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Financial Sector Governance: The Role of the Public and Private Sector


Strengthening Financial Sector Governance in Emerging Markets ... multiple objectives; governance structure is murky, and performance of PPFM is poor ... – PowerPoint PPT presentation

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Title: Financial Sector Governance: The Role of the Public and Private Sector

Financial Sector Governance The Role of the
Public and Private Sector
  • Michael Pomerleano
  • Financial Sector Development Dept.
  • The World Bank

Strengthening Financial Sector Governance in
Emerging Markets Overview by Robert E. Litan,
Michael Pomerleano, and V. Sundararajan
The Public and the Private Roles are Inextricably
  • Why Public Financial Sector Governance? The
    multiple and possibly conflicting roles of the
    State as
  • Regulator of financial institutions
  • Owner of financial institutions
  • Market participant
  • Fiduciary agent
  • Authority directly intervenes in market
  • Why Private Financial Sector Governance?
  • The ability and effectiveness of capital markets
    to improve the governance of corporates through
    private and public legal rules and equally, the
    improvements in corporate governance promote
    development of the capital markets.
  • Good governance of banks is critical for
    fostering effective corporate governance of
  • Public/Private Nexus
  • Weak states captured by powerful elite corporates
  • Public misgovernance, state exerts monopoly powers

The Governance Nexus

What is Governance?
  • Institutions and practices by which authority is
  • Arrangements by which incentives of managers,
    owners, and other stakeholders are aligned
  • Principal - agent
  • Principal - principal
  • Principal - stakeholders

Public sector governance
  • Good regulatory governance is effective and
    sustainable only with good public sector
  • Good public sector governance implies respect of
    the state for the institutions that govern
    economic and social interactions among them
  • Absence of corruption
  • Approach to competition policy
  • Effective legal environment
  • Effective judicial system
  • Government ownership
  • As long as political interference in the
    regulatory process is not costly for the
    politicians, regulatory governance can not be

Why Emphasize Financial Sector Governance? Macro
EvidenceValuing Governance The Corruption
Premium in Global Capital Flows, Shang-Jin Wei
The Cost of Weak Governance The main conclusions
are (i) corruption affects the volume as well as
quality of FDI flows, and (ii) corruption
distorts the overall structure of capital
inflows, e.g., in favor of portfolio flows and
bank lending relative to FDI flows, which makes
the host country more vulnerable to financial
Cost of corruption has been measured by deterred
FDI, which ranges from 37 deterred in China to
74 deterred in Azerbaijan
Regulatory governance
  • Good regulatory governance is important to
  • incentives to the sector in a credible manner
  • Components of good regulatory governance are
  • Agency independence WITH - accountability
  • Transparency in actions and decisions
  • Measures to ensure integrity of agency staff
  • Through FSAPs, and the assessments of compliance
  • financial sector standards and codes, the IMF
    and the World
  • Bank try to improve regulatory governance.

A clinical approach to each specialized industry
in the financial sector
  • Banks and in particular State Banksblurred
    distinction between private and public FS
  • Asset-Management Companies blurred distinction
    between private and public FS
  • Public Pension Fund Management blurred
    distinction between private and public FS
  • Mutual Funds / Collective Investment Vehicles
  • Capital markets Effective measures in capital
    markets to exert governance over corporates

Why does corporate governance in banks warrant
special attention?
  • Banks are funded by depositors their failure
    may have systemic impact
  • Operating in an increasingly competitive,
    volatile global environment
  • Facing major strategic crossroads (e.g., new
    technology, consolidation, globalization,
  • Cases during the Asian financial crisis of boards
    of directors under-performing

Bank Governance The Basle Guidelines Issued in
  • Intended complement The OECDs Corporate
    Governance Principles
  • Focused on the unique issues related to corporate
    governance of banks and set out the key elements
    of corporate governance in banks
  • Objectives
  • To encourage practices which can strengthen
    corporate governance under diverse structures
    -e.g. as regards the relative role of the board
    of directors management. Document does not
    promote a particular governance structure (e.g.,
    Anglo-Saxon vs. German models)
  • To assist supervisors in promoting the adoption
    of sound corporate governance practices by
    banking organizations in their countries

The Basle guidelines
  • 1 Strategic objectives corporate values should
    be established
  • 2 Clear lines of responsibility accountability
    should be set enforced
  • 3 Board members should be qualified, understand
    clearly their role not be subject to undue
    influence from management or outside concerns
  • 4 There should be appropriate oversight by
    senior management
  • 5 Work conducted by internal external auditors
    should be effectively utilized
  • 6 Compensation approaches should be consistent
    with the banks ethical values, objectives,
    strategy control environment
  • 7 Corporate governance should be conducted in a
    transparent manner

Issues in State Banking Corporate Governance of
Banks Concepts and International Observations
(Jerry Caprio and Ross Levine)
  • The situation. More than 40 of the worlds
    population live in countries in which most bank
    assets are held by state-owned banks
  • What are the implications? Government ownership
    thwarts competitive forces, limits effectiveness
    of government supervision banking market suffers
    from opacity, need to improve accounting,
    auditing, credit information
  • Illustrative solutions
  • Contestability of markets lessens reliance on
    family or conglomerate relationships
  • Incentives matter legal and bankruptcy
  • Select countries solutions
  • U.S. has published a book with guidelines for the
    Board of Directors (The OCC guide for bank
    directors). Thailand, Oman, and East Africa
    reported that they have recently released guides.
  • Education/ training for corporate directors re
    their obligations by a local institute of
    corporate directors. Switzerland reported that
    there is a local institute of corporate directors
    that offers training. Thailand, Philippines and
    Fiji advised that they recently established local
    institutes of directors
  • HKMA issued a guideline on corporate governance
    in locally incorporated authorized institutions
    in May 2000. HKMA recommendation 5 The board of
    each bank should establish an audit committee
    with written terms of reference specifying its
    authorities and duties the audit committee
    should be made up of non-executive directors, the
    majority of whom should be independent
  • MAS requires banks to separate financial and
    non-financial businesses to change their audit
    firms every five years

Asset-Management Companies THE GOVERNANCE OF
OBSERVATIONS (David C. Cooke, Managing Director,
Barents Group, KPMG)
  • The situation.
  • Following the East Asia crisis, IBRA in Indonesia
    controlled 70 of financial sector assets in
    Indonesia. Similarly Danaharta in Malaysia, Kamco
    in Korea.
  • Often mission statement has conflicting
    objectives restore financial stability, minimize
    taxpayer losses, etc.
  • Governance of AMCs impacts pace of problem
    resolution responsibilities poorly defined
    oversight committees not sufficiently separated
    from management.
  • Solutions Provide for independent and informed
    oversight committee to articulate policy
    objectives, review performance.
  • Areas of Oversight authority typically include
    approval of Operating policies, Budget and
    funding proposals, Operating board members,
    Outside auditor, May also include approval of
    significant NPL transactions.
  • Provide an independent operating board with
    authority to manage AMC activities
  • Transparent reporting
  • Encourage stakeholders participation in corporate

Public Pension Fund Management and Governance
(Governance Issues In Public Pension Fund
Management Gregorio Impavido)
  • The situation. 81 of world labor force covered
    by partially funded or PAYG public schemes
    Pension spending can reach 15 of GDP Implicit
    pension debt up to 200 of GDP (Transition
    economies) Publicly managed pension reserves up
    to 55 of GDP (Malaysia).
  • In numerous countries multiple objectives
    governance structure is murky, and performance of
    PPFM is poor
  • What are the implications? Identify good
    governance practices and distill into governance
    guidelines aimed at reducing the political
    influence risks that are associated with central,
    public pension fund management.
  • Solutions
  • Only one objective portfolio investing and
    maximizing returns for retirees.
  • Development of a satisfactory set of governance
    guidelines tailored to public pension funds
  • Governors independent and fit and proper
    Governors' responsibility defined by fiduciary
    law accountable for fund performance (e.g.,-
    Ireland, Canada)
  • Independent performance evaluations should be
    conducted by external and independent entities on
    a regular basis.
  • Internal controls should be established to avoid
    conflict of interests.

Mutual Funds(Mark St. Giles and Sally Buxton,
Cadogan Financial)
  • The situation.
  • In the US investment fund assets represent 50 of
    GDP, whereas in Europe 25. In the transitional
    economies funds have been used for privatization.
    Collective investment schemes can become
    increasingly important financial institutions in
    developed countries
  • Types of CIS governance structures
  • Corporate style mutual funds are found mostly in
    the U.S. and a few emerging markets, and dominate
    in terms of value of assets. Directors have a
    fiduciary responsibility to look after the
    interests of investors.
  • 75 of collective investment schemes by number
    are held in the trust or the contractual form,
    and are found mostly in developing countries.
  • The trust made by trust deed between a
    management company and a trustee.The trustee has
    the fiduciary responsibility
  • The contractual fund where investors contract
    with the management company. Protected by a
    combination of contract law, regulation and the
    actions of the depositary, which plays a quasi
    trustee role.

Mutual Funds II
  • No empirical evidence that any one fund legal
    structure provides improved fund governance ..
  • . probably
  • Better governance structure when fund management
    is separate from oversight with independent
    corporate directors
  • Regulation and enforcement are needed
  • Additional solutions.
  • Ability to exit a fund creates competitive
    commercial pressure
  • Transparency is critical to leveling the playing
    field, pressure funds to perform
  • Regulation for fair competition

How Effective are Capital Markets in Exerting
Governance on CorporatesLessons of Recent
Experience with Private and Public, Legal Rules
Cally Jordan, The World Bank and Mike Lubrano, IFC
  • The vision is that Pressures of Capital Markets
    will Improve Governance of Corporates and
    Improvements in Corporate Governance will Promote
    Development of Capital Markets. How?
  • Legal Families Matter legal families appear to
    shape legal rules, which in turn influence
    financial markets (La Porta, et al)
  • Changes designed to facilitate better governance
    are not a "silver bullet" . Solutions are
    inextricably linked to a constellation of legal
    practices, institutions, corporate governance
    structures and market conditions
  • E.g., Hostile takeovers are a strong disciplinary
    force in U.S. markets. They rely on a well
    developed high-yield bond market, that was been a
    source of funding for acquiring firms. However
    takeovers are not prevalent in emerging markets.
  • Importance of private rules for governance.
    Adopted ex ante by contract, often underpinned by
    voluntary codes of conduct, or through ex post
    enforcement through contractual dispute
    resolution, including arbitration, or through
    market discipline.

Key Messages
  • The finance sector is sufficiently unique to
    warrant specialized consideration
  • The costs of poor private and public sector
    governance in the finance sector are substantial
  • Recurring themes in the recommendations offered
    by the authors
  • Information asymmetry and the need for improved
    transparency are recurring recommendations
  • Regulatory capture and incentives must be dealt
  • Lack of independence of policy and operations
    difficulties with certain mgt structures,
    government ownerships practical obstacles
  • Inadequate skills and competency critical to
    boards of directors as well as supporting roles
    (audit, legal, accounting, etc)
  • Overview was circulated, Book is available
    fromThe Brookings Institution Press