Financial Sector, Financial Sector, Business Community & Business Community &

GovernanceGovernance

Dr. Fouad ShakerDr. Fouad Shaker

Secretary General, UABSecretary General, UAB

The World Strives to Achieve The World Strives to Achieve Economic & Social ProgressEconomic & Social Progress

Yet…Yet…The Record of Development Has Not Been Fully The Record of Development Has Not Been Fully Satisfactory:Satisfactory:Sound Macroeconomic Fundamentals Are No Longer Sound Macroeconomic Fundamentals Are No Longer Enough to Prevent CrisesEnough to Prevent CrisesThe World Needs A Better SystemThe World Needs A Better System……. Better Governance. Better GovernanceThe Private Sector may be an important part of the The Private Sector may be an important part of the corporate governance framework, if its own corporate corporate governance framework, if its own corporate governance is good; andgovernance is good; andbanks can play a detrimental role in enforcing good banks can play a detrimental role in enforcing good governance in the private sector, mainly via their governance in the private sector, mainly via their financing role.financing role.

What is “good corporate What is “good corporate governance”?governance”?

Narrowly defined, it is the system by which businesses Narrowly defined, it is the system by which businesses are directed and by which controls are implementedare directed and by which controls are implementedAt the end of the day, it is the ‘four eyes” principle in At the end of the day, it is the ‘four eyes” principle in practicepracticeAccountability plays a key role in good governanceAccountability plays a key role in good governanceTransparency is needed so accountability can be Transparency is needed so accountability can be monitoredmonitoredGovernance is often defined to cover ethical standards Governance is often defined to cover ethical standards as defense against corruption and financial abuseas defense against corruption and financial abuseThe need to strengthen governance is being The need to strengthen governance is being acknowledged by parliaments and supervisors following acknowledged by parliaments and supervisors following the international economic and banking crises, and US the international economic and banking crises, and US corporate scandals.corporate scandals.

What can good corporate What can good corporate governance achieve?governance achieve?

it protects shareholders, employees, customers, and the it protects shareholders, employees, customers, and the publicpublicConversely, bad corporate governance in institutions Conversely, bad corporate governance in institutions (financial and non-financial) can undermine economic (financial and non-financial) can undermine economic and financial stabilityand financial stabilityBad governance poses a significant reputation risk for Bad governance poses a significant reputation risk for individual firms and even for countriesindividual firms and even for countriesIf a system fails to provide incentives for good If a system fails to provide incentives for good governance and does not punish transgressors, governance and does not punish transgressors, corruption flourishescorruption flourishesFirms which practice good governance will (a) earn Firms which practice good governance will (a) earn higher ratings, (b) have access to cheaper fundinghigher ratings, (b) have access to cheaper fundingBut trade-off needed – important not to strangle But trade-off needed – important not to strangle enterprise.enterprise.

Weak corporate governanceWeak corporate governance in in BanksBanks

• many banks were controlled by owner-managers and many banks were controlled by owner-managers and independent directors played little or no role (so no independent directors played little or no role (so no ‘four-eyes” principle)‘four-eyes” principle)

• banks were often parts of wider conglomerates, so banks were often parts of wider conglomerates, so funded other parts of the group (connected lending) funded other parts of the group (connected lending) and were reluctant to forecloseand were reluctant to foreclose

• banks were subject to political influence in their banks were subject to political influence in their lending decisions and credit discipline was lending decisions and credit discipline was undermined by the legal and cultural environmentundermined by the legal and cultural environment

• management was weak and lacked self-responsibilitymanagement was weak and lacked self-responsibility• Growth was seen as more important than return on Growth was seen as more important than return on

capital.capital.

Lessons from recent corporate Lessons from recent corporate scandalsscandals

Conflicts of interest abound as finance becomes more Conflicts of interest abound as finance becomes more complex and as each firm offers greater variety of complex and as each firm offers greater variety of servicesservicesThe accounting and audit process is undervalued in The accounting and audit process is undervalued in terms of the skills needed, the responsibility and the terms of the skills needed, the responsibility and the risks incurredrisks incurredToo much latitude is given to staff whose results appear Too much latitude is given to staff whose results appear to be exceptional (that in itself is often suspicious)to be exceptional (that in itself is often suspicious)More attention is needed to the damaging incentives More attention is needed to the damaging incentives provided by badly structured compensation packagesprovided by badly structured compensation packagesSadly, no governance system can be expected on its Sadly, no governance system can be expected on its own to prevent greedy, dishonest people from putting own to prevent greedy, dishonest people from putting their personal interests ahead of the organization that their personal interests ahead of the organization that pays them.pays them.

Private Sector and Investment Private Sector and Investment Situation in the RegionSituation in the Region

Inter-Arab Investments: Inter-Arab Investments: Despite the increase in these investments from USD1.43 Despite the increase in these investments from USD1.43 bn 1995 to USD3.7 bn in 2003, yet this level constitutes bn 1995 to USD3.7 bn in 2003, yet this level constitutes only some 0.5% of the Arab economy’s GDP.only some 0.5% of the Arab economy’s GDP.FDI (Foreign direct investment):FDI (Foreign direct investment):Despite the doubling of this investment between 1995 and Despite the doubling of this investment between 1995 and 2003, yet its level constitutes only some 0.7% of total FDI 2003, yet its level constitutes only some 0.7% of total FDI in the world and 2.8% of FDI flowing into the developing in the world and 2.8% of FDI flowing into the developing world.world.The private sector remains the driving force of economic The private sector remains the driving force of economic growth and development, mainly via its role in activating growth and development, mainly via its role in activating investments in the region.investments in the region.

MENA Region ChallengesMENA Region Challenges

Economic fortunes influenced by oil price.Economic fortunes influenced by oil price.Economic policies & structures dominated by the state.Economic policies & structures dominated by the state.High regional unemployment rate (15% on average mostly High regional unemployment rate (15% on average mostly young, better educated).young, better educated).Need to create 100 million jobs in next 20 years (twice Need to create 100 million jobs in next 20 years (twice number of current jobs).number of current jobs).Large demand for infrastructure in the region: investment Large demand for infrastructure in the region: investment needs estimates over 2005-2010 US$28 billion (new needs estimates over 2005-2010 US$28 billion (new capital: US$15 billion; maintenance: US$13 billion)capital: US$15 billion; maintenance: US$13 billion)The need for good governance on the level of the macro The need for good governance on the level of the macro economy and the corporate sector.economy and the corporate sector.

MENA Potentials and ChallengesMENA Potentials and Challenges

Employment creation, through growth, at Employment creation, through growth, at core of development strategy.core of development strategy.

Region needs to develop export markets: Region needs to develop export markets: poor record of exports (beyond oil).poor record of exports (beyond oil).

Region needs to boots investments, Region needs to boots investments, through improved investment climate.through improved investment climate.

Region must improve infrastructure base.Region must improve infrastructure base.

Need for Enabling Legal, Regulatory Need for Enabling Legal, Regulatory and Governance Environmentand Governance Environment

In MENA the critical issue is NOT In MENA the critical issue is NOT availability of finance.availability of finance.(US$1.5 trillion of funds outside region)(US$1.5 trillion of funds outside region)Main issue is investment climate:Main issue is investment climate:Sound and effective legal/regulatory Sound and effective legal/regulatory environment and good corporate environment and good corporate governance environment that fosters governance environment that fosters investment and enforces contractual investment and enforces contractual obligations.obligations.

Development of Investment Development of Investment Environment in the MENA RegionEnvironment in the MENA Region

Ensuring stability in investment laws and Ensuring stability in investment laws and legislations, to stimulate investor’s confidence legislations, to stimulate investor’s confidence and trust.and trust.Unifying all investment-related institutions and Unifying all investment-related institutions and entities under one specific umbrella Fostering entities under one specific umbrella Fostering the judicial system and enhancing its the judicial system and enhancing its independence and authority.independence and authority.Development of staff in government bodies and Development of staff in government bodies and agencies, in a way leading to lower bureaucracy agencies, in a way leading to lower bureaucracy and administrative corruption.and administrative corruption.Undertaking further economic reformsUndertaking further economic reforms

Development of Investment Development of Investment Environment in the MENA RegionEnvironment in the MENA Region

Creating appropriate forward and backward Creating appropriate forward and backward investment links investment links

A greater role for the banking sector is needed A greater role for the banking sector is needed

Capital markets need to be further developed Capital markets need to be further developed

Inter-Arab economic exchanges and cooperation Inter-Arab economic exchanges and cooperation should be further enhanced. should be further enhanced.

Establishing sound and strong corporate Establishing sound and strong corporate governance rules, standards and practices in the governance rules, standards and practices in the banking sector banking sector

Specific, Important Ingredients of Effective Specific, Important Ingredients of Effective good Corporate Governance based- Investment good Corporate Governance based- Investment EnvironmentEnvironment

In the MENA region, there is a great need to In the MENA region, there is a great need to ensure healthy, sound and effective investment ensure healthy, sound and effective investment environment and good governance environment. environment and good governance environment. Formulation, implementation and monitoring of Formulation, implementation and monitoring of an effective national strategy for investment an effective national strategy for investment attraction.attraction.Foreign investment strategies need to Foreign investment strategies need to complement domestic investment strategies.complement domestic investment strategies.Linking foreign investment strategies to Linking foreign investment strategies to macroeconomic policies.macroeconomic policies.Enhancement of investment environment and Enhancement of investment environment and creating attractive investment opportunities.creating attractive investment opportunities.

Specific, Important Ingredients of Effective Specific, Important Ingredients of Effective good Corporate Governance based- Investment good Corporate Governance based- Investment EnvironmentEnvironment

Identification of the major motives behind investment Identification of the major motives behind investment attraction and promotion attraction and promotion Availability of a domestic investment map which identifies, Availability of a domestic investment map which identifies, clearly, investment projects,clearly, investment projects,Enhancement of human development, especially reforming Enhancement of human development, especially reforming the educational system.the educational system.Establishing an encouraging image for the host country in Establishing an encouraging image for the host country in the mind of investors, both local and foreign.the mind of investors, both local and foreign.Formulation and implementation of an effective and Formulation and implementation of an effective and attractive investment incentives basket Introduction of attractive investment incentives basket Introduction of sound corporate governance policies, practices and sound corporate governance policies, practices and standards.standards.

Facts about the Arab Banking Facts about the Arab Banking Sector in 2003Sector in 2003

Total Assets USD780 bn (GDP of Arab Total Assets USD780 bn (GDP of Arab economy’s is USD708bn).economy’s is USD708bn).

Total Deposits USD478bn.Total Deposits USD478bn.

Foreign Assets USD185bn.Foreign Assets USD185bn.

Shareholders’ Equity USD72bn.Shareholders’ Equity USD72bn.

Average liquidity ratio (over 60%).Average liquidity ratio (over 60%).

Average capital adequacy (over 20%).Average capital adequacy (over 20%).

Relevant Features of MENA Relevant Features of MENA BanksBanks

Large liquidity “Egypt, Kuwait, Lebanon, Large liquidity “Egypt, Kuwait, Lebanon, Libya, Morocco, Yemen… Yet:Libya, Morocco, Yemen… Yet:

Limited activities in term financing.Limited activities in term financing.

Needed in project finance (productive Needed in project finance (productive sector and infrastructure).sector and infrastructure).

Potential for maturity transformation Potential for maturity transformation (enhanced asset/liability management).(enhanced asset/liability management).

Role of MENA Banks in Meeting Growth Role of MENA Banks in Meeting Growth Challenges and Business FinancingChallenges and Business Financing

Provide more credit to private sector firms Provide more credit to private sector firms beyond energy and property sectors beyond energy and property sectors

Move from collateral-based to cash flow Move from collateral-based to cash flow based lending (especially for SMEs).based lending (especially for SMEs).

More syndications for project finance More syndications for project finance (productive sector and infrastructure).(productive sector and infrastructure).

Leading Role of Banks in Leading Role of Banks in Developing Credit MarketsDeveloping Credit Markets

MENA banks could join more in loan syndication MENA banks could join more in loan syndication to spread/diversify risk in large project finance to spread/diversify risk in large project finance with domestic, foreign and multilateral banks.with domestic, foreign and multilateral banks.

Banks must build partnerships with other Banks must build partnerships with other segments of financial industry: Bond markets segments of financial industry: Bond markets and institutional investors.and institutional investors.

Corporate debt securities part of diversified Corporate debt securities part of diversified portfolio of institutional investors.portfolio of institutional investors.

How Can Banks Exert Better How Can Banks Exert Better Governance on Corporations?Governance on Corporations?

Banks should seek to improve the Banks should seek to improve the behavior of their corporate clients, thus behavior of their corporate clients, thus improving their own corporate governance, improving their own corporate governance, and hence economic governance.and hence economic governance.

Banks should have experience in using Banks should have experience in using their expertise and knowledge to control their expertise and knowledge to control the behavior of corporations.the behavior of corporations.

How Can Banks Exert Better How Can Banks Exert Better Governance on Corporations?..Governance on Corporations?..Banks should play a role in improving the Banks should play a role in improving the efficiency of investment projects and their efficiency of investment projects and their implementation.implementation.

Banks must play a much greater role in Banks must play a much greater role in corporate control. This influence comes from the corporate control. This influence comes from the shares they own in corporations, and also from shares they own in corporations, and also from the external financing they supply corporations the external financing they supply corporations in the form of debt. Debt as a controlling device in the form of debt. Debt as a controlling device is an active force in corporate governance in is an active force in corporate governance in corporations.corporations.

How Can Banks Exert Better How Can Banks Exert Better Governance on Corporations?..Governance on Corporations?..

Banks should enforce sound corporate Banks should enforce sound corporate governance by securing projects to be funded. governance by securing projects to be funded. They should monitor performance and enforce They should monitor performance and enforce lending clauses. Before granting loans, they lending clauses. Before granting loans, they should:should:

1.1. Ask for project proposals, statements of Ask for project proposals, statements of financial conditions, and resumes of senior financial conditions, and resumes of senior management;management;

2.2. Examine the shareholding structure; andExamine the shareholding structure; and3.3. Review the borrower’s records to establish Review the borrower’s records to establish

accomplishment.accomplishment.

Role of UAB in Supporting Investment Role of UAB in Supporting Investment Environment and Good Governance in the Environment and Good Governance in the

MENA RegionMENA Region Call on governments to enhance and Call on governments to enhance and develop their investment environments.develop their investment environments.Call on the business community, both local Call on the business community, both local and foreign, to seek and pursue and foreign, to seek and pursue investment opportunities in the region.investment opportunities in the region.Introducing latest developments in modern Introducing latest developments in modern banking and finance banking and finance Identifying and promoting investment Identifying and promoting investment opportunities in the region.opportunities in the region.

Role of UAB in Supporting Investment Role of UAB in Supporting Investment Environment and Good Governance in the Environment and Good Governance in the MENA Region…MENA Region…

Introducing investment-related international Introducing investment-related international standards to the region’s banking sector, mainly standards to the region’s banking sector, mainly corporate governance.corporate governance.Working together with some governments to Working together with some governments to modernize investment and financial laws and modernize investment and financial laws and legislations.legislations.Establishing and modernization of an electronic Establishing and modernization of an electronic database for investment and financial laws for database for investment and financial laws for the region’s countries.the region’s countries.Introducing the region’s investment laws and Introducing the region’s investment laws and legislations to foreign investors.legislations to foreign investors.

Role of UAB in Supporting Investment Role of UAB in Supporting Investment Environment and Good Governance in the Environment and Good Governance in the MENA Region…MENA Region…

Encouraging financial institutions, mainly Encouraging financial institutions, mainly banks to finance (extending credit to) banks to finance (extending credit to) regional investment projects and even regional investment projects and even participate in these projects (equity participate in these projects (equity financing).financing).Soft landing international corporate Soft landing international corporate governance policies, strategies, standards governance policies, strategies, standards and practices to the Arab banking and and practices to the Arab banking and financial sector.financial sector.