Date: 6 January, 2021
by Anmol Kaur Sidhu, UILS, Panjab University
Corporate Governance can be defined as an arrangement to bring in line the interests of its investors and managers ensuring that the corporate body/institutions are run for the benefit of the investors.
It includes all the systems, processes and structures that help in the successful operation of organizations.
CORPORATE GOVERNANCE IN BANKING SECTOR
Banks are considered the largest financial intermediaries in the world and hence have a lot of powers.
Government plays a direct role in governance of banks through regulation and supervision as they need to ensure financial stability and deposit insurance liability considerations.
Banks enjoy the downside protection of deposit insurance that weakens their incentives for strong management monitoring. While a constantly encountered form of corporate control and concentrated ownership will raise new barriers to effective corporate governance, large investors can manipulate the corporate institutions contrary to the broad interests of the bank and other stakeholders.
Shareholders can arrange loans for firms they own or perform those business transactions to profit themselves at the expense of the bank thereby exposing the bank to higher risk activities in which they benefit on the upside but the bank bears the brunt of failure.
Banks and non-bank financial intermediaries can alter the risk composition of their assets more quickly than most non-financial industries. Moreover, the banks can readily hide problems by extending loans to clients that cannot service previous debt obligations.
In most sectors, when inventories of goods pile up, be it cars or computers is considered a negative sign of the company’s performance. But when inventories of money pile up liquidity is considered to be improved. It is hard to determine whether this is a negative signal or a prudent response by management to a risky environment.
CORPORATE GOVERNANCE BY RBI
Given the important place occupied by the public sector entities in the fields of industry and financial sector, any steps to improve corporate governance in the Indian economy would remain incomplete and half-hearted unless public sector units are also covered in this exercise.
Multiple layering of 'principal-agent' chains in the case of government-owned entities has important consequences for the corporate governance mechanisms that will be adopted in them.
Often the accountability chain is very weak in public sector units. The first important step to improve the governance mechanism in these units is to transfer the actual governance functions from the concerned administrative ministries to the boards and also strengthen them by streamlining the appointment process of directors.
The process of selecting directors should be made highly credible by entrusting the task to a specially constituted body of eminent experts with an independent and high status like the Union Public Service Commission.
Both the government and RBI need to bring about significant changes in the corporate governance mechanism adopted by banks and other financial intermediaries. As a matter of principle, RBI should not appoint its nominees on the boards of banks to avoid conflict of interests.
Current governance practices adopted by the PSBs have created inequality among different types of directors. Special status amounting to veto powers given to government directors is not in the interest of good corporate governance. So the banks need to have greater transparency to function properly.
In the end, we can conclude that Corporate governance of banks is an inevitable component of a country’s governance architecture. It has systemic financial stability implications and shapes the pattern of credit distribution along with an overall supply of financial services. Therefore there’s a need to have effective corporate governance in the banking sector.