Transcript Policy Brief on Corporate Governance of Banks in Eurasia Outline of the Preliminary First Draft Motoyuki YUFU Principal Administrator, OECD Tbilisi, Georgia 17 May 2007 1

Policy Brief on Corporate Governance of Banks in Eurasia
Outline of the Preliminary First Draft
Motoyuki YUFU
Principal Administrator, OECD
Tbilisi, Georgia
17 May 2007
1 1
Before we start; The Eurasian Corporate
Governance Roundtable

The OECD and the World Bank Group promote five regional
roundtables on corporate governance in the world.
– The Eurasian Roundtable (Roundtable) was established in 2000.

The Roundtable comprises policy-makers, regulators, academics,
stock exchanges, non-governmental institutions and private-sector
bodies from 9 Eurasian countries.
– Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Moldova,
Mongolia, Ukraine and Uzbekistan

The Roundtable agreed on a report (2004)
“Corporate Governance in Eurasia - A Comparative Overview”
2 2
Before we start; The Task Force on CG of
Banks in Eurasia

One of the six priorities of the “Comparative Report”
“Governments should intensify their efforts to improve the
regulation and corporate governance of banks.”

The Roundtable decided to launch a task force on
bank governance
– Experts in banking or capital market
– Experts from Eurasia, OECD countries and international
organisations
– To develop a policy recommendations/options paper
3 3
Before we start; Some notes for discussion

We would appreciate your understanding on the followings.
– Simultaneous interpreters at work. Please be advised to
speak slowly and clearly.
– There are many chapters. Please make sure your
comments best suit for the chapter being discussed.
– Any additional comments are welcomed even after the
meeting (by email).
[email protected]
– We would most welcome informal, lively discussion in your
private capacities.
4 4
Table of contents of the first draft
Background
Introduction
Recommendations section

Chapter 1; Boards, board members & committees

Chapter 2; Strategic objectives, professional conduct, etc.

Chapter 3; Clear lines of responsibilities

Chapter 4; Internal controls

Chapter 5; Internal/external audit

Chapter 6; Compensation

Chapter 7; Disclosure

Chapter 8; State owned/controlled commercial banks

Chapter 9; Banks’ monitoring function on CG

Chapter10; Supervisory roles & next steps
5 5
“Background” chapter of the Draft

Introduction to the Roundtable

Task Force; who are we?
– Personal views; do not reflect the views of the organisations they serve.

Nature of the Policy Brief
– Non-binding
– Serves as a source of reference
– Not an exhaustive textbook
OECD Principles, SOE Guidelines, Roundtable’s Comparative Report

Harmonisation with the Basel Committee’s work

Would assist wide range of people;
– Banks, banking industry associations, institute of directors, stock
exchanges, capital market authorities, and banking supervisors
6 6
“Introduction” chapter of the Draft

Why is bank governance so important?
– It is essential to sound & proper banking sector
– In Eurasia, banking is the most advanced industry; Banks can be
role models to others in improving corporate governance (CG)

Some definitions
– “board” and “senior management” (functional definitions)
– “Revision Commissions”
 Statutory bodies different from boards
 Responsibilities in relation to internal audit and supervision
 Appointed at general shareholder meetings
 Mostly report directly to general shareholder meetings
 Named/translated in various ways
7 7
Possible Discussion Points for
“Background” & “Introduction”
Paragraph 7 (Why is bank governance so important?)
1) May also refer to the point that;
Poor governance can lead to a bank failure which may undermine a
core element of market economy, people’s confidence in banks,
which was once lost during the period of economic dislocation.
2) May need more stress on depositors, which differentiates bank
governance discussion from that of general CG. While minority
shareholder protection is a focal point for CG in general, depositors
should be highlighted more in the discussion of bank governance.
Paragraph 9 (Definition of boards, etc.)
3) Instead of using “upper/lower boards”, use supervisory board and
management board
Paragraph 10 (Definition of “Revision Commissions”)
Let us discuss later (Chapter 5)
8 8
Chapter 1. Boards, board members and
committees (1/4)
Chapter 1 deals with four subjects.
1.
Importance of boards (paragraph 12)
2.
Boards’ independence (paragraph 13-16)
3.
Boards’ competence/knowledge and trainings (paragraph 17)
4.
Boards’ specialised committees (paragraph 18-20)
9 9
Chapter 1. Boards, board members and
committees (2/4)
1. Boards are crucially important
2. Boards’ independence
(A) Independence from senior management
• Former employment
• Material business relationship
• Additional remuneration
• Close family ties
• Cross directorship
AND
• Former members of lower boards
(B) Independence from controlling shareholders
10 10
Chapter 1. Boards, board members and
committees (3/4)
2. Boards’ independence (Cont.)
How many independent directors?
“a sufficient number of independent directors”
How to enforce/implement it?
• CG Codes with ‘comply or explain’ basis, but
• Laws/regulations with binding force can be another option
11 11
Chapter 1. Boards, board members and
committees (4/4)
3. Boards’ competence/knowledge and trainings
– Collective knowledge as an entire board
– Trainings including CG awareness-raising program
4. Boards’ specialised committees
– Boards’ audit committees vs. “Revision Commissions”
–
Other committees
•
•
They would normally belong to upper boards, not lower boards
Nomination committees
– Not common in Eurasia, but strongly recommended
12 12
Possible Discussion Points for Chapter 1
Board, board members & committees
(1/2)
Paragraph 13 &14 (Independent directors)
1) May stipulate more detailed definitions of independent directors.
2) May stipulate positive definition in addition to (OR instead of?) the
negative list definition of the draft.
For instance, the ability to exercise objective judgement and provide
informed opinion independent of self-interest, management or major
shareholders
3) May stipulate that chairperson must be independent.
Paragraph 15 (How many independent directors, etc)
4) May stipulate that the upper limit of the numbers of boards on which
one person can concurrently sits is NOT necessarily appropriate.
Paragraph 16 (How to enforce/implement it)
5) Which is better for the requirements of independent directors
 Hard Law (laws/regulations with binding force), and
 Soft Law (codes with “comply or explain” basis)
13 13
Possible Discussion Points for Chapter 1
Board, board members & committees
(2/2)
Paragraph 17 (Knowledge & training)
6) May stipulate that individual board members (all of them?) must
have competence in banking on their appointment, not just
general business experiences.
Paragraph 19 (Boards’ audit committees)
7) May stipulate competence of audit committee members
All members be financially literate and at least one member should
posses financial expertise
Paragraph 20 (Boards’ specialised committees)
8) Should they be committees of upper boards or lower boards?
14 14
Chapter 2. Strategic objectives and
professional conduct, etc. (1/2)

Cooperation between upper & lower boards in setting
objectives, etc.

Implement the objectives, etc.; bank culture
– Boards are responsible for nurturing sound bank cultures

Whistleblowers
– Employees should be encouraged to communicate their concerns
– Procedures (including contact point) should be specified
– Protection/confidentiality should be secured
15 15
Chapter 2. Strategic objectives and
professional conduct, etc. (2/2)

Related Party Transactions (RPTs)
– Core set of regulations exist in many Eurasian countries
•
Definition, ban on favourable transactions, lending limits
– How to secure effective observance to them
•
Make bank boards fully accountable/responsible
Prior approval of materially important RPTs
…But there is a risk of “Rubber Stamping”
– Burden of proof (Never approve it unless management
successfully proves it)
– Boards’ specialised committees
•
Public disclosure
– Outright banning of certain, limited types of RPTs
16 16
Possible Discussion Points for Chapter 2
(1/2)
Strategic objectives, professional conduct, etc.
Paragraph 21 (Co-operation in developing strategies, etc.)
1) In Uzbekistan, banking law requires different boards to draft
policies according to the nature of policies; some polices (e.g.
ALM) to upper boards, and others (e.g. credit) to lower boards.
Paragraph 22 (Nurturing sound bank cultures)
2) May elaborate more on “board members as role models”.
Paragraph 23 (Whistleblowers)
3) May stipulate boards’ obligation to (i) properly address such
(bona fide) information and (ii) report back to shareholders on
remedies taken.
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Possible Discussion Points for Chapter 2
Related party transactions
(2/2)
Paragraph 25 (Boards’ responsibility on RPTs)
4) May refer to regulatory/supervisory measures addressing
RPTs stipulated in Basel Core Principle 11.
Principle 11: “In order to prevent abuses arising from exposures to related
parties and to address conflicts of interest, supervisors must have in place
requirements that;
- banks extend exposures to related parties on an arm’s length basis;
- these exposures are effectively monitored;
- appropriate steps are taken to control or mitigate the risks; and
- write-offs of such exposures are made according to standard policies and
processes.”
5) May stipulate (as banks’ internal rules) indemnification
requirements on managers who breach relevant rules to get
involved in RPTs.
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Chapter 3. Clear lines of responsibilities
and accountability

Clear, not multiple, lines
– Boards (upper boards) should occupy superior position over
senior management (lower boards)

Upper boards ought to have power in relation to
appointment & removal of lower boards
– If not, revision of laws recommended
– In the meantime, at least, encourage upper boards to
nominate candidates for lower boards
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Possible Discussion Points for Chapter 3
Clear Lines of responsibilities
As a New Paragraph
1) May refer to possible problems arising from dual reporting
lines of banks that are subsidiaries of others such as foreign
financial institutions.
20 20
Chapter 4 Oversight by senior management
and internal control functions

Internal control serves for;
1. Performance objectives
2. Information objectives
3. Compliance objectives

Who should do, and what to do?
– In varying degrees, everyone’s responsibility in banks
– Senior management should establish, monitor and improve it
– Boards should ensure that senior management does so
21 21
Possible Discussion Points for Chapter 4
Oversight by senior management & internal control
functions
As a New Paragraph
1) May refer to the “four eyes principle”, values of
which are not widely understood.
Four eye’s principle includes; segregation of duties, cross-checking,
dual control of assets, double signatures.
22 22
Chapter 5 Internal audit and external
auditors (1/3)

“Revision Commissions”





Statutory bodies other than boards
Responsibilities in relation to internal audit and supervision
Appointed at general shareholder meetings, not by boards
Mostly report directly to general shareholder meetings
What to do with the “Revision Commissions”?
–
(Tentatively) suggests two options
Either empower/activate them, OR replace them
23 23
Chapter 5 Internal audit and external
auditors (2/3)

If they are to be empowered/activated;
1.
2.
3.
4.
5.
6.
7.
8.

Include independent members
Include full-time members
Include accounting experts
Involve in their own nomination process
Financial resource
Investigatory power
Coordination with boards
Fiduciary duties (legal liability)
Or, replace them
–
Make it optional for banks to replace them by creating boards’ audit
committees
24 24
Chapter 5 Internal audit and external
auditors (3/3)

Banks’ external auditors
– Boards and banking supervisors; exchange views with them
– legal basis for banking supervisors to hear their views without
consent of banks
– Legal obligation to report material breach of laws to banking
supervisors
– Legal protection when they report

Availability of external auditors with expertise at a
reasonable cost
– (No magic formula but..) Get together for nurturing such experts.
25 25
Possible Discussion Points for Chapter 5
“Revision Commissions”
(1/2)
Paragraph 32 (Recent reforms in other countries)
1) Any recent fundamental reforms in Eurasia or others in terms of
“Revision Commissions”?.
2) “Revision Commissions” in several countries do not have much to do
with internal audit functions
Paragraph 33 (Policy options)
3) Should “Revision Commissions” be replaced or empowered?
Should we push the replacement option a little harder?
4) Banks establish boards’ audit committees while maintaining the
“Revision Commissions”. Should it be encouraged or discouraged ?
5) Any comments on the draft in terms of the options to empower
“Revision Commissions”?
26 26
Possible Discussion Points for Chapter 5
Internal audit & external auditors
(2/2)
New Paragraph
6) May stipulate internal auditors competency, impartiality and
independence as well as their reporting line.
Paragraph 34 (Relationship with external auditors)
7) May refer to rotation principle and quality assessment.
8) May stipulate legal liability of external auditors for the loss
caused by their negligence.
9) May refer to the fact that banking supervision needs
competence in accounting standards. Invest more on
supervisors’ trainings in relation to this.
10)What are the prerequisites for making it mandatory for external
auditors to report material breaches to banking supervisors?
27 27
Chapter 6. Compensation

Extraordinary low remuneration for bank boards (and
“Revision Commissions”) is not desirable

Banking supervisors and others may want to provide
guidance on compensation

Remuneration for senior management and unitary board’s
executive members
– Long-term incentive scheme; link to long-term performances of the
bank, not short-term ones
28 28
Possible Discussion Points for Chapter 6
Compensation
Any suggestions?
29 29
Chapter 7. Transparency and disclosure in
terms of CG

Ensuring appropriate bank’ public disclosure is important
– Market oversight and discipline do work
– Harmonisation to internationally recognised accounting standards

In addition to the items listed on the Basel CG Guidance…
Information about “Revision Commissions” should be disclosed, too

Encourage co-operation between banking supervisors & capital
market authorities
30 30
Possible Discussion Points for Chapter 7
Transparency and disclosure
Paragraph 39 (Securing appropriate bank disclosure)
1) Should we specifically refer to the harmonisation with IFRS
(IASB), not just saying “internationally recognised accounting
standards”?
2) May also refer to auditing standards; ISA (IFAC)
3) May also refer to “CEBS Guidelines on Supervisory Disclosure
(Committee of European Banking Supervisors)”.
Paragraph 41 (Co-operation between banking & securities regulators)
4) May refer to the experiences of countries who have an
integrated financial supervisor. Do we recommend it?
31 31
Chapter 8. Corporate Governance of SOCBs
(1/2)

State-Owned/Controlled Commercial Banks (SOCBs)
 State’s significant control, either full, majority or significant minority
ownership
 Either direct or indirect ownership
 Either listed or non-listed
 Commercial banks

Core concept of the OECD’s SOE Guidelines
The state should;
– Make SOCBs have professional, effective and independent boards
– Utilise the boards to effectively supervise management while
reflecting from day-to-day intervention
32 32
Chapter 8. Corporate Governance of SOCBs
(2/2)

The state ownership policy
– Prioritised, clear objectives
– The state’s role in CG of the SOCB
– How to implement the ownership policy

Utilising boards in supervising management
– The states should NOT intervene into day-to-day management
– Instead, fully utilise/activate SOCB boards;
Professional and independent directors

SOCBs should subject to external auditing
– The states’ special audit; not a substitute for an independent
external audit
– States should exchange views with external auditors

SOCBs should/can be role models in improving CG
33 33
Possible Discussion Points for Chapter 8
Corporate Governance of SOCBs
Paragraph 42 (CG of banks and SOCBs)
1) May lay emphasis on the fact that challenges of CG
of SOCBs are different from that of private-sector
banks.
2) May refer to Basel Core Principles para. 14.
To summarise,
•
•
Market signals/discipline can be distorted if governments influence
banks’ commercial decisions (e.g. lending) in order to achieve
public policy goals.
In such cases, if guarantees are provided for such lending, they
should be disclosed and arrangements be made to compensate
the banks when the policy loans cease to perform.
34 34
Chapter 9. Banks’ monitoring of the CG
practices of their corporate borrowers

Two different arguments
1. Assess and monitor, ex-ante and ex-post, CG standards of
corporate borrowers
2. Intervene into CG of corporate borrowers

Assessment and monitoring (ex-ante and ex-post)
should be further encouraged
– Will benefit banking industry
One of the essential parts of risk management
– Will benefit sustainable national economic growth
Policy tool to improve CG in a country through bank-finance incentives

Banks’ direct intervention is not encouraged
– To prevent banks’ arbitrary decision, criteria on corporate
borrowers’ CG standards should be specified in covenants
– Banks themselves ought to improve their CG
35 35
Possible Discussion Points for Chapter 9
Banks’ monitoring of corporate borrowers’ CG
Paragraph 48 (Assessment & monitoring)
1) May refer to the preconditions for effective banking supervision
(Basel Core Principles para. 11-13)
 Preconditions; Effective business law, independent audit based on
accounting principles, auditors are held accountable.
 “Where shortcomings exist, banking supervisors should make the
government aware of these.”
2) May suggest that banks encourage their large customers to
obtain independent credit ratings.
Paragraph 49 (Banks’ intervention)
3) Some expressions may be a bit too restrictive for banks.
4) May also refer to banks’ acquiring holdings in non-financial
companies.
 Clear definition of banks’ permissible businesses
 Conflicts of interest being managed
36 36
Chapter 10. The role of supervisors and the
next steps

Banking supervisors should promote structures in
which banks naturally follow sound banking
– Effective banking supervision is important, but it is not a panacea.
– More emphasis on promoting good CG of banks
– Monitor whether banks really implement sound CG policies or not

Banking supervisors, in cooperation with capital
market authorities and others, should develop a
national CG code for banks
– Appropriate combination between laws/regulations and voluntary
rules (codes)
– Developing a template based on which banks would develop their
own CG codes, respectively
37 37
Possible Discussion Points for Chapter 10
The role of supervisors & next steps
Paragraph 53 (CG codes for banks)
1) Why do we need codes (soft law) in addition to laws &
regulations (hard law)? What is an appropriate
balance/combination of them?
1) Do we need national CG codes for banks in addition to general
CG codes?

Any suggestions for others chapters?
38 38
Thank you very much.
39 39