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December 17, 2010
Recommendations for Corporate Governance of Banks Seek to Avoid Past Failures
    by Robert Kropp

SocialFunds.com talks with Justin Levis of the Council of Institutional Investors about the recently issued principles for enhancing corporate governance by the Basel Committee on Banking Supervision.


The Basel Committee on Banking Supervision first published guidance on the corporate governance practices for banks in 1999, and followed with a revision in 2006. Considering the devastating effects of banking practices on global economies that followed the 2006 revision, it is not surprising to learn that the Committee has issued yet another revision four years later.

Nor is it surprising to learn that the new report, entitled
Principles for enhancing corporate governance, focuses to such a degree on risk management. Each of the six "key areas where the Committee believes the greatest focus is necessary"—Board practices, senior management, risk management and internal controls, compensation, complex or opaque corporate structures, and disclosure and transparency—make reference to risk oversight and management as essential elements.

Because the 27 countries represented in the Committee's membership includes representatives from the US—at least four US-based individuals serve as co-chairs on the Committee's various working groups—advocates for sound governance practices in the US, such as the
Council of Institutional Investors (CII), have taken a vested interest in the final form of the document, providing comments in advance of its publication.

In a letter to the Committee written by Justin Levis, Senior Research Associate at CII, the organization—described by Levis in a conversation with SocialFunds.com as "an association of pension funds, whose core mission is to enhance shareowner rights and foster good corporate governance among companies all over the world"—stated, "A significant factor in the 2008 crash was that boards at many banks failed in their responsibility to monitor the overall level of corporate risk-taking and the bank’s risk-management procedures."

"Robust board oversight of risk management is a prerequisite for lasting value creation," the letter continued.

"We have substantial policies on many of the areas covered by the Basel report," Levis told SocialFunds.com, "And we are pleased to see that the principles put out by the Committee promote good governance and risk management. Both are very much needed, these days, especially in the wake of the financial crisis."

"Boards should approve and monitor all business strategy, risk strategy, corporate governance, and policies on risk management, with an eye toward the long-term health and financial interests of the companies," Levis continued. "You can't have sustainable value creation without strong Board oversight of risk."

Using as its benchmark the
OECD Principles of Corporate Governance, issued by the Organization for Economic Co-operation and Development (OECD), the Committee makes reference to that organization's post-crisis update, entitled Corporate Governance and the Financial Crisis. In that document, the OECD states, "Corporate governance weaknesses in remuneration, risk management, board practices and the exercise of shareholder rights had played an important role in the development of the financial crisis."

In its report, the Committee recommends senior executive responsibility for risk management, ongoing monitoring of risk management with effective internal controls systems, and a risk management system sophisticated enough to "keep pace with any changes to its risk profile (including its growth) and to the external risk landscape."

On the issue of disclosure and transparency, the Committee states, "Transparency is one tool to help emphasize and implement the main principles for good corporate governance."

Levis agreed, and said, "The principle on disclosure is strong and well-written, especially dealing with disclosure of a bank's risk appetite. Transparency leads to accountability."

Given that the Committee's report addresses the corporate governance practices of financial institutions in many countries, the principles it espouses are necessarily generalized in some cases. Nevertheless, Levis observed, "We would have liked the Committee to go further on the topic of independent Board chairs. Independent Board chairs provide a better balance of power between the Board of Directors and the CEO, and provide better oversight of the CEO."

"We would have liked the Committee to take a stronger stance on the independence of Board committees as well," he continued. "According to the report, key committees should preferably have a majority of independent Board members. We would go further, and say that all members of the nominating, compensation, and audit committees should be fully independent. It fosters unbiased decision-making in the best interest of the company and its shareowners."

On the subject of executive compensation, the Committee called on banks to fully implement the
FSB Principles and Standards, published by the Financial Stability Board (FSB) in 2009. That document called for performance-based variable compensation "payable under deferral arrangements over a period of" not less than three years.

"In the event of negative contributions," the FSB continued, "Any unvested portions are to be clawed back."

In a recently published
report on the compensation practices of Wall Street banks, CII noted improved clawback provisions, but stated, "The effectiveness of the banks' stronger clawback provisions has not been tested."

Two of the issues relating to compensation that were highlighted in CII's comments to the Committee addressed clawbacks, as well as excessive severance pay that is not tied to performance. Clawback policies "should require recovery or cancellation of any unearned awards," the comments stated, and policies on severance pay unrelated to performance "encourage overly-risky behavior by shielding executives from the negative personal financial ramifications of their actions."

"We expect that with the intensified focus on corporate governance in the US after passage of the Dodd-Frank Act, the Basel principles will be a welcome addition," Levis said. In addition to the principles espoused by the Committee, core corporate governance best practices for CII include "majority voting in director elections, the right of long-term shareowners to have proxy access, and say-on-pay," he continued.

Levis concluded, "The principles are applicable to all companies, not just banks."

 

 
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