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Basel Committee on Banking Supervision Summary

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SUMMARY OF NEW CORPORATE GOVERNANCE PRINCIPLES AS OUTLINED BY BASEL COMMITTEE ON BANKING SUPERVISION (BCPS)

Overview

In October 2010 the Basel Committee on Banking Supervision (BCPS) produced new Principles on corporate governance standards for banks. The Principles do not have the force of law but provide an international benchmark for minimum corporate governance standards.

The UAE Central Bank strongly endorsed the original corporate governance principles issued in 2006 and it is inconceivable that it will adopt a different approach for this update. BCPS is directed at both bank regulators and banks. Regulatory supervisors are urged to “ensure banks practise good corporate governance”. Banks are urged to measure current corporate governance efforts against the Principles and where necessary to adopt them with any necessary modification.

We have prepared a short note highlighting the key points in this important document. Your bank may need to change aspects of its corporate governance if it is to meet the Basel Principles.

At Majlis Partners we have the expertise to guide your bank through the application of the Basel Principles and to advise you on the steps necessary to become compliant with the Principles.

Our approach is to partner with our clients using internal client resource where it is sensible to do so, ensuring that the knowledge and know-how are transferred to and remain within the client.

We would be delighted to meet with you to discuss your corporate governance needs.

David Brimacombe
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Tel.: +971 50 456 1644

Summary

In response to the accepted wisdom that sound corporate governance is of critical importance in avoiding bank failures, the Basel Committee on Banking Supervision, working on the basis of the OECD Corporate Governance Principles, published its Principles for Enhancing Corporate Governance (“BCBSP”) in October 2010.

BCBSP is a global reference point for banking supervisors and sets the international benchmark for corporate governance within banks. All financial institutions, including those in UAE, and regardless of whether publicly owned, state owned, family owned or part of a wider non-financial group, should use BCBSP as the benchmark for their corporate governance.

It is widely expected that the corporate governance code to be issued by the UAE Central Bank will reiterate BCBSP; the current Central Bank draft Guidelines already expressly cover all the principal points raised in BCBSP and, given this strong overlap, it is unthinkable that any element of BCBSP would be rejected by the Central Bank. The original Basel Principles on corporate governance are listed on page 20 of the draft Code and on page 34 the Code states:” your bank should be in compliance with the requirements of the Basel Committee”.

Conformance with BCBSP will bring tangible and intangible benefits which may include higher counter party limits, greater access to capital, enhanced relationships with regulators/ stakeholders and enhanced risk management- all of which will lead to improved profitability and “no surprises”. Ignoring BCBSP will lead to lower counter party limits, gradual exclusion from the international banking community and a tumultuous relationship with regulators and stakeholders. Importantly, BCBSP agitates for more effective, targeted supervisory guidance and involvement on corporate governance. This will herald a new dawn in regulatory supervision which is likely to be intrusive, interconnected and continuing.

The rules of the game have changed and banks have to change with it.

Highlights

The global financial crisis highlighted recurring corporate governance failures within banks, including:

  • insufficient Board oversight of senior management;
  • inadequate risk management;
  • unduly complex or opaque organizational structures.

This led BCBS to identify 6 areas of corporate governance within banks that frequently require attention.

1. The Board

1.0 Board practices. The Board must assume ultimate responsibility for and actively oversee:

  • business strategy and financial soundness: what are the long term financial interests of the bank?
  • risk strategy: what is the risk appetite and risk tolerance? How competent, independent, embedded are the risk and control functions?
  • organization: is the Board structured to facilitate effective decision-making including clear lines of responsibility and accountability?
  • effective oversight of senior management: does the Board provide critical and challenging oversight and monitoring of senior management, with a firm grasp on compensation culture, formal performance standards consistent with long term objectives, meaningful succession planning and regular refreshing of the senior management talent pool?
  • corporate values: how is the Board setting the tone from the top? Does the Code of Conduct articulate acceptable behaviours; is it actively supervising the speaking-up/whistle blowing culture which detects fraud and wrong-doing?

1.1 Board composition and support. To deliver its responsibilities of exercising sound and objective judgment, the Board should:

  • have and maintain a membership which is appropriate for the needs of the institution including relevant skills, competence and personal characteristics;
  • adopt and exemplify good corporate governance practices for itself, i.e. appropriate rules and practices, appropriate Board committees (particularly audit), effective Board evaluations, transparent management of conflicts of interests and related party transactions, transparent management of controlling shareholder influence and overt application of fiduciary duties.;
  • be supported by competent, robust and independent risk and control functions which receive effective Board oversight.
2. Senior management

Senior management must ensure that the bank’s activities are consistent with its business strategy, risk tolerance/risk appetite and conform to the policies approved by the Board. There must be transparent responsibility, accountability and delegation.

3. Risk management and internal controls

Compliance, internal audit, risk management (and possibly a Chief Risk Officer) must have authority, stature, independence from operational and revenue generating functions, with sufficient resources and uninterrupted access to the Board. The goal is firm-wide management of all risks-on and off balance sheet at portfolio and business line level. The sophistication of the bank’s risk management and internal controls should match changes in the bank’s risk profile.

Subsidiaries must have adequate tools and authorities. Robust internal communications should ensure the Board receives a timely, complete and understandable report on risk and control.

4. Compensation

Compensation must be recognised as a major driver of performance and risk taking. It cannot be segregated from governance and risk management. History records that long-term risks were exacerbated by compensation incentives to boost short-term profits. Compensation should be aligned with prudent risk taking and the Board is responsible for design and monitoring of the bank’s entire compensation system. Financial Stability Board’s Principles and Standards should be followed.

5. Complex or opaque orporate structures

Know your structure. The Board should know the bank’s overall corporate structure, legal and operational, ensuring that it is justified and does not involve inappropriate complexity. It must understand the purpose of structures that impede transparency and any risks associated with it.

6. Disclosure and transparency

Transparency is essential for sound and effective corporate governance as it provides stakeholders with key information to enable them to assess the effectiveness of the Board and senior management. Banks should disclose relevant and useful information in support of its corporate governance and the maintenance of trust and confidence in the bank, payment systems etc.

Related articles: We have prepared a summary note of the UAE Central Bank Corporate Guidelines and a summary of the EU draft paper on corporate governance in financial institutions, both of which are available on request.

For more information please contact the Corporate Governance Department of Majlis Partners