Implementing Good
Corporate Governance in Banks
May 29, 2006
Karachi, Pakistan
Dr. Nasser Saidi
Executive Director
Hawkamah ICG
DIFC

• Corporate Governance (CG) and economic development
• Why Bank CG?
• Key Players in Governance of Banking Sector
• Central Bank and Supervisors
• Banks and Financial Institutions
• Non-Bank Corporate Sector
• CG in Islamic Finance
• Complementary work to advance bank CG
• Hawkamah Institute for Corporate Governance
May 2006 2

• Consensus that sound financial systems involves countries adopting and implementing best practice standards in
12 key policy areas.
• Both public and private sector incentives are required to stimulate country adoption and compliance with these standards.
• Consensus that countries should give priority to adopting the international core standards
May 2006 3

The 12 Core Standards for Sound Financial Systems
Macro Standards
1. Data Dissemination
2. Monetary Policy
3. Fiscal Policy Transparency
Market and Infrastructure
4.Governance
5.Accounting
6.Auditing
7.Insolvency
8.Money Laundering
Financial System
9. Core Principles of
Bank Supervision
10. Core Principles of
Insurance Supervision
11. Core Principles of
Securities Supervision
12. Systemically Important
Payment System
Agency
IMF
IMF
IMF
OECD/ World Bank/BIS
IFAC
IFAD
World Bank
OECD/FATF
BIS
IAIS
IOSCO
BIS
May 2006 4

• Deficiencies in these policy areas were a source of crises, and magnified, complicated and extended economic & financial crises
• Countries complying with core standards can achieve:
1. Transparency of economic risks
2. Economy characterized by well governed institutions and companies valued and audited according to agreed upon international conventions protecting contracts & property rights
3. An ethical business environment
4. A financial system governed and regulated in a safe and sound manner, which serves the nation efficiently and sustains on going growth and economic development.
May 2006 5

CG integral element of sustainable economic growth & development
Economic growth & prosperity
PRIVATE Sector
May 2006 well performing institutions
Efficient regulatory regimes & enforcement enabling legal infrastructure
International Integration
PUBLIC Sector
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Empirical Evidence suggests ‘country effects’ are important for good CG
1. CG frameworks and reform should address both macro and sector/micro issues
2. Legal Origins matter
3. Public Governance matters. In particular:
– Control of corruption
– Regulatory quality
– Rule of law
May 2006 7

WB Governance Indicators: Regulatory Quality
Source: Kaufmann D., A. Kraay, and M. Mastruzzi 2005: Governance Matters IV: Governance Indicators for 1996-2004.
May 2006 8

WB Governance Indicators: Rule of Law
Source: Kaufmann D., A. Kraay, and M. Mastruzzi 2005: Governance Matters IV: Governance Indicators for 1996-2004.
May 2006 9

WB Governance Indicators: Corruption
Source: Kaufmann D., A. Kraay, and M. Mastruzzi 2005: Governance Matters IV: Governance Indicators for 1996-2004.
May 2006 10

Bahrain
Lebanon
Jordan
Kuwait
United Arab Emirates
Saudi Arabia
Oman
Qatar
Pakistan
Tunisia
Morocco
Egypt, Arab Rep.
Sudan
Yemen, Rep.
Djibouti
Mauritania
Algeria
Iran, Islamic Rep.
Syrian Arab Republic
Libya
Average
Table 2. Middle East and North Africa Countries: Financial Development Index, 2002/03 1/
(Based on Qualitative and Quantitative Data) Scale: 0-10 2/
Financial
Development
Index
Banking
Sector
Non-Bank
Financial
Sector
Regulation -
Supervision
Monetary
Sector &
Policy
Financial
Openness
Institutional
Environment
7.66
6.97
6.93
6.80
6.60
6.37
6.13
5.68
5.60
5.57
5.54
5.45
4.84
3.87
3.79
3.45
3.23
2.33
1.13
0.99
4.95
7.28
8.74
7.06
7.36
7.89
7.83
7.10
6.81
4.19
7.70
5.62
5.99
6.29
4.15
3.85
3.76
2.55
1.87
1.92
1.35
5.46
5.00
3.33
6.33
5.00
5.00
3.33
5.00
0.67
6.33
4.67
4.67
6.33
0.67
0.67
1.33
0.67
3.00
3.33
0.67
0.67
3.33
9.33
7.67
8.67
8.00
6.67
8.00
8.33
6.67
7.67
5.33
7.33
5.33
3.67
3.33
5.00
3.00
3.46
3.33
0.00
2.00
5.64
7.77
8.25
6.50
6.62
5.98
6.42
4.19
5.66
7.37
4.46
6.84
5.57
6.19
5.00
4.40
3.94
4.36
0.51
0.90
0.50
5.07
8.00
7.00
8.00
8.00
8.00
8.00
8.00
8.00
4.00
5.00
4.00
6.00
7.00
9.00
7.00
5.00
4.00
4.00
0.00
0.00
5.90
8.89
5.22
5.44
5.89
5.89
4.22
4.78
6.33
3.89
5.00
3.78
3.22
4.54
2.22
2.00
4.50
2.33
2.42
2.42
1.00
4.20
Source: IMF staff calculation
1/ Original "subjective" weighted index.
2/ Scale: Very Low=below 2.5, Low=2.51-5.0, Medium=5.1-6.0, High=6.0-7.5, Very High=above
7.5.
May 2006 11

Why Bank Corporate Governance Matters
• Lessons from Financial Crises
• Pressure from Analysts and Investors
• Renewed emphasis on environmental, social and governance issues
• Higher return on assets and significant market premiums
• Improved access to finance
• Better allocation of credit
• Deepening of financial markets
• Financial system stability
May 2006 12

Why Bank Corporate Governance Matters
• Banks’ dominant position in financial and payment systems
• Banks dominate both credit & investment process for economy and majority of firms
• Government ownership and concentration of ownership in banking sector
• Strengthen prudential regulation and supervision
• Strengthen Transparency, Disclosure & Reporting
• Face challenge of external competition
• Liberalization & opening up is providing greater latitude to banks
May 2006 13

Key Players in the CG Framework for Banks
External Players
Internal Players
Shareholders
Regulators and
Supervisors
The Market
The Public
Board of Directors
Legislative and
Regulatory
Framework
Executive Management
Auditors
Supervisory
Authority
Depositors
Reputational Agents:
Accountants
Credit Rating Agencies
Financial Media
Research Analysts
May 2006 14

Focus Efforts to Address CG of the Banking System
May 2006 15

1. CG of Central Banks and Bank
Supervisors
• Develop a credible and transparent regulatory environment
• Address Central Bank governance to ensure its independence and accountability
• Regulatory environment must not be perceived to be under control or influence of any particular interest group
• Follow BIS principles for sound banking CG
May 2006 16

Designing a Consistent Governance
Structure at the Central Bank
May 2006
Source: Central Bank Governance: A Survey of Boards and Management. Tony
Lybek and Joanne Morris, IMF Working Paper WP/04/226,
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Implementing an Effective Governance
Structure at the Central Bank
Source; Central Bank Governance: A Survey of Boards and Management. Tony Lybek and Joanne Morris,
IMF Working Paper WP/04/226,
May 2006 18

• Promote strong corporate governance
• Determine whether the bank has sound corporate governance policies and practices
• Hold the Board and senior management accountable for governance and internal control weaknesses
• Be attentive to warning signs of deterioration in management
May 2006 19

BIS: Sound CG Principles for Banking Organizations
•
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.
•
Principle 2
The board of directors should approve and oversee the bank’s strategic objectives and corporate values that are communicated throughout the banking organisation.
•
Principle 3 The board of directors should set and enforce clear lines of responsibility and accountability throughout the organisation.
•
Principle 4 The board should ensure that there is appropriate oversight by senior management consistent with board policy.
• Principle 5 The board and senior management should effectively utilise the work conducted by the internal audit function, external auditors, and internal control functions.
• 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.
• Principle 7 The bank should be governed in a transparent manner.
• 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”).
May 2006 20

BIS Sound CG Principles for Banking Organizations:
The Role of Supervisors
• Supervisors should provide guidance to banks on sound corporate governance and the pro-active practices that should be in place.
• Supervisors should consider corporate governance as one element of depositor protection.
• Supervisors should determine whether the bank has adopted and effectively implemented sound corporate governance policies and practices.
• Supervisors should assess the quality of banks’ audit and control functions.
• Supervisors should evaluate the effects of the bank’s group structure.
• Supervisors should bring to the board of directors’ and management’s attention problems that they detect through their supervisory efforts.
May 2006 21

2. CG of Banking Sector and
Financial Institutions
• Understand and implement BIS standards
• Address institutional barriers from implementing BIS standards
• Be transparent and disclose:
– Board and senior management structure
– Organisational structure
– Incentive structure of the bank
– Related party transactions
– Annual financial statements with supporting notes and schedules
• Develop codes of ethics and CG handbooks for banks, as guidance for directors and staff
– Jordan, Pakistan
May 2006 22

3. Banks have a role in extending CG to non-bank corporate sector
• For CG to take root in countries with relatively undeveloped financial markets, banks can play a crucial role to advance good CG practices.
• Establish ‘cascading effect’ of CG to banks’ corporate clients.
• Over 90% of firms in emerging markets are FOEs and are mostly dependent on banks, not capital markets, for source of capital.
May 2006 23

Implementing CG in Non-Bank
Financial Sector
• Two step process
1. Develop a mandatory bank CG Code
 Monitored by bank supervisors and reported on by board
 Reporting on compliance in bank annual report
2. Central Bank issues a circular relating to CG code for non-bank corporate clients of the banking system
 Develop effective monitoring by banks (i.e. market based monitoring)
 Support monitoring by development of credit bureaus and credit rating agencies
 Create incentives (such as lower risk assessment for capital adequacy requirements) for CG-compliant corporate clients thereby also providing incentives for banks
May 2006 24

Reinforcing Institutions for a CG regime for bank and non-bank corporate sector
• Central Credit Reporting Organizations
 Provide information on bank and non-bank credit (including supplier credit)
 Local CCRO’s can collect, organize, and analyze valuable material information in an efficient manner
• Companies Houses
 Act as a corporate registrar and reliable source for publicly available information about corporations
 Provide and disseminate financial reports and info on board & management actions
• Credit Rating Agencies
 Risk assessments and credit ratings for companies and governments
 Important for capital market development, and implementation of Basel
II by providing credit benchmarks for local markets
May 2006 25

PROCESS OF DEVELOPING
BANK CORPORATE GOVERNANCE CODE / GUIDELINES
Working Group (WG)
Central Bank (CB) +
Bank Supervisor (BS)
- Discuss
- Review
- Comparative Study
Issuance of
Bank Corporate Governance
Code (BCGC)
Draft
Bank Corporate Governance
Code / Guidelines (BCGC)
Approval of
Central Bank Council
Technical Committee (TC)
CB / BS +
Banks / Financial Institutions
- Discuss
- Approve
Issuance of BCGC by
Technical Committee (TC)
Approval by
Technical Committee (TC)
Workshop on BCGC
- Discuss Draft
- Peer Review
- Engage Internal / External Stakeholders
Public Hearing /
Website Posting
May 2006 26

Shari’a Compliant Financial Institutions
• Islamic Financial Services Board developed seven guiding principles, divided into four parts, on CG for institutions offering only Islamic financial services (IIFS).
• Complements current corporate governance principles issued by OECD, BCBS and other international standard setting bodies.
• Recognizes that specific CG practices will vary in scope and content
• Prudential regulations covering aspects of capital adequacy, risk management, investor protection, transparency and market discipline, accounting practices will have CG dimension on structure and business practice. Focus is on holistic compliance of regulations.
May 2006 27

Islamic Financial Institutions:
Guiding Principles (DRAFT)
• General Governance Approach of IIFS
– Establish comprehensive governance policy framework
– Reporting of financial and non-financial information meets international standards
• Rights of investment account holders (IAHs)
– Recognizes IAH’s rights to monitor performance of investments
– IIFS shall adopt sound investment strategy
• Compliance with Islamic Shari’ah rules and principles
– Put in place an appropriate mechanism for obtaining Shari’ah rulings, application of fatwa and monitoring of Shariah compliance
– IIFS shall comply with Shari’ah rules and principles
• Transparency of financial reporting
– IIFS shall make adequate and timely disclosure to the IAH and the public on investment accounts that they manage
May 2006 28

Complementary Work Needed to Advance CG
• Engage wide participation from NGO’s, chambers of commerce, media, business associations, government
• Develop necessary institutions and build human capacity in major areas (accountants, regulators, bankers, company directors)
• Design an effective regulatory system, but also create the conditions that make such a system credible.
• In the end, corporate governance is about establishing a climate of trust and confidence.
May 2006 29

• IT CG:
– Public dimension: enabling framework for Digital economies & societies. E-Government imperative
– Private dimension
• “IT governance is the responsibility of the board of directors and executive management. It is an integral part of enterprise governance and consists of the leadership and organisational structures and processes that ensure that the organisation’s IT sustains and extends the organisation’s strategies and objectives.”
• IT governance is concerned about two responsibilities:
– IT must deliver value and enable the business
– IT-related risks must be mitigated.
May 2006 30

• First Institute of its kind in the region
• An autonomous, international association, hosted by the Dubai International Financial Centre (DIFC), and serving the MENA countries, Central Asia and beyond
• Premises in DIFC to be ready by October 2006 to host Hawkamah
ICG and Hawkamah Institute of Directors (HIoD) as well as academic institutions
• Financially self-sustaining organisation with income from memberships, consultation, training, in addition to grants & sponsorship
May 2006 31

• ‘Bridge the CG gap’
• Assist the countries and companies of the region in developing sound and globally well integrated CG frameworks:
– Coordinate and sequence the designing, and implementation of CG reforms
– Monitor the outcomes of CG policies at the public and private sector level.
• “ Hawkamah-ICG will serve as a platform for regional cooperation, based on a concrete agenda for measurable and time-bound action, aiming to raise awareness of national, regional and global initiatives and build a coalition for reform ”, Joint Declaration OECD-UAE, 2005.
May 2006 32

• Strengthen institutional and capacity building by setting up a regional Institute of Directors.
• Source of CG technical assistance, monitoring, analysis, research, consultation and reform.
• Foster communication and policy dialogue on CG
• Develop home-grown CG frameworks working with national task forces
• Natural bridge and intermediary for institutions promoting
CG in the region
May 2006 33

Focal Point 1 Focal Point 2 Focal Point 3 Focal Point 4
Institution
& Capacity
Building
Knowledge
Exchange
Platform
Technical
Assistance
Analysis &
Research
Communication
&
Policy
Dialogue
May 2006 34

FOCAL PROGRAMMES
Institution & Capacity Building
Analysis, Research & Technical
Assistance
Communication & Policy Dialogue
Knowledge Exchange Platform
PROJECTS
National Task Force Creation
Regional Institute of Directors
Companies Houses for the MENA region
Centralized Credit Reporting Agencies
Academic Courses
Training and e-courses
National & Regional Surveys
Tool Kits
Governance Econometrics
Quarterly & Annual Reports
Working Papers
Advisory & Consultation services
Drafting Codes
Website
National Roundtables
Regional Forums e-Discussions – e-Forums
Awareness Raising Campaigns
CG Contests
Establishment of CG Virtual Library
Initiated Implemented
2006
IMPLEMENTATION
2007 2008 2009
May 2006 35

1.
Listed Companies, Capital Markets & Regulatory
Authorities
2.
Banks, Financial Institutions, Central Banks &
Supervisory Authorities
3.
Non-listed companies – Family-Owned Enterprises
(FOEs) & Small and Medium Enterprises (SMEs)
4.
Public Sector – State-Owned Enterprises (SOEs)
5.
Media – Academia: Raising Awareness, Building
Capacity & conducting research on CG
May 2006 36

Services
Government
Ministries &
Agencies
Central Banks &
Regulatory
Agencies
Banks & Financial
Institutions
Listed
Companies
Family Owned
Enterprises
State Owned
Enterprises
Media
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National Assessment of current corporate governance practices.
Identification of key corporate governance issues relevant to the country benchmarked against international best practices such as BIS principles
Assistance in development and followthrough of corporate governance task force and agenda development.
Workshops, seminars, outreach to various CG stakeholders
– investors, auditors, lawyers, accountants, etc.
Incorporation of national corporate governance task force into a broader regional initiative.
Advice and development of public awareness campaigns.
Development of Central Credit Reporting organization; Companies House, Credit
Rating Agencies.
Development / implementation of appropriate corporate governance regulatory regime.
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May 2006 37

Services
Government
Ministries &
Agencies
Central Banks &
Regulatory
Agencies
Banks &
Financial
Institutions
Development of codes of good corporate governance, codes of ethics.
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Listed
Companies
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Family
Owned
Enterprises
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State Owned
Enterprises
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Media
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Facilitate a peer review of corporate governance codes
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Firm level assessments (and reassessments) on corporate governance practices.
Board level seminars and workshops on corporate governance strategies in various emerging markets.
Development and implementation of action plan to incorporate good corporate governance practices in company operations.
Firm level assistance, strategy development and implementation to address firm’s core corporate governance challenges in order to attract more investments (e.g. IPO, privatization, etc.)
Training program for frontline managers on implementing corporate governance programs.
Director Training Program
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May 2006 38

Structure:
 Board,
 Executive,
 Investment advisory group,
 Scientific/expert advisory group
Board Committees
Executive Committee
Membership Committee
Corporate Governance Review Committee
Research & Publications Committee
Media and Communications Committee
Membership Structure
Corporate
Individual
Legal Committee
Activities Committee
Funding Committee
Awards Committee
Educational Institution
Academic/Research
May 2006 39

• Develop and assist in implementing bank corporate governance codes and principles
• Assist in implementing BIS Sound CG Principles
• Provide consultation, technical assistance and advisory services for Central Banks & Bank Supervisors
• Organize seminars, workshops, forums, and conferences
• Conduct bank corporate governance surveys & policyoriented research
• Bank CG capacity building and awareness
• Director training program on bank CG
• Conduct individual bank CG assessments
May 2006 40

Open to private and public sector companies, entrepreneurs of start-up companies, and people responsible for the strategic direction of a business organization.
Services offered include:
 Training and certification program
 Executive coaching
 Workshops, seminars and conferences
 Financial planning and consultancy services
 Affinity programs such as personal loans, liability insurance coverage, etc.
 Access to members only lounges and facilities
May 2006 41

Hawkamah is partnering with:
• OECD *
• WB-IFC *
• WB Global Corporate Governance Forum
• Union of Arab Banks *
• Center for International Private Enterprise*
• DSG, IMD, YAL
• Central Banks, Bank Supervisory Authorities & Bank Associations
• Capital Market Authorities, Stock Exchanges, Market Professional
Associations & SROs
• International & Regional organizations
• Countries participating in the MENA-OECD Investment Program
• CG centers, universities
May 2006 42

• Provide technical assistance and advisory services related to institutional and human resource capacity building in corporate sector reform and governance
• Establish sustained dialogue with regional and international organizations specialized in corporate governance
• Provide funding for various Corporate Governance
Programmes and Projects
• Organize seminars, workshops, forums, and conferences dedicated to issues of corporate governance in the region and the world
• Conduct research and surveys on corporate governance in the region and means of enhancement
May 2006 43

May 2006
www.hawkamah.org
Hawkamah Institute for Corporate Governance
DIFC, The Gate Level 14
T: +9714-362-2222 F: +9714-362-3333
E: info@hawkamah.org
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