CHAPTER-I

Introduction:

Banking is the crucial factor affecting economic development of an economy. It is the

life-blood of a country. It is responsible for the flow of credit and for maintaining the financial

balances of the economy. In India, since the nationalization process banks emerged as a tool of

economic development along with social justice. The banking sector started giving importance to

social banking. The liberalization policy, which was initiated in 1991 created the environment of

competition among banks. The emergence of new private sector banks made the existing banks

more quality conscious. Banking has become complex and it has been recognized that there is a

need to attach more importance to qualitative standards such as internal controls and risk

management, composition and role of the board and disclosure, for perform and remain in

competition in the era of liberalization and globalization. The entry of new private sector banks,

the freedom given to public sector banks to access capital market and series of scams particularly

the one in Madhavpura Mercantile Co-operative Bank Ltd. Has necessitated banks to pay more

attention to corporate governance1.

In India, it was only in 1998, when inadequate and inefficient management was identified

as one of the key problems associated with bank performance, which corporate governance

cropped up in financial sector agenda. In 2000, the Advisory Group on Banking cropped up in

financial sector agenda. In 2000, the Advisory Group on Banking Supervision (M.S. Verma)

1
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by P Shaha - ‎2015, Last visited on 10-03-2018.

1
suggested that all banks should accept a certain minimum level of corporate governance. It

examined the issues of ownership in establishing corporate governance practices. In 2001, an

Advisory Group on corporate governance (R.H. Patil) was formed which quickened the reforms

to make the boards of these institutions more professional and truly autonomous.

Banks are different from other corporate in important respects, and that makes corporate

governance of banks not only different but also more critical. Banks lubricate the wheels of the

real economy, are the conduits of monetary policy transmission and constitute the economy‘s

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. The presence of a large and dispersed

base of depositors in the stakeholders group sets banks apart from other corporate. Banks are

interconnected in diverse, complex and oftentimes opaque ways underscoring their ‗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 macroeconomic.

All economic agents tend to behave in a procyclical manner, and banks are no exception,

as aptly summed up by Chuck Prince, the former CEO of City group, who said that one had to

keep dancing as long as the music was on! Where banks differ is that their procyclical behavior

hurts not just the institution but the larger economy. Among the many lessons of the crisis is the

one that financial markets are not self-correcting. This is in part because the signals of financial

2
instability are difficult to detect in real time. On top of that, banks escape some of the

disciplinary pressures of the market as their balance sheets are typically opaque.

Given the centrality of banks to modern financial systems and the macro economy, the

larger ones become systemically important. That raises a moral hazard issue since systemically

important banks will then indulge in excessive risk in the full knowledge that all the gains will be

theirs; and should the risks blow up, the government or the central bank will bail them out and

thereby the losses can be socialized. Having collectively experienced the biggest financial crisis

of our generation over the last three years, we all know that these risks and vulnerabilities of the

financial system are not just text book concepts; they are all highly probable real world

eventualities.

If banks are ‗special‘ in so many ways that I have indicated above, it follows that

corporate governance of banks has to be special too, reflecting these special features. In

particular, boards and senior managements of banks have to be sensitive to the interests of the

depositors, be aware of the potentially destructive consequences of excessive risk taking, be alert

to warning signals and be wise enough to contain irrational exuberance. Post-crisis, there is a

debate on the extent to which failure of corporate governance has been responsible for the crisis.

Given such overwhelming evidence of corporate governance failure, this is a futile debate. The

short point is if the directors on the boards of banks didn‘t know what was going on, they should

3
ask themselves if they were fit enough to be directors. If they did know and didn‘t stop it, they

were complicit in the recklessness and fraud2.

In fact, the post-crisis verdict on corporate governance of banks is quite damning. The

Institute of International Finance, an association of major international banks, has concluded

after an examination of board performance of banks in 2008 that, ―events have raised questions

about the ability of certain boards to properly oversee senior managements and to understand and

monitor the business itself‖. As per an OECD report, nearly all of the 11 major banks reviewed

by the Senior Supervisors Group (an informal group of senior supervisors under the auspice of

the Financial Stability Board - FSB) in 2008 failed to anticipate fully the severity and nature of

the market stress. On the positive side, there is some early evidence that banks with stronger

corporate governance mechanisms moderated the adverse impact of the crisis on them and had

higher profitability in 2008 and provided substantially higher stock returns in the immediate

aftermath of the market turmoil.

A relevant question in this context is whether there are any additional dimensions to

corporate governance of banks in emerging economies. Indeed there are, and I will cite just two

important ones. 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 government‘s social agenda. Second, in emerging economies, the institutional

structures that define the boundaries between the regulators and the regulated and across

2
https://thenextrecession.files.wordpress.com/2014/03/liakos-speech-1.doc Last visited on 10-03-2018.

4
regulators are still evolving. Managing the tensions that arise out of these factors makes

corporate governance of banks in emerging economies even more challenging.

Each turmoil (and especially a crisis) in the financial markets brings a wave of re-adjustments

and re-regulations. After analysis of the causes of the problems the regulators seek to establish

new laws, which in their opinion will fix the system and make the supervision of the market and

its participants more effective in order to avoid a repetition of such difficulties. The subprime

financial crisis evidenced many problems specifically connected with regulations and attitudes of

many actors (in particular the financial sector). The main guilt for the collapse of the financial

markets was – not unduly – assigned to banks; the weakness and inadequacy of the mechanisms

of corporate governance in these institutions was indicated.

This paper aims to present the specificity of the corporate governance of banks and

indicate the main deficiencies in the bank governance system. The key goal of the paper is to

describe key aspects requiring reforms: the role, constitution and accountability of board of

directors, risk management function, management remuneration system, and banks‘

transparency; and to present new regulations of the financial market.

The main research methods used in the paper are the review and critical analysis of

literature and study of the regulations; based on that, a method of logical deduction is applied;

the analysis of numerical data presented (based on case studies retrieved from literature and

financial analysis of banks‘ aggregate data) allow for an illustration of the issues discussed.

5
Regulations and Corporate Governance of Banks:

Regulation has historically had a significant role in the evolution of corporate governance

principles in the banking industry. However, to believe on this basis that, good regulation can

offset bad corporate governance will be patently wrong. Regulation can complement corporate

governance, but cannot substitute for it.

The crisis has triggered a swathe of financial reforms to mitigate some of the known risks

revealed by it. Understandably, these reforms also encompass corporate governance. Several

countries have effected major structural changes to improve the functioning of their financial

institutions, to ensure the robustness of their risk management systems and to make their

operations more transparent. By far, the most notable has been the Dodd-Frank Act in the United

States which, among other things, aims to induce greater transparency with regard to the board

and the top management positions and their compensation3.

While regulation has a role to play in ensuring robust corporate standards in banks, the

point to recognize is that effective regulation is a necessity, but not a sufficient condition for

good corporate governance. 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. Let us take the example of bank audits. The effectiveness of external auditors is a
3
https://www.rsfjournal.org/doi/full/10.7758/RSF.2017.3.1.02, Last visited on 10-03-2018

6
critical component of a sound corporate governance framework. As long as audit is being done,

the regulatory requirement is complied with. But is the audit effective? Has the audit unearthed

all the frauds, excesses and mistakes? Has the audit led to sustainable and systemic corrective

action? If the answer is ‗no‘, then the corporate governance of banks is faulty or ineffective.

7
Evolution of Corporate Governance of Banks in India:

Let us briefly sketch the evolution of corporate governance of banks in India. In the pre-

reform era, there were very few regulatory guidelines covering corporate governance of banks.

This was reflective of the dominance of public sector banks and relatively few private banks.

That scenario changed after the reforms in 1991 when public sector banks saw a dilution of

government shareholding and a larger number of private sector banks came on the scene. How

did these changes shape the post-reform standards of corporate governance?

First, the competition brought in by the entry of new private sector banks and their

growing market share forced banks across board to pay greater attention to customer service. As

customers were now able to vote with their feet, the quality of customer service became an

important variable in protecting, and then increasing, market share.

Second, post-reform, banking regulation shifted from 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 judgment on the various strategy and

policy choices.

8
 Third, two reform measures pertaining to public sector banks - entry of institutional and

retail shareholders and listing on stock exchanges - brought about marked changes in their

corporate governance standards. Directors representing private shareholders brought new

perspectives to board deliberations, and the interests of private shareholders began to have an

impact on strategic decisions. On top of this, the listing requirements of SEBI enhanced the

standards of disclosure and transparency4.

Fourth, to enable them to face the growing competition, public sector banks were

accorded larger autonomy. They could now decide on virtually the entire gamut of human

resources issues, and subject to prevailing regulation, are free to undertake acquisition of

businesses, close or merge unviable branches, open overseas offices, set up subsidiaries, take up

new lines of business or exit existing ones, all without any need for prior approval from the

Government. All this meant that greater autonomy to the boards of public sector banks came

with bigger responsibility.

Lastly, a series of structural reforms raised the profile and importance of corporate

governance in banks. The ‗structural‘ reform measures included mandating a higher proportion

of independent directors on the boards; inducting board members with diverse sets of skills and

expertise; and 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

4
scholarship.law.berkeley.edu/cgi/viewcontent.cgi?article=1073&context=law., Last visited on 10-03-2018

9
and responsibilities of the boards of directors, training facilities for directors, and most

importantly, application of ‗fit and proper‘ norms for directors.

10
Important Issues Relating to Corporate Governance of Banks in India:

Bank Ownership:

The first issue concerns with ownership. There is typically a divergence between the

interests of shareholders and of depositors. Shareholders want profits to be maximized by taking

on greater risk; depositors have an overriding preference for the safety of their deposits and

hence for lower risk. At the same time, depositors have little say in the governance of banks

whereas the shareholders‘ say is very pronounced. Within the shareholder group, the extent of

control exercised by promoter shareholders too, is an important determinant of the effectiveness

of corporate governance. As some recent instances demonstrated, such excessive influence of

promoters can turn the board into a mouthpiece of the promoter to the detriment of the interests

of all other stakeholders5.

Another way to look at the issue of ownership is in terms of public vs. private ownership.

If banks are publicly owned, issues of conflict of interest between shareholders and depositors

get mitigated. Public ownership of banks would also inspire confidence in the financial system.

On the other hand, an important question is whether effective and autonomous corporate

governance is compatible with public ownership of banks. The question arises because publicly

owned banks render accountability to the government and to the democratic institutions. The

government judges them on criteria quite different from those used by the market. How can we

resolve this dilemma? Is it possible to stay with public ownership but still give near total

autonomy to the boards? Is it, in particular, possible to cede the power to appoint the CEO to the

5
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11
board, but make the board accountable to the government and the shareholders for the

performance of the bank?

Diversified ownership and ‗fit and proper' status of shareholders are other important

determinants of corporate governance. The Reserve Bank‘s guidelines on ownership and

governance in private sector banks, issued in February 2005, were aimed at ensuring that

ownership and control of banks are well diversified. The Reserve Bank has been consistently

following up with banks having concentrated ownership to ensure adherence to the prescribed

limits in a time bound manner. Similarly, to ensure ‗fit and proper‘ status of large shareholders,

acknowledgement from Reserve Bank is mandatory for any acquisition of shares in private

sector banks resulting in a shareholding of 5 per cent or more of the total paid up capital of the

bank. Having said that, it must be acknowledged that evaluating ‗fit and proper‘ is far from being

a science; it involves a considerable amount of judgment. Moreover, ‗fit and proper‘ is a onetime

exercise, not repeated unless new information comes in. These limitations need to be recognized.

Another issue in ownership of banks, one that highlighted is new bank licenses, is

whether corporate should be made eligible to promote banks. International experience in this

regard is varied. There are persuasive arguments both for and against the proposal. The strongest

point in favor is that corporate can bring in the capital as also business experience and

managerial competence. By far the biggest apprehension is about self-dealing - that corporate

will use the bank as a private pool of readily available funds6.

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https://www.psychologytoday.com/blog/cutting.../the-top-10-leadership-competencies , Last visited on 10-03-2018

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 There are, of course, both statutory and regulatory checks against self-dealing. For

example, the Banking Regulation Act expressly prohibits banks from lending to directors on the

board and to entities in which they are interested. Regulations also prohibit lending to relatives of

directors without the prior approval or knowledge of the board. Directors, who are directly or

indirectly interested in any loan proposal, are required to disclose such interest and to refrain

from participating in the discussion on the proposal,. As much as these prescriptions are

extensive, there are still gaps. For instance, if a corporate has an interest in a bank as a promoter

or a shareholder, but has no position on the board, then there is no prohibition on the bank

lending to the corporate. This opens up opportunities for self-dealing.

Another apprehension that was raised during the public debate was that it is not easy for

supervisors to prevent or detect self-dealing because banks can hide related party lending behind

complex company structures or through lending to suppliers of the promoters and their group

companies. As we contemplate allowing corporate to promote banks, there is need for changes in

statutes and regulations to address these concerns.

Accountability, Transparency and Ethics:

The separation of ownership and management can create conflict of interest if there is a

breach of trust by managers on account of intention, omission, negligence or incompetence. This

can be taken care of by making boards more accountable to all stakeholders and making their

13
functioning transparent. Over the years, we have tried to align our transparency and disclosure

standards to global best practices. But we need to ask questions. Is the voice of independent

directors always independent? Do bank CEOs countenance criticism from the board? Are boards

succumbing to ‗group think‘ and abandoning their responsibility for independent judgment? It is

only through such soul searching that corporate governance of banks can improve its

effectiveness.

The failure on the scale we saw during the recent global financial crisis is also reflective

of poor ethical standards in banks. Almost all the complex gamut of causes of the crisis relate to

how the financial system operated. The behavior of actors across the chain of the financial sector

was swayed by the opportunity for making quick profit rather than by fair, ethical and moral

standards. Neither was the sub-prime borrowers adequately warned that there was not a good

chance of fall in asset prices nor did investment advisers tell their clients of the risk they were

taking in buying MBAs and CDOs. Such behavior was not only checked, but was even

encouraged7.

Here at home, though our banking sector largely escaped the crisis, we should introspect

on our own shortcomings and loose practices. To what extent have banks deviated from proper

conduct in the sale of forex derivatives? Is there too much focus on the quarterly earnings cycle

to the detriment of longer term performance? Are aggressive strategies leading to excessive risk

taking? Issues such as these, I believe, underscore the special ethical dimension of the financial

7
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14
sector over and above that of other businesses. Boards of banks and financial institutions have to

be conscious of their obligation not to hold the larger public interest hostage to their private

profit motive.

Compensation:

Compensation in the banking sector has been another high profile issue post-crisis. It is

now widely acknowledged that the flawed incentives framework underlying banks‘

compensation structures in the advanced countries fuelled the crisis. The performance-based

compensation of bank executives is typically justified on the ground that banks need to acquire

and retain talent. We now know, with the benefit of hindsight, that this argument overlooked the

perverse incentives it would engender. Bank executives were motivated by short-term profits

even if it compromised long term interests. The Financial Stability Board (FSB) has since

evolved a set of principles to govern compensation practices, and the Basel Committee has

developed a methodology for assessing compliance with these principles. The proposed

framework involves increasing the proportion of variable pay, aligning it with long-term value

creation and instituting deferral and claw-back clauses to offset future losses caused by the

executive.

In contrast to most other jurisdictions, the Reserve Bank has the power, in terms of the

Banking Regulation Act, to regulate board compensation, including the pay and perquisites of

the CEO of private sector banks. In evaluating compensation proposals for wholetime directors

and CEOs of private sector banks, the Reserve Bank is guided by relevant factors such as the

15
performance of the bank, compensation structures in the peer group, industry practice and

regulatory concerns, if any. As regards bonus, in terms of the Reserve Bank guidelines issued in

August 2003, bonus in respect of whole time directors and CEOs has been capped at 25 per cent

of their salary or at the level of bonus paid to other employees of the bank.

Post crisis, reflecting the spirit of the global initiative on compensation structures, RBI

determined that there is a need for reform in India too. Accordingly, In July 2010, the Reserve

Bank issued draft guidelines on ‗Compensation of Whole Time Directors/Chief Executive

Officers/Risk Takers and Control Staff‘, inviting public comments. The draft guidelines

proposed that banks should have a compensation policy, align compensation structures with

prudent risk taking and institute a claw back mechanism. These guidelines were originally

intended to be implemented with effect from 2011-12 but that schedule was deferred as the Basel

Committee was in the process of finalising methodologies for alignment between risk,

performance and remuneration. Meanwhile, the Reserve Bank carried out impact studies on

select banks. Taking into account the feedback received on the draft guidelines, the result of the

impact studies and the final prescriptions issued in the matter by the Basel Committee in May

2011, the Reserve Bank is in the process of finalizing the guidelines relating to compensation.

The guidelines are scheduled to be implemented from the financial year 2012-13, and banks have

already been advised to start preparatory work in this regard.

16
 Another relevant aspect is the compensation of non-executive directors on the board.

There is a view, also articulated in the Government of India‘s Corporate Governance Voluntary

Guidelines 2009, that companies should have the option of giving a fixed contractual

remuneration, not linked to profits, to non-executive directors. In the banking sector, non-

executive directors are typically compensated through sitting fees, except non-executive

chairmen who are paid a regular remuneration.

The question is whether non-executive directors of banks should also be paid a regular or

a fixed contractual remuneration. This is probably a good concept, but difficult to implement in

practice. Typically, in banks, the outcomes of risks taken become manifest after a long gap.

While it is possible to align compensation of executives to the risks since they are long term

employees, it is more problematic in the case of non-executive directors who serve for relatively

shorter periods and have term limits. Furthermore, unlike wholetime executive directors, non-

executive directors function collectively as a part of the board and committees of boards making

it difficult to apportion responsibility on them individually. Notwithstanding these

implementation issues, we need to debate on how to align the compensation of non-executive

directors to the outcomes of corporate governance.

Splitting the Posts of Chairman and CEO of Banks:

Splitting the posts of the Chairman and the CEO of banks is another issue that has

generated a contentious debate. The Ganguly Committee appointed by the Reserve Bank had

recommended that the posts of the chairman of the board and the CEO of the bank should be

17
bifurcated. The logic is that such a bifurcation of leadership of the board from the day to day

running of the business will bring about more focus and vision as also the necessary thrust to the

functioning of the top management of the bank. It will also provide effective checks and

balances.

The Reserve Bank implemented the Ganguly Committee recommendations in all the

private sector banks in 2007. Experience shows that this arrangement has worked well. In fact,

the Ganguly Committee recommendation to this effect has been echoed by the Basel Committee

on Banking Supervision (BCBS) in its document entitled, ‗Principles for Enhancing Corporate

Governance‘ which was put out last year. Let me quote briefly from the document. It says, ―To

achieve appropriate checks and balances, an increasing number of banks require the chair of the

board to be a non-executive, except where otherwise required by law. Where a bank does not

have this separation and particularly where the roles of the chair of the board and Chief

Executive Officer (CEO) are vested in the same person, it is important for the bank to have

measures in place to minimize the impact on the bank‘s checks and balances of such a situation

(such as, for example, by having a lead board member, senior independent board member or a

similar position).8‖

Given our own positive experience as well as the global endorsement for this position,

the question is whether we should extend the principle of separation of the posts of chairman of

the board and CEO to public sector banks as well. An important criterion for deciding on this

8
https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=374, Last visited on 10-03-2018

18
will be to what extent we will be able to lay down and enforce strict eligibility criteria for the

position of the chairman of the board of a public sector bank. We will discuss this issue with the

Government. Meanwhile, it will be useful if there is some debate on this issue.

19
Corporate Governance under Financial Holding Company Structure:

The prevalent model for financial conglomerates in India has been the bank subsidiary

model as opposed to the more popular financial holding company (FHC) model around the

world. The risks of a bank subsidiary model are quite well known. First, the burden of corporate

management of the bank as well as of equity infusion in the future will fall on the bank, and that

may stretch its managerial competence and financial capacity. Second, a concern from the

regulatory perspective is that the losses of subsidiaries will impact the balance sheet of the bank

and even jeopardize the interests of the depositors of banks. Third, a bank typically has access to

implicit subsidy by way of safety-net, deposit insurance, access to central bank liquidity and

access to payment systems. The bank subsidiary model opens up an avenue for leakage of the

subsidies to the non-bank subsidiaries raising a moral hazard issue. Finally, there will also be the

problem of resolution if the bank or any of its subsidiaries, gets into trouble9.

It is interesting that in the recent global financial crisis, financial conglomerates suffered

equally irrespective of under which model they were structured. While the post-crisis reforms do

not specify a preference for either model, the focus with respect to structure is on strengthening

capital requirements at the consolidated level, reducing complexities of structures to enable

efficient resolution in case of a problem, and separation of investment banking from commercial

banking.

9
shodhganga.inflibnet.ac.in/bitstream/10603/64354/14/14_chapter%207.docx by P Shaha - ‎2015, Last visited on 10-
03-2018

20
 The Shyamala Gopinath Working Group appointed by the Reserve Bank has

recommended that the financial holding company model should be pursued as a preferred model

for the financial sector in India. We must recognize that regardless of the corporate structure,

banks cannot be totally insulated from the risks of non-banking activities of their affiliates. In

moving to a new regime, we must also contend with legacy issues relating to existing

conglomerates. Any framework to harmonies them under the FHC model will require a new

legislation and new regulatory architecture10.

10
https://www.bis.org/review/r110823a.pdf

21
Objectives of the Study:

The primary focus of the study is on the way of handling Corporate Governance issues in

different sector banks. Banks taken into consideration will be SBI from Public sector and ICICI

from Private sector. All the aspects related to Corporate Governance, like Role of Board of

Directors, Auditors and also the recommendations from committees like Basel, Birla, etc. may be

touched upon as per re In order to comply with the study undertaken, the following objectives

have been set forth -

1. To explore the emerging issues in Corporate Governance.

2. To study the trends regarding the reforms and recommendations done recently in Corporate

Governance in India.

3. To study the existing framework of Corporate Governance in India.

4. To analyze the implementation of Corporate Governance code with respect to private banks in

India.

5. To provide suggestions to improve Corporate Governance in banking sector.

The objectives have been set forth to know the new trends in Corporate Governance

practices in Indian banking sector especially in the private banks, and explore the framework of

Corporate Governance in India.

22
Hypothesis:

Null Hypothesis:

l. ―Private Banks fulfils all recommendations as per the clause 49 of Listing Agreement with

stock exchange.‖

ll. ―Corporate Governance practices of private banks in India honor and protect the rights of

stakeholders.‖

lll. ―Corporate Governance practices promote corporate fairness, transparency and

accountability.‖

Banks are different from other corporates in important respects, and that makes corporate

governance of banks not only different but also more critical. Banks lubricate the wheels of the

real economy, are the conduits of monetary policy transmission and constitute the economy‘s

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. The presence of a large and dispersed

base of depositors in the stakeholders group sets banks apart from other corporates.

Banks are interconnected in diverse, complex and oftentimes opaque ways underscoring

their ―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 macroeconomy. All economic agents tend to

behave in a procyclical manner, and banks are no exception, as aptly summed up by Chuck

23
Prince, the former CEO of Citigroup, who said that one had to keep dancing as long as the music

was on! Where banks differ is that their procyclical behaviour hurts not just the institution but

the larger economy. Among the many lessons of the crisis is the one that financial markets are

not self-correcting. This is in part because the signals of financial instability are difficult to detect

in real time. On top of that, banks escape some of the disciplinary pressures of the market as their

balance sheets are typically opaque.

Given the centrality of banks to modern financial systems and the macro economy, the

larger ones become systemically important. That raises a moral hazard issue since systemically

important banks will then indulge in excessive risk in the full knowledge that all the gains will be

theirs; and should the risks blow up, the government or the central bank will bail them out and

thereby the losses can be socialized. Having collectively experienced the biggest financial crisis

of our generation over the last three years, we all know that these risks and vulnerabilities of the

financial system are not just text book concepts; they are all highly probable real world

eventualities. If banks are ―special‖ in so many ways that I have indicated above, it follows that

corporate governance of banks has to be special too, reflecting these special features. In

particular, boards and senior managements of banks have to be sensitive to the interests of the

depositors, be aware of the potentially destructive consequences of excessive risk taking, be alert

to warning signals and be wise enough to contain irrational exuberance. Post-crisis, there is a

debate on the extent to which failure of corporate governance has been responsible for the crisis.

Given such overwhelming evidence of corporate governance failure, this is a futile debate. The

short point is this. If the directors on the boards of banks didn‘t know what was going on, they

24
should ask themselves if they were fit enough to be directors. If they did know and didn‘t stop it,

they were complicit in the recklessness and fraud.

In fact, the post-crisis verdict on corporate governance of banks is quite damning. The

Institute of International Finance, an association of major international banks, has concluded

after an examination of board performance of banks in 2008 that, ―events have raised questions

about the ability of certain boards to properly oversee senior managements and to understand and

monitor the business itself‖. As per an OECD report, nearly all of the 11 major banks reviewed

by the Senior Supervisors Group (an informal group of senior BIS central bankers‘ speeches

supervisors under the auspice of the Financial Stability Board – FSB) in 2008 failed to anticipate

fully the severity and nature of the market stress. On the positive side, there is some early

evidence that banks with stronger corporate governance mechanisms moderated the adverse

impact of the crisis on them, had higher profitability in 2008 and provided substantially higher

stock returns in the immediate aftermath of the market turmoil.

A relevant question in this context is whether there are any additional dimensions to

corporate governance of banks in emerging economies. Indeed there are, and I will cite just two

important ones. 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 government‘s social agenda. Second, in emerging economies, the institutional

structures that define the boundaries between the regulators and the regulated and across

25
regulators are still evolving. Managing the tensions that arise out of these factors makes

corporate governance of banks in emerging economies even more challenging.

Significance of study:

At its most basic level, corporate governance sets up the ―rules of the game‖ to deal with

issues arising from 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, WorldCom and Parmalat was a clear lesson of the

damage bad corporate governance can inflict. Here at home we had a corporate scandal of

unprecedented dimensions in Satyam Computers where the company‘s CEO admitted to having

falsified accounts to the tune of over 7000 crore, and that too spread over several years. Even as

the judicial process relating BIS central bankers‘ speeches to this alleged fraud is still under

way, the big question is in what ways was this failure of corporate governance and how are we

fixing those lacunae? We had instances of poor governance in the banking sector as well –

erosion of standards in forex derivative transactions and fraud in wealth management schemes –

reminding us that we need to work hard to get to best practice in every area of corporate

governance.

26
 The topical relevance of study is confined to the Corporate Governance aspect as well as

the banking sector alone. The duration scope of the study is Corporate Governance report for the

years 2009-10, 2010-11 and 2011-12 submitted by concerned banks. The analytical scope

consists of fulfillment of objectives under study. Functional scope takes cognizance of putting

forward meaningful suggestions for effective Corporate Governance. In the backdrop of the

above discussion, the researcher has studied the issues pertaining to corporate governance thus

entitled as, "To Study of Corporate Governance Practices of Indian Banks with reference to

Private Sector Banks".

Sources of the study:

The data for the study has been collected through secondary (major source). The

secondary source constitute of- archives of various libraries: browsing of websites and the annual

reports of banks. The researcher has visited a number of libraries for compilation of relevant

information. The research paper suffers from certain limitations, for e.g. the limited access to

sources of data and materials, limitations with respect to time and also with respect to the limited

text books, commentaries and materials. To fulfill the objectives and to collect the relevant data

desk research method has been adopted. In a sense all the Corporate Governance reports of

various banks listed with stock exchange has been collected and the same has been analyzed.

27
Research Methodology:

The research-methodology adopted is mainly Doctrinal. The sources of data include

secondary sources like Articles, books and Journals. The main research methods used in the

paper are the review and critical analysis of literature and study of the regulations; based on that,

a method of logical deduction is applied; the analysis of numerical data presented (based on case

studies retrieved from literature and financial analysis of banks‘ aggregate data) allow for an

illustration of the issues discussed.

Scheme of the Study:

This chapter includes introduction of research, Objectives of the Study, Justifications of

objectives, Statement of Hypothesis, , Review of literature and Outline of the Study, References

In this chapter the researcher has attempted to highlight the theoretical background of the

study topic. Various aspects related to corporate governance have been enumerated. Likewise

Definition of Corporate Governance, Issues in Corporate Governance, Corporate Governance

framework in India etc. has been discussed.

In this chapter researcher includes various types of information of all banks like history

of these banks under study and information of the Board of Directors of bank. Data Analysis and

Interpretation In this chapter researcher analyses and interprets the data collected by using

statistical techniques. Conclusions, Suggestions, Bibliography.

28
 List of Abbreviations

I(A) - Composition to board.

I(B) - Composition to directors.

I(C) - Legal compliance report review.

I(D) - No. of meeting of board and restriction on membership and

Chairmanship.

I(E) - Code of conduct.

I(F) - Term of Non-Executive Directors.

II(A) - Audit committee – members, restrictions, qualification.

II(B) - Functions of audit committee – quorum for meeting, no of

Meeting to be held

III(A) - Disclosure of deviation, reasons, financial effect of it

IV(A) - Whistle blowing

V (A) - Composition of board of holding Company, audit committee,

Minutes of meeting etc.

VI (A) - Related party transactions.

VI (B) - Risk Management.

VI(C) - IPO

VI (D) - Remuneration to Director.

VI (E) - Management Discussion and Analysis Report.

VII - Certification requirements.

IX - CGCR Report.

X - Non mandatory requirements.

29
 CHAPTER-II

CONCEPTUAL FOUNDATION

Introduction:

In this chapter the researcher has attempted to highlight the theoretical background of the

study topic. Various aspects related to corporate governance have been enumerated.

Definition:

Corporate governance by definition; is the code of practice by which a firm's

management is held accountable to capital providers for the efficient use of assets.

It exhibits how its mission, its values and philosophy govern on organization

 Governance refers to the system of directing and controlling an organization.

 A good governance system.

 Generates ideas through participation of all stakeholders.

 Harmonies different viewpoints while protecting interests of the minority stakeholders.

 Governance assumes greater significance for publicly traded companies because of the

separation of management from shareholders in general. Leading to conflict of interests

of the management and shareholders.

 Pre-requisites of good governance are education, technical skills, core competency and a

system of effective communication, both internal and external.

 The primary objective of the management of a publicly traded company is to enhance the

value of the enterprise.

30
 As a good corporate citizen, an enterprise is expected to honor and protect the rights of other

stakeholders including the local community. Increased competitiveness is all the more reason for

the Management of the board to institute corporate Governance on highly ethical grounds all

across the organization.

Governance refers to the system of directing and controlling an organization. The concept of

corporate governance is defined in several ways because it potentially covers the entire gamut of

activities having direct or indirect influence on the financial health of the corporate entities. Let

us take a look at some definitions in the context of the present day situation.

1. According to Cadbury Committee Report, 1992, "Corporate Governance is the social,

legal and economic process through which companies function and are held accountable"

2. According to some experts, "Corporate Governance means doing everything better, to

improve relations between companies and their shareholders; to improve the quality of

outside Directors; to encourage people to think long-term; to ensure that information

needs of all stakeholders are met and to ensure that executive management is monitored

properly in the interest of shareholders".

3. An article published on June 21, 1999 issue of the Financial Times J. Wolfensohn,

President, World Bank as says that "Corporate Governance is about promoting corporate

fairness, transparency and accountability".

4. According to some economists, Corporate Governance is a field in economics that

investigates how corporations can be made more efficient by the use of institutional

31
 structures such as contracts, organizational designs and legislation. This is often limited

to the question of shareholder value i.e., how the corporate owners can motivate and / or

secure that the corporate managers will deliver a competitive rate of return.

Thus, in nutshell, corporate governance is the structure and process of:

(a) Monitoring executive performance,

(b) Ensuring accountability of management to shareholders,

(c) Motivating management towards creating value for shareholders, and

(d) Protecting interests of other stakeholders including the local community.

Corporate Governance means the idea of ensuring proper management of companies through

the institutions and mechanism available to the shareholders. But the effective accountability to

all stakeholders is the essence of corporate governance. To have a clear understanding of the

important aspect of the concept, some of the important definitions have been stated as below:

In the proceeding of the silver jubilee National Conventional of I.C.S.I., "Corporate

governance is just Corporate Management; it is something much broader to include a fair,

efficient and transparent administration to meet certain well defined objectives. It is a system of

structuring, operating and controlling a company with a view to achieve long-term strategic goals

to satisfy shareholders, creditors, employees, customers and suppliers and complying with the

legal and regulatory requirements, apart from meeting environmental and local community

32
needs. When it is practiced under a well laid out system, it leads to the building of a legal,

commercial and institutional framework and demarcates the boundaries within which these

functions arc performed.

According to Dr. Geeta Gauri, "Corporate governance is a system by which companies are

run. It relates to the set of incentives, safeguards and the disputes resolution process that arc used

to control and coordinate the actions of the agents on behalf of the shareholders by the Board of

Directors. Shareholders arc responsible for appointing the Directors and auditors.

Creating of residual value is the Primary concern of shareholders, but the process of values

creation and its legality are equally important. Hence, corporate governance relates to conduct,

the management of the companies observes while exercising its power. The Kumar Maugalam

Committee acknowledges that the fundamental objective of Corporate Governance is "the

enhancement of the long-term shareholders value, while at the same time protecting the interest

of other stakeholders." The report points out that this definition harmonies the need for company

to strike a balance at all times between the need of enhance shareholders wealth whilst not in any

way being detrimental to the interest of the other stakeholders in the company such as suppliers,

customers, creditors, the bankers, the employees of the company, the government and the society

at large. According to Cadbury Committee report, 1991, Corporate Governance is "a system by

which corporate are directed and controlled". The focus was largely on accountability. In the

words of Sir Sydney the Chairman of the financial reporting council of UK, the good corporate

governance is "to ensure that the business is being soundly and effectively managed with risks

33
being properly assessed and controlled." Rahul Bajaj, the Chairman of the National Task Force

on Corporate Governance, appointed by the Confederation of Indian Industries (C.I.I.) said that it

dealt with laws, practices and implicit rules that determine a company‘s ability to take

managerial decisions vis-à-vis its claimant in particular, its shareholders and the creditors, the

state and employee in general. Various experts on the subject have opined that corporate

governance is interplay between companies, shareholders, creditors, capital, markets and

financial sectors, institutions and company law.

Although there are various attributes of corporate governance, yet some important rules and

practice include the concentration of ownership and control and the constitution of boards and

this role information to shareholders/ disclosure obligation to potential shareholders and

investors, corporate takeovers, corporate restructuring etc.

34
Issues in Corporate Governance:

Some of the issues regarding Corporate Governance are-

1. How independent docs a Board of Directors needs to enforce accountability?

2. To whom should the management be accountable?

3. Who should be on the board?

4. How should investors go about enforcing accountability?

5. How should a company align the interest of all its employees to that of the company?

6. Are we relying too much upon rules to encourage good governance?

7. What does it mean by governing well?

The primary goal of the corporation is to maximize shareholders wealth in a legal and ethical

manner.

The players involved in this game are -

1. Board of Directors

2. Various Committees

3. Management

4. Various outside stakeholders a. Shareholders

5. Employees

6. Government

7. Community

8. Suppliers

35
 In the above model, Corporate Governance the internal stake holders and the external

stakeholders are highlighted. In short we can define Corporate Governance as making the top

management more accountable and responsive. For good Corporate Governance the integrity of

the management is a must. The interest and time availability for the top management to address

important issues and participate in strategic planning is critical. It is important that the functions,

roles and responsibilities of board of directors, criteria for membership, selection of new

members, succession planning be well defined. Communication is very important with the

internal and external stake holders through various modes i.e. 1. Website, 2 Quarterly Reports,3

through suggestions, meetings, discussions etc. Flow of information is a must. Information must

be reliable, accurate and timely in nature.

Board of directors are responsible to prevent abuse of power, to ensure that proper books of

accounts are maintained, to attend the various meetings, to form committees, and to evaluate the

performance of board.

Corporate Governance is not a luxury but a necessity in today's globalized and liberalized

environment. The company will succeed in the long run if it is trusted by the various

stakeholders i.e. customers, employees, suppliers, shareholders, government, community etc.

Fairness in transaction with all stakeholders is a must. It is all about building confidence and

trust of stakeholders in the way it manages the affairs of the company.

36
 Disclosures are a must. It is of two types - voluntary and mandatory. Mandatory disclosures

are fixed by legal regulations from time to time. It is very important that the various stakeholders

have equal access to the disclosed information.

Various disclosures required, in general, are

1. Resume of each director, directorship, and membership of other committees of board.

2. Terms of appointments, elements of compensation package of all directors.

3. Remuneration of senior officers just below directors.

4. Movement of stock prices in capital market where share prices are listed.

5. Summary of financial results as per accounting standards.

6. Movement of key personnel during the period.

Responsibility towards Stakeholders:

Employees have global opportunities and global aspirations. We will be able to retain the

employees in our companies by treating them well, with courtesy and dignity and bring

transparency in the dealings with them.

Customers, today, have a lot of choice. Only if the company has a high level of

transparency and enjoys the confidence of the corporation, the customer will not do business on a

long-term basis. Government has reduced the corporate taxes and duties for the corporate. The

government expects that the corporate lives up to the expectation and pays the taxes and duties.

It will lead to government steps / policy decisions favoring the corporate world.

37
 The corporate has the responsibility towards the society for creating employment,

enlistments of locality, protecting lives of community at large, improving the quality of life

within the vicinity of operation. Suppliers should be assured of business, timely payment, and

fair treatment. In return supplier should have

1. Sense of belongingness,

2. Regular supply,

3. Quality supply,

4. Fair pricing policy.

38
Corporate Governance Framework in India

Corporate Governance was not a totally new concept in India. The Companies Act 1956

already had a set of provisions for assurance of good corporate governance. However the global

debate on corporate governance inspired confederation of Indian Industries to evolve a voluntary

code of conduct. Later on SEBI appointed a committee headed by Kumara Mangalam Birla to

suggest measures for evolving new norms of corporate governance. The recommendations of

Birla Committee were incorporated in the clause 49 of the listing agreement. At the same time

the Companies (Amendment) Act, 2000 brought on the statute book the emerging concepts of

the Audit committee, and its role, introduction of postal ballot, statement of directors‘ report etc.

Institute of Chartered Accountants of India also issued accounting standards relating to corporate

governance practices.

Recommendation of Naresh Chandra Committee:

The Department of Companies Affairs in the Ministry of Finance and company Affairs

appointed a High Level Committee, popularly known as Naresh Chandra Committee, to examine

various corporate governance issues and to recommend changes.

After a good deal of deliberations and inter-action with the trade associations and professional

bodies, the Committee made very significant recommendations for changes, inter alia, in the

Companies Act. They are:-

I. Disqualification for Audit Assignments

39
 II. The following services shall not be provided by an audit firm to an audit client

Accounting and book keeping services relating to the accounting records or financial

statements of the audit client; internal audit services.

III. Auditor's disclosure of contingent liabilities

IV. Auditors' Annual Certification of Independence

V. Appointment of Auditors

VI. CEO and CFO Certification of Annual Audited Accounts

VII. Auditing the Auditors.

VIII. Independent Directors

IX. Minimum Board Size of Listed Companies

X. Teleconferencing and Video conferencing

XI. Audit Committee should consist exclusively of independent Directors

XII. Remuneration of Non-executive Directors

XIII. Exempting Non-executive Directors from Certain Liabilities

XIV. Training of independent Directors

XV. Corporate Serious Fraud Office (CSFO)

Recommendation of N.R.Narayana Murthy Committee:

SEBI constituted a Committee on Corporate Governance under the Chairmanship of Shri.

N.R.Narayana Murthy. The Committee included representatives from the stock exchanges.

Chambers of Commerce and industry, investor associations and professional bodies and debated

on key issues and made recommendations as under:

40
The mandatory recommendations of the Committee are:

1. Audit Committee of Publicly Listed Companies should be required to review the

following information mandatory.

2. Disclosure of Accounting Treatment

3. Audit Qualifications

4. Basis for Related Party transactions

5. Risk management - Board Disclosure

6. Training of Board Members

7. Use of Proceeds of IPO

8. Written Code of Conduct for Executive Management

9. Nominee Directors - Exclusion of nominee directors from the definition of independent

directors

10. Non-executive directors Compensation - Limits on compensation paid to independent

directors

11. Independent Directors – Definition

12. Internal Policy on access to Audit Committee

13. Whistle Blower Policy

14. Subsidiary Companies - Audit committee requirements 15. Evaluation of Board

Performance - Mechanism for evaluation of non-executive Board Members.

41
Birla Committee Report:

The mandatory recommendations of the Kumar Mangalam Committee included the

constitution of Audit Committee and remuneration Committee in all listed companies,

appointment of one or more independent director on them, recognition of the leadership role of

the chairman of the company, enforcement of Accounting standards, the obligation to make more

disclosures in annual financial reports, effective use of the power and influence of institutional

shareholders and so on. The committee also recommended a few provisions which are non-

mandatory.

In short the recommendations are as follows:

1. The Board of company should have an optimum combination of executive and non-

executive directors with not less than 50 percent of the Board comprising the non-

executive directors.

2. The Board of company should set-up a qualified and an Independent Audit committee.

3. The Audit committee should have minimum three members, all being non-executive

directors, with the majority being independent and with at least one director having

financial and accounting knowledge.

4. The chairman of the Audit Committee should be an independent director.

42
5. The board of directors is a combination of executive directors and non-executive

directors.

6. The non-executive directors comprise of promoter directors and independent directors.

Independent directors are those who, apart from receiving directors, remuneration, do not

have any material pecuniary relationship or transactions with the company, its promoters,

its management or its subsidiaries that in the judgment of the Hoard may affect their

independence of judgment.

7. The chairman of Audit Committee should be present for the Annual General Meeting to

answer shareholder queries.

8. The Company Secretary should act as secretary to the audit Committee.

9. The Audit committee should meet at least thrice a year. The quorum should be either two

members or one third of the members of the Audit committee.

10. The Audit committee should have powers to investigate any Activity within its terms of

reference, to seek information from any employee, to obtain outside legal or professional

advice and to secure attendance of outsiders if necessary.

43
11. The Audit Committee should discharge various roles such as reviewing any change in

accounting policies and practices, compliance with Accounting standards, compliance

with Stock Exchange and legal requirements concerning financial statements; the

adequacy of internal control systems; the company's financial and risk management

policies. etc.

12. The Board of directors should decide the remuneration of the non- Executive directors.

13. Full disclosure should be made to the shareholders regarding the remuneration package of

all directors.

14. The Board Meeting should be held at least 4 times in a year.

15. A director should not be a member in more than ten committees or act as the chairman of

more than five committees across all companies in which he is a director. This is done to

ensure that the members of the Board give due importance and commitment of the

meeting of the Board and its committees.

16. The management must make disclosures to the Board relating to all material, financial

and commercial transactions, where they have Personal interest.

44
 17. In case of appointment of a new director, re-appointment of a director, the shareholders

must be provided with a brief resume of the director, his expertise, and the names of

companies in which the person also holds directorship and the membership of committees

of Board.

18. A Board Committee must be formed to look into the redressal of shareholders complaints

like transfer of shares, non-receipt of balance sheet, dividend etc.

19. There should be a separate section on Corporate Governance in the annual reports of the

companies with a detailed compliance report.

Apart from these, the Kumar Mangalam Birla Committee also made some recommendations

that are non-mandatory in nature. Some of the non-mandatory recommendations are as follows:

1. The Board should set-up a remuneration committee to determine the company‘s policy on

specific remuneration packages for executive directors.

2. Half yearly declaration of financial performance including summary of the significant

events in the last six months should be sent to each shareholder.

3. Non-executive chairman should be entitled to maintain a chairman's office at the

company's expense. This will enable him to discharge the responsibilities effectively.

45
 It is interesting to note that Kumar Manglam Birla Committee while drafting its

recommendations was faced with the dilemma of statutory v/s voluntary compliance. The

desirable code of Corporate Governance, which was drafted by CII and was voluntary in nature,

did not produce the expected improvement in Corporate Governance. It is in this context that the

Kumar Mangalam committee felt that under the Indian conditions a statutory rather than a

voluntary code would be a more purposive and meaningful. This led the committee to decide

between mandatory and non-mandatory provisions. The committee felt that some of the

recommendations are absolutely essential for the framework of corporate governance and

virtually from its code while other could be considered as desirable, besides some of the

recommendation needed change of statute, such as the companies Act for their enforcement.

Faced with this difficulty the committee settled for two classes of recommendations.

46
Three C Effect in Banking:

As the Indian economy looks to increase more in to the global economy, the banking

industry looks to keep pace. The 3 key strategic elements in banking today are:

1. Capital

2. Consolidation

3. Corporate Governance

Capital:

The need for additional capital is required by banks to increase competitiveness. As per the

survey conducted by FICCI about 84% respondents feel Indian banks require fresh issuance of

capital to enable banks to support large business assets, clean up balance sheets, cushion against

shock and also being compliant with future and current regulatory requirements.

i) Retail and Corporate credit growth in the near future is expected to be strong with the

improvement in economy.

ii) Many leading banks are focusing to build their presence and operations in

international, marketing so capital is required.

iii) Banks adopting approach for high-risk appetite have to keep more capital more

capital apart of unexpected losses. Migration lo Based II will require stringent and

higher capital adequacy norms and allocation of capital towards marketing and

47
 operational risk in addition to credit risk. Banks are required to give a roadmap by

Dec. 2004 to migrate to Baeel II.

iv) Minimum capital threshold in private banks is increased from 200 crores to 300

crores. The foreign banks operating in India as 100% subsidiary or new private bank

have to comply with this. Around 14 banks are likely to approach. The classification

on shareholding cap, 10% voting right cap etc. will give impetus to this process.

Consolidation:

Indian banks are not well represented on list of global banks. Consolidation is necessary

to enable banks to compete on scale and grow at national and international level.

The consolidation of Punjab National Bank with Nedugandi Bank, OBC with GTB is

government driven while ICICI Bank with Madura Bank, HDFC Bank with Times Bank is

market driven. The consolidation must lead to synergies and increase in capabilities.

Corporate Governance

It is important for the banks to collate and share information that address the varied

information needs of different internal (B.O.I) and external (R.B.I., analyst, customer, investor)

stakeholder needs. Some banks have adopted measures in this regard.

48
 As the bank look overseas, apart from the need for capital, there is a need to build

appropriate process and systems that meet international standards on risk management, anti-

money laundering, and transparent financial reporting.

In order to meet the needs and ensure greater governance and transparency of its

operations, the banks should answer the following questions –

1. How is the bank organized and run?

2. What is the financial health of bank?

3. What are the risk faced by bank in its operations and how does it overcome its.

The information required is accurate relevant and available in user friendly manner Banks

will have to understood information needs. It will also need to focus on building awareness and

educate the stake holders on interpreting the information to assist them to understand the banks

operations and performance better.

49
History of Banking in India:

Without a sound and effective banking system in India it cannot have a healthy economy.

The banking system of India should not only be hassle free but it should be able to meet new

challenges posed by the technology and any other external and internal factors.

For the past three decades India‘s banking system has several outstanding achievements

to its credit. The most striking is its extensive reach. It is no longer confined to only

metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the

remote corners of the country. This is one of the main reason of India‘s growth process.

The government‘s regular policy for Indian bank since 1969 has paid rich dividends with

the nationalization of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for getting a

draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most

efficient bank transferred money from one branch to other in two days. Now it is simple as

instant messaging or dial pizza. Money have become the order of the day.

50
 The first bank in India, though conservative, was established in 1786. From 1786 till

today, the journey of Indian Banking System can be segregated into three distinct phases. They

are as mentioned below:

I. Easy phase from 1786 to 1969 of Indian Banks

II. Nationalization of Indian Banks and up to 1991 prior to Indian banking sector

Reforms.

III. New phase of Indian Banking System with the advent of Indian Financial & Banking

Sector Reforms after 1991.

To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase III

Phase I

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan

and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay

(1840) and Bank of Madras (1843) as independent units and called it presidency Banks. These

three banks were amalgamated in 1920 and Imperial Bank of India was established which started

as private shareholders bank, mostly European shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indian, Punjab

National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913,

Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of

Mysore were set up. Reserve Bank of India came in 1935.

51
 During the first phase the growth was very slow and banks also experienced periodic

failures between 1913 and 1948. There were approximately 1100 Banks. Mostly small. To

streamline the functioning and activities of commercial banks, the Government of India came up

with the Banking Companies Act, 1949 which later changed to Banking Regulation Act 1949 as

per amending Act of 1965 (Act No.23 of 1965). Reserve Bank of India vested with extensive

powers for the supervision of Banking in India as the Central Banking Authority.

During those day‘s public has lesser confidence in the banks. As an aftermath deposit

mobilization was slow. Abreast of it the saving bank facility provided by the Postal department

was comparatively safer. Moreover, funds were largely given to traders.

Phase II

Government took major steps in this Indian Banking Sector Reform after independence.

In 1955, it nationalized Imperial Bank of India with extensive facilities on a large scale specially

in rural and semi-urban areas. It formed State Bank of India to act as the principal agent of RBI

and to handle banking transaction of the union and State Government all over the country.

Seven Banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th

July 1969, major process of nationalization was carried out. It was effort of the then Prime

Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country were

nationalized.

52
 Second phase of nationalization India Banking Sector Reform was carried out in 1980

with seven more banks. This step brought 80% of the banking segment in India under

Government ownership.

The following are the steps taken by the Government of India to Regulate Banking

Institutions in the country:

1949: Establishment of Banking Regulation Act.

1955: Nationalization of State Bank of India.

1959: Nationalization of SBI subsidiaries.

1961: Insurance cover extended to deposits.

1969: Nationalization of 14 major banks.

1971: Creation of Credit Guarantee Corporation.

1975: Creation of regional rural banks.

1980: Nationalization of seven banks with deposits over 200 crores.

After the nationalization of banks, the branches of the public sector bank India rose to

approximately 800% in deposits and advances took a huge jump by 11,000% Banking in the

53
sunshine of Government ownership gave the public implicit faith and immense confidence about

the sustainability of these institutions.

Phase III

This phase has introduced many more products and facilities in the banking sector in its

reforms measure. In 1991, under the chairmanship of M Narsimham, a committee was set up by

his name, which worked for the liberalization of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being put

to give a satisfactory service to customers. Phone banking and net banking introduced. The entire

system became more convenient and swift. Time is given more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered from any

crisis triggered by any external macroeconomics shock as other East Asian Countries suffered.

This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital

account is not yet fully convertible, and banks and their customers have limited foreign exchange

exposure.

54
 CHAPTER-III

Recent Developments:

The government is planning to refresh the corporate governance norms for state-owned

banks. The changed rules could be announced even before the Union Budget is presented, it is

learnt. Improving the quality of credit appraisal at these banks is among the likely changes. The

governance reforms, as an official put it, would bring in measures to track the performance of the

executive-rank employees of the banks, intensively. The proposed steps would also respond to

Moody‘s criticism that reforms needed for efficiency and better operating performance were

absent at public sector banks. Without such reforms, ‗‘the sector would continue to represent a

contingent liability to the sovereign‘‘, the second largest rating agency in the world had said last

November. From now instead of a hands-off approach, we intend to be hands-on, said another

officer, aware of the developments. According to him, other than wilful negligence, neglect of

human resources had brought the state-run banks to their present state, especially in credit

appraisal. In an earlier report, a Reserve Bank of India committee had recommended additional

qualifications for bank staff to be posted in credit operations, treasury and risk management

areas. It is yet to be implemented.

The move is being seen as a balance between an outright privatisation of banks, which is

considered politically unfeasible, and the option to let them continue with a business-as-usual

approach. In the current financial year, the finance ministry had to step in with a bailout package

of Rs 2.11 trillion, to be paid over the next few years to the ailing public sector banks (PSBs).

While the bailout has assuaged large investors about the immediate financial solvency of banks,

55
there are doubts among them about how far the money would shore up the balance sheets of

banks unless the quality of lending improves. The changes could also decide which way the

Bank Boards Bureau would move. The Bureau headed by former CAG Vinod Rai was supposed

to be entrusted with such a role but a turf war between the Department of Financial Services and

the Bureau came in the way. The government‘s Indradhanush plan, the first phase of the bailout

package, had also hinted that the Bureau would be tasked with helping these banks make

necessary changes in their corporate governance models.

The government believes that since the operational performance of banks means so much

to the rating agencies, it makes sense to bring in wide ranging changes in the operations of

banks. As a joint study by IIM Calcutta, Indian Institute of Corporate Affairs and Thought

Arbitrage Research Institute showed, there is a strong correlation between standards of corporate

governance in banks and the performance of their share prices. The finance ministry expects to

drive the changes in its capacity as the largest shareholder in these banks. It is also holding

negotiations with bank employees for wage revision, making it the right time to drive the

changes.

The official said mere consolidation among the banks would not help unless the incentive

structure was reorganised among the bank employees to make credit appraisal their key

competency. A paper written by Eswar Prasad and Isha Agarwal for Brookings India recently

made the same point. ―Reforms are needed to make PSBs more accountable and change their

incentive structures such that their lending practices are in line with the productive allocation of

56
credit. This can be achieved by adopting better governance practices and providing more

autonomy to PSBs.11

As corporations operate and compete in virtually all parts of the world, there has always

been a need to develop some governing law and the purpose of that law has been to integrate the

legislatively imposed standards with the realities of the market place, so that overall goals would

be promoted. However, the series of corporate failures such as Enron and WorldCom have

brought corporate governance into the limelight. These companies collapsed because of the

corporate mis-governance and unethical practices they indulged in. Satyam scandal in India is

also the case of corporate mis-governance. Satyam case exposed the complete lack of

accountability in the company and raised questions on corporate governance practices of the

country's listed entities.

Corporate Governance against the backdrop of globalization has become a delicate and

onerous task for survival as well as for seizing the opportunities. Corporate governance stipulates

parameters of accountability, control and reporting functions of the board of directors of the

corporations. According to the Organization for Economic Cooperation and Development

(OECD), ―corporate governance is a set of relationships between a company‘s management, its

Board, its shareholders, and other stakeholders. Corporate governance provides the structure

through which the objectives of the company are set, and the means of attaining those objectives

and monitoring performance are determined. Corporate governance should also provide proper

incentives for the Board and management to pursue objectives that are in the interests of the

company and shareholders and should facilitate effective monitoring, thereby encouraging firms

11
http://www.business-standard.com/article/economy-policy/govt-to-soon-bring-corporate-governance-norms-at-
state-owned-banks-118011900042_1.html-First Published: Fri, January 19 2018, last viewed on 22-01-2018

57
to use resources more efficiently.‖ From a financial industry perspective, corporate governance

involves the manner in which the business affairs of individual institutions are governed by their

Boards and management.

It also includes the effective management of compliance with applicable laws,

regulations, and guidelines. The focus on corporate governance is particularly acute in financial

services and, most of all, in the banking sector. Governance in banks is a considerably more

complex issue than in other sectors. Banks will attempt to comply with the same codes of board

governance as other companies but, in addition, factors like risk management, capital adequacy

and funding, internal control, and compliance, all have an impact on their matrix of governance.

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

ownership of other companies makes them a significant stakeholder in their own right. In the

financial system, corporate governance is not only vital at the individual company level, but it

also is a critical element in maintaining a sound financial system and a robust economy,

Romero12.

Almost eighty percent of the total banking operation in India is under the control of the

public sector banks consisting of the nationalized banks. The issues pertaining to Corporate

Governance becomes more critical in case of these banks as the controlling power of these banks

link with the Government. Government ownership is one of the primary issues that can have a

direct impact on the quality of corporate governance. The importance of Corporate Governance

12
http://www.iosrjournals.org/iosr-jbm/papers/Vol16-issue1/Version-6/B016161323.pdf

58
issues in public sector banks is important, due to two principal reasons. First, they constitute a

huge share of business in the banking industry in India, and second, it is highly unlikely that they

are going to be phased out in due course. Disclosure and transparency are thus key pillars of a

corporate governance framework in banks because they provide all the stakeholders with the

information necessary to judge whether their interests are being taken care of. Due to rapidly

changing banking environment, Indian banks must continue to implement strong corporate

governance practices.

Corporate Governance involves a set of relationship between company‘s management, its

board, its shareholders and other stakeholders. Corporate Governance provides a upright process

and structure through which the objective of the company, the means of attaining the objective

and systems of monitoring performance is also set. Corporate Governance is a system by which

corporate entities are directed and controlled. Corporate Governance is management of

companies by the Board of Directors. The concept of Corporate Governance primarily hinges on

complete transparency, integrity and accountability of the management. This is essentially the

core of good Corporate Governance.

Corporate Governance in its most simplified iteration refers to the manner in which

corporate bodies are managed and operated. Until the latter part of 1900‘s the expression good

Corporate Governance was invariably used to describe how well a business was directed and

managed from the perspective of its controllers or managers. This was no doubt a truism in the

context of privately owned companies in which the operators and shareholders were usually one

59
and the same persons and there was no conflict between the persons managing or controlling the

company and the ultimate beneficiaries. However the same could not be said in respect of

publicly owned enterprises in which the managers and controllers are not the sole beneficiaries

of the enterprise. In such circumstances situations do arise wherein the objectives of the

controllers or managers of the enterprise and the shareholders as a whole regarding the manner in

which a company is directed and managed does not necessarily coincide.

This impasse invariably gives rise to tensions between the controllers/managers and

shareholders, which can sometimes have disastrous consequences not only for the company itself

but also the commercial and economic environment the company, operate in. These tensions are

sometimes aggravated through the lack of transparency and communication between parties. In

this background good Corporate Governance in modern terminology has been often described as

the mechanism of addressing and easing the tensions which arise between the controllers or

managers and other stakeholders of a company. The expression stakeholders being an indication

of the development that has been witnessed in corporate cultures wherein a corporate citizen is

deemed to owe obligations not only to its owners but to its employees, creditors and in some

instances generally to society at large.13

13
http://shodh.inflibnet.ac.in/bitstream/123456789/1962/1/f.%20synopsis%20f%20-%20copy.pdf

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DEBUT OF CORPORATE GOVERNANCE IN INDIAN BANKS:

As a prelude to institutionalize Corporate Governance in banks, an Advisory Group on

Corporate Governance was formed under the chairmanship of Dr. R.H. Patil. Following its

recommendations in March 2001 another Consultative Group was constituted in November 2001

under the Chairmanship of Dr. A.S. Ganguly: basically, with a view to strengthen the internal

supervisory role of the Boards in banks in India. This move was further reinforced by certain

observations of the Advisory Group on Banking Supervision under the chairmanship of Shri

M.S. Verma which submitted its report in January 2003. Keeping all these recommendations in

view and the cross-country experience, the Reserve Bank of India initiated several measures to

strengthen the corporate governance in the Indian banking sector.

Indian banking system consists of Public/Private sector banks having a basic difference

between them as far as the Reserve Bank‟s role in governance matters relevant to banking is

concerned. The current regulatory framework ensures, by and large, uniform treatment of private

and PSBs in so far as prudential aspects are concerned. However, some of the governance

aspects of PSBs, though they have a bearing on prudential aspects, are exempted from

applicability of the relevant provisions of the Banking Regulation Act, as they are governed by

the respective legislations under which various PSBs were set up. In brief, therefore, the

approach of RBI has been to ensure, to the extent possible, uniform treatment of the PSBs and

the private sector banks in regard to prudential regulations.

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 In regard to governance aspects of banking, the Reserve Bank prescribed its policy

framework for the private sector banks. It also suggested to the Government the same framework

for adoption, as appropriate, consistent with the legal and policy imperatives in PSBs as well.

Hence the endeavor is to maintain uniformity in policy prescriptions to the best possible extent

for all types of banks. Since role of Independent Directors form the basis for effective

implementation of corporate governance in banks, it is necessary to reproduce the code of

conduct prescribed under SCHEDULE IV [section 149(7)] as prescribed in Companies Bill 2012

for the guidance to the companies.

History of sorts was made late on the evening of 8th August 2013 when the Rajya Sabha

(India‟s Upper House of Parliament) passed the Companies Bill, 2012; Lok Sabha (the Lower

House) had passed it earlier in December 2012. With this, India now has ―a modern legislation

for growth and regulation of corporate sector in India,‖ which is expected to ―facilitate business-

friendly corporate regulation, improve corporate governance norms, enhance accountability on

the part of corporates / auditors, raise levels of transparency and protect interests of investors,

particularly small investors.‖ This bill is applicable to companies with a net worth of Rs. 500

crore or more; a turnover of Rs 1,000 crore or more; and a net profit of Rs 5 crore or more during

any financial year. Schedule VII of the Act, which lists out the CSR activities, suggests

communities to be the focal point. On the other hand, by discussing a company‟s relationship to

its stakeholders and integrating CSR into its core operations, the draft rules suggest that CSR

needs to go beyond communities and beyond the concept of philanthropy14.

14
International Journal of Management and Commerce Innovations ISSN 2348-7585 (Online)
Vol. 5, Issue 1, pp: (565-579), Month: April - September 2017, Available at: www.researchpublish.com

62
Role of the Reserve Bank of India:

The Reserve Bank of India needs to place more emphasis on securing sound corporate

governance of banks rather than to focus only on regulatory compliance. As the role of the board

is crucial in developing sound corporate governance of banks, the RBI should assess the

performance of the entire board. This could be done by reviewing minutes of board meetings, by

checking the board members‘ accessibility to necessary information and resources, observing

board meetings of banks when it thinks it is appropriate, issuing warnings when necessary, and

even asking the bank to reorganize its board framework and operational procedures in the

interests of sound corporate governance. Reddy (2006) points out that there is a basic difference

between the private and public sector banks as far as the Reserve Bank‘s role in governance

matters is concerned. The RBI‘s regulatory framework ensures, by and large, uniform treatment

of both types of banks in so far as prudential aspects are concerned. However, since public sector

banks are governed by the respective legislations under which they were set up, some of the

governance aspects of these banks are exempt from applicability of the relevant provisions of the

Banking Regulation Act, although they have a bearing on prudential aspects. In regard to these

matters, the Reserve Bank prescribes its policy framework for the private sector banks and

suggests that the Government adopt the same for public sector banks. Corporate governance of

banks cuts across the areas of banking supervision and securities regulation.

It would be in the interests of all concerned, that the RBI should, in conjunction with

Securities and Exchange Board of India, develop and publicize a code of corporate governance

of banks, based on which banks could develop their own codes. Furthermore, the RBI could

63
provide incentives for banks to improve their corporate governance. For instance, taking into

consideration the suggested code mentioned above, the RBI could develop a rating mechanism

for the corporate governance of banks. Such a rating can be designed either as a rating

specifically focused on corporate governance, or as a part of a broader rating mechanism within

which factors regarding corporate governance play one of the major roles in determining overall

ratings. Another example of incentives is the possible differentiated deposit insurance premium

reflecting the ratings. The methodology of the ratings of corporate governance of banks should

be articulated as clearly as possible and should be announced well in advance in order to provide

time for banks to reorganize their framework. SEBI could contribute to developing the criteria by

providing its accumulated knowledge and experience about corporate governance15.

Traditionally, central banks have performed roles of currency authority, banker to the

Government and banks, lender of last resort, supervisor of banks and exchange control (now it

would be more appropriate to call it exchange management) authority. Generally, central banks

in developed economies have price or financial stability as their prime objective and are often

characterised by nearly complete autonomy. Milton Friedman11 defines central bank relations

with the government as one that is comparable to the relation between judiciary and the

government.

Rolf Hasse12 says that central bank independence relates to three areas in which the

influence of government must be either excluded or drastically curtailed. These are:

15
http://jblenet.com/journals/jble/Vol_2_No_1_June_2014/5.pdf

64
 a. Independence in personnel matters, that is, extent of influence of government in

appointment procedures

b. Financial independence, that is, ability of government to finance government expenditure

either directly or indirectly through central bank credits and

c. Policy independence , that is, extent of freedom in formulation and execution of

monetary policy

Literature suggests that central bank independence reduces inflation variability or

fluctuations over time because monetary policies will be allowed independent time horizons than

that dictated by elected governments to satisfy other objectives. In other words, inflation and

central bank independence are inversely related. As a corollary, high inflation over a sustained

period will erode central bank independence when it breaches a threshold value of inflation after

which public opposition will force politicians to step in and restrain the central bank. However,

this holds true largely for industrialized nations.

In developing countries the central bank plays a bigger role in the economy and cannot

reasonably be expected to have a total hands-off approach or be totally independent of

government; it has to nurture hand-hold and actively manage many aspects of the economy. To

that extent a central bank in a developing country plays both a traditional and a non-traditional

role that includes building independent institutions such as capital markets, sector regulators,

watchdogs, etc. and plays both a regulatory and a development role.

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 Central banking functions in India are carried out by the Reserve Bank of India since

independence by taking over the erstwhile Imperial Bank of India formed in 1935. RBI was

originally set up to regulate the issue of currency, maintain foreign exchange reserves to enable

monetary stability and generally to operate currency and credit system in the country. As the

economy progressed, RBI‘s role underwent several shifts. For instance, when India followed a

control model of economic governance, RBI‘s monetary policy was focussed on allocating

resources to various sectors and maintaining price stability. A novel mandate of RBI in its early

stages was to finance five year plans, establishing specialised institutions to promote savings and

to meet the credit needs of the priority sector.

The functions of RBI have undergone a strategic shift post liberalisation in the 1990s and

are now more in the nature of facilitation of efficient functioning of money and capital markets

besides strengthening of supporting institutional infrastructure. The leitmotif of change in RBI‘s

interventions is to move from control to facilitation in all aspects—foreign exchange reserves,

fixing interest rates, providing an operating framework for banks and setting down disclosure

and transparency parameters.

RBI has been largely successful in its objectives of growth with stability, developing

India‘s banking and financial sector and ensuring evolution of competitive markets. Inevitably,

because of the liberalisation process, Indian banking sector is subject to greater shocks from

external sources; for instance, a market-based exchange rate system has integrated the Indian

66
economy into the global economy but the exchange rate has become more volatile. To that extent

there is a partial loss of autonomy of domestic monetary policy.

The broad mandate of RBI currently is:

 Stimulate economic growth by controlling monetary expansion (or contraction) including

making adjustments to the interest rate structure.

 Maintain internal price stability by monitoring inflationary pressures.

 Developing the banking and financial sector and to maintain a proper oversight and

regulatory role.

The RBI indirectly also controls the commercial sector by regulating the lending policy

of banks and financial institutions and maintains an indirect oversight role over businesses

through mandatory information submission. The total flow of financial resources to the

commercial sector from banks was Rs 7,11,031 crores as on March 31, 2011.

The model of governance of banks and financial institutions followed by RBI is through

prescribing prudential norms and laying down broad disclosure principles coupled with periodic

surveillance rather than direct interference and micro-managing the banking section of the

67
economy but at the same time retaining the ultimate objective of strengthening market

institutions to infuse greater transparency and liquidity in financial markets.

The Main Functions of RBI:

 To act as regulator and supervisor of the financial system and prescribes broad

parameters of banking operations within which the country's banking and financial

system functions.

 To formulate, implement and monitor the monetary policy.

 To ensure adequate flow of credit to productive and priority sector.

 To protect the interests of bank customers and public at large.

 To control the monetary supply by issuing currency and regulating minimum margins for

various advances received by Banks (Cash Reserve Ratio, Statutory Liquidity Ratio)

 To act as banker for the entire financial sector by lending/ accepting deposits at the bank

rate of interest.

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  To act as controller of credit i.e. it has the power to influence the volume of credit created

by banks in India by changing the Bank rate or through open market operations. It can

impose both quantitative and qualitative restrictions.

 To monitor economic indicators and structure of the country for price stabilisation and

economic development.

 To control the banking system through the system of licensing, inspection and calling for

information.

 To facilitate external trade and payment and promote orderly development and

maintenance of foreign exchange market in India.

RBI‘s ambit of supervisory and regulatory powers covers following:

 Regional Rural Banks

 Public sector banks

 Private Banks

 Foreign banks

 Cooperative Banks

 Non-Banking Finance Companies

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  Institutions formed under special Acts (State Bank of India Act, The Industrial

Development Bank Act, The Industrial Finance Corporation, National Bank for

Agriculture and Rural Development Act, National Housing Bank Act, Deposit Insurance

and Credit Guarantee Corporation Act.

 Small Industries Development Bank of India.

RBI‘s power of supervision and control over commercial and co-operative banks relates

to licensing, branch expansion, asset liquidity, management and methods of working,

amalgamation, reconstruction, and liquidation. The RBI is authorized to carry out periodical

inspections of banks and to seek returns and necessary information.

The Reserve Bank of India has the responsibility of maintaining the official rate of

foreign exchange and acts as the custodian of India's reserve of international currencies.

RBI is mandated to promote the habit of banking, extend banking facilities to rural and

semi-urban areas, and establish and promote new specialized financing agencies. Accordingly,

RBI has helped in setting up of Industrial Finance Corporation of India, Sate Finance

Corporation, Deposit Insurance Corporation, Unit Trust of India, Industrial Development Bank

of India, Agricultural Refinance Corporation of India and Industrial Reconstruction Corporation

of India.

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RBI & Corporate Governance:

Banks play a pivotal role in the financial and economic system of any country. RBI plays

a leading role in formulating and implementing corporate governance norms for India‘s banking

sector. The ambit encompasses safeguarding and maximizing the shareholders‘ value, upholding

retail depositors‘ risk and stabilizing the financial system so as to conserve the larger interests of

the public. This role becomes important in view of the fact that in India bank assets often lack

transparency and liquidity because most bank loans, unlike other products and services, are

customized and privately negotiated. Banks are 'special' as they not only accept and deploy large

amount of uncollateralized public funds in a fiduciary capacity, but they also leverage such funds

through credit creation. They are also important for smooth functioning of the payment system.

In case of instability of one bank owing to incompetent or unethical management, the

entire financial system and the economy may be impacted adversely. As one bank becomes

unstable, there may be a heightened perception of risk among depositors for the entire class of

such banks, leading to early liquidation and exposing the entire financial system to chaos. In

such a situation, the interest of borrowers (corporates, retail, etc.) may also be affected in terms

of availability of credit, recall of credit lines and loss in valuation of mortgaged assets.

Two main features set banks apart from other business – the level of opaqueness in their

functioning and the relatively greater role of government and regulatory agencies in their

activities. The opaqueness in banking creates considerable information asymmetries between the

―insiders‖ – management – and ―outsiders‖ – owners and creditors. The very nature of the
71
business makes it extremely easy and tempting for management to alter the risk profile of banks

as well as siphon off funds.

The Reserve Bank of India performs corporate governance function under the guidance

of the Board for Financial Supervision (BFS). Primary objective of BFS is to undertake

consolidated supervision of the financial sector comprising commercial banks, financial

institutions and non-banking finance companies.

BFS was constituted in November 1994 as a committee of the Central Board of Directors

of the Reserve Bank of India. The Board comprises of four directors of RBI from Central board

and is chaired by Governor. The Board is required to meet normally once every month. It

considers inspection reports and other supervisory issues placed before it by the supervisory

departments.

The BFS oversees the functioning of Department of Banking Supervision (DBS),

Department of Non-Banking Supervision (DNBS) and Financial Institutions Division (FID) and

gives directions on the regulatory and supervisory issues.

BFS inspects and monitors banks using the ―CAMELS‖ (Capital adequacy, Asset quality,

Management, Earnings, Liquidity and Systems and controls) approach. BFS through the Audit

72
Sub-Committee also aims at upgrading the quality of the statutory audit and internal audit

functions in banks and financial institutions.

Corporate Governance mechanism followed by RBI:

There is a three-pronged approach:

a) Disclosure and Transparency

b) Off-site surveillance

c) Prompt corrective action

a) Disclosure and transparency are the main pillars of a corporate governance framework

enabling adequate information flow to various stakeholders and leading to informed

decisions. Accounting standards in India in all sectors including banking sector have been

enhanced to align with international best practices.

b) The off-site surveillance mechanism monitors the movement of assets, its impact on

capital adequacy and overall efficiency and adequacy of managerial practices in banks.

RBI promotes self- regulation and market discipline among the banking sector participants

and has issued prudential norms for income recognition, asset classification, and capital

adequacy. RBI brings out periodic data on ‗Peer Group Comparison‘ on critical ratios to

maintain peer pressure on individual banks for better performance and governance.

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 c) Prompt Corrective Action is a supervisory mechanism implemented as part of Effective

Banking Supervision in terms of Basel II requirements. It is based on a pre-determined

rule based structure of early intervention whereby benchmark ratios for three

parameters—Capital Adequacy Ratio, Non-Performing Assets Ratio and Return on

Assets—are determined. Any breach of these trigger points is considered as early

warning on the financial health of the banks and appropriate mandatory or discretionary

action is initiated by the RBI.

‗Published balance sheet, off-site returns and on-site inspection report (are) the primary

sources for identifying the banks which could be placed under the PCA framework. The 1980s

and early 1990s were a period of great stress and turmoil for banks and financial institutions all

over the globe. These events led to the search for appropriate supervisory strategies to avoid

bank failures as they can have a destabilizing effect on the economy.

For this reason, medium or large banks are rarely closed and the governments try to keep

them afloat. In both industrial and emerging market economies, bank rescues and mergers are

more common than outright closure of the banks. If banks are not to be allowed to fail, it is

essential that corrective action is taken well in time when the bank still has adequate cushion of

capital so as to minimize the cost to the insurance fund / public exchequer in the event of a

forced liquidation of the bank‘.

74
 Thus triggers based on CAR, Net NPAs and ROA are linked to a bank‘s performance in three

critical areas which are quantifiable and which form an integral part of the supervisory oversight.

The actions are designed to pre-empt any deterioration in the soundness of banks.

RBI considers Capital Adequacy norms, Non-Performing Assets (NPA) and Return on

Assets (ROA) as proxies for asset quality and profitability and undertakes effective banking

supervision and timely intervention through these early warning signals. Breach of these trigger

points invites disciplinary action from RBI, both mandatory and discretionary; some of these

actions are listed in Annexure I.

Other Corporate Governance Mechanisms:

a. Apart from working under the jurisdiction of RBI as mentioned above, listed banks, Non-

Banking Finance Companies and other financial intermediaries are governed by SEBI‘ s

clause 49 on corporate governance (as discussed in a section on SEBI).

b. Additionally, RBI has also issued various circulars and notifications that provide

guidelines on:

• Composition, Qualification, Independence and Remuneration of Board of Directors.

• Roles, Responsibilities and Training of Executive Directors.

• Resolution of Conflict of Interest in case of related party transactions

• Constitution of Nomination Committee, Risk Management Committee and Audit

Committee

75
 c. Audit of Banks:

One of the inspection and monitoring tools used by BFS is the quality of audit (both statutory

and internal) conducted on the banking sector. Although public sector banks have the operational

freedom in the matter of appointment of auditors, they need to choose from a list prepared by the

Comptroller and Auditor General of India (CAG) and the Institute of Chartered Accountants of

India (ICAI) and such names must be approved by the Reserve Bank of India (RBI) before banks

can select statutory auditors. Banks are required to allot the top 20 branches (to be selected

strictly in accordance with the level of outstanding advances) in a manner as to cover a minimum

of 15% of total gross advances of the bank by the statutory auditors. Banks do not have the

authority to remove audit firms during their working tenure without the prior approval of RBI.

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Guidelines on Ownership and Governance in Private Sector Banks:

Banks are ―special‖ as they not only accept and deploy large amount of uncollateralized public

funds in fiduciary capacity, but they also leverage such funds through credit creation. The banks

are also important for smooth functioning of the payment system. In view of the above, legal

prescriptions for ownership and governance of banks laid down in Banking Regulation Act, 1949

have been supplemented by regulatory prescriptions issued by RBI from time to time. The

existing legal framework and significant current practices in particular cover the following

aspects:

(i) The composition of Board of Directors comprising members with demonstrable

professional and other experience in specific sectors like agriculture, rural economy,

co-operation, SSI, law, etc., approval of Reserve Bank of India for appointment of

CEO as well as terms and conditions thereof, and powers for removal of managerial

personnel, CEO and directors, etc. in the interest of depositors are governed by

various sections of the B.R. Act, 1949.

(ii) Guidelines on corporate governance covering criteria for appointment of directors,

role and responsibilities of directors and the Board, signing of declaration and

undertaking by directors, etc., were issued by RBI on June 20, 2002 and June 25,

2004, based on the recommendations of Ganguly Committee and a review by the

BFS.

77
 (iii) Guidelines for acknowledgement of transfer/allotment of shares in private sector

banks were issued in the interest of transparency by RBI on February 3, 2004.

(iv) Foreign investment in the banking sector is governed by Press Note dated March 5,

2004 issued by the Government of India, Ministry of Commerce and Industries.

(v) The earlier practice of RBI nominating directors on the Boards of all private sector

banks has yielded place to such nomination in select private sector banks.

Against this background, it is considered necessary to lay down a comprehensive framework of

policy in a transparent manner relating to ownership and governance in the Indian private sector

banks as described below. The broad principles underlying the framework of policy relating to

ownership and governance of private sector banks would have to ensure that

(i) The ultimate ownership and control of private sector banks is well diversified. While

diversified ownership minimises the risk of misuse or imprudent use of leveraged

funds, it is no substitute for effective regulation. Further, the fit and proper criteria, on

a continuing basis, has to be the over-riding consideration in the path of ensuring

adequate investments, appropriate restructuring and consolidation in the banking

sector. The pursuit of the goal of diversified ownership will take account of these

basic objectives, in a systematic manner and the process will be spread over time as

appropriate.

78
 (ii) Important Shareholders (i.e., shareholding of 5 per cent and above) are ‗fit and

proper‘, as laid down in the guidelines dated February 3, 2004 on acknowledgement

for allotment and transfer of shares.

(iii) The directors and the CEO who manage the affairs of the bank are ‗fit and proper‘ as

indicated in circular dated June 25, 2004 and observe sound corporate governance

principles.

(iv) Private sector banks have minimum capital/net worth for optimal operations and

systemic stability.

(v) The policy and the processes are transparent and fair.

Minimum capita:

The capital requirement of existing private sector banks should be on par with the entry

capital requirement for new private sector banks prescribed in RBI guidelines of January 3, 2001,

which is initially Rs.200 crore, with a commitment to increase to Rs.300 crore within three years.

In order to meet with this requirement, all banks in private sector should have a net worth of

Rs.300 crore at all times. The banks which are yet to achieve the required level of net worth will

have to submit a time-bound programme for capital augmentation to RBI. Where the net worth

declines to a level below Rs.300 crore, it should be restored to Rs. 300 crore within a reasonable

time.

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Shareholding:

(i) The RBI guidelines on acknowledgement for acquisition or transfer of shares issued

on February 3, 2004 will be applicable for any acquisition of shares of 5 per cent and

above of the paid up capital of the private sector bank.

(ii) In the interest of diversified ownership of banks, the objective will be to ensure that

no single entity or group of related entities has shareholding or control, directly or

indirectly, in any bank in excess of 10 per cent of the paid up capital of the private

sector bank. Any higher level of acquisition will be with the prior approval of RBI

and in accordance with the guidelines of February 3, 2004 for grant of

acknowledgement for acquisition of shares.

(iii) Where ownership is that of a corporate entity, the objective will be to ensure that no

single individual/entity has ownership and control in excess of 10 per cent of that

entity. Where the ownership is that of a financial entity the objective will be to ensure

that it is a well-established regulated entity, widely held, publicly listed and enjoys

good standing in the financial community.

(iv) Banks (including foreign banks having branch presence in India)/FIs should not

acquire any fresh stake in a bank‘s equity shares, if by such acquisition, the investing

bank‘s/FI‘s holding exceeds 5 per cent of the investee bank‘s equity capital as

indicated in RBI circular dated July 6, 2004.

80
 (v) As per existing policy, large industrial houses will be allowed to acquire, by way of

strategic investment, shares not exceeding 10 per cent of the paid up capital of the

bank subject to RBI‘s prior approval. Furthermore, such a limitation will also be

considered if appropriate, in regard to important shareholders with other commercial

affiliations.

(vi) In case of restructuring of problem/weak banks or in the interest of consolidation in

the banking sector, RBI may permit a higher level of shareholding, including by a

bank.

Directors and Corporate Governance:

(i) The recommendations of the Ganguly Committee on corporate governance in banks

have highlighted the role envisaged for the Board of Directors. The Board of

Directors should ensure that the responsibilities of directors are well defined and the

banks should arrange need-based training for the directors in this regard. While the

respective entities should perform the roles envisaged for them, private sector banks

will be required to ensure that the directors on their Boards representing specific

sectors as provided under the B.R. Act, are indeed representatives of those sectors in

a demonstrable fashion, they fulfil the criteria under corporate governance norms

provided by the Ganguly Committee and they also fulfil the criteria applicable for

determining ‗fit and proper‘ status of Important Shareholders (i.e., shareholding of 5

per cent and above) as laid down in RBI Circular dated June 25, 2004.

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 (ii) As a matter of desirable practice, not more than one member of a family or a close

relative (as defined under Section 6 of the Companies Act, 1956) or an associate

(partner, employee, director, etc.) should be on the Board of a bank.

(iii) Guidelines have been provided in respect of 'Fit and Proper' criteria for directors of

banks by RBI circular dated June 25, 2004 in accordance with the recommendations

of the Ganguly Committee on Corporate Governance. For this purpose a declaration

and undertaking is required to be obtained from the proposed / existing directors.

(iv) Being a Director, the CEO should satisfy the requirements of the ‗fit and proper‘

criteria applicable for directors. In addition, RBI may apply any additional

requirements for the Chairman and CEO. The banks will be required to provide all

information that may be required while making an application to RBI for approval of

appointment of Chairman/CEO.

Foreign investment in private sector banks:

In terms of the Government of India press note of March 5, 2004, the aggregate foreign

investment in private banks from all sources (FDI, FII, NRI) cannot exceed 74 per cent. At all

times, at least 26 per cent of the paid up capital of the private sector banks will have to be held

by resident Indians.

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Foreign Direct Investment (FDI) (other than by foreign banks or foreign bank group):

(i) The policy already articulated in the February 3, 2004 guidelines for determining ‗fit

and proper‘ status of shareholding of 5 per cent and above will be equally applicable

for FDI. Hence any FDI in private banks where shareholding reaches and exceeds 5

per cent either individually or as a group will have to comply with the criteria

indicated in the aforesaid guidelines and get RBI acknowledgement for transfer of

shares.

(ii) To enable assessment of ‗fit and proper‘ the information on ownership/beneficial

ownership as well as other relevant aspects will be extensive.

Foreign Institutional Investors (FIIs):

I. Currently there is a limit of 10 per cent for individual FII investment with the

aggregate limit for all FIIs restricted to 24 per cent which can be raised to 49 per cent

with the approval of Board/General Body. This dispensation will continue.

II. The present policy requires RBI‘s acknowledgement for acquisition/transfer of

shares of 5 per cent and more of a private sector bank by FIIs based upon the policy

guidelines on acknowledgement of acquisition/transfer of shares issued on February

3, 2004. For this purpose RBI may seek certification from the concerned FII of all

beneficial interest.

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Non-Resident Indians (NRIs):

Currently there is a limit of 5 per cent for individual NRI portfolio investment with the

aggregate limit for all NRIs restricted to 10 per cent which can be raised to 24 per cent with the

approval of Board/General Body. Further, the policy guidelines of February 3, 2004 on

acknowledgement for acquisition/transfer will be applied.

Due diligence process:

The process of due diligence in all cases of shareholders and directors as above, will

involve reference to the relevant regulator, revenue authorities, investigation agencies and

independent credit reference agencies as considered appropriate.

Transition arrangements:

(i) The current minimum capital requirements for entry of new banks is Rs.200 crore to

be increased to Rs.300 crore within three years of commencement of business. A few

private sector banks which have been in existence before these capital requirements

were prescribed have less than Rs.200 crore net worth. In the interest of having

sufficient minimum size for financial stability, all the existing private banks should

also be able to fulfil the minimum net worth requirement of Rs.300 crore required for

a new entry. Hence any bank with net worth below this level will be required to

submit a time bound programme for capital augmentation to RBI for approval.

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(ii) Where any existing shareholding of any individual entity/group of entities is 5 per

cent and above, due diligence outlined in the February 3, 2004 guidelines will be

undertaken to ensure fulfilment of ‗fit and proper‘ criteria.

(iii) Where any existing shareholding by any individual entity/group of related entities is

in excess of 10 per cent, the bank will be required to indicate a time table for

reduction of holding to the permissible level. While considering such cases, RBI will

also take into account the terms and conditions of the banking licences.

(iv) Any bank having shareholding in excess of 5 per cent in any other bank in India will

be required to indicate a time bound plan for reduction in such investments to the

permissible limit. The parent of any foreign bank having presence in India, having

shareholding directly or indirectly through any other entity in the banking group in

excess of 5 per cent in any other bank in India will be similarly required to indicate a

time bound plan for reduction of such holding to 5 per cent.

(v) Banks will be required to undertake due diligence before appointment of directors and

Chairman/CEO on the basis of criteria that will be separately indicated and provide

all the necessary certifications/information to RBI.

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 (vi) Banks having more than one member of a family, or close relatives or associates on

the Board will be required to ensure compliance with these requirements at the time

of considering any induction or renewal of terms of such directors.

(vii) Action plans submitted by private sector banks outlining the milestones for

compliance with the various requirements for ownership and governance will be

examined by RBI for consideration and approval.

Continuous monitoring arrangements:

(i) Where RBI acknowledgement has already been obtained for transfer of shares of 5

per cent and above, it will be the bank‘s responsibility to ensure continuing

compliance of the ‗fit and proper‘ criteria and provide an annual certificate to the RBI

of having undertaken such continuing due diligence.

(ii) Similar continuing due diligence on compliance with the ‗fit and proper‘ criteria for

directors/CEO of the bank will have to be undertaken by the bank and certified to

RBI annually.

(iii) RBI may, when considered necessary, undertake independent verification of ‗fit and

proper‘ test conducted by banks through a process of due diligence as described.

On the basis of such continuous monitoring, RBI will consider appropriate measures to

enforce compliance .February 28, 2005.16

16
https://rbi.org.in/upload/content/pdfs/guidelines.pdf

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 CHAPTER-IV

Corporate Governance in Public and Private Sector Banks: A Comparative

Study of SBI and ICICI Bank.

Corporate Governance involves a set of relationship between company‘s management, its

board, its shareholders and other stakeholders. Corporate Governance provides a upright process

and structure through which the objective of the company, the means of attaining the objective

and systems of monitoring performance is also set.

Corporate Governance is a system by which corporate entities are directed and

controlled. Corporate Governance is management of companies by the Board of Directors. The

concept of Corporate Governance primarily hinges on complete transparency, integrity and

accountability of the management. This is essentially the core of good Corporate Governance.

Corporate Governance in its most simplified iteration refers to the manner in which

corporate bodies are managed and operated. Until the latter part of 1900‘s the expression good

Corporate Governance was invariably used to describe how well a business was directed and

managed from the perspective of its controllers or managers. This was no doubt a truism in the

context of privately owned companies in which the operators and shareholders were usually one

and the same persons and there was no conflict between the persons managing or controlling the

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company and the ultimate beneficiaries. However the same could not be said in respect of

publicly owned enterprises in which the managers and controllers are not the sole beneficiaries

of the enterprise. In such circumstances situations do arise wherein the objectives of the

controllers or managers of the enterprise and the shareholders as a whole regarding the manner in

which a company is directed and managed does not necessarily coincide.

This impasse invariably gives rise to tensions between the controllers/managers and

shareholders, which can sometimes have disastrous consequences not only for the company itself

but also the commercial and economic environment the company, operate in. These tensions are

sometimes aggravated through the lack of transparency and communication between parties.

In this background good Corporate Governance in modern terminology has been often

described as the mechanism of addressing and easing the tensions which arise between the

controllers or managers and other stakeholders of a company. The expression stakeholders being

an indication of the development that has been witnessed in corporate cultures wherein a

corporate citizen is deemed to owe obligations not only to its owners but to its employees,

creditors and in some instances generally to society at large. Corporate Governance in the

context of a modern corporation has become synonymous with the practices and processes used

to direct and manage the affairs of a corporate body with the object of balancing the attainment

of corporate objectives with the alignment of corporate behaviour to the expectations of society

and accountability to shareholders and other stakeholders. Corporate Governance encapsulates:-

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• The management of the relationships between a corporate body‘s management, its board,

its shareholders and other stakeholders.

• The provision of the structure through which the objectives of the company are identified

and the monitoring of the means used to attain these objectives including the monitoring of

performance in this regard.

• Bringing more transparency to bear on the decision-making processes of the company.

• The provision of proper incentives for the board and management to pursue objectives

those are in the interests of the corporate body and shareholders.

• Encouraging the use of resources in a more efficient manner.

• The management of risk and the minimization of the effects of commercial misadventure.

Corporate Governance is only part of the larger economic context in which companies

operate. It is recognised though as a key element in improving economic efficiency and is

considered a powerful micro-policy instrument and effective lever for charge in transitional

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economies. It is however, no substitute for entrepreneurial ability. It only offers a framework of

accountability and checks and balances. Further good Corporate Governance cannot prevent ill-

conceived strategies, product failures or missed opportunities. It can however contain the harm

arising from such corporate shortcomings and enable the tackling of issues such as defective

leadership, persistent poor business performance and a general erosion of trust or confidence in

or around business. In the circumstances it could be said to contribute to the preservation,

sustenance and nurturing of the fruits of entrepreneurial activity.

Corporate Governance is affected by a multiplicity of factors. It is affected by the

relationships among participants in the governance system. The legal, regulatory and institutional

environment in which, a corporate body operates affects the manner in which it governs. In

addition, factors such as business ethics and corporate awareness of the environmental and

societal interests of the communities in which it operates can also have an impact on the

governance of the corporate body.

The Basel committee published a paper for banking organisations in September 1999.

The Committee suggested that it is the responsibility of the banking supervisors to ensure that

there is an effective Corporate Governance in the banking industry. It also highlighted the need

for having appropriate accountability and checks and balances within each bank to ensure sound

Corporate Governance, which in turn would lead to effective and more meaningful supervision.

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 Efforts were taken for several years to remedy the deficiencies of Basel I norm and Basel

committee came out with modified approach in June 2004. The final version of the Accord

titled‖International Convergence of Capital Measurement And Capital Standards-A-Revised

Framework‖ was released by BIS. This is popularly known as New Basel Accord of simply

Basel II. Basel II seeks to rectify most of the defects of

Basel I Accord. The objectives of Basel II are the following:

1. To promote adequate capitalisation of banks.

2. To ensure better risk management and

3. To strengthen the stability of banking system.

Essentials of Accord of Basel II

• Capital Adequacy: Basel II intends to replace the existing approach by a system that

would use external credit assessments for determining risk weights. It is intend that such an

approach will also apply either directly or indirectly and in varying degrees to the risk weighting

of exposure of banks to corporate and securities firms. The result will be reduced risk weights for

high quality corporate credits and introduction of more than 100% risk weight for low quality

exposure.

• Risk Based Supervision: This ensures that a bank‘s capital position is consistent with

overall risk profile and strategy thus encouraging early supervisory intervention. The new

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framework lays accent on bank managements developing internal assessment processes and

setting targets for capital that are commensurate with bank‘ particular risk profile and control

environment. This internal assessment then would be subjected to supervisory review and

intervention by RBI.

• Market Disclosures: The strategy of market disclosure will encourage high disclosure

standards and enhance the role of market participants in encouraging banks to hold and maintain

adequate capital.

CORPORATE GOVERNANCE PRACTICES IN ICICI BANK

Corporate Governance policies of ICICI Bank recognise the accountability of the board

and the importance of its decisions to all their constituents, including customers, investors,

employees and the regulatory authorities. The functions of the board and the executive

management are well defined and are distinct from one another. They have taken a series of steps

including the setting up of sub committees of the board to oversee the functions of executive

management.

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 The board‘s role, functions, responsibility and accountability are clearly defined. In

addition to its primary role of monitoring corporate performance, the functions of the board

include

• Approving corporate philosophy and mission

• Participating in the formulation of strategic and business plan

• Reviewing and approving financial plans and budgets.

• Monitoring corporate performance against strategic and business plans including

overseeing operations

• Ensuring ethical behaviour and compliance with laws and regulations.

• Formulating exposure limits

• Keeping shareholders informed regarding plans, strategies and performance.

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CORPORATE GOVERNANCE OF STATE BANK OF INDIA

To enhance management transparency and Corporate Governance, SBI holdings

recognises that one of its most crucial management task is to build and maintain an

organisational structure capable of responding quickly to the changes in the business

environment as well as a fair management system that emphasis interest of the shareholders.

State Bank of India is committed to the best practises in the area of Corporate

Governance. The bank believes that good Corporate Governance is much more than complying

with legal and regulatory requirements. Good governance facilitates effective management and

control of business, enables the bank to maintain high level of business ethics and to optimise the

value for all its stake holders.

The objectives can be summarized as

• To enhance shareholder value

• To protect the interest of shareholders and other stakeholders including customers,

employees and society at large.

• To ensure transparency and integrity in communication and to make available full,

accurate and clear information to all concerned.

• To ensure accountability for performance and to achieve excellence at all levels.

• To provide corporate leadership of highest standard for others to emulate.

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 Corporate Governance & The Companies (Amendment) Act 2017 - Key

Changes

The Companies (Amendment) Act, 2017 introduces several amendments to the

Companies Act 2013, realigning provisions to improve corporate governance and ease of doing

business in India while continuing to strengthen compliance and investor protection. One of the

most significant legal reforms in recent times is the enactment of the Companies Act, 2013 (2013

Act) which overhauled the erstwhile Companies Act, 1956 (1956 Act). Though the 2013 Act was

a step in the right direction as it introduced significant changes in areas of disclosures, investor

protection, corporate governance, etc., there were multiple instances of conflicts and overreach

within the legislation leading to difficulties in its implementation. In fact, since its enactment,

more than 100 amendments have been made to the 2013 Act.

Accordingly, the Companies Law Committee (CLC) was constituted in June 2015 with

the mandate of making recommendations to resolve issues arising from the implementation of

the 2013 Act. Based on the recommendations of the report of the CLC, the Government

introduced the Companies (Amendment) Bill, 2016 (Bill) in the Lok Sabha on 16 March 2016

which was passed by the Lok Sabha on 27 July 2017 and by the Rajya Sabha on 19 December

2017. The Companies (Amendment) Act, 2017 (Amendment Act) received the assent of the

President on 3 January 2018, but different provisions of the Amendment Act will be brought into

force on different dates by the Central Government. Proposing a slew of changes, the

Amendment Act seeks to realign many provisions to ease corporate governance and doing

business in India while continuing to strengthen compliance and investor protection.

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 In this newsletter, we analyse some of the key changes effected by the Amendment Act

and their impact on corporate India:

1. Associate, Holding and Subsidiary Companies – Amendments to

Definition and Impact

(a) Associate Company

I. An associate company, in relation to another company, was defined under the

2013 Act as a company in which that other company has a 'significant

influence' and included a joint venture company.

'Significant influence' was defined as control of at least 20% of the total share capital or business

decisions under an agreement.

The Amendment Act widens the definition of 'significant influence' by, (a) referencing,

control of 20% of the total voting power as opposed to the total share capital; and (b) including

participation in (and not only control of) business decisions.

Observations:

The inclusion of participation rights as a test of 'significant influence' has been made to

align the definition with that in the Indian Accounting Standard 28 (IndAS) which deals with

investments in associates and joint ventures. While the IndAS is applicable only to public listed

companies, the amended definition of an associate company and its consequent ramifications

96
under the 2013 Act, such as consolidation of accounts, coverage under related party transactions,

etc. are applicable to all companies.

From a practical perspective, such a broad definition of 'significant influence' could result

in a minority investor with a board nominee, but having no affirmative or special rights, being

classified as exercising 'significant influence' on the investee company and consequently, making

the investee company an associate of such minority investor. Interestingly, a recent amendment

to the FDI Policy states that if a foreign investor intends to specify a particular auditor or audit

firm having an international network for the Indian investee company, then the audit of such

investee company should be carried out as joint audit wherein one of the auditors should not be

part of the same network. The foreign investor's ability to specify the auditor of the investee

company could also be viewed as an exercise of 'significant influence' by the foreign investor

over the investee company.

The Amendment Act defines the term 'joint venture' as a joint arrangement whereby

parties that have joint control of the arrangement have rights to the net assets of the arrangement.

Observations:

While the words 'arrangement' and 'joint control' have not been defined in the

Amendment Act, guidance may be sought from the IndAS 28 which defines the terms 'joint

arrangement' as 'an arrangement of which two or more parties have joint control' and the term

'joint control' as 'the contractually agreed sharing of control of an arrangement, which exists only

when decisions about the relevant activities require the unanimous consent of the parties sharing

control'.

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 Accounting Standard 27, which deals with Financial Reporting of Interests in Joint

Ventures and applies to all companies which are not mandatorily required to adopt the IndAS,

defines 'joint control' as the contractually agreed sharing of control over an economic activity

and does not make reference to decisions requiring the unanimous consent of the parties sharing

control. These differing definitions could lead to challenges in interpreting the term joint venture.

II. The concept of associate company has assumed additional significance with

its inclusion in the definition of 'financial year', allowing companies which are

associates of foreign companies to make an application to align their financial

years with the financial years of such foreign companies.

Observations:

Under the 2013 Act, Indian companies could make an application to adopt a financial year

different from the 1 April - 31 March year, only if they were required to consolidate accounts

with a holding or subsidiary company incorporated outside India. This was a roadblock for

companies that wanted to align their financial year with a group or sister concern or a

shareholder, but, owing to ownership of less than 50% and lacking management control rights,

did not satisfy the holding-subsidiary test. With the inclusion of the term 'associate company' the

definition of 'financial year', this issue has now been resolved.

(b) Holding Company

A holding company, in relation to one or more other companies, was defined under

the 2013 Act as a 'company' of which such companies are subsidiary companies. The

term 'company' refers to a company incorporated under the 2013 Act or any previous

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 company law and does not refer to an entity incorporated outside India. Accordingly,

while Indian companies qualify as subsidiaries of foreign holding companies as per

the definition of subsidiary under the 2013 Act, foreign holding companies were not

covered within the ambit of the definition of holding company.

The CLC in its report observed that though this was a minor anomaly, it could lead to

uncertainties in ascertaining the status of a foreign holding company and in determining the

applicability of the 2013 Act to such a company. The Amendment Act has therefore introduced

an explanation to the definition of holding company to clarify that a holding company includes

anybody corporate.

Observations:

Foreign companies which meet the prescribed test under the 2013 Act will consequently qualify

as holding companies. Accordingly, provisions of the 2013 Act which refer to holding

companies, such as issuance of ESOPs of a holding company to employees of the Indian

subsidiary, the restriction on auditors and audit firms providing certain non-audit services

wherein they are engaged directly or indirectly by the holding company (or any of the holding

company's associates or subsidiaries), the restriction on an Indian company giving loans to a

director of its holding company, etc. will apply to a foreign holding company as well.

(c) Subsidiary

One of the tests of a subsidiary company under the 2013 Act was the control of more

than onehalf of its total share capital by the holding company. The Amendment Act

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 has changed the criteria to control of 'voting power' instead of control of'share

capital'.

Observations:

The voting power of a shareholder in a company may not always be proportional to the

number of shares held by the shareholder (because of differential voting rights attached to shares

or voting through other instruments such as convertible instruments on a fully diluted basis).

Accordingly, under the 2013 Act, it was possible for a corporate shareholder to own majority

voting rights in a company, but not qualify as a holding company. The amendment seeks to plug

this loophole.

2. Issuance of Shares

a. Issue at a Discount

Issue of shares at a discount to face value was prohibited under the 2013 Act. The

Amendment Act permits companies to issue shares at a discount to its creditors under a

statutory resolution plan or debt restructuring scheme in accordance with any guidelines,

directions or regulations specified by the Reserve Bank of India (RBI).

Observations:

Though the 1956 Act allowed companies to issue shares at a discount with the prior approval of

the Company Law Board, the CLC noted that this facility was hardly used. The CLC therefore

felt that such a relaxation would help restructuring of a distressed company. However, the

intention behind limiting the relaxation to a Strategic Debt Restructuring Scheme and other such

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schemes issued by the RBI is unclear, especially with the introduction of the Insolvency and

Bankruptcy Code, 2016 which has led to a paradigm shift in debt recovery in India.

b. Issue of Sweat Equity Shares

Under the 2013 Act, sweat equity shares could not be issued within 1 year of

commencement of business of the company. The Amendment Act seeks to remove this

restriction.

Observations:

This amendment will enable companies, particularly start-ups, to issue sweat equity shares

immediately after incorporation and consequently enable them to attract talent and procure know

how and other value additions without any cash flow issues.

c. Private Placement Process

The Amendment Act has substantially revised the provisions on issuance of shares

through a private placement process with a view to make the provisions reader friendly.

Observations:

(i) The Amendment Act expressly states that a private placement offer cannot be

renounced in favour of a third party.

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 (ii) The 2013 Act provided that funds raised through private placement could not be

utilized until the shares were allotted. The Amendment Act provides an additional

restriction prescribing non-utilisation of funds until the requisite filing has been made

with the RoC. The timeline for the filing has also been reduced to 15 days (from 30

days under the 2013 Act).

(iii) The 2013 Act restricted a company from making a fresh private placement offer

while a previous offer was pending. The Amendment Act seeks to provide flexibility

to raise funds by permitting companies to make more than one issue of securities to

such class of identified persons as may be prescribed, subject to a maximum of 50

identified persons.

3. Changes Specifically Impacting Listed Companies

(a) Public Offer

The 2013 Act listed matters that needed to be stated in the prospectus while making a

public offer, resulting in an overlap between the 2013 Act and the requisite Securities and

Exchange Board of India (SEBI) regulations. The Amendment Act seeks to omit the

provisions that require specific matters to be stated in the prospectus and proposes that

the company should provide such information as required by the SEBI in consultation

with the Central Government.

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 (b) Liability for Misstatement in the Prospectus While the 2013 Act prescribed civil liability

for directors, promoters and experts for issuing misleading statements in a prospectus, it

did not allow directors who relied on the statements made by experts in a prospectus to

use such reliance as a defence. The CLC examined the provisions under the 1956 Act as

well as laws of other jurisdictions and recommended that it would be appropriate to hold

experts liable for statements prepared by them, and on which directors relied upon, as

long as such experts were identified in the prospectus. The Amendment Act incorporates

a defence against the liability of a director for misleading statements in the prospectus

made by an expert, provided the director can prove that he had reasonable ground to

believe that the expert making the statement was competent to make it, that such expert

had given consent to issue the prospectus and had not withdrawn such consent before

registration of the prospectus.

(c) Relaxation in Filing of Returns

Under the 2013 Act, every listed company was required to file a return with the RoC with

respect to change in the number of shares held by promoters and top 10 shareholders of

such company, within 15 days of such change. The Amendment Act has done away with

this requirement with a view to simplify compliance.

4. Directors and Key Managerial Personnel–Compliance and

Restriction on Transactions

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 (a) Key Managerial Personnel–Definition The term 'key managerial personnel' (KMP) was

defined under the 2013 Act to mean the chief executive officer, managing director,

manager, company secretary, whole time director and chief financial officer. The

Amendment Act expands the definition of KMP by giving the board of directors the

power to designate an officer of the company, who directly reports to a director in whole

time employment of the company, as a KMP.

Observations:

This provision is aimed to enable the board to designate officers in senior leadership as KMP.

However, the above phraseology creates ambiguity as to whether the requirement to be in the

company's whole-time employment applies to the director or the officer proposed to be

designated as KMP. Given that the intention is to empower the board to designate an officer of

the company as KMP, the requirement should apply to the officer in question and not the director

to whom such officer reports.

(b) Directors

(i) Resident Director

The 2013 Act required every company to have at least one resident director, i.e., a

director who has stayed in India for a total period of not less than 182 days during

the previous calendar year. The Amendment Act seeks to modify the residency

requirement, by making it applicable to the current financial year instead of the

previous calendar year.

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Observations:

While the CLC had recommended a change from using calendar year to financial year to

determine the residency status of a director, the Amendment Act has taken this one step further

by requiring the director to stay for at least 182 days in India in the current financial year (as

opposed to the previous financial year). The change brings about flexibility for non-residents,

especially those forming part of the senior management of a foreign company, to act on the

Board of the Indian company without any gestation period and reduces the dependency on

external persons already resident in India. Having said that, such action comes with an increased

burden of compliance on the Indian company to ensure that a director appointed as a resident

director meets the mandatory requirement to not fall foul of the law.

(ii) Independent Director

Under the 2013 Act, a person appointed as an independent director and his

relatives were not permitted to have any pecuniary relationship or transaction with

the company in which such a person was appointed as an independent director.

Based on the CLC's recommendation, the Amendment Act has introduced a

materiality threshold for determining whether pecuniary relationships could

impact the independence of a person to act as an independent director. The

Amendment Act permits an independent director to have limited pecuniary

relationships with the company without compromising his independence, such as

receiving remuneration as an independent director and having transactions with

the company not exceeding 10% of his total income.

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(iii) Number of Directorships

Under the 2013 Act, a person was not allowed to hold office as a director,

including alternate directorship, in more than 20 companies. The Amendment Act

excludes directorship in dormant companies in determining the limit of 20

companies, so that directorships in dormant companies is not discouraged.

(iv) Alternate Director

The 2013 Act permitted a director of a company to be appointed as an alternate to

another director of the company in case the latter is absent from India for a period

of 3 months. To avoid any potential conflict of interest, the Amendment Act

prohibits the appointment of an existing director of the company as an alternate

for a director during his absence.

(v) Disqualifications for Appointment of a Director

Under the 2013 Act, a director could not be reappointed as a director in a

company which had failed to file financial statements and annual returns for a

continuous period of three years or had not repaid deposits or interest or redeemed

debentures on the due date, etc. for a year or more. The Amendment Act provides

that a newly appointed director of a company in default should not incur such

disqualification for a period of six months from his appointment, which gives him

an opportunity to rectify the defect and avoid this disqualification within such

period. Further, if the existing director of such a company in default incurs

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 disqualification, the office of such director would become vacant in all other

companies, except the company which is in default, to ensure that the defaulting

company has the requisite number of directors to remedy the default.

(vi) Resignation of Director

In addition to the requirement of a company undertaking a filing with the ROC on

resignation of any of its directors, the 2013 Act, also required the resigning

director to forward a copy of his resignation, along with reasons, to the RoC

within 30 days of the resignation. The Amendment Act makes such filing optional

for the resigning director.

(c) Forward dealing by Whole-time Director and KMP

The 2013 Act restricted forward dealing by whole-time directors and KMP, i.e., whole-

time directors and KMP were restricted from having a right to call for, or put, the

securities of the company at a pre-determined price on a future date. The Amendment Act

has deleted this restriction.

Observations:

The SEBI regulations prescribe guidelines for forward dealings in securities of a listed and

unlisted public company and similar restrictions contained in the 2013 Act was an unnecessary

overlap. Further, extending such restrictions to private companies made it difficult to structure

transactions involving management buy-out, stock incentive to the management, etc.

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 (d) Prohibition on Insider Trading

The 2013 Act prohibited insider trading by any person (including directors and key

managerial personnel). This provision has been deleted by the Amendment Act.

Observations:

This provision has been deleted given the comprehensive insider trading regulations under the

SEBI (Prevention of Insider Trading) Regulations, 2015, applicable to listed entities and for

removing the overreach of the existing provision on unlisted and private companies.

(e) Restrictions on Loans to Directors or Persons in which Directors are Interested The 2013

Act imposed absolute restrictions on companies from giving any loan to, or any security

relating to any loan taken by a director or specified persons in which a director was

interested. Group companies with common directors were affected by this restriction,

impairing inter-group lending and provision of security. The Amendment Act substitutes

the entire section to deal with difficulties being faced in genuine transactions. Though the

amendment does not propose a complete relaxation, it seeks to allow companies to

advance a loan to a person in which a director is interested subject to:

(a) Prior approval of the company by a special resolution; and

(b) Utilization of the loan by the borrowing entity for its principal business activity. The

Amendment Act also widens the scope of the penalty imposed under the section to

companies which utilize the loan, guarantee or security in contravention of the section.

5. Ease of Incorporation, Doing Business and Compliance

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Incorporation and Registered Office

(i) The proposed name of a company to be incorporated, which is approved by the RoC, will now

be available only for 20 days from the date of approval (as opposed to the limit of 60 days from

the date of application under the 2013 Act).

Observations:

This could have an impact on companies proposing to have foreign directors or foreign

subscribers or both, as their documents would need to be not raised and apostil led outside India

within the 20-day period in order to file the incorporation form on time. That said, the

requirement to make a separate application for name approval arises only when the proposed

name resembles or conflicts with an existing name since in all other cases, a single window

application for incorporation is permitted.

(iii) The 2013 Act required every subscriber to the memorandum to provide an affidavit

confirming his compliance with the provisions of the 2013 Act with respect to the

incorporation process and the completeness of all information contained in the

documents filed with the RoC for registration of the company. The Amendment Act

seeks to do away with the affidavit and prescribes only a declaration, to simplify the

process.

(iv) The timeline to have an operational registered office post incorporation and for

notifying changes to the registered office has been increased from 15 days to 30 days

under the Amendment Act.

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 (c) Flexibility in Convening Annual and Extraordinary General Meetings The 2013 Act

required annual general meetings (AGMs) to be held at the registered office of the

company or at some other place within the city, town or village in which the registered

office of the company is situated, while extraordinary general meetings (EGMs) had to be

held in India. Further, an AGM or EGM could be convened by providing notice which is

less than 21 days, if consent was obtained from at least 95% of the members entitled to

vote at such meetings. The Amendment Act allows AGMs of an unlisted company to be

held at any place in India, if consent is given by all the members in advance. The

Amendment Act also permits a wholly owned subsidiary of a foreign company to hold its

EGM outside India. Further, an EGM may now be convened at shorter notice if consent

is obtained by members holding at least 95% of the paid-up capital permitted to vote at

the meeting.

Observations:

The rationale for having different thresholds for consent for an AGM as opposed to an

EGM seems to stem from the fact that at an AGM, critical business, such as approving the

financial statements of the company, appointing auditors and declaring dividends are transacted.

The Amendment Act therefore attempts to protect shareholder interest at an AGM by providing

certainty and lesser leverage to majority shareholders. The relaxations contained in the

Amendment Act are a positive step in providing flexibility to companies to convene general

meetings.

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 (d) Managerial Remuneration A public company was required to obtain the approval of the

Central Government if the total managerial remuneration paid by it in a financial year

exceeded 11% of the net profits for that financial year. The Amendment Act replaces the

Central Government approval with the requirement of obtaining shareholders' approval

through a special resolution. Approval of a bank, public financial institution, non-

convertible debenture holder or any secured creditor is also required where the company

has defaulted in payment of dues to them.

Observations:

Flexibility that the Amendment Act has given companies in fixing managerial

remuneration without government interference will enable public companies to attract competent

and talented individuals for senior management roles. At the same time, the necessary safeguards

introduced in the form of shareholder and other stakeholder approvals, will prevent siphoning of

funds.

(e) Annual Return and Directors' Report On the recommendation of the CLC, the

Amendment Act seeks to simplify compliances relating to annual returns and the Board's

report in the following ways:

(i) Reducing the information to be provided in the annual return and empowering the Central

Government to introduce an abridged form of annual return and directors' report for one person

companies and small companies; and

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(ii) Doing away with the requirement of having the annual return as part of the Board's report

and instead requiring only a URL of the annual report (from the website of the company) to be

published in the Board's report. Further, the Amendment Act provides that if the company's

policies are available on the website, only salient features of the policy along with any changes

can be specified in the Board's report along with the URL of the complete policy. Additionally,

where disclosures required in the Board's report are already included in the financial statements,

the same need not be repeated in the Board's report.

(e) Appointment of Auditors the Amendment Act removes the requirement of obtaining

ratification by members of the company for appointment of auditors at every AGM.

Observations:

The CLC felt that the objective of the section was to ensure independence of auditors and

any decision taken by the shareholders to not ratify any appointment during the period of five-

years was akin to removal of the auditor. This resulted in an inconsistency in the 2013 Act,

where removal of an auditor, before expiry of his term, required a special resolution and

approval of the Central Government, while removal through non-ratification needed only an

ordinary resolution. To address this inconsistency, the CLC felt that it would be advisable to

omit the provisions with respect to annual ratification, since it defeated the objective of a five-

year term.

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(f) Authentication of Documents: The Amendment Act empowers the Board to authorise any

employee of the company to execute or authenticate documents on behalf of the company. Such

authority under the 2013 Act could only be conferred on directors and KMP.

Observations:

The CLC observed that it would be practically very difficult for only top-level persons or

senior management to sign documents on behalf of a company, without providing for any other

employee to sign, even with a board resolution. The CLC also noted that since any authorization

in favour of employees would be backed by a Board resolution, it would be expected of the

Board to exercise due care while authorizing any such employee. This change also emphasises

the position that companies cannot authorise an outsider (including employees in other group

companies) to authenticate documents on behalf of the company. Accordingly, many

multinational corporations will need to review their authority delegations given this amendment.

6. Other Notable Changes

(a) Related Party

(i) As per the definition of 'related party' under the 2013 Act, only an Indian incorporated

holding, subsidiary or associate company of an Indian company could be a related party of such

a company. The CLC noted that this anomaly was unintentional and would seriously affect

compliance requirements. The Amendment Act addresses this anomaly by providing that any

body corporate (therefore including companies incorporated outside India) being a holding,

subsidiary or associate company of an Indian company would be a related party of such

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company. The Amendment Act also includes any body corporate, being an investing or venturer

of a company, within the ambit of a related party. An 'investing company' or 'venturer of a

company' means a body corporate whose investment in the company would result in the

company becoming an associate company of the body corporate.

(ii) Under the 2013 Act, a public company is required to obtain the consent of its shareholders by

way of a special resolution before entering into specified contracts or arrangements with related

parties, above prescribed financial thresholds and a member who is a related party is not allowed

to vote on such resolution. The Amendment Act clarifies that if 90% or more members (in

number) are relatives of promoters or are related parties, the bar on voting on the resolution

would not apply.

Observations:

This will resolve practical difficulties faced by closely held public companies for

obtaining shareholders' approval for related party transactions.

(b) Beneficial Interest

(i) While the concept of beneficial interest was prevalent under the 1956 Act and is recognized

under the 2013 Act as well, the term was not defined in the 2013 Act. The Amendment Act

defines beneficial interest in a share to include, directly or indirectly, through any contract

arrangement or otherwise, the right or entitlement of a person alone or together with any other

person to:

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 (i) Exercise or cause to be exercised any or all of the rights attached to the shares; or

(ii) Receive or participate in any dividend or other distribution in respect of such share.

(iii) The CLC had observed that corporate vehicles are being increasingly misused for

evading Tax, money laundering and other corrupt and illegal purposes and further,

complex structures and chains of corporate vehicles are being used to hide the real

owner or beneficiary of such transactions.

In line with steps taken in other jurisdictions to bring in transparency in company

ownership and control, the CLC was of the view that the existing provisions are inadequate and

recommended that companies may be empowered to seek information from members and apply

sanctions in the form of suspension of rights if information was not provided. The CLC also

mandated stricter reporting requirements.

In keeping with the CLC's recommendations, the Amendment Act defines persons or

trusts (including persons and trusts resident outside India) having beneficial interest of at least

25% of the shares of a company or the right to exercise or the actual exercising of significant

influence or control over a company as 'significant beneficial owners'. The Amendment Act

mandates companies to maintain a register of the interest held by significant beneficial owners

and make necessary filings with the RoC. Companies are also obligated to issue notices to

persons:

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(a) whom they believe to be significant beneficial owners currently or during 3 years

immediately preceding the date on which the notice is issued; or

(b) who are likely to have knowledge of other significant beneficial owner(s) or persons who

have such knowledge. In the event of failure to disclose such information within 30 days of

the date of the notice or if the information given is not satisfactory, the company can

approach the NCLT which has the power to restrict rights attached to the shares (such as

restriction on transfer of interest or suspension of all rights attached to the shares like

voting, receipt of dividend, etc.).

(c) Relaxation on Default in Repayment of Deposit Under the 2013 Act, a company which had

committed a default in the repayment of deposits or payment of interest was not permitted

to accept deposits from its members. The Amendment Act relaxes this stricture by

introducing a cooling-off period of 5 years from the date of remedying the default.

Observations:

This change is in line with the CLC's report, which opined that imposing a lifelong ban

on a company for a default made in the past, including for reasons beyond the company's control,

was too harsh.

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(d) Loans and Investments by Companies

The 2013 Act restricted the ability of a company to advance loans to and make

investments in other companies beyond the limits specified therein. The CLC was of the view

that these restrictions were too obstructive and impractical in the modern business world.

Interestingly, the Bill, based on the recommendations of the CLC, sought to omit the restriction

on the maximum number of layers of subsidiaries (which could be imposed by the Government)

and the prohibition in Section 186 (1) of the 2013 Act on companies making any investment

through more than 2 layers of investment companies. However, these changes have not been

carried through by the Amendment Act and these restrictions continue to exist.

That said, the Amendment Act provides for certain relaxations to promote ease of doing

business, as detailed below:

(i) The restriction on companies advancing loans beyond the specified thresholds would

not apply to employees of the company and hence, companies can provide loans to its

employees based on its internal policies, without adhering to the statutory limit.

(ii) The limits prescribed under Section 186 of the 2013 Act would not apply to: (a) loan

or guarantee given or security provided by a company to its wholly owned subsidiary

company or a joint venture company; and (b) acquisition made by a holding

company, by way of subscription, purchase or otherwise of, the securities of its

wholly owned subsidiary company.

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Observations:

The CLC had noted that while these restrictions were incorporated in the 2013 Act in the wake

of various scams in the country, they could affect legitimate business structuring and have a

substantial bearing on the functioning, structuring and the ability of companies to raise funds.

However, since these restrictions under the 2013 Act remain, they could continue to hinder the

structuring of investments, especially for companies which form part of a conglomerate or group

of companies and special purpose vehicles incorporated for specific projects or investments.

(e) Applicability of the 2013 Act to Foreign Companies The 2013 Act provides that where 50%

or more of the paid-up capital of a foreign company is held by one or more citizens of India, or

companies or body corporates incorporated in India, such companies should comply with certain

specified sections of the 2013 Act relating to making of filings, disclosures and other

compliances. The Amendment Act widens the application of this section to all foreign

companies.

Observations:

Ensuring compliance with the above requirement could pose a significant challenge for

foreign companies, particularly given that a foreign company has been broadly defined under the

2013 Act to mean any company or body corporate incorporated outside India which: (a) has a

place of business in India, whether by itself or through an agent, physically or through electronic

mode; and (b) conducts any business activity in India in any other manner.

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(f) Materiality Threshold for Fraud

The Amendment Act introduces a materiality threshold for the punishment prescribed for fraud.

When fraud involves an amount of at least INR 10,00,000 or 1% of the turnover of the company,

whichever is lower, such frauds are now liable to punishment of imprisonment for a minimum

term of 6 months but which may extend to 10 years and a minimum fine equal to the amount

involved in the fraud, but which may extend to 3 times the amount involved in the fraud, making

such offences non-compoundable. On the other hand, frauds that do not meet this new threshold

and do not involve public interest have a reduced punishment and are compoundable.

Observations:

This change is based on the CLC's recommendation to mitigate the negative impact of this

penalty on attracting professionals to the post of directors or KMP.

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 CHAPTER-V

Conclusions:

In the years to come, the Indian financial system will grow not only in size but also in

complexity as the forces of competition gain further momentum and financial markets acquire

greater depth. It is vital that banks, as the major constituent of the financial sector and the

country‘s payment system, be managed as efficiently as possible. The last six years have been a

lesson in the widespread damage and misery that can be caused by ill-considered banking

decisions. Although the Indian banking system was unaffected by the financial crisis, the

reduced trade and investment flows impacted India‘s growth and impeded progress in the area of

employment generation, poverty reduction and human development. Although poor corporate

governance was not the cause of the crisis, it was certainly a contributory factor. Tightening

corporate governance in banks is in the larger interests not only of the national economy, but the

global economy as well.

Private sector banks have complied with the requirement of the Clause 49 of the Listing

Agreement in regard to the requirement of minimum number of independent directors, while the

chairman is a non-executive director. Clause 49 I (A) of the Listing Agreement requires that not

less than 50% of the board of directors of the company (having chairman as executive director)

should comprise of non-executive directors being independent. Good corporate governance

implementation entails clear division of responsibilities at the top management level like

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Chairman and managing director, which can ensure a balance of power and authority such that

no individual has unfettered powers of decision. However, study of annual report of eight private

banks and practical difficulties faced by them in normal management practice conclude that

combination of the posts of chairman and CEO/MD in one person should be publicly justified.

Some main items of non-mandatory requirements/ disclosures are Shareholder rights (e.g.

information & half-yearly declaration of financial performance sent to shareholders), Audit

qualification, Training of board members, Evaluation of non-executive directors, Whistle blower

policy. Means of Communication and General Shareholder Information As advised by the

Listing Agreement, private as well as the public sector banks have succeeded in giving general

shareholder information and accepting a range of communication means every year.

Disclosure of Stakeholders‘ Interests of the central issue highlighted here is the disclosure

of many proposals by banks in their annual reports. This also focuses on the action taken by

these banks on the following matter so as to fulfill their obligation towards their stakeholders.

Complying with research objectives, detailed analysis of corporate governance practices

of eight private banks in India through their annual reports reflects their overall commitment

towards observing true corporate governance. Analysis of attributes from annual report shows

that items disclosed in Corporate Governance by banks include bank‘s philosophy on code of

Corporate Governance, Board of Directors: its composition, size, term, meetings, and attendance,

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Committees of the Board e.g. Audit Committee, Remuneration Committee, Remuneration policy

and Remuneration of Directors, Nomination committee, Share transfer Committee, Management

Committee etc; Management Review and Responsibility, General Body meetings, Disclosure on

Related Party Transactions, Compliance by the bank and Compliance to clause 49 of Listing

Agreement.

The research on corporate governance in Indian Banking Sector produced some

important results. Banking has become complex and it has been recognized that there is a need to

attach more importance to qualitative standards such as internal controls and risk management,

composition and role of the board and disclosure standards. Corporate Governance has become

very important for banks to perform and remain in competition in the era of liberalization and

globalization. The success of corporate governance rests on the awareness on the part of the

banks of their own responsibilities. While law can control and regularize certain practices, the

ultimate responsibility of being ethical and moral remains with the banks. It is this enlightenment

that would bring banks closure to their goals. However, while all this looks good on paper, it

runs into considerable difficulty during implementation. The difficulty is compounded given the

fact that there are easier ways, which give faster returns that are no less valuable because they are

acquired through questionable means.

The outcome of the present research in achieving the objectives of the research

establishes some important facts: The first objective of the research was to examine the

effectiveness of attributes of corporate governance in Indian Banking sector in bringing

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transparency and economic growth. The outcome of the study indicated that corporate

governance on Indian Banking Sector is at formative stage compared to developed nations. There

should be more transparency and disclosure mechanism in order to avoid even the slightest of

financial scam. So far as economic growth is concerned, there is certainly economic growth

registered by private sector in terms of penetration and share price rise and establishing strong

footing in banking sector. The compliance of certain non-mandatory requirements by ICICI,

AXIS justifies that they are quite serious in bringing about the effectiveness of implementation

of corporate governance attributes.

It is very much clear that the regulatory framework of Corporate Governance in India has

given sufficient thought to ensure good governance practices in Banking sector so as to protect

the interest of stakeholders. Even though all the international code of corporate governance

principles is not thoroughly observed, CII code and clause 49 of mandatory requirement have put

sufficient ingredient to ensure good corporate governance

The proper implementation of corporate governance attributes can minimize fraud and

malpractices in banking sector. There are provisions of fraud monitoring committee, risk

management committee, investors‘ grievance committee which can minimize the chance of

fraud. Normally such type of misgovernance is perpetuated when transparency of financial

statement is missing or proper disclosure of information is not made. However, private sector

banks are observing all mandatory requirements of corporate governance mentioned under

section 49 of the listing agreement. The opinion of senior executives of different banks were very

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much optimistic was also in the same direction of attaining perfection irrespective of our little

deficiency in adhering such compliances.

There is no significant difference in practices of corporate governance by public sector

banks and private sector banks. Since banking in India is governed by some statutory act, there is

lesser possibility of differences. The degree of applicability of corporate governance principles

differs from public sector to private sector, but the transparency and disclosure in public sector is

more than private sector. As far as voluntary adherence to corporate governance principles are

concerned, there seems to be more effort taken by private sector banks than public sector banks.

Slowly and gradually the regulatory authority will make more norms mandatory.

The private sector banks were studied with respect to Corporate Governance practices.

Compliance is observed with respect to clauses 49 of listing agreement. Hence, the all null

hypothesis is accepted. Corporate governance is not merely about preparing Corporate

Governance report to comply with listing agreement. Corporate Governance is about

transparency, openness and fair play in business activities. The directors of the banks are

responsible for the governance function. The most basic tenet of corporate governance is the

increasing dominance of non-executive directors who are independent of the management.

Independence is an ineradicable human instinct and is difficult to define.

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 Clause 49 of the Listing Agreement regulations talk about the independence of the

directors is to be seen in the intention and action of the director. Having independence of

directors is a critical issue and through regulation and practice it is required, to reach the high

level of value creation and good corporate governance practices. Remuneration to the board of

directors must be fair and adequate. Remuneration details of directors are available in Corporate

Governance report. Remuneration package must be attractive to retain and motivate the directors.

The year 2017 ended with the passing of the Amendment Act. Regarded as one of the

major legal developments of 2017, the Amendment Act seeks to address various challenges

faced in the implementation of the 2013 Act by amending problematic sections. Amendments to

sections on appointment of auditors, loans and investments by companies, related party

transactions, managerial remuneration, etc. strike the right balance between improving corporate

governance and reducing the cost of compliance without compromising the interests of

stakeholders. What remains to be seen though is whether the Central Government notifies all the

provisions of the Amendment Act (Sections 1 and 4 of the Amendment Act being made effective

on 26 January 2018) without delay and fructifies its intention of improving the ease of doing

business in India.

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Suggestions:

Along with good corporate governance practices, social responsibility is also important.

Social responsibility aspect of the bank is not studied by researcher. The banking sector today

has to concentrate on risk management, Basel requirements, Non-performing Assets

Management, Consolidation and Acquisition as per RBI regulations along with good corporate

governance practices. The entry of foreign banks makes the banking sector more competitive

today. Vide circular dated 29th Oct., 2004 SEBI has again revised clause 49. This circular is the

master circular and supersedes all the earlier circular issued by SEBI on this subject. It is

applicable from 31st DEC., 2005.

All the changes can be bifurcated into two categories – key changes and other changes.

 Definition of independent directors.

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  Requiring CEO/CFO certification of financial statements.

 Disclosure related to the risk Management.

 Requirement related to subsidiary companies.

 Requiring board to adopt formal code of conduct and also for senior management.

 Improving disclosure to shareholders.

 Restriction of the term of independent directors.

For following the spirit of Corporate Governance the director should be independent in

thought and action. Mere presence does not guarantee good governance. Code of conduct is

applicable only for Board and senior management and not for all employees. Requirement of

clause 49 relating to COE/CFO certification is imported from USA‘s SOXA.

The gap between 2 meetings has been reduced to 3 months. For the purpose of Chairmanship

in committee, now only 2 committees shall be considered. Remuneration has been excluded for

this purpose. Regarding composition of audit committee, the requirement of all directors being

NED is done away with 2/3rd of the directors must be independent. Now expertise in accounting

or related financial management is required. At least 4 meeting of AC in a year and gap between

2 meetings should not exceed 4 months. Whistle blower policy is not a mandatory requirement.

Non mandatory requirements include a tenure not exceeding in the aggregate a period of 9 years

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on the board of company, seating remuneration committee, half yearly declaration of financial

performances. Whistle blower policy, peer group evaluation to evaluate performance.

Suggestions to Improve Corporate Governors Practices

1) Chairman and CEO

It has been recognized that there should be separation of the role of Chairman and CEO.

Cadbury Committee on corporate governance states that there should be a clearly accepted

division of responsibilities at the head of the company level, which will ensure a balance of

power and authority, such that no one individual has unfettered powers of decision-making. At

present in India, in most of the banks, the CEO and the chairman‘s positions are combined.

Banks have preferred the composite position of chairman and managing director.

2) Responsibility of the Board

According to the Board of International Settlement (BIS) code, bank boards should

establish strategic objectives and set corporate values that will direct the ongoing activities of the

bank. The board should ensure that senior management implements policies that prohibit

activities and relationships that diminish the quality of corporate governance, such as conflicts of

interests, self-dealings and preferential dealings with related parties. Keeping in view their

oversight role board of directors should feel empowered to recommend sound practices, provide

dispassionate advice and avoid conflicts of interests.

3) Accountability to Shareholders/Stakeholders

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 The Securities and Exchange Board of India (SEBI) guidelines state that the Board

should be accountable to shareholders for creating, protecting and enhancing wealth and

resources for the company and reporting them on the performance in timely and transparent

manner. However, the present scenario is that in majority of banks, Boards do not enforce clear

lines of responsibility and accountability for themselves.

4) Election

The Organization for Economic Co-operation and Development (OECD) principles state

that the Board should ensure a transparent Board nomination process. In terms of the provisions

of section 9 of the Banking Companies (acquisition and Transfer of Undertakings) Act, the

government constitutes the Boards of Directors of nationalized banks. The Boards comprise of

two whole-time directors, a nominee each of the Government of India and the Reserve Bank of

India, nominees of workmen and non-workmen unions, and a chartered accountant. Besides this,

six non-official directors with specialized knowledge in agriculture and rural economy, banking,

co-operation, economics, finance, law, etc. are appointed. So, the current scenario is that the

bank board‘s consist mainly of nominated members and not the elected members. Moreover,

banks do not have nomination committees for nominating directors of Boards of banks.

5) Audit Committee

According to BIS the Audit Committee of banks should provide an oversight of the

banks‘ internal and external auditors, approving their appointment and dismissal, reviewing and

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approving audit scope and frequency, receiving their reports and ensuring that management is

taking appropriate corrective actions in a timely manner. The independence of this committee

can be enhanced when it is comprised of external Board members who have banking and

financial expertise. In India, the banks are required to set-up an Audit Committee of Board of

Directors to oversee and provide direction to the internal audit/ inspection function in banks in

order to enhance its effectiveness as a management tool.

Corporate Governance calls for a paradigm shift in the role of the Board and corporate directors.

They need to be ―evolutionary‖ and ―revolutionary‖ constantly moving the banks toward higher

level of creativity. While corporate governance is an important element of affecting the long

term financial health of banks, it is only a part of larger economic context in which bank operate.

The Corporate Governance depends upon legal and institutional framework. It will be rightly to

conclude with the remarks that the road to efficacy lies in minimizing regulatory prescription and

maximizing voluntary codes to ensure excellence in corporate governance among financial

intermediaries. Corporate Governance is the only royal road to the portal of corporate success

and there is no short cut to achieve the same.

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