Institute for Development and Research in Banking Technology

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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 Financial
Institutions. One way or the other, in the later part of my career I have been on the
Boards of the State Bank of Travancore, State Bank of India, SBI Capital Markets, SBI
Mauritius, SBI Toronto, SBI Life and SBI Cards, NABARD, NHB and Reserve Bank of
India, all of which gave me an opportunity to practice corporate governance as I
understood from the Board Room practices. By a freak coincidence of circumstances in
1993, I chaired an Annual General Meeting of a listed company from Hyderbad as an
institution nominee, as the Chairman could not reach to attend the meeting. Recent
history is replete with examples of scams and frauds hitting the headlines every now and
then. If in India, we had Harshad Mehta, C.R. Bhansali, Ketan Parekh, advanced
countries like US and Europe were no way behind with their scams of the famous Enron,
WorldCom and many more. There is thus, a growing concern world over for the
Governments, Regulators of Stock Exchanges, Banks, in particular Central Banks and
other Financial 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 mid-sized 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 relevant:

Lecture delivered by Shri Vepa Kamesam, Chairman, Governing Council, Institute for Development and Research
in Banking Technology (IDRBT), Hyderabad to the students of the BABL (Hons.) Course at NALSAR University
of Law, Hyderabad on 31st August, 2004. Speaker greatly acknowledges to various references, OECD publications,
BIS Reviews and other documents and press releases of RBI, SEBI etc. The opinions / views expressed in this
speech are that of the author.
1. I would like to quote an Economist and Noble laureate Milton Friedman. According
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 customs”

2. According to Sir Adrian Cadbury, “Corporate Governance is the system by which

companies are directed and controlled……
……to do with Power and Accountability: who exercises power, on behalf of whom,
how the exercise of power is controlled.”
3. According to OECD the Corporate Governance structure specifies the distribution of
rights and responsibilities among different participants in the corporation, such as, the
Board, managers, shareholders and other stakeholders spells out the rules and
procedures for making decisions on corporate affairs.
4. Yet another definition is “Corporate Governance is about promoting corporate
fairness, transparency and accountability.”

For convenience, I am summarizing the Cadbury Code of Best Practices (Annexure I)

and I feel the 19 points listed therein are of great relevance today which has been made
an essential condition for the listing rules in the London Stock Exchange and the
compliance is mandatory for UK based companies.

Recent Developments in USA:

History continues to tick and Sarbanes-Oxley Act of the US was a serious wake-up call.
There has been a great debate and equally vehement protests on some of the provisions in
the said Act. Nevertheless, it is a call to get back to fundamentals and it identifies 58
separate provisions that affect internal auditing and the question of the Directors of the
Boards 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 Sarbanes-
Oxley Act and compare them with the positions prevailing in other advanced countries
and in India. Recent efforts have been made by proposing a set of sweeping changes to
the Company Law in this country which is still under debate and not yet legislated. In
UK, Australia, and New Zealand, principles of good governance and Code of Best
Practices have been brought into observance. I have placed at Annexure II the
comparative position of regulations which was published in an article by Minter Ellison:
“Corporate Governance in the US, UK, Australia and New Zealand: A Comparison”,
February 2003. I am tempted to quote some of the important extracts from the BIS
review of 2003.

• The message for boards of directors is: Uphold your responsibility for ensuring the
effectiveness of the company’s overall governance process.
• The message for audit committees is: Uphold your responsibility for ensuring that
the company’s internal and external audit processes are rigorous and effective.
• The message for CEOs, CFOs, and the senior management is : Uphold your
responsibility to maintain effective financial reporting and disclosure controls and
adhere to high ethical standards. This requires meaningful certifications, codes of
ethics, and conduct of insiders that, if violated, will result in fines and criminal
penalties, including imprisonment.
• The message for external auditors is: Focus your efforts solely on auditing
financial statements and leave the add-on services to other consultants
• The message for internal auditors is: You are uniquely positioned within the
company to ensure that its corporate governance, financial reporting and
disclosure controls, and risk management practices are functioning effectively.
Although internal auditors are not specifically mentioned in the Sarbanes-Oxley
Act, they have within their purview of internal control the responsibility to

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 examine and evaluate all of an entity’s systems, processes, operations, functions
and activities.

Thus, the role of the internal auditor has substantially got escalated and the external
auditor perhaps took a back seat. However, a specific section of Sarbanes-Oxley Act
requires senior management to assess and report on the effectiveness of disclosure
controls and procedures as well as on internal controls for financial reporting. All of
these have to be in the public disclosure domain of the reports but outside the financial
statements. There 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. Further an
internal auditor must have the highest ethics and be willing to sacrifice everything
(consultation assignments) to maintain their independence within the auditing company.
If there are different sections of companies, which offer turn-key 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. Some of the
provisions in the Act are quite 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 Board and as
such all those Directors of Boards who choose to ignore this valuable advice, would, in
my opinion be consigned to the dust bin of history. Complex collapses, ponzi schemes,
misfeasance and malfeasance of staggering proportions by executive directors, auditors
failing in their duties, call for tough Regulatory responses like the above Act and related
rules introduced and interpreted by Securities and Exchange Commission in USA.

Even in United States where the Laws have progressively been tightened, there have been
umpteen instances of Board room dramas and part of their stories which keep filtering
and the very same ‘corporate governance’ has been used as a shield to protect some of the
erring Board 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 Board Directors
become ‘rubber stamps’ for management and stifle dissent and run away from fixing
accountability, where called for. Classic case of collapse of Enron, an energy producing
company indulging in a web of derivative transactions by creating SPV companies and
their senior executives running them and investing in them and being excessively
remunerated (all without the knowledge of Board of Enron). Only three US financial
analysts out of 15 or so, could sense three days in advance before Enron went bankrupt
that the company was sinking.

Indian Situation:

In this country we have followed the UK model. It is true that Audit Committees,
Managing Committees and Remuneration Committees have all come into existence and
the recommendations of Kumara Mangalam Birla are followed. The roles of a Company
with a combination of both Non-Executive and Executive Directors with atleast 50%
comprising non-executive Directors is important. I presume the hidden message is, this
50% would really be so-called ‘independent 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 Audit Committee is chaired by a qualified
independent Director, preferably a Chartered Accountant and the members of the Audit
Committee are invariably non-executive independent Directors. Senior executives like
the CFO of the Companies are invited as special invitees to the Audit Committee
meetings so that, discussions are held in a totally free atmosphere. As you are aware, the
independent Directors apart from receiving the Director’s remuneration (sitting fees) do
not have any pecuniary relationship or transactions with the company. The Audit
Committee has wide powers and also looks into the compliances with Accounting
Standards and all the regular compliances like the Stock Exchange, legal requirements
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 sub-committee of the Board, which looks at these aspects and ensures that the
compliances filed to the stock exchange are truthful and factual. Publication of quarterly
and half-yearly results of the company, apart from the annual results after being vetted by
the Audit Committee is now a well established practice. What perhaps is missing in the
Indian situation at the present moment is the equivalent legislation, inline with the
Sarbanes-Oxley Act. I do hope that the changes to the Company Law now suggested in
the public domain and which is under debate would bring about a better level of
corporate governance. The Institute of Chartered Accountants of India has set up quite
rigid Accounting Standards to be followed. I refer to my earlier comment about family
controlled companies reluctant to recognize the clear separation of the role of the
promoters, executive functionaries and other non-executive 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. Yet another aberration is pyramidical structures by layered investments and cross
holdings going unnoticed. There 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. Residents of Hyderabad have fresh
memories of GTB episode, the moratorium and the subsequent merger with OBC.

Broadly, the financial sector can be divided into following:

 Term-Lending Institutions, governed by the Companies Act or Special Acts of

Parliament.

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  Banks [public sector, private sector (old and new generation banks, Cooperative
Banks)] governed by Special Acts or BR Act.
 Finance companies also known as non-banking financial companies governed by
Companies Act and guidelines issued by RBI and FCS.

The Basel Committee in the year 1999, had brought out certain important principles on
corporate governance for banking organizations which, more or less have been adopted in
India.

Basel committee underscores the need for banks to set strategies for their operations. The
committee also insists banks to establish accountability for executing these strategies.
Unless there is transparency of information related to decisions and actions, it would be
difficult for stakeholders to make managements accountable. The underlying theme is
accountability at all levels including the Boards.

From 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. This is
determined by how banks:

• set corporate objectives (including generating economic returns to owners);

• run the day-to-day operations of the business and;
• consider the interests of recognized 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
regulations; and ofcourse protect the interests of depositors, which is supreme.

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You may be aware that the Committee has issued several papers on specific topics, where
the importance of corporate governance is emphasized. These include Principles for the
management of interest rate risk (September 1997), Framework for internal control
systems in banking organizations (September 1998), Enhancing bank transparency
(September 1998), and Principles for the management of credit risk (issued as a
consultative document in July 1999). These papers have highlighted the fact that sound
corporate governance should have, as its basis, the following strategies and techniques:

• the corporate values, codes of conduct and other standards of appropriate

behaviour and the system used to ensure compliance with them;
• a well-articulated corporate strategy against which the success of the overall
enterprise and the contribution of individuals can be measured;
• the clear assignment of responsibilities and decision-making authorities,
incorporating an hierarchy of required approvals from individuals to the board of
directors;
• establishment of a mechanism for the interaction and cooperation among the board
of directors, senior management and the auditors;
• strong internal control systems, including internal and external audit functions,
risk management functions independent of business lines, and other checks and
balances;
• 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 decision-makers within
the firm (e.g. traders);
• 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 recognition; and
• appropriate information flows internally and to the public

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For ensuring good corporate governance, the importance of overseeing the various
aspects of the corporate functioning needs to be properly understood, appreciated and
implemented.

There are four important aspects of oversight that should be included in the
organizational structure of any bank in order to ensure the appropriate checks and
balances:
(1) oversight by the board of directors or supervisory board;
(2) oversight by individuals not involved in the day-to-day running of the various
business areas;
(3) direct line supervision of different business areas; and
(4) independent risk management and audit functions.

In addition to these, it is important that the key personnel are “fit and proper” for their
jobs. The latest directive issued by RBI on 25th June, under section 35A of the BR Act is
very important. A copy of issued directive is placed at Annexure III. Certain criteria
must be fulfilled by persons aspiring to become Directors of Banks and due diligence
must be done in this regard. In future, Directors must also execute covenants binding
themselves to discharge the duties, rules individually and collectively. Qualification,
track record, integrity and other ‘fit and proper’ norms, importantly duly filled in forms
must be scrutinized by Nomination Committees. In other words, getting nominated to
Boards through networking or questionable means would not become possible.

The supervisory experience of Regulators in general, in banks consider the following as

critical elements in the governance process:

• Establishing strategic objectives and a set of corporate values that are

communicated throughout the banking organization.

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 • Setting and enforcing clear lines of responsibility and accountability throughout
the organization.
• Ensuring that board members are qualified 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.
• Ensuring that there is appropriate oversight by senior management
• Effectively utilizing the work conducted by internal and external auditors, in
recognition of the important control functions they provide
• Ensuring that compensation approaches are consistent with the bank’s ethical
values, objectives, strategy and control environment.
• Conducting corporate governance in a transparent manner
• Ensuring an environment supportive of sound corporate governance.

I would like to discuss these practices in some detail, as dealt with by Basel Committee.

Regarding establishing strategic objectives and a set of corporate values that are
communicated throughout the banking organization, Basel Committee feels that it is
difficult to conduct the activities of an organization when there are no strategic objectives
or guiding corporate values. Therefore, 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 top” and approving corporate values for itself, senior management and other
employees. The values should recognize 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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The board of directors should ensure that senior management implements policies that
prohibit (or strictly limit) activities and relationships that diminish the quality of
corporate governance, such as:

• conflicts of interest;
• lending to officers and employees and other forms of self-dealing (e.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 auditors); and
• providing preferential treatment to related parties and other favoured entities (e.g.,
lending on highly favourable terms, covering trading losses, waiving
commissions).
• Prohibiting insider trading based on knowledge of sensitive information before it
becomes public knowledge.

Processes 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 Board level.

On the practice of setting and enforcing clear lines of responsibility and accountability
throughout the organization, Basel Committee says that effective boards of directors
clearly define the authorities and key responsibilities for themselves, as well as senior
management. Such boards also recognize that unspecified lines of accountability or
confusing, multiple lines of responsibility might exacerbate a problem through slow or
diluted responses. Senior management is responsible for creating an accountability
hierarchy for the staff, but must be cognizant of the fact that they are ultimately
responsible to the board for the performance of the bank.

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Regarding the practice of ensuring that board members are qualified 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, Basel Committee stipulates that
the board of directors is ultimately responsible for the operations and financial soundness
of the bank. The board of directors must receive on timely basis sufficient information to
judge the performance of management. An 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 Board, qualified 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. Moreover, such
members can bring new perspectives from other businesses that may improve the
strategic direction given to management, such as insight into local conditions. Qualified
external directors can also become significant sources of management expertise in times
of corporate stress. The board of directors should periodically assess its own
performance, determine where weaknesses exist and, where possible, take appropriate
corrective actions.

According to the Committee the Boards of directors add strength to the corporate
governance of a bank when they:

• Understand their oversight role and their “duty of loyalty” to the bank and its
shareholders;
• Serve as a “checks and balances” function vis-à-vis the day-to-day management of
the bank;
• Feel empowered to question the management and are comfortable insisting upon
straightforward explanations from management;
• Recommend sound practices gleaned from other situations
• Provide dispassionate advice;

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 • Are not overextended;
• Avoid conflicts of interest in their activities with, and commitments to, other
organizations; meet regularly with senior management and internal audit to
establish and approve policies, establish communication lines and monitor
progress toward corporate objectives;
• Absent themselves from decisions when they are incapable of providing objective
advice;
• Do not participate in day-to-day management of the bank

It is found that in a number of countries, bank boards have found it beneficial to establish
certain specialized committees. Let us look at a few of them:

• Risk management committee: It provides oversight of the senior management’s

activities in managing credit, market, liquidity, operational, legal and other risks of
the bank. (This role should include receiving from senior management periodic
information on risk exposures and risk management activities)
• Audit Committee: It provides oversight of the bank’s internal and external
auditors, approving their appointment and dismissal, reviewing and approving
audit scope and frequency, receiving the reports and ensuring that management is
taking appropriate corrective actions in a timely manner to address control
weaknesses, non-compliance with policies, laws and regulations, and other
problems identified by auditors. The 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.

Even in very small banks, key-management decisions should always be made by more
than one person, which is known as “four eyes principles”. It is also necessary to put
strict ‘firewalls’ 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 Audit committee. The philosophy of the Board must percolate to
every employee in the organization that the Board is not unwilling to discipline
successful or key employee when he goes wrong and the company do not fear losing such
persons. The scenario in the Indian banking situation is - several audits takes place
continuously beginning with the statutory auditors, the internal auditors, the concurrent
auditors (who could be internal or external) and occasionally audit from the CAG and
ofcourse the regulatory oversight / inspection by the Reserve Bank of India under Section
35 of the BR Act. There is also a risk rating of each bank on the CAMEL parameters and
managements of the banks are called in for discussions with Regulators 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. Ownership and shareholding in PSU Banks is actively
under debate with the government desirous of having a golden share with special rights
should it disinvest more than 51% of the shares sometime in future. Recommendations
of Narsimham Committee I & II are relevant.

In India, regulation of financial sector has evolved as a product of planned development

where mobilization of savings and the corresponding investments are done through
public sector at predetermined prices. There is also tremendous belief that a sovereign
guarantee is implicit in maintaining systemic stability and would protect all the depositors
and participants. The best example was the creation of Unit Trust 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. This also brings me to the question of representation by
the executives of the Reserve Bank on the Boards of Banks and the representation of
Government of India representatives on the Bank Boards although, in the case of public
sector bank, perhaps the government have rightfully claimed that they have every
business to be on the Board. The owner has poured additional capital to clean up balance
sheets of atleast three public sector Banks in the past through budgetary allocations. It is
not beyond the realms of possibilities that the stand taken by these Directors in the Board
Meetings significantly influence the decision making process at the Board. However,
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 Boards when a stage could be visualized to have truly
independent directors.

There should be a management audit over the quality of Board deliberations which will
bring out whether a domineering CEO has his own say or the Directors of the Board are
able to moderate the decision making process. This management audit assumes great
importance. The optimum size of a Board is nowhere laid down, i.e., generally in
between 7 – 20 depending on the size of the corporates. Some empirical studies have
shown that between 7 – 10 is an optimum number, for effective decision making. One is
also reminded of an old comment attributed to the American President Abraham Lincoln
in response to a rather cheeky question on the ideal length of human legs: the answer
being ‘They 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 proper” person can be appointed as a Director of a bank and
very recently Reserve Bank has issued guidelines on this subject to which I made a brief
reference already. It is very necessary that the Directors 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. Banking, per-se, involves risk taking
and one need not and should not be afraid of taking a decision as long as the Board or the
executive suitably empowered, ensures that you have recognized the risk and taken the
decision in transparent manner and the Board is quite competent to handle it and someone
in the whole organization, atleast one level above in hierarchy is kept informed of the
exercise of discretion.

It is true that the Reserve Bank of India acts as the Regulatory and Supervisory Authority
over the Banking system in addition to its role as the Monetary Authority of the country
and the Banker to the Government. This last function can be separately identified from
the other two. Even in the area of supervision it takes the assistance of NABARD which
has been empowered to do the supervision over Cooperative institutions. It also seems
that apex authorities like NABARD, SIDBI and IDBI and even State Financial
Corporations all compete for business and some of them are also involved in the process
of supervision and regulation and the position of SFCs 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. Despite all these changes and a better appreciation of each
other’s affairs, it is true there have been serious problems in some Banks and also in
Cooperative banks both DCCBs & Urban Banks. The time to make a judgmental call in
placing a bank under moratorium and subsequently merging it with another stronger bank
or liquidating is not an easy decision. Friends, it brings me to the most painful subject of
governance in the cooperative banking sector. I had spoken on an earlier occasion in July
2002, on this very same subject where because of these institutions reporting both to the
Registrar of Cooperative societies and to the Reserve Bank 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
(NPA), loss of profit by bidding for deposits at excessive rates and weak and inadequate
action where required by the respective state governments have all contributed to the sad
scene. Some other district cooperative banks have lost moneys in the so called
investments of purchasing government securities to meet the SLR requirements. It is a
nightmare to entrust Rs.100 crores to a broker, who neither delivers the scrips purchased
nor renders an account for the purchases. These Boards have come to be known
euphemistically as “Borrower driven Boards”. Unfortunately, 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 Regulators may be looked upon as external pressure points for good corporate
governance, who must act decisively in public interest. Disclosure 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 proper” professional directors and last but
not least, as all credit institutions are linked to each other through a complex chain of
inter-bank relationships which – as recent instances have showed – in any event of
difficulty, become mechanisms for spread of the ‘contagion’ effect has to be arrested at
the earliest. Vulnerable in this chain is default in payment systems and clearing facilities.
RTGS reduces this risk largely. Cooperative banks were built on human capital and did
exceedingly well for about 100 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 Regulator regulates a financial entity
or corporate entity to prevent regulatory arbitraging. I strongly believe, State
Governments must not hesitate to take strict action where warranted against the DCCBs
rather than mild or no action being taken and also reconcile to a single Regulator even if
it meant losing a part of the turf and power to the RBI. Message to politicians is clear,

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keep off from the financial institutions like DCCBs and Apex Cooperative Banks. The
regulator, however, cannot be expected to micromanage the regulated institutions.

Let me now go back to the Dr. Ganguly Group’s Report submitted in April 2002 and
placed at RBI’s website for comments. Banks were advised to place the report to their
Boards to adopt the decisions constrained therein, some of which required legislative
changes have been referred to the Government of India. In view of its importance, the
same is placed at Annexure IV. This read together with SEBI guidelines that is placed at
Annexure V to my speech form anchor documents and efforts are underway by RBI for
harmonizing them.

Thus, it is the collective wisdom of eminent professionals serving on the Boards 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. There is an entire subject called ‘whistle blowing’ and there is enormous literature
on this subject. When to blow the whistle? Who should blow the whistle? And where
should the whistle be heard? These are the questions 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 Balance sheets on the other side. Somewhere in between lies
the governance and ethics and standards set up by virtuous men heading institutions. In
such institutions the reputation of the organization and the leader go hand in hand. In
such organizations 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 Boards to indulge in unethical practices like market rigging, insider trading,
speculation and host of other irregular practices for making huge profits. One cannot
argue that the shareholders value is enhanced and higher profits and dividends are
distributed, the Board acting as agent of the shareholder being the principal is justified in

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acting on such a mandate. Here lies the real test of governance of the Boards walking the
well defined, honest and straight path in conducting the affairs in the required atmosphere
of transparency, seen and perceived by all the stakeholders and the markets and
Regulators. Then only can one confidently state that corporate governance has taken firm
roots in the countries.

Before I conclude, I must raise one or two issues, while the regulatory policy has become
sharper and more transparent in recent years and new techniques like offsite monitoring
and differential approaches to the various segments in the Banking sector, one must
recognize that mere regulation does not imply that there would be no risk of failure or
insolvency of a regulated unit. Recent collapse of Urban Banks and problems with GTB,
MMCB etc, prove my statement. Regulation and surveillance cannot be a substitute for
corporate governance in the Board rooms of the Banks. In this country RBI as a
Regulator, does not charge a fee for the regulation and supervision it does over banks. I
am aware in some countries, Regulator does levy such a charge. Whatever be the route
adopted, the depositors and the investors must recognize that it is much their duty to do
some due diligence before they place their savings in any institution. Human nature
being what it is, frauds do get perpetrated and it is the internal systems which should
throw them up as quickly as possible and money retrieved. Zero 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 self-driven
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. The certainty is, those who take risks of frauds and bet on high stakes for
rewards, surely come to grief.

19
I come to the last point, whether India should follow model of UK in having a single
financial Regulator or the present model can continue? This can be debated and equal
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
Regulator can achieve, and it could respond more quickly and effectively to
developments in the markets. In US there are multiple Regulators who are accountable to
FDIC, Federal Reserve and the State authorities. Fortunately in India, we have four
Regulators – RBI, SEBI, IRDA and the Secretary Finance, Government of India, working
in close coordination. Over a period of time perhaps, different models will evolve. It
was a very illuminating experience that the first three Regulators shared a platform at
IDRBT, Hyderabad 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. This model has served us well.

Thank you for your patient hearing,

20
Institute for Development and Research in Banking Technology

ANNEXURES

Annexur Title
e Page

I. Cadbury Code of Best Practices 1

II. Corporate Governance in the US, UK,
Australia and NZ: A Comparison 5
III. ‘Fit and Proper’ Criteria for Directors of
Banks 13
IV. List of recommendations of the Consultative
Group of Directors of banks and financial
institutions (Dr. Ganguly Group) 15
V. Summary of the important
Recommendations of the SEBI’s Committee
on Corporate Governance 22
 ANNEXURE - I
Cadbury Code of Best Practices

The Cadbury Code of Best practices had 19 recommendations. The

recommendations are in the nature of guidelines relating to Board of Directors,
Non-executive Directors, Executive Directors and those on Reporting and
Control.

Relating to the Board of Directors these are:

• The Board should meet regularly retain full and effective control over the
company and monitor the executive management
• There should be a clearly accepted division of responsibilities at the head
of 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 Executive, it is essential that there should
be a strong and independent element on the Board, with a recognized
senior member.
• The Board should include non-executive Directors of sufficient caliber
and number for their views to carry significant weight in the Board’s
decisions.
• The Board should have a formal schedule of matters specifically reserved
to it for decisions to ensure that the direction and control of the company
is firmly in its hands.

22
 • There should be an agreed procedure for Directors in the furtherance of
their duties to take independent professional advice if necessary, at the
company’s expense.
• All directors should have access to the advice and services of the
Company Secretary, who is responsible to the Board for ensuring that
Board procedures are followed and that applicable rules and regulations
are complied with. Any question of the removal of Company Secretary
should be a matter for the Board as a whole.

Relating to the Non-Executive Directors the recommendations are:

• Non-executive Directors should bring an independent judgement to bear

on issues of strategy, performance, resources, including key
appointments, and standards of conduct.
• The 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. Their fees should reflect the time, which they commit to
the company.
• Non-executive Directors should be appointed for specified terms and
reappointment should not be automatic.
• Non-executive Directors should be selected through a formal process and
both, this process and their appointment, should be a matter for the Board
as a whole.

23
For the Executive Directors the recommendations in the Cadbury Code of Best
Practices are:

• Director’s service contracts should not exceed three years without

shareholders’ approval
• There should be full and clear disclosure of their total emoluments and
those of the Chairman and the highest-paid UK Directors, including
pension contributions and stock options. Separate figures should be
given for salary and performance-related elements and the basis on which
performance is measured should be explained.
• Executive Directors’ pay should be subject to the recommendations of a
Remuneration Committee made up wholly or mainly of Non-executive
Directors.

And on Reporting and Controls the Cadbury Code of Best Practices stipulate
that:

• It is the Board’s duty to present a balanced and understandable

assessment of the company’s position.
• The Board should ensure that an objective and professional relationship
is maintained with the Auditors.
• The Board should establish an Audit Committee of at least three Non-
executive Directors with written terms of reference, which deal clearly
with its authority and duties.

24
• The Directors should explain their responsibility for preparing the
accounts next to a statement by the Auditors about their reporting
responsibilities.
• The Directors should report on the effectiveness of the company’s system
of internal control
• The Directors should report that the business is a going concern, with
supporting assumptions or qualifications as necessary.

25
 ANNEXURE – III

‘Fit and Proper’ Criteria for Directors of Banks

In exercise of the powers conferred by Section 35A of the Banking Regulation Act,
1949 and on being satisfied that it is necessary and expedient in public interest so to
do, the Reserve Bank of India (Circular DBOD.No.BC.104/08.139.001/2003-04 dated
June 25, 2004) hereby directs, with immediate effect that:

(i) 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 Board, based
upon qualification, expertise, track record, integrity and other fit and
proper criteria. Banks should obtain necessary information and
declaration from the proposed / existing directors for the purpose.
(ii) the process of due diligence should be undertaken by the banks in
private sector at the time of appointment / renewal of appointment.
(iii) the boards of the banks in private sector should constitute
Nomination Committees to scrutinize the declarations.
(iv) 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 requirements
indicated.
(v) banks should obtain annually a simple declaration that the
information already provided has not undergone change and where
there is any change, requisite details are furnished by the directors
forthwith.

13
(vi) the board of the bank must ensure in public interest that nominated /
elected directors execute the deeds of covenants as recommended by
Dr. Ganguly Group every year.

14
 ANNEXURE – IV

List of recommendations of the Consultative Group of Directors of banks and

financial institutions (Dr. Ganguly Group) which may be considered by banks for
adoption and Implementation

A. Recommendations which maybe Implemented by all banks

(i) Responsibilities of the Board of Directors

(a) A strong corporate board, should fulfill the following four major roles viz.
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.
(b) The Board of Directors 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 areas:
• delegation of powers to various authorities by the Board,
• strategic plan of the institution
• organisational structure
• financial and other controls and systems
• economic features of the market and competitive environment.

(ii) Role and responsibility of independent and non-executive directors

(a) The independent / non-executive directors have a prominent role in

inducting and sustaining a pro-active governance framework in banks.

15
 (b) In order to familiarise the independent /non-executive 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 Board,
their role, details on delegation of powers, the profiles of the top
executives etc.
(c) It would be desirable for the banks to take an undertaking from each

independent and non-executive 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

(a) Need-based taming programmes / seminars / workshops may be designed

by banks to acquaint their directors with emerging developments/challenges
facing the banking sector and participation in such programmes could make the
directors more sensitive to their role.
(b) The Board should ensure that the directors are exposed to the latest
managerial techniques, technological developments in banks, and financial
markets, risk management systems etc. so as to discharge their duties to the best
of their abilities.
(c) While RBI can offer certain training programmes/seminars in this regard at
its training establishments, large banks may conduct such programmes in their
own training centres.

16
(iv) Submission of routine information to the Board

Reviews dealing with various performance areas may be put up to the

Management Committee of the Board and only a summary on each of the
reviews may be put up to the Board of directors at periodic intervals. This will
provide the Board 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 board meeting

(a) The draft minutes of the meeting should be forwarded to the, directors,
preferably via the electronic media, within 48 hours of the meeting and
ratification obtained from the directors within a definite time frame. The
directors may be provided with necessary technology assistance towards this
end.
(b) The Board should review the status of the action taken on points arising
from the earlier meetings till action is completed to the satisfaction of the
Board, and any pending item should be continued to be put up as part of the
agenda items before the Board.

(vi) Committees of the Board

(a) Shareholders’ Redressal Committee
As communicated to banks in our circular DBOD No.111/08.138.001/2001-02
dated June 4, 2002 on SEBI Committee on Corporate Governance, the banks
which have issued shares/debentures to public may form a committee under the
chairmanship of a non-executive director to look into redressal of shareholders’
complaints.

17
(b) Risk Management Committee
In pursuance of the Risk Management Guidelines issued by the Reserve Bank
of India in October 1999, every banking organisation is required to set up Risk
Management Committee. The formation and operationalisation of such
committee should be speeded up and their role further strengthened.

(c) Supervisory Committee

The role and responsibilities of the Supervisory Committee as envisaged by the
Group viz., monitoring of the exposures (both credit and investment) of the
bank, review of the adequacy of the risk management process and upgradation
thereof, internal control system, ensuring compliance with the statutory /
regulatory framework etc., may be assigned to the Management Committee /
Executive Committee of the Board.

(vii) Disclosure and transparency

The following disclosures should be made by banks to the Board of Directors at

regular intervals as may be prescribed by the Board 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, viz. details of lending to /
investment in subsidiaries, the asset classification of such
lending/investment, etc.
• conformity with corporate governance standards viz. in composition of
various committees, their role and functions, periodicity of the meetings
and compliance with coverage and review functions etc.

18
B. Recommendations applicable only Public sector banks

(i) Information flow

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 board:
• A summary of key observations made by the directors, which should be
submitted, in the next board meeting.
• A 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 Secretary

The Company Secretary has important fiduciary and Company Law

responsibilities. The Company Secretary is the nodal point for the Board to get
feedback on the status of compliance by the organization in regard to provisions
of the Company Law, listing agreements, SEBI regulations, shareholder
grievances, etc. In view of the important role performed by the Company
Secretary vis-à-vis the functioning of the Boards 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 Secretary for these banks also. Banks should
therefore consider appointing qualified Company Secretary as the Secretary to-
the Board and have a Compliance Officer (reporting to the Secretary) for
ensuring compliance with various regulatory / accounting requirements.

19
C. Recommendations applicable to private sector banks

(i) Eligibility criteria and ‘fit and proper’ norms for nomination of
directors.

(a) The Board of Directors of the banks while nominating / co-opting

directors should be guided by certain broad ‘fit and proper’ norms for
directors, viz. formal qualification, experience, track record, integrity
etc. For 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 questionable business practices
etc should be considered. The Board of Directors may, therefore, evolve
appropriate systems for ensuring ‘fit and proper’ norms for directors,
which may include calling for information by way of self—declaration,
verification reports from market, etc.
(b) The following criteria, which is in vogue in respect of nomination to the
boards of public sector banks, may also be followed for nominating
independent / non-executive directors on private sector banks:
• The candidate should normally be a graduate (which can be
relaxed while selecting directors for the categories of farmers,
depositors, artisans, etc.)
• He / she should be between 35 and 65 years of age.
• He / she should not be a Member of Parliament / Member of
Legislative Assembly / Member of Legislative Council.

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(ii) Commonality of directors of banks and non-banking finance
companies (NBFC)

In case, a director on the board of an NBFC is to be considered for appointment

as director on the board of the bank, the following conditions must be followed:
• He/she is not the owner of the NBFC, [i.e., share holdings (single or
jointly with relatives, associates, etc.) should not exceed 50%],
• He/she is not related to the promoter of the NBFC
• He/she is not a full-time employee in the NBFC.
• The concerned NBFC 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 Board should be commensurate with the business needs of
the banks. There is an urgent need for making the Boards of banks more
contemporarily professional by inducting technical and specially qualified
personnel. Efforts should be aimed at bringing about a blend of ‘historical
skills’ set, i.e. regulation based representation of sectors like agriculture, SSI,
cooperation etc. and the ‘new skills’ set, i.e. need based representation of skills
such as, marketing, technology and systems, risk management, strategic
planning, treasury operations, credit recovery etc. The above suggestions may
be kept in view while electing / co-opting directors to their boards.

21
 ANNEXURE - V

Summary of the important Recommendations of the SEBI’s Committee on

Corporate Governance

The Securities and Exchange Board of India (SEBI) 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 SEBI’s circular SMDRP/Policy/CIR-10/2000 dated February
21, 2000. Full text of recommendations of the Committee which form part of
the above circular can be had by access to SEBI’s website,
www.sebi.gov.in/circulars/2000. A summary of the important
recommendations of the SEBI Committee as applicable to banks is furnished
here under:
1.1. All pecuniary relationship or transactions of the non-executive directors
should be disclosed in the annual report.
1.2. The Committee is of the view that non-executive 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. The Committee therefore lays emphasis on the calibre of the
non-executive directors, especially of the independent directors.
1.3. The Committee is of the view that it is important that an adequate
compensation package be given to the non-executive independent
directors so that these positions become sufficiently financially attractive
to attract talent and that the non-executive directors are sufficiently
compensated for undertaking this work.

22
1.4. The Committee recommends that the board of a company have an
optimum combination of executive and non-executive directors with not
less than fifty per cent of the board comprising the non-executive
directors. The number of independent directors depends on the nature of
the chairman of the board. In case a company has a non-executive
chairman, at least half of board should be independent (Mandatory
recommendation).

2.1 The 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.

3.1 The Committee recommends that a non-executive 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. This will enable him to discharge the responsibilities
effectively.

4.1The Committee recommends that a qualified and independent audit

committee should be set up by the board of a company (Mandatory
recommendation)

23
 4.2 The Committee recommends that -

• the audit committee should have a minimum of three members, all

being non-executive directors, with the majority being independent
and with at least one director having financial and accounting
knowledge;
• the chairman of the committee should be an independent director;
• the chairman should be present at the Annual General Meeting to
answer shareholder queries;
• the audit committee should invite such of the executives, as it
considers appropriate (and particularly the head of the finance
function) 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. The finance director and head of internal audit and when
required, a representative of the external auditor should be present as
invitees for the meetings of the audit committee;
• the Company Secretary should act as the secretary to the committee.

4.3 The Committee recommends that the audit committee should meet at
least thrice a year. One meeting must be held before finalisation of annual
accounts and one necessarily every six months (Mandatory
recommendation).

4.4 The quorum should be either two members or one-third of the members
of the audit committee, whichever is higher and there should be a

24
 minimum of two independent directors (Mandatory recommendation).

4.5 Being a committee of the board, the audit committee derives its powers
from the authorization of the board. The Committee recommends that
such powers should include powers:

1. To investigate any activity within its terms of reference.

2. To seek information from any employee.
3. To obtain outside legal or other professional advice.
4. To secure attendance of outsiders with relevant expertise, if it
considers necessary.

4.6 As 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 following:

• Oversight 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.
• Recommending the appointment and removal of the external auditor,
fixation of audit fee and also approval for payment for any other
service.
• Reviewing with management the annual financial statements before
submission to the board, focusing primarily on:

o Any changes in accounting policies and practices.

o Major accounting entries based on exercise of judgement by

25
 management.
o Qualifications in draft audit report.
o Significant adjustment arising out of audit.
o The going concern assumption.
o Compliance with accounting standards.
o Compliance with stock exchange and legal requirement
concerning financial institutions.
o Any 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.
• Reviewing with the management, external and internal auditors, the
adequacy of internal control systems.
• Reviewing the adequacy 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
frequency of internal audit.
• Discussion with the internal auditors of any significant findings and
follow-up thereon.
• Reviewing 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.
• Discussion with external auditors, before the audit commences, of the
nature and scope of audit. Also post-audit discussion to ascertain any area
of concern.

26
 • Reviewing the company’s financial and risk management policies.
• Looking into the reasons for substantial defaults in the payments to the
depositors, debenture holders, shareholders (in case of non-payment of
declare dividends) and creditors.

This is a mandatory recommendation.

5.1 The 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.

6.1 The 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. The minimum information should be
available to the board (Mandatory recommendation).

6.2 The committee recommends that a director should not be a member in

more than 10 committees or act as Chairman of more than five
committees across all companies in which he is a director. Furthermore, it
is a mandatory annual requirement 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 (Mandatory
recommendation).

7.1 The recommendations contained in this section pertain to accounting

27
 standards on consolidation, segment reporting, disclosure and treatment
of related party transactions and deferred taxation. The Committee
recommended that the Institute of Chartered Accountants of India issue
accounting standards on these areas expeditiously.

8.1 As a part of the disclosure related to Management, the Committee

recommends that as part of the directors’ report or as an addition thereto,
a Management Discussion and Analysis report should form part of the
annual report to the shareholders (Mandatory recommendation).

8.2 The 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 (for e.g. dealing in company shares,
commercial dealings with bodies which have shareholding of
management and their relatives etc. (Mandatory recommendation).

9.1 The Committee recommends that in case of the appointment of a new

director or re-appointment of a director the shareholders must be provided
with the following information:

• A brief resume of the director;

• Nature of his expertise in specific financial areas; and
• Names of the companies in which the person also holds the directorship
and the membership of Committees of the board.

28
 This is a mandatory recommendation.

9.2 The Committee recommends that information like quarterly results,

presentation made by companies to analysts may be put on company’s
website 6r 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 (Mandatory
recommendation).

9.3 The Committee recommends that the half-yearly declaration of financial

performance including summary of the significant events in last six
months, should be sent to each household of shareholders.

9.4 The Committee recommends that a board committee under the

chairmanship of a non-executive director should be formed to specifically
look into the redressing of shareholder complaints like transfer of shares,
non-receipt of balance sheet, non-receipt of declared dividends etc. The
Committee believes that the formation of such a committee will help
focus the attention of the company on shareholders’ grievances and
sensitize the management to redressal of their grievances (Mandatory
recommendation).

9.5 The 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. The delegated authority should attend to share transfer formalities
at least once in a fortnight (Mandatory recommendation).

29
10 The Committee recommends that there should be a separate section on
Corporate Governance in the annual reports of companies, with a detailed
compliance report on Corporate Governance. Non-compliance of any
mandatory recommendation with reasons thereof and the extent to which
the non-mandatory recommendations have been adopted should be
specifically highlighted. This will enable the shareholders and the
securities market to assess for themselves the standards of corporate
governance followed by a company. (Mandatory recommendation).

30