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Bodellini Corporate Governance of Banks and Financial Stability - Critical Issues and Challenges Ahead 2018 Accepted
Bodellini Corporate Governance of Banks and Financial Stability - Critical Issues and Challenges Ahead 2018 Accepted
Marco Bodellini* **
Abstract
1. Introduction
* Marco Bodellini is an Associate Lecturer in Banking and Financial Law at Queen Mary
University of London; e-mail: m.bodellini@qmul.ac.uk.
** This paper was presented at the conference ‘Corporate Governance for Banks in the
Post-Crisis Environment’ organized in Trier on 26 and 27 April 2018 by the Academy of
European Law (ERA).
1 See Basel Committee on Banking Supervision, Corporate Governance Principles for
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policymakers.3 It follows that nowadays financial stability is the priority for both
regulators and supervisors all over the world. This means that it has to be maintained at
any cost.
The paramount importance of financial stability is one of the main lessons the
world has learnt from the global financial crisis of 2007-2009. The other important
lesson we have learnt from that crisis is that publicly-funded bail-outs should no longer
take place. However, there can be cases where it is simply not possible to reach both
aims simultaneously, namely to keep financial stability without using taxpayers’ money.4
In these cases, the goal of maintaining financial stability should prevail over the ban of
using public money to rescue banks.
A clear demonstration of the prevailing importance of maintaining financial
stability over the prohibition of rescuing banks in crisis with public money can be found
in the so-called precautionary recapitalization under article 32(4) of the BRRD. This
provision allows for the use of public money to recapitalise banks the crisis and failure
of which can generate financial instability. Such a newly introduced tool has already
been used three times, twice in Greece with regard to National Bank of Greece and
Piraeus Bank, and once in Italy with regard to Banca Monte dei Paschi di Siena.5
Accordingly, it is possible to claim that financial stability is a public interest of
primary importance. It follows that every rule that is adopted has to aim at preserving
financial stability, on one side, and at avoiding the creation of financial instability on the
other side.6
From this point of view, it is rather clear how important it is to have in place
effective corporate governance structures. This is based on the fact that their
inefficiency can lead the bank to a crisis, which, in turn, depending on the characteristics
of such a bank, can impact the stability of the financial system. Accordingly, some
empirical studies argue that the failure of many banks during the global financial crisis
of 2007-2009 was also due to inefficient corporate governance.7
The concept of corporate governance is very broad and can be described in
European Law Review, 2013, 38, pp. 342–343; see also Lastra, Legal Foundations of
International Monetary Stability, (Oxford University Press, Oxford), 2006, pp. 92 and 302, saying
that it is an evolving concept that “encompasses a variety of elements”.
4 Accordingly see Biljanovska, Aligning Market Discipline and Financial Stability: a More
Gradual Shift from Contingent Convertible Capital to Bail-in Measures, European Business
Organization Law Review, 2016, 17, pp. 105-106, arguing that “market discipline and financial
stability cannot be achieved simultaneously”.
5 See Bodellini, Greek and Italian ‘lessons’ on bank restructuring: is precautionary
recapitalisation the way forward?, Cambridge Yearbook of European Legal Studies, 2017, 19, pp.
144-164.
6 See Bodellini, To bail-in or to bail-out: that is the question, European Business
financial crisis – Regulation in the light of empiry and theory, Journal of Corporate Law Studies,
2013, 13, pp. 219-253.
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different ways. According to the EU Commission, it “refers to relations between a
company's senior management, its board of directors, 8 its shareholders and other
stakeholders, such as employees and their representatives. It also determines the
structure used to define a company’s objectives, as well as the means of achieving them
and of monitoring the results obtained”.9 Similarly, in the Basel Committee’s view,
corporate governance is “a set of relationships between a company’s management, its
board, its shareholders and other stakeholders which provides the structure through
which the objectives of the company are set, and the means of attaining those objectives
and monitoring performance. It helps define the way authority and responsibility are
allocated and how corporate decisions are made”.10
Even though for long time in the past it was believed that there were no
significant differences in efficient corporate governance arrangements of banks and
other non-financial institutions, the global financial crisis has now brought about the
awareness that banking institutions are also special in this regard.
Such a special condition of banks derives from both the peculiar type of business
activity they perform and the many different stakeholders that are involved in their
operations.
It is worth noting that commercial banks mainly make profits due to the maturity
mismatch between their assets, principally the long-term loans they grant to their
customers and their liabilities, principally the short-term deposits they collect from the
public and the bonds that are subscribed by bondholders. This way of working, by
nature, is subject to both counterparty risk and liquidity risk, which can also materialise
8 Keeping in mind that different jurisdictions have a different distribution of powers and
functions among the company’s bodies, the Basel Committee on Banking Supervision has
defined the board of directors as “The body that supervises management. The structure of the
board differs among countries”, see Basel Committee on Banking Supervision, Corporate
Governance Principles for Banks, July 2015, p. 1; differently, the CRD IV distinguishes between
the so-called ‘management body’ which is defined as “an institution's body or bodies, which are
appointed in accordance with national law, which are empowered to set the institution's
strategy, objectives and overall direction, and which oversee and monitor management decision-
making, and include the persons who effectively direct the business of the institution” and the
‘senior management’ which is defined as “those natural persons who exercise executive
functions within an institution and who are responsible, and accountable to the management
body, for the day-to-day management of the institution”. The CRD IV also states that
‘management body in its supervisory function’ means the management body acting in its role of
overseeing and monitoring management decision-making.
9 See European Commission, Corporate Governance in Financial Institutions and
remuneration policies, Green Paper, Brussels, 2 June 2010, p. 3.
10 See Basel Committee on Banking Supervision, Corporate Governance Principles for
Banks, July 2015, p. 1, defining ‘risk appetite’ as “the aggregate level and types of risk a bank is
willing to assume, decided in advance and within its risk capacity, to achieve its strategic
objectives and business plan”.
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their main role that is to make beneficial decisions for their institutions. This was due to
the fact that because of the lack of a full understanding of the complexities surrounding
banks’ operations, they often preferred to let the senior management decide without
even controlling and challenging its choices. According to the EU Commission, such
situations occurred due to several reasons, namely: 1) often directors did not devote
enough time to properly perform their role, 2) in front of an authoritarian chief
executive officer, non-executive directors often were not able to take different positions,
also because in many cases they lacked the sophisticated skills needed to realise
whether alternative choices could have been more beneficial for the bank; 3) boards
often did not have members with different backgrounds; 4) the performances of boards’
members were usually not assessed; 5) often boards were not even able to set the
institution’s risk appetite and to accordingly measure the risks taken on by the senior
management; 6) boards were often unable to perceive the systemic nature of the risks
characterising the operations of their institutions.
All this means, that there were not in place efficient systems to assess the risks
and that the natural persons sitting in the boards did not have a full understanding of
the riskiness of their institution’s activity.
Risk is therefore the most important factor to take into account in setting out
effective corporate governance arrangements. To be efficient such arrangements should
put in place mechanisms enabling non-executive directors to challenge and also curb the
decisions of risk-takers when these do not comply with the risk appetite framework set
out by the bank itself.13 But in order to work, these mechanisms need that non-executive
directors are able to understand what risk-takers do and to assess their choices in the
face of the level of risk that the institution is willing to take on.
A further critical aspect has been represented by the increasingly more relevant
presence of shareholders with a short-term investment horizon who therefore are
interested in getting rapidly economic benefits.14 This can contrast with the institution’s
interest of being viable in the long-term, since to achieve this purpose it could be
necessary, for instance, to stop dividends’ distribution for a given time.
Banks, July 2015, p. 1, defining ‘risk appetite framework’ (RAF) as “The overall approach,
including policies, processes, controls and systems, through which risk appetite is established,
communicated and monitored. It includes a risk appetite statement, risk limits and an outline of
the roles and responsibilities of those overseeing the implementation and monitoring of the
RAF. The RAF should consider material risks to the bank, as well as to its reputation vis-à-vis
policyholders, depositors, investors and customers. The RAF aligns with the bank’s strategy”.
14 Such as for example hedge funds, see Bodellini, From Systemic Risk to Financial
Scandals: the Shortcomings of U.S. Hedge Fund Regulation, Brooklyn Journal of Corporate
Financial & Commercial Law, 2017, 11, pp. 417-467.
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Corporate governance for banks has become a crucial subject in the policy-
makers’ agenda in the aftermath of the global financial crisis, when the perception of its
impact on the failure of many institutions became widespread.
From a practical point of view, effective corporate governance arrangements can
be obtained with a clear and appropriate distribution of functions and powers between
the board of directors and the senior management as well as within the different
committees that have to be set up within the board itself. Likewise, of paramount
importance are both the composition of the board and the sophisticated skills which are
required in order to be appointed as a director to properly perform such an important
role.
With regard to the EU regulation, a relevant number of rules spread among
different acts impact both directly and indirectly the functioning and composition of the
bank’s board as well as the distribution of powers and tasks.
In this context, it is also worth mentioning that the most common corporate
governance arrangements are different across the main jurisdictions, however, at EU
level it is possible to distinguish mainly among: a) the British model, b) the German
model and c) the Italian model. The British model is a one-tier system made up of a
single board composed of both executive and non-executive independent directors. The
former are in charge for the daily business operations of the bank, whilst the latter are
meant to control whether the bank is properly run. The German model is a two-tier
system with a management board in charge to run the bank and a supervisory board
that is meant to advise and monitor the former. The Italian model is based on the
division of functions between the board of directors in charge to set the guidelines and
the goals that the senior management has to follow and try to achieve and the board of
independent auditors in charge to control the legality of the activities performed by both
directors and senior managers.15
With regard to the composition of the board, an increasing importance has been
recently given to the presence of independent and non-executive directors. The main
reason is based on the ground that these directors can effectively monitor and also
challenge the strategic choices of the executive directors. The logical assumption on
which this reasoning is based is that a deep discussion on the most important business
choices to be made is always the best way to take thoughtful decisions. The
counterargument to this could be that such directors cannot have a deep and full
knowledge of all the relevant facts which can come up on a daily basis and influence the
decision making process. However, the presence of directors who are just supposed to
control the activity of the executives is, at least on paper, an effective measure to foster
the exchange of views within the board, which, in turn, could be a solid foundation for a
well-motivated decision.
15 On these aspects with regard to the Italian banking legislation, see Bodellini, L’eterno
dilemma della corporate governance della Banca Popolare di Milano, Contratto e Impresa, 2014,
4 - 5, pp. 1121 – 1170.
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However, rather obviously, independence in and of itself is not enough to provide
the board with efficiency. Banks’ directors must also have sophisticated skills allowing
them to fully understand the possible consequences of each decision they are required
to make. For this very reason, in the last years regulators have been paying much more
attention to directors’ skills than was the case in the past.
After the global financial crisis, one of the first initiatives with regard to banks’
corporate governance was the publication by the EU Commission of the Green Paper
entitled ‘Corporate Governance in Financial Institutions and Remuneration Policies’
back in June 2010. In the introduction, it is clearly stated that “although corporate
governance did not directly cause the crisis, the lack of effective control mechanisms
contributed significantly to excessive risk-taking on the part of financial institutions”.16
In the Commission’s view, to address these issues “it appears necessary for
boards of directors to ensure the right balance between independence and skills is
struck. Recruitment policies which precisely identify the skill needs of the board of
directors and which aim to guarantee the objectivity and independence of members’
judgment could help increase the board of directors’ ability to effectively monitor
management”.17 Likewise, limits to the number of directorships that each individual can
hold should enable directors to devote enough time to their duties. Equally useful could
be to assess on an annual basis the quality of directors’ performances and the
effectiveness of their actions.
Another significant initiative in this regard has been the publication of the
“Corporate Governance Principles for Banks” by the Basel Committee on Banking
Supervision in July 2015.18 These principles state that: 1) the board has ultimate
responsibility for the bank’s business strategy and financial soundness, key personnel
decisions, internal organization and governance structure and practices, and risk
management and compliance obligation; 2) board members should be and remain
qualified, individually and collectively, for their positions. They should understand their
oversight and corporate governance role and be able to exercise sound, objective
judgment about the affairs of the bank; 3) the board should define appropriate
governance structures and practices for its own work, and put in place the means for
such practices to be followed and periodically reviewed for on-going effectiveness; 4)
under the direction and oversight of the board, senior management should carry out and
manage the bank’s activities in a manner consistent with the business strategy, risk
Moving from the findings of the European Commission’s Green Paper and the
first version of the Basel Committee’s principles on corporate governance20, in 2013 the
EU legislator adopted the CRD IV on access to the activity of credit institutions and their
prudential supervision.
Accordingly, article 74(1) of the CRD IV clearly states that banks shall have
19Id.
20See Basel Committee on Banking Supervision, Principles for Enhancing Corporate
Governance, October 2010, passim, which represented a consistent development in the effort to
promote sound corporate governance practices for banking institutions reflecting key lessons
from the global financial crisis of 2007-2009.
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“robust governance arrangements, which include a clear organisational structure with
well-defined, transparent and consistent lines of responsibility, effective processes to
identify, manage, monitor and report the risks they are or might be exposed to, adequate
internal control mechanisms, including sound administration and accounting
procedures, and remuneration policies and practices that are consistent with and
promote sound and effective risk management”, whilst, article 74(2) adds that such
arrangements, processes and mechanisms have to be comprehensive and proportionate
to the nature, scale and complexity of the risks inherent in the business model and the
institution’s activities (so-called principle of proportionality).
21 Additionally, the risk committee shall also review whether prices of liabilities and
assets offered to clients take fully into account the institution's business model and risk strategy.
Where prices do not properly reflect risks in accordance with the business model and risk
strategy, the risk committee shall present a remedy plan to the management body.
22 Under article 88 of the CRD IV, “Those arrangements shall comply with the following
principles: (a) the management body must have the overall responsibility for the institution and
approve and oversee the implementation of the institution's strategic objectives, risk strategy
and internal governance; (b) the management body must ensure the integrity of the accounting
and financial reporting systems, including financial and operational controls and compliance
with the law and relevant standards; (c) the management body must oversee the process of
disclosure and communications; (d) the management body must be responsible for providing
effective oversight of senior management; (e) the chairman of the management body in its
supervisory function of an institution must not exercise simultaneously the functions of a chief
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Whilst, regarding the management body, article 91 of the CRD IV provides that its
members shall at all times be of sufficiently good repute and possess sufficient
knowledge, skills and experience to perform their duties. The overall composition of the
management body shall reflect an adequately broad range of experiences. Members of
the management body shall, in particular, fulfil some requirements and commit
sufficient time to perform their functions in the institution. About the requirements, the
management body shall possess adequate collective knowledge, skills and experience to
be able to understand the institution’s activities, including the main risks. In particular,
each member of the management body shall act with honesty, integrity and
independence of mind to effectively assess and challenge the decisions of the senior
management where necessary and to effectively oversee and monitor management
decision-making.
Also in the BRRD are rules impacting – directly and indirectly – banks’ corporate
governance as well as the decision-making process. In this vein, resolution authorities
are given the powers to remove impediments to resolvability of banks. Accordingly,
among other powers, under article 17 of the BRRD, they can require changes to legal or
operational structures of the institution or any group entity, either directly or indirectly
under its control, so as to reduce complexity in order to ensure that critical functions
may be legally and operationally separated from other functions through the application
of the resolution tools.
Clearly, the power to remove both members of the senior management and
members of the management body seems to be very intrusive. For this reason such a
power can be exercised only when there is a significant deterioration in the financial
situation of an institution or where there are serious infringements of law, of regulations
or of the statutes of the institution, or serious administrative irregularities, and other
measures taken in accordance with article 27 are not sufficient to reverse that
executive officer within the same institution, unless justified by the institution and authorised by
competent authorities”.
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deterioration. Also, where replacement of the senior management or management body
as referred to in article 28 is deemed to be insufficient by the competent authority to
remedy the situation, the latter may appoint one or more temporary administrators to
the institution. Competent authorities may, based on what is proportionate in the
circumstances, appoint any temporary administrator either to replace the management
body of the institution temporarily or to work temporarily with the management body
of the institution and the competent authority shall specify its decision at the time of
appointment.23
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have been imposed to the heads of board’s committees. As a result, Greek banks had to
replace more than a third of their board members.
The second interesting experience is the Italian reform of cooperative mutual
banks (so-called banche di credito cooperativo).25 These banks are mainly small and
local institutions whose board used to be mainly composed of people well known in the
area where the bank operates but often without specific banking knowledge. In order to
enhance the quality of their boards, in the context of a broader reform impacting also
the composition of their banking groups, the Italian legislator has decided to move from
their shareholders’ meetings to their parent companies the powers to select and appoint
the directors. In the Italian legislator’s view, such a measure should allow to appoint
more expert and independent directors than was the case in the past, also in light of the
fact that often the crisis of these small banks was due to directors’ lack of understanding
of the risks taken on by the senior management as well as to conflicts of interest.26
8. Concluding remarks
The global financial crisis has clearly shown that for banking and financial
institutions risk management is of crucial importance. Only by properly managing the
risk can such institutions survive the market turmoil that every now and then inevitably
occurs. The only way to effectively manage the risk is by putting in place effective
corporate governance arrangements. This is why, consequently, corporate governance
for banks is so important.
The new rules introduced by legislators after the global financial crisis certainly
look, on paper, effective and represent a significant step forward compared to what was
in force before. However, it will take more time to see whether in practice these new
legal tools will be really effective to properly manage the risk and put each institution on
a solid footing to face the next financial crisis.
25 See Bodellini, Localismo e mutualità nel nuovo gruppo bancario cooperativo, Rivista di
diritto bancario, 2017, 11, pp. 1 – 15.
26 See Bodellini, Attività bancaria e impresa cooperativa, 2017, pp. 1 – 265.
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