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All About Corporate Governance In The Banking Sector

January 28, 2017
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In this blog post, Khalid Khan, a Legal Counsellor at Salman Sulaibeekh & Associates and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the importance of corporate governance in the banking sector.

 

What is Governance?

“Governance, in general terms, means the process of decision-making and the process by which decisions are implemented (or not implemented), involving multiple actors. Good governance is one which is accountable, transparent, responsive, equitable and inclusive, effective and efficient, participatory and which is consensus oriented and which follows the rule of law”.[1]

In my opinion, governance is synonymous to discipline and it is the key in every sphere of life. We need good governance in our home, office, business etc too and lack of governance could lead to chaos.

If we will look at the society we live in, we would see that if there would be no rules regulating the behavior of the people, providing the rights and restrictions then society may break down and it could lead to chaos and anarchy. As there would be no rules, there would be no violations and penalty too. Due to these reasons, there is a need for governance in society at large which is done mostly by government and due to such reasons, there are watchdogs which regulate the governance of companies and financial institutions too.

 

Rise of Corporate Governance

Watergate scandal in the United States was the most immediate reason due to which the need for regulating the corporate sector was realized. The investigations undertaken by the US regulatory and legislative bodies confirmed that due to the failure of control mechanisms many major corporations were making illegal political contributions. As a result of this investigation, the Foreign and Corrupt Practices Act of 1977 in the USA was enacted. This Act contained specific provisions regarding the establishment, maintenance, and review of systems of internal control which was preceded by the Securities and Exchange Commission of USA’s proposals for mandatory reporting on internal financial controls in 1979, then came the Treadway Report 1987 which emphasizes the need for a proper control environment, independent audit committees and an objective Internal Audit function.

In the last 20 years, corporate governance in the Banking sector has changed drastically. All over the world, many committees were setting up to look into this aspect like the Cadbury Committee, OECD Code, Combined Code of London Stock Exchange, the Blue Ribbon Committee and Kumar Mangalam Birla Committee in India.[2]

In the words of Sir Adrian Cadbury, “Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations, and society.” [3]

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

The purpose of corporate governance in banking sector without any doubt build and strengthen the accountability, credibility, trust, transparency and integrity. If there won’t be any regulatory watchdog which regulates the governance of the banks then banks can decide things by their own whims and fancies. Corporate governance in banking sector protects not just economy of the country but also the shareholders, employees, supervisors, customer and public at large.

 

Reserve Bank of India and Corporate Governance in the Banking Sector in India

 

In India, the Reserve Bank of India (“RBI”) is the gatekeeper of Corporate Governance. RBI is the central bank of India which regulates all the major issues related to currency, foreign exchange reserves etc. In short, RBI is the bank responsible for securing the monetary stability in India

The preamble of the Reserve Bank of India Act, 1934 says, “An Act to constitute a Reserve Bank of India. Whereas it is expedient to constitute a Reserve Bank for India to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in 2[India] and generally to operate the currency any credit system of the country to its advantage; And whereas in the present disorganisation of the monetary systems of the world it is not possible to determine what will be suitable as a permanent basis for the Indian monetary system; But whereas it is expedient to make temporary provision on the basis of the existing monetary system, and to leave the question of the monetary standard best suited to India to be considered when the international monetary position has become sufficiently clear and stable to make it possible to frame permanent measures…”[4]

There is no one who could deny the fact banks are pivotal to the economic stability of any economy. In case a bank crashes then it does not crash alone, it also takes away the lifelong investment and savings of its entire account holders too. This is not the only reason due to which corporate governance in the banking sector is needed. Corporate Governance is also needed for the bank to keep a check on money laundering, financing immoral and criminal acts and transaction of money to the terrorists. The most recent act of RBI role in the Indian economy is demonetization, through which it has (under the decision-making capacity of Indian Parliament), strike very hard at the people hoarding black money or people printing fake currency. However, it’s a totally different issue that this could have been done in a more professional way, reducing the problems faced by the people.

RBI in India plays leading role in formulating and implementing corporate governance. The corporate governance mechanism as followed by Reserve Bank of India is based on three categories for governing the banks. They are: (i) Disclosure and transparency, (ii) Off-site surveillance, (iii) Prompt Corrective Action.

 

  1. Disclosure and transparency: Disclosure and transparency are the most important constituent of corporate governance. If the banks will not be disclosing their transactions to the RBI then they can operate at their whims and fancies and may vanish with the lifelong investments and savings of the people. The RBI through the requirement of routine reporting of financial transactions of the bank keeps a tab on the activities being undertaken by the banks in India. Any failure to abide by the requirements set out by RBI may lead to heavy fines being imposed along with the cancellation of the license to operate as a bank. Most recently cases of RBI imposing penalty are the imposition of penalty on Devi Gayatri Co-operative Urban Bank Ltd., Hyderabad, Telangana, while exercising the powers vested in it under the provisions of Section 47A (1) (b) read with Section 46 (4) of the Banking Regulation Act, 1949 (As Applicable to Co-operative Societies), for violation of Reserve Bank of India directives and guidelines on loans and advances to directors and their relatives,[5] on Credit Agricole Corporate and Investment Bank (India[6]) and The Tumkur Veerashaiva Co-operative Bank Ltd.,Tumkur, Karnataka.[7]
  1. Off-site surveillance: RBI routinely perform an annual on-site inspection of the records of the banks but in order to promote governance in banking sector RBI in the year 1995, off-site surveillance function was initiated in 1995 for domestic operations of banks[8]. The main focus of the off-site surveillance is to monitor the financial health of banks between two on-site inspections, identifying banks which show financial deterioration and would be a source for supervisory concerns. The off-site surveillance prepares RBI to take timely remedial action before things get out of control. During December 1995 the first tranche of off-site returns was introduced with five quarterly returns for all commercial banks operating in India and two half yearly returns one each on connected and related lending and profile of ownership, control and management of domestic banks. The second tranche of four quarterly returns for monitoring asset-liability management covering liquidity and interest rate risk for domestic currency and foreign currencies were introduced since June 1999. The Reserve Bank intends to reduce this periodicity with effect from April 1,2000.

 

  1. Prompt Corrective Action: RBI while promoting corporate governance in banks in India has RBI has set trigger points on the basis of CRAR, NPA and ROA. On the basis of trigger points set by RBI, the banks have to follow ‘structured action plan also called mandatory action plan’. Beside mandatory action plan RBI has discretionary action plans too. The main reason for classifying the rule-based action points into Mandatory and Discretionary is that some of the actions are essential to restore the financial health of banks must be mandatorily taken by the bank while other actions will be taken at the discretion of RBI depending upon the profile of each bank.

 

Conclusion

The special nature of banking institutions necessitates a broad view of corporate governance where regulation of banking activities is required to protect depositors.[9] Corporate governance in the banking sector is not just a formality but a dire need of society. In almost every country in the world, there is a watchdog like RBI which monitors all the transactions and activities undertaken by the banks and regulate the business of the bank by making them submit regular reports related to the business undertaken by them.

However, too much pressure on the banks must not be imposed on the banks in the name of corporate governance so much so that they feel harassed in the name of governance and their efficiency suffers leading to a slowdown of financial transactions. Additionally, internal governance must be increased which must be formulated in a way that the efficiency of banks is not.

 

 

 


 

References:

[1] Source: United Nations Economic and Social Commission for Asia and the Pacific, ‘What is good governance’

[2] Kapila Ra& Kapila Uma, Economic Developments In India: Monthly Update, Volume -51 Analysis.

[3] (Sir Adrian Cadbury, UK, Commission Report: Corporate Governance 1992)

[4] Reserve Bank of India Act 1934, https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIAM_230609.pdf

[5] RBI imposes penalty on The Devi Gayatri Co-operative Urban Bank Ltd., Hyderabad, Telangana, https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=38440

[6] RBI imposes penalty on Credit Agricole Corporate and Investment Bank (India), https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=38357

[7] RBI imposes penalty on The Tumkur Veerashaiva Co-operative Bank Ltd.,Tumkur, Karnataka, https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=38348

[8] Department of Banking Supervision, About Us, Reserve Bank of India, https://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=DeptOfBS.htm

[9] Swarup, Mridushi, Corporate Governance in the Banking Sector, http://www.cosmicjournals.com/ijmbs/12/mridushi.pdf

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