Unit 4 Flashcards
Corporate governance (as defined by FRC)
The system by which companies are directed and controlled. Purpose is to facilitate effective, entrepreneurial and prudent management that can deliver the long term success of the company
Conflicting requirements between
A bank is often required to consider the often conflicting requirements of its customers, borrowers, depositors, investors, employees, shareholders, regulators, public.
Ultimately increase value of bank for the shareholders
Structure of banks corp governance depends on
Legal
Business custom
Historical development
Good corporate governance means Board should:
- Set strategic direction
- Advise on recruitment, review performance of senior management, set senior management compensation
- Monitor performance
- Be qualified personally and professionally
- Meet regularly with senior mgt and IA to establish and approve policies
- Review reporting lines, authority, responsibilities of senior management
Outside directors should
Be independent of internal and external influences and provide sound advice without participating in the daily management of the bank
Techniques to ensure adequate checks and balances are:
• oversight by the Board
• oversight by individuals not involved in day to day running of the business areas
• direct line supervision of different business areas
• independent RM and audit functions
• key personnel who are fit and proper
• regular reporting
Cadbury code
Comply or explain with provisions, report on how applied main principles of:
Leadership
Effectiveness (balance of skills, experience, independence, knowledge to allow discharge of duties effectively)
Accountability (board responsible for determining nature and extent of risks willing to take to achieve objectives)
Remuneration (sufficient to attract, retain and motivate but avoid paying more than necessary)
Relations with shareholders ( dialogue based on mutual understanding)
BIS 13 corporate governance principles for banks
Principle 1: Board’s overall responsibilities
Principle 2: Board qualifications and composition
Principle 3: Board’s own structure and practices
Principle 4: Senior management
Principle 5: Governance of group structures
Principle 6: Risk management function
Principle 7: Risk identification, monitoring and controlling
Principle 8: Risk communication
Principle 9: Compliance
Principle 10: Internal audit
Principle 11: Compensation
Principle 12: Disclosure and transparency.
Principle 13: The role of supervisors
EIOPA- guidelines on systems of governance and RM (insurance)
Section 1: General governance requirements
Section 2: Remuneration
Section 3: Fit and proper
Section 4: Risk management
Section 5: The prudent person principle and the system of governance
Section 6: Own fund requirements and the system of governance
Section 7: Internal controls
Section 8: Internal audit function
Section 9: Actuarial function
Section 10: Valuation of assets and liabilities other than technical provisions
Section 11: Outsourcing
BIS principles 1-3
- Boards overall responsibility for the bank, including approving and overseeing management’s implementation of the bank’s strategic objectives, governance framework, and corporate culture. Responsibilities of the board- corporate culture and values; risk appetite, mgt and control; oversight of senior mgt;
- Board qualification and composition. Members should be and remain qualified, individually and collectively for their positions. They should understand their oversight and corp governance role and be able to exercise sound objective judgment.
- Board’s own structure and practices. Should define appropriate gov structures and practices for its own work and put in place the means for such practices to be followed and periodically reviewed for ongoing effectiveness.
EOIPA - guidelines 1-6
- AMSB appropriate interaction with committee and senior management-requesting information and challenging it.
- Org and operational structure-aimed at supporting strategic objectives and operations. AMSB should have relevant knowledge of the org and business models
- Significant decisions-involve at least two people who effectively run the undertaking
- Documentation of decisions taken at level of AMSB
- Allocation and segregation of duties and responsibilities
- Internal review of the system of governance
OECD principles
-effective corporate governance framework
- rights and equitable treatment of shareholders
- institutional investors and other intermediaries
- role of stakeholders in corporate governance
- disclosure and transparency
- responsibilities of board
Stakeholders include:
Internal- shareholders, directors, owners, employees, parent or group sister companies
External- customers (potential and actual), suppliers, governments, regulators, analysts, credit rating agencies, NGOs, press/social media
What delivers stakeholders expectations?
Core processes. Can be strategic, tactical, operational, compliance.
Evaluation of the effectiveness of the Board
●● membership and structure;
●● purpose and intent;
●● involvement and accountability;
●● monitoring and review;
●● performance and impact.
Nolan principles for public life
1 Selflessness.
Holders of public office should act solely in terms of the public interest and should not seek benefits for themselves, their family or friends.
3 Objectivity
In carrying out public business, the holders of public office should make choices on merit.
5 Openness
Holders of public office should be as open as possible about all the decisions and actions that they take and give reasons for their decisions.
7 Leadership
Holders of public office should promote and support these principles by leadership and example.
2 integrity
Holders of public office should not place themselves under any financial or other obligation to outside individuals or organizations.
4 accountability
Holders of public office are accountable for their decisions and actions to the public and must submit themselves to appropriate scrutiny.
6 Honesty
Holders of public office have a duty to declare any private interests relating to their public duties and to take steps to resolve any conflicts.
Stakeholders and restrictions
It is not possible to satisfy all stakeholder interests at the same time because those interests may conflict. Shareholders want a higher share price and higher dividends but, as the financial crisis showed, delivering short term profits may mean taking on more risk – which regulators do not wish to see.
• Individuals can have multiple stakeholder interests which can also lead to conflicts. Staff, particularly directors, may also be shareholders.
• Some stakeholders are of particular importance. Failing to meet the requirements of a regulator may result in a fine or loss of a licence.
Understanding these issues will help management decide which risks to accept, how they will be managed and which stakeholders to actively engage with. High on this list will be regulators followed by significant institutional shareholders and ratings agencies.
Stakeholders and capital requirements- different views
Regulatory view of firms capital and capital surplus can be different to rating agency and firms own view.
Regulators- Pillar 1 of Basel and Solvency sets minimum capital levels but regulator may require add-ons if concerned with exposure
Shareholders- return on capital ratio
Rating agencies- view on amount of capital to achieve certain credit rating.
Pillar 1 - Basel 111
• Credit risk: standardised approach, foundation internal-ratings based approach or advanced-ratings based approach.
• Market risk: standardised approach or internal models approach.
• Operational risk: basic indicator approach, standardised approach or advanced measurement approach.
Pillar 1 and definition of eligible capital under Basel II
Tier 1 capital- considered core measure of financial strength. Shareholders equity (capital left after - liabilities from assets). Innovative capital such as financial instruments that have both equity and debt features. Retained profits.
Tier 2 - subordinated term debt and reserves
Tier 3 - wider variety of subordinated debt and profits from the banks trading activities. Tier 3 only used to support the market risk the bank takes in its trading book.
Eligible regulatory capital = tier 1 plus tier 2 - deductions.
Deductions are goodwill, investments in subsidiaries, shares held by the bank in another bank
Eligible RC
___________. X 100 _> Capital ratio (min 8%)
Total RWAs
Pillar 1 and definition of eligible capital under Basel III
Increasing quality and quantity of capital held.
Stricter definition of capital. Capital must have a greater ability to absorb losses, allowing banks to withstand extended periods of more severe stress.
Tier 1 - common shares and retained earnings
Tier 2 - simplified- can become loss absorbing capital.
Tier 3 - gone
Tier 1 raised from 4% to 6% of total RWAs, so Tier 2 only 2%.
Additional capital conservation buffer intended to absorb losses during periods of stress and funded by common equity tier 1. Set at 2.5% of a banks total RWAs therefore actually 10.5%.
Systematically important banks under Basel III
Additional loss absorbing capital to strengthen ability to survive stress. 1-3.5% of RWAs.
Regulatory capital in Pillar 1 of Solvency II. 3 areas:
• Technical provisions – there are rules around the construction of the balance sheet against which the risk capital is measured.
• The Solvency Capital Requirement (SCR) requires an insurer or reinsurer to calculate the amount of capital that it should hold based on its risk profile. It is a capital calculation that takes into account insurance risk, credit risk, market risk and operational risk.
• The Minimum Capital Requirement is expressed in terms of a size of loss or risk event.
The solvency capital requirement can be calculated in one of three ways: using the standard formula prescribed by the regulator, the partial model or an internal model
SCR must be equivalent to:
the Value at Risk of basic own funds of an insurance or reinsurance firm subject to a confidence level of 99.5% over a one-year period.
