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Corporate Governance for Banks in Southeast Europe: Policy - IFC

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© Copyright 2012. All rights reserved.International F<strong>in</strong>ance Corporation2121 Pennsylvania Avenue, NW,Wash<strong>in</strong>gton, DC 20433<strong>Europe</strong>an Bank <strong>for</strong> Reconstructionand DevelopmentOne Exchange SquareLondon EC2A 2JNUnited K<strong>in</strong>gdomThe f<strong>in</strong>d<strong>in</strong>gs, <strong>in</strong>terpretations, and conclusions expressed <strong>in</strong>this publication should not be attributed <strong>in</strong> any manner to theInternational F<strong>in</strong>ance Corporation (<strong>IFC</strong>) and/or to the <strong>Europe</strong>anBank <strong>for</strong> Reconstruction and Development (EBRD) and theiraffiliated organizations, or to members of their boards ofdirectors or the countries they represent. <strong>IFC</strong> and EBRD do notguarantee the accuracy of the data <strong>in</strong>cluded <strong>in</strong> this publicationand accept no responsibility <strong>for</strong> any consequence of their use.The material <strong>in</strong> this work is protected by copyright. <strong>IFC</strong> andEBRD encourage dissem<strong>in</strong>ation of this publication and herebygrant permission to users of this work to copy portions <strong>for</strong>their personal, noncommercial use, without any right toresell, redistribute, or create derivative works there from. Anyother copy<strong>in</strong>g or use of this work requires the express writtenpermission of the International F<strong>in</strong>ance Corporation.For permission to photocopy or repr<strong>in</strong>t, please send a requestwith complete <strong>in</strong><strong>for</strong>mation to:International F<strong>in</strong>ance Corporationc/o the World Bank Permissions DeskOffice of the Publisher1818 H Street, NWWash<strong>in</strong>gton, DC, 20433All queries on rights and licenses <strong>in</strong>clud<strong>in</strong>g subsidiary rightsshould be addressed to:International F<strong>in</strong>ance Corporationc/o Office of the PublisherWorld Bank1818 H Street, NWWash<strong>in</strong>gton DC, 20433Or, fax (202) 522-2422.The <strong>Policy</strong> Brief on <strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong><strong>Southeast</strong> <strong>Europe</strong> preparation and publication was madepossible with the support of the Development Bank ofAustria (OeEB) and the Government of Luxembourg.


egion. 5 The ma<strong>in</strong> challenge that the group faced was understand<strong>in</strong>g the differences between local and<strong>for</strong>eign bank<strong>in</strong>g markets and mak<strong>in</strong>g recommendations that were specific to the circumstances and needs ofSEE.SEE is clearly not Wall Street. SEE has very high <strong>for</strong>eign ownership of the bank<strong>in</strong>g system, the equitiesmarkets are small and emergent, 6 and almost all banks are closely held. The corporate governance guidancepromulgated by the OECD, the Bank <strong>for</strong> International Settlements (BIS), the International <strong>Corporate</strong><strong>Governance</strong> Network, and others responds more directly to the needs of more developed countries. Eventhough their pr<strong>in</strong>ciples are globally sound, their application <strong>in</strong> the local context poses considerable challenges.The <strong>Policy</strong> Brief aims to help apply <strong>in</strong>ternational best practice <strong>in</strong> the SEE context. Its recommendations buildto a large extent upon the BIS Basel Committee on Bank<strong>in</strong>g Supervision (BCBS) Pr<strong>in</strong>ciples <strong>for</strong> Enhanc<strong>in</strong>g<strong>Corporate</strong> <strong>Governance</strong> (2010) and also upon the BIS Enhanc<strong>in</strong>g <strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> Bank<strong>in</strong>gOrganizations (2006). These documents provide authoritative <strong>in</strong>ternational guidance on corporate governancethat is tailored to the circumstances of the bank<strong>in</strong>g sector. 7The <strong>Policy</strong> Brief is not <strong>in</strong>tended <strong>in</strong> any way to substitute <strong>for</strong> such guidance. Rather it is <strong>in</strong>tended tocomplement it and serve as a tool <strong>for</strong> highlight<strong>in</strong>g those issues that are seen to be most germane to theregion. It should also be understood that the <strong>Policy</strong> Brief makes recommendations that are on the policy level.It is not <strong>in</strong>tended to be a detailed “toolkit” or set of <strong>in</strong>structions <strong>for</strong> supervisors or banks on how to achievebetter governance. In many cases detailed guidance exists and should be consulted when implement<strong>in</strong>g thesepolicy recommendations. In other cases more detailed guidance may need to be developed.The larger chapter head<strong>in</strong>gs of the 2010 BIS Pr<strong>in</strong>ciples have been used to structure the <strong>Policy</strong> Brief. Follow<strong>in</strong>gthis <strong>in</strong>troduction, Chapter II provides an overview of bank corporate governance <strong>in</strong> SEE. Chapter III looks atsound corporate governance pr<strong>in</strong>ciples <strong>for</strong> banks. Chapter IV discusses the role of supervisors, and ChapterV looks at how to promote a supportive environment <strong>for</strong> better governance. Some issues that are notdeveloped <strong>in</strong> the BIS Pr<strong>in</strong>ciples, such as state ownership of banks and the role of banks <strong>in</strong> client governance,are treated <strong>in</strong> Chapter VI, “Additional issues.” The annexes conta<strong>in</strong> additional <strong>in</strong><strong>for</strong>mation, <strong>in</strong>clud<strong>in</strong>g sourcesof guidance on bank governance, synopses of key Basel Committee statements on bank governance, and theresults of a significant 2010–2011 <strong>Europe</strong>an Bank <strong>for</strong> Reconstruction and Development (EBRD) study on banks<strong>in</strong> the SEE region.5 Participants <strong>in</strong> the High Level <strong>Policy</strong> Meet<strong>in</strong>g and <strong>in</strong> the ensu<strong>in</strong>g discussions are listed <strong>in</strong> Annex A.6 Morn<strong>in</strong>gstar, “Diverg<strong>in</strong>g Opportunities <strong>in</strong> Emerg<strong>in</strong>g <strong>Europe</strong>” (2011). http://www.morn<strong>in</strong>gstar.co.uk/uk/markets/articles/96403/Diverg<strong>in</strong>g-Opportunities-<strong>in</strong>-Emerg<strong>in</strong>g-<strong>Europe</strong>.aspx. Between 2008 and 2010, markets <strong>in</strong> SEE lost considerable value. The ma<strong>in</strong> <strong>in</strong>dex on the Sofia stock exchangecollapsed from a peak of 1,950 po<strong>in</strong>ts <strong>in</strong> March 2007 to a low of 260 po<strong>in</strong>ts <strong>in</strong> February 2009, a fall of 87 percent. The per<strong>for</strong>mance of the larger andmore liquid Romanian market saw an 80 percent drop <strong>in</strong> its ma<strong>in</strong> <strong>in</strong>dex.7 Synopses of both BIS documents are provided <strong>in</strong> Annexes C and D. For readers <strong>in</strong>terested <strong>in</strong> a fuller understand<strong>in</strong>g of <strong>in</strong>ternational best practice <strong>in</strong>bank governance, a complete read<strong>in</strong>g of the BIS document is recommended. In addition, the OECD Pr<strong>in</strong>ciples <strong>for</strong> <strong>Corporate</strong> <strong>Governance</strong> and the OECDGuidel<strong>in</strong>es <strong>for</strong> the <strong>Governance</strong> of State-owned Enterprises provide a broader, more comprehensive, but non-<strong>in</strong>dustry-specific view on governancepractices. Also, the OECD-EBRD <strong>Policy</strong> Brief on <strong>Corporate</strong> <strong>Governance</strong> of <strong>Banks</strong> <strong>in</strong> Eurasia provides <strong>in</strong>sight <strong>in</strong>to the governance issues faced by banks<strong>in</strong> transition economies. Further important sources of guidance on corporate governance and the governance of banks are listed <strong>in</strong> Annex B.6<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


II. Overview of bank corporate governance <strong>in</strong> SEEThe structure of the bank<strong>in</strong>g sector <strong>in</strong> SEEThe bank<strong>in</strong>g sector <strong>in</strong> SEE differs dramatically from those of the United States and Western <strong>Europe</strong>. All of thecountries <strong>in</strong> the region have stock exchanges, but the liquidity on these exchanges is, with some exceptions,very limited. Thus, bus<strong>in</strong>esses <strong>in</strong> most SEE countries are crucially reliant on banks to provide f<strong>in</strong>anc<strong>in</strong>g. Thebank<strong>in</strong>g sector provides the s<strong>in</strong>gle most important <strong>for</strong>m of f<strong>in</strong>ancial <strong>in</strong>termediation.Most of the local banks <strong>in</strong> the SEE region are classic deposit-tak<strong>in</strong>g and loan-mak<strong>in</strong>g bus<strong>in</strong>esses. Mostare quite small, and few are listed on local exchanges. They make little use of the sophisticated f<strong>in</strong>ancial<strong>in</strong>struments that contributed to the f<strong>in</strong>ancial crisis <strong>in</strong> more developed markets, and most risks are generated<strong>in</strong> the area of credits.Ownership structures are also different. SEE countries are all liv<strong>in</strong>g with the consequences of their recenttransition from central-control to market-driven economies, <strong>in</strong>clud<strong>in</strong>g a profound restructur<strong>in</strong>g of the bank<strong>in</strong>gsector. In Serbia, <strong>for</strong> example, as recently as 2001, two-thirds of the bank<strong>in</strong>g sector was state-owned, with<strong>for</strong>eign ownership represent<strong>in</strong>g approximately 13 percent of banks. By the end of 2009, state ownership haddecl<strong>in</strong>ed to about 17 percent of total assets, with <strong>for</strong>eign ownership ris<strong>in</strong>g to 74 percent and approximately 9percent <strong>in</strong> the hands of other private owners. 8The re<strong>for</strong>m process occurred differently <strong>in</strong> each SEE country, but each had its own experience withprivatization, a massive restructur<strong>in</strong>g of the bank<strong>in</strong>g sector, and the rapid emergence of new bank<strong>in</strong>g<strong>in</strong>stitutions. State ownership is now low <strong>in</strong> most countries <strong>in</strong> the region (see Table 1).Table 1: State Ownership of <strong>Banks</strong>: Percent of Registered CapitalJurisdiction/Country 2007 2008 2009 2010Albania 0.3 0.2 – –Bosnia and Herzegov<strong>in</strong>a (Federation) 2.7 1.3 1.1 1.1Bosnia and Herzegov<strong>in</strong>a (Republika Srpska) – – – –Bulgaria* 0.4 0.6 1.3 1.9Croatia 4.6 4.4 4.1 4.3FYR Macedonia 1.4 1.2 1.4 2.3Montenegro – – – –Romania 5.4 5.2 7.3 7.4Serbia na 16.0 17.5 17.9Source: Data from Bank<strong>in</strong>g Supervisors from Central and Eastern <strong>Europe</strong>, BSCEE Review 2010. http://www.bscee.org.*Percentage on the basis of total assets.Without doubt, the most strik<strong>in</strong>g feature of the bank<strong>in</strong>g sector <strong>in</strong> the SEE region is the level of <strong>for</strong>eignownership. By 2009, an average of 87 percent of bank assets <strong>in</strong> the region was <strong>in</strong> banks with majority <strong>for</strong>eignownership. These figures range from a low of 74 percent <strong>in</strong> Serbia to a high of 94 percent <strong>in</strong> the Federationof Bosnia Herzegov<strong>in</strong>a (see Table 2).8 R. Jelašic, “<strong>Europe</strong>an Integration Challenges,” Speech at Belgrade Conference 2009.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 7


Table 2: Number of <strong>Banks</strong> and Percent of Registered Capital Foreign-ownedJurisdiction/CountryNumber of banks% of registered capital<strong>for</strong>eign-owned2007 2008 2009 2010 2007 2008 2009 2010Albania 16 16 16 16 93.9 93.9 93.3 92.1Bosnia and Herzegov<strong>in</strong>a(Federation)22 20 20 19 92.4 94.3 93.9 91.9Bosnia and Herzegov<strong>in</strong>a(Republika Srpska)10 10 10 10 na 91.9* 91.1* 91.3*Bulgaria 29 30 30 30 82.1* 83.9* 84.1* 80.7*Croatia 33 39 39 38 90.6 90.8 91.0 90.4FYR Macedonia 18 18 18 18 85.9 92.7 93.3 92.9Montenegro 11 11 11 11 79.0 85.0 87.0 88.0Romania 31 32 31 32 87.7 88.2 85.3 85.1Serbia 35 34 34 33 75.6 75.5 74.3 73.5Source: Data from BSCEE Review 2009 and BSCEE Review 2010. http://www.bscee.org.*Percentage on the basis of total assets.Foreign banks typically entered the SEE region as strategic <strong>in</strong>vestors. They brought stability to the bank<strong>in</strong>gsector and a significant knowledge transfer from more developed markets. They also served to <strong>in</strong>troducegood corporate governance practices, which they did by revamp<strong>in</strong>g the banks they acquired. Foreign banksalso brought with them experience with home-country bank regulations. They typically complied with BaselII, International F<strong>in</strong>ancial Report<strong>in</strong>g Standards (IFRS), and, when listed, the stock exchange rules <strong>in</strong> their homemarkets. Because of account<strong>in</strong>g rules and prudential regulation, <strong>for</strong>eign bank subsidiaries were required tomeet both their home requirements and those of local regulators. These home regulations were typicallymore str<strong>in</strong>gent than local regulation, but, equally important, the banks had long experience <strong>in</strong> compliance.The <strong>for</strong>eign <strong>in</strong>flux has not come without challenges. Foreign banks created considerable competition <strong>for</strong>domestic banks. They had easier access to fund<strong>in</strong>g, could f<strong>in</strong>ance larger companies, and had establishedproducts and services, procedures and systems, and economies of scale. For supervisors, hav<strong>in</strong>g a greatnumber of banks that followed a sophisticated external regulatory regime seemed to provide significantbenefits <strong>in</strong> efficiency, security, and application of best practice. However, dur<strong>in</strong>g the crisis, news from abroadworried some regulators, who saw that local bank strategy was controlled from abroad, and that they hadlimited control over <strong>for</strong>eign group entities.The crisisThe 2007 crisis came as an exogenous shock to SEE. At the time, one of the fears was that <strong>in</strong>ternationalbank<strong>in</strong>g groups would withdraw from the region. Given their overwhelm<strong>in</strong>g importance to the local bank<strong>in</strong>gsector, their departure would have triggered a systemic bank<strong>in</strong>g crisis with ensu<strong>in</strong>g damage to the realeconomy. Fortunately, these fears were met by a strong national and regional response.A key factor <strong>in</strong> stabiliz<strong>in</strong>g the bank<strong>in</strong>g sector on the regional level was the <strong>Europe</strong>an Bank Coord<strong>in</strong>ationInitiative (EBCI), the so-called “Vienna Initiative” that was launched at the height of the f<strong>in</strong>ancial crisis whenbanks were try<strong>in</strong>g to take as much liquidity out of the region as possible. EBCI was designed to provide a8<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


A1. Responsibilities of the board 15The pr<strong>in</strong>cipal tasks of the board are to appo<strong>in</strong>t and dismiss management and to approve and overseebank strategy and monitor its implementation. More specific tasks (sometimes exercised with<strong>in</strong> specializedcommittees) <strong>in</strong>volve sett<strong>in</strong>g the basic direction of, approv<strong>in</strong>g, and oversee<strong>in</strong>g, among others, risk strategyand risk tolerance; risk management and compliance;Management versus Supervisory Boards“We start to become confused when we getregulatory requirements that refer to ‘board’and are not clear about which board.”Oliver Whittle, Albania<strong>in</strong>ternal systems of control, <strong>in</strong>clud<strong>in</strong>g <strong>in</strong>ternal audit;the corporate governance framework; and thecompensation system. 16 Though boards have manytasks, the essential precept of corporate governance isthat the board carries overall and ultimate responsibility<strong>for</strong> the bank’s per<strong>for</strong>mance. At the same time, it shouldbe clear that boards are not responsible <strong>for</strong> operationsand day-to-day management, which are the soleresponsibility of bank executives.There are really two different types of boards <strong>in</strong> SEE countries: boards of domestic banks and boards of thesubsidiaries of <strong>in</strong>ternational bank<strong>in</strong>g groups. Though the laws that govern their establishment and operationare usually the same, these two types of boards differ <strong>in</strong> their functions and <strong>in</strong> the challenges they face. As aconsequence, the <strong>Policy</strong> Brief recommendations <strong>for</strong> domestic bank boards and <strong>for</strong> the boards of subsidiariesof bank<strong>in</strong>g groups are different.Many domestic SEE boards were established purely to comply with regulatory requirements; some could beviewed as control bodies designed to monitor legal compliance rather than to add value to bank operations.In some cases, domestic bank boards developed excessively close relationships with management, allow<strong>in</strong>gmanagement to act with limited oversight. Similarly, the boards of <strong>for</strong>eign subsidiaries were at timesestablished as <strong>for</strong>malities. Meet<strong>in</strong>gs were <strong>in</strong>frequent, only <strong>in</strong> response to law or regulation, or their focus wason implement<strong>in</strong>g decisions from the home office.Additionally, some subsidiary boards have little understand<strong>in</strong>g of the local environment, because boardmembers are executives flown <strong>in</strong> from the home office. At times, their contact with and understand<strong>in</strong>g of theregion is limited. These <strong>in</strong>dividuals can control the localsubsidiary but may not understand the local culture orthe local bus<strong>in</strong>ess environment. The particular situationof subsidiary boards <strong>in</strong> group structures is discussed <strong>in</strong>Section III.A.7, below.For the boards of domestic banks, a betterunderstand<strong>in</strong>g of the role and responsibilities ofthe board is probably the most serious challenge tobetter bank governance. Irrespective of whether it isa domestic bank or a subsidiary of a group hold<strong>in</strong>g,board members need to understand the basic fiduciaryduties that they owe to the bank. 17 The duties of careand loyalty are primary.Board Responsibility Toward Stakeholders“I th<strong>in</strong>k corporate governance <strong>for</strong> banks isnot just dedicated to protect<strong>in</strong>g the <strong>in</strong>terestsof m<strong>in</strong>ority shareholders. However, thereis this <strong>in</strong>terest of depositors as stakeholders,which must be guaranteed by the law, byregulators, but also with<strong>in</strong> the board.”Gian Piero Cigna, Italy15 2010 BIS Pr<strong>in</strong>ciples, Section III.A, p. 7.16 For a more detailed description of board responsibilities, consult the documentation of both the BIS and the OECD.17 OECD, “<strong>Policy</strong> Brief on <strong>Corporate</strong> <strong>Governance</strong> of <strong>Banks</strong> <strong>in</strong> Asia”, (Asian Roundtable on <strong>Corporate</strong> <strong>Governance</strong>, June 2006).www.oecd.org/dataoecd/48/55/37180641.pdf12<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


The duty of care requires that board members exercise reasonable care, prudence, and diligence <strong>in</strong> theiroversight of the bank. The practical implications of this duty are that board members are expected to satisfythemselves that decision-mak<strong>in</strong>g structures and report<strong>in</strong>g and compliance systems are function<strong>in</strong>g properly,and that an external <strong>in</strong>dependent auditor is appo<strong>in</strong>ted and acts <strong>in</strong> an objective and <strong>in</strong>dependent way.On the other hand, the duty of loyalty requires an undivided and unselfish loyalty to the bank and demandsthat there be no conflict between the board member’s self-<strong>in</strong>terest and his or her duty to the bank. Thepractical implication of the duty of loyalty is that board members are required to act <strong>in</strong> the <strong>in</strong>terest of thebank and refuse any action, or to take part <strong>in</strong> any deliberation, <strong>in</strong> which they have a conflict of <strong>in</strong>terest withthe bank. An implicit obligation of both duties is that board members are to maximize the long-term value ofthe bank <strong>for</strong> shareholders. 18Generally speak<strong>in</strong>g, the fiduciary duties that require board members to act <strong>in</strong> the best <strong>in</strong>terests of the bankimply that that they also take <strong>in</strong>to account the <strong>in</strong>terests of stakeholders, depositors <strong>in</strong> particular, and actresponsibly toward them. To do otherwise implies putt<strong>in</strong>g the bank at risk.Recommendations:Roles and responsibilities of the board: SEE boards should have a clear understand<strong>in</strong>g of their role andexercise sound and objective judgment. The legal framework should make it clear that the board has overallresponsibility <strong>for</strong> the bank, <strong>in</strong>clud<strong>in</strong>g approv<strong>in</strong>g and oversee<strong>in</strong>g the bank’s strategy, budget, risk appetite,and corporate governance. The role, responsibilities, and specific tasks of boards are well-documented <strong>in</strong><strong>in</strong>ternational best practice. Boards and supervisors need to be well-versed <strong>in</strong> <strong>in</strong>ternational best practice.Oversight of management: To per<strong>for</strong>m its role, the board should have the authority to select and, whennecessary, replace senior management. A clear l<strong>in</strong>e of accountability should exist between board andmanagement.Duties of board members: The duties of loyalty and care, as well as the specific roles and responsibilitiesof board members, should be clarified <strong>in</strong> (<strong>in</strong>ternal and external) rules and regulations and should be clearlycommunicated to board members and executives. The duties and obligations of supervisory board membersshould be covered by <strong>in</strong>duction tra<strong>in</strong><strong>in</strong>g, supported by development programs offered, <strong>for</strong> example, by <strong>in</strong>stitutesof directors, and should be made explicit <strong>in</strong> the employment contracts with the bank and set out <strong>in</strong> clear termsof reference.Personal responsibility of board members: Board members are responsible <strong>for</strong> oversee<strong>in</strong>g the bank,<strong>in</strong>clud<strong>in</strong>g its compliance with the law. Board members must be aware that they may be personally liable ifthere is fraud or if they act negligently or <strong>in</strong> breach of trust. Insurance may protect board members aga<strong>in</strong>st thef<strong>in</strong>ancial consequences of such a f<strong>in</strong>d<strong>in</strong>g.Guidance on board practices: Sufficient guidance on board practices should be available. M<strong>in</strong>imum standardsare typically set <strong>in</strong> law, while best practices are generally set <strong>in</strong> voluntary codes. Boards should <strong>in</strong><strong>for</strong>m themselvesand be aware of what is expected of them and what standards they are expected to comply with.Recommendations specific to boards of subsidiaries operat<strong>in</strong>g with<strong>in</strong> group structures are found below <strong>in</strong>Section III.A.7.18 A number of papers discuss the fiduciary duties of directors towards depositors and equity-debtholders. In particular see:Jonathan R. Macey and Maureen O’Hara, “The <strong>Corporate</strong> <strong>Governance</strong> of <strong>Banks</strong>,” Federal Reserve Bank of New York, Economic <strong>Policy</strong> Review (April2003). http://www.newyorkfed.org/research/epr/03v09n1/0304mace.pdf.Bo Becker and Per Stromberg, “Fiduciary Duties and Equity-Debtholder Conflicts”, Harvard Bus<strong>in</strong>ess School (Work<strong>in</strong>g Paper 10-070 - November30,2011). www.hbs.edu/research/pdf/10-070.pdfOffice of the Comptroller of the Currency, “The Director’s Book”, US Department of The Treasury (October 2010). http://www.occ.gov/publications/publications-by-type/other-publications-reports/director.pdf<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 13


A2. Qualifications 19Bank boards should be sufficiently qualified to enablethem to effectively fulfill their responsibilities and respondto the needs of the bank. Skills that all bank boards need<strong>in</strong>clude experience and expertise <strong>in</strong> f<strong>in</strong>ance, account<strong>in</strong>g,lend<strong>in</strong>g, bank operations and payment systems,strategic plann<strong>in</strong>g, communication, governance, riskmanagement, <strong>in</strong>ternal controls, bank regulation, audit<strong>in</strong>g,and compliance. Knowledge of the bus<strong>in</strong>ess and politicalenvironment and legal issues is also important. At times,boards may need further specialist skills, depend<strong>in</strong>g onimmediate circumstances, such as experience <strong>in</strong> mergersBoard Qualifications“A good board is made up of different talents,and can collectively control all relevant issues.”Christian Strenger, Germany“Competencies are most important, andregardless of who the people are, if theyare competent they will do their job.”Belgrade Conference 2009and acquisitions. Skills need not be present <strong>in</strong> all <strong>in</strong>dividual board members, but they should be present collectivelywith<strong>in</strong> the board as a whole.The qualifications and skills of board members <strong>in</strong> SEE could stand to improve. Knowledge of doma<strong>in</strong>-specificissues, such as f<strong>in</strong>ance and bank<strong>in</strong>g, and of technical issues, such as account<strong>in</strong>g, risk, and controls, could bestrengthened, as could knowledge of issues such as corporate governance. SEE boards do not generally evaluatethe appropriateness of the mix of skills <strong>in</strong> their own structure aga<strong>in</strong>st the strategy and the board per<strong>for</strong>mance,and thus they are typically unaware of the gaps <strong>in</strong> their knowledge or of the skills they might be miss<strong>in</strong>g. SEEchairpersons may be <strong>in</strong>st<strong>in</strong>ctively aware of an area of weaknesses, but they do not generally proactively addressskills gaps by tra<strong>in</strong><strong>in</strong>g or by actively search<strong>in</strong>g <strong>for</strong> new, more qualified board members. (Tra<strong>in</strong><strong>in</strong>g issues, <strong>in</strong>clud<strong>in</strong>gthe role of chairpersons <strong>in</strong> promot<strong>in</strong>g the development of board members, are discussed <strong>in</strong> Sections III.A.3 andIII.A.5, below. Board per<strong>for</strong>mance evaluations are discussed <strong>in</strong> Section III.A.8. Each of these issues merits greaterattention <strong>for</strong> enhanc<strong>in</strong>g board per<strong>for</strong>mance.)Recommendations:Qualifications of board members: SEE boards should upgrade their qualifications and skills. The skillsthat are required on a board are well-def<strong>in</strong>ed under <strong>in</strong>ternational best practice; these skills need to bemore present locally. Increas<strong>in</strong>gly, boards are seek<strong>in</strong>g to strengthen themselves by f<strong>in</strong>d<strong>in</strong>g doma<strong>in</strong>-specificknowledge, particularly board members who are risk specialists. The skills needed on a bank board shouldbe described <strong>in</strong> a general sense <strong>in</strong> regulation, and more specifically <strong>in</strong> the <strong>for</strong>m of board-member jobdescriptions at the bank level, as well as <strong>in</strong> bank <strong>in</strong>ternal documentation. A <strong>for</strong>mal gap analysis of the boardcan help flesh out the skills that are needed. (See Section III.A.8, below.)Intangible qualities: Hav<strong>in</strong>g qualified board members is clearly a key objective. However, a mechanicallist<strong>in</strong>g of and search <strong>for</strong> <strong>in</strong>dividuals with desirable attributes may lead to “box tick<strong>in</strong>g” and possibly theerroneous conclusion that a board is competent because it boasts qualified <strong>in</strong>dividuals. The function of aboard is equally determ<strong>in</strong>ed by <strong>in</strong>tangible qualities such as leadership and capacity <strong>for</strong> teamwork. Both banksand supervisors need to be aware of the importance of <strong>in</strong>tangible factors <strong>in</strong> board per<strong>for</strong>mance—and focuson outcomes over checklists.19 2010 BIS Pr<strong>in</strong>ciples, Section III.A, p. 10.14<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


A3. Tra<strong>in</strong><strong>in</strong>g 20F<strong>in</strong>d<strong>in</strong>g board talent is hard enough <strong>in</strong> countries withlong traditions of professional board governance. Thetask is even harder <strong>in</strong> SEE, where the local bank<strong>in</strong>gsector has been <strong>in</strong> a stage of rapid development andwhere opportunities to learn from experience havebeen limited. Tra<strong>in</strong><strong>in</strong>g is the pr<strong>in</strong>cipal solution to thisdearth of knowledge. Most SEE board members needadditional tra<strong>in</strong><strong>in</strong>g to become fully effective.Tra<strong>in</strong><strong>in</strong>g can be divided <strong>in</strong>to two broad categories: 1) <strong>in</strong>duction tra<strong>in</strong><strong>in</strong>g; and 2) ongo<strong>in</strong>g tra<strong>in</strong><strong>in</strong>g. Inductiontra<strong>in</strong><strong>in</strong>g is the most commonly provided learn<strong>in</strong>g opportunity <strong>for</strong> board members. It is, <strong>in</strong> fact, less a tra<strong>in</strong><strong>in</strong>gexercise than an <strong>in</strong>troduction to the bank. It usually <strong>in</strong>cludes visits to bank sites, brief<strong>in</strong>gs from bank executives,and the provision of <strong>in</strong><strong>for</strong>mation manuals and other documentation. Induction tra<strong>in</strong><strong>in</strong>g helps board membersget up to speed quickly. In all likelihood, <strong>in</strong>duction tra<strong>in</strong><strong>in</strong>g will not help board members fill gaps <strong>in</strong> theirqualifications but it is essential <strong>for</strong> gett<strong>in</strong>g an understand<strong>in</strong>g of the key players and structure of the bank.More specific ongo<strong>in</strong>g tra<strong>in</strong><strong>in</strong>g opportunities are typically needed to respond to the needs of banks.For example, tra<strong>in</strong><strong>in</strong>g <strong>in</strong> risk management, f<strong>in</strong>ance, account<strong>in</strong>g, and other topics may provide importantbank-specific skills, and more technical knowledge of corporate governance practices and the roles andresponsibilities of board members would also be useful. In the area of governance, board members needto develop a better understand<strong>in</strong>g of why conflicts of <strong>in</strong>terest are bad, and they need to learn how to bemore assertive, more <strong>in</strong>dependent, and more articulate. Although such basic knowledge and skills may bewidely available <strong>in</strong> developed f<strong>in</strong>ancial markets, they tend to be less prevalent <strong>in</strong> markets <strong>in</strong> earlier stages ofdevelopment (see Chart 1).Chart 1: Requirements <strong>for</strong> and Monitor<strong>in</strong>g of Tra<strong>in</strong><strong>in</strong>g and Induction <strong>in</strong> SEEThe Need <strong>for</strong> Education and Tra<strong>in</strong><strong>in</strong>g“We would like to recommend to thebanks and the regulators tra<strong>in</strong><strong>in</strong>gcourses <strong>for</strong> executives and non-executivedirectors, because this was a crisisof knowledge and competence.”Bistra Boeva, BulgariaDo supervisory authorities require and/or monitor the <strong>in</strong>duction and tra<strong>in</strong><strong>in</strong>g of new directors?NOYES0 10% 20% 30% 40% 50% 60% 70% 80%Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011). Question asked to regulators <strong>in</strong> the region.How to provide the needed tra<strong>in</strong><strong>in</strong>g is a major challenge. Institutes of directors can provide tra<strong>in</strong><strong>in</strong>g <strong>in</strong>areas that are of importance to the region, such as risk management, <strong>in</strong>ternal control, and <strong>in</strong>ternal audit,and they can play an important role <strong>in</strong> creat<strong>in</strong>g a pool of competent board members, as can academia,20 2010 BIS Pr<strong>in</strong>ciples, Section III.A, p. 10.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 15


Tests <strong>for</strong> <strong>in</strong>tegrity are needed. However, probity tests havetheir limitations, pr<strong>in</strong>cipally because they work through aprocess of exclusion based on a series of negative criteria.They do not establish what is needed or test <strong>for</strong> otherimportant behavioral characteristics of board members.Behavioral characteristics <strong>in</strong>clude, <strong>for</strong> example, capacity<strong>for</strong> leadership, ability to work on a team, and ability toreceive and provide constructive criticism.Behavioral Issues and Group Dynamics“You f<strong>in</strong>d that <strong>for</strong>eigners talk too much andthe locals do not talk. That creates tension.It does not just have a neutral effect; it is baddynamics on the board.”Dragica Pilipovic Chaffey, SerbiaIn SEE, few banks have a clear notion of what skills are required on the board or have a <strong>for</strong>mal job description<strong>for</strong> the needed board member. Nor do they publish such job descriptions or disclose why board membershave been selected <strong>for</strong> their posts.IndependenceBest-practice boards have the capacity to make objective and unbiased economic decisions. Objective andunbiased judgment is also necessary to protect the bank and its shareholders from the possible negativeeffects of conflicts of <strong>in</strong>terest. The way boards typically achieve these goals is by hav<strong>in</strong>g <strong>in</strong>dependent boardmembers. Typically, there are three classifications of board members: 1) executive, 2) nonexecutive, and 3)<strong>in</strong>dependent. 23 A sufficient number of nonexecutive and <strong>in</strong>dependent board members is the way to achieveconsidered and objective decision mak<strong>in</strong>g.Independence and the capacity <strong>for</strong> <strong>in</strong>dependent judgment are particularly important on the audit,remuneration, and nom<strong>in</strong>ations committees of the board, because these three committees are tasked withoversee<strong>in</strong>g issues where the potential <strong>for</strong> a conflict of <strong>in</strong>terest is particularly acute. Best practice usuallysuggests that audit and remuneration committees be staffed fully by <strong>in</strong>dependent board members, andnom<strong>in</strong>ations committees be staffed <strong>in</strong> majority by <strong>in</strong>dependent board members. (A further discussion ofboard committees is found <strong>in</strong> Section III.A.6, below.)Chart 2: Independence of Boards <strong>in</strong> SEE <strong>Banks</strong>What percentage of your board is <strong>in</strong>dependent accord<strong>in</strong>g to applicable legislation, bank<strong>in</strong>gregulation, and/or governance codes?no <strong>in</strong>dependent directorsless than 30%30% to 50%more than 50%0 5 10 15 20 25 30 35 40Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011). Question asked to regulators <strong>in</strong> the region.23 Def<strong>in</strong>itions of <strong>in</strong>dependence vary <strong>in</strong> SEE legislation (see Background Box 1, below). Accord<strong>in</strong>g to <strong>in</strong>ternational best practice,nonexecutive board members may or may not be <strong>in</strong>dependent. Executives are never considered <strong>in</strong>dependent.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 17


Background Box 1: Legal Requirements <strong>for</strong> Independence <strong>in</strong> SEE <strong>Banks</strong>AlbaniaIn Albania, Article 35(4) of the Law on <strong>Banks</strong> requires that “At least one-third of the members of the Steer<strong>in</strong>gCouncil shall be composed of <strong>in</strong>dividuals that . . . are not connected through private <strong>in</strong>terests . . . with thebank, shareholders that control the bank or its executive directors.” There is no requirement that these“<strong>in</strong>dependent” members sit on board committees, members of which can be outsiders (not board members).Bosnia and Herzegov<strong>in</strong>aIn both entities of Bosnia and Herzegov<strong>in</strong>a, the Law on <strong>Banks</strong> requires members of the “audit board” to be<strong>in</strong>dependent from the executives of the bank. 25 Audit boards are special structures that have a different legalstatus from audit committees of the board as typically understood under best practice. 26 Members of theaudit boards can be outsiders (not board members).BulgariaIn Bulgaria, there is no requirement <strong>for</strong> the appo<strong>in</strong>tment of <strong>in</strong>dependent directors of banks that are notpublicly listed. The three largest banks are subsidiaries of EU banks that are publicly listed and whosegovernance policies are determ<strong>in</strong>ed by group practice. In general, the presence of <strong>in</strong>dependent, nonexecutiveboard members is the exception rather than the rule.CroatiaIn Croatia, few banks have <strong>in</strong>dependent board members. The requirement to have at least one <strong>in</strong>dependentboard member on the supervisory board entered <strong>in</strong>to <strong>for</strong>ce on January 1, 2010, and it is expected thatcompliance will improve <strong>in</strong> the future.FYR MacedoniaIn FYR Macedonia, Article 88(2) of the Bank<strong>in</strong>g Law requires that one-fourth of the board be <strong>in</strong>dependent(outsiders). 27 The same law requires the majority of the members <strong>in</strong> the audit<strong>in</strong>g committee to be electedfrom the members of the supervisory board, and “the other members shall be <strong>in</strong>dependent members.” Theaudit<strong>in</strong>g committee is there<strong>for</strong>e made up of a m<strong>in</strong>ority of members who do not sit on the supervisory board.MontenegroIn Montenegro, Article 30 of the Law on <strong>Banks</strong>, requires that at least two board members be <strong>in</strong>dependentfrom the bank. “Independent from the bank” means a person that 1) has no qualified stake <strong>in</strong> the bank orthe parent company of the bank<strong>in</strong>g group to which the bank belongs; and 2) <strong>in</strong> the previous three years hasnot been employed <strong>in</strong> the bank or its subsidiary company. Article 39 of the same Law, requires the auditcommittee to be made up of at least three members, the majority of whom are not connected to the bankand have experience <strong>in</strong> f<strong>in</strong>ance.25 Article 76 of the Law on <strong>Banks</strong> of Republika Srpska and Article 32h of the Law on <strong>Banks</strong> of the Federation of Bosnia and Herzegov<strong>in</strong>a provide that the“Chairman and members of Audit Board may not be appo<strong>in</strong>ted from the group that <strong>in</strong>cludes the Chairman or members of Supervisory Board andmust not be members of Management or staff with<strong>in</strong> the bank, nor may he/she have direct or <strong>in</strong>direct f<strong>in</strong>ancial <strong>in</strong>terest <strong>in</strong> the bank, except <strong>for</strong> thecompensation based upon conduct of that function.”26 Ibid.27 Accord<strong>in</strong>g to Article 2(27) of the Bank<strong>in</strong>g Law, “Independent member” is “a natural person and natural persons connected thereto, who: is notemployed or a person without special rights and responsibilities <strong>in</strong> the bank (i.e., a member of the Supervisory Board, member of the Board ofDirectors, member of the Audit<strong>in</strong>g Committee, member of the Risk Management Committee and other managers as def<strong>in</strong>ed by the Statute of thebank. In the case of a <strong>for</strong>eign bank branch: is a natural person manag<strong>in</strong>g the branch; is not a shareholder with a qualified hold<strong>in</strong>g <strong>in</strong> the bank or doesnot represent a shareholder with a qualified hold<strong>in</strong>g <strong>in</strong> the bank; does not work, or has not been work<strong>in</strong>g <strong>in</strong> an audit company over the last threeyears, which at that time audited the operations of the bank; and has no f<strong>in</strong>ancial <strong>in</strong>terest or bus<strong>in</strong>ess relation with the bank <strong>in</strong> an amount exceed<strong>in</strong>gDenar 3,000,000 annually, on average, over the last three years.”<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 19


RomaniaIn Romania, Regulation No. 18/2009 requires the establishment of board-level audit committees responsible<strong>for</strong> support<strong>in</strong>g the board <strong>in</strong> “fulfill<strong>in</strong>g its <strong>in</strong>ternal audit duties.” Accord<strong>in</strong>g to the regulation, “auditcommittees shall be comprised, <strong>in</strong> majority, of members of the bodies hav<strong>in</strong>g supervisory functions thatare <strong>in</strong>dependent of management—under a unitary board structure—and have a firm understand<strong>in</strong>g ofthe role of this committee <strong>in</strong> the <strong>in</strong>ternal audit function.” Directors’ <strong>in</strong>dependence is still a major issue <strong>in</strong>Romania, because the Companies Act (Law No. 31/1990, as revised) provides this requirement as optionaland not mandatory. To cover this gap, the Bucharest Stock Exchange <strong>Corporate</strong> <strong>Governance</strong> Code stronglyrecommends that: “An adequate number of non-executive directors shall be <strong>in</strong>dependent....” (Pr<strong>in</strong>ciple VII).SerbiaIn Serbia, bank<strong>in</strong>g regulation requires that at least one-third of members of the board of a bank shall be<strong>in</strong>dependent of the bank. A person not hold<strong>in</strong>g direct or <strong>in</strong>direct ownership <strong>in</strong> the bank or <strong>in</strong> the bank<strong>in</strong>ggroup is considered <strong>in</strong>dependent.Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011).Subsidiary boardsS<strong>in</strong>ce the bank<strong>in</strong>g sector <strong>in</strong> SEE is dom<strong>in</strong>ated by <strong>for</strong>eign banks (see Table 2, above, <strong>for</strong> levels of <strong>for</strong>eignownership), questions arise regard<strong>in</strong>g the governance of cross-border groups and, <strong>in</strong> particular, requirements<strong>for</strong> <strong>in</strong>dependent board members <strong>in</strong> subsidiaries. Another important issue is the presence of subsidiary boardmembers with local experience.In practice, wholly owned <strong>for</strong>eign bank subsidiaries have boards that are dom<strong>in</strong>ated by <strong>in</strong>siders. Such boardsmay, <strong>for</strong> example, consist of seven people, five of whom are executives from the parent bank, with the localchairperson be<strong>in</strong>g the chief executive officer or deputy chief executive officer of the parent bank. In addition,there may be two nom<strong>in</strong>ally <strong>in</strong>dependent people, or external members of the board.In all jurisdictions <strong>in</strong> the region boards of subsidiaries are held to the same <strong>in</strong>dependence requirements astheir parents. Some parties argue that this is not appropriate.However, SEE subsidiary boards could stand to be strengthened. There is a view that both subsidiaryboards and subsidiary board committees (<strong>in</strong> particular, the audit committee) need to have some level of<strong>in</strong>dependence. Independence on subsidiary boards is expected to protect local stakeholders and enhance thegovernance function <strong>for</strong> the parent. 28 In addition, subsidiary boards are expected to benefit from the presenceof board members with local expertise.The costs of better governance always need to be considered <strong>in</strong> conjunction with the anticipated benefits. Toavoid excessive burdens, there could be a requirement <strong>for</strong> systemically important banks, to have <strong>in</strong>dependentboard members, <strong>in</strong>dependent audit committees, and local board members. (A further discussion of groupstructures is found <strong>in</strong> Section III.A.7, below.)28 In particular, the Basel Committee’s Pr<strong>in</strong>ciples <strong>for</strong> enhanc<strong>in</strong>g corporate governance (2010) states, “The board of a regulated bank<strong>in</strong>gsubsidiary should reta<strong>in</strong> and set its own corporate governance responsibilities, and should evaluate any group-level decisions or practicesto ensure that they do not put the regulated subsidiary <strong>in</strong> breach of applicable legal or regulatory provisions or prudential rules. Inorder to exercise its corporate governance responsibilities <strong>in</strong>dependently, the board of the subsidiary is expected to have an adequatenumber of qualified, <strong>in</strong>dependent non-executive board members, who devote sufficient time to the matters of the subsidiary.”20<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


The value of <strong>in</strong>dependence: The value of an <strong>in</strong>dependent view of bank affairs needs to be bettercommunicated. Independent board members br<strong>in</strong>g fresh ideas and <strong>in</strong>crease objectivity. Some level of<strong>in</strong>dependence will benefit <strong>in</strong>dependence-m<strong>in</strong>ded owners of closely held banks. Independent board memberscan also demonstrate commitment to depositors and other stakeholders and help <strong>in</strong>still trust.Qualifications of <strong>in</strong>dependent board members: Independent board members need to br<strong>in</strong>g needed skillsto the bank. If <strong>in</strong>dependent board members are to sit on board committees, they should be required to havespecific expertise and background to effectively fulfill their responsibilities. Job descriptions <strong>for</strong> <strong>in</strong>dependentboard members would help def<strong>in</strong>e the required background.Def<strong>in</strong>itions of <strong>in</strong>dependence: Better and more simple def<strong>in</strong>itions of <strong>in</strong>dependence are required. Currentdef<strong>in</strong>itions are long checklists of negative characteristics that disqualify a board member from be<strong>in</strong>g labeledas <strong>in</strong>dependent. Checklists are often popular with supervisors, because they are simple to use. Althoughchecklists ensure consideration of a certa<strong>in</strong> number of key factors, they are poor at flush<strong>in</strong>g out importantqualitative factors. Def<strong>in</strong>itions should describe the qualities that are needed and not just those that are to beavoided. An overly narrow and negative def<strong>in</strong>ition of <strong>in</strong>dependence can result not only <strong>in</strong> the selection ofpoor board members but also <strong>in</strong> the loss of valuable talent.The Basel Committee provides a simple work<strong>in</strong>g def<strong>in</strong>ition of <strong>in</strong>dependence: “The key characteristic of<strong>in</strong>dependence is the ability to exercise objective, <strong>in</strong>dependent judgment after fair consideration of all relevant<strong>in</strong><strong>for</strong>mation and views without undue <strong>in</strong>fluence from executives or from <strong>in</strong>appropriate external parties or<strong>in</strong>terests.” Furthermore, the Basel Committee task <strong>for</strong>ce <strong>for</strong> the new corporate governance pr<strong>in</strong>ciples hasreduced emphasis on prescrib<strong>in</strong>g <strong>in</strong>dependence <strong>for</strong> <strong>in</strong>dividual <strong>in</strong>dependent board members and focusedmore on ensur<strong>in</strong>g that the collective board is objective, qualified, and so on, thus allow<strong>in</strong>g a good mix ofexperience as well as <strong>in</strong>clusion of <strong>in</strong>dividuals that may not meet the letter of the <strong>in</strong>dependence def<strong>in</strong>ition.Lett<strong>in</strong>g the markets decide on <strong>in</strong>dependence: Competitive pressures should be allowed to createdemand <strong>for</strong> <strong>in</strong>dependence. However, sometimes board members may be threatened by or afraid of change.So a m<strong>in</strong>imum of <strong>in</strong>dependent board members may need to be legislated to get the idea started. The numberof <strong>in</strong>dependent board members should be disclosed to allow the public to assess the potential risks associatedwith an absence of <strong>in</strong>dependence.Independence on boards of subsidiaries: It is not desirable to prevent owners of wholly owned <strong>for</strong>eignsubsidiaries from determ<strong>in</strong><strong>in</strong>g the specific composition of their supervisory boards, though some levelof <strong>in</strong>dependence on the boards of <strong>for</strong>eign subsidiaries is considered to be beneficial. The committees ofsubsidiary boards, <strong>in</strong> particular the audit committee, could benefit from the presence of <strong>in</strong>dependent boardmembers. Consideration should be given to mandat<strong>in</strong>g a m<strong>in</strong>imum level of <strong>in</strong>dependent board members <strong>for</strong>subsidiary boards. This may be particularly important if the <strong>for</strong>eign subsidiary is among the top banks with<strong>in</strong>the country.22<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


A5. Role of the chair 29The chair of the board plays a crucial role <strong>in</strong> thegovernance of the bank. A good chairperson can br<strong>in</strong>gout the talents of board members and provide theleadership and context necessary <strong>for</strong> board membersto contribute. A bad chairperson can stifle debate andhamper the board <strong>in</strong> achiev<strong>in</strong>g its objectives. One ofthe most important responsibilities of the chair is to setthe board agenda and ensure that important decisionsare subject to proper discussion and exam<strong>in</strong>ation.The Need <strong>for</strong> Strong Board Leadership“If push comes to shove, and you askedme to choose between f<strong>in</strong>ancial <strong>in</strong>dustryexpertise and leadership skills, I wouldsay go with leadership skills.”Cather<strong>in</strong>e Lawton, United K<strong>in</strong>gdomMore specifically, the chair’s responsibilities are to ensure that 1) the board receives accurate, timely, and clear<strong>in</strong><strong>for</strong>mation from management to enable the board to make sound decisions; 2) sufficient time is allowed<strong>for</strong> discussion of complex or contentious issues; 3) constructive debate and criticism flourish; 4) effectivecommunication with board committees occurs; 5) <strong>in</strong>duction and other tra<strong>in</strong><strong>in</strong>g opportunities exist; 6) theper<strong>for</strong>mance of the board is evaluated at least once a year; and 7) plans are made <strong>for</strong> strengthen<strong>in</strong>g theboard and bank governance.SEE chairpersons may not fully appreciate some of these general and specific responsibilities that contributeto the sound governance of the bank. They tend, understandably, to be more focused on per<strong>for</strong>manceissues. However, governance ultimately <strong>in</strong>fluences bank per<strong>for</strong>mance by affect<strong>in</strong>g the quality of decisionmak<strong>in</strong>g at the board level. More progressive and <strong>for</strong>ward-look<strong>in</strong>g board leadership is a key to improv<strong>in</strong>g bankgovernance. The need <strong>for</strong> leadership may be particularly important <strong>in</strong> boards of subsidiaries of <strong>for</strong>eign groups,where the work may focus narrowly on implement<strong>in</strong>g directions from the home office.Best practice <strong>in</strong>creas<strong>in</strong>gly suggests that the roles of chief executive officer and chairperson be separatedor that other means be found to provide an appropriate counterbalance to the powers of the executive. Incountries with two-tier boards, the roles should be separate by def<strong>in</strong>ition, s<strong>in</strong>ce executives should not sit onsupervisory boards. In countries where s<strong>in</strong>gle-tier boards exist, there is cont<strong>in</strong>ued discussion on whether theroles of chairperson and chief executive officer should be separated.The argument <strong>in</strong> favor of comb<strong>in</strong><strong>in</strong>g the two is that it provides a better understand<strong>in</strong>g of the operationalissues at board level, fewer decision-mak<strong>in</strong>g hurdles, better <strong>in</strong>tegration of strategy and tactics, and clearerdirection. The arguments aga<strong>in</strong>st are that it is hard <strong>for</strong> other board members to challenge a powerful chiefexecutive officer who is also chairperson, <strong>in</strong>dependent board members can be <strong>in</strong>timidated and neutralized,and the evaluation of board and executive per<strong>for</strong>mance becomes biased. In the end, the argument <strong>for</strong> isbased on the notion that there is an irreconcilable conflict between the roles of monitor and executor.In SEE, the chair of <strong>for</strong>eign subsidiaries are usually executives from the home office of the bank. So, <strong>in</strong> effect,there is a separation of the roles of chairperson and chief executive officer among the vast majority of banks,though such separation does not automatically guarantee sufficient control of the executive. Among locallyowned banks, the chair is often the major shareholder or the major shareholder’s representative, and theroles of chair and chief executive officer may be comb<strong>in</strong>ed.29 2010 BIS Pr<strong>in</strong>ciples, Section III.A, p. 12.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 23


RomaniaIn Romania, accord<strong>in</strong>g to the Law No. 31/1990, the board or, as appropriate, the supervisory board may setup consultative board committees <strong>for</strong>med by at least two board members. In companies with a s<strong>in</strong>gle-tierboard structure, at least one member of the committee needs to be an <strong>in</strong>dependent nonexecutive director;the audit and remuneration committees are to be composed exclusively of nonexecutive directors. Incompanies with a two-tier board structure, at least one member of each committee must be an <strong>in</strong>dependentmember of the supervisory board. Accord<strong>in</strong>g to Regulation No. 18/2009, banks may set up a riskmanagement committee. The Bucharest Stock Exchange <strong>Corporate</strong> <strong>Governance</strong> Code provides more directrecommendations.SerbiaIn Serbia, banks are required to establish an audit committee, credit committee, and committee <strong>for</strong> manag<strong>in</strong>gassets and liabilities. Only the audit committee is a board committee. It must be made of at least threemembers, two of whom must be board members and the third must be <strong>in</strong>dependent. A person not hold<strong>in</strong>gdirect or <strong>in</strong>direct ownership <strong>in</strong> the bank or <strong>in</strong> the bank<strong>in</strong>g group is considered <strong>in</strong>dependent.Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011).Recommendations:Board committees: The creation and composition of board committees should be carefully considered.Smaller wholly owned domestic banks and banks with small boards should be left free to decide whetherthey should have committees.Types of committees: For a well-function<strong>in</strong>g board, the most important committee is the audit committee.Audit committees should benefit from the maximum level of <strong>in</strong>dependence possible because of their centralimportance and the potential <strong>for</strong> conflicts of <strong>in</strong>terest.It should be noted that EU legislation requires all public <strong>in</strong>terest entities (listed companies, credit <strong>in</strong>stitutions,and <strong>in</strong>surance undertak<strong>in</strong>gs) to have an audit committee with at least one <strong>in</strong>dependent board member withcompetence <strong>in</strong> account<strong>in</strong>g or audit<strong>in</strong>g. 35 The def<strong>in</strong>ition of <strong>in</strong>dependence is not <strong>in</strong>cluded <strong>in</strong> the directive, but itcan be derived from the 2005 recommendation on the role of nonexecutive or supervisory board members oflisted companies and on the committees of the (supervisory) board. 36Remuneration committees are useful <strong>in</strong> def<strong>in</strong><strong>in</strong>g the bank’s goals and focus<strong>in</strong>g management’s attention ontheir achievement. A nom<strong>in</strong>ation committee can help the board better determ<strong>in</strong>e its own composition. Inpractice, most banks will f<strong>in</strong>d it useful to comb<strong>in</strong>e board committees or to use ad hoc structures <strong>in</strong>stead ofstand<strong>in</strong>g committees to make efficient use of <strong>in</strong>dependent board members.Risk management committees: Larger, systemically important, and complex banks should have a riskmanagement committee. If a risk committee is established, it is important that the full board be fullyappraised of risk-related issues so that all board members can work together <strong>in</strong> address<strong>in</strong>g the risks.Operational committees are no substitute <strong>for</strong> a risk committee at the board level.Participation and decision-mak<strong>in</strong>g power of committees: Board committees should be composedexclusively of board members. Executives and outside experts can be <strong>in</strong>vited to <strong>in</strong><strong>for</strong>m committees on specificissues, but decisions must be made exclusively by board members. Board committees act <strong>in</strong> an advisorycapacity to the board as a whole. Decision-mak<strong>in</strong>g responsibility rema<strong>in</strong>s with the full board.35 See Article 41 of Directive 2006/43/EC of the <strong>Europe</strong>an Parliament and of the Council of May 17, 2006, on statutory audits of annual accountsand consolidated accounts, amend<strong>in</strong>g Council Directives 78/660/EEC and 83/349/EEC and repeal<strong>in</strong>g Council Directive 84/253/EEC.36 The Recommendation is available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2005:052:0051:0063:EN:PDF.28<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


Brief<strong>in</strong>g of the board: Audit committees should not become gatekeepers. It is good to have the <strong>in</strong>ternalauditor periodically brief the full board to ensure good communication and not to cloister the <strong>in</strong>ternal auditorwith<strong>in</strong> the conf<strong>in</strong>es of the audit committee. Also, if the audit committees are receiv<strong>in</strong>g brief<strong>in</strong>gs from therisk managers and compliance people, they should also periodically brief the full board. In any event, the fullboard should be discuss<strong>in</strong>g risk and periodically hear from the risk manager, and the risk manager shouldhave fluid access to the board.Assessment of statutory audit bodies or “audit councils”: In SEE, it is important to dist<strong>in</strong>guish betweenstatutory audit bodies required by company law, or so-called audit councils, and an audit committee of theboard. The statutory body typically has a different role and is not a substitute <strong>for</strong> a properly constituted boardcommittee. In the majority of countries <strong>in</strong> SEE, audit councils can be made up of outsiders, which createsproblems with confidentiality and accountability. At a m<strong>in</strong>imum, the effectiveness of such structures shouldbe assessed.Qualifications and <strong>in</strong>dependence: Board committees tend to benefit greatly from specific skills and areasonable level of <strong>in</strong>dependence. A majority of <strong>in</strong>dependent members and of members with specific skillsis widely considered a m<strong>in</strong>imum. SEE banks should seek to staff board committees with experienced and<strong>in</strong>dependent <strong>in</strong>dividuals as needed.A7. Group structures 37Group structures are very important <strong>in</strong> the SEE context,given that the vast majority of bank<strong>in</strong>g activity isconducted by subsidiaries of <strong>for</strong>eign bank<strong>in</strong>g groups.In most cases, parent banks come from outsidethe region. Though, <strong>in</strong> a few cases, locally ownedbanks are parents of regional groups, as with theKomercijalna Banka ad Beograd. Although the largepresence of <strong>in</strong>ternational bank<strong>in</strong>g groups has broughtimprovements <strong>in</strong> bank<strong>in</strong>g and corporate governancepractices, the very high levels of <strong>for</strong>eign ownership havealso raised concerns.A local subsidiary of a <strong>for</strong>eign bank may not be asignificant operation from a group perspective, yeta <strong>for</strong>eign subsidiary <strong>in</strong> SEE can easily have a systemicimpact <strong>in</strong> a small country. As was famously describedby Mervyn K<strong>in</strong>g, governor of the Bank of England,“Global banks are global <strong>in</strong> life, but national <strong>in</strong> death.”In other words, when th<strong>in</strong>gs go wrong, it is ultimatelythe local entity that suffers the consequences and, to amuch lesser extent, the group. By extension, it is localstakeholders and the local economy that will suffer thecosts of a subsidiary bank failure.Subsidiary Boards“There is no way…parents are go<strong>in</strong>g towant the subsidiary board to come <strong>in</strong> onissues of strategy and risk. But that does notmean that directors can…abrogate theirresponsibilities. They have…responsibilitiesbut their position is extraord<strong>in</strong>arily difficult.”John Plender, United K<strong>in</strong>gdom“Of course, looked at on a group basis, youwould say, ‘We are responsible as a group.Here is the brand. We will look after you,’but when the balloon goes up, [and] thelocal regulator…has to sort this mess out…every legal argument is likely to be raisedthat places the responsibility with that localsubsidiary, to the detriment of the publicand the depositors <strong>in</strong> that host country.”Roger McCormick, United K<strong>in</strong>gdom37 2010 BIS Pr<strong>in</strong>ciples, Section III.A, pp. 15–16.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 29


On the SEE bank level, there is the need <strong>for</strong> a clear def<strong>in</strong>ition of the roles and responsibilities of subsidiaryboards. Best practice 38 recommends that the obligations of a parent bank board with regard to thesubsidiary are to establish governance structures adapted to the local conditions that meet all locallyapplicable governance requirements, and to ensure that resources are available to meet both group and localgovernance standards. It is important that the different decision-mak<strong>in</strong>g powers of the parent and subsidiaryboard are clearly understood. The parent board should also monitor subsidiary compliance with applicablelocal requirements.Best practice also suggests that the regulated subsidiary of a <strong>for</strong>eign bank adhere to the governancerequirements of the parent bank, tak<strong>in</strong>g <strong>in</strong>to account the nature of the local bus<strong>in</strong>ess and local legalrequirements. The local bank subsidiary must ensure that group-level decisions do not put it <strong>in</strong>to breach ofhost-country legal provisions. Similar to the obligations of any board, the local subsidiary board has a dutyof care and loyalty that should ensure the sound management of the subsidiary and its f<strong>in</strong>ancial health. Inaddition, it has an obligation to protect the legal <strong>in</strong>terests of its stakeholders.However, the implementation of these general recommendations is a considerable challenge <strong>in</strong> practice. Onthe one hand, parents do not wish to cede control over strategy, products, and risk to local subsidiary boards.Many of these local operations may almost function more as branches than as <strong>in</strong>dependent banks. On theother hand, substantive <strong>in</strong>put by local boards should protect local stakeholders and encourage a betterunderstand<strong>in</strong>g of local conditions and local risks. Local conditions do matter, and local boards cannot merelybe rubber stamps or conduits <strong>for</strong> execut<strong>in</strong>g central command. The middle ground is a substantive <strong>in</strong>teractionbetween the parent and the subsidiary that respects group strategy and ensures a full understand<strong>in</strong>g of thelocal conditions.Another concern is that different governance rules from different jurisdictions can lead to situations <strong>in</strong> which<strong>for</strong>eign and local requirements come <strong>in</strong>to conflict. In pr<strong>in</strong>ciple, this should not occur <strong>in</strong> countries that areadopt<strong>in</strong>g EU legislation and with a preponderance of <strong>for</strong>eign banks. However, <strong>in</strong> practice, bank<strong>in</strong>g groups<strong>in</strong>creas<strong>in</strong>gly po<strong>in</strong>t to a bewilder<strong>in</strong>g complexity of rules and regulations that come from the group and fromthe home and host countries. Background Box 3 provides an overview of <strong>for</strong>eign ownership of banks <strong>in</strong> SEE.Background Box 3: Foreign Ownership of SEE <strong>Banks</strong> 39AlbaniaThe Albanian bank<strong>in</strong>g sector comprises 16 banks, of which only 2 are owned by Albanian shareholders. Thethree major banks represent more than 56 percent of the Albanian market share. Only one of the three majorbanks is domestically owned; the other two are subsidiaries of important bank<strong>in</strong>g groups.Bosnia and Herzegov<strong>in</strong>aIn Bosnia, the majority <strong>for</strong>eign-owned banks dom<strong>in</strong>ate the bank<strong>in</strong>g system. They account <strong>for</strong> over 90 percentof the registered capital of banks. Domestic privately owned banks represent 7 percent of the registered capitalof banks. State-owned banks controlled 1.1 percent of total assets. The three major banks represent over 50percent of the market share.38 2010 BIS Pr<strong>in</strong>ciples BCBS (2010).39 For detailed illustrations of ownership of SEE banks by country and <strong>in</strong>dividual owners, see Annex E.2.30<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


B. Risk management and <strong>in</strong>ternal controls 43,44B1. Risk management versus <strong>in</strong>ternal control 45Risk management and <strong>in</strong>ternal control are twoprocesses that work hand <strong>in</strong> hand. Risk managementis <strong>in</strong>tended to 1) identify risks; 2) assess the bank’sexposure to risks; 3) monitor exposure and conductconsequential capital plann<strong>in</strong>g; 4) monitor and assessdecision mak<strong>in</strong>g as it relates to risk, <strong>in</strong> particular,whether risk decisions are <strong>in</strong> l<strong>in</strong>e with board-approvedrisk tolerance and policy; and 5) report to seniormanagement and the board.Internal control, on the other hand, ensures thateach key risk has an associated policy and controlmechanism, and that each control policy andmechanism is be<strong>in</strong>g applied effectively. Internal controlsprovide a variety of assurances to management, suchas the reliability of <strong>in</strong><strong>for</strong>mation, compliance with law,compliance with governance systems, prevention ofexcessive managerial discretion or fraud, and so on. It isa key responsibility of the board to ensure that effectivesystems of risk management and control are <strong>in</strong> place. 46Risk Management and RiskManagement Culture“When sophisticated risk management comestoo late, I do not th<strong>in</strong>k there is much reasonto celebrate.”George Bobvos, Montenegro“Effective risk management is not aboutelim<strong>in</strong>at<strong>in</strong>g risk-tak<strong>in</strong>g; risk-tak<strong>in</strong>g is afundamental driv<strong>in</strong>g <strong>for</strong>ce <strong>in</strong> bus<strong>in</strong>ess andentrepreneurship. The aim should be to ensurethat risks are understood and managed and,when appropriate, communicated.”Hans Christiansen, Denmark“One of the most important lessons that I th<strong>in</strong>kcomes out of the crisis from a governancepo<strong>in</strong>t of view is a focus on the risk governancerole of a board.”A best-practice board will typically need to rely onan <strong>in</strong>ternal auditor to provide the board, via theCather<strong>in</strong>e Lawton, United K<strong>in</strong>gdomaudit committee, with assurances regard<strong>in</strong>g thebank’s risk management and <strong>in</strong>ternal controls andcorporate governance processes. The <strong>in</strong>ternal auditor traditionally reports to management adm<strong>in</strong>istrativelyand to the board functionally, with the head of <strong>in</strong>ternal audit report<strong>in</strong>g directly to the chairperson of theaudit committee or to an <strong>in</strong>dependent lead board member. Internal auditors should enjoy substantive<strong>in</strong>dependence from management and have direct access to the board.Supervisors and bankers may use the term <strong>in</strong>ternal control to refer to a variety of aspects of the controlenvironment, <strong>in</strong>clud<strong>in</strong>g risk management, <strong>in</strong>ternal audit, controls, and compliance. Irrespective of how thefunctions of the control environment are named, each one is necessary and should be per<strong>for</strong>med effectively.In addition, a bank’s general counsel or legal function contributes significantly to the control of risk. Manyproblems <strong>in</strong> developed markets dur<strong>in</strong>g the recent f<strong>in</strong>ancial crisis resulted from legal risk failures.For banks <strong>in</strong> the SEE region, implement<strong>in</strong>g effective and reliable risk management and <strong>in</strong>ternal controls is oneof the most important challenges. It is only through an effective control environment that the board can beconfident that the <strong>in</strong><strong>for</strong>mation and reports that it receives are reliable. It is also the only way the board canexpress itself with any certa<strong>in</strong>ty on the risks <strong>in</strong> the bank.43 2010 BIS Pr<strong>in</strong>ciples, Section III.C, p. 17.44 For additional specific guidance on risk management, see CEBS, High Level Pr<strong>in</strong>ciples <strong>for</strong> Risk Management (2010).http://www.eba.europa.eu/documents/Publications/Standards---Guidel<strong>in</strong>es/2010/Risk-management/HighLevelpr<strong>in</strong>ciplesonriskmanagement.aspx.45 2010 BIS Pr<strong>in</strong>ciples, Section III.C, p. 17.46 See also BIS, Framework <strong>for</strong> Internal Control Systems <strong>in</strong> Bank<strong>in</strong>g Organizations (1998).34<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


Effective systems of risk management, <strong>in</strong>ternal audit, and <strong>in</strong>ternal control are often taken <strong>for</strong> granted <strong>in</strong>developed bank<strong>in</strong>g markets. For example, the Bank of Montreal recently added 200 people to strengthenits risk function, and Toronto Dom<strong>in</strong>ion Bank added 500 new staff on its risk side. SEE banks on the otherhand may have difficulty f<strong>in</strong>d<strong>in</strong>g and af<strong>for</strong>d<strong>in</strong>g one highly competent risk professional. These figures put <strong>in</strong>toperspective the relative scale of SEE banks and their capacity to respond.On the other hand, it is worth not<strong>in</strong>g that a large number of risk professionals does not equate to good riskmanagement; even <strong>in</strong> developed markets where f<strong>in</strong>ancial and human resources are broadly available, firmshave been known to accommodate their risk control to meet short-term sales or profitability objectives. Forexample, be<strong>for</strong>e the crisis, positions <strong>for</strong> risk professionals <strong>in</strong> UBS were filled by <strong>in</strong>dividuals with sales (not riskmanagement) backgrounds <strong>in</strong> order to accommodate growth. 47 This confirms the common knowledge thatthere are important human elements to develop<strong>in</strong>g a sound risk management culture.Another practical challenge <strong>in</strong> SEE is the communication of risk up to the board. In SEE banks, <strong>in</strong>clud<strong>in</strong>g<strong>in</strong>ternational subsidiaries, communication from the risk control functions goes to management first; thechief executive officer and management are <strong>in</strong>evitably the first port of call <strong>for</strong> the <strong>in</strong>ternal auditor. Theaudit committee is likely to be secondary, especially <strong>in</strong> countries where the <strong>in</strong>ternal audit function is notwell-developed and where <strong>in</strong>ternal auditors are junior and do not have sufficient stature to go to the auditcommittee or balance their authority aga<strong>in</strong>st the management structure.It is important to note that the risks <strong>in</strong>volved <strong>in</strong> bank<strong>in</strong>g <strong>in</strong> SEE perta<strong>in</strong> ma<strong>in</strong>ly to operational risk and creditrisk and not to f<strong>in</strong>ancial <strong>in</strong>struments, asset-backed securities, sophisticated market trad<strong>in</strong>g risk, or specialpurposevehicles, as was the case <strong>in</strong> more developed bank<strong>in</strong>g countries dur<strong>in</strong>g the f<strong>in</strong>ancial crisis. Thedifferent nature of risk <strong>in</strong> the SEE region calls <strong>for</strong> an adapted approach to risk management.Recommendations:The control environment: Bank boards need to assure themselves that the bank’s control environmentis function<strong>in</strong>g properly. The control environment should comprise not only risk management, compliance,<strong>in</strong>ternal controls, and the <strong>in</strong>ternal audit, but also the external audit. The importance of the general counselfunction and legal function <strong>in</strong> manag<strong>in</strong>g risk should also be recognized. Each of these functions should haveadequate authority, stature, <strong>in</strong>dependence, resources, and access to the board. Larger banks should have asufficiently <strong>in</strong>dependent audit committee to ensure professional oversight of the control environment.Communication of risk to the board: The communication of risk needs attention. Even though <strong>in</strong>ternalaudit and chief risk officers (CROs) may have organization-chart report<strong>in</strong>g l<strong>in</strong>es to the board or to an auditcommittee, it is important to ensure that these l<strong>in</strong>es of communication function <strong>in</strong> practice and are secure.Further, risk and audit committees should not localize <strong>in</strong><strong>for</strong>mation on risks, which needs to be shared with thefull board.Board review of the control environment: SEE boards should approve their bank’s control policies andassess the extent to which the bank is manag<strong>in</strong>g its risk effectively. They should regularly review (at leastannually) policies and controls with senior management to determ<strong>in</strong>e areas need<strong>in</strong>g improvement andto identify and address significant risks. The board should ensure that the control functions are properlypositioned, staffed, and resourced and are carry<strong>in</strong>g out their responsibilities <strong>in</strong>dependently and effectively. Indo<strong>in</strong>g so, they should work directly with the <strong>in</strong>ternal auditor and the CRO.47 OECD, “The Current F<strong>in</strong>ancial Crisis: Causes and <strong>Policy</strong> Issues,” F<strong>in</strong>ancial Market Trends (2008), 10.http://www.oecd.org/dataoecd/47/26/41942872.pdf.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 35


Chart 4: CRO (or Equivalent) Presence, Report<strong>in</strong>g and Access to the BoardThe bank has:No CRO, different risks are managedby different departmentsA CRO report<strong>in</strong>g to the CEO or CFObut with irregular, <strong>in</strong>direct access tothe board and/or its risk committeeA CRO report<strong>in</strong>g to the CEO or CFOand with regular, direct accessto the board and/or its risk committee0% 10% 20% 30% 40% 50% 60% 70% 80%Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011).Recommendations:CROs: The board should be able to have an <strong>in</strong>dependent view on the risks of the bank. Such an <strong>in</strong>dependentview can be provided by a CRO or equivalent. Whether a bank or a bank<strong>in</strong>g subsidiary has a dedicatedrisk officer depends on the size and nature of the operation. Smaller banks may wish to assign CROresponsibilities to other functions. Subsidiary banks may have their risk management function fulfilled bya CRO from the home office. In such cases, the CRO must fully understand the characteristics of the localenvironment. Risks should be the subject of a specific report to the board.Supervisors: Supervisors should enhance dialogue with and the frequency of meet<strong>in</strong>gs between themselvesand <strong>in</strong>ternal and external auditors and the risk management function, <strong>in</strong>clud<strong>in</strong>g the CRO, to improve thelikelihood of detect<strong>in</strong>g risk <strong>in</strong> the early stages. 56 Supervisors may wish to take a firm stand on requir<strong>in</strong>gcerta<strong>in</strong> risk management functions, if the local operation is of such significance that a failure would have acatastrophic local impact.B3. Risk methodologies and activities 57Bank risk management has come sharply <strong>in</strong>to focus as a result of the f<strong>in</strong>ancial crisis. There is a global needto enhance the sophistication of banks’ risk management and risk models. Some current best-practice trendsare to 1) consider more qualitative elements of risk <strong>in</strong> addition to quantitative elements, and not permitexcessive or bl<strong>in</strong>d reliance on quantitative models; 2) avoid overreliance on any one specific methodology ormodel; 3) consider different scenarios to better understand the impact of a broad variety of circumstances;and 4) have subsidiary banks develop their own risk analysis, and not rely exclusively on parent-bank riskassessments. Where subsidiary banks and boards should conduct their own risk assessments to evaluate local56 <strong>Europe</strong>an Commission, <strong>Corporate</strong> <strong>Governance</strong> <strong>in</strong> F<strong>in</strong>ancial Institutions (2011), p. 21.57 2010 BIS Pr<strong>in</strong>ciples, Section III.C, p. 19.38<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


circumstances, these f<strong>in</strong>d<strong>in</strong>gs should be reported to theparent bank.Risk management and risk model<strong>in</strong>g are of undeniableimportance, yet neither has been the cause of concern<strong>in</strong> SEE that they have been <strong>in</strong> more developed markets.Nevertheless, greater attention is warranted, even if itshould not be allowed to distract SEE banks from otherproblems that merit attention. Pr<strong>in</strong>cipal among theseis the need to become more proficient <strong>in</strong> the basics ofbank<strong>in</strong>g, concentrat<strong>in</strong>g on products and services thatcustomers need, and <strong>in</strong>tegrat<strong>in</strong>g risk management <strong>in</strong>tothis basic bank<strong>in</strong>g bus<strong>in</strong>ess.SEE countries also face challenges <strong>in</strong> apply<strong>in</strong>g riskmodels that were developed to respond to the riskenvironment of more sophisticated f<strong>in</strong>ancial marketsand which require considerable expertise to applyproperly. In some cases, bank executives do notunderstand the more sophisticated risk models andf<strong>in</strong>d it difficult to apply them with<strong>in</strong> their context.This <strong>in</strong>ability to properly apply risk models presents anadditional risk <strong>in</strong> its own right and suggests that betteradaptedmodels need to be developed.Excessive Focus on Technical Aspectsof Risk Management“Today risk management runs banks, and thatshould not be the case. I agree that corporategovernance should provide additionalsecurity, guarantee of transparency or be ak<strong>in</strong>d of tool, but I th<strong>in</strong>k that we first needto solve the fundamentals. I th<strong>in</strong>k thereis much to do <strong>in</strong> southeast <strong>Europe</strong> be<strong>for</strong>elook<strong>in</strong>g at more sophisticated corporategovernance. I would go back to the basics:what are the products people need?”George Bobvos, Montenegro“So what I would say is do not mistakefancy risk measurement capability <strong>for</strong> aculture of risk management; they are verydifferent th<strong>in</strong>gs.”Jon Lukomnik, United StatesRecommendations:Risk methodologies: Risk models must be sufficiently flexible to capture a fuller range of potential risks. Atthe same time, risk management should not draw excessive attention from build<strong>in</strong>g a fundamentally soundbank. Risk management models must reflect the nature of the bus<strong>in</strong>ess and become an <strong>in</strong>tegral part of thebank<strong>in</strong>g bus<strong>in</strong>ess.Credit culture: Most risks with<strong>in</strong> SEE will be credit-related risks. Although much emphasis is currently onsystems and methodologies, it is important <strong>for</strong> a bank to have a strong credit culture and <strong>for</strong> people tohave an <strong>in</strong>st<strong>in</strong>ct <strong>for</strong> credit. These are very basic items that are more important than sophisticated matrices.Ultimately, no risk model can substitute <strong>for</strong> a culture of prudent risk management.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 39


C. Compensation 58Compensation policies can have an impact on bankper<strong>for</strong>mance and risk tak<strong>in</strong>g. In developed f<strong>in</strong>ancialmarkets, and <strong>in</strong> particular <strong>in</strong> the United States,there has been <strong>in</strong>terest <strong>in</strong> the role that <strong>in</strong>centivepayments may have had on the level of risk <strong>in</strong> f<strong>in</strong>ancial<strong>in</strong>stitutions. Remuneration has captured the public’sattention because of what appear to be <strong>in</strong>ord<strong>in</strong>atepayments and the reward of bonus paymentsirrespective of bank per<strong>for</strong>mance. But, what elicitedCompensation <strong>in</strong> SEE“Compensation is not a burn<strong>in</strong>g issue <strong>in</strong> thisregion, and also probably the amounts arenot comparable to some of the grotesqueamounts that have been paid <strong>in</strong> the West.”Peter Dey, Canadathe most public outrage were the large bonuses paid at ail<strong>in</strong>g <strong>in</strong>stitutions that relied on taxpayer funds tocont<strong>in</strong>ue their operations.In developed markets, boards will be tak<strong>in</strong>g a much more active role <strong>in</strong> remuneration policies <strong>in</strong> the futureby exam<strong>in</strong><strong>in</strong>g the effectiveness of <strong>in</strong>centive compensation plans, the degree to which <strong>in</strong>centives support theachievement of bank objectives, the extent to which they encourage excessive risk, and their reputationalimpact. Board remuneration committees that are staffed entirely or predom<strong>in</strong>antly by <strong>in</strong>dependent boardmembers can be expected to play an important role.In SEE, on the other hand, high-payout compensation plans are exceed<strong>in</strong>gly rare, and risk tak<strong>in</strong>g fueledby large <strong>in</strong>centives is not a significant issue. SEE banks are almost uni<strong>for</strong>mly small. Compensation iscorrespond<strong>in</strong>gly modest and predom<strong>in</strong>antly <strong>in</strong> the <strong>for</strong>m of fixed salaries with a considerably smallercomponent of variable compensation. The trad<strong>in</strong>g, securitization, and derivatives operations that seem tohave gotten sophisticated banks <strong>in</strong>to trouble are not present. Furthermore, the <strong>in</strong>fluence of executives overtheir own pay is more limited.Chart 5: Variable Compensation as a Percentage of Total CompensationPer<strong>for</strong>mance-based variable compensation as a percentage of total compensation <strong>for</strong> seniorexecutives <strong>in</strong> the three largest SEE bankstoo opaque to have a viewless than 20%20% to 40%40% to 70%more than 70%0% 10% 20% 30% 40% 50% 60%Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011). Question asked to regulators <strong>in</strong> the region.58 2010 BIS Pr<strong>in</strong>ciples, Section III.D, p. 24.40<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


A significant concern is the large percentage of supervisors who <strong>in</strong>dicate that the per<strong>for</strong>mance-basedcompensation of the top three executives <strong>in</strong> banks is too opaque <strong>for</strong> them to have a view on it (see Chart 5).If regulators do not have a clear idea of how bank compensation is structured, it will be difficult <strong>for</strong> them toensure that compensation is <strong>in</strong> l<strong>in</strong>e with best practices and that compensation structures are <strong>in</strong> the best longterm<strong>in</strong>terests of the bank. A related concern is the question of CRO compensation. Data <strong>in</strong>dicate that CROscommonly receive a part of their compensation <strong>in</strong> the <strong>for</strong>m of variable or <strong>in</strong>centive pay (see Chart 6). Thispractice has been identified as potentially compromis<strong>in</strong>g the <strong>in</strong>dependence of the CRO.Chart 6: CRO Compensation <strong>in</strong> SEE <strong>Banks</strong>Is the CRO’s variable compensation paid accord<strong>in</strong>g to the same criteria as other senior executives?NOYES0% 10% 20% 30% 40% 50% 60%Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011). Question asked to selected banks <strong>in</strong> the region.Most board member compensation is <strong>in</strong> the <strong>for</strong>m of fixed fees. Few SEE banks use stock options, but somehave per<strong>for</strong>mance-based awards (see Chart 7).Chart 7: Board Member CompensationRemuneration of nonexecutive directors with<strong>in</strong> the bank is:fixed fee comb<strong>in</strong>edwith stock optionsfixed fee comb<strong>in</strong>edwith stock awardsfixed fee comb<strong>in</strong>edwith per<strong>for</strong>mance-based bonusa fixed fee0 10 20 30 40 50 60 70 80Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011). Question asked to selected banks <strong>in</strong> the region.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 41


The disclosure of compensation, which is viewed as a means of creat<strong>in</strong>g accountability <strong>for</strong> pay, is uncommon,though some SEE countries require banks to disclose their remuneration policy. In Bulgaria, <strong>for</strong> example, thispolicy is disclosed on the website of the Bulgarian National Bank. Where such disclosure is mandatory <strong>in</strong> SEE,it is typically <strong>in</strong> response to EU requirements. Jo<strong>in</strong><strong>in</strong>g the <strong>Europe</strong>an Union requires compliance with a setof rules, part of which is the <strong>Europe</strong>an Commission’s Capital Requirements and Bonuses Package (CRD3), 59which has explicit rules on the <strong>for</strong>m and disclosure of compensation.Nevertheless, <strong>in</strong>dividual disclosure rema<strong>in</strong>s a sensitive issue, partly because of security risks to executives.It has been suggested that the disclosure of salary <strong>in</strong><strong>for</strong>mation may expose executives to extortion orharassment. Still, aggregate disclosure and disclosure of the bank’s remuneration policies may help enhanceaccountability and control potential excesses.Recommendations:Executive remuneration: The board needs to regularly review the bank’s remuneration policies. The boardneeds to be confident that <strong>in</strong>centive programs are effective <strong>in</strong> enhanc<strong>in</strong>g bank per<strong>for</strong>mance, and to bevigilant that such programs are neither excessive nor likely to <strong>in</strong>centivize risk tak<strong>in</strong>g that is not <strong>in</strong> accord withthe bank’s risk strategy.Remuneration of control functions: Compensation <strong>for</strong> the control function (<strong>for</strong> example, CRO and riskmanagement) should be structured <strong>in</strong> a way that is based pr<strong>in</strong>cipally on the achievement of their objectivesand does not compromise the <strong>in</strong>dependence of the control functions (that is, compensation should not betied to bus<strong>in</strong>ess-l<strong>in</strong>e revenue).Board-member remuneration: Views diverge regard<strong>in</strong>g board-member remuneration. Some advocatealign<strong>in</strong>g nonexecutive board-member <strong>in</strong>terest with that of the bank via long-term compensation plans(often us<strong>in</strong>g shares and/or stock options). Others suggest that such plans co-opt boards, damage their<strong>in</strong>dependence, and <strong>in</strong>crease short-termism. They suggest that nonexecutive board members not take part<strong>in</strong> variable pay plans and that they should only be paid a fixed annual fee (and perhaps a separate fee <strong>for</strong>attend<strong>in</strong>g meet<strong>in</strong>gs). Practice with<strong>in</strong> the EU appears to favor the latter approach.Supervisors: Supervisors need to have a clear view of compensation practices <strong>in</strong> banks to ensure that banks’remuneration practices favor long-term <strong>in</strong>terests and do not encourage undue risks.59 For the specific amendments <strong>in</strong>cluded <strong>in</strong> the CRD3, see http://ec.europa.eu/<strong>in</strong>ternal_market/bank/docs/regcapital/com2009/Leg_Proposal_Adopted_1307.pdf.42<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


D. Disclosure and transparency 60Disclosure is a tool used by regulators <strong>in</strong> the most developed markets to hold banks to account to the public,shareholders, supervisors, and the markets. So-called disclosure-based regulation is often used as a less<strong>in</strong>trusive and more effective alternative to merit-based regulation, which requires companies to comply withsubstantive rules. Disclosure and transparency are widely considered fundamental to the effective governanceof any enterprise and are a key feature of best practice.Disclosure requirements usually apply to exchange-listed companies, but, <strong>in</strong> some countries, even privatecompanies of a certa<strong>in</strong> size and banks, irrespective of their size, are expected to make <strong>in</strong><strong>for</strong>mation available tothe public. The justification <strong>for</strong> such requirements is that the operations of banks and large enterprises havea significant impact on economies, and that the public <strong>in</strong>terest is served by greater transparency. This is thecase with unlisted banks whose activities can pose risks to the f<strong>in</strong>ancial system and whose f<strong>in</strong>ancial health isof fundamental <strong>in</strong>terest to creditors and consumers.In pr<strong>in</strong>ciple, banks should disclose to the public any and all “material” 61 <strong>in</strong><strong>for</strong>mation on their operations.Disclosure should focus on areas that are most likely to affect the users of <strong>in</strong><strong>for</strong>mation, and it should bepresented clearly, so it can be understood by nontechnical people. For banks, special attention needs to bepaid to disclos<strong>in</strong>g the process of risk management and the results of risk assessments.Smaller banks and bank<strong>in</strong>g subsidiaries should adapt their level of disclosure to their size, complexity, andrisk profile, to provide the <strong>in</strong><strong>for</strong>mation that is truly needed, without <strong>in</strong>curr<strong>in</strong>g excessive costs. At a m<strong>in</strong>imum,banks can be expected to disclose their audited f<strong>in</strong>ancial statements as well as a statement on their corporategovernance. 62Such governance disclosure should cover issues such as the follow<strong>in</strong>g: board composition; board-memberbackgrounds; governance structures such as committees; bank, board, and committee charters; governanceand ethics policies; remuneration; and <strong>in</strong><strong>for</strong>mation regard<strong>in</strong>g risk exposure, capital exposure, and structuresdesigned to ensure a sound control environment at the bank. 63 Furthermore, disclosure should be made onsignificant events between regular report<strong>in</strong>g periods.Appropriate account<strong>in</strong>g and disclosure standards need to be followed. IFRS is <strong>in</strong>creas<strong>in</strong>gly becom<strong>in</strong>g theglobal standard and is required <strong>for</strong> listed companies <strong>in</strong> the EU. Subsidiaries of listed EU home-country bankswill <strong>in</strong>evitably be required to use IFRS to comply with consolidation requirements. In some SEE countries, thecentral bank requires all licensed banks to use IFRS. To the extent possible, local banks should be required touse IFRS to rema<strong>in</strong> on the same foot<strong>in</strong>g with <strong>for</strong>eign banks.Bank<strong>in</strong>g is possibly the most transparent sector <strong>in</strong> SEE, and banks tend to comply well with disclosurerequirements. On the other hand, gaps can be observed. Some banks appear to be miss<strong>in</strong>g the systemsnecessary to produce f<strong>in</strong>ancial statements to an acceptable standard. Resolv<strong>in</strong>g report<strong>in</strong>g problems posesa complex challenge, because it <strong>in</strong>volves hav<strong>in</strong>g adequate account<strong>in</strong>g and audit standards, proper systemswith<strong>in</strong> the bank, and, perhaps most important, sufficient tra<strong>in</strong>ed staff to produce reliable statements on atimely basis.60 2010 BIS Pr<strong>in</strong>ciples, Section III.F, p. 29.61 Def<strong>in</strong>itions of what constitutes material <strong>in</strong><strong>for</strong>mation can be found <strong>in</strong> such <strong>in</strong>ternational guidance as the OECD Pr<strong>in</strong>ciples <strong>for</strong> <strong>Corporate</strong> <strong>Governance</strong>.62 Specific disclosure requirements are not listed <strong>in</strong> this <strong>Policy</strong> Brief. A large number of pronouncements exist that outl<strong>in</strong>e specific disclosurerequirements. Of particular <strong>in</strong>terest are those of the BCBS, which are tailored to the bank<strong>in</strong>g sector as well as to the EC. <strong>Governance</strong>-relateddisclosure requirements have been compiled by UNCTAD (United Nations Conference on Trade and Development), and a more pr<strong>in</strong>ciples-basedoverview is provided by the OECD. Numerous national requirements may also serve as guidance.63 For more detailed guidance on corporate governance disclosures, see UNCTAD’s Guidance on Good Practice <strong>in</strong> <strong>Corporate</strong> <strong>Governance</strong> Disclosure atwww.unctad.org/en/docs/iteteb20063_en.pdf.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 43


Skepticism regard<strong>in</strong>g disclosureBeyond these technical concerns, there is considerable skepticism regard<strong>in</strong>g the benefits of disclosure <strong>in</strong>the region. In best-practice countries, the usual benefits of disclosure are described as better accountabilityto owners and the public, improvements <strong>in</strong> per<strong>for</strong>mance, better access to capital, and improved publicperceptions. Yet, SEE managers and owners tend to be more conscious of the short-term costs than of theconsiderably less tangible benefits that might accrue to them <strong>in</strong> the longer term.For disclosure to work, <strong>in</strong><strong>for</strong>mation must be easily available <strong>for</strong> the public and the markets to use. The Internetis often a cost-effective way of gett<strong>in</strong>g <strong>in</strong><strong>for</strong>mation <strong>in</strong>to the public’s hands (see Chart 8). In SEE, banks makemost basic <strong>in</strong><strong>for</strong>mation publicly available directly <strong>in</strong> their branches, <strong>in</strong> government publications, or <strong>in</strong> thepublished media.Chart 8: Web-based Disclosure by SEE <strong>Banks</strong>Are the follow<strong>in</strong>g disclosures of the bank posted on the website?Director remuneration report<strong>Corporate</strong> governance reportTerms of reference/chartersof the board and committeesComposition and structureof the boardOwnership structureF<strong>in</strong>ancial statements0 10 20 30 40 50 60 70 80 90 100Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011). Question asked to selected banks <strong>in</strong> the region.Yet, even where <strong>in</strong><strong>for</strong>mation is freely available, it isuncerta<strong>in</strong> whether the public and depositors canunderstand complex issues such as risk, gear<strong>in</strong>g, orcapital adequacy, or whether they would access such<strong>in</strong><strong>for</strong>mation if it were available on a website.Some SEE supervisors express concern that <strong>in</strong><strong>for</strong>mationgiven to the public could damage trust <strong>in</strong> the f<strong>in</strong>ancialmarkets and destabilize them. Supervisors’ concernsare not with public disclosure itself but rather withwhat should be disclosed. Supervisors tend to agreethat problems should be handled <strong>in</strong>itially <strong>in</strong> discussionswith supervisors, with disclosure occurr<strong>in</strong>g only whenproblems become worse.Capacity of the Public toUnderstand Disclosures“In practice <strong>in</strong> this region I do questionwhether the depositors can reallyunderstand market risk, ord<strong>in</strong>ary risk,risk-weighted assets, all of these issueswhich are of course relevant. I wonderwhether they actually understand themand whether it gives them any com<strong>for</strong>tat all to read about it on a website.”Belgrade Conference 200944<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


Supervisors also expressed skepticism about the ability of disclosure to signal impend<strong>in</strong>g problems; they feltthat banks would not reveal truly relevant <strong>in</strong><strong>for</strong>mation. They suggested credit rat<strong>in</strong>gs as a way to strengthenand complement disclosure. One benefit of <strong>in</strong>dependent credit rat<strong>in</strong>gs is that they provide an easy shorthandthat allows the public to understand bank risk. On the other hand, rat<strong>in</strong>gs agencies were unable to warn ofrisks dur<strong>in</strong>g the recent f<strong>in</strong>ancial crisis, which suggests that their effectiveness is not a <strong>for</strong>egone conclusion.Some countries such as Bulgaria have requirements <strong>in</strong> law <strong>for</strong> banks to undergo credit rat<strong>in</strong>gs.All of these doubts merit consideration. However, they also emanate from a partial view of how disclosurebasedregulation functions. True, the <strong>in</strong><strong>for</strong>mation that is compiled and reported is <strong>in</strong>tended to be read,scrut<strong>in</strong>ized, and understood by an <strong>in</strong>telligent reader, yet a considerable part of the value of disclosure-basedregulation is that disclosure <strong>for</strong>ces the bank and management to seriously exam<strong>in</strong>e the issues that are thesubject of the disclosure, to take a position, and to make a public assertion. Such a public assertion usuallymakes the board and management legally responsible.The role of the board <strong>in</strong> disclosure under best practiceUnder best practice, the specific responsibilities of the board regard<strong>in</strong>g disclosure and transparency canbe divided <strong>in</strong>to four areas: 1) ensur<strong>in</strong>g transparent governance; 2) report<strong>in</strong>g on company per<strong>for</strong>mance; 3)ensur<strong>in</strong>g an effective and <strong>in</strong>dependent external audit; and 4) ensur<strong>in</strong>g effective <strong>in</strong>ternal control. 64In the first area, ensur<strong>in</strong>g transparent governance, the board is expected to develop <strong>for</strong>mal written mandatesor policy statements that set out the general duties and operat<strong>in</strong>g pr<strong>in</strong>ciples of the board, and disclose them.Best-practice boards report on the bank’s governance structures, policies, and governance per<strong>for</strong>mance.Basic <strong>in</strong><strong>for</strong>mation such as the charter and bylaws should be publicly available under any circumstance. Boardreport<strong>in</strong>g may take a variety of <strong>for</strong>ms, <strong>in</strong>clud<strong>in</strong>g, <strong>for</strong> example, statements of compliance with a national codeof corporate governance, and a consolidated annual report on the company’s governance. In addition, boardsare <strong>in</strong>creas<strong>in</strong>gly be<strong>in</strong>g asked to report on their own work and per<strong>for</strong>mance. 65It is generally accepted that the board has responsibility <strong>for</strong> report<strong>in</strong>g on the f<strong>in</strong>ancial and operat<strong>in</strong>g resultsof the bank. The basic responsibility of the board is to review f<strong>in</strong>ancial statements, approve them, and thensubmit them to shareholders. In addition to the external auditor, the board provides some level of assurancethat the f<strong>in</strong>ancial statements accurately represent the situation of the company. Provid<strong>in</strong>g credible assurancesis a difficult and complex task that <strong>in</strong>volves check<strong>in</strong>g the consistency of account<strong>in</strong>g and f<strong>in</strong>ancial statementsand the external auditor’s report, ensur<strong>in</strong>g the <strong>in</strong>tegrity of the company’s account<strong>in</strong>g and f<strong>in</strong>ancial report<strong>in</strong>gsystems, oversee<strong>in</strong>g the <strong>in</strong>dependent audit, and ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g an appropriate relationship with the company’sauditors. 66It is typically the audit committee that helps the board fulfill these tasks. The audit committee’s pr<strong>in</strong>cipalrole is oversee<strong>in</strong>g the <strong>in</strong>ternal and external audit, assist<strong>in</strong>g the board <strong>in</strong> supervis<strong>in</strong>g the selection of externalauditors and the audit process, and address<strong>in</strong>g the account<strong>in</strong>g issues of the company. Another responsibilityof the audit committee is to assess the reliability of the systems whereby the accounts are drawn up and thevalidity of account<strong>in</strong>g methods. 67An important aspect of this responsibility is the process of select<strong>in</strong>g and monitor<strong>in</strong>g the external auditor toensure the quality and <strong>in</strong>dependence of the audit. Best-practice audit committees are expected to prepare the64 For a detailed exam<strong>in</strong>ation of best practice, see R. Frederick, “The Role of the Board <strong>in</strong> Disclosure: An Exam<strong>in</strong>ation of What Codification Ef<strong>for</strong>ts Say,”Paper developed <strong>for</strong> the OECD and presented at the OECD’s Fifth Meet<strong>in</strong>g of the South East <strong>Europe</strong> <strong>Corporate</strong> <strong>Governance</strong> Roundtable (2004).http://www.oecd.org/dataoecd/55/33/32387383.pdf.65 Ibid.66 Ibid.67 Ibid.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 45


decision concern<strong>in</strong>g the appo<strong>in</strong>tment of the external auditor; ma<strong>in</strong>ta<strong>in</strong> contacts with the auditor and exam<strong>in</strong>ethe auditor’s reports; review and monitor the external auditor’s <strong>in</strong>dependence, <strong>in</strong>clud<strong>in</strong>g the developmentand implementation of a policy on the engagement of the external auditor to supply nonaudit services; andevaluate other services supplied by the external auditor that may lead to a conflict of <strong>in</strong>terest. 68The external auditIn SEE, the relationship between board members and external auditors is an important issue. Some SEE boardmembers express concern that audit statements do not reveal the real problems of banks, because theyare the result of negotiations between management (that appo<strong>in</strong>ts the auditors and pays them <strong>in</strong> practice)and the auditors. Questions may arise, <strong>for</strong> example, about loan provision<strong>in</strong>g or provision<strong>in</strong>g <strong>for</strong> <strong>in</strong>vestments.Management is required to provide satisfactory explanations to auditors; however, these explanations maynot be sufficient to conv<strong>in</strong>ce board members who may be aware of more profound problems. 69Such a situation poses a significant dilemma <strong>for</strong> some SEE board members. On the one hand, board membersneed to follow their conscience and act <strong>for</strong>cefully and with <strong>in</strong>tegrity. On the other hand, management may beunresponsive, and go<strong>in</strong>g public with <strong>in</strong>crim<strong>in</strong>at<strong>in</strong>g <strong>in</strong><strong>for</strong>mation may be detrimental to the value of the bankon a stock exchange or may even cause concern regard<strong>in</strong>g systemic stability.Board members may question the extent to which they should trust their own judgment versus the auditorsand management. Furthermore, there is a limit to the number of times a member can object be<strong>for</strong>e his roleon the board becomes untenable. Eventually board members who object may need to resign. However, thisalso means they can no longer act as a positive <strong>in</strong>fluence on the bank by encourag<strong>in</strong>g better governance andper<strong>for</strong>mance. 70F<strong>in</strong>ally, regard<strong>in</strong>g <strong>in</strong>ternal control, best practice describes the board’s higher-level responsibility <strong>for</strong> ensur<strong>in</strong>gthe <strong>in</strong>tegrity of the corporation’s <strong>in</strong>ternal control and management <strong>in</strong><strong>for</strong>mation systems. Where a bank hasan <strong>in</strong>ternal audit function, the audit committee should, at a m<strong>in</strong>imum, approve its mandate, ensure that it hasadequate resources, and verify that the director of <strong>in</strong>ternal audit has direct and open communication withboth the board and the external auditor.The specific responsibilities of the board concern<strong>in</strong>g the <strong>in</strong>ternal audit are to annually review the effectivenessof <strong>in</strong>ternal controls and procedures and to report the f<strong>in</strong>d<strong>in</strong>gs. The review should cover all systems of<strong>in</strong>ternal control, <strong>in</strong>clud<strong>in</strong>g f<strong>in</strong>ancial, operational, and compliance and risk management, and it should <strong>in</strong>cludeprocedures to identify and report to the board, and (where appropriate) to shareholders, situations of conflictof <strong>in</strong>terest affect<strong>in</strong>g board members, managers, or other senior employees of the company (see BackgroundBox 5). In discuss<strong>in</strong>g risk management, best practice often cites the review of unusual and complextransactions as well as transactions us<strong>in</strong>g f<strong>in</strong>ancial <strong>in</strong>struments and their level of risk. 7168 Ibid.69 Ibid.70 Ibid.71 Ibid.46<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


application of the bank’s corporate governance code; and <strong>in</strong><strong>for</strong>mation on the bank’s policy on conflictof-<strong>in</strong>terestprevention. Listed banks 73 disclose the identity of board members but do not always <strong>in</strong>cludebiographies or additional <strong>in</strong><strong>for</strong>mation.MontenegroThe Bank<strong>in</strong>g Law requires banks to disclose exposure to risks <strong>in</strong> operations and the manner of manag<strong>in</strong>gthose risks. There are no specific requirements to disclose corporate governance <strong>in</strong><strong>for</strong>mation. The <strong>Corporate</strong><strong>Governance</strong> Code recommends that listed companies adopt a written and publicly available report<strong>in</strong>g policydef<strong>in</strong><strong>in</strong>g the rules and procedures of report<strong>in</strong>g to shareholders and the public. Further, the code recommendsthat companies use their websites <strong>for</strong> disclosure of <strong>in</strong><strong>for</strong>mation and that the annual reports <strong>in</strong>clude a sectionon corporate governance, prepared by the board, that describes the level of compliance with the law andthe national code. At this writ<strong>in</strong>g, only four companies—but no banks—have adopted the code. <strong>Banks</strong> <strong>in</strong>Montenegro do not post any corporate governance <strong>in</strong><strong>for</strong>mation on their websites.RomaniaAccord<strong>in</strong>g to the Romanian Bank<strong>in</strong>g Act, to ensure market discipl<strong>in</strong>e and transparency, credit <strong>in</strong>stitutionsmust disclose, at least annually, data and <strong>in</strong><strong>for</strong>mation regard<strong>in</strong>g their activities as soon as these are available.In general, the means of disclos<strong>in</strong>g such data and <strong>in</strong><strong>for</strong>mation rema<strong>in</strong> the credit <strong>in</strong>stitution’s choice, but theNational Bank of Romania may impose credit-<strong>in</strong>stitution-specific measures regard<strong>in</strong>g the content, frequency,and means of disclosure. In general, disclosure on corporate governance by banks is limited. When documentsreferr<strong>in</strong>g to corporate governance are made available, they are not comprehensive. Nevertheless, generalcorporate <strong>in</strong><strong>for</strong>mation (annual reports, f<strong>in</strong>ancial statements, current shareholders, and the composition ofthe board) is generally appropriately disclosed. Listed banks are bound to make the follow<strong>in</strong>g disclosure:under the Companies Act, as corporations; under the Bank<strong>in</strong>g Act and Regulations and norms of the centralbank (National Bank of Romania), because of their activity; and under the Capital Market Act, Rules andRegulations of the Romanian National Securities Commission, and Rules and Regulations of the BucharestStock Exchange, <strong>in</strong>clud<strong>in</strong>g the <strong>Corporate</strong> <strong>Governance</strong> Code. The content of their <strong>in</strong><strong>for</strong>mation disclosure isclearly def<strong>in</strong>ed.SerbiaThe Law on <strong>Banks</strong> requires banks to publish audited annual f<strong>in</strong>ancial statements, unaudited quarterly f<strong>in</strong>ancialstatements, the names of members of the supervisory and management boards, ownership <strong>in</strong> the bank orthe bank’s hold<strong>in</strong>g company, along with the bank’s organizational structure and a list of organizational units<strong>in</strong> the bank. The Law on <strong>Banks</strong> also requires the supervisory board to provide an annual report to the generalshareholders’ meet<strong>in</strong>g, <strong>in</strong>clud<strong>in</strong>g <strong>in</strong><strong>for</strong>mation on salaries, fees, and other earn<strong>in</strong>gs of the members of thesupervisory and management boards and <strong>in</strong><strong>for</strong>mation on contracts between a bank and the members of theseboards or other related people. In practice, bank websites do not generally provide any dedicated specificcorporate governance disclosure. Nevertheless, general corporate <strong>in</strong><strong>for</strong>mation (annual reports, shareholders,members of the boards) is adequately disclosed. None of the websites of the 19 listed banks conta<strong>in</strong>s<strong>in</strong><strong>for</strong>mation regard<strong>in</strong>g compliance with the <strong>Corporate</strong> <strong>Governance</strong> Code of the Belgrade Stock Exchange.Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011).73 The Third Investor Relations and <strong>Corporate</strong> Social Responsibility Surveys of the websites of the lead<strong>in</strong>g companies listed on the Macedonian StockExchange was presented on April 26, 2010, and it is available at http://www.mse.org.mk/News.aspx?NewsId=4026.48<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


Recommendations:Disclosure and transparency: Disclosure is an effective governance tool. At a m<strong>in</strong>imum, banks need todisclose their accounts, governance practices and structures, risks, and risk management practices to thepublic on a regular and timely basis. This obligation should apply even if banks are unlisted, because there isa public <strong>in</strong>terest <strong>in</strong> the health of the f<strong>in</strong>ancial sector. <strong>Banks</strong> should disclose not only <strong>in</strong> accordance with locallaw, but also <strong>in</strong> accordance with best-practice standards.Disclosure requirements are often wide rang<strong>in</strong>g. Supervisors need to develop m<strong>in</strong>imum disclosurerequirements. Important guidance on bank-specific disclosure is provided by the BCBS and others and shouldbe consulted <strong>in</strong> the development of a disclosure policy. 74Web disclosure: Disclosed <strong>in</strong><strong>for</strong>mation should be provided to authorities and be easily accessible to thepublic on the Web.<strong>Corporate</strong> governance codes: In jurisdictions where corporate governance codes <strong>in</strong>clude a “comply orexpla<strong>in</strong>” approach (such as Bulgaria, Croatia, FYR Macedonia, Montenegro, Romania, and Serbia), listedbanks should be required to publish corporate governance reports and compliance statements, with detailedexplanations when the recommendations of the code are not followed.Differences on audited statements: Differences of op<strong>in</strong>ion between board members and auditors onthe f<strong>in</strong>ancial statements need to be resolved first by discussion. Discussions may be held first <strong>in</strong>ternally withmanagement, then externally via <strong>in</strong>terviews with auditors, and eventually with professional audit bodies andregulators. Compromise may be required on differences where compromise is possible. The way to encouragechange may be through small steps. But, under egregious circumstances, board members may need to resignwhen other <strong>in</strong>itiatives have failed.74 BCBS, Enhanc<strong>in</strong>g Bank Transparency (1998); Compensation Pr<strong>in</strong>ciples and Standards Assessment Methodology (2010); and Pillar III DisclosureRequirements <strong>for</strong> Remuneration (2010). See also UNCTAD, Guidance on Good Practice <strong>in</strong> <strong>Corporate</strong> <strong>Governance</strong> Disclosure (2006).<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 49


IV. The role of supervisors 75A sound governance culture drives per<strong>for</strong>manceand is able to moderate the tension between profitmaximization and prudent risk tak<strong>in</strong>g. However, thereare issues that require regulatory <strong>in</strong>tervention. Systemicrisk is an example, because market <strong>for</strong>ces and <strong>in</strong>dividualbanks cannot address it.Regulators are becom<strong>in</strong>g more proactive <strong>in</strong>ternationallyand are seek<strong>in</strong>g to extract lessons from the recentf<strong>in</strong>ancial crisis. At the same time, SEE countries are alsowork<strong>in</strong>g to enhance the basic regulatory framework,pr<strong>in</strong>cipally by focus<strong>in</strong>g on the basics: transparency,risk management, retail lend<strong>in</strong>g, licens<strong>in</strong>g of <strong>for</strong>eignbranches, and so on. Generally, such regulatory ef<strong>for</strong>tsreflect the requirements of EU legislation.Increas<strong>in</strong>g Interest of Supervisors <strong>in</strong>Bank <strong>Governance</strong>“I th<strong>in</strong>k that regulators will <strong>in</strong>creas<strong>in</strong>gly betak<strong>in</strong>g corporate governance of banks <strong>in</strong>toaccount as part of their risk assessment <strong>for</strong>banks, and not be<strong>for</strong>e time. Regulatorsdo not want to regulate on the structureof a board but they are concerned that allmembers of the board, both executive andnon-executive, understand the complexity oftheir organizations and have a role to play.”Ian Radcliffe, United K<strong>in</strong>gdomThere are, however, concerns regard<strong>in</strong>g their“transplantability” to the SEE region. A common concern is that banks comply on paper while fall<strong>in</strong>g farshort of the impact <strong>in</strong>tended by law. The standards be<strong>in</strong>g developed at the global and regional levels are ofundeniable importance and relevance, but SEE needs to have a less complicated regulatory framework andsolutions that are <strong>in</strong> step with its stage of f<strong>in</strong>ancial sector development and adapted to the needs of smallercountries.Another key concern is implementation. In many cases the implementation of policies at both the supervisoryand bank levels is quite mechanical, and it is not uncommon <strong>for</strong> <strong>for</strong>m to take priority over substance.Provisions <strong>in</strong> law, put <strong>in</strong> place with the best <strong>in</strong>tentions, can have un<strong>in</strong>tended consequences.A. Guidance by supervisors 76Supervisors are expected to provide guidance to banks concern<strong>in</strong>g corporate governance. This is particularlyimportant where rules, practices, and legislation do not address the s<strong>in</strong>gular governance aspects of bank<strong>in</strong>g.International guidanceA large number of <strong>in</strong>ternational bodies provide guidance on corporate governance, <strong>in</strong>clud<strong>in</strong>g the EU, theCommittee of <strong>Europe</strong>an Bank<strong>in</strong>g Supervisors, and the F<strong>in</strong>ancial Stability Board. Furthermore, the OECDPr<strong>in</strong>ciples of <strong>Corporate</strong> <strong>Governance</strong> have <strong>in</strong>fluenced many of the local rules and much of the legislation <strong>in</strong> theregion.Each of these sources is valuable; however, none is perfectly suited to the needs of SEE banks. For example,the OECD Pr<strong>in</strong>ciples are the global benchmark, but are generally aimed at larger listed companies and donot deal with the specificities of the bank<strong>in</strong>g sector. The Basel Committee Pr<strong>in</strong>ciples <strong>for</strong> Enhanc<strong>in</strong>g <strong>Corporate</strong><strong>Governance</strong> are sector-specific but focus on the problems of sophisticated banks <strong>in</strong> more developed markets.75 2010 BIS Pr<strong>in</strong>ciples, Section IV, p. 30.76 2010 BIS Pr<strong>in</strong>ciples, Section IV.1. p. 30.50<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


These limitations are due to the very nature of<strong>in</strong>ternational <strong>in</strong>struments; the basic problem is thatit is not possible to develop <strong>in</strong>ternational guidancethat responds perfectly to the needs of all <strong>in</strong>dividualcountries and all potential users. That is why<strong>in</strong>ternational guidance is often framed as pr<strong>in</strong>ciplesand tends to avoid detail. And, there is always theexpectation that these pr<strong>in</strong>ciples—even if they holduniversally—will be implemented differently depend<strong>in</strong>gon the local context.Thus a key concern is how to apply <strong>in</strong>ternationalguidance <strong>in</strong> SEE and avoid the “cut and paste”approach now prevalent <strong>in</strong> the region. One approachmay be the partial implementation of <strong>in</strong>ternationalguidance, us<strong>in</strong>g only those pieces where there is aneasy fit. But, this approach may result <strong>in</strong> a frameworkwith considerable gaps. An alternative might be thedevelopment of less str<strong>in</strong>gent, <strong>in</strong>termediate standardsthat could be strengthened over time.Domestic governance codesA number of voluntary codes already exist <strong>in</strong> SEE. Infact, all jurisdictions have a corporate governance code,and all of these apart from Bosnia and Albania have a“comply or expla<strong>in</strong>” requirement. However, comply-orexpla<strong>in</strong>disclosures are not broadly done. Concern mayalso be warranted when comply-or-expla<strong>in</strong> disclosuresconsistently claim full compliance. This may be an<strong>in</strong>dication that the level of per<strong>for</strong>mance required bythe code is too low or that the evaluation of whatconstitutes compliance is too easy.Some SEE banks comply with their codes pr<strong>in</strong>cipally <strong>in</strong><strong>for</strong>m rather than substance. One of the reasons maybe that boards do not see how regulations improve theprofitability or even the risk profile of their banks. Evenif bankers may agree with rules and understand theirultimate rationale, they view all of them as expenseitems. The rules do not contribute to profitability <strong>in</strong> theshort term, which is what shareholders and most boardmembers are pr<strong>in</strong>cipally <strong>in</strong>terested <strong>in</strong>.Ultimately, the effectiveness of voluntary codes dependson the local legal and bus<strong>in</strong>ess culture, with voluntarycodes and comply-or-expla<strong>in</strong> disclosures be<strong>in</strong>g muchmore likely to succeed <strong>in</strong> countries that have strongself-regulatory traditions. Their effectiveness will alsoCreat<strong>in</strong>g a Culture of Good <strong>Governance</strong>“In order to strengthen implementation,we need to create a culture of corporategovernance. A culture is essentially createdthrough dialogue, through discussion.”Gian Piero Cigna, ItalyThe Effectiveness of Voluntary Codes“In our case, we are try<strong>in</strong>g to imposesometh<strong>in</strong>g on the banks from outside. Thatis how they perceive it, ‘it is someth<strong>in</strong>gthey want to put on us.’ It is not natural<strong>for</strong> them and their behavior.”Dimitar Bogov, FYR Macedonia“It is not enough to have a fancy codepublished on the website and just stick to the<strong>for</strong>mal requirements. It is up to the substanceof implement<strong>in</strong>g those procedures <strong>in</strong> real life.Otherwise it is just a <strong>for</strong>mality but there isno obligation at all to implement them.”Josip Vukovic, Croatia“When it comes to the private corporate sectoradopt<strong>in</strong>g codes, aga<strong>in</strong> I am not entirelysure that that exercise could br<strong>in</strong>g anygood if they are not really accepted by themanagers or the owners of private firms.”Giancarlo Miranda, SerbiaThe Need <strong>for</strong> Formal Requirements“If you are go<strong>in</strong>g to <strong>for</strong>ce me by means ofsome regulation, we will def<strong>in</strong>itely react.”Rumen Radev, Bulgaria“The best way to implement corporategovernance is first to have it writtendown as the rule! Some banks apply someof these practices, but we believe thatputt<strong>in</strong>g them <strong>in</strong>to a letter is someth<strong>in</strong>gcompletely different.”Almir Salihovic, Bosnia and Herzegov<strong>in</strong>a<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 51


depend on the presence of active <strong>in</strong>stitutional <strong>in</strong>vestors. Differences <strong>in</strong> levels of acceptance and perceivedutility may also relate to whether the country comes from a common law or civil law tradition.The SEE countries thus face a sort of regulatory conundrum: the commonly used developed-market approachof rely<strong>in</strong>g on the board and voluntary codes as a nuanced, soft, outsourced <strong>for</strong>m of regulation may notsuit the local culture; on the other hand, the imposition of hard rules has been criticized as a superficialcompliance exercise that adds little value to the bank.A possible <strong>in</strong>termediate approach <strong>for</strong> better embedd<strong>in</strong>g good governance <strong>in</strong> banks might be to set up task<strong>for</strong>ces, with prom<strong>in</strong>ent bankers and bus<strong>in</strong>ess people, that develop best practices that would <strong>in</strong> turn becomeobligatory <strong>for</strong> all banks. This approach of us<strong>in</strong>g private sector <strong>in</strong>put <strong>for</strong> the development of governancepractices, which then becomes mandatory, is not uncommon <strong>in</strong> countries with more normative regulatorycultures.The <strong>in</strong>stitutional aspects of voluntary codes also need to be considered. Voluntary codes tend to be en<strong>for</strong>cedby securities regulators or stock exchanges and ultimately the markets. Given the relative size of securitiesmarkets <strong>in</strong> SEE, guidance on corporate governance would likely need to emanate from central banks.Voluntary codes <strong>in</strong> other countries have been developed by private groups and then published as central bankcirculars.Recommendation:Guidance on corporate governance: Regulators should provide guidance on sound governance practices.Such guidance must be adapted to the local environment and go beyond the mere transposition of<strong>in</strong>ternational rules and codes. 77 The implementation of the guidance must also be <strong>in</strong> accord with the localbus<strong>in</strong>ess and legal culture. Voluntary corporate governance codes should be developed with the participationof the private sector; however, the correct balance between hard and soft law needs to be found. SEEcountries may require more <strong>for</strong>mal means of implement<strong>in</strong>g codes than other countries require.B. Monitor<strong>in</strong>g 78Supervisors need to have processes <strong>for</strong> evaluat<strong>in</strong>g the quality of bank governance and the implementation oflegal requirements. Regulators are <strong>in</strong>creas<strong>in</strong>gly expected to take corporate governance <strong>in</strong>to account as part oftheir risk assessment <strong>for</strong> banks. This monitor<strong>in</strong>g can take different <strong>for</strong>ms, such as the follow<strong>in</strong>g: the collectionof <strong>in</strong>ternal and prudential reports, <strong>in</strong>clud<strong>in</strong>g statements of external auditors; the use of <strong>for</strong>mal evaluations orscorecards; and onsite <strong>in</strong>spections. Such monitor<strong>in</strong>g should focus on the bank’s risk profile and those aspectsof governance that have an impact on the bank’s overall safety and soundness.This approach implies look<strong>in</strong>g closely at the bank’s control environment and risk management functions aswell as the capacity of the board to monitor the effectiveness of such systems. Further items that can beexam<strong>in</strong>ed at board level are fit-and-proper tests, and whether the board has the necessary comb<strong>in</strong>ationof skills to ensure safe and sound operations. Bank evaluations can <strong>in</strong>volve regular meet<strong>in</strong>gs with boards,executives, and people responsible <strong>for</strong> key aspects of the control environment.With<strong>in</strong> SEE, supervisors conduct full-scope exam<strong>in</strong>ations of banks and may develop recommendations <strong>for</strong>executives and boards. Such exam<strong>in</strong>ations can cover any number of issues. However, the extent to which77 Nevertheless, the guidance of <strong>in</strong>ternational bodies should not be ignored. In particular, the 2006 and 2010 BIS Pr<strong>in</strong>ciples (see Annexes C and D)should receive broad consideration.78 2010 BIS Pr<strong>in</strong>ciples, Sections IV.2 and IV.3. pp. 31–32.52<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


exam<strong>in</strong>ations permit a systematic evaluation of a bank’sMeet<strong>in</strong>gs with Bank Boardsgovernance is uncerta<strong>in</strong>. It is common that supervisorsonly meet with boards when there is a problem.“We have found…that the supervisor…doesFurthermore, local supervisors rarely have a clear view not have <strong>in</strong>teraction with the board; theyof the structure of responsibility and authority with<strong>in</strong> have a lot of <strong>in</strong>teraction with management.group structures, which makes it difficult <strong>for</strong> them It is surpris<strong>in</strong>g…how many supervisors doto <strong>for</strong>m a global picture as to where the weaknesses not meet with the board on a regular basis.”might lie <strong>in</strong> the group. At present, there is no clearEsad Zaimovic, Montenegroconcept of what criteria are to be used and howto monitor the process of implementation of goodgovernance. Supervisors’ ability to make mean<strong>in</strong>gfulcomparisons of governance between banks is alsolimited by the lack of a standardized supervisory report<strong>in</strong>g process.F<strong>in</strong>ally, some concern has been expressed over the tendency of regulators to rely on checklists and box-tick<strong>in</strong>gexercises <strong>for</strong> their monitor<strong>in</strong>g responsibilities. Checklists and box tick<strong>in</strong>g are often criticized, though they havethe merit of ensur<strong>in</strong>g that all issues of relevance are at least considered. Their weakness is that the issues maynot be exam<strong>in</strong>ed <strong>in</strong> sufficient detail to reveal deficiencies or risks. Nor is it clear how <strong>in</strong>dividual componentson a checklist may <strong>in</strong>terrelate or how they affect the risk of the bank. Ultimately, checklists can work ifapplied <strong>in</strong>telligently by <strong>in</strong>dividuals who understand the substance. Gett<strong>in</strong>g at the substance requires time andmay call <strong>for</strong> additional tra<strong>in</strong><strong>in</strong>g <strong>for</strong> supervisory staff.Recommendations:Monitor<strong>in</strong>g bank governance: The monitor<strong>in</strong>g of bank governance should be <strong>for</strong>malized and strengthened.The basis of any monitor<strong>in</strong>g should be an agreed standard of governance. Standardized frameworks <strong>for</strong> theanalysis of banks will make evaluations more rigorous and allow <strong>for</strong> <strong>in</strong>terbank comparison. Supervisors shouldthemselves be held accountable and report on their own progress <strong>in</strong> enhanc<strong>in</strong>g governance <strong>in</strong> the bank<strong>in</strong>gsystem.Meet<strong>in</strong>gs with bank boards: Supervisors should meet regularly with boards and chief risk officers, orequivalent, dur<strong>in</strong>g visits and <strong>in</strong>spections. This <strong>in</strong>cludes subsidiary boards. Supervisors should require the fullboard to meet locally at least once a year. The supervisor should meet annually with the board to discusscurrent issues, even when the bank is <strong>in</strong> satisfactory condition. These meet<strong>in</strong>gs should be conducted locally.Understand<strong>in</strong>g home-subsidiary relations: To vary<strong>in</strong>g extents, supervisors place confidence <strong>in</strong> the abilityof head offices to oversee their local subsidiaries. This trust should not turn <strong>in</strong>to bl<strong>in</strong>d confidence. Supervisorsneed to develop the capacity to look through to the parent’s control systems. Supervisors should be awareof and understand the scope of report<strong>in</strong>g and oversight provided by head offices, <strong>in</strong> part by review<strong>in</strong>g thenature and configuration of key reports. If obvious gaps exist, it may require dialogue between the supervisor,the parent and the subsidiary and understand<strong>in</strong>g of the issue or risk by all parties.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 53


Focus on substance and outcomes: Regulators need to avoid mechanistic implementation of policy (boxtick<strong>in</strong>g) and focus their attention on substance and outcomes. Checklists should be applied <strong>in</strong>telligently as ameans of gett<strong>in</strong>g to the deeper issues. Supervisors need to focus on outcomes. Report<strong>in</strong>g requirements thatare <strong>in</strong>tended to reduce risk among banks may actually <strong>in</strong>crease risk if they distract the board from substantiveissues.Be aware of costs: Be<strong>in</strong>g aware of outcomes implies be<strong>in</strong>g aware of costs. Comply<strong>in</strong>g with regulation<strong>in</strong>evitably costs money. Supervision must be efficient <strong>in</strong> the sense that the burdens it imposes need to bejustified and have a clear benefit not only <strong>for</strong> the bank<strong>in</strong>g system but also <strong>for</strong> the <strong>in</strong>dividual bank.C. Remedial action 79When material deficiencies <strong>in</strong> bank governance are found, supervisors need to be able to take effective andtimely remedial action. The pr<strong>in</strong>cipal need is <strong>for</strong> supervisors to have the authority to compel such action.Chart 9 shows how rarely remedial action is applied <strong>in</strong> SEE banks.Chart 9: Use of Remedial Action by Regulators <strong>in</strong> SEEHow often over the last five years has remedial action been used to address material corporategovernance deficiencies of SEE banks?neverrarelyoccasionallyvery often0 10 20 30 40 50 60 70 80Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010–2011). Question asked to regulators <strong>in</strong> the region.In practice, a lack of authority poses some difficulties both with<strong>in</strong> SEE and elsewhere. In a number ofjurisdictions, regulators have identified weak corporate governance practices and have written to banks onlyto be told to go away. In addition, regulators are typically reluctant to compel action based on voluntarycodes of best practice when these are not embedded <strong>in</strong> law. In some cases, public reports by supervisorsmay be used to encourage banks to take action; however, there may not be any legal basis <strong>for</strong> supervisors tomake their concerns public. With <strong>for</strong>eign bank<strong>in</strong>g groups, local supervisors may not have access to remedies,because the <strong>in</strong>tegration and design of the function are not effectuated with<strong>in</strong> the jurisdiction, but rather takeplace somewhere else.79 2010 BIS Pr<strong>in</strong>ciples, Section IV.4, p 32.54<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


Recommendation:Remedial action: Supervisors need to have the authority to compel remedial action when materialdeficiencies are found <strong>in</strong> bank governance. Where important aspects of governance are embedded <strong>in</strong>voluntary codes, which are not be<strong>in</strong>g en<strong>for</strong>ced by market pressures, greater authority may need to be givento regulators.D. Home-host supervisory cooperation 80Supervisors are expected to be <strong>in</strong> contact with, cooperate with, and share <strong>in</strong><strong>for</strong>mation with their counterparts<strong>in</strong> other jurisdictions. Such cooperation is necessary <strong>for</strong> a number of reasons: 1) to permit oversight of banksthat operate <strong>in</strong> multiple jurisdictions; 2) to betterassess and control <strong>for</strong> the potential <strong>for</strong> <strong>in</strong>ternationalcontagion; 3) to enhance understand<strong>in</strong>g of <strong>in</strong>ternationalbest practice <strong>in</strong> governance and supervision; and 4)to better understand the regulations and supervisoryapproaches of other countries and their potentialimpact on the host supervisor. The tools used <strong>for</strong> suchcooperation are usually memoranda of understand<strong>in</strong>gand periodic meet<strong>in</strong>gs among supervisors.Cooperation between SEE and home-countrysupervisors needs substantial enhancement. There iswidespread disappo<strong>in</strong>tment with the memoranda ofunderstand<strong>in</strong>g signed with home supervisors, whichproved to be of limited use dur<strong>in</strong>g the recent crisis.Despite such understand<strong>in</strong>gs, the ma<strong>in</strong> sources of<strong>in</strong><strong>for</strong>mation on home-country banks were the mediaand the Internet. In<strong>for</strong>mation provided by homesupervisors was often <strong>in</strong>complete and out of date.Cooperation Between Supervisors“The recent crisis <strong>in</strong> the f<strong>in</strong>ancial sectorhas shown that the monetary authoritiesand <strong>in</strong>stitutions and supervisory bodiesneed to co-operate more closely <strong>in</strong> order tomitigate the consequences of the crisis.”Kemal Kozarić, Bosnia and Herzegov<strong>in</strong>a“The l<strong>in</strong>kages between parent and subsidiarybanks and between different parent banksare more <strong>in</strong>tertw<strong>in</strong>ed. At the same time,the regulatory system globally, not just<strong>in</strong> <strong>Europe</strong>, has not kept up with it.”Jon Lukomnik, United StatesInternational cooperation is of fundamental importance, because it is not possible to regulate global capitallocally <strong>in</strong> an <strong>in</strong>creas<strong>in</strong>gly globalized economy. L<strong>in</strong>ks between banks are more <strong>in</strong>tertw<strong>in</strong>ed, and capital and riskcan move almost <strong>in</strong>stantaneously, often propagated by <strong>in</strong>creas<strong>in</strong>gly complex f<strong>in</strong>ancial <strong>in</strong>struments.Recommendation:Home- and host-country cooperation between supervisors: Cooperation needs to be greatly enhancedbetween home-country and SEE host-country supervisors. Supervisors have to try to establish a dialogueboth with home-country supervisors and the parent on all matters to do with liquidity, capital, risk, andgovernance. Resources need to be applied to help achieve the <strong>in</strong>tent of memoranda of understand<strong>in</strong>g. Newsystems and strategies may need to be devised to allow <strong>for</strong> better <strong>in</strong><strong>for</strong>mation shar<strong>in</strong>g both on banks and onsupervisory policies.80 2010 BIS Pr<strong>in</strong>ciples, Section IV.5 on cooperation with relevant supervisors <strong>in</strong> other jurisdictions, p 32.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 55


V. Promot<strong>in</strong>g an environment that supports sound governance 81Gett<strong>in</strong>g Beyond the <strong>Governance</strong> Infrastructure“We have come a long way <strong>in</strong> the last 15 to 20years. We understand well the <strong>in</strong>frastructureof governance; we know how boards shouldbe constituted; we know what committees weshould have; we know what qualificationsare necessary <strong>for</strong> the chair of the board. Weneed to get beyond the <strong>in</strong>frastructure andunderstand how we can make function<strong>in</strong>g<strong>in</strong> the boardroom more effective.”Peter Dey, Canada“The problem with corporate governance, andalso <strong>in</strong> crisis, is a behavioral issue. At theend of the day, there<strong>for</strong>e, we have to havegood managers, good CEOs, good boardmembers, <strong>in</strong> order to have good banks.”Bistra Boeva, BulgariaThe corporate governance of banks is determ<strong>in</strong>ed bythe legal framework and a sound <strong>in</strong>teraction betweenshareholders, boards, managers, supervisors, and otherstakeholders such as depositors. It represents a system<strong>in</strong> which a variety of players contribute jo<strong>in</strong>tly to itseffectiveness. In countries with strong governancepractices, there is good <strong>in</strong>teraction between all of thesecomponents.In SEE, some of these factors may require enhancementor may be miss<strong>in</strong>g altogether as countries seek todevelop their economies. Certa<strong>in</strong>ly, excessive attentionto rules, codes, and standards risks address<strong>in</strong>g onlyhalf of the corporate governance equation and turnsgovernance <strong>in</strong>to a compliance exercise <strong>in</strong> which banksengage to keep regulators at bay. Ultimately, goodcorporate governance has to do with establish<strong>in</strong>g theproper governance environment that encourages theright behaviors.Recommendation:Incentives and behavioral issues: Companies and regulators are encouraged to look at behaviors andculture ahead of structure and processes. Boxes and checklists may have value but they are <strong>in</strong>sufficient. Moreattention needs to be paid to the variety of stakeholders <strong>in</strong> the governance process and the <strong>in</strong>centives thatcontribute to good governance. A multipronged, long-term approach <strong>in</strong>volv<strong>in</strong>g a wider range of players <strong>in</strong>the governance equation may serve to create the desired cultural change. To start, a more active dialogue isneeded between banks and supervisors.81 2010 BIS Pr<strong>in</strong>ciples, Section V on promot<strong>in</strong>g an environment supportive of corporate governance, p. 33.56<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


VI. Additional issuesA. State ownership of banksA number of countries <strong>in</strong> the SEE region still havestate-owned banks, which may have had a stabiliz<strong>in</strong>geffect dur<strong>in</strong>g the recent crisis, but they are alsovulnerable to political <strong>in</strong>fluence, politically directedlend<strong>in</strong>g, and the <strong>in</strong>efficiencies common to other stateownedenterprises. Each of these factors can exposestate-owned banks and the bank<strong>in</strong>g sector to risks. Inaddition, the l<strong>in</strong>ks between political structures and thebank<strong>in</strong>g system have at times had a negative impact onthe regulatory framework.State Ownership of <strong>Banks</strong>“The state is a funny owner. We had a boardmember who did not say a word <strong>for</strong> threeyears. Constructive, clever, or at least commonsense comments would be more welcome.”Dragica Pilipovic Chaffey, Serbia“State-owned banks are part of thepolitical economic distribution of powerafter the election. Membership of theboard of directors is understood not asa professional responsibility but as a‘thank you’ <strong>for</strong> political support.”Radovan Jelašic, SerbiaRecommendation:State-owned banks: The rema<strong>in</strong><strong>in</strong>g state-owned banks <strong>in</strong> SEE need to be governed professionally andbrought <strong>in</strong>to l<strong>in</strong>e with private sector governance practices. Where these banks exist, patronage must bechecked and brought under control. Changes <strong>in</strong> their governance pose considerable political challenges.Guidance on best practice <strong>in</strong> state-owned enterprise governance is available from the OECD, <strong>IFC</strong>, and theWorld Bank.B. Monitor<strong>in</strong>g of borrower governanceInternational best practice suggests that credit decisions, loan classifications, and provision<strong>in</strong>g be based on anassessment, made under the responsibility of the bank, of both quantitative and qualitative factors, <strong>in</strong>clud<strong>in</strong>gthe corporate governance of the borrower. Interest <strong>in</strong> the impact of banks on borrower governance alsoemanates from the expectation that banks can helpimprove the governance practices of their clients andthereby exercise a positive effect on the economy as awhole.In developed f<strong>in</strong>ancial markets, borrower governanceis taken <strong>in</strong>to account to vary<strong>in</strong>g degrees, with somebanks us<strong>in</strong>g <strong>in</strong><strong>for</strong>mal and others more structured andsophisticated approaches. These evaluations do appearto moderate credit risk. They tend to be located <strong>in</strong>credit quality control divisions that analyze losses andfactors beh<strong>in</strong>d these losses and develop lessons that go<strong>in</strong>to the evaluation of other debtors.Though largely a qualitative assessment, a numberof basic quantitative measures can be used to assessborrower governance risk. At the top of the list areBorrower <strong>Governance</strong>“We recommend banks to requirecorporate governance <strong>in</strong><strong>for</strong>mation ofcustomers as a bus<strong>in</strong>ess pre-condition.”Bistra Boeva, Bulgaria“Borrower governance is still, even <strong>in</strong>developed countries, <strong>in</strong> bank<strong>in</strong>g terms, <strong>in</strong> itsearly stages; there is a need <strong>for</strong> reflection onconcepts, procedures, methodology and mostimportantly on tra<strong>in</strong><strong>in</strong>g, not only tra<strong>in</strong><strong>in</strong>gof the staff but...also tra<strong>in</strong><strong>in</strong>g of the clients.”Leo Goldschmidt, Belgium<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 57


elated-party transactions, because historically the number of companies that fail as a result of relatedtransactions is high. Another measure is the extent to which nonexecutives on the board are <strong>in</strong>dependent.Further measures are the quality of management, their track record, and the regularity and quality of thef<strong>in</strong>ancial reports (are they audited, who are the auditors, quality of <strong>in</strong>ternal control, systems, transparency,and management stability, and so on).In SEE, qualitative factors do come <strong>in</strong>to play when assess<strong>in</strong>g loan applications. Some of these factors areclearly governance-related, such as the capacity of the borrower to produce credible f<strong>in</strong>ancial <strong>in</strong><strong>for</strong>mation.However, the evaluation of governance is not usually subject to <strong>for</strong>malized approaches, at least not <strong>in</strong> locallyowned banks.Beyond the necessary analytical tools, encourag<strong>in</strong>g better practices among borrowers ultimately requiresdirect contact with the client. One approach observed <strong>in</strong> SEE is to <strong>in</strong>vite managers and shareholders ofclients to sem<strong>in</strong>ars. These sem<strong>in</strong>ars serve to sensitize participants to governance problems and educate themabout governance. The message from such meet<strong>in</strong>gs is that governance <strong>for</strong>ms an <strong>in</strong>tegral part of borrowerevaluation and has an <strong>in</strong>fluence on the client’s creditworth<strong>in</strong>ess and ultimately on loan pric<strong>in</strong>g and conditions.For clients undergo<strong>in</strong>g restructur<strong>in</strong>g, banks can <strong>in</strong>troduce conditions concern<strong>in</strong>g client governance, to beassured that the restructur<strong>in</strong>g process will be approved.An example of client education comes from Croatia, where banks and the bank<strong>in</strong>g association have providedworkshops <strong>for</strong> small and medium enterprises. The target of Croatian workshops is not corporate governanceper se but more general <strong>in</strong><strong>for</strong>mation on how to approach banks and how to make it easier to obta<strong>in</strong> a loan.The objective is to help potential clients understand why the bank is ask<strong>in</strong>g them <strong>for</strong> <strong>in</strong><strong>for</strong>mation. <strong>Corporate</strong>governance issues are only touched upon but could become a more significant part of such ef<strong>for</strong>ts.Recommendations:Borrower governance: The governance of corporate borrowers should be taken <strong>in</strong>to account <strong>in</strong> lend<strong>in</strong>gdecisions as a way to reward borrowers that have better governance practices <strong>in</strong> place. Formal methodologiesshould be devised to take governance practices <strong>in</strong>to account. <strong>Banks</strong> should encourage borrowers to raise thelevel of their governance <strong>in</strong> l<strong>in</strong>e with best practice. Such encouragement should serve to enhance banks’ levelof com<strong>for</strong>t with borrowers and should have an effect on credit pric<strong>in</strong>g decisions. There may also be a role <strong>for</strong>bank<strong>in</strong>g associations <strong>in</strong> educat<strong>in</strong>g the bus<strong>in</strong>ess community about governance.Assessment methodologies: In matters of governance, the credit function should address problemsof if, what, and how: “if” corporate governance is a real concern that should be taken <strong>in</strong>to account;“what” aspects of borrowers’ corporate governance should be scrut<strong>in</strong>ized; and “how” procedures andmethodologies should be applied and what data should be gathered. Credit analysis requires the assessmentof both qualitative and quantitative factors <strong>for</strong> the purposes of loan classification, provision<strong>in</strong>g, and mostimportantly the credit decision proper. 82Bank<strong>in</strong>g supervisors: Supervisors should encourage banks to assess and monitor the quality of thecorporate governance of their clients as a critical part of their ongo<strong>in</strong>g credit risk management.Conflicts of <strong>in</strong>terest: <strong>Banks</strong>’ <strong>in</strong>terests do not necessarily converge with those of other stakeholders. To avoidconflicts of <strong>in</strong>terest and to contribute effectively to the enhancement of borrower governance, banks shouldbe transparent regard<strong>in</strong>g the governance-related requirements they may impose on their borrowers.82 Methodologies, <strong>in</strong>clud<strong>in</strong>g scorecards that benchmark companies aga<strong>in</strong>st local governance codes, are discussed on <strong>IFC</strong>’s website: www.ifc.org andwww.gcgf.org.58<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


VII. AnnexesA. <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief ContributorsPROJECT COORDINATIONGian Piero Cigna, Senior Consultant, EBRDRichard Frederick, Consultant, Senior Consultant, <strong>IFC</strong> Global <strong>Corporate</strong> <strong>Governance</strong> ForumMarie-Laurence Guy, Senior Projects Officer, <strong>IFC</strong> Global <strong>Corporate</strong> <strong>Governance</strong> ForumRalitza Germanova, Projects Coord<strong>in</strong>ator, <strong>IFC</strong> Global <strong>Corporate</strong> <strong>Governance</strong> ForumCOUNTRY TASKFORCE MEMBERS IN SOUTHEAST EUROPEAlbaniaGenc Mamami, Chief of Cab<strong>in</strong>et of the Governor of AlbaniaIndrit Banka, Head of Supervision Department <strong>in</strong> the Central Bank of AlbaniaToni Gogu, Director of the Legal Department, Bank of AlbaniaJuna Bozdo, Head of Credit Risk Division, Bank of AlbaniaLibero Catalano, Chair of Association of <strong>Banks</strong>Oliver Whittle, Chief Executive Officer, Raiffeisen Zentralbank Österreich AGEdmond Leka, Chair of Union BankMonika Milo, Deputy Executive Director, Cred<strong>in</strong>s BankMigena Aliaj, Bus<strong>in</strong>ess Credit Department Director, Cred<strong>in</strong>s BankMiranda Citozi, Banka Kombetare TregtareVaruzhan Piranjani, Chair of Audit Committee, Union BankJona Bica, Head of Bank<strong>in</strong>g Department, Senior Associate, Kalo AssociatesBosnia and Herzegov<strong>in</strong>aKemal Kozarić, Governor of the Central Bank of Bosnia and Herzegov<strong>in</strong>aRadomir Bozic, Vice-Governor, Central Bank of Bosnia and Herzegov<strong>in</strong>aMilenko Krajisnik, Member of the Govern<strong>in</strong>g Board, Central Bank of Bosnia and Herzegov<strong>in</strong>aVasilj Zarkovic, Member of the Govern<strong>in</strong>g Board, Central Bank of Bosnia and Herzegov<strong>in</strong>aZlatko Bars, Director, Federal Bank<strong>in</strong>g AgencySlavica Injac, Director, Republika Srpska Bank<strong>in</strong>g AgencyMirzeta Arnautovic, Director of Brcko Branch, Central Bank of Bosnia and Herzegov<strong>in</strong>aNedžad Tuce, Deputy Director, Federal Bank<strong>in</strong>g AgencyAlmir Salihovic, Special Assistant to Governor, Central Bank of Bosnia and Herzegov<strong>in</strong>aOrhan Pašalić, Head of Compliance and AML Department, Intesa Sanpaolo Banka, SarajevoSamir Lacevic, Head of Bank<strong>in</strong>g Operations, Education and Tra<strong>in</strong><strong>in</strong>g, Association of <strong>Banks</strong>Dragan Dz<strong>in</strong>ic, Legal Advisor, Nova BankBulgariaKal<strong>in</strong>ka Dimitrova, Head of Division, Special Supervision Directorate, Bulgarian National BankMaria Grigorova, Director, Special Supervision Directorate, Bulgarian National BankBistra Boeva, University Professor, University <strong>for</strong> National and World Economic StudiesRumen Radev, Vice Chair of the Bulgarian Industrial Capital AssociationPlamen Tchipev, Institute of Economics, Bulgarian Academy of Science<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 59


CroatiaMart<strong>in</strong>a Drvar, Chief Advisor <strong>in</strong> the Prudential Regulation Area, Croatian National BankSanja Petr<strong>in</strong>ić Turković, Chief Advisor <strong>in</strong> the Bank Supervision Area, Croatian National BankZoran Bohacek, President of the Croatian Bankers AssociationCedo Maletic, President of the Management Board Hrvatska postanska bankaRonald Given, Manag<strong>in</strong>g Director, Wolf Theiss Attorneys at LawFYR MacedoniaEvica Delova Joleska, Portfolio Manager, Central Bank of MacedoniaCveta Jankoska, Senior Advisor Supervisor, Central Bank of MacedoniaVioleta Stojanovska Petrovska, Assistant Head <strong>for</strong> F<strong>in</strong>ancial Systems, M<strong>in</strong>istry of F<strong>in</strong>anceDonka Markovska, Assistant Division Manager at NLB Tutunska BankaGjorgji Jancevski, President, Macedonian Bankers AssociationKristijan Polenak, Macedonian Stock ExchangeMontenegroLjubisa Krgovic, Governor of the Central Bank of MontenegroDarko Bolatovic, Legal Adviser at the Supervision Department Central Bank of MontenegroGeorge Bobvos, CKB - OTP GroupD<strong>in</strong>o Redžepagić, Director of Retail Department, NLB Montenegrobanka ad PodgoricaEsad Zaimovic, Chief Executive Director, Hipotekarna banka AD PodgoricaJelena Vuletic, Executive Director Risk Management, Hipotekarna banka AD PodgoricaNatasa Lakic, Director <strong>for</strong> Payment Operations and Treasury Division, Hipotekarna banka AD PodgoricaRomaniaOana Balanescu, Chief of Department, Regulation and Authorisation Division, National Bank of RomaniaLiliana Michaely, Regulations and Licens<strong>in</strong>g Department, National Bank of RomaniaGabriela Raluca Folcut, Communication Counsellor of Romanian Bank<strong>in</strong>g AssociationGabriel Mateescu, Chief F<strong>in</strong>ancial Officer, Alpha Bank RomaniaPetra Alexandru, Capital Market Expert, FreelancerPeter Frankl<strong>in</strong>, Non-executive Director, Bank TransilvaniaSerbiaRadovan Jelašic, Governor, National Bank of SerbiaMalica Katic, Head of Legal Division <strong>in</strong> Bank<strong>in</strong>g Supervision, National Bank of SerbiaAna Trifunovic, Junior Expert Associate <strong>in</strong> Legal Division, National Bank of SerbiaGiancarlo Miranda, Chief Operations Officer and Deputy President of the Executive Board, Banca IntesaPhilippe Delpal, Board Member, Komerciljana BankaVeljko Visic, Head of Legal and Ethical Compliance Department, Compliance Division, Komercijalna bankaDragica Pilipovic-Chaffey, Non-executive Director, Komercijalna BankMilos Vuckovic, Manag<strong>in</strong>g Director, DCA Brands Serbia, Millhouse DOODarko Jovanovic, Manag<strong>in</strong>g Director, Telsonic DOO, PromontaOlivera Trikić, Executive Manager of Human Resources Sector, Komercijalna BankMirjana Čolović, Compliance Division Director, Komercijalna BankMarija Bojovic, Partner, Bojovic, Dasic, Kojovic Attorneys at LawTanja Momcilovic, <strong>Corporate</strong> <strong>Governance</strong>, Eurobank EFG ad Beograd60<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


INTERNATIONAL EXPERTSPeter Dey, Chair, Paradigm Capital, and Chair of the <strong>IFC</strong> Global <strong>Corporate</strong> <strong>Governance</strong> Forum’s PrivateSector Advisory Group (PSAG)Leo Goldschmidt, Honorary Manag<strong>in</strong>g Partner, Bank Degroof and Found<strong>in</strong>g Member <strong>Europe</strong>an<strong>Corporate</strong> <strong>Governance</strong> Institute (PSAG member)Elie Beyrouthy, Assistant of Department, Retail F<strong>in</strong>ancial Services, Legal and Social Affairs, <strong>Europe</strong>anBank<strong>in</strong>g FederationDavid Beatty, Chair of the Risk Review Committee and Executive and <strong>Governance</strong> Committees of Bank ofMontreal; Professor, Rotman School of Management, University of Toronto (PSAG member)Christian Strenger, Director, DWS Investment GmbH, Frankfurt; Member of the German GovernmentCommission on <strong>Corporate</strong> <strong>Governance</strong>; Director, Center <strong>for</strong> <strong>Corporate</strong> <strong>Governance</strong>, HHL Leipzig GraduateSchool of Management (Deputy Chair of PSAG)Patrick Zurstrassen, Chair, <strong>Europe</strong>an Confederation of Directors’ Associations (PSAG member)Stilpon Nestor, Manag<strong>in</strong>g Director, Nestor AdvisorsJohn Plender, Senior Editorial Writer, F<strong>in</strong>ancial Times (PSAG member)Ian Radcliffe, Director, Tra<strong>in</strong><strong>in</strong>g & Consultancy, World Sav<strong>in</strong>gs <strong>Banks</strong> Institute - <strong>Europe</strong>an Sav<strong>in</strong>gs <strong>Banks</strong>GroupBertrand Rossert, Head of <strong>Corporate</strong> <strong>Governance</strong> <strong>Policy</strong> and Coord<strong>in</strong>ation Division Secretariat Generaland Legal Affairs, <strong>Europe</strong>an Investment BankMikhail Nadel, Chair, Board of Directors, Asia Universal BankOlli Virtanen, Head, F<strong>in</strong>nish Association of Professional Board Members (PSAG member)Peter Montagnon, Senior Investment Advisor, F<strong>in</strong>ancial Report Council. United K<strong>in</strong>gdom (PSAG member)Ken Rushton, Former Director of the U.K. List<strong>in</strong>g at the F<strong>in</strong>ancial Services Authority (PSAG member)Ilkka Salonen, Partner, Septum PartnersMar<strong>in</strong> Mar<strong>in</strong>ov, Deputy General Counsel, Black Sea Trade Development BankThomas Grasse, Consultant, TG Consult<strong>in</strong>gIrakli Kovzanadze, Professor, Chair of the F<strong>in</strong>ance and Bank<strong>in</strong>g Department, Tbilisi State UniversityYerlan Balgar<strong>in</strong>, Independent Director, Dana BankArman Aloyan, Head of the EU Integration Division of the Legal Department, Central Bank of ArmeniaSvyatslav Abravov, Deputy Head of Company Law Division, Russian Federation M<strong>in</strong>istry of EconomicDevelopmentAla Abakumov, Consultant, Board Nom<strong>in</strong>ee – SDM Bank, Russian FederationTeodor Volcov, Board Member, Volksbank, Ukra<strong>in</strong>eRoger McCormick, Law Division, London School of EconomicsAnna Grosman, PhD Researcher, Imperial College Bus<strong>in</strong>ess SchoolSaleh Alhamrani, PhD Candidate, University of LeedsJeremy Denton-Clark, Director, GBRW Limited<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 61


Paul Rex, Director, GBRW Limited, UKEsra Suel, Research Assistant, University of IstanbulAndrzej Witak, Consultant, UKPeter Werner, Senior Director, International Swaps and Derivatives AssociationRoman Chapaev, Foreign Qualified Lawyer, DLA Piper UK LLPCarsten Gerner-Beurle, Lecturer, London School of Economics and Political ScienceVictoria Miles, Emerg<strong>in</strong>g Market Director, J.P. MorganCather<strong>in</strong>e Lawton, Director, EMEA <strong>Corporate</strong> <strong>Governance</strong> Consult<strong>in</strong>g, Nestor AdvisorsMary Ellen Coll<strong>in</strong>s, Independent F<strong>in</strong>ancial Consultant, Blue Ridge Lane F<strong>in</strong>ancial Services, USAINTERNATIONAL ORGANIZATIONSEBRDNick Tesseyman, Manag<strong>in</strong>g Director F<strong>in</strong>ancial Institutions, EBRDKiyoshi Nishimura, Act<strong>in</strong>g Director Western Balkans, F<strong>in</strong>ancial Institutions, EBRDMichel Nussbaumer, Chief Counsel, EBRDElena Urumovska, Head of EBRD Office <strong>in</strong> SkopjeHuw Williams, Senior Banker – <strong>Corporate</strong> Equity, EBRDPredrag Radlovacki, Pr<strong>in</strong>cipal Banker, EBRDDamir Cosic, Associate Banker, EBRD Office <strong>in</strong> SarajevoJosip Vukovic, Pr<strong>in</strong>cipal Banker, EBRD Office, ZagrebMilos Grk<strong>in</strong>ic, Senior Analyst, EBRD, PodgoricaVeronica Bradautanu, Consultant, EBRD<strong>IFC</strong>Philip Armstrong, Head, <strong>IFC</strong> Global <strong>Corporate</strong> <strong>Governance</strong> ForumOliver Orton, Regional Project Manager - <strong>Corporate</strong> <strong>Governance</strong>, <strong>IFC</strong> Advisory Services, <strong>Southeast</strong> <strong>Europe</strong>Merima Zupcevic Buzadzic, Operations Officer, <strong>IFC</strong> Advisory Services Southern <strong>Europe</strong>Kiril Nejkov, Associate Operations Officer, <strong>IFC</strong> Advisory Services Southern <strong>Europe</strong>OECDHans Christiansen, Senior Economist <strong>Corporate</strong> Affairs, OECDWorld BankLaura Ard, Lead F<strong>in</strong>ancial Sector Specialist, World BankCharles McDonough, Vice President - Controller, World BankJohn Hegarty, Advisor on F<strong>in</strong>ancial Report<strong>in</strong>g and Regulation to the Chief F<strong>in</strong>ancial Officer and the VicePresident/Controller, World BankNote: This list <strong>in</strong>cludes participants <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> High Level <strong>Policy</strong> Meet<strong>in</strong>gs on <strong>Corporate</strong> <strong>Governance</strong>of <strong>Banks</strong> held <strong>in</strong> Belgrade <strong>in</strong> 2009 and London <strong>in</strong> 2011. Please note that some of the representatives, whocontributed to the preparation of the <strong>Policy</strong> Brief <strong>in</strong> the positions listed above, may no longer hold the samepositions.Op<strong>in</strong>ions expressed by task <strong>for</strong>ce members, <strong>in</strong>ternational experts and other participants to the Belgradeand London meet<strong>in</strong>gs were those of participants only and do not necessarily represent the views of the<strong>in</strong>stitutions where they were or are currently work<strong>in</strong>g.62<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


B. Important sources of guidance on bank governanceBasel Committee on Bank<strong>in</strong>g SupervisionCompensation Pr<strong>in</strong>ciples and Standards Assessment Methodology (2010): www.bis.org/publ/bcbs166.pdf.Enhanc<strong>in</strong>g Bank Transparency (1998). www.bis.org/publ/bcbs41.pdf.Enhanc<strong>in</strong>g <strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> Bank<strong>in</strong>g Organizations (2006): www.bis.org/publ/bcbs122.pdf.Pr<strong>in</strong>ciples <strong>for</strong> Enhanc<strong>in</strong>g <strong>Corporate</strong> <strong>Governance</strong> (2010): www.bis.org/publ/bcbs168.pdf.EBRDEBRD-OECD <strong>Policy</strong> Brief on <strong>Corporate</strong> <strong>Governance</strong> of <strong>Banks</strong> <strong>in</strong> Eurasia:http://www.ebrd.com/pages/sector/legal/corporate/eurasia.shtmlEUCapital Requirements and Bonuses Package (CRD3):http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2010:329:0003:0035:EN:PDF.<strong>IFC</strong>/World BankGovern<strong>in</strong>g <strong>Banks</strong>, a supplement to the <strong>Corporate</strong> <strong>Governance</strong> Board Leadership Tra<strong>in</strong><strong>in</strong>g Resources, <strong>IFC</strong>Global <strong>Corporate</strong> <strong>Governance</strong> Forum (2010): http://www.gcgf.org/ifcext/cgf.nsf/Content/Govern<strong>in</strong>g_<strong>Banks</strong>.Guidance <strong>for</strong> the Directors of <strong>Banks</strong>, Focus 2, Jonathan Charkham, CBE, <strong>for</strong>mer advisor to the governor ofthe Bank of England (2003): http://www.gcgf.org/ifcext/cgf.nsf/AttachmentsByTitle/Focus_2_Guidance_<strong>for</strong>_Directors/$FILE/Focus_2_Guidance_<strong>for</strong>_Directors_of_<strong>Banks</strong>.pdf.<strong>IFC</strong> <strong>Corporate</strong> <strong>Governance</strong> Progression Matrix—F<strong>in</strong>ancial Institutions (2007): http://www.ifc.org/ifcext/corporategovernance.nsf/AttachmentsByTitle/CG_Matrix_F<strong>in</strong>_Inst_Oct07/$FILE/Matrix_F<strong>in</strong>_Inst_Oct2007.pdf.<strong>Corporate</strong> <strong>Governance</strong> Screen<strong>in</strong>g Tool <strong>for</strong> Bank<strong>in</strong>g Organizations, <strong>IFC</strong> Advisory Services <strong>in</strong> <strong>Europe</strong> andCentral Asia (2010): http://www.ifc.org/ifcext/acgp.nsf/AttachmentsByTitle/CG_Screen<strong>in</strong>g_tool/$FILE/Bank<strong>in</strong>g+Screen<strong>in</strong>g+Tool.pdf.<strong>Corporate</strong> <strong>Governance</strong> Guidel<strong>in</strong>es <strong>for</strong> UAE Bank Directors, <strong>IFC</strong> and Association of <strong>Banks</strong> <strong>in</strong> Lebanon(2006): www.ifc.org/ifcext/corporategovernance.nsf.Guidance <strong>for</strong> Supervisory Board Members of <strong>Banks</strong>, <strong>IFC</strong> Ukra<strong>in</strong>e (2006): http://www.gcgf.org/ifcext/cgf.nsf/AttachmentsByTitle/Ukra<strong>in</strong>e_Eng_Guidance_Supervisory_Board_+Members_of_+<strong>Banks</strong>/$FILE/Charkham+Manual+F<strong>in</strong>al_Eng.pdf.Analyz<strong>in</strong>g Bank<strong>in</strong>g Risk, A Framework <strong>for</strong> Assess<strong>in</strong>g <strong>Corporate</strong> <strong>Governance</strong> and Risk Management (2009):http://imagebank.worldbank.org/servlet/WDSContentServer/IW3P/IB/2009/04/22/000334955_20090422084743/Rendered/PDF/482380PUB0Anal101OFFICIAL0USE0ONLY1.pdf.Bank <strong>Governance</strong>, Lessons from the F<strong>in</strong>ancial Crisis, The World Bank (2010): http://siteresources.worldbank.org/EXTFINANCIALSECTOR/Resources/Note13_Bank_<strong>Governance</strong>.pdf.OECDGuidel<strong>in</strong>es <strong>for</strong> the <strong>Governance</strong> of State-owned Enterprises (2005): http://www.oecd.org/document/33/0,3746,en_2649_34847_34046561_1_1_1_1,00.html.<strong>Policy</strong> Brief on <strong>Corporate</strong> <strong>Governance</strong> of <strong>Banks</strong> <strong>in</strong> Asia: www.oecd.org/dataoecd/48/55/37180641.pdf.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 63


<strong>Policy</strong> Brief on Improv<strong>in</strong>g <strong>Corporate</strong> <strong>Governance</strong> of <strong>Banks</strong> <strong>in</strong> the Middle East and North Africa:http://www.hawkamah.org/events/conferences/conference_2009/files/mena-policy-brief-banks.pdf.Pr<strong>in</strong>ciples of <strong>Corporate</strong> <strong>Governance</strong> (2004): www.oecd.org/dataoecd/32/18/31557724.pdf.The Role of the Board <strong>in</strong> Disclosure: An Exam<strong>in</strong>ation of What Codification Ef<strong>for</strong>ts Say (2004):http://www.oecd.org/dataoecd/55/33/32387383.pdf.UNCTADGuidance on Good Practice <strong>in</strong> <strong>Corporate</strong> <strong>Governance</strong> Disclosure: www.unctad.org/en/docs/iteteb20063_en.pdf.64<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


C. Synopsis: BCBS Enhanc<strong>in</strong>g corporate governance <strong>for</strong> bank<strong>in</strong>g organizations (2006)Sound corporate governance pr<strong>in</strong>ciplesPr<strong>in</strong>ciple 1: Board members should be qualified <strong>for</strong> their positions, have a clear understand<strong>in</strong>g of their role <strong>in</strong>corporate governance and be able to exercise sound judgment about the affairs of the bank.Pr<strong>in</strong>ciple 2: The board of directors should approve and oversee the bank’s strategic objectives and corporatevalues that are communicated throughout the bank<strong>in</strong>g organization.Pr<strong>in</strong>ciple 3: The board of directors should set and en<strong>for</strong>ce clear l<strong>in</strong>es of responsibility and accountabilitythroughout the organization.Pr<strong>in</strong>ciple 4: The board should ensure that there is appropriate oversight by senior management consistentwith board policy.Pr<strong>in</strong>ciple 5: The board and senior management should effectively use the work conducted by the <strong>in</strong>ternalaudit function, external auditors, and <strong>in</strong>ternal control functions.Pr<strong>in</strong>ciple 6: The board should ensure that compensation policies and practices are consistent with the bank’scorporate culture, long-term objectives and strategy, and control environmentPr<strong>in</strong>ciple 7: The bank should be governed <strong>in</strong> a transparent manner.Pr<strong>in</strong>ciple 8: The board and senior management should understand the bank’s operational structure,<strong>in</strong>clud<strong>in</strong>g where the bank operates <strong>in</strong> jurisdictions, or through structures, that impede transparency (that is,“know your structure”).The role of supervisorsSupervisors should provide guidance to banks on sound corporate governance and the proactive practicesthat should be <strong>in</strong> place.Supervisors should consider corporate governance as one element of depositor protection.Supervisors should determ<strong>in</strong>e whether the bank has adopted and effectively implemented sound corporategovernance policies and practices.Supervisors should assess the quality of banks’ audit and control functions.Supervisors should evaluate the effects of the bank’s group structure.Supervisors should br<strong>in</strong>g to the board of directors’ and management’s attention problems that they detectthrough their supervisory ef<strong>for</strong>ts.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 65


D. Synopsis: BCBS Pr<strong>in</strong>ciples <strong>for</strong> enhanc<strong>in</strong>g corporate governance (2010)Sound corporate governance pr<strong>in</strong>ciplesBoard’s overall responsibilitiesPr<strong>in</strong>ciple 1: The board has overall responsibility <strong>for</strong> the bank, <strong>in</strong>clud<strong>in</strong>g approv<strong>in</strong>g and oversee<strong>in</strong>g theimplementation of the bank’s strategic objectives, risk strategy, corporate governance, and corporate values.The board is also responsible <strong>for</strong> provid<strong>in</strong>g oversight of senior management.Board QualificationsPr<strong>in</strong>ciple 2: Board members should be and rema<strong>in</strong> qualified, <strong>in</strong>clud<strong>in</strong>g through tra<strong>in</strong><strong>in</strong>g, <strong>for</strong> their positions.They should have a clear understand<strong>in</strong>g of their role <strong>in</strong> corporate governance and be able to exercise soundand objective judgment about the affairs of the bank.Board’s own practices and structurePr<strong>in</strong>ciple 3: The board should def<strong>in</strong>e appropriate governance practices <strong>for</strong> its own work and have <strong>in</strong> placethe means to ensure that such practices are followed and periodically reviewed <strong>for</strong> ongo<strong>in</strong>g improvement.Group StructuresPr<strong>in</strong>ciple 4: In a group structure, the board of the parent company has the overall responsibility <strong>for</strong> adequatecorporate governance across the group by ensur<strong>in</strong>g that there are governance policies and mechanismsappropriate to the structure, bus<strong>in</strong>ess, and risks of the group and its entities.Senior managementPr<strong>in</strong>ciple 5: Under the direction of the board, senior management should ensure that the bank’s activities areconsistent with the bus<strong>in</strong>ess strategy, risk tolerance/appetite, and policies approved by the board.Risk management and <strong>in</strong>ternal controlsPr<strong>in</strong>ciple 6: <strong>Banks</strong> should have an effective <strong>in</strong>ternal controls system and a risk management function(<strong>in</strong>clud<strong>in</strong>g a chief risk officer or equivalent) with sufficient authority, stature, <strong>in</strong>dependence, resources, andaccess to the board.Pr<strong>in</strong>ciple 7: Risks should be identified and monitored on an ongo<strong>in</strong>g firmwide and <strong>in</strong>dividual-entity basis,and the sophistication of the bank’s risk management and <strong>in</strong>ternal control <strong>in</strong>frastructures should keep pacewith any changes to the bank’s risk profile (<strong>in</strong>clud<strong>in</strong>g its growth) and to the external risk landscape.Pr<strong>in</strong>ciple 8: Effective risk management requires robust <strong>in</strong>ternal communication with<strong>in</strong> the bank about risk,both across the organization and through report<strong>in</strong>g to the board and senior management.Pr<strong>in</strong>ciple 9: The board and senior management should effectively use the work conducted by <strong>in</strong>ternal auditfunctions, external auditors, and <strong>in</strong>ternal control functions.CompensationPr<strong>in</strong>ciple 10: The board should actively oversee the compensation system’s design and operation, and shouldmonitor and review the compensation system to ensure that it operates as <strong>in</strong>tended.Pr<strong>in</strong>ciple 11: An employee’s compensation should be effectively aligned with prudent risk tak<strong>in</strong>g:compensation should be adjusted <strong>for</strong> all types of risk; compensation outcomes should be symmetric with riskoutcomes; compensation payout schedules should be sensitive to the time horizon of risks; and the mix ofcash, equity, and other <strong>for</strong>ms of compensation should be consistent with risk alignment.66<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


Complex or opaque corporate structuresPr<strong>in</strong>ciple 12: The board and senior management should know and understand the bank’s operationalstructure and the risks that it poses (that is, “know your structure”).Pr<strong>in</strong>ciple 13: Where a bank operates through special-purpose or related structures or <strong>in</strong> jurisdictions thatimpede transparency or do not meet <strong>in</strong>ternational bank<strong>in</strong>g standards, its board and senior managementshould understand the purpose, structure, and unique risks of these operations. They should also seek tomitigate the risks identified (that is, “understand your structure”).Disclosure and transparencyPr<strong>in</strong>ciple 14: The governance of the bank should be adequately transparent to its shareholders, depositors,other relevant stakeholders, and market participants.The role of supervisors1. Supervisors should provide guidance to banks on expectations <strong>for</strong> sound corporate governance.2. Supervisors should regularly per<strong>for</strong>m a comprehensive evaluation of a bank’s overall corporate governancepolicies and practices and evaluate the bank’s implementation of the pr<strong>in</strong>ciples.3. Supervisors should supplement their regular evaluation of a bank’s corporate governance policies andpractices by monitor<strong>in</strong>g a comb<strong>in</strong>ation of <strong>in</strong>ternal reports and prudential reports, <strong>in</strong>clud<strong>in</strong>g, as appropriate,reports from third parties such as external auditors.4. Supervisors should require effective and timely remedial action by a bank to address material deficiencies <strong>in</strong>its corporate governance policies and practices, and should have the appropriate tools <strong>for</strong> this.5. Supervisors should cooperate with other relevant supervisors <strong>in</strong> other jurisdictions regard<strong>in</strong>g the supervisionof corporate governance policies and practices. The tools <strong>for</strong> cooperation can <strong>in</strong>clude memoranda ofunderstand<strong>in</strong>g, supervisory colleges, and periodic meet<strong>in</strong>gs among supervisors.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 67


E. Additional In<strong>for</strong>mation from EBRD SEE Bank AssessmentsE1. Board structures <strong>in</strong> SEEAlbaniaJo<strong>in</strong>t stock companies <strong>in</strong> Albania have the option to choose either a one-tier or two-tier system. In the lattercase, management board members can be elected and dismissed by the general shareholders meet<strong>in</strong>g or bythe supervisory board, as provided by the charter. The Law on <strong>Banks</strong> requires banks to be organized undera two-tier system, where the general shareholders’ meet<strong>in</strong>g appo<strong>in</strong>ts both a supervisory board (“steer<strong>in</strong>gcouncil”) and the members of the management board (“directorate”). The steer<strong>in</strong>g council is the bank’sdecision-mak<strong>in</strong>g and supervisory body. At least one-third of its members must not be related to controll<strong>in</strong>gshareholders or to the bank’s management board members. Members of the directorate can also sit on thesteer<strong>in</strong>g council, but they should not be <strong>in</strong> the majority.Bosnia and Herzegov<strong>in</strong>a<strong>Corporate</strong> governance and bank<strong>in</strong>g <strong>in</strong> Bosnia and Herzegov<strong>in</strong>a is regulated at the entity level. In practice,two dist<strong>in</strong>ct corporate governance regimes exist and each entity has its own framework of primary andsecondary legislation and a Bank<strong>in</strong>g Agency. In both the Federation of Bosnia and Herzegov<strong>in</strong>a and <strong>in</strong>the Republika Srpska, the Law on <strong>Banks</strong> requires f<strong>in</strong>ancial <strong>in</strong>stitutions to have a supervisory board and amanagement board. The latter is appo<strong>in</strong>ted by the general meet<strong>in</strong>g of shareholders and is responsible <strong>for</strong> thesupervision of the bus<strong>in</strong>ess operations of a bank. The management board is appo<strong>in</strong>ted by the supervisoryboard and is responsible <strong>for</strong> the direct bus<strong>in</strong>ess operations of the bank. The supervisory board must appo<strong>in</strong>tan audit committee consist<strong>in</strong>g of five members <strong>for</strong> a term of four years. Members may be reappo<strong>in</strong>ted. Auditcommittee members cannot be bank staff or members of the supervisory or management boards.BulgariaBulgarian jo<strong>in</strong>t stock companies, <strong>in</strong>clud<strong>in</strong>g public companies and banks, can opt <strong>for</strong> a one-tier systemor a two-tier system. In l<strong>in</strong>e with Article 41 of the 8th EU Company Law Directive, the Law on F<strong>in</strong>ancialIndependent Audit requires public <strong>in</strong>terest companies (<strong>in</strong>clud<strong>in</strong>g banks) to establish an audit committee. Inlisted companies and banks, one-third of board members must be <strong>in</strong>dependent.Detailed rules on <strong>in</strong>dependent board members are <strong>in</strong>cluded <strong>in</strong> the National Code of <strong>Corporate</strong> <strong>Governance</strong>.F<strong>in</strong>ally, the Law on Credit Institutions promulgated <strong>in</strong> July 2006 requires banks to regularly review theirorganizational structure and the procedure <strong>for</strong> def<strong>in</strong><strong>in</strong>g and delegat<strong>in</strong>g powers and responsibilities of boardmembers.CroatiaIn Croatia, the Companies Act allows jo<strong>in</strong>t stock companies to choose between one-tier or two-tier boardsystems. Accord<strong>in</strong>g to the Credit Institutions Act, banks are required to establish a management board and asupervisory board. The Act requires the supervisory board to have at least one <strong>in</strong>dependent member. Thereare no specific requirements <strong>for</strong> board committees, although the Act expressly provides report<strong>in</strong>g duties by<strong>in</strong>ternal audit to the audit committee. On the other hand, the <strong>Corporate</strong> <strong>Governance</strong> Code recommends thatboards <strong>in</strong> listed companies and banks establish nom<strong>in</strong>ations, remuneration, and audit committees with amajority of <strong>in</strong>dependent board members.FYR MacedoniaIn FYR Macedonia, banks are governed under a two-tier system, where the general shareholders meet<strong>in</strong>gappo<strong>in</strong>ts the supervisory board, and the latter appo<strong>in</strong>ts and removes the members of the management68<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


oard. The supervisory board is responsible <strong>for</strong> the oversight of the operations of the board of directors. Atleast one-fourth of a bank’s supervisory board members must be <strong>in</strong>dependent, pursuant to the def<strong>in</strong>ition<strong>in</strong>cluded <strong>in</strong> the Bank<strong>in</strong>g Law.MontenegroAccord<strong>in</strong>g to the Bus<strong>in</strong>ess Organisation Law of Montenegro, jo<strong>in</strong>t stock companies are organized undera one-tier system, where the general shareholders meet<strong>in</strong>g appo<strong>in</strong>ts the board. The same structure canbe found <strong>in</strong> the Bank<strong>in</strong>g Law <strong>for</strong> banks. The board is responsible <strong>for</strong> the oversight of the bank’s bus<strong>in</strong>essactivities. Bank boards are required to have at least two <strong>in</strong>dependent board members.RomaniaIn Romania, credit <strong>in</strong>stitutions can be organized under a one-tier or a two-tier board structure. Accord<strong>in</strong>gto Law No. 31/1990, the board or, as appropriate, the supervisory board can set up consultative boardcommittees <strong>for</strong>med by at least two board members. With a one-tier board, at least one member of thecommittee needs to be an <strong>in</strong>dependent nonexecutive director, and the audit and remuneration committeesare to be composed exclusively of nonexecutive directors. In companies with a two-tier board structure, atleast one member of each committee has to be an <strong>in</strong>dependent member of the supervisory board. Accord<strong>in</strong>gto Regulation No. 18/2009, banks can set up a risk management committee.SerbiaIn Serbia, the Law on <strong>Banks</strong> requires banks to have a supervisory board and a management board. Thesupervisory board is responsible <strong>for</strong> the oversight of the bank’s activities. Board members are appo<strong>in</strong>ted andremoved by the shareholders meet<strong>in</strong>g. At least one-third of supervisory board members must be <strong>in</strong>dependent(people not hold<strong>in</strong>g direct or <strong>in</strong>direct ownership <strong>in</strong> the bank or <strong>in</strong> the bank’s hold<strong>in</strong>g), and at least three ofits members must have experience <strong>in</strong> the field of f<strong>in</strong>ance. The management board is appo<strong>in</strong>ted and removedby the supervisory board. <strong>Banks</strong> are also required to establish an audit committee, a credit committee,and a committee <strong>for</strong> manag<strong>in</strong>g assets and liabilities. At least one member of the audit committee must be<strong>in</strong>dependent.<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 69


E2. Ownership of SEE <strong>Banks</strong> 83Albania13.6% National Commercial Bank13.4% Intesa-Sanpaolo Bank9.5% Tirana Bank7.6% Alpha Bank5.8% Cred<strong>in</strong>s Bank4.8% NBG4.5% Procredit Bank29.1% Raiffeisen Bank4.3% Popular Bank (Soc Gen)3.3% Emporiki Bank (CA)4.0% OthersBosnia and Herzegov<strong>in</strong>a21.6% Raiffeisen Bank44.5% Others18.5% Hypo Group16.4% Unicredit Group5.6% Intesa Bank5.7% Volksbank Group9.3% NLB Group83 The source of the charts <strong>for</strong> Albania, Bosnia and Herzegov<strong>in</strong>a, Bulgaria, Croatia, Romania and Serbia is: CEE Bank<strong>in</strong>g Sector Report, September 2010,Raiffeisen Research, available at: http://www.rzb.at/eBus<strong>in</strong>ess/services/resources/media/677012584775275435-677012584775275436_677251119927032833_677257048341086064-679588600387211306-1-9-DE.pdfThe source of the charts <strong>for</strong> FYR Macedonia and Montenegro is: BankScope70<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


Bulgaria19.1% Others16.3% Unicredit Bulbank2.9% <strong>Corporate</strong> Commercial Bank3.2% Alpha Bank4.2% SG Expressbank12.5% DSK Bank (OTP)11.5% United Bulgarian Bank5.1% Piraeus Bank5.8% First Investment Bank11.0% Raiffeisenbank 8.5% Eurobank EFGCroatia19.4% Privredna banka (Intesa) 25.3% Zagrebacka2.6% Others13.7% Erste2.1% Volksbank3.5% OTP banka11.7% Raiffeisenbank3.8% HPB7.5% Splitska banka (SocGen)10.6% Hypo Group<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 71


FYR Macedonia8% Others2% Stopanska BankaA.D. Bitola2% Halka Banka A.D. Skopje3% Alpha Bank A.D. Skopje3% Universal Investment BankA.D. Skopje23% Komercijalna BankaA.D. Skopje22% Stopanska BankaA.D. Skopje4% ProCredit Bank A.D.6% Ohridska BankaA.D. Ohrid21% NLB Tutunska BankaA.D. SkopjeMontenegro1% First F<strong>in</strong>ancial Bank A.D. Podgorica1% Invest banka Montenegro3% Komercijalna BankaA.D. Budva5% Hipotekarna BankaA.D. Podgorica6% Atlas BankA.D. Podgorica25% Crnogorsko KomercijalnaBanka A.D. Podgorica-CKBBank10% Erste Bank A.D. Podgorica9% Podgorica Banka SocieteGeneral Group AD19% NLB MontenegrobankaA.D. Podgorica9% Prva Banka Crne Gore A.D.12% Hypo Alpe Adria72<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


Romania19% BCR (Erste)13.1% BRD (SocGen)7.2% Raiffeisenbank2.4% Banca Romanesca3.0% Pireus Bank6.1% Volksbank5.8% Alpha Bank6.0% Unicredit4.0% Bank Post (EFG Eur.)5.0% CEC5.3% Banca TransilvaniaSerbia13.1% Bank Intesa35.2% Others9.5% Komercijalna banka8.3% Raiffeisenbank6.3% Hypo Group6.1% Eurobank EFG5.8% Unicredit banka2.6% ProCredit3.7% Vojvodjanska banka4.3% SocGen5.1% AIK banka<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 73


E3. Supervisor oversight of remuneration practices 84Is the l<strong>in</strong>k between compensation and per<strong>for</strong>mance reviewed as part of the supervisory process?NOYES0% 10% 20% 30% 40% 50% 60%Are there specific regulatory requirements as regards the alignment of compensation to prudentrisk management?NOYES0% 10% 20% 30% 40% 50% 60% 70% 80%84 Source: Data from EBRD, <strong>Corporate</strong> <strong>Governance</strong> Assessment of <strong>Banks</strong> (2010-2011).74<strong>Policy</strong> Brief<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong>


For <strong>in</strong><strong>for</strong>mation requests and general <strong>in</strong>quiries, please contact Gian Piero Cigna at cignag@ebrd.com andMarie-Laurence Guy at mguy@ifc.org<strong>Corporate</strong> <strong>Governance</strong> <strong>for</strong> <strong>Banks</strong> <strong>in</strong> <strong>Southeast</strong> <strong>Europe</strong> <strong>Policy</strong> Brief 75

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