Corporate Governance in Banks

Importance: Highly Important

Marks Number of Questions
2 2

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 Contents
1 Introduction....................................................................................................................... 4
2 Why is Corporate Governance Important in Banks ................................................................... 4
3 Mechanisms of Corporate Governance in Banks ...................................................................... 4
4 Risk Management in the Banks ............................................................................................. 5
5 Other Governance Aspects of the Banks................................................................................. 5
5.1 Corporate Governance Clauses in Banking Regulation Act .................................................. 6
5.2 Corporate Governance Through Companies Act, 2013 ....................................................... 7
5.3 Corporate Governance Through Clause 49 of SEBI ............................................................ 7
5.4 Ganguly Committee Recommendations........................................................................... 7
5.4.1 Responsibilities of Board of Directors ....................................................................... 7
5.4.2 Training of Directors.............................................................................................. 8
5.4.3 Establishment of Various Committees ...................................................................... 8
5.4.4 Fit and Proper Criteria ........................................................................................... 9
6 Corporate Governance Principles by Basel Committee ............................................................10
6.1 Principle 1: Board’s overall responsibilities .....................................................................10
6.2 Principle 2: Board qualifications and composition ............................................................11
6.3 Principle 3: Board’s own structure and practices..............................................................12
6.4 Principle 4: Senior Management....................................................................................13
6.5 Principle 5: Governance of group structures....................................................................13
6.6 Principle 6: Risk Management Function ..........................................................................14
6.7 Principle 7: Risk identification, monitoring and controlling ................................................14
6.8 Principle 8: Risk Communication....................................................................................14
6.9 Principle 9: Internal Audit.............................................................................................14
6.10 Principle 10: Disclosure and transparency .......................................................................15
7 MCQ’s (Multiple Choice Questions) ......................................................................................16

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 1 Introduction
You would have already read in detail on Corporate Governance in General like (What is Corporate
Governance, what does it means, its importance etc.) in the Corporate Governance unit in the
Management Part of the Syllabus. While reading this document we assume that you have already
gone through the Corporate Governance Unit in the Management Part. If not, please read that topic
and then return to this topic

2 Why is Corporate Governance Important in Banks

1. Banks are different from other corporates as their presence of a large and dispersed base of
Depositors in the stakeholders group
2. Banks lubricate the wheels of the real economy, are the conduits of monetary policy
transmission and constitute the economy’s payment and settlement system
3. By the very nature of their business, banks are highly leveraged
4. They accept large amounts of uncollateralized public funds as deposits in a fiduciary capacity
and further leverage those funds through credit creation
5. Banks are interconnected and have serious ‘contagion ‘potential
6. If a corporate fails, the fallout can be restricted to the stakeholders but if a bank fails, the impact
can spread rapidly through to other banks with potentially serious consequences for the entire
financial system and the macro economy
7. Boards and senior managements of banks be aware of the potentially destructive consequences
of excessive risk taking, be alert to warning signals and be wise enough to contain irrational
exuberance

3 Mechanisms of Corporate Governance in Banks

We basically see corporate Governance from two broader aspects when it comes to banks
1. First is the Risk Management part of the Corporate Governance which is very important in
banking sector. This is very important when it comes to Corporate Governance
2. Second aspect is the overall governance part to run the bank such as Composition of Board,
Compensation of Board members, Audits, Various committees in the boards , fit and proper
criteria etc.

We will discuss in this document on these lines

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 4 Risk Management in the Banks
RBI as a regulator has issued various guidelines to the banks for Risk Management. They are categorized
as

Risk Management Framework

CAMELS Framework PCOA Base 1,2 and 3 Laws

We have discussed all these in the unit for ‘Risk Management in Banking Sector’. Please read that unit
for the details

5 Other Governance Aspects of the Banks

There are many laws which govern the Governance of the Banks. Basically these are

Banking Regulation Act,1949

Companies Act, 2013

SEBI Clause 49

1. Since there are multiple laws governing corporate governance, in case of conflict the laws
supersedes the other as per the order above in the diagram. So if there is something mentioned
in the Banking Regulation Act then it will supersede what is mentioned in Companies Act and
SEBI Clause 49

2. Though Banking Regulation Act supersedes Companies Act, 2013 but there is very less with
respect to Corporate Governance in Banking Regulation Act.

3. Companies Act, 2013 is mainly the mainstay of corporate governance guidelines. Before
Companies Act, 2013 it was clause 49 of SEBI listing agreement which used to be the mainstay of
Corporate Governance. But post companies Act, 2013, even SEBI is trying to make changes in
clause 49 to be in line with the companies Act, 2013.

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 5.1 Corporate Governance Clauses in Banking Regulation Act
1. Clause 10 A - Not less than fifty-one per cent, of the total number of members of the Board of
Directors of a banking company shall consist of persons, who have special knowledge or
practical experience in respect of one or more of the following matters, namely:-
(i) Accountancy
(ii) Agriculture and rural economy
(iii) Banking
(iv) Co-operation
(v) Economics
(vi) Finance
(vii) Law
(viii) Small-scale industry
(ix) Any other matter the special knowledge of, and practical experience in, which would, in
the opinion of the Reserve Bank, be useful to the banking company

Out of the aforesaid 51% of directors, not less than 2 directors shall have special knowledge or
Practical experience in respect of agriculture and rural economy, co-operation or small-scale
industry

Clause 10 A also mentions the following

I. Directors should not have substantial interest in a company or a firm. Substantial interest
means an amount paid-up exceeding Rs 5 lakh or 10 per cent of the paid-up capital of the
company, , whichever is less
II. It does not permit a bank to lend money to a company if any of its board members is also a
director on the board of that company. But the catch is that there is no prohibition on a
bank to sanction a loan to a company where the director is shareholder with high % of
equity in the company
III. No Director of a banking company, other than its Chairman can hold office for more than 8
years

2. Clause 10 B - Banking Company to be managed by whole time Chairman. If appointment is

made on part-time basis then it should be done with the approval of RBI and as per the terms
and conditions specified by RBI at the time of giving approval

3. Clause 10BB: If the office of the Chairman of the board of Directors appointed on a whole-time
basis or a Managing Director of a banking company is vacant, the Reserve Bank may, if it is of
opinion that the continuation of such vacancy is likely to adversely affect the interests of the
banking company, appoint a person to be the Chairman of the board of Directors

4. Clause 10 C: Chairman and certain Directors not to be required to hold qualification shares to
become chairman and director of the company

5. Clause 10 D : Any appointment or removal of a Director, Chairman of the board of Directors who
is appointed in pursuance of section I0A or section 10B [or section 10BB] shall not be entitled to
claim any compensation for the loss or termination of office and will prevail even if there is

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 anything contradictory in any other law or in any contract, memorandum or articles of
association

6. Clause 16: No banking company incorporated in India shall have as a Director in its Board of
Directors any person who is a Director of any other banking company.

7. Clause 36AA: If Reserve Bank is satisfied that in the public interest or for preventing the affairs
of a banking company being conducted in a manner detrimental to the interests of the
Depositors, the Reserve Bank may remove from office, any Chairman, Director chief executive
officer(by whatever name called) or other officer or employee of the banking company.

8. Clause 36AB: If the Reserve Bank is of opinion that in the interest of banking policy or in the
public interest it is necessary so to do, it may appoint one or more persons to hold office as
additional Directors of the banking company

9. Clause 36AC: The provisions of section 36AA and 36AB overrides any other contrary provision in
the Companies Act, 1956 or any other law operating at that time

5.2 Corporate Governance Through Companies Act, 2013

The company’s bill 2012 got the approval from President in 2013 and hence it became a Companies Act,
2013. For Corporate governance details as per Companies Act, 2013 please refer to our Unit of
“Corporate Governance’ in the Management Section.

5.3 Corporate Governance Through Clause 49 of SEBI

Clause 49 of the SEBI listing agreement was the mainstay of Corporate Governance guidelines before
Companies Act, 2013 came into picture. But post companies Act, 2013 SEBI is trying to make changes In
the clause 49 to be in line with the Companies Act, 2013

For Details on the clause 49, you can read the ‘Corporate Governance’ unit in the Management Section
of the RBI syllabus. Please note clause 49 applies only to companies which are listed on Stock Exchange

5.4 Ganguly Committee Recommendations

Ganguly Committee recommendations were made in 2002. RBI has issued some guidelines a s per
these recommendations to the banks. The main areas are basically
1. Responsibilities of Board of Directors
2. Training Facilities for Board of Directors
3. Establishment of various Committees
4. Fit and Proper Norms for Directors

We will discuss these three points below

5.4.1 Responsibilities of Board of Directors

1. A strong corporate board should fulfil the following four major roles viz.

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 a. Overseeing the risk profile of the bank
b. Monitoring the integrity of its business
c. Control Mechanisms
d. Ensuring the expert management, and maximizing the interests of its stakeholders.

2. The Board of Directors should ensure that every director should be familiarized on the functioning
of the bank before his induction, covering the following essential areas:
a. Delegation of powers to various authorities by the Board,
b. Strategic plan of the institution
c. Organizational structure
d. Financial and other controls and systems
e. Economic features of the market and competitive environment.

5.4.2 Training of Directors

a. Need-based training programmes / seminars/ workshops may be designed by banks to acquaint
their directors with emerging developments/challenges facing the banking sector

b. The Board should ensure that the directors are exposed to the latest managerial techniques,
technological developments in banks, and financial markets, risk management systems etc. so as
to discharge their duties to the best of their abilities.

5.4.3 Establishment of Various Committees

Ganguly committee suggested establishment of various committees on the board and RBI has issued
guidelines on the same from time to time

1. Shareholders' Redressal Committee : The banks which have issued shares, debentures to
public may form a committee under the chairmanship of a non-executive director to look into
redressal of shareholders’ complaints.

2. Risk Management Committee: Every banking organization is required to set up Risk

Management Committee. The formation and operationalization of such committee should be
speeded up and their role further strengthened. Risk Management Committee should take care of
the Risks that can affect the banks or its customers

3. Supervisory Committee: The role and responsibilities of the Supervisory Committee would be to
monitor the exposures (both credit and investment) of the bank, review of the adequacy of the
risk management process, ensuring compliance with the statutory / regulatory framework etc.

4. Nomination Committee: The purpose of nomination committee to see the fitment of people to
become directors on the board of the company. Committee will see the skill of the people and
analyze whether those skills are relevant to become the director of the bank

5. Compensation Committee: Evaluation of performance of CMD and ED’s for payment of

incentive linked to the performance of the Bank.

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 5.4.4 Fit and Proper Criteria
Following guidelines were issued for the Fit and Proper criteria for the Board of Directors in the Private
Banks. This initially did not apply to public sector and nationalized banks as there the appointments
were being made by the government. Following were the guidelines

a. The Board of Directors of the banks while nominating/ co-opting directors should be guided by
certain broad 'fit and proper’ norms for directors, viz. formal qualification, experience, track
record, integrity etc.

b. The board for assessing integrity and track record can ask for self-declaration asking for
information like criminal records, financial position, and civil actions initiated to pursue personal
debts, refusal of admission to or expulsion from professional bodies etc. A person can be
rejected if he does not fulfil fit and proper criteria, for example anyone having criminal case
against him would be rejected

c. The following criteria should be followed for nominating independent/ non-executive directors
on private sector banks:

a. The candidate should normally be a graduate (which can be relaxed while selecting directors
for the categories of farmers, depositors, artisans, etc.)

b. He / she should be between 35 and 65 years of age.

c. He / she should not be a Member of Parliament / Member of Legislative Assembly/ Member

of Legislative Council.

Later the RBI persuaded government of India to make amendments in the Section 9(3)(i) of the Banking
Companies (Acquisition and Transfer of Undertakings) Act 1970/1980 and State bank of India Act 1959
to include the ‘Fit and Proper Criteria’ to be fulfilled by persons being elected as the directors on the
boards of the nationalized banks. Under this amendment following points are of Importance

1. The nomination committee should determine the ‘fit and proper’ status of the existing elected
directors/proposed candidates based on the broad criteria as mentioned hereunder:
a. Educational Qualification
b. Track Record
c. Integrity

2. The nomination committee should be set up having minimum three directors (all independent
and non-executive) to determine the ‘fit and proper’ status of the existing elected
directors/proposed candidates based on the broad criteria as explained above

3. This act also provides for

a. Increase in whole time directors of nationalized banks from 2 to 4

b. Nomination of up to 3 shareholder directors on the boards of nationalized banks on the
basis of percentage of shareholding
c. RBI to appoint one or more additional directors if necessary in public interest

Please note that nationalized banks are governed by Banking Companies (Acquisition and Transfer of
Undertakings) Act 1970/1980 and State bank of India is governed by State bank of India Act 1959

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 6 Corporate Governance Principles by Basel Committee
At the end of 1974, the Central Bank Governors of the Group of Ten countries formed a Committee
of banking supervisory authorities. As this Committee usually meets at the Bank of International
Settlement (BIS) in Basel, Switzerland, this Committee came to be known as the Basel Committee

This committee has outlined some principles for Corporate Governance in the banking sector. These
are just guidelines and each country or each bank need to have policies which try to implement
these guidelines

6.1 Principle 1: Board’s overall responsibilities

Principle: The board has overall responsibility for the bank, including approving and overseeing
management’s implementation of the bank’s strategic objectives, governance framework and
corporate culture

Details

The board has ultimate responsibility for the bank’s business strategy and financial soundness, key
personnel decisions, internal organisation and governance structure and practices, and risk
management and compliance obligations. The board may delegate some of its functions, though
not its responsibilities, to board committees where appropriate

The board should

i. actively engage in the affairs of the bank and keep up with material changes in the bank’s
business and the external environment as well as act in a timely manner to protect the long-
term interests of the bank

ii. oversee the development of and approve the bank’s business objectives and strategy and
monitor their implementation

iii. play a lead role in establishing the bank’s corporate culture and values

iv. oversee implementation of the bank’s governance framework and periodically review that it
remains appropriate in the light of material changes to the bank’s size, complexity, geographical
footprint, business strategy, markets and regulatory requirements;

v. Establish, along with senior management and the CRO (Chief Risk Officer), the bank’s risk
appetite, taking into account the competitive and regulatory landscape and the bank’s long -
term interests, risk exposure and ability to manage risk effectively

vi. approve the approach and oversee the implementation of key policies pertaining to the bank’s
capital adequacy assessment process, capital and liquidity plans, compliance policies and
obligations, and the internal control system

vii. require that the bank maintain a robust finance function responsible for accounting and
financial data

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 viii. approve the annual financial statements and require a periodic independent review of critical
areas

ix. approve the selection and oversee the performance of the CEO, key members of senior
management and heads of the control functions

x. oversee the bank’s approach to compensation, including monitoring and reviewing executive
compensation and assessing whether it is aligned with the bank’s risk culture and risk appetite

xi. Oversee the integrity, independence and effectiveness of the bank’s policies and procedures for
whistleblowing.

6.2 Principle 2: Board qualifications and composition

Principle: Board members should be and remain qualified, individually and collectively, for their
positions. They should understand their oversight and corporate governance role and be able to
exercise sound, objective judgment about the affairs of the bank .

Details

Board composition
1. The board must be suitable to carry out its responsibilities and have a composition that
facilitates effective oversight. For that purpose, the board should be comprised of a
sufficient number of independent directors

2. The board should be comprised of individuals with a balance of skills, diversity and
expertise, who collectively possess the necessary qualifications commensurate with the size,
complexity and risk profile of the bank

Board Member Selection and Qualifications

1. The selection process should include reviewing whether board candidates:
I. Possess the knowledge, skills, experience and, particularly in the case of non-
executive directors, independence of mind given their responsibilities on the board
and in the light of the bank’s business and risk profile;
II. Have a record of integrity and good repute
III. Have sufficient time to fully carry out their responsibilities
IV. Have the ability to promote a smooth interaction between board members
2. Board candidates should not have any conflicts of interest with the bank
3. The bank should have in place a nomination committee or similar body, composed of a
sufficient number of independent board members, which identifies and nominates
candidates after having taken into account the criteria described above

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 6.3 Principle 3: Board’s own structure and practices
Principle: The board should define appropriate governance structures and practices for its own
work, and put in place the means for such practices to be followed and periodically reviewed for
ongoing effectiveness

Details

Organisation and assessment of the board

To support its own performance, the board should carry out regular assessments – alone or
with the assistance of external experts – of the board as a whole, its committees and
individual board members. The board should:

I. Periodically review its structure, size and composition as well as committees’

structures and coordination;
II. Assess the ongoing suitability of each board member periodically (at least annually),
also taking into account his or her performance on the board;
III. The board should maintain appropriate records (e.g. meeting minutes or summaries of
matters reviewed, recommendations made. decisions taken and dissenting opinions)
of its deliberations and decisions

Board Committees
To increase efficiency and allow deeper focus in specific areas, a board may establish certain
specialized board committees. The following Committees should be established
I. Audit Committee
a. It should have a chair who is independent and is not the chair of the board or
of any other committee;
b. Audit committee would be responsible for internal audit and financial
reporting
c. Appointment, remuneration and dismissal or external auditors

II. Risk Management Committee

a. It should have a chair who is independent and is not the chair of the board or
of any other committee and majority of members should be independent
b. Members should have experience in Risk management
c. The risk committee of the board is responsible for advising the board on the
bank’s overall current and future risk appetite, overseeing senior
management’s implementation of the Risk Assessment Framework, reporting
on the state of risk culture in the bank, and interacting with and overseeing
the Chief Risk Officer

III. Compensation Committee

a. The compensation committee should support the board in overseeing the
remuneration system’s design and operation and in ensuring that
remuneration is appropriate and consistent with the bank’s culture, long-term
business and risk appetite
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 IV. Nomination Committee:
a. Provides recommendations to the board for new board members and
members of senior management. The nomination committee should analyze
the role and responsibilities of the board member and the knowledge,
experience and competence which the role requires

V. Ethics Committee
a. ensures that the bank has the appropriate means for promoting proper
decision-making, due consideration of the risks to the bank’s reputation, and
compliance with laws, regulations and internal rules

6.4 Principle 4: Senior Management

Principle: Under the direction and oversight of the board, senior management should carry out and
manage the bank’s activities in a manner consistent with the business strategy, risk appetite,
remuneration and other policies approved by the board

Details
1. Senior management consists of a core group of individuals responsible and accountable to
the board for the sound and prudent day-to-day management of the bank
2. The organisation and procedures and decision-making of senior management should be
clear and transparent and designed to promote effective management of the bank.
3. Members of senior management should have the necessary experience, competencies and
integrity to manage the businesses and people under their supervision
4. Members of senior management should be selected through an appropriate promotion or
recruitment process which takes into account the qualifications required for the position in
question
5. Senior management is responsible for delegating duties to staff and should establish a
management structure that promotes accountability and transparency throughout the bank

6.5 Principle 5: Governance of group structures

Principle: In a group structure, the board of the parent company has the overall responsibility for the
group and for ensuring the establishment and operation of a clear governance framework among the
child companies of the parent company.

For example ICICI Group as a whole should have governance policies ensuring that all the child
companies like ICICI Bank, ICICI Direct, and ICICI Lombard are able to operate with clarity and as per
governance standards

Details

This principle is not important. We will not go in details

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 6.6 Principle 6: Risk Management Function
Principle: Banks should have an effective independent risk management function, under the direction
of a chief risk officer (CRO), with sufficient stature, independence, resources and access to the board.

Details

Key activities of the risk management function should include :

1. Identifying material individual, aggregate and emerging risks

2. Assessing these risks and measuring the bank’s exposure to them;
3. Establishing an early warning or trigger system for breaches of the bank’s risk appetite or limits
4. Reporting to senior management and the board or risk committee on all these items, including
proposing appropriate risk-mitigating actions

6.7 Principle 7: Risk identification, monitoring and controlling

Principle: Risks should be identified, monitored and controlled on an ongoing bank-wide and
individual entity basis. The sophistication of the bank’s risk management and internal control
infrastructure should keep pace with changes to the bank’s risk profile, to the external risk landscape
and in industry practice.

Details

The bank’s risk governance framework should include policies, supported by appropriate control
procedures and processes, designed to ensure that the bank’s risk identification, aggregation, mitigation
and monitoring capabilities are commensurate with the bank’s size, complexity and risk profile.

6.8 Principle 8: Risk Communication

Principle: An effective risk governance framework requires robust communication within the bank
about risk, both across the organisation and through reporting to the board and senior management

Details

A strong risk culture should promote risk awareness and encourage open communication and challenge
about risk-taking across the organisation as well as vertically to and from the board and senior
management. Senior management should actively communicate and consult with the control functions
on management’s major plans and activities so that the control functions can effectively discharge their
responsibilities

6.9 Principle 9: Internal Audit

Principle: The internal audit function should provide independent assurance to the board and should
support board and senior management in promoting an effective governance process and the long-
term soundness of the bank .

The board and senior management contribute to the effectiveness of the internal audit function by:

1. Providing the function with full and unconditional access to any records, file data and physical
properties of the bank, including access to management information systems and records and
the minutes of all consultative and decision-making bodies

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 2. Requiring the function to independently assess the effectiveness and efficiency of the internal
control, risk management and governance systems and processes
3. Requiring internal auditors to adhere to national and international professional standards, such
as those established by the Institute of Internal Auditors;
4. Requiring that audit staff collectively have or can access knowledge, skills and resources
commensurate with the business activities and risks of the bank
5. Requiring timely and effective correction of audit issues by senior management

6.10Principle 10: Disclosure and transparency

Principle: The governance of the bank should be adequately transparent to its shareholders,
depositors, other relevant stakeholders and market participants.

1. Transparency is consistent with sound and effective corporate governance. It is difficult for
shareholders, depositors, other relevant stakeholders and market participants to effectively
monitor and properly hold the board and senior management accountable when there is
insufficient transparency. The objective of transparency in the area of corporate governance is
therefore to provide these parties with the information necessary to enable them to assess the
effectiveness of the board and senior management in governing the bank.
2. Disclosure should include, but not be limited to, material information on the bank’s objectives,
organizational and governance structures and policies (in particular, the content of any
corporate governance or remuneration code or policy and the process by which it is
implemented), major share ownership and voting rights, and related party transactions
3. An annual report on compensation should be disclosed to the public
4. The bank should also disclose key points concerning its risk exposures and risk management
strategies without breaching necessary confidentiality
5. Disclosure should be accurate, clear and presented such that shareholders, depositors, other
relevant stakeholders and market participants can consult the information easily. Timely public
disclosure is desirable on a bank’s public website, in its annual and periodic financial reports, or
by other appropriate mean

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 7 MCQ’s (Multiple Choice Questions)
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