CORPORATE GOVERNANCE

NAME OF STUDENTS

• BHAVIK DESAI-7
• RAMEEZ KHAJHA-13
• NAKUL MEHTA-20
• HIRAL PAREKH -28
• SAPNA SISODIA-52
• KHUSHBOO VADGAMA-58
 DEFINITIONS
Corporate governance is the set of processes, customs, policies, laws and
institutions affecting the way a corporation is directed, administered or controlled.
Corporate governance also includes the relationships among the many shareholders
involved and the goals for which the corporation is governed. The principal
stakeholders are the shareholders, management and the board of directors. Other
stakeholders include employees, suppliers, customers, banks and other lenders,
regulators, the environment and the community at large.

Corporate governance is a multi-faceted subject. An important theme of corporate

governance is to ensure the accountability of certain individuals in an organization
through mechanisms that try to reduce or eliminate the principal-agent problem.
With a strong emphasis on shareholders welfare, a related but separate thread of
discussions focuses on the impact of a corporate governance system in economic
efficiency. There are yet other aspects to the corporate governance subject, such as
the stakeholder view and the corporate governance models around the world

In recent times quantities of domestic and international capital is being availed by

business. A prime benefit of corporate governance is the improvement in the
prospects for attracting long term capital. The investors are offered a wide range of
choices by the worldwide development of corporate financial and control system.
Providers of finance today emphasize on good corporate governance and
creditability aspects of the corporation. Good practices in corporate governance
must be evolved in order to attract international investors and also encouraging
domestic investors.

In a Board Culture of Corporate Governance, business author Gabrielle

O’Donovan defines corporate governance as ‘an internal system encompassing
policies, processes and people, which serves the needs of shareholders and other
stakeholders, by directing and controlling management activities with good
business savvy, objectivity, accountability and integrity. Sound corporate
governance is reliant on external marketplace commitment and legislation, plus a
healthy board culture which safeguards policies and processes’.

A Gandhian Definition
Trusteeship obligations inherent in company operations, where assets and
resources are pooled and entrusted to the managers for optimal utilization in the
stakeholders interests.

Corporate governance is essentially about leadership:

Leadership for efficiency;

Leadership for probity;

Leadership with responsibility;

and Leadership which is transparent and which is accountable.

- Principles for Corporate Governance in the COMMONWEALTH

An OECD Definition

“Corporate governance involves a set of relationships between a company’s

management, its board, its shareholders and other stakeholders ….also the structure
through which objectives of the company are set, and the means of attaining those
objectives and monitoring performance are determined”.

- Preamble to the OECD Principles of Corporate Governance, 2004

An Indian Definition

“The fundamental objective of corporate governance is the enhancement of the

long-term stakeholder value while at the same time protecting the interest of
stakeholders”.

- SEBI (KUMARAMANGALAM BIRLA COMMITTEE) Report on

Corporate Governance, 2000

“Corporate Governance is the system by which companies are directed and

controlled…”

- Cadbury Report (UK), 1992

PRINCIPLES OF CORPORATE GOVERNANCE

Key elements of good corporate governance principles include honesty, trust and
integrity, openness, performance orientation, responsibility and accountability,
mutual respects and commitment to organization.

Of importance is how directors and management develop a model of governance

that aligns the values of the corporate participants and then evaluate this model
periodically for its effectiveness. In particular, senior executives should conduct
themselves honestly and ethically, especially concerning actual or apparent
conflicts of interest, and disclosure in financial reports.

Commonly accepted principles of corporate governance include:

Organizations should respect the rights of shareholders and help shareholders to

exercise those rights. They can help shareholders exercise their rights by
effectively communicating information that is understandable and accessible and
encouraging shareholders to participate in general meetings.

Interest of other stakeholders:

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

Role and responsibilities of the board:

The board needs a range of skills and understanding to be able to deal with various
business issues and have the ability to review and challenge management
performance. It needs to be of sufficient size and have an appropriate level of
commitment to fulfill its responsibilities and duties. There are issues about the
appropriate mix of executive and non-executive directors.

Integrity and ethical behavior:

Ethical and responsible decision making is not only important for public relations,
but it is also a necessary element in risk management and avoiding lawsuits.
Organizations should develop a code of conduct for their directors and executives
that promotes ethical and responsible decision making. It is important to
understand, though, that reliance by a company of integrity and ethics of
individuals is bound to eventual failure. Because of this, many organizations
establish Compliance and Ethics Programs to minimize the risk that the firm steps
outside of ethical and legal boundaries.

Disclosure and transparency:

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

Issues involving corporate governance principles are:

• Internal controls and internal auditors

• The independence of the entity’s external auditors and the quality of their
audits

• Oversight and management of risk

• Oversight of the preparation of the entity’s financial statements

• Review of the compensation arrangements for the chief executive officer

and other senior executives

• The resources made available to directors in carrying out their duties

• The way in which individuals are nominated for positions on the board

• Dividend policy
 FACTORS INFLUENCING QUALITY OF GOVERNANCE

Integrity of the Management

A board of directors with a low level of integrity is tempted to misuse the trust,
reposed by shareholders and other stakeholders to take decisions that benefit a few
at the cost of others.

Ability of the Board

The collective ability in terms of knowledge and skill of the board of directors to
effective supervise the executive management determines the effectiveness of the
board. A board which does not have members with right specialization lacks his
ability.

Adequacy of the Process

Board of directors cannot effectively supervise the executive management if the

process fails to provide sufficient and timely information to the board necessary for
reviewing plans and the performance of the enterprise. Similarly the processes
should be such that it should not dampen the entrepreneurial spirit of the executive
management.

Commitment level of individual board members

The quality of a board depends on the commitment of individual members to tasks,

which they are expected to perform as board members.

Quality of Corporate Reporting

The quality of corporate reporting depends on transparency and timelines of

corporate communication with shareholders. This helps the shareholders in making
economic decision and in correctly evaluating the management in its stewardship
functions.
 NEED, IMPORTANCE AND GENESIS

When banks efficiently mobilize and allocate funds, this lowers the cost of capital
to firms, boosts capital formation, and stimulates productivity growth. Thus, the
functioning of banks has ramification for the operations of firms and the prosperity
of nations.

Given the importance of banks, the governance of banks themselves assumes a

central role. If bank managers face sound governance mechanisms, they will be
more likely to allocate capital efficiency and exert effective corporate governance
over the firms they fund. In contrast, if banks managers enjoy enormous discretion
to act in their own interests rather than in the interests of shareholders and debt
holders, then banks will be correspondingly less likely to allocate society’s savings
efficiently and exert sound governance over firms. Banking crises dramatically
advertise the enormous consequences of poor governance of banks. Banking crises
have crippled economies, destabilized governments, and intensified poverty. When
bank insiders exploit the bank for their own purposes, this can increase the
likelihood of bank failures and thereby curtail corporate finance and economic
development.

It will certainly not be out of place here to recount how issues relating to corporate
governance and corporate control have come to the fore the world over in the
recent past. The seeds of modern corporate governance were probably sown by the
Watergate scandal in the USA. Subsequent investigations by US regulatory and
legislative bodies highlighted control failures that had allowed several major
corporations to make illegal political contributions and bribe government officials.
While these developments in the US stimulated debate in the UK, a spate of
scandals and collapses in that country in the late 1980s and early 1990s led
shareholders and banks to worry about their investments. Several companies in UK
which saw explosive growth in earnings in the 80s ended the decade in a
memorably disastrous manner. Importantly, such spectacular corporate failures
arose primarily out of poorly managed business practices.
This debate was driven partly by the subsequent enquiries into corporate
governance (most notably the Cadbury Report) and partly by extensive changes in
corporate structure. In May 1991, the London Stock Exchange set up a Committee
under the chairmanship of Sir Arian Cadbury to help raise the standards of
corporate governance and the level of confidence in financial reporting and
auditing by setting out clearly what it sees as the respective responsibilities of
those involved and what it believes is expected of them. The Committee
investigated accountability of the Board of Directors to shareholders and to the
society. It submitted its report and the associated ‘code of best practices’ in
December 1992 wherein it spelt out the methods of governance needed to achieve
a balance between the essential powers of the Board of Directors and their proper
accountability. Being a pioneering report on corporate governance, it would
perhaps be in order to make a brief reference to its recommendations which are in
the nature of guidelines relating to, among other things, the Board of Directors and
Reporting & Control.

The Cadbury Report stipulated that the Board of Directors should meet regularly,
retain full and effective control over the company and monitor the executive
management. There should be a clearly accepted division of responsibilities at the
head of the company which will ensure balance of power and authority so that no
individual has unfettered powers of decision. The Board should have a formal
schedule of matters specifically reserved to it for decisions to ensure that the
direction and control of the company is firmly in its hands. There should also be an
agreed procedure for Directors in the furtherance of their duties to take
independent professional advice.

The Cadbury Report generated a lot of interest in India. The issue of corporate
governance was studied in depth and dealt with by the Confederation of Indian
Industries (CII), Associated Chamber of Commerce and Industry (ASSOCHAM)
and Securities and Exchange Board of India (SEBI). These studies reinforced the
Cadbury Report‘s focus on the crucial role of the Board and the need for it to
observe a Code of Best Practices. Co-operative banks as corporate entities possess
certain unique characteristics. Paradoxical as it may sound, evolution of co-
operatives in India as people’s organizations rather than business enterprises
adopting professional managerial systems has hindered growth of professionalism
in co-operatives and proved to be a neglected area in their evolution.
Thus, factors such as:

• Lay foundation for progress for business

• A source of competitive advantage

• Maximize long-term shareholders value

• According to the Institute for Company Secretaries of India it is- application

of best management practices, compliance of law, and adherence to ethical
standards, distribution of wealth & discharge of social responsibility

• Poor governance can harm national economic performance

• Poor disclosures and audit procedures result in deteriorating financial

conditions of the corporations.

• Poor governance undermines the confidence in the markets and hold the
financial system hostage

• Social responsibility

• Multiple, divergent expectations of shareholders

• Fair business deals

• Prevention of corruption

• Scandals (sub-prime mortgage, Satyam)

Gave rise to need and shows the importance of corporate governance.

CLAUSE 49

SEBI – Amendments to Clause 49 of the Listing agreement

Background

The SEBI had constituted a Committee on Corporate Governance under the

Chairmanship of Shri N.R.Narayana Murthy to further improve the standards of
corporate governance in India.

In late 2002, SEBI constituted the Narayana Murthy Committee to assess the
adequacy of current corporate governance practices and to suggest improvements.
Based on the recommendations of this committee, SEBI issued a modified Clause
49 on 29 October 2004 (the ‘revised Clause 49’) which came into operation on 1
January 2006.

Highlights of the new amendments:

• Broadening of the definition of independent director

• Fixing of norms relating to Non-executive directors compensation and

disclosures

• Additional duty on the independent director to periodically review the legal

compliance reports prepared by the Company and steps taken by the
Company to improve

• Obligation on the Board of Directors to lay down a Code of Conduct for all
Board members and senior management of the company

• Fixation of the term Non-executive Directors to a maximum of nine years

 • Requirement of all members of the Audit Committee being financially
literate

• Increase in the powers of the Audit Committee

• Additional duty on the Audit Committee to review of certain information by

the Audit Committee

• Requirements relating to Audit reports and Audit Qualifications

• New requirement of Whistle Blower Policy

• Applicability of the requirements to subsidiary companies relating to

composition of the Board of Directors, laying of minutes of the board
meeting before the Board of the holding company and additional
requirement to be included in the Board report of the Holding Company

• Disclosure of contingent liabilities

• Additional disclosures

• Certification by CEO/CFO

• Change in the format of reporting to Stock Exchanges relating to Corporate

Governance

• Entitlement to practicing company secretaries to certify the compliance of

the conditions of corporate governance

Clause 49 of the Listing Agreement to the Indian stock exchange comes into effect
from 31 December 2005. It has been formulated for the improvement of corporate
governance in all listed companies.

In corporate hierarchy two types of managements are envisaged: i) companies

managed by Board of Directors; and ii) those by a Managing Director, whole-time
director or manager subject to the control and guidance of the Board of Directors.

• As per Clause 49, for a company with an Executive Chairman, at least 50

per cent of the board should comprise independent directors. In the case of a
 company with a non-executive Chairman, at least one-third of the board
should be independent directors.

• It would be necessary for chief executives and chief financial officers to

establish and maintain internal controls and implement remediation and risk
mitigation towards deficiencies in internal controls, among others.

• Clause VI (ii) of Clause 49 requires all companies to submit a quarterly

compliance report to stock exchange in the prescribed form. The clause also
requires that there be a separate section on corporate governance in the
annual report with a detailed compliance report.

• A company is also required to obtain a certificate either from auditors or

practicing company secretaries regarding compliance of conditions as
stipulated, and annex the same to the director's report.

• The clause mandates composition of an audit committee; one of the directors

is required to be "financially literate".

• It is mandatory for all listed companies to comply with the clause by 31

December 2005.

Following disclosures have been made mandatory by way of Clause 49 of the

Listing Agreement:

Disclosure of contingent liabilities

I. The management has to provide description of each material contingent liability

and its risks, which shall be accompanied by the auditor’s comments on the
management’s view. This section shall be highlighted in the significant
accounting policies and notes on accounts, as well as, in the auditor’s report
where necessary.

II. A statement of all transactions with related parties including their basis shall be
placed before the Audit Committee for formal approval/ratification. If any
 transaction is not on an arm’s length basis, management shall provide an
explanation to the Audit Committee justifying the same.

III. The management shall put in place procedures to inform Board members about
the risk assessment and minimization procedures. These procedures shall be
periodically reviewed to ensure that executive management controls risk
through means of a properly defined framework.

IV. Management shall place a report certified by the compliance officer of the
company, before the entire Board of Directors every quarter documenting the
business risks faced by the company, measures to address and minimize such
risks, and any limitations to the risk taking capacity of the corporation. This
document shall be formally approved by the Board.

V. Further in case of proceeds from IPOs disclosures shall be made to the Audit
Committee.

CORPORATE GOVERNANCE IN BANKS

INTERNAL ELEMENTS OF EXTERNAL ELEMENTS OF

CORPRATE GOVERNANCE CORPRATE GOVERNANCE

Factors of Sound Corporate Principal Factors

Governance
• Stakeholders
• Shareholders rights protection
• Takeovers/acquisitions
• Rights and responsibilities of
• Bankruptcy framework
Board of Directors and
Shareholders • Collateral and Foreclosure rules
• Quality of Disclosure • Enterprise Restructuring
• Monitoring • Investors and Creditors
• Effectiveness of core
Enabling Environment

• International Accounting and Auditing Standards

• Securities Markets Legal and Regulatory Frameworks

• Financial Sector Participants: Investors, Issuers, Intermediaries

• Financial Market Infrastructure and Architecture

OVERVIEW ON BANK CORPORATE GOVERNANCE
• Product and Factor Competitiveness

• Foreign Direct Investments

Effective corporate governance practices are essential to achieving and maintaining
public trust and confidence in the banking system, which are critical to the proper
functioning of the banking sector and economy as a whole. Poor 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 in turn trigger a
bank run or liquidity crisis. Indeed, in addition to their responsibilities to
shareholders, banks also have a responsibility to their depositors.

The OECD principles define corporate governance as involving “a set of

relationships between a company’s 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. Good corporate
governance should provide proper incentives for the board and management to
pursue objectives that are in the interests of the company and its shareholders and
should facilitate effective monitoring. The presence of an effective corporate
governance system, within an individual company and across an economy as a
whole, helps to provide a degree of confidence that is necessary for the proper
functioning of a market economy.”

From a banking industry perspective, corporate governance involves the manner in

which the business and affairs of banks are governed by their boards of directors
and senior management, which affects how, they:

• Set corporate objectives;

• Operate the bank’s business on a day-to-day basis;
• Meet the obligation of accountability to their shareholders and take into
account the interests of other recognized stakeholders;
• Align corporate activities and behavior with the expectation that banks will
operate in a safe and sound manner, and in compliance with applicable laws
and regulations; and
• Protect the interests of depositors.

Supervisors have a keen interest in sound corporate governance as it is an essential

element in the safe and sound functioning of a bank and may affect the bank’s risk
profile if not implemented effectively. As the functions of the board of directors
and senior management with regard to setting policies, implementing policies and
monitoring compliance are key elements in the control functions of a bank,
effective oversight of the business and affairs of a bank by its board and senior
management contributes to the maintenance of an efficient and cost-effective
supervisory system. Sound corporate governance also contributes to the protection
of depositors of the bank and permits the supervisor to place more reliance on the
bank’s internal processes. In this regard, supervisory experience underscores the
importance of having the appropriate levels of accountability and checks and
balances within each bank. Moreover, sound corporate governance practices are
especially important in situations where a bank is experiencing problems, or where
significant corrective action is necessary, as the supervisor may require the board
of director’s substantial involvement in seeking solutions and overseeing the
implementation of corrective actions.

There are unique corporate governance challenges posed where bank ownership
structures either lack transparency or where there are insufficient checks and
balances on inappropriate activities or influences of insiders or controlling
shareholders. The Committee is not suggesting that the existence of controlling
shareholders is in and of itself inappropriate. Indeed, controlling shareholders can
be beneficial resources for a bank, and in many markets and for many small banks
this is a quite common and appropriate ownership pattern that does not raise
concerns on the part of supervisors. It is nevertheless important that supervisors
take steps to ensure that such ownership structures do not impede sound corporate
governance. In particular, supervisors should have the ability to assess the fitness
and propriety of bank owners.

Good corporate governance requires appropriate and effective legal, regulatory and
institutional foundations. A variety of factors, including the system of business
laws and accounting standards, can affect market integrity and overall economic
performance. Such factors, however, are often outside the scope of banking
supervision. Supervisors are nevertheless encouraged to be aware of legal and
institutional impediments to sound corporate governance, and to take steps to
foster effective foundations for corporate governance where it is within their legal
authority to do so.

Corporate governance arrangements, as well as legal and regulatory systems, vary

widely between countries. Nevertheless, sound governance can be achieved
regardless of the form used by a banking organization so long as several essential
functions are in place. There are four important forms of oversight that should be
included in the organizational structure of any bank in order to ensure appropriate
checks and balances:

(1) Oversight by the board of directors or supervisory board;

(2) Oversight by individuals not involved in the day-to-day running of the various
business areas;

(3) Direct line supervision of different business areas; and

(4) Independent risk management, compliance and audit functions. In addition, it is
important that key personnel are fit and proper for their jobs.

Although government ownership of a bank has the potential to alter the strategies
and objectives of the bank, a state-owned bank may face many of the same risks
associated with weak corporate governance that are faced by banks that are not
state-owned. Consequently, the general principles of sound corporate governance
should also be applied to state-owned banks. Likewise, these principles apply to
banks with other types of ownership structures, for example those that are family-
owned or part of a wider non-financial group, and to those that are non-listed.

CORPORATE GOVERNANCE IN CO-OPERATIVE BANKS

For the co-operative banks in India these are challenging times. Never before has
the need for restoring customer confidence in the cooperative sector been felt so
much. Never before has the issue of good governance in the co-operative banks
assumed such criticality. The literature on corporate governance in its wider
connotation covers a range of issues such as protection of shareholders’ rights,
enhancing shareholders’ value, Board issues including its composition and role,
disclosure requirements, integrity of accounting practices, the control systems, in
particular internal control systems. Corporate governance especially in the co-
operative sector has come into sharp focus because more and more co-operative
banks in India, both in urban and rural areas, have experienced grave problems in
recent times which have in a way threatened the profile and identity of the entire
co-operative system. These problems include mismanagement, financial
impropriety, poor investment decisions and the growing distance between
members and their co-operative society.
The purpose and objectives of co-operatives provide the framework for co-
operative corporate governance. Co- operatives are organized groups of people and
jointly managed and democratically controlled enterprises. They exist to serve their
members and depositors and produce benefits for them. Co-operative corporate
governance is therefore about ensuring co-operative relevance and performance by
connecting members, management and the employees to the policy, strategy and
decision-making processes.

At the instance of the Confederation of Indian Industries (CII) and the Securities
Exchange Board of India (SEBI), joint stock companies, which are registered
under the Companies Act, have evolved a set of procedures for corporate
governance. In the light of the recent developments in the world of co-operative
banking, for better working of urban co-operative banks (UCB), such guidelines
have become absolutely imperative.

The dictionary meanings of ‘governance’ include both “the action or manner of

governing” and “a mode of living, behavior, and demeanor.” But what is sought to
be done by the CII and SEBI is bringing about complete transparency, integrity
and accountability of the management.

When the co-operative movement which is based on the Friendly Societies Act of
England, got recognition in India with the enactment of the Co-operative Societies
Act of 1904, the possibilities of the movement embracing all types of activities had
not been visualized. The basic objective at that time was giving a boost to self help
and mutual trust. People hailing from a particular community, class or region came
together and registered co-operative societies. UCBs belong to one such breed.

Over the years and more particularly during the 1960s, open membership started
replacing community membership. March 1, 1966, saw an extension of the
provisions of the Banking Regulation Act to UCBs. Ever since, these banks have
grown rapidly, spreading their branches not only within a state, but also outside the
home states.

The proliferation of co-operative banks all over India over the century has been
quite impressive. They have been able to mobilize nearly Rs.75, 000 crore in terms
of deposits and over Rs.30, 000 crore in terms of advances. Out of the 2,060 UCBs
in existence today, 51 have attained the ‘Scheduled Bank’ status – i.e., each of
them has demand and time liabilities exceeding Rs.100 crore.

As long as UCBs were confined to and serving a particular area or community,

there was no need for stringent regulations. In fact, when their deposits were
brought on par with those of commercial banks with the extension of the Banking
Regulation Act in 1966 and Deposit Insurance in 1971, people’s confidence in
them took a big leap forward. This is crystal clear from a simple fact that the non-
member deposits in urban banks far exceed the member deposits.

However, recently, the confidence in the working UCBs has received a severe jolt.
It is to refurbish this soiled image and to restore customer confidence in urban
banks than the concept of corporate governance is being bandied out.

Much can be said in favor of the concept of corporate governance, on the lines of
the system prevailing in joint stock companies. But, before bringing it into effect, a
proper debate on its pros and cons is a must. The RBI could appoint a small
committee, with representatives from all the sectors concerned, to pave the way for
this change-over. And the committee could come up with a time-bound programme
and evolve the necessary guidelines.

If every bank, along with its annual report, publishes a report on its corporate
governance, it would go a long way in helping the authorities to monitor the
functioning of urban banks effectively. Not only can they keep a watch on the
working of these banks, but also they could take timely action wherever necessary.
Since banking is based on trust, shareholders and depositors would feel relieved if
these two factors are made palpably visible.

The report on corporate governance submitted by a bank every year could include,
details of elections – when was the last election held, who conducted it, names of
the person who contested and the votes polled by each. It is observed that a
majority of shareholders do not exercise their voting rights for various reasons. A
provision may be made in the bye laws to debar a member to deny dividend and
other benefits, if he does not exercise his voting rights. It is also advisable to
introduce postal ballot with the postage paid or hold elections at each branch. Or
defaults: particulars of default or a declaration saying there were no defaults in
respect of maintaining SLR/CRR, payment of premium on deposit to the Deposit
insurance & Credit Guarantee Corporation, submission of statutory returns to the
RBI and other authorities.

The relevance as well as importance of corporate governance can be conveyed best

with the following quotation of Benjamin Franklin: “A little neglect may breed
great mischief. For want of a nail, the shoe was lost; for want of a shoe, the horse
was lost; for want of a horse, the rifer was lost; and, for want of a rider, the battle
was lost”.
ROLE OF GOVERNMENT AND REGULATOR

Regulators 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. RBI’s 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
emphasized 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 organization have a professional board which can drive the organization
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 developments.

THE SPECIAL PLACE OF BANKING

The banking sector is not necessarily totally corporate. Some part of it is, of
course, but a segment of banks is mostly government owned as statutory
corporations or run as cooperatives – just like your bank. Banking as a sector has
been unique and the interests of other stakeholders appear more important to it than
in the case of non-banking and non-finance organizations. 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. Since 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.

REASONS FOR HIGH DEGREE OF OVERSIGHT

There are three reasons for degree of government oversight in this sector.
Firstly, it is believed that the depositors, particularly retail depositors, cannot
effectively protect themselves as they do not have adequate information, nor are
they in a position to coordinate with each other.
Secondly, bank assents are usually 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 customized and privately negotiated.
Thirdly, it is believed 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.
 ROLE OF SUPERVISORS

A bank’s board of directors and senior management are primarily responsible and
accountable for the performance of the bank. Likewise, shareholders should hold
the board accountable for governing the bank effectively. A key role of supervisors
is then to promote strong corporate governance by reviewing and evaluating a
bank’s implementation of the sound principles set forth in section III above. This
section therefore sets forth several principles that can assist supervisors in
assessing bank corporate governance.

Supervisors should provide guidance to banks on sound corporate governance

and the pro-active practices that should be in place:
In developing guidance, supervisors should recognize that banks will need to adopt
different approaches to corporate governance that are proportional to the size,
complexity, structure and risk profile of the bank. The supervisory process should
take this into consideration in evaluating bank corporate governance.

Supervisors should consider corporate governance as one element of depositor

protection:
Sound corporate governance considers not only the interests of shareholders, but
also the interests of depositors. Supervisors should determine that individual banks
are conducting their business in such a way as to not be detrimental to the interests
of depositors. Therefore, depositors’ interests should be considered in conjunction
with any applicable deposit insurance systems, the need to avoid “moral hazard”
which may result from particular approaches to consumer protection, and other
relevant principles.

Supervisors should determine whether the bank has adopted and effectively
implemented sound corporate governance policies and practices:
An important element of supervisory oversight of bank safety and soundness is an
understanding of how corporate governance affects a bank’s risk profile.
Supervisors should not only evaluate corporate governance policies and
procedures, but also evaluate banks’ implementation of these policies and
procedures. Supervisors should expect banks to implement organizational
structures that include the appropriate checks and balances. Regulatory guidance
should emphasize accountability and transparency.
Supervisors, as well as licensing authorities, should obtain necessary information
to evaluate the expertise and integrity of proposed directors and management. The
fit and proper criteria should include, but may not be limited to: (1) the
contributions that an individual’s skills and experience are likely to make to the
safe and sound operation of the bank, and (2) any record of criminal activities or
adverse regulatory judgments that in the supervisor’s judgment make a person unfit
to uphold important positions in a bank. Moreover, supervisors should determine
that the boards and senior management of individual institutions have in place
processes to review the fulfillment of their duties and responsibilities. It may be
helpful in this regard for supervisors to meet with individual directors and senior
managers as part of the ongoing supervisory process.

Supervisors should assess the quality of banks’ audit and control functions:
Supervisors should evaluate whether the bank has in place effective mechanisms
through which the board and senior management execute their oversight
responsibilities. Such mechanisms include internal and external audit, risk
management and compliance functions. In this regard, supervisors should assess
the effectiveness of oversight of these functions by a bank’s board of directors.
This could include (with the consent of senior management, if necessary) meetings
with internal and external auditors as well as senior risk managers, compliance
officers, and other key personnel in control functions. Supervisors should ensure
that the internal audit function conducts independent, comprehensive and effective
reviews of bank risk management and internal controls. Supervisors should assess
the adequacy of internal controls that foster effective governance. It is important
that effective internal controls not only be well-defined in policies and procedures,
but also that they be properly implemented.

Supervisors should evaluate the effects of the bank’s group structure:

Supervisors should be able to obtain information regarding the structure of the
group to which a bank belongs. For example, management should, upon request by
supervisors, be able to provide a full list of all group entities affiliated with the
bank, as well as business lines of the group. Information about the group structure
should allow for an assessment of the fitness and propriety of the major
shareholders and directors of the parent company and the adequacy of the
oversight process within the group, including coordination of the same functions at
the bank and group level. Supervisors should also ensure that there is appropriate
internal reporting and communication from the bank to the parent board, and vice
versa, in respect of all material risk and other issues that may affect the group (e.g.
group-wide “know-your-structure”). Where a bank or the group to which it belongs
are internationally active, banking supervisors should cooperate and share
information with other supervisors to enhance supervisory effectiveness and reduce
supervisory burden.33 Where banks operate in jurisdictions, or through structures,
that impede transparency, countries should work to adopt laws and regulations
enabling bank supervisors to obtain and review the documentation of a bank’s
analysis and authorization process and to take appropriate supervisory action to
address deficiencies and inappropriate activities when necessary.

Supervisors should bring to the board of directors’ and management’s

attention problems that they detect through their supervisory efforts:
Poor corporate governance practices can be either a cause or a symptom of larger
problems that merit supervisory attention. Supervisors should be attentive to any
warning signs of deterioration in the management of the bank’s activities. When
supervisors believe that the bank has taken risks that it is unable to fully measure
or control, they should hold the board of directors and senior management
accountable and require that corrective measures be taken in a timely manner.
MEASURES TAKEN TOWARDS CORPORATE GOVERNANCE

MEASURES TAKEN BY BANKS TOWARDS IMPLEMENTATION OF

BEST PRACTICES

Prudential norms in 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 31st March 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 31st March 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 importance.

\
MINISTRY OF COMPANY AFFAIRS

The Ministry of Company Affairs (MCA) is gearing itself to meet the challenges
arising out of the current economic growth in the country, emergence of new areas
of activities and corresponding business models, and the need for mobilizing
investment in the private sector. The Ministry is primarily concerned with the
administration of the legal framework governing corporate functioning and the
administration of the Companies Act, 1956. In addition, it also administers the
Chartered Accountants Act, 1980. The Government has also introduced the
Competition Act, 2002, which would eventually replace the monopolies and
Restrictive Trade Practices Act, 1969.

Many changes have taken place in the Indian economy since the Companies Act,
1956 was enacted. The aspirations of the Indian corporate sector are continuously
evolving. Growth in size is accompanied by rapid diversification and integration
with the international economy. Knowledge and service based sectors are playing
increasingly important role in the overall economic growth. There is greater
emphasis on good corporate governance along with need for confidence building
measures among the investors. In this scenario the need of the hour is to provide a
compact framework that also contains adequate flexibility to allow for timely
evolution of new arrangements so as to improve the qualitative and quantitative
aspects of regulations of the companies by revamping the Companies Act, 1956
and other related Acts.

Introduction of a culture of Corporate Governance is the need of the hour for the
comfort of all stakeholders. The MCA, after consultations with industry
associations and professional institutes, has set up National Foundation for
Corporate Governance (NFCG) as a not-for-profit trust on October 01, 2003
with MCA, Confederation of Indian Industry (CII), Institute of Company
Secretaries of India (ICSI) and Institute of Chartered Accountants of India
(ICAI) as participating trustees Shri Narayana Murthy, Chief Mentor, Infosys has
been nominated as Vice-Chairman of the foundation. The main objectives of
NFCG are to provide a platform to deliberate on issues relating to good corporate
governance and to sensitize corporate leaders on the importance of good corporate
governance, self-regulation and directional responsibilities.
It also facilitates exchange of experiences and ideas between corporate leaders,
policy makers, regulators, law enforcing agencies and NGOs. Another objective
enables it to prepare a code of best practices for Corporate Governance and to give
advice, provide consultancy and technical and managerial support to the
beneficiaries of the Trust’s programme. The foundation has already started its
work by organizing a number of conferences and would expand further in due
course of time. In fact, the MCA is striving hard to continue with endeavour to
fulfill the aspirations of various stakeholders and come up to their expectations.

SERIOUS FRAUD INVESTIGATION OFFICE (SFIO)

The SFIO is a multi-disciplinary organization under Ministry of Corporate Affairs,

consisting of experts in the filed of accountancy, forensic auditing, law,
information technology, investigation, company law, capital market and taxation
for detecting and prosecuting or recommending for prosecution white-collar
crimes/frauds. The SFIO will normally take up for investigation only such cases,
which are characterized by

• complexity and having inter-departmental and multi-disciplinary

ramifications;
• substantial involvement of public interest to be judged by size, either in
terms of monetary misappropriation or in terms of persons affected, and;
• the possibility of investigation leading to or contributing towards a clear
improvement in systems, laws or procedures. The SFIO shall investigate
serious cases of fraud received from Department of company Affairs.

CHARTER AND RESPONSIBILITIES OF SFIO

a) Detecting and prosecuting or recommending for prosecution white collar

crimes/corporate frauds.

b) SFIO will normally take up investigation of only such cases which are
characterized by:-

i. complexity and having inter-departmental and multi-disciplinary

ramifications’
ii. substantial involvement of public interest to be judged by size, either in
terms of monetary misappropriation or in terms of persons affected and
iii. the possibility of investigation leading to or contributing towards a clear
improvement in systems, laws and procedures.
SFIO takes up investigation of cases referred by the Government under section 235
to 239 of the Companies Act, 1956. SFIO, at present, does not initiate investigation
on its own.