corporate governance in banks

Corporate governance in banking

What is corporate governance?

“Corporate governance is the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal and corporate funds in the management of a company.” Report of the Committee on Corporate Governance of the Securities and Exchange Board of India, 2003

In the last 20 years, corporate governance in the Banking sector has changed drastically. All over the world, many committees were set up to look into this aspect like the Cadbury Committee, OECD Code, Combined Code of London Stock Exchange, the Blue Ribbon Committee and Kumar Mangalam Birla Committee in India.

The latest reason, which we all can remember due to which corporate governance in banking sector is being enhanced, is the financial crisis of 2007-2008 during which Lehman Brothers went bankrupt and many other big names like Merrill Lynch, AIG, Freddie Mac, Fannie Mae, HBOS, Royal Bank of Scotland, Bradford & Bingley, Fortis, Hypo and Alliance & Leicester all came close to bankruptcy and were rescued by government intervention.

In the Indian context, failure of cooperative banks and collapse of Yes bank, governance problems in ICICI and PSBs have raised a major question on the effectiveness level of corporate governance being  followed by the banks.

Why we need corporate governance for banks?

Corporate governance and economic development are inter- linked. Efficient corporate governance systems encourage the development of robust financial systems. Banks play a crucial role in the flow of capital. Banks are an imperative constituent of any economy. Hence, the proper governance of banks is very crucial for growth and development of the economy and the country as a whole. Failure of one institution may have a cascading effect resulting in significant costs to the economy. Fundamentally, banks must act in a way that promotes “confidence” to its stakeholders. Good corporate governance and supervisory actions harmonize one another.

Basel Committee

Appreciating the diversity in structure of corporate governance mechanisms across the world, the Basel Committee in 1999, recommended four important forms of oversight that should be included in the organisational structure of any bank in order to ensure the appropriate checks and balances. They are

  • oversight by the board of directors or supervisory board;
  • oversight by individuals not involved in the day-to-day running of the various business areas;
  • direct line supervision of different business areas
  • Independent risk management and audit functions.

The committee also emphasizes on the importance of key personnel being fit and proper for their jobs.

Corporate governance and cooperative banks

Urban Cooperative Banks are a key sector in the Indian Banking Industry. In recent years, this sector has faced a lot of turmoil and turbulence, resulting in bankruptcy and closure of many cooperative banks. The cooperative movement started in India with the enactment of Cooperative Societies Act in 1904. In 1966, the Banking Regulation Act was made applicable to UCBs. To address the issue, the RBI has been given more powers have been given to the central bank.

In India, SEBI, through the Clause 49 of the Listing Agreement, requires all listed banks to adhere to corporate governance regulations officially. Cooperative Banks, however, are not listed as they do not trade in shares. This is the main difference between cooperative banks and other banks in the banking sector. But the RBI has been making continuous efforts to see that cooperative banks also maintain the highest standards of corporate governance. Most of the problems faced by the cooperative banks can be attributed to corporate governance issues.

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. Also, norms governing provisioning requirements in respect of doubtful assets have been made more stringent in a phased manner.

Capital Adequacy: All the banks barring are required to comply with the minimum capital requirement

ALM and Risk Management Practices – Steps have been taken to address liquidity issues and manage risks of the banks, like the recently launched liquidity framework and LCR, NSFR requirements by the RBI. Risk management is done thr’

  • CAMELS and CALCS framework
  • PCA
  • Basel norms

Measures taken by regulator towards corporate governance

Reserve 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:

  1. Transparency b) Off-site surveillance c) Prompt corrective action

 Transparency and disclosure standards are also important constituents of a sound corporate governance mechanism.

Recent paper by the RBI to overhaul corporate governance

  • To build a robust culture of sound governance practice, professional management of banks and to adopt the principle of separating ownership from management, it is desirable to limit the tenure of the WTDs (Whole Time Directors) or CEOs

  • It is felt that 10 years is an adequate time limit for a promoter / major shareholder of a bank as WTD or CEO of the bank to stabilise its operations and to transition the managerial leadership to a professional management.

  • Further, in the overall interest of good governance, a management functionary who is not a promoter / major shareholder can be a WTD or CEO of a bank for 15 consecutive years

  • The board, through its NRC, is responsible for oversight of management’s implementation of compensation system for the entire bank. In addition, the board, through its NRC, shall regularly monitor and review outcomes to assess whether the bank-wide compensation system is creating desired incentives. The NRC shall review the compensation plans, processes and outcomes at least annually.

by- Kanika Berry

Source: RBI website, economic times, iosjournal.org