Transcript Corporate Governance of Banks: Why it is important, how it is special and what it implies by Stijn Claessens Senior Adviser, Operations and Policy Department Financial.

Corporate Governance of Banks:
Why it is important, how it is
special and what it implies
by
Stijn Claessens
Senior Adviser, Operations and Policy Department
Financial Sector Vice-Presidency, World Bank
for the Consultative OECD/World Bank
Meeting on Corporate Governance
December 6-7, Hanoi, Vietnam
1
Outline of presentation
• Why care in general about corporate
governance (CG)?
• Why care specifically about the CG of banks?
• What is special about CG of banks?
• What does this imply for bank CG,
regulation/supervision?
• What do we know about CG of banks?
• Implications for CG of banks
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Why care about corporate
governance?
Corporate governance matters for development
1. Increased access to financing  investment,
growth, employment
2. Lower cost of capital and higher valuation 
investment, growth
3. Better operational performance  better
allocation of resources, better management,
creates wealth
4. Less risk, at the firm and country level  fewer
defaults, fewer financial crises
5. Better relationship with stakeholders 
improved environment, social/labor
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Why care about corporate
governance?
•
All of these relationships matter for growth,
employment, poverty reduction
Empirical evidence has documented these
relationships
•
•
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At the level of country, sector and individual firm and
from investor perspective using various techniques
Quite strong relationships
•
But so far mainly documented for non-financial
corporations that are listed on stock exchanges
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Access to financing: better creditor rights
and rule of law lead to
more developed credit markets
0.9
0.8
0.6
0.5
0.4
0.3
0.2
0.1
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3
Creditor Rights * Rule of Law
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Depth of the financial system
0.7
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Access to financing: higher quality of
shareholder protection leads to more
developed stock markets
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Degree of capital market development
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Median Voting Premium
Weak corporate governance translates into
higher cost of capital
0.35
0.3
0.25
0.2
0.15
0.1
0.05
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Equity Rights
Excludes Brazil
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Return on Assets
Better corporate governance translates into
somewhat higher returns on assets
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0
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Equity Rights
Excludes Mexico and Venezuela
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Return on Investment relative to
Costs of Capital
But much better higher returns on
investment relative to cost of capital
1.1
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0.9
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0.8
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0.6
0.5
Equity Rights
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Why care about CG of banks? (I)
• Banks are corporations themselves
• CG affects banks’ valuation and their cost of
capital. CG of banks thereby affects the cost of
capital of the firms and households they lend to
• CG affects banks’ performance, i.e., costs of
financial intermediation, and thereby the cost of
capital of the firms and households they lend to
• CG affects banks’ risk-taking and risks of financial
crises, both for individual banks and for countries’
overall banking systems
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Why care about CG of banks? (II)
• Bank behavior influences economic outcomes
• Banks mobilize and allocate society’s savings.
Especially in developing countries, banks can be very
important source of external financing for firms
• Banks exert corporate governance over firms,
especially small firms that have no direct access to
financial markets. Banks’ corporate governance gets
reflected in corporate governance of firms they lend to
• Thus, governance of banks crucial for growth,
development
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What is special about CG of banks? (I)
• Banks are “special,” different from corporations
• Opaque, financial information more obscure: hard to
assess performance and riskiness
• More diverse stakeholders (many depositors and often
more diffuse equity ownership, due to restrictions):
makes for less incentives for monitoring
• Highly leveraged, many short-term claims: risky,
easily subject to bank runs
• Heavily regulated: given systemic importance, as
failure can lead to large output costs, more regulated
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What is special about CG of banks? (II)
• Because special, banks more regulated, with
regulations covering wide area
• Activity restrictions (products, branches), prudential
requirements (loan classification, reserve reqs. etc)
• Regulations often more important than laws
• Government, instead of depositors, debt or
equity-holders, takes role of monitoring banks
• Power lies with government, e.g., supervisor,
deposit insurance agency, central bank
• Raises in turn public governance questions
13
What is special about CG of banks? (III)
• Banks enjoy benefits of public safety net
• Banks, as they are of systemic importance, get
support, i.e., deposit insurance, LOLR, and other
(potential) forms of government support
• Costs of support provided often paid for by
government, i.e., in the end taxpayers
• Implies banks less subject to normal disciplines
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Debt-holders less likely to exert discipline
Bankruptcy is applied differently or rarer
Competition is less intense as entry restricted
Public safety net is large, creating moral hazard
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What is special about CG of banks? (IV)
• Same time, banks more subject to CG-risks
• Opaqueness means scope for entrenchment, shifting
of risks, private benefits and outright misuse
(tunneling, insider lending, expropriation, etc.)
larger than for non-financial firms
• As for any firm, bank shareholder value can
come from increased risk-taking
• Shareholder value is residual claim on firm value
• Increased risk-taking raises shareholder values at
expenses of debt claimholders and government
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Studies on CG of banks:
monitoring and risk
•
Banks are indeed more difficult to monitor
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Moody’s and S&P disagreed on only 15% of all
non-financial bond issues, but disagreed on 34%
of all financial bond issues
Banks are more vulnerable
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Recessions increases spreads on all bond issues,
but increases spreads on riskier banks more than
for non-financial firms
Partly result of a flight to safety, but also greater
vulnerability of banks compared to non-financial
firms
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Studies on CG of banks:
bank failings and financial crises
• In practice, banks with weak corporate
governance have failed more often
• 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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Higher currency depreciation in weaker
corporate governance countries during
periods of stress
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What does this imply for bank CG and
regulation and supervision?
• Quality of bank CG interfaces with supervision
and regulation
• More effective banks’ CG can aid supervision since
with better CG, banks can be sounder, valuations
higher, thereby making supervision easier
• Good CG-framework can make bank regulation and
supervision less necessary, or at least, different
• Need to consider therefore bank CG and
regulation and supervision together
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What does this imply for bank CG and
regulation and supervision?
• Two approaches to CG and supervision
• Basel: capital standards and powerful supervisors
• Market failures/externalities, so need regulations
• Empower private sector through laws & information
• Market failures, but also government failures
• Approaches not mutually exclusive
• What is best mix of private market and government
oversight of banks? What does this imply for bank
CG?
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What do we know about CG of banks?
• So far, little evidence on the standard CG-questions and
more complex issues of CG and regulation/supervision
• Some have documented effects of bank ownership
• LSV/BCL: banking systems with more state-ownership: less
stable, less efficient, worse credit allocation
• More foreign banks: more stable, efficient, competitive effects
• Few so far investigated bank governance
• Many studies on effects of laws & regulations for corporations
• But few on banks, except for recent evidence from Caprio,
Laeven, and Levine
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Bank ownership: possible ownership
and control patterns
• Widely-held, not-controlled by any single owner
• Controlling owner
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Family (individual)
State
Widely-held (non-financial) corporation
Widely-held financial institution
Other (trust, foundation, which may be “shell”)
• With small or large deviations of control rights
from ownership (cash-flow) rights
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Difference between ownership
and control
• Controlling owner vs. widely-held bank
• Controlling owner if direct + indirect control > (say) 10%
• Widely-held if no entity owns > 10% directly + indirectly
• Ultimate owners versus direct owners
• If any major shareholders are (F/NF) corporations, then find
their major shareholders. Continue until ultimate owners
• Example: Shareholder has x% of indirect control over
bank A if she controls directly firm C that, in turn, controls
firm B, which directly controls x% of bank A. Control
chain can be long
• Controlling owner – if any – will be the one with the
maximum direct + indirect control
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Ownership and control do deviate
Control vs Cash-flow rights
100
90
80
Indonesia
Cash-flow rights
70
60
50
India
Mexico
Turkey
Finland
Peru
Thailand
Israel
France Colombia
40
Austria
HK
Greece Pakistan
Venezuela Malaysia
Sw itzerland
30
Philippines
Singapore S. KoreaAverage
Chile
Taiw anJordan
Keyna
20
EgyptSpain
Portugal
Netherlands
Italy SriDenmark
Japan
Lanka
10
S. Africa
AustraliaNorw ayGermany Sw eden Zimbabw
e
UKUnited States
0
Canada
Ireland
0
10
20
30
40
50
60
70
Argentina
Brazil
80
90
100
Control
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Shares o f different owners
Bank control varies greatly
internationally
Ownership Structures
100%
80%
60%
40%
20%
0%
Widely
Family
State
Fin
Corp
Other
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Bank control internationally
Country mean
CF
Widely
Family
State
Fin
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Other
27.45%
25%
39%
14%
7%
2%
14%
1) Banks are generally not widely-held
2) Family ownership of banks is very important,
and so is the state ownership
3) Cross-country differences are large, though
•
In 14 of 44 countries, the controlling owner has more
than 50% of voting shares. But in Australia, Canada,
Ireland, UK, and US, either NO bank has a
controlling owner or the average is less than 2%
4) Legal protection of shareholder is associated
with more widely-held banks, i.e., with better
legal protection less need/desire for close control
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Effects of control on firms and banks
• Some firm and bank owners can be better than others
• Insiders may expropriate firm resources
• Expropriation = theft, transfer pricing, asset stripping, nepotism, and
“perquisites” that benefit insiders
• Ownership & shareholder protection laws  value
• Cash-flow rights up  expropriation less  valuation higher
• Shareholder protection laws better  valuations up
• Interactions between ownership & protection  valuation
• Are banks different?
• Laws insufficient with powerful, complex, opaque banks?
• Regulations: laws superfluous or superceded?
• Role of ownership less important?
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Valuation and shareholder rights
• Valuation
• Market-to-Book Value: Em/Eb
• Rights: shareholder rights (0-6)
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(1) Mail proxy votes
(2) Not required to deposit shares
(3) Proportional representation of minorities on board allowed
(4) Oppressed minorities mechanism
(5) Percentage for ESM < 10%
(6) When shareholders have preemptive rights, they can only be
waived by a shareholders meeting
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Supervision and regulation powers
• Official
• Power to change internal organization, management, directors, etc
• Power to supercede rights of shareholders to intervene or close bank
• Power to meet, get reports, from, and take legal action against auditor
• Restrict
• Regulatory restrictions on banks (i) securities, (ii) insurance, (iii) real
estate, and (iv) owning non-financial firms
• Capital
• Regulatory restrictions on source of funds, BIS minimum, risk-based,
are loan, security, FX loses deducted from capital, etc.
• Independence
• Degree of supervisory independence from government and banks
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Valuation effects of bank ownership
and equity rights
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When cash-flow rights of controlling owner higher and equity
rights stronger, bank valuation higher. Effects can be large:
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A one-standard deviation increase in shareholder protection laws (1.25)
raises market-to-book by 0.28, or 21 percent of mean
A one-standard deviation increase in cash flow rights (0.27) raises
market-to-book by 0.42, or 31 percent of mean
More cash-flow rights can even offset some of negative effects
of weak equity rights
Suggests strong owners, both in share and in their rights, can
help corporate governance of banks
Surprising, perhaps, quality of supervision and the degree of
regulation does not robustly influence valuations
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Bank CG and valuation
Market to Book Value and Equity Rights
Market to Book Value
1.6
1.5
1.4
1.3
1.2
1.1
1
0.9
0.8
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3
4
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Equity Rights
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Implications for CG of banks
• Bank ownership
• Be very careful on state ownership: negatively
related to valuation, stability and efficiency
• Consider inviting foreign banks
• Bank governance, regulation and supervision
• Strong private owners necessary, but they need to
have their own capital at stake
• Better shareholder protection laws can improve
functioning of banks
• Supervision/regulation less effective in monitoring
banks
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