1. Disclaimer
This working paper was prepared for the Conference: "Corporate Governance and Reform: Paving the Way towards
Financial Stability and Development" that was held in Cairo, Egypt on May 7-8, 2007.
The views and opinions presented in this paper are those of the author and may not necessarily coincide with those
of HSBC Bank Egypt.
THE ROLE OF COMMERCIAL BANKS
IN PROMOTING CORPORATE
GOVERNANCE OF THEIR CLIENTS
THE SMALL AND MEDIUM ENTERPRISE PERSPECTIVE
BASSAM AZAB
SENIOR MANAGER
SMALL AND MEDIUM ENTERPRISE BANKING SERVICES
HSBC BANK EGYPT
May 2007
2. 2
TABLE OF CONTENTS
Acknowledgment …………………………………………………………………… 3
About the Author …………………………………………………………………… 4
Abstract ……………………………………………………………………………… 5
Introduction…………………………………………………………………………… 6
Corporate Governance in Commercial Banks ………………………………… 7
A. Corporate Governance for Commercial Bank Clients ……………… 8
B. Corporate Governance for Bank SME Clients ………………………… 9
Conclusion …………………………………………………………………………… 11
References …………………………………………………………………………… 12
Appendix ……………………………………………………………………………… 13
3. 3
ACKNOWLEDGEMENT
The author would like to thank the Egyptian Institute of Directors for the
valuable assistance during the preparation and publishing of this paper,
which is aspired to add value to the area of research in Corporate
Governance in Egypt.
4. 4
ABOUT THE AUTHOR
Bassam Azab, born in 1973 and graduated from the Faculty of Commerce
and Business Administration, Helwan University in 1995. Bassam holds an
MBA degree in International Banking and Finance from the University of
Birmingham, The United Kingdom and a Banking Certificate from the
Chartered Institute of Bankers, UK
In 1996 Bassam Joined HSBC Bank Egypt (Former Egyptian British Bank) and
has covered several position in retail banking and custody operations. In
2003, he Headed the Custody Operation of HSBC Bank Egypt and was elected
the Head of Custodians' Committee in Egyptian Capital Market Association
(ECMA).
In 2006, Bassam joined the Egyptian Corporate Governance Project at the
International Finance Corporation, The World Bank Group in the capacity of a
Financial Expert.
In 2007, Bassam rejoined HSBC Bank Egypt to Head the Small and Medium
Enterprise Banking Services.
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ABSTRACT
he author in this paper presents the corporate governance of banks.
As the Traditional role of banks is to efficiently mobilize and allocate
funds, the application of corporate governance is argued to lowers the
cost of capital to firms, improve capital formation, and further encourage
productivity growth. In the contrary, weak application of corporate
governance is considered to be a bad indicator of how the company is run.
After reviewing the major governance concepts for corporations in general,
the author discusses two special attributes of banks, first, corporate
governance for commercial banks’ clients and second, the paper discusses
the corporate governance for bank SME clients emphasizing that corporate
governance evaluation for lending medium-size and small- size companies
is very important as The CAPMAS has published a census which showed that
85 per cent of the Egyptian companies were small and 9 per cent were
medium size and only 5 per cent are large companies.
T
6. 6
INTRODUCTION
anks are vital institutions in any economy as they form an important
source for providing finance to businesses. Their role becomes more
important in emerging markets, where the majority of finance to new
and existing businesses comes from the banking sector, as opposed to
finance through the stock market.
The figures show that this is particularly true for Egypt that despite the
recent revival of the stock market, most of the activity was in secondary
trading with very few private sector companies exposing themselves to
primary stock market issues.
Having this vital role, it is important to ensure that banks are properly
governed “internally” and to ensure sound governance structures to their
customers “externally” in order to protect the interests of the various
stakeholders and to sustain the healthy functioning of the monetary system
in the Economy.
Egyptian banks differ in size, complexity and sophistication and, hence, the
Corporate Governance model adopted for themselves and for assessing their
customers may vary from one bank to another and from one customer
category to another.
The key message is that Corporate Governance is important to banks and
their clients and the extent of application should be flexible to offer the best
model for each bank/customer according to their differing size and
structure.
B
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CORPORATE GOVERNANCE IN COMMERCIAL BANKS
orporate Governance is the system by which an organisation is
directed and controlled. In a public-held company, the board of
directors acts on behalf of the shareholders (owners) in overseeing
management to ensure that their activities ensure maximisation of the value
and sustainability of the company.
Due to this key role of the board of directors, the main focus of corporate
governance is to provide the framework and tools for board members to help
them carry out their responsibility of management oversight.
Within this scope, the duty of the board members to ensure that
shareholders' rights are exercised and that all categories of shareholders
(minority versus majority) are receiving equitable treatment is essential.
The scope in corporate governance also extends beyond the direct owners of
the company to other stakeholders that have interest in the company's
operations, including creditors, regulators and employees. The heavily
geared nature of banks makes the attention to stakeholders' interest very
essential to the survival and success of a bank.
From this perspective, corporate governance should not be confused with the
narrower focus on risk management, which is governed by the Basel II
recommendations and which is only one component of a complete corporate
governance framework, but the view for corporate governance should be
more of a strategic role of the board of directors to ensure that management
of a bank, when performing their duties, are aiming at achieving the bank's
strategic objectives, within the strategic risk appetite, to maximize the value
of the bank to its owners, taking into consideration the interests of the
relevant stakeholders.
This perspective should render the expected rewards to the bank applying a
sound framework of corporate governance in achieving the target results,
managing the risks associated (and hence, reducing the costs of doing
business) and gaining the confidence and trust of the bank's owners,
depositors and regulators.
C
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Needless to say that the implementation of a sound corporate governance
framework requires a great effort form both the management and the board,
and this requires a great commitment form both to ensure sound
application. This commitment should come form the understanding of the
rewards that corporate governance promise to the bank.
The Basel Committee on Banking Supervision paper "Enhancing Corporate
Governance for Banking Organisations", published in February 2006 is based
on the Principles of Corporate Governance set by the Organisation for
Economic Cooperation and Development (OECD). The paper provides eight
principles of sound Corporate Governance and explains the role of
supervisors and the supportive environment needed to form a sound
governance framework for a bank. Appendix I provides a copy of the full
paper.
A. Corporate Governance for Commercial Bank Clients
Commercial banks, in their traditional banking role, try to assess the
capability of the borrower to operate successfully, thereby try to assess their
client's ability to repay both the principal and interest of the loan as they fall
due.
The traditional focus of banks on mere financial risk measures has changed
in the past few years to encompass other non-financial risk aspects (e.g.
Operational, Reputational, Environmental and compliance risk) of the client.
Operational Risk, arguably in this context, has two folds:
The risk of loss or damage that may result from staff or management being
erroneously interpreting and/or executing the rules and procedures laid
down by the organization;
And more importantly,
The risk of setting the wrong rules and procedures to be followed by the
members of the organization.
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Here, the role of Corporate Governance of looking at the company's Board
Practices comes to the picture.
The Egyptian commercial banks should start giving more attention to
Corporate Governance as part of the non-financial risk assessment when
evaluating the lending proposition to a company as the structure,
qualifications, background, track record of strategic decisions of the board
would not only affect the interests of shareholders, but would also affect the
company's ability of repaying its debts to the debt holders, mainly banks.
B. Corporate Governance for Bank SME Clients
According to the census published by the Central Agency for Public
Mobilization and Statistics (CAPMAS) in 1996, out of a total 109,337
companies, 85 per cent were small and 9 per cent were medium size while
only 5 per cent represented large companies. Two important observations
can be drawn from these figures.
First, in a country like Egypt, a very good number of the 94 per cent of the
small-medium sized companies would have a legal form of Joint-stock or
Limited Liability by Stock. This legal form mandates the existence of a board
for the company.
As such, Corporate Governance evaluation would be very important, at least,
when lending to medium-size and the upper tear of small-size companies.
Second, the fact that in so many cases, the Small and Medium size
companies may not have a separation of ownership from management. In
this respect, the claim that Corporate Governance should be of no relevance
as the owners bear the consequences of their deeds is, in effect, a fallacy.
In fact, taken collectively, the improper strategic management and practices
of the owners/managers of such companies would cause a systematic failure
that would harm the banking sector and the economy as a whole.
This may become very clear in a down-turn phase of an economy when
badly-run companies would start suffering the symptoms of debt deflation
10. 10
causing difficulties to banks to recover their loans and the economy as a
whole to suffer from severe recession.
The above observation shows the importance of considering Corporate
Governance when lending to such companies. However, the governance focus
here should shift from the risk to shareholders as the primary concern to the
risk to stakeholders (debt holders and the economy at large). This shift
should represent what the author wishes to coin as "Corporate Economic
Responsibility". CER should be understood as the company's responsibility,
through the actions of its owners/managers to achieve not only its business
and profitability objectives but also the wider objective of developing the
economy in which it operates.
Traditionally, commercial banks used to apply the classical "Judgemental"
evaluation approach of credit granting proposals. The large number of small
and medium size companies and the varying size of those companies make
judgemental evaluation both time consuming and cost inefficient.
To overcome this hurdle, many commercial banks in the world, that have
exposed themselves to the SME finance world have opted to mix the classical
judgemental approach with the new technique in retail banking finance
known as "credit scoring".
The resulting hybrid approach can best be described as "Criteria-based"
Lending, where banks try to use the expertise gained through the history of
credit granting to large corporates and retail individuals to come up with a
list of criteria that a bank believes, if fulfilled by the applying company,
should make it eligible for the credit.
In that respect, having certain elements of Corporate Governance, adapted to
the size and complexity of the borrowing company, as part of the lending
criteria to such small and medium size companies would effectively enhance
the assessment of credit to such companies.
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CONCLUSION
he paper focuses on the vital role played by banking sector in
financing new and existing businesses in the emerging markets. It
shows the importance of applying sound corporate governance for
banks specially the commercial banks. As the traditional focus of commercial
banks has been changed to include not only financial risks but also non-
financial risks (e.g. operational, Reputational, environmental and compliance
risk) of the client. Finally, the paper shows that having certain elements of
corporate governance adapted to the size and complexity of the borrowing
company would effectively enhance the assessment of credit to such
companies.
• The scope of corporate governance has been extended to include not
only the direct owners of the company but also other stakeholders
that have interest in the company’s operation ( creditors, regulators
and employees).
• Eliminating the confusion between corporate governance and risk
management governed by Basel II.
• The view for corporate governance should be more of strategic role of
the board of directors to maximize the value of the bank to its
owners.
• Commercial banks should go beyond its traditional focus on financial
risk measures to encompasses other non- financial risk aspects when
evaluating the lending proposition to a company.
• Corporate governance evaluation is an important aspect when lending
medium-size and small-size companies.
• The improper strategic management and practices of the owners and
managers would cause a systematic failure that would harm both the
banking sector and the economy.
• The small and medium enterprise governance should shift its focus
from the risk to shareholders to the risk to stakeholders represented
by the Corporate Economic Responsibility as the company not only
achieving its business and profitability objectives but wider objective
in developing the economy.
• Mixing the classical judgmental approach with the new retail banking
finance ( credit scoring) may be an effective tool for medium-size and
small-size companies.
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12. 12
Empirical evidence shows that the good application of corporate governance
principles adds value, reduces risk and increases returns. This makes it
more convenient for banks to look at the extent to which their clients are
applying these principles.
The Key Challenges banks are facing now are if we assume that banks
includes Corporate Governance as on of the criteria in its decision-making
process, then, the question what are the tools used to assess corporate
governance application, should this be used for all corporate clients or just
for key accounts, and finally what would the bank offer as an advantage for
those who apply good corporate governance.
13. 13
REFERENCES
1. OECD Principles of Corporate Governance. (http/www.oecd.org)
2. The Bank for International Settlements. The Basel Committee on
Banking Supervision. Enhancing Corporate Governance for Banking
Organisations (http://www.bis.org/publ/bcbs122.htm)
3. Ministry of Finance. "Profile of M/SMEs in Egypt" Update Report.
October 2005
4. Mishkin, F. S., The Economics of Money, Banking and Financial
Markets Addison-Wesley, Fifth ed., 1998
5. International Finance Corporation, World Bank Group, Corporate
Governance Newsletter, Several issues.
