THE CHARTERED INSTITUTE OF BANKERS OF NIGERIA

(LAGOS BRANCH)

CONFERENCE ON RISK MANAGEMENT
Topic:
The Role of Corporate Governance in Basel II

Presented by

BAYO OLUGBEMI, FCIB
Managing Director/Chief Executive Officer
First Registrars Nigeria Limited
TABLE OF CONTENT
Introduction

Corporate Governance Defined

Who is responsible for corporate governance in Banks?

Basel II & Corporate Governance
3 Cs : Control
3 Cs : Culture
3 Cs : Clarity

8 Principles for Bank Boards & Senior Management

Common Factors in Corporate Governance Breakdown in Banks

Conclusion 2
INTRODUCTION
Since late 2008 the financial crisis has rapidly weakened the global
economy and has demonstrated that Nigeria is not isolated from
disturbances in the global financial markets.

Although at first the problem was considered to be one of solidity, affecting
only a few companies, it has turned out to be a more widespread problem
requiring state involvement.

According to a recent analysis published by the Financial Supervisory
Authority in April 2009, the profitability of the banking sector has materially
weakened, but loss-bearing capacity remains fairly solid.

Banking supervisors have long recognized the importance of good
governance; supervision can not function properly if sound corporate
governance is not in place

Good corporate governance and supervisory actions complement one
another. The guidance, inspections and oversight activities of supervisors
cannot guarantee, on their own, the prudent operation and financial
soundness of a supervised bank.

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CORPORATE GOVERNANCE DEFINED

The Organization for Economic Co-operation and Development (OECD)
principles define corporate governance as involving:
a set of relationships between a companys management, its board, its
shareholders, and other stakeholders. Corporate governance also provides the
structure through which the objectives of the company are set, and the means of
attaining those objectives and monitoring performance are determined. Good
corporate governance should provide proper incentives for the board and
management to pursue objectives that are in the interests of the company and its
shareholders and should facilitate effective monitoring.

The Basel Committee document states:
From a banking industry perspective, Corporate Governance involves the
manner in which the business and affairs of banks are governed by their boards of
directors and senior management, which affects how they:
Set corporate objectives;
Operate the banks business on a day-to-day basis;
Meet the obligation of accountability to their shareholders and take into account the
interests of other recognised stakeholders;
Align corporate activities and behaviour with the expectation that banks will operate in a
safe and sound manner, and in compliance with applicable laws and regulations.


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WHO IS RESPONSIBLE FOR CORPORATE GOVERNANCE IN
BANKS?
Primary responsibility rests with bank boards and senior
management (Guidance Paper, s. III)

Bank supervisors have an important role to play by providing
guidance & assessing bank practices (Guidance Paper, s. IV)

Others can promote good governance (Guidance Paper, s. V), e.g.:
Shareholders
Depositors & customers
Employees
Auditors
Banking industry associations
Credit rating agencies
Governments, securities regulators and stock exchanges

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BASEL II & CORPORATE GOVERNANCE
Fundamentally, banks must act in a way that promotes confidence to the public and the
markets in general and, more specifically, to their primary stakeholders.

Banks play a crucial role in the flow of capital within an economy and are charged with a
special public trust to safeguard customers wealth.

A stable and healthy banking system is critical to the long-term growth of an economy.

The primary responsibility for the conduct of the banks business lies with its board and
management. Indeed, it is difficult to conceive that a bank could carry out activities in the
absence of strategic objectives or guiding corporate values.

Therefore the responsibilities of the board and management would include, among other
things, approving ethical standards, establishing and maintaining strategic objectives,
policies and procedures as well as ensuring that the bank complies with the statutory and
supervisory obligations.

Basel II is fundamentally about better risk management anchored in sound corporate
governance.

With that in mind, I would like to focus now on three areas that will bring to light the role of
effective Corporate Governance in Basel II. I will refer to these as the three Cs: Controls,
Culture and Clarity.


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CONTROLS
The first C is Controls.

A bank can use the most sophisticated measurement tools in
the world, but if it is poorly governed, it will be vulnerable to
financial and operational weaknesses.

The first pillar aligns minimum capital requirements more
closely with banks actual underlying risks.

Effective risk controls are essential to the successful
implementation of the new capital framework. Under Basel II,
the board of directors is expected to establish the institutions
risk tolerances, policies, and code of conduct, and to ensure
that a sufficiently strong risk control framework is in place.

Senior management, in turn, is responsible for implementing
the risk control framework set forth by the board.

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CULTURE
The second C is Culture.

I believe that the increased responsibilities of the board of directors and
senior management under Basel II will foster a culture of improved risk
management.

This notion underlies the second pillar of the new framework, which
takes as its starting point that the board and senior management have an
obligation to understand the banks risk profile and ensure that the bank
holds sufficient capital against its risks.

Supervisors, in turn, are responsible for reviewing the banks assessment
to evaluate and determine whether that assessment seems reasonable.

The key, in my view, is that risk awareness starts at the top of the
organisation. The board and senior management cannot abdicate their
responsibility to understand and manage the risks arising from the banks
activities.

I believe that this focus on sound risk management at the very top will
help to set the tone throughout the bank that effective risk management
is everyones job.
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CLARITY
The third C is clarity.

I believe that Basel II will provide greater clarity regarding banks
measurement and management of risk. This will be achieved first of all
through the third pillar market discipline which aims at ensuring that
the market provides an additional layer of oversight.

The third pillar is intended to focus the board and senior management on
heightening disclosure, which should strengthen incentives for prudent
risk management.

Greater transparency in banks financial reporting should allow majority
and minority shareholders, depositors, debt-holders, and other market
participants to evaluate banks and reward or penalise them according to
how prudently they are managed.

Basel II will enhance clarity in other ways as well. Not only will banks be
expected to improve their external transparency, but they will also be
expected to operate more transparently internally. In particular, banks will
be expected to ensure that the board of directors and senior
management are sufficiently well-informed to be able to meaningfully
assess the banks risk profile.
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8 PRINCIPLES FOR BANK BOARDS
& SENIOR MANAGEMENT
Principle 1: Board qualifications, capabilities and responsibilities.

Principle 2: Boards role regarding the banks strategic objectives and
corporate values.

Principle 3: Lines of responsibility & accountability.

Principle 4: Ensuring oversight by senior management.

Principle 5: Auditors and internal control functions.

Principle 6: Board & key executive compensation.

Principle 7: Transparent governance.

Principle 8: Know your operational structure
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PRINCIPLE 1
Board members should be qualified for their positions, have a clear
understanding of their role in corporate governance and be able to exercise
sound judgment about the affairs of the bank.

Some responsibilities apply to any kind of organisation (bank or non-bank), for
example:
The board should understand its oversight role


Some responsibilities are unique to the banking sector:
Promote bank safety and soundness
Understand the regulatory environment
Ensure that the bank maintains an effective relationship with supervisors

Board should have an adequate number of independent members.

Independence = ability to exercise objective judgment, independent of
the views of management,
political interests, and
inappropriate outside interests

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PRINCIPLE 2
The board of directors should approve and oversee the banks strategic
objectives and corporate values that are communicated through the banking
organisation.

Standards should address, among other things:
Corruption
Self-dealing
Other illegal, unethical or questionable behaviour

Employees should be encouraged to raise concerns about illegal or unethical
practices to the board or an independent committee without fear of reprisal or
retaliation.

Watch out for practices that could diminish the quality of corporate governance,
for example:
Internal lending (to officers, employees, board members or controlling shareholders)
Preferential treatment for related parties and other favoured entities
Conflicts of interest

The board should ensure senior management implements effective policies to
prevent (or limit) such activities.

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PRINCIPLE 3
The board of directors should set and enforce clear lines of
responsibility and accountability throughout the organisation.

Role of the board:
Define authorities & key responsibilities
Oversee management actions

Senior managements role:
Delegate to staff & promote accountability
Be responsible to the board for banks performance

Guidance also addresses:
Accountability where bank is part of a larger group structure
Outsourcing of bank functions
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PRINCIPLE 4
The board should ensure that there is appropriate oversight by
senior management consistent with board policy.

Senior management should:
Have the necessary skills to manage the business
Oversee line managers consistent with board policies (but avoid micro-managing
line managers)
Under boards guidance, establish system of internal controls
Apply the four eyes principle, even in small banks

Watch out for senior managers who are unwilling or unable to
exercise effective control over star employees


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PRINCIPLE 5
The board and senior management should effectively utilise the work
conducted by the internal audit function, external auditors and internal
control functions.

Internal audits the board & senior management should:
Recognise & communicate importance of audit & internal control processes throughout the
bank
Use the findings of internal audits and require timely correction of problems by management
Promote the internal auditors independence, e.g. through reporting to the board or boards
audit committee
Engage internal auditors to judge effectiveness of key internal controls

External audits - the board and senior management should:
Ensure that external auditors comply with applicable codes & standards of professional
practice
Ensure that external auditors understand their duties
Engage external auditors to review internal controls relating to financial statements
Encourage the principal auditor to take responsibility for other external audits of financial
statements conducted within a group
For state-owned banks, maintain a dialogue as appropriate with state supreme audit
institutions, state controllers and external auditors



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PRINCIPLE 6
The board should ensure that compensation policies and
practices are consistent with the banks corporate culture,
long-term objectives and strategy, and control environment.

Board (or independent committee) should approve
compensation, consistent with remuneration policy.

Avoid compensation policies that create incentives for
excessive risk-taking.

Policies should be clear regarding:
Holding and trading of stock in bank or affiliated companies
Granting and repricing of stock options
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PRINCIPLE 7
The bank should be governed in a transparent manner.

Disclosure should be made on the banks website, in its
annual/periodic reports and/or in reports to supervisors about:
Board and senior management structure
Basic ownership structure & organisational structure
Incentive structures (e.g. remuneration policies)
Code of business conduct and/or ethics code
Bank policies relating to conflicts of interest & related party transactions
States ownership policy, if the bank is state-owned
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PRINCIPLE 8
The board and senior management should understand the
banks operational structure, including where the bank
operates in jurisdictions, or through structures, that impede
transparency (i.e. know-your-structure).

Banks sometimes operate in jurisdictions, or employ
structures, that lack or impair transparency
This sometimes occur for legitimate business purposes

But doing so can:
Pose significant financial, legal and reputational risks for bank
Impede board and senior management oversight
Make it more difficult for authorities to effectively supervise the bank
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PRINCIPLE 8 (CONTINUED)
The risks should be appropriately assessed and managed
Information regarding the activities and risks should be easily available at the banks
head office & reported to the board and banks supervisors.

Clear policies and procedures should exist:
For board approval of the banks use (or sale) of complex structures, instruments and
products.
For the identification and management of material risks.

Regularly evaluate the need to operate in jurisdictions or use structures that reduce
transparency.

Set clear corporate governance expectations for all relevant entities and business lines.

Assess compliance with applicable laws and internal policies.

Activities should be subject to enhanced audit procedures and internal control reviews.
COMMON FACTORS IN CORPORATE GOVERNANCE
BREAKDOWN IN BANKS
Many of the recent corporate governance breakdowns appear to have several factors in
common:
The board of directors failed to understand the risks that the firm was taking, and did
not exercise appropriate oversight or questioning of senior managers and employees
actions;

Conflicts of interest and a lack of independent board members and senior executives
resulted in decisions that benefited a few at the expense of the many;

Internal controls were either weak or non-existent, or appeared to be adequate on
paper but were not implemented in practice;

Internal and external audit fell asleep at the switch and failed to detect fraudulent
behaviour, and in some cases even aided and abetted such behaviour;

Transactions and organizational structures were designed to reduce transparency and
prevent market participants and regulators from gaining a genuine picture of the firms
condition;
And perhaps most importantly, the corporate culture fostered unethical behaviour and
discouraged questions from being raised.

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REFERENCE
Caruana J (2005), Basel II and Corporate Governance Issues

Office of the Secretary General (2007), Corporate Governance Framework

Holmes J (2006),Basel Committee Guidance on Corporate Governance for
Banks

Johnson D.J (2004),OECD Principles of Corporate Governance
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CONCLUSION
I would just like to emphasize that sound corporate
governance should be considered a key element of a
banks ability to understand and manage its risks.

Supervisors should direct their resources to helping
banks improve their controls, culture and clarity in
respect to risk management.

In so doing, I believe that we will help achieve our
objective of a stable and healthy banking system that
contributes to the proper functioning of our economy.

Thank you for your attention.
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