Seminar titled "Enhancing and Reforming the Way Banks are Governed" delivered by Philip J. Weights at the Abu Dhabi Center for Corporate Governance on February 24, 2016
The Role of Fishbone Diagram in Analyzing Cause and Effect
Enhancing and Reforming the Way Banks are Governed
1. 1
Enhancing and Reforming the way
Banking is Governed
Abu Dhabi Center for Corporate Governance
February 24, 2016
Prepared by:
Philip Weights, Managing Director
Enhanced Banking Governance LLC
Bubikon, Zürich, Switzerland
weights@e-bkgov.com
2. 2
1. Introduction
2. Corporate Governance Framework
3. Corporate Governance Committee
4. Chief Governance Officer
5. Banking Conduct and Culture
6. Remuneration of the Board and Key Executives
7. Three Lines of Defence
Overview
4. 4
Introduction – Importance of Banking Governance
Corporate Governance for Banking
Organisations is arguably of greater
importance than for other companies given
the crucial financial intermediation role of
banks in the economy. It is essential to
achieving and maintaining public trust and
confidence in the banking system.
The Basel Committee
5. 5
Introduction – Banks too Big?
Are global systemically
important banks (G-SIBs)
now too big to manage,
too big to govern, and too
big to regulate?
6. 6
Introduction – Failures of Corporate & Risk Governance
“We conclude dramatic failures of
corporate governance and risk
management at many systemically
important financial institutions were a key
cause of this crisis.”
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Introduction – Have Lessons been Learned?
Principles of good governance have been a major
component of international financial standards and are seen
as essential to the stability and integrity of financial systems.
So, how to explain the events of 2007–08? What about the
2016 financial crisis?
Many problems can be traced to flawed implementation of
good principles and to behavior prompted by increasingly
short-term performance horizons.
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Introduction – Failures in Financial Regulation
Crisis avoidable - caused by:
Widespread failures in financial
regulation, incl. the Federal
Reserve’s failure to stem the
tide of toxic mortgages;
Dramatic breakdowns in
corporate governance including
many financial firms acting
recklessly - taking on too much
risk - with too little capital -
and too much dependence on
short-term funding.
Breaches in accountability and
ethics at all levels.
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Introduction – Women now running the financial world?
Christine Lagarde noted that there is still
work to be done to address distorted
incentives in the financial system given that
actions precipitating the crisis were mostly
driven by short-term profit motivation.
She suggests we need to build a financial
system that is both more ethical and
oriented more to the needs of the real
economy, a financial system that serves
society and not the other way round. Her
view is that regulatory frameworks are not
tight enough and oversight not strong
enough.
Remarks made by Christine
Lagarde, IMF managing director
in Washington DC on May 6,
2015 in a conversation with Janet
Yellen, chair of the Board of
Governors of the Federal
Reserve System. The topic was
“Ethics and Finance - Aligning
Financial Incentives with
Societal Objectives”.
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Introduction – So What to Do?
“Enhancing banking governance is not only
about the rules and regulations. It concerns the
need for more robust implementation, to all
levels of the organization, in all regions, with
improved monitoring, auditing, and board
oversight, enabled by assigned responsibility
andaccountability”. PhilipJ.Weights
12. 12
Introduction – What can go wrong today you might ask?
Corporate Governance and the U.A.E.
The USD 900 million Kabul Bank fraud ranks, at around 5% of the GDP of the Afghan economy,
as one of history's biggest ever banking scandals. Former chairman Sherkhan Farnood, and
the bank's CEO Khalilullah Ferozi, were jailed for 15 years on Dec 11, 2014 for money
laundering and embezzlement. The court awarded a fine of $334 million to Farnood for the
embezzlement of Kabul Bank funds, and a fine of s196 million to Ferozi. The assets of Mahmood
Karzai, brother of former President Hamid Karzai, were also frozen by the court
13. 13
Introduction – Cash flown (laundered) to Dubai
The Financial Transactions and Reports Analysis
Centre of Afghanistan was advised that Kabul
Bank was moving money through food trays on
Pamir Airway flights. This is supported by a Kabul
Bank account used to pay 10 Pamir Airways pilots
$320,000 for cash shipments between March 2008
and November 2010. The description “Pilots of
Cash Delivery” is particularly suspicious given that
Kabul Bank was laundering large amounts of cash
through Kabul Airport to Dubai.
Pamir Airways operated
a scheduled service to
Dubai International
airport until 2011.
Hundreds of millions of
U.S. dollars were
smuggled and flown out of
Afghanistan secretly
stashed in bags and airline
food trays.
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Introduction – Money laundered to buy Dubai real estate.
Sherkhan Farnood, the
bank Chairman, controlled
the titles of prime Dubai
real estate purchased with
bank money but registered
in his and his wife’s name.
He had properties worth
about $160 million.
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Corporate Governance Framework
It is recommended that the
Board of Directors of all banks
should formally adopt and
implement the “Corporate
Governance Principles for
Banks” published by the Basel
Committee on Banking
Supervision.
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Corporate Governance Framework
Primary objectives of the 2015 revision are:
• to explicitly reinforce the collective oversight and risk
governance responsibilities of the board.
• to emphasize key components of risk governance such as
risk culture, risk appetite and their relationship to a bank’s
risk capacity.
• to delineate the roles of the board, board committees,
senior management, control functions, including the CRO
and internal audit.
• to emphasize strengthening banks’ overall checks and
balances.
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Corporate Governance Framework
Principle 1: Board’s overall responsibilities
“The board has overall responsibility for the bank, including
approving and overseeing management’s implementation of the
bank’s strategic objectives, governance framework and corporate
culture.”
This Principle requires a combined approach, with approval and oversight at the
board level, and implementation by management.
Under the “duty of care” on Principle 1, the board should:
“oversee implementation of the bank’s governance framework and
periodically review that it remains appropriate in the light of
material changes to the bank’s size, complexity, geographical
footprint, business strategy, markets and regulatory requirements;”
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Corporate Governance Committee
The creation of a specialized board committees for governance
and ethics is recommended in Principle 3 of the Basel Principles.
Principle 3: Board’s own structure and practices
Other board committees
77. Other specialized committees that are recommended include:
• Nomination / human resources / governance committee:
• Ethics and compliance committee:
Some banks have created a dedicated “Corporate Governance
Committee”, others have established a combined “Corporate
Governance and Business Ethics Committee”, or “Corporate
Governance & Nomination Committee”.
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Corporate Governance Committee
One example of a
successful Corporate
Governance Committee
is the Abu Dhabi
Commercial Bank
(ADCB) in the UAE.
The Bank’s ongoing
achievements in
corporate governance
resulted in the Bank
receiving the “Corporate
Governance Award -
UAE” from World
Finance magazine in
2014. The Bank also
received the Hawkamah
Bank Corporate
Governance Award.
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Chief Governance Officer – Different Approaches
Appointing a Chief
Governance Officer sends a
powerful message to
investors and other
stakeholders that integrity,
transparency and
accountability matter to your
company.
“Policy Governance®” model, a system of organizational governance
developed by Dr. John Carver PhD. Principles 1-3 an organization's
ownership, the board's responsibility to it, and the board's authority. 4-7 the
board defines in writing policies identifying the benefits from the
organization, how the board conducts itself, and staff behavior. 8-10 board's
delegation and monitoring. Describes the Chief Governance Officer as a
“specially empowered member of the board who ensures the integrity of the
board’s process and the completion of its products”
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Chief Governance Officer – CGO Role and Responsibility
Assess and monitor the governance framework - The CGO provides an
ongoing evaluation of the company’s board structure and governance practices
and recommends modifications as the company’s circumstances or regulatory
environment changes.
Ensure compliance - This involves coordination with various corporate
departments, internal audit, compliance, risk, legal, human resources and
investor relations, to ensure the company complies with laws and regulations
related to corporate governance.
Develop Policy - The CGO helps the company develop code of conduct /
ethics / conflict-of-interest standards and other governance policies.
Educate the Board - The CGO keeps the board of directors and management
up to date with the latest corporate governance trends, regulations and best
practices.
Support the Governance Committee - The CGO should support the creation
of a Governance Committee and assist in developing the Terms of Reference,
and subsequently the activities of the Committee in supporting the Board fulfill
its governance oversight responsibility.
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Chief Governance Officer – CGO Role and Responsibility
Validate External Governance Reporting - Review and recommend to the
Board the Bank’s annual disclosure of its corporate governance practices;
Assess Subsidiary Governance - Ensure the preparation of an annual report
on Subsidiary Governance. In this regard, it is not sufficient for banks to only
have good governance in H.O. and the main group board. The CGO is
positioned to take a global and holistic view on governance at all levels, in all
regions, where the bank operates. The CGO should be guided by Principle 5
“Governance of group structures” of the Basel “Corporate Governance
Principles for Banks”.
Oversight of the 3 Lines of Defense - Risk governance, and the related
internal control systems, involves the business (front office) as the first line of
defense, risk and compliance as the 2nd line of defense, and internal audit as
the 3rd line of defense. In many instances there can be substandard
coordination and communication between the different actors in the
governance and control systems within banks. It is therefore critical for the
CGO, as the governance central command, to maintain strong, effective and
frequent contact with all 3 lines of defense.
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Banking Conduct and Culture – Need for Industry Reform
“Banking Conduct
and Culture”
published July
2015 should be
read and adopted
by every bank
director and C-
Suite executive.
It highlights five areas where banks should focus their attention:1) Fundamental
shift in the Mindset on Culture; 2) Senior Accountability and Governance; 3)
Performance management and incentives; 4) Staff development and promotion;
5) An effective Three Lines of Defence.
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Banking Conduct and Culture – Not just Tone at the Top
Desired values and conduct should be reflected in the daily habits and practices
of employees - how they work; how they are evaluated; who is hired, promoted,
and rewarded; and how employees act when managers are not present and
when matters of personal judgment arise.
The key takeaway is: “Tone at
the Top – Echo at the Bottom”.
Boards must ensure senior
managers demonstrate the
right "tone at the top". Desired
values and conduct should be
evident in the tone from the
top. The voices of the middle
manager should be heard in
an echo from the bottom and
should infuse the entire
organization and its
businesses.
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Remuneration of the Board and Key Executives
Boards of banks should adopt a rule, applicable globally, whereby the
remuneration of the Board and the key executives is subject to an annual vote
(preferably binding) by the shareholders.
Switzerland and Italy have binding "say on pay" votes.
Australia introduced the Corporations Amendment (Improving Accountability on
Director and Executive Remuneration) Act 2011 which says that if at two
consecutive meetings over 25% of shareholders vote against the directors’
remuneration package, the directors have to stand for election again in 90 days.
EU has not taken a position on this issue, however Germany passed reforming
legislation to the Stock Corporation Act to introduce a non-binding say on pay.
In the US and the UK there are also non-binding, or advisory votes on pay.
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Three Lines of Defence
A risk governance framework should include well defined
organizational responsibilities for risk management, typically
referred to as the three lines of defence.
1st line is comprised of the business units;
2nd line a risk management function and a compliance function
independent from the first line of defence;
3rd line an internal audit function independent from the first and
second lines of defence.
Depending on the bank’s nature, size and complexity, and the risk
profile of its activities, the specifics of how these 3 lines of defence
are structured can vary. Regardless of the structure, responsibility
for each line of defence should be well defined & communicated.
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Three Lines of Defence
This is how the Board can meet the challenge of providing
oversight of the “Three Lines of Defence” that is so critical
for ensuring risk governance.
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Three Lines of Defence
Too Big to Manage: JP Morgan and the Mega Banks
In a complex organization like JP Morgan, with many separate entities and
lines of business, an effective “control agenda” is a huge undertaking.
“It means “process mapping” the myriad business functions; assessing
business, legal and ethical risks at various points; mitigating that risk through
education, checks and balances; and ensuring that problems are discovered
early and handled promptly. It is a vexing, complicated task which requires
both outstanding leadership and management. It also requires a significant
investment of time and resources which, while sizeable, amounts to far less
than the huge resource drain which scandal can cause. Ultimately, it means
having an open, transparent performance-with-integrity culture that
encourages but bounds business risk and that does not cut legal or ethical
corners to make the numbers.”
Harvard Business Review - Oct 3, 2013 - Ben W. Heineman, Jr
From https://hbr.org/2013/10/too-big-to-manage-jp-morgan-and-the-mega-banks/