Banks are a critical component of any
economy and a failure of the banking system can lead to a systemic
failure of the economy. Banking crises in developing countries has
translated into currency instability, payment difficulties and even
an external debt crisis, for example, East Asia in ‘97-98, Mexico
in the early ‘90s and the ‘91 crisis in India.
Depositor protection and public policy considerations, in addition to concerns that individual bank failure would have a contagious run on healthy banks, the banking industry is highly regulated.
The guidelines issued by the Bank for
International Settlements (BIS) is the benchmark against which
regulatory bodies grade the health of governance systems of their
banking industry.
The Reserve Bank of India (RBI) has
set up various working groups to evaluate its existing corporate
governance norms for banks. The Khan Working Group Report, though it
did not deal with corporate governance per se, recommended full
operational autonomy and flexibility to the management and boards of
banks.
The Narasimham Committee I (1991)
recommended a gradual progress towards BIS norms and suggested the
ending of the dual control over the sector by the RBI and the
ministry of finance. The Narasimham Committee II (1998) recommended
reducing government control and strengthening of internal controls.
Additionally, Dr Patil Advisory Group
and Varma Group have made recommendations on international best
practices of corporate governance for banking companies. The most
recent AS Ganguly committee has, inter alia, made recommendations
for setting up of nomination committees to recommend appointment of
independent directors and creation of a pool of professionals for
board level appointments in banks. A system of corporate governance
exists under the present legal and regulatory framework. In India,
there are multiple statutes, which govern banking companies.
Private banks are governed both by the
Banking Regulation Act, 1949 (the Act), the Companies Act and SEBI
regulations. The Bank Nationalisation Act, 1969, governs
nationalised banks while the State Bank is under the State Bank of
India Act, 1955. In addition to the above, the RBI has overall
supervision powers over banks. The Act prescribes professional
qualification or other special knowledge for the board of directors.
There are restrictions on the
directors of a bank from carrying trading, commercial or industrial
concern and on banks from having business relationships with
affiliates and subsidiaries. In addition to the specific
restrictions, the RBI has vast powers to stipulate prudential norms
for banks. RBI has the power to remove any chairman, director or
other officer/employee of the bank or issue directions in public
interest or in the interest of depositors or shareholders.
Corporate governance of banks and
financial institutions becomes difficult because of it being more
opaque than other sectors. An individual can cripple or bring down a
large bank, examples being, Barings in the ‘90s and AIB/All First
in ‘02. This problem of information opaqueness of banks weakens
traditional corporate governance mechanisms.
While public policy considerations and
fears of contagious bank runs seems to justify governmental
regulation and supervision of banks and governmental ownerships of
large parts of the banking industry, this involvement comes at a
cost. Government’s ownership of banks removes the government as an
independent monitor of the financial sector.
Regulatory restrictions on voting
powers, entry, exit and takeovers reduce competition, which in turn
reduces the pressure on the board to maximise profits. The special
nature of banking business dictates that the duty of care owed by
bank directors is more extensive than others (Macy & O’Hara
2001) and the scope of this fiduciary duty should be expanded beyond
the shareholders to include creditors, depositors, borrowers,
employees et al.
The emphasis of the regulatory bodies
should not be on imposing more control over banks , but enhancing
information disclosure systems, induction of professional
independent directors in the board and setting prudential norms
benchmarked to international standards.
Governmental control in form of
ownership of banks should be reduced and its role as an independent
monitoring, supervisory and facilitatory role should be developed.
The multiple regulations governing banks should be consolidated into
a uniform code governing all banking companies for ensuring same
standards of governance.