Basel III : Enhancing Corporate

Governance
METAC USAID Regional Workshop on
Basel III: Challenges and Implications
Cairo Egypt
October 16 18, 2012

AGENDA

Introduction
Weaknesses identified
Supervisory initiatives
Reminding basic principles
Key points

INTRODUCTION
The crisis showed that banking governance suffered
from various defects that, in certain cases, led banks to
adopt a very risky conduct.
Weak governance was not a trigger, but a major
underlying factor of the financial crisis.

WEAKNESSES IDENTIFIED DURING

THE CRISIS
Insufficient understanding of new risks:
Very few people in management and supervisory
functions with adequate knowledge to understand the
ins & outs of innovative & structured products;
Valuation models built on inappropriate / outdated
assumptions and overreliance on the predictive power
of quantitative models;
Poor understanding of interactions between new
activities & strategies using innovative & structured
instruments and key mechanisms of banking activities
e.g. liquidity, assets & liabilities management, ...
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WEAKNESSES IDENTIFIED DURING

THE CRISIS
Inadequate
Governance
management in banks:

and

Risk

Inadequate incentives: compensation package of

executives and traders providing inappropriate
stimulus;
Poor information and internal communication:
strategic decisions based on wrong information;

WEAKNESSES IDENTIFIED DURING

THE CRISIS
Inadequate Governance and Risk management
in banks:
Inconsistent approaches to risk through the institution:
inadequate framework for risk management of non
standard / non transparent / new activities and
strategies;
Lack of discipline: no sanctions when risk limits were
exceeded, short term opportunistic approach instead of
a more balanced (risk / profitability) & medium term
approach.

WEAKNESSES IDENTIFIED DURING

THE CRISIS
Insufficient implementation of the BCBS
corporate governance principles:
The principles of the BCBS, issued in 1999, and
reviewed in 2006 were quite good and we would have
been much better off if they had been properly
implemented.
Supervisors must ensure that sound governance and
risk management principles are thoroughly and
consistently implemented.

WEAKNESSES IDENTIFIED DURING

THE CRISIS
Weak internal governance
conditions

Internal governance players did

not take the necessary actions

Actions of internal governance

players were not effective

Unclear definition of roles

within the organization
Not sufficient or sufficiently
qualified and experienced
staff
No clear segregation of duties
led to conflicts of interests
(e.g. role of CRO and CFO
mixed up)
Management functions of
subsidiaries not able to act
because of dominant group
management
Central functions often lacked
holistic set of information due
to too complex organization

No real challenge of actions

and proposals;
"herd mentality"
Long term perspective and
stability in the organization's
architecture were missing
No sufficient integration of the
different parts of the
organization

Ineffective whistle blowing

mechanisms
Insufficient reporting between
the different control functions
Communication between
management body and audit
committee weak
No common language and
methodology (e.g. risk
definition or limit system) in
groups
Unclear procedures for
decision making in
subsidiaries and lack of
escalation procedures

SUPERVISORY INITIATIVES
Basel Committees Principles for enhancing
corporate governance (issued in October
2010)
14 principles for banks: Board practices /
responsibilities / structure, Group structures,
Senior Management, Risk Management (CRO),
Internal communication, Compensation aligned with
risk, Disclosure and Transparency.

SUPERVISORY INITIATIVES
Basel Committees Principles for enhancing
corporate governance (issued in October
2010)
5 principles for supervisors: clear and practical
guidance, regular evaluation on banks practices &
policies, use of external evaluations, require
effective and timely remedial action, international
cooperation.
Principles widely applicable in terms of banks,
countries, corporate and board structures,
commensurate with bank size, complexity and risk
profile.
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SUPERVISORY INITIATIVES
Basel Committees Principles for enhancing
corporate governance (issued in October
2010)
Applies to wide range of banks and countries
Applicable to diverse corporate and broad structures
Principles, not rules
Not as prescriptive as some national legislation
Commensurate with bank size, complexity and risk
profile

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SUPERVISORY INITIATIVES
EBA Guidebook on internal governance
(2011):
Consistency between European and BCBS
frameworks: EBA guidelines follow the new Basel
Principles for enhancing corporate governance.
The CEBS consultation paper (October 2010)
provides 30 very detailed principles focused on
banks: corporate structure and governance,
management body, risk management, internal control,
systems and continuity, transparency.
Principles applicable to different European corporate
and board structures, proportionate to banks
specificities.
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11

REMINDER : PILLAR II

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REMINDERS: CONCEPTS
Corporate governance :
is a broad concept that can be described
as the set of relationships between an
institution,
its
management,
its
shareholders and other stakeholders.

Internal governance :
is a limited but crucial component of
corporate governance, focusing on the
internal structure and organization of an
institution.

CORPORATE
GOVERNANCE

INTERNAL
GOVERNANCE

ICAAP

ICAAP :
identify amount and quality of internal
capital in relation to risk profile (for all
material risks) and strategies.

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REMINDER : BASIC PRINCIPLES

Board => Top
Management

Market

Risk
management
and internal
control

Credit

Other

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REMINDER: WHAT IS THE BOARD ROLE?

Boards overall responsibilities

(oversees, approves and monitors)

overall risk
strategy,
(including its risk
tolerance/appetite)

policies for risk,

risk management,
compliance, audit

internal controls
system

corporate
governance
framework,
principles and
corporate values,
including a code of
conduct

compensation
system

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THREE-LINES-OF-DEFENCE MODEL
Risk management
(risk control function)

Identification

Internal control
framework
(compliance
function)

Internal Audit

Effective and efficient operations

Adequate control of risk

Measurement
Prudent conduct of business

Independent review of the first two

lines of defence

Monitoring
Reliability of of financial information

Reporting and internal communication

Compliance with regulations and internal

policies

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REMINDER: BASIC PRINCIPLES

Good management and functioning of the entire
organization
Implying the elaboration
implementation

of

policies

and

their

Safe, reliable and exhaustive framework

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REMINDER : BASIC PRINCIPLES

The framework should rely on the following
principles:
Independence from business activities
Four eyes principles
Written procedures
Audit trail for operations
A complete
control
compliance, periodic)

framework

(permanent,

Determination of limits, compliance and surveillance

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KEY MESSAGES OF THE NEW

PRINCIPLES
The financial crisis has highlighted the shortcomings in
corporate governance, mainly in the following areas:
(1) Role of the board and board practices
(2) Group structures
(3) Role of senior management
(4) Risk management and internal controls
(5) Compensation
(6)Complex or opaque corporate structures (know-your-structure)
(7) Disclosure and transparency

Among these areas, the role of the board and board

practices and risk management have been most updated
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(1) Role of the board and board practices:

Principles 1-3
Qualifications of the board, including the appropriate
experience, competencies and personal qualities
Tailored initial and ongoing training of board members
Composition of the board, including a sufficient number
of non-executive members with the ability to make
objective, independent judgements
Board assessment, including the use of external
facilitators
Increasing role of the chair of the board and its
separation with the chief executive officer
Importance of formal conflicts of interest policy
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(2) Group structures:

Principle 4
Overall responsibility of the board of the parent company
to ensure adequate corporate governance across the
group

21

(3) Senior management:

Principle 5
Need for senior management to ensure that the banks
activities are consistent with the business strategy, risk
tolerance/appetite and policies approved by the board,
under the direction of the board

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(4) Risk management and internal controls:

Principles 6-9
Independent risk management function with sufficient
authority, stature, independence, resources and
access to the board
Appointment of a chief risk officer (CRO) or equivalent
Importance of the board to oversee risk management
issues
Need for risks to be identified and monitored on an
ongoing firm-wide basis and individual entity basis
Need for the sophistication of the banks risk
management and internal control infrastructures to
keep pace with any changes to the banks risk profile
and to the external risk landscape
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(4) Risk management and internal controls:

Principles 6-9

Importance of robust internal communication within the bank about risk,

both across the organisation and through reporting to the board and senior
management
Importance of the board and senior management to effectively utilise the
work conducted by internal audit functions, external auditors, and internal
control functions

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(5) Compensation:
Principles 10-11
Board role to actively oversee the compensation
systems design and operation
Compensation should be effectively aligned with
prudent risk taking
The two principles are in line with the Financial Stability
Boards Principles for Sound Compensation Practices
(April 2009), Implementation Standards (September
2009) and the Basel Committees Compensation
Principles and Standards Assessment Methodology
(January 2010)
The message to banks is to fully implement the FSB
Practices and Standards, no additional guidance
provided by the Basel Committee
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(6) Know-your-structure:
Principles 12-13
Need for the board and senior management to be well
aware of the structure of their entire organisation and
the risks it poses
Board should approve policies and clear strategies for the
establishment of new structures
Internal audits can be complemented with regular assessments
of the risks posed by the groups structure

Need for the board and senior management to

understand the reasons for operating in jurisdictions
which impede transparency or do not meet international
banking standards, and seek to mitigate the risks
indentified
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(7) Transparency:
Principle 14
Necessary for shareholders, depositors, other relevant
stakeholders and market participants to monitor and
hold accountable the board and senior management
Should disclose on public website or in published
reports information on corporate structure and
ownership, etc proportional to size/ complexity
Disclosure is also important for non-listed banks

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IMPLEMENTATION
Lack of implementation of the 2006 corporate
governance principles was key lesson from the financial
crisis
Provide additional guidance on how to measure and
assess compliance with the principles. Various
additional approaches include:
Development of self-assessment
supervisors (peer review process)

notes

to

banks

and

Seminars (eg Financial Stability Institute, joint conference with

industry)
Adding the issue of corporate governance to the agenda of
supervisory colleges

Basel Committees Standards Implementation group will

play key role
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INCREASED ROLE OF SUPERVISION

Supervisors are not primarily responsible for banks
corporate governance standards
Need to enhance supervision by:
Regularly conducting comprehensive evaluation of a banks
overall corporate governance policies and practices and
evaluate the implementation process
Ongoing monitoring of internal reports and prudential reports
Taking remedial action when necessary
Cooperating with other relevant supervisors (eg memorandum
of understanding, supervisory colleges and periodic meetings
among supervisors)

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CONCLUSION
The financial crisis has demonstrated
importance of sound corporate governance.

the

The key elements are:

Board of directors = Oversight,
Senior management = Risk management and internal controls,
Supervisors = Promote and assess sound governance.

Effective implementation is key.

Actual practice (and supervision) is just as important
as written policies and procedures (and regulation).

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STRUCTURES AND PRINCIPLES

Governance arrangements

Clear organizational structure

Well defined,
transparent
lines of
responsibilities

Effective
processes to
identify
manage,
monitor the
risks

Adequate
internal control
mechanisms
(sound
administrative
and accounting
procedures)

Remuneration
policies and
practices

Standards and principles

Objectives,
strategies and
risk tolerance

How business is
organized

Allocation of
responsilities

Reporting lines
and
organisation

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