Institute for Development and Research in Banking Technology

Corporate Governance in Financial Institutions

I am happy to be here this afternoon to participate in a Top management workshop on
Corporate Governance and Corporate Social Responsibility in Public Enterprises. I am fully
aware along with all of us assembled here that, corporate governance is a subject of
tremendous relevance, focus and significance in the present day context. Recent history is
replete with examples of scams and frauds making headlines every now and then. If in India,
we had Harshad Mehta, C.R. Bhansali, Ketan Parekh, advanced countries like US were no
way behind with their scams of Enron and WorldCom and many more all of which fell like
the nine pins. Thus, there is growing concern world over for the Governments, Regulators of
stock exchanges, Banks and other financial institutions to continuously review the system
and procedures and how to enhance corporate governance.

In developing countries

governance issues of small and mid-sized companies, often family controlled also is an issue.
It would be good to refresh ourselves briefly with some definitions of eminent persons who
understood corporate governance and as they visualized it:
Definitions
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.
Speech delivered by Shri Vepa Kamesam, Chairman, Governing Council, Institute for Development
and Research in Banking Technology (IDRBT), Hyderabad at the top management workshop on
Corporate Governance & Corporate Social Responsibility in Public Enterprises, organized by ICFAI
and Indian Institute of Public Administration at New Delhi on 8 th July, 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.

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.
There are many more points of view all revolving around the process and structure to direct
and manage the affairs of a company with the objective of enhancing shareholder value
which not only includes the financial numbers in the balance sheet but the value system and
the ethics observed in achieving at the numbers.
Ironically, it was US which brought in legislation called Foreign and Corrupt Practices Act of
1977 followed by Securities and Exchange Commissions tightening of mandatory reporting
of internal financial controls in 1979. The Treadway commission was formed in 1987 after
the collapse of several Savings and Loan institutions in US. The Treadway report highlighted
the need for a proper control environment, Independent Audit committees and an objective
internal audit function. It also requested the sponsoring organizations to write for themselves
and develop an integrated set of control criteria for betterment of the companies. Despite of
this in 1990s, companies like Polly Peck, BCCI and Robert Maxwell group of companies in
UK became victims of spectacular failures, primarily out of poorly managed business
practices often times, standards set by the respective Boards. In the Annexure I to my
speech, I am summarizing the Cadbury Code of Best Practices and I feel the 19 points there
are of great relevance even today. The Combined code was subsequently derived from the
Ron Hampel report and the Greenbury Report all of which were appended to the listing rules
of London Stock Exchange. Compliance is mandatory for all listed companies in the UK.

Recent Developments in USA:

History continues to tick and Sarbanes-Oxley Act of the US was a serious wakeup call. It has
been much debated and there are very mild protests in some quarters. Nevertheless, it is a
call to get back to fundamentals and it identifies 58 separate provisions that affect internal
auditing and the question of Directors of Boards looking the other way is unacceptable and
must change. This message is applicable to the public and private companies alike. I am
tempted to quote some of the important extracts from the BIS review 2003.

The message for boards of directors is: Uphold your responsibility for ensuring the
effectiveness of the companys overall governance process.

The message for audit committees is: Uphold your responsibility for ensuring that the
companys 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 examine and evaluate all of an
entitys 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
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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 become ritualistic. It would be
good to be associated with the framing of the robust audit programme and the companys
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 turnkey management consultation, at least those who are involved in the audit exercise should
disassociate themselves from being a part of consulting side of the companys 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 auditors voice is heard loud and clear by the Board and as such all those Boards
who choose to ignore this valuable advice would in my opinion be consigned to the dust bin
of history. Complex collapses, misfeasance and malfeasance of staggering proportions,
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.
Indian Situation:
Next I would like to turn to Indian situation. By and large we have followed the Cadbury
model.

It is true that Audit Committees, Managing Committees and Remuneration

Committees have all come into existence. In most Indian companies and the CIIs studies of
1999 chaired by Mr. Kumara Mangalam Birla was a landmark document with 25
recommendations 19 of them which are mandatory.

The roles of a company with a

combination of Executive and Non-Executive Directors with atleast 50% comprising nonexecutive directors is important. Likewise, the audit committee is chaired by qualified
independent Director preferably a Chartered Accountant and the members of the Audit
Committee are invariably non-executive independent Directors.

We all know that the

independent Directors apart from receiving Directors remuneration, do not have any
pecuniary relationship or transactions with the company. The Audit Committee has wide
powers and also looks into the compliance with Accounting Standards and all of the other
regular compliances like the stock exchange, legal requirements and it also looks into several

internal control systems. There is sub-committee of the Board, which also looks at the
shareholders grievances and files its compliances to the stock exchange. Publication of
quarterly or half yearly results of the companies 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 although,
the dust has not settled down on the subject. The Institute of Chartered Accountants of India
have set up quite rigid Accounting Standards to be followed which have progressively
tightened compliances. This assumes importance as many mid-sized and small companies
are family controlled and at times pyramidical structures are developed so that layered
investments and crossholdings go unnoticed. There is urgency to ensure against controlling
of companies in the group by a group of people who are not direct investors.
Corporate Governance for Banking Organizations:
I am afraid, I could not avoid the lengthy preamble.
The subject given to me is to speak about financial institutions, which if one would look from
right perspective would encompass all the financial institutions within our country.
Particularly, you may divide them into following:
Term-Lending Institutions, governed by the Companies Act or Special Act
Banks [public sector, private sector (old and new generation banks, Cooperative
Banks)] governed by Special Act 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.

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;
6

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

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 25 th June, under section 35A of the BR Act is very
important. A copy of issued directive is placed as Annexure II. Certain criteria must be
fulfilled by persons aspiring to become Directors of Banks and due diligence must be done in
7

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.
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.

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 banks 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.
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.
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.

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 that are not members of the banks
management, or having a supervisory board of 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--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;

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

10

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 managements

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 banks 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 banks culture, objectives, strategy and control environment

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
11

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.
For the same reason of governance, I would like to raise an issue - Should there be officials
of RBI on the Boards of the Banks and would there not be a conflict of interest in the role of
a Regulator and a Board member taking the decisions? Likewise Government servants
serving on the Bank Boards also raises a similar issue. I am aware there is no immediate
resolution to this dilemma but a compromise could be worked out by having well reputed
eminent professionals as nominees in the transition period before totally exiting from the
Boards.
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 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.

12

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 others
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 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. 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. 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 50 to 60 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 arbitraging. I strongly believe, State

13

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.
Let me now go back to the Dr. Ganguly Groups Report submitted in April 2002 and placed
at RBIs 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 as an
Annexure III. This read together with SEBI guidelines that is placed as Annexure IV 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. 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, to which thanks to CVC are now ignored, 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 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. 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.
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Friends, I thank you for your patience in listening through this somewhat lengthy, important
and sensitive subject as understood by me, after being on the Boards of State Bank of
Travancore, State Bank of India, SEBAL, SBI Mauritius and SBI Canada, NABARD, NHB
and Reserve Bank of India finally before I retired. I thank the organizers for inviting me to
speak today.
***

15

ANNEXURES (I IV)

16

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 Boards 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.

There should be an agreed procedure for Directors in the furtherance of their duties to
take independent professional advice if necessary, at the companys 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.

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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.

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

Directors 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 Boards duty to present a balanced and understandable assessment of the

companys position.

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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.

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 companys system of internal
control

The Directors should report that the business is a going concern, with supporting
assumptions or qualifications as necessary.

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ANNEXURE II
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.

(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.

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ANNEXURE III
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.
(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.

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(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.
(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

22

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 nonexecutive director to look into redressal of shareholders complaints.
(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.

23

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.

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--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.

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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 selfdeclaration, 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 / nonexecutive 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.

(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

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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.

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ANNEXURE - IV
Summary of the important Recommendations of the SEBIs 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 SEBIs 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 SEBIs 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 boards 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.

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).

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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 Chairmans office at the companys expense and also allowed
reimbursement of expenses incurred in performance of his duties. This will enable him
to discharge the responsibilities effectively.

4.1

The Committee recommends that a qualified and independent audit committee should
be set up by the board of a company (Mandatory recommendation)

4.2

The Committee recommends that

the audit committee should have a minimum of three members, all being nonexecutive 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.

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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 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.

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.
Reviewing the companys 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 companys policy on specific remuneration packages for executive
29

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 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

recommendation).

30

and

their

relatives

etc.

(Mandatory

9.1

The Committee recommends that in case of the appointment of a new director or reappointment of a director the shareholders must be provided with the following
information:

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 companys 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 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

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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.

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.
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 companys 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 nonexecutive director should be formed to specifically look into the redressing of
shareholder complaints like transfer of shares, non-receipt of balance sheet, nonreceipt 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
32

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).

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).

33