Corporate Governance

1. 1
“The Importance of Good Corporate
Governance for Banks”
David Carse
Deputy Chief Executive
Hong Kong Monetary Authority
3 November 2000

2. 2
The importance of corporate governance
• Corporate governance is the system by which
companies are directed and controlled.
• Good corporate governance is a key element in
improving economic efficiency.
• Conversely, bad corporate governance,
particularly in banks, can undermine economic
and financial stability.
• This was demonstrated by the Asian Crisis.

3. 3
The role of bad corporate governance in the
Asian crisis
• Weak corporate governance in Asian banks (and their
customers) was one of the key factors in the Asian crisis:
– many banks were controlled by owner-managers and the board of
directors played little role
– banks were often parts of wider conglomerates and used to fund other
parts of the group or the owners (connected lending)
– banks were subject to political influence in their lending decisions
– management was weak and lacked self-responsibility
– growth was more important than return on capital
– risk management was poor
• lack of credit controls and skills
• excessive risk concentrations in individual borrowers and sectors
• excessive funding and currency mismatches

4. 4
The situation in Hong Kong
• Corporate governance of Hong Kong banks is relatively good by
regional standards as has been shown by their ability to survive the
Asian crisis intact.
• However, the HKMA considers that there was a vacuum in
leadership in a few local banks during the Asian crisis because the
board of directors did not play an effective leadership role.
• This may result in either inadequate supervision of management or
the main shareholders becoming directly involved in the running of
the business.
• In either case, the board of directors is bypassed and checks and
balances are lost.
• To address these issues the HKMA issued a guideline on corporate
governance in locally incorporated authorized institutions in May
2000.

5. 5
Contents of the HKMA Guideline
 Major responsibilities of the board
 ensure competent management
 approve objectives, strategies and business plans
 ensure that the bank’s operations are conducted prudently and
within the framework of laws and board policies
 ensure that the bank’s affairs are conducted with a high degree of
integrity
 Legal obligations of directors
 including liability for breaches of the Banking Ordinance
 The use of auditors
 including role of internal audit
 Specific requirements

6. 6
Specific Requirements
1. The board should ensure that the bank establishes
policies, procedures and controls to manage the
various types of risk with which it is faced.
– The HKMA has identified 8 types of risk for purposes of its
supervision (i.e. credit, interest rate, market, liquidity,
operational, reputation, legal and strategic risk).
– The board should approve relevant policies to manage these
risks while senior management should put them into effect.
– It is important that the policies should not exist merely for
form’s sake (e.g. to satisfy the regulator), but should dictate
how the bank is actually run in practice.

7. 7
Specific Requirements
2. The board should ensure that the bank fully
understands the provisions of section 83 of the Hong
Kong Banking Ordinance on connected lending and
establishes a policy on such lending.
– Section 83 of the Hong Kong Banking Ordinance limits the
unsecured advances of banks to connected parties (e.g. directors
and their relatives). A breach of section 83 is a serious offence.
– The board is required to ensure that the bank fully understands
its legal obligations and establishes a policy on connected
lending according to the minimum standards specified in the
Guideline.

8. 8
Specific Requirements
3. The board should ensure that it receives the
management letter from the external auditor without
undue delay, together with the comments of
management.
– The management letter should normally be received within 4
months from the financial year-end. The board should ask for
management’s explanation if prolonged delay is experienced.
– The board and/or audit committee should ensure appropriate
action is taken to address any weaknesses identified in the
management letter.
– A copy of the management letter should be given to the HKMA.

9. 9
Specific Requirements
4. The board should maintain appropriate checks and
balances against the influence of management and/or
shareholder controllers, in order to ensure that decisions
are taken with the bank’s best interests in mind.
– Independent non-executive directors help to provide the necessary
checks and balances and bring in outside experience.
– The board should have at least 3 independent directors to provide a
sufficient pool of independent directors to sit on committees (in
particular the audit committee) and cover absences.
– In cases where the chairman is also the chief executive of a bank,
more than 3 independent directors may be required to provide a
strong independent element on the board.
– Banks should notify the names of their independent directors to the
HKMA. The HKMA may require additional independent directors to
be appointed.

10. 10
Specific Requirements
5. The board should establish an audit committee with written
terms of reference specifying its authorities and duties.
– The audit committee serves as the board’s “eyes and ears” in
monitoring compliance with board policies, regulations etc. It also
provides oversight of the internal and external auditors and assists in
providing independent review of the effectiveness of internal control
systems.
– The above functions should be performed by non-executive (preferably
independent) directors to avoid conflicts of interest and ensure
impartiality.
– The audit committee should therefore be made up of non-executive
directors, the majority of whom should be independent.

11. 11
Specific Requirements
6. Board meetings of a bank should be held preferably
on a monthly basis but in any event no less than once
every quarter.
– The board can only fulfil its responsibility if it meets frequently
enough and receives sufficient information from management to
enable it to monitor the bank’s financial position and
performance.
– Banks should keep full minutes of board meetings.
– The HKMA will require banks to provide it with a record of the
number of board meetings held each year.

12. 12
Specific Requirements
7. Individual directors should attend at least half of
board meetings held in each financial year and all
meetings where major issues are to be discussed.
– While effectiveness of a director cannot be measured simply by
attendance at board meetings, it is difficult for even the most
competent individual to make a contribution if he/she does not
turn up for meetings in the first place.
– Participation of directors in board meetings can be facilitated by
video or telephone conferencing.
– The HKMA will monitor the attendance records of individual
directors.

13. 13
Specific Requirements
8. The HKMA will meet the full board of directors of
each bank every year.
– The HKMA’s intention is not to participate in board meetings but
to strengthen communication between the HKMA and the banks
at the highest level.
– The meeting will enable the HKMA to convey first hand its
views on the bank’s current financial position and quality of its
risk management and internal controls and to communicate any
major supervisory concerns.
– The board will also have the opportunity to convey its views
directly to the HKMA.

14. 14
Questions raised on our Guideline
• Is the HKMA interfering too much in the way in which
banks choose to manage themselves?
• Is too much burden being placed on the board, and on non-
executive directors in particular, in terms of establishing
policies and controls?
• Should we draw a distinction between listed and non-listed
banks?
• Is it right to place more onerous requirements on banks
compared with other companies, e.g. as regards the number
of independent directors?
• Where are truly independent directors going to be found?

15. 15
The HKMA response
• Promotion of good corporate governance falls clearly within the
supervisory responsibilities of the HKMA.
• Banks are different from other companies because of the nature
of the risks they take on and because they are looking after other
people’s money.
• Corporate governance is therefore particularly important for
banks, whether listed or non-listed.
• Directors need to ensure that the risks in banks are properly
managed, and under the Hong Kong Banking Ordinance they
have a specific legal responsibility to do so.
• This does not mean that the directors should themselves
formulate policies for managing risk, but they should certainly
approve such policies.

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The problem of independent directors
• We do acknowledge that it is not easy to find truly independent
directors or those that are prepared to oppose dominant
shareholders.
• There is also the risk that quasi-independent directors will be
used to give a false impression of good governance.
• The process of establishing a cadre of truly independent
directors in Hong Kong and elsewhere in Asia will take time.
• Training courses for directors and organizations to promote the
use of independent directors like the UK PRO NED can help, as
can the use of mechanisms such as board nomination
committees.

17. 17
The need for transparency
• Financial disclosure and accountability are also important
aspects of good corporate governance.
• The increased focus on shareholder value means that banks need
to be more open about their financial performance and the
nature and size of the risks they are running.
• Depositors and other providers of funds (including minority
shareholders) also need sufficient information to be able to tell
good banks from bad.
• The HKMA has therefore focussed in the last six years on
encouraging banks to disclose more information in their annual
and interim accounts, in particular on asset quality.

18. 18
Conclusions
• The Asian crisis has demonstrated the need for Asian banks to
improve their corporate governance through such means as:
– giving greater prominence to the role of the board and outside directors in
particular
– introduction of professional management
– greater transparency
– effective internal and external audit
• Globalization of financial services is in any case driving banks in this
direction:
– investors and fund providers will increasingly expect minimum standards of
good governance
– foreign banks operating in Asian markets will provide a role model
– “Western” and “Asian” models of governance will converge
• The Guideline issued by the HKMA is consistent with this global trend and
is intended to keep Hong Kong banks at the forefront of good governance.