WILP - CGEC - Reading Material PDF

Corporate Governance, Ethics & Compliance
Unit 1
Introduction to Corporate Governance
Unit 1 – Introduction to Corporate Governance
Introduction
Since 2001, infamous scandals like Enron Corporation, Satyam Computers etc. have refocussed the spotlight on Corporate Governance. Furthermore, the
global markets haven been witnessing a rising wave of deregulation, privatization, private saving growth. These accounting frauds, scandals and
progressively volatile changes have spooked, many; especially the investors & shareholder who are now demanding increased transparency, accountability
and engagement. It is, after all, their capital at stake. Businesses, on the other hand, need the capital to grow, compete, succeed, and create jobs.
However, investors and shareholders cannot be expected to come together and manage that company’s business and affairs. As a result, that is the job of
a full time management team.
Having said that, any management team cannot operate without an oversight mechanism. Left unchecked, even the most capable management team,
could end up taking counterproductive decisions. This is where the importance of a capable board of directors, elected by the shareholders, is felt. Not only
do they provide oversight, insight and foresight; they also help to fulfil the interests of the shareholders and stakeholders, board as well as management
aptly.
All the above is possible when the company adopts and adheres to the robust Corporate Governance Policy. Good corporate governance helps
shareholders and their representatives to hire the right managers and helps make sure that the managers remember they ultimately answer to
shareholders. Additionally, good corporate governance also helps to remind the company’s directors that they work for the company’s shareholders, not for
themselves, and certainly not for management.
Learning Objectives
At the completion of this unit, you will be able to:
• Explain the process of evolution of corporate governance methods and models
• Discuss the regulatory framework associated with Corporate Governance
2
Table of contents
S.No Details Page No.

1 Understanding Corporate Governance 5
1.1 – Salient Features of Corporate Governance 6
1.2 – Scope of Corporate Governance 7
1.3 – Corporate Governance Principle 8
1.4 – Corporate Governance Theories 9
1.5 – Development of Codes and Guidelines 13
1.6 – Popular Models for Governance 16
1.7 – Principle Activities of Corporate Governance 21
1.8 – What Corporate Governance Achieves? 21
1.9 – Difference in the focus of Corporate Governance v/s Management 22
1.10 – Participants to Corporate Governance 22
1.11 – Importance and Benefits of Corporate Governance 23
1.12 – Role of Corporate Governance 26
3
Table of contents

2 Systems of Corporate Governance 27
3 Regulatory Framework 28
3.1 – Prevention of Corruption Act 28
3.2 – Serious Fraud Investigation Office 30
3.3 – Enforcement Directorate 30
3.4 – Companies Act, 2013 30
3.5 – SEBI Guidelines 31
3.6 – Accounting Standards 31
3.7 – Competition Commission of India 31
3.8 – Reserve Bank of India 32
4 Appendix 1 32
4
1. Understanding Corporate Governance

Corporations have evolved into global entities, with capabilities far beyond what they started out with. However, this growth also presents challenges. One
of these challenges is protection of shareholder rights, which is ensured by Corporate Governance.
In a contracted sense, corporate governance involves a set of relationships amongst the company’s management, its shareholders, auditors, the board of
directors, and other stakeholders. These associations, which comprise of various rules and incentives, provide the arrangement through which the
objectives of the corporation are set, and the means of accomplishing these objectives as well as monitoring performance are determined. Hence, the key
aspects of good corporate governance comprise of transparency of corporate structures and operations, the liability of managers and the boards to
shareholders and corporate responsibility towards stakeholders.
In a broader sense, however, good corporate governance – the extent to which companies are run in an open and honest manner – is imperative for overall
market confidence, the efficacy of capital allocation, the development and growth of countries, industrial base and eventually the nations’ wealth and
welfare. The concepts of transparency and disclosure occupy center stage in both the views of corporate governance. In the former case, they create trust
at the organization level and among the suppliers of finance. In the latter, they create confidence at the aggregate economy level.
Corporate governance is concerned with methods of bringing the interests of managers and investors in to line and ensuring that businesses run for the
benefits of investors. Corporate governance includes – the structures, processes, cultures, and systems that prompt the successful operation of
organizations.
In the words of N.R. Narayana Murthy, Chief Mentor, Infosys Limited (in the capacity as head of Narayana Murthy committee) “Corporate Governance is
maximizing the shareholder value in a corporation while ensuring fairness to all stakeholders, customers, employees, investors, vendors, the government
and the society-at-large. Corporate governance is about transparency and raising the trust and confidence of stakeholders in the way the company is run. It
is about owners and managers operating as the trustees on behalf of every shareholder large or small.”
5
1.1 Salient Features of Corporate Governance

Let us now look at some of the salient features of corporate governance categorized as principles, scope, mechanism, and
how it differs with the general management function:
• Lay solid foundations for management and oversight by recognizing and publishing the respective roles and
responsibilities of board and management,
• Structure the board to add value by having a board of a suitable composition, size, and commitment to adequately
discharge its responsibilities and duties,
• Actively promoting ethical and responsible decision making,
• Safeguard integrity in financial reporting by having a structure to independently verify and safeguard the integrity of the company’s financial reporting,
• Promoting balanced and timely disclosure of all material matters concerning the company,
• Respecting the rights of shareholders and facilitate the effective exercise of those rights,
• Recognize and manage risk by establishing a sound system of risk oversight and management and internal control,
• Encourage enhanced performance by fairly reviewing and promote encourage enhanced board and management effectiveness,
• Compensate justly and responsibly by guaranteeing that the level and composition of remuneration is reasonable and adequate that its relationship to
individual performance and corporate is defined and
• Recognize the legitimate interests of stakeholders.
6
1.2 Scope of Corporate Governance

Corporate governance includes the below mentioned functional areas of governance:
1. Preparing the company’s financial statements: A critical and crucial aspect of corporate governance is financial disclosure. To verify and safeguard
the integrity of the company’s financial reporting, the company should independently implement required procedures. To guarantee all investors’ get
access to clear and factual information, material matters related to the organization should be disclosed in a timely and balanced manner.
2. Independence of entity’s auditors and internal controls: The board of directors, management, audit committee, and other personnel implement
internal control to provide assurance about the organization accomplishing its objectives related to consistent financial reporting, being compliant with
existing laws and regulations, and operating efficiency. Internal auditors, who are tasked with the responsibility of design testing and internal control
procedures implementation, and the financial reporting reliability, being allowed to work in an independent environment.
3. Compensation arrangements review for CEO and other senior executives: Performance-based remuneration is designed to slot some share of
the salary to individual performance. The form of benefits might be of cash or non-cash payments such as shares and share options, pension or any
other benefits. These type of incentive schemes can elicit biased or opportunistic behavior, as they are reactive in the sense that they offer no
mechanism from mistakes happening.
4. Nominations procedure for the positions on the board: The Board of Directors have the authority to hire, fire and compensate the top
management. The business owners have decision-making, and voting rights, and specific responsibilities, which differs from organization to
organization and is separate and distinct from the authority and responsibilities of owners and managers of the business entity
5. The resources made available to directors in carrying out their duties: The fiduciary duties of the directors are like those of an agent or trustee.
They are assigned adequate authority to control the activities of the organization.
6. Management of risk and oversight: It is important for the shareholders to know how the company plans on tackling the risks, and for the company to
be fully aware of the current and possible perils, as well as about opportunities facing the business.
7
1.3 Corporate Governance Principles

The OECD principles of Corporate Governance were published in 1999 (revised in 2004), but is wasn’t until after the Enron and WorldCom debacles, and
the US Sarbanes Oxley response in 2002, that most other OECD countries made a determined effort to adopt codes of corporate governance. Except for
US, individual OECD countries have all implemented corporate governance codes that work on the “comply and explain” principle. The US Sarbanes Oxley
Act (‘SOX’) works on the basis of “comply or be punished”.
The requirement for all organizations to adopt best corporate governance practices, regardless of their nationality or location, is – despite the resistance
from many executives in many regions – growing stronger. The acceptance of western accounting and corporate governance norms is increasingly
becoming the ‘entry price’ for access to western capital markets.
Honesty, openness, trust and integrity, responsibility and accountability, performance orientation, mutual respect, and commitment to the organization are in
general a few key elements that are included in good corporate governance. Senior executives, especially, have the responsibility to conduct the business
honestly and ethically, specifically when it concerns actual or apparent conflicts of interest, and disclosure in financial reports.
The following are some commonly accepted corporate governance principles:
• Shareholders rights protection: It is done through the equitable treatment of the shareholders. The rights of shareholders should be respected by the
organization and it should help shareholders to exercise them. By effectively communicating information that is comprehensible and handy, and by
encouraging shareholders to join in general meetings, they can help shareholders exercise their rights.
• Interests of other stakeholders: The legal and other obligations to all legitimate stakeholders which the organization has, should be recognized by
them.
• Roles and responsibilities of the board: To be able to deal with various business issues and have the capability to review and challenge
management performance, the board needs a range of skills and comprehension abilities. It should have a proper level of commitment to fulfill its
8
responsibilities and obligations and should be of sufficient size as well. The suitable mix of executive and non-executive directors should be
considered. The different board committees can be utilized by the board of directors to discharge their duty as per the need.
• Responsible and ethical behavior: Responsible and ethical decision making is not only significant for public relations but is also an essential
component in risk management and avoiding lawsuits. To promote ethical and responsible decision making, organizations should develop a code of
conduct for their directors and executives. Numerous organizations establish Compliance and Ethics Programs to reduce the risk that the firm steps
outside of ethical and legal boundaries, as reliance by the company on the integrity and ethics of individuals often end up in failure.
• Disclosure and transparency in reporting: To provide shareholders with a level of accountability, organizations should explain and make publicly
known the roles and responsibilities of board and management. Procedures should be implemented to independently verify and safeguard the integrity
of the company's financial reporting. To ensure that all investors have access to clear, factual information, disclosure of material matters regarding the
organization should be done in a balanced and timely manner.
1.4 Corporate Governance Theories

Theories have contributed to our understanding of corporate governance issues, and we shall go over four widely discussed theories which are frequently
used to understand how corporations are governed and how the structure of corporate governance can be improved upon. The development of corporate
governance is bound closely with the economic advance of industrial capitalism: different governance structures have evolved with different corporate
forms intended to pursue new economic prospects or resolve new economic complications.
Shareholders Theory vs. Stakeholders Theory

Shareholder theory or agency theory asserts that shareholders provide capital to a company’s managers, who are supposed to spend corporate funds only
in ways that are authorized by the shareholders.
9
The agency problem was identified by Adam Smith when he argued that company directors were not likely to be as careful with other people’s money as
with their own. Agency theory offers shareholders a pre-eminent position in the firm legitimized not by the idea that they are the firm’s owners, but instead
its residual risk-takers.
The agency view recommends that shareholders are the ‘principals’ and businesses should be run in their interest even though they rely on others for the
actual running of the corporation. It is appealed that shareholders have the right to residual claims because they are the residual risk bearers. The
maximization of shareholder value will result in superior economic performance, not only for the particular firm, but for the economy as a whole, it is held,
as other stakeholders in the organization will receive the returns for which they have contracted.
Since the self-interested utility-maximizing motivation of individual actors forms the basis of agency theory, it is supposed that the relationship between
shareholders (principals) and managers (agents) will be challenging. Internal and external governance mechanisms help to bring the interests of managers
and those of the shareholders in line, including:
• An effectively structured board;
• Compensation contracts that encourage a shareholder orientation;
• Concentrated partnership holdings that lead to active monitoring of executives;
• The market for corporate control that is an external mechanism activated when internal mechanisms for controlling managerial opportunism or failure
have not worked.
Whereas, stakeholder theory states that managers have a duty to both the corporation's shareholders and "individuals and constituencies that contribute,
either voluntarily or involuntarily, to a company's wealth-creating capacity and activities, and who are therefore its potential beneficiaries and/or risk
bearers”.
The organization is a system of stakeholders functioning within the larger system of host society that provides mandatory legal and market infrastructure
10
for the organization’s activities. The purpose of the corporation is to create wealth or value for its stakeholders by transforming their stakes into goods and
services.
This institutional setting pressures and creates strategic possibilities for the company. While management does receive finance from shareholders, they
depend on employees to fulfill strategic goals. External stakeholders are equally vital and relationships with suppliers, customers, competitors, and special
interest groups are also inhibited by formal and informal rules. Finally, local communities and governments set the legal and formal rules within which the
firm must operate. The commencement of the company is a set of relationships rather than a series of transactions, in which managers adopt an
comprehensive concern for all stakeholders.
Stewardship Theory
Steward is a person who manages other’s property or financial affairs and is assigned with the responsibility of proper utilization and development of
organization’s resources.
According to stewardship theory, the behavior of the steward is collective, because the steward seeks to attain the objectives of the organization. Given the
potential multiplicity of shareholders objectives, a steward’s behavior can be considered organizationally centered. Stewards in loosely coupled,
heterogenous organizations with competing stakeholders and shareholders objectives are motivated to make decisions that they perceive are in the best
interests of the group.
Therefore, a pro-organizational steward is motivated to maximize organizational performance thereby satisfying the competing interests of shareholders.
This does not imply that stewards do not have essential “survival” needs. Clearly, the steward must have an income to survive. The difference between an
agent and the principal is how these needs are met. The steward realizes the trade-off between personal needs and organizational objectives and believes
that by working towards organizational and collective ends, personal needs are met.
Stewardship theorists argue that the performance of stewardship is affected by whether the structural situation in which he or she is located facilitates
effective action. If the executive’s motivations fit the model of man underlying stewardship theory, empowering governance structures and mechanisms are
11
Appropriate. Thus, a steward’s autonomy should be deliberately extended to maximize the benefits of a steward, because he or she can be trusted.
S.NO Criteria Agency Theory Stewardship Theory

1 Model of Man Economic Man Self-Actualizing Man
2 Behaviour Self-Serving Collective Serving
Lower order/economic needs (physiological, Higher order needs (growth achievement, self-
3 Motivation
security, economic) actualization)
4 Social Comparison Other Managers Principal
5 Identification Low value commitment High value commitment
6 Power Institutional (legitimate, coercive, reward) Personal (expert, referent)
Management
7 Control oriented Involvement oriented
Philosophy
8 Risk Oriented Control mechanisms Trust
9 Time Frame Short-term Long-term
10 Objective Cost control Performance enhancement
Individualism Collective
11 Cultural Difference
High power distance Low power distance
Table 1 - Comparison of Agency Theory and Stewardship Theory
12
Property Rights Theory

In the new institutional economics, property rights are viewed simply as control rights over physical and human assets. More specifically, they are
institutions (or set of rules and enforcement attributes) that help people from reasonable expectations about control over assets. These institutions consist
of administrative arrangements, laws and social norms concerning the allocation and execution of control rights over assets.
Corporate governance is shaped by property rights in two fundamental and related ways. First, they determine what types of businesses will emerge in a
given environment. Like all organizations, corporations arise in response to the incentives and business costs generated by the existing institutional
framework.
For example – Large public forms with dispersed shareholders are not prevalent in insecure property rights environments, because, it is too costly to
establish the required corporate control mechanisms.
Second, the specific governance mechanisms available to firms are constrained by existing property rights institutions, which specify the legitimate forms of
control in any given community.
1.5 Development of Codes and Guidelines

This unit presents an overview of some of the codes and regulations designed to improve corporate governance in the UK, US and India. It reviews the
recommendations of the various committees that were formed to intensify the practices of corporate governance. The process of development of codes
and guidelines started with the setting up of different committees on corporate governance. Let us look at the following reports and acts:
• The Cadbury Report 1992
• The Turnbull Report 1999
• The Sarbanes-Oxley Act, 2002
13
The Cadbury Report 1992

The Cadbury Report and its accompanying code covered three general areas, namely:
1. The Board of Directors
2. Auditing
3. Shareholders
The Cadbury report focused attention on the board of directors as being the most important corporate governance mechanisms, requiring constant
monitoring and assessment. However, the accounting and auditing function was also shown to plan as essential role in good corporate governance,
emphasizing the importance of corporate transparency and communication with shareholders and other stakeholders. Lastly, Cadbury’s focus on the
importance of institutional investors as the largest and most influential group of shareholders has had a lasting impact. This more than any other initiative in
corporate governance reform has led to the shift of directors’ dialogue towards greater accountability and engagement with shareholders.
Further, we consider that this move to greater shareholder engagement has generated the more significant metamorphosis of corporate responsibilities
towards a range of stakeholders, encouraging greater corporate social responsibility in general. There is no denying about the substantial impact that the
Cadbury Code has had on corporate Britain and, indeed, on companies around the world.
By the late 1990s there was strong evidence to show a high level of compliance with the Cadbury Code’s recommendations (see Conyon and Mallin,
1997), partly due to the UK’s comply or explain approach. Central to the final report’s recommendations was that boards of all listed companies registered
in the UK should comply with the Code of Best Practice as set out in the report.
The Cadbury Report 1992

The Combined Code (1998) dealt with internal control in Provisions D.2.1 and D.2.2. In these, provisions the Code stated that company directors should
conduct a review of the effectiveness of the internal control systems and should report this information to shareholders. The Turnbull Committee was
established specifically to address the issue of internal control and to respond to these provisions in the Combined Code.
14
The report provided an overview of the systems of internal control in existence in UK companies and made clear recommendations for improvements,
without taking a perspective approach. The Turnbull Report was revolutionary in terms of corporate governance reform. It represented an attempt to
formalize an explicit framework for internal control in companies. The aim was to provide companies with general guidance on how to develop and maintain
their internal control systems and not to specify the details of such a system.
The Sarbanes – Oxley Act, 2002

In 2002, Paul Sarbanes, a Democrat Senator, and Michael Oxley, a Republican Congressman, were responsible for a radical piece of corporate legislation.
The Sarbanes – Oxley Act introduced sweeping corporate law changes relating to financial reporting, internal accounting controls, and personal loans from
companies to their directors, whistle-blowing and destruction of documents. In addition, Sarbanes-Oxley severely restricts the range of additional services
that an audit firm can provide to a client. There are increased penalties for directors and professionals who have conspired to commit fraud.
Some examples follow of its provisions. Section 906 of the Act requires that all periodic reports containing financial statements by the Chief Executive
Officer (CEO) and Chief Financial Officer (CFO) of the company, certifying that the report fully complies with the Securities Exchange Act and fairly present,
in all material respects, the financial condition and results of operations.
The penalties for knowingly certifying a statement, which does not comply with the requirements, can be severe: up to $1 million in fines and/or up to ten
years’ imprisonment. Section 1102 provides that ‘knowing and willful’ destruction of any record or document with intent to impair an official proceeding
carries fines and/or imprisonment up to 20 years. Section 806 provides protection for employees who provide evidence of fraud. There is also protection for
‘whistleblowers’ in publicly traded corporations. No company, officer or employee may threaten or harass an employee who reasonably believes that a
criminal offence has been committed. Section 501 of the legislation also aimed to promote rules to address conflicts of interest where analysts recommend
securities when their companies are involved in investment banking activities.
The Sarbanes – Oxley legislation also established a Public Company Accounting Oversight Board (PCAOB) to be responsible to the Securities and
15
Exchange Commission (SEC) for the regulation of auditing in US companies, inspection of accounting firms and disciplinary proceedings. As a result of the
Sarbanes-Oxley legislation, some companies felt that the burden of compliance was too high in relation to the perceived benefits.
1.6 Popular Models for Governance

Corporate governance describes the internal methods by which firms are controlled and operated. While government plays an essential role in shaping the
institutional, legal and regulatory climate within which the individual corporate governance systems are developed, the main responsibility lies with the
private sector. The unique characteristics and distinctive features of four important models of corporate governance are detailed below:
• The Anglo-American Model
• The German Model
• The Japanese Model
• The Indian Perspective (Governance in the Public Sector)
The Anglo-American Model

In this model, the board appoints and supervises the managers who manage the day-to-day affairs of the corporation. While the legal system provides the
structural framework, the stakeholders in the company will be suppliers, employees, and creditors. However, creditors exercise their lien over the assets of
the company. The policies are framed by the board of directors and implemented by the management. The board oversees the implementation through a
well-designed information system. The board of directors, being responsible to their appointers – the shareholders – commits to them certain returns within
the broad outlines of the market framework.
It will ensure an efficient organization for production, exchange and performance monitoring. However, there is no agreement on the cost-effectiveness or
efficiency of the model (Macey, 1998). While Fischel and Easterbrook (1991) and (Romano, 1993) make a very optimistic assessment of the US flawed.
16
It will not be costless for the market to provide a greater supply of institutional investor monitoring. The distinctive features are:
• Clear separation of ownership and management, which minimizes conflict of interests.
• Companies are run by professional managers who have negligible ownership stakes linked to performance. CEO has a major role to play.
Figure 1.1 – Anglo-American Model
The German Model

In this model, although the shareholders own the company, they do not entirely dictate the governance mechanism. As shown, shareholders elect 50 per
cent of members of supervisory board and the other half is appointed by labour unions. This ensures that employees and laborers also enjoy a share in the
governance. The supervisory board appoints and monitors the management board. There is a reporting relationship between them, although the
management board independently conducts the day-to-day operations of the company.
17
The distinctive features of German Model are:

a) Banks and financial institutions have substantial stake in equity
capital of companies.
b) Labour Relations Officer is represented in the management board.
Worker participation in management is practiced.
c) Both shareholders and employees have equal say in selecting the
members of the supervisory board.
Figure 1.2 – The German Model
The Japanese Model

In the Japanese model, the financial institution has an accrual role in governance. The shareholders and the bank together appoint the board of directors
and the president.
The distinctive features are:
a) Inclusion of President who consults both the supervisory board and the executive management.
b) Importance of the lending bank is highlighted
18
Figure 1.3 – The Japanese Model
The Indian Perspective (Governance in Public Sector)

India in its own right has a unique and epochal background of governance. In the ancient times, the King was always considered the representative of the
people. The wealth of the State was not the personal wealth of the king. The principle of trusteeship was also followed. Various modern authors have also
taken tips on good governance from Kautilya’s Arthasastra.
The modern Indian corporates are governed by the Company’s Act of 1956 and 2013, that follows more or less the UK model. The pattern of private
companies is mostly that of closely held or dominated by a founder, his family and associates. In respect of public enterprises, central/state government
forms the board. The hold of the government constitutes is to be dominant.
19
The distinctive features are:

a) Equity shares are owned wholly or substantially
(51 per cent or more) by the government.
b) Good deal of political and bureaucratic influence
over the management.
c) Organization often viewed as a social entity.
d) The board of directors are appointed by the
controlling administrative ministry.
e) Excessive emphasis on observing rules,
regulations and guidelines.
f) Efficiency and performance are sacrificed at the
altar of propriety.
Figure 1.4 – The Indian Perspective of Corporate Governance
20
1.7 Principal Activities of Corporate Governance

The principal activities of the board of governance are as follows:
Direction Executive Action Supervision Accountability
Formulation of strategic Recognition of

Monitoring and overseeing responsibilities to those
direction for the future of Involvement in crucial
of management making a legitimate demand
the organization in the executive decisions.
performance. for accountability.
long term.
1.8 What Corporate Governance Achieves?

The corporate governance brings in transparency among stakeholders and the management. Some of the important features of corporate governance are:
• It helps to ensure that an adequate and appropriate system of control operates within a company and hence assets may be safeguarded;
• It prevents any single individual having too powerful an influence;
• It is concerned with the relationship between a company’s management, the board of directors, shareholders, and other stakeholders;
• It aims to ensure that the company is managed in the best interests of the shareholders and the other stakeholders;
• It tries to encourage both transparency and accountability, which investors are increasingly looking for in both corporate management and corporate
performance.
21
1.9 Differences in the focus of Corporate Governance vs Management

The activities of Corporate Governance are often mixed with the activities of management. Corporate Governance is concerned with the way the directors
control the activities of the company and ensure that the management to whom they delegate many functions are accountable. The vital differences
between governance and management are:
• Focus – Governance has an external focus and the management focus is internal.
• Assumption – Governance assumes an open system whereas the management assumes the system to be closed.
• Approach – Governance gives the direction where to go and the management is more concerned with how to get there
• Orientation - Corporate Governance is strategy-oriented.
• Performers – Directors perform Governance, and the management is the job of the executives.
1.10 Participants to Corporate Governance

Corporate governance is concerned with the governing or regulatory body (e.g. the SEBI), the CEO, the board of directors and management. Other
stakeholders who take part include suppliers, employees, creditors, customers, and the community at large.
Shareholders delegate decision rights to the managers. Managers are expected to act in the interest of shareholders. This results in the loss of effective
control by shareholders over managerial decisions. Thus, a system of corporate governance controls is implemented to assist in aligning the incentives of
the managers with those of the shareholders in order to limit self-satisfying opportunities for managers.
The board of directors plays a key role in corporate governance. It is their responsibility to endorse the organization's strategy, develop directional policy,
appoint, supervise and remunerate senior executives and to ensure accountability of the organization to its owners and authorities
A key factor in an individual’s decision to participate in an organization (e.g. through providing financial capital or expertise or labour) is trust that they will
receive a fair share of the organizational returns. If somebody receives more than their fair return (e.g. exorbitant executive remuneration), then the
22
participants may choose not to continue participating, potentially leading to an organizational collapse (e.g. shareholders withdrawing their capital).
Corporate governance is the key mechanism through which this trust is maintained across all stakeholders.
1.11 Importance and Benefits of Corporate Governance

Policymakers, practitioners and theorists have adopted the general stance that corporate governance reform is worth pursuing, supporting such initiatives
as splitting the role of chairman/ chief executive, introducing non-executive directors to boards, curbing excessive executive performance-related
remuneration, improving institutional investor relations, increasing the quality and quantity of corporate disclosure, inter alia.
• However, is there really evidence to support these initiatives?
• Do they really improve the effectiveness of corporations and their accountability?
There are certainly those who are opposed to the ongoing process of corporate governance reform.
Many company directors oppose the loss of individual decision-making power, which comes from the presence of non-executive directors and independent
directors on their boards. They refute the growing pressure to communicate their strategies and policies to their primary institutional investors. They
consider that the many initiatives aimed at ‘improving’ corporate governance in UK have simply slowed down decision-making and added an unnecessary
level of the bureaucracy and red tape.
The Cadbury Report emphasized the importance of avoiding excessive control and recognized that no system of control can completely eliminate the risk
of fraud (as in the case of Maxwell) without hindering companies’ ability to compete in a free market. This is an important point, because human nature
cannot be altered through regulation, checks and balances.
Nevertheless, there is growing perception in the financial markets that good corporate governance is associated with prosperous companies. Institutional
investment community considered both company directors and institutional investors welcomed corporate governance reform, viewing the reform process
as a ‘help rather than a hindrance’. Specifically, towards corporate governance reform.
23
Benefits of Corporate Governance

The initiation of the process of corporate governance in PEs is likely to result into a series of important benefits. Firstly, the flip-flop about owning of the
responsibility for low performance would perhaps come to an end. The owners will be on enterprise board. Secondly, goal and role clarity would improve.
Enterprise would be mission – vision driven. Thirdly, opportunity for top management to create a cultural transformation from government entities to
corporate entities, and from state-financed to self-sustaining ones
Think About It:

Should Corporate Governance be Voluntary or Mandatory?
Today no one argues against the need for a system of good corporate governance to attract capital to the corporate sector. Regulators, which have the
responsibility to protect the interest of shareholders, continuously endeavour to improve the standard of corporate governance. There is a trend towards
the convergence of the Anglo-Saxon corporate governance model.
The corporate governance structure, which requires a balanced board of directors with adequate number of independent directors, is widely accepted. It is
also widely accepted that the role of the board of directors is to protect the interest of non-controlling shareholders through effective monitoring. But, in
practice, companies do not prefer a monitoring board of directors.
They see value in having an advisory board of directors. This is so because companies do not see a business case for a board of directors, which
effectively monitors the executive management. Although researchers argue that good and effective corporate governance system in a company reduces
the cost of capital, their research findings do not provide conclusive evidence of reduced cost of capital. The argument is based on the principle that higher
the risk, higher is the expected return.
Therefore, if corporate governance reduces the total risk by reducing the risk of expropriation of shareholders’ wealth by the executive management, the
return expected by shareholders, which measures the cost of capital, should also reduce. The logic is simple. But that may not work in practice. If corporate
governance results in too much and too many controls, it kills the managerial entrepreneurship and innovation resulting in less than the optimal
performance. Shareholders are not benefitted as both the expected return and actual return on investment are reduced.
24
This is likely to happen if independent directors exercise too much control over the executive management. Performance of companies improve if,
independent directors restrain themselves from imposing controls on the management and intervene when there are signs of mismanagement. Therefore,
companies prefer advisory board of directors and shareholders do not resent to the same.
Shareholders are not too much bothered about the quality of corporate governance in a company because the quality of corporate governance is not
observable. What is observable is the composition of board, qualifications of board of directors, number of meetings held, number of meetings attended by
each board member, constitution of various board committees and number of meetings held by them and attendance members in those meetings. The
board process is not observable to those who are not privy to board proceedings. Therefore, the adequacy of the corporate governance system can be
observed but its effectiveness cannot be observed.
On the other hand, performance of the company is observable. Often, enterprise performance is used as a measure of the effectiveness of the corporate
governance system. Capital flows to companies, have good track record of economic performance in terms of creating shareholders’ wealth. In fact,
shareholders have little to choose between companies in terms of the corporate governance system because the corporate governance system is uniform
for all the companies.
The government has interest in reducing the cost of capital for companies. If the cost of capital can be reduced, some projects that are unviable will
become viable with reduced cost of capital. Companies prefer to use effective supervisory board to improve performance rather than establishing an
effective monitoring board.
The alternative way of reducing the cost of capital is to reduce the information asymmetry between the executive management and the capital market and
to reduce the chances of earnings management. These also strengthen the passive monitoring by capital mar-ket participants and others and enhance
activities in the corporate control market.
Quality of Accounting practices, disclosures in annual reports and in financial statements, disclosures to investors through stock exchanges and audit
effectiveness reduces information asymmetry and chances of earnings management. Therefore, the government should focus on all those aspects.
25
1.12 Role of Corporate Governance

The role of effective corporate governance is of immense significance to the society as a whole.
It can be summarized as follows:
1. Corporate governance ensures the efficient use of resources.
2. It makes the resources flow to those sectors or entities where there is efficient production of goods and services and the return is adequate enough to
satisfy the demands of stakeholders.
3. It provides for choosing the best managers to administer scarce resources.
4. It helps managers remain focused on improving performance and making sure that they are replaced when they fail to do so.
5. It pressurizes the organization to comply with the laws, regulations and expectations of society.
6. It assists the supervisor in regulating the entire economic sector without partiality and nepotism.
7. It increases the shareholders’ value, which attracts more investors. Thus, corporate governance ensures easy access to capital.
8. As corporate governance leads to higher consumer satisfaction, it helps in increasing market share and sales. It also reduces advertising and
promotion costs.
9. Employees are more satisfied in organizations that follow corporate governance policies. This reduces the employee turnover, which results in the
reduction in the cost of human resource management. Only a satisfied employee can create a satisfied customer.
10. Corporate governance reduces the procurement and inventory cost. It helps in maintaining a good rapport with suppliers, which results in better and
more economical inventory management system.
11. Corporate governance helps in establishing good rapport with distributors providing not only better access to the market, but also reducing the cost of
production.
26
2. Systems of Corporate Governance

The occurrence of the financial scandals mentioned in the earlier sections and the questions regarding avoidance of recurrence of such incidents have led
thinking through different paths. The need for some kind of regulatory mechanism for corporate governance has been made obvious by the recurrence of
financial scams and scandals. While forming such a regulatory mechanism, the following two questions are of importance:
• Is it advisable to have definite rules that govern the corporate behavior? or
• Is it better to have self-regulation based on certain principles?
Both have got their own advantages and disadvantages as given in the succeeding paragraphs. These advantages and disadvantages of rule-based
corporate governance and self–regulation-based corporate governance are given below:
Rule-based Systems with External Monitoring

Rules are generally well laid down, and there is a clear-cut demarcation between what is acceptable and what is not. On the flip side, however, it is not
possible to formulate rules to cater for all situations a priori. Therefore, the perceived clarity will be available only in situations that have precedence. The
rules also often turn out to be impractical.
Principle-based Systems with Self-regulation

Principles are generally defined and formulated by each sector/industry and it is left to the individual to undertake self-regulation. Following well-thought-out
principles can also prevent legislation imposed by over-enthusiasm. The application of principles, however, during each situation is liable to individual
interpretation and, therefore, may not be as clear cut as a laid down law.
There are continual arguments going on about the relative merits and demerits of the two approaches – one a compliance-led approach and the other a
value-led approach. Does compliance-led approach induce a minimum standard of behavior, which often lacks risk-taking ability and aggressive initiatives?
Does value-led approach give an occasion for anyone to interpret and justify all kinds of actions?
27
3. Regulatory Framework
The conceptual framework of corporate governance in India takes off from the ministry of corporate affairs and includes the companies act. From the
regulatory angle, the ministry of corporate affairs regulates governance by the institution of various acts. The ministry also provides investor protection and
provides important safeguards that are aimed at protecting the interests of stakeholders. The ministry of corporate affairs launched an e-governance
initiative titled MCA 21 (mission mode project). It involves moving towards a paperless governance model, and the forms and processes have been made
e-centric.
3.1 Prevention of Corruption Act

India’s anti-bribery and anti-corruption (ABAC) regime went through a massive change recently. After years of deliberation, the Indian parliament has
enacted the Prevention of Corruption (Amendment) Act, 2018 (Amendment Act), bringing about crucial changes that could really impact the way companies
do business in India.
The amendments brought in by the Amendment Act are prospective in nature and take effect from the date the legislation received presidential assent – i.e.
July 26, 2018. Hence, companies currently doing business in India need not retrospectively assess their compliance with the requirements introduced by
the Amendment Act and shall only be regulated by these provisions prospectively.
Major aspects of the Prevention of Corruption (Amendment) Act, 2018 (Amendment Act) are:
Offense of Giving Bribes:
The most significant change that the Amendment Act brings about is in the nature of bribery offenses. In the earlier avatar of the Prevention of Corruption
Act (PCA), giving a bribe was merely an indirect offense, i.e. it was punishable as abetment to the offense of acceptance of bribes by a public official. So,
effectively, the offense of giving a bribe was hinged upon the bribe taker being prosecuted and punished. With the Amendment Act, however, giving or
promising to give a bribe or ‘undue advantage’ to a public servant is now a distinct offense.
28
Offense of Bribery by Commercial Organizations:

Prior to the Amendment Act, the PCA wholly lacked any provision in relation to the liability of commercial organizations for bribery committed by its
employees, agents or other associated third parties.
So, in effect, the erstwhile law neither incentivized compliance nor contained a provision providing for corporate criminal liability. However, the Amendment
Act has introduced a specific set of provisions regulating the conduct of, and laying down requirements for, commercial organizations carrying on business
in India. Section 9 of the amended PCA creates the offence of bribery by commercial organizations and provides that a commercial organization shall be
fined if any person associated with such commercial organization bribes a public servant. This means that the legislation now explicitly targets companies
and in absence of an affirmative defense, companies will be liable for payment of bribes.
Furthermore, the capacity in which the person performs services for or on behalf of the organization is immaterial and such organization may be penalized
irrespective of whether such person is an employee, agent or subsidiary of such organization. The corollary is that if an Indian subsidiary of a non-resident
multinational corporation commits the offense of bribery, the parent company may also be held liable for the offense.
Liability of Management:
The Amendment Act’s most significant change for management personnel of a company is the creation of a specific offense where officials of a commercial
organization may also be penalized with imprisonment between three to seven years along with a fine. By specifically introducing such a provision under
the Amendment Act, it is likely that the law enforcement authorities and prosecution will come down heavy on the personnel of the commercial organization
while investigating and prosecuting the commercial organization for acts of bribery.
This, in turn, translates into the need to conduct management focused compliance training and workshops, and likely higher premiums for D&O liability
insurance. Furthermore, this provision markedly serves as a strong reminder to set the tone at the top and ensure that a zero-tolerance approach to bribery
and corruption is clearly communicated to all employees, agents and other associated third parties performing services for or on behalf of the commercial
organization.
29
3.2 Serious Fraud Investigation Office

Serious Fraud Investigation Office (SFIO), has been formed under the Companies Act, 2013 to investigate serious fraudulent crimes committed by senior
executives of large organizations (generally known as “white-collar crimes”). It is a multi-disciplinary organization having the requirement of experts from
various fields such as corporate law, criminal law, banking, accounting, forensic audit, capital markets, taxation, etc. It was set up on the recommendation
of a committee headed by Naresh Chandra, a former Cabinet Secretary on corporate governance in order to tackle serious crimes related to corporate
financial fraud.
The Serious fraud investigation office is set up under the ministry of corporate affairs and is a multidisciplinary set up designed to investigate corporate
frauds. The SFIO consists of experts from forensic, auditing, legal, Information technology, capital markets, taxation, etc. These experts work on detecting
frauds besides providing recommendations for white-collar crimes.
3.3 Enforcement Directorate

Directorate of Enforcement is a specialized financial investigation agency under the Department of Revenue, Ministry of Finance, Government of India,
which enforces the following laws: -
• Foreign Exchange Management Act,1999 (FEMA) - A Civil Law, with officers empowered to conduct investigations into suspected contraventions of
the Foreign Exchange Laws and Regulations, adjudicate, contraventions, and impose penalties on those adjudged to have contravened the law.
• Prevention of Money Laundering Act, 2002 (PMLA) - A Criminal Law, with the officers empowered to conduct investigations to trace assets derived
out of the proceeds of crime, to provisionally attach/ confiscate the same, and to arrest and prosecute the offenders found to be involved in Money
Laundering.
3.4 Companies Act 2013

The companies act has many provisions that relate to corporate governance. The act has provisions related to the composition of the board of directors,
30
constitution of the audit committee, internal audit, risk management, etc. The companies act requires corporate entities to devise a corporate social
responsibility plan and also specified minimum expenditure on Corporate social responsibility related aspects.
3.5 SEBI Guidelines

The securities and exchange board of India has laid down guidelines related to corporate governance. For instance, the act has guidelines that require
shareholder approval for related party transactions. The act also has guidelines related to insider trading. While insider trading by itself is not a violation of
the act though it prohibits insider trading on the basis of information that is not yet in the public domain.
3.6 Accounting Standards

ICAI ( Institute of chartered accountants of India) has laid down guidelines on disclosure norms such as disclosure of accounting policies followed by
preparing financial statements.
3.7 Competition Commission of India

The Competition Act, 2002, as amended by the Competition (Amendment) Act, 2007, follows the philosophy of modern competition laws. The Act prohibits
anti-competitive agreements, abuse of dominant position by enterprises and regulates combinations (acquisition, acquiring of control and M&A), which
causes or likely to cause an appreciable adverse effect on competition within India.
The objectives of the Act are sought to be achieved through the Competition Commission of India (CCI), which has been established by the Central
Government with effect from 14th October 2003. CCI consists of a Chairperson and 6 Members appointed by the Central Government.
The Commission is also required to give an opinion on competition issues on a reference received from a statutory authority established under any law and
to undertake competition advocacy, create public awareness and impart training on competition issues.
31
3.8 Reserve Bank of India

RBI has laid down guidelines on corporate governance. Most of these rules are largely applied to the private sector banks as public sector banks have
other governmental regulations that deal with some of these facets.
4. Appendix
OECD Principles - https://www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf
32
Unit 1 – Additional Read

OECD Principles of Corporate Governance
OECD Principles of Corporate Governance
I. Ensuring the basis for an effective corporate governance framework

The corporate governance framework should promote transparent and fair markets, and the efficient allocation of resources. It should be consistent with
the rule of law and support effective supervision and enforcement.
a. The corporate governance framework should be developed with a view to its impact on overall economic performance, market integrity and the
incentives it creates for market participants and the promotion of transparent and well-functioning markets.
b. The legal and regulatory requirements that affect corporate governance practices should be consistent with the rule of law, transparent and
enforceable.
c. The division of responsibilities among different authorities should be clearly articulated and designed to serve the public interest.
d. Stock market regulation should support effective corporate governance.
e. Supervisory, regulatory and enforcement authorities should have the authority, integrity and resources to fulfil their duties in a professional and
objective manner. Moreover, their rulings should be timely, transparent and fully explained.
f. Cross-border co-operation should be enhanced, including through bilateral and multilateral arrangements for exchange of information.
2
II. The rights and equitable treatment of shareholders and key ownership functions
The corporate governance framework should protect and facilitate the exercise of shareholders’ rights and ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their
rights.
a. Basic shareholder rights should include the right to:

o Secure methods of ownership registration;
o Convey or transfer shares;
o Obtain relevant and material information on the corporation on a timely and regular basis;
o Participate and vote in general shareholder meetings;

o Elect and remove members of the board; and
o Share in the profits of the corporation.
b. Shareholders should be sufficiently informed about, and have the right to approve or participate in, decisions concerning fundamental corporate
changes such as:
o Amendments to the statutes, or articles of incorporation or similar governing documents of the company;
o The authorization of additional shares; and

o Extraordinary transactions, including the transfer of all or substantially all assets, that in effect result in the sale of the company.
3
c. Shareholders should have the opportunity to participate effectively and vote in general shareholder meetings and should be informed of the rules,
including voting procedures, that govern general shareholder meetings:
o Shareholders should be furnished with sufficient and timely information concerning the date, location and agenda of general meetings, as well as
full and timely information regarding the issues to be decided at the meeting.
o Processes and procedures for general shareholder meetings should allow for equitable treatment of all shareholders. Company procedures
should not make it unduly difficult or expensive to cast votes.
o Shareholders should have the opportunity to ask questions to the board, including questions relating to the annual external audit, to place items
on the agenda of general meetings, and to propose resolutions, subject to reasonable limitations.
o Effective shareholder participation in key corporate governance decisions,such as the nomination and election of board members, should be
facilitated. Shareholders should be able to make their views known, including through votes at shareholder meetings, on the remuneration of
board members and/or key executives, as applicable. The equity component of compensation schemes for board members and employees
should be subject to shareholder approval.
o Shareholders should be able to vote in person or in absentia, and equaleffect should be given to votes whether cast in person or in absentia.
o Impediments to cross border voting should be eliminated.

d. Shareholders, including institutional shareholders, should be allowed to consult with each other on issues concerning their basic shareholder rights as
defined in the Principles, subject to exceptions to prevent abuse.
e. All shareholders of the same series of a class should be treated equally. Capital structures and arrangements that enable certain shareholders to
obtain a degree of influence or control disproportionate to their equity ownership should be disclosed.
4
o Within any series of a class, all shares should carry the same rights. All investors should be able to obtain information about the rights attached
to all series and classes of shares before they purchase. Any changes in economic or voting rights should be subject to approval by those
classes of shares which are negatively affected.
o The disclosure of capital structures and control arrangements should be required.

f. Related-party transactions should be approved and conducted in a manner that ensures proper management of conflict of interest and protects the
interest of the company and its shareholders.
o Conflicts of interest inherent in related-party transactions should be addressed.
o Members of the board and key executives should be required to disclose to the board whether they, directly, indirectly or on behalf of third
parties, have a material interest in any transaction or matter directly affecting the corporation.
g. Minority shareholders should be protected from abusive actions by, or in the interest of, controlling shareholders acting either directly or indirectly, and
should have effective means of redress. Abusive self-dealing should be prohibited.
h. Markets for corporate control should be allowed to function in an efficient and transparent manner.
o The rules and procedures governing the acquisition of corporate control in the capital markets, and extraordinary transactions such as mergers,
and sales of substantial portions of corporate assets, should be clearly articulated and disclosed so that investors understand their rights and
recourse. Transactions should occur at transparent prices and under fair conditions that protect the rights of all shareholders according to their
class.
o Anti-take-over devices should not be used to shield management and the board from accountability.
5
III. Institutional Investors, Stock Markets, and Other Intermediaries

The corporate governance framework should provide sound incentives throughout the investment chain and provide for stock markets to function in a way
that contributes to good corporate governance.
a. Institutional investors acting in a fiduciary capacity should disclose their corporate governance and voting policies with respect to their investments,
including the procedures that they have in place for deciding on the use of their voting rights.
b. Votes should be cast by custodians or nominees in line with the directions of the beneficial owner of the shares.
c. Institutional investors acting in a fiduciary capacity should disclose how they manage material conflicts of interest that may affect the exercise of key
ownership rights regarding their investments.
d. The corporate governance framework should require that proxy advisors, analysts, brokers, rating agencies and others that provide analysis or advice
relevant to decisions by investors, disclose and minimize conflicts of interest that might compromise the integrity of their analysis or advice.
e. Insider trading and market manipulation should be prohibited and the applicable rules enforced.
f. For companies who are listed in a jurisdiction other than their jurisdiction of incorporation, the applicable corporate governance laws and regulations
should be clearly disclosed. In the case of cross listings, the criteria and procedure for recognizing the listing requirements of the primary listing should
be transparent and documented.
g. Stock markets should provide fair and efficient price discovery as a means to help promote effective corporate governance.
6
IV. The Role of Stakeholders in Corporate Governance

The corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active
co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.
a. The rights of stakeholders that are established by law or through mutual agreements are to be respected.
b. Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain effective redress for violation of their rights.
c. Mechanisms for employee participation should be permitted to develop.
d. Where stakeholders participate in the corporate governance process, they should have access to relevant, sufficient and reliable information on a
timely and regular basis.
e. Stakeholders, including individual employees and their representative bodies, should be able to freely communicate their concerns about illegal or
unethical practices to the board and to the competent public authorities and their rights should not be compromised for doing this.
f. The corporate governance framework should be complemented by an effective, efficient insolvency framework and by effective enforcement of creditor
rights.
7
V. Disclosure and Transparency

The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation,
including the financial situation, performance, ownership, and governance of the company.
a. Disclosure should include, but not be limited to, material information on:
o The financial and operating results of the company.

o Company objectives and non-financial information.
o Major share ownership, including beneficial owners, and voting rights.

o Remuneration of members of the board and key executives.
o Information about board members, including their qualifications, the selection process, other company directorships and whether they are
regarded as independent by the board.
o Related party transactions.
o Foreseeable risk factors.
o Issues regarding employees and other stakeholders.
o Governance structures and policies, including the content of any corporate governance code or policy and the process by which it is
implemented.
b. Information should be prepared and disclosed in accordance with high quality standards of accounting and financial and non-financial reporting.
8
c. An annual audit should be conducted by an independent, competent and qualified, auditor in accordance with high-quality auditing standards in order
to provide an external and objective assurance to the board and shareholders that the financial statements fairly represent the financial position and
performance of the company in all material respects.
d. External auditors should be accountable to the shareholders and owe a duty to the company to exercise due professional care in the conduct of the
audit
e. Channels for disseminating information should provide for equal, timely and cost-efficient access to relevant information by users.
9
VI. The Responsibilities of the Board

The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the
board’s accountability to the company and the shareholders.
a. Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the
shareholders.
b. Where board decisions may affect different shareholder groups differently, the board should treat all shareholders fairly.
c. The board should apply high ethical standards. It should take into account the interests of stakeholders.
d. The board should fulfil certain key functions, including:
o Reviewing and guiding corporate strategy, major plans of action, risk management policies and procedures, annual budgets and business plans;
setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions
and divestitures.
o Monitoring the effectiveness of the company’s governance practices and making changes as needed.
o Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning.
o Aligning key executive and board remuneration with the longer-term interests of the company and its shareholders.
o Ensuring a formal and transparent board nomination and election process.

o Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets
and abuse in related party transactions.
10
o Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the independent audit, and that appropriate
systems of control are in place, in particular, systems for risk management, financial and operational control, and compliance with the law and
relevant standards.
o Overseeing the process of disclosure and communications.
e. The board should be able to exercise objective independent judgement on corporate affairs.
o Boards should consider assigning a sufficient number of non-executive board members capable of exercising independent judgement to tasks
where there is a potential for conflict of interest. Examples of such key responsibilities are ensuring the integrity of financial and non-financial
reporting, the review of related party transactions, nomination of board members and key executives, and board remuneration.
o Boards should consider setting up specialized committees to support the full board in performing its functions, particularly in respect to audit,
and, depending upon the company’s size and risk profile, also in respect to risk management and remuneration. When committees of the board
are established, their mandate, composition and working procedures should be well defined and disclosed by the board.
o Board members should be able to commit themselves effectively to their responsibilities.
o Boards should regularly carry out evaluations to appraise their performance and assess whether they possess the right mix of background and
competences.
f. In order to fulfil their responsibilities, board members should have access to accurate, relevant and timely information.
g. When employee representation on the board is mandated, mechanisms should be developed to facilitate access to information and training for
employee representatives, so that this representation is exercised effectively and best contributes to the enhancement of board skills, information and
independence.
11
Unit 2
Corporate Governance in Banks in India
Unit 2 – Corporate Governance in Banks in India
Table of contents
1 Corporate Governance & Banks 4
2 Role of RBI in Bank Governance 6
2.1 – Reserve Bank of India 6
2.2 – Reserve Bank of India (RBI) and Corporate Governance 7
2.3 – RBI’s Corporate Governance Mechanism 7
2.4 – Additional Responsibilities of RBI 9
3 Board of Directors 10
3.1 – Meaning of Directors 11
3.2 – Types of Directors 12
3.3 – Director’s Appointment 13
3.4 – Director Identification Number (DIN) 14
3.5 – Duties and Responsibilities of Directors 15
3.6 – Powers of Director 16
3.7 – Liabilities of Director 19
2
Table of contents
3.8 – Qualification and Disqualifications of Directors 21
3.9 – Role of Directors 22
3.10 – Role of the Board 25
3.11 – Director’s Remuneration 28
3.12 – Resignation of Director (Section 168) 29
3.13 – Removal of Director (Section 169) 30
4 Board of Directors and Board Committees 31
4.1 – Board Committees 31
4.2 – Various Committees of the Board 31
5 Audit Committee 32
6 Appendix 36
3
1. Corporate Governance & Banks

Banks are critically important for industrial expansion, the governance of firms and capital allocation. When banks efficiently mobilize and allocate funds,
capital costs are lowered, capital formation gets a boost, and productivity growth is stimulated. Thus, the functioning of banks has ramifications for the
operations of firms and prosperity of nations.
Given the importance of banks, the governance of banks is critical. If banks have efficient governance mechanisms, it is more likely that they will allocate
efficiently and exert thoughtful corporate governance over the companies they fund. In contrast, if banks enjoy unchecked discretion, they may end up,
knowingly or unknowingly, acting in their own interests. As a result, interests of shareholders and debt holders might be ignored. Consequently, banks will
be less likely to allocate society’s savings efficiently and exert sound governance over firms.
In the past, banking crisis have crippled economies as well as disestablished governments (for example – Global recession of 2008-2010). When banks
are exploited by bankers for their own purposes, the likelihood of bank failures increase. This leads to curtailing corporate finance and economic
development. Recently, banks in India have been victims of lack of governance. In the Nirav Modi case, a single rogue employee’s actions have threatened
to wipe out more than a quarter of Punjab National Bank (PNB) shareholder’ equity.
So, the question arises, how should governance work for banks?
Indeed, banks are firms, with shareholders, debt holders, board of directors, competitors, etc.
Does this then mean that governance for banks can be on the same lines as that of an automobile company or an FMCG company.?
Before we answer the above questions, let us examine how banks are different from other firms.
Banks, inherently, are different from other firms or companies, due to the nature of the banking business, the complexity of its organization, the uniqueness
of banks’ balance sheet, the need for protection of the weakest party in the chain (i.e. depositors), and the systematic risks caused by bank failures.
4
• Firstly, outsiders find it difficult to accurately evaluate the bank’s balance sheets and consequently its true financial position
• Secondly, banks serve several conflicting interest, from equity holders, to borrowers or depositors and good governance is important for balancing
those interests.
• Finally, the potential negative effects of banks failures are very damaging for both the economy and society, as was demonstrated vividly by the 2008
global financial crisis.
For these reasons, it is now acknowledged that the corporate governance of banks should be addressed with specific recommendations, focusing more on
the “internal governance” than the protection of minority shareholders.
Learning Objectives
• Explain the role of RBI in Corporate Governance in Banks
• Discuss the roles and powers of board of directors
• Know the board’s committees
5
2. Role of RBI in Bank Governance

The corporate governance mechanism everywhere depends on the general legal, contractual and enforcement process in any jurisdiction, rather than
being left to the process of self-regulations and individual commitments. Corporate governance and enforcement mechanism are closely linked as they
form integrated framework of linkages to protect the interest of all stakeholders.
Stock exchange and capital market regulators function as powerful agents for instilling good governance, especially in a country like India where capital
market are going through process of transformation. A contribution of good regulations and efficient gate-keeping would lead to the development of strong
capital markets.
Gate-keepers are individual institutions or agencies that are interposed between investors and managers/owners, in order to play a role of a watchdog to
help reducing the agency cost. Institutions like Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), and individual like Comptroller
Audit General (CAG) and others in their capacity as auditors and analysts can act as gate-keepers.
2.1 Reserve Bank of India

The financial sector is very commonly referred to as the lifeblood of an economy. In a developing economy, a completely hands-off approach may not be
ideal, the central bank could contribute substantially to build robust institutions and mechanisms by stipulating norms and requirements and enforcing
corporate governance and financial reporting requirements.
Traditionally, central banks have performed the roles of currency authority, banker to the government and other banks, lender of last resort, supervisor of
banks and exchange management authority.
Central bank functions in India have been carried out by the Reserve Bank of India (RBI) since independence, when it took over the erstwhile Imperial bank
of India that had been formed in 1935. RBI was originally set up to regulate the issue of currency, maintain foreign exchange reserves to enable monetary
stability and generally to operate the currency and credit system in the country.
6
The broad mandates of RBI currently are:

• Stimulate economic growth by controlling monetary expansion
• Including market adjustments in interest rate structures
• Maintain internal price stability by monitoring inflationary pressures
• Develop the banking and financial sectors and to perform a proper regulatory role.
2.2 Reserve Bank of India (RBI) & Corporate Governance

Banks play a pivotal role in the financial and economic system of any country RBI plays a leading role in formulating and implementing corporate
governance in banks. RBI performs the corporate governance function under the guidance of the Board of the Financial Supervision (BFS). The primary
objective of BFS is to undertake consolidated supervision of the financial sector comprising of commercial banks, financial institutions and non-banking
financial companies. It was constituted in November 1994 as a committee of the Central Board of Directors of RBI.
BFS inspects and monitors banks by using the “CAMEL” (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity & Systems and Controls)
approach. Through the Audit Sub-Committee BFS also aims to upgrade the quality to the statutory audit and functions in banks and financial institutions.
2.3 RBI’s Corporate Governance Mechanism

RBI follows three categories to govern the corporate sectors:
i. Disclosure and transparency constitute the main pillars of the corporate governance framework. They supply an adequate form of information to the
stakeholders and lead to informed decisions.
ii. Off-site surveillance mechanism monitors the movement of assets and its impact on capital adequacy and overall efficiency and adequacy in
managerial practices in banks. RBI promotes self-regulation and market discipline among the banking sector participants and has issued prudential
7
norms for income recognition, asset classification and capital adequacy. RBI brings
out the periodic data on “Peer Group Comparison”. RBI’s Corporate Governance
iii. Prompt Corrective Supervision (PCS) is a supervisory mechanism implemented as a Mechanism
part of Electronic Banking Supervision. It is based on pre-determined rule-based
structure of early intervention where the benchmark ratios of three parameters –
Capital Adequacy Ratio, Non-Performing Asset Ratio and Return on Assets, are Elective Banking Supervision
determined. Any breach of these points is considered as warning and RBI initiates
appropriate measures to overcome that.
Apart from working under the jurisdiction of RBI as mentioned above, listed banks, Triggers CAR, NPA and ROA
NBFCs, and other financial intermediaries are governed by SEBI’s Clause 49 on
Corporate Governance. Additionally, RBI has also issued various circulation and
notifications that provide guidelines on:
Prompt Corrective Action
• Composition, qualification, independence and remuneration of Board of Directors
• Roles, responsibilities and training of executive directors
Corporate Governance Compliance
• Resolution of conflict of interest in case of related party transaction results in Shareholders’ wealth
• Constitution of nomination committee, risk management committee & audit committee
One of the inspection and monitoring tools used by the BFS is the quality of audit (both statutory and internal) conducted on the banking sector. The
Comptroller and Auditor General (CAG) of India and the Institute of Chartered Accountants of India (ICAI) prepared a list of auditors and such names are
approved by RBI and the private banks can choose theirs auditors from that list.
8
2.4 Additional Responsibilities of RBI

As a regulator of the banking sector, RBI has an immense bearing on the corporate sector as well as in the entire economy of India in terms of rates of
interest, foreign exchange, and anti-money laundering, among other things as written below.
S.No Policy Effects
It determines the cost of borrowing of the corporate sectors affecting profitability, capital
Monetary policy determines the Repo Rate,
1 budgeting decisions and creation of production capacities depending upon the credit
Bank Rate, CRR, SLR
availability among other things.
It controls the inflationary pressures on both capital assets and the price of consumable
2 Monetary Policy
goods.
It reduce the currency risk involved in marketing payment of imports, repayment of loans
3 Interventions in the Foreign Exchange Market
and thereon.
Export proceeds should be realized within twelve months of the date of the export, with
4 Export/Import Regulations
encourages time-bound collections.
Regulation of Investment in Indian Companies

by Foreign Institutional Investors, Non-
RBI has imposed sectoral cap and statutory and statutory ceiling for corporate. These
5 Residential Investors, and the Persons of
approval determines the investible funds in Indian Corporate Sector.
Indian Origins via the Portfolio Investment
Scheme.
9
S.No Policy Effects
Guidelines for Indian Direct Investment in joint

It affects business strategic expansion decisions, foreign technology sourcing, and
6 ventures and wholly owned subsidiaries
resource availability and export market development.
abroad
The borrower must obtain a Loan Register Number from RBI with the prior approval from
7 External Commercial Borrowings
RBI.
Guidelines for issuance of Foreign Currency It can be issued up to $ 550 million under the automatic approval route. RBI’s approval is
8
Convertible Bonds required.
9 Anti-money Laundering Corporates have to fulfil bank account norms.
All these indicators suggest that the monitoring and oversight mechanism instituted by RBI for improving the corporate governance of the banks and by
interference of individual borrowers, is robust and effective. It is effective as a regulator of banking sector and a good gate-keeper of corporate governance.
3. Board of Directors
The separation of the ownership from active directorship and management is an essential feature of the company form of organization. To manage the
affairs of the company, the shareholders elect their representatives in accordance with the laid down policy. These representatives are called the “directors”
of the company. A number of such directors constitutes the “board of directors” and that is the top administration body of the corporation. The board may
sometimes appoint an executive committee to carry on certain assigned functions under its discretion. The board generally has only part-time directors.
10
3.1 Meaning of Directors

In general terms, a director is someone appointed to take responsibility for the policy formation and control of a company because of particular ability and
expertise in an industry. Directors advise management of the company on behalf of the shareholders (the owners of the company).
Section 2(13) of the Companies Act defines a director as follows: “A director includes any person occupying the position of director, by whatever name
called. The important factor to determine, whether a person is or is not a director, is to refer to the nature of the office and its duties. It does not matter by
what name he is called. If he performs the functions of a director, he would be termed as a director in the eyes of the law, even though he may be named
differently. A director may, therefore, be defined as a person having control over the direction, conduct, management or superintendence of the affairs of a
company. Again, any person, in accordance with whose directions or instructions, the board of directors of a company is accustomed to act is deemed to
be a director of the company”.
The directors act as agents of the company and the ordinary rules of agency apply. They exercise the powers and are subject to duties within the
framework of the company's Articles, and the Act. For instance, they may make contracts on behalf of the company and they will not be personally liable as
long as they act within the scope of their authority. But if they contract in their own name, or fail to exclude personal liability, they also will be liable. If the
directors exceed their authority, the same act may be ratified by the company. But if they do something beyond the objects clause of the company, then the
act is “ultra vires” and the company cannot ratify the same.
However, directors are not agents for the individual shareholders, they are the agents of the company-the artificial person. The directors have also been
described as trustees. But they are not trustees in the full sense of the term in as much as no proprietary rights of the company's property are transferred to
them and, therefore, they enter into contracts on behalf of the company and in the name of the company.
On the other hand, in the case of a trust, the legal ownership of the trust property is transferred to the trustee and therefore, he can enter into contract in his
own name, but whatever he does, he does for the benefit of the beneficiaries. The directors are also sometimes described as managing partners. They
manage the affairs of the company on their own behalf and on behalf of other shareholders who elect them.
11
3.2 Types of Directors

Various types of directors that can exist in a company are:
1. Ordinary Directors: Ordinary directors are also referred to as simple directors who attends Board meeting of a company and participate in the
matters put before the Board. These directors are neither whole time directors nor managing directors.
2. Managing Director: Managing Director is a director who, by virtue of an agreement with the company or of a resolution passed by the company in
general meeting or by its Board of directors or, by virtue of its Memorandum or Articles of Association, is entrusted with substantial powers of
management which would not otherwise be exercisable by him, and includes a director occupying the position of a managing director, by whatever
name called.
3. Executive Directors: An executive director is a director who performs a specific role in a company under a service contract which requires a regular,
possibly daily, involvement in management. Such a director may also be an employee of the company. This fact may create a potential conflict of
interest which in principle a director is required to avoid. To allow an individual to be both a director and employee the articles usually make express
provision for it, but prohibit the director from voting at a board meeting on the terms of their own employment.
4. Non-executive Directors: A non-executive director does not have a function to perform in Notes a company's management but is involved in its
governance. They are subject to the same legal duties as executive directors. In listed companies, corporate governance codes state that boards of
directors are more likely to be fully effective if they comprise both executive directors and strong, independent non-executive directors.
5. Shadow Directors: According to company law, a director is a person who is responsible for the overall direction of the company's affairs. This means
any person occupying the position of director, by whatever name they are called. A shadow director has also been defined as any person in
accordance with whose instructions the directors are accustomed to act. However this does not include professionals such as accountants or
solicitors. A person might seek to control a company as a director but avoid the legal responsibilities of being a director. The law seeks to prevent this
by extending several statutory rules to shadow directors. Shadow directors are directors for legal purposes if the board-of-directors is accustomed to
act in accordance with their directions and instructions.
12
6. Additional Directors: Additional Directors are appointed by the Board between the two annual general meetings subject to the provisions of the
Articles of Association of a company. Additional directors shall hold office only up to the date of the next annual general meeting of the company.
Number of the directors and additional directors together shall not exceed the maximum strength fixed for the Board by the Articles.
7. Alternate Director: An Alternate Director is a person appointed by the Board if so authorized by the Articles or by a resolution passed by the company
in the general meeting to act for a director called "the original director" during his absence for a period of not less than three months from the State in
which meetings of the Board are ordinarily held. Generally, the alternate directors are appointed for a person who is Non-resident Indian or for foreign
collaborators of a company.
8. Professional Directors: Any director possessing professional qualifications and do not have any pecuniary interest in the company are called as
"Professional Directors". In big size companies, sometimes the Board appoints professionals of different fields as directors to utilize their expertise in
the management of the company.
9. Nominee Directors: The banks and financial institutions which grant financial assistance to a company generally impose a condition as to
appointment of their representative on the Board of the concerned company. These nominated persons are called as nominee directors.
10. Independent Directors: As per the definition of independent director in the code of Corporate Governance, an independent director should not have
any pecuniary relations or transactions with the company or its promoters; his decisions should be independent of those who have controlling stake in
a company and be in the overall interest of the company and its stakeholders.
3.3 Director’s Appointment

The Articles of Association of a company usually name the first set of directors by their respective names or prescribe the method of appointing them. If the
first set of directors are not named in the Articles, the number and the names of directors shall be determined in writing by the subscribers of the
Memorandum of Association or majority of them.
If the first set of directors are not appointed in the above manner, the subscribers of the Memorandum, who are individuals, become director s of the
company. They shall hold office until directors are duly appointed in the first general meeting. Certain provisions of the Companies Act in India govern the
13
appointment or reappointment of directors by a company in a general meeting.
3.4 Director Identification Number (DIN)

Section 153 of the Companies Act requires that every person who is to be a director of a company has to apply for a Director Identification Number. DIN is
a 8 digit identifier that helps identify a director of a company. Only one DIN number is allotted during a person’s lifetime and the number is the reference
number that is used for all purposes of statutory compliance. For obtaining a DIN the director should have a digital signature certificate (DSC).
Digital Signature Certificate (DSC)
A DSC contains details about the identity and other relevant details of a person. The relevance of a DSC is that it obviates the need for a
person to be physically present at a person in order to sign a document. It is pertinent to note that the Ministry of corporate affairs has made
DSC mandatory for almost all purposes of filing and documentation related work needed for the purpose of official records.
For example, certain firms are mandated to ensure that their tax returns are mandatorily filed using a DSC. These certificates have a validity
period, which is generally one or two years after which they have to be renewed. It should also be noted that a person can obtain a DSC for
official purposes and another for personal purposes.
DIN permits easy identification of a Director as it provides a unique identity number. Why is this necessary? There have been instances of Directors who
have managed to cheat customers at one place and later on start another firm. This number records all details about a director and any change in address
or other relevant details have to be updated within the stipulated time.
14
3.5 Duties and Responsibilities of Directors

Directors have certain duties to discharge. These are:
• Fiduciary duties
• Duties of care, skill and diligence
• Duties to attend the board meetings

• Duties not to delegate their functions, except to the extent authorized by the Act or the constitution of a company and to disclose his interest.
With regards to fiduciaries, directors must:
a) Exercise their powers honestly and bona fide for the benefit of the company as a whole and
b) Not to place themselves in a position in which there is a conflict between their duties to the company and their personal interests
c) They must not make any secret profit out of their position
d) Further, the fiduciary duties of directors are owned to the company not to individual shareholders.
Of these four, the first two duties need elucidation. Directors should carry out their duties with reasonable care and exercise such degree of skill and
diligence as is reasonably expected of persons of their knowledge and status. However, a director is not bound to bring any special qualification to his
office, as for instance, the director of a medical insurance company is not expected to have the expertise of an actuary or a skill of a physician. But if a
director fails to exercise due care and diligence expected of him, he is guilty of negligence. The standard of care, skill and diligence depends upon the
nature of the company’s business and circumstances of the case.
15
Factors such as type and nature of work, division of powers between the directors and other executives, general usages, customs and conventions in the
line of business in which the company is engaged and whether the directors work gratuitously or for a remuneration will have an impact on the standards of
care and diligence expected of the directors.
Duties of Directors, as per the Companies Act 2013

1. Subject to the provisions of this Act, a director of a company shall act in accordance with the articles of the company.
2. A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best
interests of the company, its employees, the shareholders, the community and for the protection of environment.
3. A director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment.
4. A director of a company shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the
interest of the company.
5. A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or
associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to the company.
6. A director of a company shall not assign his office and any assignment so made shall be void.
7. If a director of the company contravenes the provisions of this section such director shall be punishable with fine which shall not be less than one lakh
rupees but which may extend to five lakh rupees.
3.6 Powers of Director

The directors are considered as the head and brain of a company. When the brain functions, the company is said to function. For the proper functioning,
the directors should be properly entrusted with some powers. The directors generally acquire their powers from the provisions of the “Articles of
Association” and then from the Companies Act.
16
General Powers of a Company Director

As per Sec. 291 of the Act, the Board is entitled to exercise all such powers and to do all such acts and things as the company is authorized to do. The
exceptions are the acts, which can be done by the company only in the general meetings of the members as required by law.
Specific Powers of Company Director

1. As per Sec. 262, in the case of a public company or a private company, which is a subsidiary of a public company, the power to fill a casual vacancy of
directors is to be exercised at a Board meeting.
2. As per Sec. 292, the following powers of the company shall be exercised by the Board by means of resolution passed at the meeting of the Board:
• to make calls,
• to issue debentures,
• to borrow moneys by other means,
• to invest the funds of the company, and
• to make loans.
The last three powers cannot be delegated to the Manager or to a Committee of Directors but must be exercised only at a Board meeting.
Powers of Director subject to the Consent of the Company

The directors of a public company or of a private company can exercise the following powers, which is a subsidiary of a public company only with the
consent of the company in the general meeting:
1. To sell, lease or otherwise dispose of the undertaking of the company.

17
2. To remit or give time for repayment of any debt due to the company by a director.
3. To invest the sale proceeds of any property of the company in securities other than trust securities.
4. To borrow moneys where the moneys already borrowed (other than temporary) exceeds the total of the paid-up capital and free reserves of the
company.
5. To contribute to charities and other funds not directly relating to the business of the company or to the welfare of the employees in any year in excess
of ₹ 50,000 or 5% of the average net profits of the three preceding financial years whichever is greater.
Powers of Director subject to the Consent of Central Government

1. As per Sec. 268, any provision relating to the appointment or reappointment of a Managing Director can be altered by the Board with the consent of
the Central Government.
2. As per Sec. 295, the Board, subject to the Central Government’s consent, has the power to appoint a person for the first time as a Managing Director.
3. As per Sec. 295, the Board, only with the previous approval of the Central Government, can make any loan or give any guarantee or provide any
security in connection with a loan made by any other person to
a. any of its directors or any director of its holding company, or
b. any partner or relative of such director, or
c. any firm in which any such director or relative is a partner, or

d. any private company of which any such director is a member or director, or
e. any body corporate, 25% or more of whose total voting power may be exercised or controlled by any such director or two or more directors
together, or
18
f. any body corporate, whose Board or Managing director or Manager is accustomed to act in accordance with the directions or instructions of any
director or directors of the leading company.
4. Subject to the approval of the Government, the Board has the power to invest in the shares of another company in excess of the limits specified in
Sec. 372.
3.7 Liabilities of the Director
Directors of a company may be held liable under the following situations:
1. The Directors of a company may be liable to third parties in connection with the issue of a prospectus, which does not contain the particulars required
under the Companies Act or which contains material misrepresentations.
2. The Directors may also incur personal liability under the Act on the following conditions:
a. On their failure to repay application money, if the minimum subscription has not been subscribed.
b. On an irregular allotment of shares to an allottee (and likewise to the company), if loss or damage is sustained.
c. On their failure to repay the application money if the application for the securities to be dealt in on a recognized stock exchange is not made or
refused and,
d. On the failure by the company to pay a bill of exchange, hundi, promissory note, cheque or order for money or goods wherein the name of the
company is not mentioned in legible characters.
The directors responsible for fraudulent trading on the part of the company may by an order of the Court, be made personally liable for the debts or
the liabilities of the company at the time of its winding up.
3. Apart from the liability of the director under the Companies Act, he or she has certain other liabilities which are independent of the Act. Though a
director as an agent of the company, he is not personally liable on contracts entered into on behalf of the company, there could be some exceptional
circumstances that may make him liable.
19
For instance,
a. By signing a negotiable instrument without the company’s name and the fact that he is signing on behalf of the company, he is personally liable
to the holder of such an instrument,
b. Besides, if a director enters in to a contract, which is ultra vires the Articles of the company, the director is personally liable for the breach of
implied warranty of authority,
c. Any director who personally committed a fraud or any other tort in the course of his duties is liable to the injured party. The contract of agency or
service cannot impose any obligation on the agent or servant to commit or assist in committing of a fraud or any other illegality. The company
also be held liable, but it does not exonerate the concerned director.
The Directors’ Liability to the Company

The directors are also liable to the company under the following heads:
1. Ultra Vires Acts: Directors are personally liable to the company in matters of illegal acts. For instance, if directors pay dividend out of capital or when
they dissipate the funds of the company in ultra vires transactions, they are jointly and severally liable.
2. Negligence: A director may be held liable for the negligence in the exercise of his duties. Though there is not statutory definition of negligence, if a
director has not shown due care and diligence, then he is concerned negligent. However, it is essential in an action for negligence if the company has
suffered some damage. Negligence without damage or damage without negligence is not actionable.
3. Breach of Trust: Since the directors of a company are trustees of its money and property, they must discharge their duties in that spirit to the best of
interest of the company. They are liable to the company for any material loss on account of the breach of trust. Likewise, they are also accountable to
the company for any secret profits they might have made in transactions carried out on behalf of the company.
4. Misfeasance: Directors are liable to the company for misfeasance, i.e., willful misconduct. For this purpose, they may be sued in a Court of Law.
20
Liability for Breach of Statutory Duties

The Directors should carry out several statutory duties most of which relate to the maintenance of proper accounts, filing of returns, or observance of
certain statutory formalities. If they fail to perform these duties, they render themselves liable to penalties.
The Companies Act imposes penalty upon the directors for not complying with or contravening the provisions of the Act, which include sections on criminal
liability for mis-statements in prospectus, penalty for fraudulently inducing persons to invest money, purchase by a company of its own shares,
concealment of names of creditors entitled to object to reduction of capital, penalty for default in filing with the Registrar for registration of the particulars of
any change created by the company.
In all these sections, the person, sought to be made liable is described as an “officer who is in default”. The expression “officer in default” includes a
director also.
Directors’ Liability for Acts of his Co-Directors

A director is not liable for the acts of his co-directors provided he has no knowledge and he is not party to it. His co-directors are not his servants or agents
who can by their acts impose liability on him. Likewise, if a director is fraudulent, his co-directors are not liable for not discovering his fraud in the absence
of circumstances to arouse their suspicion.
Moreover, when more than one director is alleged to have neglected his duties of care, all the directors are jointly and severally liable. If an action is
brought by the company against only one of them, he is entitled to contribution from other directors.
3.8 Qualification and Disqualifications of Directors

To be appointed as a director of a company, public authorities prescribe some qualifications. “No corporate, association of firm can be appointed as director
of a company”. A director must:
• Be an individual
21
• Be competent to enter in to a contract and

• Hold a share qualification, if so required by the Articles of Association.
As there are qualifications for being a director, there are some disqualifications too.
The following persons are disqualified for appointment as the director of a company:
1. A person of unsound mind
2. An undischarged insolvent or one whose petition for declaring himself so is pending in a Court
3. A person who has been convicted by a Court for any offence involving moral turpitude
4. A person whose calls in respect of shares of the company are held for more than 6 months have been in arrears and
5. A person who is disqualified for appointment as director by an order of the Court on grounds of fraud or misfeasance in relation to the company
And, of course, the directors can be removed from office by:
• The shareholders
• The Central (Federal) Government
• The Company Law Board
3.9 Role of Directors

As discussed earlier, the board has to shoulder a larger responsibility than the CEO, whose role is limited to being actively engaged with routine
management functions. However, “there are many boards that overlook more than they oversee”. This is more so in the family-owned enterprises which
are common in Asia and Latin America.
In India, for instance, it is common to find family-owned concerns being run by promoters as their personal fiefdoms. Though their investments may be
22
meagre, they manage the firms, holding positions of CEOs, managing directors, chairmen and members of the board of directors. In such a set-up, the
board acts more like a rubber stamp, rather than shouldering large responsibilities. For better governance, the board should function as follows:
1. Directors should exhibit total commitment to the company: An efficient and independent board should be conscious of protecting the interests of
all stakeholders and not concerned too much with the current price of the stock. According to Roz Ridgway, the hallmark of a good director is that he
or she attends and actively participates in the meetings. This requires a cent percent commitment.
2. Directors should steer discussions properly: Another important function of the director is to set priorities and to ensure that these are acted upon.
The directors should see that all important issues concerning the company’s business are discussed and decision taken, and nothing trivial dominates
and bods them down. A good director rarely dominates or hijacks the discussion to his line of thinking, but steps in when the discussion needs to be
directed or adds new thoughts after letting other have their say.
3. Directors should make clear their stand on issues: A director is also expected to have the courage of conviction to disagree. A good, responsible
and duty bound director should be willing to register dissent, when and where needed. The management led by the CEO should know that they are
being challenged, should be kept on alert and should not take things for granted. Directors should also be alert to any deteriorating situations in the
functional areas of finance, stock market, sales, personnel and especially those relating to moral issues.
4. Directors’ responsibility to ensure efficient CEOs: Directors have great responsibility in the matter of the employment and dismissal of the CEO.
The board as a whole, should recruit the best CEO they can probably hire, based on antecedents and market reports, evaluate objectively on a
continuing basis his or her implementing effectively or otherwise the strategic planning devised by the board. “Great boards are those which
proactively govern, help avoid big mistakes, strategies and most importantly the best leadership is in place with the resources to lead”.
5. Challenges posed by decisions on acquisitions: One of the toughest challenges confronted by boards arises while approving acquisitions. It so
happens in most cases that the board takes up the issue of acquisition only when the process has been set in motion and substantially gone through
by the management. It will lead to a terrible embarrassment both to the CEO and the board, if the half-way-gone-through proposal has to be shelved.
More of these none-too-worthy proposed acquisitions have to be accepted because of these predicaments.
6. A board should anticipate business events: An efficient board should be able to anticipate business events that would spell success or lead to
23
disaster if proper measures are not adopted in time. The directors should alert to such ensuing situations and be ready with the strategy to meet them
so that either way the company stands to gain.
7. Directors should have long-term focus and stakeholder interests: Directors have a duty to act bona fide for the benefit of the company as a
whole. This duty is owed to the company, that is, the separate legal person that incorporation brings into existence, and not to any individual or group
of individuals. This would imply, as per the current laws, that directors are required to act in the interests of the shareholders, but at the same time, to
consider such interests with a long-time focus. They ought to build productive relationships between the company and its employees, customers and
suppliers, or any other kind of investment that would serve the long-term interests of its shareholders.
8. Promoting overall interests of the company and its stakeholders are of paramount importance: In recent times, those who advocate reform of
laws governing corporate practices stress the importance of reformulation of the concepts behind these laws.
For instance, John Parkinson in his article “Reforming Directors’ Duties” opines that while accepting that directors should not be required to do
anything that would be contrary to the interest of shareholders, stresses that these interests should be understood as long-term ones. This
reformulation of the concept should encourage managers to pay great attention to the relationships that are source of long-term value.
Once this becomes accepted, it will be logically consistent for the directors to exercise their powers in order to promote the success of the company as
a business enterprise. By doing so, they shall have regard to the interests of shareholders, employees, creditors, customers and suppliers. Stretched
further, it would become imperative that directors guide the company to be a socially responsible organization.
Social responsibility in this context should be seen as a means of not only compensating the society for anti-social corporate behavior such as causing
ecological damages, making money at the cost of patients by launching fully untested medicines, but also for making use of the resources created by
the society such as trained manpower markets for the supply of inputs and for the disposal of produced goods and services.
24
3.10 Role of the Board

The clear message from the series of corporate debacles that occurred in America and several parts of the world, is simple that the board of directors is
increasingly being recognized as a critical success factor for corporations, be they large or small, private or public. This understanding and appreciation of
the role of the boards as being valuable has resulted in several recommendations to boost their contributions to the success of the companies by
innumerable committees that have been appointed by governments and public-spirited organizations all over the world.
Company laws enacted by various countries make it a point to stress that the duty of statutory board is to protect and represent the interests of the
shareholders. The board cannot and does not run the company. There are executives who run the day-to-day affairs of the company as dictated by the
board. The role of the board is to work out business strategy and address big issues.
A board’s role is evolved from law, custom, tradition and current practice, while it gets its authority from the shareholders as their representatives to run the
company’s mission. It is the broader responsibility of the board to ensure that the management works in the best interest of the corporation and the
shareholders to enhance corporate economic value.
It is not clearly understood that no set of systems with a checklist and the laws of state governing them can ever ensure good governance. The quality of
directors, their competence, commitment, willingness and ability to assume a high degree of obligation to the company and its shareholders as members of
the board alone drives the value of any board.
A strategic board with broad governing responsibilities rather than one that acts in response to the demands of the CEO has become the need of an
intensely competitive world.
To strengthen their position and capacity to guide the company and protect the long-term shareholder’s value, many big corporates are turning to advisory
boards to draw on the collective wisdom of several professionals. All of these decisions will of course, depend on the policy, its critical needs and long-time
goal of the company.
25
Susan. F. Shultz, founder of SSA Executive Search International, author of several best sellers on the subject and a member o f several boards of directors
condenses her experiences and research in the following summation”
How can a strategic board ensure good governance?

1. If the board is smaller, the directors’ involvement will be greater .
2. Independence is the essence of strategic boards.
3. Diversity (of board) means that a company has access to the best. It also means that the company is not arbitrarily limited to single subset of its global
constituency.
4. If the board is not informed appropriately, intelligently and comprehensively, it cannot function. In simple words, the output is not only as good as the
output.
5. If the board has a broader responsibility to the long-term shareholder value than the CEO, who is necessarily focusses on day-to-day operations.
The above chart summarizes how a strategic board can be built to ensure better governance practices.
1. Small Size of the Board: The smaller the size of the board, the greater will be the involvement of its members. This will lead to a more cohesive
functioning and decision making could be expedited, all of which will add to the efficiency of the organization.
2. Independence of the Board: Independence should be the essence of strategic boards. To achieve this end, it is advisable to have less number of
insiders and more of outsiders. As Susan. F. Shultz points out, this kind of composition of the board will add to the “proactiveness of the company’s
board. Further, an insider’s loyalty is likely to be to his or her boss and not necessarily to the company’s shareholders. Another downside to an insider
dominated board is that only can the CEO intimidate insiders, but insiders can also inhibit the CEO. Management have a vested interest to prefer
insiders as directors to the board as they are likely to continue the status quo in policies and procedures that they themselves have helped to create
and retain the present senior managers.
26
3. Diversity of the Board: It is of great importance that the board is composed of members with varied experience and expertise and diverse
professional qualifications, but also of people with different ethnic and cultural backgrounds. “With markets in general, and shareholders in particular
becoming active in governance issues, the pressures are intensifying on companies to diversify and broaden board membership. And thankfully, the
phenomenon is not restricted to just the US and the UK, this increased activism is forcing companies worldwide to reform their boards in tune with the
rapid globalization of business.
In India, for instance, with the Cadbury Committee Report and the worldwide interest on corporate governance issues, several scams that have
highlighted regulator’s failures on this front, have brought to the center stage the importance of the board of directors with sizeable number of non-
executive directors.
4. A well-informed Board: It goes without saying that the effectiveness and efficiency of the board of directors depends on the intelligent, timely and
accurate information it gets from the management. The information they get should be appropriate and comprehensive. Various committees on
corporate governance have recommended that even non-executive, independent directors should have access to a free flow of information on various
issues in which they are called upon to decide. They should be allowed to have professional advice, if needs be, and the cost of it should be borne by
the company.
5. The board should have a longer vision and broader responsibility: The very objective and the composition of the board dictate the need for a
broader responsibility and longer vision that those of chief executives. The CEO has a specific and focused mission of running the enterprise as a
profitable one by concentrating on the day-to-day transactions. While the concerns of the CEO will center around his immediate tasks on hand to
enable the company solve its problems and tackle issues that would lead to the profitability of the firm during a financial year, the board, especially
when it is composed of several outside directors, will work out long term strategies, take investment decisions and each other policy perspectives that
would ensure not only the secular interests of the firm, but also of all its shareholders.
27
3.11 Directors’ Remuneration

In the wake of several corporate failures, excessive and disproportionately large payments to directors have almost become a scandal It has also become
one of the most visible and politically sensitive issues of corporate governance.
As usual, there are divergent views on the subject. Some experts on the subject are of the view that directors are generally underpaid for their work and the
onerous responsibilities that they shoulder. They argue that constructive boards are responsible for untold millions going to the bottom-line. The value of a
single idea of strategic succession planning, of risk avoidance, and the value of one mistake prevented is incalculable”.
On the other hand, critic argue that the hefty fees directors receive for attending meetings, million of dollars paid as severance payment, huge pay-outs as
bonus and other perquisites. A major criticism is that executives and directors are not properly controlled in their virtual self-awards of stock options.
Executive compensation linked to share performance through share options has resulted in encouraging a focus on short term growth with destructive
long-term consequences.
The Indian Companies Act 2013 and Corporate Governance

The Indian Companies Act 2013 extensively deals with the role of board of directors in the corporate governance. They are broadly classified under the
following heads:
• Number of directors • Formal letter of appointment of directors
• Composition of director board • Performance evaluation of independent directors
• Independent directors • Separate meeting of independent directors
• Woman director • Training of directors
• Limit in the directorship • Compensation of non-executive directors
• Tenor of independent directors • Director board meeting procedure
28
Directors’ Remuneration in India

Section 198 of the Companies Act 1956 deals with the overall maximum managerial remuneration, and managerial remuneration in case of absence or
inadequacy of profits. According to this section:
1. The total managerial remuneration payable by a public limited company or a private company which is a subsidiary of a public company, to its
directors and its managers in respect of any financial year shall not exceed 11 percent of the profits of the company for that financial year, except that
the remuneration of the directors shall not be deducted from the gross profits.
2. The 11 percent shall be exclusive of any fees payable to directors.
3. With the limits of the maximum remuneration specified in sub-section (1), a company may pay a monthly remuneration to its managing or whole-time
director.
4. Notwithstanding anything contained above if, in any financial year, a company has no profits or its profits are inadequate, the company shall not pay to
its directors, including any managing or whole-time director or manager, by way of remuneration any sum exclusive of fees payable to directors,
except with the previous approval of the central government.
3.12 Resignation of Director (Section 168)

A director may resign from his office by giving a notice in writing to the company and the Board shall on receipt of such notice take note of the same and
the company shall intimate the Registrar in such manner, within such time and in such form as may be prescribed and shall also place the fact of such
resignation in the report of directors laid in the immediately following general meeting by the company. A director shall also send a copy of his resignation
along with detailed reasons for the resignation to the Registrar within thirty days of resignation in such manner as may be prescribed.
There is no need for the acceptance by the board but it will take note of resignation.
The resignation of a director shall take effect from the date on which the notice is received by the company or the date, if any, specified by the director in
the notice, whichever is later the director who has resigned shall be liable even after his resignation for the offences which occurred during his tenure.
29
Where all the directors of a company resign from their offices, or vacate their offices under section 167, the promoter or, in his absence, the Central
Government shall appoint the required number of directors who shall hold office till the directors are appointed by the company in general meeting.
3.13 Removal of Director (Section 169)
A company may, by ordinary resolution, remove a director, not being a director appointed by the Tribunal under section 242, before the expiry of the period
of his office after giving him/her a reasonable opportunity of being heard. The provision relating to removal shall not apply where the company has availed
itself of the option to appoint not less than two-thirds of the total number of directors according to the principle of proportional representation.
A special note shall be required of any resolution, to remove a director, or to appoint somebody in place of a director so removed. On receipt of notice of a
resolution to remove a director, the company shall immediately send a copy thereof to the director concerned, and the director, whether or not he is a
member of the company, shall be entitled to be heard on the resolution at the meeting.
The director concerned may make representation in writing to the company and requests its notification to members of the company. The company shall, if
the time permits it to do so:
a) in any notice of the resolution given to members of the company, state the fact of the representation having been made; and
b) send a copy of the representation to every member of the company to whom notice of the meeting is sent. If, a copy of the representation is not sent
as aforesaid due to insufficient time or for the company’s default, the director may without prejudice to his right to be heard orally require that the
representation shall be read out at the meeting.
The copy of the representation need not be sent out and the representation need not be read out at the meeting if, on the application either of the company
or of any other person who claims to be aggrieved, the Tribunal is satisfied that the rights conferred by this sub-section are being abused to secure
needless publicity for defamatory matter; and the Tribunal may order the company’s costs on the application to be paid in whole or in part by the director in
spite of that he is not a party to it.
A vacancy created by the removal of a director under this section may, if he had been appointed by the company in general meeting or by the Board, be
filled by the appointment of another director in his place at the meeting at which he is removed, provided special notice of the intended appointment has
30
been given. A director so appointed shall hold office till the date up to which his predecessor would have held office if he had not been removed. If the
vacancy is not filled, it may be filled as a casual vacancy. The director who was removed from office shall not be re-appointed as a director by the Board of
Directors.
4. Board of Directors and Board Committees
At the core of corporate governance practices is the Board of Directors which oversees how the management serves and protects the long-term interests
of all the stakeholders of the company. The institution of Board of Directors is based on the premise that a group of trustworthy and respectable people
should look after the interests of the large number of shareholders who are not directly involved in the management of the company. The position of board
of directors is that of trust as the board is entrusted with the responsibility to act in the best interests of the company.
4.1 Board Committees

Committees appointed by the board focus on specific areas and take informed decisions within the framework of delegated authority, and make specific
recommendations to the board on matters in their areas or purview. All decisions and recommendations of the committees are placed before the board for
information or for approval.
To enable better and more focused attention on the affairs of the corporation, the board delegates particular matters to the committees of the board set up
for the purpose. Committees review items in great detail before it is placed before the board for its consideration. These committees prepare the
groundwork for decision making and report at the subsequent board meeting.
4.2 Various Committees of the Board

The following are some of the important committees of the board:
• Audit Committee
• Shareholders Grievance Committee
31
• Remuneration committee
• Risk committee
• Nomination committee
• Corporate Governance committee
• Corporate Compliance committee
In this unit, we will focus on the Audit Committee
5. Audit Committees
The Audit Committee shall assist the Board of Directors in the oversight of:
1. The integrity of the financial statements of the Company,
2. The effectiveness of the internal control over financial reporting,
3. The independent registered public accounting firm’s qualifications and independence,
4. The performance of the Company’s internal audit function and independent registered public accounting firms,
5. The Company’s compliance with legal and regulatory requirements,
6. The performance of the Company’s compliance function.
Organization and Membership

The committee shall be appointed by the Board and consist of at least three directors, each of whom are independent of management and the company as
defined by the bylaws of the company, the SEC and the New York Stock exchange as well Clause 49 o the listing agreement. Two thirds of the members
shall be independent directors.
32
All Committee members shall be financially literate, or shall become financially literate within a reasonable period of time after appointment to the
Committee. The Committee shall aspire to have at least one member who is an “audit committee financial expert” as such term is defined by the SEC.
The Chairman of the Committee shall be an independent director. No Director may serve as a member of the Committee if such Director serves on the
audit committees of more than two other public companies unless the Board determines that such simultaneous service would not impair such Director’s
ability to serve effectively on the Committee. The Board shall designate one member of the Committee as its Chairman. Directors will serve the Committee
at the pleasure of the Board and for such terms as the Board may determine. The Committee shall meet at least quarterly and otherwise as the members
of the Committee deem appropriate. Minutes shall be kept of each meeting of the Committee.
Meeting of Audit Committee

The audit committee shall meet at least thrice a year. One meeting shall be held before finalization of annual accounts and one every six months. The
quorum shall be either two members or one third of the members of the audit committee, whichever is higher and minimum of two independent directors.
Powers of Audit Committee

The audit committee shall have powers which should include the following:
• To investigate any activity within its terms of reference.
• To seek information from any employee.
• To obtain outside legal or other professional advice.
• To secure attendance of outsiders with relevant expertise, if it considers necessary.
33
Role of Audit Committee

The role of the audit committee shall include the following:
• Oversight of the company’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct,
sufficient and credible.
• Recommending the appointment and removal of external auditor, fixation of audit fee and also approval for payment for any other services.
• Reviewing with management the annual financial statements before submission to the board, focusing primarily on;
• Any changes in accounting policies and practices.
• Major accounting entries based on exercise of judgment by management.
• Qualifications in draft audit report.
• Significant adjustments arising out of audit.
• The going concern assumption.
• Compliance with accounting standards.
• Compliance with stock exchange and legal requirements concerning financial statements
• Any related party transactions
• Reviewing with the management, external and internal auditors, the adequacy of internal control systems.
• Reviewing the adequacy of internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading
the department, reporting structure coverage and frequency of internal audit.
• Discussion with internal auditors any significant findings and follow up there on.
34
Role of Audit Committee – Contd.

• Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of
internal control systems of a material nature and reporting the matter to the board.
• Discussion with external auditors before the audit commences about nature and scope of audit as well as post-audit discussion to ascertain any area of
concern.
• Reviewing the company’s financial and risk management policies.
• To look into the reasons for substantial defaults in the payment to the depositors, debenture holders, shareholders (in case of non-payment of declared
dividends) and creditors.
Review of Information by Audit Committee

The Audit Committee shall mandatorily review the following information:
• Financial statements and draft audit report, including quarterly / half-yearly financial information;
• Management discussion and analysis of financial condition and results of operations;
• Reports relating to compliance with laws and to risk management;
• Management letters / letters of internal control weaknesses issued by statutory / internal auditors; and
• Records of related party transactions
• The appointment, removal and terms of remuneration of the Chief internal auditor shall be subject to review by the Audit Committee
35
6. Appendix
Basel III Corporate Governance - https://www.bis.org/bcbs/publ/d328.pdf
36
Unit 3
Companies Act, 2013
Unit 3 – Companies Act, 2013
Table of contents
1 Introduction to Companies Act 2013 4
1.1 – Key Definitions and Concepts 5
1.2 – Purpose/Objectives of the Companies Act, 2013 11
1.3 – Definition of a Company 11
1.4 – Characteristics of a Company 12
1.5 – Types of a Company 13
1.6 – Forms of Business Organization 18
2 Corporate Governance and Companies Act 2013 21
2.1 – Independent Director Under the Companies Act, 2013 21
2.2 – Audit Committee 21
2.3 – Internal Audit 22
2.4 – Serious Fraud Investigation Offence (SFIO) 22
3 E-Governance under the Companies Act, 2013 22
3.1 – Maintenance, Security and Inspection of Books and Records in Electronic Form 22
2
Table of contents
3.2 – Service of Documents (Section – 20) 23
3.3 – Notice of Meetings 23
3.4 – Payment of Dividend 23
3.5 – Admissibility of Certain Documents as Evidence 24
3.6 – Voting Through Electronic Means (Electronic Voting System) 24
4 Companies (amendment) Act, 2015 25
5 Insider Trading 27
6 Whistle-Blower Policy 32
3
1. Introduction to Companies Act 2013

The companies act of 1956 needed a substantial revamp for quite some time now, to make it more contemporary and relevant to corporates, regulators and
other stakeholders in India. While several unsuccessful attempts have been made in the past to revise the existing 1956 Act, there have been quite a few
changes in the administrative portion of the 1956 Act. The most recent attempt to revise the 1956 Act was the Companies Bill, 2009 which was introduced
in the Lok Sabha, one of the two houses of Parliament of India, on 3rd August 2009.
The Companies Bill, 2009, was referred to the Parliamentary Standing Committee on Finance, which submitted its report on 31st August 2010 and was
withdrawn after the introduction of the Companies Bill, 2011. The Companies Bill, 2011 was also considered by the Parliamentary Standing Committee on
Finance which submitted its report on 26th June 2012. Subsequently, the Bill was considered and approved by the Lok Sabha on 18th December 2012 as
the Companies Bill, 2012 (the Bill).
The Bill was then considered and approved by the Rajya Sabha too on 8th August, 2013. It received the President’s assent on 29th August, 2013 and has
now become the Companies Act, 2013.
The changes in the 2013 Act have far-reaching implications that are set to significantly change the manner in which corporates operate in India.
Learning Objectives
• Explain the key essentials of the Companies Act 2013
• Illustrate the need for governance with respect to the Companies Act 2013
• Explain Insider Trading and Whistle blowing policy
4
1.1 Key Definitions and Concepts

The 2013 Act has introduced several new concepts and has also tried to streamline many of the requirements by introducing new definitions. This unit
covers some of these new concepts and definitions in brief.
Companies
1. One-person company: The 2013 Act introduces a new type of entity to the existing list i.e. apart from forming a public or private limited company, the
2013 Act enables the formation of a new entity a ‘one-person company’ (OPC). An OPC means a company with only one person as its member
[section 3(1) of 2013 Act].
2. Private company: The 2013 Act introduces a change in the definition for a private company, inter-alia, the new requirement increases the limit of the
number of members from 50 to 200. [section 2(68) of 2013 Act].
3. Small company: A small company has been defined as a company, other than a public company:
i. Paid-up share capital of which does not exceed 50 lakh INR or such higher amount as may be prescribed which shall not be more than five
crore INR
ii. Turnover of which as per its last profit-and-loss account does not exceed two crore INR or such higher amount as may be prescribed which
shall not be more than 20 crore INR:
As set out in the 2013 Act, this section will not be applicable to the following:
• A holding company or a subsidiary company
• A company registered under section 8
• A company or body corporate governed by any special Act [section 2(85) of 2013 Act]
5
4. Dormant company: The 2013 Act states that a company can be classified as dormant when it is formed and registered under this 2013 Act for a
future project or to hold an asset or intellectual property and has no significant accounting transaction. Such a company or an inactive one may apply
to the ROC in such manner as may be prescribed for obtaining the status of a dormant company. [Section 455 of 2013 Act]
Role and Responsibilities

1. Officer: The definition of officer has been extended to include promoters and key managerial personnel [section 2(59) of 2013 Act].
2. Key managerial personnel: The term ‘key managerial personnel’ has been defined in the 2013 Act and has been used in several sections, thus
expanding the scope of persons covered by such sections [section 2(51) of 2013 Act].
3. Promoter: The term ‘promoter’ has been defined in the following ways:
• A person who has been named as such in a prospectus or is identified by the company in the annual return referred to in Section 92 of 2013 Act
that deals with annual return; or
• who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
• in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act.
The provision to this section states that sub-section (c) would not apply to a person who is acting merely in a professional capacity. [section 2(69) of
2013 Act]
4. Independent Director: The term’ Independent Director’ has now been defined in the 2013 Act, along with several new requirements relating to their
appointment, role and responsibilities. Further some of these requirements are not in line with the corresponding requirements under the equity listing
agreement [section 2(47), 149(5) of 2013 Act].
6
Investments
Subsidiary: The definition of subsidiary as included in the 2013 Act states that certain class or classes of holding company (as may be prescribed) shall
not have layers of subsidiaries beyond such numbers as may be prescribed. With such a restrictive section, it appears that a holding company will no
longer be able to hold subsidiaries beyond a specified number [section 2(87) of 2013 Act]
Financial Statements
1. Financial year: It has been defined as the period ending on the 31st day of March every year, and where it has been incorporated on or after the 1st
day of January of a , the period ending on the 31st day of March of the following year, in respect whereof financial statement of the company or body
corporate is made up. [section 2(41) of 2013 Act]. While there are certain exceptions included, this section mandates a uniform accounting year for all
companies and may create significant implementation issues.
2. Consolidated financial statements: The 2013 Act now mandates consolidated financial statements (CFS) for any company having a subsidiary or an
associate or a joint venture, to prepare and present consolidated financial statements in addition to standalone financial statements.
3. Conflicting definitions: There are several definitions in the 2013 Act divergent from those used in the notified accounting standards, such as a joint
venture or an associate, etc., which may lead to hardships in compliance.
Audit and Auditors

1. Mandatory auditor rotation and joint auditors: The 2013 Act now mandates the rotation of auditors after the specified time period. The 2013 Act
also includes an enabling provision for joint audits.
2. Non-audit services: The 2013 Act now states that any services to be rendered by the auditor should be approved by the board of directors or the
audit committee. Additionally, the auditor is also restricted from providing certain specific services.
7
3. Auditing standards: The Standards on Auditing have been accorded legal sanctity in the 2013 Act and would be subject to notification by the NFRA.
Auditors are now mandatorily bound by the 2013 Act to ensure compliance with Standards on Auditing.
4. Cognizance to Indian Accounting Standards (Ind AS): The 2013 Act, in several sections, has given cognizance to the Indian Accounting Standards,
which are standards converged with International Financial Reporting Standards, in view of their becoming applicable in future. For example, the
definition of a financial statement includes a ‘statement of changes in equity’ which would be required under Ind AS. [Section 2(40) of 2013 Act]
5. Secretarial audit for bigger companies: In respect of listed companies and other class of companies as may be prescribed, the 2013 Act provides
for a mandatory requirement to have secretarial audit. The draft rules make it applicable to every public company with paid-up share capital > Rs. 100
crores*. As specified in the 2013 Act, such companies would be required to annex a secretarial audit report given by a Company Secretary in practice
with its Board’s report. [Section 204 of 2013 Act]
6. Secretarial Standards: The 2013 Act requires every company to observe secretarial standards specified by the Institute of Company Secretaries of
India with respect to general and board meetings [Section 118 (10) of 2013 Act], which were hitherto not given cognizance under the 1956 Act.
7. Internal Audit: The importance of internal audit has been well acknowledged in Companies (Auditor Report) Order, 2003 (the ‘Order’), pursuant to
which auditor of a company is required to comment on the fact that the internal audit system of the company is commensurate with the nature and size
of the company’s operations. However, the Order did not mandate that an internal audit should be conducted by the internal auditor of the company.
The Order acknowledged that an internal audit can be conducted by an individual who is not in appointment by the company. The 2013 Act now moves
a step forward and mandates the appointment of an internal auditor who shall either be a chartered accountant or a cost accountant, or such other
professional as may be decided by the Board to conduct internal audit of the functions and activities of the company. The class or classes of
companies which shall be required to mandatorily appoint an internal auditor as per the draft rules are as follows:
• Every listed company
• Every public company having paid-up share capital of more than 10 crore INR
8
• Every other public company which has any outstanding loans or borrowings from banks or public financial institutions more than 25 crore INR or
which has accepted deposits of more than 25 crore INR at any point of time during the last financial year.
8. Audit of items of cost: The central government may, by order, in respect of such class of companies engaged in the production of such goods or
providing such services as may be prescribed, direct that particulars relating to the utilization of material or labor or to other items of cost as may be
prescribed shall also be included in the books of account kept by that class of companies. By virtue of this section of the 2013 Act, the cost audit would
be mandated for certain companies. [section 148 of 2013 Act]. It is pertinent to note that similar requirements have recently been notified by the central
government.
Regulators
1. National Company Law Tribunal (Tribunal or NCLT): In accordance with the Supreme Court’s (SC) judgement, on 11 May 2010, on the composition
and constitution of the Tribunal, modifications relating to qualification and experience, etc. of the members of the Tribunal has been made. Appeals
from the Tribunal shall lie with the NCLT. Chapter XXVII of the 2013 Act consisting of section 407 to 434 deals with NCLT and appellate Tribunal.
2. National Financial Reporting Authority (NFRA): The 2013 Act requires the constitution of NFRA, which has been bestowed with significant powers
not only in issuing the authoritative pronouncements, but also in regulating the audit profession.
3. Serious Fraud Investigation Office (SFIO): The 2013 Act has bestowed legal status to SFIO.
Mergers and Acquisitions

The 2013 Act has streamlined as well as introduced concepts such as reverse mergers (merger of foreign companies with Indian companies) and squeeze-
out provisions, which are significant.
The 2013 Act has also introduced the requirement for valuations in several cases, including mergers and acquisitions, by registered valuers.
9
Corporate Social Responsibility

The 2013 Act makes an effort to introduce the culture of corporate social responsibility (CSR) in Indian corporates by requiring companies to formulate a
corporate social responsibility policy and at least incur a given minimum expenditure on social activities.
Class Action Suits

The 2013 Act introduces a new concept of class action suits which can be initiated by shareholders against the company and auditors.
Prohibition of Association or Partnership of Persons exceeding certain number

The 2013 Act puts a restriction on the number of partners that can be admitted to a partnership at 100. To be specific, the 2013 Act states that no
association or partnership consisting of more than the given number of persons as may be prescribed shall be formed for the purpose of carrying on any
business that has for its object the acquisition of gain by the association or partnership or by the individual members thereof, unless it is registered as a
company under this 1956 Act or is formed under any other law for the time being in force:
As an exception, the aforesaid restriction would not apply to the following:
• A Hindu undivided family carrying on any business
• An association or partnership, if it is formed by professionals who are governed by special acts like the Chartered Accountants Act, etc.[section 464 of
2013 Act]
Power to Remove Difficulties

The Central government will have the power to exempt of modify provisions of the 2013 Act for a class or classes of companies in public interest. Relevant
notification shall be required to be laid in draft form in Parliament for a period of 30 days. The 2013 Act further states no such order shall be made after the
expiry of a period of five years from the date of commencement of section 1 of the 2013 Act [Section 470 of 2013 Act].
10
1.2 Purpose/Objectives of the Companies Act 2013

Following are the objectives of the Companies Act 2013:
• To develop the economy by encouraging entrepreneurship
• Creating flexibility and simplicity in the formation and maintenance of companies.

• To encourage transparency and high standards of corporate governance.
• To recognize new concepts and procedures to facilitate ease of doing business while protecting interests of all the stakeholders
• To enforce strict action against fraud

• To set up institutional structure in the form of various authorities, bodies and panels.
• To cater to the need for more effective and time bound approvals and compliance requirements
1.3 Definition of a Company

• As per the Indian Companies Act a company is “one formed or registered under the Indian Companies Act 2013 or an existing company”. An existing
company is a company formed or registered under any of the previous company laws. The distinctive characteristics of a company are not revealed by
this definition.
• According to Marshall, “A company is a person artificial, invisible, intangible and existing only in the contemplation of law. It possesses only those
properties which the character of its creator confers upon it either expressly or as incidental to its very existence”.
11
• Lord Justice Lindlay gives us alternative comprehensive and clear definition of a company, “A company means an association of many persons who
contribute money or money’s worth to a common stock and employs it in some trade or business, and who share the profit and loss (as the case may
be) arising there from. The common stock contributed is denoted in money as the capital of the company. The persons who contribute it, or to whom it
belongs are members. The proportion of capital to which each member is entitled is his share. Shares are always transferrable although the right to
transfer them is often more or less restricted.”
From the definitions as discussed above, we can conclude that a company is a registered institution - an artificial legal person, which has an
independent legal entity with a continuous succession, a common seal for its signatures, a mutual capital containing transferrable shares and carrying
limited liability.
1.4 Characteristics of a Company

1. Artificial Legal Person – A company is an artificial person and will be treated as a legal person just like a natural person and possess all the rights
and duties of a natural person. However a company does not have any physical attributes of a natural person and is intangible. It only exists in the
eyes of the law.
2. Separate Legal Entity – A company can sue and be sued, it has the right to own and transfer the title to property as it is a legal person in the eyes of
the law.
3. Limited Liability – A Company which is limited by shares, has liability up to the unpaid amount on shares held by its members.
4. Perpetual Succession – The life of a company does not depend upon the death, insolvency, or retirement of any or all the shareholders. There a
company is an immortal entity.
5. Separate property – No member of the company can claim himself to be the owner of the company’s properties either during its existence or during
its winding up.
12
6. Transferability of shares – The shares are said to be a movable property and transferability of shares are subjected to certain conditions provided by
the act.
7. Common Seal – A company has no physical existence; it must act through its agents. The common seal of the company acts as the official signature
of the company which can be used by the agents of the company to authorize official documents.
8. Capacity to sue and be sued – A company, being a body corporate, can sue and be sued in its own name.
9. Contractual Rights – A company being a legal entity different from its members can enter into contracts with third parties for conducting business in
its own name.
10. Limitation of Actions – A Company registered under the companies act cannot go beyond the powers of its charter i.e. the Memorandum of
Association. The actions and objects of the company are limited by its memorandum and articles.
11. Separate management – The members of the company can derive profits out of the company without being burdened with the management of the
company.
12. Voluntary Association for profit – The Company which is incorporated under the companies Act 2013 is formed for the accomplishment of some
public goals and whatsoever profit is gained is being divided between the shareholders.
13. Termination of existence – It has the existence only in contemplation of law. It is created by law, carries on its affairs according to law.
1.5 Types of Company

According to Haney, “A Joint Stock Company is a voluntary association of individuals for profit, having a capital divided into transferable shares. The
ownership of which is the condition of membership”.
13
Types of Company
Joint Stock Company can be of different types. The following are the important types:
On the Basis of Mode of Incorporation

Basis on the mode of incorporation, there are 3 classes of joint stock companies:
1. Chartered Companies: Under a special charter of the Kind or Queen, these companies are incorporated. Examples of charted companies
incorporated in England are The East India Company, The Bank of England, etc., The charter which incorporates the company, defined its powers and
nature of business. A chartered company has extensive powers. Like any ordinary person, it can deal with its property and bind itself to any. In case
the firm diverges from its business as prescribed by the charter, the Sovereign can annual the latter and close the company. Such companies do not
exist in India.
2. Statutory Companies: The companies which are incorporated by a Special Act of Parliament or State Legislature are called statutory company. State
bank of India, RBI, Industrial Finance Corporation, State Trading Corporation, Unit Trust of India, and LIC are some of the examples of statutory
companies. Such corporations do not have any memorandum or articles of association. Their powers stem from the acts constituting them and the
businesses enjoy certain authority that companies incorporated under the Companies Act do. Legislative amendments can bring about the alteration in
the powers of such companies.
3. Registered Companies: These are formed under the Companies Act, 2013 or under the Companies Act passed prior to this. Such companies come
in to existence only when the Registrar of Companies issues a certificate of incorporation after they are registered under the Act. This is the most
common mode of incorporating a company. They can further be classified in to three categories namely:
a) Company limited by shares: These types of companies have a share capital and the liability of each member of the corporation is limited by
the Memorandum to the degree of face value of share subscribed by him. As in, while the company exists, or in the event of winding up, an
14
associate can be called upon to pay the amount remaining unpaid on the shares subscribed by him. Such a company is called company limited by
shares. A company limited by shares can be public or private. These are the most prevalent type of corporations.
b) Companies Limited by Guarantee: Capital may or may not be shared by this type of companies. In the event of liquidation, each member promises
to pay a fixed sum of money specified in the memorandum for payment of the debts and liabilities of the firm. This amount promised by him is called
“Guarantee”. The articles of association of the company state the number of members with which the company is to be registered. The amount of
guarantee of each member is in the nature of reserve capital. This amount can only be called upon in the event of winding up of the business. Such a
company is called a company limited by guarantee.
c) Unlimited Companies: When a company does not have any limit on the liability of its members, it is called an “Unlimited Company”. The whole
amount of the company’s debt and liabilities is the extent to which each member is liable for. It is more or less similar to a partnership form of entity
except the fact that third party cannot sue the members of the company directly as in the case of partnership because of the separate legal entity
status. Thus, the creditors shall have to institute the proceedings for winding up of the company for their claims. The official liquidator may be called up
on the members to discharge the debts and liabilities without limit. An unlimited company can either have or not have share capital. If it does have a
share capital it can either be public or private company. If the company has a share capital, the article shall state the amount of share capital with
which the company is to be registered.
On the Basis of Number of Members

On the basis of number of members, a company may be:
1. Private Company: The term “Private Company” has been defined under section 2(68) of the Indian Companies Act 2013. According to it a private
company means a company, which has a minimum paid up share capital of Rs.1,00,000 and which provides the following restrictions through its
Articles of Association and Memorandum:
• Restricts the transfer of shares by its members.
15
• Limits the maximum number of members to 50.

• Prohibits any invitation to public for debentures of the company. It also enjoys special privileges such as:
o It can be started with only two members,
o Issuing of prospectus is not required and
o After receiving the Certificate of Incorporation, it can immediately start its operations.
2. Public Company: According to Indian Companies Act 2013, “A Public Company is not a Private Company”. If we explain the definition of Indian
Companies Act in regard to the public company, we note the following:
• The transfer of shares of the company is not restricted by the articles
• No restriction on the maximum number of members on the company is imposed.
• General public is invited to purchase the shares and debentures of the companies
a) Minimum Number – The minimum number of persons required to form a public company is seven.
b) Maximum Number – For a public company, there is no restriction in the maximum number of persons, whereas for private company, the
maximum number cannot exceed 50.
c) Public Subscription - A public company can invite the public to purchase its shares and debentures.
d) Issue of Prospectus – a private company, unlike a public one is not expected to issue a prospectus or file a statement in lieu of prospectus with
the Registrar before allotting the shares.
e) Transferability of Shares – In a public company, the shares are freely transferable.
16
On the Basis of Control

On the basis of control, a company may be classified in to:
1. Holding Company: If a company has control over the other company, it is known as the holding company of another company. A company is deemed
to be the holding company of another if, the other is its subsidiary. A company can become a holding company of another company in any of the
following three ways:
• By holding more than 50% of the normal value of issued equity capital of the company, or
• By holding more than 50% of its voting rights; or

• By securing to itself the power to hire directly or indirectly, the majority of the directors of the other company.
The other company in that case is known as “subsidiary company”. The affairs of both the companies are controlled and managed by the holding company,
even though the two companies remain separate legal entities. A holding company may have unlimited number of subsidiaries. It is required from the
annual accounts of the holding company to disclose full information about the subsidiaries.
Subsidiary Company: A company is known as subsidiary of another company when its control is exercised by the latter (called holding company) over the
former called a subsidiary company. Where a firm (Company A) is subsidiary of another corporation (say Company C), the former (Company A) becomes
the subsidiary of the controlling corporation (Company C).
On the Basis of Ownership

On the basis of ownership, a company may be:
1. Government Company: A company in which not less than 51% of the paid-up capital is held by the Central Government or by the State Government
itself or jointly is known as Government Company. It includes a company subsidiary to a Government Company.
17
The share capital of a Government Company may be wholly or partly owned by the Government.
2. Non-Government Companies – Any company, which is not a government company can be called non-government company. The characteristics of a
Government company as mentioned above, are not satisfied by them.
On the Basis of Nationality

On the basis of nationality, a company may be:
1. Indian Companies: The firms that are registered in India under the Companies Act, 1956 and have their registered office in India. Nationality of the
members in there is immaterial.
2. Foreign Companies: It means any corporation incorporated outside of India which has an established place of business in India. A company has an
established place of business in India if it has a specified place at which it carries on business such as an office, store house or other premises with
some visible indicate of premises.
1.6 Forms of Business Organizations

Right from the beginning of economic history of mankind to date, the business is carried out in four different forms namely:
1. Sole Proprietorship Form
2. Partnership Form
3. Corporate Form
4. Co-operative Form
18
Proprietary Form of Business

The earliest and most widely used model of business all over the world is the sole proprietorship or proprietary business. As the name indicates it is one-
man business. The proprietor or sole trader generates business idea, contributes capital and takes complete risk of running the business. He also takes the
whole profit. He is personally liable for the whole obligations of the business. Not only are his business properties liable for the obligation of the business
but also his private properties.
The ownership and control also rest with the same individual. There is no differentiation of ownership and management. There is no distinction between the
business and business man. Hence the business ceases to exist at the death of the proprietor. This mode of business is used when the amount of capital
required is less, business risk is low, and scale of operation is not large.
Partnership Form of Business

When the scale of operation is increased, more capital is required and risk level increases, the business assumed partnership form with two or more
business men joining together and conduct the business. According to section 4 of the Indian Partnership Act, a partnership is a relationship between two
or more individuals who have settled to share the profits of a business carried out by all or any one acting for all. The people who have entered into a
partnership with one another are called individually as partner and collectively as firm.
This form of business is able to generate more capital and reduce individual risk. Profit and loss are shared by the partners. Partners are jointly and
severally liable for the whole obligations of the firm as in the case of sole tradership. There is no independent existence of the firm. It ceases to exist with
the retirement or death of one or more partners. The firm cannot sue its own or be sued upon it.
Joint Stock Company Form

During the last two centuries all over the world we have witnessed significant changes such as advent of industrial revolution, trend of colonization,
identification of huge unexploited natural wealth, emergence of US as a super power, increased economic integration between nations, convergence of
19
and wants, advent of modern technology in manufacturing and service sectors, increased trade cooperation between nations, eliminations of barriers of
trade within and between nations, free movement of technology and capital across nations, etc., All these have contributed to the development of new
thinking about large types of business forms with huge capital, reduced risk, limited liability, separation of ownership and control, transferability of rights,
liquidity, etc.,
The development of company form of business format is the result of this thinking. Today, all over the world a large part of business in terms of volume and
value assumed joint stock company format or business with characteristics like sperate entity, separation of ownership and control, transferability of right,
risk diversification etc.,
Co-operative Form of Business

Another form of business organization though not very popular but powerful in certain sectors in commercial lines is the co-operative society. But it
eliminates most of the negative aspects of joint stock form of business. A co-operative society is an enterprise formed and directed by an association of
users, applying within directly meant to serve both its own members and the society as a whole. To put it in other words, a co-operative organization is an
association of persons who come together voluntarily to achieve some common purpose, through an economic enterprise, working at their own risk and
with resources which all members contribute.
The basic principles upon which a cooperation form of enterprise is built are:
• Universality of membership
• Democratic control
• Political and religious neutrality
• Self-help and mutual help
• Principle of limited liability and
• Limited interest on capital
20
2. Corporate Governance and Companies Act 2013

There has been a sea change in Companies Act, 2013 by bringing about the principle of corporate governance practices as the new key change in the act.
The Companies Act, 2013 has taken a foot forward from SEBI’s Clause 49 of listing agreement by introducing provision in the Companies Act, 2013 which
promotes corporate governorship code in such a manner that it will no longer be restricted to only listed public companies but also unlisted public
companies.
The new Companies Act, 2013 has introduced various key provisions which have changed the corporate regime in such a way to run the corporate
machinery in alignment with the globalized corporate world by mandatory disclosure requirements.
2.1 Independent Director Under the Companies Act, 2013
The strength of number of Independent Directors for the prescribed companies under Section 149(4) read with Rule 4 of Companies (appointment and
qualifications of directors) rules, 2014 for listed public company is at least one third of total number of directors and public companies having turnover of
100 crores rupees or more at least 2 directors and public companies having paid up capital of 10 crores rupees or more at least 2 directors.
2.2 Audit Committee
The Audit Committees of the Companies Act,2013 has undertaken both private and public companies within its ambit to constitute audit committees. The
constitution of audit committee has also seen change as compared to clause 49 with minimum with three independent directors on the board along with the
chairperson who should be able to read and understand the financial statement.
Section 177 of the Companies Act,2013 and Rule 6 and 7 of Companies (Meetings of Board and its Powers) Rules,2014 deals with the Audit Committee.
The Board of directors of every listed company and the following classes of companies, as prescribed under Rule 6 of Companies (Meetings of Board and
its powers) Rules,2014 shall constitute an Audit Committee.
• All public companies with a paid-up capital of Rs.10 crores or more;
• All public companies having turnover of Rs.100 crores or more;
21
2.3 Internal Audit

Companies Act, 2013 has mandated the internal audit for certain classes of companies as specified under Section 138 of the Companies Act, 2013.
2.4 Serious Fraud Investigation Offence (SFIO)

Section 211 (1) of the Companies Act, 2013 shall establish an office called the Serious Fraud Investigation office to investigate fraud relating to Company.
The powers are given to SFIO under the act as mentioned that he can investigate into the affairs of the company or on receipt of report of Registrar or
inspector or in the public interest or request from any Department of Central Government or State Government.
3. E-Governance under the Companies Act, 2013

In this age of well-developed information technology and telecommunications, the Electronic Governance of all business-related activities, administrative
activities, and managerial functions of the corporate world, can certainly be very convenient, efficient, transparent, and fully accountable and responsible.
Therefore, undoubtedly, e-governance in the corporate sector is an imperative and highly prudent requirement in every country of the world, inevitably
including India.
As India is one of the major, fast-progressing, and highly influential economies of the world, this e-governance is absolutely essential and beneficial to
Indian corporate world, especially in present-day world of cutthroat corporate competition, and ever-increasing need for greater transparency and
accountability in the corporate sector. Considering these highly significant facts and business scenarios, the Government of India has rightly promulgated
the provisions for e-governance in the corporate sector of the country, in its latest Companies Act of 2013.
3.1 Maintenance, Security, and Inspection of Books and Record in Electronic Form
Regarding the account keeping and maintenance of records and books related with the business activities of a company, and the well-rounded security and
efficient and transparent inspection of these documents, the new Companies Act of India has proper provisions, suggestions and recommendations.
22
These prudent provisions and recommendations are provided in the Section 120 of the Indian Companies Act of 2013, and the Companies (Management
and Administration) Rules of 2014.
The Section 120 facilitates that a company must keep a safe account of all business and management related documents, records, registers, minutes, etc.,
preferably in the electronic forms, in such a manner that these could easily be inspected or reproduced whenever necessary.
3.2 Service of Documents (Section-20)

This advocates that every presentation, submission, or dispatch of company related documents should preferably be made through electronic means, to
the concerned officials, shareholders, or the registrar.
3.3 Notice of Meetings

The notices of the Board Meetings and the General Meetings, are also to be sent by electronic means and in the prescribed manner, as are described in
the Section 173(3), and Section 101, respectively. Also, the Rule 18 of the Indian Companies Rules of 2014 recommends that a record of any failed
transmissions of such notices and subsequent re-sending of these, must be retained by the company as "Proof of Sending".
Notices to shareholders, directors, or auditors regarding electronic voting on a resolution and participation in a general meeting, may also be published on
the website of the company. In addition to presenting all details about the concerned meeting, the company has also to clearly mention that the facility of
voting through electronic means is available.
3.4 Payment of Dividend

As per Section 123, any dividend payable in cash, can also be remitted in any electronic mode to the entitled shareholders, besides being paid by Cheques
or Warrant.
23
3.5 Admissibility of Certain Documents as Evidence

Any document reproduced from returns, or any document related with the administration, management, or business activities of a company formally filed
with the Registrar on paper of in electronic form and duly authenticated by the Registrar, shall be admissible to any proceedings of the company, without
any further proof or production of the original documents as evidence.
3.6 Voting through Electronic Means (Electronic Voting System)

Voting through electronic means at the general meetings of a company, is one of the highly significant provisions introduced by the new Indian Companies
Act of 2013, to support e-management and governance. Section 108, New Revised Clause 35B of the Listing Agreement of SEBI, and the Rule 20 of the
Companies (Management and Administration) Rules of 2014, all emphasize that every listed company or a moderately big company with at least 1000
shareholders, should utilize preferably the facility of voting electronically by the shareholders and members at the general meetings of the company, for
passing any resolution (Ordinary/Special).
Swift Electronic Voting offers certain exclusive advantages to both the company [and its share transfer agents] and the shareholders, provided it is fully
secured and unbiased. Some of the most significant and outstanding advantages of electronic voting [e-voting] are the following: ---
• It is Fast and Cost-Effective
• Full Authenticity
• Reduces Paperwork and Eliminates the Need of Storing the Physical Ballot Papers
• Quick and Accurate Counting of Votes
• Votes are not Delayed or Lost in Transit
• Voting from Everywhere in any time
• Increased Efficiency and Transparency
24
4. Companies (Amendment) Act, 2015

In the wake of constantly changing business atmosphere and scenarios in India and countries worldwide, to make businesses in India easier, fully
convenient, and safely transparent, the Indian Government opted for making certain changes in the provisions of the newly promulgated Companies Act of
2013. These changes have been brought about through the Companies (Amendment) Act of 2015.
The changes introduced by this Companies Amendment Act of 2015, are related with many aspects of corporate establishment and corporate governance,
including the minimum amount of paid-up share capital required; common seal of the company; requirement of obtaining the certificate of commencement
of business; public inspection of Board Resolutions; related party transactions; responsibilities of the Audit Committee; fraud reporting by auditors;
provisions of special courts for hearing the winding up cases and offences; etc.
Highlights of Companies Amendment Act, 2015

Some of the major and most significant changes made under the Companies (Amendment) Act of 2015, are the following:
• No Minimum Paid-Up Share Capital: After this Indian Companies (Amendment) Act of 2015, a private limited company and a public limited company
can be registered without the minimum paid-up share capital requirement of Rupees One Lac and Rupees Five Lacs, respectively. Consequently, the
definitions of these types of companies given in the Sections 2(68) and 2(71) of the Indian Companies Act of 2013 now stand amended.
• No Requirement for getting the Commencement of Business Certificate: Now, there is no mandatory requirement for obtaining the Certificate for
Commencement of Business (prescribed in the Section 11 of the CA-2013), after incorporation of a company (private or public limited), through filing e-
form INC-21 with the concerned RoC.
• Common Seal Made Optional: In the CA-2013, for providing various authorizations, attestations, and affixations on certain documents (such as bills of
exchange, share certificates, etc.) on behalf of the company, a common seal was made mandatory. But now, use of this common seal has been made
optional, and such documents may now instead be signed by the two directors or one director and a company secretary of the company. Consequently,
several Sections of the CA-2013 dealing with this common seal, such as Sections 9, 12, 223, etc., have been amended.
25
Highlights of Companies Amendment Act, 2015 – Contd.

• Rigorous Penalty for Company Inviting or Accepting Deposit: Though the CA-2013 had introduced provisions in the Section 73 and Section 76 in
connection with acceptance/renewal/repayment of deposits from public, it (CA-2013) was curtly silent with respect to the specific penalties for those
companies which invited/accepted/renewed/repaid deposits from public, without getting proper approval from the concerned regulatory authorities.
Hence, this Companies (Amendment) Act of 2015 prescribed certain strict penalties and fines against non-compliance with the provisions given in CA-
2013. Consequently, a new Section 76A has been inserted in the CA-2013.
• Board Resolutions are made Confidential: So far, Board Resolutions of a company filed with the Ministry of Corporate Affairs (MCA) through form
MGT-14 for the purposes given in the Section 179(3), were open for public inspection (entitled under Section 399) paying the prescribed fee. But now,
this Amendment Act of 2015 has prohibited people from inspecting or obtaining copies of such resolutions, through making amendments in the Section
117(3) of the CA-2013, for the main objective of protecting confidentiality. Hence now, board resolutions of companies will not be accessible on MCA
portal.
• Dividends Not to be Declared by Companies Having Losses: Regarding distribution of dividends, the following provisions has been inserted in the
Section 123 of the CA-2013 --- "Provided also that no company shall declare dividend unless carried over previous losses and depreciation not
provided in previous year or years are set off against profit of the company for the current year." Hence, companies undergoing losses or having
negative reserves, now cannot declare dividends.
• Clarifications on Loans from the Holding Company to Subsidiary Company: Amendments made through adding clauses (c) and (d) in the Section
185 of the CA-2013, clarify that a holding company can provide loans/guarantees to its wholly-owned subsidiary, "Provided that the loans made under
clauses (c) and (d) are utilized by the subsidiary company for its principal business activities".
26
5. Insider Trading
Insider trading is the buying or selling of a security by someone who has access to material non-public information about the security. Insider trading can be
illegal or legal depending on when the insider makes the trade. It is illegal when the material information is still non-public.
The 2013 Act for the first time defines ‘insider trading and price-sensitive information and prohibits any person including the director or key managerial
person from entering into insider trading [section 195 of 2013 Act]. Further, the Act also prohibits directors and key managerial personnel from forward
dealings in the company or its holding, subsidiary or associate company [section 194 of 2013 Act].
Meaning of the term “Insider”

The term ‘insider’ has been defined under Regulation 2(e) of SEBI (Prohibition of Insider Trading) Regulations, 1992. Basically, the term ‘insider’ can be
classified into three broad categories, which are:
• Persons who are connected to the company,
• Persons who were connected with the company,
• Persons who are deemed to be connected to the company.
In order to become an insider a person has to fulfil three elements, viz;
• The person should be a natural person or legal entity;
• The person should be connected person or deemed to be connected;
• Acquisition of the unpublished price sensitive information by virtue of such connection.
Unpublished Price Sensitive Information

Unpublished price sensitive information means any information which refers to the internal matters of the company and ordinarily not disclosed by the
company in the regular course of the business.
27
Insider Trading and the Securities and Exchange Board of India

Insider trading in India is basically determined by SEBI laws which govern the whole trading in national stock exchange or Bombay stock exchange. The
main aim of this law is that to ensure traders that no one is gained by trading on ‘insider’ or ‘unpublished’ information- information that is not made public.
Another aim of this law is to make the information available to all the participants. The enforcement of insider trading laws increases the market liquidity and
decreases the cost of equity. Insider trading laws are found in developed countries where strong trading regulations are adopted. The main aim of
government in the enactment of insider trading laws is that all the participants in the market have the same information. When the Indian economy was
liberalized and security market was open to foreign institutional investors, common investors aim to get quick returns in short period of time.
In India, SEBI (Insider Trading) Regulation, 1992 framed under the Section 11 of the SEBI Act, 1992 intends to curb and prevent the menace of insider
trading in securities. An insider is a person who is an accepted member of a group or organization who has special knowledge regarding his firm.
Evolution
Bombay stock exchange was established in 1875 and since then Indian securities markets started functioning. Before the enactment of SEBI Act 1992,
there were two acts namely Capital Issues Control Act,1947 and Securities Contract Regulation Act,1956.
After independence, there was no such as act which governed the insider trading practices in India.
Penalties for Committing Insider Trading
The penalties and punishments for committing insider trading have been defined under Chapter IV-A of the SEBI Act. The penalties have been discussed
below according to the SEBI (Amendment) Act, 2002.
• Section 15(G)(i) – if an insider either on its own or on behalf of any person has dealt on behalf of his company any unpublished information then he
may be fined with RS. 25 crores or 3 times the profit made, whichever is higher.
• Section 15G(ii) – if an insider has given any price sensitive information then he may be fined up to Rs.25 crores or 3 times the profit made.
28
• Section 15G(iii) – if an insider has procured any other person to deal in securities of anybody corporate on basis of published information then he may
be fined up to RS. 25 crores or 3 times the profit made which is higher.
Role and Power of SEBI in Curbing Insider Trading
SEBI is established as a statutory body which works under the framework of Securities and Exchange Board of India, 1992. The various roles and power of
SEBI have been discussed under Section 11 of the SEBI Act,1992.
• The main duty of SEBI is to protect the safeguard of investors and ensure proper trading.
• The main power of SEBI is that if any person has violated the provisions of this Act then SEBI set up an enquiry committee.
• In order to investigate SEBI may appoint officers who look after the books and records of insider and other connected persons.
• It is the duty of SEBI to give a reasonable notice to the insider before starting the investigation.
• The board can also appoint an auditor who may inspect the books of accounts and affairs of an insider.
• It is the duty of insider to provide necessary documents to the investigating authority. However, it has neither any power to examine on oath, nor does it
have the same power as are vested in a civil court under the Code of Civil Procedure,1908 while trying a suit.
• After all the investigations, the officer has to submit the report within 1 month as per SEBI 1992 regulations. It also depends on the investigating officer
to take longer time if he funds that the work could not be completed within the stipulated time.
• After the final report submission, SEBI has to communicate the findings to the insider and issue a show cause to the insider or other person within 21
days of the receipt of the communication.
• The person to whom the finding has been communicated has to give the reply to the notice within 21 days of receiving the notice. The Expert Group
(headed by Justice M.H. Kania) constituted by the SEBI in August, 2004, recommended in its Report that, Section ll(2)(i) of SEBI Act be amended to
empower SEBI to call for information from professionals, subject to the professional’s rights (for not parting with the privileged information in their
possession).
29
• Any person who feels aggrieved by the directions of the SEBI can appeal to the Securities Appellate Tribunal (Regulation 15).
• An appeal can be filed within 45 days of the receipt of the copy of the order from the date on which appeal had been filed. SEBI (insider trading)
regulations, 1992 consists of three chapters and twelve regulations.
An insider is a connected person who is connected to the company directly or indirectly with the company. The term ‘connected person’ is an important
concept for defining the charge of insider trading. It represents a person who is a director of a listed company or is an officer or an employee of a listed
company. Connected persons have access to the unpublished price sensitive information of the company. It also includes a person who has been
connected to the company prior to 6 months to the implementation of insider trading regulations.
There are various regulations under SEBI Regulations, 1992 that defines the term ‘connected persons’. They are as follows:
• Regulation 2(h)(i)- an officer or employee of the same company under subsection(1b) of Section 370(1b) or subsection (11) of Section 372 of the
Companies Act, 1956 or subsection (g) of Section 2 of the MRTP Act,1969.
• Regulation 2(h)(ii)
• Regulation 2(h)(iii)
• Regulation 2(h)(iv)- a member of the board of directors
• Regulation 2(h)(v)- an official or an employee of a self-regulatory organization
• Regulation 2(h)(vi)- any relative of any of the aforementioned persons
• Regulation 2(h)(viii)- a relative of the connected person
• Regulation 2(h)(ix)- a concern, firm, trust, Hindu undivided family
30
Insider Trading and Companies Act 2013 (Section 195)

Prohibition on insider trading of securities:
1. No person including any director or key managerial personnel of a company shall enter in to insider trading:
Provided that nothing contained in this sub-section shall apply to any communication required in the ordinary course of business or profession or
employment or under any law.
Explanation – for the purposes of this section:
a. Insider trading means:

• An act of subscribing, buying, selling, dealing or agreeing to subscribe, buy, sell or deal in any securities by any director or key managerial
personnel or any other officer of a company either as principal or agent if such director or key managerial personnel or any other officer of
the company is reasonably expected to have access to any non-public price sensitive information in respect of securities of company; or
• An act of counselling about procuring or communicating directly or indirectly any non-public price-sensitive information to any person;
b. Price-sensitive Information means any information which relates, directly or indirectly, to a company and which is published is likely to
materially affect the price of securities of the company.
2. If any person contravenes the provisions of this section, he shall be punishable with imprisonment for a term which may extend to five years or with
fine which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times of the amount of profits made out of
insider trading, whichever is higher, or with both,
31
6. Whistle-blower Policy
The term “whistle-blowing” originates from the practice of British policemen who blew their whistles whenever they observed commission of
crime. Whistle blowing means calling the attention of the top management to some wrong doing occurring within an organization.
A whistle blower may be an employee, former employee or member of an organization, a government agency, who have willingness to take
corrective action on the misconduct.
As per Sec.177 of the Companies Act, 2013, certain companies have to establish Vigil/Whistle-Blowing mechanism to report any unethical
behavior or other concerns to the management.
Types of Whistle Blower
Internal: A whistle blower may be within the organization who discloses any illegal, immoral or illegitimate practices to the employer. He/she may ne;
• Employee
• Superior officer or
• Any designated officer
External: A whistle blower may be outside the organization who discloses any illegal, immoral or illegitimate practices to the company. He/she may be:
• Lawyers
• Media
• Law Enforcement
• Watchdog agencies
32
Sarbanes-Oxley Act, 2002 (SOX)

An Act enacted by US Congress in 2002 to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the
securities law, and for other purposes.
It is a set of standards that all US public companies and public accounting firms must comply and adhere with good quality reporting. SOX is an essential
law which has brought discipline in financial reporting process. The transparency brought by this act is boosting investor’s confidence that further helps
building a strong capital market in the economy
Clause 49 of the listing agreement is pretty much on the lines of Sarbanes Oxley Act of 2002 provided by SEC for companies listed on US stock
exchanges. According to Clause 49, the top management becomes directly accountable for all financial statements and internal controls of the
organization, which is also the bottom line in case of Section 302 of Sarbanes Oxley Act of 2002.
Applicability
Whether SOX is applicable in India?
Yes, all companies, including Indian, which are listed on US stock exchanges, are required to comply with the requirements of the Act. Corporate
governance in India too has taken a folio from provisions of Section 404 of the Act.
Provisions of SOX for Whistle-Blowers
• Make it illegal to “discharge, demote, suspend, threaten, harass or in any manner discriminate against” whistle blowers
• Establish criminal penalties of up to 10 years for executives who retaliate against whistle blowers
• Require board audit committees to establish procedures for hearing whistle blower complaints
33
• Allow the secretary of labor to order a company to rehire a terminated employee with no court hearing.
• Give a whistle blower the right to a jury trial, bypassing months or years of administrative hearings
Objectives of Whistle-Blowing
• To encourage employees to bring ethical and legal violations they are aware of to an internal authority so that action can be taken immediately to
resolve the problem.
• To minimize the organization’s exposure to the damage that can occur when employees circumvent internal mechanisms.
• To let employees know the organization is serious about adherence to codes of conduct.
Barriers to Whistle-Blowing
• A lack of trust in the internal system
• Unwillingness of employees to be “snitches”
• Belief that management is not held to the same standard
• Fear of retaliation
• Fear of alienation from peers
Steps for Creating a Whistle-blowing Culture
• Create a Policy
• Get Endorsement From Top Management
• Publicize the Organization’s Commitment
• Investigate and Follow Up
• Assess the Organization’s Internal Whistle-blowing System
34
Process for Whistle-Blowing Mechanism
Employee/Director raises a
concern
Disciplinary action &

Preventive measures, if the Compliance Officer
concern is proved.
Initial enquiry and if further

investigation required appoint
Investigator
Now the corporate(s) will have to institute rigorous policy to allow employees to bring unethical and illegal practices to the forefront and also train managers
and executives on how to encourage openness. Some of the companies already have Whistle-Blower policy as a good corporate governance practice and
now most of the companies have started to frame this policy to comply with section 177 of the Companies Act, 2013 and corresponding rules.
35
Unit 4
Basel Committee on Banking Supervision
Unit 4 – Basel Committee on Banking Supervision
Table of contents
1 Banks and Corporates 4
2 Corporate Governance in Banks 6
3 Basel Committee On Corporate Governance 7
3.1 –Basel III - Introduction 7
3.2 – Pillars of Basel Framework 8
3.3 – Objectives of Basel III 8
3.4 – Major Changes in Basel III with respect to Basel I and Basel II 9
3.5 – Basel III – Principles 10
3.6 – Impact Analysis of Basel III on Indian Banking 11
4 Sound Corporate Governance Practices for Banks 13
5 Ensuring Sound Corporate Governance Environment 20
6 The Role of Supervisors 21
7 Phases of Growth in Indian Banks 21
2
Table of contents
8 Corporate Governance in Indian Banks 22
9 Indian Banking Sector’s Unique Nature and its Implications 23
10 Government Control and Withdrawal Effects 24
11 Review of Indian Experience in Corporate Governance 25
12 Policy Implications 26
3
1. Banks and Corporates

Banks, in a broad sense, are institutions whose business is handling other’s money. A joint stock bank, also generally known as commercial bank, is a
company whose business is banking. These are more particularly institutions that deal directly with the general public, as opposed to the merchant banks
and other institutions more concerned with trade and industry. These banks specialise in business connected with bills of exchange, especially the
acceptance of foreign bills.
A merchant banker is thus financial intermediary who helps in transferring capital from those who possess it to those who need it. Merchant Banking
includes a bank with wide range of activities such as management of customers’ securities, portfolio management, project counselling and appraisal,
underwriting of shares and debentures, loan syndication, acting as banker for refund orders, handling interest and dividend warrants, etc., Thus a merchant
banker renders a host of services to corporates and promotes industrial development in the country. Further, there are also investment banks which acquire
shares in limited companies on their own account, and not merely as agents for their customers.
Sometimes, banks are set up to handle specialized functions for particular industries such as the Industrial Development Bank of India (IDBI), National
Bank for Agricultural and Rural Development (NABARD) and Export-Import Bank (Exim Bank).
Banks are thus a critical component of any economy. They provide financing for commercial enterprises, basic financial services to a broad segment of the
population and access to payment systems. In addition, some banks are expected to make credit and liquidity available in difficult market conditions. 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. It is of crucial importance, therefore, that banks have strong corporate governance.
There has been a great deal of attention given recently to the issue of corporate governance in various national and international forums. In particular, the
OECD has issued a set of corporate governance standards and guidelines to help governments “in their efforts to evaluate and improve the legal,
institutional and regulatory framework for corporate governance in their countries, and to provide guidance and suggestions for stock exchanges, investors,
corporations, and other parties that have a role in the process of developing good corporate governance”.
4
Learning Objectives
• Identify the provisions of Basel Committee on corporate governance
• Impact analysis of Basel-III on Indian Banking
5
2. Corporate Governance in Banks

If we examine the need for improving corporate governance in banks, two reasons stand out:
1. Banks exist because they are willing to take on and manage risks. Besides, with the rapid pace of financial innovation and globalization, the face of
banking business is undergoing a sea-change. Banking business is becoming more complex and diversified. Risk taking and management in a less
regulated competitive market will have to be done in such a way that investors’ confidence is not eroded.
2. Even in a regulated set-up, as it was in India prior to 1991, some big banks in the public sector and a few in the private sector had incurred substantial
losses. This, along with the massive failures of non-banking financial Companies (NBFCs), had adversely impacted investors’ confidence.
Protecting the interests of depositors becomes a matter of paramount importance to banks. Regulators the world over have recognized the vulnerability of
depositors to the whims of managerial misadventures in banks and, therefore, have been regulating banks more tightly than other corporates.
Moreover, protecting the interests of depositors becomes a matter of paramount importance to banks. In other corporates, this is not and need not be so for
two reasons:
1. The depositors collectively entrust a very large sum of their hard-earned money to the care of banks. It is found that in India, the depositor’s
contribution was well over 15.5 times the shareholders’ stake in banks as early as in March 2001.5 This is bound to be much more now.
2. The depositors are very large in number and are scattered and have little say in the administration of banks. In other corporates, big lenders do
exercise the right to direct the management. In any case, the lenders’ stake in them might not exceed 2 or 3 times the owners’ stake.
Banks deal in people’s funds and should, therefore, act as trustees of the depositors. Regulators world over have recognized the vulnerability of depositors
to the whims of managerial misadventures in banks, and therefore, have been regulating banks more tightly than other corporates.
To sum up, the objective of corporate governance in banks should first be protection of depositor’s interest and then be to “ optimize” the shareholder’s
interests. All other considerations would fall in place once these two are achieved.
6
As part of its ongoing efforts to address supervisory issues, the Basel Committee on Banking Supervision (BCBS) has been active in drawing from the
collective supervisory experience of its members and other supervisors in issuing supervisory guidance to foster safe and sound banking practices. The
committee was set up to reinforce the importance for banks of the OECD principles, to draw attention to corporate governance issues addressed by
previous committees, and to present some new topics related to corporate governance for banks and their supervisors to consider.
Banking supervision cannot function effectively if sound corporate governance is not in place and, consequently, banking supervisors have a strong interest
in ensuring that there is effective corporate governance at every banking organization. Supervisory experience underscores the necessity of having the
appropriate levels of accountability and checks and balances within each bank. Put plainly, sound corporate governance makes the work of supervisors
infinitely easier. Sound corporate governance can contribute to a collaborative working relationship between bank management and bank supervisors.
Recent “sound practice papers” issued by the Basel Committee underscore the need for banks to set strategies for their operations and establish
accountability for executing these strategies. In addition, transparency of information related to existing conditions, decisions and actions is integrally
related to accountability in that it gives market participants sufficient information with which to judge the management of a bank.
3. Basel Committee on Corporate Governance
3.1 Basel III - Introduction

In December 2010, the Basel Committee on Banking Supervision (BCBS) published its reforms on capital and liquidity rules to address problems, which
arose during the financial crisis. One of the main reasons the crisis became so severe was that the banking sectors of many countries had built up
excessive on and off-balance sheet leverage. This was accompanied by the wearing down of quantity and quality of capital. Therefore, the banking system
was unable to absorb the resulting losses.
The objective of the BCBS to strengthen the regulatory capital framework resulted in the Basel III framework. The framework consists of two separate
policy documents (BCBS 2010a) and (BCBS 2010b) wherein capital and liquidity standards are set out. Basel III strengthens the Basel II framework rather
7
than replaces it. Whereas Basel II focused on the asset side of the balance sheet, Basel III mostly addresses the liabilities, i.e. capital and liquidity.
The new framework will:
a. impose higher capital ratios, including a new ratio focusing on common equity,
b. increase capital charges for many activities, particularly involving counterparty risk and
c. narrow the scope of what constitutes Tier 1 (T1) and Tier 2 (T2) capital.
3.2 Pillars of Basel Framework

The Basel framework (continues to) consists of three pillars:
• Pillar 1 is the part of the new Basel Accord, which sets out the calculations of regulatory capital requirements for credit, market and operational risk.
• Pillar 2 is the part of the new Basel Accord, which sets out the process by which a bank should review its overall capital adequacy and the process
under which the supervisors evaluate how well financial institutions are assessing their risks and take appropriate actions in response to the
assessments.
• Pillar 3 is the part of the new Basel Accord, which sets out the disclosure requirements for banks to publish certain details of their risks, capital and risk
management, with the aim of strengthening market discipline. This is intended to improve effective risk management by allowing for comparison of the
performance across sectors through these disclosure requirements.
3.3 Objectives of Basel III

Basel III measures aim to:
1. Improve the banking sector’s ability to absorb ups and downs from financial and economic instability.
8
2. Improve risk management ability and governance of banking sector

3. Strengthen banks' transparency and disclosures
Thus we can say that Basel III guidelines are targeted at to improve the ability of banks to withstand periods of economic and financial stress as the new
guidelines are more stringent than the earlier requirements for capital and liquidity in the banking sector.
3.4 Major Changes in Basel III with respect to Basel I and Basel II
1. Better Capital Quality: One of the key elements of Basel 3 is the introduction of much stricter definition of capital. Better quality capital means the
higher loss-absorbing capacity. This in turn will mean that banks will be stronger, allowing them to better withstand periods of stress.
2. Capital Conservation Buffer: Another key feature of Basel iii is that now banks will be required to hold a capital conservation buffer of 2.5% . The aim
of asking to build conservation buffer is to ensure that banks maintain a cushion of capital that can be used to absorb losses during periods of financial
and economic stress.
3. Countercyclical Buffer: This is also one of the key elements of Basel III. The countercyclical buffer has been introduced with the objective to increase
capital requirements in good times and decrease the same in bad times. The buffer will slow banking activity when it overheats and will encourage
lending when times are tough i.e. in bad times. The buffer will range from 0% to 2.5% , consisting of common equity or other fully loss-absorbing
capital.
4. Minimum Common Equity and Tier 1 Capital Requirements: The minimum requirement for common equity, the highest form of loss-absorbing
capital, has been raised under Basel III from 2% to 4.5% of total risk-weighted assets. The overall Tier 1 capital requirement, consisting of not only
common equity but also other qualifying financial instruments, will also increase from the current minimum of 4% to 6% . Although the minimum total
capital requirement will remain at the current 8% level, yet the required total capital will increase to 10.5% when combined with the conservation buffer.
5. Leverage Ratio: Review of financial crisis of 2008 has indicated that the value of many assets fell quicker than assumed from historical experience.
9
Thus, now Basel III rules include a leverage ratio to serve as a safety net. A leverage ratio is the relative amount of capital to total assets (not risk-
weighted). This aims to put a cap on swelling of leverage in the banking sector on a global basis. 3% leverage ratio of Tier 1 will be tested before a
mandatory leverage ratio is introduced in January 2018.
6. Liquidity Ratios: Under Basel III, a framework for liquidity risk management will be created. A new Liquidity Coverage Ratio (LCR) and Net Stable
Funding Ratio (NSFR) are to be introduced in 2015 and 2018, respectively.
7. Systemically Important Financial Institutions (SIFI): As part of the macro-prudential framework, systemically important banks will be expected to
have loss-absorbing capability beyond the Basel III requirements. Options for implementation include capital surcharges, contingent capital and bail-in-
debt.
3.5 Basel III Principles
Effective Corporate Governance is crucial for the proper functioning of the banking sector and the economy as a whole. Corporate governance in banks
determines the allocation of authority and responsibilities by which the banks carry out their business by the board of directors and the senior management.
The Basel Committee’s October 2010 principles for enhancing corporate governance represented a consistent development in the Committee’s
longstanding efforts to promote sound corporate governance practices for banks. These principles reflect the key lessons from the 2008-09 financial crisis
and enhance how banks govern themselves and how supervisors oversee this critical area.
The Financial Stability Board reviewed in 2013. The FSB underscored the critical role of the Board of Directors and the Board Risk Committees in
strengthening the banks risk governance. This includes involvement in evaluating and promoting a strong risk culture in the organization. Establishing the
bank’s risk appetite and overseeing its implementation. The increased focus on risk and supporting governance framework includes “three lines of
defense” as follows:
1st line of defense – The business line, which manages risk that incurs in conducting the business.
10
• 2nd line of defence: Identifying, measuring, monitoring and reporting risk, independently from the 1st line of defence.
• 3rd line of defence: Conduct of risk-based general audits.
The implementation of these principles should be commensurate with the size, complexity, structure, economic significance and risk profile of the bank.
This means making reasonable adjustments where appropriate for banks with lower risk profiles and being alert to the higher risks that may accompany
more complex and publicly listed institutions.
Systemically important financial institutions (SIFIs) are expected to have in place the corporate governance structure and practices commensurate with
their role in and potential impact on national and global financial stability.
3.6 Impact Analysis of Basel III on Indian Banking

Significance of Basel III for Indian Banking
Basel III guidelines attempt to enhance the ability of banks to withstand periods of economic and financial stress by prescribing more stringent capital and
liquidity requirements for them.
The new Basel III capital requirement would be a positive impact for banks as it raises the minimum core capital stipulation, introduces counter-cyclical
measures, and enhances banks' ability to conserve core capital in the event of stress through a conservation capital buffer. The prescribed liquidity
requirements, on the other hand, would bring in uniformity in the liquidity standards followed by the banks globally. This liquidity standard requirement,
would benefit the Indian banks manage pressures on liquidity in a stress scenario more effectively.
Although implementing Basel III will only be an evolutionary step, the impact of Basel III on the banking sector cannot be underestimated, as it will drive
significant challenges that need to be understood and addressed. Working out the most cost-effective model for implementation of Basel III will be a critical
issue for Indian banking.
11
Impact of Basel III on the Financial System

Basel III framework implementation would lead to reduced risk of systemic banking crises as the enhanced capital and liquidity buffers together lead to
better management of probable risks emanating due to counterparty defaults and or liquidity stress circumstances. Further, in view of the stricter norms on
Inter-bank liability limits, there would be reduction of the interdependence of the banks and thereby reduced interconnectivity among the banks would save
the banks from contagion risk during the times of crises.
Undoubtedly, Basel III implementation would strengthen the Indian banking sector's ability to absorb shocks arising from financial and economic stress,
whatever the source be, and consequently reduce the risk of spillovers from the financial sector to the real economy
Impact of Basel III on Weaker Banks

Further, there would be a drastic impact on the weaker banks leading to their crowding out. As is well established, as conditions deteriorate and the
regulatory position gets even more intensive, the weaker banks would definitely find it very challenging to raise the required capital and funding. In turn, this
would affect their business models apart from tilting the banking businesses in favor of large financial institutions and thereby tilting the competition.
Increased Supervisory Vigil

Banking operations might experience a reduced pace as there would be an increased supervisory vigil on the activities of the banks in terms of ensuring
the capital standards, liquidity ratios – LCR and NSFR and others.
Reorganization of Institutions
The increased focus of the regulatory authorities on the organizational structure and capital structure ability of the financial firms (mainly banks) would lead
the banks to reorganize their legal identity by resorting to mergers & acquisitions and disposals of portfolios, entities, or parts of entities wherever possible.
12
International Arbitrage
In case of inconsistent implementation of Basel III framework among different countries would lead to international arbitrage thereby resulting in disruption
of global financial stability.
Capital Standards for India

Indian banks need to look for quality capital and also have to preserve the core capital as well as use it more efficiently in the backdrop of Basel III
implementation. Though on the basis of numbers Indian banks look comfortably placed, they will have to phase out those instruments from their capital that
are disallowed under Basel III.
4. Sound Corporate Governance Practices for Banks

Supervisors have a keen interest in determining that banks have sound corporate governance. The practices to be viewed as critical elements of any
corporate governance process are:
1. Establishing strategic objectives and a set of corporate values that are communicated throughout the banking organization: It is difficult to
conduct the activities of an organization when there are no strategic objectives or guiding corporate values. Therefore, the board should establish
strategies that will direct the ongoing activities of the bank. It should also take the lead in establishing the “tone at the top” and approving corporate
values for itself, senior management and other employees. The values should recognize the critical importance of having timely and frank discussions
of problems. In particular, it is important that the values prohibit corruption and bribery in corporate activities, both in internal dealings and external
transactions.
The board of directors should ensure that senior management implements policies that limit activities and relationships that diminish the quality of corporate
governance, such as conflicts of interest.
The board of directors should ensure that the senior management implements policies that prohibit (or strictly limit) activities and relationships that diminish
13
the quality of corporate governance, such as:

• Conflicts of interest.
• Lending to officers and employees and other forms of self-dealing (e.g., internal lending should be limited to lending consistent with market terms and to
certain types of loans, and reports of insider lending should be provided to the board, and be subject to review by internal and external auditors).
• Providing preferential treatment to related parties and other favored entities (e.g., lending on highly favorable terms, covering trading losses, waiving
commissions). Processes should be established that allow the board to monitor compliance with these policies and ensure that deviations are reported
to an appropriate level of management.
2. Setting and enforcing clear lines of responsibility and accountability throughout the organization: Effective boards of directors clearly define
the authorities and key responsibilities for themselves, as well as senior management. They also recognize that unspecified lines of accountability or
confusing multiple lines of responsibility may exacerbate a problem through slow or diluted responses. Senior management is responsible for creating
an accountability hierarchy for the staff and must be aware of the fact that they are ultimately responsible to the board for the performance of the bank.
3. Ensuring that board members are qualified for their positions, have a clear understanding of their role in corporate governance and are not
subject to undue influence from management or outside concerns: The board of directors is ultimately responsible for the operations and financial
soundness of the bank. The board of directors must receive on a timely basis sufficient information to judge the performance of management. An
effective number of board members should be capable of exercising judgement, independent of the views of management, large shareholders or
government. Including on the board qualified directors who are not members of the bank’s management, or having a supervisory board or board of
auditors separate from a management board, can enhance independence and objectivity. Moreover, such members can bring new perspectives from
other businesses that may improve the strategic direction given to management, such as insight into local conditions. Qualified external directors can
also become significant sources of management expertise in times of corporate stress. The board of directors should periodically assess its own
performance, determine where weaknesses exist and, wherever possible, take appropriate corrective actions.
14
The board of directors add strength to the corporate governance of a bank when they:
• Understand their oversight role and their “duty of loyalty” to the bank and its shareholders.
• Serve as a “checks-and balances” function vis-à-vis the day-to-day management of the bank.
• Feel empowered to question management and are comfortable insisting upon straightforward explanations from management.
• Recommend sound practices observed from other situations.
• Provide dispassionate advice.
• Are not overextended.
• Avoid conflicts of interest in their activities with, and commitments to, other organizations.
• Meet regularly with senior management and internal audit to establish and approve policies, establish communication lines and monitor progress
toward corporate objectives.
• Absent themselves from decisions when their own role or interests are bring discussed or they are incapable of providing objective advice.
• Do not participate in day-to-day management of the bank.
In a number of countries, bank boards as recommended by several committees on corporate governance have found it beneficial to establish certain
specialized committees that include the following:
i. A risk management committee: This committee is formed with a view to providing oversight of the senior management’s activities in
managing credit, market, liquidity, operational, legal and other risks of the bank. (This role should include receiving from senior management
periodic information on risk exposures and risk management activities.)
15
ii. An audit committee: This committee is formed with a view to providing oversight of the bank’s internal and external auditors, approving their
appointment and dismissal, reviewing and approving audit scope and frequency, receiving their reports and ensuring that management is taking
appropriate corrective actions in a timely manner to address control weaknesses, non-compliance with policies, laws and regulations, and other
problems identified by auditors. The independence of this committee can be enhanced when it is composed of external board members that
have banking or financial expertise.
iii. A compensation committee: This committee is expected to provide oversight of remuneration of senior management and other key personnel
and ensure that compensation is consistent with the bank’s culture, objectives, strategy and control environment.
iv. A nomination committee: A nomination committee is formed with a view to providing important assessment of board effectiveness and
directing the process of renewing and replacing board members.
Senior management is a key component of corporate governance. While the board of directors provides checks and balances to senior managers, senior
managers should assume that oversight role with respect to line managers in specific business areas and activities.
4. Ensuring that there is appropriate oversight by senior management: Senior management is a key component of corporate governance. While the
board of directors provides checks and balances to senior managers, similarly, senior managers should assume that oversight role with respect to line
managers in specific business areas and activities. Even in very small banks, key management decisions should be made by more than one person
(four eyes principle). Management situations to be avoided include the following managers:
• Senior managers who are overly involved in business line decision-making.

• Senior managers who are assigned an area to manage without the necessary prerequisite skills or knowledge.
• Senior managers who are unwilling to exercise control over successful, key employees (such as traders) for fear of losing them.
Senior management consists of a core group of officers responsible for the bank. This group should include such individuals as the Chief Financial Officer,
16
division heads and the chief auditor. These individuals must have the necessary skills to manage the business under their supervision as well as have
appropriate control over the key individuals in these areas.
5. Effectively utilizing the work conducted by internal and external auditors, in recognition of the important control function they provide: The
role of auditors is vital to corporate governance process. The effectiveness of the board and senior management can be enhanced as given below:
• Recognizing the importance of the audit process and communicating this importance throughout the bank.
• Taking measures that enhance the independence and stature of auditors.
• Utilizing, in a timely and effective manner, the findings of auditors.
• Ensuring the independence of the had auditor through his reporting to the board or the board’s audit committee.
• Engaging external auditors to judge the effectiveness of internal controls.
• Requiring timely correction by management of problems identified by auditors.
The board should recognize and acknowledge that the internal and external auditors are their critically important agents. In particular, the board should
utilize the work of the auditors as an independent check on the information received from management on the operations and performance of the bank.
6. Ensuring that compensation approaches are consistent with the bank’s ethical values, objectives, strategy and control environment: Failure
to link incentive compensations to the business strategy can cause or encourage managers to book business based upon volume and/or short-term
profitability to the bank with little regard to short or long-term risk consequences. This can be seen particularly with traders and loan officers but can
also adversely affect the performance of other support staff.
The board of directors should approve the compensation of members of senior management and other key personnel and ensure that such compensation
is consistent with the bank’s culture, objectives, strategy and control environment. This will help to ensure that senior managers and other key personnel
17
will be motivated to act in the best interests of the bank.

In order to avoid incentives being created for excessive risk-taking, the salary scales should be set, within the scope of general business policy, in such a
way that they do not overly depend on short-term performance, such as short-term trading gains.
Conducting corporate governance in a transparent manner: As set out in the Basel Committee’s paper Enhancing Bank Transparency, it is difficult to
hold the board of directors and senior management properly accountable for their actions and performance when there is a lack of transparency. This
happens in situations where the stakeholders, market participants and general public do not receive sufficient information on the structure and objectives of
the bank with which to judge the effectiveness of the board and senior management in governing the bank.
Transparency can reinforce sound corporate governance. Therefore, public disclosure is desirable in the following areas:
• Board structure (size, membership, qualifications and committees); senior management structure (responsibilities, reporting lines, qualifications and
experience).
• Basic organizational structure (line of business structure, legal entity structure).
• Information about the incentive structure of the bank (remuneration policies, executive compensation, bonuses, stock options).
• Nature and extent of transactions with affiliates and related parties.
For example, the International Accounting Standards Committee9 (IASC) defines related parties as “those able to control or exercise significant influence.”
Such relationships include:
1. parent-subsidiary relationships.
2. entities under common control.
3. associates.
4. individuals who, through ownership, have significant influence over the enterprise and close members of their families.
18
will be motivated to act in the best interests of the bank.

In order to avoid incentives being created for excessive risk-taking, the salary scales should be set, within the scope of general business policy, in such a
way that they do not overly depend on short-term performance, such as short-term trading gains.
7. Conducting corporate governance in a transparent manner: As set out in the Basel Committee’s paper Enhancing Bank Transparency, it is difficult
to hold the board of directors and senior management properly accountable for their actions and performance when there is a lack of transparency.
This happens in situations where the stakeholders, market participants and general public do not receive sufficient information on the structure and
objectives of the bank with which to judge the effectiveness of the board and senior management in governing the bank.
Transparency can reinforce sound corporate governance. Therefore, public disclosure is desirable in the following areas:
• Board structure (size, membership, qualifications and committees); senior management structure (responsibilities, reporting lines, qualifications
and experience).
• Basic organizational structure (line of business structure, legal entity structure).
• Information about the incentive structure of the bank (remuneration policies, executive compensation, bonuses, stock options).
• Nature and extent of transactions with affiliates and related parties.
For example, the International Accounting Standards Committee9 (IASC) defines related parties as “those able to control or exercise significant
influence.” Such relationships include:
1. parent-subsidiary relationships.
2. entities under common control.
3. associates.
4. individuals who, through ownership, have significant influence over the enterprise and close members of their families.
19
5. key management personnel.

The IASC expects that disclosures in this area should include
• the nature of relationships where control exists, even if there were no transactions between the related parties.
• the nature and amount of transactions with related parties, grouped as appropriate.
The Basel Committee recognizes that primary responsibility for good corporate governance rests with Boards of Directors and senior management of
banks. However, there are many other ways that corporate governance can be promoted, which include government.
5. Ensuring Sound Corporate Governance Environment
The Basel Committee recognizes that primary responsibility for good corporate governance rests with boards of directors and senior management of banks;
however, there are many other ways that corporate governance can be promoted, which include the following:
• Government — through laws.
• Securities’ regulators, stock exchanges — through disclosure and listing requirements.

• Auditors — through audit standards on communications to board of directors, senior management and supervisors.
• Banking industry associations — through initiatives related to voluntary industry principles and agreement on and publication of sound practices.
For example, corporate governance can be improved by addressing a number of legal issues, such as the protection of shareholder rights; the
enforceability of contracts, including those with service providers; clarifying governance roles; ensuring that corporations’ function in an environment that is
free from corruption and bribery; and laws/regulations (and other measures) aligning the interests of managers, employees and shareholders. All of these
can help promote healthy business and legal environments that support sound corporate governance and related supervisory initiatives.
20
6. The Role of Supervisors

Supervisors should be aware of the importance of corporate governance and its impact on corporate performance. They should expect banks to implement
organizational structures that include appropriate checks and balances. Regulatory safeguards must emphasize accountability and transparency.
Supervisors should determine that the boards and senior management of individual institutions have in place processes that ensure they are fulfilling all of
their duties and responsibilities.
A bank’s board of directors and senior management are ultimately responsible for the performance of the bank. As such, supervisors typically check to
ensure that a bank is being properly governed and bring to management’s attention any problems that they detect through their supervisory efforts. When
the bank takes risks that it cannot measure or control, supervisors must hold the board of directors accountable and require that corrective measures be
taken in a timely manner. Supervisors should be attentive to any warning signs of deterioration in the management of the bank’s activities. They should
consider issuing guidance to banks on sound corporate governance and the proactive practices that need to be in place. They should also take account of
corporate governance factors while issuing guidance on other topics.
Sound corporate governance considers the interests of all stakeholders, including depositors, whose interests may not always be recognized. Therefore, it
is necessary for supervisors to determine that individual banks are conducting their business in such a way as not to harm depositors.
7. Phases of Growth in Indian Banks
Since Independence, organised Western type of banking in India has evolved through four distinct phases.
1. Foundation phase covering the decades of 1950s and 1960s: This period witnessed the development of the required legislative framework for
facilitating the organization of the banking system to cater to the growing and development needs of the Indian economy.
2. Expansion phase of the mid-1960s: This trend gained momentum after the nationalization of private banks in late 1960s.
3. Consolidation phase since 1985: Greater attention was paid to improving housekeeping, customer service, credit management, productivity and
profitability of banks starting 1985 onwards.
21
4. Reforms phase commencing from 1991: Important and significant initiatives were taken with a view to reforming the banking system such as the
introduction of accounting and prudential norms relating to income recognition, provisioning and capital adequacy in 1991.
The three constituents of commercial banking structure in India are public sector banks, private banks and foreign banks. Presently, there are 295 banks
with 66, 514 branches; out of these, as many as 223 banks and 60,640 branches are in the public sector.
8. Corporate Governance in Indian Banks
Although the subject of corporate governance has received a lot of attention in recent times in India, corporate governance issues and practices by Indian
banks have received only a scanty notice. The question of corporate governance in banks is important for several reasons.
• First, banks have an overwhelmingly dominant position in developing the economy’s financial system and are extremely important engines of growth.
• Second, as the country’s financial markets are underdeveloped, banks in India are the most significant source of finance for a majority of firms in Indian
industry.
• Third, banks are also the channels through which the country’s savings are collected and used for investments.
• Fourth, India has recently liberalized its banking system through privatization, disinvestments and has reduced the role of economic regulation and
consequently managers of banks have obtained greater autonomy and freedom with regard to running of banks.
This would necessitate their observing best corporate practices to regain the investors’ confidence now that the government authority does not protect them
anymore. Corporate governance in banks has assumed importance in India post-1991 reforms because competition compelled banks to improve their
performance.
Even the majority of banks and financial institutions, owned, managed and influenced by the government with neither high quality management nor any
exemplary record of practicing corporate governance have realised the importance of adopting better practices to protect their depositors and the banking
public.
22
9. Indian Banking Sector’s Unique Nature and its Implications

The unique nature of the banking firm, be in the developed or developing world, requires a broad view of corporate governance to be adopted by banks
which encapsulates both shareholders and depositors. In particular, the nature of the banking firm is such that regulation is necessary to protect depositors
as well as the overall financial system. Using this insight, we should examine the corporate governance of banks in India in the context of ongoing banking
reforms.
The unique nature of the banking firm requires a broad view of corporate governance to be adopted by banks which encapsulates both shareholders and
depositors.
The narrow approach to corporate governance views the subject as the mechanism through which shareholders are assured that managers will act to
promote their interests. Indeed, as far back as at the time of Adam Smith, it has been recognized that managers do not always act in the best interests of
shareholders, leading to a separation of ownership and control. The separation of ownership and control has given rise to an “agency problem” whereby
management operates the firm in their own interests, and not those of shareholders.
This creates opportunities for managerial shirking or empire building and, in the extreme, outright expropriation. However, there is a broader view of
corporate governance, which views the subject as the methods by which suppliers of finance control managers in order to ensure that their capital is not
expropriated and that they earn a return on their investment. Thus, the special nature of banking will call for the adoption of the broader view of corporate
governance for banks. Besides, the special nature of banking requires government intervention in order to restrain the behavior of bank management.
Depositors do not know the true value of a bank’s loan portfolio as such information is incommunicable and very costly to reveal. As a consequence of this
asymmetric information problem, bank managers are prompted to invest in riskier assets than they promised they would ex ante. In order to credibly
commit that they will not expropriate depositors, banks could make investments in brand-name or reputational capital, as these schemes give depositors
confidence, especially when contracts have a finite nature and discount rates are sufficiently high. The opaqueness of banks also makes it very costly for
depositors to constrain managerial discretion through debt covenants. Consequently, rational depositors will require some form of guarantee before they
would deposit with a bank. Government-provided guarantees in the form of implicit and explicit deposit insurance15 might encourage economic agents to
23
deposit their wealth with a bank, as a substantial part of the moral hazard cost is borne by the government.
However, the special nature of the banking company also affects the relationship between shareholders and managers. For example, the opaqueness of
bank assets makes it very costly for diffuse equity holders to write and enforce effective incentive contracts or to use their voting rights as a vehicle for
influencing the bank’s decisions. Furthermore, the existence of deposit insurance may reduce the need for banks to raise capital from large, uninsured
institutional investors who have the incentive to exert corporate control.
A further issue is that the interests of bank shareholders may oppose those of governmental regulators, who have their own agendas, which may not
necessarily coincide with maximizing bank value. Shareholders may want managers to take more risk than is socially optimal, whereas regulators have a
preference for managers to take substantially less risk due to their concerns about system-wide financial stability. Shareholders could motivate such risk-
taking using incentive-compatible compensation schemes. However, from the regulators point of view, managers’ compensation schemes should be
structured so as to discourage banks from becoming too risky.
10. Government Control and Withdrawal Effects
In India, the issue of corporate governance in banks is complicated by extensive political intervention in the operation of the banking system. Government
ownership of banks is a common feature in India. The reasons for such ownership may include solving the severe informational problems inherent in
developing financial systems, aiding the development process or supporting vested interests and distributional cartels. With a government-owned bank, the
severity of the conflict between depositors and managers very much depends upon the credibility of the government. Given a credible government and
political stability, there will be little conflict as the government ultimately guarantees deposits.
The inefficiencies associated with government-owned banks, especially those emanating from a lack of adequate managerial incentives have led
governments under some pressure from international agencies to begin divesting their ownership stakes. In the case of India too, there are subtle
pressures on the government from international organizations that provide development funds such as the World Bank and International Monetary Fund to
withdraw their stakes in commercial banks. The divestment of government-owned banks raises several corporate governance issues. If banks are
completely privatized, then there must be adequate deposit insurance schemes and supervisory arrangements established in order to protect depositors
24
and prevent a financial crash.

On the other hand, if divestment is partial, then there may be opportunities for the government as the dominant shareholder to expropriate minority
shareholders by using banks to aid fiscal problems or support certain distribution cartels. A further issue, which complicates the corporate governance of
banks in India is the activities of “distributional cartels”. These cartels consist of corporate insiders who have very close links with or partially constitute the
governing elite. The existence of such cartels will undermine the credibility of investor legal protection and may also prevent reform of the banking system.
Obviously, good political governance can be considered as a prerequisite for good corporate governance.
The Basel Committee norms relate only to commercial banks and financial institutions. Banking and financial institutions stand to benefit only if corporate
governance is accepted universally by industry and business, with whom banks and financial institutions have to interact and deal. SEBI, the Indian capital
market regulator only partially attends to this need. SEBI is a functional statutory body and it can prescribe regulations only within its functions.
11. Review of Indian Experience in Corporate Governance
The Kumar Mangalam Birla Committee appointed by SEBI confined itself to submitting recommendations for good corporate governance and left it to SEBI
to decide on the penalty provisions for non-compliance. In the absence of suitable penalty provisions, it would be difficult to establish good corporate
governance in firms including banks. Some of the penalty provisions are not sufficient enough to discipline the corporates. For example, the penalty for
non-compliance of the stipulated minimum of 50 per cent in respect of the number of directors in the board that should be non-executive directors is
delisting of shares of the company. This would hardly serve the purpose. In fact, this would be detrimental to the interest of the investors and to the effective
functioning of the capital market.
Similarly, an audit committee, which is in perpetual conflict with the board, may result in stalemates to the detriment of the company. If a company is to
function smoothly, it should be made clear that the findings and recommendations of the audit committee need not necessarily have to be accepted by the
board which is accountable to the shareholders for its performance and which, under Section 291 of the Companies Act, is entitled to “exercise all such
powers, and do all such things as the company is authorized to exercise and do”.
25
12. Policy Implications

Thus, the special nature of banking institutions necessitates a broad view of corporate governance where regulation of banking activities is required to
protect depositors. In developed economies, protection of depositors in a deregulated environment is typically provided by a system of prudential
regulation, but in India such protection is undermined by the lack of well-trained supervisors, inadequate disclosure requirements, the high cost of raising
bank capital and the presence of distributional cartels.
A broad view of corporate governance where regulation of banking activities is required is to protect depositors. In order to deal with these problems, some
analysts suggest that India needs to adopt the following measures: gradual liberalization policies enhancement in the quality of financial reporting system
and improvement in investor protection laws.
In order to deal with these problems, some analysts suggest that India need to adopt the following measures:
• First, liberalization policies need to be gradual, and should be dependent upon improvements in prudential regulation.
• Second, India need to expend resources enhancing the quality of their financial reporting systems, as well as the quantity and quality of bank
supervisors.
• Third, given that bank capital plays such an important role in prudential regulatory systems, it may be necessary to improve investor protection laws,
increase financial disclosure and impose fiduciary duties upon bank directors so that banks can raise the equity capital required for regulatory
purposes.
A further reason as to why this policy needs to be implemented is the growing recognition that the corporate governance of banks has an important role to
play in assisting supervisory institutions to perform their tasks and allowing supervisors to have a working relationship with bank management, rather than
adversarial one.
26
It is an unquestionable fact that the corporate governance of banks in India is severely affected by political considerations. First, given the trend towards
privatization of government-owned banks in India, there is a need for the managers of such banks to be granted autonomy and be gradually introduced to
the corporate governance practices of the private sector prior to divestment. Second, where there has only been partial divestment and government has 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, it should be beneficial that India partially opens up her banking sector to foreign banks.
27
Unit 4 – Additional Read

Basel III
Basel III
Table of contents
1 Basel III – Introduction 4
2 Basel III - Principles 6
2
Basel III
Basel III - Introduction

In December 2010, the Basel Committee on Banking Supervision (BCBS) published its reforms on capital and liquidity rules to address problems, which
arose during the financial crisis. One of the main reasons the crisis became so sever was that the banking sectors of many countries had built up excessive
on and off-balance sheet leverage.
This was accompanies by the wearing down of the quantity and quality of capital. Therefore, the banking system was unable to absorb the resulting losses.
The objective of the BCBS to strengthen the regulatory capital framework resulted in the Basel III framework. The framework consists of two separate
policy documents (BCBS 2010a) and (BCBS2010b) wherein capital and liquidity standards are set out. Basel III strengthens the Basel II framework rather
than replaces it. Whereas Basel II focused on the asset side of the balance sheet, Basel III mostly addresses the liabilities, i.e. capital and liquidity.
The new framework will:

a. impose higher capital ratios, including a new ratio focusing on common equity,
b. increase capital charges for many activities, particularly involving counterparty risk and
c. narrow the scope of what constitutes Tier 1 (T1) and Tier 2 (T2) capital.
The Basel framework (continues to) consists of three pillars:
• Pillar 1 is the part of the new Basel Accord, which sets out the calculations of regulatory capital requirements for credit, market and operational risk.
• Pillar 2 is the part of the new Basel Accord, which sets out the process by which a bank should review its overall capital adequacy and the process
under which the supervisors evaluate how well financial institutions are assessing their risks and take appropriate actions in response to the
assessments.
3
Basel III
• Pillar 3 is the part of the new Basel Accord, which sets out the disclosure requirements for banks to publish certain details of their risks, capital and risk
management, with the aim of strengthening market discipline. This is intended to improve effective risk management by allowing for comparison of the
performance across sectors through these disclosure requirements.
Basel III - Principles

Effective Corporate Governance is crucial for the proper function of the banking sector and the economy as a whole. Corporate Governance in banks
determines the allocation of authority and responsibilities by which the banks carry out their business by the board of directors and the senior management.
The Basel Committee’s October 2010 Principles for enhancing corporate governance represented a consistent development in the Committee’s
longstanding efforts to promote sound corporate governance practices for banks. These principles reflect the key lessons from the 2008-09 financial crisis
and enhance how banks govern themselves and how supervisors oversee this critical area.
The Financial Stability Board reviewed this in 2013. The FSB underscored the critical role of the Board of Directors and the Board Risk Committees in
strengthening the bank’s risk governance. This includes involvement in evaluating and promoting a strong risk culture in the organization. Establishing the
bank’s risk appetite and overseeing its implementation. The increased focus on risk and supporting governance framework includes “three lines of defense”
as follows:
• The first line of defense – The Business Line: Manages risk that incurs in conducting its business.
• The second line of defense – Identifying, measuring, monitoring and reporting risk, independently from the first line of defense
• The third line of defense – Conduct of risk-based general audits.
The implementation of these principles should be commensurate with the size, complexity, structure, economic significance and risk profile of the bank.
This means making reasonable adjustments where appropriate for banks with lower risk profiles, and being alert to the higher risks that may accompany
more complex and publicly listed institutions.
4
Basel III
Systemically important financial institutions (SIFIs) are expected to have in place the corporate governance structure and practices commensurate with
their role in and potential impact on national and global financial stability.
We shall deliberate upon the principles of corporate governance.
Principle 1
a. Board’s Overall Responsibilities

The board has overall responsibility for the bank, including approving and overseeing the implementation of the bank’s strategic objectives, governance
framework, and corporate culture. The board is also responsible for providing oversight of senior management.
a. Responsibilities of the Board
The board has ultimate responsibility for the bank’s business strategy and financial soundness, key personnel decisions, internal organization and
governance structure and practices, and risk management and compliance obligations.
Accordingly, the board should:
• establish and monitor the bank’s business objectives and strategy;
• establish the bank’s corporate culture and values;
• oversee implementation of the appropriate governance framework;
• develop, along with senior management and the CRO, the bank’s risk appetite
• Monitor the bank’s adherence to the RAS, risk policy and risk limits;
5
Basel III
• approve and oversee the implementation of the bank’s Capital Adequacy Assessment Process, capital and liquidity plans, compliance policies and
obligations, and the internal control system;
• approve the selection and oversee the performance of senior management; and
• oversee the design and operation of the bank’s compensation system, and monitor and review the system to ensure that it is aligned with the bank’s
desired risk culture and risk appetite.
b. Corporate Culture and Values

A fundamental component of good governance is a demonstrated corporate culture of reinforcing appropriate norms for responsible and ethical behavior. In
order to promote a sound corporate culture, the board should take the lead in establishing the “tone at the top” by:
• setting and adhering to corporate values for itself, senior management and other employees that create expectations that all business should be
conducted in a legal and ethical manner;
• promoting risk awareness within a strong risk culture, conveying the board’s expectation that it does not support excessive risk-taking and that all
employees are responsible for helping ensure that the bank operates within the agreed risk appetite and risk limits;
• ensuring that appropriate steps are taken to communicate throughout the bank the corporate values, professional standards or codes of conduct it sets,
together with supporting policies; and
• ensuring that employees, including senior management, are aware that appropriate disciplinary or other actions will follow unacceptable behaviors and
transgressions.
A bank’s code of conduct or code of ethics, or comparable policy, should define acceptable and unacceptable behaviors. The bank’s corporate values
should recognize the critical importance of timely and frank discussion and escalation of problems to higher levels within the organization.
6
Basel III
c. Risk Appetite, Management and Control

Developing and conveying the bank’s Risk Appetite Statement (RAS) is essential to reinforcing a strong risk culture. The board should clearly outline
actions to be taken when stated risk limits are breached, including disciplinary actions for excessive risk-taking, escalation procedures and board of director
notification.
The board should take an active role in developing the risk appetite and ensuring its alignment with the bank’s strategic, capital and financial plans and
compensation practices. The bank’s risk appetite should be clearly conveyed through a RAS that is easily understood by all relevant parties:
The bank’s Risk Appetite Statement (RAS) should:
• include both quantitative and qualitative considerations;
• establish the individual and aggregate level and types of risk that the bank is willing to assume in advance of and in order to achieve its business
activities within its risk capacity;
• define the boundaries and business considerations in accordance with which the bank is expected to operate when pursuing the business strategy; and
• communicate the board’s risk appetite effectively throughout the bank, linking it to daily operational decision-making and establishing the means to
raise risk issues and strategic concerns across the bank.
A risk governance framework should include well defined organizational responsibilities for risk management, typically referred to as the three lines of
defense.
c. Risk Appetite, Management and Control
The board should select the CEO and may select other key members of senior management, as well as the heads of the control functions. The board
should provide oversight of senior management. It should hold members of senior management accountable for their actions and enumerate the
consequences of those actions are not aligned with the board’s performance expectations. This includes adhering to the bank’s values, risk appetite, and
7
Basel III
risk culture, regardless of financial gain or loss to the bank.

In doing so, the board should:
• monitor that senior management’s actions are consistent with the strategy and policies approved by the board, including the risk appetite;
• meet regularly with senior management;
• question and critically review explanations and information provided by senior management;
• set appropriate performance and remuneration standards for senior management consistent with the long-term strategic objectives and the financial
soundness of the bank;
• ensure that senior management’s knowledge and expertise remain appropriate given the nature of the business and the bank’s risk profile; and
• ensure that appropriate succession plans are in place for senior management positions.
8
Basel III
Principle 2
Board Qualifications and Composition

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.
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.
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.
In assessing the collective suitability of the board, the following should be taken into account:
• Board members should have a range of knowledge and experience in relevant areas and have varied backgrounds to promote diversity of views.
Relevant areas of competence include financial and capital markets, financial analysis, financial stability, strategic planning, risk management,
compensation, regulation, corporate governance, and management skills.
• The board collectively should have a reasonable understanding of local, regional and, if appropriate, global economic and market forces and of the
legal and regulatory environment. International experience, where relevant, should also be considered.
• Where board expertise is insufficient in any of the above areas, the board should be able to employ independent experts as needed.
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.
• The nomination committee should analyze the responsibilities relating to the role the board member will play and the knowledge, experience, and
competence, which the role requires.
9
Basel III
• Where a supervisory board or board of auditors is formally separate from a management board, objectivity and independence still need to be assured
by appropriate selection of board members.
• The nomination committee should strive to ensure that the board is not dominated by any one individual or small group of individuals in a manner that is
detrimental to the interests of the bank as a whole.
Where there are shareholders with the power to appoint board members, the board should ensure such board members understand their duties. Board
members have responsibilities to the bank’s overall interests, regardless of who appoints them.
Principle 3
Board’s Own Structure and Practices

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.
Organization and assessment of the board.
The board should structure itself in terms of leadership, size and the use of committees so as to effectively carry out its oversight role and other
responsibilities. This includes ensuring that the board has the time and means to cover all necessary subjects in sufficient depth and have a robust
discussion of issues.
The board should maintain and periodically update organizational rules, by-laws, or other similar documents setting out its organization, rights,
responsibilities, and key activities.
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.
10
Basel III
The board should:

• periodically review its structure, size, and composition;
• assess the ongoing suitability of each board member periodically (at least annually) also taking into account his or her performance on the board;
• either separately or as part of these assessments, periodically review the effectiveness of its own governance practices and procedures, determine
where improvements may be needed, and make any necessary changes; and
• use the results of these assessments as part of the ongoing improvement efforts of the board and, where required by the supervisor, share results with
the supervisor.
The board should maintain appropriate records (for example - meeting minutes or summaries of matters reviewed, recommendations made and decisions
taken) of its deliberations and decisions. These should be made available to the supervisor when required.
Role of the Chair

The chair of the board plays a crucial role in the proper functioning of the board. The chair provides leadership to the board and is responsible for its
effective overall functioning, including maintaining a relationship of trust with board members. The chair should possess the requisite experience,
competencies and personal qualities in order to fulfill these responsibilities.
• The chair should ensure that board decisions are taken on a sound and well-informed basis.
• The chair should encourage and promote critical discussion and ensure that dissenting views can be freely expressed and discussed within the
decision-making process.
• To promote checks and balances, the chair of the board should be a non-executive board member and not serve as chair of any board committee.
11
Basel III
Board Committees
To increase efficiency and allow deeper focus in specific areas, a board may establish certain specialized board committees. The committees should be
created and mandated by the full board. The number and nature of committees depend on many factors, including the size of the bank and its board, the
nature of the business areas of the bank, and its risk profile.
In the interest of greater transparency and accountability, a board should disclose the committees it has established, their mandates and their composition.
Committees should maintain appropriate records of their deliberations and decisions. A committee chair should be an independent, non-executive board
member.
Audit Committee
The audit committee is required for systemically important banks. For banks of large size, risk profile or complexity it is strongly advised. For other banks, it
remains strongly recommended.
Some of the features of the Audit Committee are:
• is required to be distinct from other committees.
• should have a chair who is independent and is not the chair of the board or any other committee. • should be made up entirely of independent or non-
executive board members.
• should include members who have experience in audit practices and financial literacy at banks.
The audit committee is responsible, among other things, for:

• the financial reporting process;
12
Basel III
• providing oversight of and interacting with the bank’s internal and external auditors;
• approving, or recommending to the board or shareholders for their approval, the appointment compensation and dismissal of external auditors;
reviewing and approving the audit scope and frequency; receiving key audit reports and ensuring that senior management is taking necessary
corrective actions in a timely manner the problems identified by auditors and other control functions;
• overseeing the establishment of accounting policies and practices by the bank; and
• reviewing the third-party opinions on the design and effectiveness of the overall risk governance framework and internal control system.
Risk Committee
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 RAS, reporting on the state of risk culture in the bank, and interacting with and overseeing the CRO. The committee’s
work includes oversight of the strategies for capital and liquidity management, as well as for all relevant risks of the bank, such as credit, market,
operational, compliance and reputational risks, to ensure they are consistent with the stated risk appetite.
The risk committee of the board:

• is required for systemically important banks. For banks of large size, risk profile or complexity it is strongly advised. For other banks, it remains strongly
recommended.
• should be distinct from the audit committee, but may have other related tasks, such as finance.
• should have a chair who is an independent director and not the chair of the board, or any other committee.
• should include a majority of members who are independent.
13
Basel III
• should include members who have experience in risk management issues and practices.
• should discuss all risk strategies on both an aggregated basis and by type of risk and make recommendations to the board thereon, and on the risk
appetite.
• is required to review the bank’s risk policies at least annually.
• should oversee that management has in place processes to ensure the bank’s adherence to the approved risk policies.
Compensation Committee
The compensation committee is required for systemically important banks. It should oversee the compensation system’s design and operation and ensure
that compensation is appropriate and consistent with the bank’s culture, long-term business and risk appetite, performance and control environment, as
well as with any legal or regulatory requirements. The compensation committee should be constituted in a way that enables it to exercise competent and
independent judgment on compensation policies and practices and the incentives they create. The compensation committee works closely with the bank’s
risk committee in evaluating the incentives created by the compensation system.
Other board committees are specialized committees like Nominations/human resources/governance committee, Ethics/compliance committee.
Conflict of Interest
The board should have a formal written conflicts of interest policy and an objective compliance process for implementing the policy. The policy should
include:
• a member’s duty to avoid to the extent possible activities that could create conflicts of interest or the appearance of conflicts of interest;
• examples of where conflicts can arise when serving as a board member;
• a rigorous review and approval process for members to follow before they engage in certain activities (such as serving on another board) so as to
ensure that such activity will not create a conflict of interest;
14
Basel III
• a member’s duty to promptly disclose any matter that may result, or has already resulted, in a conflict of interest;
• a member’s responsibility to abstain from voting on any matter where the member may have a conflict of interest or where the member’s objectivity or
ability to properly fulfil duties to the bank may be otherwise compromised;
• adequate procedures for transactions with related parties so that they be made on an arm’s length basis; and
• the way in which the board will deal with any non-compliance with the policy.
Principle 4
Senior Management
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, incentive compensation and other policies approved by the board.
Senior management consists of a core group of individuals who are responsible and accountable to the board for effectively overseeing the day-to-day
management of the bank. The organization and procedures and decision-making of senior management should be clear and transparent and designed to
promote effective management of the bank. This includes clarity on the role and authority of the various positions within senior management, including the
CEO.
Members of senior management should have the necessary experience, competencies, and integrity to manage the businesses and people under their
supervision. They should receive access to regular training to maintain and enhance their competencies and stay up to date on developments relevant to
their areas of responsibility.
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.
15
Basel III
Senior management contributes substantially to a bank’s sound corporate governance through personal conduct (eg by helping to set the “tone at the top”
along with the board). Members of senior management should provide adequate oversight of those they manage, and ensure that the bank’s activities are
consistent with the business strategy, risk appetite and the policies approved by the board.
Senior management is responsible for delegating duties to staff. They should establish a management structure that promotes accountability and
transparency throughout the bank.
Senior management should implement, consistent with the direction given by the board, risk management systems, processes and controls for managing
the risks – both financial and non-financial – to which the bank is exposed and for complying with laws, regulations and internal policies.
• This includes comprehensive and independent risk management, compliance and audit functions, as well as an effective overall system of internal
controls.
• Senior management should recognize and respect the independent duties of the risk management, compliance, and internal audit functions and should
not interfere in their exercise of such duties.
• Senior management should provide the board with the information it needs to carry out its responsibilities, supervise senior management and assess
the quality of senior management’s performance. In this regard, senior management should keep the board regularly and adequately informed of
material matters, including:
• Changes in business strategy, risk strategy/risk appetite;
• Bank performance and condition;
• Breaches of risk limits or compliance rules;
• Internal control failures; and
• Legal or regulatory concerns.
16
Basel III
Principle 5
Governance of Group Structures

In a group structure, the board of the parent company has the overall responsibility for the group and for ensuring that there is a clear governance
framework appropriate to the structure, business, and risks of the group and its entities. The board and senior management should know and understand
the bank’s operational structure and the risks that it poses.
Parent company boards
In operating within a group structure, the board of the parent company should be aware of the material risks and issues that might affect both the bank as a
whole and its subsidiaries. It should exercise adequate oversight over subsidiaries while respecting the independent legal and governance responsibilities
that might apply to subsidiary boards.
In order to fulfill its responsibilities, the board of the parent company should:
• establish a group structure and a governance framework with clearly defined roles and responsibilities, including those at the parent company level and
those at the subsidiary level;
• define an appropriate subsidiary board and management structure to contribute to the effective oversight of businesses and subsidiaries;
• assess whether the group’s corporate governance framework includes adequate policies, processes and control, and addresses risks across the
business and legal entity structures;
• ensure the group’s corporate governance framework includes appropriate processes and controls to identify and address potential intragroup conflicts
of interest;
• approve policies and clear strategies for establishing new structures and legal entities, and ensure that they are consistent with the policies and
interests of the group;
17
Basel III
• assess whether there are effective systems in place to facilitate the exchange of information among the various entities;
• have sufficient resources to monitor compliance of subsidiaries with all applicable legal, regulatory and governance requirements; and
• maintain an effective relationship with both the home regulator and, through the subsidiary board or direct contact, with the regulators of all subsidiaries.
Subsidiary boards
While the strategic objectives, risk governance framework, corporate values and corporate governance principles of the subsidiary bank should align with
that of the parent company (referred to here as “group policies”). The subsidiary board should make necessary adjustments where a group policy conflicts
with an applicable legal or regulatory provision or prudential rule or would be detrimental to the sound and prudent management of the subsidiary.
In the case of a significant regulated subsidiary (due to its risk profile or systemic importance or due to its size relative to the parent company), the board of
the significant subsidiary should take such further steps as are necessary to help the subsidiary meet its independent corporate governance responsibilities
and the legal and regulatory requirements that apply to it.
18
Basel III
Principle 6
Risk Management
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.
This function is responsible for overseeing risk-taking activities across the enterprise. The independent risk management function (bank-wide and within
subsidiaries) should have authority within the organization to oversee the bank’s risk management activities.
Key activities of the risk management function should include:
• identifying material individual, aggregate and emerging risks;
• assessing these risks and measuring the bank’s exposure to them;
• supporting the board in its implementation, review, and approval of the enterprise-wide risk governance framework which includes the bank’s risk
culture, risk appetite, RAS and risk limits;
• ongoing monitoring of the risk-taking activities and risk exposures to ensure they are in line with the board-approved risk appetite, risk limits and
corresponding capital or liquidity needs.
• establishing an early warning or trigger system for breaches of the bank’s risk appetite or limits;
• influencing and, when necessary, challenging material risk decisions; and
• reporting to senior management and the board or risk committee, as appropriate, on all these items, including but not limited to proposing appropriate
risk-mitigating actions.
19
Basel III
Role of Chief Risk Officer

• The CRO has primary responsibility for overseeing the development and implementation of the bank’s risk management function.
• The CRO is responsible for supporting the board in its development of the bank’s risk appetite and RAS and for translating, the risk appetite into a risk
limits structure.
• The CRO, together with management, should be actively engaged in the process of setting risk measures and limits for the various business lines and
monitoring their performance relative to risk-taking and limit adherence.
• The CRO’s responsibilities also include managing and participating in key decision-making processes (eg strategic planning, capital and liquidity
planning, new products and services, compensation design and operation)
20
Basel III
Principle 7
Risk Identification, Monitoring and Controlling
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.
Risk identification should encompass all material risks to the bank, on- and off-balance sheet and on a group-wide, portfolio-wise and business-line level.
The risk assessment process should include ongoing analysis of existing risks as well as the identification of new or emerging risks. Concentrations
associated with material risks shall likewise be factored into the risk assessment. Risk identification and measurement should include both quantitative and
qualitative elements. Risk measurements should also include qualitative, bank-wide views of risk relative to the bank’s external operating environment.
Banks should also have a method to identify and measure hard-to-quantify risks, such as reputation risk.
Internal controls are designed to ensure that each key risk has a policy, process or another measure, as well as a control to ensure that such policy,
process or other measure is being applied and works as intended. The internal controls help ensure process integrity, compliance, and effectiveness.
Internal controls provide reasonable assurance that financial and management information is reliable, timely and complete and that the bank is in
compliance with its various policies and applicable laws and regulations.
Risk measurement and modelling techniques should be used in addition to, but should not replace, qualitative risk analysis and monitoring. Risk
measurement and modelling techniques should be used in addition to, but should not replace, qualitative risk analysis and monitoring.
As part of its quantitative and qualitative analysis, the bank should utilize stress tests and scenario analyses to better understand potential risk exposures
under a variety of adverse circumstances.
In addition to identifying and measuring risk exposures, the risk management function should evaluate possible ways to mitigate these exposures. In some
cases, the risk management function may direct that risk be reduced or hedged to limit exposure. When there is a decision to accept or take risk that is
beyond risk limits (ie on a temporary basis) or take risk that cannot be hedged or mitigated, the risk management function should report and monitor the
positions to ensure that they remain within the bank’s framework of limits and controls or within exception approval.
21
Basel III
Principle 8
Risk Communication
An effective risk governance framework requires robust communication within the bank about risk, both across the organization and through reporting to
the board and senior management.
Ongoing communication about risk issues, including the bank’s risk strategy, throughout the bank is a key tenet of strong risk culture. A strong risk culture
should promote risk awareness and encourage open communication and challenge about risk-taking across the organization as well as vertically to and
from the board and senior management.
Information should be communicated to the board and senior management in a timely, accurate and understandable manner so that they are equipped to
make informed decisions.
Material risk-related ad hoc information that requires immediate decisions or reactions should be promptly presented to senior management and the board
so that suitable measures and activities can be initiated at an early stage.
Risk reporting to the board requires the careful design in order to ensure that bank-wide, individual portfolio and other risks are conveyed in a concise and
meaningful manner.
Risk reporting systems should be dynamic, comprehensive and accurate, and should draw on a range of underlying assumptions.
22
Basel III
Principle 9
Compliance
The bank’s board of directors is responsible for overseeing the management of the bank’s compliance risk. The board should approve the bank’s
compliance approach and policies, including the establishment of a permanent compliance function.
An independent compliance function is a key component of the bank’s second line of defense. This function is responsible for promoting and monitoring
that the bank operates with integrity and in compliance with applicable, laws, regulations and internal policies.
Compliance starts at the top. The bank’s senior management is responsible for establishing a written compliance approach and policies that contain the
basic principles to be followed by the board, management, and staff, and explains the main processes by which compliance risks are to be identified and
managed through all levels of the organization.
While the board and management are accountable for the bank’s compliance, the compliance function has an important role in supporting corporate values,
policies, and processes that help ensure that the bank acts responsibly and observes all obligations applicable to it.
The compliance function should advise the board and senior management on compliance laws, rules, and standards, including keeping them informed of
developments in the area. The compliance function is independent of management and provides separate reporting to the board on the bank’s efforts in the
above areas and on how the bank is managing its compliance risk.
To be effective, the compliance function must have sufficient authority, stature, independence, resources, and access to the board. Management should
respect the independent duties of the compliance function and not interfere with them.
The compliance function includes those that could create reputational risk for the bank, including bribery, money laundering, country sanctions, fair
treatment of the consumer and practices raising ethical issues.
23
Basel III
Principle 10
Internal Audit
The internal audit function provides independent assurance to the board and supports board and senior management in promoting an effective
governance process and the long-term soundness of the bank. The internal audit function should have a clear mandate, be accountable to the
board, be independent of the audited activities and have sufficient standing, skills, resources, and authority within the bank.
The board and senior management should recognize and acknowledge that an independent and qualified internal audit function is vital to an effective
governance process.
An effective internal audit function provides independent assurance to the board of directors and senior management on the quality and effectiveness of a
bank’s internal control, risk management, and governance systems and processes, thereby helping the board and senior management protect their
organization and its reputation.
The internal audit function should be accountable to the board on all matters related to the performance of its mandate as described in the internal audit
charter. It must be independent of the audited activities and have sufficient standing, authority, and resources within the bank to enable the auditors to carry
out their assignments effectively and objectively.
The board and senior management can enhance the effectiveness of the internal audit function by:
• requiring the function to independently assess the effectiveness and efficiency of the internal control, risk management, and governance systems and
processes;
• requiring internal auditors to adhere to national and international professional standards, such as those established by the Institute of Internal Auditors;
and ensuring that audit staff have skills and resources commensurate with the business activities and risks of the bank.
24
Basel III
The board and senior management should respect and promote the independence of the internal audit function by,
• ensuring that internal audit reports are provided to the board without management filtering and that the internal auditors have direct access to the board
or the board’s audit committee.
• requiring timely and effective correction of audit issues by senior management.
• requiring a periodic assessment of the bank’s overall risk governance framework including, but not limited to, an assessment of:
o the effectiveness of the risk management and compliance functions;
o the quality of risk reporting to the board and senior management; and
o the effectiveness of the bank’s system of internal controls.
Principle 11
Compensation
The bank’s compensation structure should be effectively aligned with sound risk management and should promote the long-term health of the organization
and appropriate risk-taking behavior. Compensation systems form a key component of the governance and incentive structure through which the board and
senior management promote good performance, convey acceptable risk-taking behavior and reinforce the bank’s operating and risk culture. The board is
responsible for the overall oversight of the compensation system for the entire bank. In addition, the board should regularly monitor and review outcomes to
ensure that the bank-wide compensation system is operating as intended.
The board should review the compensation policy at least annually. The FSB principles on compensation are intended to apply to significant financial
institutions but they are especially critical for large, systemically important firms. The board should approve the compensation of senior executives, the
CEO, CRO and the head of internal audit, and should oversee management’s development and operation of compensation policies, systems, and related
control processes.
25
Basel III
Significant financial institutions should have a board remuneration committee as an integral part of their governance structure and organization to oversee
the compensation system’s design and operation on behalf of the board of directors
The compensation structure should promote long-term performance, be in line with the business and risk strategy, objectives, values and long-term
interests of the bank, and incorporate measures to prevent conflicts of interests
Principle 12
Disclosure and Transparency
The governance of the bank should be adequately transparent to its shareholders, depositors, other relevant stakeholders, and market
participants.
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.
Disclosure should be proportionate to the size, complexity, structure, economic significance and risk profile of the bank. At a minimum, banks should
disclose annually the following information:
• the recruitment approach for the selection of members of the board and their knowledge, skills, and expertise;
• the policy for ensuring board membership that represents appropriate diverse views, its objectives and the extent to which these objectives have been
achieved; and
• whether the bank has set up board committees and the number of times these committees have met.
26
Basel III
The bank should also disclose key points concerning its risk exposures and risk management strategies without breaching necessary confidentiality.
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
means. It is good practice to have an annual corporate governance-specific and comprehensive statement in a clearly identifiable section of the annual
report depending on the applicable financial reporting framework. All material developments that arise between regular reports should be disclosed to the
bank supervisor and relevant stakeholders as required by law without undue delay.
Principle 13
The Role of Supervisors
Supervisors should provide guidance for and supervise corporate governance at banks, including through comprehensive evaluations and
regular interaction with boards and senior management, should require improvement and remedial action as necessary and should share
information on corporate governance with other supervisors.
The board and senior management are primarily responsible for the governance of the bank, and shareholders and supervisors should hold them
accountable for this
Guidance on expectations for sound corporate governance: Supervisors should establish guidance or rules, consistent with the principles set forth in
this document, requiring banks to have robust corporate governance policies and practices. Such guidance is especially important where national laws,
regulations, codes or listing requirements regarding corporate governance are too generic or not sufficient to address the unique corporate governance
needs of banks.
Comprehensive evaluations of a bank’s corporate governance: Supervisors should have processes in place to fully evaluate a bank’s corporate
governance. Such evaluations may be conducted through regular reviews of written materials and reports, interviews with board members and bank
personnel, examinations, self-assessments by the bank, and other types of on- and off-site monitoring.
27
Basel III
Regular interaction with directors and senior management: Supervisors should interact regularly with boards of directors, individual board members,
senior managers and those responsible for the risk management, compliance, and internal audit functions.
Requiring improvement and remedial action by a bank: Supervisors should have a range of tools at their disposal to address governance improvement
needs and governance failures. They should be able to require improvement steps and remedial action and assure accountability for the corporate
governance of a bank. These tools may include the ability to compel changes in the bank’s policies and practices, the composition of the board of directors
or senior management, or other corrective actions.
Cooperation and sharing of corporate governance information with other relevant supervisors: Cooperation and appropriate information sharing
among relevant public authorities, including bank supervisors, can significantly contribute to the effectiveness of these authorities in their respective roles.
Such information sharing is particularly important between home and host supervisors of cross border banking entities
(Source: Basel Committee of Banking Supervision Consultative Document – Guidelines on Corporate Governance Principles for Banks)
28
Unit 5
Introduction to Business Ethics
Unit 5 – Introduction to Business Ethics
Table of contents

1 Corporate Culture & Values 4
1.1 – Defining Corporate Culture 6
1.2 – Components of Corporate culture 6
1.3 – What is the link between Corporate Culture, Values and Ethics? 9
2 Introduction to Business Ethics 10
2.1 – Ethical Principles in Business 11
2.2 – Need and Objectives of Business Ethics 12
2.3 – What Business Ethics is Not? 13
2.4 – Importance of Business Ethics 14
2.5 – Why does Business have such a negative image? 17
2.6 – How ethics can make Corporate Governance more meaningful? 19
2.7 – Characteristics of an Ethical Organization 20
2
Table of contents

3 Ethical Dilemma 23
3.1 – What is an Ethical Dilemma? 23
3.2 – Corporate Dilemma over Ethical Behaviour 24
3.3 – How do Corporations Observe Ethics to reduce Dilemmas? 25
3
1. Corporate Culture and Values

Companies have grown in size and influence to the extent that they have, effectively, passed out of direct control of their owners. Owners of large,
influential companies are themselves often huge institutions that prioritize financial returns over ethical or moral behaviour. These huge multinational
companies are controlled by directors who, agency theory tell us, incline towards maximizing short-term rewards rather than long-term gain as this will be
more likely to bring immediate and direct benefit to them.
We have seen how multinational and national corporations have an influence on the everyday lives of billions of people and that, consequently, the power
vested in a small number of individuals within these corporations is considerable and, to a large extent, may be unable to be controlled by either regulators
or even market forces because they straddle many jurisdictions, and operate in many markets. As a result, the ethics of management, and thus the morality
of the organization, is of considerable interest.
During the early part of this century the drive towards increased transparency and accountability of action, together with an increasing awareness of
environment-related issues, has accelerated from its beginnings in the early 1990s following the publication of the Cadbury Report (1992) and its adoption
as mandatory by the London Stock Exchange. This code was followed by other, similar codes around the world such as the Sarbanes– Oxley legislation in
the USA after the corporate scandals of the early part of this millennium.
Not all organizations are the same; even organizations of comparable size have different cultures and values, for an organization is not a machine, nor is it
a passive vehicle for carrying out tasks, it is an entity that embodies the collective values and efforts of the people who inhabit and control it.
Common sense might say that the culture and values of the organization are principally determined by those who are in a position to set the rules and to
enforce compliance, but this is too simplistic and undervalues the individual employee and the collective will. The people who inhabit the organization
cannot, ultimately, be bullied into compliance with a set of values and mores with which they disagree; management who adopt a bullying culture will tend
to find that the staff counteract this by avoidant behavior and the growth of sub-cultures that adopt their own sets of values and approaches to corporate
behavior. In effect, whilst paying lip service to management, staff institute practices that may seek to undermine unpopular managers or to damage the
institution in some way without overtly seeming to do so.
4
So in understanding organizations, we must also take into consideration the prevailing views, customs, and values of the soci ety within which the
organization operates and within which the employees live.
Learning Objectives
• Define corporate culture
• Identify the components of corporate culture

• Identify the characteristics of an ethical organization
• Explain ethical dilemma
• Identify steps to resolve ethical dilemmas and problems
5
1.1 Defining Corporate Culture

Corporate culture is more than simply a set of company rules, the mission statement and corporate objectives, or even set of common values; it is a more
complex mix of factors that combine together to form the prevailing culture of the organization. Some of these attributes of culture are visible but one key
aspect of corporate culture is not.
Culture incorporates:
• Unwritten rules;
• Assumptions about expected behavior;
• Styles and attitudes formed from national culture; and
• Prevailing orthodoxies or moralities in the society and environment that surrounds the organization and from which most of the employees come.
1.2 Components of Corporate Culture

Iceberg Model of Corporate Culture shows the combination of factors that are similar to the iceberg in so far as only a portion of it is visible and a large
proportion isn’t. Clearly this is not a representation of proportions, it is a picture of the construct of corporate culture, but it makes the point.
The visible aspects of culture are what you see when you walk in the door. They include the:
• Attitude of the staff
• The expression of common corporate objectives
• The staff handbook containing all the policies
• The management style and how this affects the employees of the organization.
6
Figure 1: Iceberg Model of Corporate Culture
Espoused (Promoted) Values

These are the overt values of the organization, the ones they make public. They are the mission statement, the corporate objectives, and goals, in other
words, they are the stated aims and aspirations of the organization that someone new to it is told about and which existing staff has been made familiar with
through training and management reminders. These are not financial goals but the commitments the organization makes to its stakeholders and towards
which corporate effort is directed.
Financial strategies may be subordinated, in some cases, to these goals; for example, the organization may eschew employing part-time, contract workers
in favor of full-time employees because of a commitment to creating jobs and developing individuals, even though this is a much more expensive staffing
option.
7
Artefacts
This is a slightly peculiar word that has its derivation from the period when studies of organizations were a branch of social anthropology. Artefacts to an
archaeologist or an anthropologist could be cooking pots or knives but to an organization, they are the visible manifestation of the espoused values that are
comprised, for example, in the hierarchical structure of the organization, its arrangements for management and supervision and the policies and procedures
in the staff handbook. Employees will be familiar with these.
The management structure can be an indicator of the style of the organization – is it bureaucratic and controlled with many layers of management or is it a
flatter, less rigid organization with a more informal style? Policies, procedures, and protocols are part of the way the organization carries on its activities and
the extent to which they control the activities of the employees is, again, an integral part of the prevailing culture.
Unwritten Rules
What is not apparent are the hidden or unwritten rules of the organization that can derive from the prevailing national culture or is unwritten rules of the
business.
Other unwritten rules may be more sinister, such as ‘you never argue with the Chief Executive’. This kind of implicit or unspoken understanding is part of
corporate culture and is the part that new employees take time to understand. This is not to say that they are necessarily wrong, bad or in any way
detrimental; they simply represent a kind of unspoken consensus within the workforce that everyone understands, and they are part of the way things are
done.
Unwritten rules can be used to resist management pressure for change where the workforce do not accept changes and will effectively sabotage
management’s efforts without any of it being over simply because the workforce is reluctant to alter its shared hidden values. This is one of the reasons
why institutionalized attitudes, towards race and gender, in particular, are very difficult to change.
8
Six Components of Corporate Culture

The six components of corporate culture are:
1. Vision: Great culture starts with a vision or mission statement.
2. Values: The Company’s values are core of its culture.
3. Practices: Values of the company are important but it is of little importance if it is not practiced.
4. People: Company cannot build a coherent culture without the people in the company who share the core values and have the willingness and ability to
embrace these values.
5. Narrative: Ability to unearth the history of the company and craft it into a narrative is a core element of corporate creation.
6. Place: Geography, architecture or aesthetic design impacts the values and behaviors of the people in a workplace.
1.3 What is the link between Corporate Culture, Values & Ethics?
Culture has always been important in how organizations operate. So why is it getting so much attention lately? One reason is that regulators have come to
the realization that without a culture of integrity, organizations are likely to view their ethics and compliance programs as a set of check-the-box activities, or
even worse, as a roadblock to achieving their business objectives.
Being one of the biggest determinants of how employees behave, strong cultures have two common elements: there is a high level of agreement about
what is valued, and a high level of intensity with regard to those values.
While executive leadership may work hard to establish a culture of integrity at headquarters, something often gets lost in translation as one moves farther
away from the central office. This is why attention to culture needs to be active and continuous, especially in large organizations with distant outposts.
9
Values—with ethics and integrity at their core—must be clearly and consistently communicated. Messaging needs to be explicit and repeated so that it
becomes embedded in how work gets done.
Values need to be articulated in a manner that transcends nationality— for example, the concepts of honesty and trustworthiness are universally
acknowledged. Nevertheless, it is important to recognize that cultural differences will influence how messages are heard and interpreted, and adjustments
may need to be made in training, employee onboarding, and performance reviews.
2. Introduction to Business Ethics
Earlier, we identified what we mean by corporate culture in any organization from the top executive to bottom line employees, ethics is considered as
everybody business. It is not just only achieving a high level of economic performance but also to conduct one of the business’s most important social
challenges, ethically at the same time. Here what we get a combination of two familiar words – “Ethics and Business” in “Business Ethics”. Different
meaning is given to business as follows:
• Business ethics are the application of general ethical rules to business behavior.
• Business ethics are rules of business by which propriety of business activity may be judged.
By Cater McNamara – “Business ethics is generally coming to know what is right or wrong in the workplace and doing what is right – this is in regard to
effects of products/services and in relationship with stakeholders.” “Attention to ethics in the workplace sensitizes managers and staff to know they should
act so that they retain a strong moral compass. Consequently, business ethics can be strong preventive medicine.”
According to John Donald's on Business Ethics, in short, can be described as the systematic study of ethical matters pertaining to the business industry or
related activities, institutions and beliefs. Business ethics is the systematic handling of values in business and industry.
• Business ethics concentrate on moral standards as they apply to business policies, institutions, and behavior. It is a specialized study of moral right or
wrong. It is a form of applied ethics.
10
• Business ethics are nothing but the application of ethics in business. It proves that business can be and have been ethical and still make profits. Today
more and more interest is being given to the application of ethical practices in business dealings and the ethical implications of business.
2.1 Ethical Principles in Business

Ethical principles can be classified into two categories: teleological and deontological. The teleological theories determine the ethics of an act by looking at
the consequences of the decision (the end), while deontological theories determine the ethics of an act by looking to the process of the decision (the
means).
1. Teleological (Utilitarianism) Ethical System: The teleological morality of a decision is determined by measuring the probable outcome. The theory
most representative of this approach is utilitarianism, which seeks the greatest ‘good’ (or utility) of the greatest number. The most basic form of
utilitarian analysis is a cost-benefit analysis, where one tallies the costs and benefits of a given decision and follows the decision that provides for the
greatest overall gain. Utilitarianism holds that actions are right in proportion as they tend to promote happiness, wrong as they tend to produce the
reverse of happiness.
2. Deontological Ethical System: A deontological system is based on rules or principles that govern decisions. In this system, ethics are measured by
the rightness of an act and depend little on the results of the act. According to this, a moral person is one of goodwill, and that person makes ethical
decisions based on what is right, regardless of the consequences of his decision. Thus, the student who refuses to cheat during examinations is
morally worthy if his or her decision springs from but a sense of duty. But it is morally unworthy if the decision is merely one born of self-interest, such
as fear of being caught.
3. Hybrid Theory: Robert Nozick holds that justice and fairness, right and wrong are measured not by equality of results for all, but from ensuring equal
opportunity for all to engage in informed choices about their own welfare. Enlightened ethical egoism holds that it is important to the individual that the
world is a ‘good’ world; therefore the individual may have a self- interest in curbing pollution or participating in community projects, even though she or
he may not individually and personally benefit from the decision.
11
4. Distributive Justice and Social Contract: Prof. Rawls of Harvard University propounded this theory. According to it, that when people get together,
they form societies and engender cooperation, but when they come together conflict also arises because people do not receive a just distribution of the
benefits yielded through their activities. Rawls believes that the base of all distribution systems should be just and the primacy of justice in the basic
structure of our system of society necessitates greater equality.
5. Individual Freedom: According to this theory, all individuals must be allowed to make informed choices by society. Such choices must be within the
law and the same freedom enjoyed by one individual in the society must be extended to all within the society. Informed choices mean everybody
shares the information and is allowed to make his or her own choice, but without transgressing the law of the state.
2.2 Need and Objectives of Business Ethics
The Need for Business Ethics

The needs for business ethics arises on account of:
• The business operates within the society
• Every business irrespective of size exists more on ethical means or in total regards to all its social concern to survive long.
• Business needs to function as a responsible corporate citizen in a country.
Objectives of Business Ethics

According to Peter Pratley – Business ethics has two fold objectives – “it evaluates human practices by calling upon moral standards”, also it may give
prescription advice on how to act morally in a specific kind of situation”.
12
• Analysis and evaluation: Ethical analysis and ethical diagnosis of past events, happenings, clarifying the standards, uncover the moral values, habits
of thought. How to evaluate the situation? Ethics provides rational methods for answering the present situation and related future issues. Well-equipped
information is a must to achieve this second objective, a careful assessment of relevant information will lead to balanced judgments.
• Approaches to resolving ethical dilemmas: It provides therapeutic advice when facing the present dilemmas and future dangers. Only the condition
which requires a true identification of relevant stakeholder and a clear-cut understanding of crucial issues at stake.
2.3 What Business Ethics is NOT?

It is also equally important to clarify what is not ethics.
• Ethics is Different from Religion
Though all religions preach high ethical/moral standards generally, they do not address all the types of problems people confront today. For instance,
cyber crimes and environment related issues are totally new in the context of most religions. Moreover, many persons today do not subscribe to
religious beliefs and have turned agnostics. But ethics applies to all people, irrespective of their religious affiliations.
• Ethics is Not Synonymous with Law

Generally, a good legal system may incorporate many moral/ethical standards. However, there are several instances where lay deviates from what is
ethical. Legal systems may vary from society to society depending upon its social, religious and cultural beliefs. For instance, the United States law
forbids companies from paying bribes either domestically or overseas; however, in other parts of the world bribery is an accepted way of doing
business. Similar contradictions may be seen in child labor, employee safety, work hours, wages, discrimination, and environmental protection laws.
Law can be corrupted and debased by dictators and made to cater to serve interests of narrow groups. Sometimes, the law could be unreasonable and
even stupid, as, for instance, it is illegal in Israel for a hen to lay an egg on a Friday or Saturday. It is also slow to respond to the ethical needs of the
society. People are often skeptical about the objectives of any legal system and comment ‘Law is an Ass’, while few people question ethical standards.
13
• Ethical Standards Are Different from Cultural Traits

The English adage ‘When in Rome, do as the Romans do’ leads to unethical cultural behavior. Some cultures may be ethical, but many of them or not.
They may be quite oblivious to ethical concerns. For instance, our system of castes reflects an unethical streak inasmuch as it tends to take for
granted that some people are superior to others in God’s creation.
• Ethics Is Different from Feelings
Our ethical choices are based on our feelings. Most of us feel bad when we indulge in something wrong. But many, specially hardened criminals, may
feel good even when they do something wrong. Most people when they do something wrong for the first time may feel bad, but if they find it to be
beneficial or if it brings them pleasure, they may make it a habit without feeling any remorse.
• Ethics Is Not A Science in The Strictest Sense Of The Term
We draw data from the sciences to enable us to make ethical choices. But science is not prescriptive and does not tell us what we ought to do in
certain situations leading to ethical dilemmas. But ethics being prescriptive offers reasons for how humans ought to act under such situations.
Moreover, just because something is scientifically or technologically possible, it may not be ethical to do it; human cloning, for instance.
2.4 Importance of Business Ethics

“Good business ethics promotes good business”, this statement is supported by the research findings of some well-known authorities – Raymond
Baumhart, Brener and Molander, and Strom and Ruch. It was clear from their findings that only those businesses can develop on a long-term base which
conducts activities on ethical grounds.
Once Robert Day has said that good ethics not only promotes professionalism in management, but it purifies the inner mind of every businessman.
Another writer Thomas Donaldsom (ethics in business a new look) has observed that – “there are some key reasons why business ethics is vital and why
ethics play a key role in business.”
14
Following are the reasons:

• Positive consequences: Business depends on the approval of society, acceptance of rules, mutual trusts, and confidence. Prof. Robert Day writes-
“when ethical conduct is displayed, it puts some kind of trust and confidence in the relationship.” So, business with ethics always leads to positive
consequences.
• Goodwill of the business and businessman: Good ethical behavior will increase the goodwill of both business as well as the businessman. Strong
public image is a symptom of success in the long run. On the other hand, once an organization’s image is tarnished it would have direct consequences
on sales, profits, morale or day-to-day running of the business.
• Protection - Both Sides: If ethical implications are there in the organization; businessmen act more sincerely, and the level of commitment would be
higher. Ethics protects people in dealing with each other. Prof. Robert Day writes “Good ethics is sound business insurance.”
• Self-satisfaction: In the dynamic world, businessmen are seeking self-satisfaction, mental relief, free from anxiety, release tension. To attain the inner
satisfaction certain people, consider only good ethics can promote good business. As a businessman is first a member of the society than a
businessman, so some do not implement a decision which stands on the unethical ground because it wouldn’t provide the satisfaction to their sub-
conscious mind.
• Encourage others: When a few people start following ethics side by side to profit-making, they encourage, motivate others and set examples for them.
As Prof. Learned and Associates writes— “Businessman who follows the ethical principles in the conduct of business, motivates others also, to follow
the same principles”. Business Ethics 6/JNU OLE
• Success & Development: Ethical conduct of business leads to development and a series of success. Learned writes— ‘A sincere person who does
hard work becomes ethical and always succeed in his efforts, but an unethical person cannot’.
• New Management: In the era of the global economy, new principles are required in new management. Prof. ‘Day’ writes that management cannot
become a profession so far as it does not follow good ethics. An important feature of a profession is that it has a laid down code of conduct which
remains on all the principles of “service to humanity. So, to run the good business in the modern scenario you must develop and follow ethics.
15
3 Cs of Business Ethics
Following are the 3 C’s of business ethics:
Compliance (The need for compliance of rules including):
• Laws
• Principles of morality
• The policy of the company
Contribution (Business can make to society):
• The core values
• Quality of products/services
• Employment
• The usefulness of activities to surrounding activities
• QWL (Quality of work life)
Consequences (of business activity):
• Toward the environment inside and outside the organization
• Social responsibility toward shareholders, bankers, customers, and employees of the organization
• Good public image, sound activity, good image
16
2.5 Why does business have such a negative image?

The fact that by and large business has a negative image cannot be overstressed. Books, journals, movies and TV shows invariably depict business in a
bad light. Even though businessmen may not want to be unethical, factors such as competitive pressures, individual greed, and differing cultural contexts
generate ethical issues for organizational managers. ‘Further, in almost every organization some people will have the inclination to behave unethically (the
ethical egoist) necessitating systems to ensure that such behavior is either stopped or detected and remedied’.
Why should businesses act ethically?
An organization has to be ethical in its behavior because it has to exist in the competitive world. We can find a number of reasons for being ethical in
behavior, few of them are cited below: Most people want to be ethical in their business dealings. Values give management credibility with its employees.
Only perceived moral righteousness and social concern brings employee respect. Values help better decision making.
There are a number of reasons why businesses should act ethically:
• to protect its own interest;
• to protect the interests of the business community as a whole so that the public will have trust in it;
• to keep its commitment to society to act ethically;
• to meet stakeholder expectations;
• to prevent harm to the general public;
• to build trust with key stakeholder groups;
• to protect themselves from abuse of unethical employees and competitors;
• to protect their own reputations;
• to protect their own employees; and
• to create an environment in which workers can act in ways consistent with their values.
17
Besides, if a corporation reneges on its agreement and expects others to keep theirs, it will be unfair. It will also be inconsistent on its parts if the business
agrees to a set of rules to govern behavior and then to unilaterally violate those rules. Moreover, to agree to a condition where business and businessmen
tend to break the rules and also get away with it is to undermine the environment necessary for running the business.
Hard decisions which have been studied from both an ethical and an economic angle are more difficult to make, but they will stand up against all odds
because the good of the employees, public interest, and the company’s own long- term interest and those of all stakeholders would have been taken into
account.
Ethics within organizations is a must. It should be initiated by the top management, and percolate to the bottom of the hierarchy. Then alone, will the
company be viewed as ethical by the business community and the society at large. ‘Further, a well-communicated commitment to ethics sends a powerful
message that ethical behavior is considered to be a business imperative’. If the company needs to make a profit and to have a good reputation, it must act
within the confines of ethics. Ethical communication within the organization would be a healthy sign that the company is marching towards the right path.
Internalization of ethics by the employees is of utmost importance. If the employer has properly internalized ethics, then the activities that individuals or
organizations carry out will have ethics in them.
How do corporations observe ethics in their organizations?
Organizations have started to implement ethical behavior by publishing in-house codes of ethics which are to be strictly followed by all their associates.
They have started to employ people with a reputation for high standards of ethical behavior at the top levels. They have started to incorporate consideration
of ethics into performance reviews. Corporations which wish to popularize good ethical conduct have started to reward ethical behavior. Codes promulgated
by corporations and regulatory bodies continue to multiply. Some MNCs such as Nike, Coca Cola, GM and IBM, and Indian companies such as ICICI,
TISCO, Infosys, Dr Reddy’s Lab, NTPC, ONGC, Indian Oil and several others want to be seen as ‘socially responsible’ and have issued codes governing
all types of activities of their employees.
Securities and Exchange Board of India (SEBI), the Indian capital market regulator, The Confederation of Indian Industries (CII) and such organizations
representing corporations have issued codes of best practices and enjoin their members to observe them.
18
These normative statements make it clear that corporate leaders anxious for business growth should not make plans without looking at the faces and lives
of those oppressed by poverty and injustice. In fact, today, managers and would- be entrepreneurs are groomed to be ethical and socially responsible even
while being educated.
The Indian Institutes of Management (IIMS) and highly rated B- schools such as Xavier Labor Relations Institute (XLRI) and Loyola Institute of Business
Administration (LIBA) have courses in their curriculum and give extensive and intensive instruction in business ethics, corporate social responsibility, and
corporate governance. Many corporations conduct in Ethics Audit and at the same time, they are continuously looking for more ways to be more ethical.
2.6 How ethics can make Corporate Governance more meaningful?

1. Corporate governance is meant to run companies ethically in a manner that all stakeholders, creditors, distributors, customers, employees and even
competitors, the society at large – are dealt with in a fair manner.
2. Good corporate governance should look at all stakeholders and not just shareholders alone. Otherwise, a chemical company, for example, can
maximize the profit of shareholders, but completely violate all environmental laws and make it impossible for the people around the area even to lead a
normal life. Ship-breaking at Valinokkam, near Arantangi in Tamil Nadu, leather tanneries and hosiery units in Tirupur, has brought about too much of
environmental degradation, and along with it, untold miseries to people in and around the location.
3. Corporate Governance is not something which regulators have to impose on management, it should come from within. There is no point in making
statutory provisions for enforcing ethical conduct. There had been dozens of violations of SEBI rules, RBI guidelines, etc., when company
management was not inclined to follow them. On the other hand, there have also been several instances where companies had gone beyond these
rules to serve stakeholders since the top management preferred them that way.
4. There are several provisions in the Companies Act, e.g.,

a. Disclosing the interest of directors in contracts in which they are interested;
19
b. Abstaining from exercising voting rights in matters they are interested; and
c. Statutory protection to auditors who are supposed to go into the details of the financial management of the company and report the same to the
shareholders of the company.
But most of these may be observed in the letter, not in spirit. Members of the board and top management should ensure that these are followed both in
letter and spirit.
*** Task
You must have heard about the unethical practices at Satyam Computers that came in to limelight a few years ago. Find out
the details about the case and analyse how is it related to corporate governance.
2.7 Characteristics of an Ethical Organization

Mark Pastin in his work, The Hard Problems of Management – Gaining an Ethical Edge provides the following characteristics of ethical organizations:
1. They are at ease interacting with diverse internal and external stakeholders’ groups. The ground rules of these firms make the good of these
stakeholder groups part of the organization’s own good.
2. They are obsessed with fairness. Their ground rules emphasize that the other persons’ interests count as much as their own.
3. Responsibility is individual rather than collective, with individuals managing personal responsibility for actions of the organization. These organizations’
ground rules mandate that individuals are responsible for themselves.
4. They see their activities in terms of purpose. This purpose is a way of operating that members of the organization highly value. And purpose ties the
organization to its environment.
20
There will be clear communications in ethical organizations. Minimized bureaucracy and control paves way for sound ethical practices.
Benefits from Managing Ethics in the Workplace

Several benefits accrue to an enterprise if it is managed ethically. They are the following:
1. Attention to business ethics has substantially improved society - Establishment of anti-trust laws, unions, and regulatory bodies have contributed
to the development of society. There was a time when discriminations and exploitation of employees were high, the fight for equality and fairness at the
workplace ended up in establishing certain laws which benefited the society.
2. The ethical practice has contributed to high productivity and strong teamwork - Organizations being in the collection of individuals, the values
reflected will be different from that of the organization. Constant check and dialogue will ensure that the value system of the employee matches the
values of the organization. This will, in turn, result in better cooperation and increased productivity.
3. Changing situations require ethical education - During turbulent times, when chaos becomes the order of the day, one must have clear ethical
guidelines to take right decisions. Ethical training will be of great help in those situations. Such training will enable managers managing corporations to
anticipate situations and equip themselves to face them squarely.
4. Ethical practices create a strong public image - Organizations with strong ethical practices will possess a strong image among the public. This
image would lead to strong and continued loyalty of employees, consumer, and the general public. Conscious implementation of ethics in organizations
becomes the cornerstone for the success and image of the organization. It is because of ethical perception that the employees of TISCO and the
general public protested in 1977 when the then Minister for Industries in the Janata Government, George Fernandes, attempted to nationalize the
company.
21
Code of Conduct & Ethics for Managers

Having gone through the definitions of what is and what is not ethics, let us see now how ethics and values should form the bases of the code of conduct
that ought to govern the behavior of business managers. In the exercise of their duties and responsibilities, managers must observe the following ethical
values:
• Integrity: Integrity is the cornerstone of all values. A business manager should be morally upright. It is the characteristic that distinguishes a
professional manager from a mercenary.
• Impartiality: A manager should look at and treat all aspects of an issue in a fair and unprejudiced manner.
• Responsiveness to the public interest: Though a manager is paid to serve the interests of the stockholders of the company, the public interest is no
less important. In fact, managers should consider it as of paramount importance, if they have to be successful in their tasks.
• Accountability: Accountability is one of the basic characteristics of a good business manager. Business managers are responsible for all their actions
and are accountable to all the stakeholders—stockholders, creditors, employees, consumers, government and the society at large.
• Honesty: A cardinal ethical value that a manager should possess is quality. Managers should be fair, just and sincere both in character and behavior.
They should not indulge in cheating or stealing and should be free of deceit and untruthfulness.
• Transparency: Good business managers should be transparent and set standards for others to follow. They should be frank and open. Their actions
should be easily discussed and understood by others.
What values are to individuals, ethics is to business.
22
3. Ethical Dilemma
3.1 What is an Ethical Dilemma?

An ethical dilemma is a moral situation on which a choice has to be made between two equally undesirable alternatives. Dilemmas may arise out of various
sources of behavior or attitude, as for instance, it may arise out of the failure of personal character, conflict of personal values and organizational goals,
organizations goals versus social values, etc.,
A business dilemma exists when an organizational decision maker faces a choice between two or more options that will have various impacts on:
1. Organization’s profitability and competitiveness; and
2. It's stakeholders.
In situations of this kind, one must act out of prudence to take a better decision. As we can see, many of these ethical choices involve a conflict of values.
Doing what is A bad outcome or

Either Results in
morally right bad effects
Good or at least
Doing what is
Or Results in better effect or
morally wrong
outcome
23
Some of the ethical issues in an organization or at the workplace are:

• Identification of conflict issues and trying to avoid them.
• Deciding different methods of motivating the employees.
• Fairness in employee performance appraisals.
3.2 Corporate Dilemma over Ethical Behaviour

Several corporate managements are in a dilemma whether it is worth their while to act ethically and practice corporate governance in their companies.
Investing in ethical practices and being fair to all stakeholders will cost the corporates dearly. Therefore, most of them are in a dilemma. Moreover, in
business, more than elsewhere, we are faced with moral and ethical dilemmas daily. We are faced with moral choices not only between right and wrong but
also between right and right. An ethics poster in Boeing said it all: “Between right and wrong there is a troublesome grey area”
Those in business come across several ethical problems that cause ethical dilemmas. The following are some instance:
1) They feel that there is a lack of a clear linkage between business ethics and financial success, they know of several instances where unethical
business persons flourish and often enjoy fruits of other’s labor, while many others, scrupulously honest and ethical, have failed in their business and
fallen by the wayside; there is no magical formula that would help in resolving such a dilemma.
2) They are not clear as to how much they should invest in the business ethics system; they would like to know how much is good enough.
3) They are unclear about the right balance between business ethics and the investment required for the same; many business concerns may be a loss
to know when and where to strike a balance in the allocation of time, efforts and resources between the two.
4) The seemingly long gestation periods and the lack of short-term gains is an obstacle. Investment in ethical business may be large, in diverse areas
and multi-dimensional. They may bear fruits after a very long time. For instance, companies that are working in restoring ecological balance may have
to wait very long to know the fruits of their labor. Sometime, it may be even a fruitless wait.
24
3.3 How do Corporations observe ethics to reduce dilemmas?

Organizations have started to implement ethical behavior by publishing in-house codes of ethics that are to be strictly followed by all their associates. They
have started to employ people with a reputation for high standards of ethical behavior in the top levels. They have started to incorporate consideration of
ethics into performance reviews. Corporations that want to prioritize good ethical conduct have started to reward ethical behavior. Most of these
corporations conduct an ethics audit and at the same time, they are looking for more ways to be more ethical.
How to resolve an ethical problem?
• Is it a policy, a decision or an action?
• Is it ethical or unethical?
To resolve these questions that create a dilemma, ask three questions:
1. Utility – Does its benefits exceed the cost (shareholder)?

2. Right – Does it respect human rights (society)?
3. Justice – Does it distribute benefits and burdens evenly (employees)?
Answers to these questions in the affirmative will be the first step in the process of solving ethical problems.
How to resolve Ethical Dilemmas?

Ethical issues take center-stage in organizations today as managers, executives, and employees face increasingly complex decisions. Most of these
decisions are made with different value systems, moral philosophies, competitive pressure, and political ideologies, all of which provide ample opportunity
for misconduct.
25
Approaches to resolving Ethical Dilemmas

There are two basic approaches to resolving ethical dilemmas:
1. Deontological and
2. Teleological
Under the deontological (action-oriented) approach, an ethical standard is consistent with the fact that it is performed by a rational and free person. These
are inalienable rights of human beings and reflect the ‘characteristic and defining feature of our nature’. These fundamental moral rights are inherent in our
nature and are universally recognized as part of human beings, defining their very nature. These fundamental human characteristics are inter alia, rights of
fairness, equality, honesty, integrity, justice and the respect of our dignity. If we follow a deontological outlook while analyzing an ethical dilemma, we are led
to a much narrow focus. We confront such questions as: ‘Which actions are inherently good?’ ‘Does it respect the basic rights of everyone involved?’ ‘Does
it avoid deception, coercion, and manipulation?’ ‘Does it treat people equitably?’
Ethicists are of the view that the major problem with this approach is its inflexibility and uncompromising stance. There could be occasions when people
may lie to help someone in dire straits. A co-worker may feign ignorance if the management makes a big fuss about the loss of worthless scrap of asbestos
when he or she knows that one of his or her colleagues has taken them to provide roof material for inhabitants of several hutments who otherwise would
suffer when it rained cats and dogs. A deontological approach to either of these cases will still condemn these acts.
The other approach to ethical dilemmas and their resolution lies in teleological (results-oriented) ethics. This approach to ethics takes a pragmatic, common
sense, layman’s approach to ethics. According to this school of thought, ‘The moral character of actions depends on the simple, practical matter of the
extent to which actions actually help or hurt people. Actions that produce more benefits than harms are “right”; those that don’t are “wrong”. A teleological
approach to the above-mentioned examples will tend to condone those acts of charity.
From these two political standpoints to ethics, we can draw two methods of resolving ethical dilemma; one that focuses on the practical consequences of
what can be done, and the other that focuses on the actions.
26
While the first school of thought argues that as long as no harm is done, there is nothing wrong, the other considers that some actions are always wrong.
Which of these two is the right approach to resolve an ethical dilemma has been at the centre of debate among ethicists for centuries, with no definite
answer in sight? However, many of them do agree, as pointed out earlier, that both approaches provide complementary strategies to help solve ethical
problems. The Centre for Ethics and Business offers “a brief, three-step strategy in which both the deontological and teleological approaches converge. The
strategy is as follows:
Step 1 – Analyze the consequences

Assuming that the resolution to the ethical dilemma is to be found within the confines of the law – ethical dilemmas that arise in business should be
resolved at least within the bare minimum of law and legal framework that would follow one’s proposed actions. And when one has several options to
choose from, there will be an array of consequences connected with each of such options, both positive and negative.
Before one acts, answers to the following questions will help find the type of action that can be contemplated:
1. Who are the beneficiaries of your action?

2. Who is likely to be harmed by the action?
3. What is the nature of the ‘benefits’ and ‘harms’?
The answer to this question is important because some benefits may be more valuable than others. Letting one enjoy good health is better than
letting one enjoy something which gives trivial pleasure. Likewise, some ‘harms’ are less harmful than others.
4. How long or how fleetingly are these benefits and harms likely to exist?
After finding answers for each of one’s actions, one should identify the best mix of benefits or harms.
27
Step 2 – Analyze the actions

Once you identified the best possible option, concentrate on the actions. Find out how your proposed actions measure against moral principles such as
‘honesty, fairness, equality, respect for the dignity and rights of others, and recognition of the vulnerability of people who are weak, etc.,’. Then there are
questions of basic decency and general ethical principles and conflicts between principles and the rights of different people involved in the process of
choice of the options that have to be considered and answered in one’s mind.
After considering all these possible factors in the various options, it is sensible to choose the one which is the least problematic.
Step 3 – Make A decision
Having considered all factors that lead to choices among various options, analyze them carefully and then take a rational decision.
This three-step strategy should give one at least some basic understanding to resolve an ethical dilemma.
28
Unit 6
Ethical Issues in Functional Areas
Unit 6 – Ethical Issues in Functional Areas
Table of contents
1 Ethics in the Functional Area 5
2 Ethics in Marketing 6
2.1 – Sales and Ethics 6
2.2 – Advertising, Promotion and Ethics 7
2.3 – After Sales and Ethics 10
2.4 – Marketing Research and Ethics 11
3 Ethics in Information Technology 11
3.1 – Ten Commandments of Computer Ethics 12
4 Ethics in Banking & Finance 13
4.1 – Finance Department and Ethics 14
4.2 – Accounting and Ethics 15
4.3 – Costing and Ethics 15
4.4 – Auditing and Ethics 16
2
Table of contents
5 Business Ethics in India 17
5.1 – Ethical Indian Firms 18
5.2 – Unethical Indian Firms 19
5.3 – Why are some firms unethical in India? 19
6 Future of Business Ethics 22
6.1 – The Path Forward 22
7 Corporate Social Responsibility 25
7.1 – Justification 25
7.2 – Scope 27
7.3 – Major Social Responsibilities of Business 30
7.4 – CSR and Indian Corporations 33
3
Introduction
Ethics in the functional areas of any business is necessary to ensure a good rapport between the management and the employees. In fact, all functional
areas, namely marketing, finance, human resources as well as information technology should follow code of ethics so as to function well and give
maximum output.
Only one person alone cannot achieve this. Each employee should feel responsible and try to stand by what is right in any given situation. In other words, it
should be a team effort across all levels of the organization.
Learning Objectives
• Identify the ethical guidelines applicable to various functional areas
• Explain corporate social responsibility
4
1. Ethics in the Functional Area

Ethical issues can arise in various functional areas of a business such as marketing, research and development, human resources, production and finance.
Ethical issues in all these functional areas must be controlled or coordinated by the Chief Executive Officer (CEO) of the enterprise.
Figure below shows the main functional areas of a business that usually give rise to ethical issues.
Chief Executive Officer (CEO)
Human
Research &
Marketing Resource Production Finance
Development
Management
Figure 1.1 – Different Functional Areas of Business
5
2. Ethics in Marketing
Marketing is a technique that is used to attract and persuade customers. Marketing provides a way in which a product is sold to the target audience.
Marketing is a management process that identifies, anticipates and supplies consumer requirements efficiently and effectively. The main aim of marketing is
to make customers aware of the products and services. It also focuses on attracting new customers and keeping existing customers interested in the
product. The marketing department consists of various subdivisions, such as sales, after-sales service, advertising and promotion, marketing and research.
2.1 Sales and Ethics

In the field of sales, the following ethical issues require safeguards against unethical behaviors:
• Not supplying the products made by the company as per the order
• Not accepting responsibility for the defective product
• Not giving details about the hidden costs, such as transportation cost, while making the contract with the client
• Changing the specifications of the product without giving any prior information to the customer
• Changing the terms of the business without taking any approval from the client
• Delaying the delivery of the goods without giving any proper reason
• Treating two customers differently

• Not providing the after sales service as per the contract
• Selling the same product at different prices to different customers
6
2.2 Advertising, Promotion and Ethics

Advertising and promotion provide the means for communicating with the customer. In the field of advertising and promotion, the following are examples of
unethical communication practices:
• Making false commitments to the customers about the benefits of the product
• Supplying products that are different from those that are advertised
• Giving wrong prices to the customers during advertising
• Not giving the promised gift in the promotional campaign
• Hiding major flaws of the product
• Providing wrong testimonials about the product to prospective customers
• Not providing the advertised service to the customers as a part of the promotional plans
• Increasing the price of the product before starting its promotional campaign
• Making false references about the competitive products
In the advertising field, the ethical issues include decision on what business and market, a corporate organization should enter. Another ethical issue can be
the decision on what product should be provided by a corporate organization to its customers. Though it is important that ethical standards be provided for
the advertising of a particular product, it is not easy to establish common ethical standards which are agreed upon by different organizations.
According to Ferrel and Gresham, “There is no clear consensus about ethical conduct; that ethical standards ae neither absolute not constant; and that
attempts to determine whether particular marketing activities are ethical or non-ethical cannot produce a definitive code of marketing behavior”.
In the advertising field, marketing promotion is the area where a large amount of public scrutiny takes place. Media persons report immediately any lack in
ethical standards while selling products, in public relations and advertising. Organizations follow various methods that are unethical while advertising for
7
their products and services. These methods are:

1. Ambiguity
2. Concealed facts
3. Exaggeration
4. Psychological appeal
Ambiguity
Ambiguous advertisements are mostly deceiving for customers. Advertisements become ambiguous when they are wrongly interpreted and also with, the
use of words through which organizations can avoid making direct statements. For example, you can consider the word ‘help’. This word is used by
organizations to ambiguously advertise their products. It can be used in the following ways in advertisement:
• Help us keep young

• Help you improve your complexion
• Help prevent cavities
• Help keep our house insect free
Organizations must provide clear information about products even though their advertisements can be interpreted differently by individuals. Ambiguity in
advertisements can affect the health, loyalty and expectations of people who will be purchasing the product that has been advertised.
Concealed Facts
Organizations can conceal information related to a product that may result in less selling of that product thereby resulting in loss. The advertising practice of
concealing facts us unethical because it, in a way, allows the exploitation of people. There are mainly two considerations regarding advertisements that
8
force organizations to conceal facts.

• The first consideration is that information that will help in selling a product in the best way should be provided.
• The second consideration is that the information about a product should be provided in such a manner that:
o Individuals, who will be purchasing the product do not feel that false promises have been made to them and that they have been let down
o Advertisements related to a product are able to avoid objections from agencies that are responsible for monitoring and advertising
Organizations may conceal facts that may be important in fulfilling the needs of customers. This way the organizations may be exploiting the customers and
causing serious health injuries to them. Customers may also not be able to obtain the products of their choice.
Exaggeration
Organizations may mislead the customers by providing exaggerated information in the advertisements of their products. The exaggerated information is
information that is not supported by evidence. Organizations can exaggerate information in advertisements by using superlative phrases. For example, an
organization manufacturing pain relief ointments, can exaggerate information by stating that a pain reliever provides extra pain relief. The use of these
superlatives may not cause any harm to customers but may be misleading sometimes.
For example, if a washing powder manufacturing organization uses the phrase, ‘best loved by housewives’ then no harm may be caused to consumers of
washing powders.
Exaggeration
A psychological appeal is the appeal made considering the emotions of customers. The main objective of psychological appeal is to persuade customers to
purchase products by appealing to their emotions and not to reason. For example – consider a car advertisement which focuses on the desire of the elite
9
class to achieve status. Similarly, a life insurance company may use emotions, such as pity and fear in its advertisement to persuade people to take
insurance policies. Through psychological appeal, the organizations make promises about their product that are not fulfilled when customers but the
products.
2.3 After Sales and Ethics
While selling the product to the customer, a company provides some extended features or facilities along with the product, such as after-sales service.
These facilities are provided to increase the sale of the product. In the field of after-sales service, the following ethical issues require safeguards against
unethical behavior:
• Using below-standard material for the service and charging for relatively better material from the customer
• Using outmoded service equipment which can be harmful for the products during service
• Not taking the service calls if the location is not easy to reach, while free service was promised before the sale of the product
• Making only temporary adjustment in the product, which can last only for a short time or to make the product useful for the time being
• Not keeping proper service records of major products for future use, as they can help in easy diagnosis of problem
• Overbilling the service charges, when the customer is not aware of the actual rates
• Using rejected or below-standard components for customer’s temporary relief
• Refusing the service of the product due to personal reasons
• Exchanging healthy parts with below-standard parts when the product comes for servicing
10
2.4 Marketing Research and Ethics

Marketing research is done to find out the needs of the market, its trends and competitive activities. In the field of marketing research, the following are
example of unethical behavior:
• Research is conducted only to substantiate the viewpoint of the manager.

• Research is focused on the areas that do not need to be covered.
• Some old research is presented as the new one just for the purpose of financial gain.
• A biased research report is prepared to suit the marketing manager.

• The research report is sold to the competitor.
• The report does not include important facts.
3. Ethics in Information Technology

Information technology refers to the gathering, processing, creation, delivery and storage of information and all the processes that make all this possible.
The volume of work that is handled using IT continues to increase almost everyday. Whatever be the field, one is sure to find IT at work.
Information technology is new to the world in which the clear legal environment is yet to develop, so getting benefits by using IT cannot be surely ethical or
legal. Therefore, when we talk about ethics and IT, many new problems crop up.
The characteristic of IT is that it is a particular field which has no geographical boundaries but application of IT may affect culture and environment
differently. The features which are acceptable in one culture may be unethical in another.
11
Computer ethics was founded by MIT Professor Norbert Wiener in the early 1940s when he was providing a helping hand in the development of an aircraft
cannon, capable of gunning down fast-moving war planes. Wiener created a new branch of science called cybernetics—the science of information
feedback. By combining cybernetics with digital computers, he foresaw revolutionary social and ethical consequences.
Technology Ethics: Technology ethics is a new subject. The profile of technology ethics is as follows:
1. Thinking ethically about human biotechnology.
2. Taking responsibility for e-wastage like environmental damage from computer and other electronic wastages.
3. Employers must check whether employees are wasting time at recreational websites or sending unprofessional e-mails.
4. Sometimes the invasions of piracy occurs through to use of the Internet services.
In 1986, Masovi had classified ethical issues in the following four groups:
1. Accessibility: It involves the right of accessing the required information as well as the true payment of charges to access the information.
2. Privacy: It deals with the degree of privacy and dissemination of information about an individual.
3. Property: It talks about ownership and value of information.
4. Accuracy: The information which is viable and being accessed is now much more accurate and authentic.
3.1 Ten Commandments of Computer Ethics

The Computer Ethics Institute in Washington DC has laid down the following ten commandments of computer ethics:
12
10 commandments of computer ethics:

1. You will not use computer to harm other people.
2. You will not interfere with the computer network of other people.
3. You will not snoop around in files of other people’s computer.
4. You will not use a computer to steal.
5. You will not use a computer to bear false witness.
6. You will not copy or use proprietary software for which you have not paid.
7. You will not use other people’s computer resources without authorization.
8. You will not use other people’s intellectual output.
9. You will think about the social consequences of the program you are writing or the system you are designing.
10. You will always use a computer in ways that demonstrate considerations and respect for your fellow humans.
4. Ethics in Banking and Finance

Finance is an important element of an organization and it helps in its growth and development. Finance plays an important role in making resources
available in an organization, such as man, machine, material, market and money. The finance manager of the firm is responsible for arranging the finances
of the firm. The finance manager can raise funds from the following two sources:
• Internal Sources: Internal sources means the owner’s own funds that are invested as equity in the organization. In case of small organizations, the
owner’s contribution in terms of equity is low. Therefore, large amount of money is raised from external sources.
The entrepreneur can raise finance internally from various sources:

13
o Deposits and loans given by owner

o Personal loan from provident fund and life insurance policy
o Funds accumulated by the retention of profits
o Ploughing back of profits
• External Sources: External sources means the various financial institutions from where entrepreneurs can raise funds, such as fixed capital,
commercial banks and development banks. The entrepreneur can raise finance by:
o Borrowing money from friends and relatives
o Borrowing from financial institutions
4.1 Finance Department and Ethics
The finance department of an enterprise is prone to the following unethical practices:
• Overestimating promoters’ capital utilization
• Overbudgeting project costs
• Using underhand tactics with the financers to gain benefits for the firm as well as for themselves
• Purchasing capital equipment's at a time when there is no requirement for it
• Selling the capital equipment's in order to raise additional and unaccounted funds
• Siphoning funds for the promoter’s personal benefit
• Investing unapproved funds in order to gain extra profits
• Claiming insurance cover for losses that never happened
• Overpricing the current assets in order to gain more working capital than permitted
• Using working capital funds for personal gains
14
4.2 Accounting and Ethics

The accounts department of an enterprise is prone to the following types of unethical issues:
• Showing inflated salaries and getting receipts from employees for an amount larger than what they actually get
• Playing inflated vendor bills in order to get discounts or commissions
• Paying overtime wages when there in no requirement for them
• Maintaining two different sets of books, one for the management and the other for income tax
• Refusing to reject unacceptable raw materials when the vendor bills have to be paid
• Delaying the clearance of the bills payable in order to get maximum interest for the amount to be paid
• Allotting extra travelling allowances to favorite employees
• Showing wrong figures in the monthly trial balances for personal benefits
4.3 Costing and Ethics
The following are the unethical practices of the costing manager:
• Reducing manufacturing costs by manipulating work hours
• Ignoring cost of rejects
• Ignoring cost of rework
• Not accounting for man-hours lost due to strikes and absenteeism
• Not accounting for man-hours lost in maintenance work
15
• Not considering the work stoppages due to change in models

• Ignoring the man-hours lost due to change in the manufacturing process
• Ignoring time lost in failed experimentations
• Not taking into account the benefits of economies of sales and experience curve
4.4 Auditing and Ethics

The following points describe the unethical behavior of the auditing manager:
• Ignoring major deviations from the budgets
• Rejecting the tender having lowest cost among all due to personal reasons
• Helping in hiding black money in order to reduce the tax payable amount
• Ignoring inflated travel bills of selected employees
• Accepting payments made by the directors for personal purchases as official payments
• Enabling the directors in sending and receiving money from overseas through unofficial hawala channels
• Approving payments to suppliers without checking bills or deliverables
• Approving the sub-standard construction made by the constructor and approving their bills for payment
16
5. Business Ethics in India

India is now in a post-ethical stage. However, many business firms based particularly in semi-urban or rural surroundings are at the ethical stage and follow
many of the ethical principles like justice and fairness, non-discrimination, cordial personal relationship, honesty and social responsibility. But this is not the
story of small and medium business firms. Some of them are over-ambitious and want to get rich quick. They do not much care about ethics in business
and use corrupt practices, adulteration, tax evasion, account manipulation, and so on. Although Indian firms, particularly some of the big ones, are at post-
ethical stage because of the influence of globalization and fierce competition, some of the bid businesses in India are still at the ethical stage and do not
indulge in large-scale unethical practices.
A bit of historical development of corporate ethical practices will be necessary here to understand the evolution of corporate mentality and, hence, the
corporate ethics. There are three distinct periods of industrial development in India – pre-independence, the period between 1947-1990 and the post 1991
period (period of economic liberalization). In the pre-independence period, there was hardly any industrial growth and corporate ethics was not elaborate,
and there was strict control by the British colonial power.
The industries like the Ahmedabad Textile Mills, Jute Mills in Kolkata and some other existing industries did practice some unethical labor relations and
exploitation but serios scams were absent. In the second period (1947 – 1990), India experienced many unethical industrial practices because of the lack of
strict government control, unethical bureaucratic practices, and flexible industrial rules and regulations.
Tax evasion, bribery and labor unrest were the usual practices. During the period of economic liberalization, many firms tried to be more internationally
competitive and they became outward-looking. So, these firms started following international ethical practices and standard, at least on paper, and because
of the conflux of efficiency and ethicality, many of the Indian firms like the Tata, Infosys and Ranbaxy, to name only a few, have become well-known. The
positive spread effect compelled many other firms to follow suit and this has been improving the corporate ethics in India by and large. But all this does not
mean that all firms are ethical in India.
In fact, there are two types of business firms in India – ethical small, medium and large firms, and unethical small, medium and large firms.
17
5.1 Ethical Indian Firms

They are both spiritual and many a time religious with the following managerial styles:
• Decisions are taken on the basis of the merit of the case and these are not unreasonable or unethical.
• At the working place, respect is shown to elderly people and senior officials.
• Work is regarded as worship and official duty is performed without much consideration for its material reward, as the Bhagvad Gita teaches.
• Human rights are respected and allowed and disputes are amicably settled on the basis of cooperation and negotiation.
• Women employees are allowed privacy and respect.
• Working place discrimination is avoided as far as possible.
• Firms are engaged in performing social and ethical responsibilities.
• Employees are treated well. And often empathy plays an important role.
• Sexual harassment is conspicuous by its absence.
• Management is value-based and embezzlement, bribery and corruption are mostly absent.
• Accountability and transparency are widely practiced.
• Reliable price and product qualities. Promises are kept with regard to after-sales services. Customer’s satisfaction is the motto of many firms.
Customers are regarded as Lakshmi (The Goddess of Wealth).
• The margin of profit is reasonable, and there is no attempt to cheat the customers.
Firms are guided by the idea of creation of goodwill and reputation.
18
5.2 Unethical Indian Firms

Unethical firms are characterized by many overwhelmingly unethical practices. The following are the manifestations of some of these practices:
• Discrimination is rampant in the matter of selection, promotion and job allocation. Nepotism and favoritism are widely prevalent.
• Adulteration, sub-standard and even dangerous products are marketed.
• Imitation of foreign brand names to hoodwink customers.
• Political pressure impinges on the ethical standard of firms. The appointment in the high post is often political.
• In some types of industries, like carpet manufacturing, use of child labor is rampant.
• Delay in wage payments and promotions are the usual practices in many small and medium firms.
• Window-dressing in the balance sheet is widely done to attract investors and increase the share prices.
• Many types of company scams have cropped up in India (for details, see Fernando, 2006). Some of the scams include issues by non-descript
companies (1993-94), Mutual fund scam (1998), Market manipulation scams of Harshad Mehta (1992 and 1998), insider trading scam (1994),
fraudulent share delivery scam (1995) and IT scam (2000).
Ethical Dichotomy (one firm having two-ethical standards) is one of the important characteristics of Indian firms. The dichotomy is both internal and
external. Internally, even the same ethical firm may have some unethical frills, and the unethical firms may have some ethical appendices. Examples are
abundant in India. Our categorization of ethical and unethical firms is based on overwhelming characteristics of the firms.
5.3 Why are some firms Unethical in India?

All firms are not basically unethical to begin with. But as it goes on doing the business, it is confronted with a number of problematic situations that almost
compel a firm to deviate from its chartered path of honesty and scruple. The circumstances are:
19
1. Bureaucratic pressure, including delay-dally tactics, compels a firm to spend some speed money to move the file. Even after liberalization,
bureaucratic tentacle has not yet been completely eliminated from India. Officials often demand bribe to perform a task.
2. To keep up with the Joneses, business firms often have to do the same thing as other firms are doing like benami transactions, tax-evasion,
accounts manipulation to record less income, reduced sales and so on.
3. While point 2 discussed above is the corporate practice to survive competition, the idea of going ahead of Smith, compels many unscrupulous
firms to devise ways and means to go a step further to win the race. These include creative destruction, like, forgery, window dressing in the
balance sheet, product adulteration (say instead of 500 mg of paracetamol as written on the label, the actual content may be 300 mg. of the real
medicine), manufacturing of duplicate products (like medicines) and so on.
4. Absence of strong and ethical corporate policy. If the policy is weak and the manager does not make any strong commitment to ethical practices,
a company cannot work coherently towards any ethical goal.
5. Absence of ethical leadership. This prevents many companies to draw ethical working plans and programs. It is very often true that if the
manager is ethically committed and very strong in character, the idea percolates down to the lower level and the whole company become ethical.
A company is what its director or manager is. The percolation effect is a very strong factor for ethicality or otherwise of a company. On one
occasion a senior executive of a Tata company thought of saving some money on taxes. He expressed the idea and showed his account records
to the then Chairman, JRD Tata. Mr. Tata said “It is not illegal but is it right? It is not after all a virtue” (Lala, 2004). The executive never came to
him with the same issue and request, and the ethical ambience of the company totally changed from then onwards.
Having had some inkling about the ethical practices in India and America, we can now summarize the basic differences in the Western and Indian cultural-
traditional outlook in Table below.
India thinks about value-based management, humanistic and socialistic pattern of society, and a type of balanced and total man who is imbued with the
idea or mortality and spirituality and plain living and high thinking. But the Western nations prefer to have a system of profit-based management, rationality
and materialism, and the type of man they want is a calculated economic person who always buys in the cheapest market and sells in the dearest market.
20
Such a type of man lives on the ideals of high living and plain thinking and is endowed with a capitalistic mentality. For the Western counties, development
means that you have to have more and more and but you still remain unsatisfied (like Oliver in Charles Dicken’s novel, Oliver Twist), but for India,
development means you should grow accordingly with a high level of human development.
Table below summarizes basic differences between the Indian and Western cultural traditions.
India Western Countries
Value-based management Profit-based management
Socialistic and Holistic Capitalistic
Morality Rationality
Balanced Man Economic Man
Spiritualism Materialism
Emphasis on ethics Emphasis on economics
Human development Material development (acquisition)
Plain living, high thinking High living and plain thinking
Cooperation Conflict
Focusing on society Focusing on self and market
21
6. Future of Business Ethics

After decades of investing in compliance and ethics, the corporate world nonetheless finds itself confronting challenges that can pose reputational risk.
Companies face ever-louder calls to adopt and enforce ethical business practices. Despite a growing focus on organizational culture, many still
compartmentalize their efforts. No single department can own responsibility for installing and maintaining an ethical culture in an organization. Ethics and
compliance should be common goal for all and everyone in an organization.
Companies professing a deep commitment to sustainable, ethical business practices to help foster genuinely positive organizational culture must
understand that, where integrity is concerned, we must think beyond the “business case.” Sometimes a company simply needs to walk away from a
lucrative opportunity that would contradict its core principles. The public increasingly distrusts private sector rhetoric on ethical business, and there is a
pressing need for leaders that will take, and adhere to, clear decisions about core values and priorities.
6.1 The Path Forward

Ethical concerns over business practices are not going away. The transformation of the transparency environment and an exponential growth in data leaks
and hacks mean that companies now need to behave as if everything they say or do might become subject to public scrutiny. This includes internal emails,
lobbying and political advocacy efforts, and efforts to avoid tax burdens via offshore investment structures. Companies must also struggle to manage their
reputations amid a public debate that has grown more diffuse and fragmented. It no longer suffices to treat reputation management as primarily an issue of
communications and public relations.
This means that every employee in the company needs to consider ethical issues from a strategic perspective, making special effort to behave in a way
that is consistent with their statements of purpose. Codes of conduct and values statements should be backed with meaningful commitments, resources,
and processes. Particular attention needs to be paid to potential contradictions between what a company says and what it does. For example, an avowed
commitment to not mis-sell and protecting customer data should amount to more than a policy statement; it should be accompanied by efforts to
understand and address impacts, engage with the supply chain, and (most importantly) disclose and address ongoing challenges. No company is free of
such conflicts. A focus on only good news and progress will rightly be greeted with skepticism.
22
There is no doubt that the public image of banks has deteriorated. While we cannot place all the blame for the financial crisis solely on the banking sector, a
series of ethically questionable practices can indeed be attributed to some banks and especially some of their top executives (e.g. fraud in the sale of
preferred stocks, the securitization of toxic financial assets, abusive mortgage clauses, millionaire compensation packages, cruel evictions, fiscal paradises,
etc.)
Banks still can and do perform a very valuable role to society, but with trust so low how can banks recover the confidence of their clients to be able to
perform this role appropriately? Of course this is a complex situation that needs deep and far ranging solutions, but there are some basic recommendations
that can be made to improve things immediately. Some of them are already included within the legislation of many countries; others aren’t. But in any case,
ethics don´t count when they just remain as written laws, they count only when they are put in to practice.
1. Recover the social role of banks: Banks have a social role, which is to create wealth by investing adequately the capital of savers and facilitating
credit for families and businesses. This social function is what justifies the financial bailouts: the failure of the financial system would have had a
devastating effect not only on businesses but on all economic activity and society as a whole. Banks need to reprioritize this social function and place
it at the heart of their decision making processes.
2. Transparency beyond the law: banks must provide relevant information beyond what’s minimally required by legislation. The effect of the toxic assets
securitization and the preferred assets fraud has been devastating – and it is imperative that banks learn from these dark episodes. Securitization and
preferred assets aren’t bad in and of themselves, but the reasoning behind using them, if needed, has to be thoroughly and transparently explained.
3. Intelligent administration of funds: banks´ funds are not the property of the executive board (most of the time, the executive board own only a small
part). There are many small shareholders and savers that can be affected by bad board decisions, and the board must bear in mind how their
decisions will affect all these small actors.
4. Know where credits go: when giving credit banks must not only take into account profitability and solvency, but weigh up the activity to which the
credit is assigned and the social value of such activity. The opposite is also true: banks must agree to deny credit to unethical activities (pollution,
denying human rights, etc.)
23
5. Do not abuse dominant position of banks in society and do not take advantage of other’s necessities (e.g. through abusive mortgage clauses or the
sale of fraudulent assets).
6. Avoid sale pressures in employees’ investment advice. Clients often are advised by bank employees on their investments. A corporate policy that
puts pressure or give incentives to bank employees regarding investment advice, can lead them to sell financial products to people who are not
suitable, or to make poor recommendations to clients.
7. Use “moral imagination”: look for ethical solutions that replace current or easy solutions. Why have banks evicted families at risk of exclusion
instead of looking for particular solutions to each case? Wasn’t the dation in payments possible in many of those cases? The shocking lack of agility
and creativity in looking for other solutions affected many families. Maybe it wasn’t included in the company’s protocol or they thought it wasn’t their
problem, but this lack of quick reaction led to the decline of confidence in the financial sector.
8. Don’t condone or cooperate with unethical practices or behaviors: fiscal paradises, collaboration with money laundering. Even if it’s an important
client, a bank should never cooperate with such practices if they want to keep their good image.
9. Sense of civic responsibility: banks have to act and be seen as a social actor. Many banks designate part of their benefits to social activities. This is
not a justification for bad practices, but it must be better known and praised. It´s important for banks to become a valuable part of the community.
10. Integrity: having ethical codes and auto-regulation systems can help, but it is important to have a shared culture of integrity beyond regulation. It is not
enough to comply with the rules; people working in the banking sector have to have truly moral integrity.
Some can ask: is this possible? How can someone be competitive and ethical at the same time? It is a challenge that requires creativity and effort, but
honesty and integrity are also competitive assets.
24
7. Corporate Social Responsibility

Milton Friedman claims that the ethical mandate of business is to increase the shareholders’ profit. It is a general belief that business is accountable to its
shareholders because it is running on their resources. But this is a misconception. If business is accountable to shareholders because it uses their
resources, then a business should primarily be responsible to society because in real terms, it uses society’s resources. The money that business borrows
from banks is that of the society. Business directly or indirectly uses natural resources of the nation which belong to the society. Business uses human
resources of society, and above all, exists because of society. It is the society that gives business an opportunity to earn. So business is primarily
accountable to society.
The socio-economic obligation of business refers to its responsibility in preventing to prevent economic consequences of business from adversely affecting
public welfare. Social-human obligation denotes to the obligation of business to nurture and develop its human resources so that employees get every
opportunity to grow, develop and advance through life and their careers and to promote human values within the organization.
Keth Devis has defined social responsibility in the following words: “Social responsibility refers to the businessman’s decision and actions taken for reasons
at least partially beyond the firm’s direct economic or technical interest.”
Business should play a dominant, dignified and ethical role in discharging its responsibility towards the people and the nation by practicing values of self-
respect and humanity with a noncorrupt approach and morally high conduct and character.
7.1 Justification
The major arguments that justify the need for the social responsibility of business are as follows:
1. Public Expenditure: There is a deep conviction within sections of the public that business has a clear obligation towards the greater good of the
society.
2. Long Run Viability: If a business fails to meet this need, other groups will assume the responsibility and the power that goes with it.
25
3. Public Image: Socially responsible behavior creates a positive public image for business. Tata and Birla enjoy a very good image among people
because of their social welfare programs.
4. Better Environment: Businesses can create a better environment, which will be more Notes conducive to future business success.
5. Avoidance of government regulation: If business is perceived as meeting its social obligations, costly and restrictive government regulations can be
avoided.
6. Balance of Responsibility and Power: Since a business already has a great deal of social power, its social responsibility should be of equal
importance.
7. Let Business Try: Since other social institutions have failed to resolve many social problems, it’s time to give business a try.
8. Business has the resources: Business has a reservoir of capital and expertise that has great potential for public service.
9. Problems can become profit: If the innovative skills of businesses can be applied to social problems, some efforts might lead to profits in the
traditional business sense.
10. Prevention is better than cure: If there are any further delays in resolving social problems they are only going to become worse.
11. Shareholder Interest: Businesses will prosper from an improved social environment.
26
7.2 Scope
Corporate Social Responsibility is one such niche area of Corporate Behavior and Governance that needs to get aggressively addressed and implemented
tactfully in the organizations. At the same time CSR is one such effective tool that synergizes the efforts of Corporate and the social sector agencies
towards sustainable growth and development of societal objectives at large.
The following forces ensure that businesses recognize and honor its new social responsibilities:
1. The pressure of organized labor.
2. Growing public awareness about quality of life and the need to remove all types of pollution.
3. Public opinion stressing on business morality and integrity to be observed by all organizations in any field of human endeavor.
4. The threat of nationalization or of severe regulations in business, to prevent public exploitation and evils of monopoly.
5. The development of consumerism in many countries, insisting on consumer protection in the market place.
6. The managerial revolution enabling managers to act as trustees and to adopt an objective attitude in the distribution of surplus among all the interested
parties.
There are four important groups that influence and are influenced by business. Business is expected to accept its responsibilities towards these groups:
1. The owner of the business, i.e., shareholders
2. The employees
3. The customers
4. The society at large
27
The interests of this diverse group are not identical; rather, they are often conflicting. Each group wants a lions’ share of the pie. Customers crave for value
– added but economical products, employees demand better remuneration and working conditions, society expects philanthropy and healthy environment
and owners demand for higher and higher ROI. The Management has to bring about an effective synthesis and secure good relations among these four
diverse interests.
Responsibilities Towards Shareholders
People invest in money to make money. Milton Friedman claims that the ethical mandate of business is to increase shareholders’ profit. The primary
responsibility of business is to increase shareholders’ wealth, to give good returns on investment, to give dividends at the proper time, to protect the
interests of even small shareholders, to listen to and respect shareholders, to regularly invite shareholders to participate in decision-making.
So, the basic responsibility of a business towards shareholders is to create wealth for them. Economic Value-Added analysis is an effective tool to measure
the increment in shareholder wealth. Economic values added are increments in the shareholder’s wealth beyond its expected return.
Responsibilities Towards Employees

The Success of an organization is dependent on its employees. Gone are the days when employees were the most neglected resource of the organization.
Today, HRM is the Critical Success Factor for the success of all industries, be it Old Economy industries like steel, cement or FMCG or New Economy ones
like BPOs and software services. Organizations have many responsibilities, towards their employees:
1. Fair treatment
2. No discrimination on the basis of sex, caste or creed
3. Fair wages
4. Fair appraisal system
5. Healthy and safe working environment
28
6. Establishment of fair work standards and norms

7. The provision of labor welfare facilities
8. Fair opportunity for accomplishment and promotion
9. Proper recognition, appreciation and encouragement of special skills and capabilities of the workers Installation of an efficient grievance handling
system
10. An opportunity for participating in managerial decisions to the extent desirable
11. Proper training and development programs so that workers can develop themselves according to a changing environment
12. Family Welfare
Responsibilities Towards Customers

1. Providing products of proven quality
2. Regular R&D to augment the product and to innovate
3. To ensure that product reaches the customer and to check any sort of black marketing or Notes profiteering by middlemen and anti social elements
4. To supply goods at reasonable prices
5. To provide required after-sale services, and to ensure that spare parts should be available in the market
6. To fulfil its commitments impartially and courteously, in accordance with sound and straightforward business principles
7. To provide sufficient information about the product, including its adverse effects, risks and the care to be taken while using the product
8. To ensure that the product supplied does not have any adverse effect on the customer
29
6. To hear and redress the genuine grievances of customers

7. To avoid any type of cartel formation that attempts to reap monopoly profits
Responsibilities Towards Community

1. To prevent environmental pollution and to prevent ecological imbalance
2. Improve the efficiency of business operations
3. Contributing to research and development
4. Development of backward areas
5. Promotion of small-scale industry
6. Development of region in which they are operating. This includes working on development of schools, social awareness programs, adult education,
health, medical facilities, helping NGOs and the government for social causes such as the Pulse Polio Mission, etc.
7. Taking steps to conserve scarce resources and developing alternatives, wherever possible.
7.3 Major Social Responsibilities of Business

1. Optimum Utilization of Scarce National Resources: All corporations must use resources judiciously and not waste, mis-utilize, damage or cause to
deteriorate the resources at its disposal. It is essential in an energy/power scarce country like India. Not only this, business should develop alternative
sources of energy and power. For instance, ITC uses wind power for some of its projects, while Mahindra and Mahindra spends on research an
alternatives fuels.
2. Responsibility Not to Make Losses: A loss-making unit is a burden on society. It should not only conserve resources of the society but perform its
duty towards the customer by providing better products, towards the shareholder by creating wealth, towards the society by utilizing the resources well,
30
and towards its employees by meeting better HR standards.

Most PSUs that make losses but are kept alive in the name of socialism and employment, are basically burden on the society. Their losses are met by
taxing the society. One can say that society pays higher taxes to subsidize the inefficiencies of PSUs. The question arises, why should they?
3. Improved Quality of Life: An organization should help improve the society’s standard of living, which is based on financial power and material growth.
4. Responsibility of Employment and Income: Every business should make provisions for the payment of fair wages, satisfactory working conditions,
steady employment and job security, prospects for promotion, growth and development of workers, and also take adequate measures for employee
welfare.
5. Offering Quality Products at Fair Prices: Business is all about creating customers, and the customer can only be created when customers are
satisfied. Customers can be satisfied when they are provided with value – added products at fair prices, after sales services, timely information, and
when the product reaches the right customer, etc.
6. Environmental Protection: Industrialization is doing much irreparable harm to the environment. It is therefore an obligation on them to not only
morally, but also legally undo the damage by taking serious and responsible steps to protect the environment and to keep it healthy condition. They
should adopt modern technology to ensure that their operations do not harm the environment. Businesses should also take actions to educate their
employees and people about the environment in general.
7. Fair trade practices:
Fair trade practices of business include:
1. Avoidance of formation of cartels or following monopolistic practices.
2. Not creating shortages for the purpose of black marketing and speculation.
3. Not exaggerating and making false statements regarding claims.
31
4. Not buying political favors to sway decisions it its favor.

5. Following healthy competition with competitors by not indulging in industrial espionage or other unethical means.
6. Not deliberately making the organization sick to avoid obligations or to escape from responsibilities.
7. Not to involve in insider trading or to take undue advantage of inside information.
8. Not bribing public servants and corrupting the democratic structure of the country.
9. Paying taxes, duties and other dues honestly and on time.
10. To provide required information to shareholders and all other stakeholders.
11. Making timely payment of borrowings and interest.
12. While dealing with suppliers, instead of using their bargaining power, corporations should invest in good relations with them. This will help
suppliers maintain quality and develop new products for the organization. This may appear to be costly initially Notes but it ultimately pays. The
Japanese usually believe in establishing a good rapport with their suppliers.
13. Not adopting a communication strategy that is not compliant with social norms.
14. Business should abide by the laws of the land.
8. Local Development: Businesses use resources of the society are therefore responsible for the development of their surrounding areas. A business
can perform various functions to develop its local area. In fact, if every business house takes responsibility of some villages, miracles can happen in
India.
32
7.4 CSR and Indian Corporations

India is a fast growing economy and is booming with national and multinational firms. At the same time, the Indian land also faces social challenges like
poverty, population growth, corruption, illiteracy just to name a few. Therefore it is all the more imperative for the Indian companies to be sensitized to CSR
in the right perspective in order to facilitate and create an enabling environment for equitable partnership between the civil society and business.
Indian companies are now expected to discharge their stakeholder responsibilities and societal obligations, along with their shareholder-wealth
maximization goal. Nearly all leading corporates in India are involved in corporate social responsibility (CSR) programs in areas like education, health,
livelihood creation, skill development, and empowerment of weaker sections of the society.
CSR initiatives by Indian Companies

1. Aircel: Mobilizes public opinion in partnership with WWF India for the ‘Save Our Tigers Initiative’
2. Coca-Cola India: Partners with government agencies and NGOs to combat water scarcity and depleting groundwater levels
3. Dabur India: Its initiative, SUNDESH, in UP and Uttarakhand aims for the overall socio-economic development of the poor
4. Maruti Suzuki India: Runs employee volunteering program, ‘e-Parivartan’, with NGO Literacy India, for teaching underprivileged people
5. Nasscom Foundation: Promotes development through use of information and communication technology, provides tech donations to NGOs
Although corporate India is involved in CSR activities, the central government is working on a framework for quantifying the CSR initiatives of companies to
promote them further. According to Minister for Corporate Affairs, one of the ways to attract companies towards CSR work is to develop a system of CSR
credits, similar to the system of carbon credits which are given to companies for green initiatives. Moreover, in 2009, the government made it mandatory for
all public sector oil companies to spend 2 per cent of their net profits on corporate social responsibility. However, for private sector it is still voluntary, but
government is making effort to make it mandatory for all companies to invest 2% of their net profits on CSR.
33
Besides the private sector, the government is also ensuring that the public sector companies participate actively in CSR initiatives. The Department of
Public Enterprises (DPE) has prepared guidelines for central public sector enterprises to take up important corporate social responsibility projects to be
funded by 2-5 per cent of the company’s net profits.
Indian Corporations have joined hands to adjust all its activities falling under CSR. For this, it has set up a global platform to showcase all the work done by
Indian firms.
34
Unit 7
Compliance in Indian Banks
Unit 7 – Compliance in Indian Banks
Table of contents
1 Compliance 4
1.1 – Compliance Mechanism 6
1.2 – Compliance in Organizations 7
1.3 – Compliance Function 8
2 Indian Banks & Compliance 10
3 Banking Regulatory Authorities 11
3.1 – Important Regulations 11
3.2 – Principal Regulatory Challenges for Indian Banking Industry 14
3.3 – Extent of Oversight by Banking Regulators 16
3.4 – Enforcement of Banking Regulations 17
3.5 – Common Enforcement Issues 17
4 Capital Adequacy Norms 18
4.1 – Enforcing Capital Adequacy Norms 20
2
Table of contents
5 Audits in Banks 20
6 RBI’s Customer Service Guidelines 21
6.1 – Customer Rights as per RBI 22
6.2 – Important RBI Guidelines on Banking Services – An outline 23
7 Importance of Maintaining Accuracy and Adherence to Compliance 25
8 Conclusion 26
3
1. Compliance
Every organization has a set of rules and regulations that employees across all levels have to abide by. Most of them are clearly stated and documented
set of rules and some are implied. These guidelines are framed based on regulatory and statutory requirements. It is necessary for organizations to ensure
compliance with statutory guidelines to avoid consequences and penalty. Compliance with laws, regulations and other statutory requirements is a matter of
course for organizations whose violations can lead to both legal and business issues as seen in the opening case. Non-compliance often leads to stoppage
of business activities and can lead to loss of opportunities.
To take an example ensuring compliance is a particularly important issue for banks because of their central role in the financial system. Typically,
compliance function identifies, assesses, advises on, monitors and reports on the compliance risk, that is, the risk of legal or regulatory sanctions, financial
loss or loss to reputation a company may suffer as a result of its failure to comply with all applicable laws, regulations, codes of conduct and standards of
good practice (together “laws, rules and standards”).
All corporate entities, irrespective of their size and business, are expected to have clearly laid compliance policies. Companies in India have shown
tremendous effort in putting in place rules and regulations. Failing to adhere to such norms/rules/regulations attracts penal actions that can stretch to
anyone ranging from directors, officers, employees to agents.
On a broader perspective, for any company, compliance with rules and regulations is important for the following reasons:
• To maintain stability and confidence in the economic system, thereby reducing the risk of loss to stakeholders.
• To encourage good corporate governance (through an appropriate structure and set of responsibilities) and enhancing market transparency and
surveillance.
• To have operational independence so as to carry out tasks effectively.
• To ensure that the risks incurred are being adequately managed to the maximum extent possible;
4
• To have effective control systems, standards and accounting records in place;

• To hold a close cooperation with other supervisors across boundaries for better trade relations;
• To generate greater confidence in the organizational processes and thereby generate greater trust and confidence in the organization.
Learning Objectives
• Identify the compliance mechanism
• Identify the banking regulatory authorities
• Identify the capital adequacy norms

• Explain the RBI’s customer service guidelines
5
1.1 Compliance Mechanism

The compliance mechanism can be classified as measures
under two levels:
• External – The primary external governance
mechanism of any company in any industry are the
legislations under which it is governed. A company
must also follow the guidelines as applicable under
various Acts of the country.
• Refer to the figure given below. Externally, companies
are governed not only by the government regulations
but are also indirectly governed by the markets, the
competitor companies and also by other financial
institutions
• Internal – The factors that are internal to the
compliance mechanism of a company are the
shareholders, the managing committee and the board
of directors. There are certain rules and regulations that
may vary from company to company, industry to
industry but by and large they must adhere to the
regulations as imposed upon them by the various Acts
governing them.
6
1.2 Compliance in Organizations

In an organization, several duties should be performed as part of compliance. Some of the key duties are:
1. Assigning overall responsibility for overseeing compliance with established standards, policies and procedures to a specific high-level individual within
the organizations, such as a compliance officer.
2. Establish compliance standards, policies and procedures to be followed by employees and other company representatives such as subcontractors,
consultants and vendors who are capable of reducing the possibility of regulatory violations.
3. Effectively communicate compliance standards, policies and procedures to all employees and other company representatives.
4. Establish compliance training programs to ensure employees and other company representatives are aware of their compliance re sponsibilities.
5. Ensure substantial discretionary authority is delegated to trustworthy individuals, not persons whom the organization knew (o r should have known
through the exercise of due diligence) are likely to engage in illegal activity.
6. Maintain monitoring and auditing systems that are based on a compliance risk assessment and are designed to detect intentiona l or unintentional
regulatory compliance violations by employees and other company representatives.
7. Maintain and publicize a whistle-blower hotline and e-mail account, whereby individuals can report potential regulatory compliance violations by
employees and other company representatives confidentially and without fear of reprisal.
8. Consistently enforce compliance standards, policies and procedures through appropriated, case -specific disciplinary mechanisms, including discipline
of individuals responsible for the failure to detect a violation.
9. Take all reasonable steps to respond appropriately to violations that have been detected and to prevent future similar occurr ences, including making
any necessary modifications to the compliance program.
7
Implementation of these key components should reduce the

instances of noncompliance with regulations as well as reduce
the impact to the organizations should an instance occur.
In addition, many regulatory agencies consider an organization's
overall approach to compliance when assessing monetary fines
and penalties and may assess a lower fine if the organization
has a strong corporate compliance program.
Source: www.nochubank.or.jp/annual/pdf/ar2005_31.pdf
1.3 Compliance Function

Compliance is made complex by the lack of a single unified set of laws that govern all aspects of a business’s legal requirements. Regulations are
numerous and sometimes even conflict with one another. The complexity of interpreting the law and ensuring its compliance has forced large organizations
to create the role of a compliance officer.
The chief compliance officer should consider establishing a corporate compliance committee that includes representation from:
• Internal Auditing
8
• Finance
• Human Resources
• Regulatory compliance
• Quality assurance
• Information Technology
• Environmental health and safety

• Legal and ethics
• Contracts and procurement
• Risk management
• Corporate security
Functions of a corporate compliance committee:

The committee, under the direction of the corporate compliance officer, would oversee and administer the corporate compliance program and framework,
including developing a charter for the corporate compliance committee, defining goals and objectives of the corporate compliance function, and determining
the functional operating structure. The structural should be flexible enough to keep abreast of and address changes in regulations as well as support the
organization from a regulatory compliance perspective when entering new markets or countries that represent new regulatory environments.
9
2. Indian Banks & Compliance

Indian banks, once admired for their sound and safe conduct, are now increasingly getting caught breaking the rules. This week, the Reserve Bank of India
(RBI), has slapped a hefty fine of Rs 58.9 crore on the country's second large private bank, ICICI Bank Ltd, for the failure to follow the maturity guidelines
for securities portfolio. Imagine a new bank, Airtel Payments Bank, just starting its operations, has been caught for violating the Know Your Customer (KYC)
guidelines, which is the most basic requirement in the banking industry. In less than a year, the private banks, which are perceived to be well-managed,
have often received the wrath of the banking regulator. Some of the banks fined, recently, were IDFC Bank, Yes Bank and IndusInd Bank.
Why are banks falling by the wayside on the most critical compliance issues? The compliance is one issue, which creates confidence amongst depositors,
investors and also the government. Banks are like public and privileged institutions that are allowed to accept public deposits. And there are reputational
risk issues. So is there a lack of focus as most resources are chasing growth or just a casual attitude towards compliance?
Many say the responsibility lies in the top management and the board. In fact, the board should take these compliance violation issues seriously. It actually
cost Shashi Arora, CEO of Airtel Payments Bank, his job when the KYC norms violation came out in the open.
The amount of fine imposed by RBI in the past shows that it won't tolerate compliance violations. In fact, the focus on compliance has accelerated, globally,
after the global financial meltdown. There are risks that are known and there are risks that are unknown. Regulators don't want another 2008-like crisis in
the banking industry. According to an estimate, the banking regulators in US and Europe have levied a cumulative fines of over $340 billion, since, the
global financial meltdown for various violations of banking guidelines. However, what is alarming is the estimate about these fines, which can go up to $400
billion by 2020.
Back home, Indian banks have their own share of non-compliance. In the last decade, banks have been found to be violating guidelines relating to KYC,
anti-money laundering, selling complex derivatives product etc. The risks for banks are only increasing day by day with technology and digitization. While
banks are moving at a fast pace in terms of innovation and also tying up with third-party vendors, the regulators are watching their every step for any slip-
up. Clearly, the cost of non-compliance would be heavy.
10
3. Banking Regulatory Authorities

The RBI supervises and is responsible for managing the operation of the Indian financial system. In addition to issuing regulations and guidelines for
banking operations, it also administers the provisions of the RBI Act, the BR Act and FEMA. It has wide discretionary powers and is authorized to inspect
and investigate the affairs of banks and to impose penalties in the event of non-compliance.
3.1 Important Regulations
The Indian banking sector is regulated by the Reserve Bank of India Act 1934 (RBI Act) and the Banking Regulation Act 1949 (BR Act). The Reserve Bank
of India (RBI), India’s central bank, issues various guidelines, notifications and policies from time to time to regulate the banking sector. In addition, the
Foreign Exchange Management Act 1999 (FEMA) regulates cross-border exchange transactions by Indian entities, including banks.
India has both private sector banks (which include branches and subsidiaries of foreign banks) and public-sector banks (i.e., banks in which the
government directly or indirectly holds ownership interest). Banks in India can primarily be classified as:
• scheduled commercial banks (i.e., commercial banks performing all banking functions);
• cooperative banks (set up by cooperative societies for providing financing to small borrowers); and
• regional rural banks (RRBs) (for providing credit to rural and agricultural areas)
Recently, the RBI has also introduced specialized banks such as payments banks and small finance banks that perform only some banking functions.
The key statues and regulations that govern the banking industry in India and particularly scheduled commercial banks are as follows:
a. RBI Act: The Reserve Bank of India Act, 1934 was enacted to constitute the Reserve Bank of India with an objective to:
• Regulate the issue of bank notes
11
• for keeping reserves to ensure stability in the monetary system

• to operate effectively the nation’s currency and credit system.
The RBI Act covers:
o the constitution
o powers
o functions of the Reserve Bank of India.

The act does not directly deal with the regulation of the banking system except for few sections like Sec 42 which relates to the maintenance of CRR by
banks and Sec 18 which deals with direct discount of bills of exchange and promissory notes as part of rediscounting facilities to regulate the credit to the
banking system.
The RBI Act deals with:
o incorporation, capital, management and business of the RBI
o the functions of the RBI such as issue of bank notes, monetary control, banker to the Central and State Governments and banks, lender of last
resort and other functions
o general provisions in respect of reserve fund, credit funds, audit and accounts (d) issuing directives and imposing penalties for violation of the
provisions of the Act
12
b. BR Act
Where on one hand Reserve Bank of India Act, 1934, governs the Reserve Bank functions, the Banking Regulation Act, 1949, governs the financial sector.
Some of the key regulations impacting banks are:
• It prescribes minimum capital requirement of banks

• Regulates opening of branches and change of location of branches
• To ensure smooth and efficient working of banks it empowers RBI to approve appointment, reappointment and removal of chairman, directors or
officers of the Bank
• It prescribes cash reserve and liquidity ratios to ensure that depositor’s interests are protected
c. FEMA
• FEMA is the primary exchange control legislation in India. FEMA and the rules made thereunder regulate cross-border activities of banks. These
are administered by the RBI.
d. Other Key Statutes
• The Negotiable Instruments Acts, 1881;
• The Recovery of Debts Due to Banks and Financial Institutions Act, 1993;
• The Bankers Books Evidence Act, 1891;
• The Payment and Settlement Systems Act, 2007;
13
d. Other Key Statutes

• The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002; and
• The Banking Ombudsman Scheme 2006.
Public sector banks are regulated by the BR Act and the statute pursuant to which they have been nationalized and constituted. These include:
• Banks constituted under the Banking Companies (Acquisition and Transfer of Undertakings) Act 1970 or the Banking Companies (Acquisition
and Transfer of Undertaking Act) 1980; and
• The State Bank of India and subsidiaries and affiliates of the State Bank of India constituted and regulated by the State Bank of India Act 1955
and the State Bank of India (Subsidiary Banks) Act, 1959 respectively.
3.2 Principal Regulatory Challenges for Indian Banking Industry

The key regulatory challenges are as follows:
a. Basel III Implementation: Indian banks are required to fully comply with the Basel III Capital Regulations (Basel Regulations) by 31st March 2019.
Most of the public-sector banks will need additional capital infusion to meet the higher capital requirements, which will consequently reduce the return
on equity. As a result, government support will be required, which may exert significant pressure on government’s fiscal position.
b. Specialized Banking: The RBI has currently granted approximately 10 small finance bank licenses and approximately seven payments bank licenses.
While the RBI has set up the mechanism for the use of these licenses, the current provision of these services seems to be falling short of catering to
the unbanked sectors that include rural areas and other underdeveloped and unorganized sectors. Further orientation of regulatory and supervisory
resources is likely needed to widen access to these systems, in light of the wider objective of financial inclusion.
14
c. Asset Quality: The quantity of net non-performing assets (NPAs) of Indian banks has been increasing significantly. The RBI has, over the years, taken
significant measures, both regulatory and structural, in order to tackle the issue. However, the rise in NPAs continues to be one of the most
fundamental threats to the banking sector.
d. Priority Sector Lending and NPAs: The RBI requires banks to provide mandatory credit to certain weaker sections of society and sets out targets for
the same. In the past, banks have struggled to meet these targets. These sectors often yield low profits, and they adversely impact banks’ profitability.
Separately, the agricultural sector (one of the main sectors for priority lending) has a high level of NPAs. The new measures introduced by the RBI to
reduce stressed assets, as mentioned above, do not take into account agricultural NPAs.
e. Challenges from the Cashless Economy: The shift to a cashless economy has brought with it a specific set of issues, which primarily revolve
around access. The RBI has taken concerted measures such as setting up an e-wallet linked to the unique identification number system (AADHAAR)
set up (akin to the social security number structure in the United States) and encouraging retailers, as well as other local businesses, to provide
discounts and cash-back schemes for using electronic means of payment. There is a severe lack of infrastructure in most parts of the country for such
payment systems to be used regularly, ranging from a functional internet connection to the sophistication of its users. Recently, privacy concerns, and
legal challenges on this basis, have been raised. While these issues are currently being grappled with, there is a long way to go before India becomes
a cashless economy.
f. Enforcement of the New Insolvency Regime: The Insolvency and Bankruptcy Code (IBC), which was brought into effect in December 2016, has
been in operation for a year and a notable shift has been seen in the approach of the RBI, as well as creditors, in bringing action against defaulters.
The National Company Law Tribunal and the National Company Law Appellate Tribunal have provided judgments that have helped clarify some points
that were unclear in the IBC itself. While the jurisprudence is gradually developing, the Ministry of Finance has been quick to identify the challenges
and update the IBC with regulations aimed to make the process more efficient. It remains to be seen if the IBC process actually keeps pace with
increasing NPAs, therefore improving the status of banks as creditors within the Indian financial system.
15
3.3 Extent of Oversight by Banking Regulators

The RBI conducts periodic audits and also acts as a consumer disputes ombudsman for retail banking. Based on its findings, and sometime Suo-moto, the
RBI also supervises the Indian Banking system through various methods such as on-site inspection, surveillance and reviewing regulatory filings made by
the banks.
Each year, the RBI conducts an on-site financial inspection of a bank’s books of accounts, loans and advances, balance sheet and investments. Following
this, the RBI issues supervisory directions to banks highlighting the major areas of concern. Banks are then required to draw up an action plan and
implement corrective measures to comply with the inspection findings.
The RBI also monitors compliance on an ongoing basis by requiring banks to submit detailed information periodically under an off-site surveillance and
monitoring system. Based on this, the RBI analyzes the financial health of banks between two on-site inspections and identified banks that show financial
deterioration that thereby require closer supervision.
Additionally, the RBI conducts:
• quarterly discussions with the banks’ executives on issues emanating from analysis of off-site surveillance, status of compliance with annual inspection
findings and new products introduced by banks; and
• bi-annual meetings with the chief executive officers of the banking groups identified as financial conglomerates.
The RBI has taken special initiatives to supervise weaker banks such as quarterly monitoring visits to banks displaying financial and systemic weaknesses,
appointment of monitoring officers and direct monitoring of problem areas in housekeeping.
16
3.4 Enforcement of Banking Regulations

The RBI issues directions from time to time to ensure compliance with the banking statutes and rectify non-compliance, if any. In the case of non-
compliance with regulatory requirements, the RBI may impose a variety of sanctions, including fines, orders for the suspension of a bank’s business and
cancellation of the bank’s banking license.
3.5 Common Enforcement Issues
The most common enforcement issues are discussed below:
• Deterioration of asset quality of the banking system: Deteriorating asset quality is often attributable to poor underwriting by bank staff while
undertaking credit appraisal of the projects. The RBI conducts ad hoc asset quality reviews of banks’ assets. Based on this review, the RBI issues
directions to banks for them to comply with capital adequacy norms (see question 18). Additionally, the RBI has directed banks to take other corrective
measures such as conversion of debt into equity and has permitted longer repayment schedules for long-term projects. In light of the demonetization
measures, there is speculation that the asset quality review that is generally conducted at the end of the financial year will be postposed to the next
financial quarter.
• Deficiencies in compliance with know-your-customer (KYC) anti-money laundering (AML) norms by banks: In 2013, investigations carried out
by the Cobra post media portal exposed serious violation of KYC and AML norms leading to imposition of a total fine of 500 million rupees by the RBI
on 22 banks. To combat such a breach, the RBI is also considering imposing operational curbs on banks in addition to the monetary fines. The RBI has
advised banks to undertake employee training programs on KYC and AML policy as violations have often been attributable to the staff’s lack of
familiarity with, and ability to monitor compliance with, the KYC and AML policy.
• Mis-selling of financial and structured products: A wide range of complex structured financial products were being sold by banks to unsophisticated
customers (such as retail and individual customers) without providing sufficient information. In 2011, the RBI imposed a total fine of 19.5 million rupees
17
million rupees on 19 banks for mis-selling derivative products to clients and failing to match the complexity of products to clients with appropriate risk
profiles and determining whether clients have appropriate risk management policies prior to investing in these products. The RBI has framed a Charter
of Customer Rights as overarching principles to protect customers, pursuant to which banks must formulate board-approved customer rights policies
and conduct periodic reviews.
• Internal fraud: In 2015, investigations revealed a sum of 60,000 million rupees being routed to Hong Kong for non-existent imports through Bank of
Baroda, leading to the arrest of certain bank employees. To combat fraud, the RBI has issued instructions for banks to take corrective measures, such
as investing in data analytics and intelligence, gathering and maintaining internal vigilance and undertaking employee background checks. Further, a
central fraud registry has been established, which acts as a centralized database to detect such fraud. Some banks have set up internal investigation
teams to probe fraud allegations and implement anti-fraud controls.
• Financial inclusion: For meeting financial inclusion targets, the RBI observed that banks were incorrectly classifying their contingent liabilities and off-
balance sheet items (such as letters of credit, bank guarantees, and derivative instruments). The RBI asked banks to immediately declassify such credit
facilities with retrospective effect. Failure to meet the priority sector lending targets results in penalties and can hamper regulatory approvals in the
future.
4. Capital Adequacy Norms
On 2 May 2012, the RBI laid down guidelines for Indian banks as recommended under the Basel III Capital Accord of the Basel Committee on Banking
Supervision (BCBS) and introduced the Basel Regulations. The Basel Regulations have been implemented with effect from 1 April 2013 and are going
through a transitional period that lasts until 31 March 2019. The capital adequacy framework is based on three mutually reinforcing pillars: minimum capital
requirements (Pillar 1), supervisory review of capital adequacy (Pillar 2) and market discipline (Pillar 3).
The minimum capitalization requirements under Pillar 1 require banks in India to maintain a minimum capital to risk-weighted assets ratio (CRAR) of 13 per
cent for the first three years of commencing operations subject to a higher ratio specified by the RBI) and 9 per cent on an ongoing basis (against the 8 per
18
cent requirement under the Basel II accord). CRAR is the ratio of a bank’s capital in relation to its risk-weighted assets. The requirement under Pillar 1
includes the total regulatory capital (comprising of Tier 1 and Tier 2 capital) and the different approaches for risk-weighting the assets in terms of their
credit, operational and market risk (comprising of the standardized framework and basic indicator framework). Tier 1 capital, among others, consists of
paid-up capital, stock surplus, statutory reserves and Tier 2 capital, among others, comprises debt capital instruments, preference share capital and
revaluation reserves, etc.
In addition to the minimum 9 per cent requirement, there are contingent capital arrangements that a bank is required to make in the form of maintaining a
capital conservation buffer (CCB), countercyclical capital buffer (CCCB) and Tier 1 leverage ratio.
Serial Number Type Ratio

1 Capital Conservation Buffer (CCB) 2.5 percent
2 Counter Cyclical Capital Buffer (CCCB) 0 to 0.25 percent
3 Tier 1 Leverage Ratio 3 percent
Payment banks are required to maintain a CRAR of 15 percent on an ongoing basis and a minimum Tier 1 capital ratio of 7.5 percent. These banks are not
required to maintain a CCB and a CCCB ratio.
The Basel III framework applies to all scheduled commercial banks (except regional rural banks) and such banks are required to comply with the Basel
Regulations on a ‘solo and consolidated basis’.
Every year commencing from April 2015, the RBI categorizes some systematically important financial institutions as D-SIBs under different buckets, who
are then required to maintain certain additional capital. At present, three banks, namely State Bank of India, ICICI Bank Limited and HDFC Bank Limited
have been declared as D-SIBs maintaining an additional current ratio of 0.6 per cent and 0.2 per cent respectively. The RBI requires the D-SIBs to maintain
an additional common equity Tier 1 capital ratio ranging from 0.2 per cent to 0.8 per cent.
19
4.1 Enforcing Capital Adequacy Norms

The capital adequacy requirements are enforced under Pillar 2 and Pillar 3 of the Basel III Regulations.
Pillar 2 provides for supervision at the bank level and at the supervisory authority level.
Supervision at the bank level includes assessment of capital adequacy of banks in relation to their risk profiles by implementing an internal process called
the Internal Capital Adequacy Assessment Process (ICAAP). Every bank is required to have an ICAAP, which is the bank’s procedure for identification and
measurement of risks, maintaining appropriate level of internal capital in relation to the bank’s risk profile and application of suitable risk management
systems. Banks are required to annually submit the ICAAP report to the RBI.
Supervision at the supervisory authority level (i.e., by the RBI) makes all banks subject to an evaluation process called the Supervisory Review and
Evaluation Process (SREP). Pursuant to the SREP, the RBI reviews and evaluates a bank’s ICAAP, indirectly evaluates a bank’s compliance with the
regulatory capital ratios and takes remedial action if such a ratio is not maintained. The RBI may consider prescribing a higher level of minimum capital ratio
for each bank under the Pillar 2 framework on the basis of their respective risk profiles and risk management systems. Failure to comply with the minimum
regulatory capital requirements, may subject the bank to fines that may extend to 10 million rupees and a further penalty of 100,000 rupees for every day of
default. The relevant bank may also be subject to prompt corrective action by the RBI (see question 18).
Pillar III implements market discipline through extensive disclosures by banks that allow market participants to assess risk exposure, risk assessment
process and capital adequacy of a bank. Every bank should have an internal disclosure policy that is approved by the board of directors and assessed
periodically. The disclosures are to be made on a half-yearly basis and should either be published in the bank’s financial statements or displayed on the
bank’s website.
5. Audits in Banks
The following are some types of audits followed at Banks to ensure compliance with the various statutes as also their internal stipulations:
• Statutory Audit – Stipulated by statute such as balance sheet related audit, RBI audit etc.,
20
• Concurrent audit – audit on an ongoing basis at large branches (in terms of volume of business)
• Internal audit
• Stock audit
• Revenue audit
• Snap audits – surprise audits conducted by management
(Periodic inspection and rating of branches based on inspection reports is one of the key stipulations of the Jilani committe e recommendations)
6. RBIs Customer Service Guidelines

Customer service has great significance in the banking industry. The banking system in India today has perhaps the largest outreach for delivery of
financial services and is also serving as an important conduit for delivery of financial services. While the coverage has been expanding day by day, the
quality and content of dispensation of customer service has come under tremendous pressure mainly owing to the failure to handle the soaring demands
and expectations of the customers.
The vast network of branches spread over the entire country with millions of customers, a complex variety of products and services offered, the varied
institutional framework – all these add to the enormity and complexity of banking operations in India giving rise to complaints for deficiencies in services.
This is evidenced by a series of studies conducted by various committees such as the Talwar Committee, Goiporia Committee, Tarapore Committee, etc.,
to bring in improvement in performance and procedure involved in the dispensation of hassle-free customer service.
Reserve Bank, as the regulator of the banking sector, has been actively engaged from the very beginning in the review, examination and evaluation of
customer service in banks. It has constantly brought into sharp focus the inadequacy in banking services available to the common person and the need to
benchmark the current level of service, review the progress periodically, enhance the timeliness and quality, rationalize the processes taking into account
technological developments, and suggest appropriate incentives to facilitate change on an ongoing basis through instructions/guidelines.
21
Depositors' interest forms the focal point of the regulatory framework for banking in India. There is a widespread feeling that the customer does not get
satisfactory service even after demanding it and there has been a total disenfranchisement of the depositor. There is, therefore, a need to reverse this trend
and start a process of empowering the depositor.
Broadly, a customer can be defined as a user or a potential user of bank services. So defined, a ‘Customer’ may include:
• a person or entity that maintains an account and/or has a business relationship with the bank;
• one on whose behalf the account is maintained (i.e. the beneficial owner);
• beneficiaries of transactions conducted by professional intermediaries, such as Stock Brokers, Chartered Accountants, Solicitors, etc., as permitted
under the law, and
• any person or entity connected with a financial transaction which can pose significant reputational or other risks to the bank, say, a wire transfer or
issue of a high value demand draft as a single transaction.
6.1 Customer Rights as per RBI

a. Right to Fair Treatment: This right prohibits banks from discriminating against customers on grounds of gender, age, religion, caste and physical
ability while offering products and services. Banks can, however, continue to offer differential rates of interest or products to customers. “The financial
services provider may, however, have certain special products which are specifically designed for members of a target market group or may use
defensible, commercially acceptable economic rationale for discriminating between its customers,” the central bank had elaborated in the draft charter
released in August.
b. Right to Transparency, Fair and Honest Dealing: You can expect language in bank documents to be simplified and transparent. The charter
requires banks to ensure that all contracts are transparent and easily understood by the common person. The onus of sending out effective
communication will rest with banks. Information on the product’s price, customer’s responsibilities and key risks will have to be clearly disclosed.
22
“Any features that may disadvantage the customer should be made known to him. Important terms and conditions should be clearly brought to the
notice of the customer,” the charter says.
c. Right to suitability: Despite several regulations, complaints related to mis-selling continue to plague the distribution space, particularly in case of life
insurance policies. Lured by higher commissions, sales officials tend to push products without ascertaining their suitability for the customer. With this
charter coming into force, such officials might find it difficult to palm off say market-linked insurance products to senior citizens who are looking for
stable returns. The charter has now made it mandatory for banks to sell products after keeping in mind customers’ needs, financial circumstances and
understanding.
d. Right to privacy: Banks are duty-bound to keep customers’ personal information confidential, unless the disclosure is required by law or customers
have given their consent. “Customers have the right to protection from all kinds of communications, which infringe upon their privacy,” the charter
states. Banks cannot pass on your details to telemarketing companies or for cross-selling. “There have been instances where bank officials, on the
basis of transaction details, have asked customers to route their investments through them (since banks also act as distributors for mutual funds and
insurance companies). This is unethical,” says Roongta.
e. Right to grievance redressal and compensation: The right to grievance redressal is at your aid if your bank fails to adhere to basic norms. The
charter makes banks accountable for their own products as well as those of third parties like insurance companies and fund houses. They will no
longer be able to wash their hands of the responsibility once the product is sold. Banks will have to communicate the policy for compensating for
mistakes on their part, lapses in conduct and non-performance or delays. The redressal and compensation policy will have to state the rights of
customers when such events occur.
6.2 Important RBI Guidelines on Banking Services – An outline
• In order to improve the quality of service available to customers in branches, the banks have been advised to ensure that full address/ telephone
number of the branch is invariably mentioned in the pass books/statement of accounts issued to accountholders.
• Banks are therefor advised to invariably offer pass book facility to all its savings bank account holders (individuals) & in case the bank offers the facility
23
of sending statement of account and the customer chooses to get statement of account, the banks must issue monthly statement of accounts.
• Banks are required to make the customer aware of both the options available to him i.e. dropping cheques in the drop-box or tendering them at the
counters so that he can take an informed decision in this regard. Banks are therefore advised to invariably display on the cheque drop-box itself that
'Customers can also tender the cheques at the counter and obtain acknowledgment on the pay-in-slips’.
• Banks are advised to give wide publicity and provide guidance to deposit account holders on benefits of nomination facility & the survivorship clause.
• Banks with core banking solution are advised to provide “payable at par"/ "Multi-city” cheque issuance facility to all the eligible & requesting customers.
• Banks are required to display and update, on their websites, the details of certain service charges. They are also required to place service charges and
fees on the homepage of their websites at a prominent place under the title of ‘Service Charges and Fees’ so as to facilitate easy access to the bank
customers.
• Banks are required to place a complaint form, along with the name of the nodal officer for complaint redressal, in the homepage itself to facilitate
complaint submission by customers. The complaint form should also indicate that the first point for redressal of complaints is the bank itself and that
complainants may approach the Banking Ombudsman only if the complaint is not resolved at the bank level within a month. Similar information is to be
displayed in the boards put up in all the bank branches to indicate the name and address of the Banking Ombudsman. In addition, the name, address
and telephone numbers of the controlling authority of the bank to whom complaints can be addressed is to be given prominently.
• Banks are therefore, advised to ensure that none of their branches/staff refuse to accept lower denomination notes and / or coins and to issue strict
instructions to all branches that the staff concerned should in no case refuse to accept small denomination notes and coins tendered at the counters.
• Detailed guidelines have been issued by RBI on Safe Deposit Locker facility offered by the Banks, including prohibition of linking allotment of lockers to
placement of fixed deposits, fixed deposits as security for lockers, wait list of lockers, operations, due diligence, monitoring/break-open of un-operated
lockers, access / handing over the contents upon death of the locker-holder, etc.
• In order to encourage a formal channel of communication between the customers and the bank at the branch level, banks are advised to take
necessary steps for strengthening the branch level committees with greater involvement of customers. It is desirable that branch level committees
include their customers too. Further as senior citizens usually form an important constituency in banks, senior citizen may preferably be included
therein.
24
7. Importance of Maintaining Accuracy and Adherence to Compliance

a. Stronger business relationships: Successful compliance with following the laws applicable to the business indirectly governs the credibility of the
company. Sound governance sends out a message to customers, partners, employees, the media and anyone else who is associated with the
company by portraying trustworthiness of its business and procedures.
b. Helps in avoiding system breaches: A company’s careful attention to security and compliance requirements enables it to avoid system breaches and
other threats to the integrity of its operations. For example, the influence of some individual in the organization will never allow him to trap others into
wrong doing due to the constant fear of being caught.
c. Improvement in customer satisfaction: The moment system breaches are avoided; the quality of deliverables is also tremendously affected leading
to sustained/increased profits. Consequently, customers, partners, employees, and others become increasingly confident towards the company for the
fact that their sensitive data will not be compromised, and their privacy will be consistently protected. Customers, partners and employees have a safe,
secure experience in their dealings with the business, which in turn increases their loyalty and improves the company’s competitive advantage.
d. Improved Business Opportunities and Business Growth: With sustained compliance levels over a period of time helps drive new growth by
making it easier for companies in networking. The company can also partner with confidence, with ease and security. In a customer-facing
environment like that of banks, sound compliance measures and strict adherence can boost customer satisfaction and loyalty. This is because the
customer knows it for a fact that his account -related information will not be tampered with and his money lies safe with the bank.
e. Increased Efficiency in Business Operations: A business simply cannot run very efficiently when almost all of its key resources are concentrated
towards addressing only compliance and auditing issues. This will only hamper the functioning of the other business units. Introducing processes like
identity management to the will enable businesses to operate more efficiently by meeting compliance and audit requirements without making
extraordinary demands on existing resources.
f. Greater Focus on Core Business Priorities: As we have seen in point 4 above, making compliance a sustainable part of everyday operations is a
source of business opportunity in itself. Compliance when easily managed becomes an integral part of its day-to-day operations. This automatically
frees up tremendous resources thereby enabling the management to channelize the resources to the core business functions.
25
8. Conclusion
The rules and regulations governing the various aspects of businesses are complex as there is no unified set of regulations. Compliance is made complex
by the lack of a single unified set of laws that govern all aspects of a business’s legal requirements. Regulations are numerous and sometimes even conflict
with one another. The complexity of interpreting the law and ensuring its compliance has forced large organizations to create the role of a compliance
officer. The role of the compliance officer is to ensure that internal processes are in place, which ensures compliance with the various statutes.
Financial sector regulation in India has evolved over the last few years. The focus has been primarily on prudential regulations for the companies.
Measures to deal with the fast-paced world economy and to keep pace with globalization regulatory measures are seen in all forms of industries whether
banking or non-banking.
The list of the regulations in India is unending. Rules and regulations change and are succeeded by newer laws. However, the basis of all of them remains
the same – streamlining the system and making it more transparent and healthier. These compliance measures should not remain as just another circular in
the mail box or for use only by the top management but should be a practice across the entire organization. Timely measures will lead to organizational
growth and eventually to the nation’s prosperity.
26
Unit 8
Governance, Risk & Compliance (GRC)
Unit 8 – Governance, Risk & Compliance (GRC)
Table of contents

1 Creating Compliance Culture Across the Organization 4
2 Governance, Risk and Compliance – GRC Framework 7
3 Benefits of Integrated GRC Approach 8
4 Whistle-Blower Mechanism 9
5 Components of Whistle-Blower Policy 11
Benefits of Whistle-Blower Policy
6 • How to make the whistle-blower policy a success? 12
• Reasons for compliance failures
2
Learning Objectives
• To understand why compliance culture is important to any compliance program.
• To understand the GRC model and why an integrated approach is necessary.
• To study the importance of whistle-blower mechanism to prevent or curb frauds and compliance failures.
3
1. Creating Compliance Culture across the Organization

A culture of compliance is crucial. Compliance must be visibly embraced by senior management and built in to the hiring and training process. Ideally, it
should be linked to pay and promotions as well. Moreover, the right metrics can make the culture of compliance concrete. It is important to address such
questions as:
• Who delivers the compliance message – line or staff?

• How senior are the messengers?
• How often do they address compliance issues?

Culture, like other aspects of compliance process, can be managed and measured over time. Banks around the world are building more effective
compliance programs. It describes the current state of compliance and how banks are struggling to understand and improve the effectiveness of their
programs in order to meet the challenges of the future.
More deliberate measurement and management of compliance risk is needed. It can help to anticipate where compliance mis-steps are most likely to
surface. How well are compliance process working? Knowing the level of enterprise-wise compliance risk helps to gauge the effectiveness of compliance.
The Indian Financial Regulators always emphasize the importance of an organization’s “Culture of Compliance”. Having a robust compliance can help firms
avoid severe financial consequences.
But what is a robust culture of compliance?

Essentially, it is an overall environment that fosters ethical behavior and decision making. Even the most clearly written, comprehensive compliance
program is destined for failure without such an environment. The challenge, however, is that a “robust culture of compliance” can be an elusive concept. To
take some of the guess work out of developing a culture of compliance, here are 10 typical attributes that regulators look for:
4
10 typical attributes of “Culture of Compliance:

1. Tone at the top: this is the most important hallmark of a culture of compliance. Regulators are increasingly meeting with senior management during
examinations to get a sense of their engagement in compliance. Tone at the top is often evidenced by the processes for making critical decisions. For
example, if senior management conducts a cost benefit analysis when deciding whether to engage in a transaction that is illegal, the tone at the top is
that compliance is not the most important factor in decision making. Simply put, if a firm’s leaders only pay lip service to the importance of compliance,
there is no culture of compliance.
2. Integration across the enterprise is key: Risks in banking are both complex and often inter-related – credit can be accompanied by interest rate risk,
market and other risks can aggravate liquidity risk, and compliance risk can overlap with other types of risk, especially operational risk. To ensure that
risk is managed thoughtfully across the enterprise, compliance must work closely and communicate well with all risk areas and businesses.
3. Silos: The compliance department should not be walled off from the rest of the organisation. Is compliance staff present when business decisions are
made? Does the firm seek their input? Firms with a strong culture of compliance would answer “yes” to both.
4. Power: Regulators also look at who holds power in the firm. Is the compliance officer (CCO) part of senior management? Is the compliance
department independent? Is it respected? Or does the CCO sit in a back office, neither seen nor heard? When discussing an issue, who winds-
business or compliance?
5. Cowboys: Does the organization reward risk-taking without limits? Are rewards based solely on financial performance? In a strong culture of
compliance, risks are taken within an organizations tolerance for risk and is seen as being bigger than any one individual.
6. Resources: Compliance costs money. Is the compliance program appropriately structured and sufficiently funded? Is there a strong disparity in
organization's investment in technology and other resources to make money versus its investment in technology and other resources to facilitate
compliance?
5
10 typical attributes of “Culture of Compliance:

7. Employee Buy-in: Once the compliance infrastructure is established, it is the employees who carry out the mandate. The firm’s culture of compliance
must be embedded in the culture of the employees. To facilitate employee, buy-in, organizations should have a zero tolerance policy for employee
misconduct and should have a continuing training program to ensure that employees understand their obligations and that the firm takes compliance
seriously.
8. Living Compliance Program: The compliance program should not be a stagnant checklist of procedural requirements. It must be tailored to the
organizations business and risks; it must be tested and modified; and it must be enforced. Are the policies actually working? Are issues escalated to
senior management?
9. Technology: Is compliance handled with pencil and paper? Does the organisation look for ways to automate compliance and limit human error, as it
does with portfolio and risk management? How are workflows and documents managed? Technology allows organizations to spend less time
managing paper and people and more time actively managing risk.
10. Documentation: Regulators love documentation and so should organizations.
Good record keeping reflects a strong compliance culture.

• When testing compliance policies, can be organization prove that they work?
• Is testing documented?
• Is a documented workflow in place to track the process of marketing materials being approved, and how to show that sign-off was received from the
legal department?
6
2. Governance, Risk and Compliance – GRC Framework

Growing regulatory environment, higher business complexity and increased focus on accountability have led enterprises to pursue a broad range of
governance, risk and compliance initiatives across the organisation. However, these initiatives are uncoordinated in an era when risks are independent, and
controls are shared. As a result, these initiatives get planned and managed in silos, which potentially increases the overall business risk for the
organisation. In addition, parallel compliance and risk initiatives lead to duplication of efforts and cause costs to spiral out of control. Governance, Risk and
Compliance process through control, definition, enforcement and monitoring has the ability to coordinate and integrate these initiatives.
The span of a Governance, Risk and Compliance process includes three elements:
1. Governance is the oversight role and the process by which companies manage and mitigate business risks. With an increase in activism among
shareholders and increased scrutiny from the regulatory bodies, corporate boards and executive teams are more focused on governance related
issues that ever before. The governance process within an organisation includes elements such as definition and communication of corporate control,
key policies, enterprise risk management, regulatory and compliance management and oversight (e.g., compliance with ethics and options compliance
as well as overall oversight of regulatory issues) and evaluating business performance through balanced scorecards, risk scorecards and operational
dashboards. Agovernance process that integrates all these elements into a coherent process to drive corporate governance.
2. Risk management enables an organisation to evaluate all relevant business and regulatory risks and controls and monitor mitigation actions in a
structured manner. With the recent jump in regulatory mandates and increasingly activist shareholders, many organizations have become sensitized to
identifying and managing areas or risk in their business: whether it is financial, operational, IT, brand or reputation related risk. These risks are no
longer considered the sole responsibility of specialists – Executives and the boards demand visibility in to exposure and status so they can effectively
manage the organization's long-term strategies. As a result, companies are looking to systematically identify, measure, prioritize and respond to all
types of risks in the business, and then manage any exposure accordingly. A risk management process provides a strategic orientation for companies
for all sizes in all geographies with a formal process to identify measure and manage risk.
7
The span of a Governance, Risk and Compliance process includes three elements: (Contd.)
3. Compliance ensures that an organisation has the processes and internal controls to meet the requirements imposed by governmental bodies,
regulators, industry mandates or internal policies. An initiative to comply with a regulation typically begins as a project as companies race to meet
deadlines to comply with that regulation. These projects consume significant resources as meeting the deadline becomes the most important objective.
However, compliance is not a one-time event – organizations realize that they need to make it into a repeatable process, so that they can continue to
sustain compliance with that regulation at a lower cost that for the first deadline. When an organisation is dealing with multiple regulations at the same
time, a streamlined process of managing compliance with each of these initiatives is critical, or else, costs can spiral out of control and the risk of non-
compliance increases. The compliance process enables organizations to make compliance repeatable and hence enables them to sustain it on an
ongoing basis at a lower cost.
3. Benefits of Integrated GRC Approach
Many organizations find themselves managing their governance, risk and compliance initiatives in silos – each initiative managed separately even if
reporting needs overlap. Even though, each of these initiatives individually follow the governance, risk and compliance process outlined above, when they
deployed software solutions to enable these processes, the selections were made in a very tactical manner, without a thought for a broader set of
requirements. As a result, organizations have ended up with dozens of such systems to manage individual governance, risk and compliance initiatives,
each operating in its own silos.
Majority of the Fortune 1000 organizations find themselves in this situation today. However, they are quickly finding that as the multiple risk and compliance
initiatives become more intertwined from regulatory and organizational perspectives, multiple systems cause confusion due to duplicative and contradictory
processes and documentation. In addition, the redundancy of work, as well as sheer expense of maintaining multiple point software solutions causes the
cost of compliance to spiral out of control.
By taking an integrated GRC process approach and deploying a single system to manage the multiple governance, risk and compliance initiatives across
the organisation, the issues listed above can be easily addressed.
8
Such an approach can:

• Have a dramatic positive impact on organizational effectiveness by providing a clear, unambiguous process and a single point of reference for the
organisation.
• Eliminate all redundant work in various initiatives.
• Eliminate duplicative software, hardware, training and rollout costs as multiple governance, risk and compliance initiatives can be managed with one
software solution.
• Provide a “single version of the truth” available to employees, management, auditors and regulatory bodies.
• An integrated GRC approach enables an organisation to integrate and streamline these individual compliance initiatives. So it can significantly reduce
the cost of compliance.
It is critical that a GRC solution must be able to address a wide range of compliance and risk management initiatives so that an organisation can leverage
GRC to deploy a consistent framework across the organisation for compliance and risk management. Many vendors window dress their point solution by
re-labelling it as a GRC solution or adding support for a few additional regulations to claim multi-regulatory label.
4. Whistle Blower Mechanism
Securities Exchange Board of India (SEBI) has prescribed the listing agreement that is required to be executed between a stock exchange and a company
whose securities are to be listed on that exchange. Clause 49 of the listing agreement is titled “Corporate Governance” and lays down the principles of
Corporate Governance that are required to be followed by the listed company. In addition to a list of mandatory requirements that a listed company is
obliged to comply with, there are a few non-mandatory requirements that have been specified in terms of Annexure I D of the specimen listing agreement.
One such non-mandatory requirement relates to “Whistle-Blower Policy” Corporate Governance Code
9
Clause 49 of the Listing Agreement of Stock Exchanges places a non-mandatory requirement for listed companies in India to adopt a Whistle-Blower
Policy. The specific recommendation, placed in Annexure I D to clause 49 specifies that:
• The company will establish a mechanism for employees to report to the management concerns about unethical behavior, actual or suspected fraud or
violation of the company’s Code of Conduct or Ethics policy.
• The mechanism must provide for adequate safeguards against victimization of employees who avail of the mechanism.
• The mechanism must also provide, where senior management is involved, direct access to the Chairman of the Audit Committee.
• The existence of the mechanism must be appropriately communicated within the organisation.
• The Audit Committee must periodically review the existence and functioning of the mechanism. •
While this is a non-mandatory requirement, the company also has a mandatory requirement to disclose, in its report on corporate governance the extent of
adoption of such non-mandatory requirements. Numerous companies have adopted the Whistle-Blower Policy in their organisation in their quest to uphold
the highest governance standards or in the fear of being considered late entrants to the “well-governed companies” club.
A logical starting point would be to examine the key components of whistle-blower policy. There are four broad components of whistle-blower
policy:
1. A whistle-blower
2. A wrongful or unethical practice
3. An authority
4. A policy
10
5. Components of Whistle-Blower Policy

1. A whistle-blower: “A whistle-blower is a person who raises a concern about wrong-doing occurring in an organisation or body of people. Usually this
person would be from that same organisation. The revealed misconduct may be classified in many ways; for example, a violation of law, rule,
regulation and/or a direct threat to public interest, such as fraud, health/safety violations, and corruption. Whistle-blowers may make their allegations
internally (for example, to other people within the accused organisation) or externally (to regulators, law enforcement agencies, to the media or groups
concerned with the issues).”
2. A wrongful or unethical practice: There are various grievance or compliant mechanisms that are instituted by organizations. The wrongful practice
or unethical conduct that is sought to be covered under the whistle-blower policy is expected to be grave and serious in nature, and may involve
several parties. These practices may concern serious disregard to the law of the land (e.g., dealing in narcotics), a crime against human rights (e.g.,
child trafficking, dealing in human organs), corruption of a high order (e.g., supply/use of substandard or expired medicines in a hospital), compromise
of the organizational values (e.g., bribery, unfair trade practices) and similar serious acts. It is clear that trivial issues or unfounded claims should not
be escalated through this policy.
3. An authority: The policy defines a specific process to be followed for escalation of information regarding the wrongful or unethical practice. The
person/authority to which the communication may be sent, the manner of sending communication and the manner in which the information received
would be dealt with is clearly defined in the policy. It is felt that the management is often the last in the knowledge-chain where a rampant wrong doing
is concerned, as the employees and other stakeholders are not sure who to report to and not secure as to how it would impact their relationship with
the organisation. Thus, the authority which deals with the information provided by a whistle-blower must be independent, senior and responsible – and
the policy must provide for confidentiality of the information as well as the identity of the informer.
4. A policy: A whistle-blower policy is thus an internal policy on access to the appropriate designated authority, by persons who wish to report on
unethical or improper practices. The policy is intended to create a platform for alerting the management of the company or those charged with the
Governance of the company about potential issues or serious concern, by ensuring confidentiality, protection and expedient action.
11
The Corporate Governance Code in India specifically states that the whistle-blower must have a direct access to the Chairman of the Audit Committee
for reporting on wrong doings by the senior management.
The association of Certified Fraud Examiners has highlighted five reasons for “why employees don’t report unethical conduct”
1. No corrective action
2. No confidentiality of reports
3. Retaliation by superiors
4. Retaliation by co-workers
5. Unsure whom to contact

6. Benefits of Whistle-Blower Policy
There is no doubt that in today’s fast-paced world and mega corporations, institution of a whistle-blower policy is not a corporate luxury, but an
organizational necessity. The benefits of such a policy are many:
• Fostering good governance by encouraging employees to escalate deceitful actions by colleagues/seniors/third parties.
• Promotion of the organizational values thus nurturing a culture of openness in workplace.

• Sending a clear message that severe action will be taken against unethical and fraudulent acts.
• Dissuading employees from committing fraud by instilling fear of unfavorable consequences when caught.
• Early alerts to diffuse a potentially larger disaster.
12
6.1 How to make the whistle-blower policy a success?

The success of the Whistle-Blower Policy largely depends upon various factors viz. the level of the tone at the top and the signals that it sends down the
level, organizational philosophy and code of conduct; whistle-blower policy campaigning, orientation and awareness in the organisation.
The Whistle-Blower Policy should clearly state that:

• Anonymity of the informant will be maintained.
• The authenticity of the information will be confirmed and there will be no reprisal for reporting the information.
• Appropriate and disciplinary action will be taken after investigation and on confirmation of the information.
6.2 Reasons for compliance failures
Regulation that fails to elicit an adequate level of compliance not only fails to meet its underlying policy objective, but also:
• Creates unnecessary costs through fruitless administration and implementation.
• Postpones the achievement of the policy objective.

• Erodes general confidence in the use of the regulation, the rule of law, and government in general.
• Cumulatively leads to the undermining of other regulations and regulation itself, which can lead to a vicious cycle in which more and more rules are
promulgated.
We have identified the following causes of non-compliance from the point of view of those targeted:
• Failure to Understand Law: Requirements are too complex to know and understand. People cannot comply with regulations if they do not understand
13
what is required. In regulatory design and development, policymakers often feel pressure to issue new rules or expand existing ones to cover
unforeseen circumstances, to close loopholes, and to address new problems. The cumulative effect of reacting to such pressure can lead cumulatively
to a loss of simplicity and therefore the loss of the ability in the target groups to understand what compliance with the resulting regulatory structure
involves. The German Tax Law has been famously called, “not a law but a novel.”
• Collapse of Belief in Law: Compliance is too costly. Voluntary compliance is likely to be low when costs (in time, money, or effort) of complying with a
rule are considered to be high. Many factors contribute to what may be viewed as unreasonable compliance costs: substantive standards are too high,
the transition time for coming into conformity is too short, or the regulation is inflexible. If a rule seems unreasonable, instead of complying, businesses
may dedicate more time and money to lobbying regulators to change it or asking for special treatment.
• Overly Legalistic Regulation: People lose confidence in regulators and governments if they are required to comply with technical rules that do not
appear to relate to any substantive purpose. An overly rule-based or “legalistic” approach to compliance can have the same effect, undermining a
government’s achievement of substantive policy objectives.
• Regulation is at odds with Market Incentives or Cultural Practices: Compliance rates are lower when regulation does not fit well with existing
market practices or is not supported by cultural norms and civic institutions. Of course, sometimes the whole point of issuing a rule is to counter an
existing market or cultural practice. For example, consumer protection provisions may be necessary to outlaw over-selling in an insurance industry
because it has become common practice. However, is a rule cuts across existing culture and fails to build support through education, market incentives,
or linkage with institutions of civil society, then it is unlikely to be effective at eliciting compliance.
• Failure to Monitor: A rule that is on the books, but not monitored is unlikely to elicit compliance. Random inspections among the target group have the
effect of making people and enterprises that are normally law-abiding constantly aware of the existence of enforcement activities and tend to reduce the
likelihood of future non-compliance. However, manufacturing that is not rigorous enough or not targeted at high risk areas is less likely to be effective.
• Procedural Injustice: Researchers have found that is people feel they are treated unfairly by the government or a regulatory agency, then they will
often respond by refusing to comply with the regulatory requirements. People who believe they have been or will be dealt with fairly by a regulatory
14
system are much more likely to comply with its requirements, whatever they are, than hose who believe the system is not fair.
• Deterrence Failure: Regulators can face a failure of deterrence because of so many kinds of business rule breaking have high rewards and low
probabilities of detection. When fines are not high enough to offset the high profits potentially available from crime (e.g., illegal stock market
manipulation can easily net multi-million-dollar profits), the government can find itself in a “deterrence trap”. If it imposes a fine large enough to deter, it
may bankrupt the firm or at least so deplete the liquid assets of the firm “that workers will lose jobs”.
• Failures of Administrative Capacity: Not only should agencies rely on good drafting and enforcement practices, but they should also devote
resources to adequate implementation policies, aimed at making it feasible for the target group able to comply with the rules. Voluntary compliance
levels may be compromised if Agencies do not ensure that implementation includes the provision of necessary information and other support or
mechanisms.
• Failure to Understand the Problem: If the problem was clearly understood, objectives could be more effectively attained through other means.
Governments and regulators sometimes rely though habit upon certain types of regulatory instruments to solve problems, with out first adequately
defining and analyzing the particular problem to determine the most appropriate solution. Too often, the problem itself is defined as “a lack of
regulation”. If a government accurately defines the cause of the problem and clearly defines its policy objective, the government can then use the least
coercive and most effective means to achieve the objective.
• Failure of Casual Relation between Regulation and Objective: Desired outcomes cannot be achieved through the means required. Some rules do
not describe what is to be achieved, but instead detail the actions that the regulated entity must carry out, which the regulator hopes will produce the
desired outcome. While sometimes necessary when results are difficult to measure, regulations of this type are undesirable as a general approach. The
prescribed actions may in practice achieve very little but leave no room for adjustment by the regulated entity. This is related to a failure to identify the
exact casual relation between the policy instrument and the regulatory objective.
15
A bank’s compliance policy will not be effective unless there is a clear commitment by the board of directors promoting the values of honesty and integrity
throughout the organisation. Today, compliance is often involved in executing compliance controls over daily business transactions (operational
compliance), as well as providing ongoing compliance oversight. This causes another potential conflict of interest that can be mitigated through the “tone at
the top” (instilling a compliance culture throughout the organisation); consistent, ongoing performance measures to ensure that business is fully cognizant
of its compliance responsibilities; and separate reporting lines the risk of not keeping pace with the rising regulatory bar.
The bank’s compliance function should be independent from the business activities of the bank. Staff exercising compliance responsibilities should have
the necessary qualifications, professional experience and personal qualities to enable them to carry out their duties effectively.
The bank’s compliance function should have a formal status within the bank. The compliance function for banks that conduct business in other jurisdictions
should be structured to ensure that local compliance issues are satisfactorily addressed within the framework of the compliance policy for the bank as a
whole.
The GRC is the most complete and integrated framework to success of an organisation in achieving growth in a regulatory compliance environment. “Tone
at the top” (instilling a compliance culture throughout the organisation); consistent, ongoing performance measures to ensure that business is fully
cognizant of its compliance responsibilities; and separate reporting lines is the way forward.
16

WILP - CGEC - Reading Material PDF

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

WILP - CGEC - Reading Material PDF

Uploaded by

Copyright:

Available Formats

Corporate Governance, Ethics & Compliance

S.No Details Page No.

S.No Details Page No.

1. Understanding Corporate Governance

1.1 Salient Features of Corporate Governance

1.2 Scope of Corporate Governance

1.3 Corporate Governance Principles

1.4 Corporate Governance Theories

Shareholders Theory vs. Stakeholders Theory

S.NO Criteria Agency Theory Stewardship Theory

Table 1 - Comparison of Agency Theory and Stewardship Theory

Property Rights Theory

1.5 Development of Codes and Guidelines

The Cadbury Report 1992

The Cadbury Report 1992

The Sarbanes – Oxley Act, 2002

1.6 Popular Models for Governance

The Anglo-American Model

Figure 1.1 – Anglo-American Model

The German Model

The distinctive features of German Model are:

Figure 1.2 – The German Model

The Japanese Model

Figure 1.3 – The Japanese Model

The Indian Perspective (Governance in Public Sector)

The distinctive features are:

Figure 1.4 – The Indian Perspective of Corporate Governance

1.7 Principal Activities of Corporate Governance

Direction Executive Action Supervision Accountability

Formulation of strategic Recognition of

1.8 What Corporate Governance Achieves?

1.9 Differences in the focus of Corporate Governance vs Management

1.10 Participants to Corporate Governance

1.11 Importance and Benefits of Corporate Governance

Benefits of Corporate Governance

Think About It:

1.12 Role of Corporate Governance

2. Systems of Corporate Governance

Rule-based Systems with External Monitoring

Principle-based Systems with Self-regulation

3.1 Prevention of Corruption Act

Offense of Bribery by Commercial Organizations:

3.2 Serious Fraud Investigation Office

3.3 Enforcement Directorate

3.4 Companies Act 2013

3.5 SEBI Guidelines

3.6 Accounting Standards

3.7 Competition Commission of India

3.8 Reserve Bank of India

OECD Principles - https://www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf

Unit 1 – Additional Read

I. Ensuring the basis for an effective corporate governance framework

a. Basic shareholder rights should include the right to:

o Participate and vote in general shareholder meetings;

o The authorization of additional shares; and

o Impediments to cross border voting should be eliminated.

o The disclosure of capital structures and control arrangements should be required.

III. Institutional Investors, Stock Markets, and Other Intermediaries

IV. The Role of Stakeholders in Corporate Governance

V. Disclosure and Transparency

o The financial and operating results of the company.

o Major share ownership, including beneficial owners, and voting rights.

VI. The Responsibilities of the Board