A Standing Committee on International Financial Standards and Codes was constituted to, inter alia, assess the status in India vis-à-vis the best global practices in regard to standards and codes. An Advisory Group on Corporate Governance (Chairman: Dr. R. H. Patil) made detailed assessment and gave recommendations of which those relating to PSBs is an important component. The Report provides the most comprehensive set of recommendations on the subject are summarised hereunde.

Currently in India, about four-fifths of the banking business is under the control of public sector banks (PSBs), comprising the SBI and its subsidiaries and the nationalised banks. Corporate governance in PSBs is complicated by the fact that effective management of these banks vests with the government and the top managements and the boards of banks operate merely as functionaries. The ground reality is such that the government performs simultaneously multiple functions vis-à-vis the PSBs, such as the owner, manager, quasi-regulator, and sometimes even as the super-regulator. Unless the issues connected with these multiple, and sometimes conflicting, functions are resolved and the boards of banks are given the desired level of autonomy it would be difficult to improve the quality of corporate governance in PSBs. One of the major factors that impinge directly on the quality of corporate governance is the government ownership. It is desirable that all the banks are brought under a single Act so that the corporate governance regimes do not have to be different just because the entities are covered under multiple Acts of the Parliament or that their ownership is in the private or public sector.

Even when the government dilutes its holdings to bring them significantly below the threshold limit of 51 per cent, efforts to institute good governance practices would remain at superficial level unless the government seriously redefines its role de novo. The changes proposed in the composition of the boards as per legislation under contemplation would result in government directly appointing 9 out of the 15 directors including the 4 whole time directors. Moreover, the voting rights of any of the other shareholders will continue to be restricted, thereby negating the basic principle of equal rights to all the shareholders. The rights of private shareholders' of SBI/PSBs are abridged considerably, since their approval is not required for paying dividend or adopting annual accounts. The subsidiaries of the SBI enjoy very limited board autonomy as they have to get clearance on most of the important matters from the parent even before putting them up to their boards. Further, as things stand today, there is no equality among the various board members of the PSBs. Nominees of RBI and Government are treated to be superior to other directors.

Another major problem affecting banks has been the representation given to the various interest groups on the boards of the banks. The main objective behind these representations was to give voice to various sections of the society at the board level of the banks. Hence, a major reform is needed in the area of constitution of the boards of the banks. The Chairmen, Executive Directors and non-executive directors on the boards of the PSBs (including the SBI and its subsidiaries) need to be appointed on the advice of an expert body set up on the lines of the UPSC, with similar status and independence. Such a body may be set up jointly by RBI and the Ministry of Finance. There is also no need to have directors that represent narrow sectional and economic interests. All the objectives that the banks are supposed to achieve should become an integral part of the corporate mission statements of these institutions.

Although RBI maintains a tight vigil and inspects these entities thoroughly at regular time intervals, the quality of corporate level governance mechanism does not appear to be satisfactory. In its role as the regulator, RBI need not have representation on the bank boards, given the fact that it leads to conflicts of interests with its regulatory functions. This should apply even in the case of SBI where RBI is the major shareholder. Further, any policy measures to protect banks that are less careful in their lending policies at the cost of tax payers' money need to be tempered in such a way that they do not encourage profligate lending by banks.

Current regulatory provisions do not permit a bank to lend money to a company if any of its board members is also a director on the board of that company. The negative impact of this rule has been that the banks are not able to get good professionals for their boards. This archaic rule should be modified immediately so that the professionals who are on the boards of non-banking companies as professional or independent directors do not suffer from any handicaps. The current rule may, however, be continued only in respect of directors of companies who are their promoters and have a stake in their companies beyond being merely a director. In the interest of good governance, it is desirable that government directors should not participate in the discussion on such matters and also abstain from voting.

The Report of the Advisory Group on Banking Supervision (Chairman : Mr. M.S. Verma) has also made some recommendations on corporate governance, which are summarised below:

The quality of corporate governance should be the same in all types of banking organisations irrespective of their ownership. The process of induction of directors into banks' boards and their initial orientation may be streamlined. Banks need to develop mechanisms, which can help them ensure percolation of their strategic objectives and corporate values throughout the organisation. Boards need to set and enforce clear lines of responsibility and accountability for themselves as well as the senior management and throughout the organisation. Linkage between contribution and remuneration/reward should be established. Compensation Committees of the board could be set up for the purpose. Nomination Committees to assess the effectiveness of the board and direct the process of renewing and replacing board members are desirable. Disclosures in respect of committees of the board and qualifications of the directors, incentive structure and the nature and extent of transactions with affiliated and related parties need to be encouraged. Finally, a provision on the lines of Section 20 of the Banking Regulation Act, 1949, which prohibits loans and advances to directors and their connected parties, will have to be made in respect of large shareholders also. Information on transactions with affiliated and related parties should be disclosed.

It would be evident that the Reports of Advisory Groups contain far reaching proposals to improve corporate governance and many, if not all, do require legislative processes and they are necessarily time consuming and often realizable only in medium-term. While proceeding with analysis and possible legislative actions, it may be necessary to consider and adopt changes that could be brought about within the existing legislative framework.

To this end, Governor Jalan in his Monetary and Credit Policy Statement of October 2001 constituted a Consultative Group of Directors of banks and financial institutions (Chairman Dr. A.S. Ganguly) to review the supervisory role of Boards of banks and financial institutions and to obtain feedback on the functioning of the Boards vis-à-vis compliance, transparency, disclosures, audit committees etc. and make recommendations for making the role of Board of Directors more effective. The Group made its recommendations very recently after a comprehensive review of the existing framework as well as of current practices and benchmarked its recommendations with international best practices as enunciated by the Basel Committee on Banking Supervision, as well as of other committees and advisory bodies, to the extent applicable in the Indian environment. The report has been put in public domain for a wider debate and its major recommendations are under:

On appointment of Directors, due diligence of the directors of all banks - be they in public or private sector, should be done in regard to their suitability for the post by way of qualifications and technical expertise. Involvement of Nomination Committee of the Board in such an exercise should be seriously considered as a formal process. Further, the Government while nominating directors on the Boards of public sector banks should be guided by certain broad "fit and proper" norms for the Directors. The criteria suggested by the Bank for International Settlements (BIS) may be suitably adopted for considering "fit and proper" test for bank directors.

In the present context of banking becoming more complex and knowledge-based, there is an urgent need for making the Boards of banks more contemporarily professional by inducting technical and specially qualified individual. While continuing regulation based representation of sectors like agriculture, SSI, cooperation, etc., the appointment/nomination of independent/ non-executive directors to the Board of banks (both public sector and private sector) should be from a pool of professional and talented people to be prepared and maintained by RBI. Any deviation from this procedure by any bank should be with the prior approval of RBI.

On the functioning, the independent/non-executive directors should raise in the meetings of the Board, critical questions relating to business strategy, important aspects of the functioning of the bank and investor relations. In the case of private sector banks where promoter directors may act in concert, the independent / non-executive directors should provide effective checks and balances ensuring that the bank does not build up exposures to entities connected with the promoters or their associates. The independent / non-executive directors should provide effective checks and balances particularly, in widely held and closely controlled banking organizations.

As a step towards effective corporate governance, it would be desirable to take an undertaking from every director to the effect that they have gone through the guidelines defining the role and responsibilities of directors, and understood what is expected of them and enter into a covenant to discharge their responsibilities to the best of their abilities, individually and collectively.

In order to attract quality professionals, the level of remuneration payable to the directors should be commensurate with the time required to be devoted to the bank's work as well as to signal the appropriateness of remuneration to the quality of inputs expected from a member. The statutory prohibition under section 20 of the Banking Regulation Act, 1949 on lending to companies in which the director is interested, severely constricts availability of quality professional directors on to the Boards of banks. This would require a change in the existing legal framework. We need to move towards this goal.

It would be desirable to separate the office of Chairman and Managing Director in respect of large sized public sector banks. This functional separation will bring about more focus on strategy and vision as also the needed thrust in the operational functioning of the top management of the bank. The directors could be made more responsible to their organization by exposing them to an induction briefing need-based training programme/seminars/workshops to acquaint them with emerging developments/challenges facing the banking sector. RBI as the regulator, could take the initiative to organizing such seminars. RBI may bring out an updated charter indicating clear-cut, specific guidelines on the role expected and the responsibilities of the individual directors. The whole-time directors should have sufficiently long tenure to enable them to leave a mark of their leadership and business acumen on the bank's performance. All banks should consider appointing qualified Company Secretary as the Secretary to the Board and have a Compliance Officer (reporting to the Secretary) for monitoring and reporting compliance with various regulatory/accounting requirements.

The information furnished to the Board should be wholesome, complete and adequate to take meaningful decisions. A distinction needs to be made between statutory items and strategic issues in order to make the material for directors 'manageable'. The Reviews dealing with various performance areas could be put up the Supervisory Committee of Board and a summary of each such review could be put up to the Main Board. The Board's focus should be devoted more on strategy issues, risk profile, internal control systems, overall performance, etc. The procedure followed for recording of the minutes of the board meetings in banks and financial institutions should be uniform and formalized. Banks and financial institutions may adopt two methods for recording the proceedings viz., a summary of key observations and a more detailed recording of the proceedings.

It would be desirable if the exposures of a bank to stockbrokers and market-makers as a group, as also exposures to other sensitive sectors, viz., real estate etc. are reported to the Board regularly. The disclosures in respect of the progress made in putting in place a progressive risk management system, the risk management policy, strategy followed by the bank, exposures to related entities, the asset classification of such lendings/investments etc. conformity with Corporate Governance Standards etc., be made by banks to the Board of Directors at regular intervals as prescribed.

As regards Committees, there could be a Supervisory Committee of the Board in all banks, be the public or private sector, which will work on collective trust and at the same time, without diluting the overall responsibility of the Board. Their role and responsibilities could include monitoring of the exposures (credit and investment) review of the adequacy of risk management process and upgradation thereof, internal control systems and ensuring compliance with the statutory/regulatory framework. The Audit Committee should, ideally be constituted with independent/non-executive directors and the Executive Director should only be a permanent invitee. However, in respect of public sector banks, the existing arrangement of including the Executive Director and nominee directors of Government and RBI in the Audit Committee may continue. The Chairman and Audit Committee need not be confined to the Chartered Accountant profession but can be a person with knowledge on 'finance' or 'banking' so as to provide directions and guidance to the Audit Committee, since the Committee not only looks at accounting issues, but also the overall management of the bank. It is desirable to have a Nomination Committee for appointing independent/non-executive directors of banks. In the context of a number of public sector banks issuing capital to the public, a Nomination Committee of the Board may be formed for nomination of directors, representing shareholders. The formation and operationalisation of the Risk Management Committees in pursuance of the guidelines issued by the RBI should he speeded up and their role further strengthened. With a view of building up credibility among the investor class, the Group recommends that a Committee of the Board may be set up to look into the grievance of investors and shareholders, with the Company Secretary as a nodal point.

Finally the banks could be asked to come up with a strategy and plan for implementation of the governance standards recommended and submit progress of implementation, for review after twelve months and thereafter half yearly or annually, as deemed appropriate.