Corporate Governance Code for Banks – make or break period?

By Kuvera de Zoysa

There has been considerable interest in the corporate governance practices of modern corporations, particularly since the high-profile collapses of a number of large U.S. firms such as Enron Corporation and Worldcom and the recent scandals such as those involving Nortel and Crocus (Canada), and Parmalat and Royal Ahold (EU) which exposed failures in corporate governance that shook the capital markets in developed countries and put the spotlight on weak corporate governance in developing, emerging and transitional economies.

It is supposedly in consideration of these developments in the international arena and certain bank management issues observed in Sri Lanka that the Central Bank of Sri Lanka has followed suit and introduced a draft mandatory code of corporate governance for banks in Sri Lanka, in addition to the rules on corporate governance for listed companies that is imposed by the Colombo Stock Exchange that is coming into effect from January 2008.

Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way in which a corporation is directed, administered or controlled. Corporate governance also includes the relationships among the many players involved (the stakeholders) and the goals for which the corporation is governed. The principal players are the shareholders, management and the board of directors. One must agree that good corporate governance is essential for the development of a competitive private sector that in the long-term is able to attract and retain the capital needed for investment.

However, in introducing such governance it is even more essential that the policy makers bear in mind the need to give adequate consideration to factors such as the structure of capital markets, major players in the economy, the privatisation policy, the cultural and legal environment of corporate governance, the development of stock markets and accounting and financial reporting standards in the country.

The exposure draft on corporate governance issued by the Central Bank specifically indicates that this code would be introduced as a mandatory code. However the trend internationally is that the codes of corporate governance developed by various organizations such as the Organization for Economic Corporation and Development (OECD), the Basel Committee on Banking Supervision and the World Bank are non mandatory codes from which supervisors or organizations can derive best practices. However the Central Bank is attempting to impose this proposed code as a mandatory code, which gives rise to concerns as to whether the Bank is in effect attempting to get involved in the management of banks forgetting its role of supervisor.

Term of office
One of the most alarming aspects introduced by this draft is that the term of the office of a director other than the director who holds the position of chief executive officer should be four years and can be re-elected only for another term. It further provides that in the case of current directors, the term of office will include the period that has been served by directors as at the effective date of the code. In the event this proposed draft comes into effect, directors of banks who have served on boards for a long period of time and have contributed to the success of banks would become ineligible to continue as directors. Further it would restrict the rights of shareholders to appoint directors and limit the shareholders choice.
The resulting position of this would be to create instability in commercial banks as almost 90% of directors in almost all commercial banks would become ineligible to serve on the respective boards.
The four year rule for the term of office of directors, if abused, would also pave the way for directors to engage in corruption and mismanagement and disrupt the commercial stability of banks.

Fit and proper test for directors
The exposure draft also stipulates the criteria for fit and proper persons to be appointed to the board of commercial banks in addition to the requirements laid out by section 42 of the Banking Act. As per the code a person would be deemed fit and proper to be appointed as a director only if such person possesses academic or professional qualifications or effective experience in economics, banking, finance, business or human resource management.
This clearly leaves out persons who may be qualified in various other fields such as law, IT, marketing etc, whose contribution would be of immense importance for the proper management of a commercial bank.

Restrictions
The exposure draft also restricts the number of companies in which a director of a bank can hold office as a director to 10 companies/entities/institutions inclusive of subsidiaries or associate companies of the bank. This will restrict the contribution that certain individuals could make to different institutions of the economy.
Many entrepreneurs who serve on many boards of various companies contribute to the success of these organizations through their knowledge, expertise and unique ideas and thereby help in the overall economic development of the country.
These provisions will merely pave the way for certain individuals to indirectly control banks from behind the scene while purporting to adhere to all rules, regulations and procedures.

Distinction between Chairman and CEO
The exposure draft also suggests that there be a clear difference between the Chairman and CEO of a bank. What may seem like a straightforward change of responsibilities is actually a complicated process influenced by unpredictable variables, such as the personal psychology of the two people chosen for the posts. Many companies in the west which adopted this were of the impression that they were splitting the roles well, only to stumble along the way.

Independent non-executive directors
The exposure draft also suggests that boards of banks should have at least three independent non-executive directors or one third of the total number of directors, whichever is higher.
However in a developing country such as Sri Lanka with a diminutive business community it would be a tedious task for banks to find directors who would strictly qualify as “independent directors”.
Tatiana Nenova, Financial Economist, Policy Practice of the Corporate Governance Department of the World Bank Group has stated in “A Corporate Governance Agenda for developing Countries” on the topic of ‘Board Actions: independent and audit committees’ that “In countries with concentrated ownership, a requirement for independent directors is ineffective.”

(The writer is an Attorney at Law presently engaged in active practice and advises many corporate clients. He was a Director of the Peoples Bank, acting Chairman of Peoples Bank and Chairman of People’s Merchant Bank.)