Manual Corporate Governance in Banking: A Global Perspective

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Governance improvements may not always result in better performance as performance depends on many factors. In certain circumstances e. It has been argued that the creation of fora for shareholder cooperation and information sharing, including internet fora could help overcome these obstacles. Conflicts of interest and identification with the interest of companies for commercial reasons seem to contribute to the passivity of shareholders.

However, conflicts of interest can arise within institutional investors and asset managers too in numbers of ways, for instance on a personal level, as a consequence of the existence of "old boys' networks". To mitigate more effectively such conflicts of interest, some institutional shareholders and asset managers have adopted policies with regard to conflicts of interest, which include the obligation to identify, manage and disclose such conflicts.

It has further been suggested that a requirement that the majority of the members of the asset managers' governing body should be independent from the parent company in the financial group could also protect the interests of the beneficial owners of the equity The ICGN Statement of Principles on Institutional Shareholder Responsibilities considers it good practice that institutional investors recognise and address conflicts of interest to safeguard the interest of beneficiaries. The ICGN Statement of Principles on Institutional Shareholder Responsibilities considers it good practice that institutional investors recognise and address conflicts of interest to safeguard the interest of beneficiaries.

Financial institutions have a duty to ensure that information provided to shareholders is comprehensive, but at the same time accessible and understandable for shareholders, who are not necessarily experts. Shareholders have indicated that more comprehensive information is needed on risk appetite, key risk exposures and the risk management system See also Section 3 above. One of the financial institutions of the case study mentioned that they have chosen to publicly disclose additional information with regard to risk following the financial crisis in order to better inform shareholders. The representative said that it would be important to ensure that the additional reporting would become permanent.

The representative also indicated that there are other financial institutions which have not taken this approach, which could form a possible competitive disadvantage for financial institutions which perform additional disclosure. The financial institution also confirmed that some additional disclosures were made after intervention from shareholders. Furthermore, it has been argued that a more regular dialogue between the shareholders and companies, in which problems are be discussed and diffused before reaching confrontation, would probably contribute to the effectiveness of shareholder engagement.

Such dialogue is only useful if companies are open to it. However, care should be taken to maintain a balance between public disclosure and engaging in bilateral meetings with shareholders, to ensure equivalent treatment of shareholders. It has been suggested that companies should disclose bilateral contacts with shareholders.

Institutional investors have indicated that uncertainty about the scope of EU and national acting in concert provisions prevents them from cooperating with other investors, and thus reduces possibilities for active engagement. Better possibilities for cooperation between investors would also reduce costs of active engagement. OJ L, The financial crisis has shown that shareholders have not been vocal on a number of key issues, such as remuneration policy, strategy and risk appetite.

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Some shareholders have indicated that in certain jurisdictions they do not have sufficient rights or information to be able to monitor these issues. The Commission recommended in that shareholders should have the possibility to vote on the remuneration policy The European Commission recommended an advisory or mandatory shareholder vote on remuneration in paragraph 4. This issue is considered in the report on the application of the Commission's recommendations on directors' remuneration published alongside this report.

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The European Commission recommended an advisory or mandatory shareholder vote on remuneration in paragraph 4. The financial crisis revealed serious limitations in the existing supervisory framework globally, both in a national and cross-border context. Supervisors did not enjoy sufficient resources and an adequate mix of skills which lead to a lack of understanding and proper monitoring of financial institutions' activities.

Also, the existence of different national systems of supervision has lead to inconsistent supervisory powers across Member States, regulatory competition and supervisory capture. In general, the evidence tends to show that the crisis prevention function of supervisors has not been performed well.

It recommended in particular strengthening national supervisory authorities in order to upgrade the quality of supervision in the European Union and creating a European System of Financial Supervision. As a follow-up to these recommendations, the Commission adopted in September an important package of draft legislation in order to significantly strengthen the supervision of the financial sector in Europe by creating a new European Systemic Risk Board ESRB to detect risks to the financial system as a whole and a European System of Financial Supervisors ESFS , composed of national supervisors and three new European Supervisory Authorities for the banking, securities and insurance and occupational pensions sectors.

The Commission is also currently reflecting on other issues, in particular with regard to the harmonisation of supervisory powers across Member States and other issues relating to accountability of supervisors. However, these measures do not address the issue of the involvement of supervisors in monitoring effective corporate governance, while deficiencies have also been observed with regard to the role of supervisors in the review of corporate governance practices of financial institutions.

Corporate governance

The financial crisis highlighted a poor enforcement of existing rules and regulations on corporate governance and inadequate supervisory control of governance practices in financial institutions. In many cases, supervisors did not monitor whether risk management frameworks and internal organisation were well-adapted to changes of business model and financial innovation. They also failed to ensure appropriate expertise of boards and to apply "fit and proper" test, focusing essentially on probity test See, for example, OECD November , p.

Supervisors were too much focused on formal compliance by financial institutions rather than on the proper functioning of the boards and on effective implementation by financial institutions of sound corporate governance principles. In a number of cases supervisors did not or could not take account of existing guidelines for corporate governance of banks and insurance which are intended, inter alia, to guide supervisors, in the lightly regulated non-banks sector Ibid.

Supervisory authorities are key in ensuring a sound corporate governance framework in financial institutions and have a keen interest in sound corporate governance as it is an essential element in the safe and sound functioning of a financial institution and may affect its risk profile if not implemented effectively See, for example, BCBS March Involvement of supervisors with regard to corporate governance practices in financial institutions. It has been argued that supervisory authorities should take measures to ensure that all existing national and international principles on sound corporate governance such as the OECD and Basel principles are known and effectively implemented.

Moreover, governance matters should become an important topic of discussions between boards of financial institutions and their supervisors. However, not all national supervisory authorities may be sufficiently resourced and empowered to deal with corporate governance weaknesses that have become apparent. In addition, it has been argued that supervisors should be aware of legal and institutional impediments to sound corporate governance, and take steps to foster an effective basis for corporate governance See BCBS March , p. In the context of the new EU supervisory architecture, it is important to ensure that each supervisory authority is provided with sufficient resources and powers to deal with corporate governance issues in their respective areas.

The "fit and proper test" of board members performed by supervisors takes the form essentially of probity requirements. It does not include a review of technical and professional competence of candidates, such as general governance and risk management skills and behavioural and other qualities, and does not clarify their strategy and personal objectives as board members. It has been argued that the assessment by competent authorities of fit and proper criteria should be done through interviews of candidates.

In that connexion, supervisory authorities should disclose their procedures and criteria, and where candidates are rejected, provide written explanation to the board of the proposing company. The test should also address the independence and objectivity of the candidates. This assessment will be performed through interviews involving a panel of senior advisors on governance with a view to evaluate a range of competences and notably the degree of awareness, understanding and ability of the candidate with regard to such competence areas as market knowledge; business strategy, risk management and control; financial analysis and controls; governance, oversight and controls; regulatory framework and requirements.

Non-technical skills and behaviours will be considered as part of the FSA assessment of the candidate's competences and ability. However, supervisors do not always have access to these meetings. Moreover, some supervisors do not make use of the right to attend board meetings.. Feedback from supervisors of their assessments after participation in board meetings is often seen as helpful with a view to improving the functioning of the board. Supervisors could also be consulted on draft terms of reference of the external evaluation of performance of the board before they are adopted.

It has been argued that supervisors should frequently inspect financial institutions' internal risk management systems to ensure that they function properly, have sufficient standing and authority and appropriate to the size and the complexity of the financial institution's activities. It has been mentioned on several occasions that supervisors should pay particular attention to remuneration schemes to ensure that they are properly aligned with sound risk management and long term interest of financial institutions.

Exchanges between national supervisory authorities enable them to share the best supervisory practices as well as information on systemic issues specifically related to larger cross-border financial institutions with systemic importance. It has been argued that corporate governance issues could be part of the agenda of the supervisory colleges' meetings in the context of supervision of these financial institutions.

Sufficient cooperation could also be beneficial at national level between authorities responsible for different supervisory areas or different institutions which are part of the same group. By expressing their independent opinion on accounts, external auditors provide assurance both to shareholders and the market at large on the quality and soundness of the financial information produced by issuers.

The contribution of auditors to the confidence that markets and particularly financial markets need to function in an optimal manner, is therefore crucial. There seems to have been a tacit consensus that the problems at stake and their systemic nature were beyond the control of financial institutions' auditors. Nevertheless, questions have arisen A report released on 11 March by the US examiner, Anton Valukas, about the Lehman Brothers bankruptcy, expressed serious concerns about the use of repurchase agreements made by Lehman to present its end-year balance sheet in a too favourable light, as well as the silence of Lehman's auditors in this respect.

A report released on 11 March by the US examiner, Anton Valukas, about the Lehman Brothers bankruptcy, expressed serious concerns about the use of repurchase agreements made by Lehman to present its end-year balance sheet in a too favourable light, as well as the silence of Lehman's auditors in this respect. There was no timely or sufficient alert given by bank auditors to supervisors on the situation of certain banks before they collapsed.

The Commission has no information on whether this provision has been effectively respected during the crisis and whether such reporting to competent authorities by auditors took place in individual cases. Disclosure of financial information to shareholders regarding risks aspects is not informative and reliable enough.

In many instances, the serious difficulties and failures of banks occurred only a few months after their accounts had been issued without any qualification, emphasis of matter or even indication in the auditors' reports regarding such risks in the financial statements. Auditing standards require the auditors to judge, based on information available by the time the auditor's report is issued, whether the company's assessment is correct.

Auditors argue that it is difficult for them to predict potential circumstances that may in the near future affect the going concern of financial institutions, because of the oft unforeseeable nature of markets' behaviour. Furthermore, auditors have tended to justify their "hands-off" attitude by their fear that the issuing of statements on the going concern of companies, a fortiori financial institutions and notably banks, could become self-fulfilling prophecies: financial markets could overreact and hence trigger catastrophic events particularly for banks, ranging from a loss of inter-banking confidence, a possible reduction in lending to depositors' runs on banks.

As a result of this, shareholders and markets are to some extent deprived of some information on the risks taken by financial institutions. Knowledge gathered by external auditors through their work may be useful to supervisors, whilst acknowledging that there might be some limitations to take into account certain professional secrecy obligations which auditors have towards their clients. Besides the knowledge that external auditors hold about individual banks, this approach is based on the assumption that they are in a good position to assist supervisors in developing a better understanding of the banking and financial services sector.

It is the practice in many countries for such reports to be made available to the supervisors. Where this is applied, it is perceived as an effective means for both auditors and supervisors to cross-check information. It has been argued that such enhanced cooperation between supervisors and auditors could also be achieved through more frequent meetings. Reporting of serious facts by external bank auditors to both the Board and the supervisor.

However, neither the frequency nor the specific situations are spelled out in these standards. However, the timing and specific duties of the auditor in this respect are often seen as not clear enough. In addition, it is perceived unclear in which risk circumstances, auditors of financial institutions would be obliged to alert the supervisory authorities. Research conducted sofar reveals that the board or supervisory authorities are indeed probably the best placed to take urgent action in the public interest in the case of an imminent crisis. This channel is essential for ensuring that the problem is addressed, without unduly spreading panic in the market and triggering systemic consequences.

In many banks, the external auditors attend the Audit Committee's meetings. There is in fact a growing tendency towards regular attendance by bank auditors also at the Risk Committee's meetings See Walker, D. November , Recommendation 25 : " The board risk committee should be attentive to the potential added value from seeking external input to its work as a means of taking full account of relevant experience elsewhere and in challenging its analysis and assessment"; However some financial institutions of the case studies disagree on the use of external advice from statutory auditor because of potential conflict of interest.

See Walker, D. The role of bank auditors in the assurance providing connected to risk related financial information. There is an ongoing debate about the level of involvement of auditors with regard to corporate governance information and the practices vary across Europe See FEE , p. The focus here is on practical improvements in the area of risk disclosure within financial information, as this is the shortcoming most relevant for investors. See FEE , p. It has been argued that bank auditors should play a role, as far as risks disclosure is concerned, in providing stakeholders with assurance on the quality of financial data and hence help boost investor confidence in the vision of a bank's risks House of Commons Treasury Committee , Mr Hayward Independent Audit :"financial statements… had headed for compliance rather than communication".

House of Commons Treasury Committee , Mr Hayward Independent Audit :"financial statements… had headed for compliance rather than communication". In that connexion, it has also been suggested that the mandate of auditors should be expanded to provide some assurance, or conduct specific procedures on:. Basel II includes an option to require Pillar 3 disclosures to be audited. The Government and FSA took the view that it would not require an audit of these disclosures.

An extensive bibliography is provided in Annex 3.

What Might This Mean for Islamic Finance in the UK?

In their work, the Commission staff benefited from the advice of the European Corporate Governance Forum ECGF and of the ad hoc advisory group on corporate governance composed of some members of the ECGF and other renowned corporate governance specialists. This paper also builds on the outcome of a seminar organised by the Commission on 12 October about corporate governance in financial institutions in order to gather stakeholders' views on the role and competence of the board of directors, governance issues related to internal control and risk management, the respective role of shareholders, supervisors and statutory auditors.

Questionnaires on their corporate governance practices were also addressed to a diverse cross-section of 10 major listed banks or insurance companies established in the EU. Some of these had been more affected than others by the financial crisis.

beyondBanking: banking on global sustainability

The ensuing desk work was supplemented by about 30 follow-up interviews with board members, company secretaries, chief financial officers, chief risk officers, internal controllers. Whilst these case studies have an anecdotal character due to the small size of the sample, they nevertheless provided a better understanding of what best practices emerged as a result of the firms' own reflection and stakeholders' feedback about their future course of action. A questionnaire was also addressed to the European banking, insurance and securities markets supervisors about their views and role regarding corporate governance of financial institutions.

Similarly, a cross-section of major European institutional investors and shareholders' associations were the recipient of a questionnaire on their practices and expectations regarding corporate governance of financial institutions. A follow-up meeting with about 30 investors was held on 2 February A limited series of open interviews also took place with a few financial analysts, asset managers, and statutory auditors.

Lack of time commitment and independent judgement Limiting the number of mandates of non-executive board members to ensure effective fulfilment of duties. Ineffective functioning of the board Clarify the role of the Chairman in organising the board's work. The board should have a formal written conflicts of interest policy which should be disclosed in the annual report. Unsatisfactory board performance Regular external independent evaluation of the board, e. Lack of effective risk oversight and accountability on risk matters Stand-alone Risk Committee at board level, expertise in risk in the Risk Committee.

Role of the board with regard to approving risk appetite and the parameters of risk oversight and overseeing their implementation. Role of the board with regard to regularly reviewing the complexity of the structure of the financial institution including the activities of the different parts of it, and designing policies for the establishment of new structures. Boards to review the main features and inherent risks of new products through a new product approval process. Boards closely involved in the preparation and analysis of stress-testing programmes and assessment of the effectiveness of proposed mitigating actions.

Risk alert for board executive or non-executive board members should notify supervisors of material risks they become aware of and which have a systemic implication. Executive and non-executive board members should take into account the information from the supervisor regarding systemic risks when determining and overseeing the implementation of the risk appetite and risk strategy.

Lack of accountability Duty of care of the executive and non-executive board members for the long-term sustainability of the FI. Examine enforcement-related issues, in particular obstacles to holding executive and non-executive board members responsible for excessive risk-taking. Lack of accountability on risk matters Duty for executive directors to sign off on the effectiveness of the internal control framework for risk management. Proper weight not been given to risk function RF.

CRO not always in a position to speak up or to bring upwards any concern due to hierarchical limitation Strengthening the independence and authority of the CRO by setting up its position at a level at par with the CFO in terms of institutional gravitas. CRO to attend all meetings of the Risk Committee at the board and this way have direct reporting line to it. Reporting on risks not always timely, comprehensive and understandable for decision-making or control levels; staff of the risk function not always directly involved into the day-to-day monitoring of risk exposures Establishment of an effective and efficient risk management and risk reporting system, backed by IT system; Involvement of risk staff into daily operations through "escalation procedure" to enable assessment of risk with internal capabilities; Direct reporting lines of risk managers to senior risk officers and CRO.

Inadequate remuneration schemes with a large variable part based on short-term bonuses greatly contributed to the excessive short-term risk-taking Set up appropriate remuneration schemes across financial institutions to motivate staff and management to focus on sustainable value creation rather than short-term risk taking. Short-term investment strategies, lack of adequate shareholder engagement Adherence by institutional investors and asset managers to a stewardship code such as the ICGN Statement of Principles on Institutional Shareholder Responsibilities or a similar national Code on shareholder responsibility on a "comply or explain" basis.

Short-term investment strategies Disclosure of voting policies by institutional investors and asset managers, including disclosure of voting records ex post of the shareholder meeting. Disclosure by asset managers whether their mandates from major clients, such as insurance companies and pension funds include provisions in support of engagement activity. Short-term oriented incentives of asset managers Disclosure by institutional investors of information on the general terms of the remuneration of their agents.

Conflicts of interest Institutional investors identify, mitigate and disclose conflicts of interests which may have an impact on their engagement activity. A majority of the members of the asset managers' governing body should be independent from the parent company in the financial group.

Lack of appropriate information on risk Financial institutions ensure that information provided to shareholders on risk is comprehensive, accessible and understandable for shareholders.

The corporate governance of banks

Inappropriate legal framework for shareholder cooperation Consider possibilities for clarification of acting in concert rules in the context of ongoing reviews of legislative texts where relevant. Inadequate supervisory control of governance practices in financial institutions Improve the involvement of supervisors with regard to oversight of corporate governance systems.

Focus on formal compliance by financial institutions rather than on the proper functioning of the boards Enhance the role of the supervisor in the review of the functioning of the board. Failure to ensure that management frameworks and the internal organisation were adapted to changes of business model Improve the supervisory review of the governance arrangements of risk management. Inadequate supervision of remuneration schemes Enhance the role of the supervisors with regard to remuneration schemes.

No alert given by auditors on banks' situation before they collapsed Strengthen cooperation with supervisory bodies. Disclosure of financial information regarding risk is not informative and reliable enough Strengthen the role of auditors in the assurance providing connected to risk related financial information.

Corporate governance in banking: a global perspective by Gup, Benton E

Basel Committee on Banking Supervision, Enhancing corporate governance for banking institutions, February Becht, M. Borio, C. Chen, C. Guerrera and P. Thal-Larsen, Gone by the Board: why the directors of big banks failed to spot credit risk, Financial Times, 26 June Felton, A.

Hagendorff, J. Honohan, P. KPMG , Audit committees put risk management at the top of their agendas, www. Ladipo, D. Mateos de Cabo, R. Tabellini, G. Walker D. This site uses cookies to improve your browsing experience. Would you like to keep them? Accept Refuse. Skip to main content. This document is an excerpt from the EUR-Lex website. EU case-law Case-law Digital reports Directory of case-law. Quick search. Need more search options?

Use the Advanced search. Help Print this page. Expand all Collapse all. Title and reference. Languages and formats available. Multilingual display. Language 1 English en. Language 2 Please choose English en. Language 3 Please choose English en. Miscellaneous information. Author: European Commission Form: Staff working document. Procedure number: Relationship between documents. Introduction A response from the European Commission Scope Boards Background and key findings Examples of best practices Risk management Shareholders Supervisors External auditors Annex 1 — The methodology applied for the establishment of this paper Annex 2 — Summary of Findings Annex 3 — Bibliography Scope The analysis and best practices gathered in this working paper may be of relevance for all regulated financial institutions.

Boards 2. Extent xii, p. Isbn Label Corporate governance in banking : a global perspective Title Corporate governance in banking Title remainder a global perspective Statement of responsibility edited by Benton E. Label Corporate governance in banking : a global perspective, edited by Benton E. Gup, electronic resource Instantiates Corporate governance in banking : a global perspective Publication Cheltenham, UK Northampton, MA, Edward Elgar, c Antecedent source unknown Bibliography note Includes bibliographical references and index Color multicolored Control code ocn Dimensions 24 cm.

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Barth Mark J. Registered: James R. Recent corporate scandals, together with the effects of globalization, have led to an increasing interest in corporate governance issues. Little attention has been paid, however, to international laws and recommendations dealing with corporate governance in banking from a global perspective.

This impressive international set of expert contributors — academics, practitioners and regulators — remedies the lack of attention by examining the various issues and concerns of this important topic. James R.