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1F I N A N C I A L S T A B I L I T Y I N S T I T U T E

BANK FOR INTERNATIONAL SETTLEMENTS

Some Thoughts on Corporate Governance in Financial Institutions

3rd Annual International Seminar for Central Bank Deputy Governors

Washington DC, 4-6 June 2003

Josef TošovskýChairman

Financial Stability Institute

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F I N A N C I A L S T A B I L I T Y I N S T I T U T E

Contents

I. Addressing weaknesses in market foundations

II. Some issues of corporate governance in financial institutions

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I. Addressing weaknesses in market foundations

1. Why is corporate governance such a hot topic?

• Enron

• Allied Irish Bank

• WorldCom

• Ahold

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2. Global concerns

• Weaknesses in market foundations are not an isolated US problem

• Weaker institutional framework in emerging economies makes it easier to adopt bad practices and more difficult to get rid of them

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3. What has contributed to these problems?• Financial institutions have become larger:

Shareholder control has diminished– Ownership more dispersed– Majority of corporate share ownership is for investment

not for operating control of a company– Few shareholders have sufficient stakes to influence

the choice of board of directors and CEOs

• Financial institutions have become more complex– More difficult for board members to monitor risk profile

of the institution

• And more…

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4. Weaknesses in internal safeguards

• Board and management oversight

• Internal controls

• Internal audit

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5. Weaknesses in external safeguards

• Accountancy

• External audit

• Regulation and supervision

• Rating agencies

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6. Why did both internal and external safeguards fail simultaneously?

• Liberalisation, deregulation, growth of financial markets and financial institutions was not accompanied by adequate institutional framework strengthening

• Economic cycle – bad loans are made in good times; similar can be valid for corporate governance – bad decisions are made during good times

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7. Broad register of issues

• Corporate governance (including compensation schemes)

• Auditors oversight, independence and standards

• Accounting standards

• Credit rating agencies

Market based system has worked very well for many years.

Balanced approach addressing weaknesses necessary – danger of overreaction.

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II.Some issues of corporate governance in financial institutions1. Definitions• OECD principles of corporate governance

“Corporate governance relates to the internal means by which corporations are operated and controlled”

• Cadbury Report, 1992“Corporate governance is the system by which companies are directed and controlled”

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2. Importance of corporate governance in financial institutions

• Not only for well-being of an individual company and its stakeholders but because corporate governance:– Promotes effective allocation of the

nation’s savings– Essential for financial stability – Important for long-term performance of

the economy

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3. Specific reasons for sound corporate governance in financial institutions

• Reliance on debt funding and the confidence of creditors

• Opaqueness and complexity of the risks of financial institutions

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4. Key players• Systemic

– Legal and regulatory authorities– Supervisory authorities

• Institutional– Shareholders– Board of directors– Executive management– Audit committee/internal audit– External audit

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4. Key players (continued)• Public/consumer

– Investors/depositors– Rating agencies– Analysts– Media

• International Organisations– OECD– The IMF and World Bank– Basel Committee on Banking Supervision– The Joint Forum

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5. What is happening now?

• Worldwide discussion on corporate governance

• Reduced significance of national/domestic legislation

• Tendency towards harmonisation and benchmarking

• Creation of international best corporate governance standards

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Conclusions• Public concern caused by recent

scandals has been a potent driver of improved governance practices

• Public scrutiny of company/board practices has risen markedly

• Desire to avoid reputation/legal risk should provide an ongoing incentive

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Character, attitude and integrity of

top representative determine good

corporate governance.