The Group noted that banks in India are governed by separate statutes as under:

• The Banking Regulation Act, 1949 is applicable to all banks,

• The public sector banks are in addition governed by the statutes under which they were incorporated, viz.,

• State Bank of India under State Bank of India Act, 1955

• The Associate Banks of SBI under the State Bank of India (Associate Banks) Act, 1959

• Nationalised banks under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/'80.

The public sector banks are exempted from some of the provisions of the Banking Regulation Act in view of the separate statutes governing them.

The statutes governing banks provide for constitution of the Board of Directors, appointment of the Chairmen and Managing Directors, audit of books and accounts, appointment of statutory auditors, publication of the balance sheets, etc. The Banking Regulation Act, 1949 provides that not less than 51% of the total number of members of the Board of Directors of a banking company shall consist of persons who shall have special knowledge or practical experience in respect of one or more of the following areas: viz., Accountancy, Agriculture and Rural Economy, Banking, Co-operation, Economics, Finance, Law, Small Scale Industry or any other matter the special knowledge or practical experience in, which would, in the opinion of Reserve Bank, be useful to the banking company. Out of the aforesaid 51% of directors, not less than 2 directors shall have special knowledge or practical experience in respect of agriculture and rural economy, co-operation or small-scale industry. The directors representing the aforesaid sectors shall also not have substantial interest in or be connected with whether as employee, Manager or Managing Agent in any company (other than a Section 25 company) or a firm which carries on any trade, commerce and industry and which is not a small scale industry concern. The statutes governing the public sector banks also provide for election of shareholder nominees in proportion to the shares issued to public, subject to a maximum of six nominees in respect of banks which have issued capital to public up to 40% of the bank's paid-up capital.

The Boards of private sector banks are constituted by the promoters / shareholders keeping in view the requirements of the Banking Regulation Act as indicated above. The appointment of the Chief Executive Officers of the private sector banks, however, requires the prior approval of the RBI as per the provisions of the Banking Regulation Act, 1949.

The Banking Companies (Acquisition and Transfer of Undertakings) Acts, 1970/'80, do not provide for any explicit representation from the aforesaid sectors of the economy. However, the six directors nominated to the Boards of nationalised banks by the Central Government or elected by the shareholders (of banks which have issued capital to the public) shall have special knowledge or practical experience in respect of one or more of the above fields.

The Boards of nationalised banks and State Bank of India are constituted by the Central Government. The Nationalisation Acts and the SBI Act vest powers with the Central Government to appoint the Chairmen and Managing Directors of the banks in consultation with the Reserve Bank. The majority of the directors in the case of public sector banks are also appointed by the Central Government. In the case of development finance institutions (viz., IDBI, NABARD, NHB, etc.) the Central Government is empowered as per the statutes governing them, to constitute the Board with the majority of the directors representing the owner, viz., the Central Government.

The Group noted that the corporate governance structure of banks in India thus, has the elements of both the "outsider" model of the U.S. and the U.K. where there is separation of ownership and management as in the case of public sector banks, and the "insider" model with families, inter-connected entities or promoters running management as in the case of some of the private sector banks.

The BIS Paper on Enhancing Corporate Governance in Banking Organisations (September, 1999), reports of Dr. Patil Advisory Group as also of the Verma Group enumerate the best practices in corporate governance for banking organisations. The Hong Kong Monetary Authority had also issued guidelines on corporate governance to the domestic banking organisations. The most important elements of these best practices emphasised by the BIS Principles and other expert Committees are the following:

1. Constitution of the Board and related aspects:

   1. Ensure that the Board members are qualified for their positions, have a clear understanding of their role in corporate governance and are not subject to undue influence from management or outside interests.

   2. The Board should appoint as a Chief Executive, a person with integrity, technical competence and experience in banking.

   3. Clearly stated assignment of responsibilities / accountabilities and establish a mechanism for interaction and cooperation among Board members.

   Ensure that the organisation has a mechanism for oversight as under:

   Oversight by the Board

   1. Oversight by independent committees of the Board

   2. Oversight by independent Board members not involved in day-to-day running of the business.

   3. Monitoring of risk exposures as also exposures where conflicts of interest are likely, including business relationships with parties connected with the bank, large shareholders, senior management, etc.

2. Internal control and independent committees of the Board for

   Risk management and independent audit

   1. Strong internal control system including internal and external audit functions

   2. Independent Audit Committee comprising non-executive directors.

   3. Disclosure and transparency

   4. Appropriate information flow internally and to the public

   5. Public disclosures in regard to organisational structure, incentive structure, transactions with related parties, etc.

The three crucial ingredients of good corporate governance standards as could be observed from the above, are thus:

1. Clear division of responsibility throughout the organization.

2. Checks and balances, incorporating "four eyes" principles, and

3. Disclosures and transparency.

The Group notes that the best governance practices suggested for banks in the BIS paper and other documents which are implementable within the existing legal framework, have been implemented by the Reserve Bank. The banks have set up Board level Committees in areas like risk management (both for credit risk and market risk) and audit. The role and responsibilities of the Audit Committee of the Board have been further enhanced to ensure monitoring of exposure to connected parties, sensitive sectors, etc. The disclosure requirements of banks have been enhanced and banks are now required to disclose besides critical financial parameters, investment in equity shares and debentures, advances against shares and debentures, exposure to stock brokers, etc., as part of ' Notes on Accounts', to their balance sheet .

The Group deliberated upon the legal framework governing the banking sector, the public ownership, the management control of the Government in the case of the public sector banks, and other related issues. In the case of private sector banks, although there are no legal impediments to introducing internationally accepted corporate governance standards, particularly in regard to constitution of the Board and defining its fiduciary responsibilities, etc., in practice, in several instances and in spite of RBI directives, however, there is in practice, no check on the Chief Executive Officer, who is generally closely linked to the promoters. Furthermore, there is little or no formal accountability on the Boards or the internal audit systems are weak.

Considering the legal framework governing the PSBs and the existing governance practices in banks, the Group noted that the manner of appointment of directors have led to certain inadequacies over a period of time and needed to be remedied. The Group is of the view that in order to introduce effective corporate governance standards as enunciated in the BIS Paper or those suggested in the reports of the Patil Group or Verma Group, it would be necessary to effect amendments to the various statutes governing the banks. In the meantime, the corporate governance standards for banks have to be defined within the given legal framework. Therefore, taking into account the existing legal framework, the Group's attempt was to define, both "desirable" and "doable" practices for enhancing the supervisory role and effectiveness of the Boards of banks in order to significantly improve the corporate governance standards in banks and financial institutions. The major conclusions and the views of the Group thereon are given in the following Chapter (4).