Corporate Governance: Need & Significance in Nepalese Banking System Good corporate governance is a key part of any regime

which has confidence, integrity and efficiency as its bedrock and which is looking to attract and retain capital on a sustained long term basis. For this reason, it is important that good corporate governance is not only driven by compliance or regulatory requirements, but very importantly is also seen as a means by which companies and economies can improve their performance, competitiveness and sustainability. Corporate governance as properly understood describes the framework of rules, relationships, systems and processes within which and by which authority is exercised and controlled in corporations. Understood in this way, the expression corporate governance embraces not only the models or systems themselves but also the practices by which that exercise and control of authority is in fact effected. Good corporate governance can also be defined by looking at the opposite and some of the catastrophic failures, such as Enron, Palarmat, Barings, HIH, many of which happened very quickly, and involved companies which ostensibly appeared to be doing very well. Concisely, corporate governance is all about responsibility and accountability of the directors and the management team to the stakeholders. It has to be a transparent and fair system where all the shareholders are treated equally and have the opportunity for redressing the violation of their individual rights. It is a combination of corporate policies and best practices adopted by corporate bodies in achieving its objectives in relation to their stakeholders. It addresses the principal/agency problem through a mix of company law, stock exchange rules and sub regulatory codes. It arises from high profile corporate scandals, globalization and increased investor activism. Involvement of governments, regulators and market participants A key feature of developments in corporate governance in recent years is the involvement of various players it is not being left to one group alone, nor can it be. Governments have a major role, including in Providing the overall legal and regulatory regime with appropriate incentives and sanctions for good corporate governance; and robust and independent and regulatory and judicial structures, with appropriate enforcement mechanisms, Addressing the critical interface of corporate governance with company, securities, insolvency and criminal law; and Having appropriate mechanisms to address market crises or failures.

Significance of Corporate Governance in Banking Sector

From the viewpoint of banks and financial institutions, corporate governance includes maintaining capital adequacy, transparency in the publication of accounts, management of operational, credit, market and environmental risks, to name a few. As for example, when Standard Chartered Bank started its operation in Nepal, we were aware of only two risks operational and credit. Today, so many added risks have come through the process of evolution because markets have matured and newer instruments have been introduced. So, as a result to that, regulators have to devise additional control mechanisms. Corporate governance enhances performance of the corporation by motivating manager to maximize returns on investment, raising operational efficiencies and ensuring long- term productive growth. It is very crucial and essential element for the banking system because bank and financial institutions depends on the other peoples money. The corporate governance is important in banking sector because it helps to emphasis the significance of corporate governance in the banking sector because of: 1) Banking system stability is important for economic growth; 2) Good corporate governance is required in banks to achieve corporate governance in other firms. 3) Banks have wider 1

stakeholders-government, regulators and most importantly depositors. 4) Promotes market confidence, helps to attract additional capital, and fosters market discipline through good disclosure and transparency. It also helps to ensure that company takes into account the interest of not only of a group of people but also of the communities within which they operate. A good corporate governance practices can strongly contribute to financial market development and financial stability. Many different financial institutions has developed and presented the various guidelines on enhancing corporate governance in banking and financial sector. Corporate Governance: Need & Significance in Nepalese Banking System In Nepalese context, the regulators very kindly agreed for the entry of international players in the form of joint venture banks into the market. This shows that government/regulators are open to competition from international companies. With Nepals accession to World Trade Organization, other major international players are expected to join in who will bring in fresh dimensions to the sector. In other developing markets, the entry of international players has made all the difference; they have galvanized the market and imparted healthy competition. Banking reforms can only be fully implemented once prudential regulatory systems are in place. As a matter of fact, Nepal has plenty of it. The potential returns from good corporate governance include: An increased willingness of quality investors to invest in diverse sectors of the economy on a sustained basis Improved company and market performance Enhanced soundness of the financial system and financial markets Long-term benefits to the economy, and its comparative advantage Existing Laws and Regulation There are many laws and bylaws. It is critically important for making corporate governance effective in an economy like Nepal. Most of the markets, which have developed today, have gone through this phase for many years. Nepal is not an exception. Nepal Government and central bank are working to develop transparent, competitive and strong financial sector. Till date there have been several efforts towards building regulatory mechanism for corporate governance. In Nepal, NRB has issued directives on good corporate governance. It is a clear indication of central banks commitment to bring about high level of corporate governance. To be very specific, Directive Number 6 of the central bank is related to the code of ethics to be observed by directors and chief executive officers of banks and financial institutions. These codes of ethics require all the directors, regardless of their executive or non-executive status, to sign a declaration which prohibits directors involvement in activities against the interest of the company. I firmly believe that good governance and good performance reinforce each other. With good governance, good performance comes automatically. Challenges of Corporate governance Frequently changed government and different political unrest keep different problem in governance issues. Nepalese economy is rapidly integrated with global economy with its outward oriented policies followed by membership of WTO, SAFTA and BIMSTEC. On the other hand, last few years data gives contradictory result about industry return of different sector of economy. Some of the major challenges of corporate governance are: failure by the boards of direction to understand the risks their firm is taking conflicts of interest and a lack of independent (and even more importantly , independently minded) Board members or senior executives boards entering into, or allowing, transactions that benefited a few at the expense of the 2

many weak or non-existent internal controls , or controls which appeared to be adequate on paper, but which were not implemented in practice internal and external audit failure, either through negligence or incompetence, or through aiding and abetting fraudulent or inappropriate behavior transactions, and organizational structures, designed to reduce transparency and prevent market participants and regulators from gaining a genuine picture of the firms condition and perhaps most importantly, a corporate culture which fosters unethical behavior and in particular discourages difficult questions from being asked

In conclusion, I would like to emphasize that for the betterment of the overall financial system in the country, it is incumbent upon all of us i.e the regulators, the companies, the directors, employees and the shareholders to gracefully honor the principles of governance. It is our collective responsibility and we cannot just hold the central bank or the chief executive officer responsible for any setback. I strongly believe that banks and financial institutions reforms can fully be implemented if and only if prudential regulatory systems are practiced with a strong desire for success. Nevertheless, an efficient judiciary system would also be required for effective implementation. Article No: 3 Corporate Governance the Foundation for Corporate Citizenship and Sustainable Businesses presented by Rupak Shrestha A well-governed company takes a longer-term view that integrates environmental and social responsibilities in analyzing risks, discovering opportunities and allocating capital in the best interests of shareowners. There can be no better way to restore public confidence in both businesses and markets and build a prosperous future. Good corporate governance practices instill in companies the essential vision, processes, and structures to make decisions that ensure longer-term sustainability. More than ever, we need companies that can be profitable as well as achieving environmental, social, and economic value for society. Corporate Governance is a manner by which organizations are directed and controlled. It provides a structure through which a companys objectives are set and the means of monitoring the performance of those objectives are outlined. It includes the laws governing the formation of individual units, firms, companies etc. and the bylaws established by themselves in their Memorandum of Association and Article of Association. The fundamental concern of corporate governance is to ensure that a companys directors and managers act in the interest of the company and all its stakeholders. Good governance thus aims to protect shareholders rights, enhance disclosures and transparency facilitating an effective functioning of the board and provide an efficient legal and regulatory environment and enforcement framework. It is important for stopping Corruption/Bribery, Principal-agent problem through the implementation of Corporate Governance, Protect stakeholders rights, Reduce corruption in business dealings, Keep managers focus, Pressure on the management, Globalization, Importance of Social Responsibility, Takeovers and Mergers. Frequently changed government and different political unrest keep different problem in governance issues. There are many laws and bylaws. It is critically important for making corporate governance effective in an economy. It is very crucial and essential element for the banking system because bank and financial institutions depends on the other peoples money. The corporate governance is important in banking sector because it helps to emphasis the significance of corporate governance in the banking sector because of: 1) Banking system stability is important for economic growth; 2) Good corporate governance is required in banks to achieve corporate governance in other firms. 3) Banks have wider stakeholders-government, regulators and most importantly depositors. 4) 3

Promotes market confidence, helps to attract additional capital, and fosters market discipline through good disclosure and transparency.

ENRON - ATTEMPTS AT CORRECTING THE WRONG

Enron brings to mind the collapse of the seventh largest company in the United States of America and the largest bankruptcy seen by the country till date. Its stock was valued at $90 per share in 2001 and is worth almost nothing at the end of the same year.The downward spiral that began since Enrons accounting fraud was exposed affected all their shareholders and employees. Billions of dollars were lost and thousands of jobs were mislaid. Following this debacle, the US authorities have analyzed the situation and have attempted at undoing the wrong in a variety of ways. We will summarize the efforts made by the US authorities in rectifying the discrepancies in the regulations of business practices in corporate America. We will take a look at the crucial Sarbanes-Oxley Act of 2002 that was conceived and implemented following the Enron disaster and the reforms presented by the New York Stock Exchange and the NASDAQ. Finally we will take a closer look at the involvement of the board of directors of public companies to comply with corporate governance procedures after the debacle of Enron.

WHAT WENT WRONG WITH ENRON?

Enron managed to hide millions in dollars in debt and losses through unlawful accounting practices. They hid these losses under their many subsidiaries, often in foreign countries. In event of the fraud being exposed, Enrons stock crashed but few of the management members managed to bail themselves out by selling the stock when it was still at a high. The investors and employees were left high and dry to face the loss of their investment, pension and retirement amounts. There are many criminal investigations and cases registered for Enron executives. These executives have been known to receive hefty bonuses just before the collapse of Enron. Other accounting scandals like WorldCom and Xerox were bought to light further reducing public confidence in corporate investment. There are many issues that were raised with the collapse of Enron as described in the CRS Report for the Congress in 2002: Auditing - There may have been a possibility that the auditors were misled into preparing the wrong financials for the company. Often companies pay more to auditors for non-audit fees than for audit fees, which may bring the auditors to compromise their standards. Accounting - There are several questionable accounting techniques like subsidiary accounting, derivatives and third party investors used by Enron. The loopholes in the accounting system need to be rectified. Pension - More than 60% of the assets held in the 401(k) plan consisted of Enron stock, which when plummeted put stockholders and employees in huge losses and setbacks. Such grave scenarios need to be avoided in the future. Corporate Governance - The board of directors is meant to protect the interest of the shareholders. In Enrons case the CFO was allowed to create private partnerships to deal with the company which is against the best interest of the company. LLP Formation - The ease with which general partnerships can be converted to limited liability partnerships in the US by filing the requisite paperwork with the state department can lead to additional Enron-like disasters. Securities Analyst - The creditability of analysts came under question following the collapse of Enron stock in November 2001 as even the Wall Street analysts failed to predict the Enron disaster. Banking - J.P. Morgan and Citigroup have both suffered due to their involvement as investment banks and commercial banks for Enron. The reputation of banks is often at stake in events like an Enron collapse. 4

CORPORATE GOVERNANCE ENHANCEMENTS FOLLOWING ENRON

Having covered the major issues that require rectification following Enron, we will now take a closer look at the corporate governance regulations that were improvised in the wake of the destruction left by the former energy giant.

SARBANES-OXLEY ACT OF 2002

The Sarbanes-Oxley Act is meant to bring accuracy and reliability of corporate disclosures by requiring certifications done to the quarterly and annual reports by the chief executive and financial officers. The Sarbanes-Oxley Act was enforced in July 2002 following a series of high profile accounting scandals. For all financial statements that were to be filed deadlines were provided to comply with the provisions highlighted in the act. There are 11 components to the Sarbanes- Oxley Act of 2002 and they are as follows along with a brief idea of the issues they address, as described by Price Water house Coopers: 1. Public Company Accounting - Registrations with board, auditing procedures, public accounting firms, accounting standards, funding, etc. 2. Auditor Independence - Conflict of interest, audit partner rotation, commission authority, etc. 3. Corporate Responsibility - Fair funding for investors, audit committees, financial reports, conduction of audits, etc. 4. Enhanced Financial Disclosures - Periodic reporting, transactions involving management and principal stockholders, code of ethics, exemptions, etc. 5. Analyst Conflict of Interest - Treatment and appointment of security analyst 6. Commission Resources and Authority - Authorization of appropriations, appearance and practice before the commission, etc. 7. Studies and Reports - Study of investment banks, violators and violations, enforcement actions, etc. 8. Corporate and Criminal Fraud Accountability - Criminal penalties, protection of employees, security fraud, etc. 9. White Collar Crime Penalty - Criminal fraud offenses, corporate responsibility, criminal penalties, etc. 10. Corporate Tax Return - Signing of corporate tax return by chief executives 11. Corporate Fraud and Accountability - Tampering with records, persons serving as officers or directors, increased criminal penalties, etc. We see here that most of these issues are under the light of the Enron scandal. This act was a major move by the authorities and its enforcement and execution is causing companies a great deal of grief; however SEC has been known to give extensions for the deadlines.

NEW YORK STOCK EXCHANGE AND NASDAQ PROVISIONS

The NYSE and NASDAQ require that companies comply with the new listing standards that are approved by the US Securities and Exchange Commission (SEC). For this purpose all companies to be listed require an internal audit function and this is meant to increase governance of listed companies. The approved provisions under the corporate governance reforms by NYSE and NSADAQ though similar to the Sarbanes-Oxley Act of 2002 cover the following grounds: Majority directors must be independent Empowerment of Independent Directors Strengthen the Audit Committee Internal Audit Function 5

 Annual Meeting Calendars Codes of Conduct Corporate Governance Guidance New CEO Certification Responsibilities New Penalty Regime Prescribed Timeline

ROLE OF BOARD OF DIRECTORS

According to a special investigation report for the role of board of directors in Enron, it was found that the a few directors heavily profited from the debacle of Enron and were in compromise of the professional and ethical standards expected in corporate America. For this reason there were reforms conducted for the board of directors of companies. The board of directors is responsible for protecting the interest of the shareholders. When the board makes decisions they adversely affect the company and they also affect the shareholders and company employees. Here is what the board of directors must comply with following the Enron scandal and the Sarbanes-Oxley act of 2002: Restructure the directors and audit committees so that the requirements in the Sarbanes-Oxley Act of 2002 are met. Study the revised corporate governance policies and ensure that the same are met in the best possible way. Make certain that the role of any company player does not bring conflict of interest to the company policies and actions Make sure that the management performance and compensation does not compromise the interest of the company. Give shareholders direct input to the corporate governance measures in place in the company. Educate board members of the responsibility they have towards the shareholders. It is recommended that having a majority of truly independent directors can benefit the organization and its performance in the CPA Journal of March 2004. A director may not have any material relationship with a company that compromises the independence clause. Both the NYSE and NASDAQ recommend the same measures regarding the board of directors. We thus see that the Enron debacle was an eye opener for corporate America and bought about accounting reforms, audit committee changes, board of directors regulations, security analyst recommendations, etc. The Sarbanes-Oxley Act of 2002 led in the implementation of changes following Enron. New York Stock Exchange and NASDAQ underwent reform for listed companies which were approved by the Securities and Exchange Commission. Now a major public relations drive is underway to mend the reputations of disgraced banks and accounting firms. The invaluable lessons from Enron have humbled corporate America to bring reforms to improvise upon the past. Hopefully it will be able to keep such scandals from erupting again and ensure the protection of the investors and the employees that are disconnected from the management and the board of directors in large organizations. Enron, WorldCom and Xerox are the past - Sarbanes-Oxley, NYSE and NASDAQ reforms are the future.

WorldCom
In 1998, the telecommunications industry began to slow down and WorldCom's stock was declining. CEO Bernard Ebbers came under increasing pressure from banks to cover margin calls on his 6

WorldCom stock that was used to finance his other businesses endeavors (timber, yachting, etc.). The company's profitability took another hit when it was forced to abandon its proposed merger with Sprint in late 2000. During 2001, Ebbers persuaded WorldCom's board of directors to provide him corporate loans and guarantees totaling more than $400 million. Ebbers wanted to cover the margin calls, but this strategy ultimately failed and Ebbers was ousted as CEO in April 2002. Beginning in 1999 and continuing through May 2002, WorldCom under the direction of CFO, Controller and Director of General Accounting used shady accounting methods to mask its declining financial condition by falsely professing financial growth and profitability to increase the price of WorldCom's stock. The fraud was accomplished in two main ways. First, WorldCom's accounting department underreported interconnection expenses with other telecommunication companies by capitalizing these costs on the balance sheet rather than properly expensing them. Second, the company inflated revenues with bogus accounting entries from corporate unallocated revenue account'. The first discovery of possible illegal activity was by WorldCom's own internal audit department who uncovered approximately $3.8 billion of the fraud in June 2002. The company's audit committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired, Myers resigned, and the Securities and Exchange Commission launched an investigation. By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion. On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy protection, the largest such filing in United States history. The company emerged from Chapter 11 bankruptcy in 2004 with about $5.7 billion in debt. At last count, WorldCom has yet to pay its creditors, many of whom have waited years for the money owed. On March 15, 2005 Bernard Ebbers was found guilty of all charges and convicted on fraud, conspiracy and filing false documents with regulators. He was sentenced to 25 years in prison. Other former WorldCom officials charged with criminal penalties in relation to the company's financial misstatements include former CFO entered a guilty plea on March 2, 2004 to one count each of securities fraud, conspiracy to commit securities fraud, and filing false statements, former controller pleaded guilty to securities fraud, conspiracy to commit securities fraud, and filing false statements on September 27, 2002, former accounting director pleaded guilty to conspiracy and fraud charges on October 7, 2002, and former accounting managers both pleading guilty to conspiracy and securities fraud on October 10, 2002). Ebbers reported to prison on September 26, 2006 to begin serving his sentence. Major finding from the article are as follows: What did WorldCom say? The company said an internal audit had discovered that $3.3bn in profits were improperly recorded on its books from 1999 to the first quarter of 2002. That is on top of the $3.8bn in expenses the company said it had improperly reported as capital investments. WorldCom now says it must issue revised financial statements for 2000 and 1999 as well. The revision will reduce 2000 profits by more than $3.2bn, but this may not be the end of accounting horrors as the company warned it may find more problems. Is there a new twist to the latest disclosures? WorldCom said most of the $3.3bn irregularity involved the manipulation of reserves. Companies set aside reserves to cover estimated losses such as uncollected payments from customers and judgments in lawsuits and other expected costs. Are reserves normal business practice? It is a perfectly legitimate practice, like setting aside funds for a rainy day. But reserves can be abused to create the accounting equivalent of a slush fund. If a company wanted to massage profits to meet Wall Street expectations it can transfer the necessary sums from the reserve. The suspicion is that WorldCom deliberately inflated its reserves to be able to dip into them to boost profits in order to meet profit projections. 7

Who is to blame? WorldCom's chief executive, John Sidgmore, blamed the company's former chief financial officer, Scott Sullivan, and the former controller, David Myers. The two were fired for claiming $3.8bn in regular expenses as capital investment in 2001. The pair were arrested in New York, handcuffed and paraded in front of TV cameras as part of the Bush's administration crackdown on corporate crime. Charged with securities fraud, conspiracy and other charges, they face 65 years in prison. WorldCom's founder and former chief executive, Bernie Ebbers, says he was unaware of the accounting problems, and has not been charged. What is wrong with filing expenses as investment? Operating expenses must be subtracted from revenue immediately, while the cost of capital expenses can be spread over time. Improperly spreading operating costs inflated WorldCom's profits. Why did WorldCom's accountants not spot the problem? WorldCom's accountants at the time were Arthur Andersen, the same people that looked after Enron's books as well as other companies hit by accounting issues - Tyco, Global Crossing and Adelphia. Andersen accused Mr Sullivan of withholding information from them. The deputy US attorney general, Larry Thompson, said: "We have to ask where the professionals were, the accountants and the lawyers." What is being done to get a proper accounting? WorldCom has new accountants, KPMG, who have been asked to scour the books back to 1999. It will be virtually impossible to get an accurate picture until a comprehensive audit for the past several years is done, a process expected to last months. The company is also under investigation by the department of justice and the Securities and Exchange Commission, the US financial regulator. WorldCom, which has been charged with fraud for allegedly hiding $1.2bn in losses, is now under bankruptcy protection. In Conclusion from the three articles , corporate governance is a key part of any regime which has confidence, integrity and efficiency as its bedrock and which is looking to attract and retain capital on a sustained long term basis. It is important that good corporate governance is not only driven by compliance or regulatory requirements, but very importantly is also seen as a means by which companies and economies can improve their performance, competitiveness and sustainability. Corporate governance describes the framework of rules, relationships, systems and processes within which and by which authority is exercised and controlled in corporations. A key feature of developments in corporate governance in recent years is the involvement of various players. Corporate governance includes maintaining capital adequacy, transparency in the publication of accounts, management of operational, credit, market and environmental risks, to name a few. It is very crucial and essential element for the banking system because bank and financial institutions depends on the other peoples money. It also helps to ensure that company takes into account the interest of not only of a group of people but also of the communities within which they operate. A good corporate governance practices can strongly contribute to financial market development and financial stability. Frequently changed government and different political unrest keep different problem in governance issues. In conclusion, I would like to emphasize that for the betterment of the overall financial system in the country, it is incumbent upon all of us i.e. the regulators, the companies, the directors, employees and the shareholders to gracefully honor the principles of governance. It is our collective responsibility and we cannot just hold the central bank or the chief executive officer responsible for any setback. I strongly believe that banks and financial institutions reforms can fully be implemented if and only if prudential regulatory systems are practiced with a strong desire for success. Nevertheless, an efficient judiciary system would also be required for effective implementation. By Rajiv Lamichhane 8

Roll No.: 20