Banks miss out on good corporate governance

http://today.thefinancialexpress.com.bd/anniversary-issue-2/banks-miss-out-on-good-corporate-
governance-1511358519
The root cause of global recession (2008 onwards) can be traced back to the mismanagement of banks
and financial institutions. Despite all the measures taken by different countries, with the US taking the
lead, full recovery has not yet been forthcoming. The year 2017 has been a challenging one. Small
economies like Bangladesh are by no means invulnerable to fallouts from global downturns or negative
spill over of policies of large economies and therefore have a strong stake in global stability and
economic growth. In forums such as the G-20, countries like Bangladesh need to argue forcefully for
the same priority in stability as recovery, as well as for stability action agenda going beyond addressing
symptoms (i.e. lapses in risk management, inadequacies of regulation and supervision) to addressing
underlying causes (i.e. lax policies, non-compliance of prudential and management norms, poor
financial reporting, unbridled liquidity expansion that incubate bubbles.)
So what are the implications of the Bangladesh economy minimizing external shocks and internal
shocks? This article will mainly address the several challenges faced by the banking sector in creating
internal shocks in the economy. The Hallmark and Bismillah Group financial scams and then the
financial irregularities in the BASIC Bank which are state-owned commercial banks, have
demonstrated cracks in the management of these banks. From the Board of Directors to the
management group to the lower level officials, these banks have not shown any sign of good
governance, transparency and accountability. The disturbing fact is that these irregularities have
permeated to private commercial banks as well.
There are several state-owned and private banks that have slightly different governing structures but
follow the operational guidelines of Bangladesh Bank in terms of prudential and management norms.
The norms provided by Bangladesh Bank are fairly well formulated and follow international standards.
The International Accounting Services Board (IASB) under the Bank for International Settlements
(BIS) in Basel, Switzerland, has provided three major norms namely Basel I, Basel II and Basel III.
Basel I of 1988 required that banks and financial institutions have sufficient capital adequacy, which
was originally 8% of risk weighted assets (RWA). Later on, it was raised to 10% for banks, including
those in Bangladesh. There are some banks in Bangladesh whose required capital adequacy falls short
of the norm. Basel I set up a mechanical, non-market oriented measurement of capital adequacy which
could not take care of fundamental risks, e.g. operational risk and market risk. Basel II, introduced in
2004, took care of the different types of risk for financial intermediaries (i.e. banks) as well as the
supervisory review process for the management of banks.
The global community realized the inadequacies of Basel I and Basel II during the recent global
financial crisis of 2007. Basel III was introduced in 2013 and is supposed to be completed in 2020. The
major aspects of Basel III are: first, to strengthen the capital framework of banks and to give more
emphasis on equity capital (Tier-1, core capital); second, to ensure global liquidity; third, to highlight
systematic risks as well as mitigation measures that address the risks. Two major aspects regarding
liquidity are Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). Bangladesh bank
has recently issued a circular to implement Basel-III liquidity ratios. Besides the three international
Basel norms discussed above, banks follow other guidelines prescribed in the various Acts and
Regulations in their respective countries.
Financial reporting by banks is very important in ensuring the interest of depositors, as well as that of
the clients. I shall now highlight the aspects that are related to the compliance of different rules,
regulations and norms, prescribed for banks. In Bangladesh, as pointed out earlier, the regulatory
requirements of banks follow international standards. Besides these, the Bank Company Act provides
guidelines for the preparation of reports, including audit reports. On top of that, state-owned
commercial banks and specialized banks, like Krishi Unnayan Bank (RAKUB), follow the
requirements laid down in the respective Acts through which they were established. The Registrar of
the Joint Stock Companies and Firms (RJSC&F) also has certain rules for entities registered under the
Company Act and the Societies Registration Act. Similarly, Bangladesh Securities and Exchange
Commission (BSEC) has laid down rules for companies to prepare their financial reports.
On the whole, requirements for the financial reports of banks, non-bank financial institutions (regulated
under the Financial Institution Act) and various companies are quite satisfactory in Bangladesh. The
disturbing part is that these requirements are not properly complied with by various institutions. This
means that the implementation (enforcement and compliance) of rules and regulations is the "Achilles
Heel". Despite supervision and monitoring by the regulatory bodies such as Bangladesh Bank and
BSEC, serious mismanagement and malpractices have occurred in the banking sector as well as in the
capital market. The disclosure of banks in their financial reports is prepared following the International
Accounting Standards-30 (IAS-30). This has been replaced by International Financial Reporting
Standards (IFRS-7).
According to this format the financial disclosure is more logical, which means that banks now face
higher risk in investment and management of capital. If the required standard is followed then
depositors and clients of the bank and the general people will not face any loss. Besides IAS-30, there
are also IAS-32, IAS-39 and IFRS -9, which are prescribed for the management, supervision, and
monitoring of financial intermediaries. The government of Bangladesh has promulgated the Financial
Reporting Act (FRA Act) in September 2015. Under the aegis of FRA Act 2015, the Financial
Reporting Council (FRC) has started functioning from the middle of this year. The 12 members
Council will ensure accountability and highest standards of performance of the professional
accountants and auditors and enhance credibility of financial reporting. The FRC is empowered to
cancel the registration of auditors and give punishments for fabricating audit reports. We expect that
FRC will be proactive to bring discipline in the banking sector.
It must be pointed out that a balance must be made between the regulation and independence of a bank.
This means that banks should neither be overregulated nor should they be left alone to enjoy complete
freedom, which often results in banking disasters. This point has been very aptly articulated by Jean
Tirole, the Nobel Prize winner of Economics (2014) in a book jointly written with his colleagues. It is
important to keep in mind what financial regulation is meant to achieve. The most important objective
is to protect depositors, investors, the general public and the real economy (real goods and services) as
a whole. The second rationale for regulation is to minimize the domino effect of the systematic risks of
the financial institutions which destroy the foundation of economic activities resulting in loss of real
output, lower growth, higher unemployment and reduction of human welfare. Good governance in the
banking sector is an important agenda of our country, especially in the present context of the crisis in
the banking sector. Transparency and accountability have recently become an issue of greater concern
with revitalised importance in the context of public and private responsibility of managing banks. The
International Monetary Fund (IMF) has defined transparency as "an environment in which the
objectives of policy, its legal, institutional and economic framework, policy decisions and their
rationale, data and information related to monetary and financial policies, and in terms of agencies'
accountability, are provided to the public on an understandable, accessible and timely basis" (IMF-
1999). Transparency in government operations is an important pre-condition for macro-economic fiscal
sustainability good governance, and overall fiscal discipline. Accountability, in the words of Lessinger
(1970), "is the product of a process which means that an agent, public or private, entering into a
contractual agreement to perform a service will be held answerable to perform according to agreed
upon terms, within an established time period and with stipulated use of resources and performance
standard ."
Transparency is necessary to ensure accountability among the major group of participants in financial
markets: borrowers and lenders; issuers and investors; and national authorities and international
financial institutions. Transparency and accountability are mutually reinforcing. Transparency enhances
accountability by facilitating monitoring, and accountability enhances transparency by providing an
incentive for agents to ensure that the reasons for their actions are properly disseminated and
understood. Perfect examples are the Hallmark, Basic Bank and Bismillah Group scandals which
occurred due to the lack of both transparency and accountability. Both the borrowers and the officials
colluded in a non-transparent manner and siphoned off huge amounts of public money. The people who
are responsible have not yet been subjected to administrative and legal actions, in fact they got
"perverse incentives" and the honest and dedicated people working in the same bank and elsewhere are
pushed back into inefficiency. As the saying goes, "Bad money drives away the good money."
The transparency of financial statements of banks is secured through full disclosure and by providing
fair presentation of useful information necessary for making economic decisions to a wide range of
users. In the context of public disclosures, financial statements should be easy for users to interpret.
Whereas more information is better than less, the provision of information is costly. Therefore the net
benefits of providing more transparency should be carefully evaluated by standard setters. The adoption
of internationally accepted financial reporting standards is necessary to facilitate transparency and
contribute to proper interpretation of financial statements. In the context of fair presentation, no
disclosure is probably better than disclosure of misleading information. Left to themselves, markets
cannot generate a sufficient level of disclosure. Here is the vital role of the accountants, as the bulk
portion of useful financial information used by the market participants are provided by the accounting
information systems, where the preparers (the employed accountants) provide information which is
authenticated by external accountants on the basis of International Accounting Standards (IAS) and
International Standards of Auditing (ISA). An accountant should not depend on numbers only, one
should engage one's own logic and judgment to analyze a set of numbers.
With the view of strengthening good governance in the financial sector, especially in the banking
sector, Bangladesh Bank embarked on several financial sector reforms over the years. A large number
of home grown reforms have already been taken and some are underway. Bangladesh Bank attempted
to strengthen the legal framework of the financial sector, bring in dynamism, extend autonomy to the
central bank, combat money laundering offences, and stop financing for terrorism. There are several
other prudential norms already discussed in the previous section in relation to the Basel Guidelines and
the guidelines of various Acts of Bangladesh. One important aspect is the management norms, which
concern the fit and proper test for CEOs and directors of a bank, restrictions on the composition and
functions of the Board of Directors. Banks have been directed by Bangladesh Bank to include one
independent director in the Board of Directors. Audit Committees for all banks were mandated with
clear guidelines, and TORs and an early warning system (EWS) were introduced. The Core Risk
Management Guidelines on five major risks were introduced quite some time back and credit risk
assessment by External Credit Assessment Institutions (ECAI) have been recommended for all
commercial banks. However, in recent times we have seen that many of these management norms are
not followed by banks. There are several privately owned banks where a number of family members
are on the Board of Directors, which is contrary to the notion of good corporate governance. Therefore
one of the main challenges for the banking sector is to ensure good corporate governance which will
benefit the depositors, borrowers and investors; expand potential markets; broaden ownership; create
alternative financing options; accelerate growth; increase employment and help reduce poverty in
Bangladesh.
To balance the objectives of good governance and ensure compliance of regulations, three major steps
are necessary: (a) a strong and independent central bank with more focus on core banking issues, (b) a
well thought out set of prudential and management norms of the central bank that are not subject to
frequent changes due to external political/administrative pressure, and (c) a system of prompt
corrective actions for management of crises and for legal/administrative actions against persons
responsible for crises in a particular bank or in the banking 'system' as a whole. If we fail, the financial
crisis like a contagious disease will spread to the real sector of the economy which will pose serious
threats to and path for sustainable economic development.
Dr Salehuddin Ahmed is a former governor, Bangladesh Bank & professor, Business School, BRAC
University. asalehuddin@gmail.com

Improving corporate governance: Making

independent directors really independent
http://today.thefinancialexpress.com.bd/views-opinion/improving-corporate-governance-making-
independent-directors-really-independent-1528287226
An independent director is quite often termed an outside director. He is a member of the Board
of Directors (BoD) who does not have a material or pecuniary relationship with the company or
related persons, except sitting on board meetings and getting fees. In USA, independent directors
constitute 66 per cent of all boards and 72 per cent of S&P 500 company boards (The Wall Street
Journal).
"No director qualifies as 'independent' unless the board of directors affirmatively determines that the
director has 'no material relationship' with the listed company, either directly or as a partner,
shareholder or officer of an organization that has a relationship with the company" the New York Stock
Exchange Standards stipulate. Nasdaq's rules say, an independent director must not be an officer or
employee of the company, or its subsidiaries, or any other individual having a relationship that, in the
opinion of the company's board of directors, would interfere with the exercise of independent
judgement in carrying out the responsibilities of a director.
In Bangladesh, the Companies Act 2013 has made a provision for Independent Director (ID). Section
85 deals with the Appointment or Removal of Directors. Section 85(5) describes the Independent
Director and his qualification. The subsection 85 [ Ka, Kha (O, Ao) Ga, Gha, Umo (Aa)] spells out in
detail about the qualifications of Independent Directors. An independent director is to comply with the
rules of schedule (IV) of the Act, Section 85(7). Subsection 85(8) states that any ID will only take
meeting fee and allowances along with the approved commission etc. ID will not get any other
remuneration whatsoever from the company.
An ID will remain in position for a 3-year term only. However, BoD of the company concerned can
recommend renewal of contract for another 3-year term. No ID will retain the position in BoD for more
than two consecutive terms. But after the lapse of three years following two consecutive terms, an ID
can be reappointed by the BoD. ID can not be involved, directly or indirectly, with any other business
of the company and cannot indulge in any activity of the company. Section 85 (II) mentions about the
accountability of ID and also of the situation when the ID knowingly gets involved in company affairs
beyond his jurisdiction.
The new provision for ID in the Companies Act depict the importance of ID in a BoD. Over time, the
Companies Act 1913, the Companies Act 1994 and the Companies Act 2013 have reflected the changes
in global businesses and appropriate reforms have been brought about accordingly. The issue of
governance has become vitally important. Indeed, it is more of a central issue in the management of
publicly listed and other companies.
The guidelines on corporate governance of Bangladesh Securities & Exchange Commission (BSEC)
also elaborate about ID. It states that - all companies shall encourage effective representation of
independent directors on their Board of Directors. At least one-fifth of the total number of directors in a
company's board shall be independent directors. Such ID will either not hold any share in the company
or hold less than 1.0 per cent shares of the total paid-up capital of the company. S/he will not be a
sponsor of the company and should not be connected with any sponsor or director or shareholder of the
company based on family relationship. His/her family members also should not hold such shares in the
company and must not have any other relationship, whether pecuniary or otherwise, with the company
or its subsidiary/associated companies. An ID must not be a member, director or officer of any stock
exchange and should be one who is not a shareholder, director or officer of any stock exchange or any
intermediary of the capital market. An ID must not be a partner or executive or should not be a partner
or executive of the concerned company's statutory audit firm during the preceding three years. S/he
should not be an independent director in more than three listed companies, and must not have been
convicted by a court of competent jurisdiction as a defaulter in respect of payment of any loan to a
bank or a Non-bank Financial Institution (NBFI). An ID must not be convicted for a criminal offence
involving moral turpitude.
Are the IDs really independent? It has been and is still a question omnipresent in the governance arena.
Many IDs are the subject of appointment by BoDs, which are dominated mostly by promoters as they
hold majority shares. So, when the IDs demonstrate too much independence, renewals of their tenure in
BoD are often jeopardised. Consequently, IDs are hardly independent in reality. It is indeed difficult for
an ID to remain truly independent, while a renewal is dependent on the BoD.
Also, properly qualified IDs can give hardly enough time for company matters, as the meagre meeting
fees rarely allows them to work with due diligence. In fact, dearth of capable people in the market for
ID positions is a great limitation for choosing alternatives to incumbent IDs. Again, An ID may be asset
for a company, but at the same time, may be a liability for the Top Management.
Too much independence exerted by IDs in company matters may defeat the very purpose of the
concept, or for that matter, the spirit of ID. Rationally speaking, independence of IDs is a theoretical
matter as they are appointed by the BoDs. Most likely, the IDs move ahead by getting attuned with the
BoD demands, without which they cannot survive. This contradicts the very spirit based on which the
Independent Directors are appointed. However, if over 50 per cent of BoD members were IDs, then real
good governance could replace the persistent poor management and bad governance observed in the
concerned companies.
The Tata-Mistry fiasco in India brought to focus the need for reassessment of the institution of
independent directors and the role they should play in ensuring effective corporate governance.
Though independent directors are often expected to protect the interests of minority shareholders, their
foremost duty is to act for the benefit of the company as a whole. And that would benefit the
shareholders - be they minority or a majority. The independent director holds a special place in the
system of governance of a company, its board and its management. S/he is required to exercise proper
judgement on corporate affairs objectively. This role is especially critical when there is a divergence of
opinion between the shareholders, the company and its management.
The 2013 Companies Act sought to bring about better corporate governance through provisions that
facilitated increased transparency, accountability and professionalism in BoD. The BSEC has been and
is still in the forefront of the efforts to improve corporate governance through its pivotal role. Time is
ripe for making efforts for its successful implementation.
Masih Malik Chowdhury, an FCS & FCA, is Managing Partner of Masih Muhith Haque & Co.,
Chartered Accountants, and a Past President of ICAB.
masih@masihmuhith.com