Towards Corporate Governance

Basic Ideas

Governance in common parlance refers to the way some administrative system or institution is run. So corporate governance is the term referring to the governance in the context of institutions of corporate structure where the ownership and management are on the hands of different people. When organizations were small firms run by the owners, the governance was not the big issue. But when organizations got bigger, businesses expanded in terms of geographical coverage, customer base, product lines etc, management got more complex and the need of entrusting managerial functions to professionals evolved. This way management emerged as a separate part of functions with professional managers representing a different kind of stake in the organization. The uneasiness in maintaining a trust and faith in this newly developed agency structure was the one that first sowed the roots of corporate governance.

In a professionally run corporate institution where the owners and management are separate, there exists a gap in the role, concerns and accordingly, the way of thinking among the stakeholder like owners, management. Still different is the perspective of customers and in the case of banks, depositors. All cannot have equal access to the information regarding the resources, decision or the financial performance of the organization. Similarly, all may not have the capacity to read, analyze and examine the information in the pursuit if their concerns. Out of the lack of transparency and control mechanism, there may be the chances that people run on their vested interest and give way to moral hazard problems. The present idea and the conceptual framework of corporate governance are aimed to capture these issues.

It is a universally admitted that better transparency contributes to enhancing trust and an impression of fairness in activities. The business of banks is much sensitive in that they are to act as the custodian of the money of the public and any kind of failure in keeping the faith of depositors upright can be devastating. Incidences of bank runs and bank panics have been noted as the episodes of real panic and hardships in the history. This is one among the reasons why banks and FIs are held under much stringent frameworks of rules and regulations by the state.

Right from the practice that corporate management is entrusted on the hands of professional managers (as independent from the owners), the agency conflict evolved. From the part of owners, managers are to be held abreast with the interest of the owners that naturally revolves around earning a fair and competitive return on the investment. The golden rule of capitalism maintains that control should be where the ownership rests. So owners remain always anxious that professional managers albeit entrusted with the managerial functions, remain within their control so that they do not fool them and happen to squander resources in suboptimal ventures. On the side of the managers, managers are to be granted some reasonable degree of autonomy to exercise their managerial exercise. They prefer to stay free of interventions from the owners in the day to day operations and management. The concept of corporate governance assumes its foundations from the search around for a resolution to this inborn conflict in a corporate management system.

Corporate Governance in Banking Business

Coming down to the context of banking business, following can be enumerated as the key points regarding the high emphasis on corporate governance in the banking sector.

1. Stability in the banking system is important for attaining a sustained economic growth.
2. Good corporate governance is required in banks to achieve good corporate governance in other firms.
3. Banks have wider range of stakeholders-government, regulators and most importantly depositors.
4. Well functioning banking system promotes market confidence, helps to attract additional capital, and fosters market discipline.
5. Corporate governance helps to dispel an impression of profiteering and maintain that the company takes into account the interest of not only of a group of people but also of the communities within which they operate.
6. Good corporate governance practices in banks contribute to financial market development and financial stability.

The Nepalese Context

Nepal has implemented the Basel Accord known as Basel II from 2008 July in the banking sector where good corporate governance forms an important dimension of the accord. So complying with the corporate governance provisions set forth in Basel II has become essential as well as mandatory for the banks and FIs. The framework of acts, rules, regulations and central bank directives pertaining to corporate governance are therefore the basic premise of the of corporate discipline which are put up with high importance.

Every welfare state has to work to develop and maintain conducive environment for economic activities to boost up. A robust and efficient financial system with coverage to all corners of the country constitutes a ground-work for economic development. Nepal Government and Nepal Rastra Bank (NRB) as the Central Bank are working to build up a transparent, competitive and strong financial sector. Strong regulatory mechanism encompassing the interests of all corporate stakeholders and ultimately the people is the ultimate foundation for this. The corporate governance of banks and financial institutions in Nepal is ensured with the following three regulatory instruments.

1. Banks and Financial Institutions Act 2073: This is the most fundamental act governing the functioning of the banks and financial institutions in Nepal.
2. Unified Directives of NRB (Especially the Directive No 6): Unified directives are updated every year consolidating the all circulars issued by the NRB throughout the fiscal year. The corporate governance related directions are incorporated in the Directive No 6.
3. Companies Act 2063: Company Act 2063 represents the fundamental legal document supposed to guide the running of companies in Nepal. Various provisions pertaining to the governance include the ones in Section 50, 70, 92, 93, 105, 101, 109.

The concept of corporate governance is manifested in the form of various concerns relating to the smooth and professional functioning of the organization. In this regard, the issues emphasized by the regulatory framework of Nepalese banking system can be discussed as follows:

1. Conflict of Interest
   The issue of conflict of interest is one of the key issues addressed in the acts, rules and regulations. There are several provisions aimed at preventing the conflict of interest of the board of directors with the bank or financial institution. Some of them can be elaborated as follows:
   
   
   • Banks and Financial Institutions Act 2073 (BAFIA 2073) in its section No 50 has prohibited various activities in order to prevent the conflict of interest and keep transparency in the operations. This section restricts granting loans to the promoters, directors, or executive officers holding more than 1% of the shares of the bank or ones the persons having a financial interest in the company. Similarly, lending on the backing of guarantees of such persons is also prohibited.
   • In the section no 11 of the act, the promoters in the company, promoters are not allowed to sell or get loans against the shares of the company for a period of 5 years. Even after five years barred period, permission is to be taken from NRB.
   • The section no 22 of the act explicitly requires the Board of Directors to keep assurance that they work to preserve the overall interest of the depositors, customers and shareholders and not intervene in the day to day businesses like taking deposits, providing loans, managing the staff and spending from the budget of the bank.
   • The subsections under Section 23 of the act clearly prohibits a director from deriving any kind of personal benefit from the course of day to day activities of the bank. If anything is got done crossing the jurisdiction, he/she is to remain personally liable. He/she should not intervene in the day to day activities of the bank management.
   • Section No 24 has a provision that requires a director to disclose if he/she or family members have any kind of financial interest with the bank or in the appointment of the company secretary, Chief Executive Officer or Auditor of the bank. Similarly, with the provision in section no 25, a director is abstained to participate in the discussion pertaining to any matter that has any kind of interest to him/her.
   
   Companies Act 2063 has some provisions pertaining to Conflict of Interest and Transparency. Section 50 of the Act requires that the substantial shareholder of a public company has to furnish the information of being so. Section 70 maintains that the shareholders having conflict are not qualified to vote in general meetings. Section 92 requires a director to give information about transaction between company and him/her or close relatives. According to Section 93, if a director or close relatives have to enter into any transaction with the company, approval of general meeting is required. As per the Section 101, a company is restricted provide loans to directors and officers.
   
   
2. Competent Key Personnel
   The next issue traced to have emphasis in the legislative framework is the provision of ensuring the involvement of competent people in the key positions of the bank. The provisions can be stated as follows:
   
   
   1. Provisions relating to the qualifications for directors and chief executive officers specified in the section 16 and 29 ensure reasonable level of relevant knowledge, work exposure and a professional standing for the persons to be in the posts.
   2. In addition, section No 17 of the act has mandated a requirement to appoint professional director who would have ensure a presence of a person of appropriate education and professional exposure required for the banking institution.
   
   
   NRB Unified Directive No 6 has set for the Code of Conduct for Directors of the banks and financial institutions. The major provisions in the directive include the clauses that prohibit the directors from interference in day-to-day operation of the financial institution. If there is some conflict of interest, the concerned director has to inform the board before assuming office. Similarly, directors should not involve in any activity which is against the interest of the company (conflict of interest). Directors of one deposit taking institution cannot act as director of other FI. Director cannot act as custodian or trustee of any of the customer.
   

Challenges

Tracing the Nepalese scenario, though legal framework looks sound the impression of corporate governance is not comfortable. As other sectors banking industry is also affected by the culture of influence and intervention backed by familial or political status. Political influence appears more in the context of government owned banks. Political instability and prolonged political transition has built the culture of political intervention instead of running by a system of rules. While the governance weaknesses, challenges of improvement and the thrust for cleaning up the system recognized during the phase of Financial Sector Reform initiatives appear losing the emphasis, risks in the banking sector have intensified with the emergence of technology, financial innovation and greater links to the global financial system with the growth of international transactions. The quest of the bank investors to earn high profits in short time has also created aggression and unhealthy measures in business. This all has made the business of banks much demanding of sound corporate governance so that the system runs intact and goes hand in hand in the grand move of nation building and development.

Final Remarks

In conclusion corporate Governance is crucial for each and every organization. Corporate governance is the fairest strategic direction of a company. Monitoring of management by the board and the board’s accountability to the company shareholders represent the authority mechanism for control. The ultimate responsibility of enacting and maintaining good governance lies with the professionally driven senior management. As a conclusive message to state it may be asserted that ethical intellect and self regulation is always superior to any threat of regulatory impositions.