DR.

RAM MANOHAR LOHIYA NATIONAL LAW

UNIVERSITY, LUCKNOW
2020-21

BANKING AND INSURANCE LAW

CONTEMPORARY ISSUES ON CORPORATE GOVERNANCE IN BANKING

SECTOR

SUBMITTED TO: - SUBMITTED BY:-

Dr. Aparna Singh Tanurag Ghosh
Asst. Professor of Law Enrolment no.- 180101147
RMLNLU Section B,B.A.LLB. (Hons)-2023

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 Table of Contents
Acknowledgement ............................................................................................................3
Introduction .....................................................................................................................4
Concept Background of Corporate Governance ................................................................5
Need of Corporate Governance in banking sector..............................................................7
Conflict of Interest: Compliance and its contribution to corporate governance in Banking
sector ...............................................................................................................................9
Suggestions for the proper implementation of Corporate Governance in Banking Sector in
developing economies .....................................................................................................11
Conclusion .....................................................................................................................12
Bibliography ..................................................................................................................13

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 Acknowledgement

First, I would like to thank Dr. Aparna Singh for giving me this opportunity to make the
project on such an interesting topic and all the support and guidance that I have received from
her without which, this project could not have turned into a reality. I would also like to thank
all my colleagues and seniors for providing me support, and material data related to this
topic. Last but not the least; I would like to thank my parents for providing me appropriate
guidance and support to prepare the project. All the aforementioned people whole-heartedly
helped me to compile this project in the present shape.

-Tanurag Ghosh

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 Introduction

The term “Corporate Governance” in the Banking sector has become an all-pervasive term in
the recent decade. Banking system plays a very important role in the economic life of the
nation. The health of the economy is closely related to the soundness of its banking system.
Banks figure out a decisive bonding between its financial system and overall financing needs
of all other sectors of business of the economy and hence the well-being of banking sector is
imperative.1
The Indian banking system is among the healthier performers in the world. In the liberalized
economic environment and integration of the country, in the world market the corporate sector
in India at present cannot ignore the importance of Corporate Governance2.Weakness in the
banking system can threaten financial stability both within the country and globally. The
considerable renovation of the Indian banking sector is palpable from the modernization taken
place in the financial markets, institutions and variety of financial products after globalization
of Indian economy. Sharing of resources at International level and the entry of international
new products has influenced the market to remain competitive globally. These circumstances
ensure Indian banks to cope up with the changing environment by establishing good corporate
governance practices only.3

1 Mitesh Dadhania & Sanjay Bhayani, Corporate Governance & Financial Performance: Comparative Study of

Indian Banking and I.T Firms, Gujarat Technological University Journal.(4)

2 Ankit katrodia, Corporate Governance Practices in Banking sector, Abhinav Journal of research in Commerce

and Management, Vol No.1, Issue No.4, (2)

3 Supra at 1, pp-3

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 Concept Background of Corporate Governance

The seeds of modern corporate governance were probably sown by the Watergate scandal in
the USA. Subsequent investigations by US regulatory and legislative bodies highlighted
control failures that had allowed several major corporations to make illegal political
contributions and bribe government officials. While these developments in the US stimulated
debate in the UK, a spate of scandals and collapses in that country in the late 1980s and early
1990s led shareholders and banks to worry about their investments. Several companies in UK
which saw explosive growth in earnings in the ’80s ended the decade in a memorably
disastrous manner. Importantly, such spectacular corporate failures arose primarily out of
poorly managed business practices.
This debate was driven partly by the subsequent enquiries into corporate governance (most
notably the Cadbury Report) and partly by extensive changes in corporate structure. In May
1991, the London Stock Exchange set up a Committee under the chairmanship of Sir Adrian
Cadbury to help raise the standards of corporate governance and the level of confidence in
financial reporting and auditing by setting out clearly what it sees as the respective
responsibilities of those involved and what it believes is expected of them. The Committee
investigated accountability of the Board of Directors to shareholders and to the society. It
submitted its report and the associated ‘code of best practices’ in December 1992 wherein it
spelt out the methods of governance needed to achieve a balance between the essential powers
of the Board of Directors and their proper accountability. Being a pioneering report on
corporate governance, it would perhaps be in order to make a brief reference to its
recommendations which are in the nature of guidelines relating to, among other things, the
Board of Directors and Reporting & Control.
The Cadbury Report stipulated that the Board of Directors should meet regularly, retain full
and effective control over the company and monitor the executive management. There should
be a clearly accepted division of responsibilities at the head of the company which will ensure
balance of power and authority so that no individual has unfettered powers of decision. The
Board should have a formal schedule of matters specifically reserved to it for decisions to
ensure that the direction and control of the company is firmly in its hands. There should also
be an agreed procedure for Directors in the furtherance of their duties to take independent
professional advice4.
OECD defined Corporate Governance as, “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.” In its most recent corporate governance report, the OECD
emphasized the important role that banking and financial supervision plays in developing
corporate-governance standards for financial institutions. Consequently, banking supervisors
have a strong interest in ensuring effective corporate governance at every banking organization.
Supervisory experience underscores the necessity of having appropriate levels of
accountability and managerial competence within each bank. Essentially, the effective
supervision of the international banking system requires sound governance structures within
each bank, especially with respect to multi-functional banks that operate on a transnational

4 Cadbury, Sir Adrian Committee on the Financial Aspects of Corporate Governance (1992)

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basis. A sound governance system can contribute to a collaborative working relationship
between bank supervisors and bank management5.
The Cadbury Report generated a lot of interest in India. The issue of corporate governance
was studied in depth and dealt with by the Confederation of Indian Industries (CII), Associated
Chamber of Commerce and Industry (ASSOCHAM) and Securities and Exchange Board of
India (SEBI). These studies reinforced the Cadbury Report’s focus on the crucial role of the
Board and the need for it to observe a Code of Best Practices. Co-operative banks as corporate
entities possess certain unique characteristics. Paradoxical as it may sound, evolution of co-
operatives in India as peoples’ organisations rather than business enterprises adopting
professional managerial systems has hindered growth of professionalism in co-operatives and
proved to be a neglected area in their evolution6.
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 recommendations made by the Committee
were accepted and implemented by SEBI in the year 2000.

5 Org. for Econ. Co-operation & Dev., Survey of Corporate Governance Developments in OECD Countries 12,
http://www.oecd.org/dataoecd/58/27/21755678.pdf (2002)
6 V. Leeladhar, Corporate Governance in Banks, pp-3

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 Need of Corporate Governance in banking sector

Banks figure out a decisive bonding between its financial system and overall financing needs
of all other corporate sectors and the whole of the country and hence the well being of banking
firms is imperative for any economy. The need for corporate governance in financial sector
cannot be ignored and especially in the banking sector because this is the sector which thrives
on trust the most7. Banks form the integral part of the economy of the country and any
discrepancy in the banking sector may have a direct bearing on the financial health of the
country. Banks help in channelizing the people’s savings8. Banks are also incorporated entities
just like any other organization so primary rules of corporate governance apply to banks but in
addition to these certain other features also apply for the corporate governance of banks.
Corporate governance helps in averting banking crisis; it helps in promoting sound financial
system. Governance in banks is a considerably more complex issue than in other sectors. Banks
will attempt to comply with the same codes of board governance as other companies but, in
addition, factors like risk management, capital adequacy and funding, internal control, and
compliance all have an impact on their matrix of governance. Governance is also a curiously
two-sided issue for banks since their funding and, often, ownership of other companies makes
them a significant stakeholder in their own right. The Board of Directors stands at the heart of
many systems and structures encompassing the totality of corporate governance.
Basel Committee has emphasized that banking supervision cannot function well if sound
corporate governance is not in place. It can be ensured by having appropriate levels of
accountability, and checks and balances within each bank. Sound corporate governance can
contribute to a collective working relationship between bank management and bank
supervisors. The Basel committee has further underscored the need for banks to set strategies
for their operations and establish accountability for executing these. In addition, transparency
of information related to accountability in that it gives market participants sufficient
information with which to judge the management of a bank 9. The guidance of Basel
committee refer to a management structure composed of a board of directors and senior
management. The committee recognises that there are significant differences in the legislative
and regulatory framework across countries as regards the functions of board of directors and
senior management. The notions of board of directors and senior management in the context
of a bank are taken to represent two decision making units10. The large number of
stakeholders (such as employees, customers, suppliers etc), whose economic well-being
depends on the health of the banking industry, depend on appropriate regulatory practices and
supervision. Indeed, in a healthy banking system, the supervisors and regulators themselves
are stakeholders acting on behalf of society at large. Their primary function is to develop
substantive standards and other risk management procedures for financial institutions in
which regulatory risk measures correspond to the overall economic and operational risk faced
by a bank. Accordingly, it is imperative that financial regulators ensure that banking and

7. The need for Corporate Governance in averting banking crises - Lessons from the Banco Latino Crisis-.Speech

delivered by Drs. Alberto G. Romero; Executive Director Bank van de Nederlandse Antillen at the KPMG
banking seminar in the Dominican Republic. (October 2, 2003)
8 Stiglitz J.E., “Reforming the Global Financial Structure: Lessons from Recent Crises” Journal of Finance Vol.

154, pp. 508-1522, (1999)

9 Basel Comm. on Banking Supervision, Enhancing Corporate Governance for Banking Organisations 5,

http://www.bis.org/publ./bcbs56.pdf (Sept. 1999).

10C.L Bansal, Taxmann’s Corporate Governance Law Practice & Procedure with case studies, Taxmann Allied

Services ltd., (2005) ,pp-520

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other financial institutions have strong governance structures, especially in light of the
pervasive changes in the nature and structure of both the banking industry and the regulation
which governs its activities 11.

11 Kern Alexander, Corporate Governance and Banking Regulation, Cambridge Endowment for Research in
Finance, (June 2004) pp-6

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 Conflict of Interest: Compliance and its contribution to corporate
governance in Banking sector

Much of the contemporary interest in corporate governance is concerned with mitigation of the
conflicts of interests between stakeholders. Ways of mitigating or preventing these conflicts of
interests include the processes, customs, policies, laws, and institutions which have an impact
on the way a company is controlled. An important theme of corporate governance is the nature
and extent of accountability of people in the business. In large firms where there is a separation
of ownership and management and no arises between upper management (the "agent") which
may have very different interests, and by definition considerably more information, than
shareholders (the "principals"). The danger arises that rather than overseeing management on
behalf of shareholders, the board of directors may become insulated from shareholders and
beholden to management12. Financial markets can be subject to inherent instability, induces
governments to intervene to provide depositor protection in some form or other. To control the
incentives of bank owners who rely too heavily on government funded deposit insurance,
governments typically enforce some control over bank owners. Adequate corporate governance
structures for banking institutions require internal control systems within banks to address the
inherent asymmetries of information and the potential market failure that may result. This form
of market failure suggests a role for government intervention13. And then arises the conflict of
interest because in the public sector banks this government intervention may be more and it
can affect the interests of the stakeholders.
Government ownership of banks is a common feature in many developing economies. The
reasons for such ownership may include solving the severe informational problems inherent in
developing financial systems, aiding the development process or supporting vested interests
and distributional cartels with a government-owned bank, the severity of the conflict between
depositors and managers very much depends upon the credibility of the government.
However, if the government is not credible and there is less political stability then the extensive
political intervention in the banking sector also arises conflict of interest and complicates the
issue of bank corporate governance14.
Other kinds of conflict on interests arise whenever the bank’s ability to act exclusively in the
best interest of the account beneficiaries or clients is impaired. It occurs whenever a person (as
agent), who is contractually bound to safeguard another party’s (as principal) interest, has
incompatible interests of his own or is oblige or willing to safeguard the conflicting interests
of another principal. The law should set out a clear standard by which agent’s behaviour is to
be judged and similarly these laws and regulations should be complied with to avoid conflict
of interest. The link between good corporate governance and compliance is very close. From a
banking industry perspective, corporate governance involves the manner in which the business
and affairs of banks are governed by their board of directors and senior management. This
affects not only how they set corporate objectives and operate the bank’s day-to-day business,
but ‘align corporate activities and behaviour with the expectation that banks will operate in a
safe and sound manner, and in compliance with applicable laws and regulations 15.

12 Supra at 16, pp-1.

13
Supra at 11, pp-8
14 Supra at 13,pp-11
15 Anne Peters & Lukas Handschin, Conflict of Interest in Global, Public and Corporate Governance,Cambridge

University Press,pp-256-57

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Banks should establish, implement and maintain an effective conflict of interest policy by
way of corporate governance which set out standards of expected behaviour, including,
amongst other matters, the treatment of any non-compliance with the policy. Personal and
business affairs of the directors or major stakeholders should be arranged so as to avoid the
conflict of interest.

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 Suggestions for the proper implementation of Corporate Governance in
Banking Sector in developing economies

This paper has argued that the special nature of banking institutions necessitates a broad view
of corporate governance where regulation of banking activities is required to protect depositors.
In developed economies, protection of depositors in a deregulated environment is typically
provided by a system of prudential regulation, but in developing economies such protection is
undermined by the lack of well-trained supervisors, inadequate disclosure requirements, the
cost of raising bank capital and the presence of distributional cartels.

In order to deal with these problems, developing economies need to adopt the following
measures. Firstly, liberalisation policies need to be gradual, and should be dependent upon
improvements in prudential regulation. Secondly, developing economies need to expend
resources enhancing the quality of their financial reporting systems, as well as the quantity and
quality of bank supervisors. Thirdly, given that bank capital plays such an important role in
prudential regulatory systems, it may be necessary to improve investor protection laws,
increase financial disclosure and impose fiduciary duties upon bank directors so that banks can
raise the equity capital required for regulatory purposes. A further reason as to why this policy
needs implemented is the growing recognition that the corporate governance of banks has an
important role to play in assisting supervisory institutions to perform their tasks, allowing
supervisors to have a working relationship with bank management, rather than adversarial
one16.
As mentioned that the corporate governance of banks in developing economies is severely
affected by political considerations. Firstly, given the trend towards privatisation of
government-owned banks in developing economies, there is a need for the managers of such
banks to be granted autonomy and be gradually introduced to the corporate governance
practices of the private sector prior to divestment. Secondly, where there has only been partial
divestment and governments have not relinquished any control to other shareholders, it may
prove very difficult to divest further ownership stakes unless corporate governance is
strengthened. Finally, given that limited entry of foreign banks may lead to increased
competition, which in turn encourages domestic banks to emulate the corporate governance
practices of their foreign competitors, developing economies would partially open up their
banking sector to foreign banks. If the entry of foreign banks is permitted, it may improve the
standards of corporate governance.

Banks usually account for lion share of financial system in most of the economies and this
dominance is overwhelming in case of the developing countries that are actually in greater need
of a sound financial system. Turbulence or failures of the banking sector would push these
countries’ economies to serious problems.17

16 Supra at 9.
17 Supra at 15, pp-4

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 Conclusion

It has been analysed that the strong corporate governance structure has a positive impact on
the performance of the banks. Financial crisis are not random events, but are set in motion by
the decisions of the individuals and institutions operating within a given framework of laws,
regulations etc., For each financial instrument that becomes a “weapon of mass financial
destruction” or creates an economy wide bubble, there is an underlying failure of incentives
among the executives of banks and other financial institutions, their owners and creditors,
and regulators.
Corporate governance has the potential to identify problem spots where incentives are
mismatched in a way that could lead to undesired firm behaviour or even system wide
instability. Corporate governance policies that mandate rather than motivate information
production and disclosure shall be more successful in governing of banking institutions. In
the years to come, the Indian financial system will grow not only in size but also in
complexity as the forces of competition gain further momentum and financial markets
acquire greater depth.
The growth of efficient corporate governance in banking sector, especially in a developing
economy like India, has been partly held back due to weak legal protection, poor disclosure
prerequisites and overriding owners. The real success of our financial sector reforms will
however depend primarily on the organizational effectiveness of the banks, including
cooperative banks, for which initiatives will have to come from the banks themselves.

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 Bibliography
1. Mitesh Dadhania & Sanjay Bhayani, Corporate Governance & Financial
Performance: Comparative Study of Indian Banking and I.T Firms, Gujarat
Technological University Journal.

2. Ankit katrodia, Corporate Governance Practices in Banking sector, Abhinav Journal

of research in Commerce and Management, Vol No.1, Issue No.4

3. Cadbury, Sir Adrian Committee on the Financial Aspects of Corporate Governance

(1992)

4. Org. for Econ. Co-operation & Dev., Survey of Corporate Governance Developments
in OECD Countries 12, http://www.oecd.org/dataoecd/58/27/21755678.pdf (2002)
5. The need for Corporate Governance in averting banking crises - Lessons from the
Banco Latino Crisis-.Speech delivered by Drs. Alberto G. Romero; Executive Director
Bank van de Nederlandse Antillen at the KPMG banking seminar in the Dominican
Republic. (October 2, 2003)

6. V. Leeladhar, Corporate Governance in Banks, pp-3

7. Stiglitz J.E., “Reforming the Global Financial Structure: Lessons from Recent Crises”
Journal of Finance Vol. 154, pp. 508-1522, (1999)
8. Basel Comm. on Banking Supervision, Enhancing Corporate Governance for Banking
Organisations 5, http://www.bis.org/publ./bcbs56.pdf (Sept. 1999).

9. C.L Bansal, Taxmann’s Corporate Governance Law Practice & Procedure with case
studies, Taxmann Allied Services ltd., (2005) ,

10. Kern Alexander, Corporate Governance and Banking Regulation, Cambridge

Endowment for Research in Finance, (June 2004)
11. T.G Arun and J.D Turner, Corporate Governance of banks in developing economies:
Concepts and Issues, Institute for Development Policy and Management, (2004), 371-
377

12. T.G Arun and J.D Turner ,Public Sector Banks in India: Rationale and Prerequisites
for Reform, Annals of Public and Cooperative Economics, Vol.73, No.1.,(2002a)

13. Regulation, corporate Governance and the Banking Sector- A Political Economy
perspective from Bangladesh,

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 14. Rajat Deb,Corporate Governance Practices in Indian Banks, Journal of Business
Management & Social Sciences Research, Vol.2,No.5, (2003), pp-7

15. .V Reddy, Banking Corporate Governance in banks in India.

16. Address by Mr Anand Sinha, Deputy Governor of the Reserve Bank of India,
delivered on his behalf, at the L & T Management Development Centre, Lonavla, (19
March 2013),pp-2.

17. Kshama V Kaushik & Rewa P Kamboj, Study on the state of Corporate Governance in
India.
Anne Peters & Lukas Handschin, Conflict of Interest in Global, Public and Corporate
Governance,Cambridge University Press,.

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