On 8 July the Basel Committee (BIS) issued a paper setting out 13 corporate governance principles for banks. These principles supersede the 2010 BIS principles and are to be applied and adapted by national bank regulators as they see fit. This work has been some time in the making with a peer review conducted by the Financial Stability Board (FSB) back in 2013. The FSB found that although banks exhibit a better understanding of the important elements of corporate governance and strengthening their risk frameworks after the financial crisis, more work was needed to establish effective risk governance frameworks. The peer review also found that the board and the board risk committees play a critical role in strengthening a bank’s risk governance.
The 13 corporate governance principles address the following four main objectives:
- reinforcing the collective oversight and risk governance responsibilities
- emphasising risk culture and risk appetite
- defining the specific roles and responsibilities of committees, mainly the audit and risk committees, and
- reinforcing the importance of maintaining adequate checks and balances.
These objectives are reflected in existing prudential standards and guidelines issued by APRA (CPS 510 and 520). However, there are some areas where the BIS has gone further and provided more detailed guidance on what compliance with these principles will look like. Those areas are:
- Emphasis on the risk culture of an organisation – establishing an effective Risk Appetite Statement (RAS) which outlines the levels and types of risk a bank is willing to assume in its business activities, including definition of the boundaries and effective communication of the RAS throughout the bank with proper linkage to everyday decision-making processes;
- Effective communication – the theme of good communication is repeated in different sections of this paper, with emphasis on effective communication of the RAS, a need to demonstrate the culture through a ‘tone from the top’ approach; transparency in the nomination of board members, that boards have diversified skill sets to ensure robust and in-depth discussion and risk and audit committees to have direct and unfettered access to the board (along with direct reporting lines);
- Remuneration to reflect risk governance framework – although APRA’s CPS 520 already provides guidelines as to how responsible persons should be remunerated, the BIS paper goes further. Remuneration programmes should encourage a sound risk culture, and remuneration outcomes should not incentivise staff to take on excessive risk. It also acknowledges that risk outcomes may not necessarily materialise for some time and therefore, part of the remuneration should be structured on a multi-year horizon to take this into account. Arrangements that defer a sufficiently large part of the compensation until risk outcomes materialise are supported as long as they include clawback or forfeiture provisions, where the total compensation may be reduced or reversed upon discovery of failure to comply with the bank’s risk framework requirements;
- Complex or opaque structures – unnecessarily complex structures were singled out as having the potential to pose financial, legal, reputational and other risks to the bank because those structures can impede board and senior management oversight and may hinder effective supervision.
It will be a matter for APRA to consider whether any of these principles and guidelines call for revision of any of its prudential standards and guidelines: significant changes are probably unlikely. Many of the 13 principles reflect existing ASX corporate governance guidelines with which Australian banks, as listed entities, already comply.