Corporate Governance of Banks

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Corporate governance is the system by which companies are directed and controlled. The corporate governance of banks differs from the corporate governance of ordinary companies. This is due to the nature of the banking business, the complexity of its organisation, the uniqueness of banks’ balance sheets, the need for protection of the weakest party in the chain (i.e. the depositors), and the systemic risks caused by bank failures.

The balance sheet of banks presents a much greater inherent opacity; it is difficult for outsiders to evaluate the quality of the assets which a bank holds and, therefore, its true financial position. Furthermore, a bank serves several conflicting interests, from equity holders, to borrowers or depositors and good governance is important for balancing those interests. Finally, the potential negative effects of bank failures are very damaging for both the economy and society, as was demonstrated vividly by the 2008 global financial crisis. For this reason, it is now acknowledged that the corporate governance of banks should be addressed with specific recommendations, focusing more on the “internal governance” than the protection of minority shareholders.

The way that banks fund their operations means that, in comparison to other companies, their corporate governance needs to provide protection to a much broader pool of stakeholders, particularly depositors who do not usually have the possibility to influence the banks’ business decisions. This requires a much deeper involvement of the board in strategic issues and risk oversight, as it must fully understand the risks the bank is exposed to and be able to monitor them effectively. As a result, this requires that the balance of skills at the board level and the expertise of its members are regulated in detail and closely scrutinised by bank supervisors. There is greater emphasis and more detailed guidance on the internal control functions of the so-called “second and third line of defence” : i.e.  risk management, compliance and internal audit, which are becoming mandatory for banks in an increasing number of jurisdictions. Banks are also subject to stricter disclosure requirements. In order to better address the specific circumstances of corporate governance in banks, regulators and standard setters have issued comprehensive guidance, which can be accessed here.

In the EBRD’s countries of operations, the good corporate governance of banks is particularly important because banks are the most significant (and in some cases, only) providers of credit. Difficulties in their operations could disrupt the entire economy. At the same time, this situation puts banks in a unique position to influence the governance practices of their corporate borrowers, so reducing risk in their own operations and becoming promoters of better corporate governance practices for all other companies.
Our interest in the corporate governance of banks stems both from the EBRD’s role as an active investor as well as that of an international financial institution deeply involved in policy dialogue that promotes good governance and resilient economies. So, our approach towards enhancing  the corporate governance practices of banks in our countries of operations is twofold, as we seek to implement improvements both at the level of individual companies and at the level of generally applicable regulations and codes.

During 2010-2012 we undertook several policy dialogue activities to further improve the corporate governance of banks in our countries of operations. This included launching a comparative assessment of the corporate governance of banks in several countries.  The assessment was aimed at providing the EBRD with an overview of the legal and regulatory framework governing the corporate governance of banks and an understanding of how diligently the various rules and best practice guidelines are implemented.

The EBRD has also worked together with the OECD and IFC to develop two Policy Briefs that target the Corporate Governance of Banks in South East Europe and the Corporate Governance of Banks in Eurasia (available in English and in Russian).

 

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