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Institute for Development and Research in Banking Technology


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Institute for Development and Research in Banking Technology



Governance Issues in Banking



  1. I thank the ASCI authorities for giving me this opportunity to participate in a programme on Governance in the New Millennium to very senior bureaucrats in very responsible positions in the government. During my sojourn in my banking career of four decades, I have found governance issues occupying a center stage position in the last 10 years. There have been scams time and again in this country not to talk of scams of gigantic proportions even in the global economies. Each country has evolved its own solutions by enacting stringent laws to tighten the loopholes and to safeguard the interest of the investors. There is always a dilemma of conflict of interest in a company between the investors who look to optimum rewards and the Board of Directors and all the other stakeholders including employees and functionaries that go to make up a company. In the case of banking institutions, you will all agree with me that they are highly leveraged institutions who have access to cheap deposits in the form of current and savings banks accounts and fixed deposits and who inturn lend it to the needy borrowers. Over the centuries since banking took roots, a safe credit deposit ratio is defined in many textbooks somewhere between 60% and 65 %. The management of the banks has to take intelligent decisions in lending to the various categories of borrowers. Overtime, regulation became very important over these institutions and therefore, the concept of introducing a CRR and SLR to meet emergencies has come to stay world over. There are several models of regulation. In most of the countries it is the Central Bank, which is responsible for supervision over all the financial institutions and in some other countries a Regulator uniquely empowered by law known as a ‘Financial Services Authority’ looks after all the financial entities including banks and financial institutions. I am mentioning all these as a sort of a backdrop to the governance issues and a need for utmost probity and transparency in conducting the affairs of banks.




  1. We have a large chunk of Indian Banking industry in the public sector domain although, more than a dozen institutions are listed on the Stock Exchange and the public has widely dispersed shareholding in these listed banks. It appears Government has no intentions of giving up the majority shareholding. Side by side, we have behemoth State Bank of India with 59% equity held by Reserve Bank of India. Likewise, we have NABARD where RBI owns a significant portion of equity. It is true in cases of listed banks, there is a sort of overlap in the control as they have to necessarily fulfill the requirements of the Stock Exchange and also all the regulatory requirements prescribed by the Reserve Bank of India and within the ambit of Banking Companies Act, Reserve Bank Act, and Special Acts of Parliament by which they are created, like the SBI Act of 1955 when SBI was created, Act of 1959 when the subsidiary Banks of SBI were created, and the Nationalization of Banks Act in 1969 and its further amendments. Over a period of time, corporate governance has been implemented in one form or the other in both public and private sector Banks by creating the various committees of the Board, inducting professionals on to these Boards and taking informed decisions by a free and frank debate after a consensus emerges at the Board or its subcommittees. Such prescription may sound very idealistic, but it never happens in practice in the manner expected. You will all agree with me that it would appear at the surface, differential treatment is necessary in dealing with governance issues between public sector and private sector, while the principles are the same. Let me flag some of these issues:




  1. The appointment of the Chief Executive of Public Sector Banks and nomination of other Directors to the Boards of the Banks.

  2. Election of shareholders in public sector banks which are listed on the Stock Exchanges.

  3. Constitution of empowered committees like the Business Sanctions Committee, Audit Committee, Remuneration Committee, Nominations Committee etc., Shareholders Grievance Committee.

  4. In respect of private sector banks the present ownership pattern in the recent guidelines issued by the RBI is right in the public domain and being debated. A set of draft guidelines issued in July 2004 (Annexure – I) has generated a lot of discussions and the recent speech of Deputy Governor, indicates a second draft would be put out after some discussions and a final view would be taken.

  5. How the Banks run their affairs in conducting their day-to-day business. Is there sufficient delegated authority empowering the functionaries to act together with proper reporting and controlling mechanisms? Are there extra institutional influences affecting decisions without responsibility?

  6. Cooperative Banks in the states and also the urban banks which are also in Cooperative sector – How are they faring and why are many of them falling and collapsing frequently, for example, in Ahmedabad and Hyderabad to cite a few examples although Maharashtra, Tamilnadu and Kerala are also having large presence of urban banks.

  7. What is the way out and way forward?




  1. Let me first confine my observations to the present debate on the suggested ceilings:




    1. All shareholdings of 5% and above representing important shareholding would have to meet the ‘fit and proper’ tests of competence, reputation, track record, integrity, sources of funds etc. The latest directive issued by RBI on 25th June, on ‘Fit and Proper criteria for Directors of Banks’ is placed at Annexure – II. Where the investors happen to be corporates, ‘fit and proper’ criteria would include good corporate governance, financial strength and integrity in addition to the assessment of individuals and other entities associated with these corporates.




    1. Reserve Bank’s concern was to ensure that no single entity or group of related entities have shareholding or control, directly or indirectly, in any bank in excess of 10 percent of the paid up capital of the private sector bank. Any holdings higher than this limit will be with the prior approval of RBI and in accordance with the guidelines of February 3, 2004 (Annexure – III).




    1. Minimum net worth of Rs. 300 crores is suggested as being desirable for optimal operations and systemic stability as against Rs. 100 crores a sort of benchmark till recently. Banks with net worth lower than this limit will be encouraged to increase it to this level within a reasonable period.




    1. In case of the new licenses, promoter’s shareholding will normally be expected to be brought down to 10 percent to fulfill the Reserve Bank’s criteria.




    1. Guidelines have already been issued to restrict crossholdings




    1. Where NRIs and FIIs seek to invest, maximum limit for portfolio investment schemed, need to be respected and would be subject to GOI guidelines from time to time. Where the investing account from abroad is a ‘sub account’, full details of the investor/s and other particulars required for due diligence will be called for.




    1. In the case of family members and close relatives dominating the Board, now it is suggested having not more than one member.




    1. Continuing compliance of ‘fit and proper’ criteria for shareholders and directors will have to be ensured by the bank on an ongoing basis and reviewed once in a year.




  1. Most of these guidelines contained in the draft took into account the emerging trends in the international practices. There is an urgency to implement these as soon as possible, in view of the recurrent crises appearing in the markets and considerable importance is attached to achieve these objectives, as the banking sector is already quite large and wide spread with several banks of varying sizes with divergent shareholding patterns and governing practices. Further, as banks form an important part in the entire payment mechanisms in the country, it is necessary for the Regulator to ensure the ‘fit and proper’ status of each bank and that it is following governance principles. There is no escape for any bank now in making substantial investments in Information Technology to fall inline with sophisticated online payment systems, RTGS, core banking solutions etc. In other words, the Board of Directors must have eminent persons who are capable of providing a necessary oversight coupled with their duties of loyalty to the shareholders and provide the necessary checks and balances. The Board is also empowered to question the management and must be comfortable in insisting upon straightforward explanations from them. The Board should ensure impartial decision-making and should not indulge in day-to-day management or micromanagement of the banks. Therefore, selecting an effective number of Board members with the necessary vision is a very important function both for public and private sector banks. The present processes do not appear to be very comfortable as you come across some surprise choices of Directors on the bank Boards, who do not possess many of the desired attributes nor skills to bring value to the Boards.




  1. Let me now go back to the Dr. Ganguly Group’s Report submitted in April 2002 and placed at RBI’s website for comments. Banks were advised to place the report to their Boards to adopt the decisions constrained therein, some of which required legislative changes have been referred to the Government of India. In view of its importance, the same is placed as an Annexure – IV. There was reluctance for some Directors to even sign the covenants. This read together with SEBI guidelines that is placed as Annexure – V to my speech form anchor documents and efforts are underway by RBI for harmonizing them.




  1. It is also an important issue, should the government and Reserve Bank continue to have their officials on the Board. These officials on the Board generally wield enormous powers, particularly in public sector banks as the power of appointment of the Chairman is with the government and where the Regulator is also consulted. Even though the Reserve Bank has been appointing their nominees on the Board who do not directly deal with the bank in a particular region, there is still a sort of a conflict in the discharge of the duties. In the annual inspections of the banks by Reserve Bank some of the decisions are called into question. Therefore, the Nominations Committee would be really the ideal forum that may have a large panel of eminent professionals, who could be selected to the Boards. It is desirable to have nominees of eminence as their representatives with clear mandate. Once this is ensured, the investors and the shareholders would feel assured that their interests are well protected. The working committee of the Companies Act has come out with large number of suggestions to achieve effective corporate governance. These are still being debated and it is hoped that the balance sheets and the notes to the accounts voluntarily disclose many important pieces of information, which bring about the governance issues, making the financial statements easily understandable by the shareholders and the disclosures made by the Directors are meaningful to prove that they are men who are very tall and practice what they are expected to do so. The practice of tucking away sensitive disclosures in small print must be avoided. It is also proposed that the penalties for any breaches must be extremely severe. In the public sector banks, the compensation paid to the CMDs and Directors is very small compared to counterparts. It is therefore, to the credit of these men who despite the small compensation they receive, have been holding the position of great responsibility. Oftentimes, some of the posts remain vacant for several months as the procedure is so time consuming and the files have to travel through several layers in the administration before the Appointments Committee of the cabinet clears the appointment. During such periods of vacuum, those banks are left without a leader and suffer in their working results. While men of eminence in Accountancy, Agriculture and Rural Economy, Economics, Finance, Law, Small Scale Industry are chosen as other Directors, there appears to be other considerations through which the names representing these groups enter the panels. It is of course, expected that directors shall not have substantial interest in any of those banks or have a banking relationship with the bank where he would be serving on the Board.




  1. Amongst the various subcommittees of the Board, the Audit Committee enjoys a unique position of taking the responsibility for upholding the Company’s internal and external audit processes, which are expected to be rigorous and effective. The Audit Committee members have a combination of both non-executive and executive directors with atleast 50% comprising non-executive directors. The hidden message is that this 50% would really be the so-called independent directors and it is customary that the Audit Committee is chaired by a qualified independent director preferably a Chartered Accountant. The CEO of the Company generally does not attend the Audit Committee meetings while the CFO and other executives are invited as special invitees. It is also customary for the Audit Committee to talk to the external auditors and understand and appreciate their concerns. There is a practice of the Audit Committee vetting the financial results of the corporate. In the US post Enron, the Sarbanes-Oxley Act has come into force which has given tremendous importance to the role of ongoing concurrent audits. There is no corresponding legislation in this country but the annual audits are becoming rigorous with the Accounting Standards set by Institute of Chartered Accountants of India.




  1. In conclusion, the pursuit for corporate governance is endless and continues to be refined. The basic principles that key-management decisions made by one executive are seen at another level, known as “four eyes principle” and “firewalls” between persons in the frontline operations and the policy makers, the philosophy of the Board has been fair and is not unwilling to discipline a successful employee when he goes wrong are something which need to be enshrined as foundations of corporate governance. I am aware, there are no easy solutions to some of these observations and administrators of eminence of your calibre need to provide the necessary impetus for bringing about these changes when you deal with policies. I have purposely not commented upon the pathetic condition of some of the district cooperative banks and the urban banks that indulge in Regulatory Arbitrage arising out of dual control of State Governments and the Reserve Bank of India as a Bank Regulator. People in Hyderabad are well aware of collapsing of several urban banks whose Boards have been dominated by borrowers and where opacity is practiced to perfection. I do hope you will bring about the necessary changes in course of time and protect the ultimate interest of depositors and the investors.




  1. The subject is no doubt complex and can be looked upon from various angles. Frauds in the banking system are also increasing but I do believe computer Management Information Systems should be able to detect them early and the Board must have the will to deal with such mischief-makers in an exemplary manner. Zero tolerance should be the goal for frauds in the banking system. I firmly believe that it is the individual leader at the helm of affairs who makes a difference and who do not compromise themselves to deliver value. I would like to make an observation about the close coordination that exists through HLCC between RBI, SEBI, IRDA and the Secretary Finance, Government of India who have a formal structure for reviewing the affairs which impact the whole financial system. This model has served us well and it was a very illuminating experience to have had the three Regulators share a platform recently in Hyderabad where they explained the delicate and intricate relationship each has with the other. Of course, the US and UK models are different, but our model has served us well and we seem to be comfortable to continue with the same for sometime more to come.




  1. Finally, the four aspects of oversight that should be included in the organizational structure of any bank or financial institution to ensure appropriate checks and balances are:




  1. oversight by the board of directors or supervisory board;

  2. oversight by individuals not involved in the day-to-day running of the various business areas;

  3. direct line supervision of different business areas; and

  4. independent risk management and audit functions.


I now conclude my speech on this important subject.


Thank you,





ANNEXURES




Annexure

Title

Page












Draft Guidelines issued by RBI in July 2004

1



‘Fit and Proper’ Criteria for Directors of Banks

8



Guidelines for acknowledgement of transfer/allotment of shares in private sector banks

9



List of recommendations of the Consultative Group of Directors of banks and financial institutions (Dr. Ganguly Group)

13



Summary of the important Recommendations of the SEBI’s Committee on Corporate Governance

19


ANNEXURE – I


A comprehensive policy framework for

Ownership and governance in private sector banks

^

Draft Guidelines issued by RBI in July 2004



Introduction

Banks are “special” as they not only accept and deploy large amount of uncollateralized public funds in fiduciary capacity, but also they leverage such funds through credit creation. They are also important for smooth functioning of the payment system. In view of the above, legal prescriptions for ownership and governance of banks laid down in Banking Regulation Act, 1949 have been supplemented by regulatory prescriptions issued by RBI from time to time. The existing legal framework and significant current practices in particular cover the following aspects:

  1. The composition of Board of Directors comprising members with demonstrable professional and other experience in specific sectors like agriculture, rural economy, cooperation, SSI, law, etc., approval of Reserve Bank of India for appointment of CEO as well as terms and conditions thereof, and powers for removal of managerial personnel, CEO and directors, etc. in the interest of depositors are governed by various sections of the B. R. Act, 1949.

  2. Guidelines on corporate governance covering criteria for appointment of directors, role and responsibilities of directors and the Board, signing of deed by covenants by directors, etc., was issued by RBI on June 20, 2002, based on the recommendations of Ganguly Committee and a review by the BFS.

  3. Guidelines for acknowledgement of transfer / allotment of shares in private sector banks was issued in the interest of transparency by RBI on February 3, 2004 (Annexure - III).

  4. Foreign investment in the banking sector is governed vide Press Note dated March 5, 2004 issued by the Government of India, Ministry of Commerce and Industries.

  5. The earlier practice of RBI nominating directors on the Boards of all private sector banks has yielded place to such nomination in select private sector banks.


2. Against this background, it is considered necessary to lay down a comprehensive framework of policy in a transparent manner relating to ownership and governance in the Indian private sector banks as described below.


3. The broad principles underlying the framework of policy relating to ownership and governance of private sector banks would have to ensure that:

  1. The ultimate ownership and control of private sector banks is well diversified.

  2. Important Shareholders (i.e., shareholding of 5 per cent and above) are ‘fit and proper’, as laid down in the guidelines dated February 3, 2004 on acknowledgement for allotment and transfer of shares.

  3. The directors and the CEO who manage the affairs of the bank are “fit and proper” and observe sound corporate governance principles.

  4. To avoid conflict of interest, RBI will not appoint its nominee on the Boards of private sector banks unless there are exceptional circumstances.
  5. ^

    Private sector banks have minimum capital / net worth for optimal operations and systemic stability.

  6. The policy and the processes are transparent and fair.



4. Minimum capital

The capital requirement of existing private sector banks should be on par with the entry capital requirement for new private sector banks prescribed in RBI guidelines of January 3, 2002, which is initially Rs.200 crore, with a commitment to increase to Rs.300 crore within three years. In order to meet with this requirement, all banks in private sector should have a net worth of Rs 300 crore at all times. Where the net worth declines to level below Rs 300 crore, it should be restored within reasonable time.


5. Shareholding

  1. The RBI guidelines on acknowledgement for acquisition or transfer of shares issued on February 3, 2004 will be applicable for any acquisition of shares of 5 per cent and above of the paid up capital of the private sector bank.

  2. In the interest of diversified ownership of banks, the objective will be to ensure that no single entity or group of related entities has shareholding or control, directly or indirectly, in any bank in excess of 10 per cent of the paid up capital of the private sector bank. Any higher level of acquisition will be with the prior approval of RBI and in accordance with the guidelines of February 3, 2004 for grant of acknowledgement for acquisition of shares.

  3. Where ownership is that of a corporate entity, the objective will be to ensure that no single individual/entity has ownership and control in excess of 10 per cent of that entity. Where the ownership is that of a financial entity the objective will be to ensure that it is a widely held entity, publicly listed and a well established regulated financial entity in good standing in the financial community.

  4. In respect of a new license for private sector banks, promoter shareholding may be allowed to be higher to start with as at present, but will be required to be brought down to the limit of 10 per cent in a time bound manner normally within a period of three years.

  5. As per existing policy, large industrial houses will not be allowed to set up banks but will be permitted to acquire by way of strategic investment shares not exceeding 10 per cent of the paid up capital of the bank subject to RBI's prior approval.

  6. Any private sector bank will be allowed to hold shares in any other private sector bank only upto 5 per cent of the paid up capital of the investee bank. On the same analogy, any foreign bank with presence in India will be allowed to hold shares in any other private bank only upto 5 per cent of the paid up capital of the investee bank.



6. Directors and Corporate Governance

  1. The recommendations of the Ganguly Committee on corporate governance in banks have highlighted the role envisaged for the Board of Directors. The Board of Directors should ensure that the responsibilities of directors are well defined and the banks should arrange need-based training for the directors in this regard. While the respective entities should perform the roles envisaged for them, private sector banks will be required to ensure that the directors on their Boards representing specific sectors as provided under the B. R. Act, are indeed representatives of those sectors in a demonstrable fashion, they fulfill the criteria under corporate governance norms provided by the Ganguly Committee and they also fulfill the criteria applicable for determining 'fit and proper' status of Important Shareholders (i.e., shareholding of 5 per cent and above).

  2. As a matter of desirable practice, not more than one member of a family or a close relative (as defined under Section 6 of the Companies Act, 1956) or an associate (partner, employee, director, etc.) should be on the Board of a bank.

  3. Guidelines have been provided by the Ganguly Committee on Corporate Governance according to which a covenant has to be signed by all the directors on the Boards of the banks. All directors will be required to sign the covenant in "public interest".

  4. Being a Director, CEO should satisfy the requirements of the “fit and proper” criteria applicable for directors. In addition RBI may apply any additional requirements for the Chairman and CEO. The banks will be required to provide all information that may be required while making application to RBI for approval of appointment of Chairman /CEO.


7.^ Foreign investment in private sector banks


In terms of the recent GOI press note of March 5, 2004, the aggregate foreign investment in private banks from all sources (FDI, FII, NRI) cannot exceed 74 per cent. The limit of 74 per cent will be reckoned by taking the direct and indirect holding. At all times, at least 26 per cent of the paid up capital of the private sector bank will have to be held by residents.


7.1 Foreign Direct Investment (FDI)


    1. The policy already articulated in the February 3, 2004 guidelines for determining fit and proper status of shareholding of 5 per cent and above will be equally applicable for FDI. Hence any FDI in private banks where shareholding reaches and exceeds 5 percent either individually or as a group will have to comply with the criteria indicated in the aforesaid guidelines.

(ii) In the interest of diversified ownership, the percentage of FDI by single entity or group of related entities may not exceed 10 percent.


7.2 Foreign Institutional Investors (FIIs)

  1. Currently there is a limit of 10 per cent for individual FII investmentwith the aggregate limit for all FIIs restricted to 24 per cent which can be raised to 49 per cent with the approval of Board / General Body. This dispensation will continue.

  2. The present policy of RBI’s acknowledgement for acquisition/ transfer of shares of 5 percent and more of a private sector bank by FIIs will continue and will now be based upon the policy guidelines on acknowledgement of acquisition/transfer for shares issued on February 3, 2004. For this purpose RBI may seek certification from the concerned FII of all beneficial interest.


7.3 Non Resident Indians (NRIs)

Currently there is a limit of 5 per cent for individual NRI portfolio investment with the aggregate limit for all NRIs restricted to 10 per cent but can be raised to 24 per cent with the approval of Board / General Body. This dispensation will continue. But, the policy guidelines of February 3, 2004 on acknowledgement for acquisition/transfer will be applied.
^
8. Due diligence process

The process of due diligence in all cases of shareholders and directors as above, will involve reference to the relevant regulator, revenue authorities, investigation agencies and independent credit reference agencies as considered appropriate.
^
9. Transition arrangements

  1. The current minimum capital requirements for entry of new banks is Rs. 200 crore to be increased to Rs. 300 crore within three years of commencement of business. A few private sector banks which have been in existence before these capital requirements are prescribed are having less than Rs.200 crore net worth. In the interest of having sufficient minimum size for financial stability, all the existing private banks should also be able to fulfill the minimum net worth requirement of Rs. 300 crore required for new entry. Hence any bank falling below this level will be required to submit a time bound programme for capital augmentation to RBI for approval.

  2. Where any existing shareholding of any individual entity/group of entities is 5 per cent and above, due diligence outlined in the February 3, 2004 guidelines will be undertaken to ensure fulfillment of fit and proper criteria.

  3. Where any existing shareholding by any individual entity / group of related entities is in excess of 10 per cent, the bank will be required to indicate a time table for reduction of holding to the permissible level.

  4. Any bank having shareholding in excess of 5 per cent in any other bank in India will be required to indicate a time bound plan for reduction in such investments to the permissible limit. The parent of any foreign bank having presence in India, having shareholding directly or indirectly through any other entity in the banking group in excess of 5% in any other bank in India will be similarly required to indicate a time bound plan for reduction of such holding to 5 per cent.

  5. Banks will be required to undertake due diligence of directors and Chairman / CEO on basis of criteria that will be separately indicated and provide all the necessary certifications/ information to RBI.

  6. Banks having more than one member of family, close relative or associate on the Board will be required to ensure compliance with this requirement at the time of considering any induction or renewal of terms of such directors.

  7. Action plans submitted by private sector banks outlining the milestones for compliance with the various requirements for ownership and governance will be examined by RBI for consideration and approval.



^ 10. Continuous monitoring arrangements

  1. Where RBI acknowledgment has already been obtained for transfer of shares of 5 per cent and above, it will be the bank’s responsibility to ensure continuing compliance of the fit and proper criteria and provide an annual certificate to the RBI of having undertaken such continuing due diligence,

  2. Similar continuing due diligence on compliance with the fit and proper criteria for directors/CEO of the bank will have to be undertaken by the bank and certified to RBI annually,

  3. RBI may, when considered necessary, undertake independent verification of fit and proper test conducted by banks through a process of due diligence as described in paragraph 8.


11. On the basis of such continuous monitoring, RBI will consider appropriate measures to enforce compliance.

^ ANNEXURE – II


Fit and Proper’ Criteria for Directors of Banks


In exercise of the powers conferred by Section 35A of the Banking Regulation Act, 1949 and on being satisfied that it is necessary and expedient in public interest so to do, the Reserve Bank of India (Circular DBOD.No.BC.104/08.139.001/2003-04 dated June 25, 2004) hereby directs, with immediate effect that:


  1. the banks in private sector should undertake a process of due diligence to determine the suitability of the person for appointment / continuing to hold appointment as a director on the Board, based upon qualification, expertise, track record, integrity and other fit and proper criteria. Banks should obtain necessary information and declaration from the proposed / existing directors for the purpose.

  2. the process of due diligence should be undertaken by the banks in private sector at the time of appointment / renewal of appointment.

  3. the boards of the banks in private sector should constitute Nomination Committees to scrutinize the declarations.

  4. based on the information provided in the signed declaration, Nomination Committees should decide on the acceptance and may make references, where considered necessary to the appropriate authority / persons, to ensure their compliance with the requirements indicated.

  5. banks should obtain annually a simple declaration that the information already provided has not undergone change and where there is any change, requisite details are furnished by the directors forthwith.

  6. the board of the bank must ensure in public interest that nominated / elected directors execute the deeds of covenants as recommended by Dr. Ganguly Group every year.


^ ANNEXURE – III

Guidelines for acknowledgement of transfer/allotment of shares in private sector banks

RBI/2004/38

DBOD.No.PSBS.BC. 64 /16.13.100/2003-04

February 3, 2004

Magh 14, 1925(Saka)

All Scheduled Commercial Banks


Dear Sir,

Guidelines for acknowledgement of transfer/allotment of shares in private sector banks

Please refer to our circulars DBOD.No.BP.BC.68/21.01.055/2001-02 dated February 16, 2002 on foreign direct investment in banking sector and DBOD.No.PSBS.BC.349/16.13.100/99-2000 dated September 21, 1999 on transfer of shares. In paragraphs 4(i) and 2 respectively of the above circulars, banks were advised that transfer of shares of 5 per cent and more of the paid-up capital of a private sector bank requires acknowledgement of RBI.

2. As regards demat shares, banks were advised in terms of our circular DBOD.No.PSBS.BC.182/16.13.100/99-2000 dated May 31, 2000 that they should promote an amendment to their Articles of Association to this effect.

3. With a view to streamlining the procedure for obtaining acknowledgement and removing uncertainties for investors including foreign investors (FDI, FII and NRI) in regard to the allotment or transfer of shares and indicate in a transparent manner the broad criteria followed by RBI for the purpose, it has been decided to issue detailed guidelines as furnished in the Annexure. For private sector banks, it has to be ensured through an amendment to the Articles of Association that no transfer takes place of any acquisition of shares to a level of 5 percent or more of the total paid-up capital of the bank unless there is a prior acknowledgement by the RBI. Boards of private sector banks are advised to take the guidelines into account while seeking acknowledgement for transfer of allotment of shares.

4. Please acknowledge receipt.

Yours faithfully,

( B. Mahapatra )

Chief General Manager

Encl: As above


Guidelines for Acknowledgement of Shares in Private Banks

The Reserve Bank has issued the following guidelines on the grant of acknowledgement for acquisition and transfer of shares in private banks after a review of the operation of existing instructions and recent developments. These guidelines build on the existing policy and clarify and streamline existing procedures for obtaining acknowledgement to remove uncertainties for potential investors, both domestic and foreign, in regard to allotment and transfer of shares in private banks. The guidelines also take into account the use of demat shares, emerging trends in banking and international best practices.

^ Current status

2. As per the existing policy of RBI, any allotment or transfer of shares which will take the aggregate shareholding of an individual or a group to equivalent of five percent and more of the paid-up capital of the bank requires acknowledgement of RBI before the bank can effect the allotment or transfer of shares. The bank is required to approach the Reserve Bank of India with all the relevant details for acknowledgement of transfer/allotment of shares after the Board makes a review. The bank is required to await the Reserve Bank's acknowledgement, for approving the registration of the transfers in their books. Such measures are necessary to protect depositors interest and the integrity of the financial system.

^ Proposed Guidelines for grant of acknowledgement 

3. In order to streamline the procedures for obtaining acknowledgement by removing uncertainties for investors including foreign investors (FDI, FII and NRI) in regard to the allotment or transfer of shares and indicate in a transparent manner the broad criteria followed by RBI for the purpose, the following decisions have been taken.

4. As hitherto, acknowledgement from RBI for acquisition/transfer of shares will be required for all cases of acquisition of shares which will take the aggregate holding of an individual or group to equivalent of 5 percent or more of the paid-up capital of the bank. RBI while granting acknowledgement may require such acknowledgement to be obtained for subsequent acquisition at any higher threshold as may be specified.

5. The term "holding" in paragraph 4 above refers to both direct and indirect holding, beneficial or otherwise. The holdings will be computed with reference to the holding of the applicant, relatives (where the applicant is a natural person) and associated enterprises.

"relative" has the same meaning as assigned under section 6 of the Companies Act, 1956.

"associate enterprise" has the same meaning as assigned under

Section 92A of the Income Tax Act 1991

6. The term "applicant" in these guidelines denotes the applicant, relatives and associate enterprises as indicated in paragraph 5 above.

7. In deciding whether or not to grant acknowledgement, RBI may take into account all matters that it considers relevant to the application, including ensuring that shareholders whose aggregate holdings are above specified thresholds meet the fitness and propriety tests. The application of such tests is a common regulatory mechanism adopted internationally to ensure that the banks are operated in a sound and prudent manner. In this context, the RBI may call for additional information and documents including shareholder agreements while considering the requests for grant of acknowledgement.

^ Illustrative criteria for acknowledgement of transfer of shares

8. In determining whether the applicant (including all entities connected with the applicant) is fit and proper to hold the position of a shareholder, RBI may take into account all relevant factors, as appropriate, including, but not limited to

  • The applicant’s integrity, reputation and track record in financial matters and compliance with tax laws.

  • Whether the applicant has been the subject of any proceedings of a serious disciplinary or criminal nature, or has been notified of any such impending proceedings or of any investigation which may lead to such proceedings.

  • Whether the applicant has a record or evidence of previous business conduct and activities where the applicant has been convicted for an offence under any legislation designed to protect members of the public from financial loss due to dishonesty, incompetence or malpractice.

  • Whether the applicant has achieved a satisfactory outcome as a result of financial vetting. This will include any serious financial misconduct, bad loans or whether the applicant was judged to be bankrupt.

  • The source of funds for the acquisition.

  • Where the applicant is a body corporate, its track record of reputation for operating in a manner that is consistent with the standards of good corporate governance, financial strength and integrity in addition to the assessment of individuals and other entities associated with the body corporate as enumerated above.

9. Where acquisition or investment takes the shareholding of the applicant to a level of 10 percent or more and up to 30 percent, the RBI will also take into account other factors including but not limited to the following: (a) source and stability of the funds for the acquisition and the ability to access financial markets as a source of continuing financial support for the bank, (b) the business record and experience of the applicant including any experience of acquisition of companies, (c) the extent to which the corporate structure of the applicant will be in consonance with effective supervision and regulation of the bank; and (d) in case the applicant is a financial entity, whether the applicant is a widely held entity, publicly listed and a well established regulated financial entity in good standing in the financial community.


10. Acknowledgement for transfer of acquisition or investment exceeding the level of 30 percent will be considered keeping the above criteria in view and also taking into account but not limited to the following (a) the acquisition is in public interest, (b) the desirability of diversified ownership of banks, (c) the soundness and feasibility of the plans of the applicant for the future conduct and development of the business of the bank; and (d) shareholder agreements and their impact on control and management of the bank


^ Compliance with other regulations


11. As hitherto, the RBI acknowledgement will be subject to compliance by the applicant with other applicable laws and regulations such as those issued by SEBI, DCA and IRDA.


Constitution of Independent Advisory Committee.


12. The RBI will constitute an independent Advisory Committee which will make appropriate recommendations to RBI for dealing with applications for grant of acknowledgement as indicated in paragraph 4 above.


Voting Rights etc


13. Voting rights restrictions and other related provisions of the B.R.Act will continue to be applicable as appropriate.


^ Applicability and effective date


14. As stated in paragraph 3, these guidelines are applicable to acknowledgement of acquisition of shares by residents and non-residents above the specified thresholds in private banks. These guidelines will be effective from the date of issue.

^ ANNEXURE – IV


List of recommendations of the Consultative Group of Directors of banks and financial institutions (Dr. Ganguly Group) which may be considered by banks for adoption and Implementation


A. Recommendations which maybe Implemented by all banks

(i) Responsibilities of the Board of Directors


(a) A strong corporate board, should fulfill the following four major roles viz. overseeing the risk profile of the bank, monitoring the integrity of its, business and control mechanisms, ensuring the expert management and maximising the interests of its stakeholders.

(b) The Board of Directors should ensure that responsibilities of directors are well defined and every director should be familiarised on the functioning of the bank before his induction, covering the following essential areas:

  • delegation of powers to various authorities by the Board,

  • strategic plan of the institution

  • organisational structure

  • financial and other controls and systems

  • economic features of the market and competitive environment.


(ii) Role and responsibility of independent and non-executive directors


  1. The independent / non-executive directors have a prominent role in inducting and sustaining a pro-active governance framework in banks.

  2. In order to familiarise the independent /non-executive directors with the environment of the bank, banks may circulate among the new directors a brief note on the profile of the bank, the sub committees of the Board, their role, details on delegation of powers, the profiles of the top executives etc.

  3. It would be desirable for the banks to take an undertaking from each independent and non-executive director to the effect that he/she, has gone through the guidelines defining the role and responsibilities and enter into covenant to discharge his/her responsibilities to the best of their abilities, individually and collectively.


(iii) Training facilities for directors


(a) Need-based taming programmes / seminars / workshops may be designed by banks to acquaint their directors with emerging developments/challenges facing the banking sector and participation in such programmes could make the directors more sensitive to their role.

(b) The Board should ensure that the directors are exposed to the latest managerial techniques, technological developments in banks, and financial markets, risk management systems etc. so as to discharge their duties to the best of their abilities.

(c) While RBI can offer certain training programmes/seminars in this regard at its training establishments, large banks may conduct such programmes in their own training centres.


(iv) Submission of routine information to the Board


Reviews dealing with various performance areas may be put up to the Management Committee of the Board and only a summary on each of the reviews may be put up to the Board of directors at periodic intervals. This will provide the Board more time to concentrate on more strategic issues such as risk profile, internal control systems, overall performance of the bank. etc.


(v) Agenda and minutes of the board meeting


(a) The draft minutes of the meeting should be forwarded to the, directors, preferably via the electronic media, within 48 hours of the meeting and ratification obtained from the directors within a definite time frame. The directors may be provided with necessary technology assistance towards this end.


(b) The Board should review the status of the action taken on points arising from the earlier meetings till action is completed to the satisfaction of the Board, and any pending item should be continued to be put up as part of the agenda items before the Board.
^

(vi) Committees of the Board


(a) Shareholders’ Redressal Committee

As communicated to banks in our circular DBOD No.111/08.138.001/2001-02 dated June 4, 2002 on SEBI Committee on Corporate Governance, the banks which have issued shares/debentures to public may form a committee under the chairmanship of a non-executive director to look into redressal of shareholders’ complaints.


(b) Risk Management Committee

In pursuance of the Risk Management Guidelines issued by the Reserve Bank of India in October 1999, every banking organisation is required to set up Risk Management Committee. The formation and operationalisation of such committee should be speeded up and their role further strengthened.


(c) Supervisory Committee

The role and responsibilities of the Supervisory Committee as envisaged by the Group viz., monitoring of the exposures (both credit and investment) of the bank, review of the adequacy of the risk management process and upgradation thereof, internal control system, ensuring compliance with the statutory / regulatory framework etc., may be assigned to the Management Committee / Executive Committee of the Board.


(vii) Disclosure and transparency


The following disclosures should be made by banks to the Board of Directors at regular intervals as may be prescribed by the Board in this regard.

  • progress made in putting in place a progressive risk management system, and risk management policy and strategy followed by the bank.

  • exposures to related entities of the bank, viz. details of lending to / investment in subsidiaries, the asset classification of such lending/investment, etc.

  • conformity with corporate governance standards viz. in composition of various committees, their role and functions, periodicity of the meetings and compliance with coverage and review functions etc.


B. Recommendations applicable only Public sector banks


(i) Information flow


In order to improve manner in which the proceedings are recorded and followed up in public sector banks, they may initiate measures to provide the following information to the board:

  • A summary of key observations made by the directors, which should be submitted, in the next board meeting.

  • A more detailed recording of the proceedings which will clearly bring out the observations, dissents, etc. by the individual directors which could be forwarded to them for their confirmation.


(ii) Company Secretary


The Company Secretary has important fiduciary and Company Law responsibilities. The Company Secretary is the nodal point for the Board to get feedback on the status of compliance by the organization in regard to provisions of the Company Law, listing agreements, SEBI regulations, shareholder grievances, etc. In view of the important role performed by the Company Secretary vis-à-vis the functioning of the Boards of the banks, as also in the context of some of the public sector banks having made public issue it may be necessary to have Company Secretary for these banks also. Banks should therefore consider appointing qualified Company Secretary as the Secretary to-the Board and have a Compliance Officer (reporting to the Secretary) for ensuring compliance with various regulatory / accounting requirements.


C. Recommendations applicable to private sector banks


(i) Eligibility criteria and ‘fit and proper’ norms for nomination of directors.

  1. The Board of Directors of the banks while nominating / co-opting directors should be guided by certain broad ‘fit and proper’ norms for directors, viz. formal qualification, experience, track record, integrity etc. For assessing integrity and suitability features like criminal records, financial position, civil actions initiated to pursue personal debts, refusal of admission to or expulsion from professional bodies, sanctions applied by regulators or similar bodies, previous questionable business practices etc should be considered. The Board of Directors may, therefore, evolve appropriate systems for ensuring ‘fit and proper’ norms for directors, which may include calling for information by way of self—declaration, verification reports from market, etc.

  2. The following criteria, which is in vogue in respect of nomination to the boards of public sector banks, may also be followed for nominating independent / non-executive directors on private sector banks:

    • The candidate should normally be a graduate (which can be relaxed while selecting directors for the categories of farmers, depositors, artisans, etc.)

    • He / she should be between 35 and 65 years of age.

    • He / she should not be a Member of Parliament / Member of Legislative Assembly / Member of Legislative Council.


(ii) Commonality of directors of banks and non-banking finance companies (NBFC)


In case, a director on the board of an NBFC is to be considered for appointment as director on the board of the bank, the following conditions must be followed:

  • He/she is not the owner of the NBFC, [i.e., share holdings (single or jointly with relatives, associates, etc.) should not exceed 50%],

  • He/she is not related to the promoter of the NBFC

  • He/she is not a full-time employee in the NBFC.

  • The concerned NBFC is not a borrower of the bank.


(iii) Composition of the Board


In the context of banking becoming more complex and competitive, the composition of the Board should be commensurate with the business needs of the banks. There is an urgent need for making the Boards of banks more contemporarily professional by inducting technical and specially qualified personnel. Efforts should be aimed at bringing about a blend of ‘historical skills’ set, i.e. regulation based representation of sectors like agriculture, SSI, cooperation etc. and the ‘new skills’ set, i.e. need based representation of skills such as, marketing, technology and systems, risk management, strategic planning, treasury operations, credit recovery etc. The above suggestions may be kept in view while electing / co-opting directors to their boards.

^ ANNEXURE - V


Summary of the important Recommendations of the SEBI’s Committee on Corporate Governance


The Securities and Exchange Board of India (SEBI) had constituted a Committee on Corporate Governance and circulated the recommendations to all stock exchanges for implementation by listed entities as part of the listing agreement vide SEBI’s circular SMDRP/Policy/CIR-10/2000 dated February 21, 2000. Full text of recommendations of the Committee which form part of the above circular can be had by access to SEBI’s website, www.sebi.gov.in/circulars/2000. A summary of the important recommendations of the SEBI Committee as applicable to banks is furnished here under:

  1. All pecuniary relationship or transactions of the non-executive directors should be disclosed in the annual report.

  2. The Committee is of the view that non-executive directors help bring an independent judgement to bear on board’s deliberations, especially on issues of strategy, performance, management of conflicts and standards of conduct. The Committee therefore lays emphasis on the calibre of the non-executive directors, especially of the independent directors.

  3. The Committee is of the view that it is important that an adequate compensation package be given to the non-executive independent directors so that these positions become sufficiently financially attractive to attract talent and that the non-executive directors are sufficiently compensated for undertaking this work.




  1. The Committee recommends that the board of a company have an optimum combination of executive and non-executive directors with not less than fifty per cent of the board comprising the non-executive directors. The number of independent directors depends on the nature of the chairman of the board. In case a company has a non-executive chairman, at least half of board should be independent (Mandatory recommendation).




    1. The Committee recommends that when a nominee of the institutions is appointed as a director of the company, he should have the same responsibility, be subject to the same discipline and be accountable to the shareholders in the same manner as any other director of the company. In particular, if he reports to any department of the institutions on the affairs of the company, the institution should ensure that there exist Chinese walls between such department and other department which may be dealing in the shares of the company in the stock market.




    1. The Committee recommends that a non-executive Chairman should be entitled to maintain a Chairman’s office at the company’s expense and also allowed reimbursement of expenses incurred in performance of his duties. This will enable him to discharge the responsibilities effectively.




    1. The Committee recommends that a qualified and independent audit committee should be set up by the board of a company (Mandatory recommendation)




    1. The Committee recommends that -




  • the audit committee should have a minimum of three members, all being non-executive directors, with the majority being independent and with at least one director having financial and accounting knowledge;

  • the chairman of the committee should be an independent director;

  • the chairman should be present at the Annual General Meeting to answer shareholder queries;

  • the audit committee should invite such of the executives, as it considers appropriate (and particularly the head of the finance function) to be present at the meetings of the Committee but on occasions it may also meet without the presence of any executives of the company. The finance director and head of internal audit and when required, a representative of the external auditor should be present as invitees for the meetings of the audit committee;

  • the Company Secretary should act as the secretary to the committee.


4.3 The Committee recommends that the audit committee should meet at least thrice a year. One meeting must be held before finalisation of annual accounts and one necessarily every six months (Mandatory recommendation).


4.4 The quorum should be either two members or one-third of the members of the audit committee, whichever is higher and there should be a minimum of two independent directors (Mandatory recommendation).


4.5 Being a committee of the board, the audit committee derives its powers from the authorization of the board. The Committee recommends that such powers should include powers:


1. To investigate any activity within its terms of reference.

2. To seek information from any employee.

3. To obtain outside legal or other professional advice.

  1. To secure attendance of outsiders with relevant expertise, if it considers necessary.


4.6 As the audit committee acts as the bridge between the board, the statutory auditors and internal auditors, the Committee recommends that its role should include the following:


 Oversight of the company’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible.

 Recommending the appointment and removal of the external auditor, fixation of audit fee and also approval for payment for any other service.

 Reviewing with management the annual financial statements before submission to the board, focusing primarily on:


  • Any changes in accounting policies and practices.

  • Major accounting entries based on exercise of judgement by management.

  • Qualifications in draft audit report.

  • Significant adjustment arising out of audit.

  • The going concern assumption.

  • Compliance with accounting standards.

  • Compliance with stock exchange and legal requirement concerning financial institutions.

  • Any related party transactions i.e. transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives, etc., that may have potential conflict with the interests of company at large.

  • Reviewing with the management, external and internal auditors, the adequacy of internal control systems.

  • Reviewing the adequacy of the internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading the department, reporting structure, coverage and frequency of internal audit.

  • Discussion with the internal auditors of any significant findings and follow-­up thereon.

  • Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board.

 Discussion with external auditors, before the audit commences, of the nature and scope of audit. Also post-audit discussion to ascertain any area of concern.

 Reviewing the company’s financial and risk management policies.

 Looking into the reasons for substantial defaults in the payments to the depositors, debenture holders, shareholders (in case of non-payment of declare dividends) and creditors.


This is a mandatory recommendation.


5.1 The Committee recommends that the board should set up a remuneration committee to determine on their behalf and on behalf of the shareholders with agreed terms of reference, the company’s policy on specific remuneration packages for executive directors including pension rights and any compensation payment.


6.1 The Committee therefore recommends that board meetings should be held at least four times in a year, with a maximum time gap of four months between any two meetings. The minimum information should be available to the board (Mandatory recommendation).


6.2 The committee recommends that a director should not be a member in more than 10 committees or act as Chairman of more than five committees across all companies in which he is a director. Furthermore, it is a mandatory annual requirement for every director to inform the company about the committee positions he occupies in other companies and notify changes as and when they take place (Mandatory recommendation).


7.1 The recommendations contained in this section pertain to accounting standards on consolidation, segment reporting, disclosure and treatment of related party transactions and deferred taxation. The Committee recommended that the Institute of Chartered Accountants of India issue accounting standards on these areas expeditiously.


8.1 As a part of the disclosure related to Management, the Committee recommends that as part of the directors’ report or as an addition thereto, a Management Discussion and Analysis report should form part of the annual report to the shareholders (Mandatory recommendation).


8.2 The committee recommends that disclosures be made by management to the, board relating to all material financial and commercial transactions, where they have personal interest, that may have a potential conflict with the interest of the company at large (for e.g. dealing in company shares, commercial dealings with bodies which have shareholding of management and their relatives etc. (Mandatory recommendation).


9.1 The Committee recommends that in case of the appointment of a new director or re-appointment of a director the shareholders must be provided with the following information:


  • A brief resume of the director;

  • Nature of his expertise in specific financial areas; and

  • Names of the companies in which the person also holds the directorship and the membership of Committees of the board.


This is a mandatory recommendation.


9.2 The Committee recommends that information like quarterly results, presentation made by companies to analysts may be put on company’s website 6r may be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own website (Mandatory recommendation).


9.3 The Committee recommends that the half-yearly declaration of financial performance including summary of the significant events in last six months, should be sent to each household of shareholders.


9.4 The Committee recommends that a board committee under the chairmanship of a non-executive director should be formed to specifically look into the redressing of shareholder complaints like transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends etc. The Committee believes that the formation of such a committee will help focus the attention of the company on shareholders’ grievances and sensitize the management to redressal of their grievances (Mandatory recommendation).


9.5 The Committee further recommends that to expedite the process of share transfers the board of the company should delegate the power of share transfer to an officer, or a committee or to the registrar and share transfer agents. The delegated authority should attend to share transfer formalities at least once in a fortnight (Mandatory recommendation).


10 The Committee recommends that there should be a separate section on Corporate Governance in the annual reports of companies, with a detailed compliance report on Corporate Governance. Non-compliance of any mandatory recommendation with reasons thereof and the extent to which the non-mandatory recommendations have been adopted should be specifically highlighted. This will enable the shareholders and the securities market to assess for themselves the standards of corporate governance followed by a company. (Mandatory recommendation).

 Lecture delivered by Shri Vepa Kamesam, Chairman, Governing Council, Institute for Development and Research in Banking Technology (IDRBT), Hyderabad and former Dy. Governor of RBI, to the senior level IAS Officers at Administrative Staff College of India, Hyderabad on 21st September, 2004. Speaker gratefully acknowledges source material from various publications of RBI.







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