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
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
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?
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:
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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