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ASTRENGTHENING CORPORATE GOVERNANCE IN BANKS
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ASTRENGTHENING CORPORATE GOVERNANCE
IN BANKS
AUTHORED BY - KHUSHI KUMARI
Introduction
Banking institutions owe high and
unique fiduciary responsibility, and in light of the same, there lies a need of
high accountability standards to be followed by it. India has seen many cases
where poor governance in banks has resulted into various scams and banking
frauds. PNB Case and Yes Bank Case are two recent ones, where poor governance
in the respective banks shocked the nation.
In 2018, Punjab National Bank, which
is India’s one of the largest public sector lenders was involved in transaction
fraud case involving Rs. 11,400 crores. In this particular case, Nirav Modi
while using his listed company ‘Gitanjali Gems’ defrauded PNB and other banks
by opening letter of credits of large amounts without any underlying
transactions. In doing so, few junior level banking officials were involved
with him. The requirement of recording the letter of credits in the RTGS system
was not fulfilled and therefore, their existence was not known. It only came to
limelight after the fraud was discovered. Another incident involving the same
bank was that of Mehul Choksi, where the involved amount was around Rs. 16,000
crores. As a result of the ignorance of bank management and regulators, the
fraud could not be brought to attention in due time.
Another infamous case involves Yes
Bank, which witnessed a sudden and unexpected fall as a result of a fraud. Rana
Kapoor was the promoter of the bank with top connections. He held an important
stake in making key decisions including sanctioning large loans. The bank was
involved with imprudent lending practices, evergreening of loans, charging high
commission not in line with industry practice to borrowers, overstatement of
profits due to front loading of commission income and gross under provisioning
of NPAs compared to RBI guidelines.[1]
These practices resulted into the fraud, where significant differences were
observed between actual and required provisioning for various years.[2]
In the fraudulent activities
mentioned above, involvement of both top level and mid level employees can be
seen. Therefore, it is important to strengthen all the tiers in a banking
institution to ensure good governance practices. For this matter, the Reserve
Bank of India (RBI) in 2020, came up with a Discussion Paper on ‘Governance
in Commercial Banks in India’ to improve the quality of governance in
financial intermediaries, and in order to implement few aspects of the paper, a
Circular was issued in 2021, which was aimed at strengthening corporate
governance in banks to prevent banking frauds and hence, to keep the
stakeholders’ interest protected. This paper aims at analysing the RBI’s
Circular on ‘Corporate Governance in Banks – Appointment of Directors and
Constitution of Committees of the Board’ and understanding its role in
enhancing the governance standards followed by Banks in India.
RBI’s Discussion Paper on ‘Governance
in Commercial
Banks in India’
The RBI on June 11, 2020 released a
Discussion Paper on ‘Governance in Commercial Banks in India’, whose
objective was to align the current regulatory framework with global best
practices, while keeping in mind the context of domestic financial system.[3] The
major highlights of the paper included – empowering board of directors to set
the culture and values of the organisation, recognise and manage conflicts of
interest, set the appetite for risk and manage risks within the appetite, and
improve the supervisory oversight of senior management, empowering the
assurance functions through various interventions, achieving clear division of
responsibilities between the board and the management, and encouraging the
separation of ownership from management.[4]
The discussion paper was aimed at
improving the quality of governance in financial intermediaries, as it was
important to determine and ensure the financial stability, protection of
interest of depositors, and efficiency in allocation of resources.
RBI’s Circular on ‘Corporate
Governance in Banks – Appointment of Directors and Constitution of Committees
of the Board’
In order to address a few operative
aspects received through the feedback on the Discussion Paper, instructions
were issued by the RBI in the form of a Circular on ‘Corporate Governance in
Banks – Appointment of Directors and Constitution of Committees of the Board’
on April 26, 2021. The Circular laid down instructions with respect to the
Chair and meetings of board, composition of certain committees of the Board,
age, tenure and remuneration of directors, and appointment of the whole-time
directors.[5] The
date from which the instructions came into effect is the date of issue of Circular
itself, but banks were permitted to comply with the instructions latest by
October 1, 2021 for enabling smooth transition to the revised requirements.
Applicability:
The revised instructions are
applicable as follows:
1. to Private Sector Banks (including
wholly owned subsidiaries of Foreign Banks and Small Finance Banks);
2. to State Bank of India and
Nationalised Banks, to the extent the stipulations are consistent with
provisions of specific statutes applicable to these banks or instructions
issued under the statutes.
As mentioned above, the Circular has
limited applicability on Nationalised Banks. It has been provided that the Circular
should be read along with other relevant governing statutes, which gives the
effect of it being supplementary in nature. Also, anything contained in the licensing
conditions, instructions, guidelines, regulations, directions, notifications,
etc., issued by RBI before the Circular, will not affect the application of the
Circular.
It is not applicable in case of foreign
banks operating in India through its branches. The RBI has also specified that
the applicability of the Circular on other commercial banks like Regional Rural
Banks, Local Areas Banks and Payment Banks will be notified separately.
Guidelines provided by the Circular:
1. Independence of the Board: The independence of the Board of
Directors is one of the focus points of the Circular. The instructions provide
for the Chair of the Board to be an independent director, so as to ensure
transparency and fairness in the functioning of the Board. While emphasizing
the importance of independent director, it has been provided with the
responsibility of chairing the Board in absence of the Chair. The circular has
clarified that the Chair of the Board, who is not an independent director,
appointed before the issuance of this circular will be allowed to complete the
current tenure as already approved by the RBI.
In the meetings of the
Board, the prescribed quorum is one-third of the total strength of the board or
three directors, whichever is higher. Also, to hold a valid meeting, the
minimum strength of the independent director present shall be half of the total
number of directors attending the meeting. RBI has taken a step towards protecting
the interest of the stakeholders as it has increased the requirement regarding
the number of independent directors to be present in the quorum in comparison
to the provisions provided under the Listing Regulations, according to
which the Board meeting of banks which are listed on Indian stock exchanges
shall have the quorum of one-third of the total strength of the Board or three
directors, whichever is higher, including minimum one independent director.[6]
2. Audit Committee of the Board: Aduit Committees plays a vital role
in ensuring good corporate governance by being involved in maintaining the
financial stability of any entity. Non-executive directors are essential to
further this objective as they can monitor and control the actions of executive
directors. The circular provides for constitution of such committee, in which
only non-executive directors can be part. This keeps the interest of the
stakeholders maintained as they cannot directly get influence the business
decisions of banks.
In order to prevent any
conflict of interest, the Chair of the Board is prohibited from becoming the
member of the committee. The committee has to be chaired by an independent
director, who shall not chair any other committee of the Board and shall not be
member of any committee of the board which has a mandate of sanctioning credit
exposures.[7] Also,
to form the minimum quorum of the meeting, for which at least three members
shall be present, at least two-thirds of such present members shall be
independent directors. In comparison to the guidelines provided under the Listing
Regulations, which prescribes for the committee to meet once in every year,[8]
the instructions under the circular increases the frequency of meeting to once
every quarter.
The qualification of
members of such committee includes understanding of all financial statements
and notes attached to it. Also, at least one member should have necessary
qualification and expertise in financial management and financial accounting.
3. Risk Management Committee of the
Board: There is
always a possibility that banking industry comes across uncertainties or
threats while achieving its objectives and therefore, a risk management
committee holds an important position due to the crucial role of banks in
organising and regulating whole financial system. As was provided for the audit
committee, the circular prescribes the constitution of risk management
committee, in which majority of the members should be non-executive directors
and which shall meet once in every quarter.
The minimum quorum
prescribed is three members and at least half of the members present in the
meeting shall be independent directors, out of which at least one member shall
have professional qualification and expertise in risk management.[9]
Also, the qualification prescribed for a Chair is to be an independent
director, not a Chair of the board and not a Chair of any other committee of
the board. An exception is provided for a Chair of the board to be Chair of the
risk management committee, when such member has necessary expertise in risk
management.
4. Nomination and Remuneration
Committee: This is
another important committee for corporate governance as it aims to ensure that
the executive compensation offered is competitive, fair and aligned to the goal
of the organisation. This further ensures that the reward policy adopted by the
board is appropriate and motivates executives to protect the interest of
shareholders through long-term perspective. Similar to the committees mentioned
above, this committee has to be constituted with only non-executive directors,
it shall meet with a quorum of three members, at least half of attending
members shall be independent directors, meetings shall be chaired by
independent director and the chair of board shall not be a chair of this
committee.[10]
Also, one of the
attending members in a meeting of nomination and remuneration committee shall
be member of risk management committee. There is no frequency defined for the
meetings of this committee, as the circular mentions that it shall meet as and
when required.
5. Age and Tenure of Non-Executive
Directors: In
comparison to the guidelines provided under the Listing Regulations,
where in a listed company, a person can only be appointed or can continue to
hold the position of non-executive director after attaining the age of
seventy-five years, if a special resolution justifying the reason for such
appointment is passed,[11]
the instructions under the circular increases the upper age limit of
non-executive directors by ten years and prohibits any reappointment or
continuation of tenure. It provides that after the person appointed as
non-executive director, including Chair of the board, attains the age of
seventy-five years, they cannot continue to hold their positions.
The maximum period for
which a person can remain a non-executive director on the board of bank in any
case is prescribed to be eight years. A cooling period has been provided under
the instructions for this matter, which is three years. Therefore, a person can
be re-appointed to the board only after a minimum gap of three years has
elapsed after the end of term of eight years. The circular does not obstruct
the person to be appointed as director in another bank and therefore, he/she
can be appointed in another bank if fulfils the requirements.
6. Remuneration of Non-Executive
Directors: In order
to attract and encourage the non-executive directors to serve in the board, the
circular has tried to increase the forms in which compensation can be awarded
to them. Prior to the circular, non-executive directors were only provided with
sitting fees and expenses related to attending meeting of the board and its
committees, but now, a bank can offer them a fixed remuneration commensurate.
The maximum amount of compensation in form of fixed remuneration that can be
provided to a non-executive director, other than the Chair of the board, is
twenty lakh rupees per annum.
7. Tenure of Managing Director &
Chief Executive Officer and Whole Time Directors: As compared to the guidelines
prescribed under the Banking Regulation Act, 1949, the circular has
increased the tenure of the Managing Director & CEO or Whole Time Director
from five years at a time with reappointment criteria of another five year
after a cooling period of two years, to a maximum period of fifteen years with
reappointment criteria if considered desirable and necessary by the board after
a cooling period of three years. Additionally, the instructions provides that
during the three years cooling period, the individual cannot be associated or
appointed with the bank or it group entities in any capacity, either directly
or indirectly.[12]
RBI has further clarified
in relation to private sector banks that the Managing Director & CEO and
Whole Time Directors cannot continue to hold their positions beyond the age of
70 years. Also, a lower retirement age can be prescribed by the board of a bank
as a part of their internal policy.
In case where a Managing
Director & CEO or Whole Time Director is also a promoter or major
shareholder, the maximum tenure prescribed is 12 years, where they can be
allowed to continue up to 15 years at sole discretion of the RBI in
extraordinary circumstances. For this matter, the RBI shall consider factors
like adherence to the milestone for dilution of shareholding of the promoters
in the bank and the level of progress thereof. Lastly, where the tenure of the
Managing Director & CEO or Whole Time Director has already been completed till
twelve or fifteen years on the date of issuance of the Circular, and has been
further extended, they will be allowed to complete the remainder of their
current term.[13]
Conclusion
The Circular on ‘Corporate Governance
– Appointment of Directors and Constitution of Committees of Board’ has
tried to separate management from ownership, which has been the intention of
RBI all along. This is because, where management and ownership do not interfere
with one other’s jurisdiction, best interest of bank is maintained and it
ensures unbiased or uninfluenced decisions. The Circular includes adequate
instructions in order to equip the Board with relevant skills, knowledge and
experience.
The Circular has focused on the role
of Independent Directors in the Board so as to improve corporate accountability
and credibility. The power of the Board has been effectively decentralised
through the requirement of constituting Committees, which will be vital in
providing effective and necessary support to it while improving the quality of
management and preventing any one-sided decisions. It has also been ensured
that the Board gets deeply involved into risk oversight, which will help the
Board in monitoring the risks by understanding them.
Separation between the Committees is
maintained by providing for different chairmanship in each one of them in order
to avoid any interference by one another. The Circular sufficiently prescribes
the terms of managing directors and directors of banks to prevent governance
issues and to enable involvement of new talents into the board. Therefore, by
analysing the Circular, it can be stated that the instructions provided therein
has tried to enhance the governance standards in India for Banks to de-rail any
future banking frauds and scams and safeguarding the interest of stakeholders.
[1] CA Naresh Kataria, Corporate
Frauds in India – Part I, LAWSTREETINDIA,
http://www.lawstreetindia.com/experts/column?sid=488.
[2] CA Naresh Kataria, Corporate
Frauds in India – Part I, LAWSTREETINDIA, http://www.lawstreetindia.com/experts/column?sid=488.
[3] RBI releases Discussion Paper
on ‘Governance in Commercial Banks in India’, RESERVE BANK OF INDIA,
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49937.
[4] RBI releases Discussion Paper
on ‘Governance in Commercial Banks in India’, RESERVE BANK OF INDIA,
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49937.
[5] Corporate Governance in Banks –
Appointment of Directors and Constitution of Committees of the Board, RESERVE
BANK OF INDIA,
https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12078&Mode=0.
[6] Regulation 17(2A), Securities and
Exchange Board of India (Listing Obligations and Disclosure Requirements)
Regulations, 2015, https://www.sebi.gov.in/legal/regulations/jul-2023/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-regulations-2015-last-amended-on-july-4-2023-_74143.html.
[7] Corporate Governance in Banks –
Appointment of Directors and Constitution of Committees of the Board, RESERVE
BANK OF INDIA,
https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12078&Mode=0.
[8] Regulation 18, Securities and
Exchange Board of India (Listing Obligations and Disclosure Requirements)
Regulations, 2015, https://www.sebi.gov.in/legal/regulations/jul-2023/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-regulations-2015-last-amended-on-july-4-2023-_74143.html.
[9] Corporate Governance in Banks –
Appointment of Directors and Constitution of Committees of the Board, RESERVE
BANK OF INDIA,
https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12078&Mode=0.
[10] Corporate Governance in Banks –
Appointment of Directors and Constitution of Committees of the Board, RESERVE
BANK OF INDIA,
https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12078&Mode=0.
[11] Souvik Ganguly, Saumya Sharma and
Altamash Qureshi, RBI Pushes For Massive Governance Reforms Of Banks In The
Aftermath Of Recurring Bank Frauds, MONDAQ, https://www.mondaq.com/india/corporate-governance/1093700/rbi-pushes-for-massive-governance-reforms-of-banks-in-the-aftermath-of-recurring-bank-frauds#:~:text=On%2026%20April%202021%2C%20RBI,the%20banking%20sector%20in%20India.
[12] Corporate Governance in Banks –
Appointment of Directors and Constitution of Committees of the Board, RESERVE
BANK OF INDIA,
https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12078&Mode=0.
[13] Souvik Ganguly, Saumya Sharma and
Altamash Qureshi, RBI Pushes For Massive Governance Reforms Of Banks In The
Aftermath Of Recurring Bank Frauds, MONDAQ, https://www.mondaq.com/india/corporate-governance/1093700/rbi-pushes-for-massive-governance-reforms-of-banks-in-the-aftermath-of-recurring-bank-frauds#:~:text=On%2026%20April%202021%2C%20RBI,the%20banking%20sector%20in%20India.
Article Information
ASTRENGTHENING CORPORATE GOVERNANCE IN BANKS
Authors: KHUSHI KUMARI
- Journal IJLRA
- ISSN 2582-6433
- Published 2023/08/25
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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