By Sujit Mundul

Corporate Governance is a well discussed subject over the last decade or so. A good governance aims to protect shareholders rights and enhance disclosure and transparency. It facilitates effective functioning of the board and provides an efficient legal and regulatory enforcement framework.

If we look at the definition of Corporate Governance (CG), it transpires, “The fundamental concern of CG is to ensure the conditions whereby a firm’s directors and managers i.e. executives act in the interests of the firm and its shareholders. It also ensures the means by which managers are hailed responsible to capital providers for the use of assets.”

So it clearly shows a direction towards:

Responsibility

Accountability

Transparency 

Fairness

for the board of directors and the relevant executives who run day-to-day business and administration. This much discussed subject “governance” once again has taken the centre stage in the global financial world. The recent collapse of the European Bank Dexia sent shock waves across the global banking industry hardly three months after it was given a clean chit by the European Banking Authority (EBA).

EU-wide stress test covering 91 banks, representing virtually 65 per cent of the EU banking assets was conducted in the not too distant past by EBA in cooperation with few central banks, European Central Bank, European Commission and European Systemic Risk Board. On the basis of their results announced in July this year, Dexia issued a statement on its website that there is “no need for Dexia to raise additional capital.” However, since October 5th, it is inching towards bankruptcy. This phenomenon has raised an intellectual debate on the limitations of bank regulation and supervision.

For quite some time, the major concern of the policy makers was to monitor and administer prudential controls i.e. provisioning for non-performing assets, capital adequacy in the process of regulating banks and ensuring their stability. Perhaps, regulatory oversight was considered to be a substitute to corporate governance. It looked like corporate governance was considered to be less critical for banks compared with non-banking entities. The global financial crisis has clearly revealed the fact that regulation and supervision of banks has not ensured a sound banking system. As a logical corollary to this, it has now become a very convincing argument than ever before that good corporate governance complements regulation and supervision.

Banks play a critical role in the development of economies around the world. Effective corporate governance in banks helps foster financial stability, strengthen risk management and ultimately contribute to sound economic development. Banks are really unique; therefore, corporate governance of banks goes beyond the conventional agency theory. We cannot deny the fact that the banks are the most leveraged commercial enterprises. Typically, bank owners contribute circa 10 per cent of the regulatory capital. Public deposits constitute a major share of their fund base (may be up to 80 per cent). We all know that banks have a fiduciary relationship with their customers, i.e., hold the wealth of depositors and manage it on their behalf. This constitutes an additional principalagent relationship that does not exist with non-financial firms.

Let us take a look at India. Despite the existence of the Banking Regulation Act, 1949 - which inter alia contains the key parameters of good corporate governance - the issues relating to corporate governance in banks did not assume significance, especially after the nationalisation of major banks and several social obligations placed on them. The sense of urgency in implementing good corporate governance was recognised when these banks started accessing the capital markets from 1994.

One important point must be noted in this connection. After 1994, the listed banks are not only governed by banking regulation act and the various statuettes under which they are incorporated, but also by the provisions of the Companies Act related to management and administration and minority shareholders protection.

It goes without saying that long-term survival and success of an institution depends greatly on the skills, experience and knowledge of its directors and top management. The “working board” requires individuals who are informed, competent and independent to ensure enterprise and integrity which can promote sound growth of the company.

In the context of corporate governance, it would be interesting to note that while reviewing the policy of granting fresh licenses to corporations, the RBI Governor Dr D Subbarao raised concerns of “possible self-dealing” by promoter groups in private banks. He also cautioned the banks’ boards regarding excessive risk taking. In April 2011, the RBI levied a penalty on 19 banks including India’s largest bank – State Bank of India for violations on the sale of derivatives. It also imposed a fine of Rs 25 lakhs on Citibank for frauds relating to portfolio management by one of its managers.

Sending a strong message to the banks’ boards, the RBI governor said the boards and senior management of the banks would require to be more sensitive to the interests of the depositors and careful of the “potentially destructive consequences of risk taking, be alert to the warning signals and be wise enough to contain exuberance.” Dr Subbarao further said “the short point is this: if the directors on the boards of the banks did not know what was going on, they should ask themselves if they were fit enough to be directors. If they did know and did not stop it, they were complicit in the recklessness and fraud.” One of the biggest challenges in India is the dearth of professionals who are capable and willing to accept the mandate of independent directors. Now let us take a look at Nepal in this regard. Nepal Rastra Bank - the fountainhead of the country’s monetary system - has issued directives on good corporate governance. (NRB Directives No 6: Code-of-Ethics to be observed by Directors/CEO of Banks and Financial Institutions), the salient points of which are:

A declaration be signed as to observe the NRB regulations.

Prohibitions to involve in activities against the interest of the Bank/FI.

Prohibition for CEO to work part-time.

Director of a Bank not to become a director of other institutions licensed by NRB.

Prohibition for Directors to hold Trusteeships.

Prohibition to misuse the position for personal benefits.

Maintenance of confidentiality and fair and equal treatment.

If we undertake a critical appreciation of the situation in the Nepali banking industry, the picture would not be very different from India in that finding appropriate and willing professionals for board positions continues to remain a major challenge. As a sequel to the recent global financial crisis, the regulators in most of the countries have placed much emphasis on the selection of board directors in Banks/FIs as they would play pivotal roles in the implementation of good governance in order to ensure sound health of the organisation.

Despite strengthening of rules, regulations, codes of conduct etc relating to good corporate governance over the years, we have found that major incidents in frauds, mis-selling, insider trading etc continue to recur in many parts of the world. So, it seems that these rules/regulations have not really strengthened the spirit of corporate governance. The spirit lies in the hearts of the managers. It is deep rooted in the foundation of moral sentiments and values, rendering it difficult for the regulators to measure.