The corporate governance of Non-Banking Financial Corporation (NBFCs) is different and unique as compared to other organisations. This is because the activities of the NBFC are less transparent. Thus, it becomes difficult for shareholders and creditors to monitor the activities of the NBFCs. Additionally, these financial institutions also differ from most other companies in terms of the complexity and range of their business risks, and the consequences if these risks are poorly managed.
The NBFC Sector in India has definitely not remained unaffected by the developments taking place worldwide. Enhancing the level of the corporate governance structure of Indian NBFCs is imperative. The regulatory bodies in India are the Reserve Bank of India (RBI) and the Securities Exchange Board India. The RBI prescribes prudential principles and norms. The RBI performs the corporate governance function under the Board for Financial Supervision (BFS).
Supervisory framework comprising
(a) on-site inspection (CAMELS pattern)
(b) off-site monitoring through returns
(c) market intelligence, and
(d) exception reports by statutory auditors
Capital: NBFC has to maintain minimum net owned fund (NOF) as per guidelines of RBI.
Maintenance of Liquid Assets: NBFCs have to invest in unencumbered approved securities, valued at a not exceeding current market price, an amount which, at the close of business on any day, 25.0 per cent specified by RBI, of the deposits outstanding at the close of business on the working day of the second preceding quarter.
Creation of Reserve fund: Every non-banking financial company shall create a reserve fund and transfer thereto a sum not less than 20.0 per cent of its net profit every year as distribution in the profit and loss account and before any dividend is declared. Such fund to be created by every NBFC irrespective of the fact whether it accepts deposits or not. Further, no appropriation can be made from the fund for the purpose without prior written approval of RBI.
Capital to Risk Assets ratio (CRAR): NBFC has to maintain CRAR OF 15 per cent . CRAR comprises – tier I and tier II capital.
Credit Concentration norms: Single borrower exposure limits credit – 15 percent of owned fund, Single group of borrower exposure 25 percent of owned funds. Exposure norms also applicable to own group companies and subsidiaries Include all forms of credit and credit related and certain other receivables as also off-balance sheet exposures and Debentures/bonds to be treated as credit for the purpose of prudential norms but as investments for the purpose of balance sheet and compliance with investment obligations.
Income Recognition norms: Only on cash basis and no accrual allowed.
Restrictive norms: Loan against own shares not allowed.
Accounting for Investment: All NBFCs to have a well defined investment policy. Investments classified into two categories – (1) long term and (ii) current investments. Long term investments to be valued as per Accounting Standard, issued by ICAI. Current investments to be classified into – (a) quoted and (b) unquoted. Current quoted investments to be valued at lower of cost or market value. Block valuation permitted – Notional gains or losses within the block permitted to be netted – but not inter-block, net notional gains to be ignored but notional losses to be provided for.
Provisioning of Nonperforming Assets: Standard assets- 10 per cent of outstanding balance, Doubtful assets – on unsecured portion 100 per cent and on secured portion 20, 30 and 50 per cent depending on the age of the doubtful assets, Loss asset – 100 per cent of the outstanding.
Risk Weighted and Credit Conversion assets: Risk – weights to be applied to all assets except intangible assets. Risk – weights to be applied after netting off the provisions held against relative assets. Risk weights are 0, 20 and 100. Assets deducted from owned fund like exposure to subsidiaries or companies in the same group or intangibles to be assigned 0 per cent risk – weight. Exposures to all-India financial institutions (AIFIs) at 20 per cent risk -weight and all other assets to attract 100 per cent risk – weights. Off-balance sheet items to be factored at 50 or 100 and then converted for risk – weight.
Recent Steps Taken by NBFCs in India for Corporate Governance Induction of non-executive members on the boards
*Constitution of various Committees like Management committee, Investor’s Grievances
committee, ALM committee, etc.
*Role of Independent Auditor
*Gradual implementation of prudential norms as prescribed by the RBI,
*Introduction of Citizens Charter in NBFCs
*Implementation of “Know Your Customer” concept
*The Board of Directors and top management of the NBFC are chiefly responsible for good
Frauds by others
*Forgery and altered cheques -This type of fraud involves altering the amount on the face of a cheque for nefarious purposes
*Stolen cheques -This type of fraud is initiated by the theft of a few cheques. Then accounts are opened using fake identities, and the suitably altered stolen cheques are deposited, followed by convenient withdrawal of the amount. In a similar way, stolen blank cheque books are misused by fraudsters.
*Accounting fraud -Overstating sales and income, dishonest accounting and inflating the worth of the company’s assets to hide that the company is actually functioning in loss constitute Accounting Fraud. E.g., Satyam.
*Credit card fraud – Credit cards lend themselves to several opportunities for fraud. Made of three PVC sheets, of which the central sheet is known as the core stock, credit cards carry substantial data. Credit card frauds can be carried out in several ways.
*Power of Attorney fraud- A “Power of Attorney” (“POA”) is a legal document through which the donor grants the power to his attorney to ‘step into the donor’s shoes’ and conduct legal and financial matters on the donor’s behalf.
*Phishing- In this type of fraud, sensitive data such as account numbers, login Independent Directors (IDs), passwords, and other verifiable information are extracted from gullible individuals either through fraudulent telephone calls or emails. These data are then misused for dishonest purposes, including identity theft. Phishing is most often perpetrated through mass emails and spoofed websites.
ETHICAL ISSUES IN CORPORATE GOVERNANCE
Corporate fraud is defined as “one that occurs within an organisation or by its owners or managers and involves deliberate dishonesty to deceive the public, investors or lending companies, usually resulting in a financial gain to the individuals or organisation.” Most of the corporate frauds fall under the categories of asset misappropriation, money laundering, accounting frauds, frauds committed by senior management, bribery and corruption and regulatory non-compliance. It is practices such as these that are denting the image of our financial system. The organisations, therefore, must be attentive to these challenges and adopt pro-active anti-fraud measures rather than being reactive. Otherwise, organisations and entire societies have to bear the risk of fraud and its consequences, which will become more devastating.
Keys to solving ethical issue
Sound Risk Management Framework
Data Management and analysis
Code of Conduct for Board of Directors
Internal & External control system
Independent auditor’s role
Role of top management
Whistle blowing policy
Sound Risk Management Framework
- With the occurrence of such major financial crisis globally a lot of emphasis is laid on strengthening risk management practices for both financial and non-financial institutions. However, with respect to the financial institutions, it is evident that much attention is being paid to financial risk such as market risk, credit and liquidity, despite the focus being on managing operational risk.
Data Management and Analysis
An organisation’s ability to generate revenue, manage the expenses and extenuate risks is determined by its ability to successfully share, store, retain and retrieve the escalating data. Effective data management practices can bring in large customer base, improve customer relationships which in turn help in generating revenue.
Strict code of Conduct for Board of Directors
Although people have always questioned the need for having corporate boards, it is empirically proven that their presence matters a lot at the time of organisational crisis. This can be verified as in the case of Enron, Worldcom and Parmalat scandals where the directors in particular were held liable for the fraud. Consequently, more attention is being paid to research on the role of corporate boards.
Internal and External Control Systems
Internal control system refers to the approved policies and procedures followed by the management in order to carry out smooth and proper functioning of business thereby avoiding various types of risks such as improper maintenance of accounts, unauthorised transactions and frauds which may affect the organisation’s financial performance.
On the other hand external control system refers to the government regulations, market competition, media exposure, takeover activities, public release and assessment of financial statements. In spite of the fact that the company’s governance process also comprises of government regulations the role of external control systems in the financial sector is still a mystery.
Forensic accounting is a special field related to accountancy profession where the accountants implement their accounting, auditing and investigative skills to detect frauds, bankruptcy and other litigations. The role of forensic accountants in investigating corporate frauds has long been identified by many countries and they now play a major role in probing corporate frauds. However the field is still in its nascent stage in India due to rapid increase in “white collar crimes” and the notion that the law enforcement agencies do not have sufficient time or expertise to expose the frauds committed. Therefore the researcher anticipates studying the role of forensic auditors and auditing process which may determine the quality of Corporate Governance practices in the banking sector.
Independent auditor’s role
The purpose of designing a set of codes for Corporate Governance is to enhance the efficiency of auditing process in order to retain the interests of all the stakeholders and investors. This is where the role of independent auditor comes into picture. The auditor has all the authority to capture the offender, eliminate bias from financial reports of the company and report objectively. Recently a lot of emphasis is placed on the role of auditor with respect to Corporate Governance as auditors’ are solely responsible in detecting the scam. On the contrary, the auditor’s must not be forced into any kind of obligation which may bind his hands from discharging his duties veritably.
Role of top management
According to the Basel Committee report on banking supervision published in the year 2014 (Bank for International Settlements, 2014), it is the responsibility of the senior managers to carry out and manage all the activities of the banks in accordance with the business strategy, risk policies and other strategies as approved by the board. The top management’s personal conduct also contributes significantly in achieving “sound Corporate Governance” along with the members of the board.
Whistle blowing policy
Whistle blowing policy in a company refers to the particular internal policy designed for its employees to report to the management about any suspicious behavior or frauds or any kind of infringement in company’s norms or code of conduct. The policy enables an employee to report to the senior managers or top management directly without informing his immediate manager(s). Because of this advantage, whistle blowing policy is considered to be a valuable tool in an organisation’s effective Corporate Governance strategy.
(This article is written by Paras Mittal, Managing Director, Gurdevi Leasing & Finance)