Effective corporate governance vital, banks told

Being at centre of the economy, banks must ensure effective corporate governance to avoid the spread of failures to the financial system, the Reserve Bank of India (RBI) has said.

Issues related to corporate governance that need adequate attention include bank ownership, accountability, transparency and ethics compensation, RBI has said in the Report on Trend and Progress of Banking in India 2010-11.

Splitting the posts of chairman and chief executive officer in banks and corporate governance under a financial holding company structure also deserve adequate attention, it said.

Banks are interconnected in diverse, complex and opaque ways, underscoring their 'contagion' potential. If a corporate fails, the fallout can be restricted to stakeholders. But if a bank fails, the impact can spread rapidly to other banks, with potentially serious consequences for the entire system, the central bank said. It added the corporate governance of banks was not only different, but also more critical.

Banks are the conduits of monetary policy transmission and constitute the economy's payment and settlement system. Also, by the very nature of their business, banks are highly leveraged, the report said. Banks accept large public funds as deposits in a fiduciary capacity and further leverage these funds through credit creation, RBI said.

Regulation has a role to play in ensuring robust corporate standards in banks. However, though effective regulation is necessary, it is not a sufficient condition for good corporate governance, RBI added.