“Corporate Governance and Bank Performance in the Indian Banking Sector”

A PROJECT STUDY SUBMITTED IN PARTIAL FULFILLMENT

FOR THE REQUIREMENT OF THE

TWO YEAR (FULL‐TIME)

POST‐GRADUATE DIPLOMA IN MANAGEMENT

(2019 – 21)

BY

Priyanka Tejwani

095 / 2019

UNDER THE GUIDANCE OF

DR. Vishakha Bansal

LAL BAHADUR SHASTRI INSTITUTE OF MANAGEMENT, DELHI

March 2021
 LAL BAHADUR SHASTRI INSTITUTE OF MANAGEMENT, DELHI

CERTIFICATE

This is to certify that the present study on “Corporate Governance And Bank
Performance in The Indian Banking Sector” is based on my original research work
and my indebtedness to others’ works, publications, etc. Wherever cited in this study
report has been duly acknowledged at appropriate places. This work has not been
submitted either in part or in full for the award of any diploma or degree in any other
university/Institute, and is now being submitted for evaluation in partial fulfilment
for the requirement of the Two-year Full Time Post-Graduate Diploma in
Management .

_____________________________ Signature of the Student

(Priyanka Tejwani 095/2019)

The student consulted / did not consult (strike off whichever is not applicable) me
while doing this Final Research Project.

Faculty Guide: Dr. Vishakha Bansal

 Acknowledgement
I am extremely grateful to LBSIM, Delhi for providing me this opportunity to
complete a research project on “Corporate Governance And Bank Performance in
The Indian Banking Sector”. The fulfilment of this project has helped me gain
invaluable knowledge. Institute has provided me the best state of the art
infrastructure and resources to enable me to complete and enrich my project.
It has always been desiring of every management student to get an opportunity to
pursue a research project and show his skill in taking an independent research on his
own. This project has provided me a good start to get in touch with the practical
aspects of working in a professional setup.
I would like to express my gratitude towards my mentor Dr. Vishakha Bansal for
giving me unconditional support and opportunity to enhance my skill in the field of
my project. Her comments and suggestions regarding this study have been very
valuable in completing this project. In the end, I am also grateful to my family and
friends for their constant support and guidance.
 Table of Contents
S.No. Particular

1. Introduction

2. Corporate Governance

3. Bank Performance

4. Literature Review

5. Hypothesis

6. Data and Methodology

7. Analysis and Results

8. Conclusion

9. Bibliography
 Introduction
With the ongoing transition of Indian Economy, the economy is going through an
overall change. The financial sector, especially the banking sector, is the most
emerging sector and is passing through a lot of change. In the midst of the economic
maelstrom, India stands out as a relative oasis of stability. Prudent regulatory
oversight from RBI over the last decade has successfully steered Indian banks
towards robust health and performance.

Productivity excellence, however, is not merely an opportunity for higher value

creation, but it is an obligation for Indian banks. Global banking crisis has
highlighted the criticality of banks behaving responsibly; aligning to priorities of the
real economy. For India to achieve its vision of rapid and inclusive growth, Indian
banks have an obligation to serve the vast number of unbanked masses, under–
banked farmers, and MSMEs. In order to do so at low cost and reasonable margins
banks have to push the frontier on every dimension of productivity. Productivity
increase can counter the short term pressures on profitability from rising interest
rates, rising bad debts, and imminent savings bank rate deregulation.

Whilst the industry, on an average, has an impressive bad debt performance, the bad
debt levels in priority sectors of MSME and agriculture are high. NPA management
processes at banks need major overhaul. Speed of response to default and speed of
foreclosure are found to be slower than required. Some banks have alarmingly high
NPA levels in relatively safe products like home loans.

The issues relating to Corporate Governance turns out to be progressively basic if

there should arise an occurrence of the banks as the controlling intensity of the banks
connect with the Government. Revelation and straightforwardness are the key
mainstays of a corporate administration system in the financial area. Because of the
quickly changing financial condition, Indian banks must keep on actualizing solid
corporate administration rehearses.
Corporate Governance
Corporate governance is a system of rules, policies, and practices that dictate how a
company’s board of directors manages and oversees the operations of a company. It
oversees whether the top management is in accordance with the company’s benefit
and not misusing its power. Good governance is one which is accountable,
transparent, responsive, equitable and inclusive, effective and efficient,
participatory and which is consensus oriented and which follows the rule of law.
Governance is required in every level of management specially for the decision
makers as it can affect the other stakeholders of the company. Decision of
stakeholders can affect the decision of lower management and can hamper the
overall bank performance; any decision taken by the board of director of the
company have a direct relation on its bank performance.
Separation of ownership and management is essential in every company but we need
to make sure that their goals are in alignment with each other. The main criteria for
corporate governance is transparency, accountability and responsibility.
Corporate governance for a company may differ from governance in banks due to
interference of regulatory bodies like RBI. In India, the Reserve Bank of India (“RBI”)
is the gatekeeper of Corporate Governance. RBI is the central bank of India which
regulates all the major issues related to currency, foreign exchange reserves etc. In
short, RBI is the bank responsible for securing the monetary stability in India
The preamble of the Reserve Bank of India Act, 1934 says, “An Act to constitute a
Reserve Bank of India. Whereas it is expedient to constitute a Reserve Bank for India
to regulate the issue of Bank notes and the keeping of reserves with a view to
securing monetary stability in 2[India] and generally to operate the currency any
credit system of the country to its advantage; And whereas in the present
disorganisation of the monetary systems of the world it is not possible to determine
what will be suitable as a permanent basis for the Indian monetary system; But
whereas it is expedient to make temporary provision on the basis of the existing
monetary system, and to leave the question of the monetary standard best suited to
India to be considered when the international monetary position has become
sufficiently clear and stable to make it possible to frame permanent measures…”
There is no one who could deny the fact banks are pivotal to the economic stability
of any economy. In case a bank crashes then it does not crash alone, it also takes
away the lifelong investment and savings of its entire account holders too. This is
not the only reason due to which corporate governance in the banking sector is
needed. Corporate Governance is also needed for the bank to keep a check on money
laundering, financing immoral and criminal acts and transaction of money to the
terrorists.
The corporate governance mechanism as followed by Reserve Bank of India is
predicated on three categories for governing the banks. They are: (i) Disclosure and
transparency, (ii) Off-site surveillance, (iii) Prompt Corrective Action.

1. Disclosure and transparency: Disclosure and transparency are the foremost

important constituent of corporate governance. If the banks won't be disclosing their
transactions to the RBI then they will operate at their whims and fancies and should
vanish with the lifelong investments and savings of the people. The RBI through the
need of routine reporting of monetary transactions of the bank keeps a tab on the
activities being undertaken by the banks in India. Any failure to abide by the wants
began by RBI may cause heavy fines being imposed along side the cancellation of
the license to work as a bank.

2. Off-site surveillance: RBI routinely perform an annual on-site inspection of the

records of the banks but in order to promote governance in banking sector RBI in
the year 1995, off-site surveillance function was initiated in 1995 for domestic
operations of banks. The main focus of the off-site surveillance is to watch the
financial health of banks between two on-site inspections, identifying banks which
show financial deterioration and would be a source for supervisory concerns. The
off-site surveillance prepares RBI to require timely remedial action before things get
out of control. During December 1995 the primary tranche of off-site returns was
introduced with five quarterly returns for all commercial banks operating in India
and two half yearly returns one each on connected and related lending and profile of
ownership, control and management of domestic banks. The second tranche of 4
quarterly returns for monitoring asset-liability management covering liquidity and
rate of interest risk for domestic currency and foreign currencies were introduced
since June 1999. The Reserve Bank intends to scale back this periodicity with effect
from April 1,2000.

3. Prompt Corrective Action: RBI while promoting corporate governance in banks

in India has RBI has set trigger points on the idea of CRAR, NPA and ROA. On the
idea of trigger points set by RBI, the banks need to follow ‘structured action plan
also called mandatory action plan’. Beside mandatory action plan RBI has
discretionary action plans too. The main reason for classifying the rule-based action
points into Mandatory and Discretionary is that a number of the actions are essential
to revive the financial health of banks must be mandatorily taken by the bank while
other actions are going to be taken at the discretion of RBI depending upon the
profile of every bank.

The special nature of banking institutions necessitates a broad view of corporate

governance where regulation of banking activities is required to guard depositors.
Corporate governance within the banking sector isn't just a formality but a dire need
of society. In almost every country within the world, there's a watchdog like RBI
which monitors all the transactions and activities undertaken by the banks and
regulate the business of the bank by making them submit regular reports associated
with the business undertaken by them.

However, an excessive amount of pressure on the banks must not be imposed on the
banks within the name of corporate governance such a lot in order that they feel
harassed within the name of governance and their efficiency suffers leading to a
slowdown of financial transactions. Additionally, internal governance must be
increased which must be formulated during a way that the efficiency of banks isn't.

Bank Performance
There are many ways to check performance of any bank. Many banks use ratios to
compare their performance. Some of these ratio are : ROA , ROE , liquidity ratios,
LDR (Loan deposit Ratio) , Capital Adequacy Ratio, etc. Return on Assets and
Return on equity are profitability ratios as it measures the company’s return on
investment in a format that is easily comparable with other institutions. ROA is a
ratio of net income produced by total assets during a period of time. In other words,
it measures how efficiently a company can manage its assets to produce profits.
Whereas Return on equity is calculated by taking the amount of net income returned
as a percentage of the shareholders equity. Return on Equity looks at how well a
bank’s (or company’s) management is using its assets to create profits.
The capital adequacy ratio (CAR) is a measurement of a bank's available capital
expressed as a percentage of a bank's risk-weighted credit exposures. The capital
adequacy ratio, also known as capital-to-risk weighted assets ratio (CRAR), is used
to protect depositors and promote the stability and efficiency of financial systems
around the world. Two types of capital are measured: tier-1 capital, which can
absorb losses without a bank being required to cease trading, and tier-2 capital,
which can absorb losses in the event of a winding-up and so provides a lesser degree
of protection to depositors.
As of 2020, under Basel III, a bank's tier 1 and tier 2 minimum capital adequacy
ratio (including the capital conservation buffer) must be at least 10.5% of its risk-
weighted assets. That combines the total capital requirement of 8% with the 2.5%
capital conservation buffer.
The loan-to-deposit ratio (LDR) is used to assess a bank's liquidity by comparing a
bank's total loans to its total deposits for the same period. The LDR is expressed as
a percentage. If the ratio is too high, it means that the bank may not have enough
liquidity to cover any unforeseen fund requirements. Conversely, if the ratio is too
low, the bank may not be earning as much as it could be.
 Literature Review

1. Corporate Governance in Indian Banking Sector – Ram Singh and Rohit

Bansal (Feb 2020)

The research paper talks about the corporate administration as the board framework
in banks, its need in the financial area. The productive Corporate Governance
rehearses give increase in comes back to financial specialists by bringing down cost
of capital, by diminishing the hazard and the banks assume a critical job in the
progression of capital, this is a basic constituent of any economy.
2. Risk Management in Banking Sector -an empirical study- Thirupathi
Kanchu; M. Manoj Kumar

Risk Management is the application of proactive strategy to plan, lead, organize, and
control the wide variety of risks that are rushed into the fabric of an organization’s
daily and long-term functioning. . The research paper makes an attempt to identify
the risks faced by the banking industry and the process of risk management
3. Corporate Governance and impact on Bank Performance- Ashenafi Fanta ,
January 2013

The study assessed the relationship between selected internal and external corporate
governance mechanisms, and bank performance as measured by ROE and ROA. The
findings indicated that board size and existence of audit committee in the board had
statistically significant negative effect on bank performance; whereas bank size had
statistically significant positive effect on bank performance.
4. The Effect Of Corporate Governance On Bank Financial Performance:
Evidence From The Arabian Peninsula- Mohamed A. Basuony, Ehab K. A.
Mohamed, Ahmed M Al-Baidhani

This paper investigates the effect of internal corporate governance mechanisms and
control variables, such as bank size and bank age on bank financial performance. It
showed that the correlation between corporate governance and firm performance is
still not clearly established and that impact of corporate governance on bank
financial performance in developing countries is still relatively limited.
Research Hypothesis:
H1: There is positive relationship between Board size and bank performance.
H2: There is positive relationship between existence of audit committee in the board
and bank performance.
H3: There is positive relationship between external corporate governance
mechanisms as measured by CAR and bank performance.
H4: There is negative relationship between loan to deposit ratio and bank
performance.

Data and Methodology:

1. Data Collection
Data for this research paper is mainly vollected from annual report of banks. In this
paper, we have taken 10 public sector bank s and 15 private sector banks in India.
For corporate governance , we have also checked whether RBI guidelines and Basel
Norms are followed by every bank or not. Consequently, this study uses panel data
of 25 banks ( 10 public and 15 private banks) of last 5 years i.e. from 2016 to 2020
(125 observations).
2. Methodology
A quantitative method of data analysis was employed which involved descriptive
and inferential statistical analysis and multivariate regression analysis. The
descriptive statistics were used to analyze the means and standard deviations of
regression variables.
Public Sector banks which were used for this study:
• Union Bank of India • Bank of India

• State Bank Of India • Indian Bank

• Punjab National Bnak • Central Bank of India

• Bank Of Baroda • Indian Overseas Bank

• Canara Bank • UCO Bank

Private sector banks which were used for this study:

• IDBI Bank • ICICI Bank

• IDFC First Bank • IndusInd Bank

• Axis Bank • Kotak Mahindra Bank

• Bandhan Bank • YES Bank
• HDFC Bank • RBL Bank

• CSB Bank • Dhanlaxmi Bank

• City Union Bank • Federal Bank
• Dcb Bank

Panel Data is collected for 25 banks for 5 year consisting ROA, ROE, CAR , LDR ,
Bank size (log of total assets of bank) and Net NPA.

Public Banks ROE ROA CAR LDR Bank Size Net NPA
State Bank Of India 3.51 0.2 13 76.88 6.501183728 3.846
Punjab National Bnak -12.84 -0.65 11.2 69.714 5.874948806 8.068
Bank Of Baroda -2.778 -0.17 13.038 69.464 5.896505266 4.292
Canara BANK -5.384 -0.25 12.542 70.05 5.800091412 5.644
Union Bank Of India -6.7 -0.346 11.688 74.17 5.677099481 6.468
Bank of India -13.676 -0.71 12.876 67.988 5.796136327 6.498
Indian Bank 5.77 0.364 13.344 73.548 5.397688311 3.826
Central Bank of India -17.474 -0.952 10.346 55.372 5.518577506 8.726
Indian Overseas Bank -34.884 -1.946 10.068 64.178 5.407993944 11.45
UCO Bank -32.37 -1.376 10.78 57.998 5.364631712 9.09
Private Banks ROE ROA CAR LDR Bank Size Net NPA
Axis Bank 6.28 0.59 16.036 91.972 5.84756695 2.112
Bandhan Bank 16.98 2.966 29.462 92.644 4.62735835 0.432
CSB Bank -9.71 -0.532 14.354 62.266 4.22181935 3.636
City Union BANK 13.19 1.354 15.988 81.106 4.59920473 2.058
DCB Bank 10.586 0.884 15.764 83.864 4.45642622 1.032
Dhanlaxmi Bank -6.244 -0.232 11.96 58.872 4.0873267 2.51
Federal Bank 8.472 0.7 13.902 77.778 5.12735904 1.462
HDFC Bank 15.818 1.69 16.106 85.488 6.03341567 0.072
ICICI Bank 7.622 0.886 17.09 94.75 6.04799921 3.366
IndusInd Bank 13.61 1.492 15.008 94.652 5.33503235 0.624
KOTAK Mahindra Bank 11.136 1.48 17.334 87.344 5.41792693 0.942
Yes Bank -3.854 -0.298 15.38 100.364 5.40751313 1.806
RBL Bank 9.164 0.86 14.38 90 4.78516154 1.21
IDFC First Bank -2.674 -0.174 17.558 222.15 5.08360365 1.388
IDBI -38.68 -2.748 11.534 71.116 5.53175286 10.238
 Data Analysis and Results
1. Descriptive Statistics

PUBLIC BANKS PRIVATE BANKS TOTAL

Mean Standard Deviation Mean Standard Deviation Mean Standard Deviation
ROE -11.6826 13.68017999 3.4464 14.29373268 -2.6052 15.70296798
ROA -0.5836 0.706392903 0.594533 1.302540697 0.12328 1.234427651
CAR 11.8882 1.225380286 16.12373 4.086823137 14.42952 3.845897133
LDR 67.9362 6.920667177 92.95773 37.68589298 82.94912 31.66931671
Bank Size 5.723486 0.341147058 5.107298 0.629656351 5.353773 0.608142543
Net NPA 6.7908 2.529419644 2.192533 2.443334427 4.03184 3.341808239

The descriptive statistics indicates that private banks have mean CAR of 16%,
compared to 11% for state-owned banks, implying that private banks tend to be a bit
more cautious about capital adequacy. The average CAR for entire banking sector is
14%, which is above the minimum CAR of 8% required by Basel Accord.
State-owned banks have mean loan to deposit ratio (LDR) of 67%, compared to 92%
for private banks, signifying a higher degree of reliance of private banks on the
depositors fund to make loan.
Bank size shows that state-owned banks have larger mean total assets than private
banks , which is partly due to the fact that the largest bank in the sample is a state-
owned bank.
The mean ROE of private banks is 3.44 is better as compared to public banks i.e. -
11.68. Return on Assets predicts the financial performance of bank which is better
for private bank if we consider the data for last 5 years.
Variables
In this research paper, we have taken several variables to check the relation between
Corporate governance and Bank performance.
Dependent Variables: We have taken 2 dependent variables to measure the bank
performance i.e. Return on Assets and Return on Equity. For regression analysis, we
have taken data of 10 public and 10 private banks.
Independent variables: We have taken several independent variables like board size,
no. of Independent Director, Bank Size, presence of Audit Committee, Ownership
type ( state owned bank or private bank) and Loan Deposit Ratio.
We have used Linear Regression Model on SPSS for our analysis.
1. Return on Assets as Dependent Variable
2. Return on Equity as Dependent Variable
The regression output reveals that the dependent variable is well explained by the
explanatory variables in the model with R Square of 0.605 (ROA as dependent
variable) and 0.750 (ROE as dependent variable). The adjusted R square is 0.579
and 0.734.
From table 2, we can see that board size and ownership type have a significant
impact on bank performance.
From table 4, we can notice that capital adequacy ratio, loan to deposit ratio and
ownership type have a significant impact on bank performance.
 Conclusion
In India, we have recently seen many cases of poor corporate governance which
ultimately hampers the bank performance and leads to increase in net NPA. Our
study was also focused on how the structure of board of directors can affect daily
working of the bank. Ownership type plays a significant role in this. Bank
performance also depends on the type of ownership. If we look at the descriptive
statistics, private bank performs better in terms of ROA and ROE than public
banks.
According to Basel norms, it is mandatory for every bank to maintain capital
adequacy ratio 8%. CAR as a proxy of external corporate governance has positive
relationship with bank performance indicating that better corporate governance
leads to better bank performance. Similarly, size of board of directors in the board
has adverse impact on the profitability of the bank while loan to deposit ratio
show a significant impact on profitability of bank.
We have seen various mergers and acquisitions in the banking sector to overcome
the problem of corporate governance. Government and RBI has also tighten the
regulation policy for private and public banks.
In further research, we can also take other factors in consideration while assessing
corporate governance like perspective of different stakeholder and how it can
impact bank’s performance.
 Bibliography
1. Annual Report of every bank
2. WWW.Screener.com
3. WWW.RBI.ORG.IN
4. Research Papers
• Rogers, M 2008, ‘Corporate governance and financial performance of
selected commercial banks in Uganda’, Paper presented at CRRC 2008,
Queen's University, Belfast 7-9 September 2008.

• Al-Hawary, S 2011, ‘The Effect of banks governance on banking

performance of the Jordanian commercial banks Tobin’s q model’
International Research Journal of Finance and Economics.

• Investment opportunity set, corporate governance practices and firm

performance- Marion Hutchinson