Institute for Development and Research in Banking Technology

Corporate Governance

I am happy to be here in an outstanding academic atmosphere with legal experts and luminaries all around. In fact, there is some trepidation on my part in addressing such an august audience. Nevertheless, I wanted to come to your campus and speak to you on the subject of Corporate Governance in general and with specific reference to inancial Institutions. !ne way or the other, in the later part of my career I have been on the "oards of the #tate "ank of $ravancore, #tate "ank of India, #"I Capital %arkets, #"I %auritius, #"I $oronto, #"I &ife and #"I Cards, N'"'(), N*" and (eserve "ank of India, all of which gave me an opportunity to practice corporate governance as I understood from the "oard (oom practices. "y a freak coincidence of circumstances in +,,-, I chaired an 'nnual General %eeting of a listed company from *yderbad as an institution nominee, as the Chairman could not reach to attend the meeting. (ecent history is replete with examples of scams and frauds hitting the headlines every now and then. If in India, we had *arshad %ehta, C.(. "hansali, .etan /arekh, advanced $here is thus, a growing concern world over for the countries like 0# and 1urope were no way behind with their scams of the famous 1nron, 2orldCom and many more. Governments, (egulators of #tock 1xchanges, "anks, in particular Central "anks and other inancial Institutions to continuously review the systems and procedures and how to enhance corporate governance. In developing countries governance issues have a different focus for the small and mid3si4ed segments which are often family controlled and who are reluctant to professionalise and share power. I would not like to dwell too much on the basic definitions but I would capture four of them which I feel it relevant5
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&ecture delivered by #hri 7epa .amesam, Chairman, Governing Council, Institute for )evelopment and (esearch in "anking $echnology 8I)("$9, *yderabad to the students of the "'"& 8*ons.9 Course at N'&#'( 0niversity of &aw, *yderabad on -+st 'ugust, :;;<. #peaker greatly acknowledges to various references, !1C) publications, "I# (eviews and other documents and press releases of ("I, #1"I etc. $he opinions = views expressed in this speech are that of the author.

+. I would like to >uote an 1conomist and Noble laureate %ilton riedman. 'ccording to him ?Corporate Governance is to conduct the business in accordance with owner or shareholders@ desires, which generally will be to make as much money as possible, while conforming to the basic rules of the society embodied in law and local customsA :. 'ccording to #ir 'drian Cadbury, ?Corporate Governance is the system by which companies are directed and controlledBB BBto do with /ower and 'ccountability5 who exercises power, on behalf of whom, how the exercise of power is controlled.A -. 'ccording to !1C) the Corporate Governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the "oard, managers, shareholders and other stakeholders spells out the rules and procedures for making decisions on corporate affairs. <. Cet another definition is ?Corporate Governance is about promoting corporate fairness, transparency and accountability.A or convenience, I am summari4ing the Cadbury Code of "est /ractices 8'nnexure I9 and I feel the +, points listed therein are of great relevance today which has been made an essential condition for the listing rules in the &ondon #tock 1xchange and the compliance is mandatory for 0. based companies. Recent Developments in USA: *istory continues to tick and #arbanes3!xley 'ct of the 0# was a serious wake3up call. $here has been a great debate and e>ually vehement protests on some of the provisions in the said 'ct. Nevertheless, it is a call to get back to fundamentals and it identifies DE separate provisions that affect internal auditing and the >uestion of the )irectors of the "oards not taking sufficient responsibility is clearly unacceptable and would not be
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tolerated. It would be interesting if somebody were to list out the provisions of #arbanes3 !xley 'ct and compare them with the positions prevailing in other advanced countries and in India. (ecent efforts have been made by proposing a set of sweeping changes to the Company &aw in this country which is still under debate and not yet legislated. In 0., 'ustralia, and New Fealand, principles of good governance and Code of "est /ractices have been brought into observance. I have placed at 'nnexure II the comparative position of regulations which was published in an article by %inter 1llison5 ?Corporate Governance in the 0#, 0., 'ustralia and New Fealand5 ' ComparisonA, ebruary :;;-. I am tempted to >uote some of the important extracts from the "I# review of :;;-. $he message for boards of directors is5 0phold your responsibility for ensuring the effectiveness of the company@s overall governance process. $he message for audit committees is5 0phold your responsibility for ensuring that the company@s internal and external audit processes are rigorous and effective. $he message for C1!s, C !s, and the senior management is 5 0phold your responsibility to maintain effective financial reporting and disclosure controls and adhere to high ethical standards. $his re>uires meaningful certifications, codes of ethics, and conduct of insiders that, if violated, will result in fines and criminal penalties, including imprisonment. $he message for external auditors is5 ocus your efforts solely on auditing financial statements and leave the add3on services to other consultants $he message for internal auditors is5 Cou are uni>uely positioned within the company to ensure that its corporate governance, financial reporting and disclosure controls, and risk management practices are functioning effectively. 'lthough internal auditors are not specifically mentioned in the #arbanes3!xley 'ct, they have within their purview of internal control the responsibility to

examine and evaluate all of an entity@s systems, processes, operations, functions and activities. $hus, the role of the internal auditor has substantially got escalated and the external auditor perhaps took a back seat. *owever, a specific section of #arbanes3!xley 'ct re>uires senior management to assess and report on the effectiveness of disclosure controls and procedures as well as on internal controls for financial reporting. 'll of these have to be in the public disclosure domain of the reports but outside the financial statements. $here is one risk to merely lean heavily on the certification, which after a while becomes ritualistic. It would be good to be associated with the framing of the robust audit programme and the company@s disclosure control framework. urther an internal auditor must have the highest ethics and be willing to sacrifice everything 8consultation assignments9 to maintain their independence within the auditing company. If there are different sections of companies, which offer turn3key management consultation, at least those who are involved in the audit exercise should disassociate themselves from being a part of consulting side of the company@s work. #ome of the provisions in the 'ct are >uite draconian particularly one would be the internal auditor of publicly traded financial services company, as there are threats of fines and imprisonment, the internal auditor@s voice is heard loud and clear by the "oard and as such all those )irectors of "oards who choose to ignore this valuable advice, would, in my opinion be consigned to the dust bin of history. Complex collapses, pon4i schemes, misfeasance and malfeasance of staggering proportions by executive directors, auditors failing in their duties, call for tough (egulatory responses like the above 'ct and related rules introduced and interpreted by #ecurities and 1xchange Commission in 0#'. 1ven in 0nited #tates where the &aws have progressively been tightened, there have been umpteen instances of "oard room dramas and part of their stories which keep filtering and the very same Gcorporate governance@ has been used as a shield to protect some of the erring "oard members and executives who have deviated from laid out rules and there are
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many examples replete in history in all the countries where most of the "oard )irectors become Grubber stamps@ for management and stifle dissent and run away from fixing accountability, where called for. Classic case of collapse of 1nron, an energy producing company indulging in a web of derivative transactions by creating #/7 companies and their senior executives running them and investing in them and being excessively remunerated 8all without the knowledge of "oard of 1nron9. !nly three 0# financial analysts out of +D or so, could sense three days in advance before 1nron went bankrupt that the company was sinking. Indian Situation: In this country we have followed the 0. model. It is true that 'udit Committees, %anaging Committees and (emuneration Committees have all come into existence and the recommendations of .umara %angalam "irla are followed. $he roles of a Company with a combination of both Non31xecutive and 1xecutive )irectors with atleast D;H comprising non3executive )irectors is important. I presume the hidden message is, this D;H would really be so3called Gindependent directors@ who have no linking to a single group company, upholding values and laws to ensure that the company functions properly. It is also essential that the 'udit Committee is chaired by a >ualified independent )irector, preferably a Chartered 'ccountant and the members of the 'udit Committee are invariably non3executive independent )irectors. #enior executives like the C ! of the Companies are invited as special invitees to the 'udit Committee meetings so that, discussions are held in a totally free atmosphere. 's you are aware, the independent )irectors apart from receiving the )irector@s remuneration 8sitting fees9 do not have any pecuniary relationship or transactions with the company. $he 'udit Committee has wide powers and also looks into the compliances with 'ccounting #tandards and all the regular compliances like the #tock 1xchange, legal re>uirements and it also looks into several internal control systems and satisfies itself that the grievances of the shareholders have been properly addressed and an appropriate
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mechanism exists in the company for recording and disposing of the grievances. In fact, there is a sub3committee of the "oard, which looks at these aspects and ensures that the compliances filed to the stock exchange are truthful and factual. /ublication of >uarterly and half3yearly results of the company, apart from the annual results after being vetted by the 'udit Committee is now a well established practice. 2hat perhaps is missing in the Indian situation at the present moment is the e>uivalent legislation, inline with the #arbanes3!xley 'ct. I do hope that the changes to the Company &aw now suggested in the public domain and which is under debate would bring about a better level of corporate governance. $he Institute of Chartered 'ccountants of India has set up >uite rigid 'ccounting #tandards to be followed. I refer to my earlier comment about family controlled companies reluctant to recogni4e the clear separation of the role of the promoters, executive functionaries and other non3executive independent directors. In such companies there is complete blurring of the lines of authority and there is often times, a mix up and the employees develop divided loyalties to various groups in the family. Cet another aberration is pyramidical structures by layered investments and cross holdings going unnoticed. $here is an urgency to ensure against the strangle hold in controlling companies, by a group of people who are not direct investors and do not become accountable to anyone including a poor investor shareholder. Corporate Governance for the Financial Sector No one will deny that, the one sector which deserves close attention in terms of regulation is the financial institutions in the country. (esidents of *yderabad have fresh memories of G$" episode, the moratorium and the subse>uent merger with !"C. "roadly, the financial sector can be divided into following5 $erm3&ending Institutions, governed by the Companies 'ct or #pecial 'cts of /arliament.
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 "anks Jpublic sector, private sector 8old and new generation banks, Cooperative "anks9K governed by #pecial 'cts or "( 'ct. inance companies also known as non3banking financial companies governed by Companies 'ct and guidelines issued by ("I and C#. $he "asel Committee in the year +,,,, had brought out certain important principles on corporate governance for banking organi4ations which, more or less have been adopted in India. "asel committee underscores the need for banks to set strategies for their operations. $he committee also insists banks to establish accountability for executing these strategies. 0nless there is transparency of information related to decisions and actions, it would be difficult for stakeholders to make managements accountable. $he underlying theme is accountability at all levels including the "oards. rom the perspective of banking industry, corporate governance also includes in its ambit the manner in which their boards of directors govern the business and affairs of individual institutions and their functional relationship with senior management. $his is determined by how banks5 set corporate objectives 8including generating economic returns to owners9L run the day3to3day operations of the business andL consider the interests of recogni4ed stakeholders i.e., employees, customers, suppliers, supervisors, governments and the community and align corporate activities and behaviours with the expectation that banks will operate in a safe and sound manner, and in compliance with applicable laws and regulationsL and ofcourse protect the interests of depositors, which is supreme.

Cou may be aware that the Committee has issued several papers on specific topics, where the importance of corporate governance is emphasi4ed. $hese include /rinciples for the management of interest rate risk 8#eptember +,,M9, ramework for internal control systems in banking organi4ations 8#eptember +,,E9, 1nhancing bank transparency 8#eptember +,,E9, and /rinciples for the management of credit risk 8issued as a consultative document in Nuly +,,,9. $hese papers have highlighted the fact that sound corporate governance should have, as its basis, the following strategies and techni>ues5 the corporate values, codes of conduct and other standards of appropriate behaviour and the system used to ensure compliance with themL a well3articulated corporate strategy against which the success of the overall enterprise and the contribution of individuals can be measuredL the clear assignment of responsibilities and decision3making authorities, incorporating an hierarchy of re>uired approvals from individuals to the board of directorsL establishment of a mechanism for the interaction and cooperation among the board of directors, senior management and the auditorsL strong internal control systems, including internal and external audit functions, risk management functions independent of business lines, and other checks and balancesL special monitoring of risk exposures where conflicts of interest are likely to be particularly great, including business relationships with borrowers affiliated with the bank, large shareholders, senior management, or key decision3makers within the firm 8e.g. traders9L the financial and managerial incentives to act in an appropriate manner offered to senior management, business line management and employees in the form of compensation, promotion and other recognitionL and appropriate information flows internally and to the public

or ensuring good corporate governance, the importance of overseeing the various aspects of the corporate functioning needs to be properly understood, appreciated and implemented. $here are four important aspects of oversight that should be included in the organi4ational structure of any bank in order to ensure the appropriate checks and balances5 8+9 oversight by the board of directors or supervisory boardL 8:9 oversight by individuals not involved in the day3to3day running of the various business areasL 8-9 direct line supervision of different business areasL and 8<9 independent risk management and audit functions. In addition to these, it is important that the key personnel are ?fit and properA for their jobs. $he latest directive issued by ("I on :D th Nune, under section -D' of the "( 'ct is very important. ' copy of issued directive is placed at 'nnexure III. Certain criteria must be fulfilled by persons aspiring to become )irectors of "anks and due diligence must be done in this regard. In future, )irectors must also execute covenants binding themselves to discharge the duties, rules individually and collectively. Oualification, track record, integrity and other Gfit and proper@ norms, importantly duly filled in forms must be scrutini4ed by Nomination Committees. In other words, getting nominated to "oards through networking or >uestionable means would not become possible. $he supervisory experience of (egulators in general, in banks consider the following as critical elements in the governance process5 1stablishing strategic objectives and a set of corporate values that are communicated throughout the banking organi4ation.
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 #etting and enforcing clear lines of responsibility and accountability throughout the organi4ation. 1nsuring that board members are >ualified for their positions, have a clear understanding of their role in corporate governance and are not subject to undue influence from management or outside concerns. 1nsuring that there is appropriate oversight by senior management 1ffectively utili4ing the work conducted by internal and external auditors, in recognition of the important control functions they provide 1nsuring that compensation approaches are consistent with the bank@s ethical values, objectives, strategy and control environment. Conducting corporate governance in a transparent manner 1nsuring an environment supportive of sound corporate governance. I would like to discuss these practices in some detail, as dealt with by "asel Committee. (egarding establishing strategic objectives and a set of corporate values that are communicated throughout the banking organi4ation, "asel Committee feels that it is difficult to conduct the activities of an organi4ation when there are no strategic objectives or guiding corporate values. $herefore, the board should establish the strategies that will direct the ongoing activities of the bank. It should also take the lead in establishing the ?tone at the topA and approving corporate values for itself, senior management and other employees. $he values should recogni4e the critical importance of having timely and frank discussions on problems. In particular, it is important that the values prohibit corruption and bribery in corporate activities, both in internal dealings and external transactions.

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$he board of directors should ensure that senior management implements policies that prohibit 8or strictly limit9 activities and relationships that diminish the >uality of corporate governance, such as5 conflicts of interestL lending to officers and employees and other forms of self3dealing 8e.g., internal lending should be limited to lending consistent with market terms and to certain types of loans, and reports of insider lending should be provided to the board, and be subject to review by internal and external auditors9L and providing preferential treatment to related parties and other favoured entities 8e.g., lending on highly favourable terms, covering trading losses, waiving commissions9. /rohibiting insider trading based on knowledge of sensitive information before it becomes public knowledge. /rocesses should be established that allow the board to monitor compliance with these policies and ensure that deviations are reported to an appropriate level of management, if need be escalated to "oard level. !n the practice of setting and enforcing clear lines of responsibility and accountability throughout the organi4ation, "asel Committee says that effective boards of directors clearly define the authorities and key responsibilities for themselves, as well as senior management. #uch boards also recogni4e that unspecified lines of accountability or confusing, multiple lines of responsibility might exacerbate a problem through slow or diluted responses. #enior management is responsible for creating an accountability hierarchy for the staff, but must be cogni4ant of the fact that they are ultimately responsible to the board for the performance of the bank.

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(egarding the practice of ensuring that board members are >ualified for their positions, have a clear understanding of their role in corporate governance and are not subject to undue influence from management or outside concerns, "asel Committee stipulates that the board of directors is ultimately responsible for the operations and financial soundness of the bank. $he board of directors must receive on timely basis sufficient information to judge the performance of management. 'n effective number of board members should be capable of exercising judgement, independent of the views of management, large shareholders or the government. Inclusion on the "oard, >ualified directors who are not members of the bank@s management, or having a supervisory board of auditors, separate from the management board, can enhance independence and objectivity. %oreover, such members can bring new perspectives from other businesses that may improve the strategic direction given to management, such as insight into local conditions. Oualified external directors can also become significant sources of management expertise in times of corporate stress. corrective actions. 'ccording to the Committee the "oards of directors add strength to the corporate governance of a bank when they5 0nderstand their oversight role and their ?duty of loyaltyA to the bank and its shareholdersL #erve as a ?checks and balancesA function vis3P3vis the day3to3day management of the bankL eel empowered to >uestion the management and are comfortable insisting upon straightforward explanations from managementL (ecommend sound practices gleaned from other situations /rovide dispassionate adviceL $he board of directors should periodically assess its own performance, determine where weaknesses exist and, where possible, take appropriate

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 're not overextendedL 'void conflicts of interest in their activities with, and commitments to, other organi4ationsL meet regularly with senior management and internal audit to establish and approve policies, establish communication lines and monitor progress toward corporate objectivesL 'bsent themselves from decisions when they are incapable of providing objective adviceL )o not participate in day3to3day management of the bank It is found that in a number of countries, bank boards have found it beneficial to establish certain speciali4ed committees. &et us look at a few of them5 Risk management committee: It provides oversight of the senior management@s activities in managing credit, market, li>uidity, operational, legal and other risks of the bank. 8$his role should include receiving from senior management periodic information on risk exposures and risk management activities9 Audit Committee: It provides oversight of the bank@s internal and external auditors, approving their appointment and dismissal, reviewing and approving audit scope and fre>uency, receiving the reports and ensuring that management is taking appropriate corrective actions in a timely manner to address control weaknesses, non3compliance with policies, laws and regulations, and other problems identified by auditors. $he independence of this committee can be enhanced when it is comprised of external board members that have banking or financial expertise. Compensation committee: It provides oversight of remuneration of senior management and other key personnel and ensuring that compensation is consistent with the bank@s culture, objectives, strategy and control environment

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 Nominations committee: It provides important assessment of board effectiveness and directing the process of renewing and replacing board members. 1ven in very small banks, key3management decisions should always be made by more than one person, which is known as ?four eyes principlesA. It is also necessary to put strict Gfirewalls between the persons involved in the frontline business taking risks and decisions, getting involved in framing policies or serving in any of the important set of committees like the 'udit committee. $he philosophy of the "oard must percolate to every employee in the organi4ation that the "oard is not unwilling to discipline successful or key employee when he goes wrong and the company do not fear losing such persons. $he scenario in the Indian banking situation is 3 several audits takes place continuously beginning with the statutory auditors, the internal auditors, the concurrent auditors 8who could be internal or external9 and occasionally audit from the C'G and ofcourse the regulatory oversight = inspection by the (eserve "ank of India under #ection -D of the "( 'ct. $here is also a risk rating of each bank on the C'%1& parameters and managements of the banks are called in for discussions with (egulators to express their concerns in certain areas. In respect of public banks, the majority is held by the government as such regulatory concerns are also periodically and confidentially shared with the government as well. !wnership and shareholding in /#0 "anks is actively under debate with the government desirous of having a golden share with special rights should it disinvest more than D+H of the shares sometime in future. (ecommendations of Narsimham Committee I Q II are relevant. In India, regulation of financial sector has evolved as a product of planned development where mobili4ation of savings and the corresponding investments are done through public sector at predetermined prices. $here is also tremendous belief that a sovereign guarantee is implicit in maintaining systemic stability and would protect all the depositors and participants. $he best example was the creation of 0nit $rust of India and the problems it went through, three years ago, and the relief packages which had to be
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worked out by the Government. $his also brings me to the >uestion of representation by the executives of the (eserve "ank on the "oards of "anks and the representation of Government of India representatives on the "ank "oards although, in the case of public sector bank, perhaps the government have rightfully claimed that they have every business to be on the "oard. $he owner has poured additional capital to clean up balance sheets of atleast three public sector "anks in the past through budgetary allocations. It is not beyond the realms of possibilities that the stand taken by these )irectors in the "oard %eetings significantly influence the decision making process at the "oard. *owever, when these institutions act as a regulator and also take other action as instrumentalities of the state, to my mind there is a clear conflict which needs to be resolved. I am aware there is no immediate solution and I am not too sure whether a compromise could be worked out by having eminent professionals as nominees in the transition period before totally exiting from the "oards when a stage could be visuali4ed to have truly independent directors. $here should be a management audit over the >uality of "oard deliberations which will bring out whether a domineering C1! has his own say or the )irectors of the "oard are able to moderate the decision making process. $his management audit assumes great importance. $he optimum si4e of a "oard is nowhere laid down, i.e., generally in between M R :; depending on the si4e of the corporates. #ome empirical studies have shown that between M R +; is an optimum number, for effective decision making. !ne is also reminded of an old comment attributed to the 'merican /resident 'braham &incoln in response to a rather cheeky >uestion on the ideal length of human legs5 the answer being GThey should be long enough to reach the ground and the adequacy is a function of the need and Company Boards are no exception. It is true that only a ?fit and properA person can be appointed as a )irector of a bank and very recently (eserve "ank has issued guidelines on this subject to which I made a brief reference already. It is very necessary that the )irectors seriously address themselves to
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the various risks that the bank faces particularly in their operations in the various types of businesses and to design proper risk mitigation measures and to adopt suitable measures for effective control so that the risk is mitigated. "anking, per3se, involves risk taking and one need not and should not be afraid of taking a decision as long as the "oard or the executive suitably empowered, ensures that you have recogni4ed the risk and taken the decision in transparent manner and the "oard is >uite competent to handle it and someone in the whole organi4ation, atleast one level above in hierarchy is kept informed of the exercise of discretion. It is true that the (eserve "ank of India acts as the (egulatory and #upervisory 'uthority over the "anking system in addition to its role as the %onetary 'uthority of the country and the "anker to the Government. $his last function can be separately identified from the other two. 1ven in the area of supervision it takes the assistance of N'"'() which has been empowered to do the supervision over Cooperative institutions. It also seems that apex authorities like N'"'(), #I)"I and I)"I and even #tate inancial Corporations all compete for business and some of them are also involved in the process of supervision and regulation and the position of # Cs and Cooperatives is in a rather poor shape to say it mildly. It is also well known that when certain financial parameters are breached, like the well known trigger points, action is taken immediately to put the bank on proper monitoring till such time it improves. )espite all these changes and a better appreciation of each other@s affairs, it is true there have been serious problems in some "anks and also in Cooperative banks both )CC"s Q 0rban "anks. $he time to make a judgmental call in placing a bank under moratorium and subse>uently merging it with another stronger bank or li>uidating is not an easy decision. riends, it brings me to the most painful subject of governance in the cooperative banking sector. I had spoken on an earlier occasion in Nuly :;;:, on this very same subject where because of these institutions reporting both to the (egistrar of Cooperative societies and to the (eserve "ank of India there have been cases
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of regulatory arbitrage. It is also widely known that in Cooperative banks the general principle of governance of collective decision making is not always followed resulting in related parties being shown special favours, accumulation of non performing assets 8N/'9, loss of profit by bidding for deposits at excessive rates and weak and inade>uate action where re>uired by the respective state governments have all contributed to the sad scene. #ome other district cooperative banks have lost moneys in the so called investments of purchasing government securities to meet the #&( re>uirements. It is a nightmare to entrust (s.+;; crores to a broker, who neither delivers the scrips purchased nor renders an account for the purchases. $hese "oards have come to be known euphemistically as ?"orrower driven "oardsA. 0nfortunately, in such banks there is no one to represent the poor depositor, whose deposits are leveraged for lending. I would not like to go into a host of other delicate and sensitive issues but, I would only reiterate that (egulators may be looked upon as external pressure points for good corporate governance, who must act decisively in public interest. )isclosure and transparency are also very important so that all the stockholders can judge the strength and weaknesses of a bank. Collective decision making by ?fit and properA professional directors and last but not least, as all credit institutions are linked to each other through a complex chain of inter3bank relationships which R as recent instances have showed R in any event of difficulty, become mechanisms for spread of the Gcontagion@ effect has to be arrested at the earliest. 7ulnerable in this chain is default in payment systems and clearing facilities. ($G# reduces this risk largely. Cooperative banks were built on human capital and did exceedingly well for about +;; years. Its time to introspect and see how the lost luster can be regained using the tool of corporate governance, risk management etc., and also bringing about legislative changes so that a single (egulator regulates a financial entity or corporate entity to prevent regulatory arbitraging. I strongly believe, #tate Governments must not hesitate to take strict action where warranted against the )CC"s rather than mild or no action being taken and also reconcile to a single (egulator even if it meant losing a part of the turf and power to the ("I. %essage to politicians is clear,

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keep off from the financial institutions like )CC"s and 'pex Cooperative "anks. $he regulator, however, cannot be expected to micromanage the regulated institutions. &et me now go back to the )r. Ganguly Group@s (eport submitted in 'pril :;;: and placed at ("I@s website for comments. "anks were advised to place the report to their "oards to adopt the decisions constrained therein, some of which re>uired legislative changes have been referred to the Government of India. In view of its importance, the same is placed at 'nnexure I7. $his read together with #1"I guidelines that is placed at 'nnexure 7 to my speech form anchor documents and efforts are underway by ("I for harmoni4ing them. $hus, it is the collective wisdom of eminent professionals serving on the "oards of the financial institutions, which can further enhance corporate governance. I am afraid this search for improvement is not limited by time or geographical location. It would continue forever and it is only hoped that scamsters are brought to justice sooner than later. $here is an entire subject called Gwhistle blowing@ and there is enormous literature on this subject. 2hen to blow the whistleS 2ho should blow the whistleS 'nd where should the whistle be heardS $hese are the >uestions for which one need to find the answers between spate of anonymous letters to which any one working in public sectors is used to and often honest officials harassed on one side and damaging investigative audit reports and doctored "alance sheets on the other side. #omewhere in between lies the governance and ethics and standards set up by virtuous men heading institutions. In such institutions the reputation of the organi4ation and the leader go hand in hand. In such organi4ations the shareholders and other stakeholders truly derive their value. It is myopic bordering on foolishness to look for astronomical return by the shareholders to allow the "oards to indulge in unethical practices like market rigging, insider trading, speculation and host of other irregular practices for making huge profits. !ne cannot argue that the shareholders value is enhanced and higher profits and dividends are distributed, the "oard acting as agent of the shareholder being the principal is justified in
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acting on such a mandate. *ere lies the real test of governance of the "oards walking the well defined, honest and straight path in conducting the affairs in the re>uired atmosphere of transparency, seen and perceived by all the stakeholders and the markets and (egulators. $hen only can one confidently state that corporate governance has taken firm roots in the countries. "efore I conclude, I must raise one or two issues, while the regulatory policy has become sharper and more transparent in recent years and new techni>ues like offsite monitoring and differential approaches to the various segments in the "anking sector, one must recogni4e that mere regulation does not imply that there would be no risk of failure or insolvency of a regulated unit. (ecent collapse of 0rban "anks and problems with G$", %%C" etc, prove my statement. (egulation and surveillance cannot be a substitute for corporate governance in the "oard rooms of the "anks. In this country ("I as a (egulator, does not charge a fee for the regulation and supervision it does over banks. I am aware in some countries, (egulator does levy such a charge. 2hatever be the route adopted, the depositors and the investors must recogni4e that it is much their duty to do some due diligence before they place their savings in any institution. *uman nature being what it is, frauds do get perpetrated and it is the internal systems which should throw them up as >uickly as possible and money retrieved. Fero tolerance should be the goal for frauds. I firmly believe that it is the individuals who make a difference who are aware of the constantly changing goals but do not compromise upon their own self3driven values, which over a life time get refined and are not mere statements of pious declarations. Cadbury has concluded that the companies which have been successful over the long time, generally follow high standards of corporate governance and none of them were involved in corporate disasters or scams so long as they adhere to this observance. $he certainty is, those who take risks of frauds and bet on high stakes for rewards, surely come to grief.

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I come to the last point, whether India should follow model of 0. in having a single financial (egulator or the present model can continueS $his can be debated and e>ual number of reasons can be said on both the sides but what is important is to avoid a regulatory arbitrage to which I referred earlier in my speech which perhaps a single (egulator can achieve, and it could respond more >uickly and effectively to developments in the markets. In 0# there are multiple (egulators who are accountable to )IC, ederal (eserve and the #tate authorities. ortunately in India, we have four (egulators R ("I, #1"I, I()' and the #ecretary inance, Government of India, working in close coordination. !ver a period of time perhaps, different models will evolve. It was a very illuminating experience that the first three (egulators shared a platform at I)("$, *yderabad and explained the intricate relationship each has with the other and how through the high level Committees they have been coordinating the affairs in good times and crises times. $his model has served us well. $hank you for your patient hearing,

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Institute for Development and Research in Banking Technology

ANN !"R #
Annexur e I$ II. III$ I7. Title Page Cadbury Code of "est /ractices Corporate Governance in the 0#, 0., 'ustralia and NF5 ' Comparison G it and /roper@ Criteria for )irectors of "anks &ist of recommendations of the Consultative Group of )irectors of banks and financial institutions 8)r. Ganguly Group9 #ummary of the important (ecommendations of the #1"I@s Committee on Corporate Governance + D +-

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ANN !"R & I

Cad'ury Code of Best (ractices $he Cadbury Code of "est practices had +, recommendations. $he

recommendations are in the nature of guidelines relating to "oard of )irectors, Non3executive )irectors, 1xecutive )irectors and those on (eporting and Control. (elating to the "oard of )irectors these are5 $he "oard should meet regularly retain full and effective control over the company and monitor the executive management $here should be a clearly accepted division of responsibilities at the head of a company, which will ensure balance of power and authority, such that no individual has unfettered powers of decision. In companies where the Chairman is also the Chief 1xecutive, it is essential that there should be a strong and independent element on the "oard, with a recogni4ed senior member. $he "oard should include non3executive )irectors of sufficient caliber and number for their views to carry significant weight in the "oard@s decisions. $he "oard should have a formal schedule of matters specifically reserved to it for decisions to ensure that the direction and control of the company is firmly in its hands.

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 $here should be an agreed procedure for )irectors in the furtherance of their duties to take independent professional advice if necessary, at the company@s expense. 'll directors should have access to the advice and services of the Company #ecretary, who is responsible to the "oard for ensuring that "oard procedures are followed and that applicable rules and regulations are complied with. 'ny >uestion of the removal of Company #ecretary should be a matter for the "oard as a whole. (elating to the Non31xecutive )irectors the recommendations are5 Non3executive )irectors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct. $he majority should be independent of the management and free from any business or other relationship, which could materially interfere with the exercise of their independent judgement, apart form their fees and shareholding. $heir fees should reflect the time, which they commit to the company. Non3executive )irectors should be appointed for specified terms and reappointment should not be automatic. Non3executive )irectors should be selected through a formal process and both, this process and their appointment, should be a matter for the "oard as a whole.

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or the 1xecutive )irectors the recommendations in the Cadbury Code of "est /ractices are5 )irector@s service contracts should not exceed three years without shareholders@ approval $here should be full and clear disclosure of their total emoluments and those of the Chairman and the highest3paid 0. )irectors, including pension contributions and stock options. #eparate figures should be given for salary and performance3related elements and the basis on which performance is measured should be explained. 1xecutive )irectors@ pay should be subject to the recommendations of a (emuneration Committee made up wholly or mainly of Non3executive )irectors. 'nd on (eporting and Controls the Cadbury Code of "est /ractices stipulate that5 It is the "oard@s duty to present a balanced and understandable assessment of the company@s position. $he "oard should ensure that an objective and professional relationship is maintained with the 'uditors. $he "oard should establish an 'udit Committee of at least three Non3 executive )irectors with written terms of reference, which deal clearly with its authority and duties.

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 $he )irectors should explain their responsibility for preparing the accounts next to a statement by the 'uditors about their reporting responsibilities. $he )irectors should report on the effectiveness of the company@s system of internal control $he )irectors should report that the business is a going concern, with supporting assumptions or >ualifications as necessary.

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ANN !"R ) III *+it and (roper, Criteria for Directors of Banks
In exercise of the powers conferred by #ection -D' of the "anking (egulation 'ct, +,<, and on being satisfied that it is necessary and expedient in public interest so to do, the (eserve "ank of India 8Circular )"!).No."C.+;<=;E.+-,.;;+=:;;-3;< dated Nune :D, :;;<9 hereby directs, with immediate effect that5

8i9

the banks in private sector should undertake a process of due diligence to determine the suitability of the person for appointment = continuing to hold appointment as a director on the "oard, based upon >ualification, expertise, track record, integrity and other fit and proper criteria. "anks should obtain necessary information and declaration from the proposed = existing directors for the purpose.

8ii9 8iii9 8iv9

the process of due diligence should be undertaken by the banks in private sector at the time of appointment = renewal of appointment. the boards of the banks in private sector should constitute Nomination Committees to scrutini4e the declarations. based on the information provided in the signed declaration, Nomination Committees should decide on the acceptance and may make references, where considered necessary to the appropriate authority = persons, to ensure their compliance with the re>uirements indicated.

8v9

banks should obtain annually a simple declaration that the information already provided has not undergone change and where there is any change, re>uisite details are furnished by the directors forthwith.
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8vi9

the board of the bank must ensure in public interest that nominated = elected directors execute the deeds of covenants as recommended by )r. Ganguly Group every year.

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ANN !"R ) I% &ist of recommendations of the Consultative Group of )irectors of banks and financial institutions 8)r. Ganguly Group9 which may be considered by banks for adoption and Implementation

A$ Recommendations hich ma!"e Implemented "! all "anks -i. Responsi'ilities of the Board of Directors 8a9 ' strong corporate board, should fulfill the following four major roles vi4. overseeing the risk profile of the bank, monitoring the integrity of its, business and control mechanisms, ensuring the expert management and maximising the interests of its stakeholders. 8b9 $he "oard of )irectors should ensure that responsibilities of directors are well defined and every director should be familiarised on the functioning of the bank before his induction, covering the following essential areas5 delegation of powers to various authorities by the "oard, strategic plan of the institution organisational structure financial and other controls and systems economic features of the market and competitive environment. -ii. Role and responsi'ility of independent and non&e/ecutive directors 8a9 $he independent # non3executive directors have a prominent role in

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inducting and sustaining a pro3active governance framework in banks. 8b9 In order to familiarise the independent =non3executive directors with the environment of the bank, banks may circulate among the new directors a brief note on the profile of the bank, the sub committees of the "oard, their role, details on delegation of powers, the profiles of the top executives etc. 8c9 It would be desirable for the banks to take an undertaking from each independent and non3executive director to the effect that he=she, has gone through the guidelines defining the role and responsibilities and enter into covenant to discharge his=her responsibilities to the best of their abilities, individually and collectively. -iii. Training facilities for directors 8a9 Need3based taming programmes = seminars = workshops may be designed by banks to ac>uaint their directors with emerging developments=challenges facing the banking sector and participation in such programmes could make the directors more sensitive to their role. 8b9 $he "oard should ensure that the directors are exposed to the latest managerial techni>ues, technological developments in banks, and financial markets, risk management systems etc. so as to discharge their duties to the best of their abilities. 8c9 2hile ("I can offer certain training programmes=seminars in this regard at its training establishments, large banks may conduct such programmes in their own training centres.

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-iv. #u'mission of routine information to the Board (eviews dealing with various performance areas may be put up to the %anagement Committee of the "oard and only a summary on each of the reviews may be put up to the "oard of directors at periodic intervals. $his will provide the "oard more time to concentrate on more strategic issues such as risk profile, internal control systems, overall performance of the bank. etc. -v. Agenda and minutes of the 'oard meeting 8a9 $he draft minutes of the meeting should be forwarded to the, directors, preferably via the electronic media, within <E hours of the meeting and ratification obtained from the directors within a definite time frame. $he directors may be provided with necessary technology assistance towards this end. 8b9 $he "oard should review the status of the action taken on points arising from the earlier meetings till action is completed to the satisfaction of the "oard, and any pending item should be continued to be put up as part of the agenda items before the "oard. -vi. Committees of the Board -a. #hareholders, Redressal Committee 's communicated to banks in our circular )"!) No.+++=;E.+-E.;;+=:;;+3;: dated Nune <, :;;: on #1"I Committee on Corporate Governance, the banks which have issued shares=debentures to public may form a committee under the chairmanship of a non3executive director to look into redressal of shareholders@
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complaints. -'. Risk 0anagement Committee In pursuance of the (isk %anagement Guidelines issued by the (eserve "ank of India in !ctober +,,,, every banking organisation is re>uired to set up (isk %anagement Committee. $he formation and operationalisation of such committee should be speeded up and their role further strengthened. -c. #upervisory Committee $he role and responsibilities of the #upervisory Committee as envisaged by the Group vi4., monitoring of the exposures 8both credit and investment9 of the bank, review of the ade>uacy of the risk management process and upgradation thereof, internal control system, ensuring compliance with the statutory = regulatory framework etc., may be assigned to the %anagement Committee = 1xecutive Committee of the "oard. -vii. Disclosure and transparency $he following disclosures should be made by banks to the "oard of )irectors at regular intervals as may be prescribed by the "oard in this regard. progress made in putting in place a progressive risk management system, and risk management policy and strategy followed by the bank. exposures to related entities of the bank, vi4. details of lending to = investment in subsidiaries, the asset classification of such lending=investment, etc. conformity with corporate governance standards vi4. in composition of

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various committees, their role and functions, periodicity of the meetings and compliance with coverage and review functions etc. $% Recommendations applica"le onl! &u"lic sector "anks -i. Information flo1 In order to improve manner in which the proceedings are recorded and followed up in public sector banks, they may initiate measures to provide the following information to the board5 ' summary of key observations made by the directors, which should be submitted, in the next board meeting. ' more detailed recording of the proceedings which will clearly bring out the observations, dissents, etc. by the individual directors which could be forwarded to them for their confirmation. -ii. Company #ecretary $he Company #ecretary has important fiduciary and Company &aw responsibilities. $he Company #ecretary is the nodal point for the "oard to get feedback on the status of compliance by the organi4ation in regard to provisions of the Company &aw, listing agreements, #1"I regulations, shareholder grievances, etc. In view of the important role performed by the Company #ecretary vis3P3vis the functioning of the "oards of the banks, as also in the context of some of the public sector banks having made public issue it may be necessary to have Company #ecretary for these banks also. "anks should

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therefore consider appointing >ualified Company #ecretary as the #ecretary to3 the "oard and have a Compliance !fficer 8reporting to the #ecretary9 for ensuring compliance with various regulatory = accounting re>uirements. C% Recommendations applica"le to private sector "anks -i. ligi'ility criteria and *fit and proper, norms for nomination of

directors$ 8a9 $he "oard of )irectors of the banks while nominating = co3opting directors should be guided by certain broad Gfit and proper@ norms for directors, vi4. formal >ualification, experience, track record, integrity etc. or assessing integrity and suitability features like criminal records, financial position, civil actions initiated to pursue personal debts, refusal of admission to or expulsion from professional bodies, sanctions applied by regulators or similar bodies, previous >uestionable business practices etc should be considered. $he "oard of )irectors may, therefore, evolve appropriate systems for ensuring Gfit and proper@ norms for directors, which may include calling for information by way of selfTdeclaration, verification reports from market, etc. 8b9 $he following criteria, which is in vogue in respect of nomination to the boards of public sector banks, may also be followed for nominating independent = non3executive directors on private sector banks5 $he candidate should normally be a graduate 8which can be relaxed while selecting directors for the categories of farmers, depositors, artisans, etc.9

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 *e = she should be between -D and ID years of age. *e = she should not be a %ember of /arliament = %ember of &egislative 'ssembly = %ember of &egislative Council. -ii. Commonality of directors of 'anks and non&'anking finance

companies -NB+C. In case, a director on the board of an N" C is to be considered for appointment as director on the board of the bank, the following conditions must be followed5 *e=she is not the owner of the N" C, Ji.e., share holdings 8single or jointly with relatives, associates, etc.9 should not exceed D;HK, *e=she is not related to the promoter of the N" C *e=she is not a full3time employee in the N" C. $he concerned N" C is not a borrower of the bank. -iii. Composition of the Board In the context of banking becoming more complex and competitive, the composition of the "oard should be commensurate with the business needs of the banks. $here is an urgent need for making the "oards of banks more contemporarily professional by inducting technical and specially >ualified personnel. 1fforts should be aimed at bringing about a blend of Ghistorical skills@ set, i.e. regulation based representation of sectors like agriculture, ##I, cooperation etc. and the Gnew skills@ set, i.e. need based representation of skills such as, marketing, technology and systems, risk management, strategic planning, treasury operations, credit recovery etc. $he above suggestions may
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be kept in view while electing = co3opting directors to their boards.

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ANN !"R & % #ummary of the important Recommendations of the # BI,s Committee on Corporate Governance $he #ecurities and 1xchange "oard of India 8#1"I9 had constituted a Committee on Corporate Governance and circulated the recommendations to all stock exchanges for implementation by listed entities as part of the listing agreement vide #1"I@s circular #%)(/=/olicy=CI(3+;=:;;; dated the above circular can be had ' by access to of #1"I@s the ebruary website, important :+, :;;;. ull text of recommendations of the Committee which form part of www.sebi.gov.in=circulars=:;;;. here under5 +.+. +.:. 'll pecuniary relationship or transactions of the non3executive directors should be disclosed in the annual report. $he Committee is of the view that non3executive directors help bring an independent judgement to bear on board@s deliberations, especially on issues of strategy, performance, management of conflicts and standards of conduct. $he Committee therefore lays emphasis on the calibre of the non3executive directors, especially of the independent directors. +.-. $he Committee is of the view that it is important that an ade>uate compensation package be given to the non3executive independent directors so that these positions become sufficiently financially attractive to attract talent and that the non3executive directors are sufficiently compensated for undertaking this work. summary

recommendations of the #1"I Committee as applicable to banks is furnished

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$he Committee recommends that the board of a company have an optimum combination of executive and non3executive directors with not less than fifty per cent of the board comprising the non3executive directors. $he number of independent directors depends on the nature of the chairman of the board. In case a company has a non3executive chairman, at least half of board should be independent 8%andatory recommendation9.

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$he Committee recommends that when a nominee of the institutions is appointed as a director of the company, he should have the same responsibility, be subject to the same discipline and be accountable to the shareholders in the same manner as any other director of the company. In particular, if he reports to any department of the institutions on the affairs of the company, the institution should ensure that there exist Chinese walls between such department and other department which may be dealing in the shares of the company in the stock market.

-.+ $he Committee recommends that a non3executive Chairman should be entitled to maintain a Chairman@s office at the company@s expense and also allowed reimbursement of expenses incurred in performance of his duties. $his will enable him to discharge the responsibilities effectively. <.+$he Committee recommends that a >ualified and independent audit committee should be set up by the board of a company 8%andatory recommendation9

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$he Committee recommends that 3 the audit committee should have a minimum of three members, all being non3executive directors, with the majority being independent and with at least one director having financial and accounting knowledgeL the chairman of the committee should be an independent directorL the chairman should be present at the 'nnual General %eeting to answer shareholder >ueriesL the audit committee should invite such of the executives, as it considers appropriate 8and particularly the head of the finance function9 to be present at the meetings of the Committee but on occasions it may also meet without the presence of any executives of the company. $he finance director and head of internal audit and when re>uired, a representative of the external auditor should be present as invitees for the meetings of the audit committeeL the Company #ecretary should act as the secretary to the committee.

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$he Committee recommends that the audit committee should meet at least thrice a year. !ne meeting must be held before finalisation of annual accounts and one necessarily every six months 8%andatory recommendation9.

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$he >uorum should be either two members or one3third of the members of the audit committee, whichever is higher and there should be a minimum of two independent directors 8%andatory recommendation9.

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"eing a committee of the board, the audit committee derives its powers from the authori4ation of the board. $he Committee recommends that such powers should include powers5 +. :. -. <. $o investigate any activity within its terms of reference. $o seek information from any employee. $o obtain outside legal or other professional advice. $o secure attendance of outsiders with relevant expertise, if it considers necessary.

<.I 's the audit committee acts as the bridge between the board, the statutory auditors and internal auditors, the Committee recommends that its role should include the following5 !versight of the company@s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible. (ecommending the appointment and removal of the external auditor, fixation of audit fee and also approval for payment for any other service. (eviewing with management the annual financial statements before submission to the board, focusing primarily on5 o 'ny changes in accounting policies and practices. o %ajor accounting entries based on exercise of judgement by management. o Oualifications in draft audit report.
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o #ignificant adjustment arising out of audit. o $he going concern assumption. o Compliance with accounting standards. o Compliance with stock exchange and legal re>uirement concerning financial institutions. o 'ny related party transactions i.e. transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives, etc., that may have potential conflict with the interests of company at large. (eviewing with the management, external and internal auditors, the ade>uacy of internal control systems. (eviewing the ade>uacy of the internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading the department, reporting structure, coverage and fre>uency of internal audit. )iscussion with the internal auditors of any significant findings and follow3up thereon. (eviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board. )iscussion with external auditors, before the audit commences, of the nature and scope of audit. 'lso post3audit discussion to ascertain any area of concern. (eviewing the company@s financial and risk management policies. &ooking into the reasons for substantial defaults in the payments to the
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depositors, debenture holders, shareholders 8in case of non3payment of declare dividends9 and creditors. $his is a mandatory recommendation. D.+ $he Committee recommends that the board should set up a remuneration committee to determine on their behalf and on behalf of the shareholders with agreed terms of reference, the company@s policy on specific remuneration packages for executive directors including pension rights and any compensation payment. I.+ $he Committee therefore recommends that board meetings should be held at least four times in a year, with a maximum time gap of four months between any two meetings. $he minimum information should be available to the board 8%andatory recommendation9. I.: $he committee recommends that a director should not be a member in more than +; committees or act as Chairman of more than five committees across all companies in which he is a director. urthermore, it is a mandatory annual re>uirement for every director to inform the company about the committee positions he occupies in other companies and notify changes as and when they take place 8%andatory recommendation9. M.+ $he recommendations contained in this section pertain to accounting standards on consolidation, segment reporting, disclosure and treatment of related party transactions and deferred taxation. $he Committee
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recommended that the Institute of Chartered 'ccountants of India issue accounting standards on these areas expeditiously. E.+ 's a part of the disclosure related to %anagement, the Committee recommends that as part of the directors@ report or as an addition thereto, a %anagement )iscussion and 'nalysis report should form part of the annual report to the shareholders 8%andatory recommendation9. E.: $he committee recommends that disclosures be made by management to the, board relating to all material financial and commercial transactions, where they have personal interest, that may have a potential conflict with the interest of the company at large 8for e.g. dealing in company shares, commercial dealings with bodies which have shareholding of management and their relatives etc. 8%andatory recommendation9. ,.+ $he Committee recommends that in case of the appointment of a new director or re3appointment of a director the shareholders must be provided with the following information5 ' brief resume of the directorL Nature of his expertise in specific financial areasL and Names of the companies in which the person also holds the directorship and the membership of Committees of the board. $his is a mandatory recommendation.

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$he Committee recommends that information like >uarterly results, presentation made by companies to analysts may be put on company@s website Ir may be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own website 8%andatory recommendation9.

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$he Committee recommends that the half3yearly declaration of financial performance including summary of the significant events in last six months, should be sent to each household of shareholders.

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$he Committee recommends that a board committee under the chairmanship of a non3executive director should be formed to specifically look into the redressing of shareholder complaints like transfer of shares, non3receipt of balance sheet, non3receipt of declared dividends etc. $he Committee believes that the formation of such a committee will help focus the attention of the company on shareholders@ grievances and sensiti4e the management to redressal of their grievances 8%andatory recommendation9.

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$he Committee further recommends that to expedite the process of share transfers the board of the company should delegate the power of share transfer to an officer, or a committee or to the registrar and share transfer agents. $he delegated authority should attend to share transfer formalities at least once in a fortnight 8%andatory recommendation9.

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$he Committee recommends that there should be a separate section on

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Corporate Governance in the annual reports of companies, with a detailed compliance report on Corporate Governance. Non3compliance of any mandatory recommendation with reasons thereof and the extent to which the non3mandatory recommendations have been adopted should be specifically highlighted. $his will enable the shareholders and the securities market to assess for themselves the standards of corporate governance followed by a company. 8%andatory recommendation9.

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