Anupama Nair
www.mediaeyenews.com
India has a bank-based financial system and banks form the backbone of the financial system. While banks finance firms, they themselves need to be financed and have to attract investors. Given the predominance of banks and the significance of good corporate governance practices in enhancing the credibility of institutions, it is relevant to study corporate governance in banks in India. Against this backdrop, this study aims to analyze corporate governance in the major public sector banks (PSBs) and private sector banks (PVBs) in our nation. The analysis is based on the computation of a benchmark index and the calculation of a corporate governance index on the basis of this benchmark index.
India had a fairly well-developed commercial banking system prevalent in the time of independence in 1947. The Reserve Bank of India (RBI) was established in 1935 and while the RBI became a state-owned institution from January 1, 1949, the Banking Regulation Act was enacted in 1949 providing a framework for regulation and supervision of commercial banking activity. The first step towards the nationalization of commercial banks was the result of a report under the aegis of RBI by the Committee of Direction of All India Rural Credit Survey (1951) which till today is the locus classicus (a passage considered to be the best known or most authoritative on a particular subject). The Committee recommended one strong integrated state sponsored commercial banking institution to stimulate banking development in general and rural credit in particular. Thus, the Imperial Bank was taken over by the Government and was renamed as the State Bank of India (SBI) on July 1, 1955 with the RBI acquiring overriding substantial holding of shares. A number of erstwhile banks owned by erstwhile Princely States were made subsidiaries of SBI in 1959.
There was a feeling that though the Indian banking system had made considerable progress two decades after independence, it established close links between commercial and industry houses, resulting in cornering of bank credit by the segments to the exclusion of agriculture and small industries. To meet these concerns, in 1967, the Government introduced the concept of social control in the banking industry. The scheme of social control was aimed at bringing some changes in the management and distribution of credit by the commercial banks. The close link between big business houses and big banks was intended to be snapped or at least made ineffective by the reconstitution of the Board of Directors to the effect that 51 per cent of the directors were to have special knowledge or practical experience of running a bank.
The appointment of whole-time Chairman with special knowledge and practical experience in working of commercial banks or financial / economic or business administration was intended to professionalize the top management. Imposition of restrictions on loans to be granted to the directors’ concerns was another step towards avoiding undesirable flow of credit to the units in which the directors were interested. Political compulsion then partially attributed to inadequacies of the social control, led to the Government of India nationalizing in 1969 — 14 major scheduled commercial banks which had deposits above a cut-off size. The objective was to serve better the needs of development of the economy in conformity with national priorities and objectives. In a repeat of the same experience, eleven years after nationalization, the Government announced the nationalization of six more scheduled commercial banks above the cut-off size. The second round of nationalization gave an impression that if a private sector bank grew to the cut-off size it would be under the threat of nationalization.
The regulatory framework for the banking industry under the Banking Regulation Act was restricted by the special provisions of the Bank Nationalization Act which had elements of corporate governance incorporated with regard to composition of Board of Directors in terms of representation of directors. While technically there was competition between banks and non-banking systems, substantively competition was conditioned by policy as well as regulatory environment, common ownership by the Government and agreement between the Government of India as an owner and the workers represented by the Unions.
The events during liberalization in terms of hesitancy in permitting industrial houses as well as foreign owned banks should be viewed in this historical context. If the policy environment was considered, it must be recognized that almost the whole of financial intermediation was on account of public sector, with PSBs being the most important source of mobilization of financial savings. Banks, mainly public sector banks became the most dominant vehicle of the financial intermediation in the country.
“To a large extent, entry was restricted and exit was impossible and there was little or no scope for functions of risk assessment and pricing of risks”. The Government, thus combined in itself the role of owner, regulator and sovereign. The legal as well as policy framework emphasized co-ordination in the interest of national development as per Plan priorities with the result, the issue of corporate governance became subsumed in the overall development framework. Each bank, even after nationalization, maintained its distinct identity, governance structure as incorporated in the concerned legislations provided for a formal structure of relationship between the RBI, Government, Board of Directors and management.
The role of the RBI as a regulator became essentially, one of being an extended arm of the Government so far as highest priority was accorded to ensuring co-ordinated actions in regard to activities particularly of PSBs. The SBI, which was owned by the RBI, was in substance no different from the other banks owned by the Government in terms of Board composition, appointment procedures of the executives and non-executive members of the Board of Directors. Both Government and RBI were represented on the Board of Directors of the PSBs. There has been significant cross representation in terms of owner or lender and in other relationships between banks and all other major financial entities. In other words, cross holdings and inter-relationships were more a rule than an exception in the financial sector, since the basic objective was coordination for ensuring planned development, with the result, the concepts of conflicts of interests among players, checks and balances etc., were subordinated to the social goals of the joint family headed by the Government.
The measures taken so far can be summarized as follows — Firstly, greater competition had been permeated in the banking system by permitting entry of private sector banks, and liberal licensing of more branches by foreign banks and the entry of new foreign banks. With the development of a multi-institutional structure in the financial sector, emphasis is now on efficiency through competition irrespective of ownership. Since non-banking intermediation has increased, banks have had to improve efficiency to ensure survival. Secondly, the reforms accorded greater flexibility to the banking system to manage both the pricing and quantity of resources. There has been a reduction in statutory pre-emptions to less than a third of commercial banks resources. The mandatory component of market financing of Government borrowing has decreased.
“Thirdly, the RBI has moved away from micro-regulation to macro-management”. RBI has replaced detailed individual guidelines with general guidelines and now leaves it to individual boards of each bank to set their guidelines on credit decisions. A Regulation Review Authority was established in RBI, whereby any bank could challenge the need for any regulation or guideline and the department had to justify the need and usefulness for such guideline relative to costs of regulation and compliance. Fourthly, to strengthen the banking system to cope up with the changing environment, prudential standards have been imposed in a progressive manner.
As banks have greater freedom to take credit decisions, prudential norms setting out capital adequacy norms, asset classification, income recognition, and provisioning rules, exposure norms, and asset liability management systems have helped to identify and contain risks, thereby contributing to greater financial stability. Then, an appropriate legal, institutional, technological and regulatory framework has been put in place for the development of financial markets. There is now increased volumes and transparency in the primary and secondary markets. Development of the Government Securities, money and forex markets has improved the transmission mechanism of monetary policy, facilitated the development of a yield curve and enabled greater integration of markets. The interest rate channel of monetary policy transmission is acquiring greater importance as compared with the credit channel. Regulatory environment prudential regulation and supervision have formed a critical component of the financial sect.
India had experimented with Self-Regulatory Organizations (SROs) in the financial system since the pre-independence days. At present, there are four SROs in the financial system – Indian Banks Association (IBA), Foreign Exchange Dealers Association of India (FEDAI), Primary Dealers Association of India (PDAI) and Fixed Income Money Market Dealers Association of India (FIMMDAI).
