Deepali Pant Joshi: NISM Conference on ethics and corporate
governance
Speech by Dr Deepali Pant Joshi, Executive Director of the Reserve Bank of India, at the
National Institute of Securities Markets Conference on ethics and corporate governance,
Kolkata, 11 December 2013.
* * *
Introduction
At the outset, let me congratulate the organisers for this topical choice of subject, one which
concerns us all. I thank Director, National Institute of Securities Markets, Dr Sandip Ghose
and the Institute of Company Secretaries for having me here and my dear friend, Prashant
Saran, for that brilliant opening address, which quite sets the tone for this panel.
Que custodiet ipso custodes? Who will guard the guards ?
Over the last two decades, corporate governance has attracted a great deal of public
interest, it is now widely appreciated that this is critical for the economic health of
Corporations and of larger society. The headlines of newspapers of the past few years in
particular, portray a dismal story of lack of corporate ethics: Satyam, Enron, falling stock
markets, corporate failures, dubious accounting practices, abuses of corporate power,
criminal investigations reflect that the entire economic system on which investment returns
depend is showing signs of infirmity and stress that have undermined investor confidence.
Almost as if checks and balances that should protect our interests are pushed to one side,
driven by the overwhelming need to move fast in relentless pursuit of profits. Notably some
failures were the result of fraudulent accounting and other illegal practices, others were just
bad governance.
Company Boards or Old Boy's Clubs?
Company Boards often deteriorate to being a cosy club, friends of the boss, who just met to
rubber stamp his decisions. I read the Economist (of 7th December) on flight, and the turn of
phrase (on page 67) was interesting. Critics have compared directors to "parsley on fish",
decorative but ineffectual; or honorary colonels, ornamental in parade but fairly useless in
battle". Ralph Nader calls them "cuckolds" who are always the last to know when managers
have erred.
The corporate scandals of the early 2000s forced boards to take a more active role. The
Sarbanes-Oxley Act of 2002 and the New York Stock Exchange's New Rules in 2003 obliged
directors to take more responsibility for preventing fraud and self-dealing. This led to a big
increase in the quality of boards. But it also wasted a lot of talent on form-filling and
boxticking. Many of the same companies exhibited actual corporate governance risks such as
conflicts of interest, inexperienced directors, overly lucrative compensation, or unequal share
voting rights. In the face of such scandals and malpractices, there has been a renewed
emphasis on corporate governance.
OECD definition of corporate governance
"Corporate governance is the system by which business corporations are directed and
controlled. The corporate governance structure specifies the distribution of rights and
responsibilities among different participants in the corporation, such as, the board,
managers, shareholders and other stakeholders and spells out the rules and procedures for
making decisions in corporate affairs. By doing this, it also provides the structure through
which the company objectives are set and the means of attaining those objectives and
monitoring performance"
Thus corporate governance includes within its ambit, the relationship of a company to its
shareholders and to society; the promotion of fairness, transparency and accountability;
reference to mechanisms that are used to "govern" managers and to ensure that the actions
taken by them are consistent with the interests of key stakeholder groups. The salient
features span issues of transparency and accountability, the legal and regulatory
environment, appropriate risk management measures, information flows, the responsibility of
senior management and the board of directors.
The Banking Regulation Act
Section 10A of the Banking Regulation Act lays down stipulations for the Board of Directors.
They must have special knowledge of the following

Accountancy

Agriculture and Rural Economy
 Banking

Cooperation

Economics

Finance

Law
 Small Scale Industry

Or any other matter, the special knowledge of, and practical experience in
which, in the opinion of the Reserve Bank, would be useful to the Banking
Company. Provided that out of the aforesaid number of Directors, not less
than two shall have special knowledge of, practical experience, with respect to
agriculture and the rural economy, cooperation or small scale industry and
shall not (i) have substantial interest in, or be connected with, whether as an
employee, manager or managing agent,

Any company, not being a company registered under section 25 of the
Companies Act, 1956 (1 to 1956), or

Any firm, which carries on any trade, commerce or industry and which, in
either case, is not a small scale industrial concern, or (ii) be proprietors of any
trading, commercial or industrial concern, not being a small scale industrial
concern.
Voting rights will be distributed amongst the Board of Directors in a manner such that no
more than three Directors are entitled to exercise voting rights in excess of twenty percent of
the total voting rights of all the shareholders to the Banking Entity.
The tenure of Directors except the Chairman or the whole time director is limited to eight
continuous years.
The Chairman of the Board (appointed on a whole time basis) or the Managing Director of
the Banking entity and any Director (appointed by the Reserve Bank under Section 10A of
the Banking Regulation Act) will not be required to hold qualification shares in the Banking
Entity.
The RBI has the power, from time to time, to appoint one or more persons to hold office as
additional directors of any Banking Company, if it is of the opinion that the same is in the
interests of banking Policy/public interest/banking company depositors, it may also require
the banking company to elect or appoint any other person as the Chairman in case it is of the
opinion that the current elected Chairman is not a fit and proper person to hold such office.
Requirements of Corporate Governance as per the RBI guidelines on Corporate
Governance
RBI issues guidelines on corporate governance for public sector banks which serve as a
base for the Corporate Governance framework in Banks.
Banks must perform due diligence of the directors in regard to their suitability for appointment
to the Board by way of qualifications and technical expertise. The Government should also
be guided by certain "fit and proper" norms for the appointment of Directors representing the
Government on the Boards of Public sector banks.
Banks need to elect 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 Banks paid up capital.
Executive Directors (EDs) are eligible for appointment as Chairman of the Board of Directors
on fulfilment of the following criteria vesting in having served in the position and residual
tenure.
Guidelines on the number of EDs - Small Banks with business of less than INR 1.5 lakh
crore may have two EDs with the responsibilities of the second Director including human
resource development and technology. Large banks with business of more than Inr 3 lakh
crore may have three EDs, the third with responsibility for HRD and Technology.
I have been a Director on the Board of Andhra Bank, I found that the Boards of Banks are
hedged with innumerable Committees - there are Management Committee, Credit Approval
Committee, Audit Committee, Risk management Committee, Special Committee to monitor
large Value Frauds/Anti-Fraud Committee, Asset Liability Committee, Customer Service
Committee, Shareholders Investors Grievance Committee, Share Transfer Committee,
Remuneration Committee and so on and so forth and yet the state of Management and
Corporate Governance in public sector banks remains a cause of grave concern.
As Deputy Governor, Dr. Chakrabarty, recently pointed out (Bancon address), if restructured
assets show further deterioration surely the appraisal mechanisms were weak RAROC Risk
adjusted Return on Capital was not correctly computed. The mechanisms of Corporate
Governance surely merit much greater attention.
Regulator as supervisor
Banks constitute the largest financial intermediaries globally and possess stupendous
powers of leverage. The RBI plays a direct role in Bank governance through the regulation
and supervision of Banking Institutions. This role assumes greater salience viewed in
conjunction with the need to ensure systemic and financial stability. Banks enjoy the benefit
of high leverage with the downside protection of deposit insurance which weakens their
incentives for strong management. They also remain "Too Big to Fail" (TBTF).
The current Basel accord lays even greater stress on risk measurement and management.
Bank Supervisors must make the Boards of banks the main locus of accountability and
assess board effectiveness. Regulatory and supervisory systems that foster more accurate
information disclosure and empower private investors, legal rights, substantially boost
banking system and profitability. Large investors may manipulate the firm contrary to the
broad interests of Banks and other shareholders.
The task of the Bank supervisor is indeed onerous. Information asymmetries plague all
sectors but this is even more tangential in finance; in product or other service markets,
purchasers part with money in exchange for something new. In finance, money is exchanged
for a promise to pay in the future. In many product or service markets, if the product sold - a
car or a haircut is defective, the buyers often find out relatively soon. However, loan quality is
not readily observable for quite some time and can be hidden for extensive periods. Banks
can also alter the risk composition of their assets more quickly than most non-financial
industries. Banks can also sweep problems under the carpet by extending further loans to
clients that cannot service previous debt obligations. In most sectors where there is an
inventory pileup, be it cars or computers, it is generally a negative sign about the company's
performance but when inventories of money pile up in a bank, it becomes more liquid.
It is much harder to sort out whether this is a negative signal or a prudent response by
management to a risky environment. Corporate governance of Banks is an essential element
of sound regulatory architecture. The regulatory response is an imperative of ethics.
Is the business of business just business?
Milton Friedman had a view that corporate executive's responsibility generally will be to make
as much money as possible while conforming to their basic rules of the society, both, those
embodied in law and those embodied in ethical custom. The objective is the maximisation of
consumption and production. "The business of business is just business". This is not an
axiom one can concur with. If you consider the business of Companies historically, it has
embraced colonialism and slavery! So the element of ethics must always underlie necessity
of both business personal and organisational conduct.
Formal codes of ethics
While many of the governance issues that organizations face are not new, the environment
in which they confront them today is more challenging than ever. Many companies are
adopting legal compliance mechanisms which address ethics or conduct issues in formal
documents.
RBI ethics@work
The RBI, with the assistance of Professor Dipankar Gupta, who is also a Director on the RBI
Central Board, has formulated a Code of Conduct for itself, which we term ethics@work. You
may well ask, why an ethics manual and I quote from the ethics manual
"An Ethics Manual promotes:
 Solidarity among colleagues;

Pride and commitment to working for the Organization;

Personal Aspirations that are aligned with organizational goals."
The ethics manual is expected

To define and clearly set out what will be deemed to be acceptable behaviour.

We hope that this will promote and ensure high standards of practice

And also establish a benchmark for self-evaluation
 Lay down the mainframe for professional behaviour and responsibilities

Enable a sense of occupational identity Ideals we can clearly ascribe to.
The written code of ethics will be useful for socialization of our new recruits in the
organization, serve as an implement of employee training. Be a benchmark transgression of
the same, will invite disciplinary action. It will also help in dispute and conflict management.
The moral dilemmas, the approach-approach conflicts will be more easily resolved with
reference to the touchstone of the code of ethics. It clarifies the organisation's expectations
from the employee and vests on enshrining complete transparency. This is a formal code of
business conduct and ethics, to be ascribed to and strictly adhered to by all employees. It is
morally incumbent upon them to do so.
Some organisations also have ethics officers but in the ultimate analysis, the foundations of
ethical behaviour go well beyond corporate culture and policies. These are rooted in one's
moral training, lessons parents and school teachers have taught from early childhood on
which affect not just individual behaviour the competitive business environment and indeed
society as a whole.
Conclusion
From an ethical dimension, at a fundamental level, the key issues of corporate governance
involve questions concerning relationships and building trust (both within and outside the
Nichomacnean Ethics
organization. Aristotle, in the explained that it is "in justice" that the
ordering of society is centered.
Ethics comes from the Greek ethos and embraces both work ethics and "mores" - the
conduct and culture of the organisation. It is therefore all encompassing and must be all
pervasive.