Conference on Risk Management

8/12/2019 Conference on Risk Management

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THECHARTEREDINSTITUTEOFBANKERSOFNIGERIALAGOSBRANCH)CONFERENCEONRISKMANAGEMENT

Topic:

The Role of Corporate Governance in Basel II

Presented by

BAYO OLUGBEMI FCIBManaging Director/Chief Executive Officer

irst Registrars Nigeria Limited


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TABLEOFCONTENT

Introduction

Corporate Governance Defined

Who is responsible for corporate governance in Banks?

Basel II & Corporate Governance 3 Cs : Control

3 Cs : Culture

3 Cs : Clarity

8 Principles for Bank Boards & Senior Management

Common Factors in Corporate Governance Breakdown in Banks

Conclusion 2


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INTRODUCTION

Since late 2008 the financial crisis has rapidly weakened the globaleconomy and has demonstrated that Nigeria is not isolated from

disturbances in the global financial markets.

Although at first the problem was considered to be one of solidity, affectingonly a few companies, it has turned out to be a more widespread problemrequiring state involvement.

According to a recent analysis published by the Financial SupervisoryAuthority in April 2009, the profitability of the banking sector has materiallyweakened, but loss-bearing capacity remains fairly solid.

Banking supervisors have long recognized the importance of goodgovernance; supervision can not function properly if sound corporategovernance is not in place

Good corporate governance and supervisory actions complement oneanother. The guidance, inspections and oversight activities of supervisorscannot guarantee, on their own, the prudent operation and financialsoundness of a supervised bank.

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CORPORATEGOVERNANCEDEFINED

The Organization for Economic Co-operation and Development (OECD)principles define corporate governance as involving:

a set of relationships between a companys management, its board, itsshareholders, and other stakeholders. Corporate governance also provides thestructure through which the objectives of the company are set, and the means ofattaining those objectives and monitoring performance are determined. Goodcorporate governance should provide proper incentives for the board and

management to pursue objectives that are in the interests of the company and itsshareholders and should facilitate effective monitoring.

The Basel Committee document states:

From a banking industry perspective, Corporate Governance involves themanner in which the business and affairs of banks are governed by their boards ofdirectors and senior management, which affects how they: Set corporate objectives;

Operate the banks business on a day-to-day basis;

Meet the obligation of accountability to their shareholders and take into account theinterests of other recognised stakeholders;

Align corporate activities and behaviour with the expectation that banks will operate in asafe and sound manner, and in compliance with applicable laws and regulations.

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WHOISRESPONSIBLEFORCORPORATEGOVERNANCEIN

BANKS?

Primary responsibility rests with bank boards and seniormanagement (Guidance Paper, s. III)

Bank supervisors have an important role to play by providing

guidance & assessing bank practices (Guidance Paper, s. IV)

Others can promote good governance (Guidance Paper, s. V), e.g.:

Shareholders

Depositors & customers

Employees

Auditors

Banking industry associations

Credit rating agencies

Governments, securities regulators and stock exchanges5


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BASELII & CORPORATEGOVERNANCE

Fundamentally, banks must act in a way that promotes confidenceto the public and themarkets in general and, more specifically, to their primary stakeholders.

Banks play a crucial role in the flow of capital within an economy and are charged with aspecial public trust to safeguard customerswealth.

A stable and healthy banking system is critical to the long-term growth of an economy.

The primary responsibility for the conduct of the banksbusiness lies with its board andmanagement. Indeed, it is difficult to conceive that a bank could carry out activities in theabsence of strategic objectives or guiding corporate values.

Therefore the responsibilities of the board and management would include, among otherthings, approving ethical standards, establishing and maintaining strategic objectives,policies and procedures as well as ensuring that the bank complies with the statutory andsupervisory obligations.

Basel II is fundamentally about better risk management anchored in sound corporategovernance.

With that in mind, I would like to focus now on three areas that will bring to light the role ofeffective Corporate Governance in Basel II. I will refer to these as the three Cs: Controls,Culture and Clarity. 6


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CONTROLS

The first Cis Controls.

A bank can use the most sophisticated measurement tools inthe world, but if it is poorly governed, it will be vulnerable tofinancial and operational weaknesses.

The first pillar aligns minimum capital requirements more

closely with banksactual underlying risks.

Effective risk controls are essential to the successfulimplementation of the new capital framework. Under Basel II,the board of directors is expected to establish the institutionsrisk tolerances, policies, and code of conduct, and to ensure

that a sufficiently strong risk control framework is in place.

Senior management, in turn, is responsible for implementingthe risk control framework set forth by the board.

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CULTURE The second Cis Culture.

I believe that the increased responsibilities of the board of directors andsenior management under Basel II will foster a culture of improved riskmanagement.

This notion underlies the second pillar of the new framework, whichtakes as its starting point that the board and senior management have anobligation to understand the banksrisk profile and ensure that the bank

holds sufficient capital against its risks.

Supervisors, in turn, are responsible for reviewing the banksassessmentto evaluate and determine whether that assessment seems reasonable.

The key, in my view, is that risk awareness starts at the top of theorganisation. The board and senior management cannot abdicate theirresponsibility to understand and manage the risks arising from the banksactivities.

I believe that this focus on sound risk management at the very top willhelp to set the tone throughout the bank that effective risk managementis everyonesjob. 8


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CLARITY

The third Cis clarity.

I believe that Basel II will provide greater clarity regarding banksmeasurement and management of risk. This will be achieved first of allthrough the third pillarmarket disciplinewhich aims at ensuring thatthe market provides an additional layer of oversight.

The third pillar is intended to focus the board and senior management onheightening disclosure, which should strengthen incentives for prudentrisk management.

Greater transparency in banks financial reporting should allow majorityand minority shareholders, depositors, debt-holders, and other marketparticipants to evaluate banks and reward or penalise them according tohow prudently they are managed.

Basel II will enhance clarity in other ways as well. Not only will banks beexpected to improve their external transparency, but they will also beexpected to operate more transparently internally. In particular, banks willbe expected to ensure that the board of directors and seniormanagement are sufficiently well-informed to be able to meaningfullyassess the banksrisk profile. 9


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8 PRINCIPLESFORBANKBOARDS

& SENIORMANAGEMENT

Principle 1: Board qualifications, capabilities and responsibilities.

Principle 2: Boards role regarding the banks strategic objectives andcorporate values.

Principle 3: Lines of responsibility & accountability.

Principle 4: Ensuring oversight by senior management.

Principle 5: Auditors and internal control functions.

Principle 6: Board & key executive compensation.

Principle 7: Transparent governance.

Principle 8: Know your operational structure


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PRINCIPLE1

Board members should be qualified for their positions, have a clear

understanding of their role in corporate governance and be able to exercisesound judgment about the affairs of the bank.

Some responsibilities apply to any kind of organisation (bank or non-bank), forexample: The board should understand its oversight role

Some responsibilities are unique to the banking sector: Promote bank safety and soundness

Understand the regulatory environment

Ensure that the bank maintains an effective relationship with supervisors

Board should have an adequate number of independent members.

Independence = ability to exercise objective judgment, independent of the views of management,

political interests, and

inappropriate outside interests


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PRINCIPLE2

The board of directors should approve and oversee the banks strategicobjectives and corporate values that are communicated through the bankingorganisation.

Standards should address, among other things: Corruption

Self-dealing

Other illegal, unethical or questionable behaviour

Employees should be encouraged to raise concerns about illegal or unethicalpractices to the board or an independent committee without fear of reprisal orretaliation.

Watch out for practices that could diminish the quality of corporate governance,for example: Internal lending (to officers, employees, board members or controlling shareholders)

Preferential treatment for related parties and other favoured entities Conflicts of interest

The board should ensure senior management implements effective policies toprevent (or limit) such activities.


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PRINCIPLE3

The board of directors should set and enforce clear lines ofresponsibility and accountability throughout the organisation.

Role of the board: Define authorities & key responsibilities

Oversee management actions

Senior managements role: Delegate to staff & promote accountability

Be responsible to the board for banks performance

Guidance also addresses: Accountability where bank is part of a larger group structure

Outsourcing of bank functions


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PRINCIPLE4

The board should ensure that there is appropriate oversight bysenior management consistent with board policy.

Senior management should: Have the necessary skills to manage the business

Oversee line managers consistent with board policies (but avoid micro-managing

line managers)

Under boards guidance, establish system of internal controls

Apply the four eyes principle, even in small banks

Watch out for senior managers who are unwilling or unable toexercise effective control over star employees


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PRINCIPLE5

The board and senior management should effectively utilise the workconducted by the internal audit function, external auditors and internal

control functions.

Internal auditsthe board & senior management should: Recognise & communicate importance of audit & internal control processes throughout the

bank

Use the findings of internal audits and require timely correction of problems by management

Promote the internal auditors independence, e.g. through reporting to the board or boards

audit committee Engage internal auditors to judge effectiveness of key internal controls

External audits - the board and senior management should: Ensure that external auditors comply with applicable codes & standards of professional

practice

Ensure that external auditors understand their duties

Engage external auditors to review internal controls relating to financial statements Encourage the principal auditor to take responsibility for other external audits of financial

statements conducted within a group

For state-owned banks, maintain a dialogue as appropriate with state supreme auditinstitutions, state controllers and external auditors


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PRINCIPLE7

The bank should be governed in a transparent manner.

Disclosure should be made on the banks website, in its

annual/periodic reports and/or in reports to supervisors about: Board and senior management structure

Basic ownership structure & organisational structure

Incentive structures (e.g.remuneration policies)

Code of business conduct and/or ethics code

Bank policies relating to conflicts of interest & related party transactions

States ownership policy, if the bank is state-owned


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PRINCIPLE8

The board and senior management should understand the

banks operational structure, including where the bank

operates in jurisdictions, or through structures, that impede

transparency (i.e. know-your-structure).

Banks sometimes operate in jurisdictions, or employ

structures, that lack or impair transparency This sometimes occur for legitimate business purposes

But doing so can: Pose significant financial, legal and reputational risks for bank

Impede board and senior management oversight

Make it more difficult for authorities to effectively supervise the bank


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PRINCIPLE8 (CONTINUED)

The risks should be appropriately assessed and managed

Information regarding the activities and risks should be easily available at the bankshead office & reported to the board and bankssupervisors.

Clear policies and procedures should exist:

For board approval of the banksuse (or sale) of complex structures, instruments andproducts.

For the identification and management of material risks.

Regularly evaluate the need to operate in jurisdictions or use structures that reducetransparency.

Set clear corporate governance expectations for all relevant entities and business lines.

Assess compliance with applicable laws and internal policies.

Activities should be subject to enhanced audit procedures and internal control reviews.


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COMMONFACTORSINCORPORATE GOVERNANCE

BREAKDOWNINBANKS

Many of the recent corporate governance breakdowns appear to have several factors in

common: The board of directors failed to understand the risks that the firm was taking, and did

not exercise appropriate oversight or questioning of senior managers and employeesactions;

Conflicts of interest and a lack of independent board members and senior executivesresulted in decisions that benefited a few at the expense of the many;

Internal controls were either weak or non-existent, or appeared to be adequate onpaper but were not implemented in practice;

Internal and external audit fell asleep at the switch and failed to detect fraudulentbehaviour, and in some cases even aided and abetted such behaviour;

Transactions and organizational structures were designed to reduce transparency andprevent market participants and regulators from gaining a genuine picture of the firmscondition;

And perhaps most importantly, the corporate culture fostered unethical behaviour anddiscouraged questions from being raised.

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REFERENCE

Caruana J (2005), Basel II and Corporate Governance Issues

Office of the Secretary General (2007), Corporate Governance Framework

Holmes J (2006),Basel Committee Guidance on Corporate Governance for

Banks

Johnson D.J (2004),OECD Principles of Corporate Governance

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CONCLUSION

I would just like to emphasize that sound corporate

governance should be considered a key element of a

banksability to understand and manage its risks.

Supervisors should direct their resources to helping

banks improve their controls, culture and clarity inrespect to risk management.

In so doing, I believe that we will help achieve our

objective of a stable and healthy banking system thatcontributes to the proper functioning of our economy.

Thank you for your attention. 22

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Conference on Risk Management