Business Ethics & Corporate Governance


“Crisis-hit PTC India Financial Services gets four independent directors” says a news item on March 30, 2022 in the Hindu business line

The independent directors of PTC Financial Services flagged an issue in credit sanction later resigned from the Board. The SEBI pulled up the NBFC for the action taken report on the governaance concerns raised by the independent directors in their resignation letters in the month of Jan 2022.The regulator SEBI immediately intervened and prohibited the Company from conducting AGM without the presence of Independence Directors.

This is not the first time a NBFC issue was referred in the headlines of business news paper. In September 2018, the Infrastructure Leasing & Finance Co (IL&FS), a prominent NBFC, defaulted on its debt obligations. Other NBFC companies like Anil Ambani-led Reliance Capital Group and also mortgage major DHF faced liquidity crunches. Dewan Housing Finance Corporation Ltd (DHFL) followed the suit in 2019. Elsewhere in the international markets the Rogue Trader Nicholas William Leeson collapsed Barings Bank in Britain (founded in 1762) in 1995. Kweku Adoboli, defrauded UBS London and caused $2.3bn (£1.8bn) in 2008.  In September 2020, JP Morgan Chase & Co, leading Investment bank, agreed to pay $920 million for spoofing for manipulating the commodities market to the Commodity Futures Trading Commission (CFTC). These incidents give the tip of the iceberg.

The Governance Issues at IL&FS and DHFL:  One of the major reasons for the collapse of IL&FS was due to asset-liability mismatch, wherein they have borrowed short for making long-term loans. This type of governance issues reflect the long-standing structural challenges in the banking and NBFC sector which highlight systemic weaknesses in governance, credit risk assessment, and mis-management  and should be addressed as suggested in Financial  Sector Assessment Program (FSAP) introduced by IMF and World Bank in 1999.  

As of October 2018 IL&FS was exposed to Rs99000 crores fund based and non fund based debt. For IL&FS, the new board led by banker Uday Kotak has over the years 2019 to 2021 been able to resolve outstanding debt of close to ₹55,000 crore.

DHFL created an inflated retail loans portfolio of 1, 81,664 false and non-existent retail loans aggregating Rs 14,095 crore as outstanding in their Bandra Branch (non existing), the loans referred to as ‘Bandra Books’ were maintained in a separate database and subsequently merged with other large project loans or OLPL (Other Large Project Loans).The funds were siphoned off by the promote group. Ultimately in 2021 DHFL, with outstanding debt of over Rs 90,000 crore, was acquired by the Piramal group for Rs37, 250 crore through the resolution process.

The Impact of the Governance Issues: The failures of IL&FS and DHFL reflected the vulnerabilities of Indian NBFC sector its governance issues. As a consequence, the NBFC players faced debt downgrades and liquidity crunch. New bond issuance by NBFCs in aggregate has come down significantly after the failure of IL&FS. Mutual Funds, the major funding source of NBFCs have reduced their exposure to commercial paper (CP) of NBFCs resulting in liquidity issues leading to low quality of assets damaging the health of the balance sheets.

Lessons to the Stakeholders: The stake holders in the NBFC market like credit rating agencies (CRAs), auditors, and securities market regulator, banks, and mutual funds have learnt important lessons from the crisis created by IL&FS and DHFL. CRAs rated the IL&FS highly initially but the sudden default sent shockwaves through the system and the credibility of Credit Rating Agencies was at stake. This highlighted crucial role of CRAs and the Securities and Exchange Board of India (SEBI).

Who will address these governance Issues? : The common thread in all these failures was lack of control systems and failure of ethical corporate governance. The issues in IL&FS and DHFL are related to compliance, risk management and governance which are to be addressed by the companies’. These NBFCs/ investment banking companies failed the investors and the market. Here the role of the Regulators is very important. Take the issue of PTC Financial Services. Any delayed decision by the regulator on the resignation of independent directors after the independent directors’ had red flagged the issues would adversely impact corporate governance in the country and set a bad precedent.

Conclusion : In an interview with ETNOW in 2020 when he was elected as President of   CII for the year 2020-21 , Uday Kotak, the veteran banker mentioned that NBFC issues should be divided into three categories  a) Issues of solvency; b) Issues of governance; and c) Issues of liquidity.

The issues of solvency and the liquidity are address by the regulator RBI by restructuring some of the systemic issues. On the governance issues side the Reserve Bank of India (RBI) has taken steps to strengthen the regulation and supervision of NBFCs, along with providing liquidity to the system. One of the remedial measures suggested was to have a holistic view of the financial sector by strengthening the FSDC mechanism (FSDC: Financial Stability and Development Council).

Discussion Questions

1. Discuss the various models of corporate governance. (30% – conceptual)

2. Outline the corporate governance issues in the IL&FS and DHFL scams. (30% – contextual)

3. Why do you think NBFCs are facing corporate governance issues in India? (40% – contextual)

Question 1: Discuss the various models of corporate governance. (30% – conceptual)


Corporate governance refers to the system and structure of rules, practices, and processes by which a company is directed and controlled. Various models of corporate governance exist globally, with each model reflecting the legal, cultural, and economic context of the country in which it operates. Here are some key models of corporate governance:

Anglo-American Model:

Shareholder Primacy: In this model, the focus is on protecting and enhancing the interests of shareholders. The board of directors and management are primarily accountable to shareholders.
Market-Driven: It relies on a free-market approach, where the emphasis is on transparency, financial performance, and maximizing shareholder value.
Examples: United States and the United Kingdom follow this model.

European Model:

Stakeholder Approach: This model recognizes the interests of various stakeholders, including employees, customers, suppliers, and shareholders. The board has a more diverse set of responsibilities.
Co-Determination: In some European countries, employees have representation on boards or councils, promoting a more cooperative approach.
Examples: Germany and France follow this model.

Japanese Model:

Long-Term Orientation: Japanese corporate governance emphasizes long-term relationships with stakeholders. There is a focus on consensus-building, relationship-based banking, and cross-shareholding.
Keiretsu: Japanese companies often belong to business groups (keiretsu) where companies have cross-ownership, sharing long-term business interests.
Examples: Japan follows this model.

Family-Owned and Emerging Markets Model:

In many emerging markets, family-owned businesses dominate. Governance in these firms is often characterized by strong control by the founding family, which may not always align with the interests of minority shareholders.
Emerging markets may have weaker legal protections and regulatory oversight.

Nordic Model:

This model combines elements of the Anglo-American and European models. It emphasizes a strong welfare state, labor unions, and a significant role for the government in corporate governance.
Examples: Sweden, Denmark, and Finland follow this model.

Global Convergence Model:

Some argue that global corporate governance standards are converging, with a growing emphasis on transparency, accountability, and shareholder rights.
International organizations and initiatives, such as the OECD Principles of Corporate Governance, promote common best practices.

State-Owned Enterprises (SOEs):

In countries with a significant presence of state-owned enterprises, governance may involve political considerations and objectives alongside financial performance.
Each model has its advantages and challenges, and companies may adapt elements of multiple models based on their specific circumstances and local regulations.

Question 2: Outline the corporate governance issues in the IL&FS and DHFL scams. (30% – contextual)

IL&FS (Infrastructure Leasing & Financial Services) Scam:

Asset-Liability Mismatch: One of the major issues in the IL&FS scandal was an asset-liability mismatch. IL&FS borrowed short-term funds to finance long-term projects, creating a significant imbalance in its financial structure. This mismatch ultimately led to a liquidity crisis.
Lack of Transparency: IL&FS’s financial statements lacked transparency, and the true extent of its debt burden was not disclosed to stakeholders.
Ineffective Board Oversight: The board of IL&FS failed to exercise proper oversight and governance. There were allegations of conflicts of interest among board members.
Regulatory Lapses: Regulators like the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) were criticized for not adequately supervising IL&FS.
DHFL (Dewan Housing Finance Corporation Ltd) Scam:

Fictitious Loans: DHFL created a portfolio of fictitious retail loans, inflating its assets and financial health. These non-existent loans were used to obtain funds from the market.
Siphoning of Funds: The promoters of DHFL allegedly siphoned off funds from the company, leading to financial irregularities.
Audit Failures: Auditors failed to detect these fraudulent activities, raising concerns about their independence and effectiveness.
Weak Regulatory Oversight: Regulatory agencies were criticized for not taking sufficient action to prevent or address the fraudulent practices at DHFL.

Question 3: Why do you think NBFCs are facing corporate governance issues in India? (40% – contextual)

Non-Banking Financial Companies (NBFCs) in India have faced corporate governance issues for several reasons:

Regulatory Gaps: Historically, there were regulatory gaps in the oversight of NBFCs. While they performed financial functions similar to banks, they were subject to less stringent regulations, creating opportunities for misconduct.

Inadequate Oversight: Weak regulatory oversight and enforcement allowed some NBFCs to engage in risky practices and governance lapses.

Risk Appetite: Some NBFCs pursued aggressive business strategies and took on excessive risks without proper risk management systems in place.

Corporate Culture: In some cases, the corporate culture within NBFCs prioritized short-term gains and financial performance over long-term sustainability and governance.

Lack of Transparency: Transparency and disclosure standards in some NBFCs were subpar, making it difficult for stakeholders to assess the true financial health and risk exposure of these companies.

Related-Party Transactions: Related-party transactions and conflicts of interest within NBFCs compromised the interests of minority shareholders.

Auditor Independence: Some NBFCs faced challenges related to the independence and effectiveness of their auditors, who failed to detect or raise red flags regarding irregularities.

Market Pressure: Pressure to meet growth and profitability expectations from investors and creditors may have driven some NBFCs to compromise on governance standards.

To address these issues, regulatory authorities in India, such as the RBI and SEBI, have taken steps to strengthen the regulatory framework for NBFCs, improve transparency, enhance risk management practices, and ensure effective corporate governance. The IL&FS and DHFL scandals have served as catalysts for reforms in the sector to mitigate governance risks.

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