Due to the banking crisis of 2008, the question of how banks can protect themselves against future failures has attracted the attention of regulators, banking experts and business media. An important area is the need for better transparency, mainly regarding remuneration in the banking sector, and how boards of banks should improve their corporate governance practices to reduce the chances of a repeat of the credit crunch.
The recent publication of Central Bank of Egypt draft Code of Corporate Governance for banks marks a significant step in this process. Banks together with their respective boards should pay close attention to the corporate governance guidelines.
There are several tips and recommendations for good governance available for the board of banks. Yet, I consider the following `10 commandments` are central in establishing a sound governance regime:
1-Set the right tone at the top.
The main concerns for the board should include guiding, approving and overseeing the bank’s strategic objectives, corporate values and policies. This could be achieved by developing a code of conduct for the bank employees, management, and board members. Likewise, the board should clearly define areas of responsibility, authority levels and reporting lines within the bank.
2-Adequate qualifications of board members
The board should have adequate knowledge and experience relevant to each of the material financial activities the bank intends to pursue to enable effective governance and oversight of the bank.
To ensure that non-executive directors have the knowledge and understanding of the business, the board should provide thematic business awareness sessions on a regular basis and each director should be provided with a tailored induction, training and development to be reviewed annually with the chairman. Similarly, suitable arrangements should be made for executive board members in business areas other than those for which they have direct responsibility.
Non-executive directors are encouraged to spend more time in the business to ensure that they can participate effectively to strategy and other board decisions.
3-Appoint independent non-executive directors
To foster an independent element within the board, banks must consider that independent directors should constitute a significant membership of the board, and that the board should have at least three independent, non-executives directors. Larger banks may have a higher proportion of non-executive directors.
Non-executives directors should be able to devote sufficient time to the role in order to assess risk and ask tough questions about strategy.
In UK, there are recommendations for banks to appoint a senior independent director (SID) whose role is to provide a sounding board for the chairman and serve as a trusted intermediary for the non-executive directors, when necessary.
4-Establish board-risk governance
Banks should establish a board risk committee to work in tandem with existing audit committee. The risk committee would concentrate on risk strategy and management, free from any conflict with demands placed on audit committees. The risk committee would report regularly (as part of the annual report) on risk strategy and risk management. The risk committee has authority to seek external advice to test its risk management assumptions, particularly in the context of risk related to significant banking transactions.
Given the importance of an independent risk management function, banks should appoint a chief risk officer (CRO) with sufficient authority, stature, independence, resources and access to the board. This executive should be reporting to both the risk committee and internally to the CEO. Removal of the CRO should be subject to board discussion and public disclosure.
5-Expand scope of the remuneration committee
The scope of the remuneration committee should be expanded to cover all aspects of remuneration policy on a bank-wide basis with particular focus on the risk dimension. The remuneration committee is responsible to review the compensation philosophy and major compensation programs.
In order to reduce the perceived excessive risk-taking within banks, this committee will also be expected to approve the links between performance targets and pay or bonus schemes. At least half of bonuses should be paid in the form of a long-term incentive scheme.
6-Develop Information Technology (IT) governance
IT governance provides the structure that links IT processes, resources and information to the bank’s strategies and objectives, enhances effective board decision-making and creates greater transparency and accountability. IT governance ensures that related risks are properly identified and managed. The board needs to approve IT expenditures and provide adequate oversight over all aspects of IT governance, including procurement, outsourcing, the efficiency of systems and procedures, IT security, customer data protection and adequacy of anti-fraud and anti-money laundering systems.
7-Improve efficiency through board evaluation
The board and board committees should be subject to a formal and rigorous performance evaluation with external facilitation of the process every three years. The evaluation statement should either be included as a dedicated section of the chairman’s statement or as a separate section of the annual report, signed by the chairman. Where an external facilitator is used, this should be indicated in the statement, together with their name and other meaningful details for the shareholders.
8-Manage conflicts of interest effectively
Banks should establish information barriers (“Chinese walls”) between the different departments so that decisions by staff in one department are made in ignorance of confidential information available to staff in other departments which might affect their decision. Conflicts by board members or senior executives should be disclosed to the banks’ compliance officer. A good corporate governance practice is to put in place and disclose a conflicts of interest policy.
9-Monitor the governance of banks’ clients
It is important for banks that their clients apply the principles of good governance. Banks may consider that it is in their own best interest to check the governance framework and practices of their corporate borrowers. Even in circumstances where a bank cannot directly influence the governance practices of their borrowers, it can have an important influence by “leading by example”.
10-Track potential governance failures
Banks should have in place a policy setting out adequate procedures for employees with concerns about the integrity of the bank’s operations or its staff (so called whistle blowing policy). Employees should be able to communicate their concerns with corporate protection from retaliation from the management. The procedure should facilitate the flow of confidential and direct or indirect communication to the board (or Audit Committee) outside the internal “chain of command”. The establishment of proper communication channels would allow bank staff to discuss their concerns in confidence without fear of retaliatory action.
Good corporate governance is crucial for today’s complex and dynamic banking environment to ensure long-term sustainability and trust of stakeholders including regulators, investors, clients and employees. Therefore, it should be cultivated and practiced regularly within banks at board and executive management levels. Remember; Corporate governance is like a muscle, should be exercised or it will atrophy!