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Corporate Governance in banks



Category: Corporate Governance

protect the interests of depositors;

set corporate objectives (including generating economic returns to owners);

run the day-to-day operations of the bank; consider the interests of recognized stakeholders

align corporate activities and behaviors with the expectation that banks will operate in a safe and sound manner, and in compliance with applicable laws and regulations.

Basel paper defines key practices that are critical elements of any corporate governance process in banks. These are as follows:

Sound corporate governance practices

1. Establishing strategic objectives and a set of corporate values

It is difficult to conduct the activities of an organization when there are no strategic objectives or guiding corporate values. Therefore, the Supervisory Council should establish the strategies that will direct the ongoing activities of the bank. It should also take the lead in establishing the «tone at the top» and approving corporate values for itself, senior management and other employees. The values should recognize the critical importance of having timely and frank discussions of problems. In particular, it is important that the values prohibit corruption and bribery in bank activities, both in internal dealings and external transactions.

The Supervisory Council should ensure that the Management Board implements policies that prohibit (or strictly limit) activities and relationships that diminish the quality of corporate governance, such as:

conflicts of interest;

lending to officers and employees and other forms of self-dealing (e.g., internal lending should be limited to lending consistent with market terms and to certain types of loans, and reports of insider lending should be approved by the Council, and be subject to review by internal and external auditors and disclosure in the financial statements); and

providing preferential treatment to related parties and other favored entities (e.g., lending on highly favorable terms, covering trading losses, waiving commissions).

Processes should be established that allow the Supervisory Council to monitor compliance with these policies, ensure that deviations are reported to them on a regular basis corrective action taken and noted in the minutes of the meetings.

Such overall strategic objectives and corporate values should not only be set by the Supervisory Council but also more importantly, should be communicated to the public, shareholders and stakeholders.

Example:

As a good example of the formulated mission strategy and overall business principles one can refer to extract from the annual report of ING Group. In a very concise manner it describes the overall mission of the Group, business objectives and social principles of its activity.

Mission, profile, strategy

Mission

ING’s mission is to be a leading, global, client-focused, innovative and low-cost provider of financial services through the distribution channels of the client’s preference in markets where ING can create value.

Profile

ING Group is a global financial institution of Dutch origin offering banking, insurance and asset management to over 50 million private, corporate and institutional clients in 65 countries. With a diverse workforce of over 110,000 people, ING comprises a broad spectrum of prominent companies that increasingly serve their clients under the ING brand.

Key to ING is its distribution philosophy: ‘click-call-face’. This is a flexible mix of internet, call centres, intermediaries and branches with which ING can fully deliver what today’s clients expect: unlimited access, maximum convenience, immediate and accurate execution, personal advice, tailor-made solutions and competitive rates.

Strategy

ING’s strategy is to achieve stable growth while maintaining healthy profitability. The Group’s financial strength, its broad range of products and services, the wide diversity of its profit sources and the good spread of risks form the basis for ING’s continuity and growth potential. More than 70% of ING’s shares are held by investors outside the Netherlands.

ING seeks a careful balance between the interests of its stake-holders: its customers, shareholders, employees and society at large. It expects all its employees to act in accordance with the Group’s Business Principles. These principles are based on ING’s core values: responsiveness to the needs of customers, intrepreneurship, professionalism, teamwork and integrity.

ING aims to be a top-10 global financial institution. Through a variety of ING companies — managed by the Executive Centres ING Europe, ING Americas, ING Asia/Pacific and ING Asset Management -ING wants to deliver added value to clients in banking, insurance and asset management. ING wants to ensure operational excellence, achieve synergies and emphasize cost control within one ING culture. The long-term financial targets are an average annual growth of operational net profit per share of at least 12%, an average annual operational net return on shareholders’ equity (ROE) of at least 18% and improving efficiency ratios.

2. Setting and enforcing clear lines of responsibility and accountability

Effective Supervisory Councils clearly define the authorities and key responsibilities for themselves, as well as members of the Management Board. They also recognize that unspecified lines of accountability or confusing, multiple lines of responsibility may cause a problem through slow or diluted responses. Management Board is responsible for creating an accountability hierarchy for the staff, but must be cognizant of the fact that they are ultimately responsible to the Supervisory Council for the performance of the bank.

Example:

The provisions of the draft Law on Joint Stock Companies can be used to illustrate the example of some authorities and responsibilities for which the Supervisory Council has responsibility. This list is not comprehensive and may be used as a guideline for much broader spectrum of authorities and responsibilities.

Approve policies and procedures that regulate the internal issues of the company’s activity.

Approval of procedural aspects of general meeting of shareholders (date, agenda etc).

Approval of procedural aspects of transactions with own securities.

Approval of market valuation of properties.

Approintment of members of Management Board, approval of their compensations.

Appointment of external auditor, approval of an independent property appraiser.

Approval of establishment and closure of branches.

Approval of issues on business combinations.

Approval of significant transactions and contracts.

Approval of methods of disclosure of information.

3. Ensuring that Supervisory Council members are qualified for their positions, have a clear understanding of their role in corporate governance and are not subject to undue influence from Management Board or outside concerns.

The Supervisory Council is ultimately responsible for the operations and financial soundness of the bank. The Supervisory Council must receive on a timely basis sufficient information to judge the performance of Management Board. All members of Supervisory Council should be capable of exercising judgement, independent of the views of Management Board, large shareholders or government.

Including on the Supervisory Council qualified individuals that are not members of the bank’s Management Board, or having a Supervisory Council separate from a Management board, enhance independence and objectivity. Moreover, such members can bring new perspectives from other businesses that may improve the strategic direction given to Management board, such as insight into local conditions.

Qualified members of the Supervisory Council can also become significant sources of management expertise in times of corporate stress. The Supervisory Council should periodically assess its own performance, determine where weaknesses exist and, take appropriate corrective actions.

This concept is very close to the requirements of the Anglo-Saxon corporate governance model where the Supervisory Council (Board of Directors) consists of outside members. It is believed that unaffiliated or outside directors are expected to contribute the fresh and broader perspectives of those who are not involved in daily operations. Retired executives and those who serve other corporations in other capacities, such as lawyers or investment bankers, can make a valuable contributions to the Council. Senior executives of other companies or those who have distinguished themselves in other fields are especially valuable as outside directors because they serve two important functions: they enrich the discussions of the Council and they qualify as independent directors in situations where that distinction becomes important.

Example:

The Supervisory Council of HSBC Holding consists of 21 individuals. It includes a number of prominent and respectful individuals such as:

Sir Mark Moody-Stuart — Chairman of Anglo American plc. Director and former Chairman of The ‘Shell’ Transport and Trading Company, plc and former Chairman of the Committee of Managing Directors of the Royal Dutch/Shell Group of Companies. A Director of Accenture Limited, a Governor of Nuffield Hospitals and President of the Liverpool School of Tropical Medicine. Member of the UN Secretary General’s Advisory Council for the Global Compact. A non-executive Director since 2001.

The Baroness Dunn — Executive Director of John Swire & Limited and a Director of Swire Pacific Limited.. A non-executive Director of The Hongkong and Shanghai Banking Corporation Limited from 1981 to 1996. Former Senior Member of the Hong Kong Executive Council and Legislative Council.

The Lord Butler — Educator, Master, University College, Oxford and a nonexecutive Director of Imperial Chemical Industries plc. A non-executive Director since 1998. Responsible for the policy overview of HSBC in the Community and Chairman of HSBC Education Trust. Secretary of the Cabinet and Head of the Home Civil Service in the United Kingdom from 1988 to 1998.

Other members of the Council have long years experience in various business fields ranging from the highest corporate levels of banking and industrial corporations to key positions in legal and accounting firms.

4. Ensuring that there is appropriate oversight function by Supervisory Council and Management board.

The Supervisory Council may choose to delegate some of its responsibilities to committees that comprise a smaller number of its members. Many Councils of western banks have established an executive committee, one or more oversight committees, and various special purpose committees.

However, all decisions and considerations of the committees should be approved by all Council members.

The original intent of the executive committee is to act on a standby basis to deal with matters that arise between Council meetings and that require prompt attention. The executive committee should report to the full Council on a regular basis and minutes of its meetings should be made available to other members of Council.

The specific roles of the major oversight committees are still evolving. Usually, these committees concentrate their attention on a particular aspect of governance issues devoting time to study of issues in detail and developing recommendations. The most common oversight committees are the audit, compensation and nominating committees.

Audit committee — provides oversight of the bank’s internal and external auditors, approving their appointment and dismissal, reviews and approves audit scope and frequency, receives their reports and ensures that Management Board is taking appropriate corrective actions in a timely manner to address control weaknesses, non-compliance with policies, laws and regulations, and other problems identified by auditors. Because of the technical nature of the questions the audit committee is likely to deal with, the committee should include among its members at least one member who is reasonably well familiar with accounting principles and practices.

Example

The New York Stock Exchange rules state that at leas one member of the audit committee must have accounting or related financial management expertise, as the Supervisory Council interprets such qualification in its business judgement.

KPMG’s Audit Committee Institute in conjunction with Corporate Board magazine conducted a survey of 5,000 audit committee members. When asked how many of the audit committee members meet the financial expertise rules, the following responses were given:

When asked how many of the audit committee members meet the financial expertise rules, the following responses were given

Compensation committee — provides oversight of remuneration of Management Board and other key personnel and ensures that compensation is consistent with the bank’s culture, objectives, strategy and control environment.

The committee’s goals are to devise compensation policies and arrangements that are sufficient to recruit, retain, and encourage a talented management teams; reward individual managers in accordance with their respective contributions; to ensure that the bank’s total compensation expense is reasonable in relation to the bank’s competition and resources. The committee therefore, should have access to information (from disclosures and other reports) concerning compensation practices of competitor banks. The committee should stay well informed of new trends in executives compensation and should periodically review the bank’s policy in light of new developments.

Nomination committee — provides an important assessment of Supervisory Council effectiveness and directs the process of renewal and replacement of the Supervisory Council members.

The principal responsibility of the committee is to develop criteria for the Council membership and to identify specific individuals for nomination. The nominating committee may also be asked to devise methods for evaluating the performance of individual Council members and to periodically review and make recommendations regarding the size of the Council, committee structure and assignments, and frequency of regular Council meetings.

Special Purpose committee — The Council can create as many ad hoc committees as it needs but such committees are typically used to develop the factual basis when the matter to be decided by the Council needs a comprehensive and sustained study. In these circumstances, the special committee’s role is to gather and evaluate information and to report relevant facts to the Council. The report may or may not include recommendations but final action is left to the full Council.

Special committees are also used to exercise the authority of the council in circumstances where the Council itself can not act because of real or apparent conflicts of interest (e.g. litigation committee is formed to evaluated litigation claims by shareholders against the Council members).

Oversight by Management Board

Management Board is a key component of corporate governance. While the Supervisory Council provides oversight to the Management Board, similarly, Management Board should assume that oversight role with respect to line managers in specific business areas and activities. Even in very small banks, key management decisions should be made by more than one person («four eyes principle»).

Management board should consist of a core group of officers responsible for the bank’s operations. These individuals must have the necessary skills to manage the business under their supervision as well as have appropriate control over the key individuals in these areas.

This example illustrates the types of oversight committees formed by the Supervisory bodies of major international banking corporations.
Bank Audit committee Compensation Committee Nomination committee Credit and Market Risk Committee Chairman committee Investments committee Mediation committee
ING Group

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Deutsche Bank

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HSBC Holding

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Central Bank of Ireland

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5. Conducting corporate governance in a transparent manner

It is difficult to hold the Supervisory Council and Management Board properly accountable for their actions and performance when there is a lack of transparency. This happens in situations where the shareholders, market participants and general public do not receive sufficient information on the structure and objectives of the bank with which to judge the effectiveness of the Supervisory Council and Management Board in governing the bank.

Transparency reinforces sound corporate governance. Therefore, public disclosure is necessary in the following areas:

Supervisory Council structure (size, membership, qualifications and committees);

Management board structure (responsibilities, reporting lines, qualifications and experience);

Basic organizational structure (line of business structure, legal entity structure);

Information about the incentive structure of the bank (remuneration policies, executive compensation, bonuses, stock options);

Nature and extent of transactions with affiliates and related parties.

Example:

As an example of the overall approach to the transparency of the corporate governance process we will illustrate the structure of the disclosure made by the ING Group in its annual report. In particular, the report contains the following sections of disclosures:

— Recent legal developments in the area corporate governance Meetings of shareholders and providers of capital (issue of shares in the form of depositary receipts, cumulative preference shares, agenda for the meeting of shareholders)

— Executive board (rules, compensation, granted option rights and holding of securities)Supervisory board (profile of the supervisory board,  rules, reappointment of supervisory board members, other offices held/independence of Supervisory board members, remuneration and holding of securities)

— Information on members and experience of the Supervisory Board

— Information on members of the Executive Board

— Remuneration — executive board (general policy, base salary, short-term performance-related bonus, long-term incentive, pensions, options, ING Group shares held by members of the Executive Board) Remuneration of the Supervisory Board

— Details of the stock option plan, granted and exercised options.

6. Ensuring an environment supportive of sound corporate governance

Primary responsibility for good corporate governance rests with Supervisory Council and as implemented by Management Board of banks; however, there are many other ways that corporate governance can be promoted, including by:

government — through laws;

securities regulators, stock exchanges — through disclosure and listing requirements;

auditors — through audit standards on communications to Supervisory Council, Management Board and bank supervision; and

banking industry associations — through initiatives related to voluntary industry principles and agreement on and publication of sound practices.

Corporate governance can be improved by addressing a number of legal issues, such as the protection of

shareholder rights; the enforceability of contracts; clarifying governance roles; ensuring that corporations function in an environment that is free from corruption and bribery; and laws/regulations (and other measures) aligning the interests of managers, employees and shareholders. All of these can help promote healthy business and legal environments that support sound corporate governance and related supervisory initiatives.

Example:

McKinsey Global Investor Survey on Corporate Governance listed the following factors chosen by the investors as top four priorities in corporate governance area for policy makers:

strengthen shareholder rights (33% of respondents)

improve accounting standards (32% of respondents)

more effective disclosure (31% of respondents)

stronger enforcement of fiduciary duties (27% of respondents)

Members of Supervisory Council are fiduciaries — people in     Fiduciary

whom others place a special trust and confidence. As such      Duties

members of Council owe to these «others» (shareholders, stakeholders etc) the duty of care and duty of loyalty.


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