The presence of an effective corporate governance system, within an individual company and across an economy as a whole, helps to provide a degree of confidence that is necessary for the proper functioning of a market economy. From a banking industry perspective corporate governance involves the manner in which the business and affairs of individual institutions are

20

governed by their boards of directors and senior management, which affects how, banks: Set corporate objectives (including generating economics returns to owners). Run the day-to-day operations of the business. Meet the obligations of accountability to their shareholders and take into account the interests of other recognized stakeholders. Align corporate activities and behavior with the expectation that banks will operate in a safe and sound manner, and in compliance with applicable laws and regulations and Protect the interests of depositors.

CORPORATE GOVERNANCE IN BANKING AND FINANCIAL INSTITUIONS

SEBI GUIDELINES FOR GOOD CORPORATE GOVERNANCE

The SEBI a committee on corporate governance and circulated the recommendations to all stock exchange for implementation by listed entities as a part of listing agreement, date Feb 21,2000. Following are some of the important recommendations of SEBI committee: 1. The committee is of the view that non-extinctive directors helps to bring an independent judgments on issue of strategies performance, policies and standards or code of conduct. The committee, therefore,

21

lays emphasis on the caliber of the non-executive directors, especially of independent directors.

2. The committee is of the view that an adequate compensation package must be given to non-executive directors so that these positions becomes financially attractive to attract talent and the non-executive directors are sufficiently compensated for undertaking their work.

3. The committee recommends that the board of the company have an optimum combination of executive and non-executive directors with not less than 50% of the board comprising the non-executive directors. 4. The committee recommends that a qualified and independent audit committee should be set up by the board of the company.

5. The committee recommends that the audit committee should have minimum 3 member, all being non-executive directors, the chairperson of the audit committee should be a qualified CA and all the members must have sound financial and accounting knowledge.

6. The committee recommends that the audit committee should meet at least 3 times in the year. One meeting must be held before the finalisation of annual accounts.

22

7. The quorum should be either 2 member or 113 of the members of audit committee, whichever is more.

8. The committee recommends that the board should set up a recommends committee to determine the recommendation packages for executive directors, including pension right and corporation payment.

9. The committee recommends that the board meeting should be held at least 4 times in a year with the gap of 3 months. The necessary information must be made available to the board.

10. The committee recommend that the directors should not be a member of more than 10 committees or he should not act as a chairman of more than 5 committee across all companies in which he is a director, furthermore, it is mandatory requirement for every directors to inform the company about the committee positions he occupies In other companies and ratify charges as and when they take place. 11. The committee recommends that as a part of the directors report or as an addition to directors report, the management discussion and Analysis report should form the part of the annual report to the shareholder.

23

12.The committee recommends that there must be proper disclosure of all material financial and commercial transactions.

13.The committee recommends that information like quarterly results, presentations by companies to the analysts must be put on company website or may be sent in such a form so as to enable the stock exchange to put on its own website.

14.The committee recommends that the half-yearly declaration of financial performance including the summary of significant event summary of significant event in last 6 months, should be sent to shareholders.

15.The committee recommends that a committee must be formed to specifically look into the problems or complaints of shares, nonreceipts of balance sheet, improper information, non-receipt of dividend etc.

16.The committee recommends that to expedite the process of share transfers. The board of the company should delegate the power of share transfer to an officer or a committee or the registrar and share transfer agent.

24

17.The committee recommends that there must be a separate section on corporate governance in annual report of the company with detailed compliance report on the corporate governance. This will enable the shareholders and securities markets to assess for themselves the standards of corporate governance followed by the company.

CORPORATE GOVERNANCE IN BANKS-INDIAN CONTEXT

In the content of corporate governance, the Indian banking sector has a special role to play, not only because of the critical nature of the business but because its the sector that has had large public ownership which is one in the process of being divested historically, banks has been used for government policy implementation. The differences and criticalities of the sector arise out of the following factors: In the case of banks and financial intermediaries, interest of other stakeholders, namely the depositors, appears to be more important as compared to other corporate to other corporate. The risk in baking institutions is many (for example credit risk, counterparty risk, liquidity risk etc.) and these have systematic implications. The East Asian crisis of the 1990s is a case in point. Corporate governance in general is a systematic process for enhancing wealth generating capacity, meeting stakeholders and social expectations. In this context, governance in banks and financial institutions (FIs) has been attracting special attention in India during the past few years for a number of

25

reasons. Firstly with liberalizations and globalizations, the Indian economy, while the global markets, on the domestic markets. It is well understood that vulnerable unstable and opaque banking and financial system can several system can severely disrupt macro economic performance of that country. It is therefore necessary to strengthen both supervisory and regulatory framework puff of the banking and financial system, further, with increasing deregulation, inspire of the fact that the banking and financial system all over the globe including India, are regulation, particularly in the areas of supervision, accounting and disclosures. However, the issues are complex and merely meeting these standards would note sufficient by themselves for stability in the long run unless there are well-established governance processes permitting throughout an

organization through a system proper conduct and professional management. When referring to a banking institution it should a read as meaning both on a solo and a consolidated basis a banking institutions must have a satisfactorily level of corporate governance related to its size and nature of its business and activities undertaken corporate governance of banks in any is important for several reasons.

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CORPORATE GOVERNANCE AND THE WORLD BANK

The World Bank reports on corporate governance is a landmark in the evolution of the theory and its implications of this concept of the best corporate behavior. Governance in relation to a business organization concerns with the intrinsic nature, purpose integrity and identify of the organization and focuses primarily on the relevance continuity and the fiduciary aspects of the organization. It involves monitoring and overseeing strategic direction, socio-economic and cultural context, externalities and constituencies of the organization. Hence, corporate governance can be called as an umbrella term encompassing specific issues arising from interactions among senior management personnel, shareholder, board of directors, depositors, borrowers, other constituencies and the society at a large. It deals with the exercise of power over the direction of enterprise, the supervision of the affairs of the corporation. The World Bank report on corporate governance recognizes the complexity of the very concept of corporate governance and therefore focuses on the principle on which it is based. These principles such as transparency accountability, fairness and responsibility are universal in their application. Corporate governance is concerned with holding the balance between economies and social goals and between individual and community goals. The governance framework is there to encourage the efficient use of resources and equally to require accountability for the corporations and the society. It marks and important milestone in the development of corporate governance.

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CHAPTER 4 CHALLENGES IN CORPORATE GOVERNANCE

CHALLENGES OF ADOPTING BETTER CORPORATE GOVERNANCE NORMS
The recent growth in corporate governance literature has focused on ways that corporations work. Firm behavior was earlier modeled on the argument of then so classicist who ascertained that firms are nothing more than productions countries. All activities of the firm were geared so as to maximize profit. Finance literature in particular came a long way in explaining the various financial theories of firms and the behavior associated with them. With the increasing understanding that mere economic and production based explanations do not exhaustively describe the motivations for governance. Researchers have focused on the behavioral side of firms performance to justify the economic rationale of such critical behaviors.

The foundational argument of corporate governance as seen by both academics well as other independent researchers can be traced back to the pioneering work of Berle and means (1932) who observed as early as 1930s that the modern corporations having acquired as very large size can create the possibility of the separation of control over the firm from its direct ownership. Earst while promoters who largely controlled and Means observations of the departure of the owners from the actual control of the corporations led to a renewed emphasis on the behavioral dimension of the theory of the firm. The modern day uproar over corporate governance

28

problems insider trading, excessive executive compensations of shareholder wealth, false reporting, non disclosure of certain accounting and governance mal practices and self dealing among others, are assumes to be related to the theory of separation of ownership and control. Theoretical interest in corporate governance in India is a recent phenomenon. It is a result of a spate of corporate scandal that shook the country during the early liberalization era. Obscure companies quickly listed on the exchanges during the stock market boom of 1993-94 only to disappear siphoning off public fund funds and leaving the retail investors with illiquid stock. The sudden appearance of fly-by-night operators during the period coupled with the emergence of a new breed of shareholders like the foreign investors, mutual funds and private equity placement companies and their demand for better governance practices has compelled the policy makers to think of the governance in corporate India. The demand of financial liberalization, it appears, have help in imparting greater control in the banks in their operations Responsibility has now been totally fixed upon them for any likely loan losses. This would enable banks to maintain proper checks and balances apropos of expropriations of shareholder value by the managers. Varied opinions were articulated in India in response to wide ranging corporate scam/scandals like violations of foreign exchanges regulations, making clandestine payment to politicians, involvement in illegal activities and unethical deals by the top industrial houses. While some suggested that the investigations might scare away the foreign investors and the economy would once again be in tatters, other stressed on the importance so social responsibilities of business. The code was prepared with the view that Indian

29

companies had to adopt the best of corporate practices if they were to access domestic as well as foreign capital at competitive rates. The code agrees that there was no unique way of understanding corporate governance. Different structures established in different countries might not be pertinent to local conditions. With increased exposure to global markets it became imperative on corporations to focus on transparency and adopt. A. That government, set government companies, societies and local authorities owned or controlled by the central government or otherwise. B. Exercise superintendence over the vigilance administration of the various Ministries of the Central Government or corporate established by rounder any Central Act, Government companies and societies, local authorities owned or controlled by that government. The persons referred in Clause ( c ) of subsection (1) are as follows : i. ii. Group A Officers of the Central Government. Such level Officers of the corporations established by or under any central Act, government companies, societies, as that Govt may, by notifications in the Official Gazette, specify in this behalf. iii. Provided that till such time a notification is issued under this clause, all officers of the said corporations, companies, societies and local authorities shall redeem to be the persons referred to clause (c ) of the subsections (1).

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CHAPTER 5 COMMITTEE REPORT

CADBURY COMMITTEE REPORT
The stated objective of the Cadbury committee was to help raise the standards of corporate governance and level of confidence in financial reporting and auditing by setting our clearly what it sees as the respective responsibility of those involved and what it believes is expected of them. The committee investigated accountability of the BOD to the shareholders and to the society. It submitted its report and associated code of best practices in December 1992. Wherein it spelt out the methods of governance needed to achieved balance between essential powers of the BOD and heir accountability, the resulting reports, and associated the Code of best practices published in Dec 1992 was generally well received while there commendations themselves were not mandatory. The companies listed on the London Stock Exchanges were required to clear state in their account whether or not code has been followed, the companies who did not comply were requires to explain the reason for that. The Cadbury Code for best practices at 19 recommendations being the pioneering on corporate governance it would in order to make brief references to them the recommendations are in the nature of the guidelines relating to board of directors, co-executives directors, executive directors and those on reporting and control. It is the boards duty to present a balanced and understandable assessment companies position that board should ensure that an objective and

31

professional relationship is maintain with auditors the board should establish an audit committee of at least three-executive directors with return terms references which deal authority and duties. The directors should explain their responsibility for preparing the accounts next to the statement by the auditors about their reporting responsibility. The directors should report on the effectiveness of the company system of the company.

BASIL

COMMITTEE

PUBLIATION FOR

ON

CORPORATE

GOVERNANCE

BANKING

ORGANIZATIONS:
Basil committee published paper on corporate governance for banking organization in September 1999. Let me share with you some of the issues shared in that paper the committee feels that it is the responsibility of the banking supervision to ensure there is effective CG in banking industry supervisory experience underscores the need having appropriate

accountability and cheques and balance with each bank to ensure sound CG which in turn lead to effective and more meaningful supervision eg could also contribute to a collaborative working relationship with banks management and supervisors. Basil committee underscores the need for banks to set strategies for their operations. The committee also insists banks to establish accountability for executing the strategies unless there is transparency of information related to

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decision and action. It would be difficult for stakeholders to make managements to more accountable. From the perspective of banking industry, CG also includes also in its ambit the manner in which there BODs govern the business and affairs of individual institutions and there functional relationship in the senior management this determines hoe banks. It has had highlighted the fact that CG should have, as the basis, the following strategies and techniques: The corporate value code of conduct and other standards of appropriate behavior and the system use to ensure compliance with them. A well articulated corporate strategy against which the successes of overall enterprise and the contributions of individual can be measured.

The clear assignment of responsibilities and decision making authorities incorporating hierarchy of required approvals from individuals to the board of directors. Establishment for mechanism for the interaction and corporation among the BOD, senior management and the auditors.

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 Strong internal control system, including internal external audit functions, risk, management functions, independent of business lines, other checks and balances.

Special monitoring of risk exposures where conflicts of interest are likely to be particularly great, including business relationship with borrowers affiliated with the bank, large shareholders, senior management or key decision makers within the firms. The financial and managerial incentives to act in an appropriate manner offered to senior management, business line management and employees in the form of compensation promotions and other recognition.

Appropriate information flows internally and to the public. For ensuring good CG, the importance of overseeing various aspects of corporate functioning needs to be property understood appreciated and implemented.

There are 4 important forms of oversight that should be included in the organizational structure of any banking order to ensure the appropriate checks and balances: 1. Oversight by BOD or supervisory board.

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2. Oversight by the individuals not involved in the day to day by running various business areas. 3. Direct line supervision of different business areas. 4. Independent risk management and audit functions.

REPORT OF THE KUMAR MANGALAM BIRLA COMMITTEE ON CORPORATE GOVERNANCE

1.1 The issue of corporate governance involves besides shareholders, all other stakeholders. The committees recommendations have looked at corporate governance from the point of view of the stakeholders and in particular that of the shareholders and investors, because they are the raison de enter for corporate governance and also the prime constituency of SEBI .The control and reporting functions of boards, the roles of the various committees of the board, the management, all assume special significance when viewed from this perspective. The other way of looking at corporate governance is from the contribution that good corporate governance makes to the efficiency of a business enterprise, to the creation of wealth and to the countrys economy. In a sense both these points of view are related and during the discussions at the meetings of the committee, there was a clear convergence of both points of view.

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1.2 The committee recognized that India had in place a basic system of corporate governance and that SEBI has already taken a number of initiatives toward raising the existing standards. The committee also recognized that the confederation of the Indian industries had published a code entitled Desirable Code of Corporate Governance and was encouraged to note that some of the forward looking companies have

already reviewed or are in the process of reviewing their board structures and have also reported in their 1998-99 annual reports the extent to which they have complied with the code. The committee however felt that under Indian conditions a statutory rather than a voluntary code would be far more purposive and meaningful, at least in respect of essential features of corporate governance.

1.3 The committee however recognized that a system of control should not so hamstring the companies so as to impede their ability to compete in the marketplace. The committee believes that the recommendations made in this report mark an important step forward and if accepted and followed by the industry, they would raise the standards in corporate governance, strengthen the unitary board system, significantly increase its effectiveness and ultimately serve the objective of maximizing shareholder value.

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The Constitution of the committee and the setting for the report
There are some Indian companies, which have voluntarily established high standards of corporate governance, but there are many more, whose practices are a matter of concern. There is also an increasing concern about standards of financial reporting and accountability, especially after have been avoided, with better and more transparent reporting practices.. Another example of bad governance has been the allotment of promoters shares, on preferential basis at preferential prices, disproportionate to market valuation of shares, leading to further dilution of wealth of minority shareholders. This practice has however since been contained. There are also many companies, which are not paying adequate attention to the basic procedures for shareholders serviced for example many of these companies do not pay adequate attention to redress investors grievances such as delay in transfer of share, delay in dispatch of share certificates also do not pay sufficient attention to timely dissemination of information to investors as also to the quality of such information. SEBI has been regularly receiving large number of investor complaints on these matters. While enough laws exits to take care of many of these investor grievances, the implementation and inadequacy of penal provisions have left a lot to be desired. Corporate governance is considered an important instrument of investor protection, and it is therefore a priority on SEBIs agenda. To further improve the level of corporate governance, need was felt for a comprehensive approach at this stage of development of the capital market,

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to accelerate the adoption of globally acceptable practices of corporate governance. This would ensure that the Indian investors are in no way less informed and protection as compared toothier counterparts in the bestdeveloped capital markets and economies of the world. Securities market regulators in almost all developed and emerging markets have for sometime been concerned about the importance of the subject and of the need to raise the standards of corporate governance. The financial crisis in the Asian market in the recent past have highlighted the need for improved level of corporate governance and the lack of it in certain countries have been mentioned as one of the causes of the crisis. Indeed corporate governance has-been a widely discussed topic at the recent meetings of the International Organization of Securities Commission (IOSCO). Besides in an environment in which emerging markets increasingly compete for global capital, it is evident that global capital will flow to markets which are better regulated and observe higher standards of transparency, efficiency and integrity. Raising standards of corporate governance is therefore also extremely relevant in this context. 2.5In the above mentioned context, the Securities and Exchange Board of India (SEBI) appointed the Committee on Corporate Governance on May 7,1999 under the Chairmanship of Shri Kumar Mangalam Birla, member SEBI Board, to promote and raise the standards of Corporate Governance terms of the reference are as follows : A) To suggest suitable amendments to the listing agreement executed by the stock exchanges with the companies and any other measures to improve the standards of corporate governance in the listed companies, in areas such as continuous disclosure of material

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information, both financial and non-financial, manner and frequency of such disclosures, responsibilities of independent and outside directors. B) To draft a code of corporate best practices, & C) To suggest safeguards to be instituted within the companies to deal with insider information and insider trading.

A number of reports and codes on the subject have already been published. Internationally notable among them are the Report of the Cadbury Committee, chairman of the repot of the Greenburg Committee, the Combined Code of the London Stock Exchange, the OECD Code on Corporate Governance and The Blue Ribbon Committee on Corporate Governance. In India, the CII has published a Code of Corporate

Governance. In preparing this extent appropriate, the primary objective of the Committee was to view corporate governance from the perspective of the investors and shareholders and to prepare a Code to suit the Indian corporate environment, as corporate governance frameworks are not exportable. The Committee also took note of the various steps already taken by SEBI for strengthening corporate governance, some of which are : Strengthening of disclosure norms for IPO following there commendations of the Committee set up by SEBI under the Chairmanship of Shri Y H Malegam . Providing information in directors reporting for utilization of funds and variation between projected and actual use of funds according to

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the requirements of the Companies Act. Inclusion of cash flow and fund flow statement in annual reports : Declaration of quarterly results. Mandatory appointment of compliance with various rules and regulations. Timely disclosure of material and price sensitive information including details of all material events having a bearing on the performance of the company. Dispatch of one copy of complete balance sheet to every household and abridged balance sheet to all shareholders. Issue of guidelines for preferential allotment at market related prices, & Issue of regulations providing for a fair and transparent framework for takeovers and substantial acquisitions. The Committee has identified the three key constituents of corporate governance as the shareholder, the Board of Directors and the Management and has attempted to identify in respect of each of these constituents, their roles and responsibilities as also their rights in the context of good corporate governance. Fundamental to this examination and permeating throughout this exercise is the recognition of the three key aspects of corporate governance, namely accountability, transparency and equality of treatment for all stakeholders. Adequate financial reporting and disclosure are the corner stones of good corporate governance. These demand the existence and implementation of proper accounting standards and disclosure requirements. A separate committee appointed by SEBI under the chairmanship of Shri Y H Malegam

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(who is also a member of this committee) is examining these issues on a continuing basis. This committee has advised that while in most areas, accounting standards in India are comparable with International Accounting Standards both in terms of coverage and content, there are a few areas where additional standards need to be introduced in India on an urgent basis. These matter are discussed in greater detail in para 12.1 of this report. The committees draft report was made public through the media and also put on the web site of SEBI for comments. The report was also sent to the Chambers of commerce, financial institutions, stock exchange, investor associations, the Association of Merchant Bankers of India, Association of Mutual funds of India, the Institute of chartered accountants of India, institute of company secretaries of India, academicians, experts and eminent personalities in the India capital market, foreign investment. S copy of the draft report was also sent to Sir Adrian Cadbury who had chaired the Cadbury Committee on Corporate Governance set up by the London Stock Exchange, the financial Reporting Council and the Accountancy Bodies in the U.K. in 1991. The committee puts on record its appreciation of the valuable inputs and painstaking efforts of Shri Anup Srivastava, Vice-President Corporate Strategy and Business Development of the Aditya Birla Group, Shri P K Bindlish, Division chief, SEBI, Shri Umesh Kumar, and other officers of the SMDRP department of SEBI, in the preparation of this report.

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CHAPTER 6 RECOMMENDATIONS OF THE COMMITTEE

This Report is the first formal and comprehensive attempt to evolve a Code of Corporation Governance, in the context of prevailing conditions of governance in Indian companies, as well as the state of capital markets. While making the recommendations the Committee has been mindful that any code of Corporate Governance must e dynamic, evolving and should change with changing context and times to time, keeping pace with the changing expectations of the investors, shareholders, and other stakeholders and with increasing sophistication achieved in capital market.

Corporate Governance the Objective

Corporate Governance has several claimants shareholders and other stakeholders which include suppliers, customers, creditors, the bankers, the employees of the company, the government and the society at large. This Report on Corporate Governance has been prepared by the Committee for SEBI, keeping in view primarily the interests of a particular class of stakeholders, namely, the shareholders, who together with the investors form the principal constituency of SEBI while not ignoring the needs of other stakeholders. The committee therefore agreed that the fundamental objective of corporate governance is the enhancement of shareholder value, keeping in view the interests of other stakeholder. This definition harmonises the need for a

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company to strike a balance at all times between the need to enhance shareholders wealth whilst not in any way being detrimental to the interests of the other stakeholders in the company. In the opinion of the Committee, the imperative for corporate governance lies not merely in drafting a code of corporate governance, but in practicing it. Even now, some companies are following exemplary practices, without the existence of formal guidelines on this subject. Structures and rules are important because they provide a framework, which will encourage and enforce good governance but alone, these cannot raise the standards of corporate governance. What counts is the way in which these are put to use. The committee is thus of the firm viw, that the best results would be achieved when the companies begin to treat the code not as a mere structure, but as a way of life. It follows that the real onus of achieving the desired level of corporate governance, lies in the proactive initiatives taken by the companies themselves and not in the external measures like breadth and depth of a code or stringency of enforcement of norms. The extent of discipline, transparency and fairness, and the willingness shows by the companies themselves in implementing the code, will be the crucial factor in achiving the desired confidence of shareholder and crucial factor in achiving the desired confidence of shareholders and other stakeholders and fulfilling the goals of the company.

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Applicability of Recommendations Mandatory and NonMandatory Recommendations

The Committee debated the question of voluntary versus mandatory compliance of its recommendations. The committee was of the firm view that mandatory compliance of the recommendations at least in respect of the essential recommendations would be most appropriate in the Indian context for the present. The committee also noted that in most of the countries where standards of corporate governance are high, the stock exchanges have enforced some form of compliance through their listing agreements. The committee felt that some of the recommendations are absolutely essential for the framework of corporate governance and virtually form its core. While other could be considered as desirable. Besides, some of there commendations may also need change of statute, such as the Companies Act, for their enforcement. In the case of other, enforcement would be possible by amending the Securities Contracts (Regulation) Rules, 1957 and by amending the listing agreement of the stock exchange under the direction of SEBI. The latter, would be less time consuming and would ensure speedier implementation of corporate governsnce. The committee therefore felt that there commendations should be divided into mandatory and nonmandatory categories and those recommendations which are absolutely essential for corporate governance, can be defined with precision and which can be enforcedthrough the amendment, which are either desirable or which may require changes of laws, may, for time being, be classified as nonmandatoey.

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Applicability
The committee is of the opinion that the recommendations should be made applicable to the listed companies, their directors, management, employees and professionals associated with such companies, in accordance with the time table proposed in the schedule given later in this section. Compliance with the ode should be both in letter and spirit and should always be in a manner that gives precedence to substance over form. The ultimate responsibility for putting there commendations into practice lie directly with the board of directors and the management of the company. The recommendations will apply to all the listed private and public sector companies, in accordance with the schedule of implementation, as for listed entities, which are not companies, but body corporate (e.g. private and public sector banks, financial institutions, insurance companies, etc) incorporated under other statutes, the recommendations will apply to the extent that they do not violate their respective statutes, and guidelines or directives issued by the relevant regulatory authorities.

Board of Directors
The board of the company provides leadership and strategic guidance, objective judgment independent of the management of the company and exercises control over the company, while remaining all the times accountable to the shareholders. The measure of the board is not simply whether it fulfills its legal requirements but more importantly, the boards attitude and the manner it translates its awareness and understanding of its

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responsibilities. An effective corporate governance system is one, which allows the board to perform these dual functions efficiently. The board of directors of a company thus directs and controls the management of a company and is accountable to the shareholders. The board directs the company, by formulating and reviewing companys policies, strategies, major plans of action, risk policy, annual budgets and business plans, setting performance objectives, monitoring implementation and corporate performance, and overseeing major capital expenditures, acquisitions and divestitures, charge in financial control and compliance with applicable laws, taking into account the interests of stakeholders. It controls the company and its management by laying down the code of conduct, overseeing the process of disclosure and communications, ensuring that appropriate systems for financial control and reporting and monitoring risk are in place, evaluating the performance of management, chief executives, executive directors and providing checks and balances to reduce potential conflict between the specific interest of management and the wider interest of the company are shareholders including misuse of corporate assets and abuse in related party transactions, it is accountable to the shareholders for creating, protecting and enhancing wealth and resources for the company, and reporting to them on the performance in a timely and transparent manner. However, it is not involved in day-to-day management of the company, which is responsibility of the management.

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Composition of the board of directors

The committee is of the view that the composition of the board of directors is critical to the independent functioning of the board. There is a significant body of literature on corporate governance, which has guided the composition, structure and responsibilities of the board. The Committee took note of this while framing its recommendations on the structure and composition of the board. The composition of the board is important in as much as it determines the ability of the board to collectively provide the leadership and ensures that no one individual or a group is able to dominate the board. The executive directors (like director-personnel) are involved in the day to day management of the companies the non-executive directors bring external and wider perspective and independence to the decision making. Till recently, it has been the practice of most of the companies in India to fill the board with representatives of the promoters of the company, and independent directors if chosen were also handpicked thereby ceasing to be independent. This has undergone a change and increasingly the boards comprise of following groups of directors, (promoters being defined by the erstwhile Malegam Committee), executive and non-executive directors, namely, those who are between two classes of non-executive directors, namely, those who are independent and those who are not.

Independent directors and the definition of independenceAmong the non-executive directors are independent directors, who have a key role in the entire mosaic of corporate governance. The committee was of the view that it was that it was important that independence be suitably,

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correctly and pragmatically defined, so that the definition itself does not become a constraint in the choice of independent directors on the boards of companies. The definition should bring out what in the view of the committee is the touchstone of independence, and which should be sufficiently board and flexible. It was agreed that material pecuniary relationship which affects independence of a directors should be the litmus test of degree of maturity when left to itself, to determine whether a director is independent or not. The committee therefore agreed on the following definition of independence. Independent directors are directors who apart from receiving directors remuneration do not have any other material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries, which in the judgment of the board may affect their independence of judgment. Further all pecuniary relationships or transactions of the non-executive directors should be disclosed in the annual report. The blue Riband committee of the USA and other committee reports have laid considerable stress on the role of independent directors. The law however does not make any distinction between the different categories of directors and all directors are equally and collectively responsible in law for the board sections and decisions. The committee is of the view that the nonexecutive directors, i.e. those who are independent and those who are independent and those who are not, help bring an independent judgment to bear on boards deliberations especially on issue of strategy, performance, management of conflicts and standards of conduct. The committee therefore lays emphasis on the caliber of the non-executive directors, especially of the independent directors.

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Good corporate governance dictates that the board be comprised of individuals with certain personal that characteristics and core competencies such as recognition of the importance of the boards tasks, integrity, a sense of accountability, track record of achievements, and the ability to ask tough questions. Besides, having financial literacy, experience, leadership qualities and ability to think strategically, the directors must show significant degree of commitment to the company and devote adequate time for meeting, preparation and attendance. The Committee is also of the view that it is important that adequate compensation package be given to the non-executive independent directors so that these positions become sufficiently financially attractive to attract talent and that the non-executive directors are sufficiently compensated for undertaking this work. Independence of the board is critical to ensuring that the board fulfils its oversight role objectively and holds the management accountable to the shareholders. The Committee has, therefore, suggested the above definition of independence, and the following structure and composition of the board and of the committees of the board. The Committee recommends that the board of the company have an optimum combination of executive and non-executive directors with not less than fifty percent of the board comprising the non-executive directors. The number of independent directors (independence being as defined in the foregoing paragraph) would depend on the nature of the chairman of the board. In case a company has a non-executive chairman, at least one-third of board should comprise of independent directors and in case a company has an executive chairman, at least half of board should be independent.

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The tenure of office of the directors will be as prescribed in the Companies Act.

Chairman of the board

The Committee believes that the role of Chairman is to ensure that the board meetings are conducted in a manner which secures the effective participation of all directors, executive and non-executive alike, and encourages all to make an effective contribution, maintain a balance of power in the board, make certain that all directors receive adequate information, well in time and that the executive directors look beyond their executive duties and accept full share of the responsibilities of governance. The Committee is of the view that the Chairmans role should in principle be different from that the chief executive, though the same individual may perform both roles. Give the importance of Chairmans role, the Committee recommends that a non-executive Chairman should be entitled to maintain a Chairmans office at the companys expense and also allowed reimbursement of expenses incurred in performance of his duties. This will enable him to discharge the responsibilities effectively.

Audit Committee
1. There are few words more reassuring to the investors and shareholders than accountability. A system of good corporate governance promotes relationships of accountability between the principal actors of sound financial reporting the board, the management and the auditor. It holds the management accountable to the board and the board accountable to the shareholders. The audit committees role flows

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directly from the boards oversight function. It acts as a catalyst for effective financial reporting. 2. The Committee is of the view that the need for having an audit committee grows from the recognition of the audit committees position in the larger mosaic of the governance process, as it relates to the oversight of financial reporting. 3. A proper and well functioning system exists therefore, when the three main groups responsible for financial reporting the board, the internal auditor and the outside auditors form the three-legged stool that supports responsible. Financial disclosure and active and participatory oversight. The audit committee has an important role to play in this process, since the audit committee is a sub-group of the full board and hence the monitor of the process. Certainly, it is not the role of the audit committee to prepare financial statements or engage in the myriad of decisions relating to the preparation of those statements. The committees job is clearly one of oversight and monitoring and in carrying outhits job it relies on senior financial management and the outside auditors. However it is important to ensure that the boards function efficiently for if the boards are

dysfunctional, the audit committee will do no better. The Committee believes that the progressive standards of governance applicable to the full board should also be applicable to the audit committee. 4. The Committee therefore recommends that a qualified and independent audit committee should be set up the board of a company. This would go along way in enhancing the credibility of the financial

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disclosure of a company and promoting transparency. This is a mandatory recommendation. 5. The following recommendations of the Committee, regarding the constitution, functions and procedures of the audit committee would have to be viewed in the above context. But just as there is no one size fits all for the board when it comes to corporate governance, same is true for audit committee. The Committee can thus only lay down some broad parameters, within which audit committee has to evolve its own guidelines,

Composition
The composition of the audit committee is based on the fundamental premise of independence and expertise. The Committee therefore recommends that The audit committee should have minimum three members, all being nonexecutive directors, with the majority being independent, and with at least one director having financial and accounting knowledge; The chairman of the committee should be an independent director; The chairman should be present at Annual General Meeting to answer shareholder queries; The audit committee should invite such of the executive, as it considers appropriate (and particularly the head of the finance function) to be present at the meetings of the Committee but on

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occasions it may also meet without the presence of any executives of the company. Finance director and head of internal audit and when required, a representative of the external auditor should be present as invitees for the meetings of the audit committee; The Company Secretary should act as the secretary to the committee.

Frequency of meetings and quorum

The Committee recommends that to begin with the audit committee should meet at least thrice a year. One meeting must be held before finalization of annual accounts and one necessarily every six months. The quorum should be either two members or one-third of the members of the audit committee, whichever is higher and there should be a minimum of two independent directors.

Powers of audit committee

Being a committee of the board, the audit committee derives its powers from the authorization of the board. The Committee recommends that such powers should include powers: To investigate any activity within its terms of reference. To seek information from any employee.

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 T o obtain outside legal or other professional advice. To secure attendance of outsiders with relevant expertise,if it considers necessary.

Functions of the Audit Committee

As the audit committee acts as the bridge between the board, the statutory auditors and internal auditors, the Committee recommends that its role include the following Oversight of the companys financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible Recommending the appointment and removal of external auditor, fixation of audit fee and also approval for payment for any other services, Reviewing with management the annual financial statements before submission to the board, focusing primarily on: Any changes in accounting policies and practices. Major accounting entries based on exercise of judgement by management. Qualifications in draft audit report. Significant adjustments arising out of audit. The going concern assumption. Compliance with accounting standards. Compliance with stock exchange and legal requirements concerning financial statements.

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 Any related party transactions i.e. transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives etc. that may have potential conflicts with the interests of company at large. Reviewing with the management, external and internal auditors, the adequacy of internal control systems. Reviewing the adequacy of internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading the department, reporting structure, coverage and frequency of internal audit. Discussion with internal auditors of any significant findings and follow-up thereon. Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board. Discussion with external auditors before the audit commences, of the nature and scope of audit. Also post-audit discussion to ascertain any area of concern. Reviewing the companys financial and risk management policies. Looking into the reasons for substantial defaults in the payments to the depositors, debenture holders, share holders (in case of non-payment of declared dividends) and creditors.

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Accounting Standards and Financial Reporting

Over time the financial reporting and accounting standards in India have been upgraded. This however is an ongoing process and we have to move speedily towards the adoption of international standards. This is particularly important from the angle of corporate governance. The Committee took note of the discussions of the SEBI Committee on Accounting Standards referred to earlier and makes the following recommendations: Consolidation of Accounts of subsidiaries companies should be required to give consolidated accounts in respect of all its subsidiaries in which they hold 51% or more of the share capital. The Committee was informed that SEBI was already in dialogue with the Institution of Chartered Accountants of India to bring about the changes in the accounting Standards on consolidated financial statements. The Institute of Chartered Accountants of India should be requested to issue the Accounting Standards for consolidation expeditiously.

Segment reporting where a company has multiple lines of business

Equally in cases of companies with several businesses, it is important that financial reporting in respect of each product segment should be available to shareholders and the market to obtain a complete financial picture of the company. The committee was informed that SEBI was already in dialogue with the Institution of Chartered Accountants of India to introduce the Accounting Standard on segment reporting. The Institution of Chartered

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Accountants of India has already issued an Exposure Draft on the subject and should be requested to finalise this at an early date.

Disclosure and treatment of related party transactions.

This again is an important disclosure. The Committee was informed that the Institution of Chartered Accountants of India ha already issued an Exposure Draft on the subject. The committee recommends that the Institution of Chartered Accountants of India should be requested to finalize this at the earliest. In the interim, the committee recommends the disclosures set out in Clause 7 of Annexure-4.

Treatment of deferred taxation

The treatment of deferred taxation and its appropriate disclosure has an important bearing on the true and fair view of the financial status of the company. The Committee recommends that the Institute of Chartered Accountants of India be requested to issue a standard on deferred tax liability at an early date.

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Shareholders
The shareholder are the owners of the company and as such they have certain rights and responsibilities. But in reality companies cannot be managed by shareholder referendum. The shareholders are not expected to assume responsibility for the management of corporate affairs. A companys management must be able to take business decisions rapidly. The shareholders have therefore to necessarily delegate many of their responsibilities as owners of the company to the directors who then become responsible for corporate strategy and operations. The implementation of this strategy is done by a management team. This relationship therefore brings in the accountability of the boards and the management to the shareholders of the company. A good corporate framework is one that provides adequate avenues to the shareholders for effective contribution in the governance of the company while insisting on a high standard of corporate behavior without getting involved in the day to day functioning of the company.

Responsibilities of shareholders
The committee believes that the General Body Meetings provide an opportunity to the shareholders to address their concerns to the board of directors and comment on and demand any explanation on the annual report or on the overall functioning of the company. It is important that the shareholders use the forum of general body meetings for ensuring that the company is being properly stewarded for maximizing the interests of the shareholders. This is important especially in the Indian context. It follows

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from the above that for effective participating shareholders must maintain decorum during the General Body Meetings.

The committee recommends that in case of the appointment of a new director or re-appointment of a director the shareholders must be provided with the following information: A brief resume of the director. Nature of his expertise in specific functional areas, & Name of companies in which the person also holds the directorship and the membership of committees of the board.

Shareholders rights The basic rights of the shareholders include right to transfer and registration of share, obtaining relevant information on the company on a timely and regular basis, participating and voting in shareholder meetings, electing members of the board and sharing in the residual profits f the corporation. The committee recommends that information like quarterly results, presentation made by companies to analysts may be put on companys web site or may be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own web-site. The committee recommends that the half-yearly declaration of financial performance including summary of the significant events in last 6 months, should be sent to each household of shareholders.

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The annual general meeting of the company should not be deliberately held at venues or the timing should not be such which makes it difficult foe most of the shareholders to attend. The company must also ensure that it is not inconvenient or expensive for shareholders to cast their vote. The committee recommends that a board committee under the chairmanship of non-executive director should be formed to specifically look into the redressing of shareholder complaints like transfer of shares, non receipt of balance sheet, non-receipt of declared dividends, etc. the committee believes that the formation of such a committee will help focus the attention of the company on shareholders grievances and sensitise the management to redressal of their grievances. The committee further recommends that to expedite the process of share transfer to an officer, or a committee or to the registrar and share transfer agents. The delegated authority should attend to share transfer formalities at least once in fortnight.

Institutional shareholders
Institutional shareholder have acquired large stakes in the equity share capital of listed Indian companies. They have or are in the process of becoming majority shareholders in many listed companies and own shares largely on behalf of the retail investors. They thus have a special responsibility given the weight age of their votes and have a bigger role to play in corporate governance as retail investors look upon them for positive use of their voting rights.

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The committee is of the view that the institutional shareholders. Take active interest in the composition of the Board of Directors. Be vigilant. Maintain regular and systematic contact at senior level for exchange of views on management, strategy, performance and the quality of management. Ensure that voting intentions are translated into practice. Evaluate the corporate governance performance of the company.

SUGGESTED LIST OF ITEMS TO BE INCLUDED IN THE REPORT ON CORPORATE GOVERNANCE IN THE ANNUAL REPORT OF COMPANIES
1. A brief statement on companys philosophy on code of governance.

2. Board of directors : Composition and category of directors for example promoter,

executive, non-executive, independent non-executive, nominee director, which institution represented as Lender or as equity investor.

Attendance of each directors at the BOD meetings and the last

AGM.

Number of BOD meetings held, date on which held.

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3. Audit committee :
Brief description of terms of reference.

Composition, name of members and Chairperson. Meeting and attendance during the year.

4. Remuneration committee :
Brief description of terms of reference. Composition, name of members and Chairperson. Attendance during the year Remuneration policy. Details of remuneration to all the directors, as per format in main report.

5. General body meeting :

Name of non-executive director heading the committee. Name and designation of compliance officer. Number of shareholders complaints received so far. Number not solved to the satisfaction of shareholders. Number of pending share transfer.

6. General body meeting :

Location and time, where last three AGMs held. Whether special resolutions. Were put through postal ballot last year, details of voting pattern. Person who conducted the postal ballot exercise.

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 Are proposed to be conducted through postal ballot. Procedure for postal ballot.

7. Disclosures :
Disclosures on materially significant related party transactions i.e. transactions of the company of material nature, with its promoters, the directors or the management, their subsidiaries or relatives etc. that may have potential conflict with the interests of company at large. Details of non-compliance by the company, penalties, strictures imposed on the company by Stock Exchange or SEBI or any statutory authority, on any matter related to capital markets, during the last 3 yrs.

8. Means of communication:
Half-yearly report sent to each household of shareholders. Quarterly results. Which newspaper normally published. Any website, where displayed. Whether it also displays official news releases and. The presentations made to institutional investors or to the analysts.

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CHAPTER 7 CASE STUDY

HDFC BANK CORPORATE GOVERNANCE INITIATIVES
The bank believes in adopting and adhering to the best recognized corporate governance practices and continuously benchmarking itself against each such practice. The bank understands and respects its fiduciary role and responsibility to shareholders and strives hard to meet their expectations. The bank believes the best board practices, transparent disclosures and shareholder empowerment are necessary for creating shareholder value. The bank has infused the philosophy of corporate governance into all its activities. The philosophy on corporate governance is an important tool for shareholder protection and maximization of their long term value. The cardinal principals such as independence, accountability, responsibility transparency, fair and timely disclosures, credibility etc, serve as the means for implementing the philosophy of corporate governance in letter and spirit. The code of ethics/conducts intends to ensure adherence to highest business and ethical standards while conducting the business of the bank and compliance of the section 406 of the Sarbanes-Oxeltey Act of 2002 and the rules and regulations framed there under by the Securities and Exchange Commission of USA and other statutory and regulatory authorities in India and USA. The bank values the ethical business standard very highly and intends adherence thereto in every segment of the business.

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ONE POSSIBLE SOLUTION :

1. Banks have an overwhelming dominant position in developing economy financial systems and are extremely importance engines of economic growth. 2. As financial markets are usually underdeveloped banks in developing economics are typically the most important source of financial of majority of the firms. 3. As well as providing a generally accepted means of payment, banks in developing countries are usually the main depository for the economys savings. 4. Many developing economies have recently liberalized their banking system through privatization disinvestment and reducing the role of economies regulation. Consequently, managers of banks in these economies have obtains greater freedom in how they run their banks. 5. Due to the unique nature of the banking firms, whether in the developing or developing world, requires that the board view of corporate governance, which encapsulates both shareholder and depositors, to be adopted for banks. In particularly, the nature of banking firm is such that regulations necessary to protect depositors as well as the overall financial system. 6. The separation of ownership and control has given rise to agency problem whereby management operated the firm in their own interest, not those of shareholders.

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CHAPTER 8 CONCLUSION
Corporate governance plays a highly significant role in banks. It is seen that the corporate governance revolves around the enhancing value,

accountability at all levels, transparent and enhancing the image of the organization would be the major ingredients of good corporate governance. After globalization and financial sector reforms, corporate governance has been receiving a lot of attention in the banking sector. Banks in a board sense are institutions whose business is handling other peoples money. A joint stock bank also known as the commercial bank is a company whose business is banking. There are more particularly institutions that deal directly with the general public, a opposed to the merchant and other institutions more with trade and industry. These banks specialize in business connected with Bills of Exchange, especially the acceptance of foreign bills. A Merchant banker is thus a financial intermediary who helps in transferring capital from those who possess it to those who helps in those need it. Merchant banking includes wide range of activities management of customer securities portfolio management project and counseling and appraisal, underwriting of shares and debenture, acting as banker for refund order, handling interest and dividend warrants etc. Thus a merchant banker renders a host of services to corporate and promotes industrial development in the country.

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Sometimes banks are step to handle some specialized functions for particular industries such as the IDBI, NABARD, and EXIM Bank. There has been a great deal of attention given recently for issue of corporate governance in various national and international forums. In particular, the OECD has issued set of corporate governance standards and guidelines to help. Government in their efforts to evaluate and improve the legal institutional and regulatory framework for corporate governance in their countries and to provide guidance and suggestion for stock exchange, Investors, corporations and other parties that have a role in the process of developing good corporate governance. Profits cannot earn by hook or crook cannot be the sole criteria for judging the success of the business. The success of liberalization requires a steady development of a new corporate ethic.

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BIBLIOGRAPHY
BUSINESS ETHICS AND CORPORATE GOVERNANCE BY MICHAEL VAZ CORPORATE GOVERNANCE IN BANKING BY ANITA BOBADE

WIBLOGRAPHY
www.google.com www.wikipedia.com

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