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BASEL COMMITTEE ON BANKING SUPERVISION Corporate Governance in the Banking System Third Pan-African Consultative Forum on Corporate Governance Dakar, Senegal.

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Presentation on theme: "BASEL COMMITTEE ON BANKING SUPERVISION Corporate Governance in the Banking System Third Pan-African Consultative Forum on Corporate Governance Dakar, Senegal."— Presentation transcript:

1 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 2 Outline Background Sound corporate governance principles The role of supervisors Unique challenges Conclusions

3 BASEL COMMITTEE ON BANKING SUPERVISION 3 Background

4 BASEL COMMITTEE ON BANKING SUPERVISION 4 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 BASEL COMMITTEE ON BANKING SUPERVISION 5 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 BASEL COMMITTEE ON BANKING SUPERVISION 6 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

7 BASEL COMMITTEE ON BANKING SUPERVISION 7 Everyones 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

8 BASEL COMMITTEE ON BANKING SUPERVISION 8 Sound corporate governance principles

9 BASEL COMMITTEE ON BANKING SUPERVISION 9 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

10 BASEL COMMITTEE ON BANKING SUPERVISION 10 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

11 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 12 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 BASEL COMMITTEE ON BANKING SUPERVISION 13 Establishing strategic objectives and a set of corporate values that are communicated throughout the banking organisation.

14 BASEL COMMITTEE ON BANKING SUPERVISION 14 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

15 BASEL COMMITTEE ON BANKING SUPERVISION 15 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

16 BASEL COMMITTEE ON BANKING SUPERVISION 16 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

17 BASEL COMMITTEE ON BANKING SUPERVISION 17 Setting and enforcing clear lines of responsibility and accountability throughout the organisation.

18 BASEL COMMITTEE ON BANKING SUPERVISION 18 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 BASEL COMMITTEE ON BANKING SUPERVISION 19 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 BASEL COMMITTEE ON BANKING SUPERVISION 20 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 BASEL COMMITTEE ON BANKING SUPERVISION 21 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 BASEL COMMITTEE ON BANKING SUPERVISION 22 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 BASEL COMMITTEE ON BANKING SUPERVISION 23 Ensuring that there is appropriate oversight by senior management.

24 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 25 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 BASEL COMMITTEE ON BANKING SUPERVISION 26 Auditors and other control functions Should be: –Independent –Competent –Qualified Identify problems in risk management & internal control Ensure financial statements are accurate

27 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 28 Ensuring that compensation policies and practices are consistent with the banks ethical values, objectives, strategy and control environment.

29 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 30 Conducting corporate governance in a transparent manner.

31 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 33 Maintaining an understanding of the banks operational structure, including operating in jurisdictions, or through structures, that impede transparency (i.e. know your structure).

34 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 37 The role of supervisors

38 BASEL COMMITTEE ON BANKING SUPERVISION 38 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 BASEL COMMITTEE ON BANKING SUPERVISION 39 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 individuals 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 BASEL COMMITTEE ON BANKING SUPERVISION 40 Unique challenges

41 BASEL COMMITTEE ON BANKING SUPERVISION 41 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 BASEL COMMITTEE ON BANKING SUPERVISION 42 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 states ownership policy should be disclosed

43 BASEL COMMITTEE ON BANKING SUPERVISION 43 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 BASEL COMMITTEE ON BANKING SUPERVISION 44 Conclusions

45 BASEL COMMITTEE ON BANKING SUPERVISION 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 BASEL COMMITTEE ON BANKING SUPERVISION 46 Questions or Comments? Kirk Odegard Member of Secretariat Basel Committee on Banking Supervision Bank for International Settlements


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