INTRODUCTION AND RESEARCH METHODOLOGY
Corporate Govanance is the mechanism by which the values, principles,
policies and procedures of a corporation are,inculcated and manifested. The essence
of Corporate Governance lies in promoting and maintaining integrity, transparency
and acwuntability in the organization, commitnpnt to values and ethical business
conduct. Accordingly, timely and adequate disclcisure of information regarding the
financial situation, performance, ownership and governance of the company is an
important part of the corporate governance. Company's*philosophy on corporate
governance envisages the attainment of the highest level of transparency,
accountability and equity, in all facets of its operations, and in a11 its interactions
with its stakeholders, including shareholders, qployees, the government and the
lenders.
Corporate Governance is aimed at ensuring proper governance of business as
well as complying with all the governance norms prescribed by regulatory board for
the benefit of all interested parties including society. The basic objective is the
maximization of long-term shareholders value within the parameters of public law
and social ethics to give an impression to customers and employees about the
transparency and fairness of business.
Corporate Governance has fast emerged as a benchmark for judging
corporate excellence in the context of national and international business practices.
From guidelines and desirable code of conduct some decades ago, corporate
governance has come a long way and is now recognized as a paradigm for
improving competitiveness and enhancing efficiency, and thus improving investors'
confidence and accessing capital, both domestic as well as foreign. ( Pushkar Gupta
2007 - 2008) The framework for corporate governance is not only an important
component affecting the long-term prosperity of companies, but it is a leading
species of a large genus namely, National Governance, Hman Governance, Societal
Governance, Economic Governance and Political Governance. Government provides
necessary conditions, framework and environment to corporate to operate. There is,
however, no universal recipe for good corporate governance since business
environment varies from country to country.
Corporate governance refers to the structures and processes for the direction
and control of companies. It concerns the relationships among the management,
Board of Directors, controlling shareholders, d o r i t y shareholders and other
stakeholders. In general, Governance is *e exercise of authority, direction and
control of an organization in order to ensure its purpose is achieved. It refers to
b Who is in charge of what;
P Who sets the direction and the parameters within which the dkection is to be
pursued;
P Who makes decisions about what;
P Who sets performance indicators, monitors progress and evaluates results;
and,
9 Who is accountable to whom and for what?
Primarily, though, corporate governance refers to the framework of all rules
and relationships by which a corporation must abide, including internal processes as
well as governmental regulations and the demands of stakeholders. It also takes into
account systems and processes, which deal with the daily working of the business,
reporting requirements, audit information, and long-term goal plans. (FBN BMG
London Seminar)
Corporate Governance is, therefore, a systematic approach where the
connected members, management and employees are expected to cooperate in the
decision making process of the company. Based on some fundamental reasons,
corporate governance holds its premise that the business should be conducted by the
desires of shareholders. It identifies the distribution of rights and responsibilities
among a variety of stakeholders in the wmpany. It also briefly outlines the structure
and process for judgment on matters related to the company dealings. In the context
of the above, the following are the broad objectives on which corporate governance
can be measured: i) Suggested model code of best practices, ii) Preferred internal
systems, iii) Rewmended disclosure requirements, iv) Board members' role, v)
Independent director, vi) Key information to the board/committee, vii) Committees
of board, viii) Policies to be established by the board and i x ) Monitoring
performance. (Buxi, 2005)
Effective corporate govtxnance is imporht for any company to be
successfhl irrespective of the type of business it does. Corporate governance has, of
course, been an important subject of discuss'ion since many years. Scholars and
researchers from finance fields have actively investigated the importance and
efficacy of corporate governance for at least a quarter of a century (Jenson and
Meckling, 1976). There have been intense debates and brainstorming over corporate
governance practices particularly in the developed nations. However, the
effectiveness of corporate governance practices in the developed nations tells an
ironic story from the CG practices point of view. The volume of scandals and lack of
transparency in governance in the developed nations nullifies its hue commitment to
governance practices compared to the developing world (Shleifer et al., 1997).
Therefore, much prior to the recent wave of corporate fi-auds in developed
economies, corporate governance has been a fundamental subject in emerging
economies.
The subject of corporate governance has attracted worldwide attention with
the collapse of a series of high profile companies lrke Emon, WorldCom, Satyarn
Computers etc. These failures have shattered the trust of investors worldwide. Some
of the scandals which made headlines all around the world were loosely related to
poor corporate governance. This collapse came at a time when many companies
were trying to get internationally listed and foreign investors were becoming more
and more eager to buy them out (Economist Intelligence Unit, 2004). Poor corporate
governance is not a new subject. A good thing that &me out of these corporate
scandals was the global acceptance of the need for necessary checks and balances.
Worldwide, it has now become necessary for big corporate houses to address the
issue of corporate governance as investor demands fluctuate. The following are the
four vital pillars for strong corporate governance.
*:* Responsibility,
*:* Transparency,
*:* Fairness and
*:* Accountability
Large and trusted companies across the globe realized the significance of
corporate governance and subsequently to@ drastic steps to ensure practice of
corporate governance. These days corporate govixmmce is a reality which can't be
overlooked by any financial institution that wants to be successfi~l. There are a
number of factors which force a company to adhere to a set of corporate g o v m c e
principles. These may include stern regulators, vigilant and smart investing
community, alert customers and the awareness among companies to be good
corporate citizens. Companies should ensure a constant flow of profits but without
crossing moral and ethical boundaries. (Pushkar Gupta 2007) However, some bad
experiences in the past have exposed the fact that big corporate houses which have
committed frauds have tacit support from banks. Questions have arisen thick and
fast as to how people entrusted with governance of these corporate/banks, had failed
to detect and stern the rot, before it was too late. Banks are constituted as companies
under the companies act and they should be concerned with good governance.
Corporate governance has always been closely monitored by Asian regulators and
this term has been a top priority for them in recent times. This is happening because
of the fact that most of the markets have introduced a wide range of regulations.
Concept of Corporate Governance
It is difficult to define the concept of corporate govemance in a universally
acceptable way because definitions vary from country to country. Moreover,
countries differ from each other in terms of culture, legal systems and historical
developments (Ramon, 2001). This explains why there is a wide range of definitions
of the concept of corporate governance. There are several definitions of corporate
governance, although they are formulated differently but the meaning is the same.
The following definition can be found in OECD's preamble:
"Corporate governance involves a sei of relationships bemeen a company's
management, its board, its shareholders and other stakeholders. Corporate
governance also provides the structure through which the objectives of the company
are set, and the means of attaining those objectives and monitoringpefimance are
determined. Good corporate governance should provide proper incentives for the
board and management to pursue objectives that are in the interests ofthe company and its shareholders and should facilitate effective monitoring. " (OECD Principles
of Corporate Governance 22 April 2004)
"Corporate Governance is concerned with holding the balance between
economic and social goals olnd between ipdividual and communal goals.(Globd
Corporate Governance Forum.2003) The coxpotate governance framework is there
to encourage the efficient we of resources and equally to require accountability for
the stewardship of those resources. The aim is io align as nearly as possible the
interests of individuals, corporations and society" (Sir Adrian Cadbury in 'Global
Corporate Governance Forum', World Bank, 2000) .
According to the Economist and Nobel Laureate, Milton Friedman,
"Corporate Governance is to conduct the business in accordance with owners' or
shareholders' desires, while conforming to the basic rules of the society embodied in
law and local customs"(Economic Times,2001). In a nutshell, it can be said that
corporate governance means doing everything better to improve relationships
between companies and their shareholders, to improve quality of outside directors,
to encourage people to think long-term and to ensure that infomation needs of all
stakeholders are met. The discussion on governance dates back more than a decade
in different economies. Traveling through the pre-1992 American discussions on
disassociation of power and money (emanating from the Watergate Scandal), post-
1992 Cadbury Report on governance codes and OECD principles (1998 & 1999),
and corporate governance has not yet settled at any universally accepted definition
(A. C. Fernando)
Corporate governance is about "the whole set of legal, cultural, and
institutional arrangements that determine what public corporations can do, who
controls them, how that control is exercised, and how the risks and return from the
activities they undertake are a1Iocated.- (Margaret Blair, 1995)
Corporate governance is the relationship among various participants [chief
executive officer, management, shareholders, employees] in determining the
direction and performance of &rporationsW - Monks and Minow, Corporate
Governance, 1995.
Corporate governance is the relationship between corporate managers,
directors and the providers of equity, people and institutions who save and invest
their capital to earn a return. It ensures that the board of directors is accountable for
the pursuit of corporate objectives and that the corporation itself conforms to the law
and regulations. - International Chamber of Commerce
Corporate governance is the method by which a corporation is directed,
administered or controlled. Corporate governance includes the laws and customs
affecting that direction, as well as the goals for which the corporation is governed
The principal participants are the shareholders, management and the board of
directors. Other participants include regulators, employees, suppliers, partners,
customers, constituents (for elected bodies) and the general community. - Wikipedia
"Corporate governance is not an abstract goal, but exists to serve corporate
purposes by providing a structure within which stockholders, directors and
management can pursue most effectively the objectives of the corporation." - US
Business Round Table White Paper on Corporate Governance September 1997
Corporate governance is the system by which companies are directed and
managed. It influences how the objectives of the company are set and achieved, how
risk is monitored and assessed, and how performance is optimized. Good
corporate governance structures encourage companies to create value (through
entrepreneurism, innovation, development and exploration) and provide
accountability and control systems commensurate with the risks involved.
(ASX Principles of Good Corporate Governance and Best Practices
Recommendations 2003)
Corporate governance is the process carried out by the board of directors,
and its related committees, on behalf of and for the benefit of the company's
stakeholders, to provide direction, authority, and oversights to management. (Paul J.
Sobel, 2005)
Importance of Corporate Governance
The governance rose from an analysis by Berle and Means (1932) following
the Great Crash in the US in 1929, which traced the problem of governance due to
the separation of ownership and control. The authors recommended stakeholder
value over the share holder value as essential for good governance, a premise on
which formal securities regulation began in the US with the setting up of the
Securities and Exchange Commission (1933). This debate led the governance being
associated with the agency problem (Coase, 1937) (Jensen and Meckling, 1976).
(Fama and Jensen, 1983) in which the essence is thb separation of ownership and
control. Agency problem refers to the difficulties financiers have in assuring that
their funds are not expropriated or wasted on unattractive projects (Shliefer and
Vishny, 1997)) Early work in the corporate law development in the 18th and 19th
centuries in Britain, Continental Europe and ~ussi'e has focused more on addressing
the problem of managerial theft rather than that of shirking or even empire building.
Shleifer and Vishny cite studies on vast managerialist literature that explains how
managers use their effective control rights to pursue projects that benefit them rather
than the investors which are described as private benefits of control (Grossman and
Hart, 1 982). Managers can expropriate shareholders rights by entrenching
themselves and staying in the job even if they are no longer competent or qualified
to run the firm. Poor managers who resist being replaced might be the costliest
manifestation of the agency problem (Jensen and Ruback 1983). Agency theory
considered the firm as a nexus of contracts; associating the firm and the entire group
of resource contributors (the team of productive inputs) and analyzing the
relationship between the principle (shareholders) and the agent (mangers), the
conceptual framework which is found.
A series of events over the last two decades have made corporate governance
issues a top concern for both the international business community and the
international financial institutions. Spectacular business failures such as the
infamous Bank of Credit and Commerce International scandal, the United States
savings and loan crisis, and the gap between executive compensation and corporate
performance drove the demand for change in developed countries.(CIPE,2002)More
recently, high profile scandals, iinancial crises and/or institutional failures in Russia,
Asia and the United States have brought corporate governance issues to the fore in
developing countries, transitional e'conomies, and emerging markets. These incidents
illustrate that the lack of corporate governance enables insiders, whether they be
company managers, company directors or public officials, to ransack companies
andlor public coffers at the expense of shareholders, creditors and other stakeholders
(employees, suppliers, the general public, and so forth). (Dr. Catherine L. Kuchta-
Helbling and Dr. John D. Sullivan) Yet, in today's globalized economy, companies
and countries with weak corporate governance systems are likely to suffer serious
consequences above and beyond financial scandals atid crises. What is increasingly
clear is that how corporations are governed, commonly refmed to as corporate
governance, largely determines the fate of individual companies and entire
economies in the age of globalization. Globalization and financial market
liberalization have opened up new, international markets with the possibility of
reaping stunning profits (John D. Sullivan, Jean Rogers 2003). Yet it has also
exposed companies to fierce competition and to considerable capital fluctuations.
National business communities and company managers are learning that in order to
expand and be internationally competitive they need levels of capital that exceed
traditional funding sources. Failure to attract adequate levels of capital threatens the
very existence of individual firms and can have dire consequences for entire
economies. Lack of sufficient capital, for example, erodes firms' competitiveness
eliminating jobs and hard-won social and economic gains, thereby exacerbating
poverty. Firms unable to attract capital run the risk of becoming suppliers and
vendors to the global multinationals or, worse yet, they will be unable to compete
and thus left out of international markets entirely, while entire economies sun the
risk of not being able to take advantage of globalization. Yet, recent financial crises
caused by corruption and mismanagement have made attracting sufficient levels of
capital particularly challenging these days.
These crises cost investors biflions of dollars and sabotaged companies'
financial viability. They also contributed to increased shareholder activism and
competition for investment. Investors, especially instih;tional Investors, are now
making it clear that they art: not willing to foot the bill for corruption and
mismanagement. Before committing any funds, investors increasingly require
evidence that companies are run according to sound business practices that minimize
the possibilities for corruption and mismanagement. Moreover, investors and
institutions in Bogota, or Boston, Beijing or Berlin, want to be able to analyze and
compare potential investments by the same standards of transparency, clarity and
accuracy in financial statements before investing. In fact, being a credible business
that can withstand the scrutiny of international investors is more than just a matter of
global marketing: it has become essential for local companies and for entire
economies to grow md prosper. The bottom line is that investom seek out
companies that have sound corporate governance structures. Corporate gov-ce
is the body of rules of the game by which companies are managed i n t d l y and
supervised by boards of directors, in order to protect the interests and financial stake
of shareholders who may be located thousands of miles away and far removed fkom
the management of the firm. Just as good government requires transparency so that
the people can effectively judge whr-ther their interests are being served,
corporations must also act in a democratic and transparent manner so that their
owners can make educated decisions about their investments. This is what corporate
governance is all about. What is often overlooked is that corporate governance is
just as important for public sector firms as for private sector companies. Instituting
corporate governance within public sector firms has recently begun to receive
increased attention. This is particularly the case when countries are attempting to
curb widespread corruption within the public sector, or when they are preparing
public enterprises for privatization. In either scenario, sound corporate governance
measures help to ensure that the public gets a fair return on their national assets.(
Rarni Wadie)
Good corporate governance benefits developing countries in a number of
ways. According to at least one scholar, good corporate-governance practices can
decrease the "likelihood of a domestic financial crisis" and severity if such a crisis
does occur. Additionally, scholars have found strong "evidence linking corporate
governance to corporate efficiencyw and have shown &at "corporate governance
creates more efficient corporate management." Finally, research shows that well-
governed firms are valued significantly higher than firms with imperfect corporate-
governance practices. It has been estimated that, by the end of this century, "funds
seeking trustworthy, productive companies in today's developing countries are likely
to top $500,000 billion." The policy challenge that exists for governments in
developing countries is to provide a hospitable environment far such funds; a sound
corporate-governance framework can play a decisive role in creating this hospitable
environment. Strong corporate governance has beneficial consequences even for
countries that choose to follow a development strategy that does not focus on
attrading foreign investment. Many developing dountries are home to strong
distribution cartels that waste scarce resources, Good corporate governance can
reduce this wasteful behavior and, thus, "overcome the obstacles to productivity
growth." Moreover, corporate governance can play a role in reducing corruption,
and decreased corruption significantly enhances a country's developmental
prospe+cts. Ultimately, corporate governance "is not just one of those imported
westem luxuries; it is a vital imperative."
Objectives of Corporate Governance
P Fairness to all Stakeholders
);. Greater transparency through better disclosures
k Greater Accountability of Executive Management to stakeholders.
P Enforcement and Verifiability of various Acts, Regulations, Recommendations,
etc.
k Creating value for the shareholders
P Protecting interests of other stakeholders.
Essentials of Good Governance
P Quality and clarity of norms
Enforcement systems and structure processes
P Dialogue and discussion and awareness
Factors affecting governance
P IntegrityoftheManagement.
Ability of the board
> Adequacy of the process
Commitment level of individual board members.
k Quality of corporate reporting
k Participation of stakeholders in the management.
Applicability
P All listed companies including PSUs and mcluding Mutual funds.
B All companies that are incorporated under other statutes, so far as the
recommendations do not violate their respective statutes and guidelines or
directives issued by the relevant regulatory authorities Implementation
Schedule.
P By all entities seeking listing for the first time, at the time of listing.
> Having a paid up share c~pital of Rs 3 crores and above or net worth of Rs 25
crores or more at any time in the history of the company. (Corporate
governance review of practice (2007) & Bombay Stock Exchange)
Emergence of Corporate Governance: World Scenario
Business failures and frauds in the USA, several scandals in Russia and the
Asian crisis (1997) have brought corporate governance issues to the forefront in
developing countries and transition economies. The virtual collapse of the Russian
economy in 1998 resulted in large measure from the weakness of governance
mechanisms. The so-called managers are said to have robbed shareholders, creditors,
consumers, the government, workers and all possible stakeholders. The fact that the
consequent distrust predictably resulted in the virtual collapse of external capital to
firms reveals that corporate misgovernance can shake the very foundations of a
society. Likewise, the Asian financial crisis also demonstrated that even strong
economies lacking transparent control, responsible corporate boards and shareholder
rights could collapse due to the dilution of investors' confidence. Consequently
various countries in the world have adopted the CG reforms over the years as
detailed below.
World Scenario of CG Reforms - First codes of Practice
Source: Jill Solomon (2007), Corporate Governance and Accountability, P-188. & www.ecgi.org
Year
1 992
1994
1995
1996
1 997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
20 1 1
In this situation, the CG mechanism gained worldwide attention due to the
h u d s and deficiencies involved in the corporate sector in the US and the UK.
Prominent among corporate failures in US was the Collapse of Enron and in UK, the
Maxwell failure (1 991), Barings Bank (1995) and the like. Based on the corporate
distress in UK, several committees were appointed for finding the root causes for
their failure and to find appropriate solutions for improving the CG practices. The
Cadbury Committee (1992), The ~ r e e n b ~ ' Committee (1995), The Harnpei
Country
United Kingdom
South Afiica, Canada
Australia, France, Pan-Europe
Spain
USA, Japan, The Netherlands
India, Belgium, Germany, Italy, Thailand
Brazil, Greece, Hong Kong, Ireland, Mexico, Portugal, South Korea, OECD, ICGN, Commonwealth
Denmark, Indonesia, Kenya, Malaysia, Romania, Philippines
China, Czech Republic, Malta, Peru, Singapore, Sweden
Austria, Cyprus, Hungary, Kenya, Pakistan, Poland, Russia, Solvakia, Switzerland, Taiwan
Finland, Lithuania, Macedonia, New Zealand, Turkey, Ukraine, Latin America, Nigeria
Argentina, Bangladesh, Iceland, Norway, Slovenia, OECD, Mauritius
Jamaica, ICGN, Latvia, Lithuania
Estonia, Lebanon, Luxemburg, Nigeria, Sri Lanka, Thailand, Bosnia and Herzegovina, Egypt, Israel, United Nations
Bulgaria, Colombia, Jordan, Kazakhstan, Moldova, Mongolia
Morocco, Qatar, Serbia, Tunisia
Algeria, Croatia, Georgia, Montenegro
Armenia, Bahrain, Baltic States, Ghana, ~ a l a w i , .~om&a, Yemen
Azerbaijan, Guernsey
Committee ( 1 998), The Turnbull Committee (1 999), f i e Higgs Committee (2003),
The Tyson Committee (2003), The Smith Committee (2003) and Redraft of the
Combined Code (2003) are the prominent oaunikees on the CG in UK. Apart hm
all these exercises, the World Bank, the OECD, ~McKinsey S w e y on Corporate
Governance and Sarbanes-Oxley Act, 2002 also contributed improving the CG
practices world over.
Emergence of Corpor'ate Governance: Indian Scenario
Interest in corporate governance by policy makers in developed countries
had grown significantly by early 1990s. In India tbo it had its beginning in the early
1990s. In India the CG represents the value, ethical and moral framework under
which business decisions are taken to maximise stakeholder value. The emergence
of CG in India is the result of a spate of scandals in corporate and stock markets,
unlike corporate failures in the other parts of the world. A good number of
Committees and Commissions have been appointed for improving CG practices in
India also. Though in India there have not been such massive corporate failures such
as Enron, Maxwell etc., it has resolved wisely and with forethought to incorporate
better governance practices in the corporate sector emulating stringent international
standards. Many large corporations are multinational in nature. They have their
impact on citizens of several countries across the globe. If things go wrong, they are
bound to affect many countries, some more severely than others. Therefore, it is
necessary to look at the international scene and examine possible international
solutions to corporate governance issues and problems. Corporate governance is
needed to create a corporate culture of consciousness, transparency, confidence
among investors and prospective investing public. It refers to a combination of laws,
rules, regulations, procedures and voluntary practices to enable companies to
maximise shareholders' long-term value. It should lead to increasing customer
satisfaction, shareholder value and wealth creation.
Driving Forces of Corporate Governance
Good corporate governance is a reflection of quality management with the
highest caliber understanding the role that high corporate governance standards
plays in maintaining checks and balances within the organisation, increasing
transpttrency and pmenting corporate abuse and rniskgement . Management of
good corporate governance companies also understands the importance of investors
of long-tam sustained operating perform~ce and tends to be inherently
performance-driven. The corporate governance scenario in India has been changing
fast over the past decade, particularly with the enactment of Sarbanes-Oxley type
measures and legal changes to improve the enforceability of creditors' rights. India
should have the quality of institutions necessary to sustain its impressive current
growth rates in the years to come, if the same trend is to be maintained.
Corporate governance provides a mechanjsm which improves the efficiency,
transparency, accountability of the wrporates and builds the confidence of the
stakeholders. Corporate governance describes the structure of rights and
responsibilities among the parties that have a stake in the firm. But the kind of
responsibility and structure of the firm varies from region to region and country to
country including the emerging economies. These economies, however, provide
unique opportunities and challenges for governance practices and research. As
pointed out already, little research in this area has taken place in these countries. In
th~s context an effort is made here to identify the driving forces for corporate
governance in India. There are a number of causes for the emergence of corporate
governance in India, apart from the ethically ambiguous business practices and
scams in the market environment. There are three major driving forces in the market
that can be identified for the emergence of corporate governance in India. These
include 1. Unethical business practices and security s a n s , 2. Globalisation and
3. Privatisation.
Parties Involved in Corporate Governance
Parties involved in corporate' governance contain the regulatory body. Other
stakeholders who take part include suppliers, employees, creditors, customers and
the community at large. In corporations, the shareholder delegates decision rights to
the manager to act in the principal's best interests. This division of ownership h m
control implies a loss of proficient control by shareholders over managerial
decisions. Partially as a result of this separation between the two parties, a system of
corporate governance controls is implemented toeassist in aligning the incentives of
managem with those of shareholders. With the major &ease in equity holdings of
investors, there has been an opportunity for a reversal of the separation of ownership
and control problems because ownership is not so diffuse.
A board of directors often plays an importarit role in corporate governance. It
is their responsibility to support the organization's strategy, develop directional
policy, appoint, supervise and remunerate senior executives and to make sure of the
accountability of the organization to its owners and authorities. The Company
Secretary, known as a Corporate Secretary in the US and often referred to as a
Chartered Secretary if qualified by the Institute of Chartered Secretaries and
Administrators (ICSA), is a high ranking professional who is trained to support the
highest standards of corporate governance, effective operations, compliance and
administration. All parties to corporate governance have an interest, whether direct
or indirect, in the efficient performance of the organization. Directors, workers and
management receive salaries, benefits and standing, while shareholders receive
capital return. Customers receive goods and services; suppliers receive
compensation for their goods or services. In return these individuals provide value in
the form of natural, human, social and other forms of capital. A key factor in an
individual's decision to participate in an organization e.g. through providing
financial capital and trust that they will get a fair share of the organizational returns.
If some parties are receiving more than their fair return then participants may choose
not to continue participating leading to organizational collapse.
Parties to corporate governance
Barid d d b e a n
CradtQon
ProrprWe Irm#rcr
Corporate Governance in Banking Sector
Banking sector being the dominant and vital segment deserves utmost
attention. Banking is the systemic institution that not only possesses the potential of
a great catalyst for growth but also, on the other hand, has the capability of cawing
calamity to an economy. There is considerable deviation in practices of corporate
governance being followed by the banks in India. When banks efficiently mobilize
and allocate h d s , this lowers the cost of capital to firms, boosts capital formation,
and stimulates productivity growth. Thus, the functioning of banks has ramifications
for the operations of firms and the prosperity of nations. (Levine (1 997,2004).)
Banking crises dramatically advertise the enormous consequences of poor
governance of banks. Banking crises have crippled economies, destabilized
governments, and intensified poverty. When bank insiders exploit the bank for their
own purposes, this can increase the likelihood of bank failures and, thereby, curtail
corporate finance and economic development. While banks are important, this alone
does not motivate a separate analysis of the governance of banks. Banks are firms.
They have shareholders, debt holders, boards of directors, competitors, etc. This
suggests that one can simply think about the governance of banks in the same way
that one thinks about the governance of a shoe company, or an automobile company,
or a pharmaceutical company. (Ross Levine July 21,2003)
Banks, however, have two related characteristics that inspire a separate
analysis of the corporate governance of banks. First, banks are generally more
opaque than nonfinancial firms. Although information asymmetries plague all
sectors, evidence suggests that these informational asymmetries are larger with
banks (Furfine, 2001). In banking, loan quality is not readily observable and can be
hidden for long periods. Moreover, banks can alter the risk composition of their
assets more quickly than most non-financial industries, and banks can readily hide
problems by extending loans to clients that cannot service previous debt obligations.
Not surprisingly, therefore, Morgan (2002) finds that bond analysts disagree more
over the bonds issued by banks than by nonfinancial firms. As detailed below, the
comparatively severe difficulties in acquiring information about bank behavior and
monitoring ongoing bank activities hinder traditional corporate governance
mechanisms.
Smnd, banks are firequently very heavily regulated. Because of the
importance of banks in the economy, because of the dullness of bank assets and
activities, and because banks are a ready source of fiscal revenue, governments
impose an elaborate array of regulations on banks: At the extreme, governments own
banks. Of course, banking is not the only regulated industry and governments own
other types of firms. Nevertheless, even countries that intervene little in other sectors
tend to impose extensive regulations on the commercial banking industry. Further
more, the explosion of international standards through the BIS, the IMF, and World
Bank. (La Porta et al. 2002)
Given the importance of banks, the governance of banks themselves assumes
a central role. If bank managers face sound governance mechanisms, they will be
more likely to allocate capital efficiently and exert effective corporate governance
over the firms they fund. In contrast, if banks managers enjoy enormous discretion
to act in their own interests rather than in the interests of shareholders arid debt
holders, then banks will be correspondingly less likely to allocate society's savings
efficiently and exert sound governance over firms. (Andra Lavinia Nichitean,
Mircea Asandului.20 1 0)
Anecdotally, the various board committees (compliance, audit, risk,
compensation) are vocal, particularly in the internationally listed banks. All this has
had a knock-on effect on the other domestic banks. In sharp contrast, the old private
sector banks have the weakest level of governance. These banks are controlled by a
few families or by communities, with non-bank interests. While these banks might
have outside directors and various board committees, these tend to be passive with
real decision-making concentrated with the large shareholders - increasing the
chance of related party lending. .
The Reserve Bank (RBI), India's central bank, is focused on governance
issues both from the perspective of improving the quality of its oversight and from
secwing the interests of depositors through transparency, off-site surveillance and
prompt corrective action, The RBI has established two major committees to look
into governance at the banks and benchmark international best practices of
implementation. These committees have made' recommendations directed at the
independence and autonomy of the board and focused on harmonizing the
OECDTSaselISOX recommendations with local regulations and practices followed
in the domestic Indian market.(K.C collage 2010)
Governance affects the firms and houseliolds they lend to. Thus, weak
governance of banks reverberates throughout the economy with negative
ramifications for economic development (Levine, 2003). Research finds that banks
are critically import& for industrial expansion, the cg of firms, and capital
allocation. However, the importance of banks to national economies is underscored
by the fact that banking is virtually universally a regulated industry and that banks
have access to government safety nets. (A P Pati)
Importance of Corporate Governance in Banks
Corporate governance is particularly important for banks, given the bank's
important role in the financial sector. The rapid changes brought about by
globalization, deregulation and technological advances are increasing risks in the
banking systems. Moreover, unlike other companies, most of the funds used by
banks to conduct their business belong to their creditors, in particular their
depositors. Linked to this is the fact that the failure of a bank affects not only its own
stakeholders, but may have a systemic impact on the stability of other banks.
Theoretically, information asymmetry gives rise to agency problems and conflicts of
interest between owners and managers. G o d corporate governance is designed to
address this problem. Further, government regulations and frequent interventions
reduce the incentive for effective monitoring and, at the same time, make
supervision (or supervisors) less effective. In this context, the corporate governance
of banks becomes a more important challenge as compared to other firms.
(Ahmed M. Khalid 2004)
Tracing the importance of cg in Indian banks, quite a few facts are discerned.
First, banks have an overwhelmingly dominant position in financial systems, and are
extremely important engines of economic growth (King and Levine,l993;and
Levine, 1997). Second, as financial markets are usually underdeveloped, banks are
typically the most important source of external finance for the majority of firms.
Third, the economy is dominated by many small scale firms and most of them
18
depend on banks. The governance of banks thus affects their governance structure.
Fourth, as well as providing a generally accepted means of payment, banks also
function as the main depositories for the through privatizationldisinvestments and
hmce reducing the role of economic regulation. @mnomic regulations are getting
replaced by prudential regulations, like capital adequacy norms, supervisory norms
and many others. However, the prudential reforms already implemented in
developing countries including India have not been effective in preventing banking
crises (e.g. the recent Global Trust Bank and other cooperative banks failures) and
the reasons can be traced to many, like poor legal structure, dominance of a docile
shareholder i.e. Government, and asymmetry' in information flow across the
stakeholders. Although in comparison to many developing countries, India is better
placed with respect to tapping the capital market for fulfilling necessary capital
requirement, the need arises here to strenthen the regulations and to make
governance more effective. The concern for good governance from the state can be
visualized from its oversight functions. In India the oversight fhction of Govt. is
conditioned by three reasons (Leeladhar 2004). Firstly, it is believed that the
depositors, particularly retail depositors, are not able to effectively protect
themselves as they do not have adequate information, nor are they in a position to
coordinate with each other. Secondly, bank assets are unusually opaque, and lack
transparency as well as liquidity. This condition arises due to the fact that most bank
loans, unlike other products and services, are usually customized and privately
negotiated. Thirdly, it is believed that there could be a contagion effect resulting
from the instability of one bank, which would affect a class of banks or even the
entire financial system and the economy. As one bank becomes unstable, there may
be a heightened perception of risk among depositors for the entire class of such
banks, resulting in a run on the deposits and putting the entire financial system in
jeopardy. Despite of such concerns from govt. side, the dominance of the latter and
its central bank casts several doubts over their intentions. Another area of concern in
Indian banking is the dominance of state owned banks. Government ownership
thwarts competitive forces, limits the effectiveness of government supervision in the
financial sector, and tends to meets use their state-owned institutions to support
excessive government spending and favor less-than- creditworthy borrowers. All of
these tendencies dampen overall economic growth (Litan et al, 2002). New private
banks are generally good on accounting, but poor on accountability. They are more
modem and computerized, but less risk conscious. One thing which is common to
all is that cg is highly centralized with very little real check on the CEO, who is
generally also closely linked to the largest' owner groups. The enormous
consequences of p r governance of banks come to limelight only in the case of
banking cxisedfailures, It is of mcial importance therefore that banks have stronger
cg than other corporate entities. (Jalan, 2002).
Review of Literature
Andrew Sheng (1991) defines The New htitutional Economics that carried
out a short review of bank failures, etc. according to analytical fiamework.
However, emphasis was laid on discussion of different techniques of bank
restructuring used in different countries designed to assist the policy makers and
financial sector professionals under different circumstances.
Ozanian, Michel K. and Bradford, Stacey L. (1996) they delivered and
focused on the stock performance of top banks in the United States as of July 8,
1996. They also focus on Total asset value of bank takeovers; Trend towards
increasing the percentage of non-interest income versus interest income; List of top
performing banks in the United States; Measures used in ranking the banks. In 1996,
World of Banking dealt with ranks of the 20 biggest banks in Russia in respect of
share of gross assets and net assets ratio; Consequences of the country's banking
crisis; Outflow of deposits fiom commercial banks and trust companies; Public's
wariness of pyramid scams; Ownership of banks, etc.
Bhattacharyya (1997) Examined the productive efficiency of 70 Indian
commercial banks during early stages (1 986- 199 1) prior to liberalization. The used
Data Envelopment Analysis to calculate radial technical efficiency scores and
Stochastic Frontier Analysis to attribute variation in the calculated efficiency scores
to three sources: a temporal component, an ownership component, and a random
noise component. He found publicly owned Indian banks to have been the most
efficient, followed by foreign-owned banks and privately owned Indian banks. It
was an attempt to explain these patterns in terms of the government's evolving
regulatory policies.
Sarkar and Bhawmik (1998) They talk about ownership but relate it to
performance rather than govemance. An implicit assumption made by sdrolars
(Singh, 2002 and Bhawrnic 2005), arguing in favour of privatization of public sector
banks relates to poor corporate governance in public sector banks if the reason
behind unsatisfactory performance of the public sector banks lies is poor corporate
govexmmce than privatization of public sector banks will not deliver the goods of the
corporate governance in private sector banks is not significantly better than their
public sector counterparts. The whole debate relating to privatization of public
sector banks appears to be devoid of any reference to corporate governance in banks.
In fad the issue is misplaced in as much as the debates veers towards privatization,
in the light of poor performance of public sector bans, instead of emphasizing good
corporate governance.
Rohit Rao (2000) States that Banking performance is the mirror reflection of
an economy. So long as banks perform their primary function of banking by lending
to the constituents of economy, they stand a chance of forging ahead.
Ciancanelli and Gonzales (2000) Argue that banking sector has different
market structures which do not meet the basic assumptions of agency theory. One
besides unusual agency problem, bank managers and owners are subject to
regulation. As a governance force, regulation is intended to serve the public
interests, particularly the interests of the consumers of the banking services.
Regulator and regulation represent external corporate governance that implies
market forces to discipline both managers and owners in a diffaent way than that in
unregulated economic-sectors. According to the Basel Accord, risk management and
minimum capital requirement in banking sector are subjects the regulator is
concerned with. However, although the regulation is concerned about governing risk
management in banking sector, liter&ures in financial banking do not clarity explain
the relationship mechanism between risk management and regulation, and how the
relationship will lead to higher bank performance.
Ciancanelli and Gonzales (2000) state that in banking sector the regulation
and regulator represent external corporate governance mechanism. In the
conventional literature on corporate governance, the market is the only external
governance force with the power to discipline the agent. The existence of regulation
means there is an additional extsmal force with the .power to discipline the agent.
The force is quite different fiom the market. This implies that the power of
regulation produces effects different from those produced by markets. Bank
regulation represents the existence of interests diffaent from the private interests of
the firm. As a governance force, regulation aims to serve the public interests,
particularly the interests of the customers of the banking services. An agent of the
public interest, the regulator, also enforces regulation itself. This agent does not have
a contractual relationship either with the firm's principal or with the banking
organisations because of different interests from the principal (Ciancanelli and
Gonzales, 2000)
Goldberg, Dages, and Kinney (2000) they compare the bank performance
of domestic- and foreign-owned banks in Argentina and Mexico. They find that
foreign banks generally have higher loan growth rates than do domestic private
owned banks which have lower volatility of lending that contributes to lower overall
volatility of credit. Additionally, in both countries, foreign banks show notable
credit growth during crisis periods. In Argentina, the loan portfolios of 2 Mutual
ownership refers to the organization format that members (customers), rather than
the shareholders, own the banks.6 foreign and domestically private-owned banks are
similar and lending rates analogously respond to aggregate demand fluctuations. In
Mexico, foreign and domestic banks with lower levels of impaired assets have been
similar to loan responsiveness and portfolios. State-owned banks (Argentina) and
banks with high levels of impaired assets (Mexico) have more stagnant loan growth
and weak responsiveness to market signals.
F u m e (2001) he Claims that although information asymmetries affect all
areas of the financial sector, the problem is more fundamental in the banking sector.
He argues that loan quality, in a banking industry, is not readily observable.
Moreover, banks can alter the risk composition of their assets more quickly than
most non-financial firms. In a system of connected lending, banks can extend loans
to clients who have a history of bad credit or were not able to service their previous
debt obligations.
M. Thenmozhi and R Khhore Kumar (2001) they expressed the view that
by 2001, the Indian financial sector which- snmd its 10th year of reforms, will
touch upon almost every segment. Nevertheless, it experienced major reforms and
has come far away from the days of nationalization. The Narasirnharn Committee
laid the foundation for refoms in the Indian banking sector and paved the way for
enhancing its efficiency and viability. With India becoming a member of WTO, it
had to be opened up for international players and to prepare the Indian banking
industry for a vibrant global competition. As the international standards became
prevalent, banks had to unlearn their traditional operational methods of directed
credit, directed investments and administered iliterest rates. Moreover, increase in
the number of banks, transparency of banks' balance sheets through prudential
nonns and increase in the role of the market forces due to deregulated interest rates
have all significantly affected the operational environment of the sector. Further,
commitments made by India in the WTO Financial Services Agreement in
December 1997 had a significant impact on the banking industry.
Arun and Turner (2002) they discussed the theoretical analysis of corporate
governance of banlung in developing economies, in general and corporate
governance of banking sector specially public sector banks in India, in particular.
The researchers argued that banks have a unique contractual nature implying that the
interests of other stakeholders appear more important to them than in the case of
non-banking Organisations. In the case of banking, the risk involved for the
depositors and the possibilities of contagion means that. the depositors of banks
assume greater importance than those of consumers of manufactured products. They
added that the Indian banking system is of interest because of the dominance of the
government in the banking system. Moreover, the Indian experience is of further
interest due to the partial divestment of public sector banks as part of the economic
reform programmes introduced in India since 1991. Their observation is the
corporate governance issues have not received much attention in the first generation
of financial sector reforms. In India, the issues have become important in the second
decade of reforms. In India, there is an urgent need to review the size and
composition of the Public Sector Banks boards to make them effective instruments
of corporate governance.
A.K.Trivedi (2002) expressed the view that technology and competition
have brought about notable changes in Indian banking today. From Internet Banking
to Cash Management Services, technology has changed both in retail and wholesale
banking. Banks have been slow to adapt to the ohanging times finding themselves
behind technology-sawy competitors. It applies particularly, to some of the state
owned banks opposed to introduction of new technology. Moreover, with lines of
demarcation between banks and financial institutions blurring, the focus has shifted
to offering all assets (e.g. loans) and liabilities (e.g. deposits) products under one
roof, heading towards Universal Banking.
Reddy (2002) Checks up Doubts whethe; corporate governance is generally
better in private sector banks. A few old private sector banks continue to be closely
held and many of them resist broadening their share holders' base and thus avoid
deepening of corporate structures. More often than not, takeover bids have been by
equally closely held groups. Promoters were expected to dilute their stakes in new
private sector banks to below 40 per cent within three years. It is yet to be fully
complied with in all the private banks. In most cases, the banks continue to be
identified with effective control by promoters' institutions.
Jalan (2002) closely shares this view. Old private sector banks also have
very poor auditing and accounting systems. New private banks are generally good in
accounting, but poor in accountability. They are more modern and computerized, but
less risk conscious. It may be added here that their exposure to off -balance sheet
activities is extremely high, second only to foreign banks. A phenomena common to
all private banks is that corporate governance is highly centralized with very little
real checks on the CEO, who also remains closely linked to the largest owner
groups. He goes to state that their boards or auditing systems are not very effective.
Claessens and Fan (2002). this study reviewed the literature on corporate
governance issues in Asia. The study confirms that, as in many other emerging
markets, the lack of protection of minority rights has been the major corporate
governance issue and much popular attention has focused on poor corporate sector
paformance. However, most studies do not suggest that firms in Asia were badly
affected. Instead, the study indicated that the conventional governance mechanisms
were weak to mitigate the agency problem, as insiders typically dominated boards of
directors and hostile takeovers were extremely rare.
KSivalogmathan (2002) Defines banking in the new millennium will be
marked by high expectations of customers who are well informed and possess
technical knowledge. Computers are rapidly taking over the hmctions and
personalized service will continue to have relevance. The sum and substance
of banking activity in future will boil down to one simple prescription: Customer
Delight.
The New Institutional Economics carried out a short review of bank failures,
etc. according to analyhcal h e w o r k . However, emphasis was laid on discussion
of different techniques of bank restructuring us@ in different countries designed to
assist the policy makers and financial sector professionals under different
circumstances (Andrew Sheng, 1991).
The financial services industry is transforming unpredictably. Nations Bank
Corporation has broadened its product line considerably; State Street Bank & Trust
Company narrowed its focus preliminarily to servicing financial assets as an
investment manager. Increased compethon fiom non-traditional institutions, new
information technologies and declining processing costs, erosion of product and
geographic boundaries, and less restrictive governmental regulations etc - all played
a role (Dwight B. Crane and Zvi Bodie, 1996).
Lang and So (2002) They examine the composition of ownership structures
of banks in emerging markets. They observe th'at foreign banks have higher holdings
than do domestic banks if state stakes are excluded. In terms of bank performance,
ownership structure has no impact on the bank performance. These findings suggest
further study to rethink about tlie system of privatization of state controlled banks.
Will the foreign banks have control of domestic banking system once the state-
controlled banks are privatized? Havrylchyk (2003) finds that foreign-owned banks
are found to be more efficient than their domestic owned bank counterparts.
Parekh (2003) According to him the term "Corporate Governance" which
was rarely encountered before the 1990s has now become an all-pervasive term in
the recent decade. In today's scenario this term has become one of the most crucial
and important concepts in the management of companies. The root of corporate
governance dates back to Adam Smith but its popularity is of recent origin. The
concept of corporate governance can be understood "the system through which shareholders are assured that their interest will be taken care of by management". In
a much wider tmn, corporate governance was defined as 'We methods by which
suppliers of finance control managers in order to 'ensure that their capital cannot be
expropriated and that they earn a return on their investment"
Arun and Turner (2003).Their study is another good theoretical discussion
of the corporate govkance of banking institutions in developing economies. They
suggested that the corporate governance of banks in developing economies is
severely affected by political considerations. Firstly, given the trend towards
privatisation of government-owned banks in developing economies, there is a need
for the managers of such banks to be granted autonomy and to be gradually
introduced to the corporate governance practices of the private sector prior to
divestment. Secondly, where there has only been partial divestment and
governments have not relinquished any control to other shareholders, it may prove
very difficult to divest further ownership stakes unless corporate governance is
strengthened. Finally, given that limited entry of foreign banks may lead to
increased competition, which in turn encourages domestic banks to emulate the
corporate governance practices of their foreign competitors, they suggested that
developing economies should partially open up their banking sector to foreign
banks.
Boubakri et al., (2003) they examined the corporate governance features of
newly privatized firms in Asia and documents how their ownership structure evolves
after privatization. The results suggest that privatization leads to a significant
improvement in profitability, while, on the other hand, it creates value for
shareholders.
Jan and kim(2003). Study on governance mechanisms and banks which
examined the impact of various governance mechanisms on bank capital,
performance and merger returns for bank holding companies. Their results are
mixed for Explain; Both managerial Compensation and the level of management
entertainment are significant factors whereas load structure has little impact on all
three aspects. Especially after controlling for other mechanisms. They found that
governance does not play a simple role in regulated industries, like
banking.(http;//www,fma.org)
G O S W ~ ~ (2003). He had made a comprehensive study of the state of
corporate governance in India. He studied almost all the areas of corporate
governance and pointed out including the roots, corporate structure, regulatory
environment initiatives taken by the authority etc: He observed that India has made
much more rapid strides in corporate govmance than most of its Asian counterparts
and that in the next few years it will witness a an greater flurry of activity by several
factors such as competition, growth of market capitalization, foreign investors, and
strong financial press. He also added that Indian corporations have appreciated the
fact that good corporate governance and internationally accepted standards of
accounting and disclosure can help them to access the US capital markets.
Hasan, lftekhar and Marton, Katherin (2003) they analyzed the
experiences and developments of Hungarian banking transitional process from a
centralized economy to a market-oriented system. They identified that early
reorgariization initiatives, flexible approaches to privatization, and liberal policies
towards foreign banks' helped to build a relatively stable and increasingly efficient
banking system.
Went, Peter (2003) analyzed a merger between two Scandinavian Universal
Banks to determine arguments for the same. It was a response to changes in
legislative and competitive environment, as well as a quest for broader fimctional
competency by integrating a smaller, more successful bank with a state-owned bank.
The most important predicted effects were improvements in the profitability and
market position.
Rime et a1 (2003) examined the performance of Swiss banks from 1996 to
1999, using a broad definition of bank output, evidence of large relative cost and
profit inefficiencies. A more narrow definition focuses on only traditional activities
leading to efficiency estimates that are even lower. Finally, evidence on scope
economies is weak for the largest banks. These results suggest a few obvious
benefits from the trend towards larger, universal banks in Switzerland.
Ippers (2003) in their paper, presented a study, based on two rather unique
data sets. They used descriptive statistics and a sophisticated model, designed for
this specific purpose, to see whether two basic premises of the theories on optimal
ranges are valid. In contrast to the widely accepted assumptions, they found that
individuals appear not to pay efficiently and that they are also not indifferent .to use
of coins and notes.
Clamen and Fan (2003) study corporate governance in Asia. They find that
agency problems arise from certain ownership structures. Conventional corporate
governance mechanisms (through takeovers and boards of direcqors) are not strong
enough to relieve the agency problems in Asia. Firms use other mechanisms to
reduce their agency problems (for example, employing reputable auditors), although
they have only limited effkdiveness. The low transparency of Asian corporations
relates to these agency problems and the prevalence of connection-based
transactions that motivate all owners and investors to protect rents. The rents often
appear from government actions, including a large safety net provided to the
financial sector. Forms of crony capitalism (i.e., the combination of weak corporate
governance and government interference) are not only leading to poor performance
and risky financing patterns but also conducive to macroeconomic crises. Their
survey suggests that corporate governance: in Asia, including Indonesia, faces
unresolved problems, both in conceptual and empirical matters of corporate
governance in banking sector. The research also attempts to cover the unresolved
problem by examining the relationship sensitivity between corporate governance and
performance for domestic-owned banks versus foreign-owned banks.
Macey and Hara (2003) argue that commercial banks pose special corporate
governance problems for managers, regulators, and claimants on banks' cash flows.
They argue that bank managers and directors should follow broader, if not higher,
set of standards than their counterparts working in unregulated, non-financial firms.
Moreover, they recommend that the scope of fiduciary duties and obligations of
bank officers and directors can be broadened to address the interests of fixed and
equity claimants. They suggest that top bank executives take solvency risk explicitly
and systematically into account when making decisions.
Adams and Mehran (2003) argue that the governance of banks may be
different from that of unregulated, non-financial firms for several reasons. They
argue that investors, depositors and regulators have a direct interest in bank
performance. Given the dependence of the whole economy on banking performance,
regulaton are more concerned about the safety of the financial system- Adams and
Mehran (2003) think that a significant difference between banking h s d
manufacturing firms relate to board size, board makeup, CEO ownership and
compensation structure, and block ownership. These differences support the theory
that corporate govemance structures should be industry-specific.
Levine (2003) argues that banks have two related characteristics that inspire
a separate analysis of corporate governance for banks. First, banks are generally
more opaque than non-financial firms. Second, banks usually operate in a highly
regulated environment. Due to the importance of banks in the economy, the opacity
of bank assets and activities, and banks being a ready source of fiscal revenue,
governments have imposed an elaborate array of regulations on banks.
Rafel, Miguel, and Vicente (2004) they argue that In India, the government
has taken appropriate steps to implement good corporate governance practices in
Indian banks. As a result of that, the public sector banks have disinvested in favour
of Indian public. But, there is literature, which account negative impact of corporate
governance on bank performance. There is a negative relationship between
governance intervention and performance for Spanish banks.
Das and Gupta (2004) they examined the issues of corporate governance in
the Indian banking system. Using data on banking systems, they studied 27 public
sector banks for the period 1996-2003. The findings reveal that CEOs of poorly
performing banks are likely to face higher turnover than CEOs of well performing
ones. The researchers pointed out that along this dimension, corporate governance is
effective. However, these findings do not imply that corporate governance in Indian
banks is perfect.
Machold and Vasudevan .(2004) they investigated governance reforms in
India over the last decade. The paper reviews changes in Indian governance codes
that indicate a preference for adoption of Anglo-American governance models. A
survey of ownership structures of Indian listed companies reveals a mixture of
governance mechanisms and a persistence of the 'business house model' of
governance. The study concluded that despite external pressures towards an 'Anglo-
Americanisation' of governance practice, the outcomes thus far reveal the emergence
of a diversity of governance mechanisms arising in a path-dependent fashion.
29
Hsimg-Tsf Chiang (2005) in his view the board of directors is the ultimate
governing body on bank affairs. The main task of bank board is to monitor and
control management on behalf of owners. The board of director is top executive unit
of a company and is charged with the responsibinty of supervising operations of the
company's management.
Zororo Muranda (2006) intended to investigateelhe relationship between
corporate governance failures and financial distress in Zimbabwe's banking sector.
The study used the case study method. It discussed cases of banks currently in
financial distress. Data collection was through desk research. The analysis is
qualitative. Judgmental sampling was used in selecting the eight abridged cases. The
author found &om research that in all cases of pronounced financial distress, either
the chairman of the board or the chief executive wields disproportionate power in
the board. The disproportionate power emanates from major shareholding. The
overbearing executive overshadows other directors, executive and non-executive,
thus creating power imbalance in the board. The study showed that financial
institutions in Zimbabwe underestimated the competitive forces that resulted fiom
first, economic deregulation and later economic decline coupled with political
meltdown. In order to survive, banking institutions significantly shifted fiom their
core business.
Samy Nathan, Vincent Ribiere (2007) they explored the concepts and
relationships between intellectual capital, knowledge, wisdom and corporate
responsibility in the context of the corporate governance of Islamic financial
institutions. The author used an adaptation of the Nicholson and Kiel intellectual
capital model of the board of directors including the role of the Shari'a Supervisory
Board (SSB). The author concluded that the need for organizations to continue their
knowledge management journey by integrating organizational wisdom with their
decisions and actions. Corporate social responsibility is perceived as being the first
step towards organizational wisdom.
Gabriella Opromolla (2008) described the Bank of Italy's new
comprehensive regulatory framework containing guidelines on the organization and
corporate governance of banks. The author covered the structure of the regulatory
fiamework and the content of the rules, including rules an a bank's choice of board
mod4 a bank's corporate governance project raprksenting by laws and intnnal
organization, tasks and powers of governing bodies, composition of governing
bodies, compensation and incentive mechanisms, and information flows. The paper
revealed that the new rules are in line with recent prudential measures that assign a
central role to corporate organization and require banks to establish appropriate
corporate governance, arrangements and efficient management and control
mechanisms aimed at affecting the risks to which they are exposed.
Duwuri Subbarao (2011) he expressed the view that in emerging
economies, banks are more than mere agents of financial intermediation; they carry
the additional responsibility of leading financiai sector development and of driving
the government's social agenda and also the institutional structures that define the
boundaries between the regulators and the regulated and across regulators.
Managing the tensions that arise out of these factors makes corporate governance of
banks in emerging economies even more challenging.
Chuck Prince (2011) was the former CEO of Citigroup, who said that one
had to keep dancing as long as the music was on! Where banks differ is that their
procyclical behavior hurts not just the institution but the larger economy.
Dr. Harmeet Kaur (2012) has concluded that there is considerable
divergence in the practices of corporate governance being followed by the banks in
India. An attempt has been made in this study to find the difference in the Corporate
Governance Disclosures being made in the Annual General Report of the public and
private sector banks in Indian Banking Industry.
Murugesan Selvam, John Raja, Arumugan Suresh Kumar Normally,
board performs variety of functions such as monitoring and controlling management,
approving dividend decisions, .deciding business policies, and facilitating
development and implementation of corporate strategy. Boards are required to
deliberate on the strategic agenda of the company. Boards play major role in
corporate governance in the bank.
James, R. Barth and Susanne Trimbarth observe that there is a significant
positive correlation between the size of a country's financial system and its real
GDP per capita. They identify a number of 'best practice' areas that financial
3 1
institutions should be focusing on. These areas include the power of the bank, it's
market entry policies, capital adequacy, mankgerial supervisory power, the extent of
autonomy enjoyed by line managers, deposit insurance, loan classification,
provisioning, asset allocation, internal managemeit and state ownership issue. They
have also discussed bond and derivatives market, off-balance sheet activities of
banks, role of venture capital, comparative advantage aqcl absolute advantage in
financial services and*e-finance from a global perspective.
James RBarth, Valentina Hartarska, Daniel E.Nolle and Triphon
Phuminwasana observe that a healthy banking system requires more insightll
regulation and supervision. In their view, efficient functioning of financial systems
requires both corporate governance and external governance. They, however, say
that very little attention has been paid to the corporate governance of banks.
Quoting Caprio and Levine, They identify four sources of governance for
banks, viz., Shareholders, debt-holders, the competitive discipline of output markets
and governments. They recognise the importance of accountability standards,
strength of external audits, financial statement transparency, and external rating and
credit monitoring as the sub-component of external governance. Empirical results of
their study indicate that external governance does indeed matter for a bank's
profitability. The magnitude of the effects of external governance measures is also
economically significant.
Uwe Neumann and Philip Turner. Take up questions about the desirability
of a market- orientated, risk sensitive framework for banks in emerging market
economies. They warn that capital requirements and acquisitions, without
considering the relevant risk factors will increasingly become unsustainable. They
conclude that the cost of credit will primarily be driven by the bank's internal risk
measures.
V, Sundararajan and Barbara Baldwin, while providing their distilled
wisdom try to tackle the trace on the question of 'single versus multiple' regulators,
conclude that the most limited option would be to leave the existing regulatory
structure in place, but to overlay it with a newly established oversight board.
32
Amar Gande, Kose Jhon, and Lemma W.Senber present different
perspective on the role of incentives in the prevention of financial crises in emerging
economies. They reject the most established approaches which debate the
determinants of financial crises and on ex-post 'resolution of a crisis. They have
suggested an approach focusing on the prevention of financial crises. They look at
the role of incentives in mitigating the vulnerability of such crises. They show that
the distorted risk incentives in investment decisions by corporation and in loan
decisions by banks as a result of implicit or explicit bailouts can lead to an increased
probability of precipitating financial crises.
Abhay Pethe and Rupa Rege Nitsure look at the activities of development
financing institutions such as Industrial Credit Investment Corporation of
India(JCIC1) and Scheduled CommerciaI Banks of India to find out their subsidy
dependence and conclude that ICICI is out of the subsidy dependent net whereas, the
State Bank of India continues to thrive on subsidies and the authors term it as a case
in 'in-perfections in Indian regulation'.
Samaresh Bardhan and Sugata Marjit have tried to formalise an attempt
to advance an understanding of the implications of the tolerable limit of NPAs. They
have tried to address the question, what is the critically maximum or the permissible
level of NPAs that a bank can tolerate, given its portfolio of various assets? The
study points out that it is largely the personal cost which is highly significant in
explaining the 'severity of NPAs'. The recovery ratio in banks is found to be
significant to the severity of NPAs. In the case of private and foreign banks, price
competition has the positive and significant coefficient in explaining the severity of
NPAs. Interestingly, in the case of public sector banks this factor appears to be
insignificant.
From the above foregoing analysis of the study it is revealed that corporate
governance in the banking sector has, fiom being a subject of debate within the
academic, regulatory, and investor circles, recently became an issue of national
global concern. More specifically, key issue in this debate is the role that corporate
governance plays not just in the generation of returns, economic and others, to
owners and stakeholders but also as an engine of economic growth and cultural
change in a country. In this case, as a developing country, like India is closely
monitoring the corporate governance issues in both financial and nonfinancial
companies and thus could be a good example for the other developing countries in
world.
Statement of the Problem
With the rapid pace of financial innovation and globalization, the face of
banking is undergoing a sea change. Banking business is becoming more complex
and diversified. In the changed scenario, it is essential that the Boards of banks are
fully geared to govern the banks well. The objective of governance in banks should
first be protection of depositors' interest and then to optimize the shareholder's
interests. While doing so, the foremost responsibilities should be to ensure fair and
transparent dealing without giving a chance of mis-governance. The governance
issues in banks cannot be understood independently. The regulatory M e w o r k has
significant implications for the corporate governance of banks. There is a growing
realization that the corporate governance arrangements of banks are significantly
different in comparison to similar efforts for firms in other sectors. The corporate
governance of banks is a complex issue. It has been observed that the legal and
regulatory fkamework, in which banks operate, makes the governance mechanism of
hostile takeova ineffective as a method of corporate governance. Thus, governance
issues in banks have to be discussed in an environment where a bank's management
has a considerably reduced threat perception from the market for corporate control.
It is the high time to revlew analytically the Corporate Governance practices
in the banking sector. Thorough investigation into different aspects relating to
corporate governance practices in this sector is highly intensified. The problems
involved in corporate governance practices in the banking sector need to be
identified and solved for better corporate governance practices in the banks in
modem times. Hence, the present study "Corporate Governance Practices in Indian
Banking Sector - A study with reference to Select Public and Private sector Banks,"
focuses on various Corporate Governance mechanisms and practices in banking
sector. Thus it is a modest attempt to fill the gap.
Need for the Study
The rationale of the study has been to examine the relationship between
corporate governance practices and bank perfo+ance in India, as a result of the
adoption of code of best practices on corporati: governance, and the extent of
changes to corporate governance practices in Indian banking sector. The banks that
operated in India were affected by political and economic instability.
No country has been free of costly banking crisis in the last quarter century.
The prevalence of banking system failure has been at least as great in developing
and transition countries as in the industrial world. The developments of new
technologies, major industry consolidation, globalization, and deregulation have
placed the banking industry at strategic crossroads. They provide finance for
commercial enterprises, basic financial services to a broad segment of the population
and access to payments systems. In addition, some banks are expected to make
credit and liquidity available in difficult market conditions.
The banking sector in general, is highly sensitized to public scrutiny and is
more vulnerable to the risk of attracting adverse publicity through failings in
governance and stakeholder relationships. It is a special sub-set of CG with much of
its management obligations enshrined in law or regulatory codes. In the light of the
above statement governance issues in banks, more particularly in PSBs assume
immense significance, but unfortunately these are less discussed and deliberated.
Although the primary reason identified for it is the prevalence of govt. ownership
across the institutions, another important reason that can be attributed to the
multiplicity of regulatory and supervisory legislations. For instance, in India there
are 5 legislations e.g. RBI Act, SBI Act, Bank Nationalization Act, Banking
Regulation Act and Companies Ac't that govern the banking sector. Because of this
multiplicity of Acts and their enforcing agencies i.e. RBI and GOI, any concrete
form of principles on bank governance is yet to emerge. India has been able to
significantly reform its banking sector, which is essential for sustainable growth.
However, with more active public and private banking sectors in place, there is a
dire need to implement some "self- discipline" measures, or corporate governance
guidelines. This study aims in this direction. .
Objectives of the study
1. To review the origin and development of corporate Governance.
2. To analyse the Structure and mechanism of Corporate Governance.
3. To evaluate the Corporate Governance practices in select Indian Commercial
Banks.
4. To assess the 'impact of Corporate Governance on profitability of select
Commercial Banks.
5. To examine the problems and measures.for good corporate governance in
Banking Sector.
Research Methodology
The present study is based on the secondary data for analysis and to draw
concrete inferences. It uses a one-way approach focusing on the seleded banks in
the public and private sector, in India. The data pertaining to the various aspects of
their business operations and performance is collected from the official records of
the sample banks. Additional information pertaining to their overall banking
development, their progress and performance over a period of time is extracted fiom
major sources of secondary data, such as annual reports, documents, journals,
statistical reports of the RBI, Indian Banks Association Bulletin (IBA) etc., The
study has extensively utilised the information regarding the later developments
available through websites of various Foreign and Indian institutions. In addition,
Economic Survey of India, journals like banking finance, Finance India, Published
and unpublished reports have also been referred to. The data, is analysed
scientifically through relevant financial and statistical tools and techniques.
Data Collection
The secondary data has been collected from various publications of the
Reserve Bank of India, both audited and un-audited reports and other publications of
the banks. The publications of the RBI include Statistical Tables Relating to Banks
in India, Report on Trend and Progress of Banking in India, Annual Reports of
Reserve Bank of India and relevant issues of Reserve Bank of India Monthly
Bulletins. The relevant materials for the study at the Government level have also
bmn collected from the Economic Survey of India, from various books relating to
financial institutions and commercial banks,-different Committee Reports relating to
financial system and banks, different websites bf banks, Indian Banks Association
Monthly and Special Bulletins, Journal of Banking Finance etc, The information
pertaining to business operations, financials products, the business strategies and
performance in various kinds of business activities, is also collected £tom various
reports, journals, and banking websites . Further, data i i also collected from the
published and un-published records and various reports of research project-reports to
supplement the other data.
Sample Design
This study is a comparative analysis to measure the changes in corporate
governance practices from 2002-2003 to 201 1-2012. Random sampling technique
has been adopted for the study. There are 20 banks in the Public sector and 20 in the
private sector operating in India. They are invariably governed by the new rules and
regulations of the RBI. Keeping in view the time and operational constraints, two
public sector banks and two private banks operating in India are chosen at random as
sample banks for an in-depth study: The ICICI Bank and HDFC Bank in the Indian
private sector and the State Bank of India (SBI), and Andhra Bank among the Public
banks operating in India are the sample banks for the study.
Tools of Analysis
To analyse scientifically and interpret the collect& data, financial tools and
techniques and various statistical tools are applied wherever necessary. The
following are the tools and techniques used: 1) Financial Ratios, 2) Percentages, 3)
Linear growth rate 4) Averages 5) Standard Deviation 6) Coefficient of variance
analyses and 7) Tests of significance etc. The SPSS software package version 20 for
calculations has also been used.
Period of the Study
The present study has been carried out for a period of 10 years commencing
fiom 2002-2003 to 201 1-2012. It is that adequate period to evaluate the corporate
governance practices in selected public and private sector banks in India.
3 7
Scope and Limitations of the study
The scope of the study is limited to the top two from each Indian Public and
Private Banks. It is strongly viewed that the top banks are more likely to have the
resources and motivation to take the opportunity to adopt good Corporate
Governance practices. The small sized bank prohibits in-depth analysis of the
relationships between the variables. The findings may have heen different depending
up on the size of the sample banks. If the study had also included a qualitative
component in designing the research, it would have provided more comprehensive
insight into the boards' accountability to all stakeholders, especially in the
Indian context.
Plan of the thesis
The Thesis consists of seven chapters as outlined below:
Chapter-I Introduction and Research Methodology: : It covers a brief
account of the need and importance of the corporate governance
practices in Indian Banking sector, review of literature followed by
methodology adopted for the study.
Chapter-I1 Origin and development of Corporate Governance: It provides an
overview of the concept of Corporate Governance and its evolution - Internal Governance Mechanisms - External Governance
Mechanisms - First Generation of International Corporate
Governance - Second Generation of International Corporate
Governance etc., are presented.
Chapter-I11 Structure and mechanism of Corporate Governance in India: It
discuss the Pre-liberalization- Post - Liberalization- Reasons For
Corporate Governance Failures - Recommendations of various
committees on Corporate Governance in India: CII Code
recommendations (1 997), Kumar Mangalam Birla Committee (SEBI)
recommendations (2000), Naresh Chandra Committee Report,
Narayana Murthy committee (SEBI) (2003), Summary of Clause 49 - Dr. J J Irani Expert Committee Report on Company Law (2005),
Corporate Governance voluntary guidelines 2009 - Guidelines on
Corporate Governance for central Public Sector Enterprises 2010 -
Companies Bill, 201 1 and its Impact on Corporate Governance in
India - Need for Concept Paper on National Corporate Governance
Policy, 2012 - Oversight Of ~~m~lementation And Coordination
Between Regulatory Agencies - Regulatory Mechanisms of corporate
governance, etc.,
Chapter-IV Structure and mechanism of Corporate Qvernance in the Indian
Banking Sector: It covers the Pre-reform status- Obstacles on the
Path of Good Governance in Banking Sector - Banking Sector
Restructuring in India - Corporate Governance regulatory
mechanisms in Banking Sector - External Corporate Governance
Mechanism- Internal Corporate Governance Mechanism - Reserve
Bank of India - RBI & Corporate Governance - Basel Committee - Dr. Ashok Ganguli committee - Corporate governance policy
implementation in India - Measures Taken By Banks towards
Implementation of Best Practices - Status of Indian Banking Industry
in Global View - The Impact Of Regulation On Governance, etc.,
Chapter-V Corporate Governance practices in select Commercial Banks: It
deals with History of Banking Sector in India - Profiles of Sample
Banks - Corporate Governance Disclosure Practices in sample Private
and Public Sector Banks are discussed.
Chapter-VI Impact of Corporate Governance practices on profitability in
select Commercial Banks: It discussed. the Firm Performance - Return on Assets of Sample Bank - Return on Equity Sample Banks - Deposits of Sample Banks - Investments of Sample Ranks - Loans
/Advances of sample banks - Total Assets of Sample Banks - Interest
income - Other Incbme of Sample Banks - Operating Expenses of
Sample Banks - Total Profit of Sample Banks - Total Expenditure of
Sample Banks etc.,
Chapter -VII: Summary of Findings and Suggestions: A brief summary of the
study and practicable suggestions for improving the Corporate
Governance Practices in select Commercial Banking sector are
presented.
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