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New corporate governance guidelines highlight the need for banks to review and refresh the functioning of their boards. The Central Bank of the UAE has recently published an extensive and revised set of guidelines for bank directors and, although they are a revision of earlier guidelines, they come at a very important time. Globally investors who saw unparalleled loss in the value of their investments in banks during the financial crisis are questioning whether board directors understood the risk their institutions were exposed to, and are calling for corporate governance to be improved in order to ensure that similar crises can be avoided in the future.
The new guidelines highlight the importance of the composition of the board and the valuable role non-executive directors have to play. They stress the role and responsibility of the board in setting clear strategies and objectives based on a comprehensive understanding of the risks an institution runs. The guidelines also suggest that in the light of the new guidelines banks need to review the performance and structure of their boards.
Key lessons*
Define the purpose and objectives of the bank
Establish Board committees needed for monitoring and control purposes
Ensure accountability and transparency
Strike the desired balance between wealth creation and controls
Rigorous process to ensure that decision making is properly managed.
*Corporate Governance Guidelines, Central Bank of UAE
The updated guidelines Corporate governance, according to the Organization for Cooperation and Development (OECD), defines the relationship between a company's management, its board, shareholders and other stakeholders. It relates to both the accountability of boards and how directors can influence and improve the performance of the bank. In banks, more than in other institutions, the challenge is to achieve sustainable wealth creation though appropriate management of the risks involved in financial intermediation.
"Good governance is essential for the long term success of a bank, and good governance depends largely on the skills, experience and knowledge of the directors. If a bank fails, it affects the whole economy, so directors are the guardians of financial stability," says HE Sultan Bin Nasser Al Suwaidi, Governor of the Central Bank of UAE.
The guideline from UAE banks build on earlier guidelines published by the Central Bank, those established by the Dubai International Finance Centre (DIFC), and the anticipated corporate governance provisions in the listing rules for Abu Dhabi.
The role of directors
The revised guidelines place considerable emphasis on the role of directors and emphasize that, once appointed, they are responsible to all shareholders rather than to any specific group. Equally important is the role of independent non-executive directors, who can exercise their judgement unaffected by conflicts of interest and be of "independent mind... who are able to stand their ground". At the same time, bank board members need to understand the line between management and the board, and should not be involved in the executive committee of the bank. The biggest challenge faced by bank board's relates to how directors exercise their responsibilities and judgment in fulfilling their key roles:
Strategy: Constructively challenge and help develop strategy Performance: Monitor and reporting of management's performance against the defined strategy Risk: Defining a risk appetite and ensuring that it is achieved through robust systems and processes People: Ensuring appropriate reward and incentives for senior executives
In most instances, boards will need to create specific sub committees to address these areas effectively. Further, given the performance of the financial sector over the past 18 months, questions must be asked as to whether strategies were realistic, and whether they encouraged excessive risk taking in order to maintain market share and return. Boards need to be informed and to understand the nature of balance sheet risks the bank may be facing, and what liquidity assumptions that have been made governing adverse conditions.
As most banks are both complex businesses comprising very different business units with different risks profiles and highly leveraged institutions, the responsibilities on the bank directors are particularly onerous.
The role of the chairman The guidelines highlight both the "soft" and "hard" responsibilities of a bank's chairman. "Soft" responsibilities include, for instance, the creation of an environment in which board members are empowered to voice dissenting opinions, and to call for appropriate information in order to make sound decisions. The chairman should also ensure that a relationship of trust is established with the CEO, and that directors have both a comprehensive induction, as well as on-going opportunities to learn about all aspects of the institution for which they are responsible.
The role of the board The guidelines further emphasize the role of the board in setting strategic direction, supervising management and ensuring adequate controls and reporting. They emphasize that it is important for the board to formally state the powers and responsibilities, that are reserved for a board, and to follow appropriate and transparent procedures. Every board member should also be clear about the bank's purpose, values and ethical standards. One of the most substantial challenges identified in the guidelines is the board's responsibility to find the right balance between information and decision making. Many board packs resemble telephone directories in size and weight, and it is unrealistic to expect board members to effectively exercise their judgment in such circumstances. The guidelines suggest that an effective board should be expected to respond to short, focused papers of not more than six pages each.
Board performance evaluationFinally, the guidelines call for the performance of bank boards, their committees and members to be evaluated at least once a year. The purpose of these evaluations should be to make the board more effective, and to reassure stakeholders of the soundness of the institution's corporate governance. Although the Central Bank has obviously not published any findings on the quality of corporate governance in banks in the UAE, the guidelines note that "most banks following these guidelines will be making fundamental changes to their structures and process over the next few years".
Board performance evaluation - key questions?
Has the board set performance objectives and achieved them?
Has the board played a meaningful role in the development of strategy?
Has the board ensured effective risk management?
Does the board have the right mix of skill and knowledge and an appropriate combination of independent and non-executive directors?
How is the relationship between the board and management?
Is the board dealing with the right issues?
Does the board get the right information to understand and address the issues, with sufficient meetings of the right duration?
Do the board have the right sub-committee's (strategy, risk, audit etc) and do they function effectively?
The corporate governance of banks, which is under the international spotlight, is a theme that has also been championed by the Hawkamah, the institute for corporate governance at the DIFC. For the past two years Hawkamah has been running an annual corporate governance award, and in 2008 the winners were National Bank of Oman (1st Prize) and Qatar National Bank (2nd Prize). Hawkamah and UAB have also made awards to Burgan Bank and Bank Dhofar for their continued distinguished corporate governance practices. Nominations for this year's awards close at the end of August. Given recent events, investors will be paying a lot more attention to the outcomes this year.
Copyright© 2009 Genesis Analytics PTY Ltd
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