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ЗмістTable 1. Main indicators of Ukrainian bank activities
4. Corporate governance regulation framework in the banks of Ukraine
4.2. The NBU regulation of banks’ liquidity in crisis
Figure 1. Recapitalization needs of banks in different countries, bln USD
CORPORATE GOVERNANCE REGULATION IN BANKS IN THE CONTEXT OF CRISIS: THE ROLE OF THE NATIONAL BANK OF UKRAINE
by Yaroslav Mozghovyi*, Kateryna Kondrunina**, Iuliia Ratnykova***, Daria D. Skidan****
This paper gives an overview of corporate governance and banking regulation in Ukrainian banks. Particular attention is paid to the regulatory changes by the National Bank of Ukraine which were made in response to the financial crisis. The paper focuses mainly on the regulation influencing the payment schemes and the size of the regulatory capital as the elements of corporate governance system. The research suggests that some documents issued by the National Bank of Ukraine have a contradictory affect on banks’ sustainability and might provoke the conflict of interests within the structure of corporate governance.
Keywords: corporate governance, Basel, crisis, regulation, banks.
Authors’ names are given in alphabetical order.
* PhD candidate, Department of International Economics, Banking Academy of the National Bank of Ukraine, member of the International Research Center for Banking and Corporate Governance, email@example.com;
** Master’s student, member of the International Research Center of Banking and Corporate Governance, Banking Academy of the National Bank of Ukraine, firstname.lastname@example.org;
*** Master’s student, member of the International Research Center of Banking and Corporate Governance, Banking Academy of the National Bank of Ukraine, email@example.com;
**** Master’s student, member of the International Research Center for Banking and Corporate Governance, Ukrainian academy of Banking of the National Bank of Ukraine, e-mail: firstname.lastname@example.org.
Banks play a significant role in promoting economic development of a country. They fulfill a very important task by matching borrowers and lenders. Banks act as intermediaries when they mobilize savings from surplus units (savers) to shortage units (borrowers) in order to finance productive activities. In the economic system only banks take deposits and grant loans.
Banks are not self-regulated institutions. Each single bank is ruled by corporate governance. Given the importance of banks, the governance of them itself assumes a central role. If bank managers face sound governance mechanisms, they will be more likely to allocate capital efficiently and exert effective corporate governance over the firms they fund. In contrast, if banks managers enjoy enormous discretion to act in their own interests rather than in the interests of shareholders and debtholders, then banks will be correspondingly less likely to allocate society’s savings efficiently and exert sound governance over firms. Clearly then, skilled corporate governance is a key factor to bank’s success.
Banking system in whole is regulated by Central Bank (National Bank of Ukraine - NBU) which fixes certain requirements, restrictions and guidelines. Because of the importance of banks in the economy, because of the opacity of bank assets and activities, and because banks are a ready source of fiscal revenue, government imposes an elaborate array of regulations on banks. This is especially true in the context of crisis, when the necessity for drastic measures increases tenfold. Crucial problems of banking system arose on the basis of poor liquidity, insufficient capital (both authorized and regulatory), problem assets, bad debts and others. In order to mitigate the effects of crisis in banking sector, several statements were issued by the government. In banks that suffered most temporary administration was introduced. However, taking into account the fact that temporary administration phenomena is widely examined already, the authors concentrated on the statement on improving liquidity of banks at a loss (№421, from 22.07.2009) and statement on enlarging the regulatory capital of banks (№273, from 09.06.2010).
The article focuses on research and assessment of regulation of corporate governance in banks by the NBU during crisis. The main aim is to estimate the timeliness and appropriateness of statements issued on the corporate governance of Ukrainian banks.
2. Literature review
The issue of CG in banks and the aspect of its regulation were examined by several authors as the topic is turning into practical question for the countries due to the globalization processes and liberalization of financial markets.
Corporate governance of banks is largely concerned with reducing the social costs of bank risk-taking and that the regulator is uniquely positioned to balance the relevant stakeholder interests in devising governance standards for financial institutions that achieve economic development objectives, while minimizing the externalities of systemic risk (Kern A., 2006).
Governance in the banking sector is achieved through a set of legal, accounting, financial, and economic rules and regulations. These rules and regulations direct the management, govern performance, and assist in carrying out the responsibilities of the sector (Mahmoud Abul Ayoun, 2003).
Central banks as the main regulators of the banking sector play an important role in defining and reinforcing the principles of good governance in banks.
For example, State Bank of Pakistan (SPB) has been on the forefront in promoting good corporate governance in the country. SBP has implemented a comprehensive corporate governance regime for banks, which is driven by a robust legal and regulatory framework, risk-based supervision and over-arching banking sector reforms, notably, privatization, liberalization and consolidation of banks (Shamshad Akhtar, 2008).
Luc Laeven & Ross Levine (2008) conduct the first empirical assessment of theories concerning risk taking by banks, their ownership structures, and national bank regulations. They show that the relation between bank risk and capital regulations, deposit insurance policies, and restrictions on bank activities depends critically on each bank's ownership structure, such that the actual sign of the marginal effect of regulation on risk varies with ownership concentration.
Peter O. Mьlbert (2010) states that poor corporate governance of banks has increasingly been acknowledged as an important cause of the recent financial crisis. Whereas banking regulation/supervision acts as a functional substitute for debt governance, equity governance benefits less from such regulation/intervention. Put succinctly, shareholder interests and supervisors’ interests do not run exactly parallel, not even from a long-term perspective.
T.G. Arun and J. D. Turner (2004) contributed into the examination of corporate governance of banks in developing economies: Based on a theoretical discussion of the issue, authors suggest that banking reforms can only be fully implemented once a prudential regulatory system is in place.
The role of financial regulation in influencing the development of corporate governance principles has become an important policy issue, however concerning the crisis period it has received little attention in the literature, especially in Ukrainian environment.
The data collection covers the wide scope of information concerning corporate governance regulation in banks with the particular attention paid to the National Bank of Ukraine as the main regulator of the Ukrainian banking environment. The relevant legislation analyzed within the framework of banking corporate governance regulation is as follows: Law of Ukraine on Companies (or: Law of Ukraine on Business Associations), No. 1576-XII, 1991 (with amendments through 1995), Law of Ukraine On Securities and Stock Market, 2006, Ukrainian Corporate Governance Principles, 2003, Law on Joint Stock Companies, 2008, Civil Code, 2004, Commercial Code, 2004, Law of Ukraine on State Regulation of Securities Markets in Ukraine, 1996, Presidential Statement on Investment Funds and Investment Companies, 1994, Bank and Banking Activity Act No. 2121, statement of the NBU No.98 as of 28.03.2007 “Guidelines for improving corporate governance in banks”. Concerning the crisis aspect of the issue the NBU statement No 273 “Amendments to the regulative documents of the NBU” (9.06.2009) and NBU statement No 421 “On some issues concerning the activities of banks during the financial crisis” (22.07.2009) were considered during the research.
This paper covers the period of 2008-2010 and the sample of the registered banks with reference to the NBU statistics (Table 1).
The research focuses on the influence of the NBU on the corporate governance in banks by introducing legislative documents and requirements aimed at stabilization of the banking sector through the impact on the regulatory capital and liquidity of the banks. The research also explores the historical background of the problem and uses the comparison method of analysis.
Source: The National Bank of Ukraine
4.1. Background to the concept
Corporate governance is a new concept in Ukraine. Nevertheless, there is a certain legislative and regulatory landscape to implement the practices of corporate governance. The concept of corporate governance in Ukrainian banks got reflected in national legislation with the Civil Code of Ukraine, Banks and Banking Activity Act, Joint Stock Companies Act and the statements of the NBU being the main provisions for the procedures related to the CG in banks.
The National Bank of Ukraine is the main regulator of the banking sector, hence its influence and role is essential enough to determine the CG performance in Ukrainian banks.
In practice the function of the NBU in the sphere of regulation of corporate governance in commercial banks is realized in several ways:
• NBU’s participation in the legislative process;
• development of the relevant provisions of the NBU.
Supervision by the NBU of the formation of the corporate governance bodies of banks is a key issue of NBU’s participation in CG in banks.
NBU’s functions in the formation of the management of banks are as follows:
• approval of the chairman of the board elected by the supervisory board of the bank;
• approval of the chief accountant of the commercial bank, appointed by chairman of the board and elected to the board by the supervisory board.
NBU’s initiative to introduce a temporary administrator in commercial banks as a way to improve the financial stability of banking institutions in the financial crisis of 2008-2009, also belongs to corporate regulation (Kostyuk A., 2010).
While there are a number of documents determining the “elements” of corporate governance in Ukrainian banks, one of the recent acts which worth attention (especially taking into account the global trend on national code/principle implementation) is the statement of the NBU of 28.03.2007, № 98 “Guidelines for improving corporate governance in bank”. These recommendations do not replace but rather complement the corporate governance principles adopted by the State Commission on Securities and Stock Market dated by 11.12.2003. This statement outlines key recommendations on the activity of Supervisory Board, Executive Board etc. For example, point 1.4 of Chapter 1 “The role and responsibility of the Supervisory Board” says that performing the functions of supervision and control over the activities of the Executive Board, Supervisory Board appoints, controls, and if necessary replaces board members taking care of certain succession plan in top management, examines possible successors in terms of their professional qualifications and skills and ability to manage the affairs of the bank. The Supervisory Board also sets the remuneration of the members of the Board, considering their responsibilities and remuneration police in the bank. Chapter 2 of the document defines the criteria for professional independence and conformity of the Supervisory Board, NBU‘s experts consider including at least 25% of qualified independent members to the Supervisory Board and creating audit and other committees headed by independent members as the instrument to strength independence and objectivity of the Supervisory Board. Chapter 4 of the document contains recommendations concerning structure, formation and procedures of the Supervisory Board.
Issues regarding committees of the Supervisory Board are developed in chapter 5. According to the National Bank, “Creation of Supervisory Board committees dealing with specific issues of its activities maximize the effectiveness of the Supervisory Board”. Taking into account recommendations, the Supervisory Board at its discretion, establishes such committees, but is responsible for the results of their activities. In this case, committee is composed of at least three board members. Besides one of the committee members should have specific professional education in the sphere of certain committee. Meetings of such committees should happen at least once a quarter or more often if this is necessary. It‘s highly appreciated if banks establish audit committees, risk management, corporate governing and nominating ones . In general, other sections of the document define recommendations for internal and external control, questions of succession, disclosure of information and the activities of the Executive Board.
It should be mentioned that one of the main possible positive outcomes of the implementation of these recommendations is that it will give NBU the opportunity to form the institute of independent directors - members of supervisory boards, active participation of whom will increase confidence in the commercial bank by shareholders, investors, customers, and as a result of the banking market regulator - the National Bank of Ukraine.
The number of bad banks in Ukraine proves inadequate current system of corporate governance, primarily meaning this formal character of relationship and the lack of oversight by supervisory boards of the risk management. Therefore, one of the main tasks of the state in solving this problem is the implementation of mobility mechanisms which influence the internal procedures of corporate governance in banks.
In fact, corporate governance practices in Ukrainian banks are formed under certain contradictory factors. Among the internal factors, above all, the peculiarities of formation of private banks with share ownership in early 1990 in a liberal state policy concerning the banking system should be mentioned. Since that time the typical features of corporate governance in banks are the high concentration of ownership and control in the hands of majority shareholders, the practice of servicing the interests of owners and their private financial-industrial groups, the opacity of corporate structure and so on. On the other hand, major incentives for the development of good corporate governance give the external factors of globalization processes: the arrival of foreign investors into the domestic market, increased competition and dependence of the Ukrainian banks on borrowing in international capital markets. Under the influence of these external factors, the role of public banks and their presence in the stock market is increasing. The current crisis implications put forward new policy emphasis on changing the formal approach of risk management in banks. State policy in the regulation of corporate governance should take into account the effect of both internal factors that shape the specifics of national environment and external factors that stimulate the most effective objective management mechanisms.
Nowadays it could be mentioned that the state and NBU particularly made significant steps towards establishment of a national legal framework in line with international standards. As a result of evaluation mission of IMF and World Bank held in 2002 and 2007 under the Financial Sector Assessment Program Ukraine (FSAP), the very positive work of the NBU on implementation of the Basel Committee standards and best practices in supervisory activities were noted. However, given the voluntary nature of the recommendations the question of their degree of compliance by banks still exists. According to the IFC research “Investigation of changes in corporate governance of the banking sector of Ukraine”, only 25% of survey participants confirmed that they improve corporate governance in accordance with the implementation of legislative documents. On the other hand, it is the NBU CG Guidelines and corporate governance principles of the State Securities Commission which are the main sources of information on corporate governance in Ukraine.
In the period of crisis risk management and internal controls in banks require an immediate attention. Hence, the priorities of the NBU today are concentrated mainly on measures to stabilize the financial performance of banks. But in terms of the post-crisis perspective the issue of banking supervisory matters transition to Basel II standards remains relevant.
Taking into account the current performance of Ukrainian banks and strategic plans of Ukraine to join the European Union, public authorities should consider the initiatives of the Basel Committee on anti-crisis and long-term measures to improve bank supervision and regulation.
Thus, the role of the Ukrainian banking regulator in post-crisis period is to strengthen legislative, regulatory and supervisory functions with reference to the following priorities:
• Accelerating the adaptation of national legal system to European norms and standards of corporate governance in banks with concern to the specific national environment;
• Continuation of market reforms on stock market development and increase of investment attractiveness of the country in order to promote the influence of good CG factors on corporate governance on Ukrainian banking system;
• Development of measures to monitor and control the activities of public banks on stock
• Improvement of the regulatory framework for the assessment and management of banking risks in accordance with Basel II;
• Spreading the practice of information disclosure by banks through the introduction of legislative and regulatory requirements, and cooperation with stock exchanges (Golovina Y., (2009).
Crisis consequences and rising number of banks at a loss forced the NBU to issue a statement №421 “On some issues concerning the activities of banks during the financial crisis” on June 22, 2009. The statement contained mandatory restrictions for the corporate governance of unprofitable banks. Among other points, the NBU obliges the corporate governance of banks that are at a loss:
• to stop dividend payment to shareholders or capital allocation in an form;
• to stop any bonus payment to all bank staff;
• not to increase the amount of capital investment and intangible assets;
• not to spend any sums of money on financial consultant service (and to review exciting contracts);
• not to establish new subsidiaries and departments;
• to take urgent measures in order to upturn the level of liquidity, profitability and optimization of bank costs.
The NBU bans the following operations for unprofitable banks:
• providing blank credits;
• carrying out active transactions with insiders, in particular regarding new loans and guarantees;
• making early repayment of debt securities of banks’ own emissions except when early repayment of debt securities of banks’ own emission occurs at a price not higher than 50% of nominal, and does not result in a significant deterioration in liquidity;
• making redemption;
• purchasing private securities on banks’ behalf.
In a year, on July 06, 2010 the statement №421 was cancelled by the statement №315, issued by the NBU “On cancellation of NBU statement on some issues concerning the activities of banks during the financial crisis”. According to the document, all the restrictions implemented by the №421 statement are not valid any more for the reason of positive trends in banking system.
The analysis of the banking system of Ukraine during the period 2009-2010 years showed that in July, 2009, when the statement №421 was issued there were 64 unprofitable banks, which fall under the effect of the statement (one of the most efficient reason for banks’ losses was reserve allocations on credit operations). However, in July, 2010 only 24 banks out of 64 under consideration still remained at a loss. At the same time, 28 banks earned profit and 12 were in process of liquidation. Moreover, as for the January 01, 2011, the number of profitable banks escalated to 31 (Appendix 1).
Prior to the 2011 Banking Supervision was prohibited to impose sanctions concerning the situation when the losses of financial institutions are caused by the forming the reserves and funds for compensation of possible losses on credit transactions effected pursuant to loan agreements entered into prior to October 1, 2008, or on restructured loans. However, such mitigation requirements were the subject to the provision by the bank schedule of gradual (within six months) bringing these economic standards to the level approved by the NBU.
Particular emphasis is placed not only on the bans, which are inherently logical and justified in crisis conditions, but also on very loyal approach to the banks, the losses of which are explained by the need to create reserves for loan portfolio. The majority of the points of the statement are aimed at minimizing the outflow of funds from banks. In particular, debt investors are hardly able to realize the right to bring debt instruments of banks to buyback. In this way the statement was able to reduce the expanses of banks in the short term and brought encouraging results.
At the same time, it should be mentioned that statement №421 was conflict-arising towards shareholders in the aspect of dividends and towards staff – in bonuses. Moreover, it did not provide any sufficient background to identify and prevent alternative ways of getting abovementioned payments, which could be determined as payment manipulations. That’s why after the cancellation of the document the necessity of the new anticrisis banking regulation came to pass.
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