Bank Negara tightens regulations
Tighter grip: A quick read on the guidelines shows that the central bank is squarely aiming to increase transparency, reduce risk arising from opaque oversight, dampen leverage and overall risk-taking for the bank.
Central bank moves to enhance corporate governance
IN the years before 2008, particularly when the global investment banking industry was riding on an unprecended wave of expansion in terms of size and revenue, how many seriously thought about the importance of regulation?
Immense wealth was being created and everybody aspired to be an investment banker, touting their Hampton homes and flashy cars and decadent lifestyles.
Then the financial crisis came in 2008.
Overnight, the industry was focused on superior regulatory and supervisory frameworks, and measures were implemented to ensure the industry would be hardy enough to brave another such storm.
Now here in Malaysia, in the wake of lapses in financial controls and the lack of a mechanism to prevent a financial crisis, Bank Negara has announced guidelines similar to the rationale the US government used when it introduced the Dodd-Frank Wall Street Reform and Consumer Protection Act back in 2010.
While banks in Malaysia are already guided by reforms under the Basel III requirements to strengthen the existing capital and liquidity standards, these measures do not cover oversight on poor internal controls to ensure a bank is able to weather a financial crisis.
Very lax internal controls can ultimately lead to banking employees making use of loopholes for their own self-serving interest.
For example, these employees bring in business deals, knowing that the client is not a good paymaster, or perhaps knowing the business isn’t that viable.
However the employee does not care, as he is singularly motivated by the commission he shall receive.
Furthermore, there are no existing checks and balances to ensure a clawback of the commissions if the deal fails halfway.
This was the situation in America before 2008.
Because of that, the scale and severity of the US subprime financial crisis left millions of Americans unemployed and resulted in trillions in lost wealth.
America’s broken financial regulatory system was a principal cause of that crisis.
“It was fragmented, antiquated, and allowed large parts of the financial system to operate with little or no oversight. And it allowed some irresponsible lenders to use hidden fees and fine print to take advantage of consumers,” said the White House in its website.
To make sure that a crisis like this never happens again, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law.
This was the most far reaching Wall Street reform in history, where Dodd-Frank will prevent the excessive risk-taking that led to the financial crisis.
Another measure which is now the norm in the US is the annual banking stress tests - which measures whether banks have enough capital and liquidity, management controls and other necessary safeguards to survive various worst-case situations.
The stress test have been required of banks with more than US$50bil in assets since the passage of the Dodd-Frank Act, which took effect in 2010.
In June this year, all but one of the US’ largest banks earned an unconditional passing grade from federal regulators on their annual stress tests.
The one American-based institution that did not pass unconditionally was Morgan Stanley, which has been struggling to regain its footing after the financial crisis of 2008.
Regulators raised concerns over the company’s internal controls and processes.
Key measures
On Wednesday, Bank Negara introduced a few key measures under its enhanced standards for corporate governance.
A quick read on the guidelines shows that the central bank is squarely aiming to increase transparency, reduce risk arising from opaque oversight, dampen leverage and overall risk-taking for the bank.
Chief among them, banks have been told to stagger the variable bonuses of senior employees and deal-makers over a period of time in a move seen as putting the brakes on bankers earning handsome rewards and leaving the bank to carry all the risk.
Another major policy announcement is of a five-year cooling-off period for chief executives of banks before they can be appointed as chairman of the financial institution.
The other salient points in the guidelines that are seen as improving governance and risk management of banks are:
• substantial shareholders cannot hold senior management positions;
• the board must approve and oversee a plan to weather a crisis when the financial system comes under stress; and
• boards cannot have more than one executive director unless there are special circumstances.
• individuals must be able to raise concerns about illegal, unethical or questionable practices in confidence and without the risk of reprisal
• the boards of banks should comprise of a majority of independent directors. The independent directors should not be sitting in the post for more than nine years.
Bank Negara said that the standards would take effect immediately, subject to a transition period for certain requirements.
On the whistle-blowing policy, the central bank outlined several measures that banks must establish a whistle-blowing policy that sets out avenues for legitimate concerns to be objectively investigated and addressed.
The current condition
On the board composition of banks, the bank with the most number of independent directors is Alliance Bank, where seven out of nine directors are independent. None of the independent directors have served for more than nine years.
Five other banks – Malayan Banking Bhd, CIMB Group Holdings Bhd, Public Bank Bhd, RHB Banking Group and Hong Leong Bank Bhd - have a majority of independent directors on their boards.
And all the independent directors, except for one, have served less than nine years on the boards.
Affin Bank has an even number of independent and non-independent directors, with only one who has served more than nine years.
The Ambank Group has five out of 11 who are independent. However, an industry official said that the group is well-placed to comply with the latest Bank Negara ruling.
On the remuneration standards, this means that a person who brought in a deal for a bank would not be rewarded all at once in the annual bonus.
“He will need to wait and receive his or her bonus over time as the risk of the deal going bad dissipates. Effectively, the bank will not be carrying the risk alone. The person who brought in the deal must be held accountable to ensure that the deal is properly and fully carried out,” an observer explains.
In addition to staggering the variable portion of the bonuses, banks have also been told to have a mechanism to claw back the payout should there be a bad performance of the business unit or if the individual commits internal policy breaches.
For the staggered remuneration, the central bank said that remuneration payout schedules must reflect the time horizon of risks and take account of the potential for financial risks to crystallise over a longer period of time.
“As such, a financial institution must adopt a multi-year framework to measure the performance of members of senior management and other material risk takers,” it says.
Meanwhile, the chairman of the board must not hold an executive position and must not have served as a chief executive officer of the financial institution in the past five years.
This would mean that the practice in the past, where the CEO or figure head of a bank is naturally appointed as the chairman of the bank, will be changed, moving forward.
For example, CIMB Group Holdings Bhd chairman Datuk Seri Nazir Razak was the CEO of CIMB Bank from 2006 to 2014. Upon his resignation in 2014, he was redesignated as non-executive chairman of CIMB.
The same can be said about Public Bank Bhd’s founder and major shareholder Tan Sri Teh Hong Piow, who was subsequently appointed as chairman of Public Bank. Tan Sri Azman Hashim, who is the major shareholder and who had initially led AMMB Holdings Bhd, was also subsequently made its chairman. There must be a clear separation between the substantial shareholder of a company and the management. A substantial shareholder must not hold a senior management position, according to the central bank.
“This serves to preserve an appropriate separation between ownership and management of financial institutions in line with the broader responsibilities of a financial institution towards its depositors, investment account holders, policy holders and participants,” says Bank Negara.
Lastly, the ultimate responsibility of a bank conducting its own ‘stress test’ and its preparedness to weathering a financial crisis may soon fall into the lap of its board of directors.
The guidelines state that the board must oversee and approve the recovery and resolution as well as business continuity plans for the financial institution to restore its financial strength, and maintain or preserve critical operations and critical services when it comes under stress.
This means that the board of directors needs to be ready with policies, safeguards or emergency measures so that it is able to survive various worst-case situations or crises that may come its way.
“With the board incorporating stress testing into the bank’s business strategy, this shows that that the board is doing its part in disaster preparedness,” says one banking analyst.
Moving forward, he foresees the board receiving regular updates about the banks’ stress test. From these tests, the board will evaluate the results and ensure that it is in line with the company’s risk appetite and overall strategy.
