Corporate Governance & Banking Basic Principles
Pushpa Raj Bhandari
Since banking organizations have important financial intermediation role and high
degree of sensitivity to potential difficulties, corporate governance in the banking system is very important for the overall health of the economy.
Though the genesis of difficulties may vary from bank to bank, the ultimate source of problems is in the poor corporate governance. This coupled with the fact that safeguarding the depositors’ fund is of paramount importance, corporate governance in banking organizations has a great importance and this is not limited to a specific country but expands to the entire international financial system.
After a publication of Basal II supervisory framework, issues related to corporate governance have continued to attract considerable national and international attention in the light of a number of high profile breakdowns in corporate governance. Due to the lack of proper corporate governance in Nepali banking industry, Nepal too has faced lots of problems and loss of public faith on banking system in not so distant past. But we can see a ray of hope now with the stringent supervision system adopted by Nepal Rastra Bank along with the implementation of Basel II framework recommended by Basel Committee on Banking Supervision (BCBS). The recommendations of Basel II framework would be helpful to address corporate governance issues in the banking institutes also in Nepal.
Effective corporate governance practices are essential to achieve and maintain public trust in the banking system as such trust is critical to the proper functioning of the banking sector as well as the entire economy. Poor corporate governance may contribute to bank failure, which can pose significant threat on public costs due to its potential impact on any applicable deposit insurance systems. Bank failure also has broader macroeconomic implications such as contagion risk and impact on payment systems. In addition, poor corporate governance can lead to loss of market confidence in the ability of a bank to properly manage its assets and liabilities, including deposits, which could in turn trigger a bank-run or liquidity crises. In addition to their responsibilities to the shareholders, the banks also have a responsibility to their depositors.
There are major eight principles formulated and evolved by BCBS for enhancing corporate governance of banking institutions. These principles, if practiced honestly, will help the banking institutions to run very efficiently and effectively resulting in good financial health of the organization. These principles are briefly discussed below in the Nepali perspectives.
Principle 1
Board members should be qualified for their positions, have a clear understanding of their role in corporate governance and be able to exercise sound judgment about the affairs of the Bank.
In most of the banking and financial institutions of Nepal, the members in the board of directors are nominated according to their share investment in the bank. The qualification and capability aspects of such nominees are almost ignored, so such nominees may not possess proper understanding of the core functioning of the banks. Because of this, in most of the banks, the policies cannot be formulated with the balanced interest of the owners and stakeholders like employees, depositors and regulators.
Principle 2
The Board of Directors should approve and oversee the bank’s strategic objectives and corporate values that are communicated throughout the banking organization.
Formulation of strategic objective and corporate values of a bank is one of the two main tasks of the board of directors. The second main task is ensuring full implementation of such formulated policies and values. Generally, the board of directors endorses the policies and strategic objectives of the bank as recommended by the employees or the consultants. But Basel II requires that the board of directors must understand the inter alia impact of the strategy in the long run and ensure the implementation in tandem with the main theme of the strategies or policies. It is also to be ensured that the set corporate values and the strategic objectives of the bank are to be properly communicated to the employees throughout the banking organization.
Principle 3
The board of directors should set and enforce clear lines of responsibility and accountability throughout the organization.
The Basel II recommendations require the board of directors to set and enforce the lines of responsibilities and accountabilities of each part of the banking organization, including individual element of the functioning teams and departments. For proper corporate governance, it is essential that a proper system of operation is set and put in force for measuring responsibility and accountability performed / assumed by the each element of the organization. Performance has to be measured according to the set responsibility and rewarded or punished accordingly so that a clear understanding of the responsibility and accountability is communicated throughout the banking organization.
Principle 4
The board should ensure that there is appropriate oversight by senior management consistent with board’s policy.
The board of directors should give clear instructions with effective review process to the senior management to ensure that they have been properly operating the banking organization in a manner that is consistent with the policy set by the board. The senior managers must have clear control over the entire management of the bank in accordance with the norms and the policy is set by the board.
Principle 5
The board and senior management should effectively utilize the work conducted by the internal audit function, external auditors and internal control functions.
Another major principle to be followed by the board of directors and the senior management of the bank for enhancing corporate governance of the banking organization is to deeply study the report submitted by the internal auditor, external auditors, regulatory instructions and other observation report of internal control functions and utilize their recommendations and remedial course of actions. Any of such reports should not be neglected; rather the board and senior management should be committed to follow the recommended course of action in order to meet the set objective of the bank.
Principle 6
The board should ensure that compensation policies and practices are consistent with the bank’s corporate culture, long-term objectives and strategy and control environment.
Compensation and remuneration to the board of directors and the senior management of the bank should be controlled and regulated by the appropriate policy and accordingly practiced throughout the banking organization. Executive or non-executive directors should not take any compensation or remuneration deviating from the set norms or the policies and they should be very much conscious about such compensation to be taken by other senior managers.
Principle 7
The bank should be governed in a transparent manner.
Transparency is a very important factor that a banking organization should ensure in order to maintain the faith of other stakeholders, like share holders and depositors. Therefore, it is also a major principle of corporate governance. According to it, all the disclosures of a bank should be published transparently and the operation of the bank should be conducted in transparent manner. It is difficult for shareholders, other stakeholders and the market participants to effectively monitor and properly hold accountable the board of directors and the senior management when there is lack of transparency.
Principle 8
The board and senior management should understand the bank’s operational structure including where the bank operates in jurisdictions, or through structures, that impede transparency. (i.e. Know-Your-Structure).
Some of the major corporate governance challenges arise when banks operate through structures that lack transparency. Banks may choose to operate in a particular jurisdiction or may establish complex structures, often for legitimate and appropriate business purposes. However, operating in such jurisdiction or through such structures may pose financial, legal, and reputational risks to the banking organization and impede the ability of the board of directors and the senior management to conduct an appropriate business oversight. Clear understanding of such possible risks by the board of directors and the senior management is very much important for effective corporate governance in a banking institution.
The board and the senior management can enhance their effectiveness by introducing internal control/review processes not only in the core banking activities but also in other activities that are carried under the jurisdictions of bank’s own behalf or on behalf of the customers. Such review process could be: regular inspection visit by internal auditors, review of compliance and performance through applicable law and regulations, review of activities to ensure that they are in line with the initial intended purpose and conducting assessment of legal and reputational risk arising from any activity being conducted by the bank. The management should ensure that existence and management of such risks are notified to the board well in time.
Hence, for enhancement of the corporate governance in a banking organization, above mentioned eight basic principles, formulated and recommended by the Basel Committee for Banking Supervision, could be of great help especially in the context of Nepali culture of managing banking organizations.
( Bhandari is the Chief Executive Officer or Birgunj Finance Ltd.)
