Structure of a consultative paper

FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS Some Thoughts on Corporate Governance in Financial Institutions 3rd Annual International Seminar for Central Bank Deputy Governors Washington DC, 4-6 June 2003 Josef Tošovský Chairman Financial Stability Institute ©2000 Bank for International Settlements FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS Contents I. Addressing weaknesses in market foundations 2 ©2001 Bank for International Settlements II. Some issues of corporate governance in financial institutions FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS I. Addressing weaknesses in market foundations 1. Why is corporate governance such a hot topic? • Enron • Allied Irish Bank ©2001 Bank for International Settlements • WorldCom • Ahold 3 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 2. Global concerns • Weaknesses in market foundations are not an isolated US problem • Weaker institutional framework in emerging economies makes it easier to adopt bad practices and more difficult to get rid of them 4 ©2001 Bank for International Settlements FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 3. What has contributed to these problems? • Financial institutions have become larger: Shareholder control has diminished – Ownership more dispersed – Majority of corporate share ownership is for investment not for operating control of a company – Few shareholders have sufficient stakes to influence the choice of board of directors and CEOs ©2001 Bank for International Settlements • Financial institutions have become more complex – More difficult for board members to monitor risk profile of the institution • And more… 5 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 4. Weaknesses in internal safeguards • Board and management oversight • Internal controls ©2001 Bank for International Settlements • Internal audit 6 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 5. Weaknesses in external safeguards • Accountancy • External audit • Regulation and supervision ©2001 Bank for International Settlements • Rating agencies 7 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 6. Why did both internal and external safeguards fail simultaneously? • Liberalisation, deregulation, growth of financial markets and financial institutions was not accompanied by adequate institutional framework strengthening ©2001 Bank for International Settlements • Economic cycle – bad loans are made in good times; similar can be valid for corporate governance – bad decisions are made during good times 8 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 7. Broad register of issues • Corporate governance (including compensation schemes) • Auditors oversight, independence and standards • Accounting standards • Credit rating agencies ©2001 Bank for International Settlements Market based system has worked very well for many years. Balanced approach addressing weaknesses necessary – danger of overreaction. 9 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS II. Some issues of corporate governance in financial institutions 1. Definitions • OECD principles of corporate governance “Corporate governance relates to the internal means by which corporations are operated and controlled” ©2001 Bank for International Settlements • Cadbury Report, 1992 “Corporate governance is the system by which companies are directed and controlled” 10 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 2. Importance of corporate governance in financial institutions • Not only for well-being of an individual company and its stakeholders but because corporate governance: – Promotes effective allocation of the nation’s savings – Essential for financial stability – Important for long-term performance of the economy 11 ©2001 Bank for International Settlements FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 3. Specific reasons for sound corporate governance in financial institutions • Reliance on debt funding and the confidence of creditors • Opaqueness and complexity of the risks of financial institutions ©2001 Bank for International Settlements 12 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 4. Key players • Systemic – Legal and regulatory authorities – Supervisory authorities • Institutional – Shareholders – Board of directors – Executive management – Audit committee/internal audit – External audit 13 ©2001 Bank for International Settlements FINANCIAL STABILITY INSTITUTE 1 4. Key players (continued) BANK FOR INTERNATIONAL SETTLEMENTS 14 ©2001 Bank for International Settlements • Public/consumer – Investors/depositors – Rating agencies – Analysts – Media • International Organisations – OECD – The IMF and World Bank – Basel Committee on Banking Supervision – The Joint Forum FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS 5. What is happening now? • Worldwide discussion on corporate governance • Reduced significance of national/domestic legislation • Tendency towards harmonisation and benchmarking • Creation of international best corporate governance standards ©2001 Bank for International Settlements 15 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS Conclusions • Public concern caused by recent scandals has been a potent driver of improved governance practices • Public scrutiny of company/board practices has risen markedly • Desire to avoid reputation/legal risk should provide an ongoing incentive ©2001 Bank for International Settlements 16 FINANCIAL STABILITY INSTITUTE 1 BANK FOR INTERNATIONAL SETTLEMENTS Character, attitude and integrity of top representative determine good corporate governance. ©2001 Bank for International Settlements 17