The confidence of the public (in a bank and the entire banking system) is necessary for a proper functioning of the financial system and economy. Effective corporate governance practices are fundamental to gain and maintain this confidence (BCBS 2006, February).
In this article my recommendation is as follows:
- Bank of Ghana should require Banks to engage the services of a consultant other than the statutory auditor to evaluate each bank’s governance practices and issue a report on it, which is also included in the financial statements for circulation.
- Bank of Ghana should require this report for risky banks every year and every 3 years for less risky banks. In addition, for all banks as part of its annual examination Bank of Ghana should issue its own report on corporate.
Corporate governance practices among banks in Ghana has become a topical issue which has attracted the attention of regulators, the public, the IMF, the World Bank, Basel Committee, academic scholars and practitioners in Ghana. A bank’s failure to follow good practices in corporate governance and the lack of effective governance are among the most important internal factors which may endanger the solvency of a bank. Weak and ineffective corporate governance mechanisms in banks are pointed out as the main factors contributing to the recent collapse of UT and Capital bank. Deep changes in the area of corporate governance guidance are necessary to reinforce the financial sector stability.
It is without doubt that effective management of organizational resources requires good corporate governance practice particularly in banking industry where there is management/shareholders.
Corporate governance practices among banks was mentioned as one of the topics that I promised my readers that I will be writing about in 2018. This is the first of the article that will deal with the corporate governance practices among banks. In this article I will not write much about corporate governance and go straight on address the elephant in the room, which is the importance of having an independent review of banks corporate governance and reporting of the findings to the general public at least every year. In my subsequent article I will touch on the following
- Gaps that exist in current corporate governance guidance for companies in Ghana
- Recommended best practices that Bank of Ghana should consider as it draft its guidance on corporate governance for banks. My recommendations will be guided by Basel Committee on Banking Supervision (BCBS) publication 328 called “Guidelines on Corporate governance principles for banks , the Canadian banking regulator (OSFI) guidance on corporate governance for banks , Financial Stability Board (FSB), Thematic review on risk governance , Organisation for Economic Co-operation and Development (OECD) principles of Corporate Governance and Nigeria code of corporate governance for public companies.
- Recommended Bank of Ghana expectations for what a “good” risk appetite framework (RAF) entails and how to supervise against theose expectations. Risk appetite framework is considered as a components of corporate governance.
- Consideration for enterprise risk management framework and risk appetite framework (components of corporate governance). This will be guided by FSB, Principles for an effective risk appetite framework
- Bank of Ghana should require an independent assessment of the financial institution’s RAF (i.e. by internal audit and independent third party other than statutory auditors) and the ongoing monitoring and evaluation of the design and overall effectiveness of a financial institution’s internal controls, risk management and risk governance.
- Other corporate governance matters relating to Banks.
The analysis of main failures of corporate governance in banks suggests that in order to repair and strengthen the system:
− Banks ought to reduce their risk exposure significantly, build a stronger capital base; banks should concentrate on typical banking activities and reduce the scale of other operations (especially investment activities); the good standards of balance-sheet adequacy (ALM) should be restored (e.g. loans-deposits relationship, assets and liabilities maturity match, leverage scale, etc.);
− the scale and scope of banking activities should be diminished, as the current level of financialization is excessive and potentially dangerous for the whole economy; special attention should be paid to systemic risk: systemically important banks ought to have more strict capital requirements (additional capital buffer); the capital and contractual relationships between financial institutions should be monitored and if the linkages would become too strong and/or concentrated, supervisors should be allowed to interfere in these relationships; − bank directors (both: executive and non-executive) should bear personal responsibility for banks’ activities and risk;
− banks’ executives remuneration should be linked to performance and risk exposure; there should be an obligation to defer part of their salary: a) not to motivate them to generate short-term profits and increase the risk and b) make the bonuses contingent on long-term sustainable outcomes; − non-executive directors engagement should be stricter
– they should devote more time and commitment to perform their oversight function; nomination of supervisory board members should be approved by the supervisors (as it is in case of management board members); the role of independent board members should be strengthened, board members should be required to have proper knowledge and experience (including the financial expertise);
− regulators and market supervisors should strengthen banks’ transparency allowing for the effective market discipline; professional bodies should promote best practice in disclosure and motivate banks to publish more informative reports;
− the accountability of external and internal auditors should be stronger and they should be obliged to report any observed non-compliance to supervisors
− “comply or explain” rule used in corporate governance area, being a sort of a “soft law” should be strengthened by the monitoring function performed by financial market and the supervisor should verify whether the disclosed information is reliable and sufficient
− In particular, important areas in which banks persistently do not comply with corporate governance best practices, supervision should make formally binding rules; one should keep in mind, however, that this should not lead to excessive growth of regulation because it would harm the competition (overly restrictive regulation can lead to inefficient provision or supply of financial services).
Without doubt, the greatest responsibility for the excessive risks is borne by the banks themselves – their management and supervisory directors. However, it is worth noting that other stakeholders also contributed to the crisis: supervisors and regulators, participants in financial markets (including investors), auditors and rating agencies, and clients. Obviously, legal, economic and ethical issues differentiate the degree of responsibility and the magnitude (severity) of the effects of the acts or omissions of several operators. Regardless of the regulatory changes, it is necessary to emphasize the importance of accountability of all banks’ stakeholders. One must realize that there are no perfect regulations, and even the best legal standards do not ensure success. This is because it is the attitude and actions of human beings; honesty and sense of responsibility of all stakeholders of the bank are necessary
It is mainly the deficiencies in corporate governance, which are to blame for the recent financial crisis. This raises the question: Were the rules inadequate or poorly implemented? Analyses of the causes of the crisis lead to indicate several issues requiring a re-structuring and strengthening of standards; these issues concern (Kirkpatrick, 2009, September, A. Turner, 2009, March, D.Walker, 2009, November 26):
• The role, tasks and responsibilities of the board, as well as its size, organization and composition (members) and the functioning of this body and the assessment of its work;
• Control of bank risk exposure;
• Evaluation of executives and its incentive pay;
• Transparency of the bank supervisory board that allows for the assessment of its activities (both by institutional and private monitoring);
• Ownership structure of banks and the role of institutional investors.
In order to avoid a similar financial crisis in the future, regulators of financial markets are planning to establish standards for sealing the system in these areas
Dr. Ernest Addison, Governor, Bank of Ghana (BoG) at the Annual Dinner of the Chartered Institute of Bankers Ghana on Dec. 2, 2017 (https://www.bog.gov.gh/privatecontent/Speeches/Speech_Annual%20Bankers%20Dinner_Final%20Dec%202017.pdf) cited the following reasons for the collapse of UT and Capital Bank:
- Co-mingling of the banks’ activities with their related holding companies. For instance, one bank was paying royalties for the brand name, even when the bank’s financial performance was abysmal and could not pay dividends. Interestingly, the royalties were approved by four (4) out of seven (7) members of the Board without the consent of the other significant minority shareholders including an International Financial Institution. As a result, the international institution placed a notice on its website abrogating all relationships with the Bank and this led to most of the foreign lenders cutting off their credit lines to the Bank and recalling their credits thereby creating serious liquidity squeeze to the bank.
- Also, very high executive compensation schemes were being operated by the affected banks, which were not commensurate with their operations. The risk and earnings profile of the banks could not support the compensation schemes.
- Non-Executive Directors of the banks compromised their independence and fiduciary duties to serve as checks on Executive Directors. This was because rewards such as business class air tickets were being granted to them annually
- Interference by Non-Executive Directors in the day-to-day administration of the banks weakened the management oversight function of executive directors. Some non-Executive Directors were also acting as consultants to the same banks with no clear mandate, which gave rise to conflict of interest situations.
- Non-adherence to credit management principles and procedures as the banks were heavily exposed to insiders and related parties. There was also no evidence of interest payments on these investments. The investments were therefore impaired, but some members of the Board at the time accepted the responsibility to pay off the said amount through a board resolution.
- Diversion of funds to holding companies and their related parties was widespread. In the case of one Bank, placements could not be traced to the bank’s records though some customers showed proof of their investments with the Bank.
- Irregular board meeting also accounted for the weaknesses in the board oversight.
- In all of these cases, one thing was clear, and that is, the banks could not delineate themselves from their past practices as finance houses. They followed the same practice of borrowing from high net worth persons at a very high cost without any plans to bring themselves in line with the industry norm.
In addition, to the above Dr. Ernest Addison, Governor, Bank of Ghana (BoG) at the Annual Dinner of the Chartered Institute of Bankers Ghana on Dec. 2, 2017 (https://www.bog.gov.gh/privatecontent/Speeches/Speech_Annual%20Bankers%20Dinner_Final%20Dec%202017.pdf) stated that Bank of Ghana soon will release directives on corporate governance for the banking sector. Among others, these directives will focus on oversight responsibilities of the Board of Directors and bank management, prioritize risk management systems, and ensure independent audit roles, among others. In particular, the guidelines will impose the tenure of Chief Executive Officers and Non-Executive Directors of banks, the size of bank Boards, the retiring age for Directors and disclosure of attendance at Board meetings by Directors in annual reports.
Primary source of corporate governance regulation for banks in Ghana
Section 56 of Banks and Specialized Deposit-taking Institutions Act 2016 (Act 930) requires that the Bank of Ghana may prescribe rules regarding any matter of corporate governance of a bank, including matters relating to
(a) the scope and nature of the duties of directors of a bank,
(b) the requirements for audit and other specific committees of the Board;
(c) the responsibilities of key management personnel;
(d) risk management;
(e) internal audit; and
(f) internal controls and compliance
Specific corporate governance regulations in Act 930 include:
i. Section 57 of Act 930 : Duty of directors to report- The board of directors or any director shall report, in writing, to the Bank of Ghana if there is sufficient reason to believe that a bank, specialised deposit taking institution or financial holding company (a) may not have the capacity to properly conduct the business of that bank, specialised deposit taking institution or financial holding company as a going concern; (b) is not likely to meet the obligations of that bank, specialised deposit taking institution or financial holding company in the near future; has suspended or is about to suspend a payment of any kind; does not or may not meet the capital requirements of that bank, specialised deposit-taking institution or financial holding company as prescribed in this Act; is engaged in, exposed to or involved in an event which is likely to have a material adverse impact on that bank, specialised deposit-taking institution or financial holding company; or (/) has contravened or is likely to contravene an enactment.
ii. Section 58 of Act 930- Disqualification of a director and key management personnel
iii. Section 59 of Act 930- Disclosure of interest- (1) A person shall, before assuming office as a director or key management personnel of a bank, specialised deposit-taking institution or financial holding company, declare to the board of directors of that bank, specialised deposit-taking institution or financial holding company and the Bank of Ghana (a) the professional interest of that person or office that person holds as manager, director, trustee or by any other designation; and (b) the investment or business interest of that person in a firm, company or institution as a significant shareholder, director, partner, proprietor or guarantor with a view to prevent a conflict of interest with the duties or interests of that person as a director or key management personnel of the bank, specialised deposit-taking institution or financial holding company. (2)A director or key management personnel of a bank, specialised deposit-taking institution or financial holding company shall (a) provide an annual declaration of the interests and offices held under subsection (l); (b) declare to the board of directors of that bank, specialised deposit-taking institution or financial holding company, any material change in business interest or holding of an office when that change occurs. (3) A director of a bank, specialised deposit-taking institution or financial holding company who has an interest in (a) a proposed credit facility to be given to a person by that bank or specialised deposit-taking institution, or (b) a transaction that is proposed to be entered into with any other person shall declare the nature and the extent of that interest to the board of directors and shall not take part in the deliberations and the decision of the board of directors with respect to that request. (4) A declaration under subsection (3) shall form part of the proceedings of the meeting of the board of directors. (5) A proposal in which a director has an interest shallbe considered and determined by the board of directors. (6) A person whow contravenes a provision of this section ceases to be a director of the bank, specialised deposit-taking institution or financial holding company and an approval granted to that person by the board of directors in respect of a matter in which that person is interested renders the approval unenforceable.
iv. Section 81 of Act 930- An auditor of a bank or specialised deposit-taking institution shall hold office for a term of not more than six years and is eligible for re-appointment after a cooling off period of not less than five years
v. Section 85 of Act 930- Report of auditor
vi. Section 87 of Act 930- Duties of auditor to the Bank of Ghana
vii. Section 90 of Act 930- Display of financial statements
viii. Section 93 of Act 930- Information and periodic returns
ix. Section 78 of Act 930-bank, specialised deposit-taking institution or financial holding company shall prepare accounts and financial statements in the form and provide details in accordance with internationally-accepted accounting standards; and rules or standards based on the Basel Core Principles as prescribed by the Bank of Ghana
x. Section 75 of Act 930- Asset classification , provisioning and write off
xi. Section 67 of Act 930- Restrictions on financial exposures to an insider
xii. Section 69 of act 930- Restrictions on lending to staff
xiii. Section 66 of Act 930- Restrictions on inter-institutional placements and loans
xiv. Section 62 of act 930- Limits on financial exposure
The specificity of the corporate governance of banks
Corporate governance in banks differs from the standard (typical for other companies), which is due to several issues :
• banks are subject to special regulations and supervision by state agencies (monitoring activities of the bank are therefore mirrored); supervision of banks is also exercised by the purchasers of securities issued by banks and depositors ("market discipline", "private monitoring");
• the bankruptcy of a bank raises social costs, which does not happen in the case of the collapse of other kinds of entities; this affects the behavior of other banks and regulators;
• regulations and measures of safety net substantially change the behavior of owners, managers and customers of the banks; rules can be counterproductive, leading to undesirable behaviour management (take increased risk) which expose well-being of stakeholders of the bank (in particular the depositors and owners);
• between the bank and its clients there are fiduciary relationships raising additional relationships and agency costs;
• problem principal-agent is more complex in banks, among others due to the asymmetry of information not only between owners and managers, but also between owners, borrowers, depositors, managers and supervisors;
• the number of parties with a stake in an institution’s activity complicates the governance of financial institutions.
To sum up, depositors, shareholders and regulators are concerned with the robustness of corporate governance mechanisms. The added regulatory dimension makes the analysis of corporate governance of opaque banking firms more complex than in non-financial firms (Wilson, Casu, Girardone, Molyneux, 2010).
In the case of banks therefore, corporate governance needs to be perceived as a need of such conduct of an institution, which would force the management to protect the best interests of all stakeholders and ensure responsible behaviour and attitudes (Tirole, 2001). Corporate fairness, transparency and accountability are thus the main objectives of corporate governance, taking into account the corporate "democracy", which is the broad participation of stakeholders (R.E. Basinger et al., 2005)
The need for independent evaluation of corporate governance practices of Banks
Effective corporate governance is critical to the proper functioning of the banking sector and the economy as a whole. While there is no single approach to good corporate governance, the Basel Committee's revised principles provide a framework within which banks and supervisors should operate to achieve robust and transparent risk management and decision-making and, in doing so, promote public confidence and uphold the safety and soundness of the banking system.
The Committee's revised set of principles supersedes guidance published by the Committee in 2010. The revised guidance emphasizes the critical importance of effective corporate governance for the safe and sound functioning of banks. It stresses the importance of risk governance as part of a bank's overall corporate governance framework and promotes the value of strong boards and board committees together with effective control functions. Under the caption of Comprehensive evaluations of a bank’s corporate governance and in paragraph 159 to 160 of the Basel Committee on Banking Supervision (BCBS) publication 328 called “Guidelines on Corporate governance principles for banks ” included this
- 159. Supervisors should have processes in place to fully evaluate a bank’s corporate governance. Such evaluations may be conducted through regular reviews of written materials and reports, interviews with board members and bank personnel, examinations, self-assessments by the bank, and other types of on- and off-site monitoring. The evaluations should also include regular communication with a bank’s board of directors, senior management, those responsible for the risk, compliance and internal audit functions, and external auditors.39
- 160. Supervisors should evaluate whether the bank has in place effective mechanisms through which the board and senior management execute their respective oversight responsibilities. Supervisors should evaluate whether the board and senior management have processes in place for the oversight of the bank’s strategic objectives, including risk appetite, financial performance, capital adequacy, capital planning, liquidity, risk profile and risk culture, controls, compensation practices, and the selection and evaluation of management. Supervisors should focus particular attention on the oversight of the risk management, compliance and internal audit functions. This should include assessing the extent to which the board interacts with and meets with representatives of these functions. Supervisors should determine whether internal controls are being adequately assessed and contribute to sound governance throughout the bank.
In the Nigeria code of corporate governance for public companies, this is stated
All public companies should state in their annual reports how they have applied this Code and the extent of their compliance
In evaluating and reporting on the extent of compliance with this Code, the board may engage independent experts. Where such is done, the name of the consultant should be disclosed. A summary of the report and conclusions of the consultant shall be included in the company’s annual report