The Department of Company Affairs (DCA) is likely to issue clarifications for exempting financial institutions' nominees on boards of companies, which are in default as far as compliance with the provisions of the Companies Act is concerned, from disqualification. This will exempt financial institution's nominees on boards of defaulting companies from the amended Section 274 (1) (g) of the Companies Act, 1956. Section 274 (1) (g) provides that directors of companies, which have failed to file annual returns for any three continuous three financial years commencing April 1999; or repay its deposits or interest thereon on the due date; or redeem debentures or pay dividend would be ineligible to be appointed directors in another company for a period of five years.

This provision actually defeats the very purpose of appointing a financial institution's nominee on a company board. As reported in our last month's issue of the Journal, financial institutions and banks have already begun the process of withdrawing their nominees from the boards of several companies.

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A survey by the ETIG is revealing as to how much the SEBI norms are being respected in spirit by corporate India. The Economic Times Intelligence Group (ETIG) undertook a random survey of 589 companies covering the alphabets A, G and S. The survey revealed that only 22 per cent of the total number of companies had disclosed segmental results along with their quarterly results. The main culprits were a large number of B1 and B2 group companies.

An analysis of the quarterly results of the companies revealed that all the companies, which did not disclose segmental results, stated that Accounting Standard 17 (AS-17) on segmental reporting is not applicable to them or that they had only one business and thus had no segments.

SEBI, in its circular issued to the stock exchanges, has said that all the companies should disclose the information as prescribed by the circular for all its reportable primary segments as identified in accordance with AS-17 issued by Institute of Chartered Accountants of India (ICAI). As-17 is applicable to all companies whose securities - debt or equity - are listed or are in process of listing on a recognized stock exchange or those enterprises with a turnover exceeding Rs. 500 million.

According to AS-17, the segments can be determined on the basis of either business segments. The Accounting Standard also specifies that a segment, which contributes at least 10 per cent of the total revenues, has to be reported in the financial statements of the company. Again a segment is defined as the business or the area, which is used by the board of directors to evaluate the performance of the company.

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A per the new insider trading regulations, SEBI (Insider Trading) Amendments Regulations 2002, which was notified in February 2002, the onus has been put on companies to frame an internal code of conduct to prevent insider trading and misuse of price-sensitive information by employees and directors. All listed companies are required to appoint a senior employee as compliance officer. The officer, who will report directly to the managing director or CEO of the company, will be responsible for ensuring that price-sensitive information does not leak out, monitoring trades and implementing the code of conduct under the board's supervision.

Apart from listed companies, public financial institutions, professional firms such as auditors, accountancy firms, law firms, consultants and analysts are under the purview of the regulations. The regulations require companies to handle price-sensitive information on a "need to know" basis, i.e. Price-sensitive information should be disclosed only to those within the company who need the information to discharge their duty.


There are also restrictions on trading the director and employees who have access to price-sensitive information. Each company should specify a "trading window" for trading in the company shares. The window should be closed during certain periods like declaration of financial results, dividend, and issue of securities by way of rights, bonus and any major expansion plans or execution of new projects. Apart from that, the window will be closed when there is amalgamation, merger, takeover and buy-back and it will be opened 24 hours after the information is made public.

To prevent misuse of confidential information organisations should adopt a "Chinese wall" which separates these areas of the organisations, which routinely have access to confidential information, considered "inside areas" from those which are "public areas". It is also required that forms should restrict trading in certain securities and designate such list as restricted or gray list. Under the new regulations, any person who holds more than 5 per cent shares or voting rights in any listed company should disclose to the company within 4 working days from acquiring the same.

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Several companies have been using the vedeo-conferencing method for interacting with Board members but there is still a legislative gap. Business line reports that "ICSI is working in close coordination with DCA. A meeting with major companies, which can contribute in this aspect, as well as representatives from the Information Technology Ministry, is scheduled for February 27 at the institute".

"The issues to be discussed at the meeting include - the legal framework, issues of management as well as the problems of technical security" the institute reportedly said.

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PTI reports that The Bombay Stock Exchange (BSE) has revised the guidelines for shifting securities of companies to 'Z group' for failure to meet certain provisions of the listing agreement.

The bourse would consider three criteria out of seven for complying with requirements - keeping a record for redressal of investors complaints, payment of annual listing fee and implementation of corporate governance code - to move company to the 'Z' group', the BSE said in a release here.

The other criteria were yearly submission of annual reports, quarterly submission of shareholding pattern, notifying book closure-record dates and publishing results on a quarterly basis, it added.

Once a security was shifted to the group, compliance record o the company would be monitored on a quarterly basis and only upon satisfactory performance for a quarter, it would be shifted back to its parent group, the exchange said.

This quarterly review would be done only in February, May, August, and November the release added.

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The government may introduce provisions within the Companies Act, 1956 to curb proliferation of investment companies by corporate houses, which have been serving dubious purposes for some.

Economic Times reports that acting on a SEBI proposal to the Joint parliamentary Committee on the stock market scam last year, the DCA recently set up a group of experts to consider measures that could rein in the activities of investment companies of corporate houses. The committee comprises DCA officials and representatives of professional institutes.

The market regulator in its reports to the JPC had emphasized that each company should be allowed only one investment firm. It had also sought to make it mandatory for the parent company to make yearly declarations about the investment company to the stock exchanges and quarterly disclosure about the change in investment pattern of such companies.

DCA officials reckon it would be tough to implement the SEBI proposal of a single investment company for a corporate house. There are no such curbs under the Companies Act that puts brakes on floatation of any number of subsidiaries.

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The Department of Company Affairs (DCA) has turned its attention to the State level Public Sector Units (PSUs) that have been defaulting in filing their annual returns regularly. DCA has sent directives to Chief Secretaries of various states to ensure that PSUs operating in their states comply with the Company Law requirement of filing their annual returns and other statutory reports on a regular basis.

DCA has been receiving a large number of requests from PSUs seeking relaxation on compliance with the Companies Act requirements. There are several PSUs, which file their returns as much as four years late. In normal circumstances, companies are required to file their annual returns with the Registrar of Companies (ROC) within 60 days of date of their annual general meeting. DCA had launched an Amnesty Scheme in May 2000 for companies in default. A large number of companies had opted for the amnesty scheme to update their records with the ROC and thereby avoid prosecution. But several PSUs continue to be in default.

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The Reserve Bank of India has directed banks to include the names of government, bank and institutional nominee directors, while reporting details of defaulting borrower companies.

This follows the Board for Financial Supervision (BFS) saying that no material fact should be suppressed while disclosing the name of a company, which is a defaulter, and the names of all directors should be published. Earlier, these nominee directors were excluded from the list. The regulator has altered its stand after the BFS observation.

As far as independent professional directors are concerned, the BFS has said that such directors do not have any material relationship with the company, its promoters or its management or its subsidiaries, which in the judgment of the board may affect their independent judgment. However, it has said that while reporting the names of FI/government nominees and independent directors, a suitable distinguishing remark could be made as a foot-note, clarifying that the concerned person is a 'nominee director' or 'independent director'.

Following these observations, RBI has advised banks and FIs to substitute the words' Professional Directors' by 'Independent Directors' and report the names of all directors in their lists of defaulters.

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It is reported that Reserve Bank of India has spotted close to 100 credit cooperatives, which are operating like "unlicensed banks" in the country. These co-operative credit societies are collecting deposits and issuing chequebooks. Over 30 such "banks" are operating in the State of Gujarat alone. Is it time for the Central Bank to start a public education campaugn apart from policing?

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Business Line reported that, the Chairmen of leading PSU banks have decided to meet at regular intervals to share information on defaulters - reversing a stoic posture for years that defaulters could benefit from. This follows the finding by some banks that there are common defaulters - a single borrower who has defaulted on payments with several banks.

The Credit Information Bureau of India (CIBIL), which was to have started functioning, is slow in getting set up and hence Banks are trying this interim measure.

The credit information bureau, jointly promoted by HDFC and State Bank of India, envisaged information sharing arrangement among banks, credit card companies, financial institutions and housing finance companies. However, due to a delay in various amendments, the bureau has been unable to take off.

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Business Line reported that regulatory challenges in the insurance industry will emerge as much from regulating insurance companies and their products in the Indian market as from cross-border operations, inter-regulatory space for supervision, inter institutional conflict and convergence in the financial services.

This will call for greater coordination among various regulators, according to Mr. G.N. Bajpai, Chairman, Life Insurance Corporation of India (LIC). Delivering the A.D.Shroff Memorial lecture on 'Challenges before the insurance industry', Mr. Bajpai called for a regulatory shift from micro-managing the insurance market and companies in the medium term.

The regulator should focus on risk-management, asset protection and asset-liability management, cost controls and solvency-based supervision which will be driven more by informed and demanding customers, proliferation of products, blurring of boundaries and the need for foreign capital.

Eventually, self-regulation will assume a pivotal role and insurance companies will have to get together to meet the challenge of co-ordination and collaboration in a competitive market place.

Mr. Bajpai said insurance operators in the Indian market would have to have a long-term perspective, deep pockets and the ability to influence the market.

According to him, the central theme of managing the Indian insurance industry in the future would be risk identification, risk assessment, risk monitoring and control. The process would have to begin from reporting of risk, risk-adjusted performance evaluation, liability and reserve administration.

The fundamental activity of the insurance industry is to manage risk, but with environmental changes, the risk landscape has undergone a metamorphosis. "The challenge before the managers of the industry will be balancing the business and risk management", he said.

Insurance companies will have to adopt corporate governance practices in a big way.

The standard of disclosure and compliance will undergo significant changes. Accounting standards will see substantive reorientation in conformity with global standards and the focus will shift to pricing distribution, risk management and investment decision-making, he said.

Emphasizing the growing importance of customer relationship management (CRM), he said, companies will have to transform CRM to value based client relationship.

The CRM challenge will have the pyramid of three sub- challenges of product development, pricing mechanism and technology management. The routes to convergence are promoting new institutions, mergers and acquisitions and strategic alliances.

It is in the interest of stakeholders of the insurance industry that convergence evolves around core competencies and there is an appropriate balance between the business model, human resources and technology, he said.

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The Consultative Group appointed by the Reserve Bank of India has suggested that a pool of potential independent directors for various bank boards be created, which should be approved by the Reserve Bank of India. This is part of the recommendations of the 12-member Consultative Group, headed by Dr. A. S. Ganguly. It is expected that the final recommendations will be submitted to the Reserve Bank by end of March 2002. The idea of pool of potential independent directors has been under debate and was initiated by the Confederation of Indian Industry (CII). The pool of directors to be approved by the regulator would include professionals with domain expertise from the fields of international finance, agriculture, infrastructure, information technology, small-scale industry etc. All banks, including foreign banks could use this list while making appointments of independent directors.

Some other issues under debate by the Consultative Group are role, responsibility and accountability of independent directors and their remuneration. The Consultative Group is also expected to identify areas and the need for change in legislations.

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It is reported that Joseph Stiglitz, whose work on market economics won him a Nobel Prize last year, slammed the Enron scandal as "a capitalism by collusion" in the French financial newspaper Les Echos today.

The accounting irregularities and electoral campaign financing that preceded the biggest corporate bankruptcy in US history showed that "we need better standards and more efficient laws", Mr. Stiglitz said in an interview.

"Investors want to be certain that the information they receive sufficiently reflects the economic situation of a company. In the current regulatory and legal framework, investors have no guarantees that's what they are getting", he said.

Enron, an energy trading group that was once the seventh largest US company and which now is the subject of Congressional and criminal probes for allegedly massaging its books and misleading investors while pumping funds into the main US political parties, underlined the need for reforms, MR. Stiglitz said.

"Most of Enron's operations were legal. Its auditors declared that its core practices observed the law and that thousands of other companies did similar things. They were right - and that's exactly the problem", he said.

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California Public Employees Retirement System ( CalPERS ), America's largest pension fund group has advised foreign investors to take into account social and human rights factors, while making equity investments in India. In a new policy statement recently released and adopted by CalPERS, it has suggested that investors should look beyond the broad financial parameters such as market liquidity and volatility and consider social and human rights criteria as well. CalPERS, currently manages assets in excess of US $ 151 billion and does not currently invest in India.

According to a spokesperson of the fund, on a scale of 1 - 3 (with 3 being the best), India scored 1 in terms of settlement proficiency and capital market openness. For labour practices also it has scored equally low.

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Securities and Exchange Commission (SEC) wants standard settlers at Financial Accounting Standards Board to take more of a European approach, issuing broad, principle based standards, rather than highly detailed rules. SEC chairman has also called for a new, private oversight body to discipline accountants, supplanting the role now played by the American Institute of Certified Public Accountants.

In a recently concluded legal conference, SEC spokesperson said that though they were not aware of any Enron type accounting disasters looming large, it was quite clear that Enron is not the only corporate giant to re-state years worth of earnings. This trend had to be stopped before more investors were harmed. It was also pointed out that compliance with US GAAP is different than compliance with anti-fraud laws. According to SEC Commissioner, corporate disclosure standards have to be better providing investors with clear, accurate and meaningful information in a timely way.

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A new monograoh by the title "Corporate Governance and The Indian Private Sector" ( Queen Elizabeth House, Oxford, 2001) has been authored by Jairus Banaji and Gautam Mody, two visiting fellows of the University of Oxford who studied corporate governance in the context of large private sector companies in India, against a changing regulatory background and mounting public concern (1998-2000). The study consists of two reports:

• The first report deals with the results of 170 interviews with a very wide range of business representatives including CEOs, non-executives, fund managers and audit firms on the main issues in question (boards, accounting and disclosure standards, institutional investors).
• The second report examines the fragmented nature of corporate regulation in India and the need for consistency at this level.
  

Based on over 170 interviews with a very wide range of business representatives including CEOs, non-executives, fund managers and audit firms, the study highlights

• The ineffectiveness of boards in Indian companies
• The lack of transparency surrounding transactions within business groups
• The divergence of Indian accounting practices from international standards, and
• The changing role of, and controversy surrounding, institutional shareholders.

The authors recommend that

• Regulatory intervention needs a much stronger definition of 'independence' for directors, in line with best practice definitions now adopted in the US and UK, as well as the mandatory introduction of nomination committees,
• Financial institutions need not rely primarily on their own resources in the job of monitoring managements; a more active approach to corporate governance on the part of these shareholders requires larger changes in the nature of the FIs' ownership and control by government, greater autonomy for institutional managers, and the active development of a market for corporate control.

Given the immense topicality and significance of the issue, CGIPS will be of considerable interest and relevance to corporates, fund managers, institutional investors, academics, auditors and management consultancies, as well as the stock exchanges and the regulatory authority.

Copies may be procured for Rs.200 + postage on contacting jairus@vsnl.com

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1. Literature has been replete with exhortations that the shareholder value be balanced with that of stakeholders interest or expectations. However, this remains unresolved as there are several definitional issues of "stakeholders" and problems in measurement of their expectations and their exchangeability with shareholder value. Dr Elaine Sternberg has lucidly described the defects of the "entitlement model of stakeholding". It was pointed out that such a model rules out business; is not workable; undermines accountability and corporate governance; undermines private property and wealth; undermines agency system and also undermines political liberty.
   
   
2. A study by the McKinsey's looked at shareholder value and the possible weightage given to stakeholders in a cross section of countries. The study held that productivity growth is an imperative for creating shareholder wealth measured by market value added. The study compares countries such as Germany and Japan which have comparatively higher place for stakeholders in their governance and management processes than that of the USA. The study suggests that whether shareholder value is an overt or a covert goal, it leads to shareholder wealth creation, which does not necessarily come at the expense of other stakeholders. The study argues that capital flows wherever wealth grows which, in turn, appears to be a function of the levels and growth in productivity. The study asserts that shareholder value is the best metrics which allows for more transparent and accurate trades off. This has been well illustrated in the study on a hypothetical scale but assuming limited types of stakeholders. An important point made by the study is that the shareholders who are the claimants for residual income are the only group, which has a right and the need to know all other claims by all other stakeholders. Conversely, a stakeholder will not have a right to the information on the claims of other stakeholders.
   
   
3. There have been scores of studies and papers pointing out to the need for stakeholder engagement, social responsibility, corporate citizenship, ethical performance, and the like. A study by Shann Turnbull asserts that empirical evidence does not support the rejection of the stakeholder theory. Strategy guru Michael Porter is also cited to have been against the "winner take all" attitude and that winning companies probably involve their strategic stakeholders through greater decentralization and information flow.
   
   
4. Jeff Gates, who has taken a path breaking approach, has argued convincingly the need for expanding share ownership throughout the economy with the particular involvement of employees. The developments in the USA reflect the success of employee bonding through ownership devices. Employee share ownership plans in the USA account for a sizable portion of the capital markets (about 9%) and there are several companies, which have majority share ownership with the employees. He has termed this as "proximate stakeholding". Recognizing the inter connectedness, the suppliers and customers of several companies have resorted to stock option plans for these stakeholders as well. There are references to shares being given away to public at large in some of the transition economies either free or on a large discount. These arguments reflect the growing practice of stakeholder involvement, in innovative ways and the possibility of the irreversibility of "stakeholderisation" of companies.
   
   
5. The crux of the arguments, for practical purposes revolves around the actual status of the stakeholders vis-a-vi the company. In my view, there are three broad choices which a company has.
   
   
6. Firstly, a company may believe in giving a primary position for one or more of its stakeholders over and above that of the shareholder. This may arise on the basis of a value, philosophy, ideal, or self-image of the governing board and the management. This is reflected, for example, in the Johnson & Johnson case and its actions during the Tylenol crises where it preferred to trade off shareholder value in keeping up the interest of the patients, who it believes are the primary stakeholder. (The impact of the absence of such value to a stakeholder in the mission/credo has been commented upon citing the case of Exxon and the oil spillages).
   
   
7. The second choice for a company is to look upon stakeholder interest and expectations as an input for the overall strategy and its implementation. A company may look at meeting stakeholder needs and expectations as an essential process for improving the shareholder value, its long-term competitive advantage, and their sustainability. In this case, the process of engaging stakeholders would depend on the linkage of stakeholder behaviors to the dynamics of shareholder value. In my view, several companies look upon the aspect of trade off between shareholder value and stakeholders interest not so much as a binary proposition as much as an integrated process. Thus, "strategic stakeholding" may actually be a process of debottlenecking, forestalling hurdles, ensuring buy-in of the stakeholders, creating better bonds with the objectives, and actions of the companies. The company's effort here in is in the hope of reducing transaction costs in aligning critical elements of the society with the company's interest by using incentive mechanisms that would signal and affect their behaviors. (It is for this reason that journalists are offered stocks from promoters' quota in the private sector; for the related party stock option plans for suppliers partnering for JIT processes; and the consumer/viewer stake ownership plans in media companies).
   
   
8. The third is probably the bane of the public enterprises and those private companies which have unwittingly got involved more than needed - it is a perspective of a "right" or a "claim" by a few stakeholders, over the company. Such a claim may arise out of (a) expectancy, (b) bargaining power, (c) new benchmarks, or (d) a combination thereof. Employees for instance, assume certain rights such as deferred wages, festival advances, right to employment of children, and the like due to historical practices. Likewise, the immediate community may believe in having a right over some of the social infrastructure available with the company, such as free medical facilities. It is this expectancy that has generated a feeling of an implicit and irrevocable contract. Such a "contract" is also evident in the expectations of even ancillary units, small-scale industries, and other public enterprise suppliers of goods and services who were encouraged by Government policy.
   
   
9. The prospects of claims also increase where the stakeholder has good bargaining power with the company. The bargaining power may arise due to lack of substitution in the services/facilities/cooperation being lent. The bargaining power mounts if such cooperation or supply is critical for the company and it cannot defer consumption of such services. The bargaining power of the stakeholder would further escalate if the company has high switching cost in finding alternatives. It is for this reason, that trade unions have probably the highest amount of bargaining power amongst the stakeholders, especially if the prospects of a reprisal by the company are weak.
   
   
10. Sometimes, expectations can be generated among stakeholders by new benchmarks created in the geographical region or in the industry. Thus, if an industry leader sets new benchmarks in giving gifts to their retailers, promoters, and distributors, these become a standard for generating a claim by the stakeholders concerned on the company. Public enterprises exposed to competition now appear to be facing these pressures on account of benchmarks being created in employee, retailer/dealer/distributor and consumer segments.
    
    
11. Connected to the first approach and yet an additional possibility for a company is to look upon the stakeholder responsibility as that of meeting all laws, standards, regulations, guidelines, and also go beyond so as to be ethically right in its actions. Several codes and principles including the OECD and the CACG, probably expect companies to fall into this category. The King's report has eminently dealt with the subject of stakeholders and ethics and suggests the non-negotiable nature of compliance and ethical conduct at all levels of management and board. The codes expect companies to factor the responsibilities towards the stakeholders into their corporate decisions. Several studies indicate that "ethical complacency" (as argued by Dawn-Marie Driscoll & W. Michael Hoffman) could lead to undue effect on the stakeholders and hence the exhortation that meeting the legal requirements is the bare minimum and that good companies ought to go beyond and ensure that their activities and actions are ethically sound. (Keeping this in mind projects have been undertaken in India for elimination of child labour through the supplier and retailing networks; metrices have been developed for protection of the environment; case studies and sensitisation launched to avoid Bhopal-like tragedies).
    
    
12. The context of stakeholders naturally evokes the question of "social responsibility" and the need to distinguish it from value-driven or ethical governance. If companies were to undertake aggressive social responsibility, there is a possibility of trading off the interests of some stakeholders or the shareholders without a justifiable cause. The criticism against some of the MNCs for getting involved in political activities, or financing doubtful causes is precisely for this reason - the fear of Milton Friedman of companies assuming fascist tendencies under the garb of social responsibility is not without evidence in the private sector. The sentiment in the public enterprises has been to take up community projects and the like as a process of direct contribution to socio-economic development - fortunately, no cases have been cited of such "run-away social responsibility" among public enterprises.
    
    
13. The important aspect of the entire debate on stakeholder expectations and its trade off with shareholder value is based on a welt of assumptions. The majority shareholder, i.e. the government in the case of public enterprises, does not ascertain from the minority shareholders as to the extent of stakeholder-related investments and expenditure that a company should incur. Management often assumes that it has to meet the expectations of the stakeholders and these are often carried through. It is only during times of financial crisis that the management would like to roll back its levels of expenditure and commitment to the stakeholders. Being part of the budget process, and fairly diffused, the flows towards stakeholders are often glossed over. Similarly, the stakeholder expectations are seldom assessed or managed (tempered) - only the claims get heard (and the wheel that squeaks get the oil). It is the claims of some stakeholders which elicits a reactive response from the public enterprise companies.
    
    
14. In conclusion, it appears that the stakeholder arguments must pass the stage of "whether or not" and get on with "why" for the company and relatedly, "how". A stakeholder policy is required for each company with deep understanding of the linkages to share holder value, outlined in the forgoing.

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Can a company remunerate its Non-executive Directors (Non-whole time directors) by way of stock options issued under the SEBIs approved schemes?

Under the SEBI (Employee Stock Option Scheme and Employees Stock Purchase Scheme) Guidelines , 1999 (hereinafter called `ESOS Guidelines') in clause sub-clause (1) of Clause 2.1 of ESOS Guidelines an employee has been exhaustively defined as follows:

"employee' means

(a) a permanent employee of the company working in Indian or out of India; or
(b) a director of the company, whether a whole time director or not; or
(c)an employee as defined in sub-clause (a) or (b) of a subsidiary, in India or out of India, or of a holding company of the company.

Hence, it transpires that a Non Wholetime Director is an employee within the meaning of the above ESOS Guidelines because the exhaustive definition of employee also talks of a director of a company whether a wholetime director or not.

Clause 4 of ESOS Guidelines reads as follows:

"Eligibility to participate in ESOS

4.1 An employee shall be eligible to participate in ESOS of the company.
4.2 An employee who is a promoter or belongs to the promoter group shall not be eligible to participate in the ESOS.
4.3 A director who either by himself or through his relative or through any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company shall not be eligible to participate in the ESOS.

In view of clause 4, as long as the Non Wholetime Director is not a promoter or does not belong to the promoter group or who by himself or through his relative or through any body corporate directly or indirectly does not hold more than 10% of the equity shares of the company, such a Non Wholetime Director being an employee within the meaning of ESOS Guidelines shall be eligible to participate in the Stock Option Scheme of the company.

The next question that arises is whether granting of options under ESOS Guidelines would amount to remuneration to such Non Wholetime Directors within the meaning of the Companies Act, 1956. The Explanation to Section 198 of the Companies Act, 1956 reads as under:

Explanation - For the purposes of this section and section 309, 310, 311, 381 and 387, "remuneration" shall include, -

(a) any expenditure incurred by the company in providing any rent free accommodation or any other benefit or amenity in respect of accommodation free of charge, to any of the persons specified in sub-section (1);

(b) any expenditure incurred by the company in providing any other benefit or amenity free of charge or at a concessional rate to any of the persons aforesaid;

(c) any expenditure incurred by the company in respect of any obligation or service which but for such expenditure by the company would have been incurred by any of the persons aforesaid;

(d) and any expenditure incurred by the company to effect any insurance on the life of, or to provide any pension, annuity or gratuity for, any of the persons aforesaid or his spouse or child."

The word `expenditure' was judicially interpreted by the Supreme Court in Indian Molasses Co. (Private) Ltd. v. Commissioner of Income Tax, AIR 1959 SC 1049. In this case the Supreme Court held as follows:

"But there is no case directly on what is `expenditure', and if the authorities under the English statute were to be of real assistance, the whole of the matter should have been before us. The question, however, limits the approach to whether the payments made towards the policy were `expenditure' within cl. (xv). `Expenditure' is equal to `expense' and `expense' is money laid out by calculation and intention though in many uses of the word this element may not be present, as when we speak of a joke at another's expense. But the idea of `spending' in the sense of `paying out or away' money is the primary meaning and it is with that meaning that we are concerned. `Expenditure' is thus what is `paid out or away' and is something which is gone irretrievably."

The Supreme Court of India in V.M.Salgaocar & Bros. (P) Ltd. v. CIT, quoted with approval the judgement in CIT v. Vazir Sultan Tobacco Co.Ltd. (1988) 173 ITR 290 (AP), on the question whether the difference between the concessional rate of interest and the prevailing market rate of interest on loans advanced to the employees was not a perquisite under Section 40-A(5) of the Income Tax Act, 1961, where it was held as follows:

"The Department says that the difference between the concessional rate of interest and the prevailing market price of interest should be disallowed under Section 40-A(5) of the Income Tax Act, 1961. On this question too, the Tribunal following its earlier decision, held in favour of the assessee. This question has to be answered with reference to language employed in sub-section (5) of Section 40-A of the Act. Insofar as it is relevant, the provision reads thus:

"40-A(5) (a) whether the assessee -

(i) incurs any expenditure which results directly or indirectly in the payment of any salary to an employee or a former employee, or incurs any expenditure which results directly or indirectly in the provision of any perquisite (whether convertible into money or not) to an employee or

(ii) incurs directly or indirectly any expenditure or is entitled to any allowance in respect of any assets of the assessee used by an employee either wholly or partly for his own purposes or benefit,

then subject to the provisions of clause (b), so much of such expenditure or allowance as is in excess of the limit specified in respect thereof in clause (c) shall not be allowed as deduction."

It would be evident from a perusal of sub-section (5) that it contemplates disallowance of certain expenditure incurred by the assessee which it claims as a deduction. Certain ceilings are fixed in the case of such expenditure. The assessee's contention is that it has not incurred any expenditure by giving the loans to its employees at a concessional rate of interest and, therefore, the said provision has no application. On the other hand, learned Standing Counsel for the Revenue says that if this money has not been lent to the employees at a concessional rate of interest, it would have earned interest at a higher rate had it been put in a fixed deposit in a bank. But, this argument involves importing a fiction into sub-section (5) of Section 40-A of the Act. We must assume that this money, if not lent to the employees, would have been put in a fixed deposit or would have been invested in some other profitable manner and then say that the difference amount should be disallowed. We do not think that the language in sub-section (5) of Section 40-A of the Act provides for or permits such a course. Sub-section (5) applies when an assessee claims a certain deduction saying that he has spent that money in providing, directly or indirectly either as salary to an employee or in the provision of perquisite to an employee. Only then shall the ceilings prescribed in the said sub-section come into play."

Since the language employed in the Explanation to Section 198 of the Companies Act, 1956 and Section 40-A(5) of the Income Tax Act, 1961 as quoted above are similar, it is reasonable to legally infer that the words "expenditure incurred" would not include imputed costs which have not been incurred by the company.

Clause 8 of ESOS Guidelines says the following:

8.1 Pricing: The companies granting option to its employees pursuant to ESOS will have the freedom to determine the exercise price subject to conforming to the accounting policies specified in clause 13.1".

Clause 13 of ESOS Guidelines reads as follows:

13.1 Every company that has passed a resolution for an ESOS under clause 6.1 of these guidelines shall comply with the accounting policies specified in Schedule 1.

The accounting policies for ESOS is enshrined in Schedule 1 of ESOS Guidelines. According to such accounting policy the accounting value of the options granted is treated as employee compensation in the financial statements of the company. It is submitted that despite such an accounting policy when options are granted to a Non Wholetime Director which is much less than the market price, the difference between the market price and the option price can by no stretch of imagination be legally called expenditure especially in the context of the above decisions of the Supreme Court. Legally speaking the company has not "paid out or away" anything which has gone irretrievably from the company when it grants options to Non Wholetime Directors which is less than the market price. The company does not incur any expenditure or any liability for future expenditure on that account. All that the accounting policy in Schedule 1 of ESOS Guidelines captures is an imputed cost of what the company would have foregone in case the company were to issue the shares in the market and not issue options to the Wholetime Director at less than the market price. The concept of imputed cost cannot be taken as expenditure incurred by the company in the legal sense and therefore cannot be roped in as remuneration in the light of explanation to Section 198 of the Companies Act, 1956 which defines remuneration for purposes of directors. Hence, granting of options below the market price can be made to the Non Wholetime Directors without legally being construed as remuneration within the meaning of the Companies Act, 1956. However, while granting options to Non Wholetime Director, the ESOS Guidelines have to be complied with.

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Appendix-1

Executive Summary
(Madhav Rao Committee)

1. The Reserve Bank of India appointed this Committee in May 1999 under the Chairmanship of Shri K.Madhava Rao, Ex-Chief Secretary, Government of Andhra Pradesh to review the performance of Urban Cooperative Banks (UCBs) and suggest necessary measures to strengthen this sector. The Terms of Reference of this Committee are (i) to evolve objective criteria to determine the need and potential for organising urban cooperative banks; review the existing entry point norms and examine the relevance of special dispensation for less/ least developed areas etc., ii) to review the existing policy pertaining to branch licensing and area of operation of urban cooperative banks; iii) to consider measures for determining the future set up of weak/ unlicensed banks; iv) to examine the feasibility of introducing capital adequacy norms for urban cooperative banks; v) to examine the need for conversion of cooperative credit societies into primary cooperative banks; and vi) to suggest necessary legislative amendments to B.R. Act and Cooperative Societies Acts of various states for strengthening the urban banking movement.
   
   The Committee feels that there are 5 broad objectives before it:
   
2. These are (i) to preserve the cooperative character of UCBs, (ii) to protect the depositors' interest, (iii) to reduce the systemic risks to the financial system, (iv) to put in place strong regulatory norms at the entry level so as to sustain the operational efficiency of UCBs in a competitive environment and evolve measures to strengthen the existing UCB structure particularly in the context of ever increasing number of weak banks and (v) to align urban banking sector with the other segments of banking sector in the context of application of prudential norms in toto and removing the irritants of dual control regime.
   
   Genesis and Architectecture of UCBs:
   
3. The urban cooperative banks have contributed significantly to the well being of lower income groups of the urban and semi urban populace. Perhaps, the urban cooperative credit movement in India, was the first ever attempt at micro credit dispensation in semi urban and urban areas. The UCBs and other cooperative banks were essentially governed by the State Governments under the provisions of their respective State Cooperative Societies Acts. But with the increasing demand for introduction of deposit insurance to cooperative banks, it was felt necessary to bring them under the purview of the Banking Regulation Act, 1949 (B.R.Act). The urban cooperative banks were, therefore, brought under the purview of B.R. Act, effective from l March, 1966. With this, UCBs were subjected to dual command by RBI exercising control over their banking related functions and State Governments exercising supervision over their managerial, administrative and other matters.
   
   
4. The deposit resources of UCBs rose from a meagre sum of Rs.153 crores as at the end of financial year 1966-67 (UCBs were brought under the purview of B.R.Act with effect from 1 March,1966) to Rs.50,544 crores as at the end of 31 March, 1999. The number of UCBs had also gone up from 1106 to 1936 during the corresponding period. Heterogeneity is a striking characteristic feature of UCB structure. Gujarat, Maharashtra, Karnataka, Tamil Nadu and Andhra Pradesh alone account for 78.9% of urban cooperative banks and over 75 per cent of their deposit resources. Notwithstanding the phenomenal progress registered by UCBs, today they, are facing five major problems (i) dual control, (ii) inadequate legal framework to regulate UCBs compared to the powers RBI has been vested with to regulate commercial banks, (iii) increasing incidence of weakness, (iv) low level of professionalism and (v) apprehensions about the credentials of promoters of some new UCBs. The Committee has attempted to address these issues in this Report.
   
   Licensing Policy of New Urban Cooperative Banks
   
5. This Committee has examined the feasibility of evolving certain objective criteria for determining the need for urban cooperative banks and assessing the potential of a proposed UCB. The Committee feels that in a fairly deregulated regime, neither it is feasible for the regulator to evolve certain objective criteria for assessing the need for an UCB in a given area nor does it have the wherewithal to do it. Certain conceptual tools like 'existence of credit gap' and the 'Average Population Per Bank Office (APPBO)' are not effective in determining the need for an urban bank in a given locale. Specific It, therefore, recommends that the regulator should prescribe the twin criteria i.e., a strong start-up capital and requisite norms for promoters eligibility. These two norms will suffice at the entry level for the new UCB. As regards the viability of an entity, it should be left to the judgement of the promoters. The Committee, therefore, recommends that the existing quantitative criteria for viability standards should be dispensed with and they should be replaced by qualitative norms like CRAR, tolerance limit of NPAs and operational efficiency.
   
   
6. The twin functions of start-up capital are (i) to meet the initial infrastructure cost and (ii) to provide a cushion against the erosion of a bank's assets. Viewed in this context, the existing Entry Point Norms (EPN) are low. The Committee also feels that EPN for UCBs should be on par with peer groups like Local Area Banks (LABs) and Regional Rural Banks (RRBs) whose clientele and area of operation are bradly similar to UCBs. The Committee also feels that the existing low EPN is one of the major causes for weakness of UCBs. The Committee, therefore, agrees with the views of Narasimham Committee Report on Banking Sector Reforms that the existing EPN are rather low. Accordingly, the Committee recommends the following 5 grades of increased EPN compared to the existing 3 grades.
   

   Table - A
   (Entry Point Norms for UCBs other than unit banks)

   Category of Centre	Capital (Rs. in crores)	Membership Nos.
   A - population over 15 lakhs	5.00	3000
   B - population over 10 lakhs but not exceeding 15 lakhs	2.50	2500
   C - population over 5 lakhs but not exceeding 10 lakhs	2.00	2000
   D - population over 2 lakhs but not exceeding 5 lakhs	1.00	1500
   E - population not exceeding 2 lakhs	0.50	1000

   
   
   
7. If promoters desire to set up unit banks (1 bank-branch), the above entry point capital norms require reduction. The Committee, therefore, recommends that banks which intend to start only unit banking, should be given 50% relaxation in the entry point norms applicable to the particular centre as under.
   

   Table - A (Entry Point Norms for UCBs other than unit banks)
   

   Category of Centre	Capital (Rs. in crores)	Membership Nos.
   A	2.5	3000
   B	1.25	2500
   C	1.00	2000
   D	0.50	1500
   E	0.25	1000

   
   However, if any UCB intends to open additional branches, it has to comply with the entry point capital prescribed for the banks as indicated in the Table A.
   
   
8. The Committee has examined the desirability of continuance of special dispensation i.e., relaxation in entry point norms for certain categories of banks organised in less/least developed area and banks set up exclusively for women and SCs/STs. There is some merit in the argument of the critics of special dispensation that, urban banks being financial entities, any relaxation in entry point norms would lead to proliferation of weak banks. But in view of constitutional provision for reservation for SCs/STs and the state policy of empowerment of women, the Committee recommends continuation of the relaxation in EPNs to the above categories of banks for a period of 5 years and, thereafter, the RBI should review the policy.
   
   
9. Good corporate governance is critical to efficient functioning of an entity and more so for a banking entity. The Committee feels that irrespective of the size of the operations, banks need to run on professional lines and UCBs are no exception to this rule. It, therefore, suggests that at least 2 directors with suitable banking experience or relevant professional background should be present on the Boards of UCBs and the promoters should not be defaulters to any financial institution or banks and should not have any association with chitfund/NBFCs/cooperative bank or commercial bank in the capacity of Director on the Board of Directors.
   
   Branch Licensing Policy and Area of Operation:
   
10. The Committee while broadly agreeing with the existing branch licensing policy, recommends a few changes in the policy particularly with reference to dispensing with viability standards as a prerequisite for issue of branch licences. Although UCBs are functioning in a compact area, any restriction on their expansion will hamper their growth. The Committee, recommends that RBI should extend to the UCBs the same freedom and discipline as is applicable to commercial banks in opening branches, if an UCB complies with the following broad norms: viz., (a) it should not have been in default of any of the provisions of the B.R.Act or RBI Act or Directives issued by RBI from time to time, (b) its capital adequacy is not lower than the minimum required level, (c) it must have fully complied with the provisioning norms specified by RBI, (d) its net NPAs are not more than 10%, (e) it has made profits in the last two years, and (f) its priority sector advances are not less than 60% of the total loans and advances. The Committee recommends that every UCB must submit to the RBI an Annual Action Plan (AAP). Scheduled UCBs which satisfy the eligibility criteria be given freedom to open new branches under the AAP. Non-scheduled UCBs should continue to obtain prior approval of RBI after complying the eligibility criteria. The Committee also recommends that non-scheduled UCBs should not open more than 10% of their existing branches subject to a minimum of one branch, in any given year. No UCB can open more than 2 branches on its inception or within a period of 2 years thereafter. Scheduled UCBs may be permitted to open mobile and satellite offices subject to compliance with guidelines.
    
    
11. Though urban cooperative banks were initially conceived to be small entities confining their area of operation to small towns and municipal limits of cities, over a period of time some of them have started expanding to the entire state and in some cases beyond their respective states of registration. The opponents of expansion of area of operation of UCBs argue that UCBs would lose their cooperative character and structure which give them their identity viz. local feel, compact area of operation and mutual help, if they indiscriminately expand their area of operation. Proponents of expansion of area of operation, on the other hand, argue that expansion of area of operation does not necessarily dilute the cooperative character because the clientele of UCBs having common interest belonging to common ethnic group, may spread over different parts of the state or more than one state. When some Cooperative Banks of Europe have nation-wide and world-wide presence, restricting UCBs operations to districts of their registration would place artificial barriers an their growth.
    
    
12. The Committee, therefore, recommends that (a) new UCBs can extend their area of operation to the entire district of their registration and adjoining districts, (b) when an UCB desires to open a branch in a district in a state other than the district in which it is registered, it must have a net worth which is not less than the entry point norms prescribed for the highest category centre in that state and (c) if an UCB desires to open a branch in a state other than the state in which it is registered, it must have a networth of not less than Rs.50 crores (which is 50% of the minimum requirement for a new private sector bank).
    
    Policy on Unlicensed and Weak Banks
    
13. Existence of large number of unlicensed banks has become a cause of concern for regulators. As on 30 September 1999, as many as 181 banks were still unlicensed entities. Of these, 97 banks continued to be unlicensed for over 3 decades. Existence of such large number of unlicensed banks over 3 decades, places the RBI in a state of "regulatory discomfiture".
    
    
14. The main reason for proliferation of unlicensed banks is on account of statute induced expansion. Under the provisions of Section 5 (ccv), a primary credit society whose paid up capital and reserves attain the level of Rs. 1 lakh and whose main objective is to carry on banking business, automatically secures urban banking status. The Committee, therefore, recommends that in order to choke this automatic route of transformation into UCBs, this Section of B.R.Act, needs to be amended. Many of the unlicensed banks were not given licenses due to non-compliance with entry point capital norms, non compliance with the provisions of B.R.Act, 1949 (AACS) and RBI Act, high level of NPAs and unsatisfactory operating results etc. The Committee, expresses its concern about RBI allowing so many unlicensed banks to continue to operate for so long a period. It, therefore, recommends that UCBs: (a) which are brought under the purview of B.R.Act, 1949 (AACS) in 1966, should be either given licence by RBI if they comply with the norms prescribed by it by 31 March 2002, or their applications for licenses be rejected. (b) Primary cooperative societies which were converted into UCBs after 1 March 1966, and remained unlicensed should be given licenses or their applications for licenses rejected by 31 March, 2002 or within 5 years from the date of commencement of banking business whichever is later and (c) for all primary credit societies which apply for license in future, the license should be granted or rejected within a period of 6 months from the date of application and pending grant of license, such societies must not be permitted to carry on banking business.
    
    
15. RBI should also make its policy of licensing of unlicensed banks more transparent and precise. The Committee, therefore, recommends that if an unlicensed bank (a) attains minimum level of CRAR prescribed by the regulator, (b) its net NPAs are not in excess of 10% , (c) it has made profits during each of the last 3 years and (d) it has complied with the statutory framework of BR.Act/Directive issued by RBI, should be licensed.
    
    
16. Increasing incidence of sickness in UCBs has become a constant cause of concern for RBI. As at the end of 31 March 1999, as many as 293 banks have been classified as weak. Of these, 112 do not comply with even the minimum capital requirement of Rs.1 lakh prescribed under Section 11 of B.R.Act, 1949 (AACS). The Committee feels that (a) inadequate entry point capital, (b) lack of professionalism and politicisation of management, (c) absence of compliance of prudential norms (d) absence of system for timely identification of weakness and (e) dual control over UCBs are some of the major attributary factors for sickness in UCBs.
    
    
17. Though there are institutional mechanisms like State Level Rehabilitation Review Committee (SLRRC) and Bank Level Rehabilitation Review Committee (BLRRC) to review the performance of weak banks, the progress has not been quite satisfactory. Besides, the existing parameters for classifying weak banks, in the opinion of the Committee, suffer from several defects. There should be a system to flash early warning signals to detect the incipient sickness so that financial position of a bank may not further deteriorate. The Committee, therefore, believes there should be separate criteria for identification of weak and sick banks and recommends the following objective criteria.
    
    

    Parameter	Weak bank	Sick bank
    CRAR	Less than 75% of minimum prescription or	Less than 50% of minimum prescription and
    Net NPA	10% or more but less than 15% of loans and advances outstanding as on 31 March or	15% or more of loans and advances outstanding as on 31 March or
    History of Losses	Showing net losses in operation for two years out of the last three consecutive financial years	Showing net losses in operation for the last three consecutive financial years

    
    
18. The Committee also feels that BLRCCs have not achieved much and it recommends dismantling the same. It, however, recommends that SLRCs should continue.
    
    
19. The Committee also recommends that once an UCB is classified as a sick bank, action may be taken under the provisions of Section 45 of the B.R.Act, 1949 to place it under moratorium. During the period under moratorium, it must, however, reconstruct or amalgamate with another UCB and if this is not possible, the bank's licence to carry on banking business must be withdrawn.
    
    
20. If, however, RBI feels that even without reconstruction or amalgamation a sick UCB can be rehabilitated and it should be allowed to continue to operate, then it would be necessary for RBI to ensure that bank's CRAR is not allowed to deteriorate below the ratio which exists when it is identified as a sick UCB. The Committee, therefore recommends that RBI/GOI create a Rehabilitation Fund which would be used as subordinated debt for the purpose of maintaining the CRAR of sick UCBs at the level which existed when it is declared sick. If the rehabilitation scheme succeeds the loan amount would be returned to the Rehabilitation Fund. Since, CRAR is not applicable to UCBs, it is not feasible to compute exact quantum of the Fund. Assuming the minimum net worth needed to be maintained for the sick UCBs would be equivalent to 4% of its loans and advances portfolio, and considering that only some of the sick UCBs with positive net worth would be considered as capable of rehabilitation, the size of the Fund is estimated at around Rs.40 crores.
    
    Application of CRAR to UCBs
    
21. In the opinion of the Committee, the continued financial stability of UCBs cannot be ensured unless they are subjected to the discipline of maintenance of prescribed minimum capital to risk assets ratio (CRAR). While a quick review of 50 (other than weak banks ) UCBs showed that 76% of them had reached the minimum CRAR prescribed for commercial banks, the Committee realises that it may be difficult for all UCBs to immediately comply if a minimum norm is made applicable to the whole UCB sector.
    
    
22. It has been represented to the Committee that the ability of UCBs to raise additional capital to meet CRAR norms is limited (a) by their inability to make public issue of capital, (b) the fact that members can reduce their capital and (c) particularly by the quantitative ceiling imposed by the State Cooperative Societies Acts, and Multi-State Cooperative Societies Act,1984, on the number of shares an individual can hold. The Committee is in favour of removing these quantitative restrictions but is in favour of imposing a percentage ceiling whereby no single individual can hold more than 5% of the share capital of an UCB.
    
    
23. The Committee is also in favour of UCBs being subjected to CRAR discipline in a phased manner with initially a lower CRAR norms being prescribed for non-scheduled UCBs as compared to scheduled UCB. The following norms are, therefore, recommended.
    
    

    Date	Scheduled UCB	Non-Scheduled UCB
    31st March 2001	8%	6%
    31st March 2002	9%	7%
    31st March 2003	As applicable to commercial banks	9%

    
    
    
24. Until an UCB attains the specified CRAR norms, the Committee recommends that it should be required to transfer not less than 50% of its net profits to the Reserve Fund and there should be a ceiling of 20% on the percentage of dividend it can distribute to its members.
    
    Conversion of Cooperative Credit Societies into UCBs:
    
25. RBI had been pursuing the policy of allowing cooperative credit societies as defined in Sec. 5 (ccii) of B.R. Act, (AACS) to convert themselves into urban cooperative banks, provided they attain entry point norms prescribed by RBI. But it has been suggested that allowing conversion of credit societies into UCBs in over banked areas might tantamount to back door entry into the Urban Banking fold.
    
    
26. The Committee, however, believes that denying the benefit of conversion of cooperative credit societies which have a good track record of profits, which comply with entry point norms prescribed by RBI and have already been serving certain sections of a given area, while allowing new urban cooperative banks whose promoters' antecedents are untested, would be an unfair policy stance. It, therefore, recommends that such of the credit societies whose net worth is not less than the entry point capital prescribed for new banks in that given centre, which have been posting profits during each of the last 3 years, which have earned "A" audit rating and whose methods of operation are not detrimental to the interests of the depositors, may be allowed to convert themselves into UCBs.
    
    Legislative reforms in central and states statutes
    
27. Application of certain provisions of B.R. Act, 1949 to urban cooperative banks in 1966, inaugrated regime of dual control. The dual control has become a very serious problem affecting the functioning of the urban cooperative banking sector. After interaction with urban cooperative banks and their Federations, independent observers of cooperative movement and banking sector and after perusal of certain provisions of some State Cooperative Societies Acts, the Committee is convinced that dual control regime is perhaps one of the most vexatious problems of urban cooperative banking movement. The Committee is of the view that duality in command, per se, is not the issue but it is the absence of clear cut demarcation between the functions of the State Governments and the Reserve Bank of India that has been responsible for the irritants thrown up by the dual control regime.
    
    
28. Branch licensing, expansion of area of operation, fixing interest rates on deposits and advances, audit, and investments are essentially banking related functions. The Registrars of Cooperative Societies of many States continue to exercise their powers over these areas under the mistaken impression that they can do so under the general provision of Cooperative Societies Act which empowers them to exercise general supervision and control. The Committee, therefore, strongly feels that the State Acts should be amended so as to categories the banking related functions and the functions of the State Governments separately. The Committee feels that areas relating to investments, prudential norms, branch licensing, remission of debt, change of management should exclusively come under the realm of banking related functions and RBI should be the sole regulatory authority. Registrar of Cooperative Societies of the State concerned should confine his activities to registration, approval and amendments to byelaws, election to Management Committees, protection of members' rights, and suppression of Management Committees for violation of the aforesaid activities. The Committee recommends that Multi-State Cooperative Societies Act, 1984, State Cooperative Societies Acts and B.R.Act be amended accordingly.
    
    
29. The Committee is conscious that in a competitive federal polity, the State Governments may be reluctant to carry out these amendments to the Acts. It, therefore, recommends that unless necessary amendments are made to the respective State Act and Multi State Cooperative Societies Act as suggested above, RBI may not license any new bank, nor allow the branch expansion of the existing banks in a State which does not carry out these amendments. Pending amendments to State Cooperative Societies Acts, UCBs will have the freedom to register under the amended Multi-State Cooperative Societies Act.
    
    
30. With a view to contain the growth of weak banks, the Committee suggests amendments under Section 5(ccv) of B.R. Act (AACS) so as to arrest automatic transformation of primary cooperative credit societies into urban cooperative banks. Similarly Section 5(ccvi) also needs to be amended to delete the word "primary" and Primary Cooperative Banks should be known as Urban Cooperative Banks. UCBs must also to be allowed to admit any cooperative society, other than a cooperative credit society or a cooperative bank, as their members. It also recommends amending Section 7 from stopping primary credit societies using the words "bank", "banker" etc. Besides, Section 30 of B.R. Act with regard to appointment of auditors should also be made applicable to UCBs. The Committee feels that RBI should be vested with powers to remove Directors, CEO of a bank and recommends that Section 36AA of B.R.Act, 1949 [As Applicable to Banking Companies (AABC) ] may be extended to UCBs. RBI should also be vested with powers in regard to moratorium of UCBs on the lines of Section 45(4) to 45(15) of B.R. Act (AABC). The Committee also suggests amendments to B.R.Act (AACS) so as to make the format of Balance Sheet be in consonance with Schedule III of B.R.Act (AABC).
    
    Other Related Issues
    
31. During its interaction with the State Government officials, bankers and federations certain related issues which are outside the scope of the Terms of Reference but have an important bearing on the functioning of UCBs were brought before the Committee. One of them relates to reduction in the target set for priority sector advances. The Committee feels that urban cooperative banks are essentially required to cater to the needs of low/middle income groups. Bringing down the targets of priority sector advances will go against the stated objective. Besides, of over 1400 reporting urban cooperative banks as on 31 March 1998, 84.1% have attained the target in deploying 60% of their advances to priority sector. The Committee is, therefore, not inclined to agree for reduction in the existing priority sector target for UCBs.
    
    
32. The Committee, during its visits to various centres, was told by UCBs that there is need for larger currency chest facility as many a time, RBI offices and scheduled commercial banks, who are maintaining currency chests, either do not entertain them nor the surplus cash is accepted for deposits. The Committee feels that this is a genuine grievance and requests RBI to increase the Currency chests facilities by allowing other scheduled commercial banks as well as scheduled urban cooperative banks to open currency chests by giving incentives to meet the initial and the recurring expenditure.
    
    
33. Under provisions of section 24 of the B.R. Act, urban cooperative banks are required to invest their SLR funds either in approved securities or with DCCBs/SCBs. Many representatives of urban cooperative banks have expressed their concern over the financial health of DCCBs and felt that they should be given an opportunity to invest their funds with scheduled urban cooperative banks and scheduled commercial banks. While there is some merit in this representation, the Committee is also aware of the impact of adoption of such a policy on the viability of DCCBs/SCBs in the event of flight of deposits from DCCBs/SCBs to other banks. It, therefore, suggests that RBI may examine this request in the light of recommendations to be submitted by Task Force under the Chairmanship of Shri Jagdish Capoor, Deputy Governor, Reserve Bank of India, to suggest suitable package for cooperative banks.
    
    
34. One member (Dr. Sawai Singh Sisodia) suggested a different Entry Point prescription for new UCBs. Another member, (Dr. Mukund L.Abhyankar) is unable to agree with our recommendation on non-voting shares and prescribing a ceiling on individual share holding in UCBs. Another member, (Shri Subhash S.Lalla) is also unable to agree with our recommendations on (1) the area of operation being taken out of the purview of RCS, (2) allowing UCBs to park SLR funds in commercial banks, (3) deleting the word "primary" from the B.R. Act and (4) on dual control.
    
    
    
    
    
    

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