BTL 767 - Corporate Governance in Banking Sector in India

 

The Banking Tutor’s Lessons

BTL 767                                                                          27-03-2025

Corporate Governance in Banking Sector in India

In India, RB is the gatekeeper of Corporate Governance. The corporate governance mechanism as followed by Reserve Bank of India is based on three categories for governing the banks. They are:

(1) Disclosure and transparency,

(2) Off-site surveillance,

(3) Prompt Corrective Action.

 

Disclosure and transparency: Disclosure and transparency is the most important constituent of corporate governance. If the banks will not be disclosing their transactions to the RBI then they can operate at their whims and fancies and may vanish with the lifelong investments and savings of the people. The RBI through the requirement of routine reporting of financial transactions of the bank keeps a tab on the activities being undertaken by the banks in India. Any failure to abide by the requirements set out by RBI may lead to heavy fines being imposed along with the cancellation of the license to operate as a bank.

Off-site surveillance: RBI performs an annual on-site inspection of the records of the banks but in order to promote governance in banking sector, off-site surveillance function was initiated in 1995 for domestic operations of banks. The main focus of the off-site surveillance is to monitor the financial health of banks between two on-site inspections, identifying banks which show financial deterioration and would be a source for supervisory concerns. The off-site surveillance prepares RBI to take timely remedial action before things get out of control.

Prompt Corrective Action (PCA)  is a system that the RBI imposes on banks showing signs of financial stress. The regulator considers banks as unsafe if they fail to meet the standards on certain financial metrics or parameters. RBI takes into account four factors to determine whether it needs to put a bank under the PCA framework. These include profitability, asset quality, capital ratios and debt level.

When RBI puts a bank on its PCA watchlist, it imposes two types of limitations on it – mandatory and discretionary. These include restrictions related to the expansion of a branch, dividend and director’s remuneration and so on.

While some banks have the capacity to withstand challenging phases of operations, others not so much. This is where RBI steps in through the PCA framework, essentially providing an opportunity for the banks to clean their operations. It can benefit both banks and depositors of the banks.

Conclusion

The special nature of banking institutions necessitates a broad view of corporate governance where regulation of banking activities is required to protect depositors. Corporate governance in the banking sector is not just a formality but a dire need of society.

However, too much pressure on the banks must not be imposed in the name of corporate governance so much so that they feel harassed in the name of governance and their efficiency suffers leading to a slowdown of financial transactions. Additionally, internal governance must be increased which must be formulated in a way that the efficiency of banks is not affected.

Sekhar Pariti

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