Corporate Governance

Factors affecting Corporate

Governance
Mechanisms of Corporate
Governance
Chindhan E B
DGM & MoF-In-Charge
RBI, ZTC, New Delhi

Corporate Governance
Corporate governance refers to the set of systems,
principles and processes by which a company is
governed
They provide the guidelines as to how the company
can be directed or controlled such that it can fulfil its
goals and objectives in a manner that adds to the
value of the company and is also beneficial for all
stakeholders in the long term
Stakeholders in this case would include everyone
ranging from the board of directors, management,
shareholders to customers, employees and society
The management of the company hence assumes the
role of a trustee for all the others

What are the principles underlying

corporate governance?
Corporate governance is based on principles such
as conducting the business with all integrity and
fairness
Transparent with regard to all transactions, making
all the necessary disclosures and decisions
Complying with all the laws of the land,
accountability and responsibility towards the
stakeholders
Commitment to conducting business in an ethical
manner

Why is it important?
Separation of ownership and management so that the
interests of all stakeholders are protected
Empirical evidence shows that businesses with
superior governance practices generate bigger profits,
higher returns on equity and larger dividend yields
Importantly, good corporate governance also shows
up in such soft areas as employee motivation, work
culture, corporate value system and corporate image
Conversely, the failure of high profile companies such
as BCCI, Enron and WorldCom was a clear lesson of
the damage bad corporate governance can cause
In India, Satyam Computers received Golden
Peacock Global Award for Excellence in Corporate
Governance in September 2008 and was rattled with
the India largest corporate frauds of over Rs.7000 cr
in December 2008

How is Corporate Governance of

Banks Different?
Banks are different from other corporates as their
presence of a large and dispersed base of
depositors in the stakeholders group
Banks lubricate the wheels of the real economy,
are the conduits of monetary policy transmission
and constitute the economys payment and
settlement system
By the very nature of their business, banks are
highly leveraged
They accept large amounts of uncollateralized
public funds as deposits in a fiduciary capacity and
further leverage those funds through credit
creation

How is Corporate Governance of

Banks Different.cont
Banks are interconnected and have serious contagion
potential
If a corporate fails, the fallout can be restricted to the
stakeholders
If a bank fails, the impact can spread rapidly through to
other banks with potentially serious consequences for
the entire financial system and the macro economy
Boards and senior managements of banks be aware of
the potentially destructive consequences of excessive
risk taking, be alert to warning signals and be wise
enough to contain irrational exuberance
If the directors on the boards of banks didnt know what
was going on, they should ask themselves if they were
fit enough to be directors

corporate governance of banks in

emerging economies
First, in emerging economies, banks are more than mere
agents of financial intermediation
They carry the additional responsibility of leading
financial sector development and of driving the
governments social agenda
Second, in emerging economies, the institutional
structures that define the boundaries between the
regulators and the regulated and across regulators are
still evolving
Managing the tensions that arise out of these factors
makes corporate governance of banks in emerging
economies even more challenging

Regulation and Corporate

Governance of Banks
Regulation has historically had a significant role in the
evolution of corporate governance principles in the
banking industry
Regulation can complement corporate governance, but
cannot substitute for it
Regulation can establish principles and lay down rules
but the motivation to implement these principles and
rules in their true spirit is a matter of organizational
culture
If banks see adherence to regulation as a mere
compliance function, and not as a culture building
objective, the ability of regulation to further corporate
governance can be quite restrictive

Banking regulation shifted from

being prescriptive to being
prudential ?
Being prescriptive to being prudential
This implied a shift in balance away from
regulation and towards corporate governance
Banks now had greater freedom and flexibility to
draw up their own business plans and
implementation strategies consistent with their
comparative advantage
The boards of banks had to assume the primary
responsibility for overseeing this
This required directors to be more knowledgeable
and aware and also exercise informed judgement
on the various strategy and policy choices

Mechanisms of Corporate Governance

Directors representing private shareholders brought new
perspectives to board deliberations, and the interests of private
shareholders began to have an impact on strategic decisions
The corporate governance structural reform measures included
mandating a higher proportion of independent directors on the
boards
Inducting board members with diverse sets of skills and expertise
Setting up of board committees for key functions like risk
management, compensation, investor grievances redressal and
nomination of directors
Structural reforms were furthered by the implementation of the
Ganguly Committee recommendations relating to the role and
responsibilities of the boards of directors, training facilities for
directors, and most importantly, application of fit and proper
norms for directors

RBI guidelines on Fit and proper criteria for elected

directors on the boards of nationalised banks
Under the provisions of Section 9(3)(i) of Banking
Companies (Acquisition and Transfer of undertakings) Act
1970/80
(a) Authority: All the nationalized banks are required to
constitute a "nomination committee" consisting of a
minimum of three directors (all independent/nonexecutive directors) from amongst the Board of Directors
(b) Manner and procedure: undertake a process of due
diligence, obtain necessary information and declaration,
the nomination committee should meet and decide
whether or not the person's candidature should be
accepted based on the criteria mentioned below.
The committee's discussions should be properly recorded
as formal minutes of the meeting and the voting if done
should also be noted in case of both existing and
proposed Directors

Fit and proper cont

(c) Criteria:(i) Educational qualification (ii) Experience and
field of expertise (iii) Track record and integrity, ETC.,
The candidate coming to the adverse notice of any
authority/regulatory agency or insolvency or default of any
loan from any bank or financial institution would make the
candidate unfit and improper to be a director on the Board of
a bank
(d) Other matters: It is desirable that the board ensures, in
the public interest, that the elected directors execute the
deed of covenants
All the elected directors must furnish a simple declaration
every year as on 31st March that the information already
provided by them has not undergone any change and where
there is any change, requisite details are furnished by the
directors forthwith

Corporate Governance in Banks

(i) Responsibilities of the Board of Directors
A strong corporate board should fulfil the following
four major roles viz. overseeing the risk profile of
the bank, monitoring the integrity of its business
and control mechanisms, ensuring the expert
management, and maximising the interests of its
stakeholders
(ii) Role and responsibility of independent and nonexecutive directors
Have a prominent role in inducting and sustaining
a pro-active governance framework in banks

Corporate Governance in Banks

(iii) Training facilities for directors
Need-based training programmes / seminars/
workshops may be designed by banks to acquaint
their directors with emerging
developments/challenges facing the banking
sector
Committees of the Board
(a) Shareholders' Redressal Committee
(b) Risk Management Committee
(c) Supervisory Committee - monitoring of the
exposures (both credit and investment) etc.,
(d) Audit Committee, (e) Customer Service
Committee (f) Compensation Committee

Banking Regulation Act (Sec 10A) Board of directors

The Banking Regulation Act, 1949 provides that
not less than 51% of the total number of members
of the Board of Directors of a banking company
shall consist of persons who shall have special
knowledge or practical experience in respect of one
or more of the following areas: viz., Accountancy,
Agriculture and Rural Economy, Banking, Cooperation, Economics, Finance, Law, Small Scale
Out of the aforesaid 51% of directors, not less than
2 directors shall have special knowledge or
practical experience in respect of agriculture and
rural economy, co-operation or small-scale industry

Journey of Corporate Governance

Banking Regulation Act, (BR Act) 1949 (Section
10)
Listed banks are also expected to follow listing
norms under Clause 49 of the Securities and
Exchange Board of India (SEBI), in so far as they
do not conflict with the BR Act
In 1984, RBI circulated among private sector
banks guidelines on the role and functions of
independent/non-executive directors on the boards
of private sector banks
March 2001-Advisory Group by Dr R.H. Patil to
bring CG in PSBs at par with international best
practices
In 1992, RBI had also circulated a list of do's and
don'ts to the private sector banks, with a view to
sensitising the directors on their role and
responsibility
Ganguly Committee Recommendations in 2002

Journey of Corporate Governance..cont

The Banking Companies (Acquisition and Transfer of
Undertaking) Act, 1970/1980 were amended in
October 2006 providing for introduction of fit and
proper' criteria for directors elected in terms of
Section 9 (3) (i) of the Act
The Act also provides for:
(a) an increase in the number of whole time directors
of nationalised banks from two to four
(b) nomination of up to three shareholder directors
on the boards of nationalised banks on the basis of
percentage of shareholding
(c) the RBI to appoint one or more additional
directors, if necessary, in the interests of banking
policy/public interest/interest of the bank or the
depositors

Section 10A (2) (b) of the Banking

Regulation Act, 1949 quality fit and
proper
Under this Act, directors should not have substantial
interest in a company or a firm. Substantial interest means
an amount paid-up exceeding Rs 5 lakh or 10 per cent of
the paid-up capital of the company, whichever is less
Also, the Banking Regulation Act does not permit a bank to
lend money to a company if any of its board members is
also a director on the board of that company. This
regulation was introduced in the pre-nationalisation phase,
when the banks were mainly in the private sector and most
of them were under the management control of one of the
industrial houses. This rule was introduced to prevent
cornering and possible misuse of bank funds by the
controlling industrial houses.
The flip side is that there is no prohibition for interested
promoter/shareholder of a bank to sanction a loan to a
company where he is a shareholder/has a substantial
interest but is not sitting on its board.

Bank Corporate governance reports

Public sector banks tend to have larger boards, less busy
(reputed) directors and greater rotation (retirements
/appointments) of directors during a financial year. This
makes their board less cohesive
Private banks have more stable boards that show little
movement during the year and across the five-year period
of the study
In April 2007, RBI has formulated a scheme for Protected
Disclosures for Private Sector and Foreign Banks against
corruption, misuse of office, criminal offences, etc.,
But a scrutiny of the top 20 banks (both public and private)
over a five-year period shows that just a few banks have a
whistle-blower policy.
The exact role of the board in this regard is not discussed
in any bank's annual report

Thank you..

ebchindhan@rbi.org.in