CORPORATE GOVERNANCE IN BANKS

International Scenario

• Cadbury Committee Report, UK

– May 1991

• OECD Principles of Corporate Governance

– April 1998

• Basel Committee Report

Indian Scenario

• Kumara Mangalam Birla Committee, 1999• Naresh Chandra Committee, 2004• Narayana Murthy Committee 2003• Reserve Bank of India Norms• Khan Working Group Report, 1998• Narasimham Committee Report I, 1992• Narasimham Committee Report II, 1998• Dr. Patil Advisory Group• Varma Group• Report of the Consultancy Group of Directors of Banks /

Financial Institutions, 2002 Chaired by A.S.Ganguly

Corporate Governance Framework

• Companies Act, 1956

• Companies Act, 1956 (Amendment in 2002)

• SEBI Regulations for Listed Companies (Clause 49)

Corporate Governance Requests

• Minority shareholder protection• Voting Rights• Firm’s capital structure• Shareholder meetings• Structure and responsibilities of the Board of Directors• Board structure• Board meetings• Nomination and election of directors• Board committees• Disclosure• Audit committee responsibilities

Voting Rights

• Shareholders can appoint a proxy. • A proxy can demand a poll and cast vote but cannot

speak at the meeting. • The notice convening the meeting must state that

shareholders can appoint a proxy.• All shares are equal within one class.• Shares with different voting rights or dividend can be

issued as long as shareholders approve the issue and such shares do not exceed 25% of total share capital.

• Issue of share capital with different voting rights or dividends (Companies Rule 2001)

Capital Structure

• Mergers require a special resolution (more than 75% of

shareholders present) at the shareholder meeting.

• In the event shareholders are not called upon to approve

the merger, the acquirer has to make a public

announcement of his/her intent to acquire the shares.

(Regulation 12 SEBI- Takeover Code)

Capital Structure

• Acquisition of 15% or more shares or voting rights of any

company requires the acquirer to make a mandatory public

offering (Regulation 10 SEBI – Takeover Code).

• Exception: Compliance not mandatory when

– Acquirer already owns 15% or more but less than 75% of

shares or voting rights of the company and in one year

acquires less than 5% of shares or voting rights,

– Acquirer already owns 75% of shares or voting rights of

the company

Capital Increase

• If a company is issuing further capital it is required to

offer the shares to existing equity holders in proportion to

the capital paid-up on those shares on that date.

• Notice for exercising the offer should be given at least 15

days prior to the issue.

• The offer can be transferred to another person unless

the Articles of the company specifically disallow such

transfer.

Capital Increase

• Exception (Section 81 of Companies Act):

– Preferential allotment if a special resolution to that effect

has been passed in the Annual General Meeting,

– If a special resolution is not passed then the number of

votes cast in favour of forfeiting preferential allotment

should exceed votes against the forfeiture

– Central Government should approve the application of the

board of directors to waive requirement of preferential

allotment.

Buyback of Shares

• A company can acquire its owns shares if

– The buy-back is authorized by its Articles,

– A special resolution has been passed in the shareholders’

meeting authorizing the buy-back,

– The buy-back is less than 25% of the total paid up capital

and free reserves,

– The ratio of debt owed by the company is not more than

twice the capital and its free reserves after the buy-back.

Buyback of Shares

• Exception (Section 77A of Companies Act):

• A special shareholders resolution is not needed if the

buy-back is less than 10% of the total paid-up equity

capital and free reserves of the company and the buy-

back has been authorized by the Board of Directors of

the company.

Shareholder Meeting

• Companies are required to hold an Annual General

Meeting (AGM) every year (Section 166 of Companies

Act).

• Notice for such meeting should be sent to shareholders

21 days in advance (Section 171 of Companies Act).

• Shareholder controlling 10% of voting rights or paid-up

capital can call for a special or Extraordinary General

Meeting (EGM) (Section 169 of Companies Act).

Shareholder Meeting

• Foreign Institutional Investors (FIIs) must register with

SEBI to participate in the market.

• Investments and returns are freely repatriable, except in

the case of certain specified items which attract the

condition of dividend balancing and/or where the

approval is subject to specific conditions such as lock in

period on original investment, dividend cap, foreign

exchanging neutrality, etc.

Shareholder Meeting

• Companies are required to create • ‘Shareholders/Investors Grievance Committee’• Chairmanship of a non-executive director to look into the

redressing of shareholder and investor complaints like transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends etc (SEBI Code, Clause 49).

• Quorum is set at five persons for a public company and two for other companies (Section 174 of Companies Act).

Board Structure

• An independent director is a non-executive director (SEBI

Code, Clause 49):

– Aside from director’s remuneration, does not have any

material pecuniary relationship or transactions with the

company, its promoters, management or subsidiaries

which may affect the independence of judgment,

– Not related to the promoter or a person in management

on the board or one level below the board,

Board Structure

– Not been an executive for the past three years,

– Not or has not been a partner in the past three years

of a statutory or internal audit firm or a firm providing

consulting services to the company.

• All pecuniary relationship/transactions of nonexecutive

directors should be disclosed in the annual report (SEBI

Code, Clause 49).

Independent Directors

• The number of independent directors is dependent on

whether the Chairman is an executive or non-executive

director.

• In the case of a non-executive chairman, at least one-

third of the board should be comprised of independent

directors and in the case of an executive chairman, at

least half of the board should be comprised of

independent directors (SEBI Code, Clause 49).

Board Responsibilities

• The Board shall meet at least four times a year, with a minimum time gap of three months between any two meetings (SEBI Code, Clause 49).

• Quorum for board meetings is 33% of total board strength or 2 members whichever is higher (Section 287 of Companies Act).

• No specific provision mandating the creation of a board-level nominating committee.

• The directors of the Board are appointed by the company in the Annual General Meeting (Section 255 of Companies Act).

Board Resposibilities

• At the time of appointment of a new director or the re-

appointment of a director, shareholders must be

provided with a brief résumé of the director, expertise in

specific functional areas and names of companies in

which the person also holds other directorships (SEBI

Code, Clause 49).

• Unless the Articles of a Company provide for the

retirement of all directors at every AGM, not less than

one-third directors have to be appointed by the company

at the AGM (Section 255 of Companies Act).

Board Committee

• Every board is required to have an audit committee and

a shareholder grievance committee.

• The board of directors is required to consider the CEO’s

remuneration.

• Creation of a separate remuneration committee is a non-

mandatory requirement (Clause 49 of SEBI’s listing

requirements).

• In practice, however, most Boards of large companies

have an audit, remuneration and nomination committee.

Disclosure

• Every company is required to appoint a compliance officer who is responsible for setting policies, procedures, monitoring adherence to the rules for the preservation of ‘price sensitive information’ to prevent insider trading (SEBI Insider Trading Regulation, 2002).

• There should be a separate section on Corporate Governance in the annual report to shareholders.

• Non-compliance with any mandatory requirements and the extent to which the non-mandatory requirements have been adopted should be specifically highlighted (SEBI Code, Clause 49).

Disclosure

• Information such as quarterly results and presentations made by companies to analysts shall be put on the company’s website, or shall be sent in such a form as to enable the stock exchange on which the company is listed to put it on its website (SEBI Code, Clause 49).

Remuneration of Directors

• All fees/compensation paid to non-executive directors

are fixed by the Board of Directors and require previous

approval of shareholders in the Annual General Meeting.

• The shareholder’s resolution should specify the limits for

the maximum number of stock options that can be

granted to non-executive directors in any financial year

and in aggregate (SEBI Code, Clause 49).

Conflict of Interest

• A company is required to disclose all bases for related

party transactions to the audit committee.

• It has to periodically provide a statement in summary

form of transactions with related parties in the ordinary

course of business, details of material individual

transactions with related parties which are not in the

normal course of business, and transactions with related

parties or others that are not on an arms length basis

with management’s justification for such transactions

(SEBI Code, Clause 49).

Conflict of Interest

• Disclosure of materially significant related party

transactions that may have potential conflicts with the

interests of the company at large have to be made in the

Report on Corporate Governance in the Annual Report

to Shareholders (SEBI Code, Clause 49).

Internal Control and Risk Management System

• The company is required to lay down procedures to

inform Board members about risk assessment and

minimization procedures. These procedures shall be

periodically reviewed to ensure that executive

management controls risk through means of a properly

defined framework (SEBI Code, Clause 49).

Internal Control and Risk Management System

• The audit committee also has to review the adequacy of

the internal audit function, if any, including the structure

of the internal audit department, staffing, seniority of the

officials heading the department, reporting structure

coverage, and frequency of internal audit (SEBI Code,

Clause 49).

Standards

• India materially conforms to

• International Financial Reporting Standards (IFRS)

• International Standards on Auditing (ISA).

• Institute of Chartered Accountants of India (ICAI)

guidelines

• Companies Act

Audit Report

• Quarterly reports are subject to limited audit review.

• As part of the non-mandatory requirements, a half-yearly

declaration of financial performance, including a

summary of the significant events in the last six months,

may be sent to each household of shareholders (SEBI

Code, Clause 49).

• Comprehensive audits are conducted annually.

Audit Quality

• Every company at each AGM shall appoint an auditor(s)

to hold office till the conclusion of the next AGM (Section

224 of Companies Act).

• The Companies Act requires annual accounts to be

audited by an independent certified chartered accountant

who is a member of the Institute of Chartered

Accountants of India (ICAI)

Audit Quality

• The quality of financial disclosures for listed companies

is determined by the Department of Company Affairs,

SEBI, and the ICAI.

• The ICAI lays down the parameters of accounting and

auditing standards.

• The Companies Act requires management to explain any

deviations from the prescribed accounting standards in

financial statements.

Audit Committee

• The audit committee shall have minimum three directors

as members, with two-thirds of the members being

independent (SEBI Code, Clause 49).

• All members of the audit committee should be financially

literate and at least one member shall have accounting

or related financial management expertise (SEBI Code,

Clause 49).

Internal and External Auditor

• The audit committee recommends to the Board the

appointment, re-appointment, and if required the

replacement or removal of the external auditor and the

fixation of audit fees.

• The committee also has to approve payment to auditors

for other services provided (SEBI Code, Clause 49).

Internal and External Auditor

• The audit committee has to review with management the

performance of the external and internal audit firm and

the adequacy of internal control systems (SEBI Code,

Clause 49).

Ownership and Control

• Senior management is required to disclose potential conflicts of interest to the board.

• Directors are required to disclose share dealings beyond prescribed thresholds.

• SEBI has issued rules against insider trading.• Monitoring and prosecuting insider trading activity is very

difficult .• An acquirer, who acquires shares or voting rights

exceeding specified threshold levels has to disclose at every stage the aggregate holdings or voting rights to the company and to the stock exchanges where the companies are listed. Current threshold limits are 5%, 10% or 14% of shares or voting rights (Regulation 7 SEBI – Takeover Code).

Regulatory Environment

• The Ministry of Company Affairs (MoCA), regulators like RBI

and SEBI and stock exchanges have surveillance functions.

• MoCA has surveillance responsibility over unlisted

companies.

• For listed companies, stock exchanges are considered to be

the first line of defence followed by SEBI.

• RBI oversees companies in the banking and financial sector.

Independence of Supervisory Body

• SEBI is an independent quasi-judicial body that plays an

active regulatory and development role in India’s security

market.

• The Central Government appoints the chairman and may

nominate a maximum of nine other members.

• The body is funded by contributions from public financial

institutions, banks and the Government of India.

Corporate Governance of Banks

• Openness

• Accountability

• Transparency

• Responsibility

• Risk Management