INTRODUCTION AND RESEARCH METHODOLOGY

Corporate Govanance is the mechanism by which the values, principles,

policies and procedures of a corporation are,inculcated and manifested. The essence

of Corporate Governance lies in promoting and maintaining integrity, transparency

and acwuntability in the organization, commitnpnt to values and ethical business

conduct. Accordingly, timely and adequate disclcisure of information regarding the

financial situation, performance, ownership and governance of the company is an

important part of the corporate governance. Company's*philosophy on corporate

governance envisages the attainment of the highest level of transparency,

accountability and equity, in all facets of its operations, and in a11 its interactions

with its stakeholders, including shareholders, qployees, the government and the

lenders.

Corporate Governance is aimed at ensuring proper governance of business as

well as complying with all the governance norms prescribed by regulatory board for

the benefit of all interested parties including society. The basic objective is the

maximization of long-term shareholders value within the parameters of public law

and social ethics to give an impression to customers and employees about the

transparency and fairness of business.

Corporate Governance has fast emerged as a benchmark for judging

corporate excellence in the context of national and international business practices.

From guidelines and desirable code of conduct some decades ago, corporate

governance has come a long way and is now recognized as a paradigm for

improving competitiveness and enhancing efficiency, and thus improving investors'

confidence and accessing capital, both domestic as well as foreign. ( Pushkar Gupta

2007 - 2008) The framework for corporate governance is not only an important

component affecting the long-term prosperity of companies, but it is a leading

species of a large genus namely, National Governance, Hman Governance, Societal

Governance, Economic Governance and Political Governance. Government provides

necessary conditions, framework and environment to corporate to operate. There is,

however, no universal recipe for good corporate governance since business

environment varies from country to country.

Corporate governance refers to the structures and processes for the direction

and control of companies. It concerns the relationships among the management,

Board of Directors, controlling shareholders, d o r i t y shareholders and other

stakeholders. In general, Governance is *e exercise of authority, direction and

control of an organization in order to ensure its purpose is achieved. It refers to

b Who is in charge of what;

P Who sets the direction and the parameters within which the dkection is to be

pursued;

P Who makes decisions about what;

P Who sets performance indicators, monitors progress and evaluates results;

and,

9 Who is accountable to whom and for what?

Primarily, though, corporate governance refers to the framework of all rules

and relationships by which a corporation must abide, including internal processes as

well as governmental regulations and the demands of stakeholders. It also takes into

account systems and processes, which deal with the daily working of the business,

reporting requirements, audit information, and long-term goal plans. (FBN BMG

London Seminar)

Corporate Governance is, therefore, a systematic approach where the

connected members, management and employees are expected to cooperate in the

decision making process of the company. Based on some fundamental reasons,

corporate governance holds its premise that the business should be conducted by the

desires of shareholders. It identifies the distribution of rights and responsibilities

among a variety of stakeholders in the wmpany. It also briefly outlines the structure

and process for judgment on matters related to the company dealings. In the context

of the above, the following are the broad objectives on which corporate governance

can be measured: i) Suggested model code of best practices, ii) Preferred internal

systems, iii) Rewmended disclosure requirements, iv) Board members' role, v)

Independent director, vi) Key information to the board/committee, vii) Committees

of board, viii) Policies to be established by the board and i x ) Monitoring

performance. (Buxi, 2005)

Effective corporate govtxnance is imporht for any company to be

successfhl irrespective of the type of business it does. Corporate governance has, of

course, been an important subject of discuss'ion since many years. Scholars and

researchers from finance fields have actively investigated the importance and

efficacy of corporate governance for at least a quarter of a century (Jenson and

Meckling, 1976). There have been intense debates and brainstorming over corporate

governance practices particularly in the developed nations. However, the

effectiveness of corporate governance practices in the developed nations tells an

ironic story from the CG practices point of view. The volume of scandals and lack of

transparency in governance in the developed nations nullifies its hue commitment to

governance practices compared to the developing world (Shleifer et al., 1997).

Therefore, much prior to the recent wave of corporate fi-auds in developed

economies, corporate governance has been a fundamental subject in emerging

economies.

The subject of corporate governance has attracted worldwide attention with

the collapse of a series of high profile companies lrke Emon, WorldCom, Satyarn

Computers etc. These failures have shattered the trust of investors worldwide. Some

of the scandals which made headlines all around the world were loosely related to

poor corporate governance. This collapse came at a time when many companies

were trying to get internationally listed and foreign investors were becoming more

and more eager to buy them out (Economist Intelligence Unit, 2004). Poor corporate

governance is not a new subject. A good thing that &me out of these corporate

scandals was the global acceptance of the need for necessary checks and balances.

Worldwide, it has now become necessary for big corporate houses to address the

issue of corporate governance as investor demands fluctuate. The following are the

four vital pillars for strong corporate governance.

*:* Responsibility,

*:* Transparency,

*:* Fairness and

*:* Accountability

Large and trusted companies across the globe realized the significance of

corporate governance and subsequently to@ drastic steps to ensure practice of

corporate governance. These days corporate govixmmce is a reality which can't be

overlooked by any financial institution that wants to be successfi~l. There are a

number of factors which force a company to adhere to a set of corporate g o v m c e

principles. These may include stern regulators, vigilant and smart investing

community, alert customers and the awareness among companies to be good

corporate citizens. Companies should ensure a constant flow of profits but without

crossing moral and ethical boundaries. (Pushkar Gupta 2007) However, some bad

experiences in the past have exposed the fact that big corporate houses which have

committed frauds have tacit support from banks. Questions have arisen thick and

fast as to how people entrusted with governance of these corporate/banks, had failed

to detect and stern the rot, before it was too late. Banks are constituted as companies

under the companies act and they should be concerned with good governance.

Corporate governance has always been closely monitored by Asian regulators and

this term has been a top priority for them in recent times. This is happening because

of the fact that most of the markets have introduced a wide range of regulations.

Concept of Corporate Governance

It is difficult to define the concept of corporate govemance in a universally

acceptable way because definitions vary from country to country. Moreover,

countries differ from each other in terms of culture, legal systems and historical

developments (Ramon, 2001). This explains why there is a wide range of definitions

of the concept of corporate governance. There are several definitions of corporate

governance, although they are formulated differently but the meaning is the same.

The following definition can be found in OECD's preamble:

"Corporate governance involves a sei of relationships bemeen a company's

management, its board, its shareholders and other stakeholders. Corporate

governance also provides the structure through which the objectives of the company

are set, and the means of attaining those objectives and monitoringpefimance are

determined. Good corporate governance should provide proper incentives for the

board and management to pursue objectives that are in the interests ofthe company and its shareholders and should facilitate effective monitoring. " (OECD Principles

of Corporate Governance 22 April 2004)

"Corporate Governance is concerned with holding the balance between

economic and social goals olnd between ipdividual and communal goals.(Globd

Corporate Governance Forum.2003) The coxpotate governance framework is there

to encourage the efficient we of resources and equally to require accountability for

the stewardship of those resources. The aim is io align as nearly as possible the

interests of individuals, corporations and society" (Sir Adrian Cadbury in 'Global

Corporate Governance Forum', World Bank, 2000) .

According to the Economist and Nobel Laureate, Milton Friedman,

"Corporate Governance is to conduct the business in accordance with owners' or

shareholders' desires, while conforming to the basic rules of the society embodied in

law and local customs"(Economic Times,2001). In a nutshell, it can be said that

corporate governance means doing everything better to improve relationships

between companies and their shareholders, to improve quality of outside directors,

to encourage people to think long-term and to ensure that infomation needs of all

stakeholders are met. The discussion on governance dates back more than a decade

in different economies. Traveling through the pre-1992 American discussions on

disassociation of power and money (emanating from the Watergate Scandal), post-

1992 Cadbury Report on governance codes and OECD principles (1998 & 1999),

and corporate governance has not yet settled at any universally accepted definition

(A. C. Fernando)

Corporate governance is about "the whole set of legal, cultural, and

institutional arrangements that determine what public corporations can do, who

controls them, how that control is exercised, and how the risks and return from the

activities they undertake are a1Iocated.- (Margaret Blair, 1995)

Corporate governance is the relationship among various participants [chief

executive officer, management, shareholders, employees] in determining the

direction and performance of &rporationsW - Monks and Minow, Corporate

Governance, 1995.

Corporate governance is the relationship between corporate managers,

directors and the providers of equity, people and institutions who save and invest

their capital to earn a return. It ensures that the board of directors is accountable for

the pursuit of corporate objectives and that the corporation itself conforms to the law

and regulations. - International Chamber of Commerce

Corporate governance is the method by which a corporation is directed,

administered or controlled. Corporate governance includes the laws and customs

affecting that direction, as well as the goals for which the corporation is governed

The principal participants are the shareholders, management and the board of

directors. Other participants include regulators, employees, suppliers, partners,

customers, constituents (for elected bodies) and the general community. - Wikipedia

"Corporate governance is not an abstract goal, but exists to serve corporate

purposes by providing a structure within which stockholders, directors and

management can pursue most effectively the objectives of the corporation." - US

Business Round Table White Paper on Corporate Governance September 1997

Corporate governance is the system by which companies are directed and

managed. It influences how the objectives of the company are set and achieved, how

risk is monitored and assessed, and how performance is optimized. Good

corporate governance structures encourage companies to create value (through

entrepreneurism, innovation, development and exploration) and provide

accountability and control systems commensurate with the risks involved.

(ASX Principles of Good Corporate Governance and Best Practices

Recommendations 2003)

Corporate governance is the process carried out by the board of directors,

and its related committees, on behalf of and for the benefit of the company's

stakeholders, to provide direction, authority, and oversights to management. (Paul J.

Sobel, 2005)

Importance of Corporate Governance

The governance rose from an analysis by Berle and Means (1932) following

the Great Crash in the US in 1929, which traced the problem of governance due to

the separation of ownership and control. The authors recommended stakeholder

value over the share holder value as essential for good governance, a premise on

which formal securities regulation began in the US with the setting up of the

Securities and Exchange Commission (1933). This debate led the governance being

associated with the agency problem (Coase, 1937) (Jensen and Meckling, 1976).

(Fama and Jensen, 1983) in which the essence is thb separation of ownership and

control. Agency problem refers to the difficulties financiers have in assuring that

their funds are not expropriated or wasted on unattractive projects (Shliefer and

Vishny, 1997)) Early work in the corporate law development in the 18th and 19th

centuries in Britain, Continental Europe and ~ussi'e has focused more on addressing

the problem of managerial theft rather than that of shirking or even empire building.

Shleifer and Vishny cite studies on vast managerialist literature that explains how

managers use their effective control rights to pursue projects that benefit them rather

than the investors which are described as private benefits of control (Grossman and

Hart, 1 982). Managers can expropriate shareholders rights by entrenching

themselves and staying in the job even if they are no longer competent or qualified

to run the firm. Poor managers who resist being replaced might be the costliest

manifestation of the agency problem (Jensen and Ruback 1983). Agency theory

considered the firm as a nexus of contracts; associating the firm and the entire group

of resource contributors (the team of productive inputs) and analyzing the

relationship between the principle (shareholders) and the agent (mangers), the

conceptual framework which is found.

A series of events over the last two decades have made corporate governance

issues a top concern for both the international business community and the

international financial institutions. Spectacular business failures such as the

infamous Bank of Credit and Commerce International scandal, the United States

savings and loan crisis, and the gap between executive compensation and corporate

performance drove the demand for change in developed countries.(CIPE,2002)More

recently, high profile scandals, iinancial crises and/or institutional failures in Russia,

Asia and the United States have brought corporate governance issues to the fore in

developing countries, transitional e'conomies, and emerging markets. These incidents

illustrate that the lack of corporate governance enables insiders, whether they be

company managers, company directors or public officials, to ransack companies

andlor public coffers at the expense of shareholders, creditors and other stakeholders

(employees, suppliers, the general public, and so forth). (Dr. Catherine L. Kuchta-

Helbling and Dr. John D. Sullivan) Yet, in today's globalized economy, companies

and countries with weak corporate governance systems are likely to suffer serious

consequences above and beyond financial scandals atid crises. What is increasingly

clear is that how corporations are governed, commonly refmed to as corporate

governance, largely determines the fate of individual companies and entire

economies in the age of globalization. Globalization and financial market

liberalization have opened up new, international markets with the possibility of

reaping stunning profits (John D. Sullivan, Jean Rogers 2003). Yet it has also

exposed companies to fierce competition and to considerable capital fluctuations.

National business communities and company managers are learning that in order to

expand and be internationally competitive they need levels of capital that exceed

traditional funding sources. Failure to attract adequate levels of capital threatens the

very existence of individual firms and can have dire consequences for entire

economies. Lack of sufficient capital, for example, erodes firms' competitiveness

eliminating jobs and hard-won social and economic gains, thereby exacerbating

poverty. Firms unable to attract capital run the risk of becoming suppliers and

vendors to the global multinationals or, worse yet, they will be unable to compete

and thus left out of international markets entirely, while entire economies sun the

risk of not being able to take advantage of globalization. Yet, recent financial crises

caused by corruption and mismanagement have made attracting sufficient levels of

capital particularly challenging these days.

These crises cost investors biflions of dollars and sabotaged companies'

financial viability. They also contributed to increased shareholder activism and

competition for investment. Investors, especially instih;tional Investors, are now

making it clear that they art: not willing to foot the bill for corruption and

mismanagement. Before committing any funds, investors increasingly require

evidence that companies are run according to sound business practices that minimize

the possibilities for corruption and mismanagement. Moreover, investors and

institutions in Bogota, or Boston, Beijing or Berlin, want to be able to analyze and

compare potential investments by the same standards of transparency, clarity and

accuracy in financial statements before investing. In fact, being a credible business

that can withstand the scrutiny of international investors is more than just a matter of

global marketing: it has become essential for local companies and for entire

economies to grow md prosper. The bottom line is that investom seek out

companies that have sound corporate governance structures. Corporate gov-ce

is the body of rules of the game by which companies are managed i n t d l y and

supervised by boards of directors, in order to protect the interests and financial stake

of shareholders who may be located thousands of miles away and far removed fkom

the management of the firm. Just as good government requires transparency so that

the people can effectively judge whr-ther their interests are being served,

corporations must also act in a democratic and transparent manner so that their

owners can make educated decisions about their investments. This is what corporate

governance is all about. What is often overlooked is that corporate governance is

just as important for public sector firms as for private sector companies. Instituting

corporate governance within public sector firms has recently begun to receive

increased attention. This is particularly the case when countries are attempting to

curb widespread corruption within the public sector, or when they are preparing

public enterprises for privatization. In either scenario, sound corporate governance

measures help to ensure that the public gets a fair return on their national assets.(

Rarni Wadie)

Good corporate governance benefits developing countries in a number of

ways. According to at least one scholar, good corporate-governance practices can

decrease the "likelihood of a domestic financial crisis" and severity if such a crisis

does occur. Additionally, scholars have found strong "evidence linking corporate

governance to corporate efficiencyw and have shown &at "corporate governance

creates more efficient corporate management." Finally, research shows that well-

governed firms are valued significantly higher than firms with imperfect corporate-

governance practices. It has been estimated that, by the end of this century, "funds

seeking trustworthy, productive companies in today's developing countries are likely

to top $500,000 billion." The policy challenge that exists for governments in

developing countries is to provide a hospitable environment far such funds; a sound

corporate-governance framework can play a decisive role in creating this hospitable

environment. Strong corporate governance has beneficial consequences even for

countries that choose to follow a development strategy that does not focus on

attrading foreign investment. Many developing dountries are home to strong

distribution cartels that waste scarce resources, Good corporate governance can

reduce this wasteful behavior and, thus, "overcome the obstacles to productivity

growth." Moreover, corporate governance can play a role in reducing corruption,

and decreased corruption significantly enhances a country's developmental

prospe+cts. Ultimately, corporate governance "is not just one of those imported

westem luxuries; it is a vital imperative."

Objectives of Corporate Governance

P Fairness to all Stakeholders

);. Greater transparency through better disclosures

k Greater Accountability of Executive Management to stakeholders.

P Enforcement and Verifiability of various Acts, Regulations, Recommendations,

etc.

k Creating value for the shareholders

P Protecting interests of other stakeholders.

Essentials of Good Governance

P Quality and clarity of norms

Enforcement systems and structure processes

P Dialogue and discussion and awareness

Factors affecting governance

P IntegrityoftheManagement.

Ability of the board

> Adequacy of the process

Commitment level of individual board members.

k Quality of corporate reporting

k Participation of stakeholders in the management.

Applicability

P All listed companies including PSUs and mcluding Mutual funds.

B All companies that are incorporated under other statutes, so far as the

recommendations do not violate their respective statutes and guidelines or

directives issued by the relevant regulatory authorities Implementation

Schedule.

P By all entities seeking listing for the first time, at the time of listing.

> Having a paid up share c~pital of Rs 3 crores and above or net worth of Rs 25

crores or more at any time in the history of the company. (Corporate

governance review of practice (2007) & Bombay Stock Exchange)

Emergence of Corporate Governance: World Scenario

Business failures and frauds in the USA, several scandals in Russia and the

Asian crisis (1997) have brought corporate governance issues to the forefront in

developing countries and transition economies. The virtual collapse of the Russian

economy in 1998 resulted in large measure from the weakness of governance

mechanisms. The so-called managers are said to have robbed shareholders, creditors,

consumers, the government, workers and all possible stakeholders. The fact that the

consequent distrust predictably resulted in the virtual collapse of external capital to

firms reveals that corporate misgovernance can shake the very foundations of a

society. Likewise, the Asian financial crisis also demonstrated that even strong

economies lacking transparent control, responsible corporate boards and shareholder

rights could collapse due to the dilution of investors' confidence. Consequently

various countries in the world have adopted the CG reforms over the years as

detailed below.

World Scenario of CG Reforms - First codes of Practice

Source: Jill Solomon (2007), Corporate Governance and Accountability, P-188. & www.ecgi.org

Year

1 992

1994

1995

1996

1 997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20 1 1

In this situation, the CG mechanism gained worldwide attention due to the

h u d s and deficiencies involved in the corporate sector in the US and the UK.

Prominent among corporate failures in US was the Collapse of Enron and in UK, the

Maxwell failure (1 991), Barings Bank (1995) and the like. Based on the corporate

distress in UK, several committees were appointed for finding the root causes for

their failure and to find appropriate solutions for improving the CG practices. The

Cadbury Committee (1992), The ~ r e e n b ~ ' Committee (1995), The Harnpei

Country

United Kingdom

South Afiica, Canada

Australia, France, Pan-Europe

Spain

USA, Japan, The Netherlands

India, Belgium, Germany, Italy, Thailand

Brazil, Greece, Hong Kong, Ireland, Mexico, Portugal, South Korea, OECD, ICGN, Commonwealth

Denmark, Indonesia, Kenya, Malaysia, Romania, Philippines

China, Czech Republic, Malta, Peru, Singapore, Sweden

Austria, Cyprus, Hungary, Kenya, Pakistan, Poland, Russia, Solvakia, Switzerland, Taiwan

Finland, Lithuania, Macedonia, New Zealand, Turkey, Ukraine, Latin America, Nigeria

Argentina, Bangladesh, Iceland, Norway, Slovenia, OECD, Mauritius

Jamaica, ICGN, Latvia, Lithuania

Estonia, Lebanon, Luxemburg, Nigeria, Sri Lanka, Thailand, Bosnia and Herzegovina, Egypt, Israel, United Nations

Bulgaria, Colombia, Jordan, Kazakhstan, Moldova, Mongolia

Morocco, Qatar, Serbia, Tunisia

Algeria, Croatia, Georgia, Montenegro

Armenia, Bahrain, Baltic States, Ghana, ~ a l a w i , .~om&a, Yemen

Azerbaijan, Guernsey

Committee ( 1 998), The Turnbull Committee (1 999), f i e Higgs Committee (2003),

The Tyson Committee (2003), The Smith Committee (2003) and Redraft of the

Combined Code (2003) are the prominent oaunikees on the CG in UK. Apart hm

all these exercises, the World Bank, the OECD, ~McKinsey S w e y on Corporate

Governance and Sarbanes-Oxley Act, 2002 also contributed improving the CG

practices world over.

Emergence of Corpor'ate Governance: Indian Scenario

Interest in corporate governance by policy makers in developed countries

had grown significantly by early 1990s. In India tbo it had its beginning in the early

1990s. In India the CG represents the value, ethical and moral framework under

which business decisions are taken to maximise stakeholder value. The emergence

of CG in India is the result of a spate of scandals in corporate and stock markets,

unlike corporate failures in the other parts of the world. A good number of

Committees and Commissions have been appointed for improving CG practices in

India also. Though in India there have not been such massive corporate failures such

as Enron, Maxwell etc., it has resolved wisely and with forethought to incorporate

better governance practices in the corporate sector emulating stringent international

standards. Many large corporations are multinational in nature. They have their

impact on citizens of several countries across the globe. If things go wrong, they are

bound to affect many countries, some more severely than others. Therefore, it is

necessary to look at the international scene and examine possible international

solutions to corporate governance issues and problems. Corporate governance is

needed to create a corporate culture of consciousness, transparency, confidence

among investors and prospective investing public. It refers to a combination of laws,

rules, regulations, procedures and voluntary practices to enable companies to

maximise shareholders' long-term value. It should lead to increasing customer

satisfaction, shareholder value and wealth creation.

Driving Forces of Corporate Governance

Good corporate governance is a reflection of quality management with the

highest caliber understanding the role that high corporate governance standards

plays in maintaining checks and balances within the organisation, increasing

transpttrency and pmenting corporate abuse and rniskgement . Management of

good corporate governance companies also understands the importance of investors

of long-tam sustained operating perform~ce and tends to be inherently

performance-driven. The corporate governance scenario in India has been changing

fast over the past decade, particularly with the enactment of Sarbanes-Oxley type

measures and legal changes to improve the enforceability of creditors' rights. India

should have the quality of institutions necessary to sustain its impressive current

growth rates in the years to come, if the same trend is to be maintained.

Corporate governance provides a mechanjsm which improves the efficiency,

transparency, accountability of the wrporates and builds the confidence of the

stakeholders. Corporate governance describes the structure of rights and

responsibilities among the parties that have a stake in the firm. But the kind of

responsibility and structure of the firm varies from region to region and country to

country including the emerging economies. These economies, however, provide

unique opportunities and challenges for governance practices and research. As

pointed out already, little research in this area has taken place in these countries. In

th~s context an effort is made here to identify the driving forces for corporate

governance in India. There are a number of causes for the emergence of corporate

governance in India, apart from the ethically ambiguous business practices and

scams in the market environment. There are three major driving forces in the market

that can be identified for the emergence of corporate governance in India. These

include 1. Unethical business practices and security s a n s , 2. Globalisation and

3. Privatisation.

Parties Involved in Corporate Governance

Parties involved in corporate' governance contain the regulatory body. Other

stakeholders who take part include suppliers, employees, creditors, customers and

the community at large. In corporations, the shareholder delegates decision rights to

the manager to act in the principal's best interests. This division of ownership h m

control implies a loss of proficient control by shareholders over managerial

decisions. Partially as a result of this separation between the two parties, a system of

corporate governance controls is implemented toeassist in aligning the incentives of

managem with those of shareholders. With the major &ease in equity holdings of

investors, there has been an opportunity for a reversal of the separation of ownership

and control problems because ownership is not so diffuse.

A board of directors often plays an importarit role in corporate governance. It

is their responsibility to support the organization's strategy, develop directional

policy, appoint, supervise and remunerate senior executives and to make sure of the

accountability of the organization to its owners and authorities. The Company

Secretary, known as a Corporate Secretary in the US and often referred to as a

Chartered Secretary if qualified by the Institute of Chartered Secretaries and

Administrators (ICSA), is a high ranking professional who is trained to support the

highest standards of corporate governance, effective operations, compliance and

administration. All parties to corporate governance have an interest, whether direct

or indirect, in the efficient performance of the organization. Directors, workers and

management receive salaries, benefits and standing, while shareholders receive

capital return. Customers receive goods and services; suppliers receive

compensation for their goods or services. In return these individuals provide value in

the form of natural, human, social and other forms of capital. A key factor in an

individual's decision to participate in an organization e.g. through providing

financial capital and trust that they will get a fair share of the organizational returns.

If some parties are receiving more than their fair return then participants may choose

not to continue participating leading to organizational collapse.

Parties to corporate governance

Barid d d b e a n

CradtQon

ProrprWe Irm#rcr

Corporate Governance in Banking Sector

Banking sector being the dominant and vital segment deserves utmost

attention. Banking is the systemic institution that not only possesses the potential of

a great catalyst for growth but also, on the other hand, has the capability of cawing

calamity to an economy. There is considerable deviation in practices of corporate

governance being followed by the banks in India. When banks efficiently mobilize

and allocate h d s , this lowers the cost of capital to firms, boosts capital formation,

and stimulates productivity growth. Thus, the functioning of banks has ramifications

for the operations of firms and the prosperity of nations. (Levine (1 997,2004).)

Banking crises dramatically advertise the enormous consequences of poor

governance of banks. Banking crises have crippled economies, destabilized

governments, and intensified poverty. When bank insiders exploit the bank for their

own purposes, this can increase the likelihood of bank failures and, thereby, curtail

corporate finance and economic development. While banks are important, this alone

does not motivate a separate analysis of the governance of banks. Banks are firms.

They have shareholders, debt holders, boards of directors, competitors, etc. This

suggests that one can simply think about the governance of banks in the same way

that one thinks about the governance of a shoe company, or an automobile company,

or a pharmaceutical company. (Ross Levine July 21,2003)

Banks, however, have two related characteristics that inspire a separate

analysis of the corporate governance of banks. First, banks are generally more

opaque than nonfinancial firms. Although information asymmetries plague all

sectors, evidence suggests that these informational asymmetries are larger with

banks (Furfine, 2001). In banking, loan quality is not readily observable and can be

hidden for long periods. Moreover, banks can alter the risk composition of their

assets more quickly than most non-financial industries, and banks can readily hide

problems by extending loans to clients that cannot service previous debt obligations.

Not surprisingly, therefore, Morgan (2002) finds that bond analysts disagree more

over the bonds issued by banks than by nonfinancial firms. As detailed below, the

comparatively severe difficulties in acquiring information about bank behavior and

monitoring ongoing bank activities hinder traditional corporate governance

mechanisms.

Smnd, banks are firequently very heavily regulated. Because of the

importance of banks in the economy, because of the dullness of bank assets and

activities, and because banks are a ready source of fiscal revenue, governments

impose an elaborate array of regulations on banks: At the extreme, governments own

banks. Of course, banking is not the only regulated industry and governments own

other types of firms. Nevertheless, even countries that intervene little in other sectors

tend to impose extensive regulations on the commercial banking industry. Further

more, the explosion of international standards through the BIS, the IMF, and World

Bank. (La Porta et al. 2002)

Given the importance of banks, the governance of banks themselves assumes

a central role. If bank managers face sound governance mechanisms, they will be

more likely to allocate capital efficiently and exert effective corporate governance

over the firms they fund. In contrast, if banks managers enjoy enormous discretion

to act in their own interests rather than in the interests of shareholders arid debt

holders, then banks will be correspondingly less likely to allocate society's savings

efficiently and exert sound governance over firms. (Andra Lavinia Nichitean,

Mircea Asandului.20 1 0)

Anecdotally, the various board committees (compliance, audit, risk,

compensation) are vocal, particularly in the internationally listed banks. All this has

had a knock-on effect on the other domestic banks. In sharp contrast, the old private

sector banks have the weakest level of governance. These banks are controlled by a

few families or by communities, with non-bank interests. While these banks might

have outside directors and various board committees, these tend to be passive with

real decision-making concentrated with the large shareholders - increasing the

chance of related party lending. .

The Reserve Bank (RBI), India's central bank, is focused on governance

issues both from the perspective of improving the quality of its oversight and from

secwing the interests of depositors through transparency, off-site surveillance and

prompt corrective action, The RBI has established two major committees to look

into governance at the banks and benchmark international best practices of

implementation. These committees have made' recommendations directed at the

independence and autonomy of the board and focused on harmonizing the

OECDTSaselISOX recommendations with local regulations and practices followed

in the domestic Indian market.(K.C collage 2010)

Governance affects the firms and houseliolds they lend to. Thus, weak

governance of banks reverberates throughout the economy with negative

ramifications for economic development (Levine, 2003). Research finds that banks

are critically import& for industrial expansion, the cg of firms, and capital

allocation. However, the importance of banks to national economies is underscored

by the fact that banking is virtually universally a regulated industry and that banks

have access to government safety nets. (A P Pati)

Importance of Corporate Governance in Banks

Corporate governance is particularly important for banks, given the bank's

important role in the financial sector. The rapid changes brought about by

globalization, deregulation and technological advances are increasing risks in the

banking systems. Moreover, unlike other companies, most of the funds used by

banks to conduct their business belong to their creditors, in particular their

depositors. Linked to this is the fact that the failure of a bank affects not only its own

stakeholders, but may have a systemic impact on the stability of other banks.

Theoretically, information asymmetry gives rise to agency problems and conflicts of

interest between owners and managers. G o d corporate governance is designed to

address this problem. Further, government regulations and frequent interventions

reduce the incentive for effective monitoring and, at the same time, make

supervision (or supervisors) less effective. In this context, the corporate governance

of banks becomes a more important challenge as compared to other firms.

(Ahmed M. Khalid 2004)

Tracing the importance of cg in Indian banks, quite a few facts are discerned.

First, banks have an overwhelmingly dominant position in financial systems, and are

extremely important engines of economic growth (King and Levine,l993;and

Levine, 1997). Second, as financial markets are usually underdeveloped, banks are

typically the most important source of external finance for the majority of firms.

Third, the economy is dominated by many small scale firms and most of them

18

depend on banks. The governance of banks thus affects their governance structure.

Fourth, as well as providing a generally accepted means of payment, banks also

function as the main depositories for the through privatizationldisinvestments and

hmce reducing the role of economic regulation. @mnomic regulations are getting

replaced by prudential regulations, like capital adequacy norms, supervisory norms

and many others. However, the prudential reforms already implemented in

developing countries including India have not been effective in preventing banking

crises (e.g. the recent Global Trust Bank and other cooperative banks failures) and

the reasons can be traced to many, like poor legal structure, dominance of a docile

shareholder i.e. Government, and asymmetry' in information flow across the

stakeholders. Although in comparison to many developing countries, India is better

placed with respect to tapping the capital market for fulfilling necessary capital

requirement, the need arises here to strenthen the regulations and to make

governance more effective. The concern for good governance from the state can be

visualized from its oversight functions. In India the oversight fhction of Govt. is

conditioned by three reasons (Leeladhar 2004). Firstly, it is believed that the

depositors, particularly retail depositors, are not able to effectively protect

themselves as they do not have adequate information, nor are they in a position to

coordinate with each other. Secondly, bank assets are unusually opaque, and lack

transparency as well as liquidity. This condition arises due to the fact that most bank

loans, unlike other products and services, are usually customized and privately

negotiated. Thirdly, it is believed that there could be a contagion effect resulting

from the instability of one bank, which would affect a class of banks or even the

entire financial system and the economy. As one bank becomes unstable, there may

be a heightened perception of risk among depositors for the entire class of such

banks, resulting in a run on the deposits and putting the entire financial system in

jeopardy. Despite of such concerns from govt. side, the dominance of the latter and

its central bank casts several doubts over their intentions. Another area of concern in

Indian banking is the dominance of state owned banks. Government ownership

thwarts competitive forces, limits the effectiveness of government supervision in the

financial sector, and tends to meets use their state-owned institutions to support

excessive government spending and favor less-than- creditworthy borrowers. All of

these tendencies dampen overall economic growth (Litan et al, 2002). New private

banks are generally good on accounting, but poor on accountability. They are more

modem and computerized, but less risk conscious. One thing which is common to

all is that cg is highly centralized with very little real check on the CEO, who is

generally also closely linked to the largest' owner groups. The enormous

consequences of p r governance of banks come to limelight only in the case of

banking cxisedfailures, It is of mcial importance therefore that banks have stronger

cg than other corporate entities. (Jalan, 2002).

Review of Literature

Andrew Sheng (1991) defines The New htitutional Economics that carried

out a short review of bank failures, etc. according to analytical fiamework.

However, emphasis was laid on discussion of different techniques of bank

restructuring used in different countries designed to assist the policy makers and

financial sector professionals under different circumstances.

Ozanian, Michel K. and Bradford, Stacey L. (1996) they delivered and

focused on the stock performance of top banks in the United States as of July 8,

1996. They also focus on Total asset value of bank takeovers; Trend towards

increasing the percentage of non-interest income versus interest income; List of top

performing banks in the United States; Measures used in ranking the banks. In 1996,

World of Banking dealt with ranks of the 20 biggest banks in Russia in respect of

share of gross assets and net assets ratio; Consequences of the country's banking

crisis; Outflow of deposits fiom commercial banks and trust companies; Public's

wariness of pyramid scams; Ownership of banks, etc.

Bhattacharyya (1997) Examined the productive efficiency of 70 Indian

commercial banks during early stages (1 986- 199 1) prior to liberalization. The used

Data Envelopment Analysis to calculate radial technical efficiency scores and

Stochastic Frontier Analysis to attribute variation in the calculated efficiency scores

to three sources: a temporal component, an ownership component, and a random

noise component. He found publicly owned Indian banks to have been the most

efficient, followed by foreign-owned banks and privately owned Indian banks. It

was an attempt to explain these patterns in terms of the government's evolving

regulatory policies.

Sarkar and Bhawmik (1998) They talk about ownership but relate it to

performance rather than govemance. An implicit assumption made by sdrolars

(Singh, 2002 and Bhawrnic 2005), arguing in favour of privatization of public sector

banks relates to poor corporate governance in public sector banks if the reason

behind unsatisfactory performance of the public sector banks lies is poor corporate

govexmmce than privatization of public sector banks will not deliver the goods of the

corporate governance in private sector banks is not significantly better than their

public sector counterparts. The whole debate relating to privatization of public

sector banks appears to be devoid of any reference to corporate governance in banks.

In fad the issue is misplaced in as much as the debates veers towards privatization,

in the light of poor performance of public sector bans, instead of emphasizing good

corporate governance.

Rohit Rao (2000) States that Banking performance is the mirror reflection of

an economy. So long as banks perform their primary function of banking by lending

to the constituents of economy, they stand a chance of forging ahead.

Ciancanelli and Gonzales (2000) Argue that banking sector has different

market structures which do not meet the basic assumptions of agency theory. One

besides unusual agency problem, bank managers and owners are subject to

regulation. As a governance force, regulation is intended to serve the public

interests, particularly the interests of the consumers of the banking services.

Regulator and regulation represent external corporate governance that implies

market forces to discipline both managers and owners in a diffaent way than that in

unregulated economic-sectors. According to the Basel Accord, risk management and

minimum capital requirement in banking sector are subjects the regulator is

concerned with. However, although the regulation is concerned about governing risk

management in banking sector, liter&ures in financial banking do not clarity explain

the relationship mechanism between risk management and regulation, and how the

relationship will lead to higher bank performance.

Ciancanelli and Gonzales (2000) state that in banking sector the regulation

and regulator represent external corporate governance mechanism. In the

conventional literature on corporate governance, the market is the only external

governance force with the power to discipline the agent. The existence of regulation

means there is an additional extsmal force with the .power to discipline the agent.

The force is quite different fiom the market. This implies that the power of

regulation produces effects different from those produced by markets. Bank

regulation represents the existence of interests diffaent from the private interests of

the firm. As a governance force, regulation aims to serve the public interests,

particularly the interests of the customers of the banking services. An agent of the

public interest, the regulator, also enforces regulation itself. This agent does not have

a contractual relationship either with the firm's principal or with the banking

organisations because of different interests from the principal (Ciancanelli and

Gonzales, 2000)

Goldberg, Dages, and Kinney (2000) they compare the bank performance

of domestic- and foreign-owned banks in Argentina and Mexico. They find that

foreign banks generally have higher loan growth rates than do domestic private

owned banks which have lower volatility of lending that contributes to lower overall

volatility of credit. Additionally, in both countries, foreign banks show notable

credit growth during crisis periods. In Argentina, the loan portfolios of 2 Mutual

ownership refers to the organization format that members (customers), rather than

the shareholders, own the banks.6 foreign and domestically private-owned banks are

similar and lending rates analogously respond to aggregate demand fluctuations. In

Mexico, foreign and domestic banks with lower levels of impaired assets have been

similar to loan responsiveness and portfolios. State-owned banks (Argentina) and

banks with high levels of impaired assets (Mexico) have more stagnant loan growth

and weak responsiveness to market signals.

F u m e (2001) he Claims that although information asymmetries affect all

areas of the financial sector, the problem is more fundamental in the banking sector.

He argues that loan quality, in a banking industry, is not readily observable.

Moreover, banks can alter the risk composition of their assets more quickly than

most non-financial firms. In a system of connected lending, banks can extend loans

to clients who have a history of bad credit or were not able to service their previous

debt obligations.

M. Thenmozhi and R Khhore Kumar (2001) they expressed the view that

by 2001, the Indian financial sector which- snmd its 10th year of reforms, will

touch upon almost every segment. Nevertheless, it experienced major reforms and

has come far away from the days of nationalization. The Narasirnharn Committee

laid the foundation for refoms in the Indian banking sector and paved the way for

enhancing its efficiency and viability. With India becoming a member of WTO, it

had to be opened up for international players and to prepare the Indian banking

industry for a vibrant global competition. As the international standards became

prevalent, banks had to unlearn their traditional operational methods of directed

credit, directed investments and administered iliterest rates. Moreover, increase in

the number of banks, transparency of banks' balance sheets through prudential

nonns and increase in the role of the market forces due to deregulated interest rates

have all significantly affected the operational environment of the sector. Further,

commitments made by India in the WTO Financial Services Agreement in

December 1997 had a significant impact on the banking industry.

Arun and Turner (2002) they discussed the theoretical analysis of corporate

governance of banlung in developing economies, in general and corporate

governance of banking sector specially public sector banks in India, in particular.

The researchers argued that banks have a unique contractual nature implying that the

interests of other stakeholders appear more important to them than in the case of

non-banking Organisations. In the case of banking, the risk involved for the

depositors and the possibilities of contagion means that. the depositors of banks

assume greater importance than those of consumers of manufactured products. They

added that the Indian banking system is of interest because of the dominance of the

government in the banking system. Moreover, the Indian experience is of further

interest due to the partial divestment of public sector banks as part of the economic

reform programmes introduced in India since 1991. Their observation is the

corporate governance issues have not received much attention in the first generation

of financial sector reforms. In India, the issues have become important in the second

decade of reforms. In India, there is an urgent need to review the size and

composition of the Public Sector Banks boards to make them effective instruments

of corporate governance.

A.K.Trivedi (2002) expressed the view that technology and competition

have brought about notable changes in Indian banking today. From Internet Banking

to Cash Management Services, technology has changed both in retail and wholesale

banking. Banks have been slow to adapt to the ohanging times finding themselves

behind technology-sawy competitors. It applies particularly, to some of the state

owned banks opposed to introduction of new technology. Moreover, with lines of

demarcation between banks and financial institutions blurring, the focus has shifted

to offering all assets (e.g. loans) and liabilities (e.g. deposits) products under one

roof, heading towards Universal Banking.

Reddy (2002) Checks up Doubts whethe; corporate governance is generally

better in private sector banks. A few old private sector banks continue to be closely

held and many of them resist broadening their share holders' base and thus avoid

deepening of corporate structures. More often than not, takeover bids have been by

equally closely held groups. Promoters were expected to dilute their stakes in new

private sector banks to below 40 per cent within three years. It is yet to be fully

complied with in all the private banks. In most cases, the banks continue to be

identified with effective control by promoters' institutions.

Jalan (2002) closely shares this view. Old private sector banks also have

very poor auditing and accounting systems. New private banks are generally good in

accounting, but poor in accountability. They are more modern and computerized, but

less risk conscious. It may be added here that their exposure to off -balance sheet

activities is extremely high, second only to foreign banks. A phenomena common to

all private banks is that corporate governance is highly centralized with very little

real checks on the CEO, who also remains closely linked to the largest owner

groups. He goes to state that their boards or auditing systems are not very effective.

Claessens and Fan (2002). this study reviewed the literature on corporate

governance issues in Asia. The study confirms that, as in many other emerging

markets, the lack of protection of minority rights has been the major corporate

governance issue and much popular attention has focused on poor corporate sector

paformance. However, most studies do not suggest that firms in Asia were badly

affected. Instead, the study indicated that the conventional governance mechanisms

were weak to mitigate the agency problem, as insiders typically dominated boards of

directors and hostile takeovers were extremely rare.

KSivalogmathan (2002) Defines banking in the new millennium will be

marked by high expectations of customers who are well informed and possess

technical knowledge. Computers are rapidly taking over the hmctions and

personalized service will continue to have relevance. The sum and substance

of banking activity in future will boil down to one simple prescription: Customer

Delight.

The New Institutional Economics carried out a short review of bank failures,

etc. according to analyhcal h e w o r k . However, emphasis was laid on discussion

of different techniques of bank restructuring us@ in different countries designed to

assist the policy makers and financial sector professionals under different

circumstances (Andrew Sheng, 1991).

The financial services industry is transforming unpredictably. Nations Bank

Corporation has broadened its product line considerably; State Street Bank & Trust

Company narrowed its focus preliminarily to servicing financial assets as an

investment manager. Increased compethon fiom non-traditional institutions, new

information technologies and declining processing costs, erosion of product and

geographic boundaries, and less restrictive governmental regulations etc - all played

a role (Dwight B. Crane and Zvi Bodie, 1996).

Lang and So (2002) They examine the composition of ownership structures

of banks in emerging markets. They observe th'at foreign banks have higher holdings

than do domestic banks if state stakes are excluded. In terms of bank performance,

ownership structure has no impact on the bank performance. These findings suggest

further study to rethink about tlie system of privatization of state controlled banks.

Will the foreign banks have control of domestic banking system once the state-

controlled banks are privatized? Havrylchyk (2003) finds that foreign-owned banks

are found to be more efficient than their domestic owned bank counterparts.

Parekh (2003) According to him the term "Corporate Governance" which

was rarely encountered before the 1990s has now become an all-pervasive term in

the recent decade. In today's scenario this term has become one of the most crucial

and important concepts in the management of companies. The root of corporate

governance dates back to Adam Smith but its popularity is of recent origin. The

concept of corporate governance can be understood "the system through which shareholders are assured that their interest will be taken care of by management". In

a much wider tmn, corporate governance was defined as 'We methods by which

suppliers of finance control managers in order to 'ensure that their capital cannot be

expropriated and that they earn a return on their investment"

Arun and Turner (2003).Their study is another good theoretical discussion

of the corporate govkance of banking institutions in developing economies. They

suggested that the corporate governance of banks in developing economies is

severely affected by political considerations. Firstly, given the trend towards

privatisation of government-owned banks in developing economies, there is a need

for the managers of such banks to be granted autonomy and to be gradually

introduced to the corporate governance practices of the private sector prior to

divestment. Secondly, where there has only been partial divestment and

governments have not relinquished any control to other shareholders, it may prove

very difficult to divest further ownership stakes unless corporate governance is

strengthened. Finally, given that limited entry of foreign banks may lead to

increased competition, which in turn encourages domestic banks to emulate the

corporate governance practices of their foreign competitors, they suggested that

developing economies should partially open up their banking sector to foreign

banks.

Boubakri et al., (2003) they examined the corporate governance features of

newly privatized firms in Asia and documents how their ownership structure evolves

after privatization. The results suggest that privatization leads to a significant

improvement in profitability, while, on the other hand, it creates value for

shareholders.

Jan and kim(2003). Study on governance mechanisms and banks which

examined the impact of various governance mechanisms on bank capital,

performance and merger returns for bank holding companies. Their results are

mixed for Explain; Both managerial Compensation and the level of management

entertainment are significant factors whereas load structure has little impact on all

three aspects. Especially after controlling for other mechanisms. They found that

governance does not play a simple role in regulated industries, like

banking.(http;//www,fma.org)

G O S W ~ ~ (2003). He had made a comprehensive study of the state of

corporate governance in India. He studied almost all the areas of corporate

governance and pointed out including the roots, corporate structure, regulatory

environment initiatives taken by the authority etc: He observed that India has made

much more rapid strides in corporate govmance than most of its Asian counterparts

and that in the next few years it will witness a an greater flurry of activity by several

factors such as competition, growth of market capitalization, foreign investors, and

strong financial press. He also added that Indian corporations have appreciated the

fact that good corporate governance and internationally accepted standards of

accounting and disclosure can help them to access the US capital markets.

Hasan, lftekhar and Marton, Katherin (2003) they analyzed the

experiences and developments of Hungarian banking transitional process from a

centralized economy to a market-oriented system. They identified that early

reorgariization initiatives, flexible approaches to privatization, and liberal policies

towards foreign banks' helped to build a relatively stable and increasingly efficient

banking system.

Went, Peter (2003) analyzed a merger between two Scandinavian Universal

Banks to determine arguments for the same. It was a response to changes in

legislative and competitive environment, as well as a quest for broader fimctional

competency by integrating a smaller, more successful bank with a state-owned bank.

The most important predicted effects were improvements in the profitability and

market position.

Rime et a1 (2003) examined the performance of Swiss banks from 1996 to

1999, using a broad definition of bank output, evidence of large relative cost and

profit inefficiencies. A more narrow definition focuses on only traditional activities

leading to efficiency estimates that are even lower. Finally, evidence on scope

economies is weak for the largest banks. These results suggest a few obvious

benefits from the trend towards larger, universal banks in Switzerland.

Ippers (2003) in their paper, presented a study, based on two rather unique

data sets. They used descriptive statistics and a sophisticated model, designed for

this specific purpose, to see whether two basic premises of the theories on optimal

ranges are valid. In contrast to the widely accepted assumptions, they found that

individuals appear not to pay efficiently and that they are also not indifferent .to use

of coins and notes.

Clamen and Fan (2003) study corporate governance in Asia. They find that

agency problems arise from certain ownership structures. Conventional corporate

governance mechanisms (through takeovers and boards of direcqors) are not strong

enough to relieve the agency problems in Asia. Firms use other mechanisms to

reduce their agency problems (for example, employing reputable auditors), although

they have only limited effkdiveness. The low transparency of Asian corporations

relates to these agency problems and the prevalence of connection-based

transactions that motivate all owners and investors to protect rents. The rents often

appear from government actions, including a large safety net provided to the

financial sector. Forms of crony capitalism (i.e., the combination of weak corporate

governance and government interference) are not only leading to poor performance

and risky financing patterns but also conducive to macroeconomic crises. Their

survey suggests that corporate governance: in Asia, including Indonesia, faces

unresolved problems, both in conceptual and empirical matters of corporate

governance in banking sector. The research also attempts to cover the unresolved

problem by examining the relationship sensitivity between corporate governance and

performance for domestic-owned banks versus foreign-owned banks.

Macey and Hara (2003) argue that commercial banks pose special corporate

governance problems for managers, regulators, and claimants on banks' cash flows.

They argue that bank managers and directors should follow broader, if not higher,

set of standards than their counterparts working in unregulated, non-financial firms.

Moreover, they recommend that the scope of fiduciary duties and obligations of

bank officers and directors can be broadened to address the interests of fixed and

equity claimants. They suggest that top bank executives take solvency risk explicitly

and systematically into account when making decisions.

Adams and Mehran (2003) argue that the governance of banks may be

different from that of unregulated, non-financial firms for several reasons. They

argue that investors, depositors and regulators have a direct interest in bank

performance. Given the dependence of the whole economy on banking performance,

regulaton are more concerned about the safety of the financial system- Adams and

Mehran (2003) think that a significant difference between banking h s d

manufacturing firms relate to board size, board makeup, CEO ownership and

compensation structure, and block ownership. These differences support the theory

that corporate govemance structures should be industry-specific.

Levine (2003) argues that banks have two related characteristics that inspire

a separate analysis of corporate governance for banks. First, banks are generally

more opaque than non-financial firms. Second, banks usually operate in a highly

regulated environment. Due to the importance of banks in the economy, the opacity

of bank assets and activities, and banks being a ready source of fiscal revenue,

governments have imposed an elaborate array of regulations on banks.

Rafel, Miguel, and Vicente (2004) they argue that In India, the government

has taken appropriate steps to implement good corporate governance practices in

Indian banks. As a result of that, the public sector banks have disinvested in favour

of Indian public. But, there is literature, which account negative impact of corporate

governance on bank performance. There is a negative relationship between

governance intervention and performance for Spanish banks.

Das and Gupta (2004) they examined the issues of corporate governance in

the Indian banking system. Using data on banking systems, they studied 27 public

sector banks for the period 1996-2003. The findings reveal that CEOs of poorly

performing banks are likely to face higher turnover than CEOs of well performing

ones. The researchers pointed out that along this dimension, corporate governance is

effective. However, these findings do not imply that corporate governance in Indian

banks is perfect.

Machold and Vasudevan .(2004) they investigated governance reforms in

India over the last decade. The paper reviews changes in Indian governance codes

that indicate a preference for adoption of Anglo-American governance models. A

survey of ownership structures of Indian listed companies reveals a mixture of

governance mechanisms and a persistence of the 'business house model' of

governance. The study concluded that despite external pressures towards an 'Anglo-

Americanisation' of governance practice, the outcomes thus far reveal the emergence

of a diversity of governance mechanisms arising in a path-dependent fashion.

29

Hsimg-Tsf Chiang (2005) in his view the board of directors is the ultimate

governing body on bank affairs. The main task of bank board is to monitor and

control management on behalf of owners. The board of director is top executive unit

of a company and is charged with the responsibinty of supervising operations of the

company's management.

Zororo Muranda (2006) intended to investigateelhe relationship between

corporate governance failures and financial distress in Zimbabwe's banking sector.

The study used the case study method. It discussed cases of banks currently in

financial distress. Data collection was through desk research. The analysis is

qualitative. Judgmental sampling was used in selecting the eight abridged cases. The

author found &om research that in all cases of pronounced financial distress, either

the chairman of the board or the chief executive wields disproportionate power in

the board. The disproportionate power emanates from major shareholding. The

overbearing executive overshadows other directors, executive and non-executive,

thus creating power imbalance in the board. The study showed that financial

institutions in Zimbabwe underestimated the competitive forces that resulted fiom

first, economic deregulation and later economic decline coupled with political

meltdown. In order to survive, banking institutions significantly shifted fiom their

core business.

Samy Nathan, Vincent Ribiere (2007) they explored the concepts and

relationships between intellectual capital, knowledge, wisdom and corporate

responsibility in the context of the corporate governance of Islamic financial

institutions. The author used an adaptation of the Nicholson and Kiel intellectual

capital model of the board of directors including the role of the Shari'a Supervisory

Board (SSB). The author concluded that the need for organizations to continue their

knowledge management journey by integrating organizational wisdom with their

decisions and actions. Corporate social responsibility is perceived as being the first

step towards organizational wisdom.

Gabriella Opromolla (2008) described the Bank of Italy's new

comprehensive regulatory framework containing guidelines on the organization and

corporate governance of banks. The author covered the structure of the regulatory

fiamework and the content of the rules, including rules an a bank's choice of board

mod4 a bank's corporate governance project raprksenting by laws and intnnal

organization, tasks and powers of governing bodies, composition of governing

bodies, compensation and incentive mechanisms, and information flows. The paper

revealed that the new rules are in line with recent prudential measures that assign a

central role to corporate organization and require banks to establish appropriate

corporate governance, arrangements and efficient management and control

mechanisms aimed at affecting the risks to which they are exposed.

Duwuri Subbarao (2011) he expressed the view that in emerging

economies, banks are more than mere agents of financial intermediation; they carry

the additional responsibility of leading financiai sector development and of driving

the government's social agenda and also the institutional structures that define the

boundaries between the regulators and the regulated and across regulators.

Managing the tensions that arise out of these factors makes corporate governance of

banks in emerging economies even more challenging.

Chuck Prince (2011) was the former CEO of Citigroup, who said that one

had to keep dancing as long as the music was on! Where banks differ is that their

procyclical behavior hurts not just the institution but the larger economy.

Dr. Harmeet Kaur (2012) has concluded that there is considerable

divergence in the practices of corporate governance being followed by the banks in

India. An attempt has been made in this study to find the difference in the Corporate

Governance Disclosures being made in the Annual General Report of the public and

private sector banks in Indian Banking Industry.

Murugesan Selvam, John Raja, Arumugan Suresh Kumar Normally,

board performs variety of functions such as monitoring and controlling management,

approving dividend decisions, .deciding business policies, and facilitating

development and implementation of corporate strategy. Boards are required to

deliberate on the strategic agenda of the company. Boards play major role in

corporate governance in the bank.

James, R. Barth and Susanne Trimbarth observe that there is a significant

positive correlation between the size of a country's financial system and its real

GDP per capita. They identify a number of 'best practice' areas that financial

3 1

institutions should be focusing on. These areas include the power of the bank, it's

market entry policies, capital adequacy, mankgerial supervisory power, the extent of

autonomy enjoyed by line managers, deposit insurance, loan classification,

provisioning, asset allocation, internal managemeit and state ownership issue. They

have also discussed bond and derivatives market, off-balance sheet activities of

banks, role of venture capital, comparative advantage aqcl absolute advantage in

financial services and*e-finance from a global perspective.

James RBarth, Valentina Hartarska, Daniel E.Nolle and Triphon

Phuminwasana observe that a healthy banking system requires more insightll

regulation and supervision. In their view, efficient functioning of financial systems

requires both corporate governance and external governance. They, however, say

that very little attention has been paid to the corporate governance of banks.

Quoting Caprio and Levine, They identify four sources of governance for

banks, viz., Shareholders, debt-holders, the competitive discipline of output markets

and governments. They recognise the importance of accountability standards,

strength of external audits, financial statement transparency, and external rating and

credit monitoring as the sub-component of external governance. Empirical results of

their study indicate that external governance does indeed matter for a bank's

profitability. The magnitude of the effects of external governance measures is also

economically significant.

Uwe Neumann and Philip Turner. Take up questions about the desirability

of a market- orientated, risk sensitive framework for banks in emerging market

economies. They warn that capital requirements and acquisitions, without

considering the relevant risk factors will increasingly become unsustainable. They

conclude that the cost of credit will primarily be driven by the bank's internal risk

measures.

V, Sundararajan and Barbara Baldwin, while providing their distilled

wisdom try to tackle the trace on the question of 'single versus multiple' regulators,

conclude that the most limited option would be to leave the existing regulatory

structure in place, but to overlay it with a newly established oversight board.

32

Amar Gande, Kose Jhon, and Lemma W.Senber present different

perspective on the role of incentives in the prevention of financial crises in emerging

economies. They reject the most established approaches which debate the

determinants of financial crises and on ex-post 'resolution of a crisis. They have

suggested an approach focusing on the prevention of financial crises. They look at

the role of incentives in mitigating the vulnerability of such crises. They show that

the distorted risk incentives in investment decisions by corporation and in loan

decisions by banks as a result of implicit or explicit bailouts can lead to an increased

probability of precipitating financial crises.

Abhay Pethe and Rupa Rege Nitsure look at the activities of development

financing institutions such as Industrial Credit Investment Corporation of

India(JCIC1) and Scheduled CommerciaI Banks of India to find out their subsidy

dependence and conclude that ICICI is out of the subsidy dependent net whereas, the

State Bank of India continues to thrive on subsidies and the authors term it as a case

in 'in-perfections in Indian regulation'.

Samaresh Bardhan and Sugata Marjit have tried to formalise an attempt

to advance an understanding of the implications of the tolerable limit of NPAs. They

have tried to address the question, what is the critically maximum or the permissible

level of NPAs that a bank can tolerate, given its portfolio of various assets? The

study points out that it is largely the personal cost which is highly significant in

explaining the 'severity of NPAs'. The recovery ratio in banks is found to be

significant to the severity of NPAs. In the case of private and foreign banks, price

competition has the positive and significant coefficient in explaining the severity of

NPAs. Interestingly, in the case of public sector banks this factor appears to be

insignificant.

From the above foregoing analysis of the study it is revealed that corporate

governance in the banking sector has, fiom being a subject of debate within the

academic, regulatory, and investor circles, recently became an issue of national

global concern. More specifically, key issue in this debate is the role that corporate

governance plays not just in the generation of returns, economic and others, to

owners and stakeholders but also as an engine of economic growth and cultural

change in a country. In this case, as a developing country, like India is closely

monitoring the corporate governance issues in both financial and nonfinancial

companies and thus could be a good example for the other developing countries in

world.

Statement of the Problem

With the rapid pace of financial innovation and globalization, the face of

banking is undergoing a sea change. Banking business is becoming more complex

and diversified. In the changed scenario, it is essential that the Boards of banks are

fully geared to govern the banks well. The objective of governance in banks should

first be protection of depositors' interest and then to optimize the shareholder's

interests. While doing so, the foremost responsibilities should be to ensure fair and

transparent dealing without giving a chance of mis-governance. The governance

issues in banks cannot be understood independently. The regulatory M e w o r k has

significant implications for the corporate governance of banks. There is a growing

realization that the corporate governance arrangements of banks are significantly

different in comparison to similar efforts for firms in other sectors. The corporate

governance of banks is a complex issue. It has been observed that the legal and

regulatory fkamework, in which banks operate, makes the governance mechanism of

hostile takeova ineffective as a method of corporate governance. Thus, governance

issues in banks have to be discussed in an environment where a bank's management

has a considerably reduced threat perception from the market for corporate control.

It is the high time to revlew analytically the Corporate Governance practices

in the banking sector. Thorough investigation into different aspects relating to

corporate governance practices in this sector is highly intensified. The problems

involved in corporate governance practices in the banking sector need to be

identified and solved for better corporate governance practices in the banks in

modem times. Hence, the present study "Corporate Governance Practices in Indian

Banking Sector - A study with reference to Select Public and Private sector Banks,"

focuses on various Corporate Governance mechanisms and practices in banking

sector. Thus it is a modest attempt to fill the gap.

Need for the Study

The rationale of the study has been to examine the relationship between

corporate governance practices and bank perfo+ance in India, as a result of the

adoption of code of best practices on corporati: governance, and the extent of

changes to corporate governance practices in Indian banking sector. The banks that

operated in India were affected by political and economic instability.

No country has been free of costly banking crisis in the last quarter century.

The prevalence of banking system failure has been at least as great in developing

and transition countries as in the industrial world. The developments of new

technologies, major industry consolidation, globalization, and deregulation have

placed the banking industry at strategic crossroads. They provide finance for

commercial enterprises, basic financial services to a broad segment of the population

and access to payments systems. In addition, some banks are expected to make

credit and liquidity available in difficult market conditions.

The banking sector in general, is highly sensitized to public scrutiny and is

more vulnerable to the risk of attracting adverse publicity through failings in

governance and stakeholder relationships. It is a special sub-set of CG with much of

its management obligations enshrined in law or regulatory codes. In the light of the

above statement governance issues in banks, more particularly in PSBs assume

immense significance, but unfortunately these are less discussed and deliberated.

Although the primary reason identified for it is the prevalence of govt. ownership

across the institutions, another important reason that can be attributed to the

multiplicity of regulatory and supervisory legislations. For instance, in India there

are 5 legislations e.g. RBI Act, SBI Act, Bank Nationalization Act, Banking

Regulation Act and Companies Ac't that govern the banking sector. Because of this

multiplicity of Acts and their enforcing agencies i.e. RBI and GOI, any concrete

form of principles on bank governance is yet to emerge. India has been able to

significantly reform its banking sector, which is essential for sustainable growth.

However, with more active public and private banking sectors in place, there is a

dire need to implement some "self- discipline" measures, or corporate governance

guidelines. This study aims in this direction. .

Objectives of the study

1. To review the origin and development of corporate Governance.

2. To analyse the Structure and mechanism of Corporate Governance.

3. To evaluate the Corporate Governance practices in select Indian Commercial

Banks.

4. To assess the 'impact of Corporate Governance on profitability of select

Commercial Banks.

5. To examine the problems and measures.for good corporate governance in

Banking Sector.

Research Methodology

The present study is based on the secondary data for analysis and to draw

concrete inferences. It uses a one-way approach focusing on the seleded banks in

the public and private sector, in India. The data pertaining to the various aspects of

their business operations and performance is collected from the official records of

the sample banks. Additional information pertaining to their overall banking

development, their progress and performance over a period of time is extracted fiom

major sources of secondary data, such as annual reports, documents, journals,

statistical reports of the RBI, Indian Banks Association Bulletin (IBA) etc., The

study has extensively utilised the information regarding the later developments

available through websites of various Foreign and Indian institutions. In addition,

Economic Survey of India, journals like banking finance, Finance India, Published

and unpublished reports have also been referred to. The data, is analysed

scientifically through relevant financial and statistical tools and techniques.

Data Collection

The secondary data has been collected from various publications of the

Reserve Bank of India, both audited and un-audited reports and other publications of

the banks. The publications of the RBI include Statistical Tables Relating to Banks

in India, Report on Trend and Progress of Banking in India, Annual Reports of

Reserve Bank of India and relevant issues of Reserve Bank of India Monthly

Bulletins. The relevant materials for the study at the Government level have also

bmn collected from the Economic Survey of India, from various books relating to

financial institutions and commercial banks,-different Committee Reports relating to

financial system and banks, different websites bf banks, Indian Banks Association

Monthly and Special Bulletins, Journal of Banking Finance etc, The information

pertaining to business operations, financials products, the business strategies and

performance in various kinds of business activities, is also collected £tom various

reports, journals, and banking websites . Further, data i i also collected from the

published and un-published records and various reports of research project-reports to

supplement the other data.

Sample Design

This study is a comparative analysis to measure the changes in corporate

governance practices from 2002-2003 to 201 1-2012. Random sampling technique

has been adopted for the study. There are 20 banks in the Public sector and 20 in the

private sector operating in India. They are invariably governed by the new rules and

regulations of the RBI. Keeping in view the time and operational constraints, two

public sector banks and two private banks operating in India are chosen at random as

sample banks for an in-depth study: The ICICI Bank and HDFC Bank in the Indian

private sector and the State Bank of India (SBI), and Andhra Bank among the Public

banks operating in India are the sample banks for the study.

Tools of Analysis

To analyse scientifically and interpret the collect& data, financial tools and

techniques and various statistical tools are applied wherever necessary. The

following are the tools and techniques used: 1) Financial Ratios, 2) Percentages, 3)

Linear growth rate 4) Averages 5) Standard Deviation 6) Coefficient of variance

analyses and 7) Tests of significance etc. The SPSS software package version 20 for

calculations has also been used.

Period of the Study

The present study has been carried out for a period of 10 years commencing

fiom 2002-2003 to 201 1-2012. It is that adequate period to evaluate the corporate

governance practices in selected public and private sector banks in India.

3 7

Scope and Limitations of the study

The scope of the study is limited to the top two from each Indian Public and

Private Banks. It is strongly viewed that the top banks are more likely to have the

resources and motivation to take the opportunity to adopt good Corporate

Governance practices. The small sized bank prohibits in-depth analysis of the

relationships between the variables. The findings may have heen different depending

up on the size of the sample banks. If the study had also included a qualitative

component in designing the research, it would have provided more comprehensive

insight into the boards' accountability to all stakeholders, especially in the

Indian context.

Plan of the thesis

The Thesis consists of seven chapters as outlined below:

Chapter-I Introduction and Research Methodology: : It covers a brief

account of the need and importance of the corporate governance

practices in Indian Banking sector, review of literature followed by

methodology adopted for the study.

Chapter-I1 Origin and development of Corporate Governance: It provides an

overview of the concept of Corporate Governance and its evolution - Internal Governance Mechanisms - External Governance

Mechanisms - First Generation of International Corporate

Governance - Second Generation of International Corporate

Governance etc., are presented.

Chapter-I11 Structure and mechanism of Corporate Governance in India: It

discuss the Pre-liberalization- Post - Liberalization- Reasons For

Corporate Governance Failures - Recommendations of various

committees on Corporate Governance in India: CII Code

recommendations (1 997), Kumar Mangalam Birla Committee (SEBI)

recommendations (2000), Naresh Chandra Committee Report,

Narayana Murthy committee (SEBI) (2003), Summary of Clause 49 - Dr. J J Irani Expert Committee Report on Company Law (2005),

Corporate Governance voluntary guidelines 2009 - Guidelines on

Corporate Governance for central Public Sector Enterprises 2010 -

Companies Bill, 201 1 and its Impact on Corporate Governance in

India - Need for Concept Paper on National Corporate Governance

Policy, 2012 - Oversight Of ~~m~lementation And Coordination

Between Regulatory Agencies - Regulatory Mechanisms of corporate

governance, etc.,

Chapter-IV Structure and mechanism of Corporate Qvernance in the Indian

Banking Sector: It covers the Pre-reform status- Obstacles on the

Path of Good Governance in Banking Sector - Banking Sector

Restructuring in India - Corporate Governance regulatory

mechanisms in Banking Sector - External Corporate Governance

Mechanism- Internal Corporate Governance Mechanism - Reserve

Bank of India - RBI & Corporate Governance - Basel Committee - Dr. Ashok Ganguli committee - Corporate governance policy

implementation in India - Measures Taken By Banks towards

Implementation of Best Practices - Status of Indian Banking Industry

in Global View - The Impact Of Regulation On Governance, etc.,

Chapter-V Corporate Governance practices in select Commercial Banks: It

deals with History of Banking Sector in India - Profiles of Sample

Banks - Corporate Governance Disclosure Practices in sample Private

and Public Sector Banks are discussed.

Chapter-VI Impact of Corporate Governance practices on profitability in

select Commercial Banks: It discussed. the Firm Performance - Return on Assets of Sample Bank - Return on Equity Sample Banks - Deposits of Sample Banks - Investments of Sample Ranks - Loans

/Advances of sample banks - Total Assets of Sample Banks - Interest

income - Other Incbme of Sample Banks - Operating Expenses of

Sample Banks - Total Profit of Sample Banks - Total Expenditure of

Sample Banks etc.,

Chapter -VII: Summary of Findings and Suggestions: A brief summary of the

study and practicable suggestions for improving the Corporate

Governance Practices in select Commercial Banking sector are

presented.

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