CORPORATE GOVERNANCE IN INDIAN BANKING SECTOR

By

Pushkar GUPTA 2007 2008

A Dissertation presented in part consideration for the degree of MA in Finance and Investment

ACKNOWLEDGEMENTS
My sincere appreciation is extended to many people who helped and supported me through this dissertation. First and Foremost, I would like to thank Professor David Owen for his invaluable advice and comments. Without his support this study would not have been possible. I would also like to thank the interview participants for their sincere feedback and suggestions. Last but not the least; I would like to thank my parents for always being there for me. They have constantly guided and encouraged me through this study.

ABSTRACT
Corporate Governance has fast emerged as a benchmark for judging corporate excellence in the context of national and international business practices. From guidelines and desirable code of conduct some decade ago, corporate governance is now recognized as a paradigm for improving competitiveness and enhancing efficiency and thus improving investors confidence and accessing capital, both domestic as well as foreign. What is important is that corporate governance has become a dynamic concept and not static one. Banks form a crucial link in a countrys financial system and their well-being is imperative for the economy. The significant transformation of the banking industry in India is clearly evident from the changes that have occurred in the financial markets, institutions and products. While deregulation has opened up new vistas for banks to augment revenues, it has entailed greater competition and consequently greater risks. Cross-border flows and the entry of new products have significantly influenced the domestic banking sector, forcing banks to adjust the product mix, as also to effect rapid changes in their processes and operations in order to remain competitive in the globalized environment. These developments have facilitated greater choices for consumers who have become more discerning and demanding compelling banks to offer a broader range of products through diverse distribution channels. In such scenario, implementation of good corporate governance practices in banks can ensure them to cope with the changing environment. Todays corporate governance means to do everything better and provides for risk assessment, risk cover, early warning systems against failure as well as prompt corrective action. This research examines the practices of corporate governance attributes in banking sector and how they adhere to corporate governance practices. The results of this research indicate the practice of corporate governance is at nascent stage although corporate governance practices by Indian Banking Sector is more than a decade. Both private and public sector banks are adhering to mandatory requirements of corporate governance attributes as a result it is bringing more transparency and minimizing the chances of fraud and malpractices. However, hope is looming large for the proper implementation of corporate governance principles in Indian Banking Sector.

TABLE OF CONTENTS

Chapters 1. INTRODUCTION

Page

1.0 Introduction1 1.1 Background of the Research..5 1.2 Need of Corporate Governance.8 1.3 Research Objectives...9 1.4 Research Questions9 1.5 Scope of the Research..10 1.5 Organization of the Research...10 2. LITERATURE REVIEW 2.0 Introduction......11 2.1 Corporate Governance: Definitions.11 2.2 History of Corporate Governance in India...12 2.3 Governance in Banks.......17 2.4 Role of Governance in Banks..21 2.5 Areas of Concern: Ownership22 2.6 Composition of Board..23 2.7 Governance through Committees24 2.8 Critical Analysis of Literature..25 3. METHODOLOGY 3.0 Introduction......27 3.1 Research Approach..27 3.2 The Research Method..28 3.3 Research Design...30 3.4 Reliability and Validity of the Research..31 3.5 Limitations of the Research.31 4

4. ANALYSIS AND INTERPRETATION 4.0 Introduction..32 4.1 Analysis from secondary Research..32 4.2 Analysis of Primary Research..51 5. CONCLUSION66 6. REFERENCE LIST.70 7. APPENDIX

CHAPTER-1
1.0 Introduction The subject of corporate governance has attracted worldwide attention with a series of collapse of high profile companies like Enron, WorldCom, HIH insurance group etc. These failures have shattered the trust of investors worldwide. Some of the scandals which made headlines all around the world were somewhere related to poor corporate governance. These include the $18 billion meltdown of Parmalat Finanziaria, SpA in 2003. Parmalat was among the largest food-based companies in the world .The Parmalat case was one of the biggest scandals to hit Europe and many analysts called this fraud as 'Europe's Enron'. The companys corporate governance structure could not keep up to some of the key existing Italian corporate governance standards of best practice (Melis, 2004). Another classic example of a corporate house collapsing due to poor decision making and weak corporate governance was the HIH insurance group of Australia. This collapse resulted in a deficiency up to $5.3 billion, making it the largest corporate failure in Australia (Lipton, 2003). The collapse of the China Aviation Oil (CAO) also created certain doubts regarding the standard of corporate governance in China. This collapse came at a time when many companies were trying to get internationally listed and foreign investors were becoming more and more eager to buy them out (Economist Intelligence Unit, 2004). Poor corporate governance in banks is not a new subject. This inefficiency has been around for a very long time. Since the beginning of Banking in Nigeria in 1914, almost 75 banks were lost primarily because of factors related to poor corporate governance. The banks did not fail due to lack of customers but due to how they were managed and governed. According to a study by the Nigerian Deposit Insurance Corporation, the main reason for these failures was interference of board members (www.allafrica.com). Moreover, the recent subprime crises highlighted many issues of corporate governance in banks world over. The main issue was that of independent directors. For e.g., UBS, one of the worlds largest banks was among the biggest losers in the subprime crisis. It suffered a loss of about $38 billion. As a result it replaced four of its directors. The departing members included three outsiders with

experience respectively in rail equipment, chemicals and information technology. This shows that banks should definitely use experts on their boards (Economic Times, 2008). According to Zabihollah Rezaee (2005), there may be seven reasons behind these high profile failings. These include lax regulations, overconfident and egoistic management, inappropriate business conduct by top level management, deficiency of alert oversight functions, unproductive audit functions, poor financial disclosures and negligent shareholders. The above frauds adversely affect corporate governance, auditors creditability and the quality of financial statements. A good thing that came out of these corporate scandals was the global acceptance of the need for necessary checks and balances. Worldwide, it has now become necessary for big corporate houses to address the issue of corporate governance as investor demands fluctuate. Responsibility, transparency, fairness and accountability are the four vital pillars for strong corporate governance. Large and trusted companies across the globe realized the significance of corporate governance and subsequently took drastic steps to ensure practice of corporate governance. These days corporate governance is a reality which cant be overlooked by any financial institution who wants to be successful. There are a number of factors which force a company to adhere to a set of corporate governance principles. These may include stern regulators, vigilant and smart investing community, alert customers and the awareness among companies to be good corporate citizens. Companies should ensure a constant flow of profits but without crossing moral and ethical boundaries. However, some bad experiences in the past have exposed the fact that big corporate houses which have committed frauds have tacit support from banks. Questions have arisen thick and fast as to how people entrusted with governance of these corporate/banks, had failed to detect and stem the rot, before it was too late. Banks are constituted as companies under the companies act and they should be concerned with good governance Corporate governance has always been closely monitored by Asian regulators and this term has been a top priority for them in recent times. This is happening because of the fact that most of the markets have introduced a wide range of regulations. This particular research Corporate Governance in Indian Banking Sector will try to unfold the cause and effect of governance principles on banks. This research also studies the effectiveness of its so-called objectives to control the misgovernance in Indian Corporate sector. Next, this research analyses the upcoming 7

evidence on which government policies improve the governance of banks and describes tentative guidelines for future modification of its principles. Corporate Governance is aimed at ensuring proper governance of business as well as complying with all the governance norms prescribed by regulatory board for the benefit of all interested parties including society. The basic objective is the maximization of long-term shareholders value within the parameter of public law and social ethics to give an impression to customers and employees about the transparency and fairness of business. Particularly in banking sector, good corporate governance is very much essential for justifying its role in money management. Best practices of corporate governance in banks are of great value to a number of stakeholders viz., depositors, creditors, customers, shareholders, employees and society at large. Corporate governance is about the nitty-gritty of how a corporation executes its commitment to investors and other stakeholders. It is about loyalty to investors, valuing principled business behavior and functioning with a high degree of transparency. The corporate governance is therefore a systematic approach where the connective members, management and employees are expected to cooperate in the decision making process of the company. Based on some fundamental reasons, the corporate governance holds its premise that the business should be conducted by the desires of shareholders. It identifies the distribution of rights and responsibilities among a variety of stakeholders in the company. It also briefly outlines the structure and process for judgment on matters related to the company dealings. In the context of the above, the following are the broad objectives on which corporate governance can be measured: i) Suggested model code of best practices, ii) Preferred internal systems, iii) Recommended disclosure requirements, iv) Board members role, v) Independent director, vi) Key information to the board/committee, vii) Committees of board, viii) Policies to be established by the board and ix) Monitoring performance. (Buxi, 2005) Effective corporate governance is important for any company to be successful irrespective of the type of business it does. But for banks and financial institutions corporate governance assumes a greater level of importance. There may be a couple of reasons for this; firstly, banks form a very vital connection in the financial system which helps to mobilize and allot funds between borrowers and depositors. Efficient banks help create healthy economies as they are the back bone of any financial system. If the saga of various financial crises across 8

the world is any indication, the banks have been the precipitators of crises. Secondly, banks are morally responsible for the funds which they move within an economy as they are the keepers of the money of their depositors. This forces the government to help them out when they are in trouble. In contrast to companies in other sectors, corporate governance in the Indian Banking sector has very different implications. The banking sector in India is subject to stricter guidelines and parameters. Further, it also makes banking a highly regulated industry, when the State keeps close to its heart. (ICFAI Journal, 2001) As per Basel committee Report 1999, Banks have to display the exemplary of corporate governance practices in their financial performance, transparency in the balance sheets and compliance with other norms laid down by section 49 of corporate governance rules. Most importantly, their annual report should disclose accounting ratios, relating to operating profit, return on assets, business per employee, NPAs, maturity profile of loans, advances, investments, borrowings and deposits. Similarly the audit reports of bank should highlight those disclosures which are in line with corporate governance rules. Hence, auditors should have the complete know how about all the features of the latest guidelines given by Reserve Bank of India (RBI) and ensure that the financial statements are made in a fraud free manner and should mirror the implementation of corporate governance. Apart from auditors seriousness to bring those requirements appropriately in audit report, there should be adequate internal control systems in the operational activities of banks. It is very much essential for banks to devote adequate attention on internal control system so as to maximize their returns on each unit of capital inducted through an effective funds management strategy and mechanism. (Basel Committee Report, 1999) Corporate governance has, of course, been an important subject of discussion since many years. Scholars and researchers from finance fields have actively investigated the importance and efficacy of corporate governance for at least a quarter of century (Jenson and Meckling, 1976). There have been intense brainstorming and debates over the practices of corporate governance practices particularly in the developed nations. However, the effectiveness of corporate governance practices in the developed nations tells an ironical story from the CG (corporate governance) practices point of view. The volume of scandals and lack of transparency in governance in the developed nations nullifies its true commitment to governance practices compared to the developing world (Shleifer et al., 1997). Therefore,

much prior to the recent wave of corporate frauds in developed economies, corporate governance has been a fundamental subject in emerging economies.

1.1 Background of the Research The subjective evidence of the 1997 Asian crisis showed that poor corporate governance contributed to the collapse of many banks and corporate firms in Thailand, Malaysia, South Korea and Indonesia. Since then, there has been a sincere effort to improve corporate governance in the crisis ridden countries (Gan et al, 2001). The financial crisis in some Asian countries in late 1990s prompted most of the countries to give improved corporate governance a priority. The losses due to weak corporate governance practices and corruption are estimated at nearly 15 percent of Chinas GDP, though the figure may be much higher (www.csis.org). An annual collaborative study of the corporate governance landscape of Asian markets titled "Spreading the World: CG Watch 2004-05" was undertaken by independent stockbrokers. From this forum the awareness and importance of corporate governance in Asian countries was realized. Asian countries do realize that CG practices would not change overnight; hence patience is the key to success in this field (Bhasin, 2006). Considering the importance of this subject, Asian Corporate Governance Association (ACGA), made a report during 2004-05, on the state of affairs of corporate governance in Asian markets, emphasizing on some key determinants behind assessing corporate governance standards such as rules and regulations, enforcement, political and regulatory environment, the adoption of international accounting standards, and corporate governance culture.

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Table : Asian Governance Regimes Indonesia Korea Singapore India Hong Kong Philippines Malaysia Taiwan N N S N S S S Y S N China CLSA/ACGA Country" Ranking Criteria Thailand Y S Y Y Y N N N N N

Rules and Regulations Most companies reports their annual results N within 2 months? Have reporting deadlines been shortened in N the past 3 years? Is quarterly reporting mandatory? S N N N Y Y N Y Y Y Y Y Y Y S N N N Y Y Y Y Y Y Y Y N N Y N Y Y Y Y Y Y

Do securities laws requires disclosure of Y ownership stakes above 5% Do securities laws require prompt disclosure Y of share transactions by directors and controlling shareholders? Are class-action lawsuits permitted? S

N S S

N N N

N N S

Y N N

N N S

N N S

N N Y

Is voting by poll mandatory for resolutions at N AGMs? Can shareholders easily remove a director S who has been convicted of fraud or other serious corporate crimes? Will share option expensing mandatory over the next 10 month? Enforcement Is there an independent commission against N corruption (or its equivalent) that is seen to be effective in taking public and private sector companies? Political and Regulatory Environment become N

11

Is the statutory regulatory (i.e., securities S commission autonomous of government (not part of the Finance Ministry)? Accounting and Auditing Do the rules require disclosure of Y Y

Y Y Y Y

Y Y Y S

Y S N S

Y Y Y S

Y Y Y Y

Y Y S Y

Y Y S Y

S S Y S

Y Y Y Y

consolidated accounts? Do the rules require segment reporting?

Do the rules require disclosure of audit and Y non-audit fees paid to the external auditor? Does the government or the accounting Y regulator have a policy of following international standards on auditing? Institutional Mechanism and Corporate Culture Are institutional promoting better investors corporate engaged in N

governance Y N S Y N S Y Y S S N N Y Y N N N N

practices? Are any retail investors engaged in promoting N better corporate governance practices? Have retail investors formed their own N

shareholder activist organization? *Japan was not covered in this survey. Keys Y= Yes, N= No. S= Somewhat Source: CLSA Asia-Pacific Markets: Asian Corporate Governance Association

(www.acgs.asia.org)

Corporate governance has been on the top priority of Asian countries with most markets introducing comprehensive regulations. Although it cannot be called a fully satisfied accomplishment from the evidence of its achievements, but the ethos of corporate governance is yet to come out fully. During the same period, the need for corporate governance was also felt in line with the international trend. The first initiative for ensuring corporate governance among Indian companies came from the corporate sector itself. The Confederation of Indian Industry (CII) came up with the Code of Desirable Corporate Governance in 1998. Then the Securities Exchange Commission of India (SEBI) which is the regulator of Indian financial market, appointed 'Kumaramangalam Birla Corporate Governance Committee'. Most of the

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recommendations made by the Committee were accepted and implemented by SEBI in the year 2000. 1.2 Need of Corporate Governance in Banking As we are marching forward towards global economy, there are many economic issues coming up in the process for developing, emerging and transitional economies. These can be correctly identified as structural changes in market institutions. It brought about much awareness among investors, bankers and public at large. Such economy faced a retarded growth in spite of having economic reform like privatization, liberalization and lifting licensing raj. Despite flow of money in such economy, the growth could not take its stand due to unbalanced approach. The holder of para-state institutions such as privatization funds remain in the hands of largest shareholders of companies. As a result, the de facto power remains loaded in the hands of few individuals considered as internal owners, while the external owners do not have enough power to control the companies and thereby cant ensure themselves to get appropriate returns (Fernando, 2002). Another important factor in banking industry in developing countries is that banks are mostly owned by government. In such situation, banks are mostly guided by government bodies and many laws based on stereotype procedures. The accountability idea is less apparent as the concept of government job discourages the spirit of competition. The need for corporate governance in developing, emerging and transitional economies not only arises from resolving problems of ownership and control, but also from ensuring transparency in achieving the desired goal of corporate governance. In many cases, developing and emerging economies are beset with issues such as the lack of property rights, the abuse of minority shareholders, contract violations, asset stripping and self-dealing. Ownership pattern, regulatory environment, societal pressure (on the developmental role of banks) and the broad structure would be the key elements in the design of a governance framework of banking. While government ownership does provide core strength to banks, the structural inefficiencies and lack of management autonomy appears to have weakened the ability of our banks (Public sector) to compete effectively in the current market situation (Ravisankar, 1999).

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Banks and financial institutions have been making pivotal contributions over the years to nations economic growth and development. Government-owned (Public Sector) banks have played a major role in economic development. During the last few years, these institutions are slowly getting corporatized and consequently corporate governance issues in banks assumes greater significance in the coming years. Considering the importance of banking sector the practice of corporate governance and how it helps banking industry in India in terms of bringing more transparency and overall growth of banking sector. So the research will identify the attributes of corporate governance and to what extent it is being implemented in Indias banking sector. 1.3 Research Objectives The research aims at studying the attributes of corporate governance in Indian banking sector. The research maintains following objectives to study in this research: How the implementations of corporate governance attributes bring changes sector in terms of transparency and economic growth? Does the compliance with corporate governance attributes by banks ensure protection of stakeholders (particularly, the shareholders') rights and interests? Can corporate governance be mandatory in banking sector so that curbing malpractices and fraud can be minimized? 1.4 Research Questions The proposed research will ask some fundamental questions on corporate governance in banking sector and will try to identify how it helps banks to ensure transparency and growth. The questions are: How the attributes of corporate governance help banking sector to create a situation, which can minimize fraud/malpractices in financial matter in banking sector? Whether ownership pattern influences the effective governance and functioning of a bank? Does the declaration of corporate governance in annual report bring more transparency in their business and how it pays in terms of business? Can it be mandatory in all sector of banking? Does the proper implementation of corporate governance principles create more public trust and acceptability of a bank as a result give boost to share price? in banking

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Is there any difference in corporate governance practices between Private sector and Public sector banks? To what extent Indian Banking sector has accepted/implemented corporate governance principles compared to international norms? What are suggestions to banking industry in regards attributes of corporate governance? 1.5 Scope of the Research This study attempts to find the implementations of some attributes of corporate governance by Indian Banking sector. Though there are a lot of corporate governance codes recommended by different committee, this study is based on some prominent governance codes in recommendations made so far. Transparency in decision making, accountability and responsibility, disclosure of important information, share price movements, and mandatory requirements under section 49 etc, are taken as indicator of good corporate governance. The study will concentrate on public and private sector banks. The scope of the research is not very wide. Hence it fails to shows the absolute impact of corporate governance attributes on the performance of banks. 1.6 Organization of the Research The organization of the present research follows conventional chapter plan. Chapter one highlights introduction of corporate governance, conceptual discussion, objectives of the research and scope of the research. Chapter two narrates the academic literature on corporate governance and especially corporate governances in banking sector. Chapter three describes the research problems, methodology of the research and limitation of the research. Chapter four presents the outcome of primary and secondary research analysis. Chapter five gives concluding remarks on the research analysis and recommendation to improve corporate governance practices in Indian Banking sector.

CHAPTER-2
Literature Review 2.0 Introduction The term Corporate Governance which was rarely encountered before the 1990s has now become an all-pervasive term in the recent decade. In todays scenario this term has become one of the most crucial and important concepts in the management of companies. The root of 15

corporate governance dates back to Adam Smith but its popularity is of recent origin. The concept of corporate governance can be understood as the system through which shareholders are assured that their interest will be taken care of by management. In a much wider term, corporate governance was defined as the methods by which suppliers of finance control managers in order to ensure that their capital cannot be expropriated and that they earn a return on their investment (Parekh, 2003).

The literature on corporate governance in its wide subtext covers a variety of aspects, such as protection of shareholders rights, improving shareholders value, board matters etc. However, the importance of corporate governance in banking sector weighs very much due to very nature of banking transactions. Banking is the crucial factor effecting economic development of an economy. It is the life-blood of a country. It is responsible for the flow of credit and for maintaining the financial balances of the economy. In India, since the nationalization process banks emerged as a tool of economic development along with social justice. Corporate Governance has become very important for banks to perform and remain in competition in this era of liberalization and globalization. 2.1 Corporate Governance: In Search of a Definition The term governance has been derived from the word gubernare, which means to rule or steer. Originally this term meant to be a normative framework for exercise of power and acceptance of accountability used in the running of kingdoms, regions and towns. However, over the years it has found significant relevance in the corporate world. This is basically due to growing number and size of the corporations, the widening base of the shareholders, increasing linkages with the physical environment, and overall impact on the societys wellbeing as we need a proper administrative system to regulate so many complex things. The analysis of World Bank definition on corporate governance seems more appropriate as it analyzes from two different perspectives. From the companys point of view, the stress is put on the relations between the various stakeholders such as owners, management, employees, customers, suppliers, investors and communities. From another perspective in defining corporate governance is reliable path where the corporate governance structures can be established. So, a nations system of corporate governance can be seen as an institutional matrix that structures the relations among owners, boards, and top managers, and determines the goals pursued by the corporation. (World Bank, 2002) 16

The OECDS (1999) original definition is: Corporate governance specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance. According to the Economist and Noble Laureate Milton Friedman, Corporate Governance is to conduct the business in accordance with owners or shareholders desires, while conforming to the basic rules of the society embodied in law and local customs(Economic Times, 2001). In nutshell, it can be said that corporate governance means doing everything better to improve relationships between companies and their shareholders, to improve quality of outside directors, to encourage people to think long-term and to ensure that information needs of all stakeholders are met. The discussion on governance has been dated back more than decade in different economies. Traveling through the pre-1992 American discussions on disassociation of power and money (emanating from the Watergate Scandal), post-1992 Cadbury Report on governance codes and OECD principles (1998 & 1999), and corporate governance has not yet settled at any universally accepted definition.

2.2 History of Corporate Governance in India Before making details into literature review, it entails to discuss the development of corporate governance practices in world. Globally, Cadbury Committee was set up in May 1991, in the United Kingdom. It was set up, inter alia by the financial reporting Council, the London Stock Exchange. This committee wanted to improve the overall standard of corporate governance in financial reporting and auditing by clearly defining the responsibilities and its expectations from those involved. The Cadbury Report states Corporate governance is the system by which companies are directed and controlled. The Boards of Directors is responsible for the governance of their companies. Shareholders should be concerned with appointing the directors and auditors such that an effective governance structure is created. The board should be responsible for making the company strategies, guide and lead the company to put them into effect, supervise the management and report to stakeholders.

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However, the boards actions are subject to rules and regulations. Their acts should be legally recognized. The Cadbury Committee made nineteen recommendations. Blue Ribbon Committee was formed under the direction of the United States Securities and Exchange Commission. It was constituted to develop recommendations to enable audit committees to function as the ultimate guardian of investors interests and corporate accountability. The committee recommended enclosing Statement of Disclosure by Audit Committee to the shareowners, and certificate of Statutory Auditors regarding Independence. Euroshareholders Corporate Governance Guidelines 2000 are more specific and detailed. It has given ten recommendations on disclosure of information in the annual reports. It states that a company should aim at maximizing shareholders value in the long term. Companies should clearly state (in writing) their financial objectives as well as their strategy, and should include these important ones in the Annual Report. Some of the important recommendations are: (1) Shareholders approval is required for major decisions which can affect the standing of shareholders within the company. This approval is also necessary for important decisions which may deeply affect the risk profile, organization, size and the nature of the business. These decisions can also be approved by the AGM. (2) There should be no bias involved in electing the auditors. The entire process of election should be very transparent. Auditors should be independent and elected by the general meeting. (3) Shareholders should be provided price sensitive information through regular as well as electronic means. Corporate governance has assumed great significance in India in the recent past. Despite the Companies Act, 1956, outlining a structure for Corporate Governance, defining the boards authority and responsibility, and creating an arrangement of checks and balances with penalty for breaking the law, a need was felt for a comprehensive code of corporate governance. In India, the confederation of Indian Industry (CII) tried to fill in this gap by outlining a code of corporate governance in April 1988 followed by the Ramakrishna Commission on PSU corporate Governance and the recommendations of the Kumar Mangalam Birla Committee on Corporate Governance in December 1999. CIIs code Desirable Corporate Governance in India- emphasized the frequency of board meetings, removal of Financial Institutions (FI) from the management where shareholding is less than 10%, withdrawal of FIs nominees from the board of companies which are not defaulting in loan payment, transparency in credit

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ratings of financial instruments, removal of restrictions on the takeover of companies and debarring companies from accepting further deposits (CII Report, 2003). The Ramakrishna Commission on Public Sector Undertakings (PSUs) corporate governance emphasized autonomy in professionalizing the board, providing incentives for the top management, accountability, autonomy in price fixation, strengthening investors interface, power to dispose of assets, providing for elected directors, setting up a pre-investigation board, freedom in investing within certain limits, and power to enter a joint venture (Ramakrishna Commission Report, 1999). Security and Exchange Board of India (SEBIs) Kumar Mangalam Birla Report has been enshrined in clause 49 of the listing agreement of every Indian stock exchange. A beginning has been made in India for mandatory observance of corporate governance practices, through clause 49 of the Listing Agreement of the Stock Exchanges. The recommendations of the committee are mandatory. The mandatory recommendations of the Report are: Half the directors on the board should be independent if the chairman is executive and onethird if the chairman is non-executive. The audit committee will investigate reasons for financial transparency. The committee should have minimum three non-executive directors. The majority of these directors should be independent. At least one director should have some knowledge in the field of accounting and finance. The audit committee should meet at least three times a year. The board of companies should meet at least four times a year. A remuneration committee should be set up to determine the remuneration packages, including performance-linked incentives, stock options etc, of the executive directors. A committee should be formed to study investors complaints. The chairman of all the committees should be present at the AGM to answer the shareholders queries. The directors cannot be members of more than 10 committees across companies and cannot chair more than five committees. The annual report should have a section on corporate governance reporting the status of compliance. The non-executive chairman should be provided with an office and the expenses should be reimbursed to make him effective. The annual report should have the detailed resumes of newly appointed directors. 19

The non-mandatory recommendations of the committee are: Non-executive Chairman to maintain Chairman's Office at company's expense. Board to set-up a Remuneration Committee to formulate companys remuneration policy on specific remuneration package for Executive Directors. Half-yearly declaration of financial performance including summary of significant events in last six months to be sent to shareholders. Company may move towards regime of unqualified financial statements. Company may train Board Members in the Business Model of the Company as well as risk profile of the business parameters of the company, the responsibilities as Director and the best way to discharge them. The evaluation of performance of non-executive Directors by other members of the Board and to decide to continue or otherwise of the Directorship of the non-executive Directors. The Company to establish the Whistle Blower Policy for reporting management concerns about unethical behaviors, actual or suspected fraud, etc. (Pradhan & Pattnaik, 2003) A significant amount of research has been done on corporate governance practices in the Indian context. Mukherjee (2002) argues that India has been moving closer to taking on an Anglo-American (Anglo-Saxon) form of corporate governance. But the author questions the usefulness of the Anglo-American model. She answers this question through an assessment of the "development impact" of the new model as pointed out by measures such as growth, employment and respect for shareholder rights. The results suggest that the Anglo-American model is not very effective in meeting the objectives of the social system in India. Rajesh Chakrabarti (2005) said that the problem of corporate in India is different from that of the Anglo-Saxon environment. In India, the problem is the exploitation of minority shareholders by the dominant shareholders, whereas in the Anglo-Saxon environment, it is exploitation of shareholders by the managers. The author argues that in the Indian context, the capital market is more capable of disciplining the majority shareholders than the regulators. The regulator can just facilitate the market to ensure corporate governance. It cannot enforce corporate governance effectively, since it involves micro-management.

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Sarkar and Sarkar (2000) provided evidence on the role of large shareholders in monitoring company value in the Indian context, whose corporate governance system is a hybrid one. Similar to other studies, this study also found that after a definite level of block holdings by directors the company value enhances. But it did not find any substantial proof that institutional investors, normally mutual funds, are active in corporate governance. The outcome advocates that lending institutions start supervising the corporation efficiently only after the equity holding cross a considerable value and this supervision is reinforced by the level of liability of these corporations. The study provides substantial proof that company value is enhanced by foreign equity ownership. In general, the analysis supports the view emerging from developed country studies that the Identity of large shareholders matters in corporate governance. The study by Mohanty (2003) suggests that companies with good corporate governance measures are easily able to borrow money from financial institutions as compared to companies with poor corporate governance measures. Moreover, there is evidence that mutual funds have invested money in companies with a good corporate governance track record as compared to companies with a poor CG track record. By making use of a simultaneous equation approach, this study wraps up by saying that this positive relationship is a result of the mutual funds (development financial institutions) investing (lent money) in companies with good governance records and also because their investments have helped to enhance the financial performance of such companies (Mohanty, 2003). Irrespective of the business goal considered, effective governance guarantees that the administration (managers and the board) are responsible for achieving it. The job of successful corporate governance is of immense significance to society as a whole. In the first place it promotes efficient use of scarce resources both within the organization and the larger economy. Secondly, it makes the resources flow to those sectors or entities where there are efficient production of goods and services and the return is adequate enough to satisfy the demands of stakeholders. Thirdly, it provides a broad mechanism for choosing the best managers to administer the scarce resources. Fourthly, it helps the managers to constantly focus on enhancing the company performance, ensuring that they are sacked when they dont succeed in doing so. Fifthly, it puts pressure on the corporation to abide by the law as well as achieve what the society expects from it. And last but not least, it assists the supervisors in regulating the entire economic sector without partiality and nepotism. 21

2.3 Governance in banks Its impossible for one to think about financial organizations including banks without proper corporate governance. Since banks have a very crucial role to play in the economy (financial and economic system) of any developing country, hence any fault on their part due to immoral practices creates a situation which may adversely affect not only the shareholders but the people who have deposited money and the economy at large. The effectiveness of sound banking system can be recognized by the standard of transparency in their performance and the increased role of government and regulatory agencies to verify their actions (Topalova, 2004). The lack of transparency tempts the management to resort to unethical practices as well as siphon off funds. Inadequate action by regulatory agencies put blanket on the omission and commission of such unethical practices, thus leads to bank failure and loss of public faith. The prevalence of banking system failure has been a common phenomenon in developing and transition countries as in the industrial world (Honohon and Daniela, 2000). The structural changes in the banking industry in the form of development of latest technologies, main industry consolidation, globalization, and deregulation have got the banking industry at a strategic junction. Hence, banks face a more competitive and volatile global environment than so called stereotype situation of management. They are engaged in a number of innovative services like providing required finances to commercial projects, fundamental financial services to majority of the population and key to all the payment systems in micro environment. Other than this, some banks provide additional credit in times of market crisis. The banking sector may be closely monitored by the public due to its nature of transactions and some bad precedents in the past. This sector is very sensitive as a small mistake can easily attract negative publicity. It is a part of corporate governance with most of its management obligations enclosed in regulatory regulations. In the light of the above statement governance issues in banks, more particularly in Public Sector Banks (PSBs), assume immense significance, but unfortunately these are less discussed and deliberated upon. Although the primary reason identified for it is the prevalence of government ownership across the institutions, another important reason can be attributed to the multiplicity of 22

regulatory and supervisory legislations. For instance, in India there are 5 legislations, e.g. RBI Act, SBI Act, Bank Nationalization Act, Banking Regulation Act and Companies Act, which govern the banking sector. Because of this multiplicity of Acts and their enforcing agencies, i.e. RBI and GoI, any concrete form of principles on bank governance is yet to emerge. The full applicability of corporate governance principles in Indian Banking sector is less apparent. Firstly, there are definitional issues of serious nature, which should be strictly adhered by Indian banking sector. Secondly, there are issues of temporal, sect oral and structural nature that have bearing on their relationship. More specifically, the literature on bank performance and corporate governance is scanty in India as well as abroad. Although the literature on corporate governance in developing countries has lately got a lot of interest from the scholars in their previous research (Oman, 2001; Goswami, 2001; Lin, 2001; Malherbe and Segal, 2001), the execution of corporate governance characteristics of banks in developing countries has been almost unnoticed by researchers (Caprio and Levine, 2002). Even research studies on corporate governance in banks are rarely found in the literature in developed economies (Macey and OHara, 2001). In developing countries, corporate governance in banks is of paramount significance as they play a vital role in the economys financial structure and also act like a catalyst in the economic growth of the country (King & Levine 1993 a, b; Levine 1997). Second, banks in developing economies provide an easy source of financing to most of the organizations as their financial markets are yet to mature. Third, banks offer a universally accepted mode of payment, hence they are considered as a warehouse of publics savings. Fourth, due to liberalization/privatization, many developing countries have liberated the economic regulations as a result managers are in search of proper governance mechanism. Coming to a developing country like India, all attributes of governance mechanism can be easily implemented due to many complexities involved in it. In a developing economy such as India, the growth of efficient corporate governance principles in banks has been partly held back due to weak legal protection, poor disclosure prerequisites and overriding owners (Arun and Turner, 2002a). Moreover, the private banking sector is purposely opting to ignore certain corporate governance ethics as it has vested interest of some parties (Banaji and Mody, 2001). 23

The economic liberalization in India created many genuine corporate governance issues for government owned bank. On the one hand, government encouraged private players to come up and compete with government owned banks, on the other hand, not giving a cushion to protect them from unfortunate misgovernance. If privatization is the slogan of the day, then there must be sufficient deposit insurance proposals and supervisory provisions instituted so as to safeguard the interest of people who deposit money and avoid a financial collapse (Arun and Turner, 2002b). Therefore, the pertinent question arises, can the government guarantee that it would facilitate all mechanisms to private capital owners for smooth operation of banking. In spite of over 10 years of financial reforms in India, the Indian government is yet to play a crucial part in many aspects like board member appointment. However, they have given some power to public sector banks to make them competitive. The impact of these reforms has been that the private sector banks now have more independence in formulating strategies for different sectors of business which include setting up branches and introducing innovative products (Muniappan, 2002) but yet this autonomy is limited, as they have to abide by the rules and regulations given by the government and central bank (AGCG, 2001). Based on statistical report, it can be aptly said that greater state ownership of banks, lesser the chance of good financial performance (Barth et al 2000). Agreeing on the same line, World Bank (2002) also voiced the same concern on state ownership and political interference. In its report it observed that: i) Recent studies indicate that state ownership of banks is inversely related to bank competence, saving and borrowing, productivity and growth; ii) However, there is no proof which suggests that state ownership reduces the chances of banking crisis; iii) The evidence clearly states that state bankers are subject to political clash that usually leads to weak performance; and iv) Privatization is perhaps the only way to guarantee that freedom from political decision making can enhance governance in banks. The report of the Advisory Group of Corporate Governance (AGCG, 2001) recommended that depositors being the major stakeholders in banks, whose interests may not always be, recognized, sound corporate governance should consider their interests and ensure that individual banks are conducting their business in such a way as not to harm interests of depositors.

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A discussion above clearly brings out the fact that the government wants to hold some kind of control in privatized public enterprises. This shows the governments concern that those enterprises might pursue shareholders objectives (other than government), even by ignoring interests of the community and other stakeholders. It is also possible that the government is unsure whether it would be required to use those enterprises as instruments as model corporate citizens. Institutional investors would like those enterprises to play the game as is being played by other private sector enterprises. Therefore, it will be difficult to avoid the conflict between interests of two major shareholders namely, the government and the strategic partner in a privatized public enterprise. The key issues in corporate governance in public sector are: (a) (b) (c) (d) What should be the corporate objective of a public sector unit? In protecting the rights of employees, the community and other stakeholders, should it stretch beyond enforcing legal rights of those stakeholders? Should it be burdened with higher social obligations as compared to its counterpart in the private sector? In which situations and how the government should exercise control on its operations with the framework of the Companies Act, 1956? (Source: Public Enterprises Survey 1997-98) The government should resolve these issues and come out with clear policy guidelines. Governments effort to push privatization without resolving these issues might do irreversible harm to the economy. We must accept that there is still a need to build infrastructure, to create employment and to promote balanced regional development. In all likelihood, market forces will not allow the government to use privatized public enterprises to achieve these objectives. Disciplined financial disclosure, which is the hallmark of good governance enhances the information environment for the mangers and ultimately leads to better economic performance. There are three channels through which financial accounting information improves economic performance, better identification of good vs. bad projects by managers and investors, governance role of financial accounting information, and reduction in information asymmetries among investors (Bushman and Smith, 2003).

25

Kumar Mangalam Committee (1999) clearly states that the fundamental objective of corporate governance is the enhancement of shareholders values, keeping in view the interests of other stakeholders. The above survey of literature highlights some issues related to corporate governance and stakeholders interest which provide inkling to the ultimate goal of a bank i.e. the enhancement financial wealth of different stakeholders, which can only be done through the improvement of performance. 2.4 Role of Governance in banks From the banking industry perspective, the attributes of corporate governance provide guidelines to the directors and the top level managers to govern the business of banks. These guidelines relate to how banks establish corporate aims, carry out their daily activities, take into account the interest of stakeholders and making sure that the corporate activities are in tune with the public expectations that banks will function in an ethical and legal manner thereby protecting the interest of its depositors (Basel Committee, 1999). All these broad issues relating to governance apply to other companies also, but they assume more significance for banks because they deal with public deposits directly. Many international bodies have formulated a clear set of guidelines for the implementation of corporate governance principles, however the reality prevalent in various countries shows that there is no universally correct solution to structural problems and that the rules and regulations need not be constant in different countries. As a result of this, sound governance practices were formulated by Basel committee. Recognizing the diversity in the structure of governance mechanism across the countries the Basel Committee (1999) recommended four important forms of oversight that should be included in the organizational structure of any bank in order to ensure appropriate checks and balances : (i) oversight by the board of directors or the supervisory board; (ii) oversight by individuals not involved in the day-to-day running of the various business areas; (iii) direct line supervision of different business areas; and (iv) independent risk management and audit functions. In addition, the committee also emphasizes the significance of the main employees being mentally and physically healthy for their work. In comparison to other sectors, governance in banks is significantly more intricate. Public Sector Banks (PSBs) endeavor to conform to the same system of board governance as other organizations, however, other elements such as risk management, capital adequacy and 26

funding, internal control affect their matrix of governance. It has been observed that 63 percent of PSBs have potentials for profitability increase through efficiency improvement (Kumar & Verma, 2003), which ultimately depends on the quality of governance. Being under government control PSBs are handicapped in many respects. As regards the issue of corporate governance in banking organization, Jalan (2001) has examined the issue of corporate governance in public versus private sector banks and thereafter Reddy (2002) has discussed the governance challenge in public sector banking. Corporate governance in PSBs is important, not only because they dominate the banking industry, but also because, they are unlikely to exit from banking business though they may get transformed. To the extent there is public ownership of PSBs, the multiple objectives of government as owner and the complex principal-agent relationships cannot be wished away. Some important troubled areas are hindering the best governance practices in these banks. These grey areas are identified and elaborated in the following paragraphs (Reddy, 2002). 2.5 Areas of Concern: Ownership Public Sector Banks (PSBs) are state-controlled banks and their boards are dominated by representatives from the various sections of society. The need of the board being the guardian of the shareholders welfare has not found favor in these banks, obviously because of the largest shareholding by the government of India (GoI). Since these banks command the largest volume of business in terms of deposits and credits, the composition of their boards is of critical importance. Particularly, the presence of outside professional directors, i.e. of those from outside RBI and GoI, is crucial for their effective governance. From the actual experience of PSBs, it shows that the dominance of government representative directors in most of the PSBs has proved to be counterproductive. In fact, it often serves to distort the incentive structure, erode discipline and reaffirm the faith of these institutions in the deep pockets of the government (RBI 2001b). The state control of PSBs has thus belied the expectation of the nation as well as landed the financial sector in more trouble. It is aptly said that on average, greater state ownership of banks tends to be associated with a more poorly operating financial system (Barth et al 2000). Similar doubts for state ownership and political interference were also raised by The World Bank in one of its reports in 2002. The management bodies of PSBs do alter the strategies and objectives of the bank as well as the internal structure of governance. This also prevents cutthroat forces, restricts the efficiency of government monitoring in the financial division, 27

and tends to raise the opacity of banks business. The government uses state-owned institutions to sustain too much spending and to support less-than-creditworthy borrowers. All these tendencies dampen overall economic growth. In addition, the government often operates establishments, or the regulatory procedure that manage them, in ways that reduce the growth of vibrant private sector contenders. (Barnier, 2001) 2.6 Composition of the board The dual charge of Managing Director and Chairman with one person is another cause of worry in most of the PSBs. On the one hand, this helps in removing the rivalry between the two positions and, on the other, it reduces the boards ability to fulfill its proper governance function as an independent body (Dayton, 1984). A proper trade-off between the duality and non-duality of the highest post is thus crucial for institutions like banks, more particularly in PSBs, where the senior directors are nominated by the government. Who is the real boss can be a matter of confusion. The boards leadership structure can be conceptualized as a doubleedged sword that forces it to choose between the contradictory objectives of unity of command and effective monitoring (Finkelstein and Aveni, 1994). Definitely the dual structure comes with costs; it carries the potentialities of rivalry and conflict between two posts. The non-dual structure, which is not conducive to effective governance, is even more detrimental. Concern was also raised by the Ganguly Committee (RBI, 2002) in this regard. Unless one is mistaken, in the public sector institutions (banks), what is being visualized is that the Chairman and the MD would both be full-time executives. This will definitely lead to a bi-polar relationship with blood-letting internecine feuds (Tarrapore, 2002). Another issue arises with the composition of executive and non-executive directors on the board and their autonomy. 2.7 Governance through committees The experience of Indian banking, so far as institutionalizing the different committees is concerned, is not encouraging. The status of banks in both public and private sectors reveals a gloomy picture. The leaders in the respective sectors, i.e. SBI and ICICI Bank, have established few committees, but are still short of the international standards. Other banks in the public sector are yet to establish many of them. The core of governance depends on transparency and disclosure. The most important committee, audit committee, being the watchdog, provides adequate stuff for achieving this most important objective. An audit committee provides overseeing the selection and removal 28

of auditors, evaluating and endorsing the extent of audits, deciding upon the regularity of audits, obtaining audit reports and making sure that management is taking corrective measures in time to control failures. Audit committee also supervises the banks internal and external auditors. Autonomy of this committee can be primarily increased by appointing external board members with expertise in banking or finance and accounts. This committee needs independent, qualified leadership and membership, which are lacking in PSBs. A key determinant of the effectiveness of an audit committee is the independent, competence, dedication and leadership skills of the audit committee chair (Blue Ribbon Commission, 1999). Financial literacy among its members and their independence of the owner are very crucial to its effective functioning. Since in PSBs the members of this committee are drawn from the pool of representative directors, there is always a question mark hanging over their effectiveness. Table 1: Committees set up by Indian banks Committees set up by banks ALM Audit Compensation/ Remuneration Risk Management Investors Grievances Credit Business Strategy SBI Y Y N N Y N N ICICI Bank Y Y Y Y Y Y Y N UTI Y Y N N N N N N

Nomination N Y Yes, N No Source: Latest Annual Reports

Risk management, being the backbone of any financial institution, is also very crucial to banks. They face a gamut of risks which are complicated in nature and require specialized hands to handle. These include credit risk, exposure concentration risk, connected exposure risk, interest rate risk, exchange rate risk, equity risk, legal risk, operational risk, liquidity risk, reputation risk, payment system interface risk and business continuity risk. Only a wellmanned risk management committee can identify these risks and manage them properly. As per the latest annual reports, most of the PSBs have not yet established any risk management committee, which exposes them to the risk of taking faulty decisions in many operational areas resulting in serious trouble. Most of the PSBs have established the first two committees, as listed in Table 1. But merely forming these two does not come handy when many of them 29

have already raised capital from the capital market. Besides, business-related committees, investor protection committee and nomination committee are of vital importance. 2.8 Critical Analysis of Literature After studying the literature on corporate governance some concrete meanings came out which would be studied thoroughly in the subsequent research. Since it is impossible for these owners to directly manage or even supervise these corporates, they appoint their representatives as Board of Directors. The Board appoints the top management, who in turn appoint other managers and employees. As put out succinctly by the Kumar Mangalam Committee: The pivotal role in any system of corporate governance is performed by the Board of Directors. It is accountable to the stakeholders and directs and controls the management. It stewards the company, sets its strategic aim and financial goals and overseas their implementation, puts in place adequate internal controls and periodically reports the activities and progress of the company in a transparent manner to the stakeholders. (Kumar Mangalam Birla Committee Report, 1999) With the rapid pace of financial innovation and globalization, the face of banking is undergoing a sea change. Banking business is becoming more complex and diversified. In the changed scenario, it is essential that the Boards of banks are fully geared to govern the banks well. The objective of governance in banks should first be protection of depositors interest and then be to optimize the shareholders interests. While doing so, the foremost responsibilities should be to ensure fair and transparent dealing without giving a chance of mis-governance. The governance issues in banks cannot be understood independently. The regulatory framework has significant implications for the corporate governance of banks. There is a growing realization that the corporate governance arrangements of banks are significantly different in comparison to firms in other sectors. The corporate governance of banks is a complex issue. It has been observed that the legal and regulatory framework, in which banks operate, makes the governance mechanism of hostile takeovers ineffective as a method of corporate governance. Thus, governance issues in banks have to be discussed in an environment where a banks management has a considerably reduced threat perception from the market for corporate control.

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Chapter 3
RESEARCH METHODOLOGY 3.0 Introduction Since the focus of the research is on evaluating corporate governance in Indian Banking sector, the focus is on corporate governance outcomes rather than on corporate governance mechanisms. Specifically, the author examine the effectiveness of corporate governance in Indian banking sector in achieving economic growth, curbing malpractices, bringing transparency of banking transactions, and how it can be mandatory. As reflected from previous research Jalan (2001) and Reddy (2001), there has been growth in the Indian 31

banking sector during the post liberalization period, can be attributed to good governance. This research throws light on the efficacy of corporate governance in achieving transparency and good banking growth in India The research philosophy for the underlying topic reflects the principles of interpretivism. This reason why this approach is taken is because interpretivism calls for finding and extracting the details of the situation to understand the reality or perhaps a reality working behind them (Saunders et al, 2003). Hence, the research methodology was prepared meticulously to identify the effectiveness of corporate governance. This chapter deals with research design, collection of the data and methodology used for the research purpose. This section of the dissertation has been developed to explain the logic and rationale behind the research methods used. The idea is to demonstrate that the chosen approach has been appropriate and the findings of the research are both applicable and dependable. From the perspective of time horizon, this research will be classified as longitudinal research (Saunders et al, 2003). This is because the research will be studying the developments and the changes that taken place in the Indian Banking sector over the past years. 3.1 Research Approach Approach can be classified according to their purpose and research strategy used. The classification most often in three folds one of exploration, description, and explanation.

Exploratory Research Exploratory research is valuable means of finding out what is happening; to seek new insight; to ask questions and to assess phenomena in a new light. This research in general is quite flexible in nature. The main purpose behind this research was to identify the potential opportunity existing in the market. Like descriptive research, exploratory causal research is also based on a planned and structured design. Exploratory research emphasizes on the discovery of new ideas. It deduces large and unclear problem statements into more accurate sub-problem research propositions and hypotheses. Exploratory research is characterized by support from secondary data with lot more flexibility and it tends to based on subjective evaluation of survey results (Tull D.S. & Hawkins, D.I. 1990). 32

Explanatory Research A clear statement of the decision problem, specific research objectives and detailed information are the highlights of this research. It is quite structured and statistical in nature. It describes the commitment of banks in adhering corporate governance principles taken from their annual report. This research will explore and explain how the Indian banking sector is doing its business in post implementation period. 3.2 The Research Method The research relies on the use of the deductive method. There are different ways of conducting a research as Yin (1994) mentioned five major research strategies namely experiment, survey, case study, archival and history. Research Strategy Experiment Case Study Survey History Archival Form of Research Needs Control over Focuses Behavioral Events Yes No Where, No on

question How, Why Why, How Who, What,

Contemporary Events Yes Yes Yes No Yes/No

How, How much How, Why No Who, What, Where, No

How, How much Source: Yin (1994) pp-6 For this study, the author has used both primary and secondary data. Primary data was collected from questionnaire survey and interview. The author met with the interviewees in their office and gave them a small questionnaire on corporate governance to complete. Prior to this the author had a brief discussion with the interviewees on the questionnaire and accordingly notes were taken on the basis of this. However, only a few interviewees gave permission to use these notes in the research analysis. The small questionnaire was handed over to them to score the important attributes of corporate governance. The secondary data was collected from literature, academic articles, and information provided in annual reports and websites. Secondary sources have been extensively used to identify the corporate governance practices by banks in India. Primary research has been used in the analysis in a qualitative way to identify the effectiveness of corporate governance practices in India. A. Primary Research

33

The main objective of primary research was to elicit the valuable opinion of senior bank professionals who can provide valuable insight and information about the implementation of corporate governance practices in the recent past. Considering these objectives and literature review, the questionnaire was prepared in a manner to derive the opinion of bank professionals regarding attributes of corporate governance principles and its contribution to the banking business. Qualitative data Qualitative research is called so because its emphasis lies in producing data that is rich in insight, understanding, explanation and depth of information, but which cannot be justified statistically (Crouch S & Housden M, 2003). Since the banks were an important source of information, interview method of data collection along with their opinion on the attributes through questionnaire survey with senior manager of different banks in Delhi were arranged. B. Secondary Research Secondary research was very important and was helpful in aligning the findings of the primary research to the facts derived from the secondary research. Many national and international journals have been used to collect the necessary facts and figures on Indian banking industry. Reports of the RBI (Reserve Bank of India) were also used.

3.3 Research Design A research design was devised in a more traditional fashion specifying the research strategy. The research strategy will use the multi- methods approach to dig in and gather more information about corporate governance. The growth of banking business in India is phenomenal as it is being reflected by the entry of private banks and foreign banks. However, the growth of banking business is linked with successful implementation of corporate governance principles. The following steps were done in order to make research design successful. Data collection Sampling criteria 34

Data analysis A. Data Collection The interview/questionnaire mechanisms were used very systematically to elicit views on corporate governance attributes. The preparation of such mechanism was quite meticulous bearing in mind each question should make contributions to the research objective (Proctor T, 2003). Since this research required lot of secondary data to complete the analysis, the websites of banks and their annual reports were extensively used. B. Selecting a Sample for Questionnaire Samples can be of two natures: Probability samples and Non-Probability samples. The Probability sample implies that everyone within the subsets of the population has a non-zero probability of selection. Non-probability samples on the other hand imply that no attempt is made to ensure that a representative cross section of the population is achieved (McDaniel and Gates, 1996). Selecting a sample procedure for this dissertation was never an easy task because it is tough to get a chance to interview senior bank professional and easy access to fill up questionnaire through senior officials. The sample procedure used in the questionnaire is non-probability sampling due to the nature of data available. The use convenience sampling is made; as the questionnaires have been, send to senior banking professionals. The sample size for the questionnaire was 10 respondents. 3.4 Reliability and Validity of the Research To ensure the authenticity of the research in synchronization with the very objectives were laid out for this dissertation certain firewalls were employed that make this research reliable and valid. The data collected was analyzed and the analysis was made from the primary and secondary sources of data using the deductive method. 3.5 Limitations of the Research

The limitation of the research is the lack of primary data collection due to difficulty in getting appointment with senior bank official in banking industry.

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The sample size is very small in comparison with the nature of the research. Study of attributes of corporate governance with interview of 10 people seems quite less and unrepresented. Time and recourses constraints restrict the scope of the research. Despite my effort to expand the scope of the research by getting into more in-depth study of corporate governance, it was not materialized due to the practical difficulties faced during the work. Although prominent banks have been incorporated in the sample, judgmental sampling seems little biased and inaccurate results might surface.

CHAPTER-4
Analysis and Interpretation 4.0 Introduction This current research tries to study the attributes of corporate governance practices which exist in the Indian Banking sector within the strict authoritarian structure. It tries to evaluate the implementation of corporate governance attributes by bank (private and public sector). Also the author tries to assess the competence of these banks in terms of substance and quality of reporting in their annual reports. For this purpose an empirical study has been undertaken on ten banks (six public sector bank, three private sector bank and one foreign bank) operating in India. The research has been undertaken to assess the level of compliance of key governance parameter in these banks in tune with statutory and non-mandatory 36

requirements given by SEBI (Securities Exchange Board of India) under clause 49 of the listing agreement. 4.1 Analysis from secondary Research Empirical Study 1. Sample Size, Period of Study and Rationale: The sample of study comprises ten banks operating in India. These banks have been selected on the ground that they are renowned banks in the banking sector in India, and their scrips practically dictate the movement of the stock market in the country. The public sector banks are (SBI, Punjab National Bank, Bank of India, Bank of Baroda, Canara Bank, & Allahabad Bank) and private sector banks are (ICICI Bank, HDFC Bank, Axis Bank & Standard Chartered Bank), though standard chartered is considered as foreign bank also. The period of study is one year (2007-08) only as it will show the latest development of corporate governance attributes in banks. The fundamental reason behind selecting 2007-2008 as the period of study is that SEBI initiated few new clauses, recommended by various committees in its revised clause 49 of listing agreement on 29th October, 2004 (Das, 2007). Thus, its quite sensible to evaluate the situation which highlights the status of CG observance by these financial institutions. Considering this, the 2007-2008 annual report of banks was considered appropriate for this study. This would definitely provide some useful insight about the present state of corporate governance practices and disclosure norms. To evaluate the structure and procedure of corporate governance adopted by banks commitment to adhere it in their annual report. As a result the author has conducted a comparison study based on statutory and non-mandatory requirements stipulated by the revised clause 49 of the listing agreement and provisions required by the Banking Act. 2. Analysis: After getting the corporate governance attributes from banks annual report, the analysis is prepared in two separate parts: a) Shareholding pattern in Public and Private sector banks, b) Key governance parameters and their compliance status in these banks.

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Table 2- Share Holding Pattern of Private and Public sector Banks in India
ATTRIBUTES OF CORPORATE GOVERNANCE President of India Government of India Life Insurance Corporation of India Deutsche Bank Trust company Americans FIIs/NRIs/OCBs/FB/FC/FN Insurance Companies Banks & Financial Institutions Mutual Funds Bodies Corporate NRIs/OCBs Resident Individuals/HUF / Trust etc. Foreign Institutional investors Domestic Companies//Trusts NRIs/OCBs/FIIs/GDRs Employees Banks HUF/Clearing Members/Trusts SUUTI HSBC IRIS Investment Orient Global Tamrind Ltd. ICICI prudential Life Insurance Company Limited The Bank of New York General Insurance Corporation of India Other Banks/Investment Company JP Morgan Chase Bank (Depository for ADS) Housing Development Finance Corporation Limited HDFC Investments Limited DBS Bank Ltd Bennett, Coleman & Co Ltd The Growth Fund of America Euro Pacific Growth Fund JP Morgan Asset Management (Europe) J P Morgan Advisors PUBLIC SECTOR BANK SBI Canara Allahabad Bank Bank 59.7 3 73.17 55.23 5.81 28.52 1.74 0.29 1.80 2.85 0.08 13.68 18.52 5.05 1.30 11.50 1.22 0.63 6.16 19.77 7.50 1.56 2.77 1.26 7.34 15.1 0 3.22 19.5 9 0.24 0.19 0.121 27.18 4.95 4.51 4.08 3.64 2.28 9.53 21.61 14.80 8.46 3.28 2.50 1.87 1.67 1.43 1.12 0.76 20.07 41.21 10.75 0.70 5.66 5.88 7.22 53.81 64.4 7 10.40 2.57 Bank of Baroda Bank Of India Punjab National Bank 57.80 PRIVATE SECTOR BANK ICIC AXIS HDFC Standard I Bank Bank Chartered Bank Bank

7.17 4.45

3.05 2.73 1.24 0.04 5.77 14.00

10.29 6.36

5.84

4.72

Source: Annual Report Survey, 2007-08. Shareholding pattern of Standard Chartered Bank is not showing in their annual report.

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Observation from table: The maximum stake in Public sector banks is kept by government whereas private sector banks are predominantly controlled by foreign promoters. Management and control of private sector banks is delegated to professional managers under the governance of board controlled by the foreign promoters whereas all public sector banks are managed by their banking board under the control of government of India. FIIs have considerable shareholdings in both public as well as private sector banks. The insurance companies also hold shares in both public and private sector banks. Considering the report of Kumar Mangalam Committee on Corporate Governance, the fundamental objective of corporate governance is the enhancement of shareholder value, keeping in view the interests of other stakeholders, many managers manipulated the profits of banks to show illusory profits of the banks and thereby enhance market value of shares. However, the shareholding pattern of public sector bank justifies the views of Barth, Capiro and Levine, (2000) and World Bank (2002) as they are under government patronage. The possibilities of misgovernance cannot be ruled out in public sector banks compared to private sector banks. The shareholding patterns of private sector banks are evenly allocated among various groups of shareholders unlike public sector banks. Key Governance Parameters & Compliance Status There are some key governance parameters that can measure to ascertain the implementation of corporate governance in banks. Some of them are discussed below: Banks philosophy on Corporate Governance: The philosophy of the Bank lies in its commitment to uphold some unique values that is based on the Idea of a bond and togetherness among all interested parties, particularly a close ties between the Bank and its many stakeholders-from customer and employees to its investors, institutions and society at large. So, overall objective is to optimize sustainable value to all stakeholders-depositors, Shareholders, customers, borrowers, employees and society through adherence to corporate values, codes of conduct and other standards of appropriate behavior. The studies of annual reports of all the banks show that all the banks are committed to corporate governance. Board of Directors

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Various aspects were analyzed from annual reports regarding board of directors viz., board structure, board strength and size, directors attendance etc. Table 3: Board Structure, strength and Size of Private and Public sector Banks in India
Particulars 1. Total Number of Directors: a) No. of Executive Directors (EDs) i) Promoters ii) Others b)No. of Non-Executive Directors (NEDs) 2. Total Number and Percentage of: i) Executive Directors (EDs) ii)Non-Executive Dir. (NEDs) PUBLIC SECTOR BANK SBI Canara Allahabad Bank Bank 9 13 11 Bank of Baroda 14 Bank Of India 15 Punjab National Bank 8 PRIVATE SECTOR BANK ICIC AXIS HDFC Standard I Bank Bank Chartered Bank Bank 16 11 12 14

2 7

3 10

3 8

3 11

3 12

3 5

3 13

3 8

3 9

4 10

22 78

23 77

27 73

21 79

20 80

38 62

19 81

27 73

25 75

28 72

Source: Annual Report Survey, 2007-08

As far as board structure is concerned Public sector banks are following Banking Companies Act 1970 as the Board of the Bank has been constituted under Section 9(3) of the Banking Companies {Acquisition & Transfer of undertaking} Act 1970 and Nationalized Bank (Management & Miscellaneous Provision) Scheme 1970. Similarly in private sector banks, Board of Directors have been constituted in compliance with the Banking Regulation Act, 1949, Companies Act, 1956 and listing agreements entered into with stock exchanges and in accordance with best practices in corporate governance. The Board functions either as a full Board or through various committees constituted to oversee specific operational areas. The practice of dual charge Managing Director and Chairman is seen in all the banks as it can help to remove the rivalry between the two positions and ensure governance function independently. The view of K.N. Dayton, (1984) seems to exist in board structure. Private sector banks have complied with the requirement of the Clause 49 of the Listing Agreement in regard to the requirement of minimum number of independent directors, while the chairman is a non-executive director. However, some public sector banks have deviated a little bit to comply with the conditions of the Clause 49 of the Listing Agreement in this regard. Clause 49 I (A) of the Listing Agreement requires that not less than 50% of the board of directors of the company (having chairman as executive director) should comprise of nonexecutive directors being independent. As suggested by many scholars and recommendation 40

by various research that good corporate governance implementation entails clear division of responsibilities at the top management level like Chairman and managing director, which can ensure a balance of power and authority such that no individual has unfettered powers of decision. However, study of annual report of ten leading banks and practical difficulties faced by them in normal management practice conclude that combination of the posts of chairman and CEO/MD in one person should be publicly justified. Committee of the Board Audit Committee: The Audit Committee is constituted as per RBI guidelines and complies with the provisions of Clause 49 of the Listing Agreement to the extent that they do not violate the directives/guidelines issued by RBI. In terms of Reserve Bank of India guidelines, the Audit Committee should have six members on the Board of Directors, including two whole time Directors, two official Directors (nominees of GOI and RBI), and two nonofficial, non-executive Directors. Meetings of the ACB are chaired by a non-executive Director. The purpose of audit committee is to oversee the bank's financial reporting process and ensuring correct, adequate and credible disclosure of financial information. Considering the aim of audit committee, the following objectives were laid down Reviewing with the management, the financial statements as per accounting policies and practices, compliance with accounting standards. Review the adequacy, quality and effectiveness of external and internal audit, internal control system. Audit Committee reviews the position with regard to issues raised in the Long Form Audit Report (LFAR). It follows up on all the issues / concerns raised in the Inspection Report of RBI. Audit committee also makes a review of reports received from Compliance Cell, InterBranch Account Reconciliation (IBAR) section, etc.

41

Table 4: Status of Audit Committee in Public sector & Private Sector Banks Serial Particulars No. 1. Private Sector Banks consists Directors, 2 2 Public Sector Banks of As per provisions laid down of by section 49 of the listing

Members and other Committee composition of the mostly committee. whom directors, 6

whole-time agreement. official

directors, 2 non-executive 2. Information members committee 3. meetings. Information committee members. director. about Clearly mention as per Clearly listing agreement. mention as per

of guidelines of Section 49 of guidelines of Section 49 of listing agreement.

ICICI and HDFC held 6 In Public sector banks the held 12 meetings. Almost a all meetings. year except attended some every

meeting attends of meetings and Axis Bank average meetings were 6 in majority members attended deviation. members in Maximum

4.

Information audit

about Mentioned

time. annual Mention in annual report. But details are missing.

committee report.

report. Source: Annual Reports 2007-08 Audit committee report is the important ingredients of corporate governance report. Both private and public sector banks have complied with audit committee laid down by section 49 of the listing agreements. However minute study of audit committee report of all the banks revealed that private sector banks do comply in better way than public sector banks. Committee of the Board Investors Grievance Committee: The Investors Grievances Committee has been constituted in terms of Clause 49 of the Listing Agreement. The Committee takes care of investors grievances by doing some important functions. It approves and monitors transfer, transmission, splitting and consolidation of shares and bonds and allotment of shares to the employees pursuant to Employees Stock Option Scheme. The Committee also monitors 42

redressal of complaints from shareholders relating to transfer of shares, non-receipt of Annual Report, dividends etc. Table 5: Status of Investor Grievances Committees in Public sector & Private Sector Banks
Serial No. 1. Particulars Transparency composition of committee. in the Private Sector Banks Committee consists of mostly 4 Directors, of whom 1 director is executive and others are independent, chairman being an independent director. Public Sector Banks Mostly Committee consists of 4 Directors; of who 2 are executive and the other 2 are NED/ independent, chairman being an independent director. Item wise break up of the nature of queries/complaints not disclosed. Some complaints pending reported. SBI has taken up all complaints in 2007-08. Four meetings in a year except Canara bank. Normally 4 members but 2 or 3 attended every time. No such survey conducted.

2.

Information about number of committee meetings.

Items wise breakup of the nature of queries/complaints not disclosed. Some complaints pending reported.

3.

Information about number of committee meetings.

In ICICI and HDFC more than 10 meetings held. There are 4 members and almost majority members attended all meetings.

4.

Information about No such survey conducted. investor/ shareholder survey conducted. Source: Annual Reports 2007-08

Observation from Table 5 1. Both private sectors and public sectors have complied with the requirements of Clause 49 of the Listing Agreement in regard to composition of the shareholders/ investors grievance committee. They have also furnished required information regarding the number of committee meetings held during the year to monitor shareholder doubts and grievances. 2. A good thing was that almost all the grievances which were received, were disposed off as reported. However these questions and complaints were not split item wise by any of these companies. 3. These banks failed to carry out a survey on their investors and shareholders level of satisfaction. 4. These institutions use their external registrars and share transfer agents to carry out tasks like physical transfer, transmission, splitting of share certificates etc. 43

Remuneration Committee The status of the remuneration committees in Public Sector and Private Sector are as follows: Table 6: Status of Remunerations Committee in Private Sector Banks and Public Sector Banks.
Particulars Information about the Committee Private Sector Banks Public Sector Banks Committee consists of 5 Committee consists of Directors, of whom 1 4 Directors; of whom director is executive and 2 are executive and other 4 are independent, the chairman being independent director. other 2 being are an an NED/independent, chairman

independent director. Information about Remuneration of Clearly mentioned in Clearly mention in Directors Information about number annual report. annual report in some mentioned have banks. of Clearly mention with Although number attended. of members banks

committee meetings.

in annual report, some dont remuneration committee since it is a non-mandatory requirement.

Source: Annual Reports 2007-08 Observation from Table 6 Formation of remuneration committee in a bank is a non-mandatory requirement of the Clause 49 of the Listing Agreement. However, both private and public sector banks have set up a remuneration committee in their organizations. Private sector banks have not complied with the conditions of Clause 49 of the Listing Agreement because the committee consists of only 2 NEDs against the minimum requirement of 3 NEDs as per the said Clause. Other Board Committees i. Nomination committee ii. Customer Service Committee 44

iii. Fraud Management Committee iv. Ethics and Compliance committee v. Investment committee vi. Share transfer committee Private sector banks have set up many committees to facilitate the work in line with section 49 of the listing agreement whereas public sector banks have set up many committees but not all the banks. Disclosures and Transparency Disclosure in the reports of corporate governance in the annual reports of private sectors and public sector banks, as required by the Clause 49 of the Listing Agreement have been studied in two parts: A. B.

Statutory requirements/ disclosures Non-mandatory requirements / disclosures Statutory requirements/ disclosures Some of the most important items of disclosures / requirements and their status of compliance in private sectors and public sector banks are given in Table 7.

Non-mandatory requirements / disclosures Some main items of non-mandatory requirements/ disclosures and their status of compliance in private sectors and public sector banks are given in Table 8.

General Body Meetings In regard to reporting of information in a companys general body meetings, following information has to be mandatorily included in the annual report:

i. ii. iii.

Location and timing of the general meetings which have taken place in last 3 years. Details of special resolution passed in the last 3 Annual General Meetings or Extraordinary General Meetings. Details of resolution passed last year through postal ballot including the name of the conducting official and voting pattern or procedure.

45

It is observed that both private sectors and public sector banks have provided required information on items (i) & (ii) above. Table 7: Items of Statutory Disclosures/ Requirements and their Status of Compliance in private sectors and public sector banks
Private Sector Banks Items of Statutory Disclosures Public Sector banks Disclosed as not being1. Significant related party Disclosed as not significant / and transactions having potential significant/ and being

potentially

potentially conflict with conflict with the interests of the conflict with the interests of the the interests of the bank. banks. bank. No non-compliance2. Non-compliance related to capital No non-compliance reported. reported. Applicable any material market matters. accounting3. Accounting treatment departure disclosure Applicable accounting

standards followed without reported. Laid down procedure to4. Board inform board about risk assessment and minimization procedure for boards review not

standards followed without any material departure reported. Risk Laid down procedure to inform board members about risk assessment and minimization procedure for boards review not reported. discussion &

members Management.

reported. Management discussion &5. Management discuss and analysis Management analysis report included in (MD&A) the annual report. Disclosed compliance 6. Shareholders information on: i) Appointment of new director / reappointment of retiring directors. ii) Quarterly results and presentation. iii) Share transfers iv)Directors responsibility statement.

analysis report included in the annual report. Disclosed compliance

Source: Annual Reports 2007-08.

46

Means of Communication and General Shareholder Information As advised by the Listing Agreement, private as well as the public sector banks have succeeded in giving general shareholder information and accepting a range of communication means every year.

CEO & CFO Certification As per clause 49 of the Listing Agreement CEO and CFO certification is compulsory for the BODs of a listed company relating to some precise matters. However, this must be disclosed in the CG report. After evaluation its clear that both private and public sector banks have fulfilled this requirement. They have succeeded in publishing this certificate in their CG report.

Compliance of Corporate Governance and Auditors Certificate. Private sector banks obtained an unqualified certificate from a practicing company secretarys firm, confirming company secretarys firm, confirming that the company has complied with all mandatory conditions of Clause 49 i.e., constitution of remuneration committee. In this connection, it may be clearly stated that both Private sector banks and public sector banks does appear to have sufficient ground for obtaining a clean certificate as there are glaring instances for compliance of certain important conditions of corporate governance. There are some areas of non-compliance, but they are non-mandatory in nature. Disclosure of Stakeholders Interests The central issue highlighted here is the disclosure of many proposals by private and public sector banks in their annual reports. This also focuses on the action taken by these banks on the following matter so as to fulfill their obligation towards their stakeholders.

47

Table 8: Items of Non-mandatory Disclosures/ Requirements and their Status of Compliance in Private sector banks and public sector banks Private Sector Banks Items of Statutory Disclosures Public Sector Banks Compliance not1. Share holder rights (e.g., Compliance not disclosed in disclosed corporate report. Compliance disclosed corporate in in the information & of half-yearly the corporate governance governance declaration financial report. Compliance not disclosed in the corporate governance report. No information provided in corporate governance report. of non-executive Evaluation disclosed in mechanism some bank

performance sent to shareholders not2. Audit qualification the governance

report. No information provided3. Training of board members in corporate governance report. Evaluation not corporate mechanism4. Evaluation in directors governance

disclosed

corporate governance report. Whistle blower policy

report. Whistle blower policy5. Whistle blower policy by some banks as disclosed by them in the corporate governance report. Source: Annual Reports 2007-08.

adopted by some banks as disclosed by them in the corporate governance report.

It is observed that private sector banks like ICICI and HDFC have disclosed in brief, the initiatives and measures taken by the bank on the above issues in the annual report 2007-08. Some public sector banks like Allahabad bank, Bank of Baroda, Bank of India & Punjab National Bank explained in details, various initiatives and measures taken by them to facilitate governance mechanism. But the fact remains that none of these banks disclosed their policies in regard to EHS, HRD, and CSR & IR in the annual reports. Share Price Movement

48

Basically, share price movement of a bank in a developing country depends on many factors, however, public sector banks are government owned and their performance is quite stagnant. The growths of private sector banks are good and are being reflected from the movement of share price. The trends of share price movement reflect how investors accept the bank and corporate governance has indirect impact on the movement of share price.
HDFC SHARE PRICE MOVEMENT
20 00 18 0 16 0 00 14 0 12 0 00 10 00 80 0 60 0 40 0 20 0 0
m ay .0 7 e. 07 ju ly .0 7 se pt .0 7 oc t.0 7 no v. 07 au gu st .0 7 de c. 07 fe b. 08 h. 08 .0 7 .0 8

Series1
1825 1615 1470

1698 1459 1274 1045 1181 1257 1197

1799

1798

Market Price of Share

ap ril

ju n

ja n

Months

ICICI BANK SHARE PRICE MOVEMENT

16 00 14 00 12 00 10 00 80 0 60 0 40 0 20 0 0
m ay .0 7 e. 07 ju ly .0 7 se pt .0 7 oc t.0 7 no v. 07 au gu st .0 7 de c. 07 fe b. 08 h. 08 .0 7 .0 8

m ar c

Series1

Market Price of Share

1257 964 950 955 1005 1063 915

1330

1316

1439 1217 1024

ap ril

ju n

ja n

Months

49

m ar c

AXIS BANK SHARE PRICE MOVEMENT

16 00 14 00 12 00 10 00 80 0 60 0 40 0 20 0 0
m ay .0 7 ne .0 7 st .0 7 se pt .0 7 ly .0 7 no v. 07 de c. 07 oc t.0 7 n. 08 fe b. 0 h. 08 .0 7 8

Series1
1439 1291 956 591 628 678 776 643 1025 1013 998

Market Price of Share

505

ap ril

au gu

Months

PUNJAB NATIONAL BANK SHARE PRICE MOVEMENT Series1

Market Price of Share

80 0 70 0 60 0 50 0 40 0 30 0 20 0 10 0 0

685 510 560 539 580 521 612 542 539

708

m ar c

ju

ju

ja

700 545

m ay .0 7

ju ne .0 7

au gu st .0 7

se pt .0 7

ju ly .0 7

no v. 07

de c. 07

oc t.0 7

ja n. 08

ap r il

fe b. 0

Months

CANARA BANK SHARE PRICE MOVEMENT Series1

421 340 324 272

Market Price of Share

45 0 40 0 35 0 30 0 25 0 20 0 15 0 10 0 50 0

280 232

277

300

287

280

299

313

m ay .0 7

ju ne .0 7

ju ly .0 7

se pt .0 7

no v. 07

au gu st .0 7

de c. 07

oc t.0 7

ja n. 08

ap ril

fe b. 0

Months

50

m ar c

h. 08

.0 7

m ar c

h. 08

.0 7

BANK OF INDIA SHARE PRICE MOVEMENT Series1

465 388 276 206 217 236 280 416 381 387 352

Market Price of Share

50 0 45 0 40 0 35 0 30 0 25 0 20 0 15 0 10 0 50 0

260

m ay .0 7

ju ne .0 7

au gu st .0 7

se pt .0 7

ju ly .0 7

no v. 07

de c. 07

oc t.0 7

ja n. 08

ap r il

fe b. 0

Months

ALLHBAD BANK SHARE PRICE MOVEMENT Series1

Market Price of Share

16 0 14 0 12 0 10 0 80 60 40 20 0
m ay .0 7 ju ne .0 7

143 125 107 82 90 88 110 98 112 126 122 108

au gu st .0 7

se pt .0 7

ju ly .0 7

no v. 07

de c. 07

oc t.0 7

ja n. 08

ap r il

fe b. 0

Months

BANK OF BARODA SHARE PRICE MOVEMENT Series1

60 0 50 0

Market Price of Share

40 0 30 0 20 0 10 0 0
m ay .0 7 ne .0 7 st .0 7 se pt .0 7 ly .0 7 no v. 07

465 407 292 284 319 322 331 353

501 435 360

251

de c. 07

oc t.0 7

n. 08

ap r il

fe b. 0

au gu

Months

51

m ar c

ju

ju

ja

h. 08

.0 7

m ar c

h. 08

.0 7

m ar c

h. 08

.0 7

STATE BANK OF INDIA SHARE PRICE MOVEMENT Series1

25 00 0

Market Price of Share

20 00 0 15 00 0 10 00 0 50 00 0
m ay .0 7 ne .0 7 st .0 7 se pt .0 7 ly .0 7

20238 14383 14576 14683 15868 15542 17361

20204

20498

21206 18895 17227

de c. 07

no v. 07

oc t.0 7

n. 08

ap ril

fe b. 0

au gu

Months

From the graph of share price movement of both private and public sector banks, it is quite clear that the share price of private sector banks are doing better than public sector banks. Private sector banks like ICICI and HDFC are very much in growth path as reflected from its share price movements. Evaluation of Governance Standard After analyzing the above issues of disclosure, structure and procedure, now the focus shifts to the level of standard achieved by private and public sector banks in terms of governance. As a result of certain authentic problems like absence of insider information, no possibility of debate with the chief officers of these institutions, etc, the author has come up with an alternative working model. The process used here for assessing the standard of CG practices in the sample banks has taken into account all the important conditions of CG laid down by the Clause 49 of the Listing Agreement and also the provisions of the banking Act, 1970. A point value method is used to evaluate the level to which these banks are obeying the governance standards. Here, based on the level of importance of each condition, a sufficient weightage (points) is given to them. Therefore, every bank has been given points on key parameter which comprises the CG procedure in banks. The key parameters as well as the decisive factors for assessing the CG standards have been chosen on a 100 point sale as illustrated in table 9. The scoring was based on empirical observation analyzing annual report thoroughly. There is no bias in scoring those variables. After determining the total score based on these parameters, an average score of individual sector is predicted. The average score private sector is 77.15 and public sector is 75.60. Thus, public sector is doing fairly well. 52

m ar c

ju

ju

ja

h. 08

.0 7

Table 9: Governance Parameter Testing

PARTICULARS 1. Strict adherence to the Code of Corporate Governance practices 2. Board of Directors: (i) Composition, Size & term (ii) Meetings & Attendance 3. Committees of the Board (i) Audit Committee (ii) Remuneration Committee (iii) Nomination Committee (iv) shareholders committee (v) Management Committee (vi) Other Committee (Finance, legal, & safety audit committee) 4. Management review and Responsibility 5.Other important information (i) Annual General Meeting (ii) Financial reporting (iii) code of ethics (iv) Perception of Insider trading (v) control on Price Sensitive Information (vi) Tenure of Non-executive Directors 6. Disclosures: (i) Related Party transactions (ii) Compliance by the CO 7. Means of Communication: (i) Half yearly Report sent (ii) Publishing Quarterly results in newspaper (iii) Publishing Quarterly results in websites (iv) Displaying official news releases (v) Are MD & A parts of the Reports of Directors? 8. Directors Remuneration 9. Compliance to clause 49 of Listing Agreement 10.Compliance to CII code on corporate governance Source: Annual Reports 2007-08 100 100 83.33 100 100 100 100 83.33 75 83.33 100 100 0 100 100 100 100 92.85 100 71.42 100 100 75 100 0 16.66 25 100 83.33 100 0 75 100 100 100 71.42 71.42 71.42 20.00 71.42 100 100 100 0 0 100 100 100 100 100 Private Sector banks 2007-08 83.33 Public Sector Banks 2007-08 71.42

Complying with research objectives, detailed analysis of corporate governance practices of ten leading banks in India through their annual reports reflects their overall commitment towards observing true corporate governance. Analysis of attributes from annual report shows 53

that items disclosed in Corporate Governance by banks in both the sector include banks philosophy on code of Corporate Governance, board of Directors: its composition, size, term, meetings, and attendance, committees of the Board e.g. Audit Committee, Remuneration Committee, Remuneration policy and Remuneration of Directors, Nomination committee, Share transfer Committee, Management Committee etc; Management Review and Responsibility, General Body meetings, Disclosure on Related Party Transactions, Compliance by the bank and Compliance to clause 49 of Listing Agreement. Analysis reveals improvement in the disclosure of various items of corporate governance in 2007-08 by banks in both the sectors. Banks strict adherence to the code of corporate governance is very impressive by both the sector. There has been a good record of strict adherence by public sector banks 71.42 whereas private sector banks have maintained a good percentage of 83.33. Out of four private sector banks only one bank is lacking to ensure absolute corporate governance practices. As far as board of directors information is concerned, both the sector has been disclosed by 100 percent in 2007-08. Coming to committee, public sector banks show better performance than private sector banks. Audit committee, Remuneration committee, shareholders committees are successfully maintained by both the sector whereas other committees are not so well maintained by public sector banks. The percentage of banks disclosing management review and responsibility is extremely low in the private sector. The information on General Body meetings, financial reporting, code of ethics, perception of insider trading, and tenure of Non-executive Directors are apparently same in both the sector. Private sector is at little advantage than public sector. Means of communication is another important item of corporate governance. The analysis of this item reveals that none of the public sector banks is sending half yearly report to its shareholders. In both the sectors, 100 percent banks are publishing quarterly and half yearly results in newspaper and their websites. For the year 2007-08, 100 percent banks of both the sectors have reported MD&A as a part of the directors report and displaying official news releases. Shareholders information has been disclosed by 100 percent banks in both the sectors. Further, compliance to clause 49 of listing agreement has been reported by 100 percent banks of both the sectors. The percentage of banks disclosing corporate governance has improved due to the reason that compliance to clause 49 has become mandatory. The position to voluntary compliance on CII

54

code on corporate governance is impressive whereas global code on corporate governance is far from satisfactory. It is also clear from the analysis of results that percentage of banks in both the sectors disclosing items corporate governance as Management Review and Responsibility is low and hence not satisfactory. Similarly adherence to global code on corporate governance is also extremely poor. On evaluation the result shows that the governance standards and practices in these private and public sector banks are encouraging in many respects except on some attributes. It also reveals that the countrys banking industry represented by these two major groups has an overall score of , thus showing merely an very good average performance in maintaining the standards and attaining the quality of governance practices. 4.2 Analysis of Primary Research The primary research was conducted through an interview process in order to elicit valuable opinion on attributes of corporate governance from the senior banks officer of both public and private sector banks. How much importance do senior bank officers in India attach to Corporate Governance? What, in the opinion of these executives, are the characteristics of good Corporate Governance? To get an answer to these and other related queries, few interviews were taken from all the sample banks. The outcome of this research would corroborate the findings from secondary research analysis. The secondary research analysis was done with the help of banks annual report of 2007-08. However, without the qualitative analysis, these objectives of the research cannot be fulfilled. Hence, an interviews method was used to make this research outcome authentic and justifying. The outcome of the interviews was presented through bar graphs. A likert scale (1 to 6) was used to measure the importance of each attribute of corporate governance practices. 6 are given for maximum importance and 1 is given for minimum importance. The esteemed officers were requested to tell regarding each attribute, average score was calculated, and presented through bar graphs. Primary research was basically done to elicit qualitative opinion from senior bank executive regarding the attributes of corporate governance and how it impacts on research objectives.

4.2.1 Interviews Results Analysis Based on literature review and secondary research analysis, Interviews of senior bank managers were conducted meticulously. The primary motive behind interview method was to 55

draw opinions on those attributes by those professionals and how far it is practical in normal business practices. Since banks and financial institutions occupy very important role in financial system of a country, attributes of corporate governance has a solidifying effect that ensures governance of banks. Considering the paucity of time and convenience of interviewee, the format of interview was prepared in a systematic manner so that the opinions of bank professionals were correctly depicted. Later on it was converted into mean score (based on likerts scale), that could be presented in a suitable bar diagram. Only 10 interviews could be taken out of 10 banks. It was due to the practical difficulties to get an appointment with senior bank manager (Assistant General Manager onward), who can say something about corporate governance.The outcomes of the interviews were connected with research objectives and research questions. Since time allotted by interviewee was limited, interview procedure was organized in some specific question format based on literature survey. Interviewees were requested to score on those attributes after giving their valuable opinion. The outcome of the interview with senior professionals of different banks helped the research analysis as their views supported many secondary researches. Most importantly, corporate governance in Indian banking is not a new phenomenon, but the outcomes of the effectiveness of its attributes are not known to many bank professionals. So the author interviewed those senior people who could say something substantial about corporate governance. Though Indian banking has been opened up for private participation a major chunk of banking pie is still controlled by public sector banks. These banks owing to their government ownership had no need to adopt all principles of corporate governance practices. Mr. Raj Kumar, Assistant General Manager, Canara Bank points out that the concept of governance itself is an altogether a new cup of tea for public sector bank even though there is a mandatory requirement of it in annual report. Mr. Sailesh Goel, AGM, Industrial Finance Branch, State Bank of India points out that these banks are burden with social responsibilities which is another burden for healthy business policies. The lack of accountability and transparency gave enough leeway for the public sector banks, which we see, transformed into crores of NPAs. Though the boards were constituted with great care with nominees from both the RBI and central government adorning the board, the performance remained lackluster and it is only due to the lack of any competition that they 56

got away with it. As K S Bajwa, deputy general manager, Punjab National Bank, rightly says, Many senior executives of Bank have complained that mostly these RBI nominees (who are not always senior in cadre), do not get involved in the framing of strategic policies, but confine merely to acting as watchdog against the blatant breach of the more quantitative guidelines. In other words, their contribution to qualitative aspects of governance is open to questions. After liberalization, the sector has been opened up leading to intense competition. Private sector banks forayed and carved niches for themselves. These banks are listed corporate and were market-driven that forced them to maintain transparency and accountability to take the place of tight-lipped secrecy. Though the regulations are stringent and entry norms strict private sector players still pose an additional risk than public sector banks. In a bid to win the trust and the confidence of the investors, private sector banks were outspoken about their plans and their achievements. They were very happy to compare their advances with those of the Public sector banks. Higher growth rates, lower NPAs, expanded business opportunities, tech-savvy nature, etc, all put together made the private sector banks look like the heavens of investment as compared to lack luster public sector banks (taken from the statement of Puneet Mathur, Deputy GM, HDFC Bank). But most of these success signals are a result of the budding state of these banks. And misunderstanding them as the signal of better and improved performance would only mean assuming the wrong things and missing out on the challenges of the real world. The previous stock market scam that shook the market inside out brings to the fore our shallow assumptions of healthy environment and well-governed companies given the unique nature of banking business, which deals essentially with the money of others. The adherence to strict ethical standards is of great importance to banks. As G.C. Tewari, General Manager, Bank of India emphasizes, In banking it is the trust of depositors that drives the industry. It is the duty of the bank to see that the money entrusted to it is safe and secure. But that realization is absent in most of the banks which is quite evident from the fact that corporate governance practices in Indian banks are conspicuous by their absence. As Sailesh Goel, State Bank of India, puts it the bankers who are coming face-to-face with the harsh realities of competition are now feeling the need for awareness. Existence of more disclosure norms, transparency and accountability is limited to what is required under the law rather than taking initiative to set new standard.

57

Key Findings The key findings from the interviews conducted are as follows:

It is of high exigency that corporate Governance in banking sector is very much in demand due to global awareness regarding corporate governance and global banking to ensure transparent service to citizens. Proper and adequate corporate governance can handle many complex banking issues and will create a transparent globalized economic environment.

Ensuring transparency in financial statements and expected on ethical behaviors and protecting shareholders interest are the key attributes of good Corporate Governance. Adherence to those attributes ensures transparency of banking transactions and minimizes the chance of fraud and malpractices.

Some major concerns like Insider trading, selective release of sensitive information, and resorting to unfair accounting practices are the biggest concerns from the Corporate Governance perspective. However adequate corporate governance practices implemented by banks helps bank to ensure shareholders interest in the long run.

It is not possible to differentiate Corporate Governance practices on the basis of ownership. Since certain attributes of corporate governance practices are mandatory, regulated by Reserve Bank of India, attributes of corporate governance put same impact on banks performance irrespective of ownership.

Corporate Governance is as important as other quantifiable factors, such as likely growth in earnings, from the point of view of investment decisions. Since the outcome of some attributes minimizes the chances of fraud, it enhances shareholders confidence; as a result increases share value.

The most important factor while studying Corporate Governance in a bank is the perceived integrity of financial statements. The facts that well governed banks are less likely to indulge in malpractice & mis-governance and more likely to protect the interests of minority shareholders. Not only that it protects the public fund by acting like a watchdog, it inculcates the habits of ethics in business.

Other notable findings from secondary research analysis reflect that corporate governance in banks is in a formative state. It is fast evolving and long way to go. While setting accountability standards for Board, there is need for enhanced transparency and disclosure in 58

respect of various aspects of board constitution and functioning. Both private and public sector banks are not practicing completely the corporate governance code in spite of its mandatory in nature. Still, the outcome is very much satisfactory. Q1. How do you score on these key attributes of good corporate governance in Indian Banking Sector? 1) Transparency of Financial Statements 2) Ensuring ethical Practices by banks 3) Protecting minority shareholder rights 4) Adhering to all legal compliance of governance 5) Ensuring shareholder value 6) Sound risk management practices. (Rank them in the order of importance. 6 for maximum importance; 1 for minimum importance).
Key Attributes of Corporate Governance
6 5
Series1

Mean Score

4 3

5.1
2 1 0

3.9

4.2

4.1

3.9

3.6

1) Ensuring shareholder value

2) Transparency 3) Ensuring 4) Protecting of Financial ethical Practices minority Statements by banks shareholder rights

5) Adhering to all legal compliance of governance

6) Sound risk management practices.

Attributes

Respondents emphasize on transparency of financial statement as the mean score is touching 5.1. It clearly indicates that transparency of financial statements will repose faith on banks from governance point of view. The misgivings of fraud and malpractice will automatically erase from the mind of investors and will lead to increase shareholders value. In addition, the respondents were very much positive about the other attributes of corporate governance practices like ethical practice, protecting minority shareholders right and legal compliance. 59

All these attributes certainly creates an environment of trust and confidence of shareholders and public at large. Since banks are characterized by repository of finance, banks executives consider it very much important to maintain transparency of financial statements and compliance with corporate governance principles. Q2. How do you score on those attributes of good Corporate Governance? 1. High level of disclosures 2. Shareholding patterns 3. Appropriate governance structure 4. Presence of a strong and independent Board of Directors 5. Adequate Committee Structure 6. Means of Communication (Rank each objective in the order of importance. 6 for maximum importance; 1 for minimum importance).
Principal Variables of Corporate Governance 6 5 Mean Score 4 3 2 1 0 1) High level of 2) Shareholding 3) Appropriate 4) Presence of a disclosures patterns governance strong and structure independent Board of Directors Variables 5) Adequate Committee Structure 6) Means of Communication 4.9 4.3 5.5 5.1 5.6 4.3 Series2

Adequate committee structure, governance structure and strong independent board are some major variables where the mean score is more than 5. From this score it revealed that the attributes of corporate governance can be properly implemented with the help of adequate committee structure and presence of strong and independent board. The outcome of respondents matches with the literature survey emphasizing on committee and board structure. Secondary research analysis from annual report also corroborates this stand to full extent as banks have emphasized on board structure and committee. 60

Q3. How do you score on some concerns from the point of view of management of banks which necessitates implementation of Corporate Governance in banking sector? 1. Unethical practices adopted by banks 2. Practice of Insider trading and selective leak of sensitive information 3. Deviation from standard accounting practices 4. Neglecting for minority shareholders 5. Excessive Promoter Control in Management 6. Unrelated Policies & Risk (Rank each objective in the order of importance. 6 for maximum importance; 1 for minimum importance).

Problems of Corporate Governance

6 5 Mean Score 4 3 2.1 2 1 0 1) Unethical practices adopted by banks 2) Practice of 3) Deviation 4) Neglecting Insider trading from standard for minority and selective accounting shareholders leak of practices sensitive information Factors 5) Excessive Promoter Control in Management 4.9 5.4 4.7 5.1 5

Series2

6) Unrelated Policies & Risk

Practice of insider trading, unrelated risk undertaken by banks and excessive promoters control in public sector banks are some of major problems highlighted by respondents which necessities implementation of corporate governance in banking sector. The banking scams in Asian countries are some of the glaring examples. From the secondary research analysis, it was revealed that government holds maximum stake in public sector banks as a result there is greater possibilities of neglecting minority shareholders.

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Q4. What is your opinion about those measures that can ensure a high level of transparency & disclosures? 1. Proper means of Communication to interested parties. 2. Speedy dissemination of sensitive information. 3. Presentation of all relevant details in Annual Report. 4. High quality of Management Discussion and Analysis (MDA). 5. Responsiveness to investors queries. 6. Periodic review of Analyst meeting. (Rank each objective in the order of importance. 6 for maximum importance; 1 for minimum importance).

Transparency & Disclosures Measures

Series1
6 5

Mean Score

4 3 2 1 0

4.9 3.8

5.1 3.7

5.2

4.8

1) Proper means 2) Speedy 3) Presentation of 4) High quality of 5) Responsiveness 6) Periodic review of Communication dissemination of all relevant details Management to investors of Analyst to interested sensitive in Annual Report. Discussion and queries. meeting. parties. information. Analysis (MDA). Attributes

Since transparency and disclosure are two important pillars of corporate governance measures the top executives of banks were requested to score on those variables. This question is aimed at taking opinion from banks executives how to ensure transparency and disclosure. From the response, it is clear that proper disclosure of information in annual report, speedy dissemination of sensitive information and satisfying investors queries are some important variables which can bring more transparency in governance. The mean score is nearly 5, justifying their opinion about those variables.

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Q.5 How do you score the importance of various committees from Corporate Governance point of view? 1. Audit Committee 2. Remuneration Committee 3. Management Committee 4. Investors Grievance Committee 5. Fraud Management Committee 6. Risk Monitoring Committee
Various Committees
7 6 Mean Score 5 4 3 2 1 0 Audit Committee Remuneration Committee Management Committee Investors Grievance Committee Fraud Management Committee Risk Monitoring Committee 5.9 5.85 4.8 5.4 5.6 5.2 Series1

Committee's Name

Study of literature and annual report revealed that formation of committee is very important for corporate governance implementation. Among all the committees audit committee, remuneration committee, investors grievance committee are some of the mandatory requirements, the outcome of this question support the efforts of banks in implementing this decision through various committees. Except management committee, all other committees are being almost set up by various banks, where the average score is more than 5. Thus, it can be correctly said that formation of those committees are very much important for corporate governance implementation. Q 6 What is your opinion about the importance of Segment reporting to ensure a high level of transparency and disclosure? 63

(Rank them in order 1) very important, 2) Moderate Important, 3) Not important.) This question was put to senior banks executives in order to know the importance of segment reporting. Segment reporting is a non-mandatory requirements of governance principles, but 90% respondents are in opinion that segment reporting is very much necessary to ensure good corporate governance. So, the authorities should ponder over to make segment reporting as a mandatory requirement for good corporate governance. Q.7 What according to you are the most desirable characteristic of the Board of Directors? 1. Presence of skilled and effective Independent Directors 2. Majority of Independent Directors 3. Separate MD and Chairman (Rank each objective in the order of importance. 6 for maximum importance; 1 for minimum importance).

64

Desirable Character of BOD

Series1

Separate MD and Chairman

2.8

Majority of Independent Directors Presence of skilled and effective Independent Directors 0 1 2 3

5.2

Mean Scores

Presence of skilled and effective independent directors is the desirable characteristics to ensure proper board that can discharge good corporate governance practices in banks as reflected from its mean score 5.2. The respondents were very much categorical about this characteristic. The average score of this feature is touching the maximum point compared to other characteristics. Hence, banks should try to establish an efficient board for better governance practices.

Q. 8. What do you think regarding the effectiveness of audit committee in preventing fraud?

65

(Ranking 1) Greatly effective, 2) somewhat effective, 3) Ineffective) Audit committee is considered very important as reflected from secondary research analysis. Both public and private sector banks were having their audit committee as mentioned in primary research analysis. However, the respondents were not in the same opinion about the efficacy of audit committee. When asked about the efficacy of preventing fraud, more than 50% respondents were of opinion that it is somewhat effective, because there is a provision of fraud monitoring committee to ensure non-happening of fraud in banking sector.

Q. 9. Will you try to achieve the maximum effectiveness in terms of good corporate governance in your Bank? 66

(Rank them in order 1) Yes 2) Sometime Yes 3) No 4) Only in exceptional case 5) Never.

Senior Bank executives participate in decision making process. Hence, this question was asked to find out their role in achieving good corporate governance. Nearly 90% executives expressed their opinion to do effort in order to achieve corporate governance.

67

Q (10) What percentage of good corporate governance practices can you expect to achieve in your bank? (Rank them in order 1) more than 20% 2) 10%-20% 3) Less than 10% 4) difficult to quantify

Although it is not easy to quantify, nearly 50% respondents were of opinion that they should try to achieve good corporate governance practices. The findings from primary research were quite satisfactory because the respondents were quite categorical in highlighting the attribute of good corporate governance. It was a qualitative analysis that reflects the prevalence of corporate governance practices in Indian Banking sector. The outcome of secondary research analysis has already established the fact that good corporate governance is a reality and Indian Banking sector has left no stone unturned to achieve this. Corroborating this outcome of secondary research, primary research was aimed at to draw significant insight into it. The outcome of primary research also reflected the sheer sincerity of senior banks executive to take this mission forward to the zenith of success. However, while Corporate Governance has emerged as a potential force for the success of banking sector, most of the executives find it difficult to specify the degree of implementation of good Corporate Governance practices. Not surprisingly, the executives are very much concerned about the integrity of accounting statements and quality of transparency and disclosures and feel that selective leak of sensitive information and dubious

68

accounting practices have been the biggest concerns from the Corporate Governance perspective.

69

Chapter-5
CONCLUSION The research on corporate governance in Indian Banking Sector produced some important results. Banking has become complex and it has been recognized that there is a need to attach more importance to qualitative standards such as internal controls and risk management, composition and role of the board and disclosure standards. Corporate Governance has become very important for banks to perform and remain in competition in the era of liberalization and globalization. The success of corporate governance rests on the awareness on the part of the banks of their own responsibilities. While law can control and regularize certain practices, the ultimate responsibility of being ethical and moral remains with the banks. It is this enlightenment that would bring banks closure to their goals. However, while all this looks good on paper, it runs into considerable difficulty during implementation. The difficulty is compounded given the fact that there are easier ways, which give faster returns that are no less valuable because they are acquired through questionable means. The outcome of the present research in achieving the objectives of the research establishes some important facts: The first objective of the research was to examine the effectiveness of attributes of corporate governance in Indian Banking sector in bringing transparency and economic growth. The outcome of the study indicated that corporate governance on Indian Banking Sector is at formative stage compared to developed nations. There should be more transparency and disclosure mechanism in order to avoid even the slightest of financial scam. So far as economic growth is concerned, there is certainly economic growth registered by private sector in terms of penetration and share price rise and establishing strong footing in banking sector. The compliance of certain non-mandatory requirements by ICICI, AXIS and HDFC justifies that they are quite serious in bringing about the effectiveness of implementation of corporate governance attributes. Coming to second objective, it is very much clear that the regulatory framework of Corporate Governance in India has given sufficient thought to ensure good governance practices in Banking sector so as to protect the interest of stakeholders. Even though all the international code of corporate governance principles is not thoroughly observed, CII code and clause 49 of mandatory requirement have put sufficient ingredient to ensure good corporate governance 70

in Indian banking sector. However the shareholding pattern of public sector banks was loaded with government share, where good corporate governance can be implemented with difficulty. Apropos third objective, the proper implementation of corporate governance attributes can minimize fraud and malpractices in banking sector. There are provisions of fraud monitoring committee, risk management committee, investors grievance committee which can minimize the chance of fraud. Normally such type of misgovernance is perpetuated when transparency of financial statement is missing or proper disclosure of information is not made. However, both private and public sector banks are observing all mandatory requirements of corporate governance mentioned under section 49 of the listing agreement. The opinion of senior executives of different banks were very much optimistic was also in the same direction of attaining perfection irrespective of our little deficiency in adhering such compliances. There is no significant difference in practices of corporate governance by public sector banks and private sector banks. Since banking in India is governed by some statutory act, there is lesser possibility of differences. The degree of applicability of corporate governance principles differs from public sector to private sector, but the transparency and disclosure in public sector is more than private sector. As far as voluntary adherence to corporate governance principles are concerned, there seems to be more effort taken by private sector banks than public sector banks. Slowly and gradually the regulatory authority will make more norms mandatory. Suggestions to Improve Corporate Governance Practices Chairman and CEO It has been recognized that there should be separation of the role of Chairman and CEO. Cadbury Committee on corporate governance states that there should be a clearly accepted division of responsibilities at the head of the company level, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision-making. At present in India, in most of the banks, the CEO and the chairmans positions are combined. The government appoints the chief executives of public sector banks and has preferred the composite position of chairman and managing director.

71

Responsibility of the Board According to the Board of International Settlement (BIS) code, bank boards should establish strategic objectives and set corporate values that will direct the ongoing activities of the bank. The board should ensure that senior management implements policies that prohibit activities and relationships that diminish the quality of corporate governance, such as conflicts of interests, self-dealings and preferential dealings with related parties. Keeping in view their oversight role board of directors should feel empowered to recommend sound practices, provide dispassionate advice and avoid conflicts of interests. Accountability to Shareholders/Stakeholders The Securities and Exchange Board of India (SEBI) guidelines state that the Board should be accountable to shareholders for creating, protecting and enhancing wealth and resources for the company and reporting them on the performance in timely and transparent manner. However, the present scenario is that in majority of banks, Boards do not enforce clear lines of responsibility and accountability for themselves. Election The Organization for Economic Co-operation and Development (OECD) principles state that the Board should ensure a transparent Board nomination process. In terms of the provisions of section 9 of the Banking Companies (acquisition and Transfer of Undertakings) Act, the government constitutes the Boards of Directors of nationalized banks. The Boards comprise of two whole-time directors, a nominee each of the Government of India and the Reserve Bank of India, nominees of workmen and non-workmen unions, and a chartered accountant. Besides this, six non-official directors with specialized knowledge in agriculture and rural economy, banking, co-operation, economics, finance, law, etc. are appointed. So, the current scenario is that the bank boards consist mainly of nominated members and not the elected members. Moreover, banks do not have nomination committees for nominating directors of Boards of banks. Audit Committee According to BIS the Audit Committee of banks should provide an oversight of the banks internal and external auditors, approving their appointment and dismissal, reviewing and approving audit scope and frequency, receiving their reports and ensuring that management is taking appropriate corrective actions in a timely manner. The independence of this committee can be enhanced when it is comprised of external Board members who have banking and 72

financial expertise. In India, the banks are required to set-up an Audit Committee of Board of Directors to oversee and provide direction to the internal audit/ inspection function in banks in order to enhance its effectiveness as a management tool. Corporate Governance calls for a paradigm shift in the role of the Board and corporate directors. They need to be evolutionary and revolutionary constantly moving the banks toward higher level of creativity. While corporate governance is an important element of affecting the long term financial health of banks, it is only a part of larger economic context in which bank operate. The Corporate Governance depends upon legal and institutional framework. It will be rightly to conclude with the remarks that the road to efficacy lies in minimizing regulatory prescription and maximizing voluntary codes to ensure excellence in corporate governance among financial intermediaries. Corporate Governance is the only royal road to the portal of corporate success and there is no short cut to achieve the same.

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Appendix
The following Public Sector Banks in Delhi were used for the study. Senior bank executives were approached in these banks. The interview process started with a brief discussion on the attributes of corporate governance and then a small questionnaire was handed over to the interviewees. Senior Managers who could share their opinion about Corporate Governance were requested to fill the questionnaire. All the banks have their regional office in Delhi (Capital of India) Allahabad Bank Bank of Baroda Bank of India Canara Bank Punjab National Bank State Bank of India

The following Private Sector Banks in Delhi were used for the study: Questionnaire Q1. How do you score on these key attributes of good corporate governance in Indian Banking Sector? 1) Transparency of Financial Statements 2) Ensuring ethical Practices by banks 3) Protecting minority shareholder rights 4) Adhering to all legal compliance of governance 5) Ensuring shareholder value 6) Sound risk management practices. 81 HDFC Bank ICICI Bank AXIS Bank Standard Chartered Bank

(Rank them in the order of importance. 6 for maximum importance; 1 for minimum importance).

Q2. How do you score on those attributes of good Corporate Governance? 7. High level of disclosures 8. Shareholding patterns 9. Appropriate governance structure 10. Presence of a strong and independent Board of Directors 11. Adequate Committee Structure 12. Means of Communication (Rank each objective in the order of importance. 6 for maximum importance; 1 for minimum importance). Q3. How do you score on some concerns from the point of view of management of banks which necessitates implementation of Corporate Governance in banking sector? 7. Unethical practices adopted by banks 8. Practice of Insider trading and selective leak of sensitive information 9. Deviation from standard accounting practices 10. Neglecting for minority shareholders 11. Excessive Promoter Control in Management 12. Unrelated Policies & Risk (Rank each objective in the order of importance. 6 for maximum importance; 1 for minimum importance). Q4. What is your opinion about those measures that can ensure a high level of transparency & disclosures? 7. Proper means of Communication to interested parties. 8. Speedy dissemination of sensitive information. 9. Presentation of all relevant details in Annual Report. 10. High quality of Management Discussion and Analysis (MDA). 11. Responsiveness to investors queries. 12. Periodic review of Analyst meeting.

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(Rank each objective in the order of importance. 6 for maximum importance; 1 for minimum importance). Q.5 How do you score the importance of various committees from Corporate Governance point of view? 7. Audit Committee 8. Remuneration Committee 9. Management Committee 10. Investors Grievance Committee 11. Fraud Management Committee 12. Risk Monitoring Committee Q 6 What is your opinion about the importance of Segment reporting to ensure a high level of transparency and disclosure (Rank them in order 1) very important, 2) Moderate Important, 3) Not important.) Q.7 What according to you are the most desirable characteristic of the Board of Directors? 4. Presence of skilled and effective Independent Directors 5. Majority of Independent Directors 6. Separate MD and Chairman (Rank each objective in the order of importance. 6 for maximum importance; 1 for minimum importance). Q. 8. What do you think regarding the effectiveness of audit committee in preventing fraud? Ranking 1) Greatly effective, 2) somewhat effective, 3) Ineffective) Q. 9. Will you try to achieve the maximum effectiveness in terms of good corporate governance in your Bank? (Rank them in order 1) Yes 2) Sometime Yes 3) No 4) only in exceptional case 5) Never.

Q (10) What percentage of good corporate governance practices can you expect to achieve in your bank? (Rank them in order 1) more than 20% 2) 10%-20% 3) Less than 10% 4) difficult to quantify 83

84