corporate governance bank

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CORPORATE

GOVERNANCE IN INDIANBANKING SECTOR

By

Pushkar GUPTA2007 2008

A Dissertation presented in part consideration for the degree ofMA in Finance and Investment

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ACKNOWLEDGEMENTS

My sincere appreciation is extended to many people who helped and supported me through

this dissertation.

First and Foremost, I would like to thank Professor David Owen for his invaluable advice and

comments. Without his support this study would not have been possible.

I would also like to thank the interview participants for their sincere feedback and

suggestions.

Last but not the least; I would like to thank my parents for always being there for me. They

have constantly guided and encouraged me through this study.

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ABSTRACT

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 decade ago, corporate governance 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. What is important is that

corporate governance has become a dynamic concept and not static one.

Banks form a crucial link in a countrys financial system and their well-being is imperative

for the economy. The significant transformation of the banking industry in India is clearlyevident from the changes that have occurred in the financial markets, institutions and

products. While deregulation has opened up new vistas for banks to augment revenues, it has

entailed greater competition and consequently greater risks. Cross-border flows and the entry

of new products have significantly influenced the domestic banking sector, forcing banks to

adjust the product mix, as also to effect rapid changes in their processes and operations in

order to remain competitive in the globalized environment. These developments have

facilitated greater choices for consumers who have become more discerning and demanding

compelling banks to offer a broader range of products through diverse distribution channels.

In such scenario, implementation of good corporate governance practices in banks can ensure

them to cope with the changing environment. Todays corporate governance means to do

everything better and provides for risk assessment, risk cover, early warning systems against

failure as well as prompt corrective action.

This research examines the practices of corporate governance attributes in banking sector and

how they adhere to corporate governance practices. The results of this research indicate the

practice of corporate governance is at nascent stage although corporate governance practices

by Indian Banking Sector is more than a decade. Both private and public sector banks are

adhering to mandatory requirements of corporate governance attributes as a result it is

bringing more transparency and minimizing the chances of fraud and malpractices. However,

hope is looming large for the proper implementation of corporate governance principles in

Indian Banking Sector.

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TABLE OF CONTENTS

Chapters Page

1. INTRODUCTION

1.0 Introduction1

1.1 Background of the Research..5

1.2 Need of Corporate Governance.8

1.3 Research Objectives...9

1.4 Research Questions9

1.5 Scope of the Research..10

1.5 Organization of the Research...10

2. LITERATURE REVIEW

2.0 Introduction......11

2.1 Corporate Governance: Definitions.11

2.2 History of Corporate Governance in India...12

2.3 Governance in Banks.......17

2.4 Role of Governance in Banks..21

2.5 Areas of Concern: Ownership22

2.6 Composition of Board..23

2.7 Governance through Committees24

2.8 Critical Analysis of Literature..25

3. METHODOLOGY

3.0 Introduction......27

3.1 Research Approach..27

3.2 The Research Method..28

3.3 Research Design...30

3.4 Reliability and Validity of the Research..31

3.5 Limitations of the Research.31

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4. ANALYSIS AND INTERPRETATION

4.0 Introduction..32

4.1 Analysis from secondary Research..32

4.2 Analysis of Primary Research..51

5. CONCLUSION66

6. REFERENCE LIST.70

7. APPENDIX

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CHAPTER-1

1.0 Introduction

The subject of corporate governance has attracted worldwide attention with a series of

collapse of high profile companies like Enron, WorldCom, HIH insurance group etc. These

failures have shattered the trust of investors worldwide. Some of the scandals which made

headlines all around the world were somewhere related to poor corporate governance. These

include the $18 billion meltdown of Parmalat Finanziaria, SpA in 2003. Parmalat was among

the largest food-based companies in the world .The Parmalat case was one of the biggest

scandals to hit Europe and many analysts called this fraud as 'Europe's Enron'. The

companys corporate governance structure could not keep up to some of the key existing

Italian corporate governance standards of best practice (Melis, 2004). Another classic

example of a corporate house collapsing due to poor decision making and weak corporate

governance was the HIH insurance group of Australia. This collapse resulted in a deficiency

up to $5.3 billion, making it the largest corporate failure in Australia (Lipton, 2003).The

collapse of the China Aviation Oil (CAO) also created certain doubts regarding the standardof corporate governance in China. 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 in banks is not a new subject. This inefficiency has been around

for a very long time. Since the beginning of Banking in Nigeria in 1914, almost 75 banks

were lost primarily because of factors related to poor corporate governance. The banks did

not fail due to lack of customers but due to how they were managed and governed. According

to a study by the Nigerian Deposit Insurance Corporation, the main reason for these failures

was interference of board members (www.allafrica.com). Moreover, the recent subprime

crises highlighted many issues of corporate governance in banks world over. The main issue

was that of independent directors. For e.g., UBS, one of the worlds largest banks was among

the biggest losers in the subprime crisis. It suffered a loss of about $38 billion. As a result it

replaced four of its directors. The departing members included three outsiders with

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experience respectively in rail equipment, chemicals and information technology. This

shows that banks should definitely use experts on their boards (Economic Times, 2008).

According to Zabihollah Rezaee (2005), there may be seven reasons behind these high profile

failings. These include lax regulations, overconfident and egoistic management, inappropriate

business conduct by top level management, deficiency of alert oversight functions,

unproductive audit functions, poor financial disclosures and negligent shareholders. The

above frauds adversely affect corporate governance, auditors creditability and the quality of

financial statements.

A good thing that came 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.

Responsibility, transparency, fairness and accountability are the four vital pillars for strong

corporate governance. Large and trusted companies across the globe realized the significance

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

governance. These days corporate governance is a reality which cant be overlooked by any

financial institution who wants to be successful. There are a number of factors which force a

company to adhere to a set of corporate governance 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.

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 stem 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. This particular research Corporate Governance in

Indian Banking Sector will try to unfold the cause and effect of governance principles on

banks. This research also studies the effectiveness of its so-called objectives to control the

misgovernance in Indian Corporate sector. Next, this research analyses the upcoming

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evidence on which government policies improve the governance of banks and describes

tentative guidelines for future modification of its principles.

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 parameter of public law and social ethics to give an impression

to customers and employees about the transparency and fairness of business. Particularly in

banking sector, good corporate governance is very much essential for justifying its role in

money management. Best practices of corporate governance in banks are of great value to a

number of stakeholders viz., depositors, creditors, customers, shareholders, employees and

society at large. Corporate governance is about the nitty-gritty of how a corporation executes

its commitment to investors and other stakeholders. It is about loyalty to investors, valuing

principled business behavior and functioning with a high degree of transparency.

The corporate governance is therefore a systematic approach where the connective members,

management and employees are expected to cooperate in the decision making process of the

company. Based on some fundamental reasons, the corporate governance holds its premise

that the business should be conducted by the desires of shareholders. It identifies thedistribution of rights and responsibilities among a variety of stakeholders in the company. 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) Recommended 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 ix) Monitoring performance. (Buxi,

2005)

Effective corporate governance is important for any company to be successful irrespective of

the type of business it does. But for banks and financial institutions corporate governance

assumes a greater level of importance. There may be a couple of reasons for this; firstly,

banks form a very vital connection in the financial system which helps to mobilize and allot

funds between borrowers and depositors. Efficient banks help create healthy economies as

they are the back bone of any financial system. If the saga of various financial crises across

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the world is any indication, the banks have been the precipitators of crises. Secondly, banks

are morally responsible for the funds which they move within an economy as they are the

keepers of the money of their depositors. This forces the government to help them out when

they are in trouble. In contrast to companies in other sectors, corporate governance in the

Indian Banking sector has very different implications. The banking sector in India is subject

to stricter guidelines and parameters. Further, it also makes banking a highly regulated

industry, when the State keeps close to its heart. (ICFAI Journal, 2001)

As per Basel committee Report 1999, Banks have to display the exemplary of corporate

governance practices in their financial performance, transparency in the balance sheets and

compliance with other norms laid down by section 49 of corporate governance rules. Most

importantly, their annual report should disclose accounting ratios, relating to operating profit,

return on assets, business per employee, NPAs, maturity profile of loans, advances,

investments, borrowings and deposits. Similarly the audit reports of bank should highlight

those disclosures which are in line with corporate governance rules. Hence, auditors should

have the complete know how about all the features of the latest guidelines given by Reserve

Bank of India (RBI) and ensure that the financial statements are made in a fraud free manner

and should mirror the implementation of corporate governance. Apart from auditors

seriousness to bring those requirements appropriately in audit report, there should be

adequate internal control systems in the operational activities of banks. It is very much

essential for banks to devote adequate attention on internal control system so as to maximize

their returns on each unit of capital inducted through an effective funds management strategy

and mechanism. (Basel Committee Report, 1999)

Corporate governance has, of course, been an important subject of discussion since many

years. Scholars and researchers from finance fields have actively investigated the importanceand efficacy of corporate governance for at least a quarter of century (Jenson and Meckling,

1976). There have been intense brainstorming and debates over the practices of corporate

governance practices particularly in the developed nations. However, the effectiveness of

corporate governance practices in the developed nations tells an ironical story from the CG

(corporate governance) practices point of view. The volume of scandals and lack of

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

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

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much prior to the recent wave of corporate frauds in developed economies, corporate

governance has been a fundamental subject in emerging economies.

1.1 Background of the Research

The subjective evidence of the 1997 Asian crisis showed that poor corporate governance

contributed to the collapse of many banks and corporate firms in Thailand, Malaysia, South

Korea and Indonesia. Since then, there has been a sincere effort to improve corporate

governance in the crisis ridden countries (Gan et al, 2001). The financial crisis in some Asian

countries in late 1990s prompted most of the countries to give improved corporate

governance a priority. The losses due to weak corporate governance practices and corruption

are estimated at nearly 15 percent of Chinas GDP, though the figure may be much higher

(www.csis.org). An annual collaborative study of the corporate governance landscape of

Asian markets titled "Spreading the World: CG Watch 2004-05" was undertaken by

independent stockbrokers. From this forum the awareness and importance of corporate

governance in Asian countries was realized. Asian countries do realize that CG practices

would not change overnight; hence patience is the key to success in this field (Bhasin, 2006).

Considering the importance of this subject, Asian Corporate Governance Association

(ACGA), made a report during 2004-05, on the state of affairs of corporate governance in

Asian markets, emphasizing on some key determinants behind assessing corporate

governance standards such as rules and regulations, enforcement, political and regulatory

environment, the adoption of international accounting standards, and corporate governance

culture.

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Table : Asian Governance Regimes

CLSA/ACGA Country" Ranking Criteria China

HongKong

India

Indonesia

Korea

Malaysia

Philippines

Singapore

Taiwan

Thailand

Rules and Regulations

Most companies reports their annual results

within 2 months?

N N N Y N Y N Y N Y

Have reporting deadlines been shortened in

the past 3 years?

N N Y Y N Y N Y N S

Is quarterly reporting mandatory? S N Y Y Y Y Y Y S Y

Do securities laws requires disclosure of

ownership stakes above 5%

Y Y Y S Y Y N Y N Y

Do securities laws require prompt disclosure

of share transactions by directors and

controlling shareholders?

Y Y Y N Y Y Y Y S Y

Are class-action lawsuits permitted? S N N N Y N N N S N

Is voting by poll mandatory for resolutions at

AGMs?

N S N N N N N N S N

Can shareholders easily remove a director

who has been convicted of fraud or other

serious corporate crimes?

S S N S N S S Y Y N

Will share option expensing becomemandatory over the next 10 month?

N Y S S N N Y Y S N

Enforcement

Is there an independent commission against

corruption (or its equivalent) that is seen to be

effective in taking public and private sector

companies?

N Y S N S S N Y N N

Political and Regulatory Environment

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Is the statutory regulatory (i.e., securities

commission autonomous of government (not

part of the Finance Ministry)?

S Y S N S S S S S S

Accounting and Auditing

Do the rules require disclosure of

consolidated accounts?

Y Y Y Y Y Y Y Y S Y

Do the rules require segment reporting? Y Y Y S Y Y Y Y S Y

Do the rules require disclosure of audit and

non-audit fees paid to the external auditor?

Y Y Y N Y Y S S Y Y

Does the government or the accounting

regulator have a policy of following

international standards on auditing?

Y Y S S S Y Y Y S Y

Institutional Mechanism and Corporate

Culture

Are institutional investors engaged in

promoting better corporate governance

practices?

N S S N S S N S S S

Are any retail investors engaged in promoting

better corporate governance practices?

N Y S N Y S N Y N N

Have retail investors formed their own

shareholder activist organization?

N N Y S Y S N Y N N

*Japan was not covered in this survey. Keys Y= Yes, N= No. S= Somewhat

Source: CLSA Asia-Pacific Markets: Asian Corporate Governance Association

(www.acgs.asia.org)

Corporate governance has been on the top priority of Asian countries with most markets

introducing comprehensive regulations. Although it cannot be called a fully satisfiedaccomplishment from the evidence of its achievements, but the ethos of corporate governance

is yet to come out fully. During the same period, the need for corporate governance was also

felt in line with the international trend. The first initiative for ensuring corporate governance

among Indian companies came from the corporate sector itself. The Confederation of Indian

Industry (CII) came up with the Code of Desirable Corporate Governance in 1998. Then the

Securities Exchange Commission of India (SEBI) which is the regulator of Indian financial

market, appointed 'Kumaramangalam Birla Corporate Governance Committee'. Most of the

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recommendations made by the Committee were accepted and implemented by SEBI in the

year 2000.

1.2 Need of Corporate Governance in Banking

As we are marching forward towards global economy, there are many economic issues

coming up in the process for developing, emerging and transitional economies. These can be

correctly identified as structural changes in market institutions. It brought about much

awareness among investors, bankers and public at large. Such economy faced a retarded

growth in spite of having economic reform like privatization, liberalization and lifting

licensing raj. Despite flow of money in such economy, the growth could not take its stand due

to unbalanced approach. The holder of para-state institutions such as privatization funds

remain in the hands of largest shareholders of companies. As a result, the de facto power

remains loaded in the hands of few individuals considered as internal owners, while the

external owners do not have enough power to control the companies and thereby cant ensure

themselves to get appropriate returns (Fernando, 2002).

Another important factor in banking industry in developing countries is that banks are mostly

owned by government. In such situation, banks are mostly guided by government bodies and

many laws based on stereotype procedures. The accountability idea is less apparent as the

concept of government job discourages the spirit of competition. The need for corporate

governance in developing, emerging and transitional economies not only arises from

resolving problems of ownership and control, but also from ensuring transparency in

achieving the desired goal of corporate governance. In many cases, developing and emerging

economies are beset with issues such as the lack of property rights, the abuse of minority

shareholders, contract violations, asset stripping and self-dealing.

Ownership pattern, regulatory environment, societal pressure (on the developmental role of

banks) and the broad structure would be the key elements in the design of a governance

framework of banking. While government ownership does provide core strength to banks, the

structural inefficiencies and lack of management autonomy appears to have weakened the

ability of our banks (Public sector) to compete effectively in the current market situation

(Ravisankar, 1999).

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Banks and financial institutions have been making pivotal contributions over the years to

nations economic growth and development. Government-owned (Public Sector) banks have

played a major role in economic development. During the last few years, these institutions are

slowly getting corporatized and consequently corporate governance issues in banks

assumes greater significance in the coming years. Considering the importance of banking

sector the practice of corporate governance and how it helps banking industry in India in

terms of bringing more transparency and overall growth of banking sector. So the research

will identify the attributes of corporate governance and to what extent it is being implemented

in Indias banking sector.

1.3 Research Objectives

The research aims at studying the attributes of corporate governance in Indian banking sector.

The research maintains following objectives to study in this research:

How the implementations of corporate governance attributes bring changes in banking

sector in terms of transparency and economic growth?

Does the compliance with corporate governance attributes by banks ensure protection of

stakeholders (particularly, the shareholders') rights and interests?

Can corporate governance be mandatory in banking sector so that curbing malpractices and

fraud can be minimized?

1.4 Research Questions

The proposed research will ask some fundamental questions on corporate governance in

banking sector and will try to identify how it helps banks to ensure transparency and growth.

The questions are:

How the attributes of corporate governance help banking sector to create a situation, which

can minimize fraud/malpractices in financial matter in banking sector?

Whether ownership pattern influences the effective governance and functioning of a bank?

Does the declaration of corporate governance in annual report bring more transparency in

their business and how it pays in terms of business? Can it be mandatory in all sector of

banking?

Does the proper implementation of corporate governance principles create more public trust

and acceptability of a bank as a result give boost to share price?

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Is there any difference in corporate governance practices between Private sector and Public

sector banks?

To what extent Indian Banking sector has accepted/implemented corporate governance

principles compared to international norms? What are suggestions to banking industry in regards attributes of corporate governance?

1.5 Scope of the Research

This study attempts to find the implementations of some attributes of corporate governance

by Indian Banking sector. Though there are a lot of corporate governance codes

recommended by different committee, this study is based on some prominent governance

codes in recommendations made so far. Transparency in decision making, accountability and

responsibility, disclosure of important information, share price movements, and mandatory

requirements under section 49 etc, are taken as indicator of good corporate governance. The

study will concentrate on public and private sector banks. The scope of the research is not

very wide. Hence it fails to shows the absolute impact of corporate governance attributes on

the performance of banks.

1.6 Organization of the Research

The organization of the present research follows conventional chapter plan. Chapter one

highlights introduction of corporate governance, conceptual discussion, objectives of the

research and scope of the research. Chapter two narrates the academic literature on corporate

governance and especially corporate governances in banking sector. Chapter three describes

the research problems, methodology of the research and limitation of the research. Chapter

four presents the outcome of primary and secondary research analysis. Chapter five gives

concluding remarks on the research analysis and recommendation to improve corporate

governance practices in Indian Banking sector.

CHAPTER-2

Literature Review

2.0 Introduction

The term Corporate Governance which was rarely encountered before the 1990s has now

become an all-pervasive term in the recent decade. In todays scenario this term has become

one of the most crucial and important concepts in the management of companies. The root of

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

concept of corporate governance can be understood as the system through which

shareholders are assured that their interest will be taken care of by management. In a much

wider term, corporate governance was defined as the 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 (Parekh, 2003).

The literature on corporate governance in its wide subtext covers a variety of aspects, such as

protection of shareholders rights, improving shareholders value, board matters etc.

However, the importance of corporate governance in banking sector weighs very much due to

very nature of banking transactions. Banking is the crucial factor effecting economicdevelopment of an economy. It is the life-blood of a country. It is responsible for the flow of

credit and for maintaining the financial balances of the economy. In India, since the

nationalization process banks emerged as a tool of economic development along with social

justice. Corporate Governance has become very important for banks to perform and remain in

competition in this era of liberalization and globalization.

2.1 Corporate Governance: In Search of a Definition

The term governance has been derived from the word gubernare, which means to rule or

steer. Originally this term meant to be a normative framework for exercise of power and

acceptance of accountability used in the running of kingdoms, regions and towns. However,

over the years it has found significant relevance in the corporate world. This is basically due

to growing number and size of the corporations, the widening base of the shareholders,

increasing linkages with the physical environment, and overall impact on the societys well-

being as we need a proper administrative system to regulate so many complex things.

The analysis of World Bank definition on corporate governance seems more appropriate as it

analyzes from two different perspectives. From the companys point of view, the stress is put

on the relations between the various stakeholders such as owners, management, employees,

customers, suppliers, investors and communities. From another perspective in defining

corporate governance is reliable path where the corporate governance structures can be

established. So, a nations system of corporate governance can be seen as an institutional

matrix that structures the relations among owners, boards, and top managers, and determines

the goals pursued by the corporation. (World Bank, 2002)

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The OECDS (1999) original definition is: Corporate governance specifies the distribution

of rights and responsibilities among different participants in the corporation, such as the

board, managers, shareholders and other stakeholders, and spells out the rules and procedures

for making decisions on corporate affairs. By doing this, it also provides the structure through

which the company objectives are set, and the means of attaining those objectives and

monitoring performance.

According to the Economist and Noble 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 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 information

needs of all stakeholders are met. The discussion on governance has been dated back more

than 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.

2.2 History of Corporate Governance in India

Before making details into literature review, it entails to discuss the development of corporate

governance practices in world. Globally, Cadbury Committee was set up in May 1991, in the

United Kingdom. It was set up, inter alia by the financial reporting Council, the London

Stock Exchange. This committee wanted to improve the overall standard of corporate

governance in financial reporting and auditing by clearly defining the responsibilities and its

expectations from those involved. The Cadbury Report states Corporate governance is the

system by which companies are directed and controlled. The Boards of Directors is

responsible for the governance of their companies. Shareholders should be concerned with

appointing the directors and auditors such that an effective governance structure is created.

The board should be responsible for making the company strategies, guide and lead the

company to put them into effect, supervise the management and report to stakeholders.

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However, the boards actions are subject to rules and regulations. Their acts should be legally

recognized. The Cadbury Committee made nineteen recommendations.

Blue Ribbon Committee was formed under the direction of the United States Securities and

Exchange Commission. It was constituted to develop recommendations to enable audit

committees to function as the ultimate guardian of investors interests and corporate

accountability. The committee recommended enclosing Statement of Disclosure by Audit

Committee to the shareowners, and certificate of Statutory Auditors regarding

Independence. Euroshareholders Corporate Governance Guidelines 2000 are more specific

and detailed. It has given ten recommendations on disclosure of information in the annual

reports. It states that a company should aim at maximizing shareholders value in the long

term. Companies should clearly state (in writing) their financial objectives as well as their

strategy, and should include these important ones in the Annual Report. Some of the

important recommendations are: (1) Shareholders approval is required for major decisions

which can affect the standing of shareholders within the company. This approval is also

necessary for important decisions which may deeply affect the risk profile, organization, size

and the nature of the business. These decisions can also be approved by the AGM. (2) There

should be no bias involved in electing the auditors. The entire process of election should be

very transparent. Auditors should be independent and elected by the general meeting. (3)

Shareholders should be provided price sensitive information through regular as well as

electronic means.

Corporate governance has assumed great significance in India in the recent past. Despite the

Companies Act, 1956, outlining a structure for Corporate Governance, defining the boards

authority and responsibility, and creating an arrangement of checks and balances with penalty

for breaking the law, a need was felt for a comprehensive code of corporate governance. In

India, the confederation of Indian Industry (CII) tried to fill in this gap by outlining a code of

corporate governance in April 1988 followed by the Ramakrishna Commission on PSU

corporate Governance and the recommendations of the Kumar Mangalam Birla Committee

on Corporate Governance in December 1999. CIIs code Desirable Corporate Governance

in India- emphasized the frequency of board meetings, removal of Financial Institutions (FI)

from the management where shareholding is less than 10%, withdrawal of FIs nominees

from the board of companies which are not defaulting in loan payment, transparency in credit

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ratings of financial instruments, removal of restrictions on the takeover of companies and

debarring companies from accepting further deposits (CII Report, 2003).

The Ramakrishna Commission on Public Sector Undertakings (PSUs) corporate governance

emphasized autonomy in professionalizing the board, providing incentives for the top

management, accountability, autonomy in price fixation, strengthening investors interface,

power to dispose of assets, providing for elected directors, setting up a pre-investigation

board, freedom in investing within certain limits, and power to enter a joint venture

(Ramakrishna Commission Report, 1999). Security and Exchange Board of India (SEBIs)

Kumar Mangalam Birla Reporthas been enshrined in clause 49 of the listing agreement of

every Indian stock exchange. A beginning has been made in India for mandatory observance

of corporate governance practices, through clause 49 of the Listing Agreement of the Stock

Exchanges. The recommendations of the committee are mandatory. The mandatory

recommendations of the Report are:

Half the directors on the board should be independent if the chairman is executive and one-

third if the chairman is non-executive.

The audit committee will investigate reasons for financial transparency. The committee

should have minimum three non-executive directors. The majority of these directors should

be independent. At least one director should have some knowledge in the field of accounting

and finance. The audit committee should meet at least three times a year.

The board of companies should meet at least four times a year.

A remuneration committee should be set up to determine the remuneration packages,

including performance-linked incentives, stock options etc, of the executive directors.

A committee should be formed to study investors complaints.

The chairman of all the committees should be present at the AGM to answer the

shareholders queries.

The directors cannot be members of more than 10 committees across companies and cannot

chair more than five committees.

The annual report should have a section on corporate governance reporting the status of

compliance.

The non-executive chairman should be provided with an office and the expenses should be

reimbursed to make him effective.

The annual report should have the detailed resumes of newly appointed directors.

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The non-mandatory recommendations of the committee are:

Non-executive Chairman to maintain Chairman's Office at company's expense.

Board to set-up a Remuneration Committee to formulate companys remuneration policy onspecific remuneration package for Executive Directors.

Half-yearly declaration of financial performance including summary of significant events in

last six months to be sent to shareholders.

Company may move towards regime of unqualified financial statements.

Company may train Board Members in the Business Model of the Company as well as risk

profile of the business parameters of the company, the responsibilities as Director and the

best way to discharge them. The evaluation of performance of non-executive Directors by other members of the Board

and to decide to continue or otherwise of the Directorship of the non-executive Directors.

The Company to establish the Whistle Blower Policy for reporting management concerns

about unethical behaviors, actual or suspected fraud, etc. (Pradhan & Pattnaik, 2003)

A significant amount of research has been done on corporate governance practices in the

Indian context. Mukherjee (2002) argues that India has been moving closer to taking on anAnglo-American (Anglo-Saxon) form of corporate governance. But the author questions the

usefulness of the Anglo-American model. She answers this question through an assessment

of the "development impact" of the new model as pointed out by measures such as growth,

employment and respect for shareholder rights. The results suggest that the Anglo-American

model is not very effective in meeting the objectives of the social system in India.

Rajesh Chakrabarti (2005) said that the problem of corporate in India is different from that of

the Anglo-Saxon environment. In India, the problem is the exploitation of minority

shareholders by the dominant shareholders, whereas in the Anglo-Saxon environment, it is

exploitation of shareholders by the managers. The author argues that in the Indian context,

the capital market is more capable of disciplining the majority shareholders than the

regulators. The regulator can just facilitate the market to ensure corporate governance. It

cannot enforce corporate governance effectively, since it involves micro-management.

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Sarkar and Sarkar (2000) provided evidence on the role of large shareholders in monitoring

company value in the Indian context, whose corporate governance system is a hybrid one.

Similar to other studies, this study also found that after a definite level of block holdings by

directors the company value enhances. But it did not find any substantial proof that

institutional investors, normally mutual funds, are active in corporate governance. The

outcome advocates that lending institutions start supervising the corporation efficiently only

after the equity holding cross a considerable value and this supervision is reinforced by the

level of liability of these corporations. The study provides substantial proof that company

value is enhanced by foreign equity ownership. In general, the analysis supports the view

emerging from developed country studies that the Identity of large shareholders matters in

corporate governance.

The study by Mohanty (2003) suggests that companies with good corporate governance

measures are easily able to borrow money from financial institutions as compared to

companies with poor corporate governance measures. Moreover, there is evidence that

mutual funds have invested money in companies with a good corporate governance track

record as compared to companies with a poor CG track record. By making use of a

simultaneous equation approach, this study wraps up by saying that this positive relationship

is a result of the mutual funds (development financial institutions) investing (lent money) in

companies with good governance records and also because their investments have helped

to enhance the financial performance of such companies (Mohanty, 2003).

Irrespective of the business goal considered, effective governance guarantees that the

administration (managers and the board) are responsible for achieving it. The job of

successful corporate governance is of immense significance to society as a whole. In the first

place it promotes efficient use of scarce resources both within the organization and the larger

economy. Secondly, it makes the resources flow to those sectors or entities where there are

efficient production of goods and services and the return is adequate enough to satisfy the

demands of stakeholders. Thirdly, it provides a broad mechanism for choosing the best

managers to administer the scarce resources. Fourthly, it helps the managers to constantly

focus on enhancing the company performance, ensuring that they are sacked when they dont

succeed in doing so. Fifthly, it puts pressure on the corporation to abide by the law as well as

achieve what the society expects from it. And last but not least, it assists the supervisors in

regulating the entire economic sector without partiality and nepotism.

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2.3 Governance in banks

Its impossible for one to think about financial organizations including banks without proper

corporate governance. Since banks have a very crucial role to play in the economy (financial

and economic system) of any developing country, hence any fault on their part due to

immoral practices creates a situation which may adversely affect not only the shareholders

but the people who have deposited money and the economy at large.

The effectiveness of sound banking system can be recognized by the standard of transparency

in their performance and the increased role of government and regulatory agencies to verify

their actions (Topalova, 2004). The lack of transparency tempts the management to resort to

unethical practices as well as siphon off funds. Inadequate action by regulatory agencies put

blanket on the omission and commission of such unethical practices, thus leads to bank

failure and loss of public faith.

The prevalence of banking system failure has been a common phenomenon in developing and

transition countries as in the industrial world (Honohon and Daniela, 2000). The structural

changes in the banking industry in the form of development of latest technologies, main

industry consolidation, globalization, and deregulation have got the banking industry at a

strategic junction. Hence, banks face a more competitive and volatile global environment

than so called stereotype situation of management. They are engaged in a number of

innovative services like providing required finances to commercial projects, fundamental

financial services to majority of the population and key to all the payment systems in micro

environment. Other than this, some banks provide additional credit in times of market crisis.

The banking sector may be closely monitored by the public due to its nature of transactions

and some bad precedents in the past. This sector is very sensitive as a small mistake can

easily attract negative publicity. It is a part of corporate governance with most of its

management obligations enclosed in regulatory regulations. In the light of the above

statement governance issues in banks, more particularly in Public Sector Banks (PSBs),

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

upon.

Although the primary reason identified for it is the prevalence of government ownershipacross the institutions, another important reason can be attributed to the multiplicity of

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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 Act,

which 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.

The full applicability of corporate governance principles in Indian Banking sector is less

apparent. Firstly, there are definitional issues of serious nature, which should be strictly

adhered by Indian banking sector. Secondly, there are issues of temporal, sect oral and

structural nature that have bearing on their relationship. More specifically, the literature on

bank performance and corporate governance is scanty in India as well as abroad. Although

the literature on corporate governance in developing countries has lately got a lot of interest

from the scholars in their previous research (Oman, 2001; Goswami, 2001; Lin, 2001;

Malherbe and Segal, 2001), the execution of corporate governance characteristics of banks in

developing countries has been almost unnoticed by researchers (Caprio and Levine, 2002).

Even research studies on corporate governance in banks are rarely found in the literature in

developed economies (Macey and OHara, 2001).

In developing countries, corporate governance in banks is of paramount significance as they

play a vital role in the economys financial structure and also act like a catalyst in the

economic growth of the country (King & Levine 1993 a, b; Levine 1997). Second, banks in

developing economies provide an easy source of financing to most of the organizations as

their financial markets are yet to mature. Third, banks offer a universally accepted mode of

payment, hence they are considered as a warehouse of publics savings. Fourth, due to

liberalization/privatization, many developing countries have liberated the economic

regulations as a result managers are in search of proper governance mechanism.

Coming to a developing country like India, all attributes of governance mechanism can be

easily implemented due to many complexities involved in it. In a developing economy such

as India, the growth of efficient corporate governance principles in banks has been partly held

back due to weak legal protection, poor disclosure prerequisites and overriding owners (Arun

and Turner, 2002a). Moreover, the private banking sector is purposely opting to ignore

certain corporate governance ethics as it has vested interest of some parties (Banaji and

Mody, 2001).

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The economic liberalization in India created many genuine corporate governance issues for

government owned bank. On the one hand, government encouraged private players to come

up and compete with government owned banks, on the other hand, not giving a cushion to

protect them from unfortunate misgovernance. If privatization is the slogan of the day, then

there must be sufficient deposit insurance proposals and supervisory provisions instituted so

as to safeguard the interest of people who deposit money and avoid a financial collapse (Arun

and Turner, 2002b). Therefore, the pertinent question arises, can the government guarantee

that it would facilitate all mechanisms to private capital owners for smooth operation of

banking.

In spite of over 10 years of financial reforms in India, the Indian government is yet to play a

crucial part in many aspects like board member appointment. However, they have given some

power to public sector banks to make them competitive. The impact of these reforms has

been that the private sector banks now have more independence in formulating strategies for

different sectors of business which include setting up branches and introducing innovative

products (Muniappan, 2002) but yet this autonomy is limited, as they have to abide by the

rules and regulations given by the government and central bank (AGCG, 2001).

Based on statistical report, it can be aptly said that greater state ownership of banks, lesser thechance of good financial performance (Barth et al 2000). Agreeing on the same line, World

Bank (2002) also voiced the same concern on state ownership and political interference. In its

report it observed that: i) Recent studies indicate that state ownership of banks is inversely

related to bank competence, saving and borrowing, productivity and growth; ii) However,

there is no proof which suggests that state ownership reduces the chances of banking crisis;

iii) The evidence clearly states that state bankers are subject to political clash that usually

leads to weak performance; and iv) Privatization is perhaps the only way to guarantee that

freedom from political decision making can enhance governance in banks.

The report of the Advisory Group of Corporate Governance (AGCG, 2001) recommended

that depositors being the major stakeholders in banks, whose interests may not always be,

recognized, sound corporate governance should consider their interests and ensure that

individual banks are conducting their business in such a way as not to harm interests of

depositors.

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A discussion above clearly brings out the fact that the government wants to hold some kind of

control in privatized public enterprises. This shows the governments concern that those

enterprises might pursue shareholders objectives (other than government), even by ignoring

interests of the community and other stakeholders. It is also possible that the government is

unsure whether it would be required to use those enterprises as instruments as model

corporate citizens. Institutional investors would like those enterprises to play the game as is

being played by other private sector enterprises. Therefore, it will be difficult to avoid the

conflict between interests of two major shareholders namely, the government and the

strategic partner in a privatized public enterprise.

The key issues in corporate governance in public sector are:

(a) What should be the corporate objective of a public sector unit?

(b) In protecting the rights of employees, the community and other stakeholders, should it stretch

beyond enforcing legal rights of those stakeholders?

(c) Should it be burdened with higher social obligations as compared to its counterpart in the

private sector?

(d) In which situations and how the government should exercise control on its operations with

the framework of the Companies Act, 1956?

(Source: Public Enterprises Survey 1997-98)

The government should resolve these issues and come out with clear policy guidelines.

Governments effort to push privatization without resolving these issues might do irreversible

harm to the economy. We must accept that there is still a need to build infrastructure, to

create employment and to promote balanced regional development. In all likelihood, market

forces will not allow the government to use privatized public enterprises to achieve these

objectives.

Disciplined financial disclosure, which is the hallmark of good governance enhances the

information environment for the mangers and ultimately leads to better economic

performance. There are three channels through which financial accounting information

improves economic performance, better identification of good vs. bad projects by managers

and investors, governance role of financial accounting information, and reduction in

information asymmetries among investors (Bushman and Smith, 2003).

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Kumar Mangalam Committee (1999) clearly states that the fundamental objective of

corporate governance is the enhancement of shareholders values, keeping in view the

interests of other stakeholders. The above survey of literature highlights some issues related

to corporate governance and stakeholders interest which provide inkling to the ultimate goal

of a bank i.e. the enhancement financial wealth of different stakeholders, which can only be

done through the improvement of performance.

2.4 Role of Governance in banks

From the banking industry perspective, the attributes of corporate governance provide

guidelines to the directors and the top level managers to govern the business of banks. These

guidelines relate to how banks establish corporate aims, carry out their daily activities, take

into account the interest of stakeholders and making sure that the corporate activities are in

tune with the public expectations that banks will function in an ethical and legal manner

thereby protecting the interest of its depositors (Basel Committee, 1999). All these broad

issues relating to governance apply to other companies also, but they assume more

significance for banks because they deal with public deposits directly.

Many international bodies have formulated a clear set of guidelines for the implementation of

corporate governance principles, however the reality prevalent in various countries showsthat there is no universally correct solution to structural problems and that the rules and

regulations need not be constant in different countries. As a result of this, sound governance

practices were formulated by Basel committee. Recognizing the diversity in the structure of

governance mechanism across the countries the Basel Committee (1999) recommended four

important forms of oversight that should be included in the organizational structure of any

bank in order to ensure appropriate checks and balances : (i) oversight by the board of

directors or the supervisory board; (ii) oversight by individuals not involved in the day-to-dayrunning of the various business areas; (iii) direct line supervision of different business areas;

and (iv) independent risk management and audit functions. In addition, the committee also

emphasizes the significance of the main employees being mentally and physically healthy for

their work.

In comparison to other sectors, governance in banks is significantly more intricate. Public

Sector Banks (PSBs) endeavor to conform to the same system of board governance as other

organizations, however, other elements such as risk management, capital adequacy and

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funding, internal control affect their matrix of governance. It has been observed that 63

percent of PSBs have potentials for profitability increase through efficiency improvement

(Kumar & Verma, 2003), which ultimately depends on the quality of governance. Being

under government control PSBs are handicapped in many respects. As regards the issue of

corporate governance in banking organization, Jalan (2001) has examined the issue of

corporate governance in public versus private sector banks and thereafter Reddy (2002) has

discussed the governance challenge in public sector banking. Corporate governance in PSBs

is important, not only because they dominate the banking industry, but also because, they are

unlikely to exit from banking business though they may get transformed. To the extent there

is public ownership of PSBs, the multiple objectives of government as owner and the

complex principal-agent relationships cannot be wished away. Some important troubled

areas are hindering the best governance practices in these banks. These grey areas are

identified and elaborated in the following paragraphs (Reddy, 2002).

2.5 Areas of Concern: Ownership

Public Sector Banks (PSBs) are state-controlled banks and their boards are dominated by

representatives from the various sections of society. The need of the board being the guardian

of the shareholders welfare has not found favor in these banks, obviously because of the

largest shareholding by the government of India (GoI). Since these banks command the

largest volume of business in terms of deposits and credits, the composition of their boards is

of critical importance. Particularly, the presence of outside professional directors, i.e. of those

from outside RBI and GoI, is crucial for their effective governance. From the actual

experience of PSBs, it shows that the dominance of government representative directors in

most of the PSBs has proved to be counterproductive. In fact, it often serves to distort the

incentive structure, erode discipline and reaffirm the faith of these institutions in the deep

pockets of the government (RBI 2001b).

The state control of PSBs has thus belied the expectation of the nation as well as landed the

financial sector in more trouble. It is aptly said that on average, greater state ownership of

banks tends to be associated with a more poorly operating financial system (Barth et al 2000).

Similar doubts for state ownership and political interference were also raised by The World

Bank in one of its reports in 2002. The management bodies of PSBs do alter the strategies

and objectives of the bank as well as the internal structure of governance. This also prevents

cutthroat forces, restricts the efficiency of government monitoring in the financial division,

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and tends to raise the opacity of banks business. The government uses state-owned

institutions to sustain too much spending and to support less-than-creditworthy borrowers.

All these tendencies dampen overall economic growth. In addition, the government often

operates establishments, or the regulatory procedure that manage them, in ways that reduce

the growth of vibrant private sector contenders. (Barnier, 2001)

2.6 Composition of the board

The dual charge of Managing Director and Chairman with one person is another cause of

worry in most of the PSBs. On the one hand, this helps in removing the rivalry between the

two positions and, on the other, it reduces the boards ability to fulfill its proper governance

function as an independent body (Dayton, 1984). A proper trade-off between the duality and

non-duality of the highest post is thus crucial for institutions like banks, more particularly in

PSBs, where the senior directors are nominated by the government. Who is the real boss can

be a matter of confusion. The boards leadership structure can be conceptualized as a double-

edged sword that forces it to choose between the contradictory objectives of unity of

command and effective monitoring (Finkelstein and Aveni, 1994). Definitely the dual

structure comes with costs; it carries the potentialities of rivalry and conflict between two

posts. The non-dual structure, which is not conducive to effective governance, is even more

detrimental. Concern was also raised by the Ganguly Committee (RBI, 2002) in this regard.

Unless one is mistaken, in the public sector institutions (banks), what is being visualized is

that the Chairman and the MD would both be full-time executives. This will definitely lead to

a bi-polar relationship with blood-letting internecine feuds (Tarrapore, 2002). Another

issue arises with the composition of executive and non-executive directors on the board and

their autonomy.

2.7 Governance through committees

The experience of Indian banking, so far as institutionalizing the different committees is

concerned, is not encouraging. The status of banks in both public and private sectors reveals a

gloomy picture. The leaders in the respective sectors, i.e. SBI and ICICI Bank, have

established few committees, but are still short of the international standards. Other banks in

the public sector are yet to establish many of them.

The core of governance depends on transparency and disclosure. The most important

committee, audit committee, being the watchdog, provides adequate stuff for achieving this

most important objective. An audit committee provides overseeing the selection and removal

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of auditors, evaluating and endorsing the extent of audits, deciding upon the regularity of

audits, obtaining audit reports and making sure that management is taking corrective

measures in time to control failures. Audit committee also supervises the banks internal and

external auditors. Autonomy of this committee can be primarily increased by appointing

external board members with expertise in banking or finance and accounts.

This committee needs independent, qualified leadership and membership, which are lacking

in PSBs. A key determinant of the effectiveness of an audit committee is the independent,

competence, dedication and leadership skills of the audit committee chair (Blue Ribbon

Commission, 1999). Financial literacy among its members and their independence of the

owner are very crucial to its effective functioning. Since in PSBs the members of this

committee are drawn from the pool of representative directors, there is always a question

mark hanging over their effectiveness.

Table 1: Committees set up by Indian banks

Committees set up by banks SBI ICICI Bank UTI

ALM

Audit

Compensation/ Remuneration

Risk ManagementInvestors Grievances

Credit

Business Strategy

Nomination

Y

Y

N

NY

N

N

N

Y

Y

Y

YY

Y

Y

N

Y

Y

N

NN

N

N

N

Y Yes, N No Source: Latest Annual Reports

Risk management, being the backbone of any financial institution, is also very crucial to

banks. They face a gamut of risks which are complicated in nature and require specialized

hands to handle. These include credit risk, exposure concentration risk, connected exposure

risk, interest rate risk, exchange rate risk, equity risk, legal risk, operational risk, liquidity

risk, reputation risk, payment system interface risk and business continuity risk. Only a well-

manned risk management committee can identify these risks and manage them properly. As

per the latest annual reports, most of the PSBs have not yet established any risk management

committee, which exposes them to the risk of taking faulty decisions in many operational

areas resulting in serious trouble. Most of the PSBs have established the first two committees,

as listed in Table 1. But merely forming these two does not come handy when many of them

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have already raised capital from the capital market. Besides, business-related committees,

investor protection committee and nomination committee are of vital importance.

2.8 Critical Analysis of Literature

After studying the literature on corporate governance some concrete meanings came out

which would be studied thoroughly in the subsequent research. Since it is impossible for

these owners to directly manage or even supervise these corporates, they appoint their

representatives as Board of Directors. The Board appoints the top management, who in turn

appoint other managers and employees. As put out succinctly by the Kumar Mangalam

Committee: The pivotal role in any system of corporate governance is performed by the

Board of Directors. It is accountable to the stakeholders and directs and controls the

management. It stewards the company, sets its strategic aim and financial goals and overseas

their implementation, puts in place adequate internal controls and periodically reports the

activities and progress of the company in a transparent manner to the stakeholders. (Kumar

Mangalam Birla Committee Report, 1999)

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 be to optimize the shareholders 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

framework 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 firms in other sectors. The corporate governance of banks is a

complex issue. It has been observed that the legal and regulatory framework, in which banks

operate, makes the governance mechanism of hostile takeovers ineffective as a method of

corporate governance. Thus, governance issues in banks have to be discussed in an

environment where a banks management has a considerably reduced threat perception from

the market for corporate control.

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Chapter 3

RESEARCH METHODOLOGY

3.0 Introduction

Since the focus of the research is on evaluating corporate governance in Indian Banking

sector, the focus is on corporate governance outcomes rather than on corporate governance

mechanisms. Specifically, the author examine the effectiveness of corporate governance in

Indian banking sector in achieving economic growth, curbing malpractices, bringing

transparency of banking transactions, and how it can be mandatory. As reflected from

previous research Jalan (2001) and Reddy (2001), there has been growth in the Indian

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banking sector during the post liberalization period, can be attributed to good governance.

This research throws light on the efficacy of corporate governance in achieving transparency

and good banking growth in India The research philosophy for the underlying topic reflects

the principles of interpretivism. This reason why this approach is taken is because

interpretivism calls for finding and extracting the details of the situation to understand the

reality or perhaps a reality working behind them (Saunders et al, 2003). Hence, the research

methodology was prepared meticulously to identify the effectiveness of corporate

governance.

This chapter deals with research design, collection of the data and methodology used for the

research purpose. This section of the dissertation has been developed to explain the logic and

rationale behind the research methods used. The idea is to demonstrate that the chosen

approach has been appropriate and the findings of the research are both applicable and

dependable. From the perspective of time horizon, this research will be classified as

longitudinal research (Saunders et al, 2003). This is because the research will be studying the

developments and the changes that taken place in the Indian Banking sector over the past

years.

3.1 Research Approach

Approach can be classified according to their purpose and research strategy used. The

classification most often in three folds one of exploration, description, and explanation.

Exploratory Research

Exploratory research is valuable means of finding out what is happening; to seek new

insight; to ask questions and to assess phenomena in a new light. This research in general is

quite flexible in nature. The main purpose behind this research was to identify the potential

opportunity existing in the market. Like descriptive research, exploratory causal research is

also based on a planned and structured design. Exploratory research emphasizes on the

discovery of new ideas. It deduces large and unclear problem statements into more accurate

sub-problem research propositions and hypotheses. Exploratory research is characterized by

support from secondary data with lot more flexibility and it tends to based on subjectiveevaluation of survey results (Tull D.S. & Hawkins, D.I. 1990).

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Explanatory Research

A clear statement of the decision problem, specific research objectives and detailed

information are the highlights of this research. It is quite structured and statistical in nature. It

describes the commitment of banks in adhering corporate governance principles taken fromtheir annual report. This research will explore and explain how the Indian banking sector is

doing its business in post implementation period.

3.2 The Research Method

The research relies on the use of the deductive method. There are different ways of

conducting a research as Yin (1994) mentioned five major research strategies namely

experiment, survey, case study, archival and history.

Research

Strategy

Form of Research

question

Needs Control over

Behavioral Events

Focuses on

Contemporary Events

Experiment How, Why Yes Yes

Case Study Why, How No Yes

Survey Who, What, Where,

How, How much

No Yes

History How, Why No No

Archival Who, What, Where,

How, How much

No Yes/No

Source: Yin (1994) pp-6

For this study, the author has used both primary and secondary data. Primary data was

collected from questionnaire survey and interview. The author met with the interviewees in

their office and gave them a small questionnaire on corporate governance to complete. Prior

to this the author had a brief discussion with the interviewees on the questionnaire and

accordingly notes were taken on the basis of this. However, only a few interviewees gave

permission to use these notes in the research analysis. The small questionnaire was handedover to them to score the important attributes of corporate governance. The secondary data

was collected from literature, academic articles, and information provided in annual reports

and websites. Secondary sources have been extensively used to identify the corporate

governance practices by banks in India. Primary research has been used in the analysis in a

qualitative way to identify the effectiveness of corporate governance practices in India.

A. Primary Research

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The main objective of primary research was to elicit the valuable opinion of senior bank

professionals who can provide valuable insight and information about the implementation of

corporate governance practices in the recent past. Considering these objectives and literature

review, the questionnaire was prepared in a manner to derive the opinion of bank

professionals regarding attributes of corporate governance principles and its contribution to

the banking business.

Qualitative data

Qualitative research is called so because its emphasis lies in producing data that is rich in

insight, understanding, explanation and depth of information, but which cannot be justified

statistically (Crouch S & Housden M, 2003). Since the banks were an important source of

information, interview method of data collection along with their opinion on the attributes

through questionnaire survey with senior manager of different banks in Delhi were arranged.

B. Secondary Research

Secondary research was very important and was helpful in aligning the findings of the

primary research to the facts derived from the secondary research. Many national and

international journals have been used to collect the necessary facts and figures on Indian

banking industry. Reports of the RBI (Reserve Bank of India) were also used.

3.3 Research Design

A research design was devised in a more traditional fashion specifying the research

strategy. The research strategy will use the multi- methods approach to dig in and gather

more information about corporate governance. The growth of banking business in India is

phenomenal as it is being reflected by the entry of private banks and foreign banks. However,

the growth of banking business is linked with successful implementation of corporate

governance principles.

The following steps were done in order to make research design successful.

Data collection

Sampling criteria

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Data analysis

A. Data Collection

The interview/questionnaire mechanisms were used very systematically to elicit views oncorporate governance attributes. The preparation of such mechanism was quite meticulous

bearing in mind each question should make contributions to the research objective (Proctor T,

2003). Since this research required lot of secondary data to complete the analysis, the

websites of banks and their annual reports were extensively used.

B. Selecting a Sample for Questionnaire

Samples can be of two natures: Probability samples and Non-Probability samples. The

Probability sample implies that everyone within the subsets of the population has a non-zero

probability of selection. Non-probability samples on the other hand imply that no attempt is

made to ensure that a representative cross section of the population is achieved (McDaniel

and Gates, 1996).

Selecting a sample procedure for this dissertation was never an easy task because it is tough

to get a chance to interview senior bank professional and easy access to fill up questionnaire

through senior officials. The sample procedure used in the questionnaire is non-probability

sampling due to the nature of data available. The use convenience sampling is made; as the

questionnaires have been, send to senior banking professionals. The sample size for the

questionnaire was 10 respondents.

3.4 Reliability and Validity of the Research

To ensure the authenticity of the research in synchronization with the very objectives were

laid out for this dissertation certain firewalls were employed that make this research reliable

and valid. The data collected was analyzed and the analysis was made from the primary and

secondary sources of data using the deductive method.

3.5 Limitations of the Research

The limitation of the research is the lack of primary data collection due to difficulty in getting

appointment with senior bank official in banking industry.

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The sample size is very small in comparison with the nature of the research. Study of attributes

of corporate governance with interview of 10 people seems quite less and unrepresented.

Time and recourses constraints restrict the scope of the research. Despite my effort to expand

the scope of the research by getting into more in-depth study of corporate governance, it wasnot materialized due to the practical difficulties faced during the work.

Although prominent banks have been incorporated in the sample, judgmental sampling seems

little biased and inaccurate results might surface.

CHAPTER-4

Analysis and Interpretation

4.0 Introduction

This current research tries to study the attributes of corporate governance practices which

exist in the Indian Banking sector within the strict authoritarian structure. It tries to evaluate

the implementation of corporate governance attributes by bank (private and public sector).

Also the author tries to assess the competence of these banks in terms of substance and

quality of reporting in their annual reports. For this purpose an empirical study has been

undertaken on ten banks (six public sector bank, three private sector bank and one foreign

bank) operating in India. The research has been undertaken to assess the level of compliance

of key governance parameter in these banks in tune with statutory and non-mandatory

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requirements given by SEBI (Securities Exchange Board of India) under clause 49 of the

listing agreement.

4.1 Analysis from secondary Research

Empirical Study

1. Sample Size, Period of Study and Rationale: The sample of study comprises ten banks

operating in India. These banks have been selected on the ground that they are renowned

banks in the banking sector in India, and their scrips practically dictate the movement of the

stock market in the country. The public sector banks are (SBI, Punjab National Bank, Bank of

India, Bank of Baroda, Canara Bank, & Allahabad Bank) and private sector banks are (ICICI

Bank, HDFC Bank, Axis Bank & Standard Chartered Bank), though standard chartered is

considered as foreign bank also. The period of study is one year (2007-08) only as it will

show the latest development of corporate governance attributes in banks. The fundamental

reason behind selecting 2007-2008 as the period of study is that SEBI initiated few new

clauses, recommended by various committees in its revised clause 49 of listing agreement on

29th October, 2004 (Das, 2007). Thus, its quite sensible to evaluate the situation which

highlights the status of CG observance by these financial institutions. Considering this, the

2007-2008 annual report of banks was considered appropriate for this study. This would

definitely provide some useful insight about the present state of corporate governance

practices and disclosure norms. To evaluate the structure and procedure of corporate

governance adopted by banks commitment to adhere it in their annual report. As a result the

author has conducted a comparison study based on statutory and non-mandatory requirements

stipulated by the revised clause 49 of the listing agreement and provisions required by the

Banking Act.

2. Analysis: After getting the corporate governance attributes from banks annual report, the

analysis is prepared in two separate parts: a) Shareholding pattern in Public and Private sector

banks, b) Key governance parameters and their compliance status in these banks.

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Table 2- Share Holding Pattern of Private and Public sector Banks in India

PUBLIC SECTOR BANK PRIVATE SECTOR BANK

ATTRIBUTES OF

CORPORATE

GOVERNANCE

SBI CanaraBank

AllahabadBank

BankofBaroda

BankOfIndia

PunjabNationalBank

ICICIBank

AXISBank

HDFCBank

StandardCharteredBank

President of India 59.7

3

57.80

Government of India 73.17 55.23 53.81 64.4

7

Life Insurance Corporationof India

5.81 10.40 2.57

Deutsche Bank Trustcompany Americans

28.52

FIIs/NRIs/OCBs/FB/FC/FN 41.21

Insurance Companies 1.74 5.05 7.50 10.75

Banks & FinancialInstitutions

7.17 3.05 0.29 1.30 1.56 10.29 0.70

Mutual Funds 4.45 2.73 1.80 11.50 2.77 6.36 5.66

Bodies Corporate 1.24 2.85 1.22 1.26 5.88

NRIs/OCBs 0.04 0.08 0.63

Resident Individuals/HUF /Trust etc.

5.84 5.77 13.68 6.16 7.34 4.72 7.22

Foreign Institutionalinvestors

14.00 18.52 19.77 15.1

0

DomesticCompanies//Trusts

3.22 0.76

NRIs/OCBs/FIIs/GDRs 19.5

9

20.07

Employees 0.24

Banks 0.19

HUF/ClearingMembers/Trusts

0.121

SUUTI 27.18

HSBC IRIS Investment 4.95

Orient Global Tamrind Ltd. 4.51

ICICI prudential LifeInsurance CompanyLimited

4.08

The Bank of New York 3.64

General InsuranceCorporation of India

2.28

Other Banks/InvestmentCompany

9.53

JP Morgan Chase Bank(Depository for ADS)

21.61

Housing DevelopmentFinance CorporationLimited

14.80

HDFC Investments Limited 8.46

DBS Bank Ltd 3.28

Bennett, Coleman & CoLtd

2.50

The Growth Fund ofAmerica

1.87

Euro Pacific Growth Fund 1.67

JP Morgan AssetManagement (Europe)

1.43

J P Morgan Advisors 1.12

Source: Annual Report Survey, 2007-08. Shareholding pattern of Standard Chartered Bank is not showing in

their annual report.

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Observation from table: The maximum stake in Public sector banks is kept by government

whereas private sector banks are predominantly controlled by foreign promoters.

Management and control of private sector banks is delegated to professional managers under

the governance of board controlled by the foreign promoters whereas all public sector banks

are managed by their banking board under the control of government of India. FIIs have

considerable shareholdings in both public as well as private sector banks. The insurance

companies also hold shares in both public and private sector banks.

Considering the report of Kumar Mangalam Committee on Corporate Governance, the

fundamental objective of corporate governance is the enhancement of shareholder value,

keeping in view the interests of other stakeholders, many managers manipulated the profits

of banks to show illusory profits of the banks and thereby enhance market value of shares.

However, the shareholding pattern of public sector bank justifies the views of Barth, Capiro

and Levine, (2000) and World Bank (2002) as they are under government patronage. The

possibilities of misgovernance cannot be ruled out in public sector banks compared to private

sector banks. The shareholding patterns of private sector banks are evenly allocated among

various groups of shareholders unlike public sector banks.

Key Governance Parameters & Compliance Status

There are some key governance parameters that can measure to ascertain the implementation

of corporate governance in banks. Some of them are discussed below:

Banks philosophy on Corporate Governance:

The philosophy of the Bank lies in its commitment to uphold some unique values that is

based on the Idea of a bond and togetherness among all interested parties, particularly a close

ties between the Bank and its many stakeholders-from customer and employees to its

investors, institutions and society at large. So, overall objective is to optimize sustainable

value to all stakeholders-depositors, Shareholders, customers, borrowers, employees and

society through adherence to corporate values, codes of conduct and other standards of

appropriate behavior. The studies of annual reports of all the banks show that all the banks

are committed to corporate governance.

Board of Directors

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Various aspects were analyzed from annual reports regarding board of directors viz., board

structure, board strength and size, directors attendance etc.

Table 3: Board Structure, strength and Size of Private and Public sector Banks in India

PUBLIC SECTOR BANK PRIVATE SECTOR BANK

Particulars SBI CanaraBank

AllahabadBank

BankofBaroda

BankOfIndia

PunjabNationalBank

corporate governance bank

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