1. Corporate Governance in the Banking System
01/04/2017
Corporate Governance in the Banking System
Third Pan-African Consultative Forum on Corporate Governance
Dakar, Senegal
9 November 2005
Kirk Odegard
Secretariat, Basel Committee on Banking Supervision

2. Sound corporate governance principles The role of supervisors
01/04/2017
Outline
Background
Sound corporate governance principles
The role of supervisors
Unique challenges
Conclusions

3. 01/04/2017
Background

4. 01/04/2017
Background
Organisation for Economic Co-operation and Development (OECD) is international standard-setter for corporate governance
OECD issued corporate governance principles in 1999
Basel Committee issued guidance in 1999 applying OECD principles to banks
Late 1990s/early 2000s: corporate scandals
OECD issued revised principles in 2004
Basel Committee currently reviewing bank guidance

5. Why guidance for banks? Critical role in the economy
01/04/2017
Why guidance for banks?
Critical role in the economy
Need to safeguard depositors’ funds
Importance of trust and confidence
High cost of bank failures
Sensitivity to liquidity crises
Access to confidential customer information
Increasing complexity of bank activities

6. Foundations of effective governance
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Foundations of effective governance
Foundations of effective corporate governance are important but may be beyond supervisory control:
Macro-economic policies
System of business laws
Market integrity and transparency
Accounting standards
Banking supervisors should be aware of impediments to sound corporate governance and take steps within their power to promote effective foundations
1st paper concordat: confidential
Last on website: compliance and the compliance function in banks
Most often downloaded paper from BIS website

7. Everyone’s responsibility
01/04/2017
Everyone’s responsibility
Board and senior management are primarily responsible for effective corporate governance
Others can help promote sound bank governance:
Shareholders
Auditors
Industry associations
Governments
Banking supervisors
Stock exchanges and securities regulators
Employees
1st paper concordat: confidential
Last on website: compliance and the compliance function in banks
Most often downloaded paper from BIS website

8. Sound corporate governance principles
01/04/2017
Sound corporate governance principles

9. Working Group on Corporate Governance
01/04/2017
Working Group on Corporate Governance
Established by Basel Committee to review guidance
Incorporated elements of 2004 OECD principles
Discussed lessons learned from corporate governance breakdowns
Met with industry groups and rating agencies
Consulted with non-BCBS supervisors
Issued consultative paper in July 2005
Final paper expected late 2005/early 2006
1st paper concordat: confidential
Last on website: compliance and the compliance function in banks
Most often downloaded paper from BIS website

10. July 2005 consultative paper  May be revised based on consultation 
01/04/2017
July 2005 consultative paper
Apply to a wide range of banks and countries
Applicable to diverse corporate and board structures
Principles, not rules
Not as prescriptive as some national legislation
Commensurate with bank size, complexity and risk profile
Not part of Basel II
 May be revised based on consultation 
1st paper concordat: confidential
Last on website: compliance and the compliance function in banks
Most often downloaded paper from BIS website

11. 2004 vs. 1999 guidance Introduction of “know your structure” guidance
01/04/2017
2004 vs guidance
Introduction of “know your structure” guidance
Expanded to consider group structures
Protection for “whistleblowers”
State-owned and other non-listed banks
More in-depth discussion of:
Conflicts of interest
Role of the board of directors
Audit and other control functions
Role of banking supervisors

12. Sound corporate governance principles
01/04/2017
Sound corporate governance principles
Strategic objectives and corporate values
Clear lines of responsibility and accountability
Role of board of directors
Oversight by senior management
Internal and external auditors and other control functions
Compensation policies and practices
Governing in a transparent manner
“Know your structure”

13. 01/04/2017
Establishing strategic objectives and a set of corporate values that are communicated throughout the banking organisation.

14. Strategic objectives and corporate values
01/04/2017
Strategic objectives and corporate values
Should be established by the board of directors
Corporate culture should foster ethical behaviour
“Tone at the top” is important
Standards should address corruption, self-dealing and other unethical or illegal behaviour
“Whistleblowers”: Employees should be encouraged to raise concerns about illegal or unethical practices to the board or an independent committee without fear of reprisal
Basel II is less a compliance exercise than an opportunity to upgrade risk management systems

15. Potential trouble situations
01/04/2017
Potential trouble situations
Lending to officers, employees or directors where allowed by national law
Consistent with market terms or terms offered to all employees
Limited to certain types of loans
Reports should be provided to the board
Subject to review by auditors and supervisors
Preferential treatment to related parties
Conflicts of interest
Basel II is less a compliance exercise than an opportunity to upgrade risk management systems

16. Addressing conflicts of interest
01/04/2017
Addressing conflicts of interest
Potential conflicts of interest arising from activities of the bank should be:
Identified
Prevented or appropriately managed
Information barriers between different units
Separate reporting lines and internal controls
Clear, fair, accurate information to customers
Appropriately disclosed
Basel II is less a compliance exercise than an opportunity to upgrade risk management systems

17. 01/04/2017
Setting and enforcing clear lines of responsibility and accountability throughout the organisation.

18. Board and senior management
01/04/2017
Board and senior management
Unclear lines of responsibility can make problems worse
The board of directors should:
Define authorities and key responsibilities
Oversee management actions
Senior management should:
Delegate responsibilities to staff and promote accountability
Be responsible to the board for the performance of the bank

19. Accountability within banking groups
01/04/2017
Accountability within banking groups
Parent board and senior management:
Set general strategies and policies for the group
Determining governance structure for subsidiaries that best contributes to effective oversight
Be aware of risks throughout the group
Integrate and coordinate governance structures
Bank board and senior management:
Responsible for governance of bank
Soundness of bank, protection of depositors, compliance with laws and regulations
Intra-group outsourcing (e.g. internal audit, risk management) do not eliminate bank board oversight
Has ultimate responsibility for corrective action at the bank

20. 01/04/2017
Ensuring that board members are qualified for their positions, have a clear understanding of their role in corporate governance and are able to exercise sound independent judgment about the affairs of the bank.

21. 01/04/2017
The board should…
Understand oversight role and duties to bank and shareholders
Avoid conflicts of interest
Have sufficient time and energy to fulfill responsibilities
Maintain collective expertise as bank grows
Implement targeted board training as necessary
Assess the effectiveness of its own governance practices
Ensure bank has an appropriate plan for executive succession
Question and receive information from senior management
Provide sound and objective advice
Do not participate in day-to-day management
Exercise due diligence in hiring external auditors

22. Independent directors
01/04/2017
Independent directors
Board should have adequate number of independent directors
Independence = ability to exercise objective judgment
Helpful if not members of bank management
Especially important in certain areas:
Ensuring integrity of reporting
Review of related-party transactions
Nomination of board members and key executives
Board and key executive compensation

23. Ensuring that there is appropriate oversight by senior management.
01/04/2017
Ensuring that there is appropriate oversight by senior management.

24. Senior management responsibilities
Should have necessary skills to manage business and exercise appropriate control
Oversee line managers consistent with board policies
Critical role: Establishing system of internal controls
Situations to avoid:
Inappropriate involvement in business line decisions
Managing areas without skills or knowledge
Inability to control “star” employees

25. 01/04/2017
Effectively utilising the work conducted by internal and external auditors, as well as other control functions, in recognition of their critical contribution to sound corporate governance.

26. Auditors and other control functions
Should be:
Independent
Competent
Qualified
Identify problems in risk management & internal control
Ensure financial statements are accurate

27. Enhancing audit & control effectiveness
Recognise importance and promote throughout bank
Enhance independence (e.g., limit non-audit services)
Auditors have duties to bank and its stakeholders
Consider rotation of audit firm or lead audit partner
Utilise audit findings and require timely correction
Report to the board or audit committee
External auditors review internal controls
Independent directors meet in the absence of bank management with external auditor and heads of internal audit, compliance, legal functions

28. 01/04/2017
Ensuring that compensation policies and practices are consistent with the bank’s ethical values, objectives, strategy and control environment.

29. Board and key executive compensation
Compensation should be consistent with:
Long-term business objectives and strategy
Corporate culture
Control environment
Should not overly depend on short-term performance
Board (or independent committee) should approve compensation
Policies re: trading bank stock and granting/re-pricing stock options

30. Conducting corporate governance in a transparent manner.
01/04/2017
Conducting corporate governance in a transparent manner.

31. Transparent governance
Necessary for shareholders, other stakeholders and market participants to monitor and hold accountable the board and senior management
Need information on corporate structure and objectives
Complex cross-shareholdings can impede transparency
At a minimum, all banks should make disclosures to supervisors

32. What should be disclosed?
Disclosure on public website or in annual report:
Board and senior management structure
Organisational structure (including ownership)
Incentive structure of the bank
Code of business conduct and/or ethics
Related-party transactions
Full annual financial statement with supporting notes and schedules

33. 01/04/2017
Maintaining an understanding of the bank’s operational structure, including operating in jurisdictions, or through structures, that impede transparency (i.e. “know your structure”).

34. Operational structure
Some bank operations may lack or impair transparency
Particular jurisdictions (e.g. some offshore centres)
Complex structures (e.g. special purpose vehicles or corporate trusts)
Banks may provide services or establish opaque structures for clients
Often legitimate and appropriate business purposes

35. Supervisory concerns
The use or sale of opaque structures/products may:
Pose potentially significant financial, legal and reputational risks
Impede board and senior management oversight
Hinder effective banking supervision
Risks should be appropriately assessed and managed

36. Risk management expectations
Clear policies and procedures should be in place
Approval for use and sale
Identify and manage all material risks
Need for such activities should be regularly assessed
Corporate governance expectations should be established for all relevant entities
Activities should be subject to enhanced audit procedures and internal control reviews
Assess compliance with applicable laws, regulations and internal policies and procedures

37. The role of supervisors
01/04/2017
The role of supervisors

38. 01/04/2017
Supervisory role
Poor corporate governance practices can be a cause or a symptom of larger problems
Banking supervisors should:
Promote strong corporate governance
Determine whether the bank has sound corporate governance policies and practices
Hold the board of directors and senior management accountable for governance and internal control weaknesses
Be attentive to warning signs of deterioration in management
Consider issuing supervisory guidance for governance

39. Supervisory questions
01/04/2017
Supervisory questions
Does the board exercise effective oversight?
Are controls to detect and mitigate conflicts of interest adequate?
Are internal controls properly implemented (as opposed to being written down but not operational)?
Do internal and external audit functions conduct independent and effective reviews?
Are major shareholders, directors and managers “fit and proper”?
Will an individual’s skills and experience contribute to bank safety and soundness?
Does criminal or regulatory record make a person unfit?
Is a group structure managed in such a way as to negatively impact management of the bank?

40. 01/04/2017
Unique challenges

41. Controlling shareholders
01/04/2017
Controlling shareholders
For example, family-owned or other non-listed banks
Controlling shareholders can be a valuable resource
Unique governance challenge because of influence
There should be sufficient checks and balances on inappropriate activities or influences
The board and its directors have responsibility to the company and all of its shareholders
Supervisors should be able to assess fitness & propriety of bank owners

42. State-owned banks OECD has issued guidance for state-owned enterprises
01/04/2017
State-owned banks
OECD has issued guidance for state-owned enterprises
General principles should be applied to state-owned banks
Ownership and supervision functions should be fully separated
Government should not be involved in day-to-day management
Board independence from political influence should be respected
Objectives of state ownership and state’s ownership policy should be disclosed

43. 01/04/2017
Two-tier boards
Some countries adopt a two-tier board of directors (e.g. management board and supervisory board)
Basel Committee recognises that both one-tier and two-tier boards may be appropriate
Two-tier boards may be structured differently across jurisdictions, so no specific guidance
Whichever structure is used, principles of sound corporate governance should be in place

44. 01/04/2017
Conclusions

45. Wrapping up
Banks have a unique role in the economy, so targeted corporate governance guidance is appropriate
Key elements:
Board of directors = oversight
Senior management = internal controls
Supervisors = promote and assess sound governance
Actual practice is just as important as written policies and procedures

46. Questions or Comments? Kirk Odegard Member of Secretariat
01/04/2017
Questions or Comments?
Kirk Odegard
Member of Secretariat
Basel Committee on Banking Supervision
Bank for International Settlements