Transcript Document

The 2006 BCBS Guidelines on
Enhancing the Corporate Governance
for Banking Organizations
May 29, 2006 – Karachi, Pakistan
Presentation Outline
1.
Why corporate governance matters … in general
and to banks in particular
2.
What is special about bank vs. corporate
governance
3.
An introduction to the Basel Committee’s guidance
on enhancing corporate governance for banking
organizations
4.
Concluding remarks
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Why corporate governance matters to
corporations in general … and banks in particular
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Defining the Starting Point: What is Corporate
Governance for Banks
System by which corporations are directed & controlled
The manner in which the business and affairs are governed by boards of
directors and senior management, which affects how they:
 Set corporate objectives
 Operate the bank’s business on a day-to-day basis
 Meet the obligation of accountability to their shareholders and take
into account the interests of other stakeholders
 Align corporate activities and behavior with the expectation that
banks will operate in a safe and sound manner, and in
compliance with applicable laws and regulations
 Protect the interests of depositors
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Corporate Governance Matters for Banks
Themselves, and Economic Development
Corporate governance:
1. Increases access to finance
 Investment, growth, employment opportunities
2. Lowers cost of capital and improves valuation
 Investment & growth opportunities
3. Improves operational performance
 Better allocation of resources & better decision-making creates wealth
4. Builds/restores a bank’s reputation
 Build trust between banks and its stakeholders, including shareholder,
investors, regulator, depositors, employees – key in weak external
environment
5. Less and better managed risk
 Fewer defaults, fewer financial crises brings economic stability
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In Particular Because of the Central Role Banks
Play in the Economy

Well-governed banks will play a positive role
in the economy …
 Mobilizing and allocating society’s savings
 Providing financing to firms (in particular in most
developing countries w/i deep equity markets)

While poorly-governed banks can lead to
disastrous outcomes
 Bank crisis at Banco Ambrosiano (1972),
Metallgesellschaft (1993), Barings Group (1995),
Sumitomo (1996), Merrill Lynch (2001), Allied Irish
Banks (2002), Freddie Mac (2003)
 Asia and Russia financial crisis
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Corporate Governance Also Matters to the Firms
and Households Banks Lend to
Corporate governance affects
Banks’ valuation & cost of
capital
Bank performance, i.e. costs
of financial intermediation
Corporate governance of banks thus affects the cost
of capital of the firms and households
they lend to
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Why Corporate Governance is Different for Banks
Then for Firms (To a Degree)
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Most banks are (publicly or privately held)
companies themselves!
And so:
 Banks also have shareholders, directors and managers,
with the same agency conflicts and costs
 Corporate governance issues relevant to companies are
thus also relevant to banks, e.g.:
 A vigilant and independent board,
 The protection of (minority) shareholder rights and
 Appropriate disclosure and transparency
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Yet Differences in the External Environment—and
Hence Corporate Governance—Exist
Varying Externalities …
Macroeconomic
lead to important differences …
 Global Market Trends: Globalization,
consolidation, new technology
 Key economic role played by banks:
Managing savings, providing financing
Microeconomic
 Financial Structure: High debt/equity
 Transparency: Opaque, culture of
secrecy
 Insider Role: Power role, conflict of
Interests
 Risk Management: More complex that
for firms; internal audit more difficult
 Employment & Incentives: Limited
mobility
Additional
Stakeholders
 Shareholders: More dispersed due to
govt. restrictions
 Regulator and supervisor
 Depositor
 Creditor
 General public
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in economic behavior!
Heavier regulation,
- Activity restrictions)
- Prudential requirements
(reserves, provisions)
Public safety net
 less mkt. discipline
Conflicts of interests
more prevalent;
harder to assess
performance & risk
 higher chance
misuse (tunneling)
Less incentive to
monitor directors and
management
 govt. plays more
active role
Studies and Practice on Bank Corporate
Governance Have a Simple, Yet Telling Story

Banks are more difficult to monitor

Banks are more vulnerable

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Recessions increases spreads on all bond issues, but increases spreads on riskier
banks more than for ‘firms’
Partly result of a flight to safety, but also greater vulnerability of banks compared
to non-financial firms
In practice, banks with weak corporate governance have failed
more often

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
Moody’s and S&P disagreed on only 15% of all ‘firm’ bond issues, but disagreed on
34% of all financial bond issues
Accrued deposit insurance, good summary measure of riskiness of banks, higher
for weaker CG
State-owned banks enjoy even larger public subsidy, that is often misused: poor
allocation, large NPLs, e.g., Indonesia, South Korea, France, Thailand, Mexico,
Russia
Fiscal costs of government support up to 50% of GDP, large output losses from
financial crises
Countries with weaker corporate governance and poorer
institutions see more crises
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What Does This Imply for Bank Corporate
Governance and Regulation?

Two approaches to corporate governance related laws
& regulations
1. Monitor banks through laws and regulations, based on
international best practices (Basel I & II)
2. Empower banks through information and best practices,
e.g. through a code based on the OECD Principles and
Basel Committee Guidelines

Approaches not mutually exclusive: But what is best mix
of private market and government oversight of banks?

Banks certainly can preempt regulatory (re)action by
implementing good corporate governance
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An Introduction to the Basel Committee’s
Guidance on Enhancing the
Corporate Governance of Banks
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Background Information on the Basel Committee
Guidance
 Applies to a wide range of banks and countries
 Including SOEs and FOEs; OECD & emerging countries
 Applicable to diverse corporate and board structures
 Principles, not rules
 Not part of Basel II; applicable regardless
 Not intended to add new layer of regulation or to
replace national codes
 Purpose: To assist banks to enhance their corporate
governance frameworks and supervisors in assessing the
quality of those frameworks
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I. Ensuring For Good Board Practices
 Are the bank’s board members qualified?
 Right mix-of-skills in banking, finance & risk mgmt., cg, etc,.
 Are the right election procedures in place
 Can directors commit sufficient time and energy
 Do they have a clear understanding of their role?
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Setting overall strategy and managerial oversight, not day-to-day
Fiduciary duties of care and loyalty
To act in the interest of the company and all shareholders
Fit and proper tests; succession planning
 Are the able to exercise independent judgment
 Free from any conflicts of interest, and thus able to monitor
financial reporting, remuneration and nomination procedures
 Right board size, leadership and procedures in place?
 Do key committees exist: audit, risk, cg/nomination, remuneration
 Ability to obtain material information in timely manner
 Do tough, but quality discussions take place
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II. Establishing Strategic Objectives and a set of
Corporate Values
 Board should establish strategic objectives and ethical
standards, conditio sine quo non to bank activities
 Interests of stakeholders should be taken into account
 Best if explicit rather than implicit, but corporate culture and
‘tone at the top’ turnkey (practice vs. theory)
 Whistleblowing procedures should be implemented
 Key issues to address: corruption & bribery, self-dealing,
unethical behavior and conflicts of interest
 Communicated throughout bank
 Board is responsible for proper implementation of corporate
governance, incl. internal/related party lending
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III. Setting and Enforcing Clear Lines of
Responsibility and Accountability
 Clearly define authorities and responsibilities between
shareholders, the board & management
 Also important in group structures:
 Board at group level responsible for overall strategy, oversight of
subsidiaries, and risk/internal control structure of entire group
 Board at subsidiary level retains cg responsibilities for subsidiary
itself
 Key issue: Open & transparent intra-group policies to deal
with conflicts of interest among entities w/i group
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IV. Ensuring For Appropriate Oversight by Senior
Management
 Senior managers should establish an effective
system of internal control
 E.g. “Four eyes principles” for key decision
 Approved and periodically reviewed by the board
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V. The Importance of Internal & External Controls
and Audit to Sound Corporate Governance
The external audit
Importance of independent, external auditor is
communicated throughout bank
The internal audit
Independent
Internal controls
Management
letter issued
Monitors compliance with corporate
governance rules, regulations,
codes and policies
Report to
board’s audit
committee
Direct reporting to the
board’s audit committee
Independence must be real: no/limited non-audit services
At minimum, rotation of external
audit partner
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VI. Ensuring that Compensation is In-Line with a
Bank’s Values, Strategy & Control Environment
 Link board and management remuneration to longterm business strategy of bank
 E.g. LT performance targets vs. st-volume or profitability
 Options should only be granted under appropriate terms
(time limits to hold/trade) and shareholder approval
 Differentiate between executive & non-executive pay
 Both should enable the bank to attract & retain top talent,
but former has stronger linked to performance while latter to
responsibility and time commitment
 Independent remuneration committee sets
remuneration  Board discusses and validate 
shareholders (ideally) approve final package
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VII. Conducting Corporate Governance in a
Transparent Manner
 Shareholders & other stakeholders can only effectively
monitor directors & managers if bank is transparent!
 Particularly important for banks’ objectives and structure
 Material and timely disclosure is key, notably on:
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Full set of financials (incl. notes)
Board and senior mgmt. structures
Basic organizational structure
Incentive structures (remuneration)
Bank-level corporate governance code and code of ethics
Nature and extent of transactions with affiliates and related
parties
 Disclose in annual report and publish on website
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VIII. Know Your Structure
 Establishing off-shore SPVs—although possibly serving
legitimate business needs—pose real oversight and
reputational risks
 Require close attention by board
 Risks need to be carefully analyses
 Purpose, structure, volume of SPVs needs to be defined and
disclosed
 Clear policies for such structures need to be developed
 Audit committee needs to pay close attention
 Internal and external audit and controls need to include these
structures
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The Role of the Supervisor
Supervisors should
 Provide guidance to banks on sound & proactive corporate
governance
 Consider corporate governance as one element of depositor
protection
 Determine whether banks have adopted & effectively
implemented sound corporate governance policies & practices
 Assess the quality of banks’ audit and control functions
 Evaluate the effects of the bank’s group structure
 Bring to the board of directors’ and management’s attention
problems that they detect through their supervisory efforts
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The Role of Stakeholders
 Shareholders – by exercising shareholder rights
 Depositors and other customers – by avoiding business with unsound banks
 Auditors – through an established and qualified audit profession, audit standards
and communication to boards and supervisors
 Banking industry associations –initiatives re. best practices and training
 Professional risk advisory firms and consultancies –assisting banks in
implementing sound corporate governance practices
 Governments – through laws, regulations, enforcement and an effective judicial
framework
 Credit rating agencies – through review and assessment of the impact of
corporate governance practices on a bank’s risk profile
 Securities regulators, stock exchanges and other self-regulatory
organizations – through disclosure and listing requirements
 Employees – through communication of concerns regarding illegal or unethical
practices or other corporate governance weaknesses.
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And One Final Remarkable Feature
“Know the corporate governance of your client”
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Thank You for Your Attention
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