The Importance of Good Corporate Governance for Banks David Carse Deputy Chief Executive Hong Kong M

1
The Importance of Good Corporate Governance for
BanksDavid CarseDeputy Chief Executive Hong
Kong Monetary Authority 3 November 2000
2
The importance of corporate governance

• Corporate governance is the system by which
  companies are directed and controlled.
• Good corporate governance is a key element in
  improving economic efficiency.
• Conversely, bad corporate governance,
  particularly in banks, can undermine economic and
  financial stability.
• This was demonstrated by the Asian Crisis.

3
The role of bad corporate governance in the Asian
crisis

• Weak corporate governance in Asian banks (and
  their customers) was one of the key factors in
  the Asian crisis
• many banks were controlled by owner-managers and
  the board of directors played little role
• banks were often parts of wider conglomerates and
  used to fund other parts of the group or the
  owners (connected lending)
• banks were subject to political influence in
  their lending decisions
• management was weak and lacked self-responsibility
  
• growth was more important than return on capital
• risk management was poor
• lack of credit controls and skills
• excessive risk concentrations in individual
  borrowers and sectors
• excessive funding and currency mismatches

4
The situation in Hong Kong

• Corporate governance of Hong Kong banks is
  relatively good by regional standards as has been
  shown by their ability to survive the Asian
  crisis intact.
• However, the HKMA considers that there was a
  vacuum in leadership in a few local banks during
  the Asian crisis because the board of directors
  did not play an effective leadership role.
• This may result in either inadequate supervision
  of management or the main shareholders becoming
  directly involved in the running of the business.
• In either case, the board of directors is
  bypassed and checks and balances are lost.
• To address these issues the HKMA issued a
  guideline on corporate governance in locally
  incorporated authorized institutions in May 2000.

5
Contents of the HKMA Guideline

• Major responsibilities of the board
• ensure competent management
• approve objectives, strategies and business plans
• ensure that the banks operations are conducted
  prudently and within the framework of laws and
  board policies
• ensure that the banks affairs are conducted with
  a high degree of integrity
• Legal obligations of directors
• including liability for breaches of the Banking
  Ordinance
• The use of auditors
• including role of internal audit
• Specific requirements

6
Specific Requirements

• 1. The board should ensure that the bank
  establishes policies, procedures and controls to
  manage the various types of risk with which it is
  faced.
• The HKMA has identified 8 types of risk for
  purposes of its supervision (i.e. credit,
  interest rate, market, liquidity, operational,
  reputation, legal and strategic risk).
• The board should approve relevant policies to
  manage these risks while senior management should
  put them into effect.
• It is important that the policies should not
  exist merely for forms sake (e.g. to satisfy the
  regulator), but should dictate how the bank is
  actually run in practice.

7
Specific Requirements

• 2. The board should ensure that the bank fully
  understands the provisions of section 83 of the
  Hong Kong Banking Ordinance on connected lending
  and establishes a policy on such lending.
• Section 83 of the Hong Kong Banking Ordinance
  limits the unsecured advances of banks to
  connected parties (e.g. directors and their
  relatives). A breach of section 83 is a serious
  offence.
• The board is required to ensure that the bank
  fully understands its legal obligations and
  establishes a policy on connected lending
  according to the minimum standards specified in
  the Guideline.

8
Specific Requirements

• 3. The board should ensure that it receives the
  management letter from the external auditor
  without undue delay, together with the comments
  of management.
• The management letter should normally be received
  within 4 months from the financial year-end. The
  board should ask for managements explanation if
  prolonged delay is experienced.
• The board and/or audit committee should ensure
  appropriate action is taken to address any
  weaknesses identified in the management letter.
• A copy of the management letter should be given
  to the HKMA.

9
Specific Requirements

• 4. The board should maintain appropriate checks
  and balances against the influence of management
  and/or shareholder controllers, in order to
  ensure that decisions are taken with the banks
  best interests in mind.
• Independent non-executive directors help to
  provide the necessary checks and balances and
  bring in outside experience.
• The board should have at least 3 independent
  directors to provide a sufficient pool of
  independent directors to sit on committees (in
  particular the audit committee) and cover
  absences.
• In cases where the chairman is also the chief
  executive of a bank, more than 3 independent
  directors may be required to provide a strong
  independent element on the board.
• Banks should notify the names of their
  independent directors to the HKMA. The HKMA may
  require additional independent directors to be
  appointed.

10
Specific Requirements

• 5. The board should establish an audit committee
  with written terms of reference specifying its
  authorities and duties.
• The audit committee serves as the boards eyes
  and ears in monitoring compliance with board
  policies, regulations etc. It also provides
  oversight of the internal and external auditors
  and assists in providing independent review of
  the effectiveness of internal control systems.
• The above functions should be performed by
  non-executive (preferably independent) directors
  to avoid conflicts of interest and ensure
  impartiality.
• The audit committee should therefore be made up
  of non-executive directors, the majority of whom
  should be independent.

11
Specific Requirements

• 6. Board meetings of a bank should be held
  preferably on a monthly basis but in any event no
  less than once every quarter.
• The board can only fulfil its responsibility if
  it meets frequently enough and receives
  sufficient information from management to enable
  it to monitor the banks financial position and
  performance.
• Banks should keep full minutes of board meetings.
• The HKMA will require banks to provide it with a
  record of the number of board meetings held each
  year.

12
Specific Requirements

• 7. Individual directors should attend at least
  half of board meetings held in each financial
  year and all meetings where major issues are to
  be discussed.
• While effectiveness of a director cannot be
  measured simply by attendance at board meetings,
  it is difficult for even the most competent
  individual to make a contribution if he/she does
  not turn up for meetings in the first place.
• Participation of directors in board meetings can
  be facilitated by video or telephone
  conferencing.
• The HKMA will monitor the attendance records of
  individual directors.

13
Specific Requirements

• 8. The HKMA will meet the full board of directors
  of each bank every year.
• The HKMAs intention is not to participate in
  board meetings but to strengthen communication
  between the HKMA and the banks at the highest
  level.
• The meeting will enable the HKMA to convey first
  hand its views on the banks current financial
  position and quality of its risk management and
  internal controls and to communicate any major
  supervisory concerns.
• The board will also have the opportunity to
  convey its views directly to the HKMA.

14
Questions raised on our Guideline

• Is the HKMA interfering too much in the way in
  which banks choose to manage themselves?
• Is too much burden being placed on the board, and
  on non-executive directors in particular, in
  terms of establishing policies and controls?
• Should we draw a distinction between listed and
  non-listed banks?
• Is it right to place more onerous requirements on
  banks compared with other companies, e.g. as
  regards the number of independent directors?
• Where are truly independent directors going to be
  found?

15
The HKMA response

• Promotion of good corporate governance falls
  clearly within the supervisory responsibilities
  of the HKMA.
• Banks are different from other companies because
  of the nature of the risks they take on and
  because they are looking after other peoples
  money.
• Corporate governance is therefore particularly
  important for banks, whether listed or
  non-listed.
• Directors need to ensure that the risks in banks
  are properly managed, and under the Hong Kong
  Banking Ordinance they have a specific legal
  responsibility to do so.
• This does not mean that the directors should
  themselves formulate policies for managing risk,
  but they should certainly approve such policies.

16
The problem of independent directors

• We do acknowledge that it is not easy to find
  truly independent directors or those that are
  prepared to oppose dominant shareholders.
• There is also the risk that quasi-independent
  directors will be used to give a false impression
  of good governance.
• The process of establishing a cadre of truly
  independent directors in Hong Kong and elsewhere
  in Asia will take time.
• Training courses for directors and organizations
  to promote the use of independent directors like
  the UK PRO NED can help, as can the use of
  mechanisms such as board nomination committees.

17
The need for transparency

• Financial disclosure and accountability are also
  important aspects of good corporate governance.
• The increased focus on shareholder value means
  that banks need to be more open about their
  financial performance and the nature and size of
  the risks they are running.
• Depositors and other providers of funds
  (including minority shareholders) also need
  sufficient information to be able to tell good
  banks from bad.
• The HKMA has therefore focussed in the last six
  years on encouraging banks to disclose more
  information in their annual and interim accounts,
  in particular on asset quality.

18
Conclusions

• The Asian crisis has demonstrated the need for
  Asian banks to improve their corporate governance
  through such means as
• giving greater prominence to the role of the
  board and outside directors in particular
• introduction of professional management
• greater transparency
• effective internal and external audit
• Globalization of financial services is in any
  case driving banks in this direction
• investors and fund providers will increasingly
  expect minimum standards of good governance
• foreign banks operating in Asian markets will
  provide a role model
• Western and Asian models of governance will
  converge
• The Guideline issued by the HKMA is consistent
  with this global trend and is intended to keep
  Hong Kong banks at the forefront of good
  governance.