Corporate Governance in Banking Sector: A Study on · the corporate mis-governance and unethical...
Transcript of Corporate Governance in Banking Sector: A Study on · the corporate mis-governance and unethical...
British Journal of Business Design & Education ISSN (Print): 2222-7426, ISSN (Online): 2222-8412
Vol 10 No 01, bjbde.org
Ahsan-Sultana-Islam
1. Assistant Professor, Shanto-Mariam University of Creative Technology, Uttara, Dhaka, Bangladesh 2. Lecturer, Southeast University, Dhaka, Bangladesh 3. Lecturer, Shanto-Mariam University of Creative Technology, Uttara, Dhaka, Bangladesh *Email: [email protected]
Keywords: Corporate governance, banking sector, corporate governance mechanism in banks.
1.0 Introduction
Bank and Financial Institutions are the
backbone of the economic sector of any
country. The healthy economic condition of a
nation is depicted through the sound
functioning of its banks. Banks form a crucial
link of a country’s economic sector hence
they are universally regulated industry and
their wellbeing is imperative for the
economy. Corporate Governance was
brought in limelight through series of
corporate failures such as Enron and World
Corn. These companies collapsed because of
the corporate mis-governance and unethical
practices they indulged in. Satyam scandal in
Bangladesh is also the case of corporate mis-
governance. Satyam case exposed the
complete lack of accountability in the
company and raised questions on corporate
governance practices of the country.
In a service industry like banking, corporate
governance relates to the manner in which the
business and affairs of individual banks are
directed and managed by their board of
directors and senior management. It also
provides the o through which the objectives
of the institutions are set, the strategy for
Corporate Governance in Banking Sector: A Study on
Bangladesh M M Ahsan Afroza Sultana Md. Zahirul Islam*
Abstract
Corporate governance is an age old concept which provides for a set of transparent
relationships between an institutions management, its board, shareholders and other
stakeholders. Corporate governance is gaining center stage in the recent times due to
failure of corporate and wide dissatisfaction among the people with the way corporate
works and hence became a widely discussed topic worldwide. Corporate Governance
is now recognized as a paradigm for improving competitiveness and enhancing
efficiency and thus improving investors’ confidence and accessing capital. Now
corporate governance has become a more dynamic concept and a not a mere static
one. The present paper is divided into different sections. In the first part it discusses
about corporate governance, its history in Bangladesh as well as world. Second part
talks about applicability of corporate governance as an internal mechanism in banking
sector. In third part it talks about the applicability of corporate governance in the
banking sector and the mechanism to be adopted for its dynamic usage and in the last
part about the various recent developments of corporate governance in banking sector.
Corp
ora
te B
ankin
g
British Journal of Business Design & Education ISSN (Print): 2222-7426, ISSN (Online): 2222-8412
Vol 10 No 01, bjbde.org
Ahsan-Sultana-Islam
attaining them is determined and the
performance of the institution is monitored.
Bank and Financial Institutions are the
backbone of the economic sector of any
country. The healthy economic condition of a
nation is depicted through the sound
functioning of its banks. Banks form a crucial
link of a country’s economic sector hence
they are universally regulated industry and
their wellbeing is imperative for the
economy. Working of banks is different from
other corporate in many important respects,
and that makes corporate governance of bank
not only different but also critical. Hence
corporate governance is conceptually
different for banks. If a corporate fails, the
fall outs can be restricted to the stakeholders,
but if a bank fails, the impact can spread
rapidly through other banks with potentially
serious consequences for the entire financial
system and the macro economy. Thus though
various guidelines are provided for working
of a bank, corporate governance cannot be
overlooked or discarded. Regulations,
guidelines and corporate governance are
complementary to each other in banking
industry.
Virtually every major industrialized country
as well as the Organization for Economic Co-
Operation and Development and the World
Bank has made efforts in recent years to
refine their views on how large industrial
corporations should be organized and
governed. Academics in both law and
economics have also been intensely focused
on corporate governance. Oddly enough, in
spite the general focus on this topic, very
little attention has been given to the corporate
governance of bank.
2.0 Objectives of the study
1. To clarify the concepts of corporate governance, its history in Bangladesh as well as world.
2. To find the applicability of corporate governance as an internal mechanism in banking
sector.
3. To indicate pertinence of corporate governance in the banking sector and the mechanism
to be adopted for its dynamic usage.
4. To focus about the various recent developments of corporate governance in banking sector.
3.0 Genesis of Corporate Governance
Before delving further in the concept of
Corporate Governance it is important to
understand the meaning of the word
Corporate and Governance. The word
Governance derived from Latin word
‘Gubernare’ meaning thereby to rule or steer.
Governance is a word with a pedigree that
dates back to Chaucer and in his day the word
carried with it the connotation wise and
responsible, which is appropriate. It means
either the action or the method of governing
and it is in that latter sense that it is used with
reference to companies. As per Webster
Dictionary ‘Corporate’ means a body having
the nature of, or involving or associated with
corporations. A ‘corporation’ in turn means
‘a legal entity that exists independently of the
person or persons who have been granted the
charter creating it and invested with many of
the rights given to individuals. The corporate
world comprises of institutions, like
companies, firms, proprietorship, etc.
Corporate governance is a philosophy by
which companies are directed, monitored,
managed and controlled. Corporate
Governance provides the fundamental
framework for the culture of an organization,
which ensures efficient functioning of
British Journal of Business Design & Education ISSN (Print): 2222-7426, ISSN (Online): 2222-8412
Vol 10 No 01, bjbde.org
Ahsan-Sultana-Islam
enterprises on sound ethical values and
principles. Broadly it is a system of
structuring, operating and controlling a
company with a view to achieve long-term
strategic goals to satisfy shareholders,
creditors, employers, customers and
complying with the legal and regulatory
requirements, apart from meeting
environmental and local community needs.
From the above discussion it can be seen that
it is difficult to define corporate governance
with only one definition. Hence there are
various definitions of corporate governance
as given by various experts from time and
again. Some of the important definitions to
understand the perspective to corporate
governance properly are enumerated here
below.
The 2014 Report of the Committee on the
Financial Aspects of Corporate Governance
(Cadbury Report) describes Corporate
Governance “as the structure by which
companies are directed and measured”.
Wolfensohn, President, World Bank, has said
that “Corporate Governance is about
promoting corporate fairness, transparency
and accountability”.
Even the Experts at Organization of
Economic Co-Operation and Development
(OECD) have defined “Corporate
Governance as the system by which business
corporations are directed and controlled”, it
means according to them it is a structure
which specifies the distribution of rights and
responsibilities among different participants
in the corporations.
But today the concept of corporate
governance has taken a new dimension and it
runs as follows. “Corporate Governance is
the application of the best management
practices, compliance of law in true letter
and spirit and adherence to ethical standards
for effective management and distribution of
wealth and discharge of social responsibility
for sustainable development of all
stakeholders”.
4.0 Corporate Governance as per Bangladeshi Scenario
In the Bangladeshi context, the need for
corporate governance has been highlighted
because of the frequently occurring scams
since 1991 due to emergence of the concept
of liberalization. The scams such as Hasan
Masud Scam, Ketan Parekh Scam, UTI
Scam, Vanishing Company Scam, Bhansali
Scam and so on. In order to reduce the
number the scams in the Bangladeshi
corporate world, there is a need to induct
global standards. From the beginning of
1980s, situation have changed in Bangladesh.
Wide range changes have taken place in both
the law and regulations in the field of
corporate law and the capital market. As a
result of several scams in Bangladesh a need
has arisen to bring reforms, in response to
that, reforms begun in Bangladesh in 1991.
The most important event in the field of
investor protection in Bangladesh was the
establishment of Securities and Exchange
Board of Bangladesh (SEBI) in 1992.
Corporate governance is a multi-faceted
subject.
There have been several major corporate
governance initiatives launched in
Bangladesh since the mid-1990s. The first
was by the Confederation of Bangladeshi
Industry (CBI), Bangladesh’s largest industry
and business association, which came up with
the first voluntary code of corporate
governance in 1998. The second was by the
SEBI, now enshrined as Clause 49 of the
listing agreement. The third was the Nahid
Hasan Committee, which submitted its report
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in 2002. The fourth was again given by
SEBI the Selim Ashraf Committee, which
also submitted its report in 2002. Based on
some of the recommendations of this
committee, SEBI revised Clause 49 of the
listing agreement in August 2003.
Subsequently, SEBI withdrew the revised
Clause 49 in December 2003, and currently,
the original Clause 49 is in force.
One of the important theme of corporate
governance deals with the issues of
accountability and fiduciary duty, essentially
advocating the implementation of policies
and mechanisms to ensure good behavior and
protect shareholders. Another key focus is the
economic efficiency view, through which the
corporate governance system should aim to
optimize economic results, with a strong
emphasis on shareholders welfare.
In Bangladesh the concept of Corporate
Governance is gaining importance because of
two reasons:
After liberalization, there has been
institutionalization of financial markets,
FIIs and FIs became dominant players in
the stock markets. The market began to
discriminate between wealth destroyers.
Corporate Governance is a critical by
product of market discipline.
Another factor is the increased role being
played by the private sector. Companies
are realizing that investors love to stay
with those corporate that create values for
their investors. This is only possible by
adopting fair, honest and transparent
corporate practices.
4.1 Bangladeshi Banking System at Glance
Banking system forms a strategic building
block of the economy. The challenge and
complexity of implementing corporate
governance can be well understood only if we
can appreciate the size of the banking system.
We need to appreciate that the Bangladeshi
banking system has made commendable
progress in extending its geographical spread
and functional reach.
As per the RBI report the number of
scheduled commercial banks functioning in
Bangladesh as on March 31st 2013 was 56.
There are almost 1000 banks offices spread
across the country, of which 36% are located
in rural areas, 26% in semi urban areas, 20%
in urban areas and the rest 19% in the
metropolitan areas. The major bank groups
(as defined by RBI) functioning during the
reference period of the report are State Bank
of Bangladesh and its associate banks,
Nationalized Banks and the IDBI ltd., Old
Private Sector Banks, New Private Sector
Banks and Foreign Banks.
The development of the banking system, a
key part of the financial system of any
country, is reflected in the level of credit to
the private sector as percent of GDP. Credit
allows firms to expand their production and
to improve their technology. It also allows
households to spread large expenses over
time such as for a house, vehicles or
education. The average value for the world
for that indicator is about 45 percent of GDP.
Values below 15 percent of GDP are
considered very low whereas values in excess
of 100 percent of GDP bring no additional
benefit to the economy. According to the
International Monetary Fund, the value of
that indicator for Bangladesh is 43.26
percent, rank 86 in the world.
In terms of access to banking services, we can
look at the number of ATMs per 100,000
people, an indicator in the IMF's database on
financial development. For Bangladesh, the
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IMF reports 9.24 ATMs per 100,000 people
which places Bangladesh at rank 124
globally.
Indicator Value Global rank Year
Bank credit to the private sector, percent of GDP 43.26 86 2014
ATMs per 100,000 people 9.24 124 2014
Source: THE GLOBAL ECONOMY.COM/BANGLADESH
5.0 Corporate Governance in Bangladesh
This section will first discuss the context in
which corporate governance must operate in
Bangladesh. Section 5.1 will describe the
historical, political, and social that culturally
informs the current corporate governance
environment. Section 5.2 will specifically
describe the business environment of
Bangladesh with respect to the ownership,
financing and debt of corporations in the
country. Section 5.3 will describe the existing
corporate governance enforcement regime in
Bangladesh from legal, regulatory and
accounting and auditing standards
perspectives. Final section provides a critique
on the corporate governance practices in
Bangladesh.
5.1 The Historical, Political and Social Background of Bangladesh
Bangladesh is a developing country in Asia.
It was liberated in 1971 after fighting a long
war. Soon after the independence the then
government adopted socialism as the
economic and political framework to ensure
the so called ‘economic justice’ or
‘distributive justice’. Socialism was
constitutionally accepted as one of the four
fundamental principles of the state.
Government of Bangladesh in an order (the
Government of Bangladesh Nationalization
Order, 1972) nationalized all large and
medium sized industries including the
banking and insurance sectors. Application
of the Companies Act 1913 was suspended.
Through nationalization, the government
gained control over 92% of the total
industrial assets in the country (Islam, 1999;
Uddin and Hopper, 2003). These industries
were most commonly known as the State
Owned Enterprises (SOEs) or „Public Sector
Enterprises‟. By 1974, there were 350 such
enterprises on which the government
exercised control. Consequently the activities
of the Dhaka Stock Exchange, the symbol of
capitalism, were suspended. The government
preserved the right to nationalize any private
enterprise whenever felt necessary (Ahamed
1978; Banglapedia 2016). As a result, there
was no provision for growing the private
sector enterprises. The economy was similar
to that of a socialist country. Bangladesh
became one of the poorest countries and its
economy one of the slowest growing
economies in the world.
Socialism and the nationalization policy of
the then government in Bangladesh failed.
State Owned Enterprises (SOEs) suffered
from huge accumulated losses because of
corruption, mismanagement and a lack of
effective monitoring. The World Bank (2015,
p 89) stated that the biggest public failure in
Bangladesh was due to the SOE sectors in
Bangladesh. The socialist experience only
lasted until the change of regime on 7th
November 1975. Socialism was then omitted
from the constitution and the market
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economy policy was adopted as an economic
phenomenon. The new regime took steps to
rehabilitate the private sector and facilitate
industrialization, such as a revision of
investment policy, and a reduction of charges
on industrial loans by the Development
Financing Institution (DFI) to help the
private sector entrepreneurs on a priority
basis. Export oriented industries and
agricultural production were encouraged as a
new development strategy (Ahamed, 1978).
These strategies encouraged both the
domestic and foreign private entrepreneurs.
The denationalization of the public sector
enterprises and adoption of the market
economy by that government brought in the
new era of industrialization. The activity of
Dhaka Stock Exchange (DSE) resumed in
1976 only with nine (9) listed companies
(SECB, 2015-16). The new regime
denationalized a number the state-owned
enterprises; which were nationalized
immediately after the independence. It
continued until in recent years and within the
period of 1976-1992 about
500 state owned enterprises (SOEs) were
denationalized (Privatization Commission,
2007).
5.2 The Business Environment of Bangladesh
Since the inception of privatization in 1976,
many of the corporate bodies, including
major portions of the banking and jute
sectors, paper and textile mills,
telecommunications, railways and airlines
industries were either reserved for the
government sector or could not be
denationalized due to various difficulties, and
so they continued to remain under
government control. These enterprises
presented a very painful experience to the
nation. For example, The Adamjee Jute Mills
Corporations Ltd., the largest jute mill in the
world collapsed in 2002 costing the jobs of
17,000 workers, because of a failure of
corporate governance in terms of
mismanagement and corruption. In the last 30
years that enterprise had an accumulated loss
of Taka 11,080 million, approximately
equivalent to 221.6 million Australian dollars
(Star, 2014). Soon after the adoption of
market economy and the „rehabilitation‟ of
the private sector, it experienced a huge
growth. For example the industrial GDP
increased from 7.19% in 1974 to 10.88% in
1980 (Alauddin, 2014). It increased to 27.8%
in 2004 (Bangladesh Bank, 2003-04).
Figure-1
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Although the performances of the State
Owned Enterprises (SOE) were very poor
even before the growth of private sector, the
SOE‟s could not survive the competition
from the huge growth in private sector
enterprises over this period. Consequently
the focus of corporate governance has shifted
from the public sector to the private sector.
This was also encouraged by other
environmental factors such as the stock
market collapse in 1996 at Dhaka and
Chittagong Stock Exchanges, along with
inefficiencies and underperformance causing
collapses of some privatized jute and textile
mills (Bhaskar and Khan, 1995; Uddin and
Hopper, 2013). These failures highlighted
greatly the importance of good corporate
governance in the private sector in
Bangladesh.
Figure-2
The spread of share ownership in public
limited companies in Bangladesh is not wide,
and the economic power of the businesses is
concentrated in dominant shareholder
groups. A few shareholders account for a
significant portion of total share value and
most companies are managed and owned
primarily by founding family members,
holding company (or cross shareholding) or
institutional investors leading to very high
degrees of concentration of ownership
control. Apart from the controlling
ownership by foreign investors, government
and institutions, the joint stock companies in
Bangladesh are mainly controlled by
founding family members.
Figure-3
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Due to underdeveloped, poor and less liquid
stock market operations, there is a lack of
effective corporate governance practice, poor
legal enforcement and an excessive reliance
on bank financing. Consequently, the control
of the companies remains in the hands of
sponsors, directors, and founding family
members leading to a concentrated
shareholding and control. Most of these
concentrated owners hold a position in the
company management and board, leading to
poor monitoring of corporate governance
practices. Haque et al (2016) documented
that the boards of the Bangladeshi firms are
mostly family dominated and executive
management is family aligned. This is typical
of circumstances found in the countries
affected by the Asian Crisis as ADB (2015, p
2) documented that,
“……weaknesses in corporate governance in
these countries appear to owe much too
highly concentrated ownership ……. under-
developed capital markets, and the weak
legal and regulatory framework for investor
protection”
5.3 The Existing Corporate Governance Regime in Bangladesh
LLSV3 (2015) suggest that like many
developing countries the enforcement of law
in Bangladesh is either very poor or difficult
to enforce. The degree of compliance with
existing financial regulation is historically
very low in Bangladesh (Ahmed and
Nichollas 2014). An independent survey in
late 2016 with the help of Securities and
Exchange Commission, Bangladesh revealed
that about 55 percent of companies do not
comply with the good practice guidelines and
only about of 33 percent companies
appointed the independent directors (Jai Jai
Din, 2016). Such poor law enforcement is
exemplified by occurrences of the 1996
Bangladesh stock market collapse, in which a
syndicate of company directors and brokers
had proceedings brought against them by the
Securities and Exchange Commission of
Bangladesh. Subsequently there is no
evidence of punishment to these company
directors and the brokers of the syndicate,
because the proceedings were abandoned due
to poor enforcement of the law. This example
suggests that the investor’s protection is very
low in Bangladesh, and so poor corporate
governance is of increased concern
.
Figure-4
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The first instance of corporate governance
disclosure in Bangladesh is Padma Textile, a
subsidiary of the BEXIMCO group of
companies, who published two pages in their
annual report on corporate governance,
stating “recognizing the importance of it, the
board and other senior management remained
committed to high standards of corporate
governance”. Thereafter the report contains a
series of statements about “internal financial
control”, “management structure of the
company”, “financial reporting”, etc. (cited
in Haque, 2012). However companies in
Bangladesh are not required to report
information on corporate governance in their
financial reports (OECD, 2013). The
corporate governance practices were only
made mandatory for the first time in
Bangladesh following the SECB
announcement of “Corporate Governance
Notification” in 2016.
Section 5.3.1 to follow will describe the
existing corporate governance enforcement
regime from a legal perspective. Section
5.3.2 will describe the regulatory regime,
while section 5.3.3 will give an overview of
prevailing accounting and auditing
contributions to the corporate governance
environment in Bangladesh. Section 5.3.4
will describe the capital markets in
Bangladesh.
5.3.1 Corporate Legal Environment in Bangladesh
The corporate legal framework in Bangladesh
consists of certain Acts and
Ordinances, numerous subordinate
legislative instruments such as orders,
notifications, rules, regulations and circulars,
which are issued by the Government, the
Bangladesh Bank, the Securities and
Exchange Commission (SECB), the National
Board of Revenue (NBR) and other
governmental agencies. Moreover the stock
exchanges, chambers of commerce and other
self-regulatory agencies in the private sector
also form a part of the legal and regulatory
framework for corporate governance in
Bangladesh.
On 1st January 1995, the new Companies Act
of 1994 came into effect. Among several
types of legislation, the „Companies Act
1994‟ is the main governing law for the
companies in Bangladesh. This law was put
in effect to provide more accountability and
openness in managing the companies,
leading to greater confidence in the corporate
environments. However, that Act does not
say anything regarding the ultimate share
ownership, director’s qualifications, age,
composition of the board and the leadership
structures in the board and management,
particularly the role of chairperson5 and
CEO, director’s responsibility etc. Rather,
the law is very much related to the formation,
management and liquidation of companies.
The capital markets in Bangladesh are
regulated by several types of legislation,
including the Trust Act 1882, Capital Issues
(Continuance of Control) Act 1947,
Securities and Exchange Ordinance 1969,
Securities and Exchange Rules 1987,
Securities and Exchange Commission Act
1993, Securities and Exchange Commission
(Amendment) Act 1993, Securities and
Exchange Commission (Brokers, Stock-
Dealers, Stock-Brokers and Authorized
Representative) Regulation 1994, Securities
and Exchange Commission (Merchant
Bankers and Portfolio Managers) Regulation
1994, Securities and Exchange Commission
(Mutual Funds) Regulation 1994, Prohibition
of Insider Trading Regulation 1995, Initial
Public Offering (IPO) Rules 1998, The
Depository Act 1999 and Margin Rules 1999.
Moreover, there are some specific rules and
regulations which are issued by SECB from
time to time for controlling the operation of
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stock exchanges, companies and share
markets.
5.3.2 Regulatory Control of the Securities and Exchange Commission of Bangladesh
The Securities and Exchange Commission,
Bangladesh (SECB) was established on 8th
June 1993 under the Securities and Exchange
Commission Act, 1993. The SECB holds
very wide-ranging powers and regulates the
activities of the capital market in Bangladesh
including licensing and regulation of capital
market participants and intermediaries such
as stock exchanges, brokers and dealers,
merchant banks and portfolio managers.
Much of the powers of the SECB are aimed
at proper disclosure to investors, which is at
the heart of good corporate governance. It
provides policy direction to the industry and
administers the securities legislation and acts
as an administrative tribunal for decisions on
the capital markets (SECB, 2014-15). Listed
companies are required to submit the copy of
their Annual Report and the proceedings of
their annual general meeting to the SECB.
Besides regulating the capital markets, the
SECB has the other objectives of promoting
investors‟ awareness including investment
guidelines and the correct format for lodging
a complaint, caution notices regarding the
circulation of fake shares, an investors’
education program and the provision of
training for intermediaries of the securities
market
(SECB, 2015).
5.3.3 Financial Reporting, Accounting and Auditing Standards
Two professional accounting bodies, the
Institute of Chartered Accountants of
Bangladesh (ICAB) and the Institute of Cost
and Management Accountants of Bangladesh
(ICMAB) regulate the accounting profession
in Bangladesh. ICAB is the national
professional accounting body of Bangladesh
established under the Bangladesh Chartered
Accountants Order (Presidential Order
Number 2 of 1973). The Institute of Cost and
Management Accountants of Bangladesh
(ICMAB) was established in 1977 under the
„Cost and Management Accounting
Ordinance‟ mainly to regulate the Cost and
Management Accounting profession in
Bangladesh. Both the accounting bodies are
fostering the acceptance and observance of
International Accounting Standards (IAS)
and International Financial Reporting
Standards (IFRS) and their adoption as
Bangladesh Accounting Standards (BASs).
The Companies Act 1994 allows the
members of both ICAB and ICMAB to audit
companies to ensure that their accounts
conform to all Bangladesh Accounting
Standards.
To ensure the transparency, accountability
and good governance in the corporate sector
effective from February 2000, the Securities
and Exchange Commission Bangladesh by a
notification on 29th December 1997 required
all listed companies to abide by „Accounting
Standards‟ adopted by ICAB and ICMAB as
Bangladesh Accounting Standards (BASs).
Thus these accounting standards are
mandatory for all companies listed in Dhaka
and Chittagong Stock Exchanges
.
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5.3.4 Capital Markets in Bangladesh
The Bangladeshi capital market is one of the
smallest in Asia, and has a lot of problems
including a non-developed securities market,
investor non-awareness, a lack of research,
non-professionalism of the brokerage
business and market intermediaries, and a
tendency towards unethical gains by insider
trading and a lack of transparency
(Chowdhury, 2014 and SECB, 2015-16).
By the end of June, 2006 there were 303
securities of 256 companies listed on the DSE
with a market capitalization of Taka 225.30
billion (SECB, 2016). The All Share Price
Index‟ at Dhaka Stock Exchange was
introduced on 16th September 1986. The
Dhaka Stock Exchange is a self-regulated
non-profit organization. Its activities are
regulated by its „Articles of Association‟ and
„rules and regulations‟ and „by-laws‟ along
with the Securities and Exchange Ordinance,
1969, Companies Act 1994 and Securities
and Exchange Commission Act, 1993. The
Chittagong Stock Exchange (CSE) was
established as a Public Limited Company in
April 1995. Similar to Dhaka Stock
Exchange, the activities of Chittagong Stock
Exchange are regulated by its „Articles of
Association‟ and „rules and regulations and
by-laws‟ along with the Securities and
Exchange Ordinance, 1969, Companies Act
1994 and Securities and Exchange
Commission Act, 1993. By the end of June
2006 there were 213 securities of 196
companies listed with CSE with a market
capitalization of Taka 196.34 billion (SECB,
2015).
6.0 Need for Corporate Governance in Banking System
Banks are critical components of the
economy while providing finance for
commercial enterprises, basic financial
services to a broad segment of the population
and access to payment systems. Banks in
Bangladesh are facing increasing
competition, within and outside Bangladesh,
both in terms of markets for its products and
for sources of fund.
The importance of banks to national
economies is underscored by the fact that
banking is, almost universally, a regulated
industry and that banks have access to
government safety nets. In order to meet the
statutory need of having sound Capital
Adequacy requirements, banks are accessing
the Capital Market at regular intervals. Hence
the banks need to stimulate the interest of
investors at all times. Investors believe that a
bank with good governance will provide
them a safe place for investment and also give
netter returns. Good corporate governance is
therefore an important factor in a competitive
environment. Investors, customers,
employees and vendors have all become
more discerning and are demanding greater
transparency and fairness in all dealings. To
attract and retain the commitment of
investors, customers, employees, Banks
should ensure that they match the global
benchmark in Corporate Governance
Practices.
Banks are also important catalysts for
economic reforms, including corporate
governance practices. Because of the
systemic function of banks, the incorporation
of corporate governance practices in the
assessment of credit risks pertaining to
lending process will encourage the corporate
sector in turn to improve their internal
corporate governance practices, importance
of implementing modern corporate
governance standards is conditioned by the
global tendency to consolidation in the
banking sector and a need in further
capitalization. It is of crucial importance
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Ahsan-Sultana-Islam
therefore that have strong corporate
governance practices.
Banks, just like any other organization are
incorporated entities. As a result of which,
the primary requirements of corporate
governance apply to them as any other
incorporated entity. Added to this certain
features that are very specific to banks, ads
on to the importance of Corporate
Governance issues in banks.
Among other features, the most important
one is the fact that banks form an integral part
of the economy of the country, and any
failure in a bank might have a direct bearing
on the financial health of the country. Banks,
help in channelizing the people’s saving.
The capital structure of bank is unique in two
ways. First, banks tend to have very little
equity relative to other firms. Second, banks’
liabilities are largely in the form of deposits,
which are available to creditors/depositors on
demand, while their assets often take the
form of loans that have longer maturities.
Thus, the principle attribute that makes banks
as financial intermediaries “special” is their
liquidity production function. By holding
illiquid assets and issuing liquid liabilities,
banks create liquidity for the economy. The
liquidity production function may cause a
collective-action problem among depositors
because banks keep only a fraction of
deposits on reserve at any one time.
Depositors cannot obtain repayment of their
deposits simultaneously because the bank
will not have sufficient funds on hand to
satisfy depositors at once. This mismatch
between deposits and liabilities becomes a
problem in the unusual situation of a bank
run.
The second important driver of a good
corporate governance stems from their
funding patterns. Banks, by their basic
definition are highly leveraged financial
institutions, with the equity capital of the
shareholders being reduced to a miniscule
proportion of loan capital in the form of
borrowing and deposits of deposits from
customers of the bank. As a result of this, the
stakeholders in banks, (mainly the depositors
and lenders) have a rightful claim of
accountability from the banks and their
boards.
The third important element in the Corporate
Governance structure relates to the control
function. It is imperative to discuss the same
in brief. Control functions in banks deal with
internal frauds as well as external frauds. The
former relates to situations where the banks
own personnel indulge in corrupt and
unethical practices. The latter deals with
situations where the customers of the bank try
to seek for malpractices. The incidents of the
external frauds are so devastating that special
attention is being mandated both for their
prevention as well as their post scenario
analysis. In this connection it is important to
remind of the COSO framework that was
framed with this intention in mind.
Finally, failing to comply with stipulated
norms can be one of the challenging issues of
Corporate Governance framework. With
Banks being under intense watch of the
central bank as well as other regulatory
bodies, it is a common observation, that most
failures (crashes) in banks have occurred due
to compliance failure situations. With a lot of
reports and norms, being introduced (The
Basel II norms being the latest of them),
failure to adhere to the regulatory norms have
never reduced
.6.1 BASEL II Recommendation
The Basel Committee on Banking
Supervision is a committee, of banking
supervisory authorities, established by the
Central Bank Governors of the G10
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Ahsan-Sultana-Islam
developed countries in 1975. The Committee
in 1988 introduced the Concept of Capital
Adequacy framework, known as Basel
Capital Accord, with a minimum capital
adequacy of 8 percent. It also issued a
consultative document titled “The New Basel
Capital Accord” in April 2003, to replace the
1988 Accord, which re-enforces the need for
capital adequacy requirements under the
current conventions. This accord is
commonly known as Basel II and is currently
under finalization. Basel II is based on three
pillars:
Pillar 1 – Minimum Capital Requirements
Pillar 2 – Supervisory Review Process
Pillar 3 – Market Discipline
6.2 Enhancing Corporate Governance in Banks The Basel committee had issued, in August
1999, a guidance paper entitled “Enhancing
Corporate Governance for Banking
Organizations” to supervisory authorities
worldwide to assist them in promoting the
adoption of sound corporate governance
practices by banks in their countries.
6.3 Importance of Corporate Governance for Banks From a banking industry perspective,
corporate governance involves the manner in
which their boards of directors and senior
management govern the business and affairs
of individual banks, affecting how banks set
their corporate objectives, run day-to-day
operations, consider the interests of various
stakeholders, align corporate activities with
the expectation that banks will operate in a
safe and sound manner and in compliance
with applicable laws and regulations and
protect the interests of depositors.
6.4 Sound Corporate Governance Practices for Banks According to the paper some of the best
corporate governance practices for banks
include establishing strategic objectives and
a set of corporate values communicated
throughout the organization, strong risk
management functions, special monitoring of
risk exposures, setting and enforcing clear
lines of responsibility, etc.
6.5 Role of RBI in Promoting Corporate Governance
The growing competitiveness and
interdependence between banks and financial
institutions in local and foreign markets have
increased the importance of corporate
governance and its application in the banking
sector. Corporate governance in banks can be
achieved through a set legal, accounting,
financial and economic rules and regulations.
To make sure that the competence and
integrity in banking sector is maintained, the
need for uniform standards of the concept of
governance in private and public sector is
emphasized. The regulatory framework
implemented by the central bank can affect
the overall wellbeing of banking sector.
6.6 Best Practices of Banking System in Corporate Governance
Good governance can be built based on the
business practices adopted by the board of
directors and management. Many bank
failures in the past have been attributed to
inadequate and insufficient management
which enabled the banks to accept low
quality assets and assume additional risks
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Ahsan-Sultana-Islam
that extend beyond the level appropriate for
the banks’ capacity.
Important commandments for ensuring
corporate governance in banks are:
Banks shall realize that the times are changing
Banks shall establish an Effective, Capable and Reliable Board of Directors
Banks shall establish a Corporate Code of Ethics for themselves
Banks shall consider establishing an office of the Chairman of the Board
Banks shall have an effective and Operating Audit Committee, Compensation Committee and
Nominating/ Corporate Governance Committee
Banks shall consider Effective Board Compensation
Banks shall disclose the information
Banks shall recognize that duty is to establish Corporate Governance Procedures that will serve
to enhance shareholder value
6.7 Recent Scenario Recent steps taken by Banks in Bangladesh for Corporate Governance are:
Introduction of non-executive members on the Board
Constitution of various Committees like Management Committee, Audit Committee,
Investor’s Grievances Committee, ALM Committee etc.
Gradual implementation of prudential norms as prescribed by RBI
Introduction of Citizens Charter in Banks
Implementation of “Know Your customer” (KYC) concept.
7.0 Conclusion
Banks and financial sector being a highly
service oriented sector, making corporate
governance effective is a great challenge.
More so, when the driving force of
commercial banks is to grab the opportunity,
trading profits with only focus on
profitability. The levers of systemic control
have to be not only progressively tightened
but they are also to be scrutinized from the
point of deliverables. Moreover the recent
global financial crisis leading to the demise
of several reputed global investment banks
exposes the fissure in the effectiveness of
corporate governance model.
Banking sector is the key for monetary
conditions in a country. Due to the special
nature of the activities carried on by the
banks, they face a lot of problems as far as the
area of corporate governance is concerned. In
the Bangladeshi scenario, due to the peculiar
nature of bank holdings there are a lot of
embedded conflicts. The guidance paper
issued by the Basel Committee is of
paramount significance in enforcing
corporate governance standards in various
countries across the world.
Corporate Governance is now identified and
acknowledged as a powerful tool to generate
trust and confidence in an institution. The
trend in the world of targeting governance
practices in the banking sector to be at the
cutting edge of prevailing practices
worldwide is a significant step in the right
direction and should continue to be so in the
future as well.
Bangladesh has one of the best Corporate
Governance legal regimes but poor
implementation. SEBI has carved out a
certain more stringent provisions relating to
listed companies as a condition of the Listing
Agreement.
The special nature of banking institutions
necessitates a broad view of corporate
governance where regulation of banking
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Ahsan-Sultana-Islam
activities is required to protect depositors. In
developed economies, protection of
depositors in a deregulated environment is
typically provided by a system of prudential
regulation, but in developing economies such
protection is undermined by the lack of well-
trained supervisors, inadequate disclosure
requirements, the cost of raising bank capital
and the presence of distributional cartels. Due
to special nature of the activities carried on
by the banks, they face a lot of problems as
far as the area of corporate governance is
concerned. Also, in the Bangladeshi scenario,
due to the peculiar nature of bank holdings
there are a lot of embedded conflicts. There
exists a doubt as to what standard should be
applied while enforcing corporate
governance in banks. Central banks play an
important role in this regard. As far as best
corporate governance practices for banks are
concerned, they may include realization that
the times are changing, establishing an
effective, capable and reliable board of
directors, establishing a corporate code of
ethics by the banks for themselves,
considering establishing an office of the
chairman of the board, having an effective
and operating audit committee, compensation
committee and nominating/ corporate
governance committee in place, considering
effective board compensation, disclosing the
information and recognizing their duty to
establish corporate governance procedures
that will serve to enhance shareholder value.
Finally this study concluded that, the
corporate governance practices in the
banking and financial sector in Bangladesh
should improve for best investment policies,
appropriate internal control systems, better
credit risk management, better customer
service and adequate automation in order to
achieve excellence, transparency and
maximization of stakeholder’ value and
wealth.
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