Basel Committee Issues Principles for Enhancing Banks' Corporate Governance

The Basel Committee on Banking Supervision has issued for consultation a set of principles for enhancing sound corporate governance practices at banking organisations.

Drawing on lessons learned during the financial crisis, the Basel Committee’s document, ‘Principles for Enhancing Corporate Governance’, sets out best practices for banking organisations. Nout Wellink, chairman of the Basel Committee and president of the Netherlands Bank, stated that “the crisis has highlighted the critical importance of sound corporate governance for banking organisations. Careful implementation of these principles by banks, along with rigorous supervisory review and follow-up, will enhance bank safety and soundness as well as the stability of the financial system.”

The committee’s principles address fundamental deficiencies in bank corporate governance that became apparent during the financial crisis. The principles cover:

• The role of the board, which includes approving and overseeing the implementation of the bank’s risk strategy taking account of the bank’s long-term financial interests and safety.
• The board’s qualifications. For example, the board should have adequate knowledge and experience relevant to each of the material financial activities the bank intends to pursue to enable effective governance and oversight of the bank.
• The importance of an independent risk management function, including a chief risk officer or equivalent with sufficient authority, stature, independence, resources and access to the board.
• The need to identify, monitor and manage risks on an ongoing firm-wide and individual entity basis. This should be based on risk management systems and internal control infrastructures that are appropriate for the external risk landscape and the bank’s risk profile.
• The board’s active oversight of the compensation system’s design and operation, including careful alignment of employee compensation with prudent risk-taking, consistent with the Financial Stability Board’s (FSB) principles.

The principles also stress the importance of board and senior management having a clear knowledge and understanding of the bank’s operational structure and risks. This includes risks arising from special purpose entities or related structures.

Supervisors also have a critical role in ensuring that banks practice good corporate governance. In line with the committee’s principles, supervisors should establish guidance or rules requiring banks to have robust corporate governance strategies, policies and procedures. Commensurate with a bank’s size, complexity, structure and risk profile, supervisors should regularly evaluate the bank’s corporate governance policies and practices as well as its implementation of the committee’s principles.

Danièle Nouy, chair of the Corporate Governance Task Force and secretary general of the French Banking Commission, said: “The financial crisis has underscored how insufficient attention to fundamental corporate governance concepts can have devastating effects on an institution and its continued viability. It is clear that many banks did not fully implement these fundamental concepts. The obvious lesson is that banks need to improve their corporate governance practices and supervisors must ensure that sound corporate governance principles are thoroughly and consistently implemented.”

The need for sound corporate governance improvements has also been observed in other financial sectors. That is why, in developing the principles, the Basel Committee has co-ordinated its work with the International Association of Insurance Supervisors (IAIS), which is currently reviewing its Insurance Core Principles to address corporate governance areas more fully. The Basel Committee and the IAIS seek to collaborate on monitoring the sound implementation of their respective principles.

Comments on the consultative document should be submitted by 15 June 2010.

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