Features

Governance of financial institutions, key to governance architecture

31 Dec 2013 - {{hitsCtrl.values.hits}}

By Dinesh Weerakkody
A few public policy issues have moved from the wings to centre stage as quickly and decisively as corporate governance. The regulators all over have made efforts in recent years to refine their views on how financial institutions should be organised and governed. The role that corporate governance plays in corporate performance is now well documented.

The success of a company is often directly connected to the character and the relationship of the directors and the top management of the company and in addition, when directors don’t put self-interest and self-preservation ahead of stakeholder interest.

Good governance in general gives the company the protection to operate effectively, the ability to do what’s right for the company and for the shareholders, win the confidence of the public and improve the public rating of the institution. Promoting good governance ultimately separates good performing from poor-performing companies.

In Sri Lanka, attempts to improve corporate governance in the past have been through the adoption of voluntary codes. We have generally followed the British methodology of enunciating principles rather than rules.

The issue of governance has much to do with a value system and unless the values are clearly accepted, perhaps the only other way in which the end could be achieved is through imposition, although this is distasteful. Some of them have chosen to interpret these principles in a manner that gives them the flexibility to ignore the principles when it suits them.

Thus, in the context of Sri Lanka, the introduction of a mandatory code, which incorporates principles and rules to be followed, was timely, desirable and commendable because financial institutions occupy a special position of trust in the national economy. They are responsible for financial stability and to shape the pattern of credit distribution and the overall supply of financial services. Hence, the necessity and importance of enforcing effective corporate governance structures in the financial sector.

Better governance
Then one of the key factors on which the regulator has sought to build a better governance framework is by having a number of ‘independent’ directors on boards. While this is commendable in theory, it needs to be borne in mind that mere ‘independence’ as defined in the code will not ensure that the director concerned will or can make the required contribution.

In fact, given the incestuous corporate relationships prevalent in our small country, the Chairman’s school buddy who fits the code’s definition of ‘independence’ may in reality be less independent than someone who is ‘not independent’ in terms of the code.

It is also a matter for debate whether so-called ‘independent’ directors who receive fixed and rather nominal fees for their services and have no real stake in the business are sufficiently motivated to enhance enterprise value.

However, true independence and effectiveness of an ‘independent’ director can only be measured by the director’s actions in the boardroom and the freedom and willingness to leave the board if he is forced to compromise on the principles of good governance and not merely through the application of rules.

Boards therefore need to somehow find broader sources of information, so they are not relying on one or two people, there is no substitute for spending time with management of different departments or sectors having them present directly to the board, visiting operations- not interfering but to understand what is really happening.

A board is expected to create and enhance the competitive advantage of the firm, identify and manage corporate governance risk at firm level and to overcome the systemic risk across the industry through shared standards of corporate governance practices.

Way forward
The practice of good corporate governance followed by financial institutions will allow them to gain the trust of the depositors, investors, the customers and the community at large. This will have a positive impact on the firm’s reputation and it will be recognized as a fair and transparent company.

This image will help the firm to prosper in the long run and achieve its goals more quickly. In the final analysis, the solution for good governance can only lie with boards; they need to realize that good governance can only benefit the firm in many ways. They have to work up the courage to create exciting challenging jobs with real decision-making authority to both senior executives and other alike.

Therefore, independence is not about ‘no-shareholding’, it is more about how independent is the director in his thinking beyond and his ability to challenge proposals at the board meeting and look beyond.

Finally, good corporate governance is about instilling the ‘right values’ into the people and also to influence the company to move beyond just short-term considerations and contribute to economic and social development with a balance mindset.

(Above is a summary of a presentation made by Dinesh Weerakkody at the Central Bank NBFI)

Features

Governance of financial institutions, key to governance architecture

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