Banks play vital role in the economic development of a country. Banking and financial sectors are undeniably the strongest backbone of any economy. This attributes to a country’s economy being in good shape which is linked to the banking sector’s smooth operation. They have evolved from traditional banking to modern online banking. As a result of changing times, banks have seen newer things and have reached greater heights.

Confidence, ethics and trust amidst these remains as the heart of banking system. Nonetheless, various scams have been witnessed in the Indian private as well as national banks such as Punjab National Bank, Yes Bank scams etc. Additionally, there have long been ethical concerns about practices such as insider dealing, consumer and market manipulation as well as mortgage loan malpractices. While the ethical consequences of these malpractices may differ, the need of the hour is to continually review and strengthen the operations in order to cope up with the rapid pace of transformation in the business.

Good corporate governance should be an important part of bank management in order for banks to work efficiently. Good Corporate governance is essential in banks and must be more than just complying with legal and regulatory requisite. It promotes good business management and regulation, allowing banks to uphold good business ethics and thereby providing value additions to stakeholders.

Corporate governance of bank is very different from other corporate entities since functioning of banks and corporate entities is different. Thus, the consequences are restricted to stakeholders if there is failure of corporate governance in corporate whereas it can have serious consequences on financial system at large in case of failure of corporate governance in banks since the impact can swiftly spread through other banks.[1]

Overview Of Ethics In The Indian Banking System

Ethics is gleaned from the Greek word “ethos” which means character. It is a subject that deals with the good and the bad in terms of moral responsibility and obligation. It is an embodiment of moral principles which aids in defining what is wrong and right in human conduct as well as what ought to be.[2]

There are various unethical issues and challenges but corruption is one of the major issues in which public office is used for personal gains. Currently, institution’s size, unhealthy competition, incentives, conflict of interests, discrimination and struggle to remain in the market are major reasons for unethical practices. Ethics is defined as cardinal principle and basic concept of good human conduct. It incorporates study of various universal values such as adherence to the rule of law, equality of all men and women, health and safety of all and also of the environment[3].

A.Fundamental Prinicples Of Banking Ethics

1. Integrity:
   This means taking actions based on values instead of seeking personal benefit from another person. To follow strong moral principles and being honest with everyone while doing any activity or operation
    
2. Neutrality:
   Success reaches those who respect humans and don’t discriminate. Refrain from discriminating anyone on the basis of race, caste, social status, sex and finances in the institutions. Further, there should be no discrimination against the employees and customers.
    
3. Reliability:
   This means that all the information provided by the bank to their customers should be clear, accurate and understandable with mutual trust in all the services they render. In this way they can serve the best to their customers and services must be timely done.
    
4. Transparency:
   The information regarding customer’s rights and obligations as well as benefits and risks must be clearly provided by the bank. Before providing any product, service or advice the bank must efficiently determine their customer’s financial needs, ability and status and offer their products and services accordingly.
    
5. Information Abuse:
   The banks must take all the appropriate precautions and steps to avoid misuse of insider information of themselves and their customers.[4]

B.Ethical Issues And Challenges

1. Rude behavior towards customers:
   At times Indian bankers are rude and their behavior is unfavorable and non- cooperative towards customers may be due to high work pressure, lack of expertise, unfavorable behavior on the part of customers and various other factors.
    
2. Problems faced By Banking Industry in India:
   
   • Banks Not able to make enough money:
     Even though there are headlines relating to banking profitability but still the banks in India are failing to generate the necessary return on investment or return on equity that shareholders need.
      
   • Customer’s Expectation:
     Nowadays, it is all about customer’s satisfaction and experience. Hence, many banks are under pressure that they are not being able to provide the quality of service that customers want, especially in terms of technology.
      
   • Adaption of Technology Issues:
     This is one of the major challenges faced by the banks and their employees because they do not have adequate understanding of technology and are not thoroughly educated on it.
      
   • Regulatory Authorities Pressure:
     Regulatory requirement continue to rise and banks must pay out significant portion of their discretionary expenditure to compliance and the development of systems to keep up with the increasing requirements.
      
3. Unethical mortgage lending practices:
   Various issues such as lack of control by the financial institutions, excessive leverages, subprime mortgage lending among many others have led to this problem. Unethical behavior of the executives working in financial institutions as well as their negligence is the root cause of these problems. “Additionally, some more problems in this are Sub-prime mortgage, Predatory lending, Complex debt instrument, Shadow Banking System, Fraudulent loan terms.”[5]
    
4. Global Banking:
   Global banking is making inroads into the Indian Banking sector and for long term growth and development industry must embrace the integration phase knows as globalization as India opened its doors for international firms in 1991. The effect of globalization creates problems for domestic businesses because they have to compete with foreign players. There are 36 banks operating in India’s banking sector which poses a significant challenge to both nationalized and private sector banks since they are very large in scale, technologically advanced and have a strong presence in the global market providing better options to Indian customers.
    
5. Money Laundering
   
   • In last few years, especially after the terrorist attacks of 11th September 2001, global efforts to tackle money laundering and terrorism funding have taken on increased importance. Money laundering and terrorism funding are major global issues which effects the economic growth by not only compromising with the stability, productivity and accountability but also threatening the security
   • The International Monetary Fund reports that laundered money produces $590 billion to $1.5 trillion per year, accounting for around 2 to 5% global GDP.
   • Money laundering and terrorism funding can have catastrophic economic and social implications for developing countries and those with weak financial system.
   • The term money laundering describes the process of concealing the true owners of illegally obtained with the funds[6]
   • This procedure gives illicit funds credibility by "washing" them through different agencies "so that they can be used without detection of the illegal activity that created them." This procedure gives illicit funds credibility by "washing" them through different agencies "so that they can be used without detection of the illegal activity that created them."[7]

C. Recommendations

1. Development of a responsible corporate- profit should not be the sole objective.
2. There should be transparency and clarity between the Bank and the customers.
3. Banker’s position of authority should not be used to abuse or exploit the needy.
4. There should be a sense of corporate citizenship while acting or discharging duty.
5. All should be treated equally or in the same way. Compliance should be done by focusing on integrity.

Overview Of Corporate Governance In The Indian Banks

Like any other organization, good corporate governance in bank regulates relation between shareholders, management and the board. It helps to resolve conflict of interest between the shareholder and depositors as well as between managers and board. Additionally, prevents abuse of power and limits imprudent behavior by the bank executives. Good corporate governance is necessary for the overall stability of the economy.[8]

A.Challenges And Priorities In Corporate Governance

The below mentioned issues are relevant for many participants such as Banks, association of banks, stock exchanges (BSE & National Stock Exchange), RBI and SEBI as bank supervisor and capital market supervisory respectively. These issues are based on the principles of good corporate governance provided under “Basel Committee on Banking Supervision in 2006” as well as the “Ganguly Committee’s recommendations in 2002.”[9]

1. Duties of Board Members
   Since banks accept and handle people’s money, bank board members must be particular of their fiduciary duty that is “duty of care” and “duty of trust” to depositors. These responsibilities cannot be carried out entirely, correctly or efficiently unless adequate skills and personal abilities are possessed. It is important to conduct training programs provided by RBI, SEBI etc. which enhances the knowledge and skills of the board members.
    
2. Disclosure
   Even though the RBI is primary/main authority for ensuring bank’s proper disclosure, SEBI is not exempted from its duties; it is expected to exercise supervision and implementation of audits, accounting and non-financial disclosure. Disclosure problems found by one of the two regulators should be informed to other organizations as well for corrective measures and sanctions.
    
3. Functions of Board
   Boards should be more concerned and involved in board strategy instead of being embroiled in bank management of routine activities. Specifically, the board should concentrate on:
   
   • Directing and supervising the bank’s strategic goals, corporate policies and values, essential one of which is the development of a code of ethics for bank staff, management and board members.
   • Establishing clear lines of duty and accountability across the bank, as well as stringent internal control mechanism. This would help to ensure successful control.
      
4. Establish special committees of board
   Formation of various types of committees such as risk management committee, audit committee etc has been recommended by the Basel Committee. Additionally, a recommendation was also made by the Ganguly committee that the banks which have issued public shares/debentures must establish a Shareholder‘s Redressal Committee headed by non-executive director.
    
5. Averting Abusive Related Party Transactions
   A reasonable number of independent directors should review and track related party transactions. Furthermore, for reviewing related party transaction, a committee of board should be formed mainly comprised of independent directors. Banks must declare material related party transaction in compliance with international accounting, auditing and non financial disclosure standards. Banks may also be barred from participating in some forms of related party transactions like controlling shareholders and personal loans to board members.
    
6. Board’s Composition
   In its position as banking supervisor, the Reserve Bank of India must ensure that bank boards have established and retained an appropriate level of expertise as banks have increased in size and complexity. “The Ganguly Committee (RBI 2002) had recommended that bank board be constituted by the blending of 'historical skills' set, (i.e. regulation-based representation of sectors like agriculture, small industries, cooperation etc.) and the 'new skills' set (i.e. need-based representation of skills such as, marketing, technology and systems, risk management, strategic planning, treasury operations, credit recovery etc.)”[10].
   
   The board should be able to use objective judgment when carrying out its responsibilities. This will imply management and controlling shareholder’s independence and objectivity. Additionally, it was recommended by the committee that a trained Company Secretary be appointed as secretary to the board as well as a Compliance officer to ensure regulatory and accounting compliance.

B. Role Of Rbi In Ensuring Good Corporate Governance

Instead of focusing solely on regulatory enforcement, RBI should put a greater emphasis on ensuring good corporate governance of banks. RBI should evaluate the performance of the entire board since the board’s position is important in establishing good corporate governance in banks. This can be done by assessing board meeting minutes, ensuring that board members have access to relevant information and resources, attending bank board meetings when needed, providing alerts when necessary and even requesting that the bank reorganize its board structure and operating procedures in the interests of good corporate governance.

There should be a basic difference in RBI’s role in corporate governance between private and public banks. In terms of prudential aspects, the RBI’s regulatory structure ensures that all types of bank are treated uniformly. Therefore, there should be little difference between public and private bank’s corporate governance.

RBI in association with SEBI should make a code and policy of corporate governance from which banks could create their own code. In addition, incentives should be provided by RBI to banks so that they can strengthen their corporate governance. For, above suggested code, RBI may create a rating system for corporate governance of banks. Such a rating may be designed as a standalone rating based on corporate governance or as a part of larger rating system in which corporate governance variables play a significant role in deciding overall ratings.

The rating system of corporate governance must be eloquent and informed well in advance to all banks so that accordingly they can reorganize their framework. SEBI also may contribute to the development of the criteria by sharing its expertise and experience in the field of corporate governance.

Scams: Ethics & Corporate Governace Failure

PNB Scam

This was country’s one of the biggest banking scam, involving a huge sum of around Rs. 11,400/- crores. Fraud was committed by Nirav Modi and Mehul Choksi who were involved in exporting and importing of diamonds under the listed company called Gitanjali Gems. No one challenged the source of funding at that time. Only after few years this fraud came to light shocking the country like never before.

As per the bank, employees provided LOUs without taking any cash reserve or collateral and didn’t even enter the transaction in the bank’s software. These LOUs were used as leverage in Hong Kong for obtaining credits from various banks such as SBI, Axis Bank etc by Nirav Modi and his company. LOUs were issued by these suspected bank officials through swift which is the medium for international cash transfer. These banks were aware that PNB had not incorporated swift in their core banking network. They made the decision not to document these transactions in the bank’s system.[11]

The scam was exposed when the three diamond firms approached PNB for obtaining bank credit to import stones from overseas. In 2018, when the three firms approached PNB for bank credit through LOU, the bank’s official in charge requested a 100% cash margin because these firms had no pre-sanctioned limit. The diamond firms challenged the bank’s demand, claiming that they had previously used this facility. The branch documents, however, revealed no evidence of such facility being provided to the aforementioned firms. This triggered an alarm, prompting the bank to conduct an internal investigation into past bank credits.

The internal investigation found that two banks had previously fraudulently given LOU to the aforementioned firms without following the proper process. These LOUs were then transmitted via the Swift upon which credit was granted to the aforementioned firms.

Yes Bank Scam

Fraud caused the surprising and abrupt fall of a private bank that was emerging as a strong competitor to other private banks. The bank had a distinct business model with special focus on retail loans, technology and branch network.

Rana Kapoor, the bank’s promoter, had developed contacts with top industrialists in the country and created an impressive reputation in the industry in a short period of time. The majority of key decisions, including large loans, were centralized in his hands. In 2020, Yes bank faced a tough time. On 5th March 2020, the RBI placed a 30-day moratorium on Yes bank, superseding the private sector lender board and appointing Prashant Kumar as administrator and overall the management was taken over by the RBI[12]. Additionally, it was announced that SBI will buy 49% stake in Yes bank.
Following are the reasons that led to the scam:

1. Huge amount of loans:
   Book of accounts of Yes bank showed a loan of 55,633 crores and a deposit of 74,192 crores on 31st March 2014. Since then loan growth has been rapid reaching 2.25 trillion on 30th September, 2019.
    
2. Bad loans:
   The bank’s asset quality also deteriorated. As per global financial firm UBS, Yes bank was providing stressed loans to companies that were unable to repay the loan on time. Yes bank took a significant risk. Such loans are referred as bad loans. These companies were DHFL, Reliance, Essel group etc. It had loans more than its net worth. “The bad loans of Yes Bank are estimated to be around Rs.40000 crores (Gross NPA). While the Gross NPA was around 19% of advances, Net NPA was around 6% of loans at the end of December 2019.”[13]
    
3. Large number of withdrawals:
   Although the loan sum was increasing at a high rate, withdrawals were increasing too. The bank experienced consistent withdrawals because of burden on the balance sheet and the bank eventually collapsed.
    
4. Financial Position:
   In 2018, Yes bank’s share price was Rs 400 but on 6th March 2020 it was Rs. 16.60. The financial situation worsened as a result of its failure to raise capital to address loan losses.
    
5. Lack of proper governance:
   It has dealt with number of governance challenges that have contributed to the crisis. Uttam Prakash, an independent director, resigned from Yes bank in January 2020 citing the bank’s deteriorating governance.

Conclusion
In the coming years, the Indian financial system will expand not only in size but also in complexity as competitive forces gain traction and financial markets deepen. Banks, as a major component of the financial sector and the country’s payment system, must be handled as effectively as possible. It is vital to tighten the corporate governance in banks which is in larger interest not only beneficial for national economy but also for the global economy.

To conclude, it can be said that the ethical issues in Indian banks are improving these days, especially in the loan department and government intervention is needed to solve these issues so that the customer can take advantage of the benefits offered by the government schemes, which can also aid in the overall growth and development of the individual, state and economy.

Unethical marketing practices and behaviors cause customers to have negative outlook of financial services which is bad for the health of any financial system. Establishment of statutory body which can handle all of these issues is the need of the hour. Since financial services are complex, the government should take some steps to increase consumer awareness and education with a focus on financial services.

End-Notes:

1. SK Mandal, Ethics in Business and Corporate Governance (2nd edn, McGraw Hill Education 2017).
2. Rajinder Kaur and Rashmi Aggarwal, Ethics and Corporate Governance (Thomson Reuters 2020).
3. Ethics, Values and Corporate Governance accessed on 3 May 2021
4. Desai P.s, ‘Ethical Issues in Indian Financial Service Industry’(2015) 3(1) International Journal of Marketing & Financial Management 30-39
5. ibid
6. KA Goyal and V Joshi, ‘A study of social and ethical issues in banking industry’ (2012) 2(5) International Journal of Economics and Research 49-57.
7. ibid
8. Dr Rana Zehra Masood, ‘Corporate Governance in Indian Banking Sector’ (2013) 1(1) International Journal of 360 Management Review.
9. Enhancing corporate governance for banking organisations < https://www.bis.org/publ/bcbs122.pdf> accessed on 3 May 2021
10. R.Seenivasan, ‘Corporate Governance Issues in Banks in India’ (2014) 2(1) Journal of Business Law and Ethics 91-101
11. What is PNB Scam accessed on 3 May 2021
12. CA Naresh Kataria,‘Corporate Frauds in India accessed on 3 May 2021
13. Diganth Raj Sehgal, Everything you need to know about yes bank scam accessed on 3 May 2021

Written By:

1. Aarushi Prabhakar, National Law University Odisha
2. Aayush Akar, National Law University Odisha