CORPORATE GOVERNANCE IN BANKING SECTOR

CORPORATE GOVERNANCE IN BANKING SECTOR

CHAPTER-1INTRODUCTION 1.1 INTRODUCTIONBanking system plays a very important role in the economic life of the nation. The health of the economy is closely related to the soundness of its banking is now an essential part of our economic system. Modern trade and commerce would almost be impossible without the availability of suitable banking services. Indian banking industry, the backbone of the country economy, has always played a key role in prevention the economic catastrophe from reaching terrible volume in the country .The Indian banking system is among the healthier performers in the world. Staying focused on fundamentals, adoption of utmost professionalism, conformity to prescribed norms of lending & investment, adherence to sound banking principles & ensuring optimum capital efficiency are vital for success & continued survival of banks. In the liberalized economic environment and integration of the country, in to world market the corporate sector in India at present cannot ignore the importance of Corporate Governance. Corporate Governance is now an issue and important factor that can be used as tool to maximize wealth of shareholders of a corporate. Corporate Governance aims are the Vision, Values and VisibilityCorporate Governance was brought in limelight through series of corporate failures such as Enron and WorldCorn. 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. In a service industry like banking, corporate governance relates to the manner in which the business and affairs of individual banks are directed and managed by their board of directors and senior management. It also provides the o through which the objectives of the institutions are set, the strategy for attaining them is determined and the performance of the institution is monitored.Corporate governance has at its backbone a set of transparent relationships between an institutions management, its board, shareholders and other stakeholders. It, therefore, needs to take into account a number of aspects such as, enhancement of shareholder value, protection of shareholder rights, composition and role of board of directors, integrity of accounting practices and disclosure norms and internal control system. In a service industry like banking, corporate governance relates to the manner in which the business and affairs of individual banks are directed and managed by their board of directors and senior management. It also provides the structure through which the objectives of the institutions are set, the strategy for attaining them is determined and the performance of the institution is monitored. Virtually every major industrialized country as well as the Organization for Economic Co-operation and Development and the World Bank has made efforts in recent years to refine their views on how large industrial corporations should be organized and governed. Academics in both law and economics have also been intensely focused on corporate governance. Oddly enough, in spite the general focus on this topic, very little attention has been given to the corporate governance of banks.

1.2DEFINITION AND MEANING OG CORPORATE GOVERNANCE"Corporate governance involves a set of relationships between a companys management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined." (OECD 2004)The 1992 Report of the Committee on the Financial Aspects of Corporate Governance (Cadbury Report) describes Corporate Governance as the system by which companies are directed and controlled.Wolfensohn, President, World Bank, has said that Corporate Governance is about promoting corporate fairness, transparency and accountabilityMEANINGCorporate Governance refers to the way a corporation is governed. It is the technique by which companies are directed and managed. It means carrying the business as per the stakeholders desires. It is actually conducted by the board of Directors and the concerned committees for the companys stakeholders benefit. It is all about balancing individual and societal goals, as well as, economic and social goals.Corporate Governance is the interaction between various participants (shareholders, board of directors, and companys management) in shaping corporations performance and the way it is proceeding towards. The relationship between the owners and the managers in an organization must be healthy and there should be no conflict between the two. The owners must see that individuals actual performance is according to the standard performance. These dimensions of corporate governance should not be overlooked

1.3 EVOLUTION OF CORPORATE GOVERNANCE IN BANKING SECTORAs 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, 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 initiated several measures to strengthen the corporate governance in the Indian Banking Sector. The noteworthy minimum benchmarks noted by the Group relate to the following Strategies and techniques basic to sound corporate governance Organizational structure to ensure oversight by board of directors and individuals not involved in day to day running of business Ensuring that the direct lines of supervision of different business areas are different Ensuring independent risk management and audit functions Ensuring an environment supportive of sound corporate governance Role of supervisorsThe issue pertaining to corporate governance becomes more critical on case of the banks whose controlling power is linked with Government. Government ownership is one of the primary issue that can have a direct impact on the quality of corporate governance. In India almost 80% of the banking operations are under the control of the public sector banks consisting of the nationalised banks, the State Bank of India and its subsidiaries. In Public sector banks, the right of the private shareholders are considerably curtailed as their approval is not required for paying dividend or formalising the annual accounts.The importance of corporate governance issues in public sector banks is important due to two principal reasons: Firstly, they constitute a huge share of business in the banking industry in India Secondly, it is highly unlikely that they are going to be phased out in due course.Though the general principle of corporate governance is valid for the public sector entities, but they simply cannot imitate the private sector banks in this respect. Things start getting worse, when uncertainties looms involving ownership issues, and the public ownership being treated as a transitional phenomenon. Further, expectation of change in ownership (dilution of Government Stake) can result in the change of institutional structure of significance difference. When Government is the owner, it is accountable to the political institutions, which in turn may not have pure economic motives in mind. A mixed ownership structure can bring the different objectives of shareholding on a common platform and help in reconciling them. Issues relating to the separation of ownership and management in both private and public sectors banks needs to be addressed, in contrast to the traditional Corporate Governance issues stemming from the outside financial, in developing countries and especially in India, things are a bit different. Here, the grueling question is not how the outside financiers (shareholders) exert management control, but also as to how they can (including minority shareholders) exercise control over the big inside shareholdersThe most important development in the field of corporate governance and investor protection in India has been the establishment of the securities and Exchange Board of India (SEBI) in 1992 and its gradual empowerment since then. The Basel committee in the year 1999 had brought out certain important principles on corporate governance for banking organisations which more or less have been adopted in India. Today the banks are governed by the Banking Regulation Act, 1949; Reserve Bank of India Act, 1934; Foreign Exchange Management Act, 1999; Payment and Settlement Systems Act, 2007; other relevant Statutes and the Directives, Prudential regulations and other Guidelines/ Instructions issued by RBI and other regulators from time to time, including the regulations of SEBI regarding public issues and other guidelines applicable to listed banking though there is scope for enhancing effective implementation1.4 RELATION OF CORPORATE GOVERNANCE IN BANKING SECTORGlobalization of financial markets necessitates some basic international standards of corporate governance for financial institutions, it is also recognized that such uniform international standards may result in different levels of systemic risk for different jurisdictions because of differences in business customs and practices and institutional and legal structures of national markets. Each country will therefore need domestic regulations that prescribe specific rules and procedures for the governance of financial institutions that address national differences in political economic and legal systems while adopting international standards and principles.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 role of banks is integral to any economy. They provide financing for commercial enterprises access to payment systems and a variety of retail financial services for the economy at large. The integral role that banks play in the national economy is demonstrated by the almost universal practice of states in regulating the banking industry and providing in many cases a government safety net to compensate depositors when banks fail. The large number of stakeholders whose economic well being depends on the health of the banking system depend on implementation of appropriate regulatory practices and supervision. Indeed in a healthy banking system the regulators and supervisors themselves are stakeholders acting on behalf of society at large. As regulators we do not act on behalf of shareholders or individual customers but on behalf of groups such as depositors policyholders or pension fund members who rely on the continued solvency of regulated institutions for their financial security but who are themselves not well placed to assess financial soundness.Banks unlike insurance companies are highly leveraged entities and asset liability mismatches are an inherent feature of their business. Consequently, they face a wide range of risks in their day-to-day operations. Any mismanagement of risks by these entities can have very serious and drastic consequences on a stand alone basis which might pose a serious threat for financial stability. This dimension further strengthens our premise that effective risk management systems are essential for financial institutions and emphasizes the need for these to be managed with great responsibility and maturity. Good corporate governance, therefore, is fundamental to achieve this objective.

CHAPTER-2OBJECTIVES,NEED,IMPORTANCE AND ROLE OF CORPORATE GOVERNANCE IN BANKING SECTOR2.1 OBJECTIVE OF CORPORATE GOVERNANCE IN BANKING SECTORPoor corporate governance may contribute to bank failures, which can pose significant public costs and consequences due to their potential impact on any applicable deposit insurance systems and the possibility of broader macroeconomic implications such as contagion risk and impact on payment systems. In addition, poor corporate governance can lead markets to lose confidence in the ability of a bank to properly manage its assets and liabilities, including deposits, which could turn, trigger a bank run air liquidity crisis. Generally, banks occupy a delicate position in the economic equation of any country such that its performance invariably affects the economy of the country. Objectives of corporate governance are to establishing strategic objectives and a set of corporate values that are communicated throughout the banking organization; Setting and enforcing clear lines of responsibility and accountability throughout the organization; Ensuring that board members are qualified for their positions, have a clear understanding of their role in corporate governance and are not subject to undue influence from management or outside concerns and Ensuring that compensation approaches are consistent with the bank's ethical values, objectives, strategy and control environment.

2.2 NEED OF CORPORATE GOVERNANCE IN BANKING SECTORSince banks are important players in the Indian financial system, special focus on the Corporate Governance in the banking sector becomes critical. The Reserve Bank of India, as a regulator, has the responsibility on the nature of Corporate Governance in the banking sector. To the extent that banks have systemic implications, Corporate Governance in the banks is of critical importance. Given the dominance of public ownership in the banking system in India, corporate practices in the banking sector would also set the standards for Corporate Governance in the private sector. With a view to reducing the possible fiscal burden of recapitalising the PSBs, attention towards Corporate Governance in the banking sector assumes added importance. Banks are critical components of the economy while providing finance for commercial enterprises, basic financial services to a broad segment of the population and access to payment systems. Banks in India are facing increasing competition, within and outside India, both in terms of markets for its products and for sources of fund. The importance of banks to national economies is underscored by the fact that banking is, almost universally, a regulated industry and that banks have access to government safety nets. In order to meet the statutory need of having sound Capital Adequacy requirements, banks are accessing the Capital Market at regular intervals. Hence the banks need to stimulate the interest of investors at all times. Investors believe that a bank with good governance will provide them a safe place for investment and also give netter returns. Good corporate governance is therefore an important factor in a competitive environment. Investors, customers, employees and vendors have all become more discerning and are demanding greater transparency and fairness in all dealings. To attract and retain the commitment of investors, customers, employees, Banks should ensure that they match the global benchmark in Corporate Governance Practices. Banks are also important catalysts for economic reforms, including corporate governance practices. Because of the systemic function of banks, the incorporation of corporate governance practices in the assessment of credit risks pertaining to lending process will encourage the corporate sector in turn to improve their internal corporate governance practices, importance of implementing modern corporate governance standards is conditioned by the global tendency to consolidation in the banking sector and a need in further capitalization. It is of crucial importance therefore that have strong corporate governance practices. Banks, just like any other organization are incorporated entities. As a result of which, the primary requirements of corporate governance apply to them as any other incorporated entity. Added to this certain features that are very specific to banks, adds on to the importance of Corporate Governance issues in banks. Among other features, the most important one is the fact that banks form an integral part of the economy of the country, and any failure in a bank might have a direct bearing on the financial health of the country. Banks, help in channelizing the peoples saving. The capital structure of bank is unique in two ways. First, banks tend to have very little equity relative to other firms. Second, banks liabilities are largely in the form of deposits, which are available to creditors/depositors on demand, while their assets often take the form of loans that have longer maturities. Thus, the principle attribute that makes banks as financial intermediaries special is their liquidity production function. By holding illiquid assets and issuing liquid liabilities, banks create liquidity for the economy. The liquidity production function may cause a collective-action problem among depositors because banks keep only a fraction of deposits on reserve at any one time. Depositors cannot obtain repayment of their deposits simultaneously because the bank will not have sufficient funds on hand to satisfy depositors at once. This mismatch between deposits and liabilities becomes a problem in the unusual situation of a bank run. The second important driver of a good corporate governance stems from their funding patterns. Banks, by their basic definition are highly leveraged financial institutions, with the equity capital of the shareholders being reduced to a miniscule proportion of loan capital in the form of borrowing and deposits of deposits from customers of the bank. As a result of this, the stakeholders in banks, (mainly the depositors and lenders) have a rightful claim of accountability from the banks and their boards. The third important element in the Corporate Governance structure relates to the control function. It is imperative to discuss the same in brief. Control functions in banks deal with internal frauds as well as external frauds. The former relates to situations where the banks own personnel indulge in corrupt and unethical practices. The latter deals with situations where the customers of the bank try to seek for malpractices. The incidents of the external frauds are so devastating that special attention is being mandated both for their prevention as well as their post scenario analysis. In this connection it is important to remind of the COSO framework that was framed with this intention in mind. Finally, failing to comply with stipulated norms can be one of the challenging issues of Corporate Governance framework. With Banks being under intense watch of the central bank as well as other regulatory bodies, it is a common observation, that most failures (crashes) in banks have occurred due to compliance failure situations. With a lot of reports and norms, being introduced (The Basel II norms being the latest of them), failure to adhere to the regulatory norms have never reducedBASEL II Recommendation:The Basel Committee on Banking Supervision is a committee, of banking supervisory authorities, established by the Central Bank Governors of the G10 developed countries in 1975. The Committee in 1988 introduced the Concept of Capital Adequacy framework, known as Basel Capital Accord, with a minimum capital adequacy of 8 percent It also issued a consultative document titled The New Basel Capital Accord in April 2003, to replace the 1988 Accord, which re-enforces the need for capital adequacy requirements under the current conventions. This accord is commonly known as Basel II and is currently under finalization. Basel II is based on three pillars: Pillar 1 Minimum Capital Requirements Pillar 2 Supervisory Review Process Pillar 3 Market Discipline2.3 IMPORTANCE OF CORPORATE GOVERNANCE IN BANKING SECTORFrom a banking industry perspective, corporate governance involves the manner in which their boards of directors and senior management govern the business and affairs of individual banks, affecting how banks set their corporate objectives, run day-to-day operations, consider the interests of various stakeholders, align corporate activities with the expectation that banks will operate in a safe and sound manner and in compliance with applicable laws and regulations and protect the interests of depositors.Banks are a critical component of the economy while providing financing for commercial enterprises, basic financial services to a broad segment of the population and access to payment systems. The importance of banks to national economies is underscored by the fact that banking is, almost universally, a regulated industry and that banks have access to government safety nets. It is of crucial importance therefore that banks have strong corporate governance practices.Banks are also important catalysts for economic reforms, including corporate governance practices. Because of the systemic function of banks, the incorporation of corporate governance practices in the assessment of credit risks pertaining to lending process will encourage the corporate sector in turn to improve their internal corporate governance practices.Importance of implementing modern corporate governance standards is conditioned by the global tendency to consolidation in the banking sector and a need in further capitalization.Best corporate governance practices will enable banks to: Increase efficiency of their activities and minimize risks; Get an easier access to capital markets and decrease the cost of capital; Increase growth rate; Improve the standards of lending; Protect the rights of minority shareholder and other counterparts; Strengthen their reputation and raise the level of investors and clients' trust

2.4 ROLE OF CORPORATE GOVERNANCE IN BANKING SECTORSince the market control is not sufficient to ensure proper governance in banks, the government does see reason in regulating and controlling the nature of activities, the structure of bonds, the ownership pattern, capital adequacy norms, liquidity ratios, etc. In the case of traditional manufacturing corporations, the issue has been that of safeguarding and maximizing the shareholders value. In the case of banking, the risk involved for depositors and the possibility of contagion assumes greater importance than that of consumers of manufactured products. Further, the involvement of government is discernibly higher in banks due to importance of stability of financial system and the larger interests of the public. The RBI has made it clear that with the abolition of minimum lending rates for co-operative banks, it will be incumbent on these banks to make the interest rates charged by them transparent and known to all customers. Banks have therefore been asked to publish the minimum and maximum interest rates charged by them and display this information in every branchDisclosure and transparency are thus key pillars of a corporate governance framework because they provide all the stakeholders with the information necessary to judge whether their interests are being taken care of. Another area which requires focused attention is greater transparency in the balance sheets of co-operative banks. The commercial banks in India are now required to disclose accounting ratios relating to operating profit, return on assets, business per employee, NPAs, etc. as also maturity profile of loans, advances, investments, borrowings and deposits. At the initiative of the RBI, a consultative group, aimed at strengthening corporate governance in banks, headed by Dr. Ashok Ganguli was set up to review the supervisory role of Board of banks. The recommendations include the role and responsibility of independent non-executive directors, qualification and other eligibility criteria for appointment of non-executive directors, training the directors and keeping them current with the latest developments. Some of the important recommendations on the constitution of the Board are to participate in the meetings of the board regularly and ensure that their participation is effective & contributory, They must study the reports submitted to them by the management team and enquire about follow up reports on definite time schedule. They should be actively involved in the matter of formulation of general policies, they should be familiar with the road objectives of the bank, and the policies laid down by the govt. and the changes in the various laws and legislations time to time. They should be loyal to the bank and must remember that they should not reveal any information relating to any constituent of the bank to anyone.In the past, when banks considered the issue of how best to differentiate themselves from their competition, Good Corporate Governance was undoubtedly not applied. Due to the fallout from past corporate failures, more and more banks are looking at good corporate governance from a new perspective. With Indian economic growth increase and major stock Indices reaching record level, the time has come to position corporate governance as a strategic force in Indian banks. Indian banks must drive growth and profitability while continuing to focus on enhancing corporate governance practices. Indian government has mandating corporate governance reforms at banks, can create the necessary infrastructure to ensure the continued flow of investment into the region. Expanding global and regional banks, such as State Bank of India, Bank of Baroda, Bank of India, Punjab National Bank, ICICI Bank, HDFC Bank, Standard Chartered, HSBC, Citibank and others along with major investments by large institutional investor, are enhancing corporate governance practices, increasing competitiveness and permanently changing the competitive landscape of Indian banking environment. Due to rapidly changing banking environment, Indian banks must continue to implement strong corporate governance practices. They must now approach corporate governance as a competitive differentiator in an environment of strong foreign entrants and growing regional competitors.Role of RBI In Promoting Corporate Governance:The growing competitiveness and interdependence between banks and financial institutions in local and foreign markets have increased the importance of corporate governance and its application in the banking sector. Corporate governance in banks can be achieved through a set legal, accounting, financial and economic rules and regulations. To make sure that the competence and integrity in banking sector is maintained, the need for uniform standards of the concept of governance in private and public sector is emphasized. The regulatory framework implemented by the central bank can affect the overall well being of banking sector.

CHAPTER-3MEASURES TAKEN BY REGULATORS TOWAERDS CORPORATE GOVERNANCE IN BANKING SECTORRegulators are external pressure points for good corporate governance. Mere compliance with regulatory requirements is not however an ideal situation in itself. In fact, mere compliance with regulatory pressures is a minimum requirement of good corporate governance and what are required are internal pressures, peer pressures and market pressures to reach higher than minimum standards prescribed by regulatory agencies. RBIs approach to regulation in recent times has some features that would enhance the need for and usefulness of good corporate governance in the co-operative sector. The transparency aspect has been emphasised by expanding the coverage of information and timeliness of such information and analytical content. Importantly, deregulation and operational freedom must go hand in hand with operational transparency. In fact, the RBI has made it clear that with the abolition of minimum lending rates for co-operative banks, it will be incumbent on these banks to make the interest rates charged by them transparent and known to all customers. Banks have therefore been asked to publish the minimum and maximum interest rates charged by them and display this information in every branch. Disclosure and transparency are thus key pillars of a corporate governance framework because they provide all the stakeholders with the information necessary to judge whether their interests are being taken care of. We in RBI see transparency and disclosure as an important adjunct to the supervisory process as they facilitate market discipline of banks.Another area which requires focused attention is greater transparency in the balance sheets of co-operative banks. The commercial banks in India are now required to disclose accounting ratios relating to operating profit, return on assets, business per employee, NPAs, etc. as also maturity profile of loans, advances, investments, borrowings and deposits. The issue before us now is how to adapt similar disclosures suitably to be captured in the audit reports of co-operative banks. RBI had advised Registrars of Co-operative Societies of the State Governments in 1996 that the balance sheet and profit & loss account should be prepared based on prudential norms introduced as a sequel to Financial Sector Reforms and that the statutory/departmental auditors of co-operative banks should look into the compliance with these norms. Auditors are therefore expected to be well-versed with all aspects of the new guidelines issued by RBI and ensure that the profit & loss account and balance sheet of cooperative banks are prepared in a transparent manner and reflect the true state of affairs. Auditors should also ensure that other necessary statutory provisions and appropriations out of profits are made as required in terms of Co-operative Societies Act / Rules of the state concerned and the bye-laws of the respective institutions.BOARD OF DIRECTORS AND THEIR COMMITTEES:At the initiative of the RBI, a consultative group, aimed at strengthening corporate governance in banks, headed by Dr. Ashok Ganguli was set up to review the supervisory role of Board of banks. The recommendations include the role and responsibility of independent non-executive directors, qualification and other eligibility criteria for appointment of non-executive directors, training the directors and keeping them current with the latest developments. Private sector banks,etc.it is unanimously accepted that the most crucial aspect of corporate governance is that the organisation have a professional board which can drive the organisation through its ability to perform its responsibility of meeting regularly, retaining full and effective control over the company and monitor the executive management. Some of the important recommendations on the constitution of the Board are: Qualification and other eligibility criteria for appointment of non-executive directors, Defining role and responsibilities of directors including the recommended "Deed of Covenant" to be executed by the bank and the directors in conduct of the board functions.Training the directors and keeping them abreast of the latest developmentsMEASURES TAKEN BY REGULATORS TOWARDS CORPORATE GOVERNANCEReserve Bank of India has taken various steps furthering corporate governance in the Indian Banking System. These can broadly be classified into the following three categories: a) Transparency b) Off-site surveillance c) Prompt corrective action Transparency and disclosure standards are also important constituents of a sound corporate governance mechanism. Transparency and accounting standards in India have been enhanced to align with international best practices. However, there are many gaps in the disclosures in India vis--vis the international standards, particularly in the area of risk management strategies and risk parameters, risk concentrations, performance measures, component of capital structure, etc. Hence, the disclosure standards need to be further broad-based in consonance with improvements in the capability of market players to analyse the information objectively.The off-site surveillance mechanism is also active in monitoring the movement of assets, its impact on capital adequacy and overall efficiency and adequacy of managerial practices in banks. RBI also brings out the periodic data on "Peer Group Comparison" on critical ratios to maintain peer pressure for better performance and governance.Prompt corrective action has been adopted by RBI as a part of core principles for effective banking supervision. As against a single trigger point based on capita adequacy normally adopted by many countries, Reserve Bank in keeping with Indian conditions have set two more trigger points namely Non-Performing Assets (NPA) and Return on Assets (ROA) as proxies for asset quality and profitability. These trigger points will enable the intervention of regulator through a set of mandatory action to stem further deterioration in the health of banks showing signs of weakness.3.1SEBI GUIDELINES ON CORPORATE GOVERNANCE IN BANKS: The Securities and Exchange Board of India (SEBI) had constituted a Committee on Corporate Governance and circulated the recommendations to all stock exchanges for implementation by listed entities as part of the listing agreement vide SEBIs circular SMDRP/Policy/CIR-10/2000 dated February 21, 2000. However it had at that time exempted body corporates such as public and private sector banks, financial institutions, insurance companies and those incorporated under separate statute. SEBI has now suggested to RBI to consider issuing appropriate guidelines to banks and financial institutions so as to ensure that all listed companies would have uniform standards of corporate governance. As requested by SEBI, it has now been proposed that the SEBI Committees guidelines may be taken up for adoption by those commercial banks listed in stock exchanges so that they can harmonize their existing corporate governance requirements with the requirements of SEBI, wherever considered appropriate.

On a review by RBI of the existing corporate governance requirements in banks, it is observed that many of the recommendations in regard to the following stand implemented in banks and may not require further action towards implementation in respect of these guidelines for the present.(a) Optimum combination of executive and non-executive directors in the Board(b) Pecuniary relationship or transactions of the non-executive directors vis--vis the bank(c) Independent Audit Committees, their constitution, chairmanship, power, roles, responsibilities, conduct of business, etc (d) Remuneration of Directors (in case of private sector banks)(e) Periodicity /number of board meeting (f) Disclosure by management to the board about the conflict of interest(g) Information to shareholders regarding appointment/re-appointment of directors, Display of quarterly results/presentation to analysts on the web- siteh) Maintenance of office by non-executive Chairman.(i) Reviewing with the management by the Audit Committee of the board the annualFinancial statements before submission to the Board, focusing primarily on: Any changes in accounting policies and practices, Major accounting entries based on exercise of judgment by management, Qualifications in draft audit report, Significant adjustments arising out of audit, compliance with accounting standards, Compliance with stock exchange and legal requirements concerning financial statements, and The going concern assumption.The Audit Committee of the board may look into the reasons for default in payment to depositors, debenture holders, shareholders (non-payment of dividends) and creditors, wherever there are any cases of defaults in payment. SEBI Committees recommendations on other additional functions to be entrusted to the Audit Committee may be complied with by the listed banks as per listing agreement.As regards the appointment and removal of external auditors, the practice followed in banks is more stringent than that recommended by the Committee and hence will continue. Further, fixation of audit fee and also approval of payment for any other services are already subject to the instructions of RBI. As regards recommendation for obtaining a certificate from auditors regarding compliance of conditions of Corporate Governance, it may be stated that the compliance of banks with RBI instructions is already being verified by the statutory auditors. Therefore, a separate certificate from the auditors is not considered necessary.With a view to further improving the Corporate Governance standards in banks, the following measures are now recommended for implementation.(a) In the interest of the shareholders, the private sector banks and public sector banks which have issued shares to the public may form committees on the same lines as listed companies under the Chairmanship of a non-executive director to look into redressal of shareholders' complaints.(b) All listed banks may provide un-audited financial results on half yearly basis to their shareholders with summary of significant developments.

3.2 REASON FOR HIGH DEGREE OF OVER SIGHTREASONS FOR HIGH DEGREE OF OVERSIGHTThere are three reasons for degree of government oversight in this sector. Firstly, it is believed that the depositors, particularly retail depositors, can not effectively protect themselves as they do not have adequate information, nor are they in a position to coordinate with each other. Secondly, bank assets are unusually opaque, and lack transparency as well as liquidity. This condition arises due to the fact that most bank loans, unlike other products and services, are usually customised and privately negotiated.Thirdly, it is believed that that there could be a contagion effect resulting from the instability of one bank, which would affect a class of banks or even the entire financial system and the economy. As one bank becomes unstable, there may be a heightened perception of risk among depositors for the entire class of such banks, resulting in a run on the deposits and putting the entire financial system in jeopardy.3.3 MEASURES TAKEN BY BANKS TOWARDS IMPLEMENTATION OF BEST PRACTICESPrudential normsin terms of income recognition, asset classification, and capital adequacy have been well assimilated by the Indian banking system. In keeping with the international best practice, starting 31stMarch 2004, banks have adopted 90 days norm for classification of NPAs. Also, norms governing provisioning requirements in respect of doubtful assets have been made more stringent in a phased manner. Beginning 2005, banks will be required to set aside capital charge for market risk on their trading portfolio of government investments, which was earlier virtually exempt from market risk requirement.Capital Adequacy:All the Indian banks barring one today are well above the stipulated benchmark of 9 per cent and remain in a state of preparedness to achieve the best standards of CRAR as soon as the new Basel 2 norms are made operational. In fact, as of 31stMarch 2004, banking system as a whole had a CRAR close to 13 per cent.On the Income Recognition Front,there is complete uniformity now in the banking industry and the system therefore ensures responsibility and accountability on the part of the management in proper accounting of income as well as loan impairment.ALM and Risk Management Practices At the initiative of the regulators, banks were quickly required to address the need for Asset Liability Management followed by risk management practices. Both these are critical areas for an effective oversight by the Board and the senior management which are implemented by the Indian banking system on a tight time frame and the implementation review by RBI. These steps have enabled banks to understand, measure and anticipate the impact of the interest rate risk and liquidity risk, which in deregulated environment is gaining importance3.4 CODE OF BEST PRACTICES OF BANKS RBI GUIDELINESThe BPC relates to detailed procedural rules for entering into transactional relations within the banks. The main objective is that such procedures, especially those in all fraud-prone areas, should be well documented, compared with national and international best practices, experimented with, and improved upon in the light of the experience gained.What is essential for BPC ? :Preparation of BPC involves examination of all procedures, processes, products, activities and systems, existing and future (as and when a new product/process is introduced). It needs to be integrated with the overall risk management strategy of the bank and should be considered as a part of the strategy to mitigate all possible operational risk losses.RBI guidelines on compiling the BPC:Based on the recommendations of Mitra Committee, RBI issued the following guidelines (Mar 15, 2004) for keeping in view while preparing the BPC, so as to bring a certain minimum level of uniformity in content and coverage of BPC.Comprehensiveness :The BPC should be a comprehensive and homogenous document. The consolidation and incorporation of circulars issued by the banks by itself, does not constitute BPC. RBIs earlier instructions issued to banks relating to the common fraud prone areas and their prevention, to be observed.Recommendations of various committees :BPC should cover / highlight the recommendations of the Ghosh Committee, Mitra Committee, relevant recommendations of the Narang Committee (large value frauds), Narasimham Committee on Banking Reforms, recommendations of the Estimate Committee on Prevention of Frauds in public sector banks, etc. advised to banks for implementation. The BPC should also take into account the instructions of the CVC, if any, issued from time to time.Minimum coverage :The BPC should, at a minimum, cover all the functional areas like cash, safe custody of other valuables (DD/TT/LC/Guarantee forms, etc.), deposit accounts, investment portfolio, credit portfolio, foreign exchange transactions, treasury operations, bills portfolio, remittances, cash receipts and payments, issue/payment of demand drafts, clearing transactions, government transactions, LCs/ Guarantees, etc.Prevention of loss to customers :BPC may incorporate practices that would help prevention of losses to its customers and include suitable guidance to such customers. Banks should, codify the precautions to be taken by customers and the same should be publicised by placing on their website or through any other medium.Revision :The BPC should be periodically revised and updated in the light of the experience gained, fresh instructions from the Reserve Bank and suggestions made by internal/external auditors.BestPracticesof Banking System InCorporateGovernance:Good governance can be built based on the business practices adopted by the board of directors and management. Many bank failures in the past have been attributed to inadequate and insufficient management which enabled the banks to accept low quality assets and assume additional risks that extend beyond the level appropriate for the banks capacity[.Important commandments for ensuring corporate governance in banks are: Banks shall realize that the times are changing Banks shall establish an Effective, Capable and Reliable Board of Directors Banks shall establish a Corporate Code of Ethics for themselves Banks shall consider establishing an office of the Chairman of the Board Banks shall have an effective and Operating Audit Committee, Compensation Committee and Nominating/ Corporate Governance Committee Banks shall consider Effective Board Compensation Banks shall disclose the information Banks shall recognize that duty is to establish Corporate Governance Procedures that will serve to enhance shareholder value

CHAPTER-4IMPACT OF CORPORATE GOVERNANCE NORMS & POLICIES IN BANKING SECTORThe RBI move to strengthen Corporate Governance led to seminal changes in the bank administration. The sustained profitability, lower level of non-performing assets, improved return on assets etc are some of the laud indicators of the sustaining policy of operating sound banking system. Moreover, the movement of share prices in the market, increased appetite of investors to look at banks for investment in bank centric equity market further speaks of broad market opinion of banks performance and reflection of market confidence. The corporate governance framework in banks has been strengthened through regulation, supervision and by maintaining constant interaction with the management. They cover identification of responsibilities of the Boards of banks, disclosure and transparency in published accounts, and shareholder and stakeholder rights and controls. The rating on management (M) which has been introduced as part of the CAMELS (Capita, Asset Quality, Management, Earnings, Liabilities and Systems) supervisory process takes into account the working of the board and its committees including the Audit committee, effectiveness of the management in ensuring regulatory compliance and adequacy of control exercised by the head/controlling offices. This model has been further modified to include risk based supervision. The new evolution is intended to manage influx of a range of financial risks entering the market with their nuances.Moreover, the audit function is an important element of the corporate governance process and the independence of this function is crucial to good corporate governance. Audit Committee of the Boards, constituted at the instance of RBI; performs the role of overseeing concerns about internal controls and recommendations for their improvement. In order to ensure both professionalism and independence of these committees, Chartered Accountant directors on the boards of banks are mandatory members and the Chairman or Chief Executive Officer is not to be part of the Audit Committee. Foreign banks are not insisted upon to have local audit committee for their Indian branches. Their branches can have a compliance function that reports to their head office on the branches compliance with RBI inspection findings and features arising out of internal inspections and statutory audit. RBI has Nominee directors on the boards of all PSBs and some of the old private sector banks. Further, the Government also nominates directors on the boards of all PSBs. Of late, RBI has been withdrawing its nominees from the boards of well-managed old private banks. In order to improve the effectiveness of the non-official directors and bring in effective corporate governance at the board level in banks, guidelines have been issued focusing the attention of directors on certain areas such as (i) the prescribed calendar of reports / returns to be placed before the Board / Managing Committee of the bank (iv) corrective action required to be taken by the bank on issues of supervisory concern (v) adherence to the deadlines for complying with various action points committed under Monitor able Action Plan during discussions in Annual Financial Inspection findings as well as achievement of targets agreed during Memorandum of Understanding (MOU) discussions with RBI. Further, the guidelines also require the directors to keep watch on matters which come to the board of the banks as also what should have come to the board and to inform the Department of Banking Supervision on matters of supervisory concern.Post reform period led to many banks accessing capital market to shore up their capital adequacy ratio, an essential prescription of Basel-I then and Basel II now. Subscription of banks equity is a function of public confidence which stems from governance policies. The Red Herring Prospectus lodged by banks as required by the capital market regulator, the Securities and Exchange Board of India (SEBI) reflects not only the numerical performance of banks as enunciated in Section-I of this paper but is also an indicator of present and future governance policies pursued by banks. The movement of stock prices is a further reflection of demand and supply of bank shares in the stock market. The entry of new Private Sector Banks and PSBs accessing capital market opened up new opportunities to the investors. It was heartening to note that in the next few years, the bank shares had picked up demand and popularity. The spurt in the capital market index is a manifestation of investor opinion on the performance, potential and standard of governance of banks. Though there may not be direct correlation between market movement of bank shares and corporate governance policies, the overall long run market opinion precipitates on this basis. Such practices form the fundamental strength of the banks and their ethical commitments. As the risk perception changes, volume of business goes up, new line of activities spur, competition heightens further, the Corporate governance practices need to be fine tuned to meet the emerging challenges. Impact of Corporate Governance Policies in Banks:Post reform period led to many banks accessing capital market to shore up their capital adequacy ratio, an essential prescription of Basel-I then and Basel II now. Subscription of banks equity is a function of public confidence which stems from governance policies. The Red Herring Prospectus lodged by banks as required by the capital market regulator, the Securities and Exchange Board of India (SEBI) reflects not only the numerical performance of banks as enunciated in Section-I of this paper but is also an indicator of present and future governance policies pursued by banks. The movement of stock prices is a further reflection of demand and supply of bank shares in the stock market. The entry of new Private Sector Banks and PSBs accessing capital market opened up new opportunities to the investors. It was heartening to note that in the next few years, the bank shares had picked up demand and popularity. The spurt in the capital market index is a manifestation of investor opinion on the performance, potential and standard of governance of banks. Though there may not be direct correlation between market movement of bank shares and corporate governance policies, the overall long run market opinion precipitates on this basis. Such practices form the fundamental strength of the banks and their ethical commitments. As the risk perception changes, volume of business goes up, new line of activities spur, competition heightens further, the Corporate governance practices need to be fine tuned to meet the emerging challenges.

CHAPTER-5CORPORATE GOVERNANCE IN BANKING SECTOR AS PER INDIAN SCENARIO In the Indian context, the need for corporate governance has been highlighted because of the frequently occurring scams since 1991 due to emergence of the concept of liberalisation. The scams such as Harshad Mehta Scam, Ketan Parekh Scam, UTI Scam, Vanishing Company Scam, Bhansali Scam and so on. In order to reduce the number the scams in the Indian corporate world, there is a need to induct global standards. From the beginning of 1980s, situation have changed in India. Wide range changes have taken place in both the law and regulations in the field of corporate law and the capital market. As a result of several scams in India a need has arisen to bring reforms, in response to that, reforms begun in India in 1991. The most important event in the field of investor protection in India was the establishment of Securities and Exchange Board of India (SEBI) in 1992. Corporate governance is a multi-faceted subject.There have been several major corporate governance initiatives launched in India since the mid 1990s. The first was by the Confederation of Indian Industry (CII), Indias largest industry and business association, which came up with the first voluntary code of corporate governance in 1998. The second was by the SEBI, now enshrined as Clause 49 of the listing agreement. The third was the Naresh Chandra Committee, which submitted its report in 2002. The fourth was again given by SEBI the Narayana Murthy Committe, which also submitted its report in 2002. Based on some of the recommendations of this committee, SEBI revised Clause 49 of the listing agreement in August 2003. Subsequently, SEBI withdrew the revised Clause 49 in December 2003, and currently, the original Clause 49 is in force.One of the important theme of corporate governance deals with the issues of accountability and fiduciary duty, essentially advocating the implementation of policies and mechanisms to ensure good behavior and protect shareholders. Another key focus is the economic efficiency view, through which the corporate governance system should aim to optimize economic results, with a strong emphasis on shareholders welfare.in India the concept of Corporate Governance is gaining importance because of two reasons: After liberalization, there has been institutionalization of financial markets, FIIs and FIs became dominant players in the stock markets. The market began to discriminate between wealth destroyers. Corporate Governance is a critical by product of market discipline. Another factor is the increased role being played by the private sector. Companies are realizing that investors love to stay with those corporate that create values for their investors. This is only possible by adopting fair, honest and transparent corporate practices.be impossible without the availability of suitable banking services. Indian banking industry, the backbone of the countrys economy has always played a key role in preventing the economic catastrophe from reaching terrible volume in the country. Hence the failure of banks due to unethical or incompetent policies and management action is detrimental to the shareholders, public depositors and the economy at large. Owing to this fact, a proper corporate governance system is crucial for banks and other financial institutions.

CHAPTER-6PROBLEMS AND KEY AREAS OF FAILUREOF CORPORATE GOVERNANCE IN BANKING SECTORA banks failure to follow good practices in corporate governance and the lack of effective governance are among the most important internal factors which may endanger the solvency of a bank.1 Corporate governance in banks differs from the standard (typical for other companies), which is due to several issues: banks are subject to special regulations and supervision by state agencies (monitoring activities of the bank are therefore mirrored); supervision of banks is also exercised by the purchasers of securities issued by banks and depositors ("market discipline", "private monitoring"); the bankruptcy of a bank raises social costs, which does not happen in the case of other kinds of entities collapse; this affects the behavior of other banks and regulators; regulations and measures of safety net substantially change the behavior of owners, managers and customers of the banks; rules can be counterproductive, leading to undesirable behaviour management (take increased risk) which expose well-being of stakeholders of the bank (in particular the depositors and owners); between the bank and its clients there are fiduciary relationships raising additional relationships and agency costs; problem principal-agent is more complex in banks, among others due to the asymmetry of information not only between owners and managers, but also between owners, borrowers, depositors, managers and supervisors; the number of parties with a stake in an institutions activity complicates the governance of financial institutions. To sum up, depositors, shareholders and regulators are concerned with the robustness of corporate governance mechanisms. The added regulatory dimension makes the analysis of corporate governance of opaque banking firms more complex than in non-financial firms (Wilson, Casu, Girardone, Molyneux, 2010). In the case of banks therefore, corporate governance needs to be perceived as a need of such conduct of an institution, which would force the management to protect the best interests of all stakeholders and ensure responsible behaviour and attitudes (Tirole, 2001). Corporate fairness transparency and accountability are thus the main objectives of corporate governance, taking into account the corporate "democracy", which is the broad participation of stakeholders (R.E. Basinger et al., 2005) . One must have in mind that there is no one model of corporate governance adaptable to all banks. Other goals, and therefore supervisory systems, will be in banks: private, cooperative and state; in the local and global banks; universal banks and investment (etc.); though priorities remain the same. In the banking sector corporate governance is therefore a way of business and affairs of the bank by the management and the board, affecting how they (BCBS, 2006, February): define the objectives and goals; lead current bank activities; fulfill the obligation of accountability to shareholders and take into account the interests of stakeholders; apply the requirement to operate safely and to ensure a good financial situation and compliance with applicable regulations; protect the interests of depositors (and other clients and creditors). Shortcomings in the governance of large financial groups have indicated that these may trigger (indirectly) systemic risks. Regulators and financial supervisors take action to ensure an individual banks stability; in the case of systemically important banks this would result in the pursuit of overall financial stability. The main issues of corporate governance matters with specific systemic impact are: the gatekeepers (esp. auditors and credit rating agencies), corporate values and codes of conduct of banks, risk management and internal governance of banks managerial incentives to act in an appropriate manner, accounting (and valuation) rules (E. Wymeersch, 2008, October). Moreover, there is some scepticism about the effectiveness of the comply or explain approach to corporate governance (FRC, 2011 December). Analysis of the statements on the application of corporate governance indicates that a vast majority of companies did not present an explanation of the reasons to withdraw from the application of certain rules or the clarification is made with low quality information. This confirms the need for support mechanisms employed by the regulator and the requirement that companies monitor statements made by the regulator and take an appropriate response to the lack of or insufficient explanation (D. Seidl, P. Sanderson, J. Roberts, 2012). As pointed out by the European Commission, the "comply or explain" approach would work much more effectively if specific monitoring bodies (such as regulatory bodies for securities,. Financial Assets and Investing 50 stock exchanges or other bodies) were entitled to check whether the available information (in particular the explanation) has an appropriate informative value and is appropriately broad. It is emphasized, however, that these institutions should not interfere with the content of the information disclosed or evaluate the solutions adopted by the company it should still be a task left to the market (EC 2011, April Key areas of failure of corporate governance in banks The confidence of the public (in a bank and the entire banking system) is necessary for a proper functioning of the financial system and economy. Effective corporate governance practices are fundamental to gain and maintain this confidence (BCBS 2006, February). As the recent Edelman trust barometer study shows, banks and financial services are the two least trusted industry sectors (for the second year in a row).Trust is a basic prerequisite for a proper functioning of banks, therefore it is necessary to carry out fundamental reforms that will bring inner harmony and allow the recovery of the public trust. Therefore, an in-depth analysis of the recent crisis causes should be done. Particularly considering that the rules of proper conduct of banking business exist and are being implemented, but it is mainly the deficiencies in corporate governance which are to blame for the recent financial crisis5 . This raises the question: Were the rules inadequate or poorly implemented? Analyses of the causes of the crisis lead to indicate several issues requiring a re-structuring and strengthening of standards; these issues concern (Kirkpatrick, 2009, September, A. Turner, 2009, March, D.Walker, 2009, November 26): the role, tasks and responsibilities of the board, as well as its size, organization and composition (members) and the functioning of this body and the assessment of its work; control of bank risk exposure; evaluation of executives and its incentive pay; transparency of the bank supervisory board that allows for the assessment of its activities (both by institutional and private monitoring); ownership structure of banks and the role of institutional investors. In order to avoid a similar financial crisis in the future, regulators of financial markets are planning to establish standards for sealing the system in these areas.

CHAPTER- 7 CONCLUSIONSThe special nature of banking institutions necessitates a broad view of corporate governance where regulation of banking activities is required to protect depositors. In developed economies, protection of depositors in a deregulated environment is typically provided by a system of prudential regulation, but in developing economies such protection is undermined by the lack of well-trained supervisors, inadequate disclosure requirements, the cost of raising bank capital and the presence of distributional cartels. Due to special nature of the activities carried on by the banks, they face a lot of problems as far as the area of corporate governance is concerned. Also, in the Indian scenario, due to the peculiar nature of bank holdings there are a lot of embedded conflicts. There exists a doubt as to what standard should be applied while enforcing corporate governance in banks. Central banks play an important role in this regard. The guidance paper issued by the Basel Committee is of paramount significance in enforcing corporate governance standards in various countries across the world. As far as best corporate governance practices for banks are concerned, they may include realization that the times are changing, establishing an effective, capable and reliable board of directors, establishing a corporate code of ethics by the banks for themselves, considering establishing an office of the chairman of the board, having an effective and operating audit committee, compensation committee and nominating/ corporate governance committee in place, considering effective board compensation, disclosing the information and recognizing their duty to establish corporate governance procedures that will serve to enhance shareholder value.CHAPTER-8BIBLIOGRAPHYREFERENCESCapiro G. Jr and Levine R., Corporate Governance of Banks: Concepts and International Observations, paper presented in the Global Corporate Governance Forum Research Network Meeting, April 5, 2002Kohli S.S., Corporate Governance in Banks: Towards Best Practices, IBA Bulletin, pp.29-31, 2003; also as seen in Mridushi Swarup,Corporate Governance in Banking Sector, IJMBS, pg 76-81, vol. 1, issue 2, june 2011 IBA Bulletin Journal of Indian Banks Association. Dr. P. K. Srivastava, Banking Theory and practice, Himalaya Publishing House Mumbai, 10th edition, 2007. Gorden-Natarajan, Banking Theory, Law and Practice, Himalaya Publishing House, Mumbai, 2009.RBI Bulletins - Different years,. RBI, Report on Trend and Progress of Banking in India, various issues. Report of the Cadbury committee on Financial aspects of corporate Governance Chartered secretary, volume XXV11, Number5, May, 1997,pp.569-580WEBSITESwww.Financeindia.org.www.ifc.orgwww.Bankersindia.com

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