Emphasising the Role of ‘Responsible Corporate Governance’ in Banking Sector: An Empirical Analysis of ‘Post Punjab National Bank Fraud Scenario’ in India

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The purpose of this empirical study is to investigate the role of ‘Responsible Corporate Governance’ in the wake of rising financial frauds in banking sector with special emphasis on India post Punjab National Bank fraud detection. Three major components of Corporate Governance (internal audit, disclosure and transparency, and external audit) were taken into account. A sample of 140 middle and senior level banking professionals in India was obtained during the month of March 2018 for this empirical study. The statistical techniques of Simple and Multiple Regression were utilized to derive the output. The study found that effectiveness of ‘Internal Audit’ system turned out to be most vital component of Corporate Governance in Indian banking sector followed by the component ‘disclosure and transparency’. ‘External audit’ system occupied the last place in the three components compared in the study. The further comprehensive analysis of the three dimensions of the components under study (existence, implementation, and effectiveness) revealed that the ‘effectiveness’ dimension turned out to be the most significant dimension in checking the possibility of fraud in banks. Therefore, the study found that the ‘Responsible Corporate Governance’ in letter and in spirit is the need of the hour to curb such frauds and maintain the trust of the general public in Indian banking. Keywords: Corporate Governance, Internal Audit, External Audit, Banking Sector in India, Financial Sector Fraud JEL Classification: G21, G32, G34, N25, O16

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  • 1. RESEARCHPAPER 82 APRIL 2018 I CHARTERED SECRETARY Dr. Harpreet Raman Bahl Assistant Professor Institute of Company Secretaries of India harpreet.bahl@icsi.edu Prabhjot Kaur Assistant Professor, Dept. of Economics Indraprastha College for Women and Doctoral Research Scholar Faculty of Management Studies University of Delhi Delhi prabhjot.fms@gmail.com Emphasising the Role of ‘Responsible Corporate Governance’ in Banking Sector: An Empirical Analysis of ‘Post Punjab National Bank Fraud Scenario’ in India Section I INTRODUCTION The above verse from Kautilaya’s Arthashastra (Book II, Chapter 9, Verse 37 “The Duties of Government Superintendents”) is aptly able to describe the insider view of the frauds being detected in Indian Banking sector latest one being Punjab National Bank fraud unearthed in February 2018. This verse is an absolute testimonial that mechanisms of responsible The purpose of this empirical study is to investigate the role of ‘Responsible Corporate Governance’ in the wake of rising financial frauds in banking sector with special emphasis on India post Punjab National Bank fraud detection.Three major components of Corporate Governance (internal audit, disclosure and transparency, and external audit) were taken into account. A sample of 140 middle and senior level banking professionals in India was obtained during the month of March 2018 for this empirical study. The statistical techniques of Simple and Multiple Regression were utilized to derivetheoutput.Thestudyfoundthateffectivenessof‘InternalAudit’system turned out to be most vital component of Corporate Governance in Indian banking sector followed by the component ‘disclosure and transparency’. ‘External audit’ system occupied the last place in the three components compared in the study. The further comprehensive analysis of the three dimensions of the components under study (existence, implementation,and effectiveness) revealed that the ‘effectiveness’ dimension turned out to be the most significant dimension in checking the possibility of fraud in banks. Therefore, the study found that the ‘Responsible Corporate Governance’ in letter and in spirit is the need of the hour to curb such frauds and maintain the trust of the general public in Indian banking. Keywords: Corporate Governance, Internal Audit, External Audit, Banking Sector in India, Financial Sector Fraud JEL Classification: G21, G32, G34, N25, O16 ׈SØæ ØÍæ‹ÌÑâçÜÜð ¿ÚU‹Ìô ™ææÌ´ Ù àæ€UØæÑ âçÜÜ´ çÂÕ‹ÌÑÐ ØéQæSÌÍæ ¤æØüçßÏõ çÙØéQæ ™ææÌé´ Ù àæ€UØæ ÏÙ×æÎÎæÙæÑÐÐ -Kautilaya’s Arthashastra (Just as fish moving under the water cannot possibly be found out either as gulping or not gulping water, in the same manner, the public servants employed in the government sector cannot be found out (while) embezzling money (for themselves) out of such system. The general public is not in a position to know whether the extent of honesty of such officials, because they (public) do not have the details of such funds and its usage. It is only when some institution or person is able to collect related information by spending a lot of effort and scrutiny, only then; the general public is able to know something.)
  • 2. RESEARCHPAPER 83CHARTERED SECRETARY I APRIL 2018 Corproate Governance are not novel to India but have been defined centuries ago. Kautilya was a sagacious minister in the Kingdom of Chandragupta Maurya (324/321/297 Before the Common Era) who penned down Arthashastra in around 300 BC and gave a comprehensive account of ancient system of governance and administration to detect and deal with corruption in Government sector. Arthshastra gives a detailed account of forty types of possible frauds and embezzlements in Chapter VIII, Book II of Arthashastra, the most common ones being prayoga or loan and vyavahara or trading, avastara or fabrication of accounts and pariahapana or causing less revenue and thereby affecting the treasury, upabhoga or embezzling funds for self enjoyment, and apahara or defalcation. Some of these types of frauds have made a room in Indian banking as data given hereunder present an account of abominable picture of Indian banking sector. Source: Reserve Bank of India as published by Reuters Source: Reserve Bank of India data published by The Quint The data presented on above figures stresses out the role of ‘Responsible Corporate Governance’ in banking sector in India as about which Kautilaya had given a hint in Sanskrit verse given above (It is only when some institution or person is able to collect related information by spending a lot of effort and scrutiny, only then; the general public is able to know something). This means that in order to curb the tendency of frauds and embezzlements, it must be ensured that every institution has got ‘Responsible Corporate Governance’ in place. In context of Indian Banking, though, Reserve Bank of India, the key regulator of Indian banking sector, issues guidelines from time to time on Corporate Governance norms for public sector banks which serve as a base for the Corporate Governance framework in Banks, yet, there is a need to review the robustness of such system of Corporate Governance in Indian banks as frauds are being detected in spite of presence of Corporate Governance mechanism in Banks in India. Therefore, this study is an attempt to investigate the perceptions of Indian Banking Professionals for exploring the relationship between possibility of fraud and presence of Corporate Governance mechanism in Indian Banking Sector. Section II REVIEW OF LITERATURE International institutions have been stressing the role of Corporate Governance in Banking sector in the past decades in the wake of rising financial crimes across the Globe (Bank for International Settlements, 2006; 2013; 2015; OECD, 2006; 2008;). The researchers all over the world have been trying to explore the impact of presence of internal and external Corporate Governance mechanisms on frauds and embezzlements in banking sector (Francis et al., 2003; Adelegan, 2005; Abdelkarim and Burbar, 2007; Mustafa et al., 2009; Adeyemi and Adenugba, 2011; Al-Baidhani 2016; Argun, 2016; Domitilla, 2016; Kaur; 2017. Components of Corporate Governance such as internal audit (European Confederation of Institutes of Internal Auditing (ECIIA), 2005; Olatunji, 2009; Socol, 2011; Teresita, 2012; Hayali, 2012; Gündoğdu, 2013; disclosure and transparency (United Nations, 2006; Tsamenyi, 2007; Saidi, 2008; Živko, 2008) and external audit (Adeyemi and Adenugba, 2011; Alabede, 2012; Bank for International Settlements, 2013; Mohammed, 2017) are found to be related with levels of frauds in banking sector. Therefore, such researches in the past have formed the empirical base to develop a research model to attain the objective of this study. Section III RESEARCH METHODOLOGY Research Gap Though there are studies in the literature that investigate into the relationship of Corporate Governance with banking related aspects, yet, there is hardly any study that stresses the need of a Responsible Corporate Governance Mechanism in the wake of such rising frauds in Indian banking sector. Therefore, when there is a rising concern of all the stakeholders post Punjab National Bank Fraud unveiling, there is a need to carry out an investigation into the role of responsible Corporate Governance in Financial Sector with special emphasis on Indian Banking sector. Objective of the Study The present study investigates the extent to which Corporate Governance components and dimensions (extracted from literature) influence the possibility of fraud in Indian banking sector. Measurement Instrument The data for the study was collected from primary sources through a structured questionnaire. The responses were collected through a Google form mailed to the randomly selected respondents. The universe of the study was banking professionals and middle and senior level working in Public sector banks in India. Though, 300 questionnaires were mailed in the month of March 2018 after unearthing of Punjab National Bank fraud, yet, the response rate of the same was 46.67 per cent leaving the final sample to be 140 respondents. Variables for Developing Research Model Independent Variables: Based on the review of existing literature, three components of Corporate Governance have been identified as independent variables. These variables are: • Internal audit system • Disclosure and transparency • External audit system For each of these variables three dimensions are identified, i.e Emphasising the Role of ‘Responsible Corporate Governance’ in Banking Sector: An Empirical Analysis of ‘Post Punjab National Bank Fraud Scenario’ in India
  • 3. RESEARCHPAPER 84 APRIL 2018 I CHARTERED SECRETARY ‘existence’, ‘implementation’, and ‘effectiveness’. Dependent Variable: The literature guides that presence and strength of above cited independent variables will influence the possibility of fraud in Banks. Therefore, ‘possibility of fraud’, has been chosen as the dependent variable in this study. Statistical Tools To draw up valid conclusions and test obtained results empirically, an exhaustive use of statistical tools has been made in the present research. Ranging from statistic to check normality such as Jarque- Bera Test (1980), statistic to check presence of autocorrelation i.e. Durbin Watson Statistic (1951), techniques such as Ordinary Least Square regressions have been employed to develop models for the study and attain the results. The results have been tested at 1 per cent and 5 per cent level of significance (α). Section IV ANALYSIS OF RESULTS Hypotheses The following hypotheses were developed to test the assumptions of the study: • Null hypothesis Ho1 : There exists no significant relationship between ‘possibility of fraud’ and presence of effective ‘Internal Audit’ system in banking sector. • Null hypothesis Ho2 : There exists no significant relationship between ‘possibility of fraud’ and extent of ‘Disclosure and Transparency’ in banking sector. • Null hypothesis Ho3 : There exists no significant relationship between ‘possibility of fraud’ and depth of effective ‘External Audit’ in Indian banking sector. Based on above hypotheses, both simple and multiple regression models were developed to detect the impact of the three Corporate Governance variables on the perceived possibility of fraud in banking sector in India. Table 1 presents the test output such as simple regression models for each of the independent variables and also the result of a multiple regression model by entering all three independent variables entered simultaneously into the multiple regression equation as shown in Model 4. Inferential Statistics Jarque-Bera Test In order to check normality of the dependent variable distribution, use of Jarque-Bera test is made in the study. In statistics, the Jarque–Bera test is a goodness-of-fit test of whether sample data have the skewness and kurtosis matching a normal distribution. The formula for the Jarque-Bera test statistic (JB test statistic) is: JB = n [(√b1 )2 / 6 + (b2 )2 / 24] Where: n is the sample size, √b1 is the sample skewness coefficient, b2 is the kurtosis coefficient. The null hypothesis for the test is that the data is normally distributed. The p-values for JB test output carried out on sample data indicated that residuals are distributed normally; therefore, it was fit for running multiple regressions on the sample. Durbin-Watson Test Durbin–Watson Statistic is a test statistic used to test first lag serial correlation between remained (errors) of regression. Autocorrelation means that the errors of adjacent observations are correlated. If the errors are correlated, then least-squares regression can underestimate the standard error of the coefficients (Minitab). The test is based on checking the hypothesis of absence of autocorrelation H0 : ρ = 0. If et is the residual associated with the observation at time t, then the test statistic is The Durbin Watson test values are within the range of 0 and 4. If there is no autocorrelation, DW is close to 2. Closeness to 0 means positive autocorrelation, to 4 - about negative autocorrelation. It can be seen that values of DW test statistic in all models are close to 2, indicating the absence of autocorrelation in the models. Research Models Linear Regression Model 1 PoF = αo + β1 IA (PoF = Possibility of Fraud, IA = Internal Audit) Linear Regression Model 2 PoF = αo + β1 DT (PoF = Possibility of Fraud, DT = Disclosure and Transparency) Linear Regression Model 3 PoF = αo + β1 EA (PoF = Possibility of Fraud, EA = External Audit) Multiple Regression Model 4 PoF = αo + β1 IA + β2 DT + β3 EA (PoF = Possibility of Fraud, IA = Internal Audit, DT = Disclosure and Transparency, EA = External Audit) The output of the regression model as presented in Table 1 confirms that upon entering independently in three different simple regression models, the coefficients of all the three independent variables (presented in regression models 1 to 3) are turning out to be statistically significant at 1 per cent level, which leads to the conclusion that the null hypotheses for all three models is rejected in favour of alternate hypotheses and there is a presence of significant relationship between dependent variable ‘perceived possibility of bank fraud’ and ‘Corporate Governance Variables’ depicted as ‘Internal Audit’, ‘Disclosure and Transparency’ and ‘External Audit’. Furthermore, further analysis of regression output presented in Table 1 reveals that though the coefficient of variable ‘Internal Audit’ as an independent variable in Simple Regression Model 1 has ‘the lowest value’ as compared to the coefficients of other two variables i.e. ‘Disclosure and Transparency’ and ‘External Audit’ as shown in regression models 2 and 3; yet; it yields the highest Pseudo R square and F statistics test values, leading to the conclusion that Model 1 is the most significant model of the three models tested in the table 1 of the study. Further exploration into output presented in table 1 depicts that when multiple regression taking all the three variables depicting ‘Corporate Governance’ simultaneously is run in regression model Emphasising the Role of ‘Responsible Corporate Governance’ in Banking Sector: An Empirical Analysis of ‘Post Punjab National Bank Fraud Scenario’ in India
  • 4. RESEARCHPAPER 85CHARTERED SECRETARY I APRIL 2018 4, the variable ‘External Audit’ does not remain significant anymore at 1 per cent level. This leads to the conclusion that respondents perceived variables ‘presence of Internal Audit system’ and ‘extent of disclosure and transparency’ to be more important in ‘Responsible Corporate Governance’ than ‘External Audit’. Table 1 Result of Regression Analysis of Corporate Governance Components Regression Model 1 Model 2 Model 3 Model 4 Intercept 4.995* (0.165) 6.465* (.541) 6.568* (.518) 4.842* (.347) Internal Audit -.586* (0.0489) -.598* (.089) Disclosure and Transparency -.874* (.159) -.318* (.169) External Audit -.882* (.173) .085 (.142) F Statistics 138.405* 39.882* 29.458* 39.412* R Square .687 .488 .247 .642 Pseudo R Square .612 .461 .234 .610 Durbin-Watson 2.251 2.541 1.997 2.011 Dependent variable: Perceived possibility of fraud * p <0.01, Standard errors in parenthesis The output of table 1 called for a deeper exploration of impact of ‘Responsible Corporate Governance’ on the ‘perceived possibility of fraud’. Therefore, each variable was further sub-divided into three dimensions namely, ‘Existence’, ‘Implementation’ and ‘Effectiveness’. Multiple regression models were again run taking these dimensions into account in table 2. The hypotheses and regression models taking above dimensions for each variable are given hereunder: Null hypothesis Ho4 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘existence’ dimension of variable ‘Internal Audit’ in banking sector. Null hypothesis Ho5 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘implementation’ dimension of variable ‘Internal Audit’ in banking sector. Null hypothesis Ho6 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘effectiveness’ dimension of variable ‘Internal Audit’ in banking sector. Null hypothesis Ho7 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘existence’ dimension of variable ‘Disclosure and Transparency’ in banking sector. Null hypothesis Ho8 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘implementation’ dimension of variable ‘Disclosure and Transparency’ in banking sector. Null hypothesis Ho9 : There exists no significant relationship between possibility of fraud’ and ‘effectiveness’ dimension of variable ‘Disclosure and Transparency’ in banking sector. Null hypothesis Ho10 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘existence’ dimension of variable ‘External Audit’ in banking sector. Null hypothesis Ho11 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘implementation’ dimension of variable ‘External Audit’ in banking sector. Null hypothesis Ho12 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘effectiveness’ dimension of variable ‘External Audit’ in banking sector. Null hypothesis Ho13 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘existence’ dimension of variable ‘Overall Corporate Governance’ in banking sector. Null hypothesis Ho14 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘implementation’ dimension of variable ‘Overall Corporate Governance’ in banking sector. Null hypothesis Ho15 : There exists no significant relationship between ‘perceived possibility of fraud’ and ‘effectiveness’ dimension of variable ‘Overall Corporate Governance’ in banking sector. Research Models Following Multiple Regression models used to test hypotheses above in this empirical research: Multiple Regression Model 5 PoF = αo + β1 ExIA + β2 ImpIA + β3 EffIA (PoF = Possibility of Fraud, ExIA= ‘existence’ of ‘Internal Audit’, ImpIA = ‘Implementation’ of ‘Internal Audit’, EffIA = ‘Effectiveness’ of ‘Internal Audit’) Multiple Regression Model 6 PoF = αo + β1 ExDT + β2 ImpDT + β3 EffDT (PoF = Possibility of Fraud, ExDT = ‘Existence’ of Disclosure and Transparency, ImpDT = ‘Implementation’ of Disclosure and Transparency + EffDT = ‘Effectiveness’ of Disclosure and Transparency) Multiple Regression Model 7 PoF = αo + β1 ExEA + β2 ImpEA + β3 EffEA (PoF = Possibility of Fraud, ExEA= ‘Existence’ of ‘External Audit, ImpEA = ‘Implementation’ of External Audit, EffEA = ‘Effectiveness’ of External Audit) Multiple Regression Model 8 PoF = αo + β1 ImpIA + β2 ImpDT + β3 ImpEA (PoF = Possibility of Fraud, ‘Implementation’ of Internal Audit, ImpDT = ‘Implementation’ of Disclosure and Transparency, ‘Implementation’ of External Audit) Multiple Regression Model 9 PoF = αo + β1 EffIA + β2 EffDT + β3 EffEA (PoF = Possibility of Fraud, EffIA = ‘Effectiveness’ of Internal Audit, EffDT = ‘Effectiveness’ of Disclosure and Transparency, EffEA = ‘Effectiveness’ of External Audit ) Multiple Regression Model 10 PoF = αo + β1 ExCG + β2 ImpCG + β3 EffCG (PoF = Possibility of Fraud, ExCG= ‘Existence’ of ‘Overall Corporate Governance’, ImpCG = ‘Implementation’ of ‘Overall Corporate Governance’, EffCG = ‘Effectiveness’ of ‘Overall Corporate Governance’) Results of Fitting Regression Model on Dimensions related to Variables of Corporate Governance After testing for basic assumptions related to regression such as Jarque-Bera Statistic and Durbin Watson Test, the output of Regressions models 5 to 10 present the effect of dimensions related to each variable. It can be observed in Models 5 to 7 that ‘implementation’ and ‘effectiveness’ are the di
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