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Corporate Governance in Banks

By Hardik Hariya TYBBI 27

Corporate Governance is the system by which companies are directed & controlled. Corporate Governance is traditionally defined as the system of laws, regulations & practices, which will promote enterprise, accelerate performance & ensure accountability. It may also be defined as a system of structuring, operating & controlling a company with the following specific aims: Fulfilling long-term strategic goals of owners; Taking care of the interests of employees; A consideration of the environment and local community; Proper compliance with all the applicable legal & regulatory requirements.

It was Indian Industry that provided the force towards a Corporate Governance. Thus, when SEBI first introduced a Corporate Governance in 1999, it put India ahead of many other countries. The formal policy announcement in regard to Corporate Governance was first made by Dr. Bimal Jalan in the Mid-Term Review of the Monetary & Credit Policy on October 21, 2001.

What is Corporate Governance?

The Manner in which a Corporation is Run; Achieving its Objectives Transparency of its Operations Accountability & Reporting Good Corporate Citizenship Better the Process & Operating Relationships, better is the Organizational Goals Achieved. Corporate Governance is concerned with holding the balance between economic & social goals & between individual & community goals. This translates to bringing a high level of satisfaction to five parties -- customers, employees, investors, vendors & the society-at-large.

Why Corporate Governance?

If examine the need for improving Corporate Governance in Banks, the reasons stands out: Banks exists because they are willing to take on & manage risk. Besides, with the rapid pace of financial innovation & globalization, banking business is becoming more complex & diversified. Risk taking & management in competitive market will have to be done in such a way that investors confidence is not shattered. Banks deal in peoples fund & should, therefore, act as trustees of the depositors. Banking supervision cannot function effectively if sound Corporate Governance is not in place.

Sound Corporate Governance Principles

Board members should be qualified for their positions, have a clear understanding of their role in Corporate Governance and be able to exercise sound judgment about the affairs of the Bank.

The Board of Directors should approve and oversee the banks strategic objectives and corporate values that are communicated throughout the banking organization. The Board of Directors should set and enforce clear lines of responsibility and accountability throughout the organization.
The Bank should be governed in a transparent manner.

The Board should ensure that there is appropriate oversight by senior management consistent with Board policy. The Board and senior management should effectively utilize the work conducted by the internal audit function, external auditors and internal control function. The Board should ensure that compensation policies and practices are consistent with the Banks corporate culture, long term objectives, strategy and control environment. The Board and the senior Management should understand the Banks operational structure, i.e., Know- yourStructure.

Corporate Governance in Indian Banks

Corporate Governance has received a lot of attention in recent times. But, Corporate Governance issues & practice by banks have received only a short notice. The question of Corporate Governance in banks is important for several reasons, such as:
Banks have dominant position in developing the economys financial system & important engines of growth. Countrys financial market is underdeveloped, banks in India are the most significant source of finance for a majority of firms. Banks are also the channels through which countrys savings are collected & used for investments.

Measures Taken by Banks Towards Implementation of Best Practices

Prudential Norms Capital Adequacy On the Income Recognition Front ALM & Risk Management Practices

Scope of Corporate Governance

Corporate Governance covers a variety of aspects such as: Protection of Shareholders right. Enhancing the Shareholders value. Issues concerning the composition and role of Board of Directors. Deciding the disclosure requirements. Prescribing the accounting system. Putting in place effective monitoring mechanism etc.

Hurdles In Implementing Corporate Governance

Inadequate understanding of banking principles at Board and senior management level.

Preference to short term achievements at cost of long term objectives.

Unhealthy competition among the Cooperative Banks. Corrupt Practices. Political Corruption.

Ignorance of the Board of Directors about their Role, Accountability and Responsibility. Lack of Professionalism. Poor Risk Management and Control System. No due importance to Internal Audit. Administrative Corruption.

General Recommendation for Effective Corporate Governance in India

Since banks are important players in the Indian financial system, special focus on the Corporate Governance in the banking sector becomes critical. The RBI, as a regulator, has the responsibility on the nature of Corporate Governance in the banking sector. Given the dominance of public ownership in the banking system in India, corporate practices in the banking sector would also set the standards for in the private sector. A proper system for guiding, monitoring, reporting & control.

Basel Committee
The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1974. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. The Committee also frames guidelines and standards in different areas - some of the better known among them are the international standards on capital adequacy, the Core Principles for Effective Banking Supervision and the Concordat on cross-border banking supervision The Basel Committee formulates broad supervisory standards and guidelines and recommends statements of best practice in banking supervision in the expectation that member authorities and other nations' authorities will take steps to implement them through their own national systems, whether in statutory form or otherwise.

The purpose of BCBS is to encourage convergence toward common approaches and standards. The Committee is not a classical multilateral organization, in part because it has no founding treaty. BCBS does not issue binding regulation; rather, it functions as an informal forum in which policy solutions and standards are developed. The Committee is further sub-divided each of which have specific task forces to work on specific implementation issues: The Standards Implementation Group (SIG) The Policy Development Group (PDG) The Accounting Task Force (ATF) The Basel Consultative Group (BCG)

Basel I
Basel I is the round of deliberations by central bankers from around the world, and in 1988, the Basel Committee (BCBS) in Basel, Switzerland, published a set of minimum capital requirements for banks. This is also known as the 1988 Basel Accord, and was enforced by law in the Group of Ten (G-10) countries in 1992 . Basel I is now widely viewed as outmoded. Indeed, the world has changed as financial conglomerates, financial innovation and risk management have developed. Therefore, a more comprehensive set of guidelines, known as Basel II are in the process of implementation by several countries.

Basel II
Basel II is the second of the Basel Accords, (now extended and effectively superseded by Basel III), which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. Basel II, initially published in June 2004, was intended to create an international standard for banking regulators to control how much capital banks need to put aside to guard against the types of financial and operational risks banks (and the whole economy) face. One focus was to maintain sufficient consistency of regulations so that this does not become a source of competitive inequality amongst internationally active banks. Advocates of Basel II believed that such an international standard could help protect the international financial system from the types of problems that might arise should a major bank or a series of banks collapse.

In theory, Basel II attempted to accomplish this by setting up risk and capital management requirements designed to ensure that a bank has adequate capital for the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability. Politically, it was difficult to implement Basel II in the regulatory environment prior to 2008, and progress was generally slow until that year's major banking crisis caused mostly by credit default swaps, mortgage-backed security markets and similar derivatives. As Basel III was negotiated, this was top of mind, and accordingly much more stringent standards were contemplated, and quickly adopted in some key countries including the USA.

Basel III
Basel III (or the Third Basel Accord) is a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in 201011, and scheduled to be introduced from 2013 until 2018. The third instalment of the Basel Accords was developed in response to the deficiencies in financial regulation revealed by the late-2000s financial crisis. Basel III strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage. Critics suggest that greater regulation is responsible for the slow recovery from the late-2000s financial crisis, and that the Basel III requirements will increase the incentives of banks to game the regulatory framework and further negatively affect the stability of the financial system.

Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth.

In addition, Basel III introduces a minimum leverage ratio and two required liquidity ratios.
The leverage ratio is calculated by dividing Tier 1 capital by the bank's average total consolidated assets; the banks area expected to maintain the leverage ratio in excess of 3%.

The OECD estimates that the implementation of Basel III will decrease annual GDP growth by 0.050.15%. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress. The revised Principles address the following key areas: Board Practices; Senior Management; Risk Management and Internal Controls; Compensation; Complex or Opaque Corporate Structures; and Disclosure and Transparency.