The governance of banks in transition economies … · Tajikistan Country Report ... owned jointly...

The governance of banks in transition economies Tajikistan country report

Prepared by:

Gian Piero Cigna

Veronica Bradautanu

November 2011

Corporate Governance of Banks in Tajikistan

Tajikistan Country Report – November 2011 PAGE 2 of 22

Table of content

Foreword......................................................................................................................................... 3 A. Methodology and overview of the banking system in Tajikistan ................................................... 4

1) Methodology ....................................................................................................................... 4

2) Overview of banking system in Tajikistan ........................................................................... 4 B. Analysis of bank corporate governance framework and practice in Tajikistan ............................... 8

1) The strategic and governance role of the board ................................................................ 8

2) Composition and functioning of the board......................................................................... 9

3) Risk Governance ................................................................................................................ 12

4) Internal Control ................................................................................................................. 14

5) Incentives and Remuneration ........................................................................................... 16

6) Transparency to the market and regulators ..................................................................... 17

7) Key recommendations ...................................................................................................... 18

8) Overall assessment of bank governance quality in Tajikistan .......................................... 20

This Report does not constitute legal advice. Readers are advised to seek appropriate legal advice before entering into any transaction, making any determination or taking any action related to matters discussed herein.

Copyright All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, without the written permission of the copyright holder. Such written permission must also be obtained before any part of this publication is stored in a retrieval system of any nature. Applications for such permission should be addressed to [email protected]

Disclaimer The contents of this publication reflect the opinions of individual authors and do not necessarily reflect the views of the EBRD.

All assessments and data in the Report are based on information gathered in the course of 2011.

For information or comments please contact Gian Piero Cigna at [email protected]

* * *

The team is grateful for the assistance provided by all parties interviewed. In particular, the team would like to acknowledge the precious assistance offered by the law firm Akhmedov, Azizov & Abdulhamidov Attorneys (www.aaa.tj).

mailto:[email protected]

mailto:[email protected]

http://www.aaa.tj/



Foreword

1. In July 2010, the Legal Transition Team of the EBRD launched a comparative assessment of the corporate governance of banks in its countries of operations. The overall objective of the assessment is to inform and support the EBRD’s policy dialogue with authorities to improve the corporate governance of banks. The assessment aims at providing the EBRD with an overview of the legal and regulatory framework governing the corporate governance of banks and how diligently the various rules and best practice guidelines are implemented.

2. The assessment focuses mostly on internal corporate governance arrangements in banks, particularly the role and composition of boards. It analyses the legal and regulatory framework; its implementation by supervisors; and the practices developed by the systemically important banks in each country. The transparency of governance arrangements to the supervisory authority and the markets is also reviewed. While the assessment analyses banks and their boards, and considers ownership structure and patterns in the banking sector, broader governance issues covered in the OECD principles such as shareholder and stakeholder rights and responsibilities as well as equity market issues are not dealt with in any detail.

3. To enhance the EBRD’s understanding of the corporate governance of banks in countries of operations, countries reviewed are subjectively rated. For this purpose, the legal framework, supervisory practice and banking practice are given an overall score. In addition, the performance of countries in the key areas mapped out in the EBRD checklist is also rated and included in the overall assessment section of each Country Report. The rating approach is detailed in the box below.

Rating

“Strong to very strong” - The corporate governance framework / practices of supervisory authorities / practices

of banks are fit for purpose and are close to best practice.

“Moderately strong” - Most parts of the corporate governance framework / practices of supervisory authorities / practices of banks are adequate but further reform is needed “Weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain some elements of good practice but overall the system is in need of reform “Very weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain significant risks and are in need of significant reform

4. This Brief Country Report is divided in two Sections: (A) Methodology and overview of the banking system; (B) Analysis of bank corporate governance framework and practice– describing the strengths and weaknesses of the corporate governance of banks and policy recommendations where appropriate.



A. Methodology and overview of the banking system in Tajikistan

1) Methodology

5. The analysis and recommendations contained in this report are based on research carried out by the EBRD and responses to written questionnaires sent to one Tajik law firm; the National Bank of Tajikistan (hereafter the “NBT”); and three of the five largest banks in the country (‘the banks reviewed’). Responses to questionnaires were complemented by a desk research of Tajikistan’s legislative framework and other information on Tajikistan’s banking sector available from on-line sources.

6. The three banks reviewed as part of this assessment control together the majority of the total assets of the Tajikistan’s banking system.1

Exhibit 1: The five largest banks in Tajikistan by share of total banking assets in 2011

Bank name (5 largest banks) Share of total asset of banking system (%)

1. OJSC Agroinvestbank 32

2. OJSC Orienbank 28

3. OJSC Tojik Sodirot Bank 15

4. State Saving Bank of RT “Amonatbonk” n/a

5. OJSC Bank Eskhata 7

Total five largest banks (except for “Amonatbonk”) 82%

Total banking system 100%

Source: BankScope, IMF

2) Overview of banking system in Tajikistan

Size and structure

7. Based on the information on the National Bank of Tajikistan website as of July 2011, there were 14 functioning banks, 2 non-bank credit institutions and 123 micro-financing institutions in the Republic of Tajikistan. As regarding overall ownership of banks, there is 1 state owned bank, 9 privately owned commercial banks and 4 subsidiaries of foreign banks. The total value of regulatory capital of all commercial banks in Tajikistan as of October 2010 was 855.4 million somoni (approximately $195 million). Banking sector assets total 5.7 billion somoni (1.2 US$ billion).

8. The five largest banks in Tajikistan are: 1) OJSC Agroinvestbank; 2) OJSC Orienbank; 3) OJSC Tojik Sodirot Bank; 4) State Saving Bank of RT “Amonatbonk”; and 5) OJSC Bank Eskhata.2

9. According to the National Bank of Tajikistan, as of July 1, 2011 the share of foreign capital in Tajik banks amounted to TJS 310mil (appx. EUR 47mln) and it increased by 13% comparing to January 1,

1 Source: BankScope, IMF

2 NBT, see at: http://www.nbt.tj/en/banking_system/basic_banking_indicators.php . NBT does not disclose the aggregate amount of

assets in the banking system, but only the regulatory capital of each bank.

http://www.nbt.tj/en/banking_system/basic_banking_indicators.php



2011. This share amounts to 35.4% of the total authorised capital of banks in Tajik banking system. The subisdiaries of foreign banks are: Tijorat (Iran); KazCommerceBank (Kazakhstan).3

10. Five banks are currently in process of liquidation: CCUB Ayom, CJSC Somon Bank, CJSC East-Credit Bank, CJSC Bank Olymp and CJSC CTB-Investbank.

11. According to the 2009 EBRD Strategy for Tajikistan, the country has enjoyed strong real GDP growth of 7.2 % per year on average since 2005. Nevertheless, the macroeconomic environment remains fragile. Whilst recent growth has been spurred by the service and construction sectors, the economy is still heavily reliant on agriculture, aluminium and hydropower, and it is vulnerable to unexpected disturbances. The discovery of undisclosed public external debt (US$ 321 million) predominantly pledged against the central bank’s international reserves for the financing of the cotton sector in late 2007 raised very serious concerns over the country’s international liquidity situation and eroded confidence in its overall macroeconomic policy management.

12. Tajikistan remains the poorest country of operations of the EBRD, with a per capita income of US$ 580 in 2007. The transition challenges in the financial sector are to improve the regulatory framework through increasing the independence of the regulator; deepen the capital base of the banking sector so that it can support further private sector growth, and expand the range products available to fully satisfy needs in the market. Improvements in these areas will enhance competition and increase confidence in the financial sector.4

13. The Tajik banking system appears to have rudimentary internal control practices and a politically driven directed lending to certain areas of economy, sometimes in disregard of the profitability or repayment capacity of the borrowers. Additionally, the lack of enforceable and trustworthy legal and regulatory framework in the country leads to reduced trust among financial institutions causing tense and insufficient collaboration on the financial market. 5

14. According to a recent IMF assessment "the small size of the financial sector and limited financial intermediation suggest the systemic risk of a bank failure to economic activity is relatively low. The narrow composition of deposits also suggests that bank runs in the classic sense are unlikely, and that the impact of a bank failure would not fall primarily on the poor. However, standardized stress tests also indicate vulnerability of capital adequacy to a range of shocks. Given the limited capacity of the deposit insurance scheme, and the net-negative position of the NBT, absorbing potential financial system losses could fall to the budget. Further, low levels of financial intermediation are a drag on prospects for future economic growth."6

15. The IMF concludes that "the weakness in the system’s financial soundness measures is attributable largely to the deterioration of the balance sheets of the two largest banks. Orien Bank (OB) and Agroinvestbank account for nearly 60 percent of system assets and hold the majority of classified loans. These banks’ exposure to problematic sectors is significant and poses ongoing challenges to their capital positions".7

3 Also to mention are First Micro Finance Bank of Tajikistan, owned jointly by the Aga Khan Fund for Economic Development and

the IFC; and AccessBank Tajikistan, a development bank owned jointly by the IFC, the EBRD, and the German development Bank KfW. 4 Strategy for Tajikistan, January 2009, see at: http://www.ebrd.com/downloads/country/strategy/tajikistan.pdf

5 These comments derive from a discussion with EBRD OCE and FI representatives, following a recent visit to the country.

6 Source: IMF Country Report No. 11/130, June 2011

7 Ibidem

http://www.ebrd.com/downloads/country/strategy/tajikistan.pdf



Supervision

16. The National Bank of Tajikistan (‘NBT’) regulates and supervises banking activities with the purpose of ensuring the stability of the banking system and protecting depositors’ interests; it issues banking regulations and monitors banks’ legal and regulatory compliance.

17. Currently the securities market of Tajikistan is not functioning and there is no independent authority overseeing the securities market. However, the Government has adopted in 2008 a “Strategy for development of the securities market in Tajikistan for years 2008-2012”. The main responsible body for the implementation of the strategy is the Ministry of Finance. In line with the Strategy, the Parliament of Tajikistan has recently adopted a new Law on securities market, in 2011.



Exhibit 2: Laws and regulations on the corporate governance of banks in Tajikistan

Major Laws

Law on Banking Activity (adopted 19 May 2009) – governs the terms and procedures for granting banking licenses, sets forth the banking activities legal framework, supervision and winding-up of credit institutions.

Law on National Bank of Tajikistan (adopted 28 June 2011) defines the status, objectives, organizational structure of the central bank, National Bank of Tajikistan (the “NBT”), and sets out the foundations for its regulatory and supervisory authority.

Law on Joint Stock Companies (adopted in 2007, as amended) – regulates the governance structure of joint stock companies and comprises key responsibilities of governance bodies, basic elements of key director duties, framework for conflicts of interests. All banks must be organised as JSC and are governed this law.

Law on securities market (adopted in 2011) – sets forth requirements towards trading of company securities and comprises a few rules on mandatory information disclosure.

Major Regulations

Ordinance No. 174 on Capital Reserves of Banks and other Non-banking Credit Institutions deposited at the National Bank of Tajikistan (adopted 28 February 2011) – establishes the requirement for banks to deposit mandatory reserves with the National Bank of Tajikistan and how such reserves should be calculated. The mandatory reserves may not exceed 20% of bank’s liabilities.

Ordinance No. 176 on Regulating Credit Institutions Activity (9 October 2009, as amended) – sets forth prudent banking requirements towards banks, describes capital reserves for various types of risks and instruments, includes limits on amounts extended to connected parties and reporting to the supervisory authority.

Ordinance No. 148 on manner of inspections of the credit institutions, micro-credit deposit organisations and their branches by the representatives of the National Bank of Tajikistan (adopted 25 February 2006, as amended) – establishes rules for on-site inspections by authorised NBT representatives. The Ordinance sets forth the requirements towards the inspectors, their authorities, obligations of banks and inspection procedure.

Regulation on organisation of internal control (25 January 2000) –n/a on line.

Guidelines on undertaking consolidated supervision (21 June 2007) – mandatory set of rules that establishes methods of consolidated financial reporting by banking groups and supervisory authority reporting requirements.

Guidelines on banking activity grading (27 March 2009) – establishes an evaluation framework, mandatory for the supervisory authority. The Guidelines include a set of ratings for the following key elements of banking: capital adequacy, management ability, income levels and quality and liquidity adequacy.

Recommendations on organisation of operational risk management in credit and micro-finance institutions (25 September 2009) – includes a set of recommendations (not mandatory) describing the operational risks, principles of such risk management and risk management supervision.

Corporate governance rules

Principles of corporate governance in commercial banks and other credit institutions, licensed by the National Bank of Tajikistan (25 February 2005) – includes a list of principles of corporate governance for Tajik banks. Although the Principles are approved by the NBT and on the face of it appear to be mandatory, the language of the Principles is vague and does not require any concrete steps to be undertaken by banks to be in compliance with the Principles. Also the Principles do not expressly state that they are mandatory or establish any compliance mechanism. The Principles require banks to: i) approve a code of corporate values; ii) approve corporate strategies; iii) develop clear distribution of responsibilities, authority and reporting; iv) set up a mechanism of interaction between the governing bodies and external and internal auditors; v) develop effective internal control system; vi) monitor areas with potential for conflict of interest; vii) develop effective system of remuneration and vii) insure adequate information flows within the bank and to other market participants.

Source: National Bank of Tajikistan (http://www.nbt.tj/ru/zakoni/) and other on-line sources.

http://www.nbt.tj/ru/zakoni/



B. Analysis of bank corporate governance framework and practice in Tajikistan

1) The strategic and governance role of the board

Key strengths

Legal Framework

18. The legal framework of Tajikistan includes the basic elements of corporate governance in banks. The relatively recent Banking Law requires banks to set up two-tier governance structure. The Law delegates to the supervisory board the authority to approve the strategy of the bank. The Law also assigns to the supervisory board the responsibility to set up and decide the principles for the risk management system, investment strategy, minimal prudential limits and internal control system. The JSC law further confirms the strategic position of the supervisory board by expressly delegating to it the responsibility to approve the business plan and budget. Note, however, that many of the provisions of the banking and other laws do not apply to the state owned companies and banks, as these are governed by separate government regulations.

19. The banking law expressly assigns to the supervisory board the duty to appoint the executive body and to supervise its activity, adopt relevant internal rules and decide executives’ remuneration. This ensures that the supervisory board has sufficient oversight authority over the senior management.

Bank Practice

20. In line with the law, in all three banks reviewed the supervisory board is the body responsible for the approval of the budget and strategy of the bank. In the majority of the banks reviewed, the board has also developed a policy for approval of the strategy. In the two private banks, the supervisory board appoints the members of the management body and supervises their activity. This reinforces the strategic role of the board and contributes to the banks’ efficient governance structure.

21. The majority of the banks reviewed have adopted corporate governance policies and all have adopted codes of ethics. The majority of banks reviewed report using the national voluntary Principles on Corporate Governance as reference for their corporate governance practices.

Key weaknesses

Legal Framework

22. A number of banking law provisions do not apply to state banks, in particular those related to the governance structure of banks. This highlights the extensive government influence on state banks and creates an uneven playing field in the banking sector.

23. There are few inconsistencies between the banking law and law on JSC, especially with regard to the responsibilities of the supervisory board. When referred to banks, the provisions of the banking law prevail, but the law on JSC is still applicable in situations not fully regulated by the banking law. This might cause inconsistencies in the practices of banks.

Supervisory practice

24. The National Bank of Tajikistan has approved the Corporate Governance Principles that include a number of valuable recommendations for improving the corporate governance in banks. The



Principles appear to be of voluntary nature and the regulatory framework of the country does not include any incentives or tools for the banks to adhere to Principles. The NBT should encourage banks to follow the Principles via its supervisory process (for instance, banks may be required to disclose to the NBT the implementation of the Principles, according to a “comply or explain” mechanism or alternatively, some of the Principles may be made mandatory in view of their importance for sound corporate governance system, as for example the disclosure requirements).

25. It appears that the state often interferes with the strategy of the banks requesting credit institutions to lend to priority sectors important for the country’s economy. Such directed lending often happens at the expense of bank thwarting prudency principles while the supervisory authority does not apply sufficient resistance to the state to protect the banking industry.

Bank Practice

26. The state owned bank is organised as a one-tier system and is governed by a board of directors which primarily comprises executive officers of the bank, with only two non-executive members out of eight. This creates a strong bias towards executives and does not ensure an objective oversight over the management. The state bank does not appear to follow any corporate governance standard and has not adopted its own corporate governance policy or code.

2) Composition and functioning of the board

Key strengths

Legal Framework

27. The banking law includes basic “fit and proper” criteria for the supervisory board members. According to the law, all supervisory board members must have university education, commercial competence, reliability and credibility. At least a quarter of the supervisory board members must have banking experience. The requirements for the executive board members are more rigorous and comprise university degree in economics, five years of banking experience, three years of management experience and knowledge of banking law. The law does not seem to provide the NBT with the authority to assess the adequacy of the supervisory board members as it is the case for the candidates for the executive board.

Bank practice

28. Banks have supervisory boards of manageable size - less than ten members - which allows all members to actively participate in board meetings and express their views. Despite the lack of any legal requirements to this end, two of the reviewed banks reported appointing at least one “independent” director on their supervisory board (it should be noted that there is no definition of independent director). While the number of independent directors and their use may not be sufficient to provide board with an “independent judgement” on key decisions, it is somehow laudable that those banks attempt to implement best international practice.



Exhibit 3: Boards' size and profiles in the three banks reviewed

29. All banks reviewed report to have mapped out the responsibilities and authorities of the board and committees in separate internal regulations. Banks have also appointed a corporate secretary to assist their board committees. However, it does not seem that the corporate secretary is in charge of monitoring the banks’ corporate governance policies and promoting good corporate governance practices

Key weaknesses

Legal framework

30. Although the law sets forth the basic “fit and proper” criteria for SB members, currently there does not seem to be any authority provided by law to the supervisory authority to approve SB members. Additionally, there is no guidance explaining what is meant by “reliability” and “credibility” of supervisory board members. Such guidance would help avoiding misinterpretations and abusive and non-transparent application of the rules by supervision authorities.

31. The law does not require banks to include independent directors on their supervisory boards and does not provide a definition of independence. Members of the board should be able to engage actively in the business of the bank and to make their own sound, objective and independent decisions and judgements. For the boards to exercise this objective and independent judgement, the OECD Corporate Governance Principles recommend to include a sufficient number of independent directors who are not related or connected or affiliated to the controlling shareholders and senior management, including via former and current employment, any material business relationship, additional remuneration, close family ties or cross directorship.

32. The legal framework on the board members’ duties of care and loyalty and their enforcement are seriously underdeveloped, with no relevant court practice in this area. Although the framework for conflicts of interests is relatively comprehensive, the other aspects of director duties, such as the time



and care the directors must dedicate to their duties, their obligation to avoid activities that are in competition with the bank do not have a robust definition or equivalent in law and practice.


33. The supervisory authority does not seem to approve the candidates for the supervisory boards in banks and there is no indication in the legal framework that the supervisor must be notified about the members' qualifications. This lack of supervision might cause boards not to be fit for the business of the bank.8 The proper implementation of fit and proper criteria by the NBT may help reduce the highly felt political influence on boards. This should be coupled with clear and transparent guidelines regarding the fit and proper criteria and the approval process.

34. The supervisory authority does not appear to monitor the nomination policies for the supervisory board members. Best practices recommend that the board should select and, when necessary, replace senior management and have in place an appropriate plan for succession. These plans should include the description of the necessary competencies and skills to ensure sufficient expertise on the board9.In this respect, it should be the role of the regulator to encourage banks’ to develop transparent nomination policies that identify the competence, experience and knowledge needs of the board, based on objective criteria. Ideally, nomination policies should reflect the results of the self-evaluations made by the banks’ boards.

Bank practice

35. Although some private banks appoint to their boards independent directors, it is not clear if their role is fully understood. None of the banks includes independent members in board committees, where the “independence of judgement” is most needed. In particular, best practices recommend that the audit committee should consist of a sufficient number of independent supervisory board members with experience and knowledge commensurate with the complexity of the banking organisation and the duties to be performed (especially in financial reporting, accounting and auditing).

36. Banks do not seem to appoint as chairman of supervisory boards candidates with extensive experience in financial and banking industry. “The chair of the board plays a crucial role in the proper functioning of the board. He or she provides leadership to the board and is responsible for the board’s effective overall functioning, including maintaining a relationship of trust with board members. The chair should possess the requisite experience, competencies and personal qualities in order to fulfil these responsibilities.”10.

37. As mentioned above there is no balance of power in the state banks as it is dominated by the executive directors and does not include any independent members.

38. The practice regarding setting up board committees indicates that they are of hybrid nature rather than purely board committees. Committees can include supervisory board members and outsiders (but not management board members). The establishment of board committees is generally recommended by best practices. The number and nature of committees (e.g., audit committee, risk committee, nomination and remuneration committee) depends on many factors, including the size of the bank and its board, the nature of the business areas of the bank, and its risk profile.

8 The Basel Committee’s Principles for enhancing corporate governance recommend that fit and proper criteria should include, but

may not be limited to: (1) the contributions that an individual’s skills and experience can make to the safe and sound operation of the bank, including general management skills and (2) any record of criminal activities or adverse regulatory judgments that in the supervisor’s judgment make a person unfit to uphold important positions in a bank. 9 See EBA Guidelines on Internal Governance (GL 44), page 24.

10 Basel Committee’s Principles for enhancing corporate governance - final document, 2010 (http://www.bis.org/publ/bcbs176.pdf)

http://www.bis.org/publ/bcbs176.pdf



39. The inclusion of outsiders (i.e., non supervisory board members) in board committee needs to be carefully considered. First, it is important that board committees include only supervisory board members if the functions delegated to the committee are typical supervisory board functions. Secondly, it is essential that those members sitting in the committee and recommending specific actions, follow up such recommendations and vote at the supervisory board, therefore reinforcing their “objective judgement” at the board. Finally, committees made of outsiders can create problems with confidentiality and accountability issues and committees made of executives create conflict of interests situations. While, it is legitimate that the committee might need external advice or expertise on specific issues, the committee should be able to request such advice, but it should not allow the advisor(s) to replace the committee in its determinations and recommendations.

Exhibit 4: Board reporting committees in the three banks reviewed

Audit Remuneration Risk

Bank 1

(includes shareholder representative and executive officers)

(includes supervisory board members

and other executive officers) X

Bank 2

(includes supervisory board

members and other executive officers)

X



Bank 3 X X



40. All banks reviewed do not organise induction programs and further professional education for the board members. In order to help board members acquire, maintain and deepen their knowledge and skills and to fulfil their responsibilities, best practices recommend the board to ensure that directors have access to programmes of tailored initial (e.g., induction) and ongoing education on relevant issues. It is also recommended that the board should dedicate sufficient time, budget and other resources for this purpose.

3) Risk Governance

Key strengths

Legal framework

41. The banking law expressly delegates to the supervisory boards the strategic responsibilities to set up the risk management system and decide the minimal prudential limits. This gives a clear indication of the strategic role of the board and allows monitoring more efficiently management's actions against limits and targets set by the board.

Supervisory framework

42. The National Bank of Tajikistan reported that it regularly requires risk appetite statements and reviews risk profiles of banks. Such practice is useful for timely identification of potential issues in banks' risk management and order prompt remedy by the banks.



Bank practice

43. The majority of banks reviewed have created senior executive risk committees having an overview of the risk issues in the bank. This is considered a good practice for effective sharing of information across the bank as executive committee allow to draw members from across the bank (e.g., from business lines and the risk management function) to discuss issues related to firm-wide risks.11 All banks have also set up credit committees and ALCO.

44. The majority of banks reviewed reported that their audit departments have audited the banks' risk management system. This is a recognised technique for improving the ability of the internal audit function to identify problems with a bank’s governance, risk management and internal control systems.12

Key weaknesses

Legal framework

45. There is no mandatory regulation setting the basic requirements on risk governance and risk management systems in banks. The NBT has adopted a voluntary set of Guidelines on operational risk management in banks and it is assumed that banks follow such guidelines. However, to ensure stability of the financial system, the regulator should provide more robust and enforceable rules regarding risk management, and include requirements regarding the various types of risks, in particular, the foreign exchange risk and exchange rate risk, which appear particularly relevant for the country's banking system.

Supervisory framework

46. In order for the banks' supervisory boards and boards of directors to adequately supervise and consider risk issues it is important that boards and their risk committees include risk management expertise. In view of this, the supervisory authority should encourage and banks should include risk management expertise on their supervisory board and be capable to seek independent external advice where necessary or appropriate.

Bank practice

47. Although, the banking law asserts the strategic role of the supervisory board in setting the risk strategy and risk governance system in banks, it does not appear that boards have such a role in practice. It seems that many of the risk limits are approved at the executive rather than by the supervisory board, while the existing risk committees mainly include executives.

48. The Guidelines on operational risk management recommends banks to appoint a Chief Risk Officer (or equivalent). Accordingly, it appears that the majority of banks reviewed have a chief risk officer (CRO), but without regular and direct access to the board. In this respect, best practices recommend the CRO to be able to report and have direct access to the board and its risk committee without impediment. Interaction between the CRO and the board should occur regularly and be documented adequately.

11

Principles on corporate governance (2010), Basel Committee on Banking Supervision, Principle 8, p.23, see at: http://www.bis.org/publ/bcbs176.pdf 12

The Basel Committee recommends "engaging internal auditors to judge the effectiveness of the risk management function and the compliance function, including the quality of risk reporting to the board and senior management, as well as the effectiveness of other key control functions", Id. Principle 9, p. 23.




Moreover, supervisory board members should have the right to meet regularly with the CRO in the absence of senior management.13

4) Internal Control

Key strengths

Legal framework

49. There is a relatively comprehensive framework regulating conflicts of interest situation that includes annual disclosure by all executives and directors of their financial interests, independent review of transactions with conflict of interest and extensive definition of the connected persons. At the same time, some of the definitions provided in the law and banking regulations for "affiliated" and "related" parties, differ and should be harmonised to insure consistency.

50. The banking law requires banks to set up separate audit departments and the head of the audit department must comply with the same "fit and proper" criteria as those set for the management board members (i.e. university degree in economics, five years of banking experience, three years of management experience and knowledge of banking law). However, the law fails to designate a body in charge for appointing and removing the head of the internal audit, therefore limiting its independence from the management.

51. The law regulates the activity of the external auditor, which should not be in conflict of interest when providing its services to banks and should be rotated every 5 years. External audit firms are prohibited from providing other than audit services to the same bank. The audit committee of the bank must monitor the report of the external auditor, recommend its candidature to the supervisory board and can require external auditors to participate at the committee’s meetings. The law requires external auditors to have direct access to the supervisory board (and not to audit committee, as it is not necessarily a supervisory board committee).


52. The National Bank of Tajikistan reports that it regularly meets with the audit committees of banks and closely monitors internal control systems in banks.

Bank practice

53. All banks have set up internal audit departments and the two privately owned banks reviewed have created audit committees, with auditing/accounting knowledge and experience.

54. All banks reviewed reported having in place policies for handling transactions with conflict of interests. This is in line with best practices that further recommend banks to include in these policies measures as segregation of duties and chinese walls (e.g., information barriers as physical separation of certain departments, preventing people who are also active outside the institution from having inappropriate influence within the institution regarding those activities).14

13

Principles on corporate governance (2010), Basel Committee on Banking Supervision, Principle 6, see at: http://www.bis.org/publ/bcbs176.pdf 14

See EBA’s Guidelines on Internal Governance (GL44), p. 30, see at:

http://www.eba.europa.eu/cebs/media/Publications/Standards%20and%20Guidelines/2011/EBA-BS-2011-116-final-(EBA-Guidelines-on-Internal-Governance)-(2)_1.pdf






Key weaknesses

Legal framework

55. The legal framework provides little guidance on they way banks should organise their internal control system and internal audit departments; or how to ensure the independence of the internal audit process and function; or on the internal audit’s reporting lines. This creates an unclear practice and accountability lines, which weaken the internal control systems in banks. A weak risk management and internal control system gives more leeway to the political pressure exerted on the banks to lend to certain areas of economy with disregard to businesses viability or repayment ability. In order to ensure the independence of the internal audit function, best practices recommend that it should report directly to the board or its audit committee (where applicable). All internal audit recommendations should be subject to a formal follow-up procedure by the respective levels of management to ensure proper implementation.15

56. The law does not set any criteria for the composition of the audit committees in banks. The law requires all banks to set up audit committees appointed by and reporting to the supervisory board. Audit committees are not required to include only supervisory board members, or to be composed of independent board members and have auditing and/or accounting experience. Moreover, audit committee members are not subject to duties of care and loyalty applicable to board members and are not made by board members, they have weak or no accountability for their actions. To enhance the effectiveness of the audit committee, the legal framework should require that all members should be financially literate and at least one member should possess recent and relevant specialist knowledge in financial reporting, accounting or auditing. The audit committee should be composed in a way that independent directors can exert influence in order to help ensure objective judgments.16


57. The NBT reports that it closely monitors the internal control structures in the banks. However, the lack of a detailed legal framework on the organisation and functioning of the internal control systems limits the ability of the supervisory authority to assess the effectiveness of the systems in predictable and transparent manner. The supervisor should consider issuing some guidance to this end. Best practices recommend that supervisors should endeavour to establish guidance or rules requiring banks to have robust corporate governance strategies, policies and procedures. This is especially important where national laws, regulations, codes, or listing requirements regarding corporate governance are not sufficient to address the unique corporate governance needs of banks.17

Bank practice

58. Audit committees are not independent. Although the reviewed privately owned banks appear to have one independent director on their supervisory boards, these are appointed at the banks’ audit committees. The independence of the committees is further undermined by the fact that committees also include executives.

15

See EBA’s Guidelines on Internal Governance (GL44), p. 44. 16

Corporate Governance of Banks in Eurasia, OECD and EBRD, § 19, see at: http://www.ebrd.com/russian/downloads/legal/corporate/policyen.pdf 17

Principles on corporate governance (2010), Basel Committee on Banking Supervision, Chapter IV, § 133, see at: http://www.bis.org/publ/bcbs176.pdf

http://www.ebrd.com/russian/downloads/legal/corporate/policyen.pdf




59. None of the banks reviewed have set up compliance function. The compliance function is in charge for managing the compliance risk,18 which can lead to fines, damages and/or the voiding of contracts and can diminish a bank’s reputation.19 The function should identify related potential risks, as well as material deviations, and report these to board and the management. Best practices recommend that board recognise and acknowledge that independent, competent and qualified compliance functions are vital to the corporate governance process in order to achieve a number of important objectives.20

60. Two of the banks reviewed do not publish their annual reports on-line or any other sources of information regarding their internal control systems. According to best international practice, the internal governance framework of a bank should be transparent. A bank should publicly disclose at least its internal control framework and how its control functions are organised, the major tasks they perform, how their performance is monitored by the management body and any planned material changes to these functions.21

61. The reviewed state owned bank does not comply with the same rules as those for the private banks and it has not set up an audit committee.

5) Incentives and Remuneration

Key strengths

Bank practice

62. Banks reviewed indicated that supervisory boards set the remuneration for the management through a formal process and established procedures. The variable part of the remuneration is generally reported to be linked to individual and firm performance. The variable part of compensation to bank executives is generally less than 20% of the remuneration package, which does not seem to pose particular risks to banks.

Key weaknesses

Legal framework/Supervisory practice

63. The Corporate Governance Principles for banks recommend that banks should link their remuneration to corporate governance values, strategic goals and long-term results. However, it does not appear that NBT encourages banks to develop remuneration policies that reflect the mentioned principles and does not closely monitor such policies.

Bank practice

64. Supervisory boards in banks tend to decide only the remuneration for the management and do not develop a bank wide remuneration policy that establish a clear vision for bonus payments and salary composition aligned with prudent banking, long-term goals and results of the bank.

18

See in particular, EBA Guidelines on Internal Governance (GL 44), page 43. Compliance risk is defined as the current or prospective

risk to earnings and capital arising from violations or non-compliance with laws, rules, regulations, agreements, prescribed practices or ethical standards) can lead to fines, damages and/or the voiding of contracts and can diminish a bank’s reputation. 19

See EBA’s Guidelines on Internal Governance (GL44) - http://www.eba.europa.eu/cebs/media/Publications/Standards%20and%20Guidelines/2011/EBA-BS-2011-116-final-(EBA-Guidelines-on-Internal-Governance)-(2)_1.pdf 20

Basel Committee’s Principles for enhancing corporate governance - final document, 2010 (http://www.bis.org/publ/bcbs176.pdf) 21

Ibidem, § 33.






65. Banks have reported that the variable compensation paid to the CRO is calculated according to the same criteria as other senior executives. Best practice recommend that for employees in the risk and compliance function, the remuneration should be determined independently of other business areas while performance measures should be based principally on the achievement of the objectives of their functions.22

6) Transparency to the market and regulators

Key strengths

Legal framework

66. The law requires all banks to prepare its financial reporting in accordance with IFRS and external auditor to audit the financial report. Banks must also include in their financial reports information about the bank’s governance system and a report about the supervisory board’s activity during the precedent year.


67. The NBT has access to the banks’ governance and risk information. The legal framework provides extensive inspection and supervision authorities to the NBT, which reported it has the capacity to obtain information about the ultimate beneficial owners in banks.

Bank practice

68. All banks reviewed disclose their shareholding structure and names of members of supervisory and management boards. Occasionally, banks also publish short bios or indicate educational background of directors.

69. Only one large bank in the country publishes on its website its most recent annual reports. Its latest report includes basic data on the bank’s risk governance, disclosure of aggregated amounts for executive remuneration and a statement of related parties’ transactions.

Key weaknesses

Legal framework

70. Tajikistan has begun adopting IFRS standards, and all financial institutions are obliged to implement the IFRS —although the degree of enforcement reportedly varies across institutions. International auditing standards are not required.

71. There is no requirement for banks to publish on-line their financial reports; and any other governance related information. The law only requires that banks publish their annual reports in one or two local newspapers. This procedure does not allow easy access to information. As recommended by best

22

Compensation Principles and Standards Assessment Methodology, Basel, 2010, Principle 3 - Standard 2, see at: http://www.bis.org/publ/bcbs166.pdf See also: FSB Principles for Sound Compensation Practices (http://www.financialstabilityboard.org/publications/r_090925c.pdf)


http://www.financialstabilityboard.org/publications/r_090925c.pdf



practices, timely public disclosure is desirable on the bank’s public website, in its annual and periodic financial reports or by other appropriate forms.23


72. The NBT does not monitor bank disclosure practices and does not encourage banks to publish on-line their financial statements.

Bank practice

73. Apart from one bank, the other banks under review do not publish their financial statements or annual reports on their websites. Banks do no publish their organisational structure, boards’ committee structure and composition and board members’ experience. Banks do not disclose their risk management policies, remuneration policies and corporate governance policies.

74. Banks do not have a dedicated webpage with shareholders and investors dedicated information, as general shareholders meetings information, shareholders meetings’ minutes and supervisory board reports.

* * *

7) Key recommendations

75. The following box is a summary of the recommendations which aim to address some of the weaknesses identified in this Report. The purpose of these recommendations is to assist the EBRD in identifying priority areas for policy dialogue.

Legal framework

1. The legal framework regulating governance structure, board composition, internal control and risk management, remuneration systems and disclosure should apply to state banks in the same manner as to private banks, so to create a level playing field.

2. Banking regulations should provide additional guidance on the fit and proper criteria for supervisory board members in order to ensure consistency in application and avoid misinterpretation.

3. The legal framework should define what is meant by “independent supervisory board member” and require banks to have a sufficient number of independent and qualified supervisory board members, with the necessary technical and professional skills.

4. The legal framework should better detail the composition and qualification of board committee and in particular the audit committee. The audit committee should be composed only of non executive/supervisory board members with a balance of skills and knowledge commensurate to the complexity of the banking organisation and the duties to be performed. The committee should include a sufficient number (at least the majority) of independent members with recent and relevant experience in financial reporting, accounting and auditing.

5. The law should be more explicit when describing directors' duties of loyalty and care and should define clear lines of responsibility for failure to comply with such duties.

23

Principles on corporate governance (2010), Basel Committee on Banking Supervision, Principle 14, §131, see at: http://www.bis.org/publ/bcbs176.pdf




6. The law should include a comprehensive framework for risk management and internal control systems in order to guide banks in setting up their internal mechanisms in a consistent order and prevent harmful practices.

7. The law should require all banks to disclose all mandatory information on their websites.


8. The supervisory authority should require banks to implement the Corporate Governance Principles issued by the NBT (for example with a “comply or explain” mechanism). Additionally, some of the recommendations may be made mandatory in view of their importance for sound corporate governance system, as for example disclosure requirements.

9. The supervisor should monitor state interference in banking activities and make sure that banks adhere to prudent lending requirements.

10. The supervisory authority should have a more active role in monitoring the skills and experience necessary on the supervisory board and should establish a transparent mechanism to approve members of the supervisory board.

11. The supervisory authority should require banks to develop nomination policies and encourage banks to periodically self-assess the necessary mix of skills adequate for the proper functioning of the board.

12. The supervisor should require banks to develop remuneration policies containing clear information on the links between compensation and performance. It should also require banks to inform the supervisor about the amount of variable remuneration paid, and ensure compensation is linked with prudent risk management.

Bank practice

13. The supervisory board in banks should be more proactive in setting the corporate governance values of the bank. Banks should appoint an officer/corporate secretary in charge of monitoring and regularly reporting to the board the bank’s corporate governance structure.

14. The chairman of the board should possess the requisite experience, competencies and personal qualities in order to insure the board’s effective overall functioning, including banking/financial experience.

15. Banks' supervisory boards should be in charge for approving the bank’s risk management policies and risk appetite. Banks’ board should possess specific risk management expertise.

16. The chief risk officer (or equivalent) must have regular access to the supervisory board and in particular to its independent directors.

17. Banks should consider compliance risk as part of their risk management function.

18. Banks' supervisory boards should set the principles for the remuneration systems in banks and adopt remuneration policies aligned with prudent risk taking. Risk management staff and independent directors’ remuneration should not be linked to bank’s performance but should be determined independently of other business areas and based principally on the achievement of the objectives of their functions in order not to compromise their independent outlook on risk.



19. Banks should improve their governance and risk disclosure on the Internet and in particular publish their annual reports, organisational structure, committee structure of their boards, information about experience of board members and names and expertise of the members of board committee. Banks also should disclose their risk management, remuneration and corporate governance policies.

8) Overall assessment of bank governance quality in Tajikistan

76. The following table provides a preliminary rating of Tajikistan’s performance in the key governance areas mapped out in the EBRD best practice assessment checklist. Rating in this table is subjective and based on the overall assessment of the strengths and weaknesses of the legal framework, supervisory practice and the practice of banks as discussed above. The rating also reflects our assessment of the legal framework, supervisory practice and the practice of banks compared to international best practice standards.24

Issues Score25

The strategic and governance role of the board

Strategic role of the board

Do boards have a sufficiently active role in developing and approving the strategic objectives and the budget of their banks?

Moderately strong

Do boards effectively review and evaluate management performance against agreed budgetary targets?

Moderately strong

Do boards effectively shape the governance framework and corporate values throughout their organisation?

Weak

Are boards of subsidiaries in a position to effectively control the operation of their banks? Weak

Is there adequate transfer of good practice between parents and subsidiaries? n/a

Board composition and functioning

Size, composition and qualification

Is the size of boards adequate to meet the requirements of their business? Moderately

strong

Are directors qualified for their position? Weak

Is the board sufficiently independent from management and controlling shareholders? Very Weak

24 Best practice standards used in our assessment: Basel Committee on Banking Supervision, Principles for enhancing corporate governance, (2010); Basel Committee on Banking Supervision, Enhancing corporate governance for banking organisations, (2006); EBRD, OECD, Corporate Governance of Banks in Eurasia, (2008); OECD, OECD Principles of Corporate Governance, (2004); European Commission, Corporate governance in financial institutions and remuneration policies, (2010); Institute of International Finance, Final Report of the IIF Committee on Market Best Practices: Principles of Conduct and Best Practice Recommendations, (2008); Netherlands Bankers’ Association, Banking Code, (2009) 25

Where: “Strong to very strong” - The corporate governance framework / practices of supervisory authorities / practices of banks are fit for purpose and are close to best practice. “Moderately strong” - Most parts of the corporate governance framework / practices of supervisory authorities / practices of banks are adequate but further reform is needed “Weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain some elements of good practice but overall the system is in need of reform “Very weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain significant risks and are in need of significant reform.



Issues Score25

Are the duties of directors to their banks, shareholders and stakeholders clearly set out? Very Weak

Is there adequate balance of power between individuals within boards and are there adequate checks to maintain the balance?

Very Weak

Do board chairs possess relevant banking and/or financial industry experience and a track record of successful leadership?

Very Weak

Do current tenure patterns of board directors suggest a high level of engagement and independence? Very Weak

Do boards provide adequate induction and professional development to their members? Very Weak

Nomination committees

Is the process for director succession and nomination sufficiently transparent? Very Weak

Functioning and evaluation

Are the responsibilities, authorities, and terms of reference of boards and board committees clearly defined and documented?

Weak

Do boards function in ways that encourage informed contribution and constructive challenge by all directors?

Weak

Do boards meet regularly? Weak

Are boards and board committees supported by a senior company secretary? Weak

Do boards evaluate their performance and discuss the outcome of such evaluation? Very Weak

Risk governance

Risk governance framework

Are boards and their risk committees sufficiently involved in setting the risk appetite and monitoring the risk profile of banks?

Weak

Do banks appoint and empower senior chief risk officers? Weak

Do senior executives have a sufficiently integrated firm-wide perspective on risk? Moderately

strong

Risk committees

Are boards in a position to effectively review risk management? Very Weak

Internal Control

Internal control framework

Does the organisational structure of banks include clearly defined and segregated duties for key officers and effective delegation of authority?

Weak

Are there enough check s and balances to ensure the independence and integrity of financial reporting?

Weak

Are conflicts of interest including related party transactions effectively managed? Moderately

strong

Have banks established effective internal audit departments? Weak

Do banks establish effective compliance departments to ensure that they comply with regulatory obligations?

Very Weak

Do boards and their audit committees effectively oversee and regularly review the effectiveness of the internal control systems?

Weak



Issues Score25

Audit committee

Do boards establish audit committees? Weak

Are audit committees fully independent? Very Weak

Do audit committees include at least one member with substantial auditing or accounting experience?

Very Weak

Incentives and compensation

Remuneration policy

Do boards and their remuneration committees have a sufficient role in shaping the compensation system of their banks?

Weak

Is remuneration meritocratic and linked to firm and individual performance? Weak

Is senior executive compensation aligned with prudent risk management? Very Weak

Remuneration committee

Do boards establish remuneration committees? n/a

Are remuneration committees independent from management? n/a

Transparency to the market and regulators

External auditor

Is external auditor independence upheld by boards and their audit committees? Moderately

strong

Financial statements

Is IFRS required by law or regulation? Moderately

strong

Corporate governance

Do banks report regularly on corporate governance matters? Very Weak

Do banks publish key governance information on their website? Very Weak

Is disclosure proportionate to size, complexity, ownership structure and risk profile of banks? Very Weak

Transparency to regulators

Can the supervisory authority obtain information about ultimate ownership and other corporate governance matters?

Weak

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