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Framework for Assessing the Quality of Bank Management and Governance


Silvia Marques de Brito e Silva Amaro Luiz de Oliveira Gomes

Banco Central do Brasil

Este trabalho não reflete necessariamente a opinião e posição do Banco Central do Brasil, mas tão somente a de seus autores.

Synopsis

This study suggests a framework for assessing the quality of bank management and governance by supervisors. It starts by reviewing the principles and practices of good corporate governance advised by renowned public and private bodies and addressing the importance of the subject for the development of any economy. After that, a model for quality assessment is proposed as guidance to supervisors for identifying weak and hazardous procedures in a proactive way, which is crucial to safeguard the soundness of the banking sector. The key features of corporate governance are initially classified into six categories: Board of Directors, Management, Auditing and Internal Controls, Shareholders, Stakeholders, and Disclosure and Transparency. Next, the elements under investigation are disposed as a ‘yes no questionnaire’ to be responded during on-site supervisions. The overall score is then traduced into one of the suggested categories of management and governance quality. The proposed framework aims to establish a minimum set of areas to be evaluated by supervisors, but do not intend to exhaust all possibilities on assessing the management and governance quality. Depending on the characteristics of the financial system and the corporate governance regulation and practices, the framework may be implemented to a greater or lesser extent or even modified in order to be adjusted to individual banking systems.


Table of Contents

1 – Introduction ................................................................................................................... 1

2 – Principles for good corporate governance ......................................................... 3

2.1 The concept and importance of corporate governance ............................................ 3

2.2 The Cadbury Report................................................................................................ 3

2.3 The OECD Principles of corporate governance...................................................... 6

2.4 The World Bank concern ........................................................................................ 11

3 – Corporate governance in banking organisations .................................................. 12

3.1 The scenario in which banks operate ....................................................................... 12

3.2 The importance of corporate governance in banks ................................................. 13

3.3 The role of regulator and supervisors ..................................................................... 14

3.4 The Basel Committee recommendations ................................................................. 14

4 – Assessing the quality of bank management and governance.............................. 19

4.1 The basis and limitations of the proposed model ................................................... 19

4.2 A template for quality assessment of management and

governance in banks ............................................................................................... 21

Bibliography......................................................................................................................... 32


List of tables

Table 2.1 Key points addressed in the Cadbury Report concerning the board of directors.......................................................................................... 4 Table 2.2 Key points addressed in the Cadbury Report concerning the audit function................................................................................................ 5 Table 2.3 Key points addressed in the Cadbury Report concerning the shareholders .................................................................................................. 6 Table 2.4 Key points addressed by the OECD for ensuring the basis for an effective corporate governance framework.............................................. 7 Table 2.5 Key points addressed by the OECD regarding the right of shareholders an key ownership functions ...................................................... 7 Table 2.6 Key points addressed by the OECD regarding the equitable treatment of shareholders .............................................................. 8 Table 2.7 Key points addressed by the OECD regarding the role of stakeholders....................................................................................... 8 Table 2.8 Key points addressed by the OECD regarding disclosure and transparency................................................................................ 9 Table 2.9 Key points addressed by the OECD regarding the responsibilities of the board.......................................................................... 10 Table 3.1 Fundamental Basel Committee on Banking Supervision publications .............. 15 Table 4.1 Levels of management and governance quality ................................................. 20 Table 4.2 Template for assessing the board of directors of banking organisations............ 21 Table 4.3 Template for assessing the management of banking organisations.................... 25 Table 4.4 Template for assessing the auditing and internal controls of banking organisations..................................................................................... 26 Table 4.5 Template for assessing the shareholders of banking organisations.................... 28 Table 4.6 Template for assessing the stakeholders of banking organisations .................... 30 Table 4.7 Template for assessing the disclosure and transparency of banking organisations..................................................................................... 30


1 – Introduction

The present study suggests a framework for assessing the quality of bank management and governance by supervisors. The assessment of those practices may lead to the identification of weak and hazardous procedures in a proactive way, which is crucial to safeguard the soundness of the banking sector and the sustainability of any economy. Nonetheless, assessing the quality of bank management and governance is absolutely a tricky task. First, any process of assessment of practices carries massive subjectivism. How can evaluators ensure that their personal believes of goodness and appropriateness are not influencing their analysis? And second, management and governance in banks cover special and complex areas. Banking businesses comprise several risks and operational details which make them by far more complex than activities in any other sector of the economy. As an attempt to overcome the subjectivism and complexity surrounding the assessment of management and governance in banks, the proposed framework aims to establish a minimum set of areas to be evaluated by supervisors, based on the principles of good corporate governance recommended internationally and the best practices issued by the Basel Committee on Banking Supervision, as well as to suggest a methodology for classification and levels of management and governance quality. Corporate governance was described by the Committee on the Financial Aspects of Corporate Governance in its report1 (Cadbury Commission, 1992) as the system by which companies are directed and controlled. That concept can be better understood by considering the words of Sir Adrian Cadbury introducing the report Corporate Governance: A Framework for implementation – Overview published in 1999 by the World Bank Group:

‘Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage the efficient use of resources and equally to require accountability2 for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations, and society.’

The role of corporate governance in balancing and aligning personal, corporate and public interests is critical to economic efficiency and social progress. Good corporate governance principles and practices are regarded to provide competitive advantage, to strength the economy, to broaden capital markets, to attract long-term capital, to promote sustained growth, and to discourage fraud and mismanagement. Despite the irrefutable importance of those principles and practices, the evolution of corporate governance systems has primarily been stimulated by systemic crises3 and 1 That report is also kwon as Cadbury Report. 2 See Licht, Amir N., “Accountability and Corporate Governance” (September 2002). http://ssrn.com/abstract=328401, for a comprehensive discussion of the concept of accountability. 3 Systemic crises as the one happened in East Asia in the late 1990s, for instance, have contributed to the corporate governance development by coercing countries to take several actions as strengthening prudential regulation and listing rules, modernizing bankruptcy and takeover laws, opening the banking sector to foreign investors, and introducing international accounting and auditing standards.

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http://ssrn.com/abstract=328401


corporate failures, which destabilize economies and harm investors and stakeholders4. And there has been no shortage of crises and failures. Even focusing in the latest 400 years, several events can be reckoned as a result of incompetence, fraud, and abuse, ranging from the Dutch Tulip Crisis to the company scandals in the 2000s. Considering the harmful consequences of systemic crises and failures and the necessity of promoting good corporate governance practices, several principles and standards related to crucial aspects of corporate governance have been established by public and private bodies including:

a) the Word Bank;

b) the World trade organisations (WTO);

c) the International Labour Organization (ILO);

d) the Bank for International Settlements (BIS);

e) the International Organization of Securities Commissions (IOSCO); and

f) the International Accounting Standards Board (IASB). Indeed, the competitive advantage of a business depends on its corporate governance and the reliability of a corporate governance system depends on its ability of discouraging harmful practices and correcting course of actions proactively. Hence, assessing the quality of management and governance, particularly in banks, is worthy of scrutiny. Corporate governance is particularly important for financial institutions due to their intrinsic relationship with a country economy and particularly because most of the funds used belong to their creditors (depositors are the most important). Also, many recent factors are reshaping their business, such as globalisation, technological advances, increased risks, and deregulation. Thus, the board of directors face additional expectations imposed by regulators and has a vital role not only in approving the objectives, strategy and business plans, but also in ensuring that neither large shareholders nor senior management abuse their power. In this sense, corporate governance is a crucial element in promoting safe and sound financial institutions and the involvement of the board of directors and senior management is critical to the successful implementation of the New Basel Capital Accord. Accordingly, the paper starts by addressing the principles of good corporate governance and its importance for any economy focusing on those principles and practices proposed by the Cadbury Commission, the OECD5 and the Word Bank. The following section, part 3, explores the corporate governance in banking organisations drawing special attention to recommendations of the Basel Committee on Banking Supervision6 for enhancing sound practices in banking organisations. In section 4 a model for assessing the quality of management and governance in banks is devised. The conclusions are presented in section 5.

4 Stakeholders include creditors, employees, customers, suppliers and the community. From a banking perspective, supervisors and governments are also considered stakeholders. 5 Organization for Economic Cooperation and Development. 6 The Basel Committee on Banking Supervision is a Committee of banking supervisory authorities which was established by the central-bank Governors of the Group of Ten countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Spain, Sweden, Switzerland, United Kingdom and the United States. It usually meets at the Bank for International Settlements in Basel, where its permanent Secretariat is located.

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2 – Principles of good corporate governance 2.1 The concept and importance of corporate governance Corporate governance was described by the Committee on the Financial Aspects of Corporate Governance in its report (Cadbury Commission, 1992) as the system by which companies are directed and controlled. Indeed, good corporate governance principles and practices aim to align as nearly as possible the interests of individuals, corporations, and society which are critical to economic efficiency and social progress. A sound and robust corporate governance system is able to provide business competitive advantage, to strength the economy, to broaden capital markets, to attract long-term capital, to promote sustained growth, and to discourage fraud and mismanagement. The main factors that have incited the evolution of corporate governance mechanisms across countries and over time are systemic crises and corporate failures of diversified nature. Those crises and failures, mainly a result of incompetence, fraud, and abuse, have destabilized economies and harmed investors and stakeholders. The first well-documented failure of governance occurred in the 1720: the South Sea Bubble. The collapse of the South Sea Company produced enormous effects on the business laws and practices in England. In 1929, a stock market crash devastated the United States economy which also interfered in the corporate governance evolution process. Similarly, the East Asia Crisis and the collapse of sizeable groups and big corporations, such as the Maxwell Group raid, the Bank of Credit and Commerce International, Barings Bank, Sumitomo, Enron, WorldCom, and Parmalat, have also contributed to the corporate governance development. Although crises and corporate failures have contributed to the evolution of the corporate governance in general, the evolution process is indeed more complex in developing and transition economies. As highlighted in the document Corporate Governance: a framework for implementation – Overview issued by the World Bank in 1999, such countries lack the supporting institutions and human resources so critical to sound corporate governance. Their challenge is enormous. Most of the time they tend to adapt existing systems of corporate governance to their own corporate structures and implementation capacities in order to establish a culture of enforcement and compliance, which do not guarantee successful functioning. But regardless the development level of the country, the importance of corporate governance for improving economic efficiency is widely acknowledged. Good corporate governance is alleged to provide proper incentives for the board and management to pursue objectives aligned to the interests of the suppliers of the capital (i.e. shareholders) and to encourage firms to use resources more efficiently (OECD, 1999). 2.2 The Cadbury Report The Cadbury Report (1992) corresponds to the Report of the Committee on the Financial Aspects of Corporate Governance elaborated by a commission set up in May 1991 in the United Kingdom by the Financial Reporting Council, the London Stock Exchange and the accountancy profession. The establishment of a committee for addressing the financial

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aspects of corporate governance was motivated by the perceived low level of confidence both in financial reporting, and in the ability of auditors to provide the adequate and expected safeguards. The main focuses, therefore, were the control and reporting functions of boards and the role of auditors. The Committee’s recommendations were subsequently consolidated as a voluntary Code of Best Practice devised to achieve high standards of corporate behaviour. That code has three interconnected principles7: openness, integrity and accountability. The Code of Best Practice made proposals in three broad areas concerning to the board of directors, auditing, and shareholders. The key points are presented in the following tables: Table 2.1 – Key points addressed in the Cadbury Report concerning the board of directors

Cadbury Report - The Code of Best Practice The Board

1. Board effectiveness – the board should be made up of a combination of both executive and non-executive directors in order to guarantee the necessary balancing of knowledge and forces.

2. The Chairman – there should be a clear separation of the position of the chairman from that of the chief executive. Chairmen should be able to stand sufficiently back from the day-to-day running of the business to ensure the independence and efficiency of the board activities.

3. Non Executive-Directors – the presence of non-executive directors should be able to bring independent judgment on issues of strategy, performance, resources, and standards of conduct.

4. Professional advice – the board should always be able to take professional advice from both insider specialists and independent advisers, in this case, at the expense of the company.

5. Directors’ Training - the directors all should undertake some form of internal or external training in order to prepare themselves for their positions.

6. Board Structure and Procedures – the audit, remuneration and nomination committees should be appointed by the board.

7. Directors’ Responsibilities – the directors should provide a statement of their responsibilities in the financial report and accounts.

7 Openness allows boards to take effective action, enables shareholders and others to scrutinise the company management and performance, and contributes to the efficiency of the market economy. Integrity is viewed as both straightforward dealing and completeness of financial reporting by presenting a balanced picture of the state of the company’s affairs. Accountability is essential to the board of directors and shareholders relationship. Boards are accountable to investors and both are responsible for making that accountability effective.

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Cadbury Report - The Code of Best Practice The Board

8. Standards of Conduct – the board should prepare codes of ethics or statements of business practice and to publish them both internally and externally.

9. Internal Controls - directors should ensure that a proper internal control is in place.

10. Auditing Committees - all listed companies should establish an audit committee consisting of non-executive directors.

11. Internal Audit - companies should establish internal audit functions, with unrestricted access to the auditing committee, to undertake regular monitoring of key controls and procedures.

12. Board remuneration – the remuneration of directors should be fair and competitive with full acknowledge to shareholders.

13. Financial Reporting – the board should pay particular attention to their duty to present a balanced and understandable assessment of the financial position of the company with a true and fair view.

14. Reporting practice – the board should ensure that financial statements be widely circulated, in fairness to individual shareholders and to minimise the possibility of insider trading.

Table 2.2 – Key points addressed in the Cadbury Report concerning the audit function

Cadbury Report - The Code of Best Practice Auditing

1. Professional Objectivity – auditors should apply their professional skills impartially, retain a critical detachment and be aware of their accountability.

2. ‘Quarantining’ audit from other services - audit firms should not provide other types of service to their audit clients. In case of proving such services, a full disclosure is necessary.

3. Rotation of auditors – a compulsory rotation of audit firms should be introduced in order to prevent relationships between management and auditors becoming too comfortable.

4. Fraud – auditors should have a duty to report fraud to the appropriate authorities.

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Table 2.3 – Key points addressed in the Cadbury Report concerning the shareholders

Cadbury Report - The Code of Best Practice Shareholders

1. Accountability of Boards to Shareholders – the board and shareholders should implement mechanisms to strength accountability.

2. Institutional Shareholders - institutional investors should encourage regular, systematic exchange of view and information on strategy, performance, board membership and quality of management with senior executives in order to make positive use of their voting rights.

3. Shareholders Communications - any significant statements should be publicly and equally available to all shareholders.

2.3 The OECD Principles of corporate governance Since the first publication of the OECD principles of corporate governance in 1999, those principles have become the most widely accepted corporate governance benchmark and have inspired the drafting of other codes issued by international organizations, countries, companies and stock exchanges. The corporate governance framework devised by the OECD comprises elements of legislation, regulation, self-regulatory arrangements, voluntary commitments and business practices that are the result of a country’s specific circumstances, history and tradition as a way to cover the crucial elements for effective corporate governance practices. In 2004, the OECD divulged a revised version of those principles covering the following areas:

a) ensuring the basis for an effective corporate governance framework;

b) the rights of shareholders and key ownership functions;

c) the equitable treatment of shareholders;

d) the role of stakeholders in corporate governance;

e) disclosure and transparency; and

f) the responsibilities of the board. The next tables bring some of the details of the OECD Principles on Corporate Governance grouped into six aspects as disposed in the original document.

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Table 2.4 – Key points addressed by the OECD for ensuring the basis for an effective corporate governance framework

OECD Principles Ensuring the Basis for an Effective Corporate Governance Framework

1. The corporate governance framework should be developed with a view to its impact on overall economic performance, market integrity and the incentives it creates for market participants and the promotion of transparent and efficient markets.

2. The legal and regulatory requirements that affect corporate governance practices in a jurisdiction should be consistent with the rule of law, transparent and enforceable.

3. The division of responsibilities among different authorities in a jurisdiction should be clearly articulated and ensure that the public interest is served.

4. Supervisory, regulatory and enforcement authorities should have the authority, integrity and resources to fulfil their duties in a professional and objective manner. Moreover, their rulings should be timely, transparent and fully explained.

Table 2.5 – Key points addressed by the OECD regarding the right of shareholders and key ownership functions

OECD Principles The Right of Shareholders and Key Ownership Functions

1. Basic shareholder rights should include the right to: (i) secure methods of ownership registration; (ii) convey or transfer shares; (iii) obtain relevant and material information on the corporation on a timely and regular basis; (iv) participate and vote in general shareholder meetings; (v) elect and remove members of the board; and 6) share in the profits of the corporation.

2. Shareholders should have the right to participate in, and to be sufficiently informed on, decisions concerning fundamental corporate changes such as: (i) amendments to the statutes, or articles of incorporation or similar governing documents of the company; (ii) the authorisation of additional shares; and (iii) extraordinary transactions, including the transfer of all or substantially all assets, that in effect result in the sale of the company.

3. Shareholders should have the opportunity to participate effectively and vote in general shareholder meetings and should be informed of the rules, including voting procedures, that govern general shareholder meetings.

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OECD Principles The Right of Shareholders and Key Ownership Functions

4. Capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership should be disclosed.

5. Markets for corporate control should be allowed to function in an efficient and transparent manner.

6. The exercise of ownership rights by all shareholders, including institutional investors, should be facilitated.

7. Shareholders, including institutional shareholders, should be allowed to consult with each other on issues concerning their basic shareholder rights as defined in the Principles, subject to exceptions to prevent abuse.

Table 2.6 – Key points addressed by the OECD regarding the equitable treatment of shareholders

OECD Principles The Equitable Treatment of Shareholders

1. All shareholders of the same series of a class should be treated equally.

2. Insider trading and abusive self-dealing should be prohibited.

3. Members of the board and key executives should be required to disclose to the board whether they, directly, indirectly or on behalf of third parties, have a material interest in any transaction or matter directly affecting the corporation.

Table 2.7 – Key points addressed by the OECD regarding the role of stakeholders

OECD Principles The Role of Stakeholders in Corporate Governance

1. The rights of stakeholders that are established by law or through mutual agreements are to be respected.

2. Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain effective redress for violation of their rights.

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OECD Principles The Role of Stakeholders in Corporate Governance

3. Performance-enhancing mechanisms for employee participation should be permitted to develop.

4. Where stakeholders participate in the corporate governance process, they should have access to relevant, sufficient and reliable information on a timely and regular basis.

5. Stakeholders, including individual employees and their representative bodies, should be able to freely communicate their concerns about illegal or unethical practices to the board and their rights should not be compromised for doing this.

6. The corporate governance framework should be complemented by an effective, efficient insolvency framework and by effective enforcement of creditor rights.

Table 2.8 – Key points addressed by the OECD regarding disclosure and transparency

OECD Principles Disclosure and Transparency

1. Disclosure should include, but not be limited to, material information on:

a) the financial and operating results of the company;

b) company objectives;

c) major share ownership and voting rights;

d) remuneration policy for members of the board and key executives, and information about board members, including their qualifications, the selection process, other company directorships and whether they are regarded as independent by the board;

e) related party transactions;

f) foreseeable risk factors;

g) issues regarding employees and other stakeholders;

h) governance structures and policies, in particular, the content of any corporate governance code or policy and the process by which it is implemented.

2. Information should be prepared and disclosed in accordance with high quality standards of accounting and financial and non-financial disclosure.

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OECD Principles Disclosure and Transparency

3. An annual audit should be conducted by an independent, competent and qualified, auditor in order to provide an external and objective assurance to the board and shareholders that the financial statements fairly represent the financial position and performance of the company in all material respects.

4. External auditors should be accountable to the shareholders and owe a duty to the company to exercise due professional care in the conduct of the audit.

5. Channels for disseminating information should provide for equal, timely and cost-efficient access to relevant information by users.

6. The corporate governance framework should be complemented by an effective approach that addresses and promotes the provision of analysis or advice by analysts, brokers, rating agencies and others, that is relevant to decisions by investors, free from material conflicts of interest that might compromise the integrity of their analysis or advice.

Table 2.9 – Key points addressed by the OECD regarding the responsibilities of the board

OECD Principles The Responsibilities of the Board

1. Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders.

2. Where board decisions may affect different shareholder groups differently, the board should treat all shareholders fairly.

3. The board should apply high ethical standards. It should take into account the interests of stakeholders.

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OECD Principles The Responsibilities of the Board

4. The board should fulfil certain key functions, including:

a) reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions and divestitures;

b) monitoring the effectiveness of the company’s governance practices and making changes as needed;

c) selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning;

d) aligning key executive and board remuneration with the longer term interests of the company and its shareholders;

e) ensuring a formal and transparent board nomination and election process;

f) monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions;

g) ensuring the integrity of the corporation’s accounting and financial reporting systems, including the independent audit, and that appropriate systems of control are in place, in particular, systems for risk management, financial and operational control, and compliance with the law and relevant standards;

h) overseeing the process of disclosure and communications.

5. The board should be able to exercise objective independent judgement on corporate affairs.

6. In order to fulfil their responsibilities, board members should have access to accurate, relevant and timely information.

According to the OECD, those principles are non-binding and do not intend to be detailed prescriptions for national legislation. They are deemed to serve as a reference point assisting Member and non-member governments in their efforts to evaluate and improve the legal, institutional and regulatory corporate governance framework in their countries. Although the OECD Principles focus on publicly traded companies, they might be a useful tool to improve corporate governance in non-traded companies as well. 2.4 The World Bank concern The mission of the World Bank is to fight poverty and improve the living standards of people in the developing world by providing loans, policy advice, technical assistance and knowledge sharing services to low and middle income countries. One of its extensive efforts is the improvement of corporate governance systems in developing and transition

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economies particularly because effective corporate governance can promote enterprise and ensure accountability, important aspects for combating poverty. Accordingly, the World Bank has provided support for client countries in undertaking several actions including complex structural changes and reforms of legal and regulatory structures. Additionally, the Bank has supplied means of technical assistance for institutional development and capacity in corporate governance related areas (e.g. accounting and auditing, legal and judicial systems, financial sector, and capital markets). These programs have addressed many issues that are central to corporate governance:

a) creating competitive markets;

b) establishing regulatory and supervisory capability in banking and capital markets;

c) introducing greater transparency;

d) adopting international accounting and auditing standards;

e) strengthening the competence and independence of boards of directors; The World Bank concern on corporate governance is well summarized in its report Corporate Governance: a framework for implementation – Overview issued in 1999. The article presents a framework for corporate governance reform grounded on the operational experience of the World Bank Group and practitioners in the area. The framework is used to identify the key elements and processes of reform required in developing and transition economies and the contribution that both the World Bank Group and its partners can give for promoting enterprise and accountability. It is also worthy to mention the joint programme of the World Bank and the IMF8 on preparing ‘Reports of the Observance of Standards and Codes (ROSCs)’. The two bodies have undertaken several assessments of the observance of selected standards relevant to private and financial sector development and stability, including a template for country assessment of corporate governance (2003). Although the Bank recognises that there is no single corporate governance model because market structures, legal systems, traditions, regulations, and cultural and societal values vary at a great extent across countries, the global market pressures (e.g. globalisation) are stimulating corporate governance practice harmonisation, reducing risk to investors and holding down the cost of capital to companies.

3 – Corporate governance in banking organisations 3.1 The scenario in which banks operate Banks are important elements of any economy. Banking organizations may raise money in special ways (e.g. taking deposits) and provide financing for businesses, not to mention other services as accessing to payments systems. Moreover, their role as financial intermediaries is essential for smooth functioning of the market. Even under market distress conditions, those financial institutions are expected to make credit and liquidity

8 International Monetary Fund.

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available. Hence, the sustainability of any economy depends upon the safety and soundness of its bank system. Banks are regarded to operate in a scenario rather different from that faced for mainly other companies:

a) regulated or administrated markets;

b) the agency problem is more complex, including the regulator and other stakeholders;

c) capital structure is highly geared, with small participation of the owners on the total capital, reflecting the bank’s function as an intermediary; and

d) regulatory limitations on risk-taking by managers. As a matter of fact, the existence of banking regulation affects the nature of markets in which banks operate and their underlying corporate governance mechanisms. Some of the pressures come from deposit insurance and government interventions limiting competition (Levine, 2003). Deposit insurance, for example, is alleged to reduce the incentives of monitoring by depositors and stimulate owners to take higher risks. Similarly, government restrictions in banking ownership and opening of branches as well as liquidity requirements and limits on interest rates and fees are assumed to restrict competition and thereby weaken natural corporate governance mechanisms. However, regulation can also improve governance of banks by enforcing safe and sound practices in several corporate spheres such as risk management, internal control and disclosure. 3.2 The importance of corporate governance in banks As stated before, banks are crucial for the sustainability of any economy. Actually, when banks are well governed, raising and allocating funds efficiently, the cost of capital to enterprise lows, capital formation boosts, and productivity growth is stimulated. In contrast, weak governance of banks sparkles throughout the economy with negative ramifications for development (Levine, 2003). Thus, it is of crucial importance ensuring that banks have strong and comprehensive corporate governance practices. In order to promote good corporate governance practices, several principles and standards have been established by public and private bodies including the Word Bank Group, the World trade organisations (WTO), the International Labour Organization (ILO), the Bank for International Settlements (BIS), the International Organization of Securities Commissions (IOSCO), and the International Accounting Standards Board (IASB). In general, those principles and standards are grounded in concepts of integrity, fairness, equity, due diligence, accountability, and transparency. Although recognising that all those proposals are significant for promoting good corporate governance in the banking sector, this study primarily relies on the principles and practices recommended by the Basel Committee on Banking Supervision as part of its on-going efforts to address supervisory issues to foster safe and sound banking practices.

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3.3 The role of regulator and supervisors The Basel Committee (1999) recognises that ‘supervision cannot function as well if sound corporate governance is not in place and, consequently, banking supervisors have a strong interest in ensuring that there is effective corporate governance at every banking organisation’. Sound corporate governance is expected to make supervisors’ tasks considerably easier and contribute to a collaborative working relationship between supervisors and bank management. Hence, improving those practices definitely brings benefits for the banking system as a whole. Supervisors play a central role in that process enforcing good practices and assessing corporate performance. First, supervisors should be aware of the importance of corporate governance and its influence on corporate performance. Second, they should certify that banks are able to implement organisational structures along with appropriate checks and balances. Third, they should require the implementation of processes for ensuring that board members and senior management are fulfilling their duties and responsibilities. Fourth, they should confirm that businesses are carried out with due diligence in such a way as not harm depositors and other bank stakeholders. Fifth, regulatory safeguards must emphasise accountability and transparency. Concisely, as underlined by the Basel Committee, supervisors should bear in mind any warning signs of deterioration in the management performance and consider issuing guidance to banks on sound corporate governance and the pro-active practices that need to be in place. 3.4 The Basel Committee recommendations As highlighted on the paper Enhancing Corporate Governance for Banking Organisations issued in 1999 by the Basel Committee, corporate governance involves the manner in which the business and affairs of institutions are governed affecting how banks:

a) set corporate objectives;

b) run the day-to-day operations of the business;

c) consider the interests of their stakeholders;

d) align corporate activities and behaviours with the expectation that banks will operate in a safe and sound manner, and in compliance with applicable laws and regulations; and

e) protect the interests of depositors. From 1982, the Committee has proposed a vast collection of best practices that address several issues in the corporate governance sphere including the need for banks to set strategies and establish accountability, the importance of transparency, internal control requirements, and risk management, not to mention a special report on corporate governance (1999). The most relevant publications addressing corporate governance issues are listed in the following table and the key points are presented afterwards.

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Table 3.1 – Fundamental Basel Committee on Banking Supervision publications

Year Basel Committee on Banking Supervision Publication

2003 The compliance function in banks

2003 Sound practices for the management and supervision of operational risk

2003 Management and supervision of cross-border electronic banking activities

2003 Principles for the management and supervision of interest rate risk

2003 The third consultative paper of the New Basel Capital Accord

2002 Internal audit in banks and supervisor's relationship with auditors: a survey

2001 Internal Audit in banks ant the supervisor’s relationship with auditors

2000 Principles for the management of credit risk

2000 Sound practices for managing liquidity in banking organisations

2000 Best practices for credit risk disclosure

1999 Enhancing corporate governance for banking organisations

1999 Recommendations for public disclosure of trading and derivatives activities of banks and securities firms

1999 Sound practices for loan accounting and disclosure

1999 Risk concentrations principles

1998 Framework for internal control systems in banking organisations

1998 Enhancing banking transparency

1998 Operational risk management

1997 Principles for the management of interest rate risk

1997 Core principles for effective banking supervision

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The compliance function in banks This consultative document was released in October 2003 for comment by 31 January 2004. It brings up eleven principles regarding three themes: (i) responsibilities of the board of directors for compliance, (ii) responsibilities of the senior management for compliance, and (iii) compliance function. Banking supervisors must be sure that effective compliance9 policies and procedures are consistently followed and that managers take appropriate corrective action when laws, rules and standards are infringed. Compliance risk management may succeed when (i) culture emphasises high standards of ethical behaviour at all levels of the bank; (ii) the role and responsibilities of the compliance function is clearly defined, and (iii) the compliance function and the business activities are independent from each other. Sound practices for the management and supervision of operational risk This paper was issued in February 2003 to provide a framework for the effective management and supervision of operational risk. It raises ten principles covering four interconnected topics: (i) developing an appropriate risk management environment, (ii) identification, assessment, monitoring, and mitigation/control of operational risk – risk management, (iii) role of supervisors, and (iv) role of disclosure. Among other crucial elements, the Committee draws attention for the importance of clear strategies and oversight by the board and senior management, effective internal reporting, contingency planning, and strong culture on both operational risk and internal control (e.g. clear lines of responsibility and segregation of duties). Principles for the management and supervision of interest rate risk This consultative paper was issued in September 2003 for comment by 31 October 2003 compiling important issues on the management and supervision of interest rate risk. Although it was originally published as a supporting document to the Second Consultative Paper on the New Basel Capital Accord in January 2001, the Committee has decided to release a revised version for a second, short period of consultation particularly due to the important issues addressed. The paper presents fifteen principles including themes that are crucial to the corporate governance discussion such as: (i) the development of a business strategy, (ii) the importance of the internal control system, (iii) the need for effective interest rate risk measurement, monitoring and control, (iv) board and senior management oversight of the risk management process, (v) and disclosure. Principles for the management of credit risk This document was published in September 2000 with the purpose of encouraging supervisors to promote sound practices for managing credit risk. The recommended sound practices are arranged into seventeen principles covering several areas including: (i) establishing an appropriate credit risk environment; (ii) operating under a sound credit- 9 The purpose of the compliance function is to assist banks in managing their compliance or integrity risk, which can be defined as the risk of legal or regulatory sanctions, financial loss, or loss to reputation a bank may suffer as a result of its failure to comply with all applicable laws, regulations, codes of conduct and standards of good practice.

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granting process; (iii) maintaining an appropriate credit administration, measurement and monitoring process; and (iv) ensuring adequate controls over credit risk. Internal audit in banks and the supervisor’s relationship with auditors This paper was published in August 2001 to address bank supervisory issues and encourages sound practices regarding internal auditing in banking organisations. The Committee emphasises that adequate internal controls within banking organisations must be supplemented by an effective internal audit function that independently evaluates the control systems within the bank. Internal auditing represents a valuable source of information for both bank management and supervisors about the quality of the internal control system. Sound practices for managing liquidity in banking organisations The Basel Committee published this document in February 2000 as part of its ongoing effort to strengthen procedures for risk management in banking organisations. Liquidity10 is critical to the viability of every bank and most of all to the system as a whole. A shortfall in liquidity might have systemic repercussions and hence is one of the most important issues in the banking business. The paper presents fourteen principles around the following central topics: (i) developing a structure for managing liquidity; (ii) measuring and monitoring net funding requirements; (iii) managing market access; (iv) contingency planning; (v) foreign currency liquidity management; (vi) internal controls for liquidity risk; (vii) role of public disclosure in improving liquidity; and (viii) role of supervisors. The core principles are herein summarised: Enhancing corporate governance for banking organisations This document was issued in September 1999 to reinforce the importance for banks of the OECD corporate governance principles, to draw attention to governance issues addressed in previous papers, and to present some new topics related to the theme. Although the Committee recognises that sound governance can be practised regardless of the structure used by a single bank, it outlines four important forms of oversight that should be present in order to ensure adequate checks and balances:

a) oversight by the board of directors or supervisory board;

b) oversight by individuals not involved in the day-to-day operations;

c) direct line supervision of different areas of the business;

d) independent risk management and audit functions. The Committee also suggests sound practices for corporate governance which are quoted below. Practice 1: Establishing strategic objectives and a set of corporate values that are communicated throughout the banking organisation. 10 Liquidity can be defined as the ability to increase asset funds in order to meet obligations as they become due.

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Practice 2: Setting and enforcing clear lines of responsibility and accountability throughout the organisation. Practice 3: Ensuring that board 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 or outside concerns. Practice 4: Ensuring that there is appropriate oversight by senior management. Practice 5: Effectively utilising the work conducted by internal and external auditors, in recognition of the important control function they provide. Practice 6: Ensuring that compensation approaches are consistent with the bank’s ethical values, objectives, strategy and control environment. Practice 7: Conducting corporate governance in a transparent manner. Framework for internal control systems in banking organisations The Committee issued this paper in September 1998 for setting up principles for internal control systems evaluation in banking organisations. An effective internal control system is a critical component of the management of a bank as it represents the foundation for the safety and soundness of every operation. A strong internal control system can help to ensure that the bank (i) will accomplish its goals and objectives, (ii) will achieve long-term profitability targets, (iii) will comply with laws, regulations and policies, and (iv) maintain reliable financial and managerial reporting. Such a system can also function as an earlier sign of problems leading to substantial losses. Enhancing banking transparency This report was published in September 1998 to discuss the role of information in effective market discipline and effective banking supervision. The main purpose is to provide general guidance (i) to banking supervisors and regulators for formulating and improving regulatory frameworks for public disclosure and supervisory reporting, and (ii) to the banking industry on core disclosures that should be provided to the public. The Basel Committee recommends that banks, in their financial reports and other disclosures to the public, provide information with some qualitative characteristics: (i) comprehensiveness, (ii) relevance and timeliness, (iii) reliability, (iv) comparability, and (v) materiality. Reliable and timely information facilitates market participants' assessment of them. The Committee also identifies the following six broad categories of information to be addressed for a satisfactory level of bank transparency:

a) financial performance;

b) financial position (including capital, solvency and liquidity);

c) risk management strategies and practices;

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d) risk exposures (including credit risk, market risk, liquidity risk, and operational, legal and other risks);

e) accounting policies; and

f) basic business, management and corporate governance information.

4 – Assessing the quality of bank management and governance 4.1 The basis and limitations of the proposed model The aim of this section is to propose a template and methodology for assessing the quality of bank management and governance by supervisors. Although the suggested model attempts to cover most of the critical elements on corporate governance, it merely represents a starting point for the quality assessment. Firstly, supervisors may bear in mind that there are significant differences of corporate structures, governance systems and supervisory approaches across countries. Secondly, the supervisory authority may need to complement its analysis with elements other than those consolidated in that template. And thirdly, real-life situations cannot be expected to fit perfectly into the proposed questions and categories. Regardless those limitations, the model presented hereafter is expected to be a worthy guide to help supervisors in devising their assessment instruments. The proposed model has basically considered four features:

a) a choice of principles and best practices advocated internationally discussed in section 2 (i.e. Cadbury Report Code of Best Practices, OECD Principles, and World Bank concerns);

b) selected recommendations addressed by the Basel Committee on Banking Supervision highlighted in section 3;

c) the template11 jointly devised by the World Bank and IMF for country assessment of corporate governance; and

d) other recommendations proposed by either academics or practitioners dedicated to the corporate governance progress (e.g. Salmon, W. J, 1993; Lorsch, J. W., 1995; Donaldson, G., 1995; Pound, J., 1995). In order to design the template, those principles, practices and recommendations were traduced into a set of ‘yes no questions’ arranged into six categories with the main purpose to identify:

a) the functions and responsibilities of the board of directors;

b) the functions and responsibilities of the bank management;

c) the role of the audit function and internal controls;

d) the rights and responsibilities of shareholders;

e) the role of stakeholders in relation to corporate governance; and

f) material financial and non-financial disclosures.

11 The Template for Country Assessment of Corporate Governance resulted from the programme of Reports on the Observance of Standards and Codes (ROSC), which have been jointly designed by the International Monetary Fund (IMF) and the World Bank to strength the international financial architecture.

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Those questions are expected to be responded by supervisors on the course of on-site supervisions. Every answer is scored either ‘1’ or ‘0’ according to the answer: (i) ‘Yes’ gets ‘1’, and (ii) ‘No’ gets ‘0’. The final score, Management and Governance Index (MGI) is obtained by the proportion of the sum of all individual scores and the total number of questions responded:

100×= ∑NQ

ISMGI ,

where IS represents the individual scores and NQ the number of questions answered. By using the Management and Governance Index (MGI) supervisors can classify the quality of management and corporate governance of every bank into one of the following ascendant categories: Table 4.1 Levels of management and governance quality Category MGI

1 Poor quality 0% to 24%

2 Modest quality 25% to 49%

3 Good quality 50% to 74%

4 Superior quality 75% to 100%

As stated before, the suggested questions and methodology intend to provide some guidance to supervisors on setting out their own assessment procedures for evaluating the quality of bank management and governance. Supervisors, for instance, can add, amend or even subtract some of the questions to better fit the financial environment. They can also attribute different weights12 in order to confer a high score to certain points they understand should be emphasized. Additionally, they can adopt a blended approach combining some questions to individual direct and indirect evaluation instruments. But, despite all limitations for setting a single model able to fit all financial systems globally, the foremost purpose of assessing the management and governance of every bank should continually be pursued.

12 Attributing weights will demand some adjustments on the CGI formula.

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4.2 A template for quality assessment of management and governance in banks This template intends to contribute for the development of instruments for assessing the quality of management and governance in banking organisations. The questions are arranged into six categories or spheres, vis-à-vis the corporate governance aspect under evaluation, as following:

Sphere 1 - Board of Directors

Sphere 2 - Management

Sphere 3 - Auditing and Internal Controls

Sphere 4 - Shareholders

Sphere 5 - Stakeholders

Sphere 6 - Disclosure and Transparency

Assessing the functions and responsibilities of the board of directors The next table presents valuable questions for assessing the functions and responsibilities of the board in banking organisation. Table 4.2 Template for assessing the board of directors of banking organisations

Board of Directors Questions Yes

(1) No (0)

1 Does the bank follow a corporate governance code of best practice?

2 Does the bank have a code of ethics published internally and externally?

3 Does the corporate governance code define the duties of care and loyalty for board members?

4 Are the bank mission, vision and values communicated throughout the institution?

5 Is there a clear separation of the position of the board chairman from that of the chief executive?

6 Are there any rules or recommendations specifying the role of the board chairman?

7 Do board members represent a range of business and leadership experiences covering the major issues of the banking operations?

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(1) No (0)

8 Do board members devote substantial time to the corporation?

9 Are board members free to request information from any employee?

10 Are the directors' compensations linked to the performance of the bank shares?

11 Are there any minimum qualification requirements for appointing of board members?

12 Is the remuneration of directors fair and competitive comparable to that of similar institutions?

13 Are there any rules or recommendations regarding the balance between executive and non-executive directors?

14 Do non-executive and independent board members have the right and ability to obtain relevant information regard the business on a timely and regular basis?

15 May non-residents and foreigns be appointed as board members?

16 Do non-executive directors formally evaluate the CEO's strengths, weakness, objectives, personal plans, and performance?

17 Are there specific rules governing the conduct of directors who are connected to major shareholders?

18 Does the board evaluate its performance on a regular basis and make changes as needed?

19 Do the directors systematically undertake some form of internal or external training in order to prepare themselves for their position?

20 Do board members disclose their attendance at board meetings?

21 Do board members have insurance policies to protect themselves on the course of their duties?

22 Do board members understand the major risks run by the bank?

23 Do the board responsibilities include approving annual budgets?

24 Do the board responsibilities include ensuring that senior management establishes and maintain an adequate and effective system of internal control?

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(1) No (0)

25 Do the board responsibilities include ensuring adequate controls over operational risk?

26 Do the board responsibilities include ensuring adequate controls over credit risk?

27 Do the board responsibilities include ensuring adequate controls over market risk?

28 Do the board responsibilities include ensuring adequate controls over legal risk?

29 Do the board responsibilities include ensuring adequate controls over liquidity risk?

30 Do the board responsibilities include ensuring adequate foreign currency liquidity management?

31 Do the board responsibilities include ensuring that senior management establishes and maintains adequate and effective systems of compliance?

32 Do the board responsibilities include ensuring that senior management establishes and maintains adequate and effective systems of internal controls?

33 Do the board responsibilities include monitoring corporate performance?

34 Do the board responsibilities include overseeing contingency planning?

35 Do the board responsibilities include overseeing major capital expenditures, acquisitions and divestitures?

36 Do the board responsibilities include overseeing risk policies?

37 Do the board responsibilities include overseeing the management of compliance risk?

38 Do the board responsibilities include preparing and reviewing codes of ethics or statements of business practice?

39 Do the board responsibilities include replacing key executives?

40 Do the board responsibilities include reviewing and guiding corporate strategy and major plans of actions?

41 Do the board responsibilities include selection of key executives?

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(1) No (0)

42 Do the board responsibilities include setting acceptable levels for the major risks run by the bank?

43 Do the board responsibilities include setting performance objectives?

44 Do the board responsibilities include monitoring and managing potential conflicts of interest of management?

45 Do the board and individual members have access to professional advice at the expense of the company?

46 Does the board include in its report to shareholders that adequate accounting records have been maintained?

47 Does the board include in its report to shareholders that an effective system of internal controls is being maintained?

48 Does the board include in its report to shareholders that suitable accounting policies have been consistently applied?

49 Does the board include in its report to shareholders that the auditor is responsible for reporting on the financial statements?

50 Does the board include in its report to shareholders that the financial statements are their responsibilities?

51 Does the board include in its report to shareholders that the financial statements fairly present the state of affairs of the company?

52 Does the board include in its report to shareholders that there is no reason to believe that the business will not be a going concern?

53 Does the function of audit committee exist?

54 Does the function of corporate governance committee exist?

55 Does the function of nomination committee exist?

56 Does the function of remuneration committee exist?

57 Does the function of risk management committee exist?

58 Is the bank prohibited to provide loans to the board of directors?

59 Is there a body responsible to oversee compliance of governance practices?

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Assessing the functions and responsibilities of the bank management Table 4.3 gathers helpful questions for the assessment of functions and responsibilities of bank management. Table 4.3 Template for assessing the management of banking organisations

Management Questions Yes

(1) No (0)

1 Do the senior management responsibilities include keeping the board members informed about the business (e.g. operations, courses of action, market shares figures)?

2 Do the senior management responsibilities include developing processes to identify, measure, monitor, control and mitigate risks incurred by the bank?

3 Do the senior management responsibilities include establishing a permanent and effective compliance?

4 Do the senior management responsibilities include establishing permanent and effective internal controls?

5 Is the senior management performance evaluated at least annually?

6 Does the CEO provide an assessment of his or her own performance?

7 Is the bank prohibited to provide loans the senior management?

8 Is the Chief Executive Officer (CEO) required to certify the company's financial statements?

9 Is the Chief Financial Officer (CFO) required to certify the company's financial statements?

Assessing the role of the audit function and internal controls for the effectiveness of corporate governance The following table highlights worthy questions for evaluation the audit function and internal controls in banks.

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Table 4.4 Template for assessing the auditing and internal controls of banking organisations

Auditing and Internal Controls Questions Yes

(1) No (0)

1 Are the annual financial statements audited by an external auditor?

2 Are auditing standards materially in conformity with International Standards on Auditing (ISA)?

3 Is the independence of the auditor defined?

4 Does the bank promote external auditor rotation every certain number of years?

5 Are auditors prohibited from performing non-audit services (e.g. book keeping, financial information system. actuarial services, consulting services, legal services)?

6 Does the bank disclose the characteristics of audit services in the annual report?

7 Does the bank disclose the characteristics of tax services in the annual report?

8 Does the bank disclose the characteristics of consulting services in the annual report?

9 Do external auditors have the responsibility to inform supervisory authorities and/or shareholders about any illegal activity, fraud or insider abuse of board members or senior management?

10 Are auditors required to purchase an insurance policy against lawsuits?

11 Do external auditors meet regulatory requirements?

12 Do external auditors follow professional codes of conduct and ethics?

13 Does a professional body oversee external auditors?

14 Is there an audit committee?

15 Is the audit committee required to be fully independent?

16 Is there annual performance evaluation of the audit committee?

17 Does the audit committee regularly report to the board of directors?

18 Does the audit committee discuss policies of risk assessment and risk management?

19 Does the audit committee oversee the internal audit function?

20 Does the bank have a permanent internal audit function?

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(1) No (0)

21 Can the head of internal audit attend audit committee meetings?

22 Are internal audit reports reviewed by external auditors?

23 Is the internal audit function independent from the business activities of the bank?

24 Are there any minimum qualification requirements for appointment of internal audit staff?

25 Does internal audit staff undertake internal and external training to enable them to carry out their duties effectively?

26 Does the internal audit function receive the appropriate resources and staffing to carry out their duties effectively?

27 Is there a staff rotation practice within the internal audit department?

28 Does the internal audit function include drawing up an audit plan for a certain period of time?

29 Does the internal audit function include examining and assessing the available information?

30 Does the internal audit function include communicating the results of the auditing?

31 Does the internal audit function include following up its recommendations?

32 Does the internal audit function include reviewing the capital assessment procedure?

33 Is the audit plan based on a methodological control risk assessment?

34 Are audit procedures documented in working papers?

35 Do bank supervisors evaluate the work of the internal audit department?

36 Is there any means of cooperation among internal auditors, external auditors and supervisors?

37 Does every activity of the bank fall into the scope of the internal auditing?

38 Does the internal audit function carry out regularly an independent review of the risk management system of the bank?

39 Does the bank have a compliance function?

40 Is the compliance function independent from the business activities of the bank?

41 Are there any minimum qualification requirements for appointment of compliance staff?

27



(1) No (0)

42 Does the compliance officer report to senior management and board of directors on a regular basis?

43 Does compliance staff undertake internal and external training to enable them to carry out their duties effectively?

44 Is the scope and extent of the activities of the compliance function subject to periodic review by internal auditors?

Assessing the rights and responsibilities of shareholders The next table presents valuable questions for evaluating the rights and responsibilities of shareholders. Table 4.5 Template for assessing the shareholders of banking organisations

Shareholders Questions Yes

(1) No (0)

1 Is the ownership diluted in the hands of several investors/groups?

2 Can shareholders obtain relevant and timely information about the business without cost?

3 Are minority shareholders able to elect board members through vote pooling?

4 Does the bank have a clear dividend policy?

5 Is the dividend policy disclosed to all shareholders?

6 Do shareholders have the right to vote on distribution of profits?

7 Do shareholders have the right to vote on appointment and removal of directors?

8 Do shareholders have the right to vote on appointment and removal of auditors?

9 Do shareholders have the right to vote on issuing share capital?

10 Do shareholders have the right to vote on amendments to company statute and articles?

11 Do shareholders have the right to vote on major corporate transactions such as acquisitions, disposal, mergers and takeovers?

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Shareholders Questions Yes

(1) No (0)

12 Do shareholders have the right to vote on changes to company business or objectives?

13 Do shareholders have the right to vote on transactions with related parties?

14 Do shareholders have the right to invalidate a decision of the board?

15 Do shareholders have the right to place items in the general meeting agenda?

16 Do all shareholders have the right to attend shareholders' meetings?

17 Can shareholders vote in abstaining?

18 Are general meetings well attended?

19 Do retail investors typically attend general meetings?

20 Do institutional investors typically attend general meetings?

21 Do retail investors use their share voting rights actively?

22 Do institutional investors use their share voting rights actively?

23 Are shareholders required to disclose shareholder agreements to the company and other shareholders?

24 Are shareholders of the same class treated equally during general meetings?

25 Are shareholders of the same class treated equally during changes of control?

26 Do senior management and board members disclose their trading in shares to shareholders?

Assessing the role of stakeholders in relation to corporate governance The following table suggests questions for assessment of the role of stakeholders in relation to corporate governance issues.

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Table 4.6 Template for assessing the stakeholders of banking organisations

Stakeholders Questions Yes

(1) No (0)

1 Does the corporate governance framework provide rights to stakeholders to participate on the decisions of the bank?

2 In practice, do stakeholders participate on the decisions of the bank?

3 Do employees participate in the bank profits?

4 Are there any rules or recommendations regarding the relationship with depositors?

5 Are branch managers properly trained to deal with depositors?

6 Are there mechanisms in place to guarantee withdraw as demanded?

7 Are depositors well informed about their rights and obligations when opening a bank account?

8 Are depositors well informed about the bank products, including terms, remuneration, fees, taxes, and other essential conditions?

9 Do stakeholders have access to corporate information?

10 Do senior management and board members disclose their trading in shares to stakeholders?

Assessing material financial and non-financial disclosures Table 4.7 disposes assorted questions for assessing of the level of disclosure and transparency of banks. Table 4.7 Template for assessing the disclosure and transparency of banking organisations

Disclosure and Transparency Questions Yes

(1) No (0)

1 Does the bank publish annual reports?

2 Does the bank publish interim reports?

3 Are financial and non-financial statutory reports free of charge to investors?

4 Can shareholders request additional information from the bank beyond what is publicly available?

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Disclosure and Transparency Questions Yes

(1) No (0)

5 Does the bank disclose its governance structure and policies?

6 Does the bank disclose the identity and qualifications of board members and key executives in the annual report?

7 Does the bank disclose the remuneration of board members and key executives?

8 Are there requirements for insiders to disclose purchases or sales of goods or services?

9 Are there requirements for insiders to disclose purchases or sales of property or other assets?

10 Are there requirements for insiders to disclose leasing arrangements?

11 Are there requirements for insiders to disclose guarantees and collaterals?

12 Are there reporting practices, either voluntary or required, on matters relating to the bank's relations with stakeholders?

13 Does the information disclosed by the bank include a discussion on company objectives?

14 Does the information disclosed by the bank include a discussion on internal controls?

15 Does the information disclosed by the bank include a discussion on financial performance?

16 Does the information disclosed by the bank include the financial position (including capital, solvency and liquidity)?

17 Does the information disclosed by the bank include the accounting policies?

18 Does the bank provide in the annual report a discussion on company objectives?

19 Is there a mechanism whereby major share ownership and voting rights are disclosed?

20 Do shareholders have access to information on major share ownership and voting rights?

21 Does the bank disclose its policies on risk management in the annual report?

22 Does the bank disclose material risk factors in the annual report?

23 Does the bank disclose material issues regarding employees (e.g. human resources policies) in the annual report?

24 Does the bank disclose material issues regarding other stakeholders (e.g. depositors, creditors, local community) in the annual report?

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In conclusion, the framework devised in this essay attempts to help supervisors in the evaluation of management and governance of banks. It is mainly based on the principles of good corporate governance recommended internationally and the best practices issued by the Basel Committee on Banking Supervision. It specifies a set of ‘yes no questions’ to be answered by supervisors on the course of their actions in order to evaluate management and governance of banks. Nevertheless, those suggestions represents only a starting point for supervisory guidance and do not intend to exhaust all possibilities on assessing the management and governance quality. Depending on the characteristics of the financial system and the corporate governance regulation and practices, the framework may be implemented to a greater or lesser extent or even modified in order to be adjusted to individual banking systems.

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