Corporate governance has become an issue of global importance. Corporate governance is the set of
processes, customs, policies, laws and institutions affecting a corporation is directed, administered or
controlled. Corporate governance also includes the relation among the players (the stakeholders)
involved and the goals for which the corporation is governed. The principal players are the shareholders,
management and the board of directors. Other players are the employees, suppliers, customers, banks
and other lenders, regulators, the environment and the society at large.
“Corporate governance – which can be defined narrowly as the relationship of a company to its
shareholders or, more broadly, as its relationship to society….”
- Financial Times, 1997.
Corporate governance is a multi-faced subject. An important part of corporate governance deals with
accountability, fiduciary duty and mechanisms of auditing and control. In this sense, corporate players
should comply with codes to the overall good of all constituents. Another important focus is economic
efficiency, both within the corporation (best practices guidelines) as well as externally (national
institutional frameworks). The concept of government controlling the commanding heights of the
economy has been given up. This, in turn, has made the market the most decisive factor in setting
economic issues. This has also coincided with the thrust given to globalization because of the setting up
of the WTO and every member of the WTO trying to bring down the tariff barriers. Globalization
involves the movement of four economic parameters namely, physical capital in terms of plant and
machinery, financial capital in terms of money invested in capital markets, technology, labor moving
across national border. The pace of movement of financial capital has become greater because of the
pervasive impact of information technology and the world having become a global village.
Corporate governance represents the value framework, the ethical framework and the moral framework
under which business decisions are taken. In other words, when an investor wants to be sure that not
only is their capital handled effectively and adds to the creation of wealth, but the business decisions
are also taken in manner which is not illegal or involving more hazards.
Corporate governance therefore calls for three factors:
1. Transparency in decision making.
2. Accountability which follows from transparency because responsibilities could br fixed easily for
actions taken or not taken
3. The accountability is for the safeguarding the interests of the stakeholders and the investors in
the organization. Implementation of corporate governance has depended upon laying down
explicit code which enterprises and the organizations are supposed to observe.
Principles of corporate governance
Key elements of good corporate governance principles include honesty, trust and integrity, openness,
performance, orientation, responsibility and accountability, mutual respect and commitment to the
organization. Of importance is how directors and the management develop model of governance that
aligns the values of the corporate participants and then evaluate this model periodically for its
Commonly accepted principles include:
1. Rights and Equitable treatment of Shareholders.
2. Interests of Stakeholders.
3. Role and Responsibilities of the Board.
4. Integrity and Ethical behavior.
5. Disclosure and Transparency.
Banks, in a broad sense, are institutions whose business is handling other people’s money. A joint stock
bank, also known as commercial bank, is a company whose business is banking. These are more
particularly institutions that deal directly with the general public, as opposed to the merchant banks and
other institutions more concerned with trade and industry. Further, there are also investment banks
which acquire shares in limited companies on their own account, and not merely as agents for their
customers. Sometimes, banks are set up to handle specialized functions for particular industries such as
the Industrial Development Bank of India (IDBI), National Bank for Agricultural and Rural Development
(NABARD) and Export-Import Bank (EXIM Bank).
Banks are thus a critical component of any economy. They provide financing for commercial enterprises,
basic financial services to a broad segment of the population and access to payment systems. In
addition, some banks are expected to make credit and liquidity available in difficult market conditions.
The importance of banks to national economies is underscored by the fact that banking is virtually
universally a regulated industry and that banks have access to government safety nets. It is of crucial
importance, therefore, that banks have strong corporate governance.
There has been a great deal of attention given recently to the issue of corporate governance in various
national and international forums. In particular, the OECD has issued a set of corporate governance
standards and guidelines to help governments in their efforts to evaluate and improve the legal,
institutional and regulatory framework for corporate governance in their countries, and to provide
guidance and suggestions for stock exchanges, investors, corporations, and other parties that have a
role in the process of developing good corporate governance”.
Corporate Governance in India – A Background
The history of the development of Indian corporate laws has been marked by interesting contrasts. At
independence, India inherited one of the world’s poorest economies but one which had a factory sector
accounting for a tenth of the national product; four functioning stock markets (predating the Tokyo
Stock Exchange) with clearly defined rules governing listing, trading and settlements; a well-developed
equity culture if only among the urban rich; and a banking system replete with well-developed lending
norms and recovery procedures.24 In terms of corporate laws and financial system, therefore, India
emerged far better endowed than most other colonies. The 1956 Companies Act as well as other laws
governing the functioning of joint-stock companies and protecting the investors’ rights built on this
The beginning of corporate developments in India were marked by the managing agency system that
contributed to the birth of dispersed equity ownership but also gave rise to the practice of management
enjoying control rights disproportionately greater than their stock ownership. The turn towards
socialism in the decades after independence marked by the 1951 Industries (Development and
Regulation) Act as well as the 1956 Industrial Policy Resolution put in place a regime and culture of
licensing, protection and widespread red-tape that bred corruption and stilted the growth of the
corporate sector. The situation grew from bad to worse in the following decades and corruption,
nepotism and inefficiency became the hallmarks of the Indian corporate sector. Exorbitant tax rates
encouraged creative accounting practices and complicated emolument structures to beat the system.
In the absence of a developed stock market, the three all-India development finance institutions (DFIs) –
the Industrial Finance Corporation of India, the Industrial Development Bank of India and the Industrial
Credit and Investment Corporation of India – together with the state financial corporations became the
main providers of long-term credit to companies. Along with the government owned mutual fund, the
Unit Trust of India, they also held large blocks of shares in the companies they lent to and invariably had
representations in their boards. In this respect, the corporate governance system resembled the bank-
based German model where these institutions could have played a big role in keeping their clients on
the right track. Unfortunately, they were themselves evaluated on the quantity rather than quality of
their lending and thus had little incentive for either proper credit appraisal or effective follow-up and
monitoring. Their nominee directors routinely served as rubber-stamps of the management of the day.
With their support, promoters of businesses in India could actually enjoy managerial control with very
little equity investment of their own. Borrowers therefore routinely recouped their investment in a short
period and then had little incentive to either repay the loans or run the business. Frequently they bled
the company with impunity, siphoning off funds with the DFI nominee directors mute spectators in their
This sordid but increasingly familiar process usually continued till the company’s net worth was
completely eroded. This stage would come after the company has defaulted on its loan obligations for a
while, but this would be the stage where India’s bankruptcy reorganization system driven by the 1985
Sick Industrial Companies Act (SICA) would consider it “sick” and refer it to the Board for Industrial and
Financial Reconstruction (BIFR). As soon as a company is registered with the BIFR it wins immediate
protection from the creditors’ claims for at least four years. Between 1987 and 1992 BIFR took well over
two years on an average to reach a decision, after which period the delay has roughly doubled. Very few
companies have emerged successfully from the BIFR and even for those that needed to be liquidated,
the legal process takes over 10 years on average, by which time the assets of the company are
practically worthless. Protection of creditors’ rights has therefore existed only on paper in India. Given
this situation, it is hardly surprising that banks, flush with depositors’ funds routinely decide to lend only
to blue chip companies and park their funds in government securities.
Financial disclosure norms in India have traditionally been superior to most Asian countries though fell
short of those in the USA and other advanced countries. Noncompliance with disclosure norms and even
the failure of auditor’s reports to conform to the law attract nominal fines with hardly any punitive
action. The Institute of Chartered Accountants in India has not been known to take action against erring
While the Companies Act provides clear instructions for maintaining and updating share registers, in
reality minority shareholders have often suffered from irregularities in share transfers and registrations
– deliberate or unintentional. Sometimes non-voting preferential shares have been used by promoters
to channel funds and deprive minority shareholders of their dues. Minority shareholders have
sometimes been defrauded by the management undertaking clandestine side deals with the acquirers in
the relatively scarce event of corporate takeovers and mergers.
Boards of directors have been largely ineffective in India in monitoring the actions of management. They
are routinely packed with friends and allies of the promoters and managers, in flagrant violation of the
spirit of corporate law. The nominee directors from the DFIs, who could and should have played a
particularly important role, have usually been incompetent or unwilling to step up to the act.
Consequently, the boards of directors have largely functioned as rubber stamps of the management.
For most of the post-Independence era the Indian equity markets were not liquid or sophisticated
enough to exert effective control over the companies. Listing requirements of exchanges enforced some
transparency, but non-compliance was neither rare nor acted upon. All in all therefore, minority
shareholders and creditors in India remained effectively unprotected in spite of a plethora of laws in the
Corporate Governance in Banks
Why Corporate Governance in Banks?
If we examine the need for improving corporate governance in banks, two reasons stand out:
i. Banks exist because they are willing to take on and manage risks. Besides, with the rapid pace of
financial innovation and globalization, the face of banking business is undergoing a sea-change.
Banking business is becoming more complex and diversified. Risk taking and management in a
less regulated competitive market will have to be done in such a way that investors’ confidence
is not eroded.
ii. Even in a regulated set-up, as it was in India prior to 1991, some big banks in the public sector
and a few in the private sector had incurred substantial losses. This, along with the massive
failures of non-banking financial Companies (NBFCs), had adversely impacted investors’
Moreover, protecting the interests of depositors becomes a matter of paramount importance to banks.
In other corporates, this is not and need not be so for two reasons:
i. The depositors collectively entrust a very large sum of their hard- earned money to the care of
banks. It is found that in India, the depositor’s contribution was well over 15.5 times the
shareholders’ stake in banks as early as in March 2OO1. This is bound to be much more now.
ii. The depositors are very large in number and are scattered and have little say in the
administration of banks. In other corporates, big lenders do exercise the right to direct the
management. In any case, the lenders’ stake in them might not exceed 2 or 3 times the owners’
Banks deal in people’s funds and should, therefore, act as trustees of the depositors. Regulators the
world over have recognized the vulnerability of depositors to the whims of managerial misadventures in
banks and, therefore, have been regulating banks more tightly than other corproates.
To sum up, the objective of governance in banks should first be protection of depositors’ interests and
then be to “optimise” the shareholders’ interests. All other considerations would fall in place once
these two are achieved.
As part of its ongoing efforts to address supervisory issues, the Basel Committee on Banking
Supervision (BCBS) has been active in drawing from the collective supervisory experience of its
members and other supervisors in issuing supervisory guidance to foster safe and sound banking
practices. The committee was set up to reinforce the importance for banks of the OECD principles, to
draw attention to corporate governance issues addressed by previous committees, and to present some
new topics related to corporate governance for banks and their supervisors to consider.
Banking supervision cannot function effectively if sound corporate governance is not in place and,
consequently, banking supervisors have a strong interest in ensuring that there is effective corporate
governance at every banking organisation. Put plainly, sound corporate governance makes the work of
supervisors infinitely easier. Sound corporate governance can contribute to a collaborative working
relationship between bank management and bank supervisors.
Recent sound practice papers issued by the Basel Committee underscore the need for banks to set
strategies for their operations and establish accountability for executing these strategies. In addition,
transparency of information related to existing conditions, decisions and actions is integrally related to
accountability in that it gives market participants sufficient information with which to judge the
management of a bank.
Corporate Governance in Indian Banks
Although the subject of corporate governance has received a lot of attention in recent times in India,
corporate governance issues and practices by Indian banks have received only a scanty notice. The
question of corporate governance in banks is important for several reasons:
First, banks have an overwhelmingly dominant position in developing the economy s financial system,
and are extremely important engines of growth.
Second, as the country’s financial markets are underdeveloped, banks in India are the most significant
source of finance for a majority of firms in Indian industry.
Third, banks are also the channels through which the country’s savings are collected and used for
Fourth, India has recently liberalised its banking system through privatisation, disinvestments and has
reduced the role of economic regulation and consequently managers of banks have obtained greater
autonomy and freedom with regard to runnnig of banks. This would necessitate their observing best
corporate practices to regain the investors’ confidence now that the government authority does not
protect them anymore.
Corporate governance in banks has assumed importance in India post-1991 reforms because
competition compelled banks to improve their performance. Even the majority of banks and financial
institutions, owned, managed and influenced by the government with neither high quality management
nor any exemplary record of practising corporate governance have realised the importance of adopting
better practices to protect their depositors and the banking public.
Instruments of Corporate Governance in Banks:
Financial statements -Balance sheet and Notes on Account
Annual General Body Meeting – report to the shareholders
Share holder information disclosure norms
The Vision and the Mission statements – giving directions to the bank.
Code of conduct for the Bank’s Board – clause 49 of listing agreement
Right to Information Act, 2005 – for PSBs
Code of commitment to customers
Bankers Fair Practice Code
KYC Norms & stipulation/guidelines &PMLA Compliance
Credit Policy, Risk Policy, Promotion and appointment policy and many other policy statements
Committees on Risk Management, A&L Management, Audit & Compliance
Basel Committee on Corporate Governance
In 1988, the Bank for International Settlement (BIS)-based Basel Committee on Banking Supervision
came out with regulations regarding the capital requirements for banks. Although these were essentially
intended for international operating banks, in due course, almost all countries adopted these
regulations for their banks.
The crux of the Basel I requirements is the assignment of risk weights for different assets in a banks
book and aggregating the risk-weighted assets of which 8 per cent was recommended as the capital of
the bank. The committee’s recommendations were not mandatory, but the world’s central banks
speeded up the process of compliance, particularly following the East Asian crisis and the collapse of
certain hedge funds in New York which threatened to bring don n banking systems of the US and the
developed world. India adopted Basel I norms in 1992 closely following the inception of economic
From a banking industry perspective, corporate governance involves the manner in which the business
and affairs of individual institutions are governed by their boards of directors and senior management
affecting how banks
Set corporate objectives (including generating economic returns to owners).
Run the day-to-day operations of business.
Consider the interests of recognized stakeholders.
Align corporate activities and behavior with the expectation that banks will operate in a safe and
sound manner, and in compliance with applicable laws and regulations.
Protect the interests of depositors.
Basel Committee published a paper on corporate governance for banking organizations in September
l999. The committee felt that it was the responsibility of the banking supervisors to ensure that there
was effective corporate governance in the banking industry. Supervisory experience underscores the
need for 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 underscored the need for banks to set strategies for their operations. The committee
also insisted banks to establish accountability for executing these strategies. Unless there is
transparency of information related to decisions and actions, it would be difficult for stakeholders to
make management accountable.
From the perspective of banking industry, corporate governance also includes in its ambit the manner in
which their boards of directors govern the business and affairs of individual institutions and their
functional relationship with senior management.
The Basel Committee has also issued several papers on specific topics, where the importance of
corporate governance has been emphasized. These include Principles for the Management of Interest
Rate Risk (September 1997), Framework for Internal Control Systems in Banking Organizations
(September 1998), Enhancing Bank Transparency (September 1998), and Principles for the Management
of Credit Risk (issued as a consultative document in July 1999).
These papers have highlighted the fact that strategies and techniques that are basic to sound corporate
governance include the following:
The corporate values, codes of conduct and other standards of appropriate behavior and the
system used to ensure compliance with them.
A well-articulated corporate strategy against which the success of the overall enterprise and the
contribution of individuals can be measured.
The clear assignment of responsibilities and decision-making authorities, incorporating a
hierarchy of required approvals from individuals to the board of directors.
Establishment of a mechanism for the interaction and cooperation among the board of
directors, senior management and the auditors.
Strong internal control systems, including internal and external audit functions, risk
management functions, independent of business lines, and other checks and balances.
Special monitoring of risk exposures where conflicts of interest are likely to be particularly great,
including business relationships with borrowers affiliated with the hank, large shareholders,
senior management, or key decision-makers within the firm (e.g. traders).
The financial and managerial incentives to act in an appropriate manner offered to senior
management, business line management and employees in the form of compensation,
promotion and other recognition.
Appropriate information flows internally and to the public.
The reality that various corporate governance structures exist in different countries reflects that there
are no universally correct answers to structural issues and that laws need not be consistent in all the
countries, Acknowledging this, sound governance can be practiced regardless of the form used by a
There are four important forms of oversight that should he included in the organizational structure of
any bank in order to ensure appropriate checks and balances:
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.
4. Independent risk management and audit functions.
In addition, it is important that key personnel are fit and proper for their jobs. Government ownership of
a bank has the potential to alter the strategies and objectives of the bank as well as the internal
structure of governance. Consequently, the general principles of sound corporate governance are also
beneficial to government-owned banks.
The New Basel Capital Accord (Basel II)
Efforts were made for 6 years to rectify the deficiencies found in the original accord, now known as
Basel I. On 26 June 2004, the committee came out with new Basel norms that are expected to change
the complexion of banking throughout the world. The final version of the revised accord, titled, “The
International Convergence of Capital Measurement and Capital Standards: A Revised Framework” is
known in short as the New Basel Capital Accord or simply Basel II. The first version of Basel II came out
in 1999. The version was widely debated and after consultation, a revised Basel II document came out in
Basel II aims at correcting most of the deficiencies that Basel I suffered from. Basel II rests on three
pillars as given below:
Implementation of Basel II and Its Impact
A recent survey conducted by the Financial Stability Institute (FSI), Basel, showed that more than 100
countries would implement Basel II in the next few years. The US has already announced that it would
he made mandatory for the ten biggest banking groups that control nearly three-fourth of the country’s
banking assets. It is also expected that Basel II will also be implemented fully in Europe.
The Reserve Bank of India (RBI) started its own consultative process involving various banks and other
experts. It has now come out with its final draft version of Basel II, which is to become operational from
The Basel II version as drafted by RBI in its letter dated 15 February 2005 is a comprehensive set of
instructions, which will initiate a parallel run by banks starting in 2006.
The instructions go into great detail regarding the various classifications of the assets and the weights to
What remains is for each bank to adopt one of the methods suggested in the circular for assessing its
risk weighted capital.
In a meeting of 60 bankers that aimed at sensitising the bank chiefs about the challenges of Basel II
norms, which are due to be implemented by March 2006 by all banks globally, the Deputy Governor of
the Reserve Bank of India, Mr. K. J. Udeshi, announced that the RBI would adopt a gradual and
sequential approach towards implementation of Basel II norms for the capital adequacy of banks. At the
meeting, the RBI has formed a Steering Committee, which in turn will have smaller focused sub-
committees for each of the pillars of Basel II. The Steering Committee will review the issues and suggest
a roadmap to adopt the new norms of Basel II. The Reserve Bank of India has advised Indian banks to
adopt Basel II norms by 31 March 2006; however, banks are expected to do a trial or parallel run from
31 March 2005 to fine-tune their systems and procedures.
Once it is implemented, Basel II is likely to have a profound impact on the way banking is conducted
worldwide. It could also lead to a shakeout in the industry given the fact that the capital requirements
favouring larger banks with better systems in place. This could result in a spate of mergers worldwide,
especially among internationally active banks in their struggle to remain competitive.
The implementation of Basel II is imperative in the context of emerging market economies that “may
face unique problems in the absence of well-developed credit rating systems, robust data collection
mechanisms and other infrastructure”. So, non-implementation, without justifiable reasons, will finally
get reflected in adverse credit ratings, higher borrowing costs and the consequent effects on the real
economy. This is one reason no country can afford to delay implementation of Basel II indefinitely.
Ganguly Committee’s Recommendations
To introduce corporate governance practices in the banking sector the recommendations of the working
group of directors of Banks Financial Institutions, known as the Ganguly Group, will be of interest.
Composition of Boards:
i. Boards should be more contemporarily professional by inducting technical and specially
qualified personnel. There should be a blend of “historical skill” set and “new skill” set, i.e. skills
such as marketing, technology and systems, risk management, strategic planning, treasury
operations, credit recovery, etc.
ii. Directors should fulfill certain “fit and proper” norms. , viz., formal qualification, experience and
track record. To ensure this, companies could call upon the candidates for directorship to
furnish necessary information by way of self- declaration, verification reports from market, etc.
iii. Certain criteria adopted for public sector banks such as the age of director being between 35
and 65, that he/she should not be a member of parliament! state legislatures, etc. may be
adopted for private sector banks also.
iv. Selection of directors could be done by a nomination committee of the board. The Reserve Bank
of India (RBI) also might compile a list of eligible candidates.
v. The banks may enter into a “Deed of Covenant” with every non-executive director, delineating
his/her responsibilities and making him/her abide by them.
vi. Need-based training should be imparted to the directors to equip them govern the banks
The Ganguly Committee has suggested the formation of the following committees of the board, in
addition to the Nomination Committee: Audit Committee, Shareholders: Redressal Committee,
Supervisory Committee and Risk Management Committee. The job of the first two committees is well
known in all big corporates in India. Incidentally, the Reserve Bank has prescribed that the audit
committee should be presided over by a Chartered Accountant Director, but Ganguly Committee opined
that it could be done by any non-executive director.
Risk management has taken centre stage in any discussion on management of banks in the recent past.
To be sure, risk taking is as old as banks. Banks are in the business of taking deposits, repayable virtually
on demand and lending/ investing the funds in illiquid assets. The action of converting liquid funds into
illiquid assets, with maturity mismatches between the two, is a certain recipe for risk. Banks have known
and managed this risk fairly well over centuries of their existence. In the last few decades, however,
newer varieties of risk have arisen, because, in the pursuit of high returns, banks have embraced higher
risks. The risks about which many bankers are not fully familiar are in the realm of off- balance sheet
commitment, market risks, interest risks and those associated with derivatives. It will not be an
exaggeration to say that a vast majority of directors of banks in India are not aware of the dimension
and magnitude of these risks. Since the job of banks is primarily to safeguard the interests of depositors
and the shareholders, these risks should be managed professionally.
Only in respect of newer business, it is essential that the board should, with the assistance of experts in
the field, lay down detailed guidelines and ask the management to report compliance at periodical
intervals. Generally in risk taking, each bank will have a different level of appetite, which needs to be
clearly spelt out by the board, on the basis of the recommendations of top management. Further, the
review of newer businesses should be at more frequent intervals than that of established businesses.
Reward and Accountability of Directors
The Ganguly Committee appointed by the Reserve Bank of India has rightly observed that the present
remuneration in the form of sitting fees is quite low for the work expected of directors. One way of
rewarding them is to give them a share in the profits and another is to give them share options in the
bank. The committee has suggested share options. Of course, there is one danger that, like some of the
top managers in failed companies in the US, the board might pursue short-term profits at the expense of
long-term stability; in some cases, there could be a temptation to boost profits by manipulating
accounts. One possible way of curbing it is to stipulate a lock in period of 3 or 4 years for such share
options. A question may arise as to weather the nominees of RBI and government should be entitled to
such remuneration. The answer is that the Reserve Bank should not have their nominees at all, as
suggested by the second Narasimham Committee on Banking Sector Reforms, because a regulator
cannot don the role of a participant also. Government should preferably withdraw their nominees from
boards of public sector banks and monitor performance only through periodical reports. It is a recorded
fact that many such banks faced massive losses, even when government and Reserve Bank nominees
were on the boards.
If directors are remunerated on the basis of their performance, they should also be held accountable for
non-performance. Almost all the expert committees aver that the directors are accountable to
shareholders, but none seems to spell out what it means. Peter Drucker is blunt in saving that “without
financial accountability, there is no accountability at all”. Thus, if the bank incurs losses over a period or
faces sudden collapse, the directors should be made financially accountable. The least that can be done
is to ask them to repay the bank a multiple (3, 4 or 5 times) of the money earned by them from the bank
in the past few years. It is realised that this is a very crude form of fixing accountability, but a beginning
ought to be made in crystallising accountability of directors in some concrete form.
To sum up, effective governance of banks must have the following minimum criteria:
1. The basic objective of governance should he safeguarding depositors’ money and optimising
2. The directors should be competent and persons of integrity.
3. The chairman of the board should preferably be unconnected with the management of the
4. Board can function through committees and Risk Management Committee assumes special
importance in the context of rapid changes taking place in the financial markets. In measuring
and monitoring risks, the board should enlist the assistance of experts.
5. The board should forbid banks from pursuing business which might be proper in form, but highly
improper in substance.
6. As a general rule, the board should ask the management to spell out as to when a transaction,
especially in derivative products, could result in losses and take a view on the probability of
incurring the losses. On the basis of the overall risk appetite of banks, the transaction may be
approved or rejected.
7. Suitable risk and reward system should he put in place for the directors of banks.
Corporate Governance in Insurance
Generally, the financial performance of a company depends on its business strategy, Skill-sets of the
work force and the soundness of the company’s governance principles.
It is not the same with an insurance company. Insurance is a major investor in the capital markets
around the world and insura nce company’s earnings and the existence depends on the performance
of other companies where they have invested. Japanese insurance companies have significant portion of
their corpus invested in equity the steep fails in the domestic stock prices in the Japanese stock market
put investment equity portfolios of many Japanese insurance majors in doldrums.
Hence, insurance industry in addition to creating, maintaining and adhering to its own governance
principles, also has the responsibility to vigil over the governance practices of the companies where they
The IRDA moreover, imposes social obligations such as:
Every life insurer, who undertakes insurance business after the commencement of insurance
regulatory authority act, 1999 shall ensure that out of the total policies written in a year, 5% in
the first financial year, 7% in the second financial year, 10% in third financial year, 12% in fourth
financial year, 15% in fifth year come from rural sector.
Every general insurer must ensure that out of the total policies written in a year, 2% in the first
financial year, 3% in the second financial year, 5% thereafter come from the rural sector.
Both the insurers shall ensure that out of the lives in insured in a financial year, 5000 lives in the
first financial year, 7500 lives in the second financial year, 10000 lives in the third financial year,
15000 in fourth financial year, 20000 lives in fifth year comes from social sector.
The insurance companies are thus under a tremendous ‘regulatory stifling, while generating the
much requirements income to survive the policy holders’ secondly it is anybody guess as to how
independent the non-executive directors are in overseeing the risk management process that
identifies, measures and priorities business and financial risk, among the insurance companies.
Need for Corporate Governance in Insurance Sector
Insurance industry bears a fiduciary relationship with policyholders and long term performances. The
honesty and integrity of insurers are paramount important as the industry has financial functions.
Officers and employees can break the regulatory measures and enjoy the money of policyholder. No
insurer will be successful unless his integrity is tested as sound and useful for the effective performances
of the functions. The need of corporate governance is realized for confidence building change-
management, investment and viability.
Insurance is based on confidence. New insurance companies can develop only if the old insurance
companies have demonstrated honestly and integrity. For example, LIC has proved the insurance has
sore reign guarantee. Long term contract is built only on confidence. Insurance particularly life insurance
is long-term contract. There should be benchmark standards against which insurers should demonstrate
Insurance companies are facing several changes in the society. They have to cope with changes and
come forward to challenge the changes. It has been observed that insurance industry is growing faster
than GDP. Specialized insurance companies are entering in the market. Many foreign companies have
entered in India to conduct insurance business. Health insurance is becoming a need of the hour. The
insurance companies have to manage themselves for maintaining safety and solvency. Non- insurers are
growing in detarrified era challenging their fair play, policyholders servicing and transparency.
Insurance companies manage their funds through investment which involves safety solvency risk
management and protection of policyholders’ interest. The actuarial experiences also help decide
insurance expansion. It grapples greater challenges such as increasing number of good governance
standard against which the companies conduct and performance would get measured against these
backdrops. They have to live up with securities market and governing rules. SEBI has formulated several
rules and regulation which have to be followed by the insurer.
The insurers have to prove their viability. Many new and existing companies now enter in the insurance
business. Foreign, insurance companies have to prove their viability. Public sector insurers have proved
their viability and private sector insurers have to operate in a safe and sound manner and in accordance
with the applicable rules and regulations.
People in Focus under Corporate Governance in Insurance
It goes without saying that the insurers are the first and foremost party to be interested in good
corporate governance practices in the insurance companies. Hence, it is the responsibility of the
regulators to impose the governance practices on insurers and it is the duty of the insurers to adhere to
the principles strictly.
The International Association of Insurance has issued a circular to insurers transacting business in the
state that reminds the companies of their responsibilities notes that corporate governance is a critical
element for the solvency factor of the insurance companies.
It would not be wrong to say that it easier to ensure the adherence of the insurance companies to the
ethical governance, as compared to the other involved bodies. While insurers are responsible for
smooth governance in the company, they are the corporate governance instruments as well. Insurers
are long-term investors in equity and bonds who are naturally interested in preventing corporate
failures and ensure positive investment returns.
Attorneys, of late, have been gradually assuming greater importance with reference to the corporate
governance practices. The Securities and Exchange Commission has drafted a set of rules which if
adopted, will require the attorneys to keep a vigil on the violations of the governance practices by the
directors, officers, and other agents of business associated with public companies.
The attorneys will have to blow the whistle up the ladder, on witnessing any material violation of
security laws or breach of the fiduciary duties. These rules hold good. For any such listed company which
is situated in US. While the attorney is expected to inform the management up the ladder regarding the
wrongdoers, if he feels that there has not been an Adequate and appropriate action by the
management, he has the right to make a ‘noisy withdrawal’ i.e.…….he can duly report the same to the
security exchange commission and withdraw his legal representation from the company.
Actuaries and Auditors:
Actuaries and auditors are frequently held liable for failure to identify corporate governance failures.
Especially, in case of the policies like professional liability insurance, the assessment of the litigation risk
becomes a vital element for the carriers.
Enron is the historical example that shook the corporate and unveiled the ill accounting practices
followed by the auditors. That was the time when only Enron and Arthur were held responsible for the
gross violation of ethics. Today, there are around 30 such auditing firms that have admitted, ‘accounting
irregularities’, which are the subject of formal investigation by the SEC. considering the significance of
the auditor’s role in a company and the deteriorating condition of the auditor’s the SEC has framed rules
under the laws like Sarbanes-Oxley Act, Patriot Act, etc. equally important is the role of an actuary.
The actuarial profession is responsible for managing insurance policyholders’ reasonable expectations
within companies. For example, for company must hold certain reserves, sufficient cash, and sufficient
stocks and bonds to make sure those products match sufficiently. That forms a part of the job of an
actuary. Hence, the statutory role for external as well as internal actuaries forms a part and parcel of the
governance mechanism in insurance industry.
Directors and officers:
Directors and officers have been much in limelight since the recent spate of corporate scandals at
WorldCom and Enron. Insurance companies offer a D&O liability insurance, which, as the name suggest,
protects directors and officers by insuring them for the risks associated with their responsibilities.
The most frequent sources of suits against D&O are the shareholders of the company. D&O insurance
was initially referred to as ‘sleep insurance’. Since D&O policies can cover acts that occurred. Well
before the inception of coverage, insurers have a corporate liabilities covered under Directors and
officers liability insurance.