Banking Governance

Banking Governance is essentially Corporate Governance applied to banks. It involves the selection, motivation, and accountability of managers and shareholders in the banking sector. Banks differ from non-financial firms in terms of financing, business models, and balance sheets.

Unique Aspects of Banking Governance

• Complexity of Banks: Banks are intricate in their operations, making governance essential for effective management.
• Unique Balance Sheets: Bank balance sheets are distinct, requiring specialized governance practices.
• Depositor Protection: Banks must prioritize the protection of depositor data and assets.
• Risk of Bank Failures: Banking Governance aims to minimize the risk of bank failures and ensure financial stability.

Corporate Governance in the Banking Sector

Corporate Governance in banking involves the mechanisms for selecting, motivating, and holding accountable managers and shareholders. Banks operate differently from non-financial firms, necessitating specific governance practices.

Role of the Reserve Bank of India (RBI)

The Reserve Bank of India (RBI) governs the Indian banking sector. It regulates currency, foreign exchange reserves, and banking activities. RBI has issued specific guidelines for corporate governance in banks, emphasizing its importance for the development of the banking industry.

Banking Governance is crucial for the effective functioning and stability of the banking sector. It ensures the protection of depositors, minimizes the risk of bank failures, and promotes the overall development of banking activities.

Evolution of Corporate Governance in the Banking Sector in India

The banking industry, one of the oldest globally, has undergone significant evolution since its inception in 2000 B.C. It began with merchants lending money to farmers and has since transformed from simple barter systems to complex, globalized, technology-driven e-banking models.

Banking’s Historical Journey

Banking traces its roots back to medieval and early Renaissance Italy, particularly in affluent northern cities like Florence, Venice, and Genoa. Innovations flourished in Europe, with notable advancements occurring in Amsterdam during the Dutch Republic in the 16th century and later in London in the 17th century.

Banking in the 20th Century and Beyond

The 20th century brought various challenges and changes to the banking sector. Advancements in telecommunications and computing revolutionized banking operations. However, the industry also faced several crises, including:

• The Great Depression (1930s - 1960s)
• Deregulation and Globalization (1970s - 2000s)
• Late-2000’s Financial Crisis

Corporate Governance Reforms in Banking

Before banking reforms, there were limited guidelines for corporate governance in banks. Public sector banks dominated the industry, while private sector banks were relatively few. However, various reforms over time helped banking governance flourish. Key reforms include:

• 1991 Reforms: The banking sector underwent a significant transformation with the entry of private sector banks. This led to a decline in the shareholdings of public sector banks.

• Liberalization: Liberalization paved the way for foreign banks to enter the industry, increasing competition among banks. This drove banks to enhance customer facilities, benefits, and governance structures.

• Involvement of Institutional and Retail Shareholders: The involvement of institutional and retail shareholders further strengthened corporate governance in banks.

• East Asian Crisis: The East Asian Crisis played a crucial role in reshaping corporate governance. Several institutions emerged to promote the development of corporate governance.

• OECD and Basel Committee Principles: The Organisation for Economic Co-operation and Development (OECD) formulated corporate governance principles in 1999 (revised in 2004). The Basel Committee also established governance principles for banks known as Basel III Norms.

• Reserve Bank of India (RBI) Initiatives: The Reserve Bank of India (RBI) took steps to further enhance corporate governance principles in the Indian banking sector, aiming to meet international standards.

In summary, the evolution of corporate governance in the banking sector in India has been a journey of transformation, driven by technological advancements, globalization, and the need for sound governance practices to ensure the stability and growth of the banking industry.

Corporate Governance in India

On August 21, 2002, the Ministry of Finance and Company Affairs (the Department of Company Affairs) established an institution to address corporate governance issues in India.

How are Banks Different?

Banks differ from other companies or firms in several ways when it comes to governance issues and mechanisms. Here are three key aspects:

1. High Leverage: Banks rely heavily on leverage, converting short-term deposits into long-term loans. They raise most of their funds through debt, either long-term or short-term, which adds up to their deposits.

2. Systemic Importance: Banks play a crucial role in the economy. Their failure can have a significant impact on society, potentially triggering disruptions in business and financial activities and harming small businesses that rely on them for funding.

3. Unique Financial Assets: Certain types of financial assets are more challenging for banks to raise and observe compared to other firms.

Working of the Banking Governance

• Firstly, banks are high gripped institutions: The shareholders may gain at creditors expenses an increase at risk and related returns.
• If the above works positively, the shareholders receive high returns and in case things go wrong, the creditor pays the price.
• The deeper involvement of the board for great strategies for resolving issues and monitoring working with ease. The risks which banks might face are to be dealt with utmost precision. That’s why the balance of skills at the board level and the expertise of the members are regulated by supervisors. This detailed guidance on the internal control functions of the so-called “Second and third line of defense ” i.e. risk management, compliance, and internal audit, which are becoming mandatory for banks in an increasing number of jurisdictions and strict disclosure requirements.
• The way that banks fund their operations means that their corporate governance needs to provide protection to a much broader pool of stakeholders, particularly depositors who do not usually have the possibility to influence the banks’ business decisions.
• The good corporate governance of banks is particularly important because banks are the most significant (and in some cases, only) providers of credit. Difficulties in their operations could disrupt the entire economy. At the same time, this situation puts banks in a unique position to influence governance practices.

Corporate Governance in the Banking Sector

Corporate governance plays a crucial role in the growth of the economy and the banking and corporate sectors. It ensures that resources are utilized efficiently and directed towards sectors that meet stakeholder demands. Corporate governance provides a framework for boards of directors to effectively manage resources and minimize wastage.

Basel Committee on Corporate Governance

Recognizing the diversity in corporate governance mechanisms globally, the Basel Committee was established in 1999 (initially formed in 1997 and 1998) to address this issue. The committee outlined four key elements that should be included in the organizational structure of any bank for proper functioning:

1. Surveillance by Board of Directors and Supervisory Board: Clear assignment of responsibilities and decision-making authorities, with a hierarchy of required approvals from individuals to the board of directors.

2. Direct Business Line Supervision: Well-defined corporate strategy against which the success of the enterprise and individual contributions are measured.

3. Surveillance by Independent Parties: Monitoring of risk exposures where conflicts of interest may arise, including business relationships with affiliated borrowers, large shareholders, senior management, or key decision-makers within the bank.

4. Independent Risk Management and Audit Functions: Establishment of a mechanism for interaction and cooperation among the board of directors, senior management, and auditors.

The committee also emphasizes the importance of personnel being fit and proper for their roles, ensuring the flow of information both internally and to the general public. Appropriate financial and managerial incentives are offered to senior management, product line management, and employees to encourage responsible behavior.

Application of Governance in the Banking Sector

During 2010-2012, several policy dialogue activities were undertaken to further improve the corporate governance of banks. This included launching a comparative assessment of the corporate governance of banks in various countries. The Reserve Bank of India (RBI) has set norms that both private and public banks must adhere to. For public sector banks, suggestions are made to the government for consideration, leading to significant changes in the banking sector.

The current regulatory framework established by the RBI provides equal treatment to private sector banks and public banks regarding prudential norms. Competition is encouraged by issuing licenses to more banks, and greater independence is given to boards of public sector banks.

Regulatory bodies worldwide define standards for corporate governance, and it is the primary responsibility of banks to develop sound corporate governance practices. Liberalization has resulted in intense international competition, forcing companies and financial institutions to adopt the best standards. The Securities and Exchange Board of India (SEBI) has also played a role in promoting corporate governance in the banking sector.

Corporate Governance in India

• Listed companies and banks in India are required to follow strict guidelines related to corporate governance.
• Indian Corporate Governance guidelines are among the best in the world.
• However, corporate governance in India is often followed in letter rather than in spirit.
• The government still plays a major role in the appointment of the board of banks.
• Despite being the sole authorities, they follow the directives issued by the government.
• In many countries, bank corporate governance is often influenced by political interventions in the banking system.
• In India, the partial divestment of the public sector has led to increased political interference in the banking sector.

Chief Risk Officer (CRO): Definition, Principle, and Working

• Chief Risk Officer (CRO) is a C-suite executive responsible for analyzing, identifying, and mitigating events that may pose a threat to a company both internally and externally.
• A CRO also holds the title of Chief Risk Management Officer.
• The CRO reports to the CEO and/or the Board of Directors.

Principle of CRO

• The CRO manages the risk management department and regulates internal and external risk factors to ensure compliance with government regulations.
• The CRO has the freedom to control and mitigate risks within permissible limits.
• For significant risks, the CRO reports to the CEO and/or the Board of Directors.
• Risk management is an ongoing process, and the CRO’s primary objective is to ensure compliance with the Sarbanes-Oxley Act (SOX).
• The CRO reviews various factors that could adversely impact the company’s investors or the performance of its business units.

Working of the CRO

• The CRO ensures compliance with regulations set forth by the government, including the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the Sarbanes-Oxley Act.
• The CRO also reviews various factors that could adversely impact the company’s investors or the performance of its business units.

Chief Risk Officer (CRO)

A Chief Risk Officer (CRO) plays a crucial role in minimizing business risks that threaten an organization’s benefits and productivity. They oversee enterprise risk management efforts and ensure the implementation of policies and procedures to mitigate operational risks, including physical risks. The CRO’s responsibilities include:

• Monitoring procedures that may expose the organization to risks, particularly data security and confidentiality.
• Modifying policies and procedures to avoid risks.

The responsibilities of a CRO vary depending on the organization’s size and industry. They are responsible for all risk management strategies and operations, supervising risk mitigation and identification procedures, and ensuring risk management priorities align with the company’s strategic plans.

Responsibilities of a CRO

• Developing risk maps and formulating strategic action plans.
• Creating and disseminating risk analysis reports and progress reports to stakeholders, including employees, board members, and C-suite executives.
• Formulating and implementing risk assurance strategies.
• Evaluating potential operational risks from human error or system failures that could disrupt business processes.
• Measuring the organization’s risk appetite and setting the acceptable level of risk.
• Developing budgets for risk-related projects and supervising their funding.

Risk Management Committee

Instead of appointing a CRO, some banks may establish a Risk Management Committee to oversee risks. This committee comprises executives from various departments, such as sales, HR, and operations, who work together to manage risks.

Foreign Banks in India & Corporate Governance

Foreign banks have significantly impacted the Indian economy since globalization. They have introduced advanced banking practices, improved customer service, and increased competition in the banking sector. Corporate governance plays a vital role in ensuring transparency, accountability, and ethical practices in foreign banks operating in India.

Banking in India: Evolution and Impact of Globalization

With the advent of globalization, the banking industry in India has undergone significant transformation. Banks now play a pivotal role in the nation’s economy, offering a wide range of customer-centric services. They have established a strong presence in 88 banking sectors across the country.

Foreign Banks in India

Foreign banks operate in India through branches, offering a variety of financial services. These banks have streamlined their corporate governance practices to align with the regulations set by the parent country’s regulatory authority. They contribute to the economy by facilitating import and export trade. Prominent foreign banks operating in India include Citibank, HSBC, and Standard Chartered Bank.

Deposit Mobilization

Banks mobilize deposits from the public through various channels, including fixed and current account deposits. This enables them to provide loans and other financial services to individuals and businesses. Foreign banks have emerged as formidable competitors to public banks in India, offering competitive interest rates and innovative banking solutions.

Basel Norms and Corporate Governance

Basel Norms

Basel Norms refer to a set of international banking regulations issued by the Basel Committee on Banking Supervision. These norms aim to strengthen the global banking system by focusing on risk management and ensuring financial stability.

Basel Committee on Banking Supervision (BCBS)

The BCBS is a global standard-setting body for prudential regulation of banks. Established in 1974 by the governors of the Group of Ten countries, it provides a platform for central banks to collaborate on banking supervisory matters.

Objectives of Basel Norms

Basel Norms recognize that banks face various risks in their lending activities, including default risk and market risk. To mitigate these risks, banks are required to maintain a certain level of capital as a safety net against potential losses. Basel Norms help banks manage these risks effectively and ensure the stability of the financial system.

Basel Accords

The Basel Accords are a series of agreements established by the BCBS under the Bank of International Securities (BIS). These accords set minimum capital requirements for banks to ensure their financial soundness and resilience. There have been three iterations of the Basel Accords:

Basel I: Introduced in 1988, Basel I focused on credit risk and established a risk-based capital framework.

Basel II: Implemented in 2004, Basel II expanded on Basel I by introducing more sophisticated risk management techniques and addressing operational risk.

Basel III: Finalized in 2010, Basel III further strengthened capital requirements and introduced liquidity standards to enhance the resilience of banks during financial crises.

In conclusion, the banking industry in India has evolved significantly due to globalization, with foreign banks playing a vital role in the economy. Basel Norms and Corporate Governance ensure the stability and soundness of the banking system by setting international standards for risk management and capital adequacy.

Basel Accords:

Basel Accord I:

• Established in 1988, focusing on credit risk.
• Central banks enforce provisions, with the Reserve Bank of India (RBI) responsible in India.

Basel Accord II:

• Published in June 2004 and established in 2005.
• Introduced statistical interpretation of potential bank losses.
• Lower capital requirements for international banks.

Basel Accord III:

• Response to the financial crisis and capital adequacy/liquidity standards appeal.
• Banks must maintain transparency and disclose transaction statements.
• Accounting ratios, business per employee, related party disclosure, and NPA information required.

Bank Board Bureau (BBB):

• Established on August 15, 2015, by the union government.
• Aims to appoint directors in Public Sector Banks (PBS) and address fundraising and stressed assets.
• Holds companies together for state-run banks, allowing them to borrow from markets and grow.

History and Facts of BBB:

1. RBI Governor and 6 PBS members discuss strategies.
2. BBB replaces existing PBS appointment boards.
3. Selects top officials for PBS, acting as a link between the government and banks.
4. First BBB chairman was Vinod Rai, former CAG of India.
5. Ministry of Finance makes final appointments in consultation with the Prime Minister’s Office.
6. BBB is an autonomous recommendation body.