Volume VIII Part 4 August 25, 2014 11 Business Advisor

Corporate governance issues in banking

Dr Sanjiv Agarwal

Banks play a vital role in the economy, and the

continued strength and stability of the banking system

is a matter of general public interest and concern, both

in regard to its linkages with the real sector and for

providing a payment and settlement system.

Banks are highly leveraged organisations. Banks can

continue to fund their operations only so long as they

enjoy the confidence of the financial markets.

Depositors‟ protection and public policy considerations of banks lead to a

comprehensive regulatory and supervisory framework. It has been

recognised that banks lead to a comprehensive regulatory and supervisory

framework.

There is a need to attach importance to qualitative standards such as

internal controls and risk management composition and role of the Board

and disclosure standards so much so that -

Corporate governance is one of the most critical issues that banks have

to pay attention to, in all earnest. Good corporate governance of banks is the sine qua non of a sound

banking system. Corporate governance in banks is of crucial value to the various stakeholders, viz, the depositors, creditors, customers,

shareholders, employees and society at large. Adequate disclosure and transparency are two key pillars of a corporate

governance framework in a bank.

Unlike companies, there is an external dimension to the issue of corporate governance in banks. It is not just shareholders interest, but

that of depositors too which is involved. Banks are custodians of public wealth, and there must be a system of

internal checks and balances to ensure that this interest is safeguarded.

Hallmarks of good governance in banks

Enhancing the value for all stakeholders, including depositors. A well understood corporate vision/ mission statement codifying its

values, ethos and culture. A broad-based Board, comprising specialist directors, with independent

dispositions. Establishment of relevant committees of the Board, with their roles

clearly defined, to oversee functions of the bank in critical areas. Setting standards for good banking practices to:

Volume VIII Part 4 August 25, 2014 12 Business Advisor

a) Ensure a transparent and fair relationship between the customers

and the bank.

b) Institute a comprehensive risk management system.

c) Proactively eliminate customer complaints and evolve a scheme for

redressed of the grievances (of customers, particularly retail

depositors and borrowers), and

d) Institute systems and processes to ensure compliance with the

statues and laws concerning banking.

A clearly enunciated code of conduct for dealing with all the stakeholders Effective systems of internal control, monitoring and vigilance

mechanism.

Corporate governance issues confronting banks and way forward

At present, corporate governance in Indian banks is governed by

following three set of guidelines/ regulations – Provisions of the Companies Act, 1956/ 2013 (in case of corporate

entities); Clause 49 of SEBI‟s Listing Agreement (in case of listed entities); RBI master circular. There is a need to revisit/ review these different guidelines and come out

with a single comprehensive set of guidelines which is acceptable to all

regulators.

A committee of bankers/ professionals/ IBA/ regulators may be framed for

drafting the draft set of guidelines.

Present composition of Board structure in banks requires a complete overhaul in changed business environment/ financial world. There could

be a two-pronged strategy, for public sector banks and private sector banks. While private sector ought to be provided with enough autonomy and

independence with checks and balances, this could be done through

government nominee (in form of independent director or professional)

and RBI nominee on Boards coupled with independent management

audit of banks.

For public sector banks, MoF and RBI should frame a comprehensive

Corporate Governance/ Business Code for implementation.

RRB‟s and co-operative banks should also be encouraged to function

professionally by broad basing of Board.

PSU Boards could be made two-tier Board, a „senior Board‟ (like central

Board) and an „executive Board‟ - a) Having a good corporate governance framework could be best or

adequately addressed by having a two-layered Board.

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b) All policy level decisions could be taken by central Board, directions

given and oversight functions carried out.

c) Executive Board could be headed by the managing director and be

made responsible for performance.

d) Central Board may have at least 50 percent non-official/ independent

directors including RBI nominee/ Government nominee directors.

e) Executive Board may have Board members comprising managing

director, 2 executive directors, officers/ staff representatives and one

non-official director.

f) While executive Board can meet on a monthly basis, central Board

may meet at least once in a quarter.

PSU Boards should be revamped/ restructured so as to ensure the following : a) Position of chairman/ chairperson and managing director/ COO are

separated.

b) Both, chairman and COO/ managing director should be executive and

independent of each other.

c) Accountability/ ownership of performance shall vest with the

managing director.

d) There is a mandatory whistleblower mechanism in place.

e) Board composition should be such that people from varied fields,

professions and experience are represented on the Board, chosen with

utmost caution, prudence and transparency, keeping in mind the

talent, experience and performance only. It should not become a

platform for retired bankers/ bureaucrats/ academicians.

f) With changing times, Board should have diversity in experience, skills

and gender. There should, inter alia, be at least one person drawn

from –

(i) Economic background;

(ii) Financial expert;

(iii)Management/ legal expert;

(iv) Risk management/ IT expert;

(v) Trade/ industry/ agriculture;

(vi) Woman director.

If necessary, Board size may be increased to about 15-18 in number.

Board level committees should also have following three committees – (i) Corporate governance committee;

(ii) Compliance management committee;

(iii)Corporate social responsibility committee.

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Most of the Board committees must have an independent director as

chairperson and majority of members as non-executive directors.

It should be ensured that in all public sector banks – a) There should be a whole-time qualified company secretary employed

as secretary to the Board;

b) One of the general managers/ chief general managers should be

designated as CFO (chief financial officer) of the bank;

c) There should be separate senior officers designated as –

(i) Chief risk officer,

(ii) Chief compliance officer,

(iii)Chief vigilance officer.

d) An annual independent compliance management audit due diligence

is carried out.

e) Corporate governance policy and compliance policy are in place, are

annually reviewed by Board and performance evaluated.

f) Corporate governance audit must be conducted by or separate

professionals who are well conversant with corporate governance

principles, polices, practices and framework rather than the routine

audit conducted by statutory auditors. There is no legal bar that only

statutory auditors can do this.

ICSI has a post-membership qualification course on corporate governance

and such professionals may be involved.

It has been seen that PSU banks have 50-80 internal committees which

results in a sheer wastage of time, resources and money, and decisions are delayed without any one taking the responsibility. It must be ensured

that increasing the number of committees is discouraged, and independent, judicious and prudent decision-making is encouraged.

In group banking (for example, State Bank of India including its

associate banks), policies and decision-making is usually not independent but is forced upon. This is to the extent that all policies are

replica of policies adopted by parent bank without proper application of independent mind and even without ascertaining whether it is

applicable, reasonable or relevant for the associate bank. Similarly, for all major decisions/ investments/ policy issues, such banks look at parent bank which makes the Boards of associate bank weak and in

effect non-functional. The independent Board members, being in minority, are helpless, except for getting their dissent recorded, at best.

Not only this, bigger loan syndications also suffer from the same problem

and once the project is appraised by parent bank, others fall in line, blindly

at times.

Donations/ charities/ philanthropic expenses are rampant in banks based upon personal choices of top management. There should be a

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broad parameter based criteria for expenditure, more so when, under the new Companies Act, 2013, there is a mandatory requirement of 2% of net

profits as corporate social responsibility (CSR) to be spent. This may encourage help MoF in its objectives including financial inclusion and

banking facilities outreach. Training and induction of Board members, at least for those coming from

non-banking background must be made compulsory. It should be ensured that Board members attend at least 75 percent of the meetings and their performance is evaluated independently as well as peer-

reviewed. Presently public sector banks have elected directors. These directors are

elected by shareholders for a period of three years but such directors are not allowed to be on Boards of banks after serving a period of six years

(i.e. two terms). There should be no bar on appointment or election of individuals as director of the bank based upon number of years served. This only blocks the right talent to be channelised into the right use and

deprives the banking sector use such talent. This ought to be reviewed subject to checks and balances.

It should be ensured that mutual funds and institutional investors actively participate in general meetings and also vote thereat.

Conclusion

All said and done, effective corporate governance in Indian banking industry

is a necessity irrespective of size, profitability or non-performing assets

(NPA) level in the banks.

However, there is a lot of improvement required in choosing right persons

for the position of directors in the banks, particularly in cases where the

Government nominates, and where they are elected by shareholders.

Banks in India need to look at larger and macro-level issues in order to

match global practices which are considered best the world over. Bank also

ought to learn from past experiences and failures in appraisals, banking

system collapse abroad and issues of corruption, integrity and performance

benchmarking

(Dr Sanjiv Agarwal is Partner, Agarwal Sanjiv & Company, Jaipur)

Effective corporate governance in Indian banking industry is

a necessity, irrespective of size, profitability or non-

performing assets (NPA) level in the banks.