Corporate Governance in Banking and Financial Institutions

Article excerpt

Introduction

A social institution, including a corporate entity, derives its legitimacy from its ability and desire to fulfill social needs. It is therefore, accountable to the society. No institution, however high and mighty it is, can ignore its responsibility towards the society from which it derives its strength and sustenance.

The recurring financial crises and the scams that rocked the nation in the recent past call for a sharper focus on corporate governance. The only way one can protect their interest and also those of the public at large is to build "firewalls" by putting in place the practices of good corporate governance. To quote famous observations on the subject Former Union Finance Minister Shri Yashwant Sinha:

"Today we need a pragmatic approach rather than a narrow doctrinaire approach to serve our needs. It is essential that we have high ethical standards of corporate governance, followed voluntarily, having community sanctions which will have much more effectiveness. Only then our endeavour at economic reforms and liberalization will fructify."

Mr. J. Wolfensohn, President, World Bank:

"Corporate Governance is about promoting corporate fairness, transparency and accountability".

What is Corporate Governance?

Corporate Governance has succeeded in attracting a good deal of public interest because of its importance for the economic health of corporations and the welfare of society, in general. However, the concept of corporate governance is defined in several ways because it potentially covers the entire gamut of activities having direct or indirect influence on the financial health of the corporate entities.

It would be useful to recall the earliest definition of Corporate Governance by the Economist and Noble laureate Milton Friedman. According to him, "Corporate governance is to conduct the business in accordance with owner or shareholders' desires, which generally will be to make as much money as possible, while conforming to the basic rules of the society embodied in law and local customers".

Corporate Governance in the present day context encompasses the interests of not only the shareholders but also many stakeholders, which includes, employees, customers, suppliers and the community. Due to the unique role of banks in national and local economies and financial system systems, supervisors and governments are also stakeholders.

Corporate Governance for Industry

The Organization for Economic Co-operation and Development (OECD) defines corporate governance as involving--"a set of relationship between a company's management, its board, its shareholders, and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objective and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and shareholders and should facilitate effective monitoring, thereby encouraging firms to use resources more efficiently."

Let us have a look at the Basel Committee Publication on corporate governance for banking organizations:

Basel Committee published a paper on Corporate Governance for banking organizations in September 1999. The Committee feels, it is the responsibility of the banking supervisors to ensure that there is effective corporate governance in the banking industry. Supervisory experience underscores the need of having appropriate accountability and checks and balances within each bank to ensure sound corporate governance, which in turn, would lead to effective and more meaningful supervision. Sound corporate governance could also contribute to a collaborative working relationship between bank managements and bank supervisors.

Basel committee underscores the need for banks to set strategies for their operations. …